Digital River Inc. (NASDAQ:DRIV)
Q2 2009 Earnings Call
July 29, 2009 4:30 pm ET
Ed Merritt – Vice President of Investor Relations
Joel Ronning – Chief Executive Officer
Tom Donnelly – Chief Financial Officer
Robert Breza - RBC Capital Markets
Philip Winslow - Credit Suisse
Jeetil Patel - Deutsche Bank Securities
[Paul] for Colin Sebastian - Lazard Capital Markets
Shyam Patil - Raymond James
Carter Malloy - Stephens Inc.
Good afternoon. My name is Brandon and I’ll be your conference operator today. At this time I would like to welcome everyone to the second quarter 2009 earnings conference call. (Operator Instructions)
Thank you. Mr. Ed Merritt, you may begin your conference.
Thank you. Welcome to Digital River’s second quarter 2009 earnings call. I’m Ed Merritt, Digital River’s Vice President of Investor Relations, and on the call is Joel Ronning, our Chief Executive Officer and Tom Donnelly, our Chief Financial Officer.
Joel is traveling today and joining us via conference call. While we don’t anticipate this will have any impact on our call, we wanted you to be aware in case there are short delays in response times.
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’d like to turn the call over to Joel Ronning. Joel?
Thanks Ed and thanks to all of you for joining our call today. In the second quarter, total revenue was $96.6 million, GAAP EPS was $0.31 and non-GAAP EPS was $0.42. I’m pleased to report that our second quarter revenue was squarely in line with expectations. Even though our year-to-year results continue to be tempered by the slow economy, we remain encouraged by the growth in our sales pipeline, our new product roadmap and our recent wins in the business-to-business software market.
Last year we outlined our core business strategy which was to strengthen our leadership position in software, diversify into complementary markets including consumer electronics and games, and finally invest in new technologies to unlock opportunities in horizontal markets such as subscriptions and business-to-business or B2B. During the first half of 2009 we continued to execute against this strategy, bearing down and realigning resources to deliver results.
In the second quarter we continued to expand our core software business. We launched an online store for Tripwire, a leader in data center compliance and infrastructure software.
We also expanded our relationship with a large U.S. based PC manufacturer. Based on a new software distribution agreement we will preload PC desktops with the software marketplace of well known brands and titles. We’re excited about this solution for several reasons. First, it represents a new distribution channel for our client base. Second, it confirms that our strategy to sell across adjacent markets like software and CE and that that strategy’s adding value for our clients and our company.
I’m also excited to report that we now have tangible traction with our new B2B solutions in the software market. In the second quarter we expanded our relationships with two long term clients. Autodesk contracted with us to use our channel partner network, a new B2B solution that automates the managing of complex margin, delivery and payment solutions to resellers and distributors. And Nuance is implementing our volume licensing solution to support online sales for its small to mid-size business customers.
We also welcomed Lominger International as a new B2B client and rolled out an online store to automate business purchases of its leadership training materials. These B2B wins are directly attributed to investments we’ve made in new product development. We’re excited to see more of these B2B opportunities in our pipeline to help clients more effectively sell directly to their business customers.
We believe that B2B represents a sizable market opportunity for Digital River. Recent research indicates that there are over 27 million small and medium sized businesses worldwide and in 2007 they spent nearly $114 billion on packaged software alone. Other surveys have reported that more than half of the SMB owners have either purchased or would purchase software online.
During the second quarter we also grew our relationship with Semantic and Microsoft. For Semantic we launched a new U.S. store that offers students a discount on purchases of Norton Antivirus. We also continued to make progress optimizing site flows for Semantics’ trial ware, OEM and retail programs. Our work on these programs is yielding some impressive early results. Overall, our relationship with Semantic continues to be strong. We’re excited about several significant opportunities in Semantics’ SMB business. We have more details to report in future quarters as these products mature. In the meantime we look forward to working with Semantic on new product strategies and remain committed to the company’s continued success.
For Microsoft we began managing all global sales for its home use program. In addition, we added a German site to its popular student initiative called Ultimate Steal. These programs offer our enterprise customers and students deep discounts on purchases of Microsoft titles including Office. We’re excited to work with Microsoft on these opportunities which drive broad consumer adoption of their products. We expect to make more announcements on new projects related to upcoming Microsoft product launches and promotions in the near future.
In addition to our solid execution in the software market, we also made progress expanding our presence in consumer electronics and games. In consumer electronics we closed a new contract with Sonim Technologies to manage global online sales for its rugged mobile phones and accessories. We also won additional business with existing clients.
We expanded Western Digital’s e-commerce operations from the U.S. into the United Kingdom and Canada, and launched five new global stores for NETGEAR. After the close of the second quarter we also signed an expend agreement with Samsung to manage their Canadian online business.
In games, we closed new business with several market leaders. We won a new e-commerce agreement with a top 10 game publisher, renewed our agreement with Electronic Arts and signed a three year contract extension with Prima Games. Our sales activity in software, consumer electronics and games continues to be driven by healthy growth in our prospect pipeline. Consumer electronics and B2B software in particular continued to gain traction. Please keep in mind, however, that new client wins can take time to sign, build and ramp.
One way to help clients drive growth is through our managed market force programs. With budgets tightening, companies are under pressure to show measurable and sustained return on their marketing dollars. We believe these factors are contributing to the increased interest in Metris based programs like multi-grade testing and dynamic personalization. Clients engaged in these programs are seeing incremental lifts of up to 15% in revenue per visitor through tested and personalized contract.
On July 15 we announced two organizational changes. First we announced our plans to outsource our customer service operation to Tennessee-based Sitel. We believe this partnership will give us the scale to more efficiently meet the growing global requirements of our client base. We’ll be able to offer more flexible staffing, expanded support in emerging markets, added multi-lingual capabilities, and in the near future new global services such as inbound and outbound tele-sales. To support other client activities we will continue to maintain a small customer service team in our Minneapolis and Shannon, Ireland offices.
Second, we announced the realignment of other resources across the company. These two actions resulted in the elimination of approximately 120 positions, largely in our customer service area. Our intention is to realign these positions primarily to accelerate new product development and expand our global sales reach.
As we have discussed in previous calls, this year we are heavily investing in new products that matter to our clients’ bottom line. Second quarter was no exception. Last quarter we launched Limited Edition E-Commerce, a specialty outlet store that manages the inventory and sales of collectibles and clearance items. To support growth in strategic marketing, we introduced the Data Network Alliance, the only online cooperative of its kind to tailor display ads exclusively for technology customers.
In addition, we launched Software Network Agent, a new tool used by OEMs and system builders to enable software trials and purchases as well as dynamic merchandising from the desktop. And most recently we expanded our B2B portfolio with a solution called Business Direct. Using this solution, our clients can manage private online portals to sell directly to their enterprise customers. These launches represent just some of the new products.
In 2009 we’re on track to deliver more than 20 new e-commerce products and technologies. In addition, we expect to launch our new SAP and client reporting systems at the end of this summer. Our new back end systems will drive accurate, consistent and timely data, and deliver world class e-commerce reporting for all our clients. By automating and simplifying a number of our back office processes and controls, Digital River is laying the foundation for future growth.
To respond to market opportunities, we’re also expanding our global sales force. In the second half of the year we intend to hire experienced sales professionals, accustomed to working with C-level executives and large global enterprises. We expect to see meaningful contributions from this investment in 2010.
Given the rapid economic shift we saw last September, a month that historically produces our strongest third quarter sales, we’re being somewhat cautious about our quarterly expectations. As we wait to see how this September is impacted by the macro economy, we remain optimistic about our new product pipeline, sales pipeline, and growth potential in key markets.
With that, I’ll turn the call over to Tom.
Thanks Joel. We’re pleased with our financial results for the quarter and encouraged by our execution winning new clients and delivering new products. Our second quarter revenue was $96.6 million, near the top end of the guidance we gave in April. The international portion of our business represented about 39.4% of our commerce sales in the quarter, down from 44.1 in the same quarter last year.
Currency fluctuations negatively impacted year-over-year revenue by about $4.6 million. Our Semantic related revenue for the quarter was 30% of total revenue, compared to 32.6% in the same period of 2008. Direct Semantic revenue during the quarter was 22.5%, compared to 23.5% last year. As we’ve noted in the past, these results are based on our revenue related to Semantic and should not be considered a reflection of Semantics’ consumer business.
GAAP net income for the second quarter totaled $11.8 million or $0.31 per share and was slightly above our guidance range. Net income was $13.2 million or $0.33 per share in the same period last year.
Switching to non-GAAP results in the second quarter, non-GAAP net income totaled $15.8 million or $0.42 per share. Non-GAAP net income per share was at the top end of the guidance range we gave in April. In the second quarter last year, we reported non-GAAP net income of $16.5 million or $0.40 per share. Operating margins for the second quarter was 13.4% on a GAAP basis, down slightly from the second quarter of 2008, related primarily to stock compensation expense. On a non-GAAP basis, which excludes stock compensation expense, and amortization of acquisition related intangibles, operating margin was 20.5% this quarter compared to 20.2% in the second quarter last year.
Looking at the individual second quarter expense lines compared to the second quarter of 2008, and excluding stock compensation expense, direct cost of services were essentially flat as a percentage of revenue year-over-year, declining in dollars by about $400,000, largely related to cost control activities over the last several months. Network and infrastructure costs increased 3.8% year-over-year, primarily related to higher client website traffic, which drove increased data communication expense, partially offset by foreign currency exchange and cost controls.
Sales and marketing expenses declined year-over-year by $400,000, or 1.1%. We do expect sales and marketing costs will increase over the second half of 2009 due to increases in quota carrying headcount.
Product R&D expense declined 1.8% from last year. We do expect R&D to increase over the second half of the year as we hire additional development resources to deliver new products and services, a critical component of our long range plan.
G&A costs were down almost 18% year-over-year, with the reduction primarily related to continued cost controls around headcount and outside services. Overall, currency fluctuations decreased year-over-year operating expenses by approximately $3.2 million when compared to the second quarter of 2008.
Note that there were a few one time items that impacted our results in the quarter. First, stock compensation expense exceeded our guidance by about $500,000 and payment processing costs spiked by over $1 million due to increased credit card related fees. Interest income for the quarter was $762,000 compared to $4.3 million last year. The decline in interest income is due to substantially lower interest rates and lower cash balances. Note that this change alone, when taxed at our non-GAAP tax rate, accounts for nearly $0.06 in lost EPS.
Other expenses in the second quarter benefited from a $1 million gain on foreign currency exchange. Our GAAP income tax rate for the quarter was 20.4% compared to 21.7% in the same quarter of 2008. And the rate this quarter benefited from the removal of a valuation allowance on acquired NOL. Last year’s results were impacted by a one time benefit related to an R&D tax credit.
Turning to cash flow, net cash provided by operating activities for the six month period ended June 30 totaled approximately $46.5 million, compared to $40 million in the similar period of 2008. Excluding changes in operating assets and liabilities, which I refer to as balance sheet leverage, net cash flow from operations for the six month period was $51.5 million and declined slightly from last year’s level of $55.7 million. The change was primarily related to lower net income and heavier use of deferred tax assets in 2008.
For the quarter, cash flow from operations was negatively impacted by the slow collection of [past] receivables, primarily in Ireland due to ongoing audit activities. These receivables are now current.
Capital expenditures were about $12.5 million in the second quarter. The bulk of the investment during the quarter was related to the SAP implementation and data management reporting projects, which remain on schedule to be completed by the end of the summer. We continue to expect full year CapEx to be $34 million.
We continue to maintain a very strong balance sheet with substantial liquidity. We ended the quarter with approximately $445 million in cash and investments.
Now on to guidance. For the third quarter of 2009, we currently expect revenue to be in the range of $96.5 to $98.5 million. GAAP net income is assumed to be in the range of $0.26 to $0.29 per share, including $4.6 million of stock compensation expense. Non-GAAP net income is assumed to be in the range of $.38 to $0.41 per share. Foreign currency is still expected to be a year-over-year headwind in the third quarter to revenue, totaling approximately $1 million.
The data in the revenue range provided largely depends on what consumers do in September, a month that has historically been one of our strongest of the year, up until 2008. Typically back to school combined with a series of product introductions drives sequential improvements in our business from Q2 to Q3. Hopefully, our business will return to the normal cyclical patterns this year.
