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Digital River, Inc. (NASDAQ:DRIV)

Q4 2012 Earnings Call

February 6, 2013 4:45 PM ET

Executives

Ed Merritt – VP, Business Development, Treasury and IR

Tom Madison – Interim CEO and Lead Director

Tom Donnelly – President and COO

Stefan Schulz – CFO

Analysts

Gene Munster – Piper Jaffray

Harris Heyer – Credit Suisse

Rob Breza – RBC Capital Markets

Shyam Patil – Raymond James

Craig Nankervis – First Analysis

Greg Schauer – Robert W Baird

Operator

Good day, ladies and gentlemen. Thank you for standing by. Welcome to the Digital River Fourth Quarter 2012 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session, and instructions will follow at that time. (Operator Instructions) As a reminder, this conference call is being recorded.

I would now like to introduce our host for today, Mr. Ed Merritt, Vice President of Investor Relations. Sir, please go ahead.

Ed Merritt

Thanks and welcome, everyone, to Digital River’s fourth quarter 2012 earnings call. I am Ed Merritt, Digital River’s Vice President of Treasury, Investor Relations and Business Development. And joining us on the call today from Digital River is Tom Madison, our Chairman and Interim CEO; Tom Donnelly, our President and Chief Operating Officer; and Stefan Schulz, our Chief Financial Officer.

I’d like to remind you that there may be statements made during the course of this conference call that are not historical facts and are forward-looking in nature. These statements may relate to the company’s future growth and financial results and contain the words believe, anticipate, expect, guidance, and similar words. These forward-looking statements involve both known and unknown risks, uncertainties, and other factors which may cause actual results to differ materially from expectations.

For a detailed review of these risks, please refer to the company’s filings with the Securities and Exchange Commission. Also a webcast of our call today will be available on the Investor Relations section of Digital River’s corporate website.

With that, I’ll turn the call over to Tom Madison.

Tom Madison

Thanks, Ed, and thanks to all of you for joining us today. In a few minutes, I’ll turn the call over to Tom Donnelly to provide a recap of our 2012 business results and details on our plans as we enter 2013, then Stefan Schulz will discuss our fourth-quarter financial results and give you some guidance on the first quarter of 2013.

To begin, I’d like to provide a brief review of our fourth quarter performance and then spend a few minutes updating you on some key initiatives we discussed during our last earnings call. Overall, we had a great fourth quarter, delivering revenue of $101 million and non-GAAP EPS of $0.31 per share. These results were above our guidance for revenue, which was $96 million to $100 million, and we ended the quarter at the top end of our guidance for non-GAAP EPS, which was $0.25 to $0.31 per share.

Regarding the fourth quarter, I also want to mention the goodwill impairment we recognized. As part of our required annual review of goodwill, it was determined that a non-cash impairment was warranted due to the variance between our enterprise value and our book value. It’s important to point out, however, that this is a non-cash charge and will not affect our future operations. Stefan will provide more details on this in his comments.

Despite solid results in the fourth quarter, we continue to face some headwinds as we move into ‘13. These include continuing uncertain macroeconomic conditions, such as the fiscal cliff discussions in the U.S. and relatively high unemployment globally. Additionally, we have identified some investments we believe are necessary to bring our technology infrastructure to where we want and need it to be.

To be clear, we know we have work to do in order to make our business more flexible in a rapidly changing marketplace, and the Board and management are clearly aligned and focused on the execution of our plan to address this. As you know, we’ve engaged in a search for a permanent CEO and we’ve been working intensely with Spencer Stuart, a leading executive search firm. We’re considering external and internal candidates and have made significant progress. This is the Board’s top priority, and we look forward to having more to say on this topic in the not-too-distant future.

While a new CEO will obviously play a key role in Digital River’s long-term strategy, our team is working diligently to ensure that we don’t miss a beat in the meantime, continuing to deliver on our commitments to our existing customers in our efforts to further strengthen the business.

