Digital River, Inc. Q4 2008 Earnings Call Transcript

Jan.29.09 | About: Digital River, (DRIV)

Digital River, Inc. (NASDAQ:DRIV)

Q4 2008 Earnings Call

January 29, 2009 4:45 pm ET

Executives

Ed Merritt - Vice President of Investor Relations

Joel Ronning - Chief Executive Officer, Director

Thomas Donnelly - Chief Financial Officer, Secretary

Analysts

Phil Winslow - Credit Suisse

Daniel Ives - Friedman, Billings, Ramsey & Co., Inc.

Carter Malloy - Stephens, Inc.

Colin Sebastian - Lazard Capital Markets

Robert Breza - RBC Capital Markets

[Shiam Patel - Raymond James]

Rod Radcliffe - Sanford Group

Tim Klasell - Thomas Weisel Partners

Matt Schindler - Bank of America

Craig Nankervis - First Analysis

Sameet Sinal - J&P Securities

Operator

Good day, my name is Lisa and I will be your conference operator today. At this time, I would like to welcome everyone to the Digital River Fourth Quarter 2008 earnings conference call. (Operator Instructions)

Mr. Ed Merritt, you may begin your conference.

Ed Merritt

Thank you and welcome everyone to this afternoon’s fourth quarter 2008 earnings call. I’m Ed Merritt, Digital River’s Vice President and Investor Relations. And, on the call with us 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, including statements regarding the company’s future growth and financial results, as well as any statement containing the words believes, anticipates, expects, and similar words. These statements involve known and unknown risks, uncertainties and other factors 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 and Exchange Commission.

A webcast of our call today will be available for a period of two weeks on the Investor Relations section of Digital River’s corporate website.

With that, I would like to turn the call over Joel Ronning. Joel.

Joel Ronning

Thanks, Ed, and thanks to all of you for joining our call today.

I’m pleased to report our results for the fourth quarter. Total revenue was $95.5 million, in line with our expectations. GAAP EPS was $0.41, which is above our guidance range. And, non-GAAP EPS was $0.48, at the high end of our guidance. During the fourth quarter, we continued to make progress growing our client base and deepening client relationships in our core markets. We believe several factors are contributing to our success.

First, tight economic times are driving companies in our direction and away from the complex e-commerce demand that they don't understand. In addition, they are moving away from high fixed cost and large infrastructure investments. We saw this happen in early 2000 and are seeing the same behavior today.

Second, ongoing changes in the retail channel are causing more companies to go direct to consumer. With some retailers declaring bankruptcy and others selling more private label brands, companies are less concerned about channel conflict today and more focused on opening new revenue streams.

And, finally, our clients are more motivated than ever in acquiring and retaining customers and generating more revenue from their products. Helping companies successfully manage through these market forces is where we excel and have clearly demonstrated industry leadership. Our continued progress in consumer electronics provides a strong case in point.

We had a successful fourth quarter, winning new opportunities or launching stores for companies including Samsung, Seagate, Phillips, Watchguard, Cables Unlimited, Logitech and Hewlett Packard. Games is another market where we expanded our presence. In the fourth quarter we won business from Square Enix, Smith & Tinker, as well as signed a new multi-year international agreement InVidia.

In software, we expanded our relationship with Business Objects, a division of SAP; as well as Adobe Systems. For Adobe, we launched a new business-to-business site to support their volume license purchases in North America. This site provides a good example of our expanded focus on the business-to-business market. Our intent is to help our software clients monetize their products online in new ways via volume licenses, subscriptions, renewals, and maintenance programs. In 2009, we intend to roll out new products and services to support the small and medium business market for software and other related product offerings.

I’m also pleased to report that Microsoft awarded us the e-commerce business for the next version of Office and various other Office-related programs. In addition, we will be working with Microsoft to support the launch of other specialized programs targeted at specific vertical markets. We will provide more information about upcoming projects once they are made public by Microsoft.

Our partnership with Symantec is also strong and healthy. In the fourth quarter, we successful launched a new payment method called Alipay on Symantec’s China store and are seeing sales gains. In addition, we worked on several projects to help Symantec further optimize the consumer experience during the renewal and upgrade process. Early results have shown some big wins on high volume sites.

In 2009, we expect to significantly expand our support of Symantec’s new customer acquisition efforts. To further support these and other clients in our core markets, in the fourth quarter we rolled out some new products and services. We launched what we believe to be the e-commerce industry’s first comprehensive automated regulatory fee management solution. This solution enables clients that are selling products online in Europe and North America to collect and remit fees in compliance with complicated copyright and recycling regulations. Failure to meet these regulations can result in fines, prosecution and other penalties including restrictions on selling. In fact, some of our clients have said that they would not be selling in Europe without this solution and Digital River’s expertise.

