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Digital River Inc (NASDAQ:DRIV)

Q3 2006 Earnings Call

October 26, 2006 4:45 pm ET

Executives

Bob Kleiber - Vice President, Investor Relations

Joel Ronning - Chief Executive Officer

Thomas Donnelly - Chief Financial Officer

Analysts

Safa Rashtchy - Piper Jaffray

Jeetil Patel - Deutsche Bank

Lee Westerfield - BMO Capital Markets

Sasa Zorovic - Oppenheimer & Company

Robert Breza - RBC Capital Market

Rodney Ratliff - Stanford Financial Group

Phil Winslow - Credit Suisse

Craig Nankervis - First Analysis

Presentation

Operator

Good afternoon ladies and gentlemen, my name is Marquida and I will be your conference operator today. At this time, I would like to welcome everyone to the Digital River Conference Call. [Operator Instructions].

It is now my pleasure to turn the floor over your host, Bob Kleiber, Vice President of Investor Relations. Sir, you may begin your conference.

Bob Kleiber - Vice President, Investor Relations

Thanks Marquida. Good afternoon everybody and welcome to our call. Joining me today are Joel Ronning, Chief Executive Officer, and Tom Donnelly, our Chief Financial Officer.

Before we begin the call, be aware 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 “believe”, “anticipate”, “expect” and similar words. These statements involve known and unknown risks, uncertainties, and other factors which may cause actual results to differ materially. 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 to turn the call over to Joel Ronning. Joe.

Joel Ronning - Chief Executive Officer

Great, thanks Bob. And thanks and thanks to all of you for joining us today. During Q3 of 2006 we exceeded our revenue and earnings expectations. We delivered $75.3 million in revenue, which is up 42% over the same period last year. During Q3 on a GAAP basis, our net income was up 20% over Q3 2005. On non-GAAP basis, our net income was up 42% over the same period last year. Our stellar performance was accompanied by the expansion of a relationship with two major partners, Symantec and Microsoft.

For those of you who saw our press release on Tuesday we’ve signed a two-year contract extension with Symantec, which runs through June 30th 2010. As part of the revised contract, we will be expanding our support for Symantec’s existing global online consumer, S&P and enterprise business in several areas. First, we’ll be ramping up our marketForce® services to support an aggressive customer acquisition program.

Second, we will be taking an expanded role in managing subscription sales. In addition, we will be driving revenue growth on a new increased traffic-based by applying our consumer segmentation strategies and optimizing the shopping experience. And finally, we will continue to play an integral role in supporting and growing Symantec’s new products and services including software service and in application sales opportunities.

Based on the revised scope of the relationships, Symantec will be paying Digital River a lower revenue share percentage while Digital River will be managing an increased volume of Symantec’s business. We also announced today that we have signed a new three-year master agreement with Microsoft. As part of this agreement, we are building, hosting, and managing e-commerce stores to support the digital delivery of popular Microsoft’s software products including its personal finance and office products. As part of our global arrangement, we’ll be marketing and selling products across North America, Europe, Asia, and Latin America.

This past spring we began investing in this project and building up the e-commerce infrastructure. We started by launching a US online store for Microsoft Money. We expect new sites for launch during the next several months including global online stores for upcoming 2007 Microsoft Office System’s products.

For the Microsoft Office products, we expect to begin proving trial downloads in late November and anticipate the conversions of the trials and commerce will begin during Q1 of 2007. In addition, Digital River will continue to provide e-commerce services and digital delivery of Windows compatible software products to the Microsoft Windows marketFlace and the digital locker.

These announcements are a testament to our global commerce infrastructure and the world-class enterprise system that we built. Today our system which is supported by nine data centers across three continents displayed in 18 languages and transacts in 20 currencies. We answer the phone in 11 languages 24/7 and we have third party fulfillment agencies in four continents. Moving forward, we plan to continue tapping in the capabilities of our system as we help our clients extend their business on a global basis.

