Digital River Q3 2007 Earnings Call Transcript

| About: Digital River, (DRIV)

Digital River Inc. (NASDAQ:DRIV)

Q3 2007 Earnings Call

October 25, 2007 4:45 pm ET

Executives

Ed Merritt - VP, IR

Joel Ronning - Founder and CEO

Tom Donnelly - CFO

Analysts

Sasa Zorovic - Goldman Sachs

Lee Westerfield - BMO Capital Markets

Phil Winslow - Credit Suisse

Robert Breza - RBC Capital Market

Colin Sebastian - Lazard Capital

Jeetil Patel - Deutsche Bank Securities

Aaron Kessler - Piper Jaffray

Tim Klasell - Thomas Weisel Partners

Operator

Good afternoon. Ladies and gentlemen my name is Aaron, and I'llbe conference operating today. At this time, I would like to welcome everyoneto the Digital River Q3 2007 Earnings Call. (Operator Instructions). Thank you

It is now my pleasure to turn the floor over to your host,Mr. Ed Merritt. Sir, you may begin your conference.

Ed Merritt

Thanks Aaron. Welcome to Digital River’sthird quarter earnings conference call. I’m Ed Merritt, Digital River’snew Vice President of Investor Relations.

I joined the company about two months ago, from the J.C.Penny Company, where I had a 24 year career, with responsibilities throughoutthe company, including Investor Relations, Financial Planning and Analysis,Strategic Planning, Corporate Finance and eCommerce. I look forward to workingwith each of you in the upcoming months.

On the call with me today is Joel Ronning, our ChiefExecutive Officer; and Tom Donnelly, our Chief Financial Officer. I would liketo remind you that statements made during the course of this conference call,that are not historical facts, are forward looking in nature, includingstatements regarding the company's future growth and financial results, as wellas any statement containing the words believes, anticipates, expects andsimilar words.

These statements involve known and unknown risks, uncertaintiesand other factors, which may cause actual results to differ materially fromexpectations. For a detailed discussion of these risk factors anduncertainties, please refer to the company's filings with the Securities andExchange Commission.

A webcast of our call today will be available for a periodof two weeks on the Investor Relation section of Digital River'scorporate website.

With that, I'd like to turn the call over to Joel Ronning.Joel?

Joel Ronning

Thanks Ed, and thanks to all of you for joining our calltoday. I am pleased to report we are on target with our earning expectationsfor the third quarter. During last quarter, we delivered $82.5 million inrevenue, which is up 10% over the third quarter of 2006.

Inline with our expectations, our GAAP net income was up 3%,compared to the third quarter of 2006, and non-GAAP net income was neutral overthe same period of last year.

Before I turn the call over to Tom for more details on ourthird quarter results, I would like to hit a few highlights and give you anupdate on the continued expansion of our relationship with Microsoft, Symantec,the strong growth in our core business which was supported primarily byperformances of our software and shareware businesses, some key client wins inthe consumer electronics and games market, and finally our acquisition ofNetgiro Systems.

Let's start with Microsoft. As I just mentioned, we continueto make good progress expanding our relationship. During the third quarter, wewere actively engaged in the strategic marketing front, running site optimizationtests that we will believe positively influence office [download] sales andtrail conversion in the future.

In the mean time, we are in regular conversions withMicrosoft about additional marketing programs including site optimization,affiliate in email marketing. We plan to accelerate efforts related to these andother marketing programs throughout remainder of this year.

Consistent with what we said during our second quarterearnings call, we expect conversion in the associated revenue from thesemarketing programs to gradually ramp late in 2007 with meaningful impactbeginning in 2008 and beyond.

In the third quarter, our business with Microsoft alsoexpanded on a couple of other fronts. We began to see an uptick of Office 2007trail activations and conversions, since the bulk of Windows XP computers havemoved through the channel. Now, consumers are primarily buying computers withthe Windows Vista Operating System; and computers which in most cases are also loadedwith the 2007 Office trials.

In addition, in September, we launched a new program thatmakes Microsoft Office Ultimate, available to college students on a specialoffer basis. The program which was referred to as the Ultimate’s deal, is offto a great start with sites up and running for students in the US, UK, Canada,Spain, France and Italy.

Given the increasing number of trial activations, theadoption of our strategic marketing programs and improved conversion rates, Iam optimistic about our relationship with Microsoft. A relationship in businessthat we intend to further expand in 2008.