In addition, we rolled out advance subscription capabilities. These new enhancements will give our clients more flexibility in packaging their online offerings and marketing their renewals, as well as more opportunities to raise their customer retention rates. Many software and game clients are offering online subscription solutions as they adopt software as a service models.

As we look back on last year, I’m pleased with our execution against our goals and at the same time our ability to manage expenses in the most challenging economic conditions in the company’s history. In 2008, we set out to build an e-commerce leadership position in games and consumer electronics. I’m pleased to say we’ve delivered on this objective. In games, we signed or expanded our relationship with some of the industry’s major players, including Aspire Media, Capcom, Electronic Arts, Midway Games, Wizards of The Coast, and Mattel.

In the consumer electronics market, we were awarded business from companies such as Eastman Kodak, SanDisk, Sure, IFI, Samsung, Seagate, Phillips, Watchguard, Cables Unlimited, Logitech, and Hewlett Packard, as well as several other leaders in this space. We expect to expand these existing relationships and win new business in 2009 and are confident in our pipeline. In addition, we expect these new markets to be more meaningful contributors to 2009 revenue.

During 2008 we also made progress against many other key strategies and initiatives. First, we extended our leadership position in the software market. We won additional business from companies such as Absolute Software, Adobe, Quark, VMWare, Mindjet, Carbonite, Server Patrol, and Broderbund.

Second, we met scheduled timelines on our SAP implementation and the complete rearchitecture of our data management and reporting infrastructure. We hit a major milestone just two weeks ago when we went live with the human resource component of SAP. I’m also pleased to report that we are in Beta with 14 Enterprise clients on our new reporting capabilities, which we believe will further separate us from the competition.

Third, in addition to rolling out our new regulatory fee management and subscription solutions, we added new online payment types and remote control functionality to our platform. These enhancements make it even easier for our clients to drive revenue and manage their stores without manual intervention.

Fourth, we continued to grow our managed strategic marketing programs. We saw strong growth from our existing email marketing and search engine optimization solutions as well as new services, such as mass dynamic personalization and multi-variant testing. Driving customer acquisition and retention has never been more important to our client base.

Finally, we completed the acquisition of THINK Subscriptions and Custom and Swift CD. We will continue to draw upon these new businesses to enhance our core subscription and on-demand physical services.

In summary during 2008 we became a recognized industry leader in consumer electronics and games, to markets that we targeted at the beginning of the year. We extended the scalability and efficiency of our online infrastructure, an advance of capabilities over e-commerce platforms and services to drive long-term growth. In short, we delivered on the business goals that we set out at the beginning of 2008. Now as we look out in 2009, we plan to push forward on our technology initiatives, while intensifying our efforts around driving client revenue.

In 2009, we will draw upon the entrepreneurial spirit that built this company in order to increase development efforts in areas such as e-marketing, the business-to-business market, payments, games, usability, and fast functionality. To support these efforts, we recently hired a new VP of product and appointed a chief scientist to our engineering team. Both of these leaders will extend an intensify our vision and world map for innovation. Our primary goal is to help our clients develop new, more creative ways of driving online sales.

In addition, we will bear down on our global sales efforts. Current clients and prospects are ramping up their e-commerce intensity in this economic environment. We believe they are shifting toward us because there is little room for mistakes or added risk in an economy that is already uncertain. Yes, this is a tight market, but this is the kind of environment where we have best proven our value proposition. Our growing list of client wins clearly demonstrates this point.

Looking forward, we’re optimistic about our strategy, our pipeline, and value proposition to clients. We also remain confident in our business model. The uncertainty in the economy makes the near term difficult to predict and will impact our financial results in 2009. As we have in the past, we will mitigate the near-term impact and capitalize on the long-term opportunity.

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

Thomas Donnelly

Thanks, Joel. Our fourth quarter revenue was $95.5 million, in line with our guidance of $94 to $97 million, and slightly down from $96.9 million reported in the fourth quarter of 2007. Foreign currency negatively impacted revenue during the quarter on a year-over-year basis by $4.5 million. International e-commerce gross sales were approximately 41.4% of total gross sales in the fourth quarter, slightly down when compared to the fourth quarter of 2007.

Symantec revenue was 32.7% of total revenue in the fourth quarter compared to 37.5% in the same period of 2007. Direct Symantec revenue during the quarter was 24.2% of total revenue compared to 25.8% in the fourth quarter of 2007. For the full year ended December 31, 2008, total revenue was $394.2 million, up almost 13% over 2007. Overall, we’re pleased with the company’s top line performance given the slowing economy in the third and fourth quarters.