Customer acquisitions and marketing programs like those included in our marketForce strategic marketing services also continue to be key factors in helping us deepen client relationships and win new business. During last quarter, we engaged five additional clients in marketForce programs for the first time. In total, we launched 11 new managed programs for six clients. Our most mature marketForce offerings including manage, search, and affiliate marketings continue to perform well and we are seeing stronger growth in managed e-mail programs and pretrial optimization.

In Q3, marketForce related revenue increased more than five fold compared to the same period last year. As the focus on global markets continues to increase, we are committed to adding even more features to our platform, features that support multi-user, multi-channel and multi-cultural solutions. One area where we made great progress increasing the depth of our offering is in the consumer electronics vertical.

Last quarter, we completed the integration of our global commerce platform with our intelligence-sourcing engine. This smart engine automatically determines the optimal warehouse source for physical product delivery based on factors such as real time inventory status, price and shipping cost. Clients will now be able to dictate customizable business roles that will drive the most cost-effective and efficient sourcing of physical products from nearly 100 warehouses across North America.

In the near future we will be sourcing from integrated third party distribution partners across Europe. What this means is, is that our global converse platform now supports what we believe are unmatched solutions for not only digital but also physical product delivery. We intend to capitalize on these new platform features and efficiencies to support our continued expansion in the high-tech manufacturing and consumer electronics marketplace.

Another great testimony to our ability to innovate is the recent launch of marketStudio™. What this integrated e-marketing toolset does is offer a marketing executives a single web-based view into the performance of their online marketing activities. It creates a deep and natural integration between e-commerce, web analytics, e-mail, keyword bid management, and affiliate technologies. The end result is that it enables marketers to measure and compare the performance of their online marketing programs and determine the real-time return on investment. We believe this is a first toolset to integrate what is traditionally been viewed as separate and distinct product offerings.

With that I’ll turn call over to Tom for details on financial performance and come back with comments on our outlook.

Thomas Donnelly - Chief Financial Officer

Thanks, Joe. Our Q3 revenue was $75.3 million, up 42% from $53.2 million reported in Q3 of 2005. International sales were approximately 39% of total sales, GAAP net income for the quarter totaled $14.8 million or $0.33 per share including $3.5 million of stock compensation expense. This compares to net income of $12.4 million, or $0.31 per share in Q3 of 2005 with no stock expense. GAAP pre-tax income grew in 19% on a year-over-year basis, absent stock compensation expense, GAAP pre-tax income would have grown 40%.

Switching to non-GAAP results in Q3 non-GAAP net income totaled $18.7 million or $0.41 per share compared with non-GAAP net income of $13.2 million or $0.31 per share for Q3 of 2005. This represents a 42% year-over-year improvement in non-GAAP net income and a 32% increase in non-GAAP net income per share.

As expected Q3 operating margin was lower on the GAAP and on non-GAAP basis when compared to Q2 of 2006 reflecting the ongoing ramp of expenses related to our Microsoft announcement today. Investments were continuing to make in the consumer electronics vertical and the acquisition of MindVision late in Q2. On the cost and expense side all operating expenses categories increased in absolute dollars on a year-over-year basis due to several factors including acquisitions made in the late 2005 and in 2006.

Stock compensation expense, international expansion and investment across the board related to expanded relationships with our largest clients. Looking at the individual expense line items compared to Q3 of 2005 and excluding stock based compensation expense, direct cost of services were up 63% primarily due to increased sales activity and acquisitions.

Network and infrastructure costs were up 54% due to increased sales activity costs related acquisitions, opening new international customer service center and operating new international data centers. Sales and marketing expenses were up 63%. Specific factors that drove of the increase include incremental payment processing fees tied to higher transaction volumes, higher costs associated with marketForce, continued investment in oneNetwork, additions to head count to target two more electronics vertical additions to head count in the Asia-Pacific region and acquisitions. R&D expense was up 49% again reflecting continued investment in our initiatives, acquisitions and R&D for Microsoft and finally G&A costs were up 27%.

