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Digital River, Inc. (NASDAQ:DRIV)

Q2 2008 Earnings Call

July 30, 2008 4:30 pm ET

Executives

Ed Merritt – Vice President, Investor Relations

Joel A. Ronning - Chief Executive Officer

Thomas M. Donnelly - Chief Financial Officer

Analysts

Colin Sebastian - Lazard Capital Markets

Philip Winslow - Credit Suisse

Michael Bahl for Daniel Ives - Friedman, Billings, Ramsey & Co.

Nat Schindler – Merrill Lynch

Leland Westerfield - BMO Capital Markets

Carter Malloy for Kyle Evans - Stephens Inc.

Herman Leung for Jeetil Patel - Deutsche Bank Securities

Semik Benja [not verified]

Robert Breza - RBC Capital Markets

Operator

Welcome everyone to the Digital River second quarter earnings conference call. (Operator Instructions) Mr. Merritt, you may begin your conference.

Ed Merritt

Welcome to Digital River's Second Quarter 2008 Earnings Call. I'm Ed Merritt, Digital River's Vice President of Investor Relations. On the call today is Joel Ronning, our Chief Executive Officer, and Tom Donnelly, our Chief Financial Officer.

Joel is traveling today and joining us via conference call. While we don’t anticipate this will have any impact on our call, we wanted you to be aware in case there are short delays in response times.

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 & Exchange Commission.

A webcast of our call today will be available for a period of two weeks on the Investor Relations section of Digital River's corporate website.

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

Joel A. Ronning

I am pleased to report that we exceeded our second quarter revenue and earnings expectations. For the quarter total revenue was $98.4 million, GAAP EPS was $0.33, and non-GAAP EPS was $0.37. All of these results exceeded our guidance for the quarter and were driven by strong performance throughout our company.

Our core software business continues to perform well and our ability to translate this success into complimentary verticals is paying off. I am pleased to report we are making solid progress extending our e-commerce services and winning new business in consumer electronics and games.

Another area that consistently drives growth for us is in our marketForce programs. These are the managed marketing services we provide our clients.

Before I turn the call over to Tom to discuss our financial results, I would like to spend a few minutes talking about each of the growth drivers I just mentioned and their impact in the second quarter.

First, let’s focus on the new business. We continue to win new business across three core markets, software, consumer electronics, and games. In software during the second quarter we expanded our relationship with Mindjet, a leading provider of productivity software. For Mindjet, we are expanding their existing online operation outside Japan to include a new affiliate site, [inaudible].

We also continue to see strong growth along small- to mid-size publishers, particularly in Asia/Pacific. We recently participated in our fourth Chinese software publishers conference and continue to see a growing level of interest from this region. Not only are we adding an increasing number of new Chinese publishers to our client base, but sales among our existing clients are also growing at a faster rate than in previous years.

As I mentioned earlier, consumer electronics was another market that contributed to our solid results in the second quarter. Revenue from existing consumer electronics clients is showing consistent growth. In addition, we continue to close new business. Last week we announced that we launched a new U.S. site for Shure, a leading manufacturer of microphones, earphones, and audio electronics. Two other companies also selected Digital River as their e-commerce provider, one in the Fortune 100 and the other in the Global 500. We are in contract negotiation with both companies and hope to provide more details in the near future. What we can say now is we expect to launch sites for them prior to the holiday season.

Overall, our pipeline of consumer electronics opportunities has increased above the level we saw at the end of the first quarter.

Finally, gaming is another market that continues to produce more prospects and opportunities for us. During the second quarter we expanded our relationship with Capcom, a leading publisher, developer, and distributor of interactive entertainment. In addition to handling the online sale and physical delivery of Capcom’s products in North America, we are now managing digitally distributed content for them. Another win in the quarter included an agreement with a major U.S. electronic retailer.

Later this year we will be hosting and managing downloadable games for this retailer’s online game store. We also signed an agreement with Mattel and launched services to manage commerce and subscriptions for BarbieGirl.com, a popular MPOG site for one of the most recognized toy brands in the world. In the third quarter we hope to be making more announcements about new relationships and expanded agreements in the games market.

In addition to capturing new business in our target vertical markets, software, games, and consumer electronics, we further expanded our markets for services. In the second quarter we once again saw a significant growth in revenue associated with our marketForce programs as we launched new managed e-mail marketing, search engine optimization, and marketing design programs for our clients. During our last call we introduced Mass Dynamic Personalization, which is one of our newest marketForce programs.

It enables us to tailor site flows, personalize shopping experiences, and deliver more relevant messages to the consumer based on their shopping patterns. I am pleased to report that ongoing tests on the sites for some of the largest clients have produced impressive results. In one client test, shoppers entering a store were dynamically presented with product options based on the previous trial experience. The corresponding results show a lift of approximately 25% in both revenue per visitor and conversion rate. We expect the momentum generated by this program to continue in the second half of the year as we roll it out to additional clients.