GAAP net income for the fourth quarter totaled $16.5 million or $0.41 per share and was above our guidance range of $0.34 to $0.39 per share. This compares to net income of $20.3 million dollars or $0.46 per share in the fourth quarter of 2007. For the full year ended December 31, 2008, GAAP net income totaled $63.3 million or $1.55 per share, compared to net income of $70.8 million or $1.58 per share reported in 2007.

Switching to non-GAAP results. In the fourth quarter, non-GAAP net income totaled $19.8 million or $0.48 per share at the high end of our guidance range. This compares with non-GAAP net income of $25.3 million or $0.56 per share for the fourth quarter of 2007. Operating margin for the fourth quarter was in line with our guidance, down approximate 4% on a GAAP and non-GAAP basis when compared to fourth quarter of 2007.

For the fourth quarter, total costs and expenses grew approximately $3 million over the fourth quarter of 2007. Looking at individual fourth quarter expense line items compared to the fourth quarter of 2007 and excluding stock compensation expenses, direct cost of services was up approximately 79%, primarily due to the acquisitions of Digital Swift and Custom CD in the first quarter of 2008. Network and infrastructure costs were up approximately 4%, primarily related to infrastructure investments and increased marketing campaigns which drove higher internet traffic and data communications costs.

Sales and marketing expenses were up 5%, primarily related to headcount additions, increased marketing activities, and the impact of our recent acquisitions. R&D expense increased approximately 3% year-over-year, mainly due to acquisitions and increase headcounts to support business initiatives including data management and client reporting. And, G&A costs were down 15%, quarter-over-quarter, with reductions primarily related to lower incentive compensation and targeted cost controls around consulting.

Interest income for the quarter was just under $3 million, compared to approximately 8.2 million in the same quarter of last year. Interest income for the full year dropped $14.1 million, from 32.2 million in 2007, to 18 million in 2008. Other expense in Q4 represents approximately $600,000 in interest expense on our convertible notes, offset by approximately $1 million of gain on foreign currency. Our GAAP tax rate in the fourth quarter was approximately 27%, compared to 32% in the same quarter of 2007.

Turning to cash flow, net cash provided by operating activities for the 12-month period ending December 31, 2008 totaled approximately $95 million, compared to $146 million in the similar period of 2007. The primary drivers for this change were timing issues related to value-added taxes and the large use of NOLs in 2007, offsetting cash income taxes.

Excluding changes in operating assets and liabilities, which I referred to balance sheet leverage, net cash flow from operations for the 12-month period was $101.5 million. This compared to 120.2 million for the similar period of 2007, with the difference year-over-year almost entirely related to the use of NOLs in 2007.

CapEx was just about $12 million in the fourth quarter. The bulk of this investment was related to the SAP implementation and data management project which are on schedule to be completed in 2009. CapEx for the full year was approximately $27 million, in line with the range we provided at the beginning of the year.

We ended the quarter with approximately $594 million in cash and investments. We recorded a $16 million or 15% temporary impairment on our auction rate securities, which are classified as long-term investments. We recorded this temporary impairment primarily due to the continued uncertainty in the financial markets and the related market illiquidity for these securities.

Subsequent to year end, holders of our convertible debt put 95.5% of the outstanding bonds back to the company. Therefore, in early January, the company used about $187 million of cash to satisfy the put. As a result of this put, our forward-looking diluted share count is approximately 4.2 million shares lower, 8.8 million in bond remained outstanding.

Now on to guidance, in light of the current economic uncertainty, at this time we are only providing guidance for the first quarter of 2009. We currently expect revenue of $96 to $100 million. Note that the U.S. dollar has strengthened significantly from last year and therefore has negatively impacted expected first quarter revenue in 2009 by about $3 million compared to 2008. GAAP net income is assumed to be in the range of $0.37 to $0.42 per share, including $3.6 million of stock compensation expense. And, non-GAAP net income is assumed to be in the range of $0.48 to $0.53 per share.

In the first quarter of 2009, expenses are planned to be relatively flat with the third and fourth quarter of 2008, excluding the higher employee benefit costs that occur in the first half of the year. We did take several actions in the fourth quarter to tighten our operating and capital spending, reinvesting most of the savings in high opportunity areas of the business.

Our approach to spending in 2009 will be a tight balance between investing in the right opportunities for the long term, which vigorously managing overall expense levels in line with our top line expectations as they evolve throughout the year. In building your models for 2009, I can provide the following color. Weighted average shares outstanding in Q1 are anticipated to be 37.3 million. An appropriate estimate to use for the full year is 37.8 million shares.