In the third quarter we expect to take a charge which is included in the guidance of approximately $2 million or $0.04 per share fully taxed. This charge includes severance, out placement and redundancy related to the outsourcing of our customer service and other realignments which we announced on July 15, including the relocation of our international headquarters in Shannon, Ireland. These actions are designed to either drive operating efficiency or revenue growth in 2010.
Weighted average shares outstanding in Q3 are anticipated to be 38.1 million. Interest income is expected to be about $600,000 in the third quarter. The decline from prior guidance is attributable to continued erosion in yields from investments in the fixed income markets. On a year-over-year basis, this represents a decline of $3.9 million, over $0.06 per share fully taxed.
Our GAAP tax rate for the third quarter is estimated at 27%. In summary, we continue to execute against our financial and strategic goals in spite of the tough economy. We will continue to manage expenses and align our investment where we see the greatest opportunity for growth.
With that I’ll turn the call back over to Joel.
Thanks Tom. To recap, given the soft economy we’re pleased with the results our team delivered in the second quarter. First, our strategy is taking hold as we continue to sign new clients in software, consumer electronics and games. In addition, we’re very excited about the opportunities that continue to surface in the B2B software market. We’re seeing great demand from software clients and continue to direct more resources toward this space and opportunity.
Second, our product pipeline has never been better. As I stated earlier, we’re devoting resources to our development team that will allow us to deliver more than 20 new products and technologies for our clients this year.
Finally, our client pipeline is strong. To respond to demand and interest in the market we are expanding our sales force by hiring account executives that are experienced in selling into complex, global enterprises. We expect to begin to see contributions from this new team in 2010.
With that, I’ll open the calls up for questions.
(Operator Instructions) Your first question comes from Robert Breza - RBC Capital Markets.
Robert Breza - RBC Capital Markets
Tom, a quick question on the guidance. When you talked about the rebound in September in your guidance are you kind of expecting that to happen or taking a wait and see attitude on September? And then Joel maybe one for you on the consumer electronics side. Do you still think that can get to be 10% of revenues for the year?
Yes, sure, Rob. You know as I said on the call I think what we’re trying to range here is a conservatism in September based on what we saw last year relative to back to school and product introductions. And at the high end kind of what we would see normally, cyclically going into the fall. And there’s different indicators out in the macro environment that I think are causing us to take that position. But we’ve got a lot of things to get done. Sooner or later the economy’s going to recover and hence the range on EPS and taking the actions that we did. We see enough opportunity that we’re just going to bear down and provide that sort of range, based on what we saw last year, because as you know typically we’re up in the third quarter, particularly September is a very important month to the third quarter.
And I’ll take the CE discussion or the question. And I think we’re going to be close. We’ve got some really good clients, signed on a bunch of really good clients, Samsung, Philips, SanDisk, Kodak. And they’re all coming up at a rate which is a little slower than we would like to see it, both in terms of the technologies and the integrations, getting a fair amount of custom work that’s coming on request from the clients. So that’s slowing our rate of being able to bring the sites live. But our sense for the market is that we clearly are the place that these companies are looking to for, you know, their direct to consumer relationships. So the pipeline looks really good. Clients are coming up a little slower than I like to see but we’re crowding it.
Your next question comes from Philip Winslow - Credit Suisse.
Philip Winslow - Credit Suisse
You know, Tom just a question back on some of the changes that you all talked about with the restructuring and the outsourcing of the support. You know once we’re through this transitional period, how do you see this net affecting your gross margins and out margins as we kind of think about this going forward? And then Joel, when you do look at the company and obviously with some of the success you’re seeing in consumer electronics, what do you think the right margin structure for Digital River is here in the near term?
Yes, sure, Phil. You know once we’re through this period it will certainly allow us to maintain and perhaps improve both through efficiency and through being able to offer other long sought after services like tele-sales.
Okay. And then on the margin structure standpoint. The margins are very similar. We’re able to sell our market force services into many of these accounts. We’re dealing with manufacturers who really don’t have a deep understanding of how to work on a direct to consumer basis, and so we’re able to bring a lot of value in that relationship.
And the other thing is that we’re dis-intermediating the channel, you know, when we work with these companies quite often where there really is no challenge from us directly to the consumer. So there’s a fair amount of margin available. So even though that we are, you know, capturing a deep margin on this it’s still a better value for them from an expense standpoint than it would be if they were going through the conventional channel.
