Digital River Management Discusses Q4 2013 Results - Earnings Call Transcript

Feb. 5.14 | About: Digital River, (DRIV)

Digital River (NASDAQ:DRIV)

Q4 2013 Earnings Call

February 05, 2014 4:45 pm ET


Melissa Fisher - Vice President of Corporate Development, Investor Relations & Treasury

David C. Dobson - Chief Executive Officer and Director

Stefan B. Schulz - Chief Financial Officer, Principal Accounting Officer and Treasurer

Souheil Badran - Senior Vice President and General Manager

Thomas E. Peterson - Executive Vice President and General Manager of Commerce


Charles Eugene Munster - Piper Jaffray Companies, Research Division

Craig Nankervis - First Analysis Securities Corporation, Research Division

Joshua Reilly

Harris Heyer

Jason Mitchell - BofA Merrill Lynch, Research Division


Good day, ladies and gentlemen, and welcome to the Digital River Fourth Quarter Earnings Conference Call. [Operator Instructions] As a reminder, this conference call is being recorded.

I'd now like to introduce your host for today's conference, Melissa Fisher, Vice President of Investor Relations. Please go ahead.

Melissa Fisher

Welcome to Digital River's fourth quarter 2013 earnings call. Joining us on the call today are Dave Dobson, our CEO; and Stefan Schulz, our Chief Financial Officer.

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

Also, a webcast of this call will be available in the Investor Relations section of Digital River's corporate website.

Now I'll turn the call over to Dave Dobson.

David C. Dobson

That's great. Thanks, Melissa, and thanks to all of you for joining us this afternoon.

I'd like to start out today's call by making a few comments on our fourth quarter and full year financial results. Then I'll give a progress update on our strategic transformation and talk about some of our key areas of focus as we move into 2014. Following my opening comments, I'll turn the call over to Stefan, who'll provide more details on the quarter's financial performance. Then we'll open it up to take your questions.

I'm very pleased to report we closed the year with solid results. In the fourth quarter, revenue totaled just over $101 million, exceeding our guidance, up 3% year-over-year. And non-GAAP earnings were $0.22 a share, meeting the high end of our guidance range. On a full year basis, revenue topped guidance of $390 million, and non-GAAP earnings were $0.61 per share, which also was at the high end of our guidance range.

In the fourth quarter, holiday sales were one of the primary contributors to the solid performance of our Commerce business. In Commerce, we processed just over $2 billion for the trailing 12 months ended December 31, a 4% increase compared to the trailing 12 months ending in September 2013. We believe the strong activity levels we saw among some of our largest Commerce customers reflects the shift in consumer purchasing preferences away from traditional brick-and-mortar retail stores towards digital direct-to-consumer commerce channels. And recent research suggests the pace is picking up. A new study from IBM reported that 27% of global consumers made their most recent purchases online, which was almost double the percentage from the previous year's study.

These market forces certainly play in Digital River's favor as more companies follow suit and begin to make investments in building direct online channels, shifts that are driving incremental revenue streams, higher margins and closer relationships with their customers.

In the fourth quarter, Payments performed in line with expectations, with revenue growing organically by 29% year-over-year. Gross volume processed by Payments was $28 billion for the trailing 12 months ended December 31 versus $26 billion, an increase of 7% over the dollar volume processed over the trailing 12 months ended in September. Consistent with our comment over the last quarter's earning call, we continue to expect strong revenue growth from this business.

We believe these results continue to point to the significant opportunity for Digital River. As we noted during our Investor Day last September, our current Commerce and Payment markets are large and growing. While there's no lack of growth opportunity in front of us, we also understood as we enter 2013 that there were some challenges holding us back. We needed to drive customer loyalty, expand into new markets, improve executions and increase our operational efficiencies.

To begin to address these challenges, we made a number of important leadership changes. We realigned our company resources around our core Commerce, Payments and Marketing businesses. We divested some non-core businesses and started to execute the key elements of our strategic transformation.

As we outlined last September, our strategic transformation is focused on the following 3 areas: First, making substantial investments in our Commerce and Payments technology platforms and optimizing our IT infrastructure to further increase robustness, drive scalability, fundamentally improve our ability to innovate more quickly for our customers and improve client retention.

Second, improving our focus on execution on how we allocate our resources, leverage acquired assets and streamline our business across a select number of markets where we can differentiate and deliver sustainable growth.

And finally, improving our operating efficiency to increase our overall competitiveness and position us to deliver improved operating margins over time.