Interest income is expected to be about $1.7 million in the first quarter and $7 million for the year. This decline from the $18 million earned in 2008 is attributable to lower cash balances due to the bond repurchase and significantly lower anticipated yield on cash when compared to 2008. Our GAAP tax rate for Q1 in the full year is estimated at 27%.

Our current plan for CapEx for the year is approximately $26 million with almost half related to the completion of our data management, client reporting, and SAP initiatives. The capital spending in the first half of the year will be slightly higher than the back half. As with our operating expenses, we will closely monitor our capital spending in line with our top line. Although these are challenging times. We remain very confident we will emerge a stronger company with significant identifiable drivers for growth as the macroeconomy recovers.

With that, I’ll turn the call back over to Joel.

Joel Ronning

Thanks, Tom. At the beginning of 2008, we established an aggressive plan designed to strengthen our core business, expand into new markets and develop new products. I’m proud of what we’ve accomplished during the year. We grew our annual revenue nearly 13% from the previous year. We introduced exciting new solutions and products and we continue to win additional business in our targeted verticals, including consumer electronics, games, software, and subscriptions.

We’ve established ourselves as a leader in the markets we identified at the beginning of the year. I’m confident that we have the right strategy and the right team in place to extend our leadership position in the future. In short, we told you what we would do in 2008 and absent the economic turmoil late in the year, we delivered on our plan. Now as we look at 2009, we are extremely focused on delivering new products and services that will drive revenue for our clients as well as selling our value. We believe our value is unmatched in the marketplace and well suited to the current economic conditions.

With that, I’d like to open up the call for questions. We have quite a few callers in the queue today. So, we’d appreciate it if you would limit yourself to one question. If we have time at the end, we will open it up for follow-up questions. Operator.

Question-and-Answer Session

Operator

(Operator Instructions)

Our first question will come from Phil Winslow with Credit Suisse.

Phil Winslow - Credit Suisse

Hi guys. Good quarter. Joel, just wondering if you could give some commentary about what you saw from just an international perspective and contrast that with the U.S., just from a buyer’s standpoint, then how you sort of were thinking about things as you start to transition into 2009. And, then also when you think about your Q1 guidance, obviously PC unit sales were weak in Q4, how does that factor into how you think about Q1?

Joel Ronning

All right. Alright, going to the buyers on an international basis, we are finding, we just continue to find very large opportunities with, particularly in the CE markets Phil, where we're going to talk with clients and they just don't have the capacity to manage the level of complexity that is going on there if you are trying to do an international E-Commerce business, and virtually every one of these CE companies are all multi-billion dollar organizations, they are all international, they have an international footprint.

So we are having to work with product managers and marketing managers all across the world, so my sense is that this economic environment is really making this a little bit easier for us because we are seeing a pull-back on many of the prospects that we have been talking to and we have seen a number of clients coming to us shutting down their internal systems, and I believe that one of the major factors there is that once you go global E-Commerce, it becomes increasingly complex and there is a lot of risk to mitigate. So, this is playing to our sweet spot, we done this in the past, we saw it in 2000 and we are seeing almost exactly the same behavior, you know, in these current conditions.

I got to tell you, I know that PC sales are down. When we have looked at the data we see them down when you include business-to-business, but when you look at the consumer side it looks flat to maybe slightly up, and that's the primary business that we are working inside of from an LAM standpoint.

And so we are, I have to say, I am feeling OK about what we've seen in terms of indications with the consumer business. You know, we saw that drop off on September 15 of this past year, and we are seeing, I guess, a slightly unexpected level of firmness in the buying patterns from the consumers out there. So I am cautiously optimistic for 2009.

Phil Winslow - Credit Suisse

OK. Thanks Ed.

Operator

Our next question will come from the line of Daniel Ives with Friedman, Billings, Ramsey.

Daniel Ives - Friedman, Billings, Ramsey & Co., Inc.

I have a question in regards to expense controls for the year, and I know you are going to give actual guidance, but, how are you going to launch your business, I mean, do you have a certain sort of operating margin target in mind? Could you kind of walk us through quarter by quarter, especially given the macro, how you guys look at expense controls throughout the year, Good quarter, thanks.

Joel Ronning

Well I mean in the fourth quarter we did take what I would characterize as a realignment action where we did let some people go, but generally funded areas of the business that were showing great promise in addition, you know, we have been pressing down real hard on, do we really need this, do we really need that.

You know, the operating margin range in Q1 implied in the guidance at the low-end of the range is down almost a couple of percent compared to last year at the high end of the range the operating margin is up 1%, and revenue will really drive that. About 47% of the cost structure of the company is employee-related cost, so you know salary and benefits and a variety of matters, and I, the good news is we kind of get daily feedback on how the business is doing, and as Joel said, it seems to have kind of stabilized here, and based on what we've seen in January we are cautiously optimistic, but we are going to watch that and monitor the spending in line with the top line.