I want to extend a note of thanks to dedicated teams at Digital River and Microsoft that have workedcountless hours during the past two years to make this opportunity a realityfor your company and our client.

Now moving on to Symantec. Our core business with Symantec continuesto perform well. We did however run into additional transition delays withSymantec’s global subscription business. At the end of the third quarter, [most]large subscription sites had shifted to our platform as expected.

Early in the quarter Symantec informed us that subscriptionsite transitions had to be sales neutral, before a switch to our platform tookplace. Meaning, we needed to improve site performance to cover Digital River's revenue share. To that end ourstrategic marketing teams have engaged in extensive atomization and testingefforts to improve conversion performance.

I am pleased to report that we are currently meeting all thethresholds for the sites [staged] to transition, and we are anticipating thelargest sites that contribute to the majority of the revenue will be live inour platform by the end of the fourth quarter.

As we mentioned on the earnings call last quarter, ourrenewals are also impacting our Symantec opportunity this year. In impact weexpect it to be offset by the transition of the subscription business.

We continue to believe this impact is accounted for in ourfinancial guidance for the remainder of this year. As we look out to 2008, webelieve that auto renewals will continue to impact our Symantec growth rates,offset by core growth in the online business we manage today and thesubscription business we expect to transition by the end of the fourth quarter.In January, we should be in a position to provide more clarity related to ouroverall expectations for 2008.

During the third quarter, Digital River'srevenues directly and indirectly related to Symantec were down 12%year-over-year. Given that we expected a meaningfully contribution fromSymantec subscription business in our third quarter, I am pleased with theoverall financial performance of the company, absent this revenue.

In the third quarter, our business excluding Symantec grewalmost 29%. From a market standpoint, our core business also continued to befuelled by international growth. During the third quarter, international saleswere approximately 43% of total gross sales compared to 39% in the thirdquarter of 2006. Growth in the quarter can be attributed to strong performancesby our software and shareware client base.

Our ability to manage the global commerce solutions,surrounded by a full suite of managed marketing and payment services, continuesto generate new and incremental business for us in the software market. Thisend-to-end approach is driving global expansion for our clients and more winsover in-house solutions.

Our Shareware business also continues to perform well. Muchof this success can be attributed to our competitive pricing model thatcontinues to attract prospects and the growth in the international softwaremarket, particularly in the Europe and China. In the third quarter,approximately three quarters of gross shareware sales were generated from productsdeveloped by publishers outside of the US.

We expect our global expansion to continue in the fourthquarter as we service primary sponsors for software conference in Moscow, Beijing and Colon.

Other markets that represent growth opportunities for usincludes consumers electronics and games. Last quarter in the consumerelectronics market, we launched the European sites for a major cell phonemanufacture and a USstore for BenQ, a $5 billion manufactured computer peripherals and consumerelectronics.

We also expanded our relationship with Skype. In addition tomanaging their USe-commerce store, we launched 18 European online Skype shops, which featureinternet phones, webcams, headsets, and other products.

And finally, we continue to grow our business with Canon,adding three consumer stores in Europe. Wehave had much success over the years with Canon in the eBay channel, now veryexcited about the future potential of this direct-to-consumer strategy.

Working with third-party fulfillment agencies in fourcontinents, today we ship in excess of $2 million physical units to consumersannually. These shipments are supported by our intelligent sourcing engine,which we believe is important competitive differentiator for us in themanufactured or direct consumer electronics market.

As this market continues to gravitate toward theinternet-based direct-to-consumer business model, we are increasinglyoptimistic on our prospects, especially in Europe,where there are complex regulations around taxes, purchasing, shipping, andrecycling high-tech goods.

We also have expertise in managing online stores that caterto cultures worldwide, which is critical to driving revenue performance. Withthe substantial majority of our consumer electronics business currently beingdriven by North American consumers, we intend to aggressively pursue newopportunities in Europe, and eventually acrossthe globe.

The gaming market represents another long-term growthopportunity for us, and is an area where we continue to make important progressin the third quarter. During our last call, we announced our relationship withElectronic Arts, managing North America online store for package goods, whichincludes consoles, handhelds and PC games, as well as PC digital downloads.

