Description
Filed with the SEC from July 26 to Aug 01:
Digital River (DRIV)
Vista Equity Partners reported ownership of 3,114,946 shares (8.4%) after buying 1,342,000 from July 16 through July 25 at prices that ranged from $16.20 to $17. Vista added that it "may wish to engage in a constructive dialogue" with management. However, it didn't issue any specific plans or proposals for Digital River, an online-commerce and marketing company.
BUSINESS OVERVIEW
Overview
We provide end-to-end global cloud-commerce and marketing solutions to a wide variety of companies in software, consumer electronics, computer games, video games and other markets. We offer our clients a broad range of services that enable them to quickly and cost effectively establish an online sales channel capability and to subsequently manage and grow online sales on a global basis while mitigating risks. Our services include design, development and hosting of online stores and shopping carts, store merchandising and optimization, order management, denied parties screening, export controls and management, tax compliance and management, fraud management, digital product delivery via download, physical product fulfillment, subscription management, online marketing including e-mail marketing, management of affiliate programs, paid search programs, payment processing services, website optimization, web analytics and reporting, and CD production and delivery.
Our products and services allow our clients to focus on promoting and marketing their products and brands while leveraging our investments in technology and infrastructure to facilitate the purchase of products through their online websites. When shoppers visit one of our clients’ branded websites they are transferred to an online commerce store and/or shopping cart operated by us on our commerce platforms. Once on our system, shoppers can browse for products and make purchases online. We typically are the seller of record for transactions through our client branded stores. After a purchase is made, we either deliver the product digitally via download over the Internet or transmit instructions to a third party for physical fulfillment of the order. We also typically process the buyer’s payment as the merchant of record, including collection and remittance of applicable taxes and compliance with various regulatory matters. We have invested substantial resources to develop our cloud-commerce and marketing platforms, including business-to-business software, and we provide access and use of our platforms to our clients as a service as opposed to selling the software to be operated on their own in-house computer hardware. Our cloud-commerce store solutions range from simple remote control models to more comprehensive online store models.
In addition to the services we provide that facilitate the completion of an online transaction, we also offer services designed to increase traffic to our clients’ websites and the associated online stores and to improve the sales productivity of those stores. Our services include paid search advertising, search engine optimization, affiliate marketing, store optimization, multi-variant testing, web analytic services and e-mail optimization. All of our services are designed to help our clients acquire customers more effectively, sell to those customers more often and more efficiently, and increase the lifetime value of each customer.
Additionally, through our Digital River World Payments subsidiary, we offer a full range of payment processing services to clients. These services include multiple payment methods, fraud management, tax management, cloud-based billing and other payment optimization services.
On September 1, 2010, we announced an amendment of our agreement with Microsoft Corporation (“Microsoft”) to extend the term of the Microsoft Operations Digital Distribution Agreement through October 31, 2013. On August 30, 2010, we entered into the Microsoft Store USA statement of work with Microsoft whereby we will build, host and manage Microsoft ® Store, an e-commerce store that supports the sale and fulfillment of Microsoft and third party software as well as consumer electronics products to customers in the United States. On March 2, 2011, Digital River began providing e-commerce hosting and payment processing services in connection with Microsoft Store. In addition to Microsoft Store, Digital River maintains its role as a reseller of Microsoft products via Digital River’s existing online stores. Currently, we are providing commerce services, ranging from transaction and payment processing, to e-marketing, digital downloads and fraud prevention in support of some of the popular Microsoft software titles, including Microsoft © Office. The global arrangement incorporates digital fulfillment across multiple geographies, including North America, Asia, Europe, Latin America and Australia.
As announced on October 12, 2009, Symantec Corporation informed us that it elected not to renew its commerce agreement with us. As a consequence, their e-commerce agreement terminated on June 30, 2010. We recorded $25.2 million in overall revenues from the Symantec contract in 2010.
We view our operations and manage our business as one reportable segment, providing outsourced commerce solutions globally to a variety of companies, primarily in the software and consumer electronics product markets.
We were incorporated in Delaware in February 1994. Our headquarters are located at 10380 Bren Road West, Minnetonka, Minnesota and our telephone number is 952-253-1234.
General information about us can be found at www.digitalriver.com under the “Company/Investor Relations” link or follow the Company on Twitter at twitter.com/digitalriverinc. Our annual report on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, as well as any amendments or exhibits to those reports, are available free of charge through our website as soon as reasonably practicable after we file such reports with the Securities and Exchange Commission.
Industry Background
Growth of the Internet and E-Commerce. E-Commerce sales continue to grow. The U.S. Commerce Department reported that e-commerce sales in 2011 rose 16.1% compared to 2010. We believe there are a number of factors that are contributing to the continued growth of e-commerce: (i) adoption of the Internet continues to increase globally; (ii) broadband technology is increasingly being used to deliver Internet service enabling the delivery of richer content as well as larger files to consumers; (iii) Internet users are becoming increasingly comfortable with the process of buying products online; (iv) the functionality of online stores continues to improve, offering a broader assortment of payment options with more promotion alternatives; (v) businesses are placing more emphasis on their online channel, reaching a larger audience at comparatively lower costs than other methods; and (vi) concerns about conflicts between online and traditional sales channels continue to subside. Additionally, we believe that current economic conditions have led to increased retail store closings which should drive more shoppers online as they shift to other channels, filling the void created by retail downsizings and bankruptcies.
Growing Interest in Direct Sales of Products to Consumers. Increasingly, companies are selling their products directly to buyers via online sales channels. This is due to increased competition for shelf space in the traditional retail channels as well as recognition that direct sales channels can co-exist with traditional sales channels. There is also a growing recognition of the value inherent in developing behavioral or personalized marketing campaigns relevant to a consumer’s interests.
Opportunities for Outsourced Cloud-Commerce Services. We believe the market for outsourced commerce will continue to grow as there are advantages to outsourced commerce that will continue to make it an attractive alternative to building and maintaining this capability in-house. These advantages include: (i) eliminating the substantial up-front and ongoing costs of computer hardware, network infrastructure, specialized application software and training and support costs; (ii) reducing the time it takes to get online stores live and productive; (iii) shifting the ongoing technology, financial, personal information security protections, regulatory and compliance risks to a proven service provider; (iv) leveraging the direct marketing expertise of an e-commerce service provider to accelerate growth of an online business; and (v) allowing businesses to focus on their specific core competencies.
Once an online store is established, it is immediately accessible to Internet users around the world. Web pages must be presented and customer service inquiries handled in multiple languages, and a variety of currencies and payment options must be accepted. The appropriate taxes must be collected and paid, payment fraud risk mitigated, fulfillment provided, and assurances made that products are not shipped to banned locations. These and other requirements of a global cloud commerce system make it an expensive and potentially risky undertaking for any business. These factors also make a comprehensive outsourced offering, such as that provided by Digital River, an attractive alternative.
Shift from Physical to Electronic Delivery of Digital Products. Consumers have grown increasingly comfortable with the electronic delivery of digital products, such as software, e-books, computer games, video games, music and video. This shift from physical to electronic delivery is being driven by benefits to both buyers and sellers of these products. For buyers, downloaded products are immediately available for use and a wider variety of products are available than can be found in most retail stores. For sellers, electronic delivery eliminates inventory-stocking requirements, shipping, handling, storage and inventory-carrying costs as well as the risk of product obsolescence.
