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VA Software Corporation (LNUX)

F2Q07 Earnings Call

February 22, 2007 5:00 pm ET

Executives

Patty Morris - SVP and CFO

Ali Jenab - President and CEO

Analysts

Doug Whitman - Whitman Capital

Stewart Barry - ThinkEquity Partners

Ruchir Lahoty - Thomas Weisel Partners.

Joe Maxa - Dougherty & Company

Denny Fish - JMP Securities

Jon Hickman - MDB Capital Group

James Gillman - Cross Research/Soleil Securities

Presentation

Operator

Greetings, ladies and gentlemen, and welcome to the VA Software Second Quarter 2007 Financial Results Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (Operator Instructions). As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Ms. Patty Morris. Thank you, Ms. Morris, you may begin.

Patty Morris

Good afternoon, and welcome to VA Software's conference call reviewing our second quarter fiscal year 2007 financial results.

Let me remind you that this discussion will include forward-looking statements which will be made pursuant to the Safe Harbor Provisions of section 21[E] of the Securities Exchange Act of 1934. Investors are cautioned that statements made during this call that are not strictly historical in nature constitute forward-looking statements, which involve risks and uncertainties, such as statements regarding current or future financial performance, management's plans and objectives for future operations, product plans and performance, management's assessment of market factors, expected contribution to revenue of various products and services offered by VA, and statements regarding the strategy and plans of VA and companies with which it collaborates.

Factors that could cause actual results to differ from our forward-looking statements are specified in VA's press release announcing the Company's quarterly results released earlier this afternoon and the Company's fillings with the Securities and Exchange Commission including VA's Annual Report on Form 10-K for fiscal year 2006 which ended July 31, 2006, and its quarterly report on Form 10-Q for the first quarter of its fiscal year 2007 which ended October 31, 2006. These documents are available at the Company's website, www.vasoftware.com or at the SEC website, www.sec.gov.

In addition to reporting financial results in accordance with Generally Accepted Accounting Principles or GAAP, VA reports non-GAAP financial results. Investors are encouraged to review the reconciliation of these non-GAAP financial measures to the comparable GAAP results which can be found in VA's earnings press release announcing VA's financial results issued after the stock markets closed today and posted on the Company's website. Non-GAAP items include stock-based compensation and amortization of intangible assets which we believe may not be indicative of our core business operating results.

A replay of this conference call will be available on our website later today. The replay will also be available by telephone toll-free at the following number: 877-660-6853 or 201-612-7415. Access requires account number 286 and ID number 226940.

With that, I'll turn the call over to VA Software's President and CEO, Ali Jenab.

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Ali Jenab

Thanks, patty. Good afternoon, and thank you for joining us today. I'm going to make a few opening remarks and give you an overview of the quarter and then turn this over to Patty Morris, our Chief Financial Officer to review the financial results. We'll then open the call to questions.

I'm pleased with our second quarter fiscal year 2007 financial results. We reported strong quarterly revenue from continuing operations of $18.8 million. We had another solid quarter of profitability generating net income from continuing operations of $.03. It was a busy quarter for us, with second quarter revenue growing organically 28% year-over-year. Media revenue grew 42% year-over-year. ThinkGeek revenue grew by 47% year-over-year. This very strong growth was driven by an increase in traffic and higher conversion of the traffic to sales.

While the robust growth in the media and e-commerce revenue was offset by a challenging quarter in the software division, we added 10 new SourceForge Enterprise Edition accounts to the roster of software customers. As many of you are aware, we also announced today that we have engaged Updata Capital to assist us with exploring strategic opportunities for the software business. We also completed the quarter with $57.1 million in cash and investments.

Let me outline some of the highlights of the second quarter. We continue to be encouraged by the progress we're making on the media side of our business.

Our network of websites served 32 million unique visitors during January 2007. And we had 72 million downloads on SourceForge.net during the month of January 2007, which was a record for us.

SourceForge.net, the world's largest distribution and development platform for open-source projects continued to experience solid growth. During Q2, registered users increased to over 1.5 million and the number of open-source projects hosted on the site climbed to more than 142,000.

SourceForge.net continued growth reinforced with the expanding interest in open-source software within the global IT and development community.

During the quarter, we continued to deploy site improvements to SourceForge.net and Slashdot, including streamlining, the user experience, and redesigning the SourceForge.net masthead and optimization of key advertising units.

During Q2, Slashdot deployed a wider rollout of a user feature we announced last quarter called the Firehose. You may recall that the Firehose allows Slashdot community members to vote on stories in the submissions queue and provides users with the ability to choose their own custom view of Slashdot.

