---

---

UNITED STATES
SECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549

---

FORM 10-K/A

(Mark one)

|/x/ | Amendment to Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the fiscal year ended December 31, 2000.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------
|OR 
|/ / | 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(State or other jurisdiction of
Incorporation or organization)

41-1901640(I.R.S. Employer
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.

EXPLANATORY NOTE TO AMENDMENT TO ANNUAL REPORT

All information contained in this Report on Form 10-K/A was current as of the date of filing of the Registrant's initial Annual Report on March 27, 2001
and the Company has not undertaken to update the same in this amendment.

---

---

---



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/A, 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/A. 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/A.



We are a 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., Egghead.com, Inc., Fujitsu Ltd., MicroWarehouse, Inc., ScanSoft, Inc., Symantec Corporation and Xircom Inc.

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.

2

---

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.



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 business, from sales by Digital River and Calico, over the 13 months following the closing.



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.

3

---

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.



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

4

---

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.



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

5

---

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.



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

6

---

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.



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

7

---

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 PublishersWeb Hosting And Channel ServicesAdaptec, Inc
Aladdin Knowledge Systems Ltd.
Autodesk, Inc
Scansoft, Inc.
Symantec Corporation Channel Services OnlyDataViz
IBM Corp.
Lotus Development Corporation
McAfee.com
PowerQuest Corp.

Online RetailersCyberian Outpost, Inc.
Egghead.com, Inc.
Micro Warehouse, Inc
Staples.com
Visioneer, Inc.


Within
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 with clients in the E-Business Services Group, including:

E-Business Services3M Company
Fujitsu Ltd.
Xircom Inc.
Polaris Industries Inc.
Nabisco



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

8

---

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.



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

9

---

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.



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. If we incur
significant costs without adequate results, or are unable to adapt rapidly to technological changes, we may fail to achieve our business plan. The Internet and the electronic 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 technology and systems obsolete. To be successful, we must adapt to rapid technological change by licensing and internally developing leading
technologies to enhance our existing services, developing new products, services and technologies that address the increasingly sophisticated and varied needs of our clients, and responding to
technological advances and emerging industry standards and practices on a cost-effective and timely basis. The development of our CNS technology and other proprietary technology involves
significant technical and business risks. We may

10

---

fail to use new technologies effectively or adapt our proprietary technology and systems to client requirements or emerging industry standards.



The
market for Internet-based, e-commerce solutions is extremely competitive and we may find ourselves unable to compete effectively. Because there are relatively low
barriers to entry in the e-commerce market, we expect competition to intensify as current competitors expand their product offerings and new competitors enter the market. In addition, our
clients and partners may become competitors in the future. Increased competition is likely to result in price reductions, lower average sales prices, reduced margins, longer sales cycles and a
decrease or loss of our market share, any of which reduce our revenues. We face competition from the following sources:



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 competitors have, and new potential competitors may have, more experience developing Internet-based software, services and e-commerce solutions, larger
technical staffs, larger customer bases, more established distribution channels and customer relationships, greater brand recognition and greater financial, marketing and other resources than we have.
In addition, competitors may be able to develop services that are superior to our services, that achieve greater customer acceptance or that have significantly improved functionality as compared to
our existing and future products and services. Our competitors may be able to respond more quickly to technological

11

---

developments and changes in customers' needs. Our inability to compete successfully against current and future competitors could cause our revenues to decline.



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 whom 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 currently have six U.S. patents issued with between 13 and 14.5 years remaining
prior to expiration, and five U.S. patent applications pending related to our e-commerce services, including fraud screening, distribution of files over the Internet, cache management and global web
site management. We pursue the registration of our trademarks and service marks in the United States and internationally. We currently have nine U.S. registered trademarks and nine trademark
applications pending in the United States and other countries. 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 our part to protect our intellectual property could make it easier for our competitors to offer similar services and thereby adversely affect our market
opportunities. 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.

12

---





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.



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

|Name               |  | Age |  | Position                                                  
|------------------ |  | --- |  | ----------------------------------------------------------
|Joel A. Ronning    |  | 44  |  | Chief Executive Officer                                   
|Perry W. Steiner   |  | 35  |  | President                                                 
|Robert E. Strawman |  | 41  |  | Chief Financial Officer and Treasurer                     
|Jay A. Kerutis     |  | 41  |  | President, Software and Digital Commerce Services Division
|Gregory 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. Steiner
has 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

13

---

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:

We have a limited operating history, a history of losses and we have yet to achieve profitability.

We were incorporated in February 1994 and conducted our first online sale through a client's Web store in August 1996. We have not yet achieved
profitability and have incurred significant losses since we were formed. As of December 31, 2000, we had an accumulated deficit of approximately $83.9 million. Our limited operating
history makes it difficult for you to evaluate our ability to achieve profitability in the future.

The
success of our business model depends upon our success in generating sufficient transaction and service fees from the use of our e-commerce solutions by existing and
future clients. Accordingly, we must maintain existing and develop new relationships with software publishers, online retailers and E-business clients. To achieve this goal, 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 near future and may increase from current levels. If we are unable to maintain existing and develop new client
relationships, we will not generate a profitable return on our investments and we will be unable to gain meaningful market share to justify these investments. Further, we may be unable to achieve
profitability if our revenues increase slower than expected, or if operating expenses exceed our expectations and cannot be adjusted to compensate for lower than expected revenues. Even if we are able
to achieve profitability, we may be unable to sustain or increase profitability on a quarterly or annual basis.

Our operating results have fluctuated in the past and are likely to continue to do so, which could cause the price of our common stock to be volatile.

Our quarterly and annual operating results have fluctuated significantly in the past and are likely to continue to do so in the future due to a variety of
factors, some of which are outside our control. As a result, we believe that quarter-to-quarter and year-to-year comparisons of our revenues and
operating results are not necessarily meaningful, and that these comparisons may not be accurate indicators of future performance. If our annual or quarterly operating results fail to meet the
expectations of securities analysts and investors, the trading price of our common stock will likely decline. Some of the
factors that have or may contributed to fluctuations in our quarterly and annual operating results include:



14

---



In
addition, revenues generated by our Software and Digital Commerce Services Division is likely to fluctuate on a seasonal basis that is typical for the software publishing market in
general. We believe that our first and fourth quarters are seasonally stronger than our second and third quarters due to the timing of demand of tax preparation software and the Christmas selling
period. We also believe that software publishers avoid new product releases in the summer months.

Our
operating expenses, which include sales and marketing, product research and development, general and administrative expenses and amortization of intangible assets, are based on
our expectations of future revenues and are relatively fixed in the short term. If our revenues for a quarter fall below our expectations and we are unable to quickly reduce spending in response, our
operating results for that quarter would be harmed. In addition, the operating results of companies in the e-commerce industry have in the past experienced significant
quarter-to-quarter fluctuations that may adversely affect our stock price.