The Digital River Solution
Our solution combines a robust cloud-commerce technology platform and a suite of services to help businesses worldwide grow their online revenues and avoid the costs and risks of running an integrated global commerce operation in-house. We offer a comprehensive e-commerce solution that operates seamlessly as part of a client’s website. We provide services that facilitate commerce transactions and drive traffic to our clients’ online stores. Our services include design, development and hosting of online stores, merchandising, order management, fraud prevention screening, popular online payment methods, export controls and management, denied parties screening, tax compliance and management, digital product delivery via download, physical product fulfillment, CD production, multi-lingual customer service, subscription management, online marketing services including email marketing, paid search program management, website optimization, web analytics and reporting. We also provide our clients with increased product visibility and sales opportunities through our large network of online channel partners, including retailers and affiliates. We generate a significant proportion of our revenue on a revenue-share basis, meaning that we are paid a percentage of the selling price of each product sold at a clients’ online store that is being managed by Digital River. We believe this revenue share model aligns our interests with those of our clients.
Benefits to Clients
Reduced Total Cost of Ownership and Risk
Utilizing the Digital River solution, businesses can dramatically reduce or eliminate upfront and ongoing hardware, software, maintenance and support costs associated with developing, customizing, deploying, maintaining and upgrading an in-house global cloud-commerce solution. They can have a global e-commerce presence without assuming the costs and risks of internal development and leverage the investments we make in our cloud-commerce platform. In addition, we help mitigate the risks of global e-commerce, including risks associated with payment fraud, data security, tax compliance, and regulatory compliance. Our ongoing investments in the latest technologies and e-commerce functionality help ensure our clients maintain pace with industry advances.
Revenue Growth
We can assist our clients in growing their online businesses by (i) facilitating the acquisition of new customers, improving the retention of existing customers, and increasing the lifetime value of each customer; (ii) extending their businesses into international markets; and (iii) expanding the visibility and sales of their products through new online sales channels. We have developed substantial expertise in online marketing and merchandising which we apply to help our clients increase traffic to their online stores, and improve order close ratios, average order sizes and repeat purchases, all of which result in higher revenues for our clients’ and Digital River.
We provide the technology and services required to establish, grow and support international sales, both for U.S-based clients seeking to reach customers overseas, and non-U.S.-based clients looking to access the U.S. and other markets. Our technology platform enables transactions to be completed in numerous currencies using a variety of payment methods. In addition, we provide localized online content and payment methods, and offer customer service in a variety of languages, extending our clients’ reach beyond their home markets.
Through our large online affiliate network marketplace, which we call oneNetworkDirect™, we provide our clients access to a new sales channel which can help grow their online businesses. Clients can offer any part of their product catalogs to our network of online channel partners, including online retailers and affiliates. This increases the exposure these products receive and can result in higher sales volumes. Our channel partners benefit because we eliminate the need for each of them to manage hundreds of relationships with product developers, while increasing the depth and breadth of products they can sell, all without requiring the management of physical product inventory.
Deployment Speed
Businesses can reduce the time required to develop a global-commerce presence by utilizing our outsourced business model. Typically, a new client can have an online store live in a matter of weeks compared with months or longer if they decide to build, test deploy and integrate the commerce capability in-house. Once they are operational on our platform, most clients can utilize our remote control toolset to make real-time changes to their online store, allowing them to take advantage of opportunities without technical assistance from Digital River.
Focus on Core Competency
By utilizing our outsourced cloud-commerce platform, clients can focus on developing, marketing and selling their products rather than devoting time and resources to building and maintaining a cloud-commerce infrastructure. This allows client management time to focus on what they know best while ensuring they have access to the latest technologies, tools and expertise for running a successful global-commerce operation.
Benefits to Buyers
Our solution emphasizes convenience as it enables products to be purchased online at anytime from anywhere in the world via a connection to the Internet. In the case of software, video games and other digital products, buyers can immediately download their purchase and, depending on file size, begin using it in a matter of minutes. Search technology allows shoppers to browse our entire catalog to find the products they are looking for quickly and easily. Our extended download service, which guarantees replacement of products accidentally destroyed through computer error or malfunction, and our 24/7 customer service provided on behalf of our clients, offer shoppers additional assurance that their buying experience will be a positive one. Our CD2Go service gives buyers the ability to obtain, for a fee, a copy of the product they have purchased and downloaded on a CD.
Strategy
Our objective is to be the cloud-commerce expert that drives client revenue for software and digital products developers, high-tech product and computer manufacturers, and video game publishers. Our strategy for achieving this objective includes the following key components:
Attract New Clients and Expand Relationships with Existing Clients. We have focused our efforts on securing new clients and expanding our relationships with existing clients primarily in the software, consumer electronics, computer game and video game markets. Our clients include software publishers, other digital content providers, high-tech product manufacturers and online channel partners.
We believe we can attract new clients and gain additional business with existing clients by expanding the range of services we offer. This includes services to enhance the commerce transaction as well as additional online marketing and payment services. We believe that by expanding the size and breadth of the catalog of products we offer, we will attract additional online retailers and affiliates seeking to offer their customers a wide range of quality products. We currently provide e-commerce services for thousands of software and digital products publishers, consumer electronic product manufacturers, game publishers and affiliates.
Expand International Sales. We believe there is a substantial opportunity to grow our business by enabling our clients to expand their sales through international online stores. Internet adoption and broadband deployment continue to increase rapidly, especially in the European and Asia Pacific regions. We have seen significant growth in sales for clients that have created international online stores. We intend to continue to enhance our technology platform, payment options and localized service offerings to increase sales in international markets.
Provide Clients with Strategic Marketing Services. We proactively develop and deliver new strategic marketing services that are designed to help our clients improve customer acquisition and retention and maximize the lifetime value of customers. These services currently include paid search advertising, search engine optimization, affiliate marketing, store optimization, web analytics, and e-mail marketing and optimization. In general, we manage these programs for our clients and have achieved significant increases in client revenue, return-on-investment or both, compared to what clients experienced when running these programs and supporting technologies in-house or through other service providers. We intend to continue to develop and/or acquire new value-added strategic marketing services and technologies to create additional sources of revenue for our clients and for Digital River.
Maintain Technology Leadership. We believe our technology platform and infrastructure afford us a competitive advantage in the market for outsourced commerce solutions. We intend to continue to invest in and enhance our platform to improve scalability, efficiency, reliability, security and performance. By leveraging our infrastructure, we can improve our ability to provide low-cost, high-value services while continuing to deploy the latest technologies. Additionally, we plan to continue investing in our infrastructure to enable our clients to further penetrate international markets, enhance their relationships with their customers, better manage the return-on-investment across all their online marketing activities, successfully adopt new selling models such as subscriptions, Software as a Service (SaaS), trial programs and volume licensing programs.
Continue to Seek Strategic Acquisitions. Historically, we have been an active acquirer of businesses, and we expect to continue actively pursuing acquisitions that further our business strategy. Some of the strategic factors we consider when evaluating an acquisition opportunity include: expanding our base of clients, improving the breadth and depth of our product offering, improving the catalog of content, extending our strategic marketing and other services offerings, expanding our geographic reach and diversifying our revenue stream into complementary or adjacent market segments.
Services
We provide a broad range of services to our clients, including design, development and hosting of online stores, merchandising, order management, fraud prevention screening, popular localized online payment methods, export controls and management, denied parties screening, tax compliance and management, digital product delivery via download, physical product fulfillment, CD production, multi-lingual customer service, subscription management, online marketing services including email marketing, paid search program management, website optimization, web analytics and reporting. Most of these offerings can be managed through client-facing, remote control self-service tools that are easily used by business users without specialized training. Since clients utilize our centralized system and processes, we can consistently offer best practices across our entire client base.