We have a platform that currently manages over $13 billion in transactions. It’s a dependable global solution that has grown our business to where we are today. But now it’s time to take this solution to the next level, and it’s critical for us to make some key changes and investments, ensuring we’re well positioned for the long term.

On last quarter’s call, we discussed the key actions we’re taking. Importantly, we’ve already made significant progress in these areas. Tom Donnelly will provide more detail, but to recap, the first action we talked about was continuing to re-architect our core global commerce platform and underlying databases to further increase stability and performance. To that end, we’ve begun moving more of our technology into the cloud and we have re-architected some of our data centers.

The second action is our transaction to a more modular plug-and-play e-commerce system. Based upon client and market feedback, we know there is a broad base of customers who favor an a la carte approach to products and services, and the pricing flexibility that comes with it. That’s why we’re executing a detailed plan for 2013 designed to create flexible and modular technology support that allows us to quickly adapt to client needs. The third action we talked about is lowering operating expenses, which includes creating a flatter and more focused organization. Since our last earnings call, we began taking some important steps in this area, including, one, divesting and restructuring some underperforming non-core assets; two, closing some satellite offices; and three, reducing our global head count, including a reduction in certain senior executive positions.

At the same time, we continued to bolster certain growth areas. On January 11, we completed the acquisition of Canadian-based LML Payment Systems, which positions us well to capitalize on our success in online payment processing and reaffirms our commitment to the payment space.

Now, moving on to the first quarter, Stefan will give you detailed first quarter guidance in a few minutes, but I want to provide you with a quick preview. First-quarter revenue is essentially flat to the same period last year, inclusive of LML revenue and non-GAAP expenses in the first quarter are planned to increase above last year’s level, primarily due to the acquisition of LML.

While on the topic of guidance, I would like to make a point that although we have a very solid operating plan for 2013, we’re only providing a first quarter outlook at this juncture. Given the various initiatives underway and our pending search for a permanent CEO, we believe this is a prudent approach.

With that, let me sum up with the following points: We have a lot of work to do in 2013 and a solid plan to take us where we need to go. The technology investments we’ve identified are essential, positioning the company for renewed growth in the long term. To our advantage, we are executing on these actions from a strong business foundation that includes, one, a base of clients representing some of the world’s most impressive brands; two, more than 15 years of global commerce experience; three, a deep bench of leaders who are energized and up to the challenge; and four, a solid financial profile.

We ended 2012 with about $740 million of cash and investments. We’re confident we’re on the right path and believe our actions will help us return and sustain our topline growth in 2014 and beyond and above all else, increase shareholder value in the years ahead.

With that, I’d like to turn it now over to Tom Donnelly.

Tom Donnelly

Thanks, Tom, and thank you for joining the call today. For the quarter, our revenue and earnings were largely in line with guidance. From a revenue perspective, enterprise commerce came in at about $82 million, in line with expectations. Remember 2011’s fourth quarter included about $7 million of revenue from a seasonally strong game launch schedule, which did not repeat this year. Also, we continued to see strong revenue growth from World Payments, which grew about 65% in the quarter. We remain deeply committed to this space, which is a core service for all our commerce clients.

Moving on to new business, in the physical commerce space we expanded our relationship with Samsung where we launched their US online store in the fourth quarter. We added in-app commerce to our Western Digital relationship and we moved Logitech into more international markets. In payments, most notably we closed on our acquisition of LML Payment Systems. With this transaction complete, we will now turn to integrating LML’s capabilities and expanding their service globally. Combined, we expect to process well over $20 billion in online transactions in 2013.

From a new business perspective in the payments area, we signed agreements in the quarter with Thomson Reuters to process payments in Australia and New Zealand. We won a contract with PartyLite for their pan-European business and with Bioventus for their European, Canadian, and Australian businesses.

In the digital commerce space, we expanded our business with NVIDIA, Trend Micro, and Nuance, who is using our subscription capabilities for certain products in the U.S., the U.K., France, and Germany. Also in the digital commerce space, we have acquired new business with Enfour, who is leveraging DR’s app-store practice and market-stream capabilities, and VMware, where we signed an exclusive 30-month contract extension.