A loss of any client that accounts for a large portion of our revenues could cause our revenues to decline.

Revenues related to three software publisher clients collectively accounted for approximately 20% of our revenues in 1999 and approximately 15% of our revenues
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 terminates,
and if we are unable to replace it with other client agreements, our revenues would decline and our losses would likely increase. It is important to our success that we maintain these client
relationships and at the same time develop new client relationships.

The success of our business strategy and our future revenue growth depends on increasing consumer acceptance of the internet as a medium of commerce.

The failure of the Internet to continue developing into a significant commercial medium will harm our ability to increase our revenues and execute our business
strategy. 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.

15

---

Our sales cycle is lengthy, which may cause us to incur substantial expenses and expend management time without generating corresponding revenues, which would impair our cash
flow.

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. 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. If at the end of a sales effort a prospective client does not purchase our products or services, we may have incurred substantial expenses and expended management time that cannot be
recovered and that will not generate corresponding revenues. As a result, our cash flow and our ability to fund expenditures incurred during the sales cycle may be impaired.

General economic uncertainty may reduce our revenues.

The revenue growth and profitability of our business depends significantly on the overall demand for Internet-based e-commerce solutions. We
believe that the market for these solutions may be adversely affected by a number of factors, including reductions in capital expenditures by clients and overall weakening of the U.S. and foreign
economies. These factors may, in turn, give rise to a number of market trends that may slow our revenue growth, including:



If
the current economic slowdown continues, the effects of the slowdown for e-commerce solutions could reduce our revenues and limit our ability to meet our profitability
goals.

Electronic Software Delivery, or ESD, is still an evolving and unproven technology and the industry may ultimately fail 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 to
end-users, and unless ESD gains widespread market acceptance, we will be unable to achieve our business plan. Factors that will influence the market acceptance of ESD include:



Even
if ESD achieves widespread acceptance, we may be unable to 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 also impair our ability to execute our business plan.

16

---

The growth of the market for our services depends on the development and maintenance of the internet infrastructure.

Our business is based on delivering services over the Internet, and the success of our business therefore depends on the development and maintenance of a sound
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. Our ability to increase the speed and scope of our services is limited by and depends upon the speed and reliability of both the
Internet and our clients' internal networks. Consequently, as Internet usage increases, the growth of the market for our services depends upon improvements being made to the Internet as well as to
individual client's networking infrastructures to alleviate overloading and congestion. In addition, any delays in the adoption of new standards and protocols required to govern increased levels of
Internet activity or increased governmental regulation may have a detrimental effect on the Internet infrastructure.

Our failure to attract and retain software publishers as clients would cause our revenues to decline.

Our Software and Digital Commerce Services Division generates revenues by providing outsourced services to software publishers. If we cannot develop and
maintain satisfactory relationships with software publishers on acceptable commercial terms, we would likely experience a decline in revenues. We also depend on our software publisher clients creating
and supporting software products that end-users will purchase. If we are unable to obtain sufficient quantities of software for any reason or if the quality of service provided by these
software publishers falls below a satisfactory level, we could also experience a decline in revenues and client satisfaction, and our reputation could be harmed. 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. Software publishers that currently supply software to us may not continue to do and we may be unable to establish new relationships with software publishers to
supplement or replace existing relationships.

Our business plans depend on increasing revenues from E-Business clients.

The success of our business strategy depends upon increasing fee and service revenues from E-Business clients. Since initiating sales of electronic
commerce outsourcing services in 1999, our E-Business Services Division has incurred only net losses. We have made substantial investments in technology and infrastructure and we may not
succeed in establishing and maintaining sufficient relationships with E-Business clients to offset these expenses. If we are unable to develop and expand our relationships with
E-Business services clients, we will fail to grow revenues as projected.

Because the electronic commerce industry is highly competitive and has low barriers to entry, we may be unable to compete effectively.

The market for Internet-based, e-commerce solutions is extremely competitive and we may find ourselves unable to compete effectively. Because there
are relatively low barriers to entry in the e-commerce market, we expect competition to intensify as current competitors expand their product offerings and new competitors enter the
market. In addition, our clients and partners may become competitors in the future. Increased competition is likely to result in price reductions, lower average

17

---

sales prices, reduced margins, longer sales cycles and a decrease or loss of our market share, any of which reduce our revenues. We face competition from the following sources:



Many
of our competitors have, and new potential competitors may have, more experience developing Internet-based software, services, and e-commerce solutions, larger
technical staffs, larger customer bases, more established distribution channels and customer relationships, greater brand recognition and greater financial, marketing and other resources than we have.
In addition, competitors may be able to develop services that are superior to our services, that achieve greater customer acceptance or that have significantly improved functionality as compared to
our existing and future products and services. Our competitors may be able to respond more quickly to technological developments and changes in
customers' needs. Our inability to compete successfully against current and future competitors could cause our revenues to decline.

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. Any compromise or elimination of our
security could be costly to remedy, damage our reputation and expose us to liability, and dissuade existing and new clients from using our services. 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 end-user credit card numbers. A party who
circumvents our security measures could misappropriate proprietary information or interrupt our operations.

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 could deter people from using the Internet to conduct transactions that involve transmitting confidential information, thereby
inhibiting the growth of the Internet. 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

18

---

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 lead to a
loss of existing clients and a deter potential clients away from our services.

Loss of our credit card acceptance privileges would seriously hamper our ability to process the sale of digital goods.

The
payment by end-users for the purchase of digital goods that we process is typically made by credit card. If we incur significant instances of credit card fraud over an
extended period of time it may result in penalties and termination of our credit card acceptance privileges. Loss of our credit card acceptance privileges would severely impact our ability to process
the sale of digital goods where the payment method is by credit card. We may be required to expend significant capital and other resources to protect against these fraudulent transactions.

Implementing our acquisition strategy could result in dilution and operating difficulties.

We
have acquired, and intend to continue acquiring, businesses, technologies, services or products that we believe are strategic, such as businesses that provide outsourcing services
to software publishers. For example, in March 2001, we acquired the Market Maker business of Calico Commerce, Inc., which we believe will improve our e-commerce services
offerings. Although the integration of the Market Maker business is largely complete, the process of integrating an acquired business, technology, service or product into our business and operations
may result in unforeseen operating difficulties and expenditures. Integration of an acquired business also may disrupt our ongoing business, distract management and make it difficult to maintain
standards, controls and procedures. Moreover, the anticipated benefits of any acquisition, including that of the Market Maker business, may not be realized. If a significant number of clients of the
acquired businesses cease doing business with us, we would experience lost revenues, and any synergies from the acquisition may be lost. Future acquisitions could result in potentially dilutive
issuances of equity securities, the incurrence of debt, contingent liabilities or amortization expenses related to goodwill and other intangible assets.

