NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES | 12 Months Ended |
Dec. 31, 2013 |
NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES | ' |
NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES | ' |
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1. NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES |
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We provide end-to-end global commerce, payments and marketing solutions to companies that want to sell their products and services online. We were incorporated in 1994 and began building and operating online stores for our clients in 1996. We generate revenue through revenue sharing, transaction fees, monthly service charges and fees for services charged to customers that utilize our solutions. |
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Principles of Consolidation and Classification |
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The consolidated financial statements include the accounts of Digital River, Inc. and our wholly owned subsidiaries. All material intercompany balances and transactions have been eliminated in consolidation. |
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Use of Estimates |
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The preparation of financial statements in accordance with United States generally accepted accounting principles (U.S. GAAP) 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. Actual results could differ from those estimates. |
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Foreign Currency Translation |
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Substantially all of our foreign subsidiaries use the local currency of their respective countries as their functional currency. Assets and liabilities are translated at exchange rates prevailing at the balance sheet dates. Revenues, costs and expenses are translated at the average exchange rates for the reported period. Gains and losses resulting from translation are recorded as a component of "Accumulated other comprehensive income (loss)" within stockholders' equity. Losses resulting from foreign currency transactions were $1.3 million, $0.4 million and $1.5 million in 2013, 2012 and 2011, respectively, and are recorded within "Other income (expense), net". |
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We are exposed to market risk from changes in foreign currency exchange rates. Our risks relate to the effect of foreign currency exchange rate fluctuations on the U.S. dollar value of foreign currency denominated operating sales and expenses and exchange rate translation losses (or gains) associated with economic interests that are denominated in a foreign currency. The risk of translation losses due to foreign exchange volatility is partially mitigated by the use of foreign exchange forward contracts with maturities of less than three months. These derivative transactions are not designated as hedges and are adjusted to fair value through income each period. The principal exposures mitigated were the Euro, Australian dollar, British pound, Canadian dollar, Danish krone and Japanese yen currencies. For the years ended December 31, 2013, 2012 and 2011, we recorded a loss of $0.1 million, a gain of $0.1 million, and a loss of $0.3 million, respectively, on derivative settlements within "Other income (expense), net". We held no open foreign exchange forward contracts at December 31, 2013 and the notional amount of holdings at December 31, 2012 was $1.9 million. The gain (loss) on derivative settlements and the notional amounts held at the respective year ends are not material when compared to our net income (loss) and our overall cash and cash equivalents reported for the respective periods. |
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Our foreign currency contracts contain credit risk to the extent that our bank counterparties may be unable to meet the terms of the agreements. We minimize such risk by limiting our counterparties to major financial institutions of high credit quality. |
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Cash and Cash Equivalents |
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We consider all short-term, highly liquid investments and money market accounts, that are readily convertible into known amounts of cash and that have original or remaining maturities of three months or less at the date of purchase to be cash equivalents. |
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Short-Term Investments |
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Our short-term investments consist of debt securities that are classified as available-for-sale and are carried on our balance sheets at their market value with cumulative unrealized gains or losses recorded net of tax as a component of "Accumulated other comprehensive income (loss)" within stockholders' equity. We classify all of our available-for-sale securities, except for our auction rate securities, as current assets, as these securities represent investments available for current corporate purposes. Upon the sale of a security classified as available-for-sale, the amount reclassified out of "Accumulated other comprehensive income (loss)" into earnings is based on the specific identification method. |
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Allowance for Doubtful Accounts |
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We use estimates in determining our allowance for doubtful accounts which are based on our historical experience and current trends. We must estimate the collectability of our billed accounts receivable. We analyze accounts receivable and consider our historical bad debt experience, customer credit-worthiness, current economic trends and changes in our customer payment terms when evaluating the adequacy of the allowance for doubtful accounts. We must make judgments and estimates in connection with the allowance in any accounting period. The uncollectible portion of receivables is charged against the allowance for doubtful accounts when collection efforts have ceased. |