Daniel Ives - Friedman, Billings, Ramsey & Co., Inc.

Thanks.

Joel Ronning

Yep.

Operator

And now our next question will come from Carter Malloy with Stephens.

Carter Malloy - Stephens, Inc.

Hey guys. Some impressive wins, you are putting up every quarter on the consumer electronics and games front. Looking forward, can you kind of give me a sense for what your expectations are, maybe just even as a percent of revenue for consumer electronics and games.

Joel Ronning

You know, I don't think we are ready to say that yet, we are feeling pretty optimistic about it, but one of the things that we've seen is that, every one of these consumer electronic companies feels a little bit like bring up an organization like Microsoft. Microsoft is a great client, but was a very complex implementation, it took us a long time to bring up.

So we are getting a lot of contracts, but these do take time, these are very demanding clients and they are looking for global roll-outs more often then not, and so they tend to be very complex, time consuming projects for us. The key here is going to be to find the inflection point, I believe we are finding -- and I am talking about from a consumer standpoint -- we are finding the inflection point, I believe we are starting to enter it with the clients where we are seeing more and more clients are just moving over to us.

Though we would be disappointed it it is not 10% sometime in the near, you know, in the near term. I am not sure if I can describe what “near term” is. But our sense is that this is going to turn into a pretty big business. We saw the same kind of client behaviors happening in very early 2000 when we were in the software industry. There was a big rush to us in 2000-2001, and that seemed to really kind of clarify our leadership position, and then we steadily grew the business.

Once you get the clients in you have a lot of work to do to grow them up, but, boy, getting them is a very first step, so I'm not quite ready to answer that, I don't think either Tom or I are quite ready to answer that.

Carter Malloy - Stephens, Inc.

That's all I was looking for. Thanks.

Joel Ronning

OK.

Operator

Now our next question will come from the line of Colin Sebastian with Lazard Capital Markets.

Colin Sebastian - Lazard Capital Markets

Thanks for taking my question, and I guess on the capital expenditures for this year that you talked about, it sounds like it is flattish year over year, and just wondering if you are uncovering any additional areas where you might see some opportunities to make infrastructure or platform upgrades beyond what you've already talked about.

And then also you know you talked about outsourcing becoming a more viable option, or a more attractive option in this economy and channel conflicts also being less of an issue. Are you seeing your existing partners allocating more of their marketing budgets online, has that also been a driver? Thank you.

Thomas Donnelly

You should go out there first.

Joel Ronning

Yeah. You know regarding CapEx, you know, most of the development efforts, in fact a huge majority of the development efforts of the company are not capital. We have, you know, as far as opportunities for further investment, you know, about half of the spend for the year is completing up the big initiatives that a large, very productive team has been working on since really the beginning of the year in the design phase. The capitalization started int eh third quarter and that should proceed throughout the year.

The rest of the CapEx if you cut it in half, $13 million, that is actually down a little bit for us compared to a normal year, and most of that investment is typically servers, routers, you know, storage, you know, expansion of data centers, and I think we are really hunkering down on that, but if we see indications that transaction volume and Internet traffic are going to pop up, you know, you could see that number come up. But I think we are tightening down and making sure that we invest in the right areas, you know, that really drive client revenue, I think is the key theme this year.

Thomas Donnelly

And I'll take the marketing budget side of it, yeah, we are feeling good about the patterns that we are seeing, especially the fact that we run this play before, this 'play' being a tough economic environment, more people pushing towards outsourcing.

And I have to say the marketing budgets are opening up faster than we have seen, that we saw in early 2000, my sense is that the clients are good deal more sophisticated than they were five, ten years ago.

And the Internet is clearly more efficient than off-line advertising. Leverage the Internet you get a very targeted, highly identifiable ROI, you know, you are not buying space at a super bowl ad, and so the clients seem to be coming across kind of pre-sold on the concept that they are going to get a higher ROI out of their marketing spent on the Internet, and we know what to do with that.

Colin Sebastian - Lazard Capital Markets

OK thanks.

Operator

Now our next question will come from Robert Breza with RBC Capital Markets.

Robert Breza - RBC Capital Markets

Hi, thanks for taking my questions. One quick one, Tom, as you think about 2009, is there anything you know from an underlying business trend that would change the seasonal pattern Should we still expect June to be seasonally down with you know a slight up tick in September with a bigger up tick in December? Is that the seasonal pattern we should be thinking about for FY09?