We have experienced rapid growth and failure to properly manage and sustain our expansion efforts could strain our management and other resources.

Our ability to successfully offer services and implement our business plan in a rapidly evolving market requires an effective planning and management process.
We have rapidly and significantly expanded our operations. In 2000, we increased our number of employees from 278 to 381 and we anticipate that further significant expansion will be required to
address potential growth in our client base and market opportunities. Failure to property manage this expansion could place 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:



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,

19

---

motivate and manage required personnel or to successfully identify, manage and exploit existing and potential market opportunities.

Failure to develop our technology to accommodate increased cns traffic could reduce demand for our services and impair the growth of our business.

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. Our inability to add software and hardware or to develop and upgrade existing technology, transaction-processing systems or network infrastructure to
manage increased traffic on the CNS may cause unanticipated systems disruptions, slower response times and degradation in client services, including impaired quality and speed of order fulfillment.
Failure to manage increased traffic could harm our reputation and significantly reduce demand for our services, which would impair the growth of our business. We may be unable to improve and increase
the capacity of our network infrastructure sufficiently or anticipate and react to expected increases in the use of the CNS to handle increased volume. 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 industry is characterized by rapid technological change that may make ourtechnology and systems obsolete or cause us to incur substantial costs to adapt to these changes.

To remain competitive, we must continue to enhance and improve the responsiveness, functionality and features of our CNS and the underlying network
infrastructure. If we incur significant costs without adequate results, or are unable to adapt rapidly to technological changes, we may fail to achieve our business plan. 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. To be successful, we must adapt to rapid technological change by licensing and
internally developing technologies to enhance our existing services, developing new products, services and technologies that address the increasingly sophisticated and varied needs of our clients, and
responding to technological advances and emerging industry standards and practices on a cost-effective and timely basis. The development of our 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 client requirements or emerging
industry standards.

System failures could reduce the attractiveness of our 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 client service, reputation and ability to attract and retain clients. We have experienced periodic interruptions, affecting
all or a portion of our systems, which we believe will continue to occur from time to time. Any damage to, or systems interruption that impairs our ability to accept and fill client orders could
result in an immediate loss of revenues to us, and could cause some clients to purchase services offered by our competitors. In addition, frequent systems failures could harm our reputation.

Our
systems and operations are vulnerable to damage or interruption from:



20

---



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.

We may become liable to clients who are dissatisfied with our services.

We design, develop, implement and manage e-commerce solutions that are crucial to the operation of our clients' businesses. Defects in the
solutions we develop could result in delayed or lost revenues, adverse end-user reaction and negative publicity or require expensive corrections. As a result, clients who experience these
adverse consequences either directly or indirectly as a result of our services could bring claims against us for substantial damages. Any claims asserted could exceed the level of our insurance. The
insurance we carry may not continue to be available on economically reasonable terms,
or at all. The successful assertion of one or more large claims that are uninsured, exceed insurance coverage or result in changes to insurance policies, including premium increases, could adversely
affect our operating results or financial condition.

Our chief executive officer and key technical employees are critical to our business and if they do not remain with us in the future, we may be unable to effectively replace
them.

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 key technical employees who are skilled in maintaining the CNS. The loss of
the services of any of our executive officers or key technical employees could harm our business if we are unable to effectively replace that officer or employee, or if that person should decide to
join a competitor or otherwise directly or indirectly compete with us. Further, we may need to incur additional operating expenses and divert other management time in order to search for a
replacement. We have a long-term employment agreement only with Mr. Ronning and we do not maintain any key person life insurance policies.

We must continually attract and retain technical and other key personnel in order to be able to successfully execute our business strategy

Our future success depends on our ability to continue to identify, attract, hire, train, retain and motivate highly skilled technical, managerial, operations,
merchandising, sales and marketing and client service personnel. Competition for this personnel is intense, particularly in the Internet industry, and we may be unable to successfully attract,
assimilate or retain sufficiently qualified personnel. Failure to do so could harm our business growth and ability to achieve profitability. In addition, the market price of our common stock has
fluctuated substantially since our initial public offering in August 1998. Consequently, potential employees may perceive our equity incentives such as stock options as less attractive and
current employees whose options are no longer attractively priced may choose not to remain with our organization. In that case, our ability to attract employees will be adversely affected. Finally,
should our stock price substantially decline, the retention value of stock options granted since our initial public offering will decline and our employees may choose not to remain with our
organization.

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

21

---

entered into confidentiality and invention assignment agreements with our employees and contractors, and nondisclosure agreements with parties with whom 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 our part to protect our intellectual property could make it easier for our competitors to offer similar services and thereby adversely affect our market
opportunities. 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.

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, we may be unable to pursue our current business plan.

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
we deliver electronically and are subsequently distributed to others. Because we did not create these software products, we are generally
not in a position to know the quality of or nature of the content of these products. Although we carry general liability insurance, our insurance may not cover potential claims of this type,
adequately cover all costs incurred in defense of potential claims or 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 be expensive and time-consuming to address, distract management and delay product deliveries even if we were ultimately successful in the defense of
these claims.

22

---



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. The adoption or modification of laws related to the Internet could harm our business, operating results and financial condition by
increasing our costs and administrative burdens. 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:



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 operating results and substantially increase the cost to us of doing business. It may also require significant management resources to respond to any changes in these laws.
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.

Laws relating to user information and online privacy may limit the collection of end-user data for our clients.

We collect and maintain end-user data for our clients, which subjects us to increasing federal and state regulation related 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, the U.S. Federal Trade Commission, or the FTC, is considering adopting regulations regarding the collection and use of personal identifying information obtained from individuals
when accessing Web sites, with particular emphasis on information obtained from minors. These regulations may include requirements that companies establish procedures to, among other things:



23

---



Bills
are also pending in Congress that would improve online privacy protections for adults. Laws of this kind require 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 these 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 limit our collection of demographic and personal information from end-users, which could adversely
affect our ability to comprehensively serve our clients.

The adoption and implementation of international laws and regulations applicable to e-commerce may impair our efforts to expand revenues from international
transactions.

The European Union has adopted a privacy directive that regulates the collection and use of information that identifies an individual person. These regulations
may inhibit or prohibit the collection and sharing of personal information in ways that could harm our clients or us. The globalization of Internet commerce may be harmed by these and similar
regulations because the European Union privacy directive prohibits transmission of personal information outside the European Union unless the receiving country has enacted individual privacy
protection laws at least as strong as those enacted by the European Union privacy directive. The United States and the European Union have not yet resolved this matter, and they may not ever do so, in
a manner favorable to our clients or us.

Future Laws imposed on e-commerce may substantially increase the costs of doing business or otherwise adversely affect our ability to offer our services.

Because our services are accessible worldwide and we facilitate sales of products to end-users worldwide, foreign jurisdictions may claim that we
are required to comply with their laws. 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 provided 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.