Now as we look back over the fourth quarter and all of 2013, I'm pleased to report we have made solid progress executing against this plan. I'm going to spend a few minutes highlighting some of our accomplishments in each of these 3 areas.

To start, we're already seeing early signs that our technology investments are paying off. First, at our Investor Day, we introduced a new customer retention metric. I'm pleased to report, Commerce customer retention remained at 93% in the fourth quarter. This result reflects the fact that attrition in our Commerce business has stabilized and we have not experienced any further meaningful attrition beyond what was communicated on our third quarter call last year.

In addition, our fourth quarter metric for Payments remained at 100%, consistent with the second and third quarters of 2013.

These early indicators of increasing customer retention are further supported by the steady progress we're making both in renewing contracts and expanding our relationship with existing customers. Some of the key highlights from 2013 include: our contract extensions with Microsoft and PayPal; we extended business opportunities with clients such as Adobe, Samsung and Spotify; and evidence that customers that had moved away from Digital River previously, such as McAfee, have returned because of the strength of our value proposition and their experience in doing business with a new Digital River.

In addition to helping drive retention and renewals, the technology investments we made during 2013 increased our technical capacity, scalability and performance. In 2013, we launched the new flagship data center based on state-of-the-art virtualization technology and one of the most sophisticated private clouds in our industry. With this new data center in place, we've been able to increase our order throughput by 10x. At the same time, we've consolidated the number of data centers supporting our Commerce business from 8 to 6 and reduced our hardware footprint, environmental impact and associated operational costs.

To further support our technology infrastructure, we also advanced our strategy to create an infrastructure-as-a-service environment. This environment enables us to quickly and easily deploy new production environments for our customers, reducing launch times for new stores and increasing our speed to revenue for new clients.

As part of this process, we have virtualized our SAP back-office financial reporting, packs and compliance engine, which powers our unique Commerce business infrastructure, offering it across the world.

Also during 2013, we executed on key elements for our product roadmap. We integrated third-party web content management solution into our Global Commerce platform, rolled out several in-game and in-app Commerce innovations and developed a unique channel management solution that help our customers drive revenues through their partner channels.

In addition, we introduced an innovative private store capability, advanced our subscription and usage-based tolling [ph] offerings and delivered several mobile storefronts for customers like Logitech and Jawbone.

Finally, we continued to make progress on our strategy to modularize and open up both our software-code base and our product offerings, which is intended to drive several important benefits. In fact, we're already seeing an increased level of engagement with prospective customers that we believe is due to a more flexible approach to both the configuration of our offering and the pricing.

As we stated earlier, we will continue to make incremental progress throughout the platform modularization project lifecycle into 2015.

Now moving onto the second area of our transformation, where we are allocating our resources to target new sources of revenue growth. Aligned with our technology investment and transformation roadmap, our primary growth strategies for 2014 include the following 4 areas: first, retain and grow our existing commerce relationships; second, expand our Commerce business into new digital products and service verticals; third, continue to build on early success with branded manufacturers outside of our software core; and finally, continue to aggressively grow our Payments business.

I'm pleased to report during 2013 we made good progress across each of these growth areas. Let me highlight some successes from the fourth quarter. In our Digital Commerce segment, which includes software and games, we signed ArenaNet, a new gaming customer to manage online and in-game purchases for their popular Guild Wars 2 game. We expanded our relationship with AVAST, and in addition to Kaspersky Labs, where we launched a new business-to-business store and a marketing program to support it. And we extended our contract for 1 year and grew our business with Microsoft.

For Microsoft, we supported more international locales this holiday season and some very key product launches in the fourth quarter like the Xbox One launch. The year benefited from the launch of Microsoft Office 2013, a significant onetime event that's not planned for 2014.

Now across our branded manufacturer market in the fourth quarter, we renewed our contracts with Canon, Razer and Sennheiser, as well as closed new business, Ventio [ph], a manufacturer of specialty kitchen appliances, and TOMY International, a global toy producer. These wins followed other 2013 wins and branded manufacturing including Thunder Tiger and GE Healthcare, as well as a significant expansion of our partnership with Lenovo.

I'm also pleased to report in the first quarter -- yes, the first quarter of this year in 2014 we added another branded manufacturer to our customer base, winning the Global Commerce business with Furla, a European luxury goods manufacturer. Furla represents our first customer in this important new category.

As we discussed during our Investor Day, we believe the branded manufacturer market continues to represent a strong important growth opportunity for Digital River.

Now moving on to Payments. In the fourth quarter, we added more than 50 new partners and 1,000 new clients in our SMB market. We signed new customer agreements with Downrange [ph], which is part of Y-Not Holdings, who offer card and alternative payments; and Novo Technology Solutions. As part of an initiative for the government of Trinidad and Tobago, Novo is developing a government 2.0 mobile app that will help citizens with tasks such as making payments for water services.

We also grew our Payments business with Heat Surge [ph] and BlackBerry, extended our white label agreement with First Data Canada by adding mobile payment services. And finally, we cemented a marketing partnership and technology integration with Retail Decisions, a leading fraud prevention provider. Together, we launched our first mutual customer, PartyLite, a global leader in direct sales of candles and home decor products.

To support the continued expansion of our Payments ecosystem, we rolled out a new developer portal with a continually refreshed code garden, APIs and developer documentation. This will help facilitate new payment partnerships and speed time to integration for developers and ISVs. In addition, we continued to grow our global Payments footprint. Recently, we extended our payment processing in Brazil, adding support for transactions across diners and ELO credit card networks.

In our third business segment, Marketing Services, in the fourth quarter, our interactive agency, which we call marketForce, continued to land new business and expand existing accounts. Working in more than 100 countries and 17 languages, this team launched a comprehensive marketForce program for Rosetta Stone to support their business in emerging markets. Their program includes search, search engine optimization, e-mail and display marketing. We signed a new marketing agreement with Uniblue to provide search engine management, support in EMEA and a full suite of marketing services in Japan. And we advanced our marketing relationship with Trend Micro, adding creative services as well as site and card optimization programs.

Now in addition, our e-mail services business unit, BlueHornet Networks, renewed a contract with High Work Solutions, expanded their relationship with Media Space Marketing, and we won the e-mail services business for TorreyCommerce, which operates the Linens n Things commerce business.

This brings me to the third and final focus area of our transformation, which is improving our operational efficiency. Some of our key efforts in this area in 2013 included rolling out a new global organization design and rebalancing our workforce, which created a run rate savings of $9 million on an annual basis, as well as evolving our procurement function, which has contributed to a run rate savings of $7 million. These actions have created financial capacity to enable us to make incremental investments in areas that will accelerate our transformation.

In addition to these cost-saving initiatives, we made significant new leadership appointments, including the addition of Ted Cahall as our Chief Operating Officer, overseeing our product, engineering, IT and delivery functions; and Tom Peterson, our EVP and General Manager of our Global Commerce business. Both are seasoned technology executives who are helping shape and accelerate our transformation.

Now with that, let me now describe some of the key actions we will take as we move into 2014.

As we have outlined earlier, we made good progress in optimizing our IT infrastructure and improving our platform as a result of the investments we've made in 2013. We are seeing the early benefit in our improved customer loyalty and retention metrics. As we enter 2014, we have made the decision to increase our previously committed level of investment in 3 areas: First, we will begin to shift our technology investment from infrastructure to accelerating our software platform strategy. This includes modularizing both our software code base and delivering more configurable products and services. This also includes delivering incremental functionality to some of our largest customers to enable our platform to handle a broader range of devices and services. We started this initiative in mid-2013 and we need to accelerate our rate of progress in 2014.

Second, we are going to increase our development, sales and marketing resources in our integrated Payments business. With the successful integration of LML now behind us, we will continue to expand global footprint, drive new mobile product innovation and increase our investment in sales and marketing to sustain the growth of this business.

And third, with a number of new customer wins outside of our core software market, we are going to make incremental investments to expand our sales and marketing footprint into Europe and Asia. As we discussed at our Investor Day in September, we believe a very important future growth engine for our Commerce business will be a Tier 2 customer base. These are businesses that we expect to have between $10 million and $1 billion in e-commerce revenue over the next few years. Our highly differentiated value proposition is resonating with these customers that want to market and sell their products on a global basis, leveraging our commerce-as-a-service business model.

Now most of these investments will not lead to material increases in the revenue for 2014. However, we believe they will position us to grow our Commerce business outside of our core software market more quickly in 2015 and beyond, albeit off a small base, and sustain the strong growth of our Payments business. As we continue to make progress with other technology transformation investments, we expect to provide regular updates on how we are growing our Tier 2 commerce revenue, which we believe is a very important indicator of the success of our transformation.

In summary, we have made good progress with the transformation of Digital River. We are getting positive feedback from our customers. We're growing existing customer relationships and beginning to win new customers outside of our core software market. As we communicated last September, we will continue to invest in our business to address the challenges that we identified and get us a significant market opportunity that continues to grow. Our focus is to create increased value for our customers, for our shareholders and our employees. And while we still have significant work ahead of us, I'm very pleased with the solid progress to date.