Turning to our e-commerce business, simply put, the ThinkGeek team hit the ball out of the park in Q2, shipping a record 201,000 orders and posting a very well executed holiday season. We added 10 new SourceForge Enterprise Edition customers during the quarter and have now sold our SourceForge EE software to a total of 188 customers.

In addition, we have provided a total of 64,000 downloads to date, from our free download program.

Let me go into a bit more detail in each of these events. As I mentioned our network of websites served 32 million unique visitors during January 2007. On a 12 month rolling average, 33 million unique visitors per month visit our aggregated media websites. We will begin to report this number on a go-forward basis, as we believe the rolling average reflects the more meaningful measurement of visitors by taking into account seasonal behaviors, given the dynamics of our domestic and international traffic.

This time last year, we discussed the improvements deployed to help SourceForge.net users find open-source code on our site.

During Q2, we streamlined the usability to download the open-source software that they find on SourceForge.net. As a first step towards improving the download experience, we enabled automatic worldwide download mirror detection, tied to our user's geographic location.

Next, we launched a feature that lets project administrators create customized download pages for each supported operating system platform. Permitting users to be automatically directed to software downloads designed to run on their system. Streamlining the software download process, enables us to serve significantly more downloads in Q2.

For the quarter, we served a record 201 million downloads or an average of 67 million downloads per month, representing a 39% increase compared to the same period, last year.

In addition to streamlining the download experience during Q2, we also coupled ambitious navigational and user experience improvements with advertising optimizations on SourceForge.net.

As a result of rolling out a redesigned SourceForge.net masthead and optimizing key advertising units, we saw a significant increase in the click-through rate, which is quite encouraging going forward.

Given that our efforts to optimize advertising placement on our sites, particularly Slashdot and SourceForge.net have also resulted in improved ad performance. We'll continue to make additional changes across our sites to further enhance the value proposition, to both our users and our advertisers.

As evidenced by recent campaigns running on our sites, we continue to make progress with larger advertisers in the technology space.

During Q2, we secured long-term renewals of campaigns that have previously proved very successful for our advertisers, including the IBM WebSphere Application Server Community Edition download program. Other Q2 campaigns included HP Blades, Intel Quad-Core initiative, Sun Solaris and Sun Galaxy Try and Buy and Oracle Services and support Linux.

Last quarter, I mentioned the introduction of the Firehose, which works for our Slashdot subscribers only. The beta launch was a success, resulting in many additional stories being submitted and posted to the site.

In Q2, Slashdot extended the data launch to all registered users. This broader offering triggered a 15% increase in story submissions, including journal submissions and RSS feeds.

The power of network continues to be validated through the progress we are making in entering into agreements with the new advertisers such as McAfee, Adobe, Citigroup, SAP and BEA during the quarter and the continued success of the current ad campaigns running across our site.

Third party research continues to support the global strength of our users' influencing and purchasing power along with the continuing improvement of Open Source's adoption and integration globally and the growing power of user and community-generated content.

According to the Nielsen//NetRatings @Plan Winter 2007 Report, OSTG maintains the number one rank against competitors in the key technology categories, such as visitors who look for technology news online, visitors who go online every day, visitors who download software online, visitors who seek or post product reviews online, visitors who read daily RSS feeds, visitors who have purchased computer hardware and software online for both work and home use in the last six months, and visitors who have purchased game consoles and gaming peripherals in the last 12 months.

In addition, the Nielsen//NetRatings @Plan Winter Report ranks OSTG number one in the category of users who publish their own block. Out of all 508 technology-based categories in the Winter 2007 @Plan report, OSTG ranks number one on 204 items or 40%.

We continue to be excited about the growth opportunities for OSTG media business in the second half of our year and remain optimistic about our long-term success in the global marketing communities.

Our e-commerce business, ThinkGeek, had a very strong holiday season with 47% year-over-year growth for the second quarter. Top sellers this holiday included products such as USB Missile Launcher, Gorilla Pad, Micro Helicopters and widescreen digital frames. The ThinkGeek team continues to excel in finding unique high-margin products, which are attractive to the tech audience.

Turning to our software business, during the second quarter we closed four six-figure deals and continued to grow the installed base for SourceForge Enterprise Edition by adding ten new customers, including CSC India, Lawson Software, ConsumerInfo.com and Sparta among others.

We also sold additional licenses or services to existing customers during the second quarter, including sales to Motorola, Capgemini, Cadence Design Systems, and US Air Force services.

As announced this afternoon, we've engaged Updata Capital to assist us with exploring strategic opportunities for the software business. We are currently focusing our attention in Capital on the opportunities in our core media assets. While we continue to believe in the software business model and growth strategy, we're pursuing alternatives to provide the software division with the focused growth customer base, while at the same time providing appropriate value to VA Software.