Your next question comes from Jeetil Patel - Deutsche Bank Securities.
Jeetil Patel - Deutsche Bank Securities
You know, I guess international business if you look at that line item it was off about 2% constant currency on a year-on-year basis in the quarter and I guess can you talk a bit about, you know, I guess where’s the weakness in that business line? Is it actually just UK? Is it mainly Europe? Was there any sort of kind of designs or products, customers that didn’t, kind of came out of number early, just talk through a little bit more on the international number. And then second if I just look in aggregate your Q3 guidance at the mid-point adjusted for FX is down maybe a percent of so sequentially. You know, is that more just a function of just September and kind of staying conservative there? Or is it based on what you’ve seen up to this point in the month of July? Just perspective on how Q3 looks. Thanks.
I’ll take the second one, Tom, if you can grab the first question. Jeetil, we’re just being cautious and, you know, with the economy being what it is we do see, you know, the impact of what’s going out there from a consumer standpoint, being that we’re selling directly to consumers. Business is not terrible but it’s not great. We’re somewhere in that in between space, and we’re just being very cautious about Q3. We’re hearing positive things from our clients but everybody’s a little bit tucked in in terms of their spending, in terms of them really leaning into new product promotions. So we’re having to be, I think, just a little bit thoughtful.
We’re not crazy about the bottom end of the guidance. You know our expectation is that we’re going to beat that nicely, but I think we’ve just got to be a little bit careful, especially given what we saw last September. We’re hoping that back to school obviously does better than last year which was very poor. I think we’re just having to be a little thoughtful right now.
Yes, and Jeetil it isn’t customer centric. It’s more regional. And because the bulk of that number is Europe, that’s where we have seen weakness. We talked about it on prior quarters. Nothing has really changed from what we’ve been saying going into the first quarter or going into the second quarter. The business is still performing kind of where it has been. And to add on to what Joel said about the third quarter, you know, September’s an important month for us. For those of you who cover the company, we usually see big payables build which means we have a really good gross month. And we went into September last year going great guns and then everybody kind of saw a sharp, sudden drop off.
So, you know, this is probably the most back end loaded quarter even though we have a very linear quarter, this is the most back end loaded quarter that we have to deal with from a guidance perspective of the year.
Jeetil Patel - Deutsche Bank Securities
Joel, is the impact that you talked about in less new product promotions, is that, do you think it’s more just your customers doing less discretionary spend to drive growth as it looks on online sales? And second just a broader kind of question about, you know, strange one, but WaMu was obviously bought by J.P. Morgan and Wells bought Wachovia. Those companies have credit cards and they’re transitioning to new credit cards to the consumer. How much of an opportunity is that as you look at some of your corporate customers, you know, handing over their list to say can you guys go re-sign these customers for subscriptions and renewal services?
Well, I’ll take the second question, I’m not sure if we have that level of precision into what’s happening, you know, from a corporate credit standpoint, Jeetil. But what we’re finding is there’s a tremendous amount of interest from our clients for us to help them do what we did in the consumer market which is essentially just intermediate the reseller channel and all the channel activities when they go straight to their corporate clients. And that we’re pretty fired up about.
We’re seeing some products that we’re seeing 60,000 unit orders for into large corporate accounts. And in doing that on a digital basis we manage the licensing and the delivery of the product. We’re working through a bunch of new technologies to allow for different credit capabilities into corporate accounts, whether that comes on a direct basis from our client, the software, the hardware company, or whether we bring in a third party or in some rare cases we may even take on that credit ourselves if there’s enough margin.
So what we’re finding is is that there’s a lot of opportunity. A, we’re helping the clients get, our clients get more margin because they’re able to just intermediate and second we’re able to help them control the licensing relationship in the corporation. So they know if look we had 68,000 units, 68,000 seats, a year from now we should be able to renew another 68,000 units. And we’re getting a tremendous amount of demand for those kinds of services.
And so credit is really inextricably wrapped inside of those products. And your question is wrapped around, you know, what kind of a payment process are we going to be using and we’re finding it’s kind of this portfolio approach, it’s got a lot of strength in it. So like I say I’m not sure I can give you precision on the cards moving across. I really can’t. But I can tell you we’re getting a lot of interest. Clients are really leaning into the whole prospect of going direct and us helping them to manage that relationship from a credit and also kind of an asset management standpoint.