In
addition, as our services are available over the Internet in multiple states and foreign countries, these jurisdictions may claim that we are required to qualify to do business as
a foreign corporation in each state or foreign country. We are qualified to do business only in California, Connecticut, Minnesota and Washington. Failure to qualify as a foreign corporation in a
required jurisdiction could subject us to taxes and penalties and could result in our inability to enforce contracts in these jurisdictions.

We intend to continue to expand our international operations and these efforts may not successful in generating additional revenues.

We sell software products and services to end-users outside the United States and we intend to continue to expand our international presence.
Expansion into international markets, particularly Europe, requires significant resources that we may fail to recover by generating additional revenues. Conducting business outside of the United
States is subject to risks, including:



24

---



We
may be unable to successfully and cost effectively market, sell and distribute our services in foreign markets. This may be more difficult or take longer than anticipated
especially due to international challenges, such as language barriers, currency exchange issues and the fact that the Internet infrastructure in foreign countries may be less advanced that the U.S.
Internet infrastructure. If we are unable to successfully expand our international operations, or manage this expansion, our operating results and financial condition could be harmed.

New obligations to collect or pay sales tax could substantially increase the cost to us of doing 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. The application of sales tax to interstate and international sales over the Internet is unclear and evolving. 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. 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 our E-Business Service Division or on shipments of software could harm our results of operations. 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.

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

The stock market, and the trading prices of Internet-related companies in particular, have recently been notably volatile. This volatility is likely to
continue in the short-term and is not necessarily related to the operating performance of affected companies. This broad market and industry volatility could significantly reduce the price
of our common stock at any time, without regard to our 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. Factors that could
cause our stock price in particular to fluctuate include:



25

---



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

We require substantial working capital to fund our business. 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. We have had significant operating losses and negative cash flow from
operations since inception and expect to continue to do so for the near 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 and the growth of sales
and marketing. 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 would harm our operating results and adversely affect our ability to achieve
profitability.

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.

26

---

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. These over-the-counter market
quotations reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not necessarily represent actual transactions.

HIGH

LOW1999First 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

$
2.19


As
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 in reliance upon
Regulation D promulgated thereunder. The recipients of securities in each such transaction represented that they are accredited investors and intend 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.

27

---

ITEM 6. SELECTED FINANCIAL DATA.

|                              |                                                                                                 | YEAR ENDED DECEMBER 31,                                                      |  
|----------------------------- | ----------------------------------------------------------------------------------------------- | ---------------------------------------------------------------------------- | -
|
|
|Statement of Operations Data: |                                                                                                 |                                                                              |  
|                              | Revenue                                                                                         |                                                                              | $
|                              | Costs and expenses (exclusive of depreciation and amortization expense shown separately below): |                                                                              |  
|                              |                                                                                                 | Direct cost of services                                                      |  
|                              |                                                                                                 | Network and infrastructure                                                   |  
|                              |                                                                                                 | Sales and marketing                                                          |  
|                              |                                                                                                 | Product research and development                                             |  
|                              |                                                                                                 | General and administrative                                                   |  
|                              |                                                                                                 | Depreciation and amortization                                                |  
|                              |                                                                                                 | Amortization of goodwill and other intangibles and acquisition related costs |  
|                              |                                                                                                 |                                                                              |  
|                              |                                                                                                 | Total operating expenses                                                     |  
|                              |                                                                                                 |                                                                              |  
|                              |                                                                                                 | Loss from operations                                                         |  
|                              |                                                                                                 | Interest income                                                              |  
|                              |                                                                                                 |                                                                              |  
|                              |                                                                                                 | Net loss                                                                     |  
|                              |                                                                                                 |                                                                              |  
|                              | Basic and diluted net loss per share (1)                                                        |                                                                              | $
|                              |                                                                                                 |                                                                              |  
|                              | Shares used in per share computation (1)                                                        |                                                                              |  
|                              |                                                                                                 |                                                                              |  

|                    |                                      | DECEMBER 31, |  
|------------------- | ------------------------------------ | ------------ | -
|
|
|Balance Sheet Data: |                                      |              |  
|                    | Cash and cash equivalents            |              | $
|                    | Short-term investments               |              |  
|                    | Working capital (deficit)            |              |  
|                    | Total assets                         |              |  
|                    | Accumulated deficit                  |              |  
|                    | Total stockholders' equity (deficit) |              |  

---

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND 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

28

---

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 in its Software and Digital Commerce Services Division fluctuate on a
seasonal basis that is typical for the software publishing market in general. The Company believes that its fiscal first and fourth quarters are seasonally stronger than its second and third quarters
due to the timing of demand for tax preparation software and the Christmas selling period. In addition, it is the Company's belief that software publishers avoid new product releases in the summer
months. 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.

29

---

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   |       | 1998   |      
|----------------------------------------------------------------------------------------------- | ---------------------------------------------------------------------------- | ------ | ---- | ------ | ----- | ------ | -----
|Revenue                                                                                         |                                                                              | 100.0  | %    | 100.0  | %     | 100.0  | %    
|Costs and expenses (exclusive of depreciation and amortization expense shown separately below): |                                                                              |        |      |        |       |        |      
|                                                                                                | Direct cost of services                                                      |        | 4.7  |        | 5.5   |        | 3.4  
|                                                                                                | Network and infrastructure                                                   |        | 25.2 |        | 30.6  |        | 53.6 
|                                                                                                | Sales and marketing                                                          |        | 82.4 |        | 119.8 |        | 271.9
|                                                                                                | Product research and development                                             |        | 41.9 |        | 70.7  |        | 91.7 
|                                                                                                | General and administrative                                                   |        | 14.9 |        | 27.6  |        | 90.9 
|                                                                                                | Depreciation and amortization                                                |        | 10.2 |        | 10.7  |        | 17.6 
|                                                                                                | Amortization of goodwill and other intangibles and acquisition related costs |        | 49.3 |        | 47.4  |        |     
|Total costs and expenses                                                                        |                                                                              | 228.6  |      | 312.3  |       | 529.1  |      
|Loss from operations                                                                            |                                                                              | (128.6 | )    | (212.3 | )     | (429.1 | )    
|Interest income                                                                                 |                                                                              | 6.4    |      | 21.7   |       | 26.1   |      
|Net 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 fees charged to use its software, integration, development and consulting services provided to its clients. This revenue is recognized as services are performed, except for software usage
fees 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 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 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 and are shown net of
depreciation expense. Cost of revenue increased substantially during 2000 and 1999, reflecting

30

---

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 increase in 2000 from 1999 resulted from 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 increase in 1999 from 1998 resulted from 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 in 2000 from 1999 resulted from an increase in wages, benefits and temporary
employee costs of $1.4 million and an increase in consulting costs of $1.1 million. The increase in 1999 from 1998 resulted from 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. The increase in 2000 from 1999 resulted from an increase in professional fees and investor
relations related expense of $332,000. The increase in 1999 from 1998 resulted from 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

31

---

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 Other Intangibles and Acquisition-related Costs.Amortization of goodwill and other
intangibles and acquisition-related costs consists of the amortization of goodwill and other intangible assets 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 other intangibles 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 and other intangibles 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 other intangibles and acquisition-related costs to increase in 2001 due to full year amortizations on 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

32

---

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 Company had 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.