We have been very busy supporting Microsoft since our last earnings call. In October, we supported the global release of the Windows 8 operating system and the initial launch of the new Surface tablet. In addition, we successfully supported Microsoft’s efforts through the important holiday selling season.

Since our last earnings call, we have launched Microsoft Store in more than 140 new geographies across the globe. We expect to finish rolling out the remaining geographies early in the second quarter. Finally, in late January we successfully supported the global launch of Office 2013 across MicrosoftStore.com. We are excited about the opportunities ahead with this very strategic client.

Now let me give you some color on our focus areas, which we outlined in our last earnings call. They largely fit into two categories, technology and efficiency. From a technology perspective, we have a commerce platform that processed over $13 billion of online transactions in 2012. We took orders in over 196 countries and over 40 languages. It’s a very good platform, but it’s now time to make it even better.

As Tom Madison mentioned, we intend to strengthen and update our core global commerce platform in 2013 and continue the transition to a modular plug-and-play ecosystem. Our IT teams are squarely focused on delivering operating environments that are virtualized and more flexible. We’re creating a robust catalogue of APIs, enabling us to onboard clients faster and open up a broader catalog of third-party services to clients. We’re designing our solutions to be more flexible and modular so that we can adapt more quickly to shifts in client needs. This technology will give us the ability to sell and provision services a la carte, allowing us to better serve clients.

In time, we’ll be able to address entirely new market opportunities. For example, a client could use another content management system and integrate into our commerce platform. These a la carte solutions will be supported by an entirely new pricing model and updated marketing materials. Our project plan calls for delivery of the key components of this technology stack by the end of the year.

Moving on, we’re also working to streamline processes and drive efficiency throughout the organization. We made quite a bit of progress already and have a plan to keep the momentum going. We’ve taken expenses out of the business by realigning responsibilities, and we’ve reduced global head count and have a flatter leadership organization. We’ve closed down two offices. We restructured education services and other businesses. We’ve divested CCNow and we plan to reduce the number of data centers we operate from eight to four by the end of the year.

As we look out to 2014 and beyond, we intend to offer more of our services through third-party clouds. In summary, we have a lot of heavy lifting to do in 2013, but we also have a solid plan driving our actions and ensuring focus. We’ve made tremendous progress since our last earnings call and will continue to provide details on our progress throughout the year. Last, I want to thank all of our employees who have done a tremendous job moving our business to where we are today.

Now I’ll turn the call over to Stefan.

Stefan Schulz

Thank you, Tom, and good afternoon, everyone. Fourth quarter revenue came in at $101.3 million, which was slightly higher than our guidance range of $96 million to $100 million. International revenue accounted for about 46% of total revenue, unchanged from the same period last year. Enterprise commerce revenue in the fourth quarter was $82.6 million, down 8% from $89.6 million in 2011.

Within enterprise commerce, and using constant currency, digital commerce was down 12%, physical commerce was also down 12%, and payments was up 65% over Q4 last year. On the supporting line, revenue in the quarter was $18.8 million, down 16% from $22.4 million in 2011.

Moving on to the full year, enterprise commerce ended at $307.6 million, which was relatively flat compared to 2011. Within enterprise commerce, and again using constant currency, digital commerce revenue declined about 1%. Microsoft ended the year accounting for 29.6% of total revenue, up from 27.7% in 2011. We’re very pleased with the results from Microsoft, given the mid-year contract renegotiation which took place.

Physical commerce revenue declined about 8% and World Payments revenue increased 46% year-over-year. We continue to see significant growth opportunities in the payments space and are investing accordingly, as evidenced by our acquisition of LML. Support revenue ended the year down about 14%, as expected.

Now moving on to expenses, I’ll start by addressing the goodwill impairment Tom mentioned earlier. As announced in our release, we took a non-cash income statement charge of $161.1 million net of tax in the fourth quarter, related to an impairment of goodwill. Prior to 2012, we have accumulated $282 million of goodwill on our balance sheet. And this resulted from acquisitions where the fair value paid for the businesses exceeded the value of the identifiable net assets. We annually assess goodwill in accordance with generally accepted accounting principles. We typically perform this assessment in the fourth quarter, and in this past fourth quarter we determined that our goodwill was impaired.