I am happy to report that we are alive not only in NorthAmerica, but also with multiple stores in Europe, and a site for Asia specific. Our contract with Electronic Artsrepresents a significant win for us, and we look forward to the first holidayseason with them as a client.

Electronic Arts joins our basic game publishers, whichincludes industrial leader such as Capcom Entertainment, Prima Games, Turbine, [Telpel].Our future development efforts for this market include technologies andcapabilities to support advance merchandising functionality, the execution ofmicrotransactions, and subscriptions-based commerce. In time, we also expect toadd additional publishers, as this market moves towards an internet-baseddirect-to-consumer model.

Our global footprint received another boost in the thirdquarter with out acquisition of Netgiro Systems. The Sweden-based company isone of the leading internet payment service providers in the Europe.At the time of the acquisition it was one of our vendors. We are excited aboutthe cross-sale opportunities that exist here. Combing Netgiro's internationalpayment platform with Digital River's payment, ande-commerce infrastructure, we intend to extend our global online transactionprocessing and payment capabilities. At the same time, Netgiro can accelerateits multiregional payment offering, especially in Asia Pacific.

During the third quarter, Netgiro's business, which willcontinue to operate out of Stockholm, Sweden,contributed almost $1 million in revenue.

With that I will turn the call over to Tom for the rest ofdetails on our financial performance. Tom?

Tom Donnelly

Thanks Joel. Our third quarter revenue was $82.5 million, up10% from $75.3 million reported in the third quarter of 2006. Internationale-commerce gross sales were approximately 43% of total growth sales in thethird quarter, compared to 39% in the third quarter of 2006. Revenues directly,and indirectly, related to the sales of Symantec products were 38% of totalrevenue in the third quarter, compared to 47% in the same period of 2006.

Direct Symantec revenues during the quarter were 26%,compared to 30% in the third quarter of 2006. The business absentSymantec-related revenues grew 28.6% for the quarter, and 26.2% absent revenuesrelated to Netgiro.

GAAP net income for the third quarter totaled $15.3 million,or $0.35 per share above our guidance of $0.34 per share. This compares to netincome of $14.8 million, or $0.33 per share in the third quarter of 2006. Theseresults represent quarter-over-quarter improvements of 3% in net income and 6%in net income per share.

As Joel mentioned, we are pleased with the results, giventhe absence of the majority of subscription revenues from Symantec during thequarter.

Switching to non-GAAP results. In the third quarter non-GAAPnet income totaled $18.8 million, or $0.41 per share in line with our guidance.This compares to non-GAAP net income of $18.7 million, or $0.41 per share forthe third quarter of 2006.

Operating margin from the third quarter declined on a GAAPand on non-GAAP basis, when compared to the third quarter of 2006 byapproximately 1.6 and 4.5 percentage points respectively in line with ourguidance when accounting for the acquisition of Netgiro on September 1st.

For the third quarter, total costs and expenses grew $7.1million over the third quarter of 2006, reflecting some leverage returning tothe model growing slightly slower than revenues.

Looking at the individual third quarter expense line itemscompared to the third quarter of 2007, and excluding stock compensationexpense, direct cost of services was up 63% primarily due to additional staffand support of our largest clients, and increased sales and associated costsrelated to our Physical-on-Demand and CD-to-Go products.

Network and infrastructure costs were up 3%. Sales andmarketing expenses were up 17%. Specific factors that drove this increaseinclude; incremental payment processing fees on higher [gross] sales volume,higher costs associated with marketForce services, specifically paid researchand addition to headcount from the prior year in support of new marketopportunities.

R&D expense was up 26% year-over-year, and risingsequentially by about $2 million, primarily due to the infrastructure projectsdiscussed on our last call. And G&A costs were up 13% quarter-over-quarter.

Our GAAP tax rate in the third quarter was approximately31%, compared to 27% in the similar quarter of 2006. On that note, you’llremember, we had a discrete item in Q3 of the last year that brought the taxrate down for the quarter.

Our US NOL at the end of the quarter was approximately $50million, and our international NOL was approximately $1million.

Turning to cash flow. Net cash provided by operatingactivities for the nine month period ending September 30, 2007, totaledapproximately $84.7 million flat when compared to the similar period of 2006.

Excluding changes in operating assets and liabilities, whichI've referred to as balance sheet leverage, net cash flow from operations forthe nine month period was $82.9 million, compared to $86.8 million for thesimilar period of 2006.