Our performance during the second quarter was solid across other areas of our business as well. During the second quarter we continued to work together with Symantec and Microsoft on initiatives to g row their online businesses.

For Symantec we tested new marketing initiatives, launched additional global subscription sites, and began offering a new payment option, called a Boleto in Brazil. Symantec accounted for 33% of Digital River’s total revenue in the second quarter. We continue to maintain a healthy relationship with this important client.

On the Microsoft front we are also pleased with our results and are working to further broaden and deepen our relationship in 2009 and beyond. We expect to announce significant new opportunities with Microsoft in the second half of 2008.

I am also pleased to report that we continue making progress executing on the initiatives in the key investment areas we outlined during our January conference call. If you recall, these initiatives were designed to further advance our core competency in commerce and marketing and were focused on the following three areas: Technology and infrastructure advancements for our core software business, key offerings for subscriptions and payments, and complimentary vertical markets, including consumer electronics and games.

Most notably in the second quarter we completed an in-depth evaluation process and made a decision to partner with SAP in the implementation of our global ERP system. We believe this system will deliver valuable operational efficiencies as well as provide added scalability for our clients.

Consistent with the discussion on our last call, we continue to believe we are on track to deliver the bulk of these initatives on time and hope to provide more details during the third quarter’s earnings call.

Before I turn the call over to Tom, I want to give some insight into our outlook for the remainder of 2008.

Overall, we are pleased with our performance in the first half of the year. We are tracking it against our investment plans, growing our core business, and finding new clients in our strategic growth markets. Our outlook for the second half of the year takes into consideration our strong first half performance, our expected attrition in EMEA, and our continue expectations of a soft global economy. Consistent with what we said last quarter, we remain cautiously optimistic in our outlook for the remainder of 2008 and hope to over-perform, as we have in the first half of the year.

With that, I will turn the call over to Tom for the rest of our details on our financial performance.

Thomas M. Donnelly

As Joel mentioned, we are pleased with the results in the second quarter. The company continues to make progress expanding our business with clients as well as landing new opportunities in consumer electronics and games, key contributors to sustainable long-term growth.

Our second quarter revenue was $98.4 million, up 26% from $78.2 million reported in the second quarter of 2007. International e-commerce gross sales were approximately 44% of total gross sales in the second quarter, on par with the second quarter of 2007.Revenues related to Symantec were 33% of total revenue in the second quarter, compared to approximately 37% in the same period of 2007. Direct Symantec revenue during the quarter was 24% of total revenue, on par with the same period last year. As we have noted on previous calls, these results are based on our revenue from Symantec and should not be considered a reflection on Symantec’s consumer business. Absent Symantec revenue, our business grew almost 35% quarter-over-quarter.

Overall, our revenue performance was solid. Delays in anticipated attrition contributed $3.3 million of the $7.4 million in over-performance for the quarter.

GAAP net income for the second quarter totaled $13.2 million, or $0.33 per share, and was above our guidance of $0.25 per share. This compared to net income of $14.5 million, or $0.32 per share, in the second quarter of 2007. Q2 GAAP net income benefited by about $980,000 from a one-time discrete tax benefit recorded in the quarter that I will discuss later on the call.

Switching to non-GAAP results, in the second quarter non-GAAP net income totaled $15.6 million, or $0.37 per share, $0.04 above our guidance. The EPS upside was clearly driven by better than expected revenues.

Operating margin for the second quarter was approximately 15% on a GAAP basis and was 20% on a non-GAAP basis, excluding stock compensation expense and amortization of acquisition-related intangibles. This was some 300 basis points better than expected, again, driven by the strong top line.

For the second quarter total expense grew by approximately $18.9 million over the second quarter of 2007, or about $1.2 million slower than revenues for the quarter.

Looking at the individual second quarter expense lines compared to the second quarter of 2007, and excluding stock compensation expense, direct cost of services was up 92%, primarily due to the digital swift and custom CD acquisitions. Cost of goods sold for these services will be reported in this line item going forward.

Network and infrastructure costs were up 42.5%. This was primarily related to infrastructure investments the company is making in support of our strategic objectives to drive efficiency, as well as from the acquisition of Netgiro.

Sales and marketing expenses were up 21%. This increase was related to incremental payment processing fees on higher gross sales volume, costs related to recent acquisitions, and additions to head count in support of new market opportunities in the games and consumer electronics space.

R&D expense increased 64% year-over-year due to investments in infrastructure and new product development in support of our market expansion efforts. Finally, G&A expenses were up 15.4%, related primarily to recent acquisitions.

Interest income for the quarter was approximately $4.3 million, about $400,000 below our prior expectation due to lower portfolio yield as the result of continued declines in rates, specifically U.S. Treasuries, and our movement of investments into almost exclusively high-grade commercial paper, