UNITED STATES
SECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549 FORM 10-K (Mark one) x
  Annual
  Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
  for the fiscal year ended December 31, 2000.ORo
  Transition
  Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of
  1934. Commission File Number: 000-24643 DIGITAL RIVER, INC.(Exact
name of registrant as specified in its charter) DELAWARE
  41-1901640(State or other jurisdiction of
  (I.R.S. EmployerIncorporation or organization)
  Identification No.) 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) Securities registered pursuant to Section
12(b) of the Act: None Securities registered pursuant to Section
12(g) of the Act: Common Stock $0.01 par value Indicate by check mark whether the registrant
(1) has filed all reports required to be filed by Section 13 or 15(d) of the
Securities Exchange Act of 1934 during the preceding 12 months (or for such
shorter period that the registrant was required to file such reports), and (2)
has been subject to filing requirements for the past 90 days. Yes    X       No Indicate by check mark if disclosure of delinquent
filers pursuant to Item 405 of Regulation S-K is not contained herein, and will
not be contained, to the best of registrants knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K. [X] The aggregate market value of the Common
Stock of the registrant held by non-affiliates as of March 21, 2001 was
approximately $100,862,204. The number of shares of Common Stock
outstanding at March 21, 2001 was approximately 24,650,472 shares. DOCUMENTS INCORPORATED BY REFERENCE Certain sections of the Registrants
definitive Proxy Statement for the 2001 Annual Meeting of Stockholders are
incorporated by reference in Part III of this Form 10-K to the extent stated
herein.


PART I ITEM 1.  BUSINESS. CAUTIONARY STATEMENT PURSUANT TO THE PRIVATE
SECURITIES LITIGATION REFORM ACT OF 1995 Certain statements set forth or incorporated
by reference in this Form 10-K, as well as in our Annual Report to Stockholders
for the year ended December 31, 2000, constitute "forward-looking
statements" within the meaning of the Private Securities Litigation Reform
Act of 1995. Words such as "believes," "anticipates,"
"expects," "intends," "estimates" and similar
expressions are intended to identify forward-looking statements, but are not
the exclusive means of identifying such statements. These statements involve
known and unknown risks, uncertainties and other factors that may cause our
actual results, performance or achievements, or industry results, to be
materially different from any future results, performance or achievements
expressed or implied by such forward-looking statements. Such factors include,
among others:  our limited operating
history and variability of operating results, the expectation of future losses,
risks associated with electronic software delivery, our dependence on the
Internet and the growth in electronic commerce and Internet infrastructure
development, our dependence on software publishers, our dependence on online retailers,
system development and electronic commerce security risks, rapid technological
changes, competition in the electronic commerce industry, the importance of
attracting and retaining personnel, management of the our growth, the
integration of acquired companies, our dependence on key employees, and other
risk factors set forth under Risk Factors and elsewhere in this Form
10-K.  We expressly disclaim any
obligation to update or publicly release any revision to these forward-looking
statements after the date of this Form 10-K. Overview We are a leading provider of comprehensive
electronic commerce outsourcing solutions. 
We were incorporated in February 1994 and commenced offering products
for sale through our clients Web stores in August 1996.  As an application service provider, we
enable our clients to access our proprietary electronic commerce system over
the Internet.   We have developed a
technology platform that allows us to provide a suite of electronic commerce
services, including Web commerce development and hosting, transaction
processing, fraud screening, digital delivery, integration to physical
fulfillment and customer service.  We
also provide analytical marketing and merchandising services to assist clients
in increasing Web page view traffic to, and sales through, their Web commerce
systems.  We provide an outsourcing
solution that allows our clients to promote their own brands while leveraging
our investment in infrastructure and technology.  Our Software and Digital Commerce Services Division serves the
software and digital products market, and our E-Business Services Division
serves manufacturers, distributors and retailers outside the software
industry.  Our clients include 3M
Company, Autodesk, Inc., CompUSA Inc., Egghead.com, Inc., Fujitsu Ltd., Siemens
AG, ScanSoft, Inc. and Symantec Corporation. Our proprietary commerce network server, or
CNS, technology serves as the platform for our solutions.  The CNS incorporates custom software
applications that enable Web store authoring, electronic software delivery,
fraud prevention, export control, merchandising programs and online
registration, and features a database of more than 100,000 software and digital
products.  Using our CNS platform, we
create Web commerce systems for our clients that replicate the look and feel of
each clients Web site.  End-users enter
the client site and are then seamlessly transferred to our CNS.  End-users can then browse for products and
make purchases online, and once purchases are made, we either deliver the
products digitally to the end-user through the Internet or communicate the
order through its integration into a number of third-party fulfillment agencies
for physical fulfillment.  We also
provide transaction processing services and collect and maintain critical
information about end-users.  This
information can later be used by our clients to facilitate add-on or upgrade
sales and for other direct marketing purposes. 
We actively manage direct marketing campaigns for our clients, and also
deliver purchase information and Web store traffic statistics to our clients
through online reporting. Recent
Acquisitions

On August 24, 2000, pursuant to an Asset
Purchase Agreement dated as of August 24, 2000 by and between Digital River and
NetSales, Inc., in exchange for 1,000,000 shares of our Common Stock, we
purchased those assets and assumed those liabilities of NetSales related to
NetSales software services business. 
The Purchase Agreement includes a contingent earnout whereby NetSales
can receive up to an additional 350,000 shares of Common Stock based on
performance over the 180 day period following August 24, 2000.  Of the 1,000,000 shares of Common Stock
issued at closing, 100,000 shares were placed in escrow to secure certain
indemnification obligations contained in the Purchase Agreement.  Subject to outstanding claims, the escrow
will terminate nine months following the closing.  See Note 2 of Notes to Consolidated Financial Statements for
more detailed information.

On March 20, 2001, pursuant to an Asset
Purchase Agreement dated as of March 20, 2001 by and between Digital River,
Calico Commerce, Inc., a Delaware corporation, and ConnectInc.com, Co., a
Delaware corporation and a wholly-owned subsidiary of Calico, we purchased
those assets and assumed those liabilities of ConnectInc related to
ConnectIncs Market Maker business, in exchange for approximately 1.63 million
shares of our Common Stock.  The
Purchase Agreement includes a contingent earnout whereby ConnectInc can receive
additional shares of Common Stock based upon the revenue generated by the
Market Maker product, from sales by Digital River and Calico, over the 13
months following the closing.

Industry Background

Growth Of The Internet And Electronic
Commerce.The Internet
has emerged as a significant global communications medium, enabling millions of
people to share information and conduct business electronically. A number of
factors have contributed to the growth of the Internet and its commercial use,
including: (i) the large and growing installed base of personal computers in
homes and businesses; (ii) improvements in network infrastructure and
bandwidth; (iii) easier and cheaper access to the Internet; (iv) increased
awareness of the Internet among consumer and business users; and (v) the
rapidly expanding availability of online content and commerce that increases
the value to users of being connected to the Internet.

The increasing functionality, accessibility
and overall usage of the Internet have made it an attractive commercial medium.
Online businesses can interact directly with end-users, both businesses and
consumers, and can frequently adjust their featured selections, shopping
interfaces and pricing. The ability to reach and serve a large and global group
of end-users electronically from a central location and the potential for
personalized low-cost customer interaction provide additional economic benefits
for online businesses. Unlike traditional retail channels, online businesses do
not have the burdensome costs of managing and maintaining a significant
physical retail store infrastructure or the continuous printing and mailing
costs of catalog marketing. Because of these advantages, online businesses have
the potential to build large, global customer bases quickly and to achieve
superior economic returns over the long term. An increasingly broad base of
products is being sold successfully online, including computers, travel
services, brokerage services, automobiles and music, as well as software
products.

Advantages Of Outsourcing Electronic
Commerce.According to a Gartner Group study, the
initial investment in an electronic commerce site that is functionally
equivalent to most industry participants is $1.0 million to $5.0 million and
requires an average of five months to implement. A market differentiating
electronic commerce solution requires an expenditure of $5.0 to $20.0 million.
Additionally, to maintain a scaleable, best-of-breed commerce solution,
businesses must continue to invest in technology, infrastructure and personnel
related to electronic commerce management.

There are a number of advantages to
outsourcing electronic commerce, including: (i) avoiding the large, upfront
investment required to purchase and implement software applications and
computer hardware; (ii) a shorter time to market with an electronic commerce
solution; (iii) the opportunity to shift the ongoing financial and technology
risk to a proven service provider; and (iv) allowing businesses to focus on
their specific core competency. Because of these advantages, we believe that an
increasing number of businesses will outsource their electronic commerce needs.

Opportunity For Electronic Commerce
Outsourcing.We believe that the market for electronic commerce outsourcing in the
software and digital products market as well as among manufacturers,
distributors and retailers will continue to grow rapidly. However, unlike
established physical distribution channels, there is currently no established,
comprehensive electronic distribution source for businesses.  We believe that providing an integrated
service offering of Web commerce development and hosting, transaction
processing, fraud screening, digital delivery, integration to physical
fulfillment and customer service is complex and requires upfront and ongoing
investments in secure, reliable and scaleable systems.  Accordingly, we believe that a substantial
market opportunity exists for a comprehensive, cost-effective, outsourced
electronic commerce solution for software publishers and online retailers as
well as for manufacturers, distributors and retailers.

The Digital River Solution

We
have developed a technology platform that enables us to provide a comprehensive
suite of electronic commerce services to our clients.  We also leverage our merchandising expertise to increase traffic
and sales for our clients.  Rather than
maintaining our own branded Web store, we provide an outsourcing solution for
Web commerce development and hosting, transaction processing, digital delivery
and merchandising services that enables our clients to promote their own brands
while leveraging our investment in infrastructure. In addition, this approach
enables us to leverage our clients brand investments and the traffic at our
clients sites to maximize the number of transactions completed through Digital
River.

Benefits To Clients.  Our electronic commerce
solution enables our clients to leverage our investment in technology,
personnel and infrastructure to provide a business-to-business or
business-to-consumer electronic commerce solution. This provides the client
with a cost-effective, proven solution that allows the clients to focus on
their core competency. Clients have the ability to offer the complete library
of their products directly to end-users from their Web commerce systems, and
for software publishers, through our network of online retailers. This benefit
is particularly significant for smaller software publishers who have limited
market access through traditional distribution methods. Our solution also
provides a channel for underdistributed products permitting clients to offer
online their complete product catalog. 
In addition, through our 100% end-user registration and data
warehousing, we provide clients with valuable end-user information that can facilitate
targeted marketing, upgrade notification and sophisticated merchandising
strategies. Finally, by exploiting the distribution relationships we have
developed with a large network of online retailers, software publishers can
reduce or eliminate the need for multiple retailer relationships, thereby
lowering administrative costs and reducing the number of master copies of their
software in existence for distribution.

Additionally, online retailers can use our
robust CNS technology to sell software products online without having to build
and maintain their own electronic commerce infrastructure.  We enable online retailers to offer their
end-users access to virtually all of our inventory of software products without
the burden of developing and maintaining relationships with hundreds of
software publishers. Like software publishers, online retailers enjoy the cost
savings from online fulfillment and the database marketing benefits we
offer.  Online retailers can effectively
outsource electronic commerce functionality while building their own brands
online. Online retailers also eliminate the cost and risk associated with
carrying inventory and the risk of inventory obsolescence. In addition, niche
market and high traffic Web sites can become online retailers at minimal cost
using our solution.

Benefits To End-Users.Our solution emphasizes
convenience by allowing end-users, both business and consumer, to purchase
products online twenty-four hours a day, seven days a week, or 24x7, from their
home or office. End-users are not required to make a trip to the store, can act
immediately on a purchase impulse and can locate products that are difficult to
find.  Because we have a global reach,
we can deliver an extremely broad selection to end-users in rural, international
or other locations that cannot support retail stores. Software and digital
products purchased online can either be quickly and conveniently downloaded and
installed through digital delivery or delivered physically.  Using our sophisticated search engine
technology, end-users visiting retailers online Web stores can access
virtually all of our inventory of products. End-users also benefit from the
protection of our archiving service, through which we guarantee replacement of
software in the event of accidental destruction through computer error or
malfunction, and from our 24x7 customer service provided on behalf of our
clients.

Strategy

Our objective is to become a global leader in
comprehensive electronic commerce outsourcing solutions to software publishers
and online retailers through our Software and Digital Commerce Services
Division as well as to manufacturers, distributors and retailers through our
E-Business Services Division.  We intend
to achieve our objective through the following key strategies:

Software And Digital Commerce Services
Division: Develop And Expand Relationships With Software Publishers And Online
Retailers.We plan to continue to build our inventory
of software products through additional contractual relationships with software
publishers. As of March 1, 2001, we had contracts with approximately 8,000
software publishers and online retailers, representing more than 100,000
software products. We believe that our ability to develop Web hosting
relationships with our software publisher clients increases our reach to
end-users and provides the basis for a long-term relationship with our software
publisher clients. We further believe that the large number of software
products that we offer from our software publisher clients will be critical to
our ability to deliver a compelling inventory of products to online retailer
clients.

Additionally, we believe that by increasing
the number of points of entry to the CNS, we will increase the number of
transactions over our network. Accordingly, in addition to expanding and
developing relationships with software publishers, we seek to expand
aggressively our network of online retailer clients. Online retailer clients
include traditional store-based and mail-order retailers with a Web presence,
online retailers dedicated to online commerce, as well as high traffic or niche
Web site operators desiring to add electronic commerce functionality. Our model
enables us to leverage our clients marketing resources to direct traffic to
our software trade network.

E-Business Services Division: Develop And
Expand Relationships With Manufacturers, Distributors And Retailers.  In late 1998, we began
exploring electronic commerce outsourcing opportunities outside of the software
industry. During 1999, sales and marketing personnel were hired to develop
contractual relationships to sell our electronic commerce outsourcing services
to manufacturers, distributors and retailers. As of December 31, 2000, we had
51 contracts to provide commerce services, such as Web commerce development and
hosting, transaction processing and fraud screening, customer service,
integration into third-party physical fulfillment, and merchandising and
analytical marketing services.  We
believe that our ability to provide a proven, cost efficient electronic
commerce solution, which can typically be implemented in a one to eight week
time frame, provides the basis for a long-term relationship with these clients.
We further believe that additional electronic commerce outsourcing
opportunities may develop as relationships with existing clients expand.

Provide Clients Value-Added Services.We believe that our growing data warehouse of end-user purchasing
information provides us with a powerful tool to assist clients with value-added
services, such as targeted advertising, promotions and direct response
merchandising.  We offer merchandising
and analytical marketing programs, customer support and communications
programs, advertising placement services, Web commerce system design services,
a returns management module and fraud screening services.  We intend to continue to expand our programs
and believe that these programs help build stronger partnerships with our
clients, while enabling them to increase their Web site sales.

Maintain Technology Leadership.We believe that our CNS
technology has given us a competitive advantage in the market for outsourcing
solutions.  We will continue to invest
in and enhance our CNS technology in order to increase redundancy, reliability
and bandwidth, and to expand services and reduce costs.  By leveraging our fixed-cost infrastructure,
we will improve our ability to provide low cost, high value services to our
clients while utilizing the latest technology.

Services

We provide a broad range of services to our
clients, including Web commerce hosting, digital delivery and physical
fulfillment services, transaction processing and fraud screening, customer
service and merchandising and analytical marketing services.



Web
Commerce Hosting.We host Web commerce activities for all of our online retailer clients,
our E-Business clients and for those software publisher clients that choose
this option.  Our outsourcing solution
is mission-critical for many of our clients. Therefore, we have a data center that
is designed to provide our clients with the performance they require for
continuous Web commerce operations. The data center features redundant, high
speed connections to the Internet, 24x7 security and monitoring, back-up
generators and dedicated power.

We can quickly and efficiently create a Web
commerce system for our clients, which can be accessed easily by clicking on a
buy button on a clients existing Web site. 
The end-user is then transferred to a Web commerce system hosted on our
CNS, which replicates the look and feel of the client Web site.  The end-user can then shop for products and
make purchases online.  By replicating
the look and feel of our clients Web sites, we support clients in conducting
electronic commerce under their own brands. 
Our solution allows clients to choose either digital or, when available,
physical delivery. The transaction information is captured and added to our
data warehouse.  Our ability to retrieve
and manipulate this information creates a powerful data mining tool, which can
be used for targeted merchandising to end-users through emails, banner
presentations and special offers.