Adjusting for the year-over-year change, and the excessbenefit of stock-based compensation, cash generated year-over-year for the ninemonth period was up 5% in line with our non-GAAP net income growth.

CapEx was approximately $3.2 million in the third quarter onpar with our depreciation expense. We ended the quarter with approximately $638million in cash and short term investments.

Now on the guidance. For the fourth quarter of 2007, wecurrently expect revenue of $96 million, GAAP net income of $0.45 per shareincluding $3.4 million of stock compensation expense, and non-GAAP net incomeof $0.53 per share.

From a non-GAAP earnings perspective, our full year guidanceremains unchanged from the guidance we gave on the July conference call. Theincrease in revenue guidance is primarily related to the acquisition of Netgrioon September 1, as is the change in the GAAP EPS expectations. We expect CapExin the fourth quarter will be in the $5 million range.

A few more comments on the updated 2007 guidance. Netgirofor the immediate term will essentially be neutral to non-GAAP earnings. On aGAAP basis, we expect the acquisition to be dilutive to earnings by about 2pennies this quarter, resulting from intangible amortization of about $800,000.

Overall expenses in the fourth quarter will essentially beflat with the third quarter absent expenses additions as a result of theNetgiro acquisition, and variable cost associated with higher anticipated salesthrough the holiday season. We are maintaining the increases in R&D andQ&A, which primarily relate to infrastructure investments through thefourth quarter.

Regarding the share repurchase program we announced in July,there was no activity under the plan in August and September.

On a final note, we received feedback from some investorsand analysts regarding our practice of issuing next year's guidance so early inthe current year.

Historically, Digital River issued annualguidance for the following year with the third quarter earnings' release. Afterreviewing common reporting practices we found the majority of companies in theinternet and technology space issue annual guidance in conjunction with theirfourth quarter earnings.

Therefore we are also adopting this practice, and will issueour 2008 annual guidance with our fourth quarter earnings release in lateJanuary. This will better align our disclosure practices with others in ourindustry.

Issuing guidance in January will also provide us additionaloperating history for some of our newer clients such as Microsoft andElectronic Arts, and preliminary results from the Symantec global subscriptionbusiness. With that I'll turn the call back over to Joel.

Joel Ronning

Thanks, Tom. Before we open the call for your questions, Iwould like to recap what we talked about today, and leave with a few comments.Overall, we are pleased with our results for the quarter, which were in linewith our guidance.

But clearly we've made some headwinds this year with arenegotiation of the Symantec contract and delays in the transition of theirsubscription business. Operationally, we've also been heavily invested in thelaunch of major clients, Microsoft and Electronic Arts. While managing theseprojects we represent important future growth opportunities. Our core businessremains solid with strong performances coming from software and sharewaremarkets.

In the near-term we will remain deeply engaged in theexecution around Symantec's global subscription business, and believe thelargest sites that contribute the majority of the revenue will be up andrunning by the end of the year.

We also intend to build on the momentum we've establishedwith Microsoft, further expanding our relationship and driving revenues. As Ilook to the future, we believe our expertise in global commerce and e-marketingsquarely places us in a dominant position in the software, and will continue towin us contracts with industry leaders.

We are fully leveraging these core strengths as we pursueconsumer electronics and games, verticals where we continue to see meaningfulopportunities unfold for us. The momentum we're seeing in the consumerelectronics and games space, with market leaders gravitating towards thedirect-to-consumer model, reminds me of the software market in early 2000 whenpublishers were making a similar shift. We intend to continue playing to thesemarket forces as we finish out this year and look into 2008.

With that let's open up the call for questions. Operator?

Question-and-AnswerSession

Operator

(Operator instructions). Your first question is coming fromSasa Zorovic of Goldman Sachs. Please go ahead.

Sasa Zorovic -Goldman Sachs

Yeah. First, my clarification question, did I understandright that you said that Netgiro was $1 million in revenue in the quarter?

Tom Donnelly

It was under $1 million, yes.

Sasa Zorovic -Goldman Sachs

It was under $1 million in the quarter?

Tom Donnelly

Yeah. It was almost $1 million.

Sasa Zorovic -Goldman Sachs

I see. Now, let me ask you a sort of a question sort ofregarding games here. So, it seems that Macrovision is somewhat exiting thatbusiness, or sort of positioning themselves differently. What are you seeing inthat business that that they are not?