Although there was growth in our operating expenses on a year-over-year basis please keep in mind that on a sequential basis, total operating expanses increased $3.6 million with much of this increase related to the MindVision acquisition and payment processing fees tied to higher revenues. Other income during the quarter benefited from a continued favorable interest rate environment.

CapEX was essentially neutral for the quarter both in transaction terms and when comparing our year-over-year revenue performance. Over GAAP tax rate in Q3 was 27%, three points higher than the 24% guidance we gave primarily related to higher than anticipated profits in the US and a lower than expected benefit related to our R&D tax credit.

We still anticipate Q4 GAAP tax rate of 33% resulting in an average of 31.8% for the full year of 2006 moderately higher than the guidance we provided in April. Our US NOL at the end of the quarter was approximately $66 million and our international NOL was approximately $3 million.

Turning to cash flow net cash provided by operating activities totaled approximately $84.7 million for the nine-month period ended September 30th compare to $64.3 million for the similar period of 2005 an increase of 31.7% excluding changes in operating assets and liabilities which I referred to as balance sheet leverage. Net cash flow from operations for the nine months ended 30th 2006 was $86.8 million up $23.6 million or 37% when compared to the prior year.

Note that the cash flow growth does not adjust for the reclassification of the excess tax benefit of stock-based compensation which is now reported in the financing section of the cash flow statement not the operation section. If we had included this benefit in the 2006 operation section it would have added another $3 million as a source of cash for the nine months ended September 30th 2006. CapEx was approximately $3.7 million in Q3 and just under $13 million year-to-date.

We anticipate CapEx for the full year to be in the $14 million to $15 million range. We ended Q3 with approximately $576 million in cash in short-term investments. There was no activity during the quarter under our stock buyback program. Now on to guidance for Q4 of 2006 we currently expect revenue of $82.4 million, GAAP net income of $0.35 per share assuming a quarterly tax rate of 33% and including $3.6 million of stock compensation expense and non-GAAP net income of $0.46 per share. For the full year ending December 31, 2007, our initial guidance is as follows: total revenue of $380 million, GAAP net income of $1.74 per share including $15.3 million of stock compensation expense, and a 32% anticipated annual effective tax rate, and non-GAAP net income of $2.14 per share.

Some notes on the guidance as you build your models for 2007. There are few items that will impact the distribution of revenue and EPS growth in 2007. One, the recent extension of our partnership with Symantec and two, the timing of investments and revenues related to our partnership with Microsoft. As Joe mentioned we’ve signed a two-year extension with Symantec that lowered our base revenue share percentage. The additional transaction volumes and services we expect to provide will ramped over the course of 2007. Therefore the impact of the revised agreement is slightly negative on Q4 revenue as well as impacting year-over-year revenue growth in the first two quarters of 2007.

Overall we are very pleased to solidify our long-term Symantec partnership and look forward to handling more of their online business as 2007 progresses. We also have and we’ll continue to invest in our expanded partnership with Microsoft. If schedule dates are met we expect new revenues from this relationship to begin late in Q1 and we expect they will ramp throughout the year as their online channel emerges and consumer awareness grows. To that end we currently expect quarterly year-over-year revenue growth in the 15% to 20% range in Q1 and Q2. With Q1 closer to the low-end and Q2 closer to the high-end of the range.

In Q3 and Q4 we expect revenue growth in the 25% to 35% range with Q3 closer to the low-end and Q4 closer to the high-end of the range. In addition, due to investments ahead of revenues, we expect year-over-year non-GAAP EPS growth in the 10% to 15% range through the first two quarters accelerating to the mid to high 20s in Q3 and Q4. For the year, we currently expect 100 to 150 basis point improvement in non-GAAP operating margin when compared to 2006.

We currently expect CapEx for 2007 to be in the $17 million to $18 million range primarily fuel by expansion of our international data center operations. Overall, we remain very confident in our underlying business model and our ability to generate significant free-cash flow. While providing our clients with a compelling cost-effective global e-commerce solution.

With that I’ll turn back over to Joe.