33

---

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.

34

---



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

|                        |  | QUARTER ENDED |        
|----------------------- |  | ------------- | -------
|
|2000                    |  |               |        
|Revenue                 |  | $             | 6,883  
|Gross profit(a)         |  |               | 4,798  
|Loss from operations(b) |  |               | (12,675
|Net loss                |  |               | (11,991
|Net loss per share (c)  |  |               | (.58   

|                        |  | QUARTER ENDED |       
|----------------------- |  | ------------- | ------
|
|1999                    |  |               |       
|Revenue                 |  | $             | 1,903 
|Gross profit(a)         |  |               | 911   
|Loss from operations(b) |  |               | (6,238
|Net loss                |  |               | (5,344
|Net loss per share (c)  |  |               | (.27  

---

35

---

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.



36

---

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.

37

---



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 Accountants        |  | 
|----------------------------------------------- |  | 
|Consolidated Balance Sheets                     |  | 
|Consolidated Statements of Operations           |  | 
|Consolidated Statements of Stockholders' Equity |  | 
|Consolidated Statements of Cash Flows           |  | 
|Notes 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 Document                                                                                                                                         
|-------------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------
|2.1(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 Calico
|3.1(4)         |  | Amended and Restated Certificate of Incorporation of the Registrant, as currently in effect.                                                                    
|3.2(5)         |  | 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.                               

38

---

|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(5) |  | 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(5) |  | 1999 Stock Option Plan, formerly known as the 1999 Non-Officer Stock Option Plan.                                                                                                       
|10.13(5) |  | Form of Non-Qualified Stock Option Agreement under the 1999 Stock Option Plan.                                                                                                          
|10.14(6) |  | Agreement and Plan of Merger, dated April 1, 1999, by and among the Registrant, Maagnum Internet Group, Inc. and Cyrus Maaghul.                                                         
|10.15(6) |  | Stock Purchase Agreement, dated April 1, 1999, by and among the Registrant and Meiman Kentjana.                                                                                         
|10.16(7) |  | 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.                        
|10.17(3) |  | Voting Agreement, dated March 20, 2001, by and between the Registrant, Calico Commerce, Inc. and ConnectInc.com, Co.                                                                    
|21.1(8)  |  | Subsidiaries of Digital River, Inc.                                                                                                                                                     
|23.1(9)  |  | Consent of Independent Public Accountants, dated March 7, 2001.                                                                                                                         
|23.2     |  | Consent of Independent Public Accountants, dated November 20, 2001.                                                                                                                     
|24.1(5)  |  | Power of Attorney.                                                                                                                                                                      

---

39

---



40

---



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/A to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Eden Prairie, State of Minnesota, on the 21st of November 2001.

| |  | DIGITAL RIVER, INC.
| |  | -------------------
| |  | By:                

Pursuant
to the requirements of the Securities Exchange Act of 1934, this Form 10-K/A 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. RONNINGJoel A. Ronning       |  | Chief Executive Officer, Member of the Office of the President and Director (Principal Executive Officer)                 |  | November 21, 2001
|/s/ROBERT E. STRAWMANRobert E. Strawman |  | Chief Financial Officer, Member of the Office of the President and Treasurer (Principal Financial and Accounting Officer) |  | November 21, 2001
|*Perry W. Steiner                       |  | Director                                                                                                                  |  | November 21, 2001
|*William Lansing                        |  | Director                                                                                                                  |  | November 21, 2001
|*Thomas F. Madison                      |  | Director                                                                                                                  |  | November 21, 2001
|*J. Paul Thorin                         |  | Director                                                                                                                  |  | November 21, 2001
|Frederic Seegal                         |  | Director                                                                                                                  |  |                  
|*Timothy C. Choate                      |  | Director                                                                                                                  |  | November 21, 2001

|*By: |  | /s/JOEL A. RONNINGJoel A. Ronning
Attorney-in-fact |  |  |  | November 21, 2001
|---- |  | -------------------------------------------------- |  |  |  | -----------------

41

---

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

42

---



DIGITAL RIVER, INC.Consolidated Balance Sheets        As of December 31        (In Thousands, Except Share Data)

|                                                                                      |                                                                                                                     | 2000                                       |        | 1999    |       
|------------------------------------------------------------------------------------- | ------------------------------------------------------------------------------------------------------------------- | ------------------------------------------ | ------ | ------- | ------
|ASSETS                                                                                |                                                                                                                    
|CURRENT ASSETS:                                                                       |                                                                                                                     |                                            |        |         |       
|                                                                                      | Cash and cash equivalents                                                                                           |                                            | $      | 16,920  |       
|                                                                                      | Short-term investments                                                                                              |                                            |        | 14,977  |       
|                                                                                      | Accounts receivable, net allowance of $975 and $593                                                                 |                                            |        | 4,903   |       
|                                                                                      | Prepaid expenses and other                                                                                          |                                            |        | 1,123   |       
|                                                                                      |                                                                                                                     |                                            |        |         |       
|                                                                                      |                                                                                                                     | Total current assets                       |        |         | 37,923
|                                                                                      |                                                                                                                     |                                            |        |         |       
|PROPERTY AND EQUIPMENT:                                                               |                                                                                                                     |                                            |        |         |       
|                                                                                      | Property and equipment                                                                                              |                                            |        | 18,369  |       
|                                                                                      | Lessaccumulated depreciation                                                                                       |                                            |        | (4,799  | )     
|                                                                                      |                                                                                                                     |                                            |        |         |       
|                                                                                      |                                                                                                                     | Net property and equipment                 |        |         | 13,570
|LONG-TERM INVESTMENTS                                                                 |                                                                                                                     |                                            |       |         |       
|GOODWILL AND OTHER INTANGIBLES, net of accumulated amortization of $15,821 and $5,560 |                                                                                                                     |                                            | 17,834 |         |       
|OTHER ASSETS                                                                          |                                                                                                                     |                                            | 76     |         |       
|                                                                                      |                                                                                                                     |                                            |        |         |       
|                                                                                      |                                                                                                                     | $                                          | 69,403 |         | $     
|                                                                                      |                                                                                                                     |                                            |        |         |       
|LIABILITIES AND STOCKHOLDERS' EQUITY                                                  |                                                                                                                    
|CURRENT LIABILITIES:                                                                  |                                                                                                                     |                                            |        |         |       
|                                                                                      | Accounts payable                                                                                                    |                                            | $      | 14,339  |       
|                                                                                      | Accrued payroll                                                                                                     |                                            |        | 2,287   |       
|                                                                                      | Deferred revenue                                                                                                    |                                            |        | 1,833   |       
|                                                                                      | Other accrued liabilities                                                                                           |                                            |        | 2,426   |       
|                                                                                      |                                                                                                                     |                                            |        |         |       
|                                                                                      |                                                                                                                     | Total current liabilities                  |        |         | 20,885
|                                                                                      |                                                                                                                     |                                            |        |         |       
|COMMITMENTS 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     |       
|                                                                                      | Additional paid-in capital                                                                                          |                                            |        | 132,403 |       
|                                                                                      | Deferred compensation                                                                                               |                                            |        | (194    | )     
|                                                                                      | Accumulated other comprehensive loss                                                                                |                                            |        | (22     | )     
|                                                                                      | Accumulated deficit                                                                                                 |                                            |        | (83,892 | )     
|                                                                                      |                                                                                                                     |                                            |        |         |       
|                                                                                      |                                                                                                                     | Total stockholders' equity                 |        |         | 48,518
|                                                                                      |                                                                                                                     |                                            |        |         |       
|                                                                                      |                                                                                                                     | Total liabilities and stockholders' equity |        | $       | 69,403
|                                                                                      |                                                                                                                     |                                            |        |         |       