Additionally, and largely due to the significant loss incurred from the goodwill impairment, we took a charge of $43.5 million related to tax valuation allowances. I want to reiterate that this write-down of goodwill is a non-cash charge and has no impact on our cash flow or liquidity. Additionally, we don’t expect it to have an effect on our future business operations.

Now let’s move onto the other fourth-quarter expense items. Total non-GAAP operating expenses were pretty much in line with prior years’ levels. General and administrative expenses were up year over year, largely due to a $1.6 million increase in legal and professional fees. G&A expenses reported in our press release included $6.8 million related to severance and accelerated stock-based compensation from the previous CEO’s separation agreement.

Network and infrastructure costs were up about $2 million, due to some of the technology investments we discussed earlier. Sales and marketing were down from last year, due to lower personnel costs and lower client marketing-related expenses. The GAAP net loss for the fourth quarter totaled $200.1 million, or a net loss of $6.11 per share. The net loss includes the non-cash write-down of goodwill and the tax valuation allowance I discussed earlier.

We earned $0.12 per share in the fourth quarter last year. For the full year, we incurred a net loss per share of $5.90, compared to earnings per share of $0.46 last year. Now switching to non-GAAP earnings, in the fourth quarter our non-GAAP net income totaled $11.2 million, or $0.31 per share, which was at the top end of our guidance of $0.25 to $0.31 per share. For the full year, we delivered non-GAAP earnings of $1.02 per share, compared to $1.15 per share last year. We have provided a table towards the back of our earnings release that reconciles our GAAP and non-GAAP results.

Turning to cash and cash flow, our net cash provided by operations for 2012 was $38.8 million, as compared to net cash provided by operations of $94.8 million last year. Lower net income and changes in working capital were the primary drivers of the change from 2011. Excluding the impact of working capital changes, our operating cash flow for the year was $60 million, down from last year’s cash flow of $80 million.

Our operating cash flow continues to be highly dependent on changes in working capital. This is especially true on changes that result from timing differences between payments we receive on our clients’ behalf and the remittance of those funds to our clients. This timing usually works in our favor during the holiday season in Q4 and in the opposite direction the following quarter. Capital expenditures were approximately $22 million in 2012, which was slightly under our expectations.

As of December 31, 2012, cash and investments totaled about $743 million. This was down about $43 million from the end of last year, and the primary drivers of this change year over year were the repurchase of about $44 million of our 2% convertible debt and the repurchase of approximately $22.7 million of our common stock during the year, including $2.4 million that was repurchased in Q4. At this time, our capital deployment emphasis has shifted from acquisitions to common stock and convertible debt buybacks.

Now moving onto 2013, as Tom Madison referenced earlier, we are providing 2013 guidance for the first quarter only. For the first quarter, we expect revenue to be in the range of $101 million to $104 million, and at the top end of the range, enterprise commerce would account for about $87 million and the supporting lines would account for about $17 million.

Expenses are expected to increase $11 million above last year’s level in the first quarter. The increase is from the inclusion of LML operating expenses post-acquisition, LML integration expenses, and a restructuring charge related to lease terminations, severance, and outplacement of about $3 million. The first quarter GAAP loss per share is expected to be in a range from $0.14 to $0.09 per share. Non-GAAP EPS is expected to be in the range of $0.18 to $0.22 per share, assuming a non-GAAP tax rate of 21%. Our non-GAAP expenses exclude charges from acquisition-related intangible amortization, restructuring, stock compensation expense, and LML acquisition and integration expense.

Now I’ll turn the call back over to Tom Madison.

Tom Madison

Thanks, Stefan. Before we move onto take your questions, I want to recap some key points you heard today. First, I think it’s clear we have a set of assets at Digital River that we believe are unique in our industry. We believe a solid fourth quarter with operating results in line with our expectations and are making good progress executing on our technology roadmap and driving efficiency.