Joel Ronning - Chief Executive Officer

Thanks Tom. Let me say we believe 2007 shaping up to be an extremely exciting year for Digital River. Much of our focus next year will be on executing in the opportunities that we’ve already identified. In 2007, our focus on and the relationship with Symantec will be expanding. We will bring to bear significant resources to continue to help them aggressively grow their online sales on a global basis. We are also expanding our relationship with Microsoft. Our focus here is on helping them roll out their Money, Office, and other products not only into the global online marketplace, but also direct to consumers for the first time.

Finally, next year we will continue to execute against the opportunities exist in the four key growth that reported on throughout 2006. Global markets, marketForce strategic marketing services, our oneNetwork online marketplace and acquisitions. In 2007, we plan to continue aggressively perusing opportunities to support the expansion of our markets and capabilities. As many of you probably know a substantial amount of private equity available in the market is impacting private company evaluations.

Now we believe we’ve been successful with acquisitions historically because one of the reasons report is we’ve been able to buy rate. We’ll continue to follow this philosophy as we look at future acquisitions. As we look ahead, we are enthused about the opportunities for growth as we see as we go deeper into the software market.

The announcement this week is to expand the relationship with Symantec and Microsoft speak volumes about our ability to bring a compelling value proposition to our software clients. Combined with increasing opportunities in consumer electronics and hi-tech manufacturing, we believe the growth potential for Digital River is substantial as we move into 2007 and beyond.

With that we’ll open the call for questions.

Bob Kleiber

Okay, Marquida we’ll go ahead and open up for questions. I would like to ask everybody to limit yourself to one question and a follow up and then feel free to get back into the queue. We’ll take as many questions as time permits. So with that, Marquida go ahead and open up the questions.

Question-and-Answer Session

Operator

[Operator Instructions]. Our first question comes from Safa Rashtchy of Piper Jaffray.

Safa Rashtchy - Piper Jaffray

Hi, its Safa Rashtchy. It’s a good quarter guys, congratulations. A couple of questions on the guidance for 2007. Could you give us some color the reason that you will have gradually increasing growth rates, is it all driven by kind of building up Microsoft relationship or other factors perhaps in the new Symantec relationship or other contracts. What’s kind of that confidence you have that you will be hitting those gross rates I believe 35% by the year-end, then I have a quick follow up.

Joel Ronning

Yeah, Safa, yeah clearly -- maybe I didn’t articulate this in the prepared remarks, but both the Symantec and the Microsoft contracts are contributing to that, as is some of the investments we have been making organically in international expansion and consumer electronics which I think we have touched another calls where we see pretty long lead times with large clients.

Safa Rashtchy - Piper Jaffray

Okay, thank you and on the expense side, you mentioned that you will be continuing to invest some more, hence the growth in the profit will not match the growth in revenues. Could you give us some ideas because you having already investing this year in building infrastructure for global expansion on oneNetwork and so forth. What else will require investment or do you need to make some investments for some of the new, a new client such as Microsoft?

Joel Ronning

We have, we have new relationships that are still coming on, Safa, and those will continue to come on for the early part of next year. And so we haven’t announced everything.

Safa Rashtchy - Piper Jaffray

Okay, thanks.

Operator

Our next question comes from Jeetil Patel of Deutsche Bank.

Jeetil Patel - Deutsche Bank

Thanks. Guys, couple of questions I guess on the -- embedded on that 24% growth in 2007. Can you give us a sense of how much is based on the existing business that you have today with all our customers versus expansion of business your existing customers and new customers that you are adding into the mix -- on that 24% growth. And second, it looks like you are kind of parlaying those success in software and to other categories, can you take about -- I guess, do you guys have contracts or getting close to raw deals with retailers and/or product vendors in the marketplace going into ’07?

Joel Ronning

Yeah, I think -- I mean even though the two partnerships that we announced this weeks were both from existing customers, so I would say -- I am sorry.

Jeetil Patel - Deutsche Bank

Yeah, about expansion within that existing customer base plus new customers, can you give us what component that represents for the growth?