Store Design, Development and Hosting. We offer our clients website design services utilizing our experience and expertise to create efficient and effective online stores. Our global-commerce solutions can be deployed quickly and implemented in a variety of ways from fully-functioning shopping carts through completely merchandised online stores. The online stores we operate for our clients often match their branding and website design to provide a seamless experience for shoppers. When a shopper navigates from a client’s website (operated by them) to their store (operated by us), the transition is seamless and the customer is unaware they are then being served by our technology platform. We manage the order process through payment processing, fraud screening and fulfillment (either digital or physical) and notify the buyer via e-mail once the transaction is completed. Transaction information is captured and stored in our database systems, an increasingly valuable source of information used to create highly targeted merchandising programs, e-mail marketing campaigns, product offers and test marketing programs.
For many of our clients, the solution we provide is critical to their businesses and therefore we operate global data centers that perform and scale for continuous e-commerce operation in a high-demand environment. We operate multiple data centers globally, which feature fully redundant high-speed connections to the Internet, server capacity to handle unpredictable spikes in traffic and transactions, 24/7 security and monitoring, back-up electric generators and dedicated power supplies.
Store Merchandising. Our technology platforms support a wide range of merchandising activities. This enables our clients to effectively execute promotions, up-sell, and cross-sell activities and to feature specific products and services during any phase of the shopping process. From the home page of our clients’ online stores through the checkout and “thank you” pages, our solution allows clients to deliver targeted offers designed to increase order close ratios and average order sizes.
Order Management and Fraud Screening. We manage all phases of a shopper’s order on our clients’ online stores. We process payment transactions for orders placed through our technology platform and support a wide variety of payment types, including credit cards, wire transfers, purchase orders, money orders, direct debit cards and many other payment methods popular both in the United States and around the world. As part of the payment process, we ensure that the correct taxes are displayed, collected, remitted and reported.
The fraud screening component of our platform uses both rules-based and heuristic scoring methods which use observations of known fraudulent activities to make a determination regarding the validity of the order, buyer and payment information. As the order is entered, hundreds of data reviews can be processed in real time. We also provide denied-parties screening and export controls, which are designed to ensure that persons and/or organizations appearing on government denied-parties lists are blocked from making purchases through our system. Once a transaction is approved and the digital product has been delivered via download or the physical product(s) has been shipped, we submit the transaction for payment.
CEO BACKGROUND
A LFRED F. C ASTINO
Mr. Castino (59) has served as our director since July 2010. Mr. Castino serves as Chair of our Audit Committee and as a member of our Nominating and Corporate Governance Committee. Since August 2008, Mr. Castino has served as an independent consultant. Mr. Castino served as Chief Financial Officer of Autodesk, Inc. from July 2002 to August 2008. Prior to July 2002, Mr. Castino held various financial positions at Hewlett-Packard Company, Sun Microsystems, Inc. and PeopleSoft, Inc., where he served as Chief Financial Officer. Mr. Castino is also a director of Synopsys, Inc and serves on its audit committee.
Areas of relevant experience: financial management of software companies; general financial expertise; public company experience; international operations and issues.
D OUGLAS M. S TEENLAND
Mr. Steenland (60) has served as our director since March 2009. Mr. Steenland serves as the Chair of our Compensation Committee and serves as a member of our Nominating and Corporate Governance Committee and Finance Committee. He served as President and Chief Executive Officer of Northwest Airlines Corporation (“NWA”) from October 2004 until October 2008 when NWA and Delta Air Lines, Inc. merged. Mr. Steenland served in a number of executive positions after joining NWA in 1991, including President from April 2001 to October 2004, Executive Vice President and Chief Corporate Officer from September 1999 to April 2001, Executive Vice President—Alliances, General Counsel and Secretary from January 1999 to September 1999, Executive Vice President, General Counsel and Secretary from June 1998 to January 1999, and Senior Vice President, General Counsel and Secretary from 1994 to 1998. Prior to joining NWA, Mr. Steenland was a senior partner at the Washington, D.C. law firm of Verner, Lipfert, Bernhard, McPherson and Hand. In the past five years, Mr. Steenland has also served as a director of Northwest Airlines Corporation. Mr. Steenland was President and Chief Executive Officer of Northwest Airlines Corporation when it filed for Chapter 11 bankruptcy in 2005. Mr. Steenland is a director of American International Group, Inc. In addition to his public company directorships, Mr. Steenland is a director of Travelport, LLC.
Areas of relevant experience: international operations, global perspective and issues; operating environment; corporate governance; legal issues.
MANAGEMENT DISCUSSION FROM LATEST 10K
Overview
We provide end-to-end global cloud-commerce and marketing solutions to a wide variety of companies in software, consumer electronics, computer games, video games and other markets. We offer our clients a broad range of services that enable them to quickly and cost effectively establish an online sales channel capability and to subsequently manage and grow online sales on a global basis while mitigating risks. Our services include design, development and hosting of online stores and shopping carts, store merchandising and optimization, order management, denied parties screening, export controls and management, tax compliance and management, fraud management, digital product delivery via download, physical product fulfillment, subscription management, online marketing including e-mail marketing, management of affiliate programs, paid search programs, payment processing services, website optimization, web analytics and reporting, and CD production and delivery.
Our products and services allow our clients to focus on promoting and marketing their products and brands while leveraging our investments in technology and infrastructure to facilitate the purchase of products through their online websites. When shoppers visit one of our clients’ branded websites they are transferred to an e-commerce store and/or shopping cart operated by us on our e-commerce platforms. Once on our system, shoppers can browse for products and make purchases online. We typically are the seller of record for transactions through our client branded stores. After a purchase is made, we either deliver the product digitally via download over the Internet or transmit instructions to a third party for physical fulfillment of the order. We also typically process the buyer’s payment as the merchant of record, including collection and remittance of applicable taxes and compliance with various regulatory matters. We have invested substantial resources to develop our e-commerce and marketing platforms, including business-to-business software, and we provide access and use of our platforms to our clients as a service as opposed to selling the software to be operated on their own in-house computer hardware. Our global-commerce store solutions range from simple remote control models to more comprehensive online store models.
In addition to the services we provide that facilitate the completion of an online transaction, we also offer services designed to increase traffic to our clients’ websites and the associated online stores and to improve the sales productivity of those stores. Our services include paid search advertising, search engine optimization, affiliate marketing, store optimization, multi-variant testing, web analytic services and e-mail optimization. All of our services are designed to help our clients acquire customers more effectively, sell to those customers more often and more efficiently, and increase the lifetime value of each customer.
On September 1, 2010, we announced an amendment of our agreement with Microsoft Corporation (“Microsoft”) to extend the term of the Microsoft Operations Digital Distribution Agreement through October 31, 2013. On August 30, 2010, we entered into the Microsoft Store USA statement of work with Microsoft whereby we will build, host and manage Microsoft ® Store, an online store that supports the sale and fulfillment of Microsoft and third party software as well as consumer electronics products to customers in the United States. On March 2, 2011, Digital River began providing cloud-commerce hosting and payment processing services in connection with Microsoft Store. In addition to Microsoft Store, Digital River maintains its role as a reseller of Microsoft products via Digital River’s existing online stores. Currently, we are providing global-commerce services, ranging from transaction and payment processing, to e-marketing, digital downloads and fraud prevention in support of some of the popular Microsoft software titles, including Microsoft © Office. The global arrangement incorporates digital fulfillment across multiple geographies, including North America, Asia, Europe, Latin America and Australia.
We view our operations and manage our business as one reportable segment, providing outsourced global-commerce solutions globally to a variety of companies, primarily in the software and consumer electronics product markets.
We were incorporated in Delaware in February 1994. Our headquarters are located at 10380 Bren Road West, Minnetonka, Minnesota and our telephone number is 952-253-1234.
General information about us can be found at www.digitalriver.com under the “Company/Investor Relations” link or follow the Company on Twitter at twitter.com/digitalriverinc. Our annual report on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, as well as any amendments or exhibits to those reports, are available free of charge through our website as soon as reasonably practicable after we file such reports with the Securities and Exchange Commission.