Thomas Donnelly

Yeah, I don't think we'll see, from what we can see right now, anything demonstrably different than prior years. We have added a lot of clients that might be more cyclical as time goes on, and that would be more Q4 dependent, but I think for now that is a safe assumption.

Robert Breza - RBC Capital Markets

Great. Maybe just a follow-up, Joel. You talked about the consumer side of the business being a little bit more firm, I think. Can you just kind of give us a little bit more insight? Are you seeing more transactions or bigger deal sizes? What do you kind of see in there that is offering that firmness, I guess?

Joel Ronning

The average order of value is not - I don’t believe it has decreased. From what I’ve seen, it hasn’t, and I just think the traffic is – I am mildly surprised given all the bad news that we’re seeing out there, on a global and national basis, so I can’t give you a lot of insight into it. This is more of I think for us we’re watching the general trends and feeling cautiously optimistic whereas you know in September we had a pretty well defined event. In mid September the numbers came down and they did a step function. We don’t have anything, I’m just trying to say it’s a little fuzzy but I’m just telling you that the data we’re seeing, it is a little firmer than we expected it to be. I’ve called us a canary in the coal mine in the past and we tend to be a pretty good early indicator of what consumers are doing, so like I said we are a little optimistic here.

Robert Breza - RBC Capital Markets

Great, I’ll jump back in the queue.

Operator

Our next question will come from Shiam Patel [ph 00:01:39] with Raymond James.

[Shiam Patel - Raymond James]

Good evening. I was wondering if you guys could comment directionally on how your non-Symantec businesses fair in the quarter, particularly at Microsoft the C.E. and the Games, more directionally than specific numbers, sequentially in year over year. And then regarding your sequentially mid point of guidance for the first quarter, is there any particular customer or category that is driving that, and what does that assume in terms of anti-virus activity in the first quarter?

Ed Merritt

Sure, I’ll take the first question. I think it was how did the business perform XR revenue from semantic and I want to emphasize that’s our revenue from Symantec, not Symantec’s revenue. I mean, you could really get to that pretty simply with the Symantec concentration numbers and the rest of the business actually grew a little bit and if you adjust for effects, you know, the overall business wasn’t down really at all, kind of a flat year on a top line basis. The second question?

Joel Ronning

Was category driving and I think we saw reasonable health across all categories. Would you concur on that?

Ed Merritt

Yeah, again we aren’t a pure retailer so we couldn’t drop all our prices by 25% to drive higher top line and as Joel has reiterated kind of since things stabilized in October, it has been decent and perhaps just a nudge up here in the New Year, so I guess given where we were, we are feeling a bit optimistic.

[Shiam Patel - Raymond James]

Great, thank you.

Operator

Our next question will come from Rod Ratcliff with Sanford Group.

Rod Radcliffe - Sanford Group

Thank you very much. One quick one here for you, Joel could you talk about – you’ve touched on it, maybe a little bit more color granularity on the B to B versus B to C e-commerce markets, what exactly it is you’re seeing? You said multiple times today that you’ve been pleasantly surprised by the amount of action you’ve seen in the B to C market so give us a general health on the B to B market if you would.

Joel Ronning

Well, we don’t do a lot B to B business but we’ve had a lot of demand recently as a product from –

Rod Radcliffe - Sanford Group

Yeah I think that’s what I was kind of driving at. You did touch on that.

Joel Ronning

Yeah a number of very large clients, very sophisticated clients, have asked us and have been asking us for years but we are getting renewed interest and there seems like there is a little bit of an inflection point going on out there where they are asking us to help them with multiunit licenses, some fairly complex pricing models where if you buy this and buy that, a little bit of configuration will give you X-amount of discount, and then a managing of license inside of the SMB infrastructure, small and medium businesses, as well as putting together credit functions where we would be able to go out and go to different credit agencies and allow the resellers to tap into those credit opportunities so it’s a series of requests that we’ve had. We are building on products right now that tend to be a little bit client specific but we are looking at generalizing that into a holistic product in 2009 and I’m optimistic. I’ll talk more about it. We will talk more about it in Q1 as we get better insight into what the product opportunity is but we are getting a pretty good tug on the line here and it’s a little bit like what we saw with Games, C.E., and subscriptions. A year and a half ago, two years ago, we started contemplating moving into those markets. This could be a good strong vertical for us.

Rod Radcliffe - Sanford Group

Wouldn’t you be worried that might be a little bit of a lumpier business?

Joel Ronning

I don’t think so. In fact, the average order value on this, I mean the thing that’s intriguing, the average order value is fairly large. You’re talking about five to 50 unit sales and we have got an extremely efficient integration with all these back ends, all the software providers and their licensing management systems, license key control, digital rights management, and we feel like we just need to bolt onto pretty good credit facility, not ours, to outsource that and we may have a pretty interesting product but no I don’t feel like it’s going to be too lumpy.