The
accompanying notes are an integral part of these consolidated balance sheets.

43

---



DIGITAL RIVER, INC.Consolidated Statements of Operations        For the Years Ended December 31        (In Thousands,
Except Per Share Data)

|                                                                                                |                                                                                       | 2000                     |         | 1999   |         | 1998    |       
|----------------------------------------------------------------------------------------------- | ------------------------------------------------------------------------------------- | ------------------------ | ------- | ------ | ------- | ------- | ------
|REVENUE                                                                                         |                                                                                       | $                        | 31,181  |        | $       | 14,507  |       
|COSTS AND EXPENSES (exclusive of depreciation and amortization expense shown separately below): |                                                                                       |                          |         |        |         |         |       
|                                                                                                | Direct cost of services                                                               |                          |         | 1,477  |         |         | 801   
|                                                                                                | Network and infrastructure                                                            |                          |         | 7,867  |         |         | 4,434 
|                                                                                                | Sales and marketing                                                                   |                          |         | 25,693 |         |         | 17,383
|                                                                                                | Product research and development                                                      |                          |         | 13,063 |         |         | 10,251
|                                                                                                | General and administrative                                                            |                          |         | 4,628  |         |         | 4,001 
|                                                                                                | Depreciation and amortization                                                         |                          |         | 3,178  |         |         | 1,552 
|                                                                                                | Amortization of goodwill and other intangibles and acquisition related costs (Note 2) |                          |         | 15,387 |         |         | 6,886 
|                                                                                                |                                                                                       |                          |         |        |         |         |       
|                                                                                                |                                                                                       | Total costs and expenses |         |        | 71,293  |         |       
|                                                                                                |                                                                                       |                          |         |        |         |         |       
|LOSS FROM OPERATIONS                                                                            |                                                                                       |                          | (40,112 | )      |         | (30,801 | )     
|INTEREST INCOME                                                                                 |                                                                                       |                          | 1,996   |        |         | 3,148   |       
|                                                                                                |                                                                                       |                          |         |        |         |         |       
|                                                                                                |                                                                                       | Net loss                 |         | $      | (38,116 | )       | $     
|                                                                                                |                                                                                       |                          |         |        |         |         |       
|BASIC AND DILUTED NET LOSS PER SHARE                                                            |                                                                                       |                          | $(1.78  | )      |         | $(1.36  | )     
|                                                                                                |                                                                                       |                          |         |        |         |         |       
|BASIC AND DILUTED WEIGHTED AVERAGE COMMON SHARES OUTSTANDING                                    |                                                                                       |                          | 21,413  |        |         | 20,312  |       
|                                                                                                |                                                                                       |                          |         |        |         |         |       

The
accompanying notes are an integral part of these consolidated financial statements.

44

---



DIGITAL RIVER, INC.Consolidated Statements of Stockholders' Equity        (In Thousands)

|                           |                                                                     | Common Stock |       |   |     |    |   |         |        |   |        |        |   |      |     
|-------------------------- | ------------------------------------------------------------------- | ------------ | ----- | - | --- | -- | - | ------- | ------ | - | ------ | ------ | - | ---- | ----
|
|
|BALANCE, December 31, 1997 |                                                                     | 9,242        |       | $ | 92  |    | $ | 6,562   |        | $ |       |        | $ |     |     
|                           | Sales of common stock                                               |              | 8,679 |   |     | 87 |   |         | 80,581 |   |        |       |   |      |    
|                           | Sales of preferred stock subsequently converted to common stock     |              | 1,000 |   |     | 10 |   |         | 2,815  |   |        |       |   |      |    
|                           | Exercise of options and warrants                                    |              | 624   |   |     | 6  |   |         | 1,346  |   |        |       |   |      |    
|                           | Deferred compensation related to stock options and warrants         |              |      |   |     |   |   |         | 2,579  |   |        | (2,579 | ) |      |    
|                           | Deferred compensation expense                                       |              |      |   |     |   |   |         |       |   |        | 1,211  |   |      |    
|                           | Net loss                                                            |              |      |   |     |   |   |         |       |   |        |       |   |      |    
|                           |                                                                     |              |       |   |     |    |   |         |        |   |        |        |   |      |     
|BALANCE, December 31, 1998 |                                                                     | 19,545       |       |   | 195 |    |   | 93,883  |        |   | (1,368 | )      |   |     |     
|                           | Common stock issued for acquisitions and earn-out arrangements      |              | 777   |   |     | 8  |   |         | 22,801 |   |        |       |   |      |    
|                           | Net common stock exchanged in Tech Squared transaction (Note 2)     |              | (350  | ) |     | (3 | ) |         | 235    |   |        |       |   |      |    
|                           | Exercise of options and warrants                                    |              | 727   |   |     | 7  |   |         | 2,416  |   |        |       |   |      |    
|                           | Deferred compensation related to stock options granted for services |              |      |   |     |   |   |         | 110    |   |        | (110   | ) |      |    
|                           | Deferred compensation expense                                       |              |      |   |     |   |   |         |       |   |        | 841    |   |      |    
|                           | Unrealized loss on investments                                      |              |      |   |     |   |   |         |       |   |        |       |   |      | (162
|                           | Net loss                                                            |              |      |   |     |   |   |         |       |   |        |       |   |      |    
|                           |                                                                     |              |       |   |     |    |   |         |        |   |        |        |   |      |     
|BALANCE, December 31, 1999 |                                                                     | 20,699       |       |   | 207 |    |   | 119,445 |        |   | (637   | )      |   | (162 | )   
|                           | Common stock issued for acquisitions and earn-out arrangements      |              | 1,124 |   |     | 11 |   |         | 9,082  |   |        |       |   |      |    
|                           | Exercise of options and warrants                                    |              | 339   |   |     | 4  |   |         | 3,585  |   |        |       |   |      |    
|                           | Common stock issued under Employee Stock Purchase Plan              |              | 113   |   |     | 1  |   |         | 291    |   |        |       |   |      |    
|                           | Deferred compensation expense                                       |              |      |   |     |   |   |         |       |   |        | 443    |   |      |    
|                           | Unrealized gain on investments                                      |              |      |   |     |   |   |         |       |   |        |       |   |      | 140 
|                           | Net loss                                                            |              |      |   |     |   |   |         |       |   |        |       |   |      |    
|                           |                                                                     |              |       |   |     |    |   |         |        |   |        |        |   |      |     
|BALANCE, December 31, 2000 |                                                                     | 22,275       |       | $ | 223 |    | $ | 132,403 |        | $ | (194   | )      | $ | (22  | )   