Digital And Physical Fulfillment
Services.We offer clients access to our electronic software delivery
capabilities to permit delivery of digital products to an end-users computer
via the Internet. Digital delivery eliminates many of the costs that exist in
the physical distribution chain, such as manufacturing, packaging, shipping,
warehousing and inventory carrying and handling costs.  Delivery is fulfilled when a copy is made
from the master on our CNS and is then securely downloaded to the end-user via
the Internet.  Our digital distribution
model not only reduces costs, thereby increasing margins available to software
publishers and online retailers, but also solves the shelf space problem
constraining product availability and sales. 
While most software publishers use our Web hosting services, certain
software publishers use only our digital delivery services, which provide them
with online distribution through our extensive network of online retailers.

In addition to fulfillment through electronic
software delivery, we offer clients physical distribution services.  We have contracted with a third-party
fulfillment agency that maintains an inventory of physical software products,
generally on consignment from our clients that select this option, for shipment
to end-users.  We also communicate
orders through integration into many third-party fulfillment agencies for
physical fulfillment for our clients. 
We believe physical fulfillment services are important to our ability to
provide a comprehensive electronic commerce outsourcing solution.

Transaction Processing And Fraud
Screening.We process transactions, primarily via credit card, generated by
end-users ordering products through our CNS. 
We obtain customer and payment information required to process
transactions. The fraud screening component of the CNS uses both rules-based
and heuristic scoring methods to make a determination regarding the validity of
the order, end-user and payment information. As the end-user is entering the
order, over 580 data reviews are processed real-time.  Depending on the contractual agreement, we either offer the use
of our proprietary fraud screening to clients to either significantly reduce
the number of fraudulent transactions or to completely shift the risk of fraud
to us.  When a credit card transaction
is completed and approved, and the ordered product has been delivered, we
process the order for payment.

Customer Service.We offer both
telephone and email customer support for products sold through our CNS on
behalf of our clients.  We will provide
end-user assistance on order and delivery questions on a 24x7 basis.  We have invested and continue to invest in
technology and infrastructure to provide fast, efficient responses to customer
inquiries.  We also provide archiving
service to the end-users that purchase digital products.

Merchandising And Analytical Marketing
Services.We offer a range of merchandising and
analytical marketing services to our clients to help them drive additional
traffic to their Web stores.  Clients
are provided with detailed reports of transactions on their Web stores, as well
as marketing information related to end-user visits to their Web stores.  The CNS captures Web page visits, banner and
pricing information and other data that can be used by the software publishers
and online retailers to analyze their Web stores performance.

We
also offer advanced merchandising services to assist clients in
increasing response rates for their marketing efforts.  These services include email campaigns for
special promotions, upgrade notification programs and the presentation of
complementary products, bundled products or other programs designed to increase
average order size based on a targeted end-user profile.  We participate in co-op dollar and market
development fund programs with our clients and buy selected banner placements
in bulk to support clients promotional campaigns.  In addition, we test and analyze merchandising techniques, such
as promotional pricing and banner advertising, based on information gathered in
the CNS data warehouse.

Clients

Within the Software and Digital Commerce
Services Division, we distribute software products through a network of
software publishers and online retailers. Online retailer clients include
traditional store-based and direct mail retailers with a Web presence, online
retailers dedicated to online commerce, as well as high traffic or niche Web
site operators desiring to add electronic commerce functionality.  In a typical online retailer contract, we
are responsible for: (i) a payment to the online retailer based on a
percentage of net sales of software products that we distribute through the
online retailers Web site; (ii) the processing of payments made by end-users;
(iii) the delivery of the software products to end-users; (iv) the payment of
applicable credit card transaction fees; (v) the collection, payment and
returns filing of applicable sales taxes; and (vi) the distribution of a report
to the online retailer detailing related sales activity that we have
processed.  We also expect to support
traditional physical retailers in developing their online stores for the sale
of software products online.  While most
software publishers use our Web hosting services, certain software publishers
use only our  channel services whereby
the software publishers are provided with digital and physical fulfillment
capability through our extensive network of online retailers. In a typical
software publisher contract, we are responsible for: (i) the maintenance of
master copies of software products in a secure format for distribution to
end-users; (ii) a payment to the software publisher for the cost of software
products that we distribute through either a retailers Web site or through the
publishers host Web site; (iii) the processing of payments made by end-users;
(iv) the delivery of software products to end-users; (v) the payment of applicable
credit card transaction fees; (vi) the collection, payment and returns filing
of applicable sales taxes; and (vii) the distribution of a report to the
software publisher detailing related sales activity that we have processed.

As of March 1, 2001, we had approximately
8,000 contracts with software publishers and online retailers.  Our Software and Digital Commerce Services
Division clients include:

Software Publishers
  Online RetailersWeb Hosting And
  Channel Services
  CompUSA
  Inc.Adaptec, Inc
  Cyberian Outpost, Inc.Autodesk,
  Inc
  Egghead.com, Inc.Novell,
  Inc.
  Micro Warehouse, IncScansoft, Inc.
  Multiple
  Zones International, Inc.Symantec
  Corporation
  Quixtar Inc.Staples.comChannel Services
  OnlyLotus
  Development CorporationNetwork
  Associates, Inc.QUALCOMM
  IncorporatedWithin the E-Business Services Group, we
provide a variety of electronic commerce services to clients outside of the
software industry, primarily manufacturers, distributors and retailers. These
services allow the client to perform electronic commerce on a
business-to-business or business-to-consumer basis. In a typical E-Business
Services contract, we are responsible for: (i) Web commerce system design,
hosting and integration into the clients management system; (ii) the
processing of payments made by end-users; (iii) the communication of orders to
the client or the clients third-party fulfillment agency for delivery of the
product to end-users; (iv) the fraud screening and processing of the applicable
credit card transaction to the clients credit card processor; (v) customer
service; and (vi) the distribution of a report to the client detailing related
sales activity that we have processed.

As
of December 31, 2000, we had 51 contracts withclients in
the E-Business Services Group, including:

E-Business Services3M CompanyFujitsu Ltd.Hewlett Packard CompanyPolaris
  Industries Inc.Siemens
  A.G.Sales And Marketing

We market our services directly to clients and prospective clients.  We do not operate our own Web store because
of our strategy to serve as a neutral provider of electronic commerce
outsourcing solutions.  Generally, our
direct marketing to end-users focuses on supporting the marketing and
promotional efforts of our clients in driving traffic to their Web stores.  This direct marketing effort leverages our
extensive data warehouse, which enables us to create and quickly implement
marketing programs targeted at specific end-user segments.  By providing consistent quality service,
branding client order pages with our name and logo, billing credit card
transactions under our name and engaging in brand positioning, advertising and
promotion, we believe we have established our brand as a trusted name for
electronic software delivery and electronic commerce outsourcing solutions
among current and prospective clients and end-users.

Our sales and marketing organization is
divided into two divisions: the Software and Digital Commerce Services Division
and the E-Business Services Division. 
The Software and Digital Commerce Services Division focuses on software
and digital content publishers and online retailers of all sizes, including
traditional physical retailers, with significant online revenue potential.  These sales are typically complex in nature
and involve a lengthy sales cycle. 
Contracts with larger clients often involve certain incentives,
principally pricing concessions.  We
make decisions with respect to contract incentives on a case-by-case
basis.  The E-Business Services Division
focuses on manufacturers, distributors and retailers, generally with total
annual revenues of $100.0 million or more. 
These sales are complex in nature and involve a lengthy sales cycle.  Both the Software and Digital Commerce
Services Division and the E-Business Services Division serve existing clients
and provide them with merchandising and database marketing assistance designed
to increase revenues.  As of March 1,
2001, we had 138 employees engaged in sales and marketing.

We currently market our services to clients
via direct marketing, print advertising, trade show participation and other
media events.  We plan to increase our
expenditures on direct marketing, seminars and print advertising, primarily directed
at potential E-Business Services clients. 
In addition, we operate a sales office in the United Kingdom.

Technology

We deliver our electronic commerce
outsourcing solution using our proprietary CNS technology, is described below:

Architecture.Our scaleable CNS is designed
to handle tens of thousands of individual Web commerce stores and millions of
products.  The CNS consists of a pool of
network servers and a proprietary software application that serves dynamic Web
pages using an Oracle technology.  Our
CNS was designed to scale to support growth by adding CPUs, memory, disk drives
and bandwidth without substantial changes to the application.  The CNS software code is written in modular
layers, enabling us to quickly adapt in response to industry changes, including
bandwidth opportunities, payment processing changes, international requirements
for taxes and export screening, new technologies such as Web Caches, Java, ML,
DHTML, VRML, SET, banking procedures and encryption technologies.  The CNS product search system, based on
Verity, allows end-users to search for items across millions of potential
products and thousands of categories specific to various product
specifications, while maintaining a fast page response that is acceptable to
the end-user.  We use sophisticated
database indexing coupled with a dynamic cache system to provide flexibility
and speed.  These caches help increase
the overall speed of each page and facilitate complex searches across our
entire inventory of software products. 
The CNS has also been designed to index, retrieve and manipulate all
transactions that flow through the system, including detailed commerce
transaction and end-user interaction data. 
This enables us to create proprietary market profiles of each end-user
and groups of end-users that can then be used to create merchandising
campaigns.  Our CNS is also used for
internal purposes, including reporting and maintenance for fraud detection and
prevention, physical shipping, return authorizations, back order processing and
full transaction auditing and reporting capabilities for all commerce
functions.

Web Commerce System Maintenance.Clients Web commerce systems
are built and maintained using the CNS centralized management system. Global
changes that affect all Web commerce systems or groups of Web commerce systems
can be made as easily as changes to an individual Web commerce system. Client
Web commerce systems typically include a main store and may optionally include
several focus stores and channel sites to which highly targeted traffic may
be routed. Clients may also link specific locations on their Web stores to
detailed product or category areas of the stores in order to better target
their end-users interests.

Security.Our security systems address
access to internal systems and illegal access to commerce data via the
Internet. Internally, log-ins and passwords are maintained for all systems,
with additional log-ins, passwords and IP access control granted on an
individual basis to only the required commerce areas for which the recipient is
responsible.  Firewalls prevent
unauthorized access from outside.  We
rely on certain encryption and authentication technology licensed from third
parties to provide secure transmission of confidential information, such as
end-user credit card numbers.  Unix,
Oracle and Web server security additionally restrict access from the outside to
the appropriate transaction data.  The
CNS security system is designed not to interfere with the end-user
experience.  Product wrappers,
clearing-house processing and additional password mechanisms that negatively
impact digital delivery performance are not needed.  The CNS security system does not allow direct access to the
clients products and ensures that an end-user requests digital delivery
through a valid page and has purchased the product.

Data Center Operations.Continuous data center operations are crucial to our success.  All transaction data is backed up
periodically and all inventory data is archived and kept in fireproof storage
facilities.  Our network software
constantly monitors clients Web commerce systems and internal system functions
and notifies systems engineers if any unexpected conditions arise.  We currently lease seven T1 lines and 4 DS3
lines from multiple vendors and maintain a policy of adding additional lines if
more than 50% of our bandwidth capacity is utilized. Accordingly, if one line
fails the other lines are able to assume the capacity of the failed line.  Our data center is located in a single location
at our main facilities in Eden Prairie, Minnesota.  In the event of electrical power failure, we have a back-up power
supply system.  We have also installed a
FM-200 automatic fire suppression system in the data center. The data center
currently incorporates redundant systems consisting of additional servers and
arrays.  We currently have no automatic
switchover in the case of equipment or software failure, although we have plans
to implement further redundancy in the future.

Product Research and Development

Our product research and development strategy
is to enhance the technology and features of our CNS.  To this end, we have numerous development projects in process,
including Internet optimization tools, personalization, business-to-business
related technologies and online interactive customer service.  Product research and development expenses
were $3.1 million, $10.3 million and $13.1 million in 1998, 1999 and 2000,
respectively.  As of March 1, 2001, we
employed 38 persons in product research and development.

To remain competitive, we must continue to
enhance and improve the responsiveness, functionality and features of the CNS
and the underlying network infrastructure. 
The Internet and the online commerce industry are characterized by rapid
technological change, changes in user and client requirements and preferences,
frequent new product and service introductions embodying new technologies and
the emergence of new industry standards and practices that could render our
existing CNS proprietary technology and systems obsolete.  Our success will depend, in part, on our
ability to both license and internally develop leading technologies useful in
our business, enhance our existing services, develop new services and
technology that address the increasingly sophisticated and varied needs of our
clients, and respond to technological advances and emerging industry standards
and practices on a cost-effective and timely basis.  The development of the CNS technology and other proprietary
technology entails significant technical and business risks.  We may be unable to use new technologies
effectively or adapt our proprietary technology and transaction-processing
systems to customer requirements or emerging industry standards.  If we are unable, for technical, legal,
financial or other reasons, to adapt in a timely manner to changing market
conditions, client requirements or emerging industry standards, our business
could be harmed.

Competition

The electronic commerce market is new,
rapidly evolving and intensely competitive. 
We expect competition to intensify in the future, particularly in the
area of electronic commerce outsourcing both for digital and software products
as well as for industries outside of the software market.  We currently compete directly with other
providers of electronic commerce solutions, including Beyond.com Corporation,
CyberSource Corporation, Preview Systems, Inc., ReleaseNow Corporation and
Network Commerce, Inc.  We also compete
indirectly with software companies, system integrators and application service
providers that offer tools and services for electronic commerce, including
companies that provide a broad range of Internet and server solutions such as
Microsoft Corporation and Netscape Communications Corporation, a subsidiary of
AOL Time Warner Inc.  We also compete
indirectly with a large number of companies that provide tools and services
enabling one or more of the transaction processing functions of electronic
commerce, including transaction control, data security, customer interaction
and database marketing, such as BroadVision, Inc., Open Market, Inc., Commerce
One, Inc., Corio, Inc., IBM Global Services, MarchFirst Inc., Open Market,
Inc., Qwest Communications International, Inc., Scient Corporation, US
Internetworking and US Web/CKS.  In
addition to direct competition with other transaction processing providers and
enablers and indirect competition with other providers of electronic commerce
software and systems, we compete with companies that sell and distribute
software products via the Internet, including Amazon.com, Inc., Ingram Micro
Inc. and Tech Data Corporation.  We also
compete with companies such as AltaVista Company, a subsidiary of CMGI, Inc.,
AOL Time Warner Inc., At Home Corporation, Terra Lycos, Inc. and Yahoo! Inc.,
which specialize in electronic commerce or derive a substantial portion of
their revenues from electronic commerce and may themselves offer, or provide
means for others to offer, software products.

We believe that the principal competitive
factors in our market are breadth of services and software product offerings,
software publisher and online retailer relationships, brand recognition, system
reliability and capacity, price, customer service, speed and accessibility and
ease of use, speed to market, scaleability, convenience and speed of
fulfillment.  The online retailers and
the other companies listed above may compete directly with us by adopting a
similar business model. Moreover, while some of these companies are also
clients or potential clients of ours, they may compete with our electronic
commerce outsourcing solution to the extent that they develop electronic
commerce systems or acquire such systems from other software vendors or service
providers.

Many of our current and potential competitors
have longer operating histories, larger customer bases, greater brand
recognition and significantly greater financial, marketing and other resources
as compared to us. Larger, well-established and well-financed entities may
acquire, invest in or form joint ventures with online competitors as the use of
the Internet and other online services increases.  In addition, new technologies and the expansion of existing
technologies, such as price comparison programs that select specific titles
from a variety of Web sites, may direct end-users to online retailers that
compete with us, which would increase our competitive pressures.  Increased competition may result in reduced
operating margins, as well as a loss of market share.  Further, as a strategic response to changes in the competitive environment,
we may from time to time make certain pricing, service or marketing decisions
or acquisitions that could harm our business. 
We may be unable to compete successfully against current and future
competitors, and any inability to do so could harm our business.