With that, let me now turn the call over to Stefan, who'll provide more details on the fourth quarter 2013 financial performance and update you on our first quarter and full year 2014 expectations.

Stefan B. Schulz

Okay. Thank you, Dave, and good afternoon, everyone. As Dave mentioned earlier, our fourth quarter revenue was $101.2 million, an increase of 3% over last year's revenue from continuing operations, which beat the top end of our guidance range of $100.5 million. Please note that we discontinued some of our operations in 2013 and all of the following comparisons with historical periods relate only to our continuing operations.

International Commerce revenue in the quarter accounted for about 42% of total revenue, down from 46% last year due to strong U.S. holiday sales this quarter.

Moving on to the full year. Revenues in 2013 were $389.7 million, which also exceeded the top end of our guidance range of $389 million and represented 5% growth over 2012 revenue.

Within our revenues, Commerce was $84.7 million, down 6% from last year's Commerce revenues of $90.1 million. For the full year of 2013, Commerce ended at $328.1 million, a 5% decrease from 2012. This decline is consistent with our expectations and largely driven by the planned attrition we previously discussed.

Our Payments revenue was $16.5 million, an increase of 105% from last year's Payments revenues of $8 million. Excluding LML, Payments grew 29%. For the full year, Payments revenues were $61.5 million, a 147% increase over 2012 and a 50% increase on an organic basis.

Now shifting to expenses. Total non-GAAP operating costs and expenses increased $7.1 million in the same quarter of last year, including approximately $4.8 million of expenses related to the LML acquisition. The remaining increase was primarily attributable to $2.5 million in incremental investments related to our technology innovation and transformation initiatives. Approximately $2.4 million related to sales and marketing and general and administrative incentive compensation as the metrics needed to earn these incentives in 2012 were not met, and $1.2 million of additional depreciation, driven primarily by our technology investment.

These increases were partially offset by some lower variable costs of $3.9 million.

Moving on to earnings. The GAAP net loss for the fourth quarter totaled approximately $43,000, representing roughly 0 earnings per share. Last year, the loss was $5.77 per share in Q4. The GAAP net loss for the full year of 2013 was $18.5 million or $0.58 per share. On a non-GAAP basis, diluted net income for the fourth quarter was $8.3 million or $0.22 per share, which was at the high end of our guidance range.

Last year, we earned $0.32 per share in the same period. For the full year, non-GAAP diluted net income was $20 million or $0.61 per share. Non-GAAP EBITDA was $17.1 million for Q4 and $54 million for the full year compared to $19.8 million and $68.8 million in the same periods last year. As in previous quarters, we have included a table at the end of our earnings release which reconciles our GAAP and non-GAAP results.

Now turning to cash and cash flow. Our net cash used by operations for 2013 was $15.3 million as compared to cash generated by operations of $38.8 million in 2012. Larger uses of working capital in 2013 combined with lower profits drove the reduction in cash generated from operations. Excluding the impact of working capital changes, our operating cash flow for 2013 was $38.4 million, down from last year's cash flow of $59.8 million.

Capital expenditures were $23.3 million in 2013 compared to $22 million last year as we continued the investment in our technical architecture during the course of 2013.

As of December 31, 2013, our cash and non-equity investments totaled $641.5 million. This was a decrease of $100 million from the end of last year, and the primary drivers of this change were the use of cash in operations I just referenced, the repurchase of $51.2 million of common stock, as well as our acquisition of LML.

Under our current buyback authorization, we repurchased $7.3 million of common stock in Q4 at an average price of $17.86 per share. As of December 31, there was $46 million remaining under the current authorization.

Our company cash, which we define as cash and non-equity investments less our client cash, was $533 million.

Now moving onto guidance for the full year of 2014 and the first quarter. Our guidance for the full year of 2014 is as follows: Total revenues are expected to decrease between 3% and 6% as compared to 2013, so our revenue range is expected to fall between $365 million and $378 million. Within that range, we expect Commerce revenue to land between $292 million and $302 million, and Payments revenue to land between $73 million and $76 million.

In Commerce, our year-over-year comparables should improve as we go through the year. We expect our Commerce revenues to experience double-digit declines in the first 2 quarters with the largest decline occurring in Q1. In the first quarter of last year, 2 of our clients launched major new and successful products that won't be repeated this year, and the effects of previously discussed client attrition will also impact the first quarter of this year. We expect Commerce in the second half of 2014 to be relatively flat with a greater degree of strength in the fourth quarter.