The accompanying notes are an integral part of these consolidated financial statements.

45

---



DIGITAL RIVER, INC.Consolidated Statements of Cash Flows        For the Years Ended December 31        (In Thousands)

|                                                     |                                                                             | 2000                                                             |                                               | 1999                                                |        | 1998    |         
|---------------------------------------------------- | --------------------------------------------------------------------------- | ---------------------------------------------------------------- | --------------------------------------------- | --------------------------------------------------- | ------ | ------- | --------
|OPERATING ACTIVITIES:                                |                                                                             |                                                                  |                                               |                                                     |        |         |         
|                                                     | Net loss                                                                    |                                                                  | $                                             | (38,116                                             | )      | $       | (27,653 
|                                                     | Adjustments to reconcile net loss to net cash used in operating activities |                                                                  |                                               |                                                     |        |         |         
|                                                     |                                                                             | Goodwill and other intangibles amortization and earn-out charges |                                               |                                                     | 13,354 |         |         
|                                                     |                                                                             | Depreciation and amortization                                    |                                               |                                                     | 3,178  |         |         
|                                                     |                                                                             | Deferred compensation expense                                    |                                               |                                                     | 443    |         |         
|                                                     |                                                                             | Change in operating assets and liabilities:                      |                                               |                                                     |        |         |         
|                                                     |                                                                             |                                                                  | Accounts receivable and prepaid expenses      |                                                     |        | (2,691  | )       
|                                                     |                                                                             |                                                                  | Accounts payable                              |                                                     |        | 3,319   |         
|                                                     |                                                                             |                                                                  | Accrued payroll and other accrued liabilities |                                                     |        | 3,501   |         
|                                                     |                                                                             |                                                                  |                                               |                                                     |        |         |         
|                                                     |                                                                             |                                                                  |                                               | Net cash used in operating activities               |        |         | (17,012 
|                                                     |                                                                             |                                                                  |                                               |                                                     |        |         |         
|INVESTING ACTIVITIES:                                |                                                                             |                                                                  |                                               |                                                     |        |         |         
|                                                     | Purchases of investments                                                    |                                                                  |                                               | (12,034                                             | )      |         | (106,487
|                                                     | Proceeds from sales of investments                                          |                                                                  |                                               | 36,416                                              |        |         | 78,000  
|                                                     | Cash paid for acquisitions, net of cash received                            |                                                                  |                                               | (45                                                 | )      |         | (4,077  
|                                                     | Purchases of equipment                                                      |                                                                  |                                               | (9,380                                              | )      |         | (4,783  
|                                                     | Patent acquisition costs                                                    |                                                                  |                                               | (26                                                 | )      |         | (117    
|                                                     |                                                                             |                                                                  |                                               |                                                     |        |         |         
|                                                     |                                                                             |                                                                  |                                               | Net cash provided by (used in) investing activities |        |         | 14,931  
|                                                     |                                                                             |                                                                  |                                               |                                                     |        |         |         
|FINANCING ACTIVITIES:                                |                                                                             |                                                                  |                                               |                                                     |        |         |         
|                                                     | Net proceeds from sales of preferred and common stock                       |                                                                  |                                               | 292                                                 |        |         |        
|                                                     | Exercise of options and warrants                                            |                                                                  |                                               | 3,589                                               |        |         | 2,423   
|                                                     | Other                                                                       |                                                                  |                                               |                                                    |        |         | 232     
|                                                     |                                                                             |                                                                  |                                               |                                                     |        |         |         
|                                                     |                                                                             |                                                                  |                                               | Net cash provided by financing activities           |        |         | 3,881   
|                                                     |                                                                             |                                                                  |                                               |                                                     |        |         |         
|NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS |                                                                             |                                                                  | 1,800                                         |                                                     |        | (48,383 | )       
|CASH AND CASH EQUIVALENTS, beginning of period       |                                                                             |                                                                  | 15,120                                        |                                                     |        | 63,503  |         
|                                                     |                                                                             |                                                                  |                                               |                                                     |        |         |         
|CASH AND CASH EQUIVALENTS, end of period             |                                                                             | $                                                                | 16,920                                        |                                                     | $      | 15,120  |         
|                                                     |                                                                             |                                                                  |                                               |                                                     |        |         |         
|NONCASH INVESTING AND FINANCING ACTIVITIES:          |                                                                             |                                                                  |                                               |                                                     |        |         |         
|                                                     | Preferred stock converted to common stock                                   |                                                                  | $                                             |                                                    |        | $       |        
|                                                     |                                                                             |                                                                  |                                               |                                                     |        |         |         
|                                                     | Common stock issued in acquisitions and earn-outs                           |                                                                  | $                                             | 9,093                                               |        | $       | 22,809  
|                                                     |                                                                             |                                                                  |                                               |                                                     |        |         |         

The
accompanying notes are an integral part of these consolidated financial statements.

46

---



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.

47

---

The following is a summary of the Company's investment securities, all of which are classified as available for sale:

|December 31, 2000          |  | Cost |            | Unrealized losses |   | Fair Value
|-------------------------- |  | ---- | ---------- | ----------------- | - | ----------
|U.S. Government securities |  | $    | 14,999,000 |                   | $ | 22,000    
|                           |  |      |            |                   |   |           

|December 31, 1999          |  | Cost |            | Unrealized losses |   | Fair Value
|-------------------------- |  | ---- | ---------- | ----------------- | - | ----------
|U.S. Government securities |  | $    | 14,994,000 |                   | $ | 162,000   
|U.S. Corporate securities  |  |      | 24,387,000 |                   |   |          
|                           |  |      |            |                   |   |           
|                           |  | $    | 39,381,000 |                   | $ | 162,000   
|                           |  |      |            |                   |   |           

As
of December 31, 2000, all securities are due in less than one year. As of December 31, 1999, all corporate securities were due in less than one year and the US
Government securities were due in more than one year and less than two years. The Company had proceeds from sales of investments of $36,416,000, $78,000,000 and $5,000,000 in the years ended
December 31, 2000, 1999 and 1998, respectively. The cost basis of investments and gains and losses are based on specific identification. Realized gains and/or losses on sales of investments
were not material in the years ended December 31, 2000, 1999 and 1998.