Joel Ronning

I'll grab that, Sasa. We just don't think that they've hadenough mass and presence in that business to really be a competitive operator.I mean, there is so much infrastructure you have to build out to do a globaljob here, and the investment that you have to pour into it. I don't knowexactly what they were thinking, but I am not sure that they were willing to goover the lengths that we have, with the long history that we have, to be playerin that space.

At the end of the day, we know this is a very, very largemarket. It's fairly complex. There is a lot of things you have to do from anin-app standpoint. Meaning, you have to manage inside the application commerce,which gets a little tricky, because some of them handle the [balloons], some doit with gold bars, some handle it in -- it's not money, but its things thatlook like money. So there is some complexity to that. There is a lot ofopportunity there. It's a very subscription oriented business.

And Digital Rights Management, we have found is important,but not critical. It's not a crucial component, and I just suspect that mayhave been the direction they are coming out of from. We think it's a hugegrowth opportunity though, and what EA as a cornerstone, we think this is agreat opportunity for us to jump deeper in.

Sasa Zorovic -Goldman Sachs

Thank you. I have some other follow-ups, but I'll wait forlater on. Thank you.

Joel Ronning

Okay. Hello. Operator?

Operator

Your next question is coming from Lee Westerfield with BMOCapital. Please go ahead.

Lee Westerfield - BMOCapital Markets

Gentlemen, good evening. Three questions, hopefully quickand straightforward ones. But, Joel I wonder if you could elaborate a littlebit more on EA. I think you mentioned in passing in your comments on Europe, and also if it can be significant, what thesignificance of holiday sales maybe coming for EA recognizing its new and earlydays.

Second, fourth quarter costs, Tom I think you are signalinghere that Netgiro is assimilated, is helpful on the revenue side, neutral onthe earning side, that implies that the costs are probably a little higher thanthe margins in the core business. I wondered if you could just confirm that, ifthat’s what you were trying to communicate.

And then third and finally, I think we are lapping theanniversary of the Symantec new contract here, recognizing that the Globalsubscription was forestalled during 2007, but there still should be a favorableanniversary. Can you remind us about out the anniversary that we are sitting uponat this stage?

Joel Ronning

All right. Well why don’t I start it off, I'll grab the EA.We are pretty early in to the relationship there, and so I don’t think I wantto comment yet. We don’t have much visibility, and we also haven't workedenough with them to be comfortable for me give you any insight into it. So Q4revenue I think we'll just see which it way it goes, but we got to get a littlebit of time under our belt with that relationship to be able to give you guysmore visibility on that.

Tom Donnelly

Yeah, and on the cost side on Netgiro what I said isessentially neutral to non-GAAP earnings. So yeah, at least for now and not forthe long run, certainly we believe the revenues and the costs excludingamortization of intangibles are within shouting distances of each other.

And then you need to add on top of that about 800,000 inacquisition amortization, which you’ll see in the guidance tables. Theamortization this quarter is going up quite a bit from the third quarter ofthis year. We don’t see that as a long term proxy by any means, but we see itbeing neutral for the fourth quarter here.

I think I’ll take the Symantec question too. Obviously thelapping of the new contract helps, that was affective last quarter. So thatshould help somewhat this quarter, yes.

Lee Westerfield - BMOCapital Markets

Gentleman, thank you.

Operator

Your next question is coming from Phil Winslow of CreditSuisse. Please go ahead.

Phil Winslow - CreditSuisse

Hi, guys. Just a couple of quick questions. One; just froman expense and sort of an investment perspective. How should we think about aswe transition through Microsoft ramping and you bring on the Symantecsubscription business, those were sort of heavily up-fronted investments.

How do we think of that as you transition to get the revenuefrom those, just from a margin perspective, relatively to also investing in thenew growth areas such as consumer electronics? I guess what is your long-termmodel when you think about it from a margin perspective balancing I guessinvestment for growth but also margin?

Tom Donnelly

Yeah, I think we’ve hit this. You know, you would like to beperfectly aligned, right, that you know exactly where the leverage comes fromand that maps exactly with the investments that you need to make in your coremarket.

We see enough opportunity in the games, in the consumerelectronic space, that we do think those are prudent investments for thecompany to make to drive future growth. And obviously, there will some leveragethat’s going to be coming into the model.