Joel Ronning

Well, I would say a large portion of our growth next year, a substantially largest is from existing relationships and we are making some good inroads into the retail channel and into the consumer electronics vertical. And we think this new deeper partnership with Microsoft and a continued strong partnership with Symantec is going to facilitate and continue to help those relationships.

Thomas Donnelly

Jeetil, if I can add a little color to that. We are not -- our exceptions are the numbers that we put out don’t have another new large client rolling in here early part of next year. So this is -- we are basically giving you an idea of where we are going to be based on what we are going to be based on what we know today.

Jeetil Patel - Deutsche Bank

Yeah, can you give us a sense of just how those conversations with non-software companies are going, selling process, kind of interest levels of what they are looking forward to outsource their platforms just a more qualitative views of why they would look at outsourcing or what are the key touching in the selling points?

Joel Ronning

This look just like the software market did six years ago Joel. It’s virtually identical, the same conversations are going on with very large brand-name vendors. We are pretty excited about this because we have done this, play before. We should only know exactly what path we need to take. So they are all working through the direct sales process and what the value of that is and how the margins, how much deep the margins are, and how valuable that future customer aim is and having that relationship on a direct basis with the customer. Meanwhile, they have to get themselves through the process of understanding of why its so valued be like Dell and how to handle multi-channel kind of relationships and how do you keep your large retailers happy while you got a pretty aggressive direct dread marketing arm on and -- so may not six years ago, but probably four years ago how I characterize the entire industry.

I think they are waking up a lot faster or they are coming onboard a lot faster because there is so many great examples of companies who are doing an excellent job, selling on the direct basis online. So the conversations are pretty deep with some very large brand names, household brand names and that’s kind of company we really like to work with. So I can just tell you, it’s very optimistic, very positive. I think we’ve got the secret sauce, I think we’ve got the global footprint. We understand how to help those guys manage it worldwide. We also help them really understand, how to help and grow revenues. So the one thing I do have to say is they are similar. It took us about six years to close the Microsoft relationship. I know that it’s going to take six years to get these guys going, but this is a long margin and as you know we are patient company and we’ll just win this one.

Jeetil Patel - Deutsche Bank

Okay congratulation.

Joel Ronning

Yeah, thanks a lot.

Operator

Our next question comes from Lee Westerfield of BMO.

Lee Westerfield - BMO Capital Markets

Thank you gentlemen, good afternoon. I just wanted to ask you Joe how you view clients in the hardware space if it all differently than traditional software publishers as far as you approach them concerning what services you can render in online distribution or online sales, or e-commerce. I’ve categorically -- if there is a substantial difference in the way you are approaching these customers?

Joel Ronning

Okay, actually no there is not a terribly large difference. I mean as you know Digital River is really combination of two domain expertise or -- that’s a funny way of describing it. But we really -- we are masters of two domains. One is direct marketing and the other is technology and really -- what we do is all about ultimately, once you got the technology, we’ve got $2 million into our back, under our back office into our commerce system. It’s all about the front end and how you capture your clients and then how do you grow the future value of those customers and so, the view we have into that client basis is really not terribly different.

It’s all about showing them what the value of that direct relationship is today. But more importantly what the future value that customer is and what you need to do to manage that customer database appropriately, how do you keep in contact with them. How do you build customer loyalty basically help them get a larger share of wallet and certainly the margins are pretty interesting to these folks. So we don’t view this as very differently I mean frankly we could be selling shoes and the system would handle it. It is just not an area that we are terribly interested in.

Lee Westerfield - BMO Capital Markets

Tom, may I ask one question of finance?

Thomas Donnelly

Yeah, let’s go ahead.

Lee Westerfield - BMO Capital Markets

Yeah, the international growths presumably stronger going to 2007 than US domestic but perhaps not with Microsoft relationship I’m wondering how we should look at that tax planning for 2007 if international’s lower tax rates should be lowering a blended taxes in 2007.