We expect our Payments revenue growth rate in the first half to be in the midteens, and we expect that growth to accelerate to the mid-20s in the second half as investments made during the first half of 2014, such as expansion of geographies, expansion of our partner network and improved product offerings, will drive increased revenue.

For the full year, we expect Payments growth to be in line with our current Payments market of -- current Payments market rate growth of approximately 20%.

Full year GAAP results are now projected to range from a net loss of $0.53 to a net loss of $0.39 per share. And finally, full year non-GAAP EPS is expected to be between $0.35 to $0.45 per share and non-GAAP EBITDA is projected to be between $47 million and $51 million, a 13% margin.

Now these earnings estimates are lower than what we signaled during our Investor Day presentation in September. In that presentation, I stated that our preliminary estimates for non-GAAP earnings should be relatively flat. However, as we completed our 2014 planning process, we decided to invest an incremental $8 million in our transformation initiatives in 2014.

These larger investments include increased spending in 3 areas: The first area is within our development team as we accelerate our platform strategy. The second area is in the areas of development and sales and marketing within our integrated Payments offering. And the third area is in the expansion of our sales and marketing footprint in Europe and in Asia.

We continue to believe that our transformation strategy will yield the go-forward target financial model we shared with you back in September.

Now for the first quarter, we expect revenues to be between $92 million and $95 million. Within that range, Commerce would account for about $76.1 million to $78.3 million. We expect Q1 to be our largest decline for Commerce revenues. And as I mentioned earlier, the year-over-year comparisons in the later quarters will improve.

Payments revenues are expected to be between $15.9 million and $16.7 million. Our first quarter GAAP EPS is expected to range between a net loss of $0.15 to a net loss of $0.09 per share, and non-GAAP EPS per share is expected to be in the range of $0.07 to $0.11 per share, and that's using a non-GAAP tax rate of 21%.

Our non-GAAP EBITDA is projected to be between $10.8 million and $12.6 million, a 12% to 13% margin.

So to wrap up, we're very pleased with our Q4 and holiday period results. We're also pleased with the progress of our transformation plan, but at the same time realize we still have a lot of work ahead. Having said that, we continue to believe signs of financial progress will begin to show in the second half of 2014 with overall organic revenue growth.

So with that, I'll turn the call back over to Dave for his closing comments.

David C. Dobson

Thank you, Stefan. So before I move on to Q&A, I want to recap some of the points that you heard on this call.

First, we have made good progress on our transformation across many fronts. We invested in optimizing our IT infrastructure, platform and tools to increase capacity, scalability and performance for our customers. We built momentum across our core Commerce, Payments and Marketing businesses, as well as expanded in high potential verticals, such as publishing and branded manufacturing.

And finally, we realigned the organization for success. We focused our talent on our key growth markets and welcomed new leadership to our team.

Secondly, while we are pleased with the progress we have made in the business, we still have work to do and we're going to be very focused on executing our transformation plan. In 2014, we intend to continue improving our infrastructure and executing our platform modularization strategy while making additional investments in Commerce and Payments.

Finally, while we will face some expected headwinds in the first half of the year, we remain confident in our plan, which will continue to drive our execution priorities. We believe the many positive results that we've seen today are early indicators that our transformation is beginning to deliver against our ultimate goal, which is to create added value for our customers and our shareholders.

With that, let's move to Q&A. Kate, if you would, please open the lines.

Question-and-Answer Session


[Operator Instructions] Our first question comes from the line of Gene Munster with Piper Jaffrey.

Charles Eugene Munster - Piper Jaffray Companies, Research Division

The retention number, 93% for Commerce. Where should that number be longer term? My first question. The second question is, you talked about the increased spending in 2014 of $8 million in kind of incremental spending. Was there anything about kind of the strategic direction that we outlined at the Analyst Day last fall that has shifted slightly to have caused that increase? And if so, what was that slight shift?

David C. Dobson

Gene, it's Dave. Let me talk-- the first one is pretty easy. We expect over time our retention should be in the mid-90s. So what you're seeing at 93% as we continue to see the tail of some of the retention that was announced a number of quarters ago, as that works its way through, we would like to see our retention in the mid-90s. And you can see Payments is at 100. We'd love to see it stay there. But realistically, mid-90s for Commerce. On your question with regards to 2014 spending, no change in our strategic direction. In fact, what we're seeing is some early signs that some of the new markets that we highlighted at Investor Day, particularly outside of our core software segment, are very real and we're choosing to spend in advance and expanding our presence in Europe and Asia to get to those market opportunities. And then secondly, with our Payments business, we clearly have an opportunity to differentiate in that so we're going to increase our rate of innovation, increase our global footprint for Payments and continue to try to drive that at or above market rates. No changes in the strategic direction at all.

Charles Eugene Munster - Piper Jaffray Companies, Research Division

Okay. I know that -- and Stefan, you outlined kind of where -- the 3 segments of that increased spending. But is it disproportional to software or to Payments or neither?

Stefan B. Schulz

Yes, it's a fair question. So it's not quite 1/3, 1/3, 1/3. But let's just say, it's almost 1/3 of it will go into our Payments business and then 40% of it goes into our technology platform, particularly around accelerating the rate around our software modularization. And then the balance goes into the expansion of our Commerce footprint in Europe and Asia.


Our next question comes from Craig Nankervis with First Analysis.

Craig Nankervis - First Analysis Securities Corporation, Research Division

Actually, the first questioner asked a couple of my questions. But your transformation timetable that you said changed with the financial benefits in Q4, can you just spell that out a little bit more? Does that mean you think you're going to be in better shape come Q4 this year than you thought you would be 90 days ago? Or how do I think about the comment that you made on that front?

David C. Dobson

I'm just going to clarify your question, Craig. The comment that was made that I made was that we created close to $20 million of run rate savings in fiscal '13, and so we commented on that. That was the comment about the benefit. I used the term "financial capacity." And we've chosen to invest $8 million of that back into the business. There really hasn't been any change in the transformation timetable that we announced back in September, and that we've communicated in a couple of updates since then. We expect -- we're in the late innings of the significant investments at our core infrastructure. We're starting to see the benefits, I think early indicators of benefits, and our customer retention is stabilizing. But the real work ahead of us is in our software code base. We continue to evolve and invest in the modularization of our platform. I would tell you that the progress on that was relatively slow in 2013 because we've put most of our efforts on infrastructure and stabilizing and preparing for the holiday. But you're going to see in 2014 us really ramping up our software modularization such that we can extend our customer wins and our platform into those markets beyond our core software base. And that's really been our focus and continues to be our focus in 2014 and into 2015.

Craig Nankervis - First Analysis Securities Corporation, Research Division

Okay. And just extending that a little, so this acceleration of your footprint overseas, what have you seen there? You talked about it being very real. What -- do you think is it pent-up demand? Is it a lot of old platforms that are ready for refresh? What's -- can you just give a little more color on what's made you incrementally more excited and compelled to invest there.

David C. Dobson

I'm really glad you asked the question. Because it's something that we saw and certainly I saw firsthand because I traveled around the world and met with many of our customers. Particularly I'll use an example, I spent -- I've now been over 3 times to Asia and particularly in Taiwan, as you know, where we have one of our large development centers. We have the team there introduce me to 3 or 4 customers that are Taiwanese-based branded manufacturers that build products. They do not have the capabilities to market and sell those products in all the countries around the world. They typically use a large network of resellers today. And so as we've launched companies like Johnson Health Care and Thunder Tiger and, hopefully many more to come. We now have Furla in Europe. We're seeing these customers saying, "Digital River, your business model of having entities and capabilities in 150-plus countries around the world is very powerful. Your competitors don't have that." And so that's what -- we saw that. And a lot of our business, Craig, in Europe and Asia, quite honestly, is multinationals, U.S.-based multinationals doing business in Europe and Asia. That's great. But we're saying, we've got an enormous opportunity to get more European and Asian-based customers to expand their presence into North America, into Latin America and into Europe or Asia or vice versa. So that's really what we've seen. And quite frankly, we're seeing more of what we call branded manufacturers that fit into our current platform capabilities that we have today. Now we think we can accelerate that over time, it's a relatively small portion of our revenue. But we're pretty excited about our prospects. And with Tom Peterson joining the team and making some of the changes to the go-to market model, it has certainly increased my confidence that this was a smart investment to make.

Craig Nankervis - First Analysis Securities Corporation, Research Division

Do you feel the competitive dynamics notably different in those geographies versus domestic? I'll say in particular the e-commerce platform players that I'm familiar with, while their approach towards Asia has been modest, although it is changing as China changes. But what do you see on that front?