Revenues were obviously up a bit for Microsoft sequentially,and that means (inaudible) was a little bit less and that trend shouldcontinue. We still believe there are plenty of opportunities for the company toinvest in future growth, and we've been kind of hanging around a range in thehigh 20s to the 30s.

You'll see the guidance for the fourth quarter has a shift-- right about flat from an operating margin, non-GAAP operating marginperspective year-over-year, which is an improvement over 460 basis points dropand even a further drop in the second quarter because we kind of had to resetexpectations.

Specifically we'll give guidance in January, when we havebetter visibility obviously on some of these components that you are askingabout.

Phil Winslow - CreditSuisse

And then also, when you do think about the Symantec businesscoming on line for late Q4 and then really heading Q1, how should we thinkabout that affecting I guess just the seasonality in the Symantec business.Typically Q4 and Q1 have been your strongest periods, how much do you thinkthat boosts I guess the Q1s or the sequentials there?

Tom Donnelly

Well I think we've said on prior calls that the subscriptionrenewals tend to follow the heavy acquisition seasons. They can be somewhatinfluence by acquisition out side of the online channel, that is in-store orOEM channels, depending on who has what placement where, during what period oftime, and how many machines or how many units were sold. But overall, we stillexpect the same sort of seasonal nature to the subscriptions as we see in theacquisition business.

Phil Winslow - CreditSuisse

And then just one last question on the Symantec side. Partof your new contract was a higher percentage cut for bringing a new incrementalbusiness driven by Digital River. I was justwondering if you could give us a sense where probably that's trending.

Tom Donnelly

Yeah. You know again the search costs were up sequentiallythis quarter because it was a heavier acquisition period around the launch and havingthis in September, and those programs continue to do reasonably well for Digital River.

Phil Winslow - CreditSuisse

Great, thanks guys. A great quarter.

Tom Donnelly

Thanks.

Operator

Your next question is coming from Robert Breza of RBCCapital Markets. Please go ahead.

Robert Breza - RBCCapital Market

Hi, thanks for taking my question. Joel maybe for you, andas you look at the - you talked about a little bit of a headwind there with Symantec,some of the transitional delays. Can you may be just walk us through a littlebit more operationally what does it mean for improving site performance? Andthen Tom on the repurchase program, clearly with an acquisition I know itstough to do that. Barring any acquisition, would you see yourself back at themarket here? Thanks.

Joel Ronning

Okay. Well in terms of the site work we are doing, we do alot of multi-variant, lot of A/B testing, and a lot kind of path management. Weare working on, how to improve the site flow for the customers, so we canincrease the average order value to close ratio, so a lifetime value of thecustomer.

It tends to be laborious because you end up having to do alot of different tests, lot of different creative rework to get to formulas atwork, and sometimes you will change 9, 15, 20 elements on a page, and then youhave to track what elements are really driving the increase in performance.

So, it's a process we are pretty good at. We think we areone of best in the world at, but it tends to custom, like I said it'slaborious. It takes time, and then you got to get, you got to let the site runlong enough to able to get statistically accurate numbers coming in from it,which is it does take a little bit of time.

We are feeling pretty good about it, we really understandhow to do this well. Like I said I believe we are one in the best in the worldat this, and the performance that we've seen so far has been pretty good, it'sjust taking a little while to get to that spot. But we are getting pretty goodclarity and getting pretty good comfort on the performance that we've had. Wasthere a second question?

Robert Breza - RBCCapital Market

Yeah.

Tom Donnelly

You know on the buyback we have $137 million under the buybackplan. As we've said in the past, it's an opportunistic, it is not a systematicprogram, and I think depending on market conditions and open windows, there isa committee of our Board that will give instructions relative to activity. AndI think the activity will be directly related to the overall market.

Robert Breza - RBCCapital Market

Great. Thank you, guys.

Joel Ronning

Thank you, Rob.

Operator

Thank you. Your next question is coming from Colin Sebastianof Lazard Capital. Please go ahead.

Colin Sebastian -Lazard Capital

Thanks, good afternoon. Couple of questions. First justfollowing up on the subscription site rollout, Joel what's your level ofconfidence there in getting or having Symantec turn on those large subscriptionsites before the end of the year?