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Prepaid Expenses and Other |
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Prepaid expenses and other are largely comprised of prepaid licenses, deferred set-up costs, deferred financing costs, notes receivable, value added taxes, income tax receivable and restricted cash. Restricted cash consists of cash and cash equivalents that are held in escrow accounts, or are otherwise restricted by agreements with third parties, for a particular purpose. As of December 31, 2013 and 2012, we had $3.6 million and $0.4 million of restricted cash, respectively. In 2012, $0.6 million of notes receivable, lent through a short term promissory note, was deemed to be uncollectable and a full reserve was recorded against the note at both December 31, 2013 and 2012, respectively. |
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Property and Equipment |
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Property and equipment is recorded at cost, less accumulated depreciation and amortization. Computer equipment, office furniture and purchased and internally developed software are depreciated or amortized under the straight-line method using estimated useful lives of three to seven years and leasehold improvements are depreciated over the shorter of the asset life or remaining length of the lease. Useful lives are based on our estimates of the period of time over which the assets will generate revenue or benefit our business. We review assets with definite lives for impairment whenever events or changes in circumstances indicate that the value we are carrying on our financial statements for an asset may not be recoverable. Our evaluation considers non-financial data such as changes in the operating environment and business strategy, competitive information, market trends and operating performance. Property and equipment at December 31 consisted of the following (in thousands): |
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| | 2013 | | 2012 | | | | |
Computer hardware and software | | $ | 174,928 | | $ | 155,916 | | | | |
Furniture, fixtures and leasehold improvements | | | 12,339 | | | 12,040 | | | | |
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Total property and equipment | | | 187,267 | | | 167,956 | | | | |
Accumulated depreciation and amortization | | | (133,497 | ) | | (114,858 | ) | | | |
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Net property and equipment | | $ | 53,770 | | $ | 53,098 | | | | |
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Depreciation and amortization expense from continuing operations was $22.1 million, $20.2 million and $22.0 million in 2013, 2012 and 2011, respectively. |
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Repairs and maintenance costs are charged directly to expense as incurred. Major renewals or replacements that substantially extend the useful life of an asset are capitalized and depreciated. |
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Software Development |
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Costs to develop software for internal use are capitalized when the criteria for capitalization under U.S. GAAP is met. This criteria includes that the project must be approved by senior management, costs must be related to new development or significant upgrades or enhancements to existing software, and completion and future utilization of the development must be probable. Costs related to development that do not meet these criteria are expensed in the period incurred. Capitalized costs of completed projects are amortized over the estimated useful life of the software. For the years ended December 31, 2013 and 2012, net software for internal use was $16.3 million and $18.6 million, respectively. |
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Goodwill |
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We have a single reporting unit. We complete our goodwill impairment analysis annually as of October 1, or more frequently if events or circumstances occur that would more likely than not reduce the fair value of our single reporting unit below its carrying amount. |
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In conducting our impairment analysis, we first assess qualitative factors to determine whether it is more likely than not that the fair value of our single reporting unit is less than its carrying amount, including goodwill. If after assessing all relevant qualitative factors, we determine that it is more likely than not that the fair value of our single reporting unit is less than its carrying amount, a blended income and market approach is then used to determine the fair value of our sole reporting unit and any applicable impairment charge. The application of goodwill impairment tests requires management judgment for many of the inputs. Key assumptions included in the impairment test include our revenue growth rate, discount rate, and estimates of our future cash flows. Changes in these estimates could result in additional impairment of goodwill in a future period. Any impairment charges reflect our view of anticipated risks based on our expectations of market and general economic conditions. See Note 5—Goodwill and Intangible Assets, for further details regarding our 2013 qualitative impairment analysis and 2012 quantitative analysis. |
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Intangible Assets |
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We amortize certain definite lived intangibles over their useful lives. Useful lives are based on our estimates of the period of time over which the assets will generate revenue or benefit our business. We review assets with definite lives for impairment whenever events or changes in circumstances indicate that the value we are carrying on our financial statements for an asset may not be recoverable. Our evaluation considers non-financial data such as changes in the operating environment and business strategy, competitive information, market trends and operating performance. If there are indications that an impairment may have occurred, we compare an undiscounted cash flow analysis to the carrying value of the assets. If the carrying amount of the asset exceeds the undiscounted cash flows, we measure the amount of the impairment by comparing the carrying amount of the asset to its fair value. See Note 5—Goodwill and Intangible Assets, for further details. |