Now, I'll turn the discussion over to Patty for a financial review. Patty?

Patty Morris

Thanks Ali, and good afternoon everyone. Let me outline how I will run through the results. I will start with a discussion of the headlines, including EPS and revenue and then provide a little more color on the revenue numbers before walking through operating costs. Finally, I will provide guidance for next quarter and turn the call back over to Ali for his finishing remarks.

Inline with the guidance we provided on the last conference call, our earnings per share from continuing operations on both the GAAP and non-GAAP basis was $.03 compared to GAAP and non-GAAP earnings per share from continuing operations of $.02 per share for the second quarter of last year. Second quarter revenue from continuing operations for the company as a whole increased 28% to $18.8 million from $14.7 million in the second quarter of last year, in line with guidance provided on the last conference call.

Online media grew by 42% to $3.8 million from $2.7 million for the second quarter of last year. Boosted by our success in attracting new advertisers sophisticated in their online spending who had not previously advertised on our media properties. In addition to these promising new advertisers added during Q2, we continue to see increased year-over-year buys from our loyal stable of repeat advertisers.

Our average CPM during Q2 was $16.09. The CPM fluctuates a bit quarter-over-quarter due to changes in the mix of ad types sold, including more action-based campaigns which our audience has a propensity to act on. Our sell through rate was 9%, and total inventory grew to 1.4 billion impressions in the current second quarter from 1.1 billion impressions in the prior year's second quarter.

E-commerce revenue generated by ThinkGeek grew by 47% to $13.3 million for the second quarter, from $9.1 million for the same period last year. And the number of orders shipped grew you by 43%. Our average order size also increased slightly to $66.20 per order from $64.48 for the same period last year.

Software revenue decreased from $3 million for the second quarter of last year to $1.7 million for the second quarter, primarily due to the large seven-figure deal transacted in the last year.

Gross margin for the second quarter of fiscal 2007 was 41% compared to 47% in the same period last year. The decline compared to last year was primarily due to the decrease in our software business revenues, which yields our highest margins, which was offset by a four point increase in margins generated by the media business.

Excluding stock-based compensation expenses and amortization of intangibles, operating expenses were $6 million for the second quarter, relatively flat to the second quarter of last year.

The GAAP second quarter net income from continuing operations was $1.8 million or $0.03 per share compared to last year's second quarter net income from continuing operations of $1.1 million or $0.02 per share.

Turning to the balance sheet, we generated cash flow from operations of $2.6 million during the current quarter, finishing the quarter with cash and investments balance of $57.1 million. We are well positioned for growth with an excellent cash position and zero debt.

For our third fiscal quarter of 2007, we expect total revenue to be between $12 million and $13 million, including media revenue to be around $5 million give or take 5% E-commerce revenue to be between $4.7 million and $5 million. And software revenue to be between $2 million and $3.5 million.

We expect our third quarter FY07 EPS on a non-GAAP basis to be in the range of $0.01 to $0.03 profit, excluding the costs associated with options expensed under FAS 123R and amortization of intangible assets.

Ali?

Ali Jenab

Thanks, Patty. Before we open this to questions, I'd like to make a few closing comments.

We had a good second quarter. We have a strong pipeline of advertising business for the third quarter.

We believe our sales and marketing efforts are gaining traction under direct sales side of the house and optimization efforts are initially producing results. We'll continue to focus on these areas to drive top-line growth.

As announced with our engagement of up data to pursue strategic alternatives for our software business. We're putting more emphasis and focus on opportunities in our core media assets.

I'm very excited about the launch of our marketplace and we are tracking well to our planned first beta release of SourceForge.net marketplace in the month of April.

Our continued focus is execution, while maintaining a growing profitable business and we look forward to the second half of our fiscal year 2007.

Operator, we'll now take questions.

Question-and-Answer Session

Operator

(Operator Instructions). Our first question comes from Doug Whitman with Whitman Capital.

Doug Whitman - Whitman Capital

Congratulations, guys, on another strong quarter. And can we talk a little about; you're selling off the software group. If you can give us some idea, it's pretty logical to assume given their revenue run-rate that they're at, that you would be profitable without it. Maybe a little direction and some guidance on how accretive it might be? Not counting the purchase, the selling price?

Ali Jenab

Doug, first of all, we're exploring strategic alternatives for the software business and depending on what quarter and what run-rate assumption you make, that could be fluctuating the bottom-line results. So software in general, as they I have guided in the past, needs about $13 million revenue run-rate for that business to be breakeven for us on an annualized basis, absorbing corporate overhead.