Intellectual Property

We regard the protection of our trademarks,
copyrights, trade secrets and other intellectual property as critical to our
success. We rely on a combination of patent, copyright, trademark, service mark
and trade secret laws and contractual restrictions to protect our proprietary
rights. We have entered into confidentiality and invention assignment
agreements with our employees and contractors, and nondisclosure agreements
with parties with which we conduct business in order to limit access to and
disclosure of our proprietary information. These contractual arrangements and
the other steps taken by us to protect our intellectual property may not
prevent misappropriation of our technology or deter independent third-party development
of similar technologies. We also seek to protect our proprietary position by
filing United States and foreign patent applications related to our proprietary
technology, inventions and improvements that are important to the development
of our business.  Proprietary rights
relating to our technologies will be protected from unauthorized use by third
parties only to the extent they are covered by valid and enforceable patents or
are effectively maintained as trade secrets. We pursue the registration of our
trademarks and service marks in the United States and internationally.
Effective trademark, service mark, copyright and trade secret protection may
not be available in every country in which our services are made available
online.

The
steps we havetaken to protect our proprietary rights may be inadequate
and third parties may infringe or misappropriate our trade secrets, trademarks
and similar proprietary rights.  Any
significant failure on our part to protect our intellectual property could harm
our business.  In addition, litigation
may be necessary in the future to enforce our intellectual property rights, to
protect our trade secrets or to determine the validity and scope of the
proprietary rights of others. 
Litigation could result in substantial costs and diversion of management
and technical resources, which could harm our business.  In addition, from time to time, we may
receive notice of claims of infringement of other parties proprietary rights.  The defense of any claims, whether these claims
are with or without merit, could be time-consuming, result in costly litigation
and diversion of technical and management personnel, cause product shipment
delays or require that we develop non-infringing technology or enter into
royalty or licensing agreements. 
Royalty or licensing agreements, if required, may be unavailable on
terms acceptable to us or at all.  In
the event of a successful claim of infringement against us and our failure or
inability to develop non-infringing technology or license the infringed or
similar technology on a timely basis, our business could be harmed.

Employees

As of March 1, 2001, we employed 417
people.  We also employ independent
contractors and other temporary employees. 
None of our employees is represented by a labor union, and we consider
our employee relations to be good. 
Competition for qualified personnel in our industry is intense,
particularly among software development and other technical staff.  We believe that our future success will
depend in part on our continued ability to attract, hire and retain qualified
personnel.

Executive Officers

The following table sets forth information
regarding our executive officers as of December 31, 2000:

Name
  Age
  PositionJoel A. Ronning
  44
  Chief Executive OfficerPerry W. Steiner
  35
  PresidentRobert E. Strawman
  41
  Chief Financial Officer and TreasurerJay
  A. Kerutis
  41
  President, Software and Digital Commerce
  Services DivisionGregory R.L. Smith
  34
  Vice President of Finance and Secretary


Mr. Ronning founded the Company in February
1994 and has been Chief Executive Officer and a director of the Company since
that time. In February 2001, Mr. Ronning was elected to the Office of the
President.  From February 1994 to July 1998,
Mr. Ronning was also President of the Company. From May 1995 to December 1999,
Mr. Ronning served as Chairman of the Board of Directors of Tech Squared, Inc.,
a direct catalog marketer of software and hardware products. From May 1995 to
July 1998, Mr. Ronning served as Chief Executive Officer, Chief Financial
Officer and Secretary of Tech Squared. From May 1995 to August 1996, Mr.
Ronning also served as President of Tech Squared. Mr. Ronning founded MacUSA,
Inc., formerly a wholly-owned subsidiary of Tech Squared, and served as a
director of MacUSA, Inc. from  April
1990 to December 1999. From April 1990 to July 1998, Mr. Ronning also served as
the Chief Executive Officer of MacUSA, Inc. Mr. Ronning also serves as a
director of the Software Publishers Association and JASC, Inc.

Mr.
Steinerhas served as a director of the Company since April 1998 and
served as President of the Company from July 1998 to February 2001.  Since February 2001, Mr. Steiner has served
as a Managing Partner of Arlington Capital Partners, a private equity
fund.  From January 1997 to July 1998,
Mr. Steiner served as Vice President of Wasserstein Perella & Co., Inc., an
investment banking firm, and as Vice President of Wasserstein Perella Ventures,
Inc., the general partner of Wasserstein Adelson Ventures, L.P., a venture
capital fund. From June 1993 to December 1996, Mr. Steiner was a principal of
TCW Capital, a group of leveraged buyout funds managed by Trust Company of the
West.  Mr. Steiner serves as a director
of Laplink, Inc. and was a director of Tech Squared from December 1998 to June
1999.

Mr. Strawman joined the Company in April 1998
as Chief Financial Officer and Treasurer. In February 2001, Mr. Strawman was
elected to the Office of the President. 
From September 1995 to April 1998, Mr. Strawman served as Director of
Finance and Vice President of Finance for Caribou Coffee Company, Inc., a
gourmet coffee retailer. From 1989 to 1995, Mr. Strawman held various financial
positions at Software Etc. Stores, Inc., a specialty retailer of software, most
recently as Chief Financial Officer.

Mr. Kerutis joined the Company in February
1999 as Vice President of Sales, served as Executive Vice President, Software
and Digital Commerce Services Division from January 2000 to December 2000 and
has been President, Software and Digital Commerce Services Division since
December 2000. In February 2001, Mr. Kerutis was elected to the Office of the
President.  From March 1997 to February
1999, Mr. Kerutis was Vice President - Retail Channel for Merisel Americas,
Inc. From April 1995 to March 1997, Mr. Kerutis was Vice President - Sales and
Marketing for New Media Corporation. From October 1993 to April 1995, Mr.
Kerutis served as Director - Sales for Merisel Americas, Inc.

Mr. Smith joined the Company as Controller in
June 1997 and has served as Vice President of Finance since June 1999. Since
December 1997, Mr. Smith has also served as Secretary. From November 1995 to
June 1997, Mr. Smith was Manager, External Reporting and Investor Relations at
Secure Computing Corporation, a developer of network and Internet security
products. From June 1988 to November 1995, Mr. Smith held various positions
with Ernst & Young LLP.

RISK FACTORS

In addition to the other information provided
in this report, stockholders or prospective investors should carefully consider
the following risk factors:

BECAUSE WE HAVE A LIMITED OPERATING HISTORY,
WE ARE ENCOUNTERING NUMEROUS RISKS THAT WE MAY FAIL TO SUCCESSFULLY ADDRESS.

We have a limited operating history. We were
incorporated in February 1994 and conducted our first online sale through a
clients Web store in August 1996. Our business and prospects must be
considered in light of the risks encountered by companies in their early stages
of development, particularly companies in new and rapidly evolving markets such
as electronic commerce. Some of these risks relate to our ability to:


  maintain or develop relationships with
  software and online retailers;
  maintain or develop relationships with
  E-Business clients and prospects;
  execute our business and marketing
  strategy;
  continue to develop and upgrade our
  technology and transaction-processing systems;
  provide superior customer service and order
  fulfillment;
  respond to competitive developments; and
  retain and motivate qualified personnel.

We may not be successful
in addressing these risks, and if we are not successful, our business will
suffer. Our current and future expense levels are based largely on our planned
operations and our estimates of future sales. It is difficult, however, for us
to accurately forecast future revenue, because our business is still new and
our market is still developing. We may be unable to adjust spending in a timely
manner to compensate for any unexpected revenue shortfall. As a result, any
significant shortfall in revenue would immediately harm our business. As a
result of our rapidly evolving business and our limited operating history, we
believe that period-to-period comparisons of our operating results are not
necessarily meaningful and investors should not rely upon our historical
results as an indication of future performance.

WE HAVE A HISTORY OF
LOSSES AND WE EXPECT OUR LOSSES TO CONTINUE FOR THE FORESEEABLE FUTURE.

We have incurred significant losses since we
were formed. As of December 31, 2000, we had an accumulated deficit of
approximately $83.9 million. We intend to continue to expend significant
financial and management resources on the development of additional services,
sales and marketing, improved technology and expanded operations.  As a result of these expenditures, we expect
operating losses and negative cash flows to continue for the foreseeable
future. In addition, our operating losses could increase from current levels.
Our revenue may not increase or even continue at its current level, and we may
not be profitable or generate cash from operations in future periods.

OUR OPERATING RESULTS
ARE LIKELY TO FLUCTUATE SIGNIFICANTLY.

Our quarterly and annual operating results
are likely to fluctuate significantly in the future due to a variety of
factors, many of which are outside our control. Some of these factors include:


  our ability to attract and retain software
  publishers and online retailers as clients;
  our ability to attract and retain
  E-Business clients;
  the introduction of new Web sites, Web
  stores, services or products by us or by others;
  price competition and margin erosion;
  the rate at which the online market for the
  purchase of software products continues to emerge;
  our ability to continue to upgrade and develop
  our systems and infrastructure to meet emerging  market needs and remain competitive in our service offerings;
  termination of any account that represents
  a significant portion of our revenue;
  technical difficulties or system downtime;
  our ability to attract new personnel as
  needed as our business grows;
  our ability to increase the proportion of
  sales from online retailers;
  the failure of Internet bandwidth to
  increase over time or any increase in the cost of Internet bandwidth; and
  U.S. and foreign regulations relating to
  our business.Due to these and other factors, our annual or
quarterly operating results may not meet the expectations of securities
analysts and investors. If this happens, the trading price of our common stock
would likely significantly decline.

A LOSS OF ANY CLIENT
THAT ACCOUNTS FOR A LARGE PORTION OF OUR REVENUE COULD CAUSE OUR REVENUE TO
DECLINE.

Revenue related to three software publisher
clients collectively accounted for approximately 20% of our revenue in 1999 and
approximately 15% of our revenue in the Software and Digital Commerce Services
Division in 2000. Contracts with these clients are generally short term in
nature. If any one of these contracts is not renewed or otherwise ends, our
revenues could decline and our business could be harmed.

OUR SALES CYCLE IS LENGTHY.

We market our services directly to software
publishers, online retailers and E-Business prospects. These relationships are
typically complex and take time to finalize. Due to operating procedures in
many large organizations, a significant amount of time may pass between
selection of our products and services by key decision makers and the signing
of a contract. As a result, the period between the initial sales call and the
signing of a  contract with significant
sales potential is difficult to predict and typically ranges from six to 12
months. Delays in signing contracts with these potential clients could harm our
business.

THERE ARE A NUMBER OF
RISKS ASSOCIATED WITH ELECTRONIC SOFTWARE DELIVERY, OR ESD, INCLUDING THE
MARKET'S POTENTIAL FAILURE TO ACCEPT ESD.

Our success will depend in large part on the
growth in end-user acceptance of ESD as a method of distributing software
products. ESD is a relatively new method of distributing software products and
the growth and market acceptance of ESD is highly uncertain and subject to a
number of risks. Factors that will influence market acceptance of ESD include:


  the availability of sufficient bandwidth to
  enable purchasers to rapidly download software products;
  the cost of time-based Internet access;
  the number of software  products that are available for purchase
  through ESD as compared to those available through physical delivery; and
  the level of end-user comfort with the process
  of downloading software via the Internet, including the ease of use and lack
  of  concern about transaction
  security.If ESD does not achieve widespread market
acceptance, our business will be harmed. Even if ESD achieves widespread
acceptance, we cannot be certain that we will overcome the substantial existing
and future technical challenges associated with electronically delivering
software reliably and consistently on a long-term basis. Our failure to do so
would harm our business.

WE ARE DEPENDENT ON
THE CONTINUED GROWTH OF ELECTRONIC COMMERCE AND DEVELOPMENT OF THE INTERNET
INFRASTRUCTURE.

We depend on the growing use and acceptance
of the Internet as an effective medium of commerce by end-users. Rapid growth
in the use of and interest in the Internet and other online services is a
recent development. The acceptance and use of the Internet and other online
services may not continue to develop and a sufficiently broad base of consumers
may not adopt, and continue to use, the Internet and other online services as a
medium of commerce. We rely on purchasers who have historically used
traditional means of commerce to purchase goods or transact business. If we are
to be successful, these purchasers must accept and use the Internet as a means
of purchasing goods and services and exchanging information and we cannot
predict the rate at which these purchasers will do so.

The
success of our service will depend largely on the development and maintenance
of the Internet infrastructure. This includes maintenance of a
reliable network backbone with the necessary speed, data capacity and security,
as well as timely development of complementary products such as high speed
modems, for providing reliable Internet access and services.   The Internet has experienced, and is likely
to continue to experience, significant growth in the numbers of users and
amount of traffic. If the Internet continues to experience increased numbers of
users, increased frequency of use or increased bandwidth requirements, the
Internet infrastructure may be unable to support the demands placed on it.
Delays in the development or adoption of new standards and protocols required
to handle increased levels of Internet activity or increased governmental
regulation could also have a similar effect. In addition, growth in Internet
usage that is not matched by comparable growth in the infrastructure supporting
Internet usage could result in slower response times or impair usage of the
Internet.

WE ARE DEPENDENT ON
SOFTWARE PUBLISHERS.

We are heavily dependent upon the software
publishers that supply us with software, and the availability of this software
is unpredictable. Our contracts with our software publisher clients are
generally one year in duration, with an automatic renewal provision for additional
one-year periods, unless we are provided with a written notice at least 90 days
before the end of the contract. As is common in our industry, we have no
long-term or exclusive contracts or arrangements with any software publishers
that guarantee the availability of software products. We cannot be certain that
the software publishers that currently supply software to us will continue to
do so or that we will be able to establish new relationships with software
publishers. If we cannot develop and maintain satisfactory relationships with
software publishers on acceptable commercial terms, if we are unable to obtain
sufficient quantities of software, if the quality of service provided by these
software publishers falls below a satisfactory level or if software returned to
us exceeds our clients expectations, our business could be harmed.

WE ARE DEPENDENT ON
ONLINE RETAILERS.

Our strategy is dependent upon increasing our
sales of software products through online retailers. We have historically
generated substantially all of our revenue from the sale of software to
end-users that were initiated through the Web stores of our software publisher
clients. In 1999 and 2000, less than 8% of our revenue for the Software and
Digital Commerce Services Division was generated through our online retailer
clients. We may not successfully establish relationships with additional online
retailers and our current relationships may not continue. If we are unable to
expand our relationships with online retailers, we will likely be unable to
continue to grow our business and establish meaningful market share.

WE ARE DEPENDENT ON
E-BUSINESS CLIENTS.

Our strategy is also dependent upon
increasing fee and service revenues from E-Business clients. We may not succeed
in establishing and maintaining relationships with sufficient numbers of
E-Business clients to support our investments in technology and infrastructure.
If we are unable to attract and retain these clients, our business will suffer.

WE MAY BE UNABLE TO
SUCCESSFULLY IMPLEMENT OUR DEVELOPMENT AND ACQUISITION STRATEGY.

To extend our electronic commerce outsourcing
capabilities, we have developed, and intend to continue developing, our
E-Business services. We have also acquired, and intend to continue acquiring,
companies that provide outsourcing services to shareware publishers. These
business initiatives require a significant expenditure of management time, and
sales, marketing and product research and development funds. These expenditures
may disrupt our ongoing business, distract management and make it difficult to
maintain standards, controls and procedures. If we make acquisitions outside of
our core business, assimilating the acquired technology, services or products
into our operations could be difficult. If we are unable to successfully
implement our new business initiatives, we will not generate a profitable
return on our investment and we will be unable to gain meaningful market share.
If a significant number of clients of the acquired companies cease doing business
with us, our business will suffer.

SYSTEM FAILURES COULD
REDUCE THE ATTRACTIVENESS OF OUR PRODUCT AND SERVICE OFFERINGS.

We provide commerce, marketing and delivery
services to our clients and end-users through our CNS transaction-processing
and client management systems. These systems also maintain an electronic
inventory of products and gather consumer marketing information. The
satisfactory performance, reliability and availability of the CNS and the
underlying network infrastructure are critical to our operations, level of
customer service, reputation and ability to attract and retain clients. Our
systems and operations are vulnerable to damage or interruption from:


  fire, flood and other natural disasters;
  and
  power loss, telecommunications failure,
  break-ins and similar events.We presently have no offsite back-up
facilities and do not carry sufficient business interruption insurance to fully
compensate us for losses that may occur. Despite the use of network security
devices, our servers are vulnerable to computer viruses, physical or electronic
break-ins and similar disruptions, which could lead to interruptions, delays,
loss of data or the inability to accept and fulfill end-user orders. Any
systems interruption that impairs our ability to accept and fill customer
orders reduces the attractiveness of our product and service offerings to
clients and end-users, which could harm our business.