Our commerce revenues are driven primarily by global commerce and payment services provided to a wide variety of companies in the software, consumer electronics, computer games and other markets. Commerce revenues include revenues generated from Microsoft and Symantec. Revenue from Symantec relates to the first half of 2010 only, since their e-commerce agreement terminated on June 30, 2010. All other non-commerce revenues are driven primarily by our e-mail and affiliate marketing businesses.
For the year ended December 31, 2011, the $34.9 million increase in revenue was driven primarily by an increase in commerce revenue of $26.8 million and foreign exchange favorability of $5.3 million compared to the prior year. For the year ended December 31, 2010, the $40.5 million decrease in revenue was driven primarily by the decline in Symantec revenue of $89.6 million. Excluding Symantec, revenue increased by 17.0% for 2010, and was driven primarily by an increase in commerce revenue of $47.5 million and foreign exchange unfavorability of $0.2 million compared to the prior year.
International sales are approximately 46.2%, 46.4% and 41.1% of revenue in 2011, 2010 and 2009, respectively.
Microsoft Corporation accounted for approximately 27.7%, 24.7% and 11.8% of our revenue in 2011, 2010 and 2009, respectively.
Symantec Corporation accounted for approximately 6.9% and 28.4% of our total revenue in 2010 and 2009, respectively. We had minimal Symantec related revenue in 2011.
Direct Cost of Services. Direct cost of services expense primarily includes costs related to product fulfillment, back-up CD production, delivery solutions and certain client-specific costs. Direct cost of service expenses were $15.5 million, $17.8 million and $17.6 million in 2011, 2010 and 2009, respectively. The decrease in 2011 compared with 2010 was primarily driven by lower CD supply costs and workforce related costs. The increase in 2010 compared with 2009 was primarily driven by revenue growth partially offset by lower CD supply costs.
As a percentage of revenue, direct cost of services was 3.9%, 4.9% and 4.4% in 2011, 2010 and 2009, respectively.
Network and Infrastructure. Our network and infrastructure expenses primarily include costs to operate and maintain our technology platforms, customer service, data communication and data center operations. Network and infrastructure expenses were $49.4 million in 2011, compared to $46.9 million and $46.0 million in 2010 and 2009, respectively. The increase in 2011 from 2010 was mainly due to increased investment in workforce related costs to drive future efficiencies in our technologies and increased hardware expense, partially offset by reductions in data communication costs and outside services. The increase in 2010 from 2009 was due to an increase in data communication expenses related to an acquisition in the second half of 2010.
As a percentage of revenue, network and infrastructure expenses were 12.4%, 12.9% and 11.4% in 2011, 2010 and 2009, respectively.
Sales and Marketing. Our sales and marketing expenses include credit card transaction and other payment processing fees, personnel and related costs, advertising, promotional and product marketing expenses, credit card chargebacks and bad debt expense. Sales and marketing expenses were $162.6 million, $150.0 million and $157.5 million in 2011, 2010 and 2009, respectively. The increase in sales and marketing in 2011 compared to 2010 was primarily driven by higher workforce costs to support our global sales initiatives and increased payment processing costs, related to higher revenue. These increases were partially offset by lower chargeback and bad debt expenses. The decrease in sales and marketing in 2010 compared to 2009 was attributable to lower payment processing costs and paid search fees.
As a percentage of revenue, sales and marketing expenses were 40.9%, 41.3% and 39.0% in 2011, 2010 and 2009, respectively.
Product Research and Development. Our product research and development expenses include costs associated with design, development and enhancement of our technology platforms and related systems and sustaining engineering of these platforms and related systems. Research and development costs are expensed as incurred, except certain internal-use software development costs eligible for capitalization and costs directly associated with preparing a client website launch. These costs are eligible to be deferred and amortized over the life of the site’s associated revenue streams. Product research and development expenses were $66.9 million in 2011, compared to $60.8 million and $54.5 million in 2010 and 2009, respectively. The increases were primarily due to higher workforce costs, which drive enhanced technologies and strengthen our leadership position in the markets we serve. These investments advance our global system scalability, e-marketing capabilities, data management and client reporting.
As a percentage of revenue, product research and development expenses were 16.8%, 16.8% and 13.5% in 2011, 2010 and 2009, respectively.
General and Administrative. Our general and administrative expenses primarily include executive, finance, human resources and other administrative workforce and related expenses, fees for professional services, bank fees, insurance costs and non-income related taxes. General and administrative expenses were $43.1 million in 2011 compared to $43.4 million and $37.7 million in 2010 and 2009, respectively. The decrease in 2011 compared to 2010 was mainly due to a decrease in regulatory fees partially offset by an increase in workforce related costs. The increase in 2010 compared to 2009 was primarily due to increased workforce related costs.
As a percentage of revenue, general and administrative expenses were 10.8%, 11.9% and 9.3% in 2011, 2010 and 2009, respectively.
Depreciation and Amortization. Our depreciation and amortization expenses include the depreciation of computer equipment, office furniture, the amortization of purchased and internally developed software and leasehold improvements. Computer equipment, software and furniture are depreciated under the straight-line method using three to seven year lives and leasehold improvements are amortized over the shorter of the asset life or the remaining length of the lease. Depreciation and amortization expense was $22.2 million in 2011 compared to $23.4 million and $19.4 million in 2010 and 2009, respectively. The decreased expenses in 2011 compared to 2010 were driven primarily by the timing and mix of capital spend year-over-year. The increased expenses in 2010 compared to 2009 resulted primarily due to the higher levels of computer equipment and capitalized software as a result of technology development and enhancements, including full-year amortization of our new enterprise resource planning system.
As a percentage of revenue, depreciation and amortization was 5.6%, 6.4% and 4.8% in 2011, 2010 and 2009, respectively.
Amortization of Acquisition-Related Intangibles. In 2011, our amortization of acquisition-related intangibles consists of the amortization of intangible assets recorded from our nine acquisitions in the past seven years. Amortization of acquisition related intangibles was $18.0 million in 2011 compared to $7.8 million and $7.6 million in 2010 and 2009, respectively. The increase in 2011 compared to 2010 was primarily driven by a $9.4 million impairment recorded related to the reduction in the book carrying values of certain customer relationship, trade name, technology, and non-compete agreements established in the purchase accounting of our Journey Education Marketing, Inc., fatfoogoo, AG and THINK Subscription, Inc. acquisitions. The increase in 2010 compared to 2009 reflects our acquisitions of Journey Education Marketing, Inc. and fatfoogoo, AG; offset by the full amortization of several intangible assets from past acquisitions. We review goodwill for impairment on an annual basis or more frequently if events occur or circumstances change that would more likely than not reduce the fair value of the reporting unit below its carrying amount. Our assessment has indicated that there is no impairment of goodwill for the years ended December 31, 2011, 2010 and 2009. We have purchased, and expect to continue purchasing, assets or businesses, which may include the purchase of intangible assets.
As a percentage of revenue, amortization of acquisition-related intangibles was 4.5%, 2.2% and 1.9% in 2011, 2010 and 2009, respectively.
Income from Operations. Our income from operations in 2011 was $20.5 million, compared to $13.0 million and $63.5 million in 2010 and 2009, respectively. Income from operations increased during 2011 from 2010 due to higher overall revenues in the software, consumer electronics, computer games and other markets.
Higher revenues were partially offset by a $9.4 million impairment of acquisition-related intangibles. Income from operations decreased during 2010 from 2009 due to lower overall revenues related to the loss of Symantec, partially offset by revenue growth across other software, online game and consumer electronic clients in the second half of 2010.
As a percentage of revenue, income from operations was 5.1%, 3.6% and 15.7% in 2011, 2010 and 2009, respectively.