David C. Dobson

Yes, the short answer is absolutely yes, the competitive dynamics are different. And it's very simple. We have a lot of competitors that can create e-commerce stores, whether it's software, software-as-a-service here in the United States. But trying to expand, if you're a Tier 2 customer, so let's just say, you've got an e-commerce revenue somewhere between $10 million and $1 billion, for you to have entities to do tax, compliance, be the merchant and seller of record, to be able to do payments, there's no one like Digital River that's got the capability to do that. So as you go into countries outside of the U.S., quite frankly, our value proposition is very strong and that's the comment we made it. It's resonating with these Tier 2 customers, particularly this branded manufacturers. So we think we've got a highly differentiated offering, and we're going to invest to extend that into Europe and Asia.

Craig Nankervis - First Analysis Securities Corporation, Research Division

Okay. And then lastly, is there a comment -- maybe this is for Stefan -- are you breaking out Microsoft for the year for us?

Stefan B. Schulz

Yes, we can do that. We do, do that, annually, Craig. And the percentage for the year was 33%.


Our next question comes from the line of Joshua Reilly with Northland Securities.

Joshua Reilly

This is Josh in for Tim Klasell. Can you tell me, are you seeing more outsourcing of payment processing to Digital River as a result of the recent securities scares in the marketplace, the Target incident and others?

David C. Dobson

Josh, it's Dave. I've got Souheil Badran, who runs our Payments business, here in the room. And I'm going to let him ask that. I don't know if in the last 2 weeks you've seen an increase as a result of that, but what are you seeing, Souheil?

Souheil Badran

Josh, we definitely see our existing clients and more process talk about what our capabilities are, I'd hate to say yes, over the last 2 weeks we've had a shift in brand-new customers. But definitely, it's a topic that as we're talking to them, people are saying, "I don't want to kind of outsource -- I want to be able to outsource your Payments page because you guys are responsible for the security aspect of my Payments data." So it's more of a discussion right now. I would not say, it's more of a true. Maybe it's based what happened in the last few weeks.

Joshua Reilly

Okay. Can you tell me in your pipeline of new customers, what area has been growing the fastest, Consumer Electronics, traditional software, et cetera?

David C. Dobson

Yes, I'll start off with that. And by the way, the other person we've got in the room is Tom Peterson. In fact, Tom, I'll give this to you and then pass it over to Souheil. So what are you seeing in Commerce, Tom, as far as pipeline building? Where is the action happening?

Thomas E. Peterson

Our Commerce business, frankly, I think, the biggest growth that we're seeing right now is in the branded manufacturers space. We've made some investments there to bring our offering to markets in Europe, Asia and the Americas. And candidly, the dependence that we've had historically on the software business, it hasn't declined. It's just not growing as rapidly as branded manufacturing. And as Dave alluded to earlier, we've had some great wins in the gaming industry as well. So I would point to branded manufacturing and gaming as the fastest growth areas of the company right now.

David C. Dobson

Souheil, do you want to add anything from a vertical standpoint to an area where you're seeing growth?

Souheil Badran

We're really seeing serious growth. As Dave mentioned earlier, we've signed over 50 new partners that are leveraging outsource and are taking our solutions to their own verticals. In addition, we continue to see an increase within the gaming vertical and within in-app purchases as well. That seems to be a growing area for us.

David C. Dobson

And Josh, just a comment on both Souheil and Tom, is one of the things we're doing that we had not taken advantage of historically is historically we've run at the time of pre-mid 2013, we had really run Payments almost like a standalone entity. And with Souheil and Tom working arm-in-arm now, we're actually looking at how do we lead as we modularize our offering? How do we lead with Payments in selected verticals and will land the customer in Payments and then over time upsell our entire commerce-as-a-service stack? So that's something that's very early on, but we're starting to guide our marketing and demand generation and targeting to customers to really take advantage of the fact that we have an integrated Payments business inside of Digital River. So I think more to come on that as we go forward.

Joshua Reilly

Okay, great. And then one final question. How do you anticipate churn for the next 6 months and possibly over 2015? Are you seeing any spikes in customer notifications?

David C. Dobson

No. We as we communicated during the call, we are right now seeing a churn or the inverse of customer retention at very low levels, which is very encouraging. So we don't certainly, in the forecast we just provided, we don't see any significant uptake -- or uptick in the churn of our customers, which I think is a really strong indicator for the progress we're making with our investments in technology and our transformation.


Our next question comes from the line of Phil Winslow with Crédit Suisse.

Harris Heyer

This is Harris Heyer for Phil Winslow. I was hoping you could give us a little bit of an update regarding your progress on re-platforming? Any key milestones you've reached and/or maybe haven't reached and also milestones that you've kind of expect to reach over the next 3 to 6 months?