To that end, we’ve identified and are taking actions to reduce costs, including divesting non-core assets, closing offices, and reducing head count, which includes eliminating certain executive management positions. We’ve completed our acquisition of LML and we’ve repurchased both convertible debt and common stock.

We know we have a lot of work ahead of us in 2013, but we have a strong management team in place that is squarely focused on, one, strengthening our technology; two, improving our efficiency; and three, and importantly, driving shareholder value.

Now let’s move onto Q&A. As in the past, we ask each participant to ask only one question with one follow-up question, if you like. Operator, please open the lines

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from the line of Gene Munster from Piper Jaffray. Mr. Munster, you line is open.

Gene Munster – Piper Jaffray

(Inaudible).

Tom Madison

Operator, I think we’ve got to go to the next question. Gene needs to call, I think, back in.

Operator

All right. Thank you. Our next question comes from the line of Phil Winslow from Credit Suisse.

Harris Heyer – Credit Suisse

This is Harris Heyer on behalf of Phil Winslow. Thanks for taking the question and congrats on a good quarter. I just was wondering, in terms of the March quarter guidance and how you are thinking about the first half of 2013, how do you kind of factor in the next release of Microsoft Office, or do you not?

Stefan Schulz

Yes, so, Harris, this is Stefan Schulz. I’ll answer the first part of that question and I’ll let Tom answer the last part of that. You know, as it relates to the first quarter, there are a couple of product launches that take place, one of which is the Office launch that you talked about. So we have factored that in, to some degree, in our numbers. You may recall that last year when it came to the Windows 8 launch, we did not factor that into our numbers, to a large extent, mainly because we were uncertain as to timing and the launch of that. However, Office is a product that we’re very familiar with. We’ve been selling it for a long period of time. So we have some indication of what that might be in the first quarter, and so we have incorporated that in our Q1 guidance. We haven’t really said anything beyond Q1 and really aren’t prepared to say anything beyond that now, so the answer to your question is yes. Tom, do you want to, I think, add any color to...

Tom Madison

No. I mean, it just released a week ago, so we’re early in the game. The client’s got a lot going on, and we will see how it goes and, I think, update you to the extent we can at the end of the first quarter.

Harris Heyer – Credit Suisse

Okay, great, and if you don’t mind me asking just a quick follow-up, it seems as though the kind of other income line came in higher than we had expected and also above consensus. Would you mind giving us some color on what drove that?

Stefan Schulz

Yes. And this is, again, Stefan, Harris. We had a small gain from one of our investments where there was a triggering event in one of those investments that did occur in the fourth quarter. It resulted in a small gain for us, and so we did record that. I will point out, though, that we excluded that in terms of our non-GAAP results. So what you see in the press release is there from a GAAP perspective only. We did pull it out as it related to one of our investments, pretty much not part of our recurring operations. I wanted to point that out just so you know we don’t just put the bad guys in the non-GAAP category. We put the good guys there, too.

Harris Heyer – Credit Suisse

All right, thank you very much.

Stefan Schulz

Yes.

Operator

Thank you. And our next question comes from the line of Robert Breza from RBC Capital Markets.

Rob Breza – RBC Capital Markets

Hi. Thanks for taking my question as well. Stefan, maybe help us understand. You guys got, like Tom mentioned, a lot going on between reducing the number of data centers, flattening the organization from a management structure. Clearly, I think you pointed out, LML is going to add an additional $3 million in expenses. But when do we start to see the inflection point here of the cost-saving operations that you’re taking, and how do we think about that? Just kind of – not trying to pin you down on any one quarter, but if you could talk to the shape of the year and how expenses might occur, that would be great. Thanks.

Stefan Schulz

Yes, a couple of things, Rob. First, the $3 million number that I quoted was related to restructuring activity. Even though we’re not providing specific guidance on LML within our numbers, I think if you looked at LML’s run rate when they were a stand-alone public company, it was north of 5 – north of $3 million, probably closer to $5 million to $6 million. So that’s probably a better indicator of what the cost structure will be for us within Digital River, excluding costs that we’re going to put into integration and things of that nature.

