Digital River Q3 2007 Earnings Call Transcript

Digital River Inc. (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

Presentation

Operator

Good afternoon. Ladies and gentlemen my name is Aaron, and I'll be conference operating today. At this time, I would like to welcome everyone to 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’s third quarter earnings conference call. I’m Ed Merritt, Digital River’s new 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 throughout the company, including Investor Relations, Financial Planning and Analysis, Strategic Planning, Corporate Finance and eCommerce. I look forward to working with each of you in the upcoming months.

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

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

A webcast of our call today will be available for a period of two weeks on the Investor Relation section of Digital River's corporate 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 call today. I am pleased to report we are on target with our earning expectations for the third quarter. During last quarter, we delivered $82.5 million in revenue, 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 over the same period of last year.

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

Let's start with Microsoft. As I just mentioned, we continue to make good progress expanding our relationship. During the third quarter, we were actively engaged in the strategic marketing front, running site optimization tests that we will believe positively influence office [download] sales and trail conversion in the future.

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

Consistent with what we said during our second quarter earnings call, we expect conversion in the associated revenue from these marketing programs to gradually ramp late in 2007 with meaningful impact beginning in 2008 and beyond.

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

In addition, in September, we launched a new program that makes Microsoft Office Ultimate, available to college students on a special offer basis. The program which was referred to as the Ultimate’s deal, is off to 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, the adoption of our strategic marketing programs and improved conversion rates, I am optimistic about our relationship with Microsoft. A relationship in business that 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 worked countless hours during the past two years to make this opportunity a reality for your company and our client.

Now moving on to Symantec. Our core business with Symantec continues to perform well. We did however run into additional transition delays with Symantec’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 subscription site transitions had to be sales neutral, before a switch to our platform took place. Meaning, we needed to improve site performance to cover Digital River's revenue share. To that end our strategic marketing teams have engaged in extensive atomization and testing efforts to improve conversion performance.

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

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

We continue to believe this impact is accounted for in our financial guidance for the remainder of this year. As we look out to 2008, we believe that auto renewals will continue to impact our Symantec growth rates, offset by core growth in the online business we manage today and the subscription 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 our overall expectations for 2008.

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

In the third quarter, our business excluding Symantec grew almost 29%. From a market standpoint, our core business also continued to be fuelled by international growth. During the third quarter, international sales were approximately 43% of total gross sales compared to 39% in the third quarter of 2006. Growth in the quarter can be attributed to strong performances by 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, continues to generate new and incremental business for us in the software market. This end-to-end approach is driving global expansion for our clients and more wins over in-house solutions.

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

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

Other markets that represent growth opportunities for us includes consumers electronics and games. Last quarter in the consumer electronics market, we launched the European sites for a major cell phone manufacture and a US store for BenQ, a $5 billion manufactured computer peripherals and consumer electronics.

We also expanded our relationship with Skype. In addition to managing their US e-commerce store, we launched 18 European online Skype shops, which feature internet phones, webcams, headsets, and other products.

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

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

As this market continues to gravitate toward the internet-based direct-to-consumer business model, we are increasingly optimistic on our prospects, especially in Europe, where there are complex regulations around taxes, purchasing, shipping, and recycling high-tech goods.

We also have expertise in managing online stores that cater to cultures worldwide, which is critical to driving revenue performance. With the substantial majority of our consumer electronics business currently being driven by North American consumers, we intend to aggressively pursue new opportunities in Europe, and eventually across the globe.

The gaming market represents another long-term growth opportunity for us, and is an area where we continue to make important progress in the third quarter. During our last call, we announced our relationship with Electronic Arts, managing North America online store for package goods, which includes consoles, handhelds and PC games, as well as PC digital downloads.

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

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

Our global footprint received another boost in the third quarter with out acquisition of Netgiro Systems. The Sweden-based company is one 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 about the cross-sale opportunities that exist here. Combing Netgiro's international payment platform with Digital River's payment, and e-commerce infrastructure, we intend to extend our global online transaction processing and payment capabilities. At the same time, Netgiro can accelerate its multiregional payment offering, especially in Asia Pacific.

During the third quarter, Netgiro's business, which will continue 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 of details on our financial performance. Tom?

Tom Donnelly

Thanks Joel. Our third quarter revenue was $82.5 million, up 10% from $75.3 million reported in the third quarter of 2006. International e-commerce gross sales were approximately 43% of total growth sales in the third quarter, compared to 39% in the third quarter of 2006. Revenues directly, and indirectly, related to the sales of Symantec products were 38% of total revenue 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 absent Symantec-related revenues grew 28.6% for the quarter, and 26.2% absent revenues related 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 net income of $14.8 million, or $0.33 per share in the third quarter of 2006. These results 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, given the absence of the majority of subscription revenues from Symantec during the quarter.

Switching to non-GAAP results. In the third quarter non-GAAP net 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 for the third quarter of 2006.