Rod Radcliffe - Sanford Group

I guess what I meant was a big pay day up front and then maybe a steep trail off, but we could take it offline, no big deal.

Joel Ronning

Okay, great.

Operator

Our next question will come from Tim Klasell, Thomas Weisel Partners

Tim Klasell - Thomas Weisel Partners

Good afternoon, everybody. My question has to do with the roll-out of the customers that are coming to your service. In this economic environment, are they rolling out their sights and their initiatives with you slower because of capital constraints? Are you seeing them roll them out at the usual pace?

Joel Ronning

No, they are definitely not rolling them out slower. There’s probably a little more intensity about getting them up and I spoke to it earlier in the script and that is with Comp USA and Circuit City going out of business and then when you go and visit some of the other logical competitors out there, which you find is a whole bunch of private label, white label versions of the store’s product and so some of the major clients that I mentioned, I think they are getting very concerned about what they are seeing happening at the retail store front, so there seems to be a high level of intensity of let’s get it out and let’s get it done and then we’ve got a number of clients who are shutting down internal systems and there are some strict dates on those. So, no, we are not seeing a slower roll-out but I have to tell you these large international, multinational companies, these $5 billion, $10 billion, $40 billion companies, they put a high value on precision and precision generally takes a little bit of time so these clients you don’t get them up in a week, it takes months and the good news is it takes months with anybody so once we capture the relationship they tend to want to stay with us because we’ve all gone through that. We’ve all walked through that swamp together but we are excited about the new clients that we’ve contracted this year because I expect they are going to be with us for a long, long time.

Tim Klasell - Thomas Weisel Partners

Great! And then just a quick follow-up. Congratulations on Office 14. I know you can’t talk about specific contract details, but are the contract’s terms substantially the same that you had for the higher version?

Joel Ronning

Yeah, they are substantially the same. We had some new opportunities and we gave some things up for the client but overall we are feeling like we’ve got a pretty good position here.

Tim Klasell - Thomas Weisel Partners

Thank you.

Operator

And our next question will come from Matt Schindler, Bank of America

Matt Schindler - Bank of America

Yes, high. Solid quarter guys. Just one thing, the indirect business, I know that’s been going down since the renegotiation of the Symantec contract, but I calculated it as down 33% year on year coming at an accelerating decline with seemingly no end in sight, is that going away and should we model it that way or will this level off?

Thomas Donnelly

Well, a big part of EDS is where we and Symantec choose to offer that, which is on upgrades and new customer acquisitions today currently, so we are now fully lapped through the first year in Europe and in the third year of auto renewals here in the U.S. I don’t think we are going to give specific guidance related to that but we have talked in the past of kind of the stabilizing of the various segments of business that we handle and that being primarily new customer acquisition, product upgrades, and the online subscriptions which are not auto renewal.

Matt Schindler - Bank of America

Okay, all right. Thank you.

Operator

Our next question will come from Craig Nankervis, First Analysis.

Craig Nankervis - First Analysis

Thank you very much, maybe Joel first, tanking onto one of the other questions about doing more SMB initiatives in ’09, is this sort of a build it and they will come thing and more of a ’010 opportunity or would you expect to see beyond Adobe and what not some SMB wins this year? We’ll start there.

Joel Ronning

Yeah I’m almost positive we are going to see a fair amount of wins. Let me characterize that, a fair amount being I’m not quite sure how many, but more than what we’ve got so far. But, it feels like one of those, we are being asked by the clients for this. This is a pull. This is not a push. We have not offered this up. Our sales people are coming in saying gee, they keep asking when are we going to deliver a product and so we built out some integrations and some technologies for some clients that tend to be a little bit client specific, now we are working on generalizing that and really roadmapping out what I think could be some pretty exciting products and then offering that. You know, my experience has been this is the best way for us to do product development, as we get the poll, we fill vacuum, and then we go out, generalize it and offer it to a large client base and I think there’s going to be a pretty big demand out there so we are working on how do you deal with very small resellers and all the way up to how do you deal with some of the largest, most complex enterprise level resellers and then keep all the components in the food chain happy and it’s a little complicated but we think we know how to do it.

Craig Nankervis - First Analysis

Does this mean adding heads? Do you have new head count for this initiative? How do you think that the resources related to this?

Joel Ronning

Nope, nope, this is a matter of just swizzling around some of the bright people that we have and taking them off of projects that may not have as much growth opportunity and we do have a philosophy here, feed the stars, and so we are going to do that. No, there will not be a large outlay of expense around this and a lot of this is already in the road map from a development standpoint so it will just get done in the normal course of business.