As it relates to the cost savings and when those will kick in, you know, you identified what we talked about in terms of some cost savings that we’ve already put in place, and those largely revolve around changes that we’re making where we’re de-emphasizing certain areas and wanting to invest in areas where we feel like it is an advantage for us as we look forward. And those opportunities, in a word, we’re not really going to disclose now when we think those are going to take place, but clearly sometime in the near future we expect that to start paying dividends for us. And I would tell you, as Tom mentioned earlier, when we have announced a permanent CEO, we’ll probably be in a better position to give you a little more color on more specific timing.

Rob Breza – RBC Capital Markets

Okay, maybe just as a follow-up, I know last quarter you guys talked about pricing pressure a little bit in Europe. I was wondering if you could just kind of give us an update on those two items. Thanks.

Tom Madison

Yeah I don’t remember talking about pricing pressure in Europe. We did lock up a lot of our top clients through the course of this year. Talked about VMware in particular on this call. We did talk about weakness primarily driven by the macro in Europe in that we still don’t have a tremendous amount of confidence that we’re going to see a big rally in the EU where, you know, a lot of our international revenue comes from. We may be able to offset some of that with some expansion we’re doing with clients in Asia. But I think overall, we’re taking a cautious view to the macro, despite the sentiment of the stock market, I guess.

Rob Breza – RBC Capital Markets

Great. Thank you.

Tom Madison

Yes.

Operator

Thank you. And our next question comes from the line of Shyam Patil from Raymond James.

Shyam Patil – Raymond James

Hi. Thank you. Stefan, just around the LML acquisition, can you remind us what it generated in terms of revenue for 2012, and if there is any seasonality to the revenue that we should be thinking about as we try to model it out for 2013?

Stefan Schulz

Yes, Shyam. The trailing 12 months that were there before the acquisition I want to say was right at $20 million, and off the top of my head, I can’t remember if there was any real significant seasonality one way or the other on there. I don’t think there was. But you can think of it as around $20 million of a run rate coming into the Digital River family.

Shyam Patil – Raymond James

Got it. And I think last quarter when you guys spoke about 2013, you gave some high-level commentary on revenue, suggesting that it may be down year over year even with LML, and margins could potentially be flat or maybe a little bit lower. Is that still a fair framework to use? I know you guys aren’t giving specific guidance, but in terms of an overall framework, is that still pretty fair at this point?

Stefan Schulz

Yes, I think the comments that we made on the last call are still applicable today, and I don’t know that we’ve necessarily said they would be down year over year with LML. I think we just said that growth would be challenging.

Shyam Patil – Raymond James

Okay, thank you.

Operator

Thank you. And our next question comes from the line of Craig Nankervis from First Analysis.

Craig Nankervis – First Analysis

Thank you. Good afternoon. I was wondering if you could talk about your outlook on your existing customers. I believe 90 days ago you talked about how you were expecting some of your existing customers to drop away this year, and I wonder if your view of that versus 90 days ago has somehow changed one way or the other, and just how do you read overall the existing base versus 90 days ago? Thanks.

Tom Madison

Yes, certainly the customers that we were – that we are or -concerned about did, in fact, or we still do anticipate, will play out. The remaining base we feel quite a bit more confident in and have signed many to longer-term contracts, both in the physical and digital space. And as you know, we have a contract that runs at least through 2014 for the store business and a longer contract for some other pieces of business with Microsoft. But obviously, that’s been an emphasis area even pre-dating the last earnings call, and we’re feeling good about the base going into 2013.

Craig Nankervis – First Analysis

And then, just secondly, can you talk about where you are with head count versus 90 days ago and where you expect to be maybe at the end of the year, if you can give some rough approximation? Thanks.