David C. Dobson

Sure, Harris, I'll start that. And then Stefan, if you want to add anything to it. The first as we commented on, as we set out on this significant investment that we're going to make in our technology core, we really talk about 2 halves: The first is our infrastructure. Think of that as our infrastructure-as-a-service, the data centers, its networks, its computing power, its reliability. And as we've indicated, we made significant investments both in OpEx and capital in 2013, and we're a long way through. I think of it as we're probably in the sixth, seventh inning of our investment in our infrastructure and we're seeing the benefits of reliability. And for those of you that aren't familiar, close to 2 years ago, we had a pretty significant event, a very bad event, for DR, where because of a lack of investment in the platform, we saw a multi-day outage. We're making these investments to dramatically improve the stability and reliability of that platform. So that was the first part and we're a long way through that. So the milestones: We launched a new data center, which is really at the core of our infrastructure. We've significantly reduced the footprint. We're seeing increased reliability. We're seeing increased throughput. Those are the milestones. The second part of our investment is around our software code modularization and then starting to open up our products and offerings to be more modular, such that we can sell parts of our capabilities as independent or standalone pieces, or integrate with third-party providers. And I would say, in that area, we really just started. We're in the early innings of our investment in 2013, and we've really started to increase our investment in 2014 and into '15. And the key milestones of that, now -- we're a multi-tenant software-as-a-service platform. So we increment our software platform every 30 days. So we're incrementally introducing new functions to the market and we're continuing to effectively go through this modularization work in an un-incremental basis, which is a real advantage to us and our customers. But the milestones of that work really won't be seen towards the end of this year and into 2015, where we think we've got functionality that is going to be very attractive to the new markets we've identified, which is getting at a much broader base of branded manufacturers, starting to innovate our product platform more quickly, which I know our customers would like to see. There's things that they want to be able to see innovated in a more rapid basis, and I think we'll start seeing that as we exit '14, into the early part of '15. So those are the key milestones that we talked about, and they're pretty consistent with what we've communicated previously. Does that help, Harris?

Harris Heyer

Yes, absolutely.


Our next question comes from the line of Nat Schindler from Bank of America Merrill Lynch.

Jason Mitchell - BofA Merrill Lynch, Research Division

This is Jason Mitchell here for Nat. I guess I kind of have a follow-up question on that. I think you had said on an earlier call that you anticipated to start releasing some of the modularity of your platform towards the latter half of 2014. How do you see that affecting your customer base? Do you expect most of your customers to remain on your platform or start to pick and choose pieces of your platform as you move along into 2014 and '15?

David C. Dobson

Yes, Jason, pretty consistent with what we've talked about previously is that for some customers, we think, some of our larger customers that they really, as they look at the investments that they're making or the systems they've had, we think we've got an opportunity to continue to work with them and have a significant part of their business as they outsource parts of their e-commerce capability. So think of these Tier 1 customers that, in some cases, they might have their own Payments platform, they might want us to provide merchandising capabilities, or they might want us to provide a content management system. That's really what modularization is doing for our largest customers. For our Tier 2 customers, which is a really core part of our growth going forward, what modularization provides is more around having a very robust API layer that they can start to plug into third-party capabilities that are incremental to the platform and the capabilities that we provide. So we've already started, as far as the way we price and the way we're packaging our offering, just in the fourth quarter we're engaged in probably 3 or 4 opportunities that we would not have been engaged in 1 year ago because of what we're doing around pricing and packaging. But over time, so I'm talking over through the course of '14 and early into '15, I think we'll start to see the benefit more from a product modularization, so going beyond pricing and the way we package our offering to start to sell capabilities that we wouldn't have had the potential for now. It's not so much that the largest customers that we land a new deal, with a module. The best example of that is Payments. We're seeing that already today. So we sell our Payments capability. But what we really think is some of the attrition that you'd seen historically at Digital River was because we were not flexible on the way we packaged and made our offering available. So our expectation is that you might see us and some of our large customers have a lower what we call take rate. So the percent of revenue we get could be lower, but as their e-commerce grows, we think we can manage the dollar volume in an attractive way and our profitability in an attractive way for Digital River.


And I'm not showing any further questions at this time. I'd like to turn the call back over to Melissa Fisher for closing remarks.

Melissa Fisher

Thank you for participating in today's call. This concludes Digital River's fourth quarter 2013 earnings call.


Again, ladies and gentlemen, thank you for participating in today's conference. This does conclude the program and you may all disconnect. Everyone, have a good day.

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