Your next question comes from [Paul] for Colin Sebastian - Lazard Capital Markets.
[Paul] for Colin Sebastian - Lazard Capital Markets
Can you provide some additional color on the pipeline? Are sales cycles lengthening? And then how is the pipeline in the game category coming out of the E3 conference? And then secondly, what should we expect in terms of timing for any update on the Semantic contract?
Well, I’ll go specifically to the game category. We’re actually doing fairly well. We haven’t seen the level of transition that we would like to see before a lot of our large game companies to an [Implog] or a subscription model. But they’re starting to get there. We had a lot of buzz at the latest conference and we’re continuing to chip away. I think we’ve got the majority of the top 20 game companies out there. And my sense is that we’re probably going to get all of them as clients. I mean the portfolio of offerings that we’re bringing to them, it’s pretty deep, pretty wide. And I think we’re just going to continue to chip away at that group.
My primary concern is that we need to see them ultimately embrace the subscription model and we would like to see them moving faster in the direction of multiplayer online games, but we have no control over that. When they do it, we expect that we’re going to be there and we should be a pretty good participant in it. But we’ve just to be patient as our clients work through strategy and their new products.
The sales pipeline continues to look really good. We’re getting more clarity, more precision, more really good updates in terms of, you know, how we’re doing in the prospect base across all fronts. And I’d say that the sales pipeline year-over-year now is about twice what it was a year ago. We started to see a ramp up about a year ago. And so we’re feeling good about the sales pipeline. That’s very deep. It’s deeper than I think maybe it’s ever been, well, probably in the last five to six years.
And in terms of close times, I’d say they’re probably not dissimilar to what we saw a couple of years ago. Corporate clients, large enterprise clients take a long time to make their decisions. And then also take a long time to do their integration, so they tend to be patient about those processes. That’s the bad news. The good news is as they are slow to make these commitments, they’re also slow to move away from these commitments. So our sense is that these are very long term relationships. Does that answer your question, Colin?
[Paul] for Shyam Patil - Raymond James Colin Sebastian - Lazard Capital Markets
It does. And on the timing of when we can expect an update on the Semantic contract?
Oh, I’m sorry. I forgot that part of it. Where we are right now with them, Semantic, is we have a very [inaudible] relationship as we talked about it. We’ve not started contract talks with them, but we’re probably not going to provide any future updates on when that contract talk starts. We don’t do it with any of our clients and we don’t think it’s a good idea with Semantic, obviously our most important client. Confidentiality and a whole bunch of other issues. And so our plan is that we’re going to file an 8-K with the SEC when the new contract is completed, but we will not be discussing it prior to that.
Your next question comes from Shyam Patil - Raymond James.
Shyam Patil - Raymond James
My first question is around consumer electronics. I believe earlier on the call you mentioned that there might be some delays in customers progressing with the launch date. I was wondering if you could elaborate a little bit on that.
This has happened with some of our largest software clients where you’ll expect to see a launch date of August and it’ll move around because the customer gets 80% of their way through the project then realizes there’s new features or something else, maybe they want to add some new regions or something like that to the project. Usually these things are additive in the relationship. We’re happy to see them. But in the short term they’re, you know, it’s a little disconcerting because you have to work through the timing issue. And so you move the schedules out. These are not material. It’s not like we’re going from 6 months to 12 months. We’re going from 6 months to 8 months.
But when you stack them all together at some point, it does impact things like Q3. I wouldn’t say this is a big impact on Q3, but it’s something that we’ve seen with these very large enterprises, especially in the consumer electronics arena. These are very large clients and they’ve got a process that they need to work through and we’ve got to cooperate with them. And so it’s not quite like the fleet of seat software clients that we’ve historically been working with that you can bring sites up in a matter of months or in some cases a matter of weeks. These are very complex global relationships and we’ve got to get all regions aligned. So there’s a lot of reasons that these things will slip.
We’re not crazy about it but I think it’s just reality. And like I said it’s not really material.