Joel Ronning

Well I have to say, you know my level of confidence has beenpretty good for the last three quarters, and I have to say I am embarrassedabout where we are today; that this hasn’t happened. So, I am bullish on it,but now clearly pretty careful in terms of the expectation. So, I am spending afair amount of time watching this and working with the team to make sure thishappens. But every piece of evidence I had seen is that we have exceeded thehurdles put in front of us, and so it should happen.

Colin Sebastian -Lazard Capital

Okay. Do you think that Symantec shares with you the goal ofhaving this up and running by the end of the year?

Tom Donnelly

I believe that's accurate

Colin Sebastian -Lazard Capital

Okay. And one follow-up, I guess from a resources point ofview, the EA and Microsoft sites are coming online and you've made a lot ofprogress there. Are their resources being freed up from those projects thatmight allow you to pursue some other opportunities or are they still activelyengaged?

Joel Ronning

Absolutely. Yes, sir, our resource is coming free, and that'sa great opportunity for us to work on some core new projects.

Colin Sebastian -Lazard Capital

Okay. Thanks a lot

Operator

Thank you. Your next question is coming from Jeetil Patel ofDeutsche Bank Securities. Please go ahead.

Jeetil Patel -Deutsche Bank Securities

Yeah. Hey, guys a couple of questions. First of all, just ifyou look at Symantec and your relationship with them, if you had not redone thecontract for the -- obviously the visibility that you've got; and can you talkabout what the kind of growth would have looked like on an apples-to-applesbasis year-on-year if that's a way we can maybe approach that segment of yourrevenue stream. And then second, your guidance went up I guess a couple ofmillion in the fourth quarter relative to what the implicit guidance waspreviously in the last call. I guess, I assume that's all Netgiro, but then canyou explain are you in the core revenue that you are already expecting. Is yourMicrosoft contribution going higher, and your Symantec contribution coming downa bit based on the subtle delay in the subscription business of Symantec? And Ihave a quick follow-up.

Tom Donnelly

Sure. I'll attempt to answer the questions that we can'tanswer. I think given the year-over-year comps on our client's business arepretty difficult for us to do. I will comment, and I thought I hit on thescript that the raise in revenue guidance, obviously absent any reduction inthe non-GAAP earnings guidance was predominantly related to the Netgiroacquisition. They did close to $1 million in September. September is a verystrong month for them, because they are exposed to the travel industry, andsome other industries that aren't quite as cyclical as the software industryis. So, they are more of a steady performer than having the big spikes in Q4and Q1 like we have. Relatively to the individual makeup by customer, what theguidance is fourth quarter, that's something we really can't touch. Although,we are happy with the progress and the progression, if you will, that we areseeing on our business with the large company in Washington.

Jeetil Patel -Deutsche Bank Securities

Right. I guess, so the down 12% on Symantec revenue, wouldthat have been up had you not restructured the contract last year?

Tom Donnelly

That's the question that's tough. I will say, and I think Philasked earlier, we do lap the contract for at least part to the upcoming quarter,and that does help the comps now year-over-year. So, clearly consistent withlast quarter the drop in year-over-year revenues is primarily impacted by theprice cut.

Jeetil Patel -Deutsche Bank Securities

Thanks. And the last question. If you look at your R&D spendof $9.8 million, can you discuss on that number? How much of that is in projectsor areas that are still likely to launch in terms of new customers or projectsversus, what is kind of focused on existing accounts that you have already beenramping with? And then just if you have expense base for Netgiro and the numberfor Q3, if you could give that, that will be great.

Tom Donnelly

I don't have a breakout. A lot of the specific large clientdevelopment efforts, some of those end up in the direct cost of service line onthe P&L. I can say that the sequential increase from Q2 to Q3 of about $2million was almost exclusively related to development in QA resources that webrought in on a contract basis to attack specific infrastructure projects thatwe hope to have a quite a bit of them complete by the end of the year.

I am not going to give you a specific expense number for Netgiro,but I will walk you through. Again, the revenue was almost $1 million inSeptember. We expected to be neutral the non-GAAP earnings, so you can assume thatexpenses will approximate what the revenue contribution will be for the fourthquarter. And then you have to add on top of that on a GAAP basis $800,000 inacquisition and amortization.

Jeetil Patel -Deutsche Bank Securities

Got it. And is Netgiro growing?

Tom Donnelly

Yes.

Jeetil Patel -Deutsche Bank Securities

Okay. 20, 25?