Interest Income. Our interest income represents the total of interest income on our cash, cash equivalents, short-term investments and certain long-term investments. Interest income was $6.1 million, $3.0 million and $3.2 million in 2011, 2010 and 2009, respectively. The increase in interest income in 2011 compared to 2010 was primarily due to the increased cash available for investment from our 2010 debt offering. The decrease in interest income in 2010 compared to 2009 was due to lower market yields on our portfolio.
Interest Expense. Our interest expense includes the total of cash and non-cash interest expense attributable to our outstanding convertible debt. Interest expense was $9.0 million in 2011, which included $2.0 million of debt financing cost amortization. Interest expense was $1.7 million in 2010, which included $0.3 million of debt financing cost amortization, and $5.3 million in 2009. The increase in 2011 compared to 2010 was due to the issuance of $345.0 million of convertible notes in the fourth quarter of 2010, which bear an annual interest rate of 2.0%. In 2009 we wrote-off $5.2 million of debt amortization costs associated with the January 2009 cash settlement of our 2004 Senior Convertible Notes.
Other Income (Expense), Net. Our other income (expense), net includes foreign currency transaction gains and losses, asset disposal gains and losses, other-than-temporary impairment of investments and dividend income. Other income (expense) was expense of $1.9 million in 2011, compared to expense of $1.1 million and income of $0.4 million in 2010 and 2009, respectively. The decrease in other income in 2011 compared to 2010 was attributable to foreign currency re-measurement losses, partially offset by increased dividend income. The decrease in other income in 2010 compared to 2009 was attributable to the $2.2 million other-than-temporary impairment of an equity investment offset by dividend income and foreign currency re-measurement gains.
Income Tax Expense. In 2011, our tax benefit was $1.6 million, consisting of approximately $1.3 million of current tax benefit and $0.3 million of deferred tax benefit. In 2010, our tax benefit was $2.5 million, consisting of approximately $4.6 million of current tax expense offset by approximately $7.1 million of deferred tax benefit. In 2009, our tax expense was $12.0 million, consisting of approximately $17.2 million of current tax expense offset by $5.2 million of deferred tax benefit. Our effective tax rate was a negative 10.0% in 2011, compared to negative 18.6% in 2010 and 19.5% in 2009. Differences in our effective tax rate from the U.S. statutory rate are primarily due to our mix of earnings from international operations and the differences in statutory rates in these countries from the U.S. rate.
As of December 31, 2011, we had a U.S. tax loss carryback/carryforward of approximately $32.2 million, of which $17.6 million can offset prior U.S. taxable income and $14.6 million can be carried forward to offset future U.S. taxable income. The tax losses consist of U.S. net operating losses of $18.8 million and acquired U.S. net operating losses of $13.4 million. The U.S. tax loss carryforwards expire in the years 2015 through 2031. As of December 31, 2011, we also had foreign tax loss carryforwards of approximately $9.0 million, consisting primarily of acquired foreign net operating losses. The foreign loss carryforwards do not expire under current law.
There is uncertainty of future realization of some of the deferred tax assets resulting from tax loss carryforwards due to anticipated limitations. Therefore, a valuation allowance was recorded against the tax effect of such tax loss carryforwards, including a portion of state net operating losses and all foreign net operating losses. At December 31, 2011, the Company had a valuation allowance on approximately $3.6 million of deferred tax assets related to operating losses and $0.2 million of deferred tax assets related to other tax attributes as we believe it is more likely than not that these deferred tax assets will not be realized. Any future release of this valuation allowance will reduce expense.
MANAGEMENT DISCUSSION FOR LATEST QUARTER
Overview
We provide end-to-end global cloud-commerce, payments and marketing solutions to a wide variety of companies in software, consumer electronics, computer games, video games and other markets. We offer our clients a broad range of services that enable them to quickly and cost effectively establish an online sales channel capability and to subsequently manage and grow online sales on a global basis while mitigating risks. Our services include design, development and hosting of online stores and shopping carts, store merchandising and optimization, order management, denied parties screening, export controls and management, tax compliance and management, fraud management, digital product delivery via download, physical product fulfillment, subscription management, online marketing including e-mail marketing, management of affiliate programs, paid search programs, payment processing services, website optimization, web analytics and reporting, and CD production and delivery.
Our products and services allow our clients to focus on promoting and marketing their products and brands worldwide while leveraging our investments in technology and infrastructure to facilitate the purchase of products through their online websites. When shoppers visit one of our clients' branded websites they are transferred to an online commerce store and/or shopping cart operated by us on our commerce platforms. Once on our system, shoppers can browse for products and make purchases online. We typically are the seller of record for transactions through our client branded stores. After a purchase is made, we either deliver the product digitally via download over the Internet or transmit instructions to a third party for physical fulfillment of the order. We also typically process the buyer's payment as the merchant of record, including collection and remittance of applicable taxes and compliance with various regulatory matters. We have invested substantial resources to develop our cloud-commerce and marketing platforms, including direct-to-buyer software, and we provide access and use of our platforms to our clients as a service as opposed to selling the software to be operated on their own in-house computer hardware. Our cloud-commerce store solutions range from simple remote control models to more comprehensive online store models.
In addition to the services we provide that facilitate the completion of an online transaction, we also offer services designed to increase traffic to our clients' websites and the associated online stores and to improve the sales productivity of those stores. Our services include paid search advertising, search engine optimization, affiliate marketing, store optimization, multi-variant testing, web analytic services and e-mail optimization. All of our services are designed to help our clients acquire customers more effectively, sell to those customers more often and more efficiently, and increase the lifetime value of each customer.
Additionally, through our Digital River World Payments subsidiary, we offer a full range of payment processing services to clients. These services include multiple payment methods, fraud management, tax management, cloud-based billing and other payment optimization services.
On May 8, 2012, we entered into with Microsoft Corporation (“Microsoft”), in the ordinary course of business, the Third Omnibus Amendment to the Microsoft Operations Digital Distribution Agreement (the “Third Omnibus Amendment”). The Third Omnibus Amendment extends the term of Microsoft Operations Digital Distribution Agreement to a date no earlier than March 1, 2014. Additionally, the Third Omnibus Amendment contemplates the expansion of the business relationship whereby we will build, host and manage the Microsoft Store, an e-commerce store that supports the sale and fulfillment of Microsoft and third party software as well as consumer electronics products, to customers throughout the world. The Third Omnibus Amendment contemplates us providing e-commerce services in connection with Microsoft Store on a global basis in addition to maintaining and expanding our role as a reseller of Microsoft products via Digital River’s existing online stores in addition to new stores offering physical media.
We view our operations and manage our business as one reportable segment, providing outsourced commerce solutions globally to a variety of companies, primarily in the software and consumer electronics product markets.
We were incorporated in Delaware in February 1994. Our headquarters are located at 10380 Bren Road West, Minnetonka, Minnesota and our telephone number is 952-253-1234.
General information about us can be found at www.digitalriver.com under the “Company/Investor Relations” link or follow the Company on Twitter at twitter.com/digitalriverinc. Our annual report on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, as well as any amendments or exhibits to those reports, are available free of charge through our website as soon as reasonably practicable after we file such reports with the Securities and Exchange Commission.
REVENUE. Our revenue was $90.8 million for the three months ended June 30, 2012, compared to $92.5 million for the same period in the prior year, a decrease of $1.7 million or 1.9%. For the six months ended June 30, 2012, revenue totaled $193.2 million, an increase of $2.5 million, or 1.3%, from revenue of $190.7 million for the same period in the prior year.
Our commerce revenues are driven primarily by global commerce and payment services provided to a wide variety of companies in the software, consumer electronics, computer games and other markets. Commerce revenues include revenues generated from Microsoft. All other non-commerce revenue or support business revenue is driven primarily by our e-mail and affiliate marketing businesses.