Shyam Patil - Raymond James
And then just switching to the 3Q guidance, how are you thinking about Europe trending in the third quarter from a sequential standpoint? And what have you sort of assumed in your 3Q guidance for Europe?
Tom, do you want to take that?
Yes, sure. As I said, you know last year we reported 96 and change in the third quarter. The guidance range is 96.5 to 98.5 and there’s a $1 million headwind in currency based on our internal assumptions. So that would be up $1 to $3 million. Of course dependent on what happens with the various foreign currencies throughout the quarter. Is that what you were looking for? Or were you looking for?
Shyam Patil - Raymond James
Just what kind of sight? I mean it seems like Europe’s been particularly weak, you know especially when you compare geography, and I was just curious to what your 3Q guidance assumes for business activity in Europe.
You know I don’t have that data. I think I can get that data. We do it more on a client level basis, and based on order volume in the native currency, and then we in treasury and finance make an FX assumption. So if you’re really intrigued by that I will say July and August tend to be more pronouncedly down as far as for months, just because of the vacation schedules in Europe in the summertime when compared to the U.S. but September tends to be good as it tends to be here in the U.S. as well. So.
Shyam Patil - Raymond James
Okay. Thank you.
Nothing major outside of historical norms is once I get at the data I’m sure that’s what it will show.
We have time for one more question. Your last question comes from Carter Malloy - Stephens Inc.
Carter Malloy - Stephens Inc.
On the pipeline that had been brought up several times in the call I think Joel you said it was up two times than it was last year and last quarter you commented and said it was up three times year-over-year. I’m just wondering if it’s down sequentially or if that’s a function of converting people out of the pipeline or if that’s just something on the [inaudible].
No. What I said in my comment is that the pipeline started to grow pretty nicely about a year ago. And so we really bore down on it, put some real energy into it. And we were also signing on some consumer electronics players. So no the size of the pipeline, it is larger than it was last quarter and it’s materially larger.
I was kind of, as I was saying that I was kind of in the back of my mind asking myself that question, but the answer is it is up. It is up from where it was. And the good news, it looks to us like we’re the place to go for, you know, consumer electronics. Obviously in the software market we are absolutely the place. You can’t go wrong working with us and I think the thing I’m really excited about is we’re getting tremendous kind of response to this B2B arena, you know, the B2B stuff that we’re doing and the fact that we understand how to dis-intermediate and can help these clients work directly with their, you know, their SMB as well as large corporate users and then track that customer and manage that relationship for them. In the years to come it’s huge, huge value.
Carter Malloy - Stephens Inc.
On the conversion of it, so if you assume that you actually convert someone in the pipeline, how long does it usually take? And I think you guys gave it before, but maybe for us small versus the large customer, just rough timeline so we can get our models kind of aligned for next [inaudible].
You know from small clients from contract to bringing them up is maybe six weeks. You know large clients, gosh, we have, I don’t know if you were watching us at the time that we brought up the first Microsoft relationship, I think it took us 14 months. And so that’s an extreme but it does happen. Thank goodness it’s not very often. And that was a very complex global roll out with a, you know, tremendous amount of products going into it. And so you’re probably looking at with large clients probably six to eight months.
Carter Malloy - Stephens Inc.
Just out of curiosity, can you give us a sense of how, I know you can’t give it in dollars, but is Microsoft a meaningful client, say, over 5% of revenues?
I’m not sure if I should comment on that, but I can tell you that they’re absolutely meaningful. And that’s a relationship that we started off I think about three years ago. It took us like all of these companies, it took us time to build up and get traction in all the departments across the organization, all the different products. But that is a really meaningful client right now.
So Tom do you want to comment on that?
I think you did.
We’re really happy with the relationship and it looks like we continue to add real substantial value to that. And they continue to grow, so it’s a big client.
I’d now like to turn the call back over to Mr. Ed Merritt.
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. First we’ll be at the Oppenheimer Annual Communications, Technology and Internet Conference in Boston on August 11 and 12. We’ll be at the Deutsche Bank 2009 Technology Conference on September 14 and 15 in San Francisco. And we’ll be at the Merrill Lynch One-on-One Conference in Boston on September 21.
Thank you for joining us this afternoon. And that concludes the Digital River second quarter 2009 earnings call.
This concludes today’s conference call. You may now disconnect.
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