FAILURE TO DEVELOP
OUR TECHNOLOGY TO ACCOMMODATE INCREASED CNS TRAFFIC COULD REDUCE DEMAND FOR OUR
SERVICES.

We have experienced periodic interruptions,
affecting all or a portion of our systems, which we believe will continue to
occur from time to time. We periodically enhance and expand our technology and
transaction-processing systems, and network infrastructure and other
technologies to accommodate increases in the volume of traffic on the CNS. We
may be unable to improve and increase the capacity of our network
infrastructure. We may be unable to anticipate increases, if any, in the use of
the CNS or to expand and upgrade our systems and infrastructure to accommodate
these increases. Our inability to add software and hardware or to develop and
upgrade existing technology, transaction-processing systems or network
infrastructure to handle increased traffic on the CNS may cause unanticipated
system disruptions, slower response times and poor customer service, including
problems filling customer orders, any of which could harm our business. In
addition, additional network capacity may not be available from third-party
suppliers when we need it. Our network and our suppliers networks may be
unable to maintain an acceptable data transmission capability, especially if
demands on the CNS increase.  Our
failure to maintain an acceptable data transmission capability could
significantly reduce demand for our services, which would impair our business.

SECURITY BREACHES
COULD HINDER OUR ABILITY TO SECURELY TRANSMIT CONFIDENTIAL INFORMATION.

A significant barrier to electronic commerce
and communications is the secure transmission of confidential information over
public networks. We rely on encryption and authentication technology licensed
from third parties to provide the security and authentication necessary for
secure transmission of confidential information, such as customer credit card
numbers. A party who circumvents our security measures could misappropriate
proprietary information or interrupt our operations. Any compromise or
elimination of our security could harm our business.

We may be required to expend significant
capital and other resources to protect against security breaches or to address
problems caused by breaches.  Concerns
over the security of the Internet and other online transactions and the privacy
of users may also inhibit the growth of the Internet and other online services
generally, and the Web in particular, especially as a means of conducting
commercial transactions.  To the extent
that our activities or those of third-party contractors involve the storage and
transmission of proprietary information, such as credit card numbers, security
breaches could damage our reputation and expose us to a risk of loss or
litigation and possible liability. Our security measures may not prevent
security breaches and failure to prevent security breaches could cause our
business to suffer.

CURRENT AND POTENTIAL
COMPETITORS COULD REDUCE OUR OPERATING MARGINS AND MARKET SHARE.

The electronic commerce market is new,
rapidly evolving and intensely competitive. We expect competition to intensify
in the future, particularly in the area of electronic commerce outsourcing both
for digital and software products as well as for industries outside of the
software market. We currently compete directly with other providers of
electronic commerce solutions, including Beyond.com Corporation, CyberSource
Corporation, Preview Systems, Inc., ReleaseNow Corporation and Network
Commerce, Inc. We also compete indirectly with software companies, system
integrators and application service providers that offer tools and services for
electronic commerce, including companies that provide a broad range of Internet
and server solutions, such as Microsoft Corporation and Netscape Communications
Corporation, a subsidiary of AOL Time Warner Inc.. We also compete indirectly
with a large number of companies that provide tools and services enabling one
or more of the transaction processing functions of electronic commerce, such as
transaction control, data security, customer interaction and database
marketing, such as BroadVision, Inc., Open Market, Inc., Commerce One, Inc.,
Corio, Inc., IBM Global Services, MarchFirst Inc., Open Market, Inc., Qwest
Communications International, Inc., Scient Corporation, US Internetworking and
US Web/CKS. In addition to direct competition with other transaction processing
providers and enablers and indirect competition with other providers of
electronic commerce software and systems, we compete with companies that sell
and distribute software products via the Internet, including Amazon.com, Inc.,
Ingram Micro Inc. and Tech Data Corporation. We also compete with companies
such as AltaVista Company, a subsidiary of CMGI, Inc., AOL Time Warner Inc., At
Home Corporation, Terra Lycos and Yahoo! Inc., which specialize in electronic
commerce or derive a substantial portion of their revenues from electronic
commerce and may themselves offer, or provide means for others to offer,
software products.

We believe that the principal competitive
  factors in our market include:
  breadth of service and product offerings;
  software publisher and online retailer
  relationships;
  brand recognition;
  system reliability and capacity;
  price;
  customer service;
  speed, accessibility and ease of use;
  speed to market;
  scaleability;
  convenience; and
  speed of fulfillment.The online retailers and the other companies
listed above may compete directly with us by adopting a similar business model.
Moreover, while some of these companies are also clients or potential clients
of ours, they may compete with our electronic commerce outsourcing solution if
they develop electronic commerce systems or acquire these systems from other
software vendors or service providers.

Many
of our current and potential competitors have longer operating histories,
larger customer bases, greater brand recognition and significantly
greater financial, marketing and other resources as compared to us. Larger,
well-established and well-financed entities may acquire, invest in or form
joint ventures with online competitors as the use of the Internet and other
online services increases. In addition, new technologies and the expansion of
existing technologies, such as price comparison programs that select specific
titles from a variety of Web sites, may direct end-users to online retailers
that compete with us, which would increase our competitive pressures. Increased
competition may result in reduced operating margins, as well as a loss of
market share. Further, in response to changes in the competitive environment,
we may from time to time make pricing, service or marketing decisions or
acquisitions that could harm our business. We may be unable to compete
successfully against current and future competitors, and any inability to do so
could harm our business.

WE MUST KEEP PACE
WITH RAPID TECHNOLOGICAL CHANGE IN ORDER TO SUCCEED.

To remain competitive, we must continue to
enhance and improve the responsiveness, functionality and features of the CNS
and the underlying network infrastructure. The Internet and the electronic
commerce industry are characterized by rapid technological change, changes in
user requirements and preferences, frequent new product and service
introductions embodying new technologies and the emergence of new industry
standards and practices that could render our technology and systems obsolete.
Our success will depend, in part, on our ability to both license and internally
develop leading technologies to enhance our existing services, develop new
products, services and technologies that address the increasingly sophisticated
and varied needs of our clients, and respond to technological advances and
emerging industry standards and practices on a cost-effective and timely basis.
The development of the CNS technology and other proprietary technology involves
significant technical and business risks. We may fail to use new technologies
effectively or adapt our proprietary technology and systems to customer
requirements or emerging industry standards. If we are unable to adapt to
changing market conditions, client requirements or emerging industry standards,
our business could be harmed.

WE MUST EFFECTIVELY
MANAGE OUR RAPID GROWTH IN ORDER TO SUCCEED.

We have rapidly and significantly expanded
our operations and anticipate that further significant expansion will be
required to address potential growth in our client base and market
opportunities. In 2000, we increased our number of employees from 278 to
381.  This expansion is placing a
significant strain on our managerial, operational and financial resources. Our
new employees include a number of key managerial, technical and operations
personnel whom we have not yet fully integrated. We expect to add additional
key personnel in the near future, including direct sales, marketing and
technical personnel. To manage the expected growth of our operations and
personnel, we will be required to:


  improve existing and implement new
  operational, financial and management controls, reporting systems and
  procedures;
  install new management information systems;
  and
  train, motivate and manage our employees.We may be unable to install management
information and control systems in an efficient and timely manner, and our
current or planned personnel, systems, procedures and controls may be
inadequate to support our future operations. In addition, we may be unable to
hire, train, retain, motivate and manage required personnel or to successfully
identify, manage and exploit existing and potential market opportunities. If we
are unable to manage growth effectively, our business will be harmed.

OUR CHIEF EXECUTIVE
OFFICER IS CRITICAL TO OUR BUSINESS AND HE MAY NOT REMAIN WITH US IN THE
FUTURE.

Our future success significantly depends on
the continued services and performance of our senior management, particularly
Joel A. Ronning, our chief executive officer and member of the office of the
president.  Our performance also depends
on our ability to retain and motivate our other executive officers and key
employees. The loss of the services of any of our executive officers or other
key employees could harm our business. We have a long-term employment agreement
only with Mr. Ronning. Our future success also depends on our ability to
identify, attract, hire, train, retain and motivate other highly skilled
technical, managerial, operations, merchandising, sales and marketing and
customer service personnel. Competition for personnel is intense, and we may be
unable to successfully attract, assimilate or retain sufficiently qualified
personnel. The failure to retain and attract the necessary personnel could harm
our business.

PROTECTING OUR
INTELLECTUAL PROPERTY IS CRITICAL TO OUR SUCCESS.

We regard the protection of our trademarks,
copyrights, trade secrets and other intellectual property as critical to our
success. We rely on a combination of patent, copyright, trademark, service mark
and trade secret laws and contractual restrictions to protect our proprietary
rights. We have entered into confidentiality and invention assignment
agreements with our employees and contractors, and nondisclosure agreements
with parties with which we conduct business in order to limit access to and
disclosure of our proprietary information. These contractual arrangements and
the other steps taken by us to protect our intellectual property may not
prevent misappropriation of our technology or deter independent third-party
development of similar technologies. We also seek to protect our proprietary
position by filing United States and foreign patent applications related to our
proprietary technology, inventions and improvements that are important to the
development of our business. 
Proprietary rights relating to our technologies will be protected from
unauthorized use by third parties only to the extent they are covered by valid
and enforceable patents or are effectively maintained as trade secrets. We
pursue the registration of our trademarks and service marks in the United
States and internationally. Effective trademark, service mark, copyright and
trade secret protection may not be available in every country in which our services
are made available online.

The
steps we have taken to protect our proprietary rights may be inadequate and
third parties may infringe or misappropriate our trade secrets, trademarks and
similar proprietary rights.  Any
significant failure on ourpart to protect our intellectual property
could harm our business.  In addition,
litigation may be necessary in the future to enforce our intellectual property
rights, to protect our trade secrets or to determine the validity and scope of
the proprietary rights of others. 
Litigation could result in substantial costs and diversion of management
and technical resources, which could harm our business.

CLAIMS OF
INFRINGEMENT OF OTHER PARTIES INTELLECTUAL PROPERTY RIGHTS COULD REQUIRE US TO
EXPEND SIGNIFICANT RESOURCES.

From time to time, we may receive notice of
claims of infringement of other parties proprietary rights.  Any future assertions or prosecutions of
claims like these could require us to expend significant financial and
managerial resources. The defense of any claims, whether these claims are with
or without merit, could be time-consuming, result in costly litigation and
diversion of technical and management personnel, cause product shipment delays
or require that we develop non-infringing technology or enter into royalty or
licensing agreements.  Royalty or
licensing agreements, if required, may be unavailable on terms acceptable to us
or at all.  In the event of a successful
claim of infringement against us and our failure or inability to develop
non-infringing technology or license the infringed or similar technology on a
timely basis, which could harm our business.

CLAIMS AGAINST US
RELATED TO THE SOFTWARE PRODUCTS THAT WE DELIVER ELECTRONICALLY COULD ALSO
REQUIRE US TO EXPEND SIGNIFICANT RESOURCES.

Claims may be made against us for negligence,
copyright or trademark infringement or other theories based on the nature and
content of software products that are delivered electronically and subsequently
distributed to others. Although we carry general liability insurance, our
insurance may not cover potential claims of this type or may not be adequate to
cover all costs incurred in defense of potential claims or to indemnify us for
all liability that may be imposed. Any costs or imposition of liability that
are not covered by insurance or in excess of insurance coverage could harm our
business.

WE MAY NEED TO RAISE
ADDITIONAL CAPITAL TO ACHIEVE OUR BUSINESS OBJECTIVES.

We require substantial working capital to
fund our business. We have had significant operating losses and negative cash
flow from operations since inception and expect to continue to do so for the
foreseeable future. We believe that our existing capital resources will be
sufficient to meet our capital requirements for at least the next 24 months.
However, our capital requirements depend on several factors, including the rate
of market acceptance of our products, the ability to expand our client base,
the growth of sales and marketing and other factors. If capital requirements
vary materially from those currently planned, we may require additional
financing sooner than anticipated. If additional funds are raised through the
issuance of equity securities, the percentage ownership of our stockholders
will be reduced, stockholders may experience additional dilution or these
equity securities may have rights, preferences or privileges senior to those of
our common stock. Additional financing may not be available when needed, on
terms favorable to us or at all. If adequate funds are not available or are not
available on acceptable terms, we may be unable to develop or enhance our
services, take advantage of future opportunities or respond to competitive
pressures, which could harm our business.

CHANGES IN GOVERNMENT REGULATION COULD LIMIT OUR INTERNET ACTIVITIES OR
RESULT IN ADDITIONAL COSTS OF DOING BUSINESS OVER THE INTERNET.

We are subject to the same federal,
state and local laws as other companies conducting business on the
Internet.  Today there are relatively
few laws specifically directed towards conducting business on the Internet.
However, due to the increasing popularity and use of the Internet, many laws
and regulations relating to the Internet are being debated at the state and
federal levels.  These laws and
regulations could cover issues such as:

user
privacy;freedom
of expression;pricing;fraud;quality
of products and services;advertising;intellectual
property rights; andinformation
security.Applicability to the Internet of existing laws governing
issues such as property ownership, copyrights and other intellectual property
issues, taxation, libel, obscenity and personal privacy could also harm our
business.  The vast majority of these
laws were adopted prior to the advent of the Internet, and do not contemplate
or address the unique issues raised thereby. Those laws that do reference the
Internet, such as the Digital Millennium Copyright Act, are only beginning to
be interpreted by the courts and their applicability and reach are therefore
uncertain.  These current and future
laws and regulations could adversely affect our future business, results of
operation and financial condition.

In addition, because our services are accessible
worldwide, and we facilitate sales of goods to users worldwide, foreign jurisdictions
may claim that we are required to comply with their laws. For example, a French
court has recently ruled that a U.S. website must comply with French laws
regarding content.  Laws regulating
Internet companies outside of the United States may be less favorable than
those in the United States, giving greater rights to consumers, content owners
and users.  Compliance may be more
costly or may require us to change our business practices or restrict our
service offerings relative to those in the United States. Any failure to comply
with foreign laws could subject us to penalties ranging from fines to bans on
our ability to offer our services.

Laws or
regulations relating to user information and online privacy may adversely
affect the growth of our Internet business or our marketing efforts.

We are
subject to increasing regulation at the federal and state levels relating to
online privacy and the use of personal user information.  Several states have proposed legislation
that would limit the uses of personal user information gathered online or
require online services to establish privacy policies.  In addition, bills pending in Congress would
extend online privacy protections to adults. Laws and regulations of this kind
may include requirements that we establish procedures to disclose and notify
users of privacy and security policies, obtain consent from users for
collection and use of information, or provide users with the ability to access,
correct and delete personal information stored by us.  Even in the absence of those regulations, the Federal Trade
Commission has settled several proceedings resulting in consent decrees in
which Internet companies have been required to establish programs regarding the
manner in which personal information is collected from users and provided to
third parties.  We could become a party
to a similar enforcement proceeding. 
These regulatory and enforcement efforts could also harm our ability to collect
demographic and personal information from users, which could be costly or
adversely affect our marketing efforts.

WE MAY NOT SUCCEED IN
DEVELOPING A SUCCESSFUL INTERNATIONAL PRESENCE.

Although we sell software products and
services to end-users outside the United States, we might not succeed in
expanding our international presence. Conducting business outside of the United
States is subject to certain risks, including:


  changes in regulatory requirements and
  tariffs;
  reduced protection of intellectual property
  rights;
  difficulties in distribution;
  the burden of complying with a variety of
  foreign laws; and
  political or economic constraints on
  international trade or instability.We may be unable to market, sell and
distribute our products and services in local markets and we cannot be certain
that one or more of these factors will not harm our future international
operations, and consequently, our business.

NEW OBLIGATIONS TO
COLLECT OR PAY SALES TAX COULD HARM OUR BUSINESS.

We do not currently collect sales, use or
other similar taxes with  respect to ESD
or shipments of software products into states other than  California, Connecticut, Minnesota and
Washington. However, one or more local, state or foreign jurisdictions may seek
to impose sales or use tax  collection
obligations on out-of-state companies like ours that engage in  electronic commerce. Any new operation in
states outside California,  Connecticut,
Minnesota and Washington could subject shipments into those  states to state sales or use taxes under
current or future laws. In addition,  any
failure by an E-Business client to collect obligatory sales or use taxes  could cause the relevant jurisdiction to
attempt imposing that obligation on  us.
A successful assertion by one or more states or any foreign country that  we should collect sales, use or other taxes
on the sale of merchandise through ESD or E–Business or shipments of
software could harm our business.