For the three months ended June 30, 2012, the $1.7 million decrease in revenue was driven primarily by an increase in commerce revenue of $3.6 million, which includes a $0.7 million client settlement associated with a prior period. This commerce revenue increase was partially offset by a decrease in our support business revenue of $2.9 million and foreign exchange unfavorability of $2.4 million compared to the same period in the prior year. For the six months ended June 30, 2012, the $2.5 million increase in revenue was driven primarily by an increase in commerce revenue of $11.8 million partially offset by a decrease in support business revenue of $6.2 million and foreign exchange unfavorability of $3.1 million compared to the same period in the prior year.
International sales were approximately 46.7% and 46.7% of total sales in the three and six month periods ended June 30, 2012, compared to 46.1% and 46.2% for the same periods in the prior year.
DIRECT COST OF SERVICES. Direct cost of services primarily includes costs related to product fulfillment, backup CD production, delivery solutions and certain client-specific costs. Direct cost of service expenses were $3.1 million for the three months ended June 30, 2012, compared to $3.9 million for the same period in the prior year. Direct cost of service expenses were $6.7 million for the six months ended June 30, 2012, compared to $8.0 million for the same period in the prior year. The decreases for both periods were primarily attributable to lower CD production and delivery costs.
As a percentage of revenue, direct cost of services was 3.4% and 3.5% for the three and six months ended June 30, 2012, compared to 4.2% and 4.2% for the same periods in the prior year.
NETWORK AND INFRASTRUCTURE. Our network and infrastructure expenses primarily include costs to operate and maintain our technology platforms, customer service, data communication and data center operations. Network and infrastructure expenses were $12.9 million and $12.5 million for the three months ended June 30, 2012 and 2011, respectively. Network and infrastructure expenses were $25.7 million and $25.1 million for the six months ended June 30, 2012 and 2011, respectively. The increases for both periods were mainly due to higher data communication related costs.
As a percentage of revenue, network and infrastructure expenses were 14.2% and 13.3% for the three and six months ended June 30, 2012, compared to 13.5% and 13.2% for the same periods in the prior year.
SALES AND MARKETING. Our sales and marketing expenses include credit card transaction and other payment processing fees, personnel and related costs, advertising, promotional and product marketing expenses, credit card chargebacks and bad debt expense. Sales and marketing expenses were $39.8 million and $39.5 million for the three months ended June 30, 2012 and 2011, respectively. Sales and marketing expenses were $82.8 million and $77.2 million for the six months ended June 30, 2012 and 2011, respectively. The increases for both periods were primarily driven by increased payment processing costs and credit card chargebacks associated with our commerce revenue.
As a percentage of revenue, sales and marketing expenses were 43.9% and 42.9% in the three and six months ended June 30, 2012, compared to 42.7% and 40.5% for the same periods in the prior year.
PRODUCT RESEARCH AND DEVELOPMENT. Our product research and development expenses include costs associated with design, development and enhancement of our technology platforms and related systems. Research and development costs are expensed as incurred, except certain internal-use software development costs eligible for capitalization and costs directly associated with preparing a client website launch eligible to be deferred and amortized over the life of the sites associated revenue streams. Product research and development expenses were $15.4 million and $18.1 million for the three months ended June 30, 2012 and 2011, respectively. Product research and development expenses were $31.4 million and $33.7 million for the six months ended June 30, 2012 and 2011, respectively. The decreases in both periods were primarily due to a reduction in workforce related costs.
As a percentage of revenue, product research and development expenses were 17.0% and 16.3% in the three and six months ended June 30, 2012, compared to 19.5% and 17.7% for the same periods in the prior year.
GENERAL AND ADMINISTRATIVE. Our general and administrative expenses primarily include executive, finance, human resources and other administrative workforce and other related expenses, fees for professional services, bank fees, insurance costs and non-income related taxes. General and administrative expenses were $11.9 million and $10.9 million for the three months ended June 30, 2012 and 2011, respectively. General and administrative expenses were $24.5 million and $21.6 million for the six months ended June 30, 2012 and 2011, respectively. The increases in both periods mainly due to higher workforce related costs and professional fees.
As a percentage of revenue, general and administrative expenses were 13.1% and 12.7% for the three and six months ended June 30, 2012, compared to 11.7% and 11.3% for the same periods in the prior year.
DEPRECIATION AND AMORTIZATION. Our depreciation and amortization expenses include the depreciation of computer equipment, office furniture, the amortization of purchased and internally developed software and leasehold improvements. Computer equipment, software and furniture are depreciated under the straight-line method using three to seven year lives and leasehold improvements are amortized over the shorter of the life of the asset or the remaining length of the lease. Depreciation and amortization expense was $5.0 million and $5.6 million for the three months ended June 30, 2012 and 2011, respectively. Depreciation and amortization expense was $10.3 million and $11.0 million for the six months ended June 30, 2012 and 2011, respectively.
As a percentage of revenue, depreciation and amortization was 5.4% and 5.3% for the three and six months ended June 30, 2012, compared to 6.0% and 5.7% for the same periods in the prior year.
AMORTIZATION OF ACQUISITION-RELATED INTANGIBLES. Amortization of acquisition-related intangibles consists of the amortization of intangible assets such as customer relationships, technology and trade names acquired in business combinations. Amortization of acquisition-related intangible assets was $1.7 million and $2.2 million for the three months ended June 30, 2012 and 2011, respectively. Amortization of acquisition-related intangible assets was $3.6 million and $4.3 million for the six months ended June 30, 2012 and 2011, respectively. The decrease for the six months ended June 30, 2012, was driven primarily by intangible assets becoming fully amortized and the impairment recorded in the fourth quarter of 2011, as reported in the 2011 Form 10-K.
As a percentage of revenue, amortization of acquisition-related intangibles was 1.9% and 1.8% for the three and six months ended June 30, 2012, compared to 2.4% and 2.3% for the same periods in the prior year.
INTEREST INCOME. Our interest income represents the total of interest income on our cash, cash equivalents, short-term investments and certain long-term investments. Interest income was $1.0 million and $1.8 million for the three months ended June 30, 2012 and 2011, respectively. Interest income was $2.1 million and $3.2 million for the six months ended June 30, 2012 and 2011, respectively.
INTEREST EXPENSE. Our interest expense includes the total of cash and non-cash interest expense attributable to our outstanding convertible debt. For the three months ended June 30, 2012, interest expense was $2.3 million, which included $0.5 million of debt financing cost amortization, compared to interest expense of $2.2 million, which included $0.5 million of debt financing cost amortization, for the same period in the prior year. For the six months ended June 30, 2012, interest expense was $4.5 million, which included $1.0 million of debt financing cost amortization, compared to interest expense of $4.5 million, which included $1.0 million of debt financing cost amortization, for the same period in the prior year.
OTHER INCOME (EXPENSE), NET. Our other income (expense), net includes foreign currency transaction gains and losses, asset disposal gains and losses, other-than-temporary impairment of investments and dividend income. Other income (expense), net was income of $1.0 million and $0.7 million for the three months ended June 30, 2012 and 2011, respectively. Other income (expense), net was income of $0.7 million and $0.5 million for the six months ended June 30, 2012 and 2011, respectively. The increase in other income is primarily driven by an increase in dividend income.
INCOME TAXES. For the three months ended June 30, 2012 and 2011, our tax expense was $0.6 million and our tax benefit was $0.2 million, respectively. For the three months ended June 30, 2012, our tax expense consisted of approximately $1.5 million of U.S. tax expense and $0.9 million of foreign tax benefit. Both the US tax expense and the foreign tax benefit were largely due to provision-to-return items, recorded as discrete events in the current quarter. For the three months ended June 30, 2012 and 2011, the tax rate was 73.8% and (108.2%), respectively. The high tax rate for the current quarter was due to the discrete items and the negative tax rate for the comparative quarter in the prior year was due to the reduction in the estimated annual effective tax rate.