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Long-Term Investments |
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Our long-term investments consist of market basis equity investments, cost method equity investments and auction rate securities. The market basis equity investments and auction rate securities are classified as available-for-sale and are carried on our balance sheet at their market value with cumulative unrealized gains or losses recorded net of tax as a component of "Accumulated other comprehensive income (loss)" within stockholders' equity. Upon the sale of a security classified as available-for-sale, the amount reclassified out of "Accumulated other comprehensive income (loss)" into earnings is based on the specific identification method. |
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We also have equity investments that are accounted for under the cost method included in long-term investments. We review the key characteristics of our investments and their classification in accordance with U.S. GAAP on an annual basis, or when indications of potential impairment exist. If a decline in the fair value of a security is deemed by management to be other-than-temporary, we write down the cost basis of the investment to fair value, and the amount of the write-down is included in net earnings. |
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Other Assets |
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The following table summarizes our other assets as of December 31 (in thousands): |
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| | 2013 | | 2012 | | | | |
Debt financing costs, net | | $ | 1,410 | | $ | 3,323 | | | | |
Other | | | 657 | | | 990 | | | | |
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Total other assets | | $ | 2,067 | | $ | 4,313 | | | | |
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Debt financing costs, net include broker, legal, accounting and other fees associated with entering into our 2010 and 2004 senior convertible notes. We amortize debt financing costs over the original term of the debt. |
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Other Current Liabilities |
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The following table summarizes our other current liabilities as of December 31 (in thousands): |
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| | 2013 | | 2012 | | | | |
Accrued expenses | | $ | 29,082 | | $ | 30,036 | | | | |
Current portion of debt | | | 10,016 | | | 1,256 | | | | |
Sales, value-added and transaction taxes | | | 15,534 | | | 18,507 | | | | |
Current deferred and other income taxes | | | 1,267 | | | 350 | | | | |
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Total other current liabilities | | $ | 55,899 | | $ | 50,149 | | | | |
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Discontinued Operations |
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We separately classify the results of operations and the assets and liabilities of material components or businesses that have been sold, disposed, or that meet the criteria for held for sale within our Consolidated Statements of Operations and Consolidated Balance Sheets. As allowed under U.S. GAAP, we do not reclassify the cash flows of discontinued businesses within our Consolidated Statements of Cash Flows. In determining if the criteria for separate presentation is met, we assess if the operations and cash flows of the business have been, or will be, eliminated from ongoing operations and whether we will have any significant continuing involvement in the operations of the business after the disposal transaction. The presentation of corresponding prior periods is updated to conform to the current period presentation. See Note 15—Discontinued Operations for further discussion. |
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Comprehensive Income (Loss) |
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Comprehensive income (loss) includes revenues, expenses, and gains and losses that are excluded from net earnings under GAAP. Items of comprehensive income (loss) are unrealized gains and losses on investments and foreign currency translation adjustments which are added to net income (loss) to compute comprehensive income (loss). Comprehensive income (loss) related to cumulative translation adjustments has no tax expense or benefit as these funds are indefinitely invested. |
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The following table summarizes the changes in accumulated other comprehensive income (loss), net of tax, by component as of December 31 (in thousands): |
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| | Foreign currency | | Unrealized gain | | Total | |
translation | (loss) on |
adjustment | investments |
Balance as of December 31, 2010 | | $ | 5,074 | | $ | (4,502 | ) | $ | 572 | |
Other comprehensive income before reclassifications | | | (9,004 | ) | | 817 | | | (8,187 | ) |
Reclassification adjustment for net gains included in net income | | | — | | | (349 | ) | | (349 | ) |
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Net current period other comprehensive income (loss) | | | (9,004 | ) | | 468 | | | (8,536 | ) |
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Balance as of December 31, 2011 | | $ | (3,930 | ) | $ | (4,034 | ) | $ | (7,964 | ) |
Other comprehensive income before reclassifications | | | 6,495 | | | (1,688 | ) | | 4,807 | |
Reclassification adjustment for net gains included in net income | | | — | | | (13 | ) | | (13 | ) |