Now, as long as the run-rate is below that, then the business is negatively impacting bottom-line. Moving forward, our goal will be to figure out exactly what it means, because also if you do exclude the assets, assuming that the asset gets excluded, then it all depends on what happens to also the corporate G&A, because there will be some cost saving associated with that. We have not fully run those numbers at this point because again, we're just exploring alternatives at this point.

Doug Whitman - Whitman Capital

You guys have historically been a fairly conservative company. So maybe you could talk about what you're seeing that is giving you the uptick on the media side? Obviously, you've got a great base on the product. But if you could talk a little about what's making you feel good in the next quarter? And what you're seeing in visibility, what kind of customers perhaps you are starting to attract?

Ali Jenab

Yes. So, as we have mentioned before, that we work hard to try to get allocation from our bigger customers of their 2007 media budgets. And we are working with numerous accounts and we feel pretty good at this time that we have a few of them in hand. As I mentioned on the script that we had, continued renewal of IBM, Webster's free download program on a long-term basis. They committed to that for the year. And also, we've had a Intel campaign that's been pretty visible on our Slashdot program that's moving forward. And we've also got a handful of other accounts that we are working that we haven't officially announced to have engaged with us yet. So, looking at the pipeline where we are right now and what's reasonable, we feel like 5 million plus or minus 5% is a reasonable guidance for us to give at this point for this quarter.

Doug Whitman - Whitman Capital

Okay. And ThinkGeek, for that quarter, was that your most diversified quarter where one of the nice things seemed like, there was no single of the product dominating it?

Ali Jenab

Yes. It was very broad, and there were probably a dozen products that drove the top 40% of the revenue for us. And again, they did a great job of managing the margins. So, the team there did a fantastic job keeping our margins high. I believe, Patty correct me, it's 22% in that that we were able to get out of that business for the quarter.

Doug Whitman - Whitman Capital

And last question I want to ask and maybe I have missed it there. But the group that came that you are doing to develop the Open Source marketplace?

Ali Jenab

Correct.

Doug Whitman - Whitman Capital

Can you give us some sort of idea or a little more color on that as well as what roughly was the cost did you have under development on the project for the quarter?

Ali Jenab

So on an ongoing basis, I would say we roughly spend about $0.5 million a quarter on an ongoing basis, and we have been for the last few quarters. And that expense probably on a continuing basis is at that level. Now, once the site is up and running and we start generating revenues, probably the expense will be a little bit higher than that as it ramps. But at this point, we are staying with that dollar amount. Again, I feel very good about launching that and we should have our closed beta launch this quarter in the month of April.

Doug Whitman - Whitman Capital

Okay. Thank you, both.

Ali Jenab

Thanks, Doug.

Patty Morris

Thanks, Doug.

Operator

Our next question comes from the line of Stewart Barry with ThinkEquity Partners.

Stewart Barry - ThinkEquity Partners

Thanks and good afternoon.

Ali Jenab

Hi Stewart.

Patty Morris

Hi Stewart.

Stewart Barry - ThinkEquity Partners

Ali, you have touched on the progress you are making with some large technology advertisers, and it sounds like you have got a strong pipeline in the second half of this year. But what about, I guess, maybe you could touch on some of the other advertising initiatives. The Oliver Smith in Europe, how that's going, whether that can be a source of upside this year? I know you have been working with more ad networks. And you've also been running some more video advertising, which should carry a higher CPM. Are those initiatives early and do you think they could start becoming more material?

Ali Jenab

They are still early, but very promising. We have been working on and actually our biggest ad network we use is actually Google. We have done some optimization on the Google site and we have noticed some nice uptick and nice results, both in click through rates, and actually the revenue that we get off of the remnant. And part of the reason that's encouraging is not just the immediate revenue that you get from Google but some of the optimization that we're doing to the site improves click through and improves usage. So our other advertisers experience similar thing when they run their campaigns as we basically optimize the site. So all of those are very encouraging to us and all of them in combination gives us more confidence to give the kind of guidance that we're doing moving forward. But again a lot of the initiatives were probably late in the quarter, last quarter, so it was only partially effecting the quarter and we feel like we're beginning to get some of it in the third quarter and more importantly more of it in the fourth quarter as we move forward.

Stewart Barry - ThinkEquity Partners

Great. If I look at some of the audience metrics, last month or last quarter if you look at the page views and downloads and I think is up close to 50% year-over-year and now I think this quarter it's more like 30-40%, and it seemed a little bit flat sequentially from last quarter. I think you were at 32 million in October in unique and you had an increase of downloads. How should we be thinking about the audience moving forward?