Thomas Donnelly

Well I still reaffirm the non-GAAP rate at 31%, the GAAP guidance did provide for 32% because we really have profits in three different jurisdictions, right Germany, Ireland, and the United States primarily. So I gave myself -- I gave the company a little bit of room because we jus launched the international restructuring effort in April.

Microsoft will actually contribute because they have extremely strong international sales, more than 50% for what we have been discussing around, Office and obviously Money is the predominantly US product. But I am still comfortable with the 31% and I suspect over the years that will creep down as international revenues continue to get traction.

Lee Westerfield - BMO Capital Markets

That’s what I suspected, thank you very much.

Thomas Donnelly

Yeah.

Lee Westerfield - BMO Capital Markets

Thank you.

Operator

Our next question is from Sasa Zorovic of Oppenheimer.

Sasa Zorovic - Oppenheimer & Company

Thank you. My first question would be regarding -- well, first of all, congratulations of Microsoft my hat is off to your team for putting this together.

Joel Ronning

Thanks, Sasa.

Sasa Zorovic - Oppenheimer & Company

Thank you and my question will be regarding the pricing change at Symantec. If you could give us any sort of indication by how much this pricing changed? Secondly, how does it compare with the Microsoft type of a pricing and how could this contract now going longer for years, if there is anything sort of built into it that -- or what is built into it regarding potential price changes as they goes alone?

Joel Ronning

Well the pricing change at Symantec is you know something I think kind of a mantra we’ve had for a long time, Sasa, is that they give us more volume and we are absolutely there helping our clients get better deals. And this is really a business of scale. And the more scale obviously we are going to be more generous in terms of the margins. With this, Symantec is a very important partner to us and frankly I think it’s a great company. We love working with these folks, it’s a fantastic group to work with. We’ve known really well and we have been talking around this topic for a long time and we went at this as aggressively as we could in light of the new volumes that we are getting.

We wanted to bring them as good a price as we could and get it into a spot where we think it’s pretty much impossible to do the kind of activities that we do any place else other than Digital River. It’s a clearly efficient program that we put in place. So we are trying to get our clients into a spot where they are not compelled to look around or certainly look internal. We believe that we are so much more efficient that its difficult for many, most of our clients I think virtually any of our clients to get to the kind of scale that we have got.

In terms of how that compares to other contracts, we have -- you know, first off, we don’t discuss contracts. But secondly, our contracts are really multifaceted, they are really custom delivered, they all required different capabilities from this company and different cost structures. And so they are vastly different. So the one we have with (inaudible) Symantec is dramatically different and I guess you got to assume that when we are with Symantec or with Microsoft is dramatically different from everything else. I guess the answer is it depends. And so in this case, I don’t think there is a tremendous correlation between those contracts.

Sasa Zorovic - Oppenheimer & Company

Okay, and then just the final here question is I guess is to maybe to iterate your -- I guess what should be obvious at this point you talk that Q2 that you would have 10% customer, likely next year. So I just want to make sure that the 10% customer in addition to Symantec rather would be Microsoft and that would be included already in this guidance that you have provided for next year.

Joel Ronning

Yeah, I think what we said is that we have some -- last quarter that we expected that we had some new relationships that could be potentially 10% customers, I don’t recall that we gave a timeline relative to that. This is a very large complex global launch, subject to delays we’re extremely excited about it I think the company is really rallying around the effort and we are ready to go and we’ll see how it goes in Q1, end of Q2 after the trail conversions start to close.

Thomas Donnelly

Yeah I may want to add, also the opportunity with Symantec to help them on some new projects, some substantial new projects we’re quite excited about that.

Bob Kleiber

Let me just add, this is Bob, quite right, I think it’s really important not to be modeling Microsoft as a 10% customer already in 2007 I think that would be a mistake. Certainly we believe they will get there soon after and that’s not out of reach that they get there next year. But in the current guidance, we have got they are not contemplated as a 10% customer.

Sasa Zorovic - Oppenheimer & Company

Great, thank you.