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Net current period other comprehensive income (loss) | | | 6,495 | | | (1,701 | ) | | 4,794 | |
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Balance as of December 31, 2012 | | $ | 2,565 | | $ | (5,735 | ) | $ | (3,170 | ) |
Other comprehensive income before reclassifications | | | 1,155 | | | 6,558 | | | 7,713 | |
Reclassification adjustment for net gains included in net income | | | — | | | (11 | ) | | (11 | ) |
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Net current period other comprehensive income (loss) | | | 1,155 | | | 6,547 | | | 7,702 | |
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Balance as of December 31, 2013 | | $ | 3,720 | | $ | 812 | | $ | 4,532 | |
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The following table summarizes the reclassifications out of accumulated other comprehensive income (loss) for the year ended December 31, 2013 (in thousands): |
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Reclassification out of Accumulated other comprehensive income | | Amount reclassified | | Affected line item in the | | | | | |
from accumulated other | Consolidated Statement of | | | | | |
comprehensive income | Operations | | | | | |
Realized gains (losses) on investments | | | | | | | | | | |
| | $ | 18 | | Other income (expense), net | | | | | |
| | | (7 | ) | Income tax benefit (expense) | | | | | |
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| | $ | 11 | | Net income (loss) | | | | | |
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Revenue Recognition |
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We recognize revenue from services rendered once all the following criteria for revenue recognition have been met: (1) persuasive evidence of an agreement exists; (2) the services have been rendered; (3) the fee is fixed and determinable; and, (4) collection of the amounts due is reasonably assured. |
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We sell both digital and physical products on behalf of our customers and charge transaction fees based on a percentage of the sale price. These revenues are recorded net of related costs of sales as generally our clients control product choices and are subject to inventory risks. Revenue for these sales is recognized upon fulfillment, when title and significant risk of ownership passes to the end customer. |
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We provide payment processing services to merchants and charge monthly service and transaction based fees. Transaction fees are recognized in the period in which the transaction occurs. Service fees are recognized over the covered period. |
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When we provide additional deliverables in connection with our e-commerce and payments solution arrangements, including site set up services, these services do not meet the criteria of separate units of accounting as the services do not have value to the client on a standalone basis. Therefore we account for these deliverables as one unit of accounting and recognize them over the term of the associated contract. When we provide client services on a standalone basis, such as website design, custom development, data backup, analytical marketing, affiliate marketing and email marketing services, revenue is recognized as the services are provided. |
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Shipping revenue is recorded net of any associated costs. Taxes assessed by a governmental authority that are directly imposed on a revenue-producing transaction between a seller and a customer are not recorded as revenue. |
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Credit Card Chargeback Reserve |
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We use estimates based on historical experience and current trends to determine accrued chargeback expenses. The following table illustrates our provision for chargeback losses as a percentage of revenue for 2013, 2012 and 2011 (in thousands, except percentages): |
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Revenue | | $ | 389,679 | | $ | 370,496 | | $ | 376,469 | |
Provision for Credit Card Chargebacks | | | 332 | | | 688 | | | 452 | |
Provision for Credit Card Chargebacks as a % of Revenue | | | 0.1 | % | | 0.2 | % | | 0.1 | % |
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Determining appropriate reserves for chargeback transactions is an inherently uncertain process. The reserves are maintained at a level we deem appropriate to provide for losses incurred on revenue earned in each period. |
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Stock-Based Compensation Expense |
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We account for share-based payments made to our employees and directors, including stock options and employee stock purchases made through our Employee Stock Purchase Plan (ESPP) based on estimated fair values. The fair value of each stock option and employee stock purchase made through our ESPP are estimated on the date of grant using the Black-Scholes option pricing model. The fair value of restricted stock, restricted stock units and performance shares is determined based on the closing price of our common stock on the date of grant. We estimated the fair value of performance share units with a market condition granted to certain executives on the date of grant using the Monte Carlo valuation model. |
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Compensation expense for all share-based payment awards is recognized over the requisite service period. Stock-based compensation expense recognized in our Consolidated Statements of Operations is based on awards ultimately expected to vest and thus has been reduced for estimated forfeitures. Forfeitures are estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Benefits of tax deductions in excess of recognized stock-based compensation expense are reported as a financing cash flow. |