For the six months ended June 30, 2012 and 2011, our tax expense was $1.6 million and $1.7 million, respectively. For the six months ended June 30, 2012, our tax expense consisted of approximately $1.3 million of U.S. tax expense and $0.3 million of foreign tax expense. For the six months ended June 30, 2012 and 2011, the tax rate was 24.5% and 19.0%, respectively.
CONF CALL
Ed Merritt - Vice President of Investor Relations
Welcome to Digital River's fourth quarter 2009 earnings call. I’m Ed Merritt, Digital River’s Vice President of Investor Relations. On the call today is Joel Ronning, our Chief Executive Officer, and Tom Donnelly, our Chief Financial Officer.
I’d like to remind you that statements made during the course of this conference call that are not historical facts are forward-looking in nature. These statements relate to the company’s future growth and financial results and may contain the words believes, anticipates, expects, and similar words. These statements involve known and unknown risks, uncertainties, and other factors that which may cause actual results to differ materially from expectations.
For a detailed discussion of these risk factors and uncertainties, please refer to the company’s filings with the Securities & Exchange Commission. A webcast of our call today will be available for a period of two weeks on the investor relations section of Digital Rivers’ corporate website. With that I’d like to turn the call over to Joel Ronning.
Joel A. Ronning - Chief Executive Officer & Director
I’m pleased to report we closed 2009 with a tremendous fourth quarter. Our results are just one of the reasons why I continue to be very bullish about the future growth and profitability of the company. We have a solid strategy in place that continues to prove successful. Our core top line growth is returning to historical levels. We have a strong pipeline of new clients and new products and we have a great team in place committed to executing against our 2010 operating plan.
During the call today I will touch on each of these points as part of a larger discussion on our fourth quarter performance in the 2010 plan. Then I will turn the call over to Tom for an update on our financial results. To start off, I’m pleased to report we not only did a great job growing revenue in the fourth quarter, we hit a record level nearly $105 million. We increased our core revenue which excludes Symantec 26% year-over-year exceeding our guidance of 16% to 18% growth.
For the first time since the recession hit, we’re seeing growth rates return to our business that are in line with the 2007, 2008 organic growth rates. This is a strong testament to the actions we began taking several quarters ago when the global recession hit. I’d like to personally thank our associates who have been committed to this objective, which is deliver on our strategy and accelerated growth in our business.
We are particularly pleased with these results given that we managed this growth while Symantec began to move its business in house. We expected Symantec would be fully transitioned off our platform by June 30th when our contract expires. Tom will provide some financial details around this transition in a few minutes.
We’ve taken this shift in our relationship with Symantec as an opportunity to thoroughly review our business. During the past several quarters our executive team has been formulated our 2010 operating plan which focuses on two key areas, revenue growth and operational excellence and stability. I’d like to spend a few minutes talking about our business plan and progress to date in each of these areas.
As I just mentioned, the first goal of our business plan is to grow revenue. In essence, replacing anticipated loss revenues as quickly as possible. In 2010, we intend to accomplish this by strengthening and expanding existing client relationships and signing new deals. We will continue to emphasize our core vertical markets including software, consumer electronics, and games on a global basis. In 2009, some of our sales successes in these markets included new and expanded relationships with companies such as Microsoft, Citrix, Electronic Arts, Kodak, Pentax, Rim, Samsung, THQ, UbiSoft, and Western Digital just to name a few.
We also plan to accelerate our emphasis on a new vertical markets for certain product offerings to maintain our growth profile well beyond 2010. We already have a plan in place to support our growth. Late last year, we increased the size of our sales force adding new seasoned sales professionals in key markets. In addition, we enhanced our sales methodology and marketing support materials and expect to see increased production from this sales team beginning in the first half of 2010.
To further support our growth objective we will also continue to emphasize new product development particularly as it relates to driving new revenue streams for existing clients. Our strategy in 2009 was to leap frog competitive product offerings by developing functionality that drives client revenue. While launching over 20 new or enhanced capabilities we both achieved our objective, expanded our opportunities in new and complimentary markets. Essentially, what we have done is frozen the competitive markets; that’s what we believe.
The role out of our new products set has caused many prospects and clients to pause on commerce decisions. They are now considering the expanded functionality of our offering in place of competitive products or a less advanced more expensive in house solutions. In 2009, we launched important new business-to-business solutions. We rolled out Business Direct which enables our clients to sell directly to their enterprise clients in large volume through private online portals. We also went live with our channel partner network which allows resellers to automate the sales of multiple licenses to their business buyers through publishers’ stores.
We saw early success in the B-to-B market last year and will continue to focus on it in 2010. In addition to expanding our B-to-B solution last year we significantly enhanced our subscription technology with state of the art capabilities. We launched a mobile commerce offering and introduced limited edition ecommerce, a specialty outlet store that manages the inventory and sales of collectibles and clearance items. These are just a few of the many new products we rolled out in 2009 to increase the breadth of our offering and drive new business for our clients.
In 2010, we plan to further drive the adoption and monetization of these new product investments and shift our focus from expanding the breadth of enhancing the products to the depth of our product portfolio. This means continuing to focus on areas where our clients have indicated they have significant interest. Our 2010 plans including going even deeper into remote control by offering an easy to deploy shopping cart and more options for enterprises to speed their time to market. We also intend to expand our merchandising and product management capabilities for our B-to-B offering, enhance our enterprise search and global business intelligence capabilities, make end customer and administrative performance improvements, and introduce more localized payments and currencies to support our expansion into rapidly growing emerging markets.
Another important growth driver for us in 2010 will be acquisitions. Many of you have asked whether acquisition strategy is in light of the Symantec announcement and our current cash balance. Our strategy continues to be the same as in previous years, we look for opportunities to acquire products, services, contracts, or technologies that can help us expand our geographical footprint, our market opportunities, and product offerings. We’ll continue to prudent and methodical in our approach to evaluating new opportunities.
Our recent minority investment in SofTonic, a leading European software download site is a great example of this. By marketing our software catalog through SofTonic, we’re expanding our market presence in Europe and Latin America. At the same time, we’re delivering even more value to our global software clients by giving them access to a sizable population of European software consumers that browse the SofTonic.com site. To give you a sense of their scale they report 45.6 million site visitors on a monthly basis. Tom will provide some details about the terms of this new relationship in a few minutes.
The second goal of our business plan is operational excellence and scalability. In order to manage profit, balancing top line growth with bottom line profitability, we intend to aggressively drive the scalability and efficiency of our organization. To that end, we’ve launched several key initiatives as part of our 2010 operating plan. We expect these initiatives will help us optimize internal processes, improve overall client satisfaction, and ultimately reduce operating expenses as a percent of revenue over the long-term.
These initiatives are focused on the following areas: data center performance, we expect to be extending our leadership position by driving even better scalability, availability, and performance and accomplishing this at a lower cost per transaction while further distancing us from our competition; reporting, giving our client even easier access to key performance metrics so they can make faster decisions which drives marketing programs and ultimately increases sales; remote control, putting more of our powerful, self-service tools in the hands of clients which frees our client marketing managers to drive incremental revenue; and platform consolidation, reducing the number of platforms we maintain to ensure our technologies scales and web services architecture, increasing our R&D leverage and lowering our longer term operating cost.
In addition to executing these initiatives in near term, we are committed to reducing our cost structure over the long term. We now expect the timing of these payroll expense reductions to occur sometime in the second quarter when Symantec has transitioned the majority of their business to their internally developed system. As we said previously, the size of the final cost reductions will be aligned with our growth profile and our estimated time line to replace lost revenue.