Ali Jenab

That's a tough one to try to predict because we have a pretty mature audience out there and that number is very fluctuating from month to month so November and December is at lower number than it is in January, just the fact that people are on holidays and the usage isn't as much. Some of the download usage, October is normally a big month because kids come back-to-school, and there's a lot of activity that happens in October and then tapers off and then January starts again.

So, that's why we've mentioned that we're going to start doing a rolling 12 months. Patty has been working on that. So that way we have a more effective consistent number to say rather than worrying about the number moving around from month to month to make people notice, well why did it go up one month and down another month. But overall, we see the usage of the site going up.

The downloads are directly related to what kind of product launches are out there and what kind of activity on particular projects there are. So, actually the $72 million compared to October of about $71 million was pretty good and normally you don't see, sequentially necessarily that kind of growth when you are in a high season period.

Stewart Barry - ThinkEquity Partners

And just in terms of going back to advertising in terms of Salesforce productivity. I know you've got 12, now I believe and is it a matter of getting greater productivity or do you think you need as more substantially. Now that you have been working on this settlement for six or nine months now, need to be adding more?

Ali Jenab

We are going to probably continue to add about one to two a quarter.

Stewart Barry - ThinkEquity Partners

Okay.

Ali Jenab

And the productivity sales organization, naturally that's going to be once they are more productive than we are right now; it's going to reflect in the revenues. But we feel like we need to keep adding on that front, one to two a quarter to get to the eventual revenue streams that we want to be in a few years.

Stewart Barry - ThinkEquity Partners

Okay, great. Thanks a lot.

Ali Jenab

Alright thanks, Stuart.

Operator

Our next question comes from the line of Ruchir Lahoty with Thomas Weisel Partners.

Ali Jenab

Hi, Ruchir.

Patty Morris

Hi, Ruchir.

Ruchir Lahoty - Thomas Weisel Partners.

Okay, my question is on the marketplace as to what are the different revenues that you expect to see from there, has I understand one of them or the primary one of them would be say Commissions. And when do you expect to start seeing that happening?

Ali Jenab

So Ruchir, what we're doing with the marketplace, the closed beta is going to be launched in April time frame. We're probably going to spend fourth quarter massaging it to make sure we got all of the -- we're doing it properly and the site is running well and all the stuff that we want it to do, it's doing it properly. With a limited audience rather than launching it in the massive audience that could cause problem for us, and we've -- as I've stated before, we expect no revenue for fiscal year '07, and we expect revenue in fiscal year '08. The primary revenue driver will be the fees that we're going to charge for making the connection between the basically people that sell support to the end-users. We are going to charge a fee for making that connection and that's our primary revenue driver. There might be others, but at this point that's going to be our primary and we feel like once we get the fourth quarter metrics, and how the site is getting traction at that point for fiscal year '08, we might be able to give a guidance as far as what we feel like the revenue stream for it could be.

Ruchir Lahoty - Thomas Weisel Partners.

Okay. Fair enough on that. What will be the headcount at the end of this quarter?

Patty Morris

The headcount at the end of this quarter was 126.

Ruchir Lahoty - Thomas Weisel Partners.

Okay. And on the software side of the business, the number of six figure deals went up, there was one seven figure deal, new customers came in. What was missing?

Ali Jenab

So, we actually didn't have the seven figure deal. The seven figure deal

Ruchir Lahoty - Thomas Weisel Partners.

Alright that was last quarter.

Ali Jenab

A year before that we had it, we had only four, six figure deals. So what end up happening during the quarter, really we didn't have as much activity. And although we have a nice pipeline that we're working this quarter, we weren't able to close the larger transaction to get the software revenue to the levels that we're hoping to get. Again, the pipeline is strong this quarter, but I feel like I wanted to make sure we are cautious in the guidance that we are giving because of the potential fluctuation we can see in that business.

Ruchir Lahoty - Thomas Weisel Partners.

Okay, and what was the average transaction size for this quarter?

Patty Morris

On the software side?

Ruchir Lahoty - Thomas Weisel Partners.

On the software side.

Ali Jenab

Patty is going to look that up for you.

Patty Morris

Yeah, I'm looking that up. Just give me one second. May be go on with your next question?

Ruchir Lahoty - Thomas Weisel Partners.

Well, I guess that would be my final question, and then I'll get back in the queue.

Patty Morris

Okay. So the average transaction size for Q2 was 64,000.

Ruchir Lahoty - Thomas Weisel Partners.

Thank you.

Patty Morris

Q2, yes.

Ruchir Lahoty - Thomas Weisel Partners.