Craig Nankervis - First Analysis

Thank you, and Tom, sort of segueing there, how do I think beyond CapX, how much is ’09 less of an investment year in terms of operating expenses than ’08 was? Is Q1 sort of implied operating margin a baseline for the rest of the year? How can you comment on that?

Thomas Donnelly

Well, I think I could comment on it more effectively if we felt comfortable talking about the full year. I think we are going to monitor as I said, we are going to monitor and be very careful and if we see demonstrable pick-ups and we see opportunities that will pay off to spend against, I think we will do that, but for now we are just kind of carrying on some of the projects, many of which are complete, and the largest one we’ll complete next year and then really making sure as Joel said that the dollars where we are investing opportunities are the best opportunities the company has in front of us.

Craig Nankervis - First Analysis

Okay, thank you very much.

Operator

Our next question will come from Sameet Sinal with J&P Securities [ph 00:04:04].

Sameet Sinal - J&P Securities

Yes, thank you. Actually picking up from the last question, you had several, covered $20 million of investment expenditure in 2008, you said most of them will end by Q1 of ’09, so I just wanted to get a sense from an absolute number perspective anything that rolls off. You also said a number of those projects have been removed or are over now, so what can we see in terms of that $20 million number versus in ’09?

Joel Ronning

Well, I mean if you just look at the historical four quarters, the total spending was higher in the first two quarters of the year than it was in the second two quarters of the year, so I think on the capital side I gave pretty much clarity, we were investing incrementally about $10 million in the data management and SAP efforts and directionally we got about $16 million to go in capital and less operating. We certainly were expecting mid year in a lot of the operating investment related to the new vertical markets and the new functionality. We expected mid year more revenue leverage from that than we are seeing right now in this economy in the first quarter. Having said that, I think the tone and theme here is we are winning the clients, we are executing on the goals, and we think we are when the macro economy comes back we are going to not only see perhaps a return to kind of normal growth rates in the software business but more contribution from the investments that we’ve made.

Sameet Sinal - J&P Securities

A question that I have, what percentage of Q1 growth can you, this might be a little tricky, but what percentage of the growth will come from clients who you’ve added in the last quarter or have started generating revenues in the last quarter or so versus clients from prior three quarters?

Thomas Donnelly

You know, I don’t even know. I’m sure I could get that data if I pressed hard enough but for clients that we added last quarter, the contribution in the first quarter is going to be very small. Chances are if we signed them last quarter they aren’t going to launch in the first quarter and clearly, let’s say it’s a global agreement, they are not going to launch in 13 geographies like Microsoft did. That was very unusual approach. I think the clients are being pretty pragmatic about let’s get up in the U.S. and then let’s phase in the big countries in Europe and then we’ll talk about the other opportunities we have in front of us.

Sameet Sinal - J&P Securities

Thank you.

Operator

We have time for just one more question and it will be from Robert Breza from RBC Capital Markets.

Robert Breza - RBC Capital Markets

Yes, just as a quick follow-up, maybe Joel can you talk about Symantec. I think that there was some confusion out to this quarter amongst investors in terms of renewals, new business, etc, can you just kind of explain for people kind of currently what you’re doing? I know you talked on this call that you’ve got some new activities and I clearly don’t expect you to talk about those but can you just refresh everybody maybe historically what you’ve been doing as it affects indirect and direct that be I think helpful for people? Thanks.

Ed Merritt

Well, we manage their new customer acquisition. We managed the renewals of subscriptions and I think that’s the extent of it, Tom. Do you want to jump in here?

Thomas Donnelly

Yeah and I think maybe your question, Rob, is around the indirect. The indirect component is largely follow-on products that are Digital River products that are sold along with Symantec products to Symantec consumers and the decline in that which we’ve seen for some period of time is related to the fact that new business the company started in 2007, that is the subscription business, in that purchase flow these add-on products are not offered.

Robert Breza - RBC Capital Markets

Great, I think that’s helpful. I just wanted to make sure it was clarified for people. Thanks.

Joel Ronning

Thank you, Bob.

Thomas Donnelly

All right before we conclude today’s call, I’d like to mention that Digital River will be participating in the following upcoming investor conferences and events. On February 10th, we will be at the Thomas Weisel Annual Technology and Telecom Conference in San Francisco. On February 28th, we will be at the Goldman Sachs Technology and Internet Conference in Las Vegas, and on March 3rd we will be at the Morgan Stanley Technology Conference in San Francisco. Thank you for joining us this afternoon and that concludes the Digital River 4th Quarter 2008 Earnings Call.

Operator

That concludes today’s conference call. You may now disconnect.

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