Stefan Schulz

Yes, Craig, this is Stefan. Right now from where we were 90 days ago, I think it’s fair to say we are down slightly from that level, from 90 days ago. And I think as you look out the remainder of the year, I don’t see our head count changing significantly, maybe up slightly. As we said in our prepared remarks, our game plan is to, as we go through the year, shift our focus from things that we were doing that were not necessarily going to be a part of our strategy going forward, and shift those resources and costs into those areas that are a part of our game plan going forward. And so, I would tell you that we’re probably looking at a relatively flat head count to where we are right now.

Craig Nankervis – First Analysis

And the down slightly versus 90 days ago, is that excluding LML or including?

Stefan Schulz

Yes. Sorry. That is excluding LML. If you include LML, we’re probably roughly flat.

Craig Nankervis – First Analysis

Thank you.

Operator

Thank you. And our next question comes from the line of Gene Munster from Piper Jaffray.

Gene Munster – Piper Jaffray

Thanks for getting me back in the queue there, and Tom, I don’t know if the first question addressing this, but as you go to this modular platform, can you remind us how far that – through that transition you are? I know you’ve talked about it over the past couple of quarters, number one. And number two is, what’s the impact, I guess, on the total revenue opportunity per customer? Is this a situation where some customers wouldn’t have even been a Digital River customer, but they are now because it’s modularized? Or is this a situation where existing customers are taking and kind of piecemealing out the ones that they want and their total revenue with you is declining? And I guess it’s probably both of them, but can you just walk us through which one of those four seems to be weighing out?

Tom Madison

Yes, I think the strategy is to address both as a way not only to access new clients in perhaps verticals where we don’t have commerce strength, and I think you see that in the payments growth that we have. That is a self-contained offering that we sell independent from the commerce stack, and we do think there are some quick wins around payments that we can add around that as we look out into 2013. As we get into 2014 and with the API effort, which is one of our largest engineering efforts, that will allow us to adapt to what a client wants.

And the example I gave on the call was we have some clients that want to use market-leading content management systems and have commerce and merchandising injected up into those upstream pages, and we’ve seen that again and again in the marketplace. But I think this is going to allow us to adapt with existing clients that don’t want the do-it-for-me completely. And it’s also going to allow us to expand the markets that we serve as we head into 2014.

Gene Munster – Piper Jaffray

Okay. And so, just again, the timing of when the modularized platform is going to be fully available today? I know you said there are APIs that needed to be, that’s probably an ongoing process. How far are we through the technology side of this? Is this a 2013 event?

Tom Donnelly

Yes. I mean, as I said in the prepared remarks, we anticipate largely being in a position to execute completely by the end of the year. We are already pricing to a certain extent, on a modular basis and have a new way that we’re responding to RFPs, etcetera. And then, the second key term in the prepared remarks was the ability to independently provision a service, and that is to take a piece of functionality and actually provision, allow it as a standalone web service or enable it as a standalone web service that a client can consume as part of their overall e-commerce system, whether it be a third-party vendor that is integrated through our API stack or whether it’s a vendor that wants to access our capabilities through the same, in essence, API stack. It’s actually a different API stack, but that is the concept behind it. I think we’ll have more to say on that in the coming months and as there is a permanent CEO appointed.

Gene Munster – Piper Jaffray

Okay. And can you remind me what percentage of revenue is payments?

Stefan Schulz

Prior to the acquisition, it was just north of 5%. After the acquisition, we’re expecting it to be just north of 10%.

Gene Munster – Piper Jaffray

Great. Okay, thank you.

Operator

Thank you. And we have time for one final question today. Our next question comes from the line of Colin Sebastian from Robert W Baird.

Greg Schauer – Robert W Baird

Yes, hi. This is Greg Schauer filling in for Colin. And I was hoping to get an understanding regarding some of the cost savings that could be realized by overhauling the tech infrastructure, reducing the data centers from eight to four, and just sort of generally overhauling the platform. Just looking back at the financials, I can see that when you look at both network and infrastructure and D&A as a percent of revenue, that it’s basically increased from around 13% of revenue in 2007 to around 18% in 2011.