Tom Donnelly

No comment.

Jeetil Patel -Deutsche Bank Securities

Then work it out.

Joel Ronning

Thank you, Jeetil.

Operator

Thank you. Your next question is coming from Aaron Kesslerof Piper Jaffray. Please go ahead.

Aaron Kessler - PiperJaffray

Yeah. Thanks guys. Couple of questions, one, can you give usthe sense may be how large the headwind will be for the auto renewals as we goin to '08 here? Also on the Symantec conference call I believe you indicatedsome softness in the demand curve, may be you can give us a sense if that'sreally not just in the consumer segment unlike it was more of theinfrastructure part of the business. And then, also in terms of the marketforce, any updates there you can give us in terms of the size, growth or newclient wins, that will be great. Thank you.

Joel Ronning

The first question was quantifying the…

Aaron Kessler - PiperJaffray

Yeah.

Tom Donnelly

Quantifying auto renewals in '08, I don't think we are in aposition to do that, nor do I think we'd breach client confidentiality bybreaking out the different components of their business. So, I have toapologize...

Aaron Kessler - PiperJaffray

And generally that would be enough if that trend continuesto have a significant impact on the growth as long as the subscription businesscame online?

Tom Donnelly

Well, let's say this a lot of the auto renewal shift hasbeen in our numbers, since really it started, which was the fourth quarter oflast year, and I think we've been pretty good at accounting for that in ourguidance this year.

Joel Ronning

You can use that as a proxy for the impact on the future, Ithink what Tom is trying to say.

Aaron Kessler - PiperJaffray

Right. Okay. And in terms of the marketForce, any updates onmaybe they grow up new client wins, or what's the current size of that about business?

Tom Donnelly

Yeah. We've got some real traction with one of our other largestclients Microsoft. And we're feeling very good about the relationship there. Wespend a lot of time, from an operational standpoint getting them up, and thenwe spend a fair amount of time showing that what could be done and they seem tobe pretty willing investors in that area. So, we're pretty excited about that.I think there is a lot of opportunity there.

Aaron Kessler - PiperJaffray

Great. And just one final question, given the strong growthwe're seeing in e-commerce, any chance at some point you may be look at more ofa direct ownership in terms of inventory as opposed to kind of third-partyplayer in the e-commerce segment?

Joel Ronning

We'll have to see how it goes. Historically, we've beenpretty comfortable with the model we have though.

Aaron Kessler - PiperJaffray

Right. Great, thank you.

Operator

Thank you. Your final question is coming from Tim Klasell ofThomas Weisel Partners. Please go ahead.

Tim Klasell - ThomasWeisel Partners

Yeah, good afternoon everybody. Just a quick question, asMicrosoft begins to ramp in your business, should we expect enhancedseasonality, because it look like the target customers that you guys are goingafter are similar to the target customers of Symantec's business? So, should weexpect fairly strong December and March quarters and should that be enhanced asMicrosoft ramps?

Tom Donnelly

I don't think so. I think part of that is going to beblurred by the growth that we see from Office in general, and people shifting offthe old Office product to new Office product. And that does takes sometime forpeople to start accepting the new Office products and putting on their desktop.And so, I think whatever seasonality is there, I think it will be complete maskedby just kind of the systematic growth that we see from that product. And then theother things is that, with the Student HERO program going, I would expect thatnext year we will see some lift in Q3 just in the back-to-school, which we havenot seen a lot of lift from back-to-school programs historically. So, I don'tthink that will turn into an issue for a while.

Tim Klasell - ThomasWeisel Partners

Okay, very good.

Joel Ronning

Seasonally. Okay.

Tim Klasell - ThomasWeisel Partners

Thank you.

Joel Ronning

Great, thank you.

Ed Merritt

Before we conclude our call, I would like to mention that Digital River management will be participatingat three upcoming investor conferences. First, we will be presenting at theGoldman Sachs Software Retreat at November 6th and 7th. The following week, we willbe at the Piper Jaffray's Third Annual Global Internet Summit on November 13thand 14th, and last we will be presenting at the Credit Suisse 2007 AnnualTechnology Conference, which takes place November 27th to the 29th. Thank youfor joining our conference today. That concludes the Digital Riverthird quarter earnings call.

Operator

Thank you. This does conclude today's Digital River Q3 2007earnings conference call. You may now disconnect.

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