OUR STOCK PRICE IS
LIKELY TO BE HIGHLY VOLATILE DUE TO BROAD MARKET AND INDUSTRY FACTORS BEYOND
OUR CONTROL.

The trading price of our common stock has
been and is likely to continue to be highly volatile and could be subject to
wide fluctuations in response to factors such as:


  actual or anticipated variations in
  quarterly operating results;
  announcements of technological innovations;
  new products or services that we or our
  competitors offer;
  changes in financial estimates by
  securities analysts;
  conditions or trends in the Internet and
  online commerce industries;
  changes in the economic performance and/or
  market valuations of other Internet, online service industries;
  changes in the economic performance and/or
  market valuations of other Internet, online service or retail companies;
  our announcements of significant
  acquisitions, strategic partnerships, joint ventures or capital commitments;
  additions or departures of key personnel;
  sales of common stock; and
  other events or factors, many of which are
  beyond our control.In addition, the stock
market in general, and the Nasdaq National Market andthe market
for Internet-related and technology companies in particular, has experienced
extreme price and volume fluctuations that have often been unrelated or
disproportionate to the operating performance of these companies.  These broad market and industry factors may
cause the market price of our common stock to decline, regardless of our actual
operating performance. In the past, following periods of volatility in the
market price of a companys securities, securities class-action litigation has
often been instituted against that company. Litigation, if instituted, could
result in substantial costs and a diversion of managements attention and
resources, which would harm our business.

PROVISIONS OF OUR
CHARTER DOCUMENTS, OTHER AGREEMENTS AND DELAWARE LAW MAY INHIBIT POTENTIAL
ACQUISITION BIDS FOR US.

Certain provisions of our Amended and
Restated Certificate of Incorporation, Bylaws, other agreements and Delaware
law could make it more difficult for a third-party to acquire us, even if a
change in control would be beneficial to our stockholders.

ITEM 2. PROPERTIES.

We currently lease approximately 70,000
square feet of office and warehouse space in two facilities in Eden Prairie,
Minnesota.  Both agreements expire on
July 31, 2003.  We also lease on a month-to-month
basis approximately 900 square feet of office space in suburban London that
houses our European sales office.  In
addition, we lease on a short-term basis offices in Cheshire, Connecticut and
Issaquah, Washington, with space of 1,700 and 800 square feet,
respectively.  We are currently seeking
to expand our office space in Minnesota by approximately 20,000 square feet,
which we believe we will be able to lease at competitive market rates.

ITEM 3. LEGAL
PROCEEDINGS.

From time to time, we may be involved in
litigation relating to claims arising out of the ordinary course of
business.  We presently are not subject
to any material legal proceedings.

ITEM 4. SUBMISSION OF
MATTERS TO A VOTE OF SECURITY HOLDERS.

None.

PART II

ITEM 5.   MARKET FOR REGISTRANTS COMMON EQUITY AND
RELATED STOCKHOLDER MATTERS.

Our Common Stock is traded on the Nasdaq
National Market under the symbol DRIV. Public trading of the Common Stock
commenced on August 11, 1998. Prior to that, there was no public market for the
Common Stock. The following table sets forth, for the periods indicated, the
high and low sale price per share of the Common Stock on the Nasdaq National
Market.

1999
  HIGH
  LOWFirst Quarter
  $61.38
  $27.44Second
  Quarter
  $51.38
  $19.56Third
  Quarter
  $36.13
  $18.25Fourth
  Quarter
  $43.63
  $19.632000First Quarter
  $37.38
  $21.00Second
  Quarter
  $22.13
  $7.00Third
  Quarter
  $9.13
  $5.38Fourth
  Quarter
  $7.38
  $2.19As
of March 21, 2001, there were approximately 408 holders of record of the Common
Stock.On March 23, 2001, the last sale price reported on the
Nasdaq National Market System for the Common Stock was $5.375 per share.

We have never declared or paid any cash
dividends on our capital stock.  We
intend to retain any future earnings to support operations and to finance the
growth and development of our business and do not anticipate paying cash
dividends for the foreseeable future.

Since January 1, 2000, we have sold and
issued the following unregistered securities:

Between February 2000 and May 2000, warrants
were exercised to purchase 14,999 shares of Common Stock at a weighted average
exercise price of $3.00.

The former owners of Maagnum Internet Group,
Inc., a company we purchased in April 1999, received earn-out payments of
124,349 shares of Common Stock valued at $3,093,000 in March 2000.

In August 2000, we purchased certain assets,
consisting principally of customer lists, of the software services business of
NetSales, Inc., in exchange for 1,000,000 shares of Common Stock valued at
$6.00 per share at the closing of the transaction, with a contingent
earn-out for up to an additional 350,000 shares of Common Stock based on
performance over the subsequent 180 days.

The sales and issuances of the unregistered
securities in the transactions described above were deemed to be exempt from
registration under the Securities Act of 1993, or the Act, in reliance upon
Section 4(2) of the Act, Regulation D promulgated thereunder, Regulation S
promulgated thereunder, or Rule 701 promulgated under Section 3(b) of the Act,
as transactions by an issuer not involving any public offering or transactions
pursuant to compensatory benefit plans and contracts relating to compensation
as provided under Rule 701. The recipients of securities in each such transaction
represented their intentions to acquire the securities for investment only and
not with a view to or for sale in connection with any distribution thereof and
appropriate legends were affixed to the securities issued in such transactions.
All recipients had adequate access, through their relationship with us, to
information about Digital River.

There were no underwritten offerings employed
in connection with the sales and issuances of the unregistered securities in
any of the transactions set forth above.

ITEM 6.  SELECTED FINANCIAL DATA.

YEAR ENDED DECEMBER
  31,2000
  1999
  1998
  1997
  1996(in thousands, except share data)Statement of
  Operations Data:Revenue
  $31,181
  $14,507
  $3,424
  $420
  $16Costs
  and expenses:Direct
  cost of services
  1,477
  801
  116
  23
  2Network
  and infrastructure
  7,867
  4,434
  1,836
  580
  86Sales
  and marketing
  25,693
  17,383
  9,310
  1,446
  57Product
  research and development
  13,063
  10,251
  3,140
  877
  131General
  and administrative
  4,628
  4,001
  3,111
  837
  402Depreciation
  and amortization
  3,178
  1,552
  604
  195
  35Amortization
  of goodwill and acquisition related costs
  15,387
  6,886
  
  
  Total
  operating expenses
  71,293
  45,308
  18,117
  3,958
  713Loss
  from operations
  (40,112)
  (30,801)
  (14,693)
  (3,538)
  (697)Interest
  income
  1,996
  3,148
  895
  53
  8Net
  loss
  $(38,116)
  $(27,653)
  $(13,798)
  $(3,485)
  $(689)Basic
  and diluted net loss per share (1)
  $(1.78)
  $(1.36)
  $(1.01)
  $(0.46)
  $(0.13)Shares
  used in per share computation (1)
  21,413
  20,312
  13,691
  7,514
  5,333

DECEMBER 31,2000
  1999
  1998
  1997
  1996(in thousands)Balance Sheet Data:Cash
  and cash equivalents
  $16,920
  $15,120
  $63,503
  $2,126
  $800Shortterm
  investments
  14,977
  24,387
  10,894
  
  Working
  capital (deficit)
  17,038
  28,777
  70,563
  1,244
  (451)Total
  assets
  69,403
  87,142
  80,328
  3,405
  1,202Accumulated
  deficit
  (83,892)
  (45,776)
  (18,123)
  (4,325)
  (840)Total
  stockholders equity (deficit)
  48,518
  73,077
  74,587
  2,329
  (58)

(1)      See Note 1 of Notes to Consolidated
Financial Statements for an explanation of the method employed to determine the
number of shares used to compute per share amounts.

ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITIONAND RESULTS OF OPERATION.

The Company is a leading provider of
comprehensive electronic commerce outsourcing solutions.  The Company was incorporated in February
1994 and commenced offering products for sale through its clients Web stores in
August 1996.  From inception through
August 1996, the Company had no sales, and its activities related primarily to
the development of its Commerce Network Server, or CNS, technology related to
electronic commerce.  In 1996, the
Company began to focus its business development efforts on the software
industry, building its inventory of software products through contracts with
software publishers.  In 1997, the
Company began to develop software distribution relationships through contracts
with online retailers.  As of December
31, 2000, the Company had approximately 8,000 software publisher clients and
online retailer clients that are served by the Software and Digital Commerce
Services Division.  In late 1998, the
Company began to offer its comprehensive electronic commerce outsourcing
services in the form of a transaction fee-based e-commerce service to clients
outside of the software industry.  As of
December 31, 2000, the Company had 51 client contracts under its E-Business
Services Division.

The Company has a limited operating history
upon which investors may evaluate its business and prospects.  Since inception, the Company has incurred
significant losses, and as of December 31, 2000, had an accumulated deficit of
approximately $83.9 million.  The
Company intends to expend financial and management resources on the development
of additional services, sales and marketing, technology and operations to
support larger-scale operations and greater service offerings, particularly
with respect to the E-Business Services Division.  As a result, the Company expects to incur additional losses and
continued negative cash flow from operations for most of 2001.  There can be no assurance that the Companys
revenue will increase or even continue at their current level or that the Company
will achieve or maintain profitability or generate cash from operations in
future periods.  The Companys prospects
must be considered in light of the risks, expenses and difficulties frequently
encountered by companies in their early stage of development, particularly
companies in new and rapidly evolving markets such as electronic commerce.  To address these risks, the Company must,
among other things, maintain existing and develop new relationships with software
publishers, online retailers and E-Business Services clients, implement and
successfully execute its business and marketing strategy, continue to develop
and upgrade its technology and transaction-processing systems, provide superior
customer service and order fulfillment, respond to competitive developments,
and attract, retain and motivate qualified personnel.  There can be no assurance that the Company will be successful in
addressing these risks, and the failure to do so would have a material adverse
effect on the Companys business, financial condition and results of
operations.  The Companys current and
future expense levels are based largely on its planned operations and estimates
of future revenue.  Revenue and
operating results generally depend on the volume and timing of orders received,
which are difficult to forecast.  The
Company may be unable to adjust spending in a timely manner to compensate for
any unexpected revenue shortfall. 
Accordingly, any significant shortfall in revenue would have an
immediate adverse effect on the Companys business, financial condition and
results of operations.  The Company is
also likely to continue to see revenue fluctuate on a seasonal basis that is
typical for the software publishing market in general.  In view of the rapidly evolving nature of the
Companys business and its limited operating history, the Company is unable to
accurately forecast its revenue and believes that period-to-period comparisons
of its operating results are not necessarily meaningful and should not be
relied upon as an indication of future performance.

Results Of Operations

The following table sets forth certain items
from the Companys consolidated condensed statements of operations as a
percentage of total revenues for the years indicated.

2000
  1999
  1998Revenue
  100.0%
  100.0%
  100.0%Costs
  and expenses:Direct
  cost of services
  4.7
  5.5
  3.4Network
  and infrastructure
  25.2
  30.6
  53.6Sales
  and marketing
  82.4
  119.8
  271.9Product
  research and development
  41.9
  70.7
  91.7General
  and administrative
  14.9
  27.6
  90.9Depreciation
  and amortization
  10.2
  10.7
  17.6Amortization
  of goodwill and acquisition related costs
  49.3
  47.4
  -Total
  costs and expenses
  228.6
  312.3
  529.1Loss
  from operations
  (128.6)
  (212.3)
  (429.1)Interest
  income
  6.4
  21.7
  26.1Net
  loss
  (122.2)%
  (190.6)%
  (402.0)%

Years Ended December 31, 2000, 1999 and 1998

Revenue.  The Company derives its revenue primarily
from transaction and service fees associated with the e-commerce services that
the Company provides to its clients. 
These services include Web commerce hosting, transaction processing,
digital and physical fulfillment services, fraud screening, customer service
and merchandising and analytical marketing services.  The Company reports its revenue on a net basis and therefore
records only the net transaction fees and service fees as its revenue.  The Company acts as the merchant of record
on the majority of the transactions processed and has contractual relationships
with its clients, primarily software publishers and online retailers, which
obligate the Company to pay to the client a specified percentage of each
sale.  The Company retains its
transaction fee and also charges various service fees.  The Company also derives revenue from
licensing, integration, development and consulting services provided to its
clients.  This revenue is recognized as
services are performed, except for licensing and certain integration and
development fees which are recognized evenly over the term of the
contract.  The Companys revenue
increased to $31.2 million in 2000 from $14.5 million in 1999 and $3.4 million
in 1998.  The revenue increases in 2000
and 1999 resulted from a of significant growth in the number of the Companys
clients, the increasing market acceptance of electronic software downloading
and merchandising activities that increased the average sales generated by the
Companys software publisher clients. 
The 1999 sales growth as compared to 1998 was also a function of the
Companys acquisition of three shareware outsourcing companies during
1999.  International sales represented
approximately 25%, 22% and 24% of sales in the years ended December 31,
2000, 1999 and 1998, respectively.  The
Company began presenting the E-Business Services Division as a separate segment
in 2000.  Prior to that, substantially
all revenue related to the Companys Software and Digital Commerce Services
Division.  In 2000, revenue for the
Software and Digital Commerce Services Division was $25.2 million and revenue
for the E-Business Services Division was $6.0 million.

Gross Profit.  Cost of revenue consists of direct cost of
services and network and infrastructure expenses.   These two expense items are primarily composed of direct labor
costs related to revenue and the costs to operate and maintain the CNS, as well
as customer service and operations functions. Cost of revenue increased
substantially during 2000 and 1999, reflecting the Companys growth in
revenue.  During 2000, 1999 and 1998,
the Companys gross profit margins were 70.0%, 63.9% and 43.0%,
respectively.  The gross profit margin
increases in 2000 and 1999 were primarily due to leveraging the Companys
infrastructure over significantly more revenue and clients.  In 2000, the gross profit margin for the
Software Services Division was 71.8% and for the E-Business Services Division
was 62.4%.  The Company believes that
Internet commerce and related services may become more competitive in the
future. Accordingly, the Company may reduce or alter its pricing structure and
policies in the future and any such change could reduce gross margins.



Sales
and Marketing. 
Sales and marketing expense consists primarily of personnel and related
expenses, advertising and promotional expenses, credit card chargebacks and bad
debt expense, and credit card transaction fees.  Sales and marketing expense increased to $25.7 million from $17.4
million and $9.3 million in 2000, 1999 and 1998, respectively, resulting from
additional sales and marketing personnel and related expenses, increased bad
debt expense and increased credit card transaction fees due to increased
revenue.  The primary components of the
increase in 2000 from 1999 were an increase in wages, benefits and consulting
fees of $4.3 million and an increase in credit card chargebacks, bad debt
expense and credit card transaction fees of $2.7 million.  The primary components of the increase in
1999 from 1998 were an increase in wages, benefits and consulting fees of $4.3
million and an increase in credit card chargebacks, bad debt expense and credit
card transaction fees of $3.0 million. 
As a percentage of revenue, sales and marketing expense decreased to
82.4% in 2000 from 119.8% in 1999 and 271.9% in 1998, primarily reflecting the
Companys increased revenue.  In 2000,
the sales and marketing expense related to the Software and Digital Commerce
Services Division was $14.7 million and for the E-Business Services Division
was $11.0 million.  The Company expects
that sales and marketing expense will continue to increase in absolute dollars
as the Company continues to build its sales and marketing infrastructure, to
develop marketing programs and from growth in volume-driven credit card
expenses.  As a percentage of revenue,
these expenses are expected to decrease as revenue increases.