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

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

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

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

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

Our GAAP tax rate in the third quarter was approximately 31%, compared to 27% in the similar quarter of 2006. On that note, you’ll remember, we had a discrete item in Q3 of the last year that brought the tax rate down for the quarter.

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

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

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

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

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

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

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

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

Overall expenses in the fourth quarter will essentially be flat with the third quarter absent expenses additions as a result of the Netgiro acquisition, and variable cost associated with higher anticipated sales through the holiday season. We are maintaining the increases in R&D and Q&A, which primarily relate to infrastructure investments through the fourth 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 investors and analysts regarding our practice of issuing next year's guidance so early in the current year.

Historically, Digital River issued annual guidance for the following year with the third quarter earnings' release. After reviewing common reporting practices we found the majority of companies in the internet and technology space issue annual guidance in conjunction with their fourth quarter earnings.

Therefore we are also adopting this practice, and will issue our 2008 annual guidance with our fourth quarter earnings release in late January. This will better align our disclosure practices with others in our industry.

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

Joel Ronning

Thanks, Tom. Before we open the call for your questions, I would 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 line with our guidance.

But clearly we've made some headwinds this year with a renegotiation of the Symantec contract and delays in the transition of their subscription business. Operationally, we've also been heavily invested in the launch of major clients, Microsoft and Electronic Arts. While managing these projects we represent important future growth opportunities. Our core business remains solid with strong performances coming from software and shareware markets.

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

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

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

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

Question-and-Answer Session

Operator

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

Sasa Zorovic - Goldman Sachs

Yeah. First, my clarification question, did I understand right 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 of regarding games here. So, it seems that Macrovision is somewhat exiting that business, or sort of positioning themselves differently. What are you seeing in that business that that they are not?

Joel Ronning

I'll grab that, Sasa. We just don't think that they've had enough 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 global job here, and the investment that you have to pour into it. I don't know exactly what they were thinking, but I am not sure that they were willing to go over the lengths that we have, with the long history that we have, to be player in that space.

At the end of the day, we know this is a very, very large market. It's fairly complex. There is a lot of things you have to do from an in-app standpoint. Meaning, you have to manage inside the application commerce, which gets a little tricky, because some of them handle the [balloons], some do it with gold bars, some handle it in -- it's not money, but its things that look like money. So there is some complexity to that. There is a lot of opportunity 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 may have been the direction they are coming out of from. We think it's a huge growth opportunity though, and what EA as a cornerstone, we think this is a great opportunity for us to jump deeper in.

Sasa Zorovic - Goldman Sachs

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

Joel Ronning

Okay. Hello. Operator?

Operator

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

Lee Westerfield - BMO Capital Markets

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

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

And then third and finally, I think we are lapping the anniversary of the Symantec new contract here, recognizing that the Global subscription was forestalled during 2007, but there still should be a favorable anniversary. Can you remind us about out the anniversary that we are sitting upon at 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 want to comment yet. We don’t have much visibility, and we also haven't worked enough with them to be comfortable for me give you any insight into it. So Q4 revenue I think we'll just see which it way it goes, but we got to get a little bit of time under our belt with that relationship to be able to give you guys more visibility on that.

Tom Donnelly

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

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

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

Lee Westerfield - BMO Capital Markets

Gentleman, thank you.

Operator

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

Phil Winslow - Credit Suisse

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

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

Tom Donnelly

Yeah, I think we’ve hit this. You know, you would like to be perfectly aligned, right, that you know exactly where the leverage comes from and that maps exactly with the investments that you need to make in your core market.

We see enough opportunity in the games, in the consumer electronic space, that we do think those are prudent investments for the company to make to drive future growth. And obviously, there will some leverage that’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 should continue. We still believe there are plenty of opportunities for the company to invest in future growth, and we've been kind of hanging around a range in the high 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 margin perspective year-over-year, which is an improvement over 460 basis points drop and even a further drop in the second quarter because we kind of had to reset expectations.

Specifically we'll give guidance in January, when we have better visibility obviously on some of these components that you are asking about.

Phil Winslow - Credit Suisse

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

Tom Donnelly

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

Phil Winslow - Credit Suisse

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

Tom Donnelly

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

Phil Winslow - Credit Suisse

Great, thanks guys. A great quarter.

Tom Donnelly

Thanks.

Operator

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

Robert Breza - RBC Capital Market

Hi, thanks for taking my question. Joel maybe for you, and as 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 little bit more operationally what does it mean for improving site performance? And then Tom on the repurchase program, clearly with an acquisition I know its tough to do that. Barring any acquisition, would you see yourself back at the market here? Thanks.