Thanks.

Operator

Our next question comes from the line of Joe Maxa with Dougherty & Company.

Joe Maxa - Dougherty & Company

Thank you. On the media side, I want to get a sense, if you can, how many customers of your's generate say mid to high six figure, in revenue for you per year or -- and how many seven figure? And what were those metrics in the last fiscal year, and what are you expecting that to trend to this year?

Ali Jenab

You know, Joe, we haven't officially released that data because frankly, I don't have it in front of me to go look at it. The customers are really campaign driven, so I would say there's a handful of clients that are probably in the seven figure category for the year. And probably a whole bunch in the six, but it fluctuates quite a bit from quarter-to-quarter according to what kind of campaigns they are -- they have. But you can assume some of the big players that you see regularly on our site, they are seven figure-type transaction, the seven figure for the year, but we don't necessarily go through and list them out.

Joe Maxa - Dougherty & Company

So do you think, the seven figure customers, do you expect that number to double this year or grow 50%, stay flattish? How do you see that?

Ali Jenab

We're hoping it's going to grow. We're counting on it to grow because that's how we get our revenues up. But I don't have any particular metrics to say I'm going from 224, or we don't have it because we really focus more on how much budget a customer has and how much of the budget allocation we can get, and then focus on the campaign during the year, which is a fluctuating activity. The large account that we've been working on in '07 we're hoping to get larger piece of their budget which pretty much means all the big players would have to be in the seven figures for the year.

Joe Maxa - Dougherty & Company

Right. What about overall number of customers? Do you have a number you can give us there as far as number of advertising customers?

Ali Jenab

It's a lot. It's a large list because there are some small players.

Joe Maxa - Dougherty & Company

Right.

Ali Jenab

Again, not counting remnant because remnant would make the number even that much larger. It's over 50 client customers that actually advertise with us in each quarter.

Patty Morris

Yeah. And that's important. It is in each quarter.

Joe Maxa - Dougherty & Company

Right. Okay, understood. I did see a couple of Vista ads out there. Is that something that could be potentially pretty large for you?

Ali Jenab

So, Microsoft has been a regular advertiser with us. And we're actually working with them closely trying to get them to be a bigger advertiser. So, Microsoft is just under seven figures historically and without them, we're hoping to get them into a larger seven figure categories. But it's not just their Vista program, we are going across the board with their X-box's everything else. But at this point, there is nothing substantial I can announce that we're doing with them.

Joe Maxa - Dougherty & Company

Got it, okay. And then how should we look or think about our gross margins in the media business as revenue start to ramp?

Ali Jenab

It should expand quite a bit. So, there's the fixed cost on there is just basically the double click cost that we pay. There is fixed editorial fee and some of the smaller sites that we do editors like Linux.com, NewsForge and that doesn't necessarily scale with revenue. So, revenue incrementally margins should be, I would say in the 80s, incrementally up, yeah.

Patty Morris

And I would agree with what Ali said, in terms of how we provide our three to five year outlook. We're looking at leveraging margins in the 80s.

Joe Maxa - Dougherty & Company

So, your incremental margin is in the mid 80s roughly?

Ali Jenab

Correct.

Joe Maxa - Dougherty & Company

Okay. Thanks, guys.

Ali Jenab.

Thank you. Thanks Joe.

Operator

Our next question comes from the line of Denny Fish. Please go ahead with your question.

Denny Fish - JMP Securities

Thank you. Just a couple of quick questions. When I look at your R&D expenses during the quarter actually ticked down quite a bit. Was that due capitalizing some of the costs associated with the marketplace, the software business, or just headcount reduction? I Just want to get a feel for what led to the decline there?

Patty Morris

Yeah, thanks, Denny. Are you referring to quarter-over-quarter or year-over-year?

Denny Fish - JMP Securities

Quarter-over-quarter.

Patty Morris

Yeah. So quarter-over-quarter, it's actually a mix of both of those. You're looking at primarily we've got a smaller number of heads but also the capitalization of internal labor on the marketplace front.

Denny Fish - JMP Securities

Okay.

Ali Jenab

And the software engineering group is running smaller than it was the previous quarter too.

Patty Morris

Correct.

Denny Fish - JMP Securities

Okay. The capitalization expense, do you have what that was during the quarter?

Patty Morris

I don't have that number in front of me, Denny.

Denny Fish - JMP Securities

Okay. Next question, just as we look forward, I understand that you guys give guidance one quarter at a time. I'd like to see sort of breaking out the businesses and give a little more visibility there. But just thinking out ahead, as we model the media business, it sounds like we have a couple of cross-currents. One being the potential for improved execution, which could continue to drive uptick, but then also we're approaching what could be some summer seasonality as well as you did experience last year. How should we be thinking about those offsets when we're modeling out the media revenue?