Operator

Our next question comes from Robert Breza of RBC Capital Market

Robert Breza - RBC Capital Market

Hi, congratulations on the nice quarter. Joe or Tom, I was wondering, can you talk a little bit about global direct and you know, more of follow up from Jeetil’s question. When you look at global direct, what would you expect that to grow at? And then could you discuss maybe the margins on a relative basis for that business compared to the traditional software download business?

Joel Ronning

Well growth in global direct will be very high, but understand it’s coming from the small base. And I think one of the things we have added here is your financial capability, our marketing wherewithal, and our back-end processes SATA 70 SOX compliance and so that’s allowing that group to go up and acquire larger customers faster. And the margins are very similar and so it looks like it will be a good business. I think -- we have got, I am not expecting this thing in turning to a gigantic part of our revenue next year but this is a good long-term investment for us and we understand exactly what to do here.

Robert Breza - RBC Capital Market

Okay. If you look at the Microsoft business and you gave us some good ideas in terms of the revenues and the margins per earnings, is it fair to say that the investment phase for bringing on Microsoft, some of these other larger customers that investment phase should be behind you after Q2?

Joel Ronning

Yeah, certainly the investment, even here in Q4 right, I mean just the bandwidth for the downloads, the trial downloads is not a small number. But yeah I think there will be ongoing expenses but being in situations where we are clearly investing more than we are receiving in revenue should be behind us. That’s the pattern that we’ve not done in the past, but we thought it was entirely appropriate this time.

Robert Breza - RBC Capital Market

Great, thank you

Operator

Our next question comes from Rodney Ratliff of Stanford Financial Group.

Rodney Ratliff - Stanford Financial Group

Congratulations guys, very nice quarter.

Joel Ronning

Thanks Rod.

Rodney Ratliff - Stanford Financial Group

Joe could you talk about the software market in general Symantec apparently had a pretty good quarter in their consumer business in Q3. I think it was basically the only bright spot that they saw. What are you guys seeing out there, we there any big virus outbreaks in Q3 to contribute significant revenue?

Joel Ronning

No just solid execution, it’s a well-run company and it’s a great team.

Rodney Ratliff - Stanford Financial Group

Okay, the next question I hasn’t been answered, so I will ask this one. Would you guys repeat the year-on-year growth stats by quarter for next year that you gave earlier in the guidance section?

Joel Ronning

Yeah. Hold on a second.

Rodney Ratliff - Stanford Financial Group

Always happen to make work for you.

Joel Ronning

I didn’t actually give, I didn’t actually give specific. The revenue in Q1 and Q2, 15% to20 % with Q1 closer to low end and Q2 closer to the high end. Q3, Q4 revenue 25% to 35% again with Q3 closer to the low end of that range and Q4 closer to the high end of the range. On the EPS side 10% to 15 % through the first two quarters and then high 20s in Q3 and Q4. And then overall we talked about 100 to 150 basis point, improvement in non-GAAP operating margin, which wouldn’t include acquisition amortizing and stock compensation, improvement of 100 to 250 basis points.

Rodney Ratliff - Stanford Financial Group

Thanks.

Joel Ronning

Yeah okay.

Bob Kleiber

Next question.

Operator

Our next question come from Phil Winslow of Credit Suisse.

Phil Winslow - Credit Suisse

Hi guys that’s a great quarter.

Joel Ronning

Thanks Phil.

Phil Winslow - Credit Suisse

Most of my questions had been answered, but if you just take some time and look at oneNetwork and some of your affiliate programs. Joe just wonder if you can comment on the traction that you are seeing there and especially in sort of attracting new software for customers. Is that becoming a key component with the acquisition strategy, I guess so?

Joel Ronning

Yeah absolutely is, you mean acquisitions of companies or --?

Phil Winslow - Credit Suisse

Yeah, customers -- yeah.

Joel Ronning

Yeah, client acquisition. Yeah it is, it’s network that we own and we believe that you know what we are doing here is building the world’s largest software affiliate network and we are pretty focused that’s being center of activity. And give a little bit of time here and it’s going to be material or significant to us. The thing is growing nicely and it a tremendously good or I should say strong part of our presentation. And it’s also tremendously sticky with current clients because that affiliate base is a channel that we are actually bringing to them and properly done. They view that as just, you know, it’s a gift that keeps on giving.