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Severance |
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We begin to accrue for severance and outplacement costs when all of the criteria for one-time employment termination benefits are met, which is generally at the time of communication to the employee. Total restructuring related severance expense for the years ended December 31, 2013, 2012 and 2011 was $5.8 million, $1.7 million, and $0.0 million respectively. |
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Advertising Costs |
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The costs of advertising are charged to sales and marketing expense as incurred. We incurred advertising expense of $0.2 million, $0.2 million and $0.4 million in 2013, 2012 and 2011, respectively. |
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Income Taxes |
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Deferred income taxes reflect the tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. We record deferred tax assets for favorable tax attributes, including tax loss carryforwards. We currently have U.S. tax loss carryforwards, including acquired operating tax loss carryforwards, and a lesser amount of acquired foreign operating tax loss carryforwards. We evaluate the need for a valuation allowance against the deferred tax assets on a quarterly basis. |
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Recent Accounting Pronouncements |
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ASU 2013-11—Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists: In July 2013, the FASB issued ASU 2013-11, which requires an entity to present unrecognized tax benefits as a reduction of the deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward, if net settlement is required or expected. To the extent that net settlement is not required or expected, the unrecognized tax benefit must be presented as a liability. The assessment of whether a deferred tax asset is available is based on the unrecognized tax benefit and deferred tax asset that exist at the reporting date and should be made presuming disallowance of the tax position at the reporting date. ASU No. 2013-11 is effective for reporting periods beginning after December 15, 2013, and should be applied prospectively to all unrecognized tax benefits that exist at the effective date. Because this standard only affects the presentation of unrecognized tax benefits and not the measurement of an unrecognized tax benefit, we do not expect this standard to have a material impact on our Consolidated Financial Statements. |
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ASU 2013-02—Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income: In February 2013, the FASB issued ASU 2013-02, which required entities to provide information about the amounts reclassified out of accumulated other comprehensive income by component. In addition, entities are required to present, either in the financial statements or footnotes, significant amounts reclassified out of accumulated other comprehensive income by the respective line items of net income but only if the amount reclassified is required under U.S. GAAP to be reclassified to net income in its entirety in the same reporting period. For other amounts that are not required under U.S. GAAP to be reclassified in their entirety to net income, entities are required to cross-reference to other disclosures required under U.S. GAAP that provide additional detail on these amounts. ASU 2013-02 is effective prospectively for fiscal periods beginning after December 15, 2012. We have adopted the new guidance in ASU 2013-02 as of the period ended March 31, 2013, and its adoption did not have a material impact on our Consolidated Financial Statements. |
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We have determined that all other recently issued accounting standards will not have a material impact on our Consolidated Financial Statements, or do not apply to our operations. |
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Reclassifications |
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Certain items in the prior years' Consolidated Statements of Operations and Consolidated Balance Sheets have been reclassified for comparative purposes to conform to the current year presentation. |
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The results of the operations of CustomCD, Inc. (CustomCD) and Digital River Education Services, Inc. (DRES), which were sold on September 30, 2013 and October 1, 2013, respectively, have been classified within Discontinued Operations in our Consolidated Statements of Operations for the year ended December 31, 2013. The operations of these entities in the corresponding years ended December 31, 2012 and 2011 have been reclassified into Discontinued Operations for comparative purposes to conform to the current year presentation. In addition, the assets and liabilities of CustomCD and DRES in the December 31, 2012 Consolidated Balance Sheet have been reclassified and separately presented as current assets and current liabilities of discontinued operations. |
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Through December 31, 2012, we reported payment processing fees, chargebacks, and directly related personnel expenses within the "Sales and marketing" and "General and administrative" line items. We have reclassified these expenses to the "Direct cost of services" line as these costs are associated directly with services rendered. For the years ended December 31, 2012 and 2011, excluding amounts related to CustomCD and DRES which have been reclassified to discontinued operations, we have reclassified $55.5 million and $49.0 million, respectively, previously reported as "Sales and marketing" and $2.0 million and $2.1 million, respectively, previously reported as "General and administrative" to "Direct cost of services". The reclassifications did not have an effect on reported consolidated net income (loss). |
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