Ali Jenab

So, at this point, all the cross-currents happen. And frankly, as we said in the past we've only given guidance one quarter at a time. So, I can't comment on fourth quarter. But in general, this year, a couple of things happened last year. One was specific to the summer seasonality. The other one was, as you all know, one of our advertiser last summer, we had a major program with basically because of financial reasons they pulled back. So, we had a couple of things that happened. We're hoping the latter won't happen this year. So we'll be able to offset that piece of it. And a lot of it will also depend on our ability to get more of the 2007 budget as we move forward from some of the big players, which basically average out our downside or protect our downside as far as the revenue is concerned.

Denny Fish - JMP Securities

Okay, that's great. And then just the last question, just want to understand a little bit, you've referenced to Intel really stepping up and you are doing some interesting things with them. Can you talk a little bit about how a program like that works and is it primarily CPM based? Is it a feed per quarter that an advertiser like that, I am just trying to understand how, for instance, you can tell Opinion Center is monetized versus advertising --?

Ali Jenab

Yeah, without getting into too much detail on a specific deal. But normally these campaigns are a mixed bag of stuff that somebody gets from us. And naturally, the Opinion Center, is you can have the Opinion Center as part of part that mixed bag at the certain monthly spend level. If I can simply put it that way. So there is a mix of CPM based advertising, the Opinion Centers basically goes with that and it's a fixed monthly rate that they commit to spend with us on an ongoing basis to have that kind of setup.

Denny Fish - JMP Securities

Okay. Great. Thank you.

Ali Jenab

Okay. Thanks, Denny.

Operator

Our next question comes from the line of Jon Hickman with MDB Capital Group.

Jon Hickman - MDB Capital Group

Hi. Just a couple of quick questions. What was the stock-based compensation for the quarter? 400 and something?

Ali Jenab

447 I think it was?

Patty Morris

Yeah, the stock based comp for the quarter is 454.

Jon Hickman - MDB Capital Group

454.

Patty Morris

Correct.

Jon Hickman - MDB Capital Group

And depreciation?

Patty Morris

Depreciation for the quarter is 140,000.

Jon Hickman - MDB Capital Group

140?

Patty Morris

That's correct.

Jon Hickman - MDB Capital Group

Okay. When you talked about the marketplace in the past, you talked about having, if someone was interested buying support, you would be directed to a different website where the transaction would actually take place. Is that how the program is rolling out? Is it still the same mechanism?

Ali Jenab

The program is going to be integrated within SourceForge.net. As far as physically how the transaction flow goes through, it's not a separate issue with the data. Do you put it as integrated part of SourceForge.net or do you keep it as separate. Its actually integrate part of SourceForge.net. But naturally the menus and how it flows, I frankly don't know exactly the flow, but its part of the site. And when you click on it, it's going to be a separate page that's going to come up actually for you to be able to transact on.

But there is going to be a multiple integrated way to get to it. Whether it's through a download page that's coming in, whether straight to the site to do search for particular things. So there's multiple ways to get through it.

Jon Hickman - MDB Capital Group

Okay. When you say you are going to do an [eyelid] or a beta --?

Ali Jenab

Closed beta, yeah.

Jon Hickman - MDB Capital Group

And you are only going to allow so much traffic?

Ali Jenab

Yeah. Basically we are going to take a limited number of suppliers and limited number of users to transact.

Jon Hickman - MDB Capital Group

How do you sell to these users?

Ali Jenab

I am sorry.

Jon Hickman - MDB Capital Group

How you are picking your users?

Ali Jenab

We are working on it. The team has got a game plan on how they are actually doing it. And that way you can control how the transactions monitor. That everything has been flowing the way we thought it was going to flow. Before you open it up to mass markets to be able to do it.

Jon Hickman - MDB Capital Group

Okay. Just one more question, Patty. You said software revenues for the next quarter would be somewhere between 2 million and 3.5 million?

Patty Morris

Correct.

Jon Hickman - MDB Capital Group

Okay. I just wanted to make sure.

Ali Jenab

Yeah, and the reason for the wide range is we are working numerous large deals. And frankly at this point, especially after what happened last quarter, we want to be safe to give a wide enough range depending if you have success on closing those, then we could be at the higher end and if not then we would be at the lower end.

Jon Hickman - MDB Capital Group

Okay. Thank you.

Ali Jenab

Thanks.

Patty Morris

You are welcome.

Operator

Our next question comes from the line of James Gillman.