Joel Ronning

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

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

So, it's a process we are pretty good at. We think we are one of best in the world at, but it tends to custom, like I said it's laborious. It takes time, and then you got to get, you got to let the site run long 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 understand how to do this well. Like I said I believe we are one in the best in the world at this, and the performance that we've seen so far has been pretty good, it's just taking a little while to get to that spot. But we are getting pretty good clarity and getting pretty good comfort on the performance that we've had. Was there a second question?

Robert Breza - RBC Capital Market

Yeah.

Tom Donnelly

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

Robert Breza - RBC Capital Market

Great. Thank you, guys.

Joel Ronning

Thank you, Rob.

Operator

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

Colin Sebastian - Lazard Capital

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

Joel Ronning

Well I have to say, you know my level of confidence has been pretty good for the last three quarters, and I have to say I am embarrassed about 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 a fair amount of time watching this and working with the team to make sure this happens. But every piece of evidence I had seen is that we have exceeded the hurdles 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 of having 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 of view, the EA and Microsoft sites are coming online and you've made a lot of progress there. Are their resources being freed up from those projects that might allow you to pursue some other opportunities or are they still actively engaged?

Joel Ronning

Absolutely. Yes, sir, our resource is coming free, and that's a 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 of Deutsche Bank Securities. Please go ahead.

Jeetil Patel - Deutsche Bank Securities

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

Tom Donnelly

Sure. I'll attempt to answer the questions that we can't answer. I think given the year-over-year comps on our client's business are pretty difficult for us to do. I will comment, and I thought I hit on the script that the raise in revenue guidance, obviously absent any reduction in the non-GAAP earnings guidance was predominantly related to the Netgiro acquisition. They did close to $1 million in September. September is a very strong month for them, because they are exposed to the travel industry, and some other industries that aren't quite as cyclical as the software industry is. So, they are more of a steady performer than having the big spikes in Q4 and Q1 like we have. Relatively to the individual makeup by customer, what the guidance 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 are seeing on our business with the large company in Washington.

Jeetil Patel - Deutsche Bank Securities

Right. I guess, so the down 12% on Symantec revenue, would that 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 Phil asked 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 with last quarter the drop in year-over-year revenues is primarily impacted by the price cut.

Jeetil Patel - Deutsche Bank Securities

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

Tom Donnelly

I don't have a breakout. A lot of the specific large client development efforts, some of those end up in the direct cost of service line on the P&L. I can say that the sequential increase from Q2 to Q3 of about $2 million was almost exclusively related to development in QA resources that we brought in on a contract basis to attack specific infrastructure projects that we 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 in September. We expected to be neutral the non-GAAP earnings, so you can assume that expenses will approximate what the revenue contribution will be for the fourth quarter. And then you have to add on top of that on a GAAP basis $800,000 in acquisition 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 Kessler of Piper Jaffray. Please go ahead.

Aaron Kessler - Piper Jaffray

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

Joel Ronning

The first question was quantifying the…

Aaron Kessler - Piper Jaffray

Yeah.

Tom Donnelly

Quantifying auto renewals in '08, I don't think we are in a position to do that, nor do I think we'd breach client confidentiality by breaking out the different components of their business. So, I have to apologize...

Aaron Kessler - Piper Jaffray

And generally that would be enough if that trend continues to have a significant impact on the growth as long as the subscription business came online?

Tom Donnelly

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

Joel Ronning

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

Aaron Kessler - Piper Jaffray

Right. Okay. And in terms of the marketForce, any updates on maybe 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 largest clients Microsoft. And we're feeling very good about the relationship there. We spend a lot of time, from an operational standpoint getting them up, and then we spend a fair amount of time showing that what could be done and they seem to be pretty willing investors in that area. So, we're pretty excited about that. I think there is a lot of opportunity there.

Aaron Kessler - Piper Jaffray

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

Joel Ronning

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

Aaron Kessler - Piper Jaffray

Right. Great, thank you.

Operator

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

Tim Klasell - Thomas Weisel Partners

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

Tom Donnelly

I don't think so. I think part of that is going to be blurred by the growth that we see from Office in general, and people shifting off the old Office product to new Office product. And that does takes sometime for people 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 masked by just kind of the systematic growth that we see from that product. And then the other things is that, with the Student HERO program going, I would expect that next year we will see some lift in Q3 just in the back-to-school, which we have not seen a lot of lift from back-to-school programs historically. So, I don't think that will turn into an issue for a while.

Tim Klasell - Thomas Weisel Partners

Okay, very good.

Joel Ronning

Seasonally. Okay.

Tim Klasell - Thomas Weisel 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 participating at three upcoming investor conferences. First, we will be presenting at the Goldman Sachs Software Retreat at November 6th and 7th. The following week, we will be at the Piper Jaffray's Third Annual Global Internet Summit on November 13th and 14th, and last we will be presenting at the Credit Suisse 2007 Annual Technology Conference, which takes place November 27th to the 29th. Thank you for joining our conference today. That concludes the Digital River third quarter earnings call.

Operator

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

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