What this means is that the faster we grow, the more resources we’ll need to support this growth. We’re going to be deliberate when reducing resources so as to not impact growth. We’re also committed to supporting Symantec in their migration to their internal platform which will require us to maintain all current sites until their transition is complete. Additionally, we’re working on a few large opportunities with other clients and prospects that will require added resources. These opportunities also influence our decision to move the business restructuring into the second quarter.
One of the core competencies of this organization is execution. We’ve demonstrated time and time again to our ability to execute to a plan. We expect 2010 will be no exception. As we kick off the year, we have a strong operating plan in place, we’ve have an expanded sales force focused on key markets and clients, our new business and product pipelines are healthy and our growth rate is returning to historical work levels. In short, we’re well positioned to accomplish our objectives for the coming year. Now for a recap of the fourth quarter financial results, I turn the call over to Tom.
Thomas M. Donnelly - Chief Financial Officer
Overall, we’re pleased with the results we delivered in the fourth quarter of 2009. Total revenue was $104.9 million and our non-Symantec revenue, which we will refer to as core revenue exceeded our expectations growing to $81.4 million. This growth represented an increase of about 26% compared to the same period last year and exceeded our guidance of a 16% to 18% increase.
Aided by a series of one time Microsoft Windows 7 promotions in the fourth quarter, Microsoft ended the full year as an 11.8% customer for us. We are extremely pleased with the results we’ve seen from the Microsoft relationship and continue to expand our business with them. We’re looking forward to a successful Office 2010 launch scheduled for the first half of the year.
Symantec revenue ended the fourth quarter at $23.5 million above our expectations. For the fourth quarter, Symantec revenue was 22.4% of total revenue and the direct contribution was 17.6%. Our international sales in the fourth quarter rose to 47.7% due to a mix change primarily related to the Symantec transition. Symantec’s early migration efforts have emphasized US sites and traffic. For the full year, international revenue was about 41.1% of total revenues.
Deepening client relationships also contributed to the success in the fourth quarter. In consumer electronics, we launched sites for Pentax and SiWii and expanded our relationship with Data Robotics, Phillips, and Seagate. In software we expanded or renewed our business with companies including Trend Micro, Computer Associates Autodesk, Quirk, and H&R Block.
For the full year, total revenue was $401.8 million with our core revenue growing 10.6% to approximately $289 million. As expected in the fourth quarter, expenses were higher sequentially as we maintained our resource levels in the quarter, reallocating people where possible to projects designed to replace anticipated lost revenue and to drive scale and efficiency in the second half of 2010. For example, we currently have larger teams focused on our largest accounts. Additionally, payment processing and customer services costs were higher on an increased transaction volume and paid search costs were up sequentially by over $1.5 million.
GAAP net income for the fourth quarter totaled $13.6 million or $0.36 per share and exceeded the high end of our guidance range by $0.14 per share. For the full year and in December 31, 2009, GAAP net income totaled $53 million or $1.41 per share. Due to the revenue mix change I discussed earlier, our full income tax rate dropped to about 21% for 2009.
Switching to non-GAAP results in the fourth quarter, non-GAAP net income totaled $15.3 million or $0.40 per share, $0.06 above our guidance range. For the year we delivered $1.80 per share in non-GAAP earnings. Capital expenses for the year were approximately $31.9 million, slightly below our guidance of $34 million. About half of this investment was related to the SAP implementation, data management and client reporting projects.
Turning to cash flow, net cash provided by operating activities for the 12 month period totaled approximately $137 million compared to $95.2 million in 2008. Excluding changes in working capital accounts, net cash flow from operations for the 12 month period was $97.7 million. This compared to $101.5 million for the similar period of 2008. You’ll also notice in the investing activities section on the statement of cash flows an investment during the quarter. On January 13th we announced a $26 million cash investment for a minority equity interest in SofTonic.
Under the terms of a separate commercial agreement, we will be the exclusive third party ecommerce provider for digital buy now software titles on the SofTonic site further expanding our market presence in Europe and Latin America. We ended the year with a very strong balance sheet and substantial liquidity holding approximately $501 million in cash and liquid investments including auction rate Securities.
Now let’s move on to our 2010 financial expectations. We expect core revenue to grow in the mid to upper teens each quarter throughout 2010. In the first quarter we expect total revenue to be between $96 million and $99 million. We expect GAAP net income of $0.05 to $0.10 per share and non-GAAP net income of $0.18 to $0.23 per share. We’re expecting core revenue between $80 million and $81 million in the first quarter. The first quarter core year-over-year revenue growth rate is declining slightly from the fourth quarter due to a series of one-time Microsoft Windows 7 promotions we managed in Q4, increased Q4 volume from consumer electronics and games, categories that benefit from holiday sales, and we have a moderately tougher comp in Q1 versus Q4 partially related to virus activity in Q1 of 2009.
As Joel mentioned earlier, we still don’t have details regarding the Symantec transition schedule but we are currently expecting first quarter revenue to be between $15 million and $18 million and second quarter revenue to be between $5 million and $10 million. The current contract ends on June 30, 2010 and we currently anticipate no revenue from them after this date.
Also note that costs associated with these revenues are much higher than historical levels as a percentage of revenue as we are still running most online marketing programs and are contractually obligated to operate all sites regardless of traffic levels. Accordingly, we do not currently plan to implement extensive restructuring in the first quarter and expect to maintain higher first half expenses similar to what we saw in Q4.
Since the October announcement, we’ve received many questions about the Symantec cost structure. Shareholders need to realize that a large component of our overall costs are fixed, in essence a partially fixed cost business model. When managing a business with expenses of this nature, we will either have to cut costs over time or grow into the fixed cost base to improve margins.
We currently anticipate recording restructuring charges of $500,000 in Q1 and between $4 million and $5 million in Q2. The charges relate to reductions in staff, costs associated with consolidating and eliminating certain technology platforms and other miscellaneous costs. We expect to begin realizing efficiency benefits from these changes beginning in the third quarter and the full financial benefit of these actions in the fourth quarter. We expect expense ratios begin to decline in the back half of the year and maintain our Q4 2010 non-GAAP operating margin view in the mid to upper teens. Long term we continue to see a path to drive non-GAAP operating profit margins back to the mid 20s.
We expect full year capital expenditures of about $28 million and full year depreciation expense of $27 million ramping from $6 million in Q1 to $7 million in Q4. Quarterly stock compensation expense is expected to be approximately $5.2 million. We currently expect interest income to be about $2.6 million for the year. Our full year GAAP tax rate is expected to be 27% and we will continue to use a non-GAAP tax rate of 27%. Weighted average shares outstanding in Q1 are anticipated to be $38.3 million and for the full year we estimate 39 million shares. Thanks and now I’ll turn the call back over to Joel.
Joel A. Ronning - Chief Executive Officer & Director
Before we take your questions I want to recap a few of the key messages you’ve heard today about driving the growth and profitability of Digital River. To start our plan to be the global leader in ecommerce hasn’t changed one bit. Our strategy has proven very successful over the years and we’ll continue to execute on that strategy growing our business and our core markets while pursuing complimentary markets over time. We closed a lot of new business in 2009 and expect similar results in 2010. In addition, we also have a great series of new products that will help us ensure continued growth going forward.
We also have an operating plan for 2010 that will not only drive core revenue growth but also make our long-term business model more efficient. We intend to take out costs of our operations while at the same time improving our scalability. Finally, we have the right people in places to successfully execute on our business plan. We’ve put together a team of ecommerce and emarketing experts unparalleled in the industry. We have the right talent to drive revenue and earnings growth in 2010 and beyond. With that, I’d like to open the call up for your questions.
|
|
Fund Letters