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 and Other Intangibles

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

Impairment
losses are recorded on goodwill and 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. The Company regularly performs reviews to determine if indicators of impairment of its goodwill and other long-lived assets exist.
The Company's evaluation
considers nonfinancial data such as changes in the operating environment and business strategy, competitive information, market trends and operating performance. 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. Based upon regular reviews, management believes that no
conditions that would require impairment charges have arisen through December 31, 2000.

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 recognizes revenue from services rendered once all the following criteria for revenue recognition have been met:

48

---

1) Pervasive evidence of an agreement exists, 2) the services have been rendered, 3) the fee is fixed and determinable and not subject to refund or adjustment and
4) collection of the amounts due is reasonably assured. 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 providing clients the right to use its software applications, integration, development and consulting services provided to clients. Signed contracts are obtained
from clients prior to recognition of these revenues. Fees for the use of software applications and any integration and development work required to set up the client are recognized ratably over the
term of the contract once collection is reasonably assured. Clients do not have the right to take possession of the software applications used in the delivery of services. Payments received in advance
of revenue recognition, even if non-refundable, are recognized as deferred revenue. Revenues from consulting services are recognized using the percentage-of-completion method for fixed-fee
arrangements or as the services are provided for time-and-materials arrangements. 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.

49

---

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.

The
Company 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 valued at $6,000,000
plus transaction expenses. 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. ("PSL"), Universal Commerce,
Incorporated ("RegNow"), and Walnut Creek CDROM, Inc. ("Walnut Creek") for an aggregate $5,500,000 in cash and 724,261 shares of Common Stock. The purchase prices of Maagnum, PSL, RegNow and
Walnut Creek were $7,166,000,
$6,797,000, $9,250,000 and $4,000,000, respectively, plus transaction expenses. In addition, the former shareholders of Maagnum and RegNow have earn-out arrangements that allow them to
receive up to approximately 900,000 shares of Common Stock and $2,000,000 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 in 2000 and 48,095 shares of Common Stock valued
at $1,046,000 in 1999. 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.

50

---

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
(consisting of customer base, assembled workforce, technology, and non-compete agreements), 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
results of each of the above acquisitions have been reflected in the Company's results beginning on the date of the respective acquisition. 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, |            
|-------------------------------- |  | ----------------------- | -----------
|
|Revenue                          |  | $                       | 32,806,000 
|Loss from operations             |  |                         | (48,252,000
|Net loss                         |  |                         | (46,256,000
|Basic and diluted loss per share |  |                         | $(2.09     

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.

The
reconciliation of the reported income tax expense to the amount the would result from applying the US federal statutory rate of 35% to the net loss is as follows:

|                                                  |  | Year ended December 31, |            
|------------------------------------------------- |  | ----------------------- | -----------
|
|Tax benefit at statutory rate                     |  | $                       | (13,341,000
|State taxes, net of federal benefit               |  |                         | (1,982,000 
|Stock compensation deductions                     |  |                         | (1,339,000 
|Non-deductible goodwill and earn-out compensation |  |                         | 3,453,000  
|Non-deductible expense and other                  |  |                         | 285,000    
|Change in valuation allowance                     |  |                         | 12,924,000 
|                                                  |  |                         |            
|Total                                             |  | $                       |           
|                                                  |  |                         |            

51

---

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

$
30,733,000

$
19,295,000Nondeductible reserves and accruals


436,000


282,000Depreciation and amortization


1,846,000


514,000Valuation allowance


(33,015,000
)

(20,091,000
)$


$



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$
1,137,000


5. 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.

52

---

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 for the 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.

53

---

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

12.46


A
summary of information about stock options outstanding at December 31, 2000 is as follows:

|             |  | Options Outstanding |  | Options Exercisable
|------------ |  | ------------------- |  | -------------------
|
|$ 1.13- 3.00 |  | 503,087             |  | 7 years            
|6.00- 6.38   |  | 2,081,501           |  | 9.5 years          
|7.50-12.50   |  | 616,357             |  | 7.5 years          
|19.50-31.13  |  | 1,826,081           |  | 8.5 years          
|             |  |                     |  |                    
|1.13-31.13   |  | 5,027,026           |  | 9 years            
|             |  |                     |  |                    

The
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        |   | 1998 |            
|--------------------------------- | ----------- | ---- | - | ----------- | - | ---- | -----------
|Net loss:                         |             |      |   |             |   |      |            
|                                  | As reported |      | $ | (38,116,000 | ) | $    | (27,653,000
|                                  | Pro forma   |      |   | (56,482,000 | ) |      | (35,204,000
|Basic and diluted loss per share: |             |      |   |             |   |      |            
|                                  | As reported |      |   | (1.78       | ) |      | (1.36      
|                                  | Pro forma   |      |   | (2.64       | ) |      | (1.73      

54

---

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 and other intangibles 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 |   | Consolidated |            
|------------------------------------------------------------- |  | ----------------------------------------------- | ---------- | ---------------------------- | - | --------------------------- | - | ------------ | -----------
|Revenue                                                       |  | $                                               | 25,221,000 |                              | $ | 5,960,000                   |   | $            |           
|Gross profit (excludes depreciation and amortization expense) |  |                                                 | 18,119,000 |                              |   | 3,718,000                   |   |              |           
|Loss from operations                                          |  |                                                 | (5,611,000 | )                            |   | (15,936,000                 | ) |              | (18,565,000
|Net loss                                                      |  |                                                 | (5,611,000 | )                            |   | (15,936,000                 | ) |              | (16,569,000
|Total assets (Dec. 31)                                        |  |                                                 | 16,256,000 |                              |   | 7,051,000                   |   |              | 46,096,000 

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, exercisable at $3.00 per share. The warrants were 100% vested at the date of grant and expire five years from the grant date (February 2003). All 200,000 warrants are outstanding as of
December 31, 2000 at $3.00 per share with a remaining contractual life of 2.2 years. The weighted average fair value of the options granted in 1998 was determined based upon the fair value of
the services to be provided. The resulting deferred compensation of $360,000 for the estimated fair value of the services is being recognized over the term of the agreement. Compensation expense of
$100,000, $120,000 and $120,000 was recognized in 1998, 1999 and 2000, respectively.

55

---

QuickLinks