Product Research and Development.  Product research and development expense
consists primarily of personnel and related expenses and consulting costs
associated with developing and enhancing the Companys CNS and related
facilities and internal systems. 
Product research and development expense increased to $13.1 million from
$10.3 million and $3.1 million in 2000, 1999 and 1998, respectively.  The increase was primarily related to
increased personnel and consulting costs related to developing and enhancing
the Companys CNS and related facilities. 
The primary components of the increase in 2000 from 1999 were an
increase in wages, benefits and temporary employee costs of $1.4 million and an
increase in consulting costs of $1.1 million. 
The primary components of the increase in 1999 from 1998 were an
increase in wages, benefits and temporary employee costs of $1.8 million and an
increase in consulting costs of $4.4 million. 
As a percentage of revenue, product research and development expense
decreased to 41.9% in 2000 from 70.7% in 1999 and 91.7% in 1998, primarily
reflecting the Companys increased revenue. 
In 2000, the product research and development expense related to the
Software and Digital Commerce Services Division was $5.8 million and for the E-Business
Services Division was $7.2 million.  The
Company expects that product research and development expenses will continue to
decrease as a percentage of revenue as revenue increases.

General and Administrative.  General and administrative expense consists
principally of executive, accounting and administrative personnel and related
expenses, including deferred compensation expense, professional fees and
investor relations expenses.  General
and administrative expense increased to $4.6 million from $4.0 million and $3.1
million in 2000, 1999 and 1998, respectively, primarily due to increased
personnel related expense and professional fees.  The primary component of the increase in 2000 from 1999 was an
increase in professional fees and investor relations related expense of  $332,000. 
The primary components of the increase in 1999 from 1998 were an
increase in wages and benefits of $204,000 and an increase in professional fees
of $535,000.  As a percentage of
revenue, general and administrative expense decreased to 14.9% in 2000 from
27.6% in 1999 and 90.9% in 1998, primarily reflecting the Companys increased
revenue.  In 2000, general and
administrative expense related to the Software and Digital Commerce Services
Division was $3.2 million and for the E-Business Services Division was $1.4
million.  The Company expects general
and administrative expense to increase in absolute dollars in the future,
particularly as the Company continues to build infrastructure to support growth
and incurs costs associated with being a public company. As a percentage of
revenue, these expenses are expected to decrease as revenue increases.

Amortization of Goodwill and
Acquisition-related Costs. 
Amortization of goodwill and acquisition-related costs consists of the
amortization of goodwill recorded from the Companys five acquisitions in 2000
and 1999 as well as other related costs such as earn-out payments.  Amortization of goodwill and
acquisition-related costs increased to $15.4 million in 2000 from $6.9 million
in 1999, primarily due to a full year of amortization of goodwill in 2000 from
the four 1999 acquisitions and due to two earn-out payments totaling $5.1
million made in 2000.  The Company
expects amortization of goodwill and acquisition-related costs to increase in
2001 due to full year amortizations on goodwill of all 2000 and 1999
acquisitions, in addition to expected earn-out payments.



Loss
from Operations. 
The Companys loss from operations increased to $40.1 million in 2000
from $30.8 million in 1999, and $14.7 million in 1998, resulting primarily from
increased investments in sales and marketing and product research and
development.  In 2000, loss from
operations related to the Software and Digital Commerce Services Division was
$5.6 million and for the E-Business Services Division was $15.9 million.  In calculating segment losses, the Company
does not include depreciation and amortization nor amortization of goodwill and
acquisition-related costs.  On a segment
basis, the Software and Digital Commerce Services Division had income from
operations in the fourth quarter of 2000.

Interest Income.  Interest income consists of earnings on the
Companys cash, cash equivalents and short-term investments.  Interest income decreased to $2.0 million in
2000 from $3.1 million in 1999, and increased to $3.1 million in 1999 from
$895,000 in 1998, resulting from changes in average cash and cash equivalent
balances.  The Company expects interest
income to decrease in the future as cash is used to fund operations and is used
for investments in infrastructure.

Income Taxes.  The Company paid no income taxes in 2000,
1999 and 1998. The Company has incurred a net loss for each period since
inception. As of December 31, 2000, the Company had approximately $78.4 million
of net operating loss carryforwards for federal income tax purposes, which
expire beginning in 2009. Due to the uncertainty of future profitability, a
valuation allowance equal to the deferred tax asset has been recorded. Certain
changes in ownership that resulted from the sales of Common Stock and Preferred
Stock will limit the future annual realization of the tax net operating loss
carryforwards to a specified percentage under Section 382 of the Internal
Revenue Code.

Liquidity and Capital
Resources

In August 1998, the Company completed its
initial public offering in which the Company sold 3,000,000 shares of Common
Stock.  Net proceeds to the Company were
$22.7 million after expenses.  In
December 1998, the Company completed a follow-on public offering in which the
Company sold 2,200,000 shares of Common Stock. 
Net proceeds to the Company were $48.1 million after expenses.  Prior to the Companys initial public
offering and follow-on offering, the Company financed its operations primarily
through the private placement of equity securities, which yielded an aggregate
of $19.3 million of net proceeds.

Net cash used in operating activities in
2000, 1999 and 1998 was $17.0 million, $13.6 million and $9.0 million,
respectively.  Net cash used for
operating activities in each of these periods was primarily the result of net
losses, offset in part by goodwill amortization and earn-out charges, increases
in accounts payable and increases in depreciation and amortization.

Net cash provided by investing activities in
2000 was $14.9 million and was a result of net sales of investments of $24.4
million partially offset by purchases of equipment of $9.4 million.   Net cash used in investing activities in
1999 and 1998 was $37.5 million and $14.5, respectively.  Net cash used in investing activities in
each of these periods was primarily the result of the purchases of equipment
and the purchase of investments in 1999 and 1998.  The equipment purchased consisted primarily of computer hardware
and software.  Additionally, in 1999,
$4.1 million of cash was used as cash paid for acquisition, net of cash
received.

Net cash provided by financing activities in
2000, 1999 and 1998 was $3.9 million, $2.7 million and $84.9 million,
respectively.  The cash provided by
financing activities was mainly the result of proceeds from the sales of the
Companys Common Stock in 1998, the sale of the Companys Series A Preferred
Stock in April 1998 and the exercise of options and warrants in 2000, 1999 and
1998.

As
of December 31, 2000 the Companyhad approximately $16.9 million of cash
and cash equivalents and $15.0 million of short-term investments.  The Companys principal commitments
consisted of obligations outstanding under operating leases. Although the
Company has no material commitments for capital expenditures, it anticipates an
increase in the rate of capital expenditures consistent with its anticipated
growth in operations, infrastructure and personnel. The Company anticipates
that it will expend approximately $22.0 million over the next 24 months on
capital expenditures based on the Companys current anticipated growth rate.
The Company further anticipates that it will expend approximately $20.0 million
over the next 24 months on product research and development based on the
Companys current anticipated growth rate in operations. The Company may also
use cash to acquire or license technology, products or businesses related to
the Companys current business. The Company also anticipates that it will
continue to experience growth in its operating expenses for the foreseeable
future and that its operating expenses will be a material use of the Companys
cash resources.

The Company believes that existing sources of
liquidity and the results of its operations will provide adequate cash to fund
its operations for at least the next 24 months, although the Company may seek
to raise additional capital during that period.  The sale of additional equity or convertible debt securities
could result in additional dilution to the Companys stockholders.  There can be no assurances that financing
will be available in amounts or on terms acceptable to the Company, if at all.

Recent Accounting
Pronouncements

In 2000, the Company commenced reporting its
company-wide revenues on a net basis and has reclassified all historical
information presented herein to conform to this presentation.  This change is based upon the consensus
reached in Issue 99-19:  Reporting
Revenue Gross as a Principal versus Net as an Agent by the Emerging Issues
Task Force (EITF) of the Financial Accounting Standards Board which revised
accounting standards regarding net versus gross revenue recognition.  Previously, substantially all revenue
generated through the Companys Software and Digital Commerce Services division
was recognized on a gross basis. 
Revenue generated through the E-Business Services division has
historically been reported on a net basis. 
This change reflects a new reporting presentation only and does not
alter the Companys net income, either historically or in the future.

The Company has also adopted the provisions
of the Securities and Exchange Commissions (SEC) Staff Accounting Bulletin
(SAB) 101, Revenue Recognition in Financial Statements in the quarter ended
September 30, 2000.  SAB 101 provides
the SEC staffs views in applying generally accepted accounting principles to
selected revenue recognition issues.  It
also provides guidance on recording revenue gross as a principal versus net as
an agent consistent with EITF Issue 99-19. 
Other than the reclassification of revenues to a net basis, the adoption
of SAB 101 did not have any impact to the Company.

In March 2000, the EITF also published its
consensus on EITF 00-2, Accounting for Web Site Development Costs. EITF 00-2
is effective for fiscal quarters beginning after June 30, 2000.  The Company has adopted EITF 00-2 and has
had no impact to date from the adoption.

ITEM 7a. QUALITATIVE
AND QUANTITATIVE DISCLOSURE ABOUT MARKET RISK.

We do not enter into financial instruments
for trading or speculative purposes and do not currently utilize derivative
financial instruments.  Our operations
are conducted primarily in the United States and as such are not subject to
material foreign currency exchange rate risk. 
We have no long-term debt.

ITEM 8. FINANCIAL STATEMENTS
AND SUPPLEMENTARY DATA.

Our Financial Statements and Notes thereto
appear beginning at page F-1 of this report.

QUARTERLY FINANCIAL DATA:
(in thousands, except per share data)

QUARTER ENDEDMarch 31
  June 30
  September 30
  December 312000Revenue
  $6,883
  $6,635
  $7,607
  $10,056Gross profit(a)
  4,798
  4,403
  5,298
  7,339Loss from operations(b)
  (12,675)
  (13,187)
  (8,456)
  (5,793)Net loss
  (11,991)
  (12,633)
  (8,074)
  (5,418)Net loss per share (c)
  (.58)
  (.60)
  (.37)
  (.24)

QUARTER ENDEDMarch 31
  June 30
  September 30
  December 311999Revenue
  $1,903
  $3,065
  $4,017
  $5,522Gross profit(a)
  911
  1,992
  2,813
  3,556Loss from operations(b)
  (6,238)
  (7,463)
  (9,439)
  (7,661)Net loss
  (5,344)
  (6,678)
  (8,688)
  (6,943)Net loss per share (c)
  (.27)
  (.33)
  (.42)
  (.33)

(a)      Gross profit is calculated as revenue less
direct cost of services and network and infrastructure expenses.
(b)      Loss from operations includes
amortization of goodwill and acquisition related costs of $5,394, $4,334,
$2,603 and $3,056, in the quarters ending March 31, June 30, September 30 and
December 31, 2000, respectively and includes amortization of goodwill and
acquisition related costs of $1,302, $3,275 and $2,309, in the quarters ending
June 30, September 30 and December 31, 1999, respectively.
(c)  Net loss per share is the same for
both basic and diluted.ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE.

None.

PART III

Certain information required in Part III of this
report is incorporated by reference to our Proxy Statement in connection with
our 2001 Annual Meeting to be filed in accordance with Regulation 14A under the
Securities Exchange Act of 1934, as amended.

ITEM 10.  DIRECTORS AND EXECUTIVE OFFICERS OF THE
REGISTRANT.

(a) 
  Identification of Directors:The information concerning our directors
  and nominees is incorporated by reference to our Proxy Statement in
  connection with our 2001 Annual Meeting to be filed in accordance with
  Regulation 14A under the Securities Exchange Act of 1934, as amended.(b) 
  Identification of Executive Officers:Please refer to the section entitled
  Executive Officers in Part I, Item 1 hereof.(c) 
  Compliance with Section 16(a) of the Exchange Act:Based solely upon a review of Forms 3 and 4
  and amendments thereto furnished to us pursuant to Rule 16a–3(e)
  during the 2000 fiscal year and Form 5 and amendments thereto furnished to us
  with respect to fiscal year 2000, no director, officer, or beneficial owner
  of more than 10 percent of any class of equity security of Digital River has
  failed to file on a timely basis, as disclosed by the above forms, reports
  required by Section 16(a) of the Securities Exchange Act of 1934, as amended,
  during the 2000 fiscal year.ITEM 11. EXECUTIVE COMPENSATION.

The information required in Item 11 of Part
III of this report is incorporated by reference to our Proxy Statement in
connection with our 2001 Annual Meeting to be filed in accordance with
Regulation 14A under the Securities Exchange Act of 1934, as amended.

ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL
OWNERS AND MANAGEMENT.

The information required in Item 12 of Part
III of this report is incorporated by reference to our Proxy Statement in
connection with our 2001 Annual Meeting to be filed in accordance with
Regulation 14A under the Securities Exchange Act of 1934, as amended.

ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED
TRANSACTIONS.

The information required in Item 13 of Part
III of this report is incorporated by reference to our Proxy Statement in
connection with our 2001 Annual Meeting to be filed in accordance with
Regulation 14A under the Securities Exchange Act of 1934, as amended.

PART IV

ITEM 14.  EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND
REPORTS ON FORM 8-K.

(a)  The following documents are filed as part of
this report:(1)  Index to Consolidated
Financial Statements and Report of Independent Public Accountants.The consolidated financial statements required by this item are
submitted in a separate section beginning on page F-1 of this report.Report of Independent Public AccountantsConsolidated Balance SheetsConsolidated Statements of OperationsConsolidated Statements of Stockholders EquityConsolidated Statements of Cash FlowsNotes to Consolidated Financial Statements(2)  Financial Statement
Schedules.Schedules not listed above have been omitted because the  information required to be set forth therein
is not applicable or is  included in the
financial statements or notes thereto.(3)  Exhibits.Exhibit Number
  Description Of
  Document2.1(1)
  Acquisition Agreement, dated as of July 11,
  1999, by and among the Registrant and Tech Squared Inc.2.2(2)
  Asset Purchase Agreement, dated August 24,
  2000, by and between the Registrant and NetSales, Inc.2.3(3)
  Asset Purchase Agreement dated as of March
  20, by and between the Registrant, Calico Commerce, Inc. and ConnectInc.com,
  Co., a wholly-owned subsidiary of Calico3.1(4)
  Amended and Restated Certificate of
  Incorporation of the Registrant, as currently in effect.3.2
  Bylaws of the Registrant, as currently in
  effect.4.1(4)
  Specimen Stock Certificate.10.1(4)
  Form of Indemnity Agreement between
  Registrant and each of its directors and executive officers.10.2(4)
  1998 Stock Option Plan.10.3(4)
  Employment and Non-Competition Agreement
  effective May 25, 1998 by and between Joel A. Ronning and the Registrant.10.4(4)
  Heads of Agreement for International
  Agreement dated February 25, 1998 by and between Christopher J. Sharples,
  David A. Taylor and the Registrant.10.5(4)
  Stock Subscription Warrant for Shares of
  Common Stock dated February 26, 1998 by and between Christopher Sharples and
  Registrant.10.6(4)
  Form of Conditional Warrant to Purchase
  Common Stock dated April 22, 1998 by and between Wasserstein Adelson
  Ventures, L.P. and Registrant.10.7(4)
  Form of Warrant to Purchase Common Stock by
  and between certain investors and Registrant.10.8(4)
  Consent to Assignment and Assumption of
  Lease dated April 22, 1998 by and between CSM Investors, Inc., IntraNet
  Integration Group, Inc. and Registrant.10.9(4)
  Assignment of Lease dated April 21, 1998 by
  and between Intranet Integration Group, Inc. and Registrant.10.10(4)
  Lease Agreement dated January 18, 2000
  between Property Reserve, Inc. and Registrant.10.11
  First Amendment of Lease dated January 31,
  2001 to that certain Lease dated April 24, 1996 between CSM Investors, Inc.
  and Registrant (as assignee of Intranet Integration Group, Inc.).10.12
  1999 Stock Option Plan, formerly known as
  the 1999 Non-Officer Stock Option Plan.10.13
  Form of Non-Qualified Stock Option
  Agreement under the 1999 Stock Option Plan.10.14(5)
  Agreement and Plan of Merger, dated April
  1, 1999, by and among the Registrant, Maagnum Internet Group, Inc. and Cyrus
  Maaghul.10.15(5)
  Stock Purchase Agreement, dated April 1,
  1999, by and among the Registrant and Meiman Kentjana.10.16(6)
  Asset Purchase Agreement, dated as of April
  15, 1999, by and among the Registrant, Public Software Library Ltd. and the
  partners of Public Software Library Ltd.21.1(7)
  Subsidiaries of Digital River, Inc.23.1
  Consent of Independent Public Accountants.24.1
  Power of Attorney. Reference is made to the
  signature page.