Are those – and I’m hoping to get – maybe we can get some clarification. Are those the two correct line items that we should be thinking of that will be most positively impacted by an overhaul or an improvement in the technology platform? And then, is that – if we look back five years, is that a level that we might look to as being attainable again in the future? Or how should we think about what the potential upside is in cost savings?

Stefan Schulz

Yes Greg, this is Stefan. Let me make sure I understood. The 13% to 18% numbers that you quoted, those were related to which line items again? I know...

Greg Schauer – Robert W Baird

Sorry, the – it’s a combination of the networking infrastructure and the depreciation and amortization lines.

Stefan Schulz

Yes, okay. So I would tell you that the savings will probably come in other line items outside of those. For example, the depreciation and amortization line item is pretty much cast today; it’s cast for the next two to three years; and the same thing is going to be true in a year from now and two years from now. So, not a lot of opportunity in the near term for that particular line item.

As it relates to the network and infrastructure, I think you might see some efficiencies from that, but I think the bigger impact will probably be seen on our R&D line item. Because in addition to development, we also do quite a bit of sustaining engineering behind the product we have today, and a lot of the investments and a lot of things Tom just talked about are really geared towards efficiency in terms of our code, in terms of our product sets, and the sustaining engineering that’s required today will go down significantly in the future.

Greg Schauer – Robert W Baird

Interesting, okay. So...

Tom Madison

I’d add, too, revenue...

Greg Schauer – Robert W Baird

Yeah, sure.

Tom Madison

The growth rate of revenue in this business model has always produced better margin because your incremental cost for the next dollar of revenue is much lower, and we’re experiencing the inverse of that, to a certain extent, recently. But the model – certainly there’s leverage and increasing returns to scale in the model as revenue increases.

Greg Schauer – Robert W Baird

Yes, sure. And I guess that’s always sort of been the attraction or the positive side of software intensive businesses. So that’s an important clarification because I previously was under the assumption that because you mentioned you were going to be doing a lot of transitioning to third-party data centers, reducing the data center footprint by 50%.

And I assume there is a significant cost saving involved in no longer buying – or buying much fewer physical servers, that more than 50% of the cost savings would be in actual hardware and equipment costs. But it sounds like you’re saying maybe it’s actually – at least 50% could actually be in head count expenses as well that just – that are part of the R&D line item?

Tom Madison

That’s true. And I think, Greg, to your question and your observation as it relates to the hardware, you are right, but the actual savings from a P&L perspective won’t really hit or benefit our P&L for a number of years because...

Greg Schauer – Robert W Baird

Okay.

Tom Madison

Servers that we are deploying today, and we are deploying servers today, have a life of three to five years. So those will be with us for a while.

Greg Schauer – Robert W Baird

Okay. And then, just – sorry, a final one, if I may. Just in terms of how this plays out, should we expect that there will sort of be gradual improvements on a quarterly basis over multiple years? Or might it be more lumpy in terms of how some of the benefits might be realized?

Tom Madison

That’s really hard to predict in terms of how that’s all going to come about and the exact timing is that far out in the future. But I think it’s safe to say we feel very confident that the value is there, that the returns are there. Exactly how they’re going to play out, the timing of that, it’s really hard for me to tell you that sitting here today.

Greg Schauer – Robert W Baird

Okay. Fair enough. Thank you.

Operator

Thank you.

Ed Merritt

All right, thanks to everyone for joining us on this call today. Before we close, I want to mention that Digital River will be participating in some analysts’ events in the first quarter and you’ll have an opportunity to hear management speak about our business.

On February 13, we’ll be in San Francisco at the Goldman Sachs technology and Internet conference. On February 27, we’ll be in Boston at the UBS SMID Cap one-on-one symposium.

On March 6, we’ll be in Orlando at the Raymond James 34th Annual Institutional Investor Conference. And finally, on March 13, we’ll be in New York at the Piper Jaffray Technology, Media, and Telecommunications Conference. Thanks for joining us today. And this concludes the Digital River fourth quarter 2012 earnings call.

Operator

Ladies and gentlemen, thank you for your participation in today’s conference. This does conclude the program, and you may now disconnect. Everyone, have a good day.

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