James Gillman - Cross Research/Soleil Securities

Good day, ladies and gentlemen. I have several questions here. In reference to media, you gave out the impressions, I did not hear that. Could you go over that again?

Ali Jenab

1.4 billion.

James Gillman - Cross Research/Soleil Securities

Say that again, please?

Ali Jenab

1.4 billion for the quarter.

James Gillman - Cross Research/Soleil Securities

And how does that compare to last quarter?

Ali Jenab

Last quarter was 1.5, the year before was 1.1.

James Gillman - Cross Research/Soleil Securities

Okay. In reference to the e-commerce business. I noticed that inventory is probably about twice the level it was in first quarter. In your revenue guidance, it is not going to be that much higher than what occurred in the first quarter. Do you think you might have to put some sale items or, what's the explanation for having a little bit higher inventory?

Ali Jenab

A couple of things. One the volume of business is higher on a monthly run-rate. It's much higher than last year, so even the guidance is higher than it was last year during the first quarter. During the third quarter I am sorry.

So one thing that we do with the inventory side of the house as the business has grown, we didn't feel like the products that they actually have in inventory are newer products. And we didn't feel like because of our strong sales to even do any sales during the month of January. We felt like we wanted to keep our main to inventory, because we didn't want to erode margins.

At the end of February, it would be much lower inventory level than you are seeing right now. It's just the timing of it and the inventory actually is teed up for the February timeframe that we had on February 14th for Valentine's Day, is a big driver for them too. So we don't see an issue with the type of inventory that we have that we're exposed on it.

James Gillman - Cross Research/Soleil Securities

Okay. And then the software business, is Open Source options that are available to the user, is that having any impact on your business?

Ali Jenab

The free download you're talking about?

James Gillman - Cross Research/Soleil Securities

No, I'm actually more referring to the competitive offerings that are available out there in the Open Source software community.

Ali Jenab

You know naturally, Open Source in general impacts everybody because there's a free solution out there that anybody can use. But that is no different today than it was a few years back. One thing we're experiencing with our free download is a lot of people are using it and the smaller deals that would have potentially bought from you could go to that lower end. But we felt like that was a small percentage and that was really not what impacted the quarter. More importantly, is our ability to get that, the larger deals done which was impacting last quarter.

James Gillman - Cross Research/Soleil Securities

Okay. And then looking ahead, just more on the financial side. How should we look at the run rate for CapEx and for depreciation?

Patty Morris

Okay. So, actually this is a good time into what was asked a little bit earlier by Danny. The capitalization for the quarter of marketplace was 380,000. And essentially, we've got a pretty constant, number of expenses that we are capitalizing specific to that. Baked into the numbers that we provided in the past, until the marketplace rolls out, we're actually not going to start depreciating those assets.

James Gillman - Cross Research/Soleil Securities

Okay.

Patty Morris

So, it's difficult to say how that's going to change right now.

James Gillman - Cross Research/Soleil Securities

Okay. So, maybe from looking at depreciation run rate is looking historically but then thinking about maybe latter part of the year, we would probably see depreciation probably increase due to the fact of the previous capitalized for the dot net marketplace?

Patty Morris

Clearly, as you look at our financials, we've been adding some baseline capital expenditures. So, there will be some appreciation of the depreciation number given that we don't expect that to be overly large. But with regards to marketplace again, it's really dependent on the timing of the launch of marketplace.

James Gillman - Cross Research/Soleil Securities

Okay. Well those were my questions, and thank you.

Patty Morris

You're welcome.

Operator

Ladies and gentlemen, there are no more questions. At this time, I'd now like to turn it back to management for closing remarks.

Patty Morris

Okay. This is Patty. I just wanted to give one clarification specific to the guidance that we have provided, which is, overall we have historically given guidance as a whole, and we haven't broken out the components of the guidance by business segment. And so, specific to the guidance, we certainly stand behind the total guidance is expected to be in the $12 million to $13 million range. The components of it, we've given some basic parameters around, how we think each of the three businesses, what kind of guidance are specific to those. But the mix of the actual results for the business units generally, we believe will fall in the $12 million to $13 million range. So, I wanted to just make that clarification.

Ali Jenab

And also, one more explanation. If you probably add the three, you get a wider range. But the fact is, you're not going to be low in all three and high in all three. So, that's why we feel like there's going to be enough mix there for us to hit the $12 million to13 million range.

Are there anymore questions in the queue? No? Okay. Thank you very much for joining us. I'm looking forward to talking with you in the next quarter. Thanks.

Operator

Ladies and gentlemen, this concludes today's teleconference. Thank you for your participation.

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