Its difficult for the clients to look at that, say gosh if I leave know may be a substantial or material portion of my business leaves along with me. Or I lose it if I break that relationships so that’s kind of (inaudible) side of this thing is that it helps our clients grow their businesses and we are pretty excited about because we think this is extremely tough for anybody else to replicate. And I think probably impossible now that we start it is and we are pretty deep into that process. So I love the stickiness and I love the value add that has the relationships.

Phil Winslow - Credit Suisse

And also just on the Microsoft side just from the affiliate standpoint, are the Microsoft products going to be available through that affiliate network next year as well?

Joel Ronning

You know, I can’t get into that level of detail on contracts and --

Phil Winslow - Credit Suisse

I guess when you -- Joe, when you do look sort of across the rest of the software energy you have talked about sort of the evolutions of digital download, we’re starting to move into sort of higher footprint, you know software applications. When you look sort of over the next couple of years, what are sort of the next areas, is it software that you see as potential growth areas or customer acquisition areas for you?

Joel Ronning

Well software as service is certainly one that we are excited about subscriptions, you know we really understand those and it all comes back to future value of the customer and wallet, average order value and retention strategies and that’s the place right into our strengths.

Phil Winslow - Credit Suisse

Great, thanks.

Joel Ronning

Thanks Joe. And one thing I want to add, is that we are seeing the download sizes are getting large and an increasingly uncomfortable. The Office trial download is you know, on a cable modem I think it takes about 20 minutes which is very doable so we are really fired up about that. Next question, please.

Operator

Our next question comes from (inaudible).

Unidentified Analyst

Can you tell me the percent of revenues they came from Symantec in the quarter?

Thomas Donnelly

Yeah, that will come out with in the Q, it should be fairly consistent with the year-to-date’s performance.

Unidentified Analyst

Was it up quarter-over-quarter?

Thomas Donnelly

It will come out in the Q in just a couple of weeks.

Unidentified Analyst

Okay, thank you.

Thomas Donnelly

All right, yeah.

Operator

Our next question comes from Craig Nankervis of First Analysis.

Craig Nankervis - First Analysis

Yes, good afternoon. Also my questions has been asked as well I guess, I wonder, Tom, are you willing to quantify the impact of the new Symantec terms on your Q4 guidance?

Thomas Donnelly

Well, in a way I think we did just based on the guidance I mean we took up the number, we gave three months ago by a little bit. I think specifically discussing that no but I think that 24% top line growth next year coming out of a renegotiation to solidify a long-term relationship with a great partner is kind of a testament to the impact on our revenue numbers.

Craig Nankervis - First Analysis

Okay, and then just on Q3, in terms of complexion of performance other than Symantec. I know the international revenue sort of dropped as a contributor. Can you just talk about how other pieces of your business this year were or anything else just performed, what worked well besides perhaps Symantec?

Joel Ronning

Well, I mean we exceeded our target by a $3 million without any as --was mentioned earlier without any kind of unusual virus activity. So we are pleased with the overall performances. It was across the board.

Craig Nankervis - First Analysis

Yes, it’s on all fronts.

Joel Ronning

Yeah. So international, you know Q3 we are always -- you know most of our international revenues are -- in fact, a lot of our international revenues are still coming out in Europe and Europe tends to be soft in Q3 but we are pleased across border with their performance.

Craig Nankervis - First Analysis

Thanks a lot.

Joel Ronning

Thanks Craig.

Operator

At this time there appeared to be no further questions, I will turn the call back to Mr. Kleiber for closing.

Bob Kleiber

Okay, thanks Marquida, thanks everybody. We look forward to chat with you again in 90 days or sooner if you feel like give us a call. Have a great afternoon, thanks.

Operator

Thank you, this does concludes today's teleconference. You may now disconnect.

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Source: Digital River Q3 2006 Earnings Call Transcript
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