(1)      Incorporated
by reference to the indicated exhibit in the Companys Current Report on Form
8-K filed on July 16, 1999.(2)      Incorporated
by reference to the indicated exhibit in the Companys Current Report on Form
8-K filed on September 8, 2000.(3)      Incorporated
by reference to the indicated exhibit in the Companys Current Report on Form
8-K filed on March 26, 2001.(4)      Incorporated
by reference to the indicated exhibit in the Companys Registration Statement
on Form S-1 (File No. 333-56787), declared effective on August 11, 1998.(5)      Incorporated
by reference to the indicated exhibit in the Companys Current Report on Form
8-K filed on April 16, 1999.(6)      Incorporated
by reference to the indicated exhibit in the Companys Quarterly Report on Form
10-Q for the quarter ended June 30, 1999.(7)      Incorporated
by reference to the indicated exhibit in the Companys Annual Report on
Form 10–K for the year ended December 31, 1999.(b)The Registrant filed a Current Report on
Form 8-K on October 20, 2000, announcing that as of the quarter ended September
30, 2000, the Registrant began reporting its company-wide revenues on a net
basis.  The Registrant filed a Current
Report on Form 8-K/A on November 7, 2000, providing financial statements of
NetSales, Inc., a company from whom the Registrant acquired certain assets on
August 24, 2000, as of December 31, 1999, and unaudited pro forma consolidated
financial statements as of June 30, 2000. 
The Registrant filed a Current Report on Form 8-K on March 26, 2001,
announcing its acquisition of certain assets from ConnectInc.com, Co., a
wholly-owned subsidiary of Calico Commerce, Inc.(c)    See Exhibits listed under
Item 14(a)(3).(d)    The financial statement
schedules required by this item are listed under 14(a)(2).SIGNATURES

Pursuant to the requirements of Section 13 or
15(d) of the Securities Exchange Act of 1934, the Registrant has caused this
report on Form 10-K to be signed on its behalf by the undersigned, thereunto
duly authorized, in the City of Eden Prairie, State of Minnesota, on the 27 day
of March 2001.

DIGITAL RIVER, INC.By:
  /s/
  JOEL A. RONNINGJoel
  A. RonningCHIEF
  EXECUTIVE OFFICER, MEMBER OF THE OFFICE OF THE PRESIDENT AND DIRECTORPOWER OF ATTORNEY

KNOW ALL THESE PERSONS BY THESE PRESENTS,
that each person whose signature appears below constitutes and appoints Joel A.
Ronning and Robert E. Strawman and each of them, jointly and severally, his
attorneys-in-fact, each with full power of substitution, for him in any and all
capacities, to sign any and all amendments to this Form 10-K, and to file the
same, with exhibits thereto and other documents in connection therewith, with
the Securities and Exchange Commission, hereby ratifying and confirming all
that each said attorneys-in-fact or his substitute or substitutes, may do or
cause to be done by virtue hereof.

Pursuant to the requirements of the
Securities Exchange Act of 1934, this Form 10-K has been signed below by the
following persons on behalf of the Registrant and in the capacities and on the
dates indicated:

SIGNATURE
  
  TITLE
  
  DATE/s/  JOEL A. RONNING
  
  Chief
  Executive Officer, Member of the Office of the President and Director
  (Principal Executive Officer)
  
  March 27, 2001Joel
  A. Ronning/s/  ROBERT E. STRAWMAN
  
  Chief
  Financial Officer, Member of the Office of the President and Treasurer
  (Principal Financial and Accounting Officer)
  
  March 27, 2001Robert
  E. Strawman/s/  PERRY W. STEINER
  
  Director
  
  March 27, 2001Perry
  W. Steiner/s/  WILLIAM LANSING
  
  Director
  
  March 27, 2001William
  Lansing/s/  THOMAS F. MADISON
  
  Director
  
  March 27, 2001Thomas
  F. Madison/s/  J. PAUL THORIN
  
  Director
  
  March 27, 2001J.
  Paul ThorinDirectorFrederic
  Seegal/s/  TIMOTHY C. CHOATE
  
  Director
  
  March 27, 2001Timothy
  C. Choate


Report of independent public accountants To
Digital River, Inc.: We
have audited the accompanying consolidated balance sheets of Digital River,
Inc. and Subsidiaries as of December 31, 2000 and 1999, and the related
consolidated statements of operations, stockholders equity and cash flows for
each of the three years in the period ended December 31, 2000. These
financial statements are the responsibility of the Companys management. Our
responsibility is to express an opinion on these financial statements based on
our audits. We
conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the
audit to obtain reasonable assurance about whether the financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion. In our opinion, the financial statements
referred to above present fairly, in all material respects, the financial
position of Digital River, Inc. and Subsidiaries as of December 31, 2000
and 1999, and the results of their operations and their cash flows for each of
the three years in the period ended December 31, 2000, in conformity with
accounting principles generally accepted in the United States. Arthur
Andersen LLP Minneapolis,
Minnesota,
January 23, 2001


DIGITAL RIVER, INC. Consolidated Balance Sheets As of December 31 (In Thousands, Except Share Data) 2000
  1999ASSETSCURRENT ASSETS:Cash and cash equivalents
  $16,920
  $15,120Short-term investments
  14,977
  24,387Accounts receivable, net allowance of $975 and $593
  4,903
  2,455Prepaid expenses and other
  1,123
  880Total current
  assets
  37,923
  42,842PROPERTY AND EQUIPMENT:Property and equipment
  18,369
  8,993Less- accumulated depreciation
  (4,799)
  (1,714)Net property and equipment
  13,570
  7,279LONG-TERM INVESTMENTS
  -
  14,832GOODWILL, net of accumulated amortization of
  $15,821 and $5,560
  17,834
  22,050OTHER ASSETS
  76
  139$69,403
  $87,142LIABILITIES AND STOCKHOLDERS
  EQUITYCURRENT LIABILITIES:Accounts payable
  $14,339
  $11,020Accrued
  payroll
  2,287
  1,909Deferred revenue
  1,833
  152Other accrued liabilities
  2,426
  984Total current liabilities
  20,885
  14,065COMMITMENTS AND CONTINGENCIES (Note 4)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; 22,275,317
  and 20,699,244 shares issued and outstanding
  223
  207Additional paid-in capital
  132,403
  119,445Deferred compensation
  (194)
  (637)Accumulated other comprehensive loss
  (22)
  (162)Accumulated deficit
  (83,892)
  (45,776)Total stockholders equity
  48,518
  73,077Total liabilities and stockholders equity
  $69,403
  $87,142 The accompanying notes are an integral part
of these consolidated balance sheets.


DIGITAL RIVER, INC. Consolidated Statements of Operations For the Years Ended December 31 (In Thousands, Except Per Share Data) 2000
  1999
  1998REVENUE
  $31,181
  $14,507
  $3,424COSTS AND EXPENSES:Direct cost of services
  1,477
  801
  116Network and infrastructure
  7,867
  4,434
  1,836Sales and marketing
  25,693
  17,383
  9,310Product research and development
  13,063
  10,251
  3,140General and administrative
  4,628
  4,001
  3,111Depreciation and amortization
  3,178
  1,552
  604Amortization of goodwill and acquisition related costs (Note 2)
  15,387
  6,886
  -Total costs and expenses
  71,293
  45,308
  18,117LOSS FROM OPERATIONS
  (40,112)
  (30,801)
  (14,693)INTEREST INCOME
  1,996
  3,148
  895Net loss
  $(38,116)
  $(27,653)
  $(13,798)BASIC AND DILUTED NET LOSS PER SHARE
  $(1.78)
  $(1.36)
  $(1.01)BASIC AND DILUTED WEIGHTED AVERAGE COMMON
  SHARES OUTSTANDING
  21,413
  20,312
  13,691 The accompanying notes are an integral part
of these consolidated financial statements.DIGITAL
RIVER, INC. Consolidated Statements of Stockholders
Equity (In Thousands) Common Stock
  Paid-In
   Capital
  Deferred
  Compensation
  Accumulated
  other
  Comprehensive 
  Income
  Accumulated
  Deficit
  Total
  Stockholders' Equity
  Comprehensive
  Income
  (Loss)Shares
  AmountBALANCE, December 31, 1997
  9,242
  $92
  $6,562
  $-
  $-
  $(4,325)
  $2,329
  $-Sales of common stock
  8,679
  87
  80,581
  -
  -
  -
  80,668
  -Sales of preferred
  stock subsequently converted to common stock
  1,000
  10
  2,815
  -
  -
  -
  2,825
  -Exercise of options
  and warrants
  624
  6
  1,346
  -
  -
  -
  1,352
  -Deferred compensation
  related to stock options and warrants
  -
  -
  2,579
  (2,579)
  -
  -
  -
  -Deferred compensation
  expense
  -
  -
  -
  1,211
  -
  -
  1,211
  -Net loss
  -
  -
  -
  -
  -
  (13,798)
  (13,798)
  (13,798)BALANCE, December 31, 1998
  19,545
  195
  93,883
  (1,368)
  -
  (18,123)
  74,587
  $(13,798)Common stock issued
  for acquisitions and earn-out arrangements
  777
  8
  22,801
  -
  -
  -
  22,809
  $-Net common stock exchanged
  in Tech Squared transaction (Note 2)
  (350)
  (3)
  235
  -
  -
  -
  232
  -Exercise of options
  and warrants
  727
  7
  2,416
  -
  -
  -
  2,423
  -Deferred compensation
  related to stock options granted for services
  -
  -
  110
  (110)
  -
  -
  -
  -Deferred compensation
  expense
  -
  -
  -
  841
  -
  -
  841
  -Unrealized loss on
  investments
  -
  -
  -
  -
  (162)
  -
  (162)
  (162)Net loss
  -
  -
  -
  -
  -
  (27,653)
  (27,653)
  (27,653)BALANCE, December 31, 1999
  20,699
  207
  119,445
  (637)
  (162)
  (45,776)
  73,077
  $(27,815)Common stock issued
  for acquisitions and earn-out arrangements
  1,124
  11
  9,082
  -
  -
  -
  9,093
  $-Exercise of options
  and warrants
  339
  4
  3,585
  -
  -
  -
  3,589
  -Common stock issued
  under Employee Stock Purchase Plan
  113
  1
  291
  -
  -
  -
  292
  -Deferred compensation
  expense
  -
  -
  -
  443
  -
  -
  443
  -Unrealized gain on
  investments
  -
  -
  -
  -
  140
  -
  140
  140Net loss
  -
  -
  -
  -
  -
  (38,116)
  (38,116)
  (38,116)BALANCE, December 31, 2000
  22,275
  $223
  $132,403
  $(194)
  $(22)
  $(83,892)
  $48,518
  $(37,976) The accompanying notes are an integral part
of these consolidated financial statements.


DIGITAL RIVER, INC. Consolidated Statements of Cash Flows For the Years Ended December 31 (In Thousands) 2000
  1999
  1998OPERATING ACTIVITIES:Net
  loss
  $(38,116)
  $(27,653)
  $(13,798)Adjustments to reconcile net loss to net cash used in operating
  activities-Goodwill amortization and earn-out charges
  13,354
  6,606
  -Depreciation and amortization
  3,178
  1,552
  604Deferred compensation expense
  443
  841
  1,211Change in operating assets and liabilities:Accounts receivable and prepaid expenses
  (2,691)
  (1,226)
  (1,713)Accounts payable
  3,319
  5,122
  3,160Accrued payroll and other accrued liabilities
  3,501
  1,184
  1,505Net cash used in operating activities
  (17,012)
  (13,574)
  (9,031)INVESTING ACTIVITIES:Purchases of investments
  (12,034)
  (106,487)
  (15,894)Proceeds from sales of investments
  36,416
  78,000
  5,000Cash
  paid for acquisitions, net of cash received
  (45)
  (4,077)
  -Purchases of equipment
  (9,380)
  (4,783)
  (3,531)Patent acquisition costs
  (26)
  (117)
  (62)Net cash provided by (used in) investing
  activities
  14,931
  (37,464)
  (14,487)FINANCING ACTIVITIES:Net
  proceeds from sales of preferred and common stock
  292
  -
  83,543Exercise of options and warrants
  3,589
  2,423
  1,352Other
  -
  232
  -Net cash provided by financing activities
  3,881
  2,655
  84,895NET INCREASE (DECREASE) IN CASH AND CASH
  EQUIVALENTS
  1,800
  (48,383)
  61,377CASH AND CASH EQUIVALENTS, beginning of period
  15,120
  63,503
  2,126CASH AND CASH EQUIVALENTS, end of period
  $16,920
  $15,120
  $63,503NONCASH INVESTING AND FINANCING ACTIVITIES:Preferred stock converted to common stock
  $-
  $-
  $2,825Common stock issued in acquisitions and earn-outs
  $9,093
  $22,809
  $- The accompanying notes are an integral part
of these consolidated financial statements.


DIGITAL RIVER, INC. Notes to Consolidated Financial Statements December 31, 2000 and 1999 1.       Nature of Operations and Summary of
Significant Accounting Policies: Digital
River, Inc., a Delaware corporation, and its wholly owned subsidiaries
(collectively, the Company) provide a suite of electronic commerce services to
its clients, including web store development and hosting, transaction
processing, electronic software delivery, fraud screening, customer service and
analytical marketing. Through contractual relationships with software
publishers and online retailers, the Company offers software products for sale
via the Internet.  Beginning in late
1998, the Company also began to offer electronic commerce services to companies
outside of the software vertical market. The
Company was incorporated in 1994 and conducted its first online sale through a
clients Web store in August 1996. The Company has experienced significant
losses since inception and has experienced significant negative cash flows from
operations. The Company expects to incur additional losses and continued
negative cash flow from operations for most of 2001. The
Companys prospects must be considered in light of the risks frequently
encountered by companies in their early stage of development, particularly
companies in new and rapidly evolving markets such as electronic commerce. To
address these risks, the Company must, among others things, maintain existing
and develop new relationships with independent software publishers, online
retailers and other companies outside of the software market, maintain and
increase its client base, implement and successfully execute its business and
marketing strategy, continue to develop and upgrade its technology and
transaction-processing systems, provide superior customer service and order
fulfillment, respond to competitive developments, and attract, retain and
motivate qualified personnel. There can be no assurances that the Company will
be successful in addressing such risks, and the failure to do so could have a
material adverse effect on the Companys business, financial condition and
results of operations. Principles of Consolidation The
consolidated financial statements include the accounts of Digital River, Inc.
and its wholly owned subsidiaries. All intercompany balances and transactions
have been eliminated in consolidation. Cash and Cash Equivalents The
Company considers all short-term, highly liquid investments, primarily high
grade commercial paper and money market accounts, that are readily convertible
into known amounts of cash and that have original maturities of three months or
less to be cash equivalents. Investments Investments held by the Company are
classified as available for sale securities and are carried at their market
value with cumulative unrealized gains or losses recorded as a component of
accumulated other comprehensive losses within stockholders
equity.  At December 31, 2000,
investments consist of commercial paper and US Government related securities.

Property and Equipment

Property
and equipment is stated at cost and is being depreciated under the straight-line
method using lives of three to seven years and consists mainly of computer
equipment and software licenses.

Goodwill

Goodwill
has been recorded as a result of certain acquisitions made by the Company and
is being amortized under the straight-line method using a life of two to three
years.

Impairment
losses are recorded on long-lived assets in operations when indicators of
impairment are present and the undiscounted cash flows estimated to be
generated by those assets are less than the assets carrying amount. Impairment
losses are measured by comparing the fair value of assets, as determined by
discounting the future cash flows at a market rate of interest, to their
carrying amount.

Patents

The
costs of developing patents are amortized over a three-year period utilizing
the straight-line method of amortization once the patent application is filed.
Patents are included in other assets on the accompanying consolidated balance
sheets, net of accumulated amortization of $336,000 and $262,000 as of December 31,
2000 and 1999.

Revenue Recognition

As
further described in Recent Accounting Pronouncements below, in 2000 the
Company changed its method of revenue recognition on certain revenue to a net
basis.  The Company derives its revenue
primarily from transaction and service fees associated with the e-commerce
services that the Company provides to its clients.  These services include Web commerce hosting, transaction
processing, digital and physical fulfillment services, fraud screening,
customer service and merchandising and analytical marketing services.  The Company acts as the merchant of record
on the majority of the transactions processed and has contractual relationships
with its clients, primarily software publishers and online retailers, which
obligate the Company to pay to the client a specified percentage of each
sale.  The Company retains its
transaction fee and also charges for various service fees.  The Company also derives revenue from
licensing, integration, development and consulting services provided to its
clients.  This revenue is recognized as
services are performed, except for licensing and certain integration and
development fees which are recognized evenly over the term of the contract as
they are deemed essential to the ongoing service.  Sales to foreign customers accounted for 25%, 22% and 24% of
sales for the years ended December 31, 2000, 1999 and 1998, respectively.

Advertising Costs

The
costs of advertising are charged to sales and marketing expense as incurred.
For the years ended December 31, 2000, 1999 and 1998, the Company incurred
advertising expense of $2,253,000, $2,442,000 and $2,569,000, respectively.



Product
Research and Development

Costs
associated with the development of new products and services are charged to
operations as incurred. Those costs totaled $6,212,000, $7,464,000 and
$3,392,000, for the three years ended December 31, 2000, 1999 and 1998,
respectively.

Net Loss per Share

Basic
loss per common share is computed by dividing net loss by the weighted average
number of shares of common stock outstanding during the year. The computation
of diluted earnings per common share is similar to the computation of basic
loss per common share, except that the denominator is increased for the assumed
conversion of convertible securities and the exercise of dilutive options using
the treasury stock method. The weighted average shares used in computing basic
and diluted loss per share were the same for the three years ended
December 31, 2000, 1999 and 1998. Options and warrants totaling 5,383,113,
3,898,313 and 2,883,059 for the three years ended December 31, 2000, 1999
and 1998, respectively, were excluded from the computation of earnings per
share as their effect is antidilutive.

Use of Estimates

The
preparation of financial statements in accordance with accounting principles
generally accepted in the United States requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Ultimate results could differ from those estimates.

Recent Accounting Pronouncements

In
2000, the Company commenced reporting its company wide revenues on a net basis
and has reclassified all historical information presented herein to conform to
this presentation.  This change is based
upon the consensus reached in Issue 99-19: 
Reporting Revenue Gross as a Principal versus Net as an Agent by the
Emerging Issues Task Force (EITF) of the Financial Accounting Standards Board
which revised accounting standards regarding net versus gross revenue
recognition.  Previously, substantially
all revenue generated through the Companys Software Services division was
recognized on a gross basis.  Revenue
generated through the E-Business Services division has historically been
reported on a net basis.  This change
reflects a new reporting presentation only and does not alter the Companys net
income or stockholders equity. The Company has also made certain other
reclassifications to its 1999 and 1998 financial statements to conform to the
2000 presentation.

The
Company has also adopted the provisions of the Securities and Exchange
Commissions (SEC) Staff Accounting Bulletin (SAB) 101, Revenue Recognition in
Financial Statements in the quarter ended September 30, 2000.  SAB 101 provides the SEC staffs views in
applying generally accepted accounting principles to selected revenue
recognition issues.  It also provides
guidance on recording revenue gross as a principal versus net as an agent
consistent with EITF Issue 99-19.  Other
than the reclassification of revenues to a net basis, the adoption of SAB 101
did not have any impact to the Company.

In
March 2000, the EITF published its consensus on EITF 00-2, Accounting for Web
Site Development Costs. EITF 00-2 is effective for fiscal quarters beginning
after June 30, 2000.  The Company has
adopted EITF 00-2 and has had no impact to date from the adoption.

TheCompany adopted SFAS No. 133, Accounting
for Derivative Instruments and Hedging Activities, in January 2001.  The Company does not currently engage in any
derivative or hedging activities and therefore there was no impact to the
financial statements upon adoption of this standard.

2.       Acquisitions and Purchases of Assets:

In
August 2000, the Company purchased certain assets of NetSales, Inc.
(NetSales) for 1,000,000 shares of Common Stock.  In addition, NetSales has an earn-out arrangement whereby it can
earn up to 350,000 additional shares of Common Stock upon attaining certain
business goals for a six month period following the close of the acquisition.

In
1999, the Company acquired or purchased the assets of Maagnum Internet Group
(Maagnum), Public Software Library Ltd., Universal Commerce, Incorporated
(RegNow), and Walnut Creek CDROM, Inc. for an aggregate $4.5 million in cash
and 724,261 shares of Common Stock.  In
addition the former shareholders of Maagnum and RegNow have earn-out
arrangements which allow them to receive up to approximately 900,000 shares of
Common Stock and $2 million in cash upon attaining certain business goals for a
period of 12 to 24 months following the close of each respective acquisition.

Former
Maagnum shareholders collectively received earn-out payments of 124,349 shares
of Common Stock valued at $3,093,000 and 48,095 shares of Common Stock valued
at $1,046,000 in 2000 and 1999, respectively. 
Former Maagnum shareholders have one final earn-out payment potential of
up to 314,531 shares of Common Stock that will be measured in March 2001.  Former RegNow shareholders received an
earn-out related payment of $2 million in cash in 2000 and did not attain the
necessary goals to earn any further shares, which subsequently have been
canceled. The Company charged such amounts to compensation expense and this is
included as amortization of goodwill and acquisition related costs in the
accompanying Consolidated Statements of Operations.  This amount would have increased general and administrative
expense had it been reported outside of that caption.

Each
of the above transactions was accounted for using the purchase method.  The purchase price in each transaction was
allocated substantially to goodwill and other intangibles, which are being
amortized over two to three years. 
Earn-out payments, as listed above, and any future potential earn-outs,
are recognized as compensation expense in the period in which the required
milestones are achieved, except for NetSales which will be recorded as
additional goodwill and amortized over the remaining amortization period.

The
following unaudited pro forma condensed results of operations for the years
ended December 31, 2000 and 1999 have been prepared as if each of the above
four transactions had occurred on January 1, 1999 and the unaudited pro forma
condensed results of operations for the year ended December 31, 1998 has been
prepared as if the 1999 acquisitions occurred on January 1, 1998:

Year Ended December 31,2000
  1999
  1998Revenue
  $32,806,000
  $16,743,000
  $4,964,000Loss from operations
  (48,252,000)
  (42,242,000)
  (23,563,000)Net loss
  (46,256,000)
  (39,195,000)
  (22,943,000))Basic and diluted loss per share
  $(2.09)
  $(1.79)
  $(1.59)

This
financial information does not purport to represent results that would actually
have been obtained if the transactions had been in effect on January 1, 1999 or
1998, as applicable, or any future results that may in fact be realized.

In
December 1999, the Company completed its acquisition of certain assets of Tech
Squared Inc., whereby the Company purchased Tech Squared assets consisting of
3.0 million shares of the Companys Common Stock and $1.2 million of cash in
exchange for 2.65 million shares of the Companys Common Stock.  For financial statement presentation
purposes, the impact of this transaction was to reduce Common Stock outstanding
by 350,000 shares and is presented on the accompanying Consolidated Statement
of Stockholders Equity net of expenses incurred in conjunction with the transaction.

3.       Income Taxes:

Deferred tax assets and liabilities are
determined based on the difference between the financial statement and tax
bases of assets and liabilities using currently enacted tax rates. No income
taxes were paid in any of the years presented.

As of December 31, 2000, the Company had
net operating loss carryforwards of approximately $78,400,000. Included in this
amount is approximately $15,900,000 of deductions resulting from disqualifying
dispositions of stock options. When these deductions are realized for financial
statement purposes they will not result in a reduction in income tax expenses,
rather the benefit will be recorded as additional paid-in-capital. These income
tax net operating loss carryforwards expire beginning in the year 2009. Because
of the uncertainty of future realization, a valuation allowance equal to the
deferred tax asset has been recorded.

The components of deferred income taxes are
as follows:

2000
  1999Net operating loss carryforwards
  $27,440,000
  $19,704,000Nondeductible reserves and accruals
  389,000
  252,000Depreciation and amortization
  1,648,000
  459,000Valuation allowance
  (29,477,000)
  (20,415,000)$-
  $-Ownership
changes resulting from the issuance of additional equity will limit future
annual realization of the tax net operating loss carryforwards to a specified
percentage of the value of the Company under Section 382 of the Internal
Revenue Code.

4.       Lease Commitments

The
Company leases five facilities. Total rent expense, including common area
maintenance charges, recognized under all leases was $839,000 and $558,000 for
the years ended December 31, 2000 and 1999, respectively.  The minimum annual rents under long-term
leases at December 31, 2000 are as follows:

Years
ending December 31

2001
  $440,0002002
  440,0002003
  257,000$1,137,0005.       Stockholders Equity:

Common Stock Sales

In
August 1998, the Company completed its initial public offering in which
the Company sold 3,000,000 shares of Common Stock at an offering price of $8.50
per share. Net proceeds to the Company after underwriting and other offering
expenses was $22.7 million.

In
December 1998, the Company completed a secondary offering in which the
Company sold 2,200,000 shares of common stock at $23.50 per share. Net proceeds
to the Company after underwriting and other offering expenses were
$48.1 million.

The
proceeds from the offerings have been or will be used for general corporate
purposes, including continued investment in product development, expansion of
sales and marketing activities and working capital.

Preferred Stock

During
April 1998, the Company sold 1,500,000 shares of its $.01 par value
Series A Preferred Stock in a private placement transaction. Net proceeds
to the Company totaled $2,825,000. The preferred stock was converted to common
stock on a 2-for-3 basis in conjunction with the closing of the Companys
initial public offering of common stock in August 1998.

Warrants

Warrants
to purchase 356,087 shares of common stock issued principally in conjunction
with sales of common stock at an exercise price of $3.00 per share were
outstanding as of December 31, 2000. The warrants expire at various dates
between February and August 2003.

6.       Stock Options:

The
Companys 1998 Stock Option Plan (the SOP) was adopted by the Board of
Directors in June 1998 as an amendment and restatement of the Amended and
Restated 1995 Stock Option Plan which had been adopted in 1997. The SOP
provides for the granting of stock options to purchase up to 3,283,333 shares of
common stock. Options granted to employees under the plan expire no later than
ten years after the date of grant. The exercise price must be at least 100% of
the fair market value of the shares at the date of grant for incentive options.
The SOP covers both incentive and nonstatutory stock options. Incentive stock
options granted to employees who immediately before such grant owned stock
directly or indirectly representing more than 10% of the voting power of all
the stock of the Company, expire no later than five years from the grant date
unless the option exercise price is at least 110% of the fair market value of
the stock.

In 1999, the Companys Board of Directors
adopted the 1999 Non-Officer Stock Option Plan (the NOP).  The NOP initially provided forthe
granting of stock options to purchase up to 1,300,000 shares of common stock
and has terms similar to those of the SOP. 
In 2000, the reserve for grants under the NOP was increased to 3,950,000
shares.  Subsequent to year-end, the
reserve under the NOP was increased to 5,450,000 shares.

In
addition to shares granted under the SOP and NOP, during 1998 the Company
granted options to purchase 605,882 shares of common stock at an exercise price
of $8.50 per share to certain members of management outside of both plans.  At December 31, 2000, options outstanding
outside of both plans totaled 414,441 shares.

A summary of change in outstanding options
under the SOP and NOP is as follows:

Options
  Outstanding
  Weighted
  Average $/ShareBalance, December 31, 1997
  792,810
  1.20Grants
  1,389,570
  8.93Exercised
  (220,350)
  1.63Cancelled
  (91,673)
  5.10Balance, December 31, 1998
  1,870,357
  6.70Grants
  2,131,636
  21.51Exercised
  (601,172)
  2.76Cancelled
  (308,035)
  24.83Balance, December 31, 1999
  3,092,786
  16.50Grants
  2,641,028
  9.01Exercised
  (303,533)
  11.11Cancelled
  (817,696)
  16.96Balance, December 31, 2000
  4,612,585
  12.46A summary of information about stock options
outstanding at December 31, 2000 is as follows:

Options Outstanding
  Options ExercisableExercise Price
  Number Outstanding
  Weighted Ave. Life Remaining
  Number Exercisable
  Weighted Ave. Price$1.13-3.00
  503,087
  7
  years
  278,238
  $2.696.00-6.38
  2,081,501
  9.5
  years
  159,888
  6.367.50-12.50
  616,357
  7.5
  years
  487,420
  8.7019.50-31.13
  1,826,081
  8.5
  years
  591,525
  22.381.13-
  31.13
  5,027,026
  9
  years
  1,517,071
  10.34The Company recorded deferred
compensation for the difference between the grant price and the deemed fair
value of the Companys common stock on options to purchase
454,468 shares at exercise prices of $3.00 to $7.50 during May and June
1998.  In addition, the Company
recognized $110,000 in expense during 1999 related to options granted for
consulting services.

The Company has elected to apply the
disclosure-only provisions of SFAS No. 123, Accounting for Stock-Based
Compensation. Accordingly, the Company accounts for stock-based compensation
using the intrinsic value method prescribed in Accounting Principles Board
Opinion (APB) No. 25, Accounting for Stock Issued to Employees, and related
interpretations. Compensation cost for stock options is measured as the excess,
if any, of the fair value of the Companys common stock at the date of grant
over the stock option exercise price. Had compensation costs for these plans
been determined consistent with SFAS No. 123, the Companys net loss would have
been adjusted to the following pro forma amounts:

2000
  1999
  1998Net loss:As reported
  $(38,116,000)
  $(27,653,000)
  $(13,798,000)Pro forma
  (56,482,000)
  (35,204,000)
  (15,037,000)Basic and diluted loss per share:As reported
  (1.78)
  (1.36)
  (1.01)Pro forma
  (2.64)
  (1.73)
  (1.10)The
fair value of each option grant is estimated on the date of grant using the
Black-Scholes option pricing model with the following weighted average
assumptions used:  risk-free interest
rates of 6%, 6% and 5.5% no expected dividends; expected lives of five years;
and a volatility factor of 1.2, 1.1 and 1.3 in 2000, 1999 and 1998,
respectively. The weighted average fair value of the options granted in 2000,
1999 and 1998 was $20.46, $17.21 and $8.36, respectively.

The company also sponsors  an employee stock purchase plan under which
200,000 shares have been reserved for purchase by employees. The purchase price
of the shares under the plan is the lesser of 85% of the fair market value on
the first or last day of the offering period. Offering periods currently are
each six months. Employees may designate up to ten percent of their compensation
for the purchase of stock under the plan.

7.       Segment Information:

The
Company has two operating segments, Software and Digital Commerce Services and
E-Business Services, which have been identified as components of the Company
that are reviewed regularly by management to determine resource allocation and
assess performance.  No disclosure of
segments for 1999 has been presented as Software and Digital Commerce Services
represented substantially all operations in 1999.  Unallocated corporate items consist of depreciation, goodwill
amortization, acquisition-related costs and interest income for operational
results and consist of certain cash, investments and goodwill for total
assets.  Segment information for 2000 is
as follows:



Software and Digital Commerce Services
  Division
  E-Business Services Division
  Unallocated Corporate Items
  ConsolidatedRevenue
  $25,221,000
  $5,960,000
  $-
  $31,181,000Gross profit
  18,119,000
  3,718,000
  -
  21,837,000Loss from operations
  (5,611,000)
  (15,936,000)
  (18,565,000)
  (40,112,000)Net loss
  (5,611,000)
  (15,936,000)
  (16,569,000)
  (38,116,000)Total
  assets (Dec. 31)
  16,256,000
  7,051,000
  46,096,000
  69,403,000

8.       Related-Party Transactions:

Prior
to the acquisition by the Company of certain assets of Tech Squared, Inc. as
further described in Note 2, the Companys CEO owned 43% of Tech Squared Inc.
where he spent a portion of his time working as Tech Squareds Chairman.  The Company paid to Tech Squared a total of
$254,000 and  $453,000 in 1999 and 1998,
respectively for rent, fulfillment fees and other direct expenses.

In
February 1998, two stockholders, one of which is a director for the Company,
entered into an agreement with the Company whereby the stockholders will help
establish and oversee the international operations for the Company for a term
of three years. As consideration for entering into the agreement, the
stockholders each received warrants to purchase 100,000 shares of common stock,
at $3.00 per share. Deferred compensation has been reflected for the estimated
fair value of the services and is being recognized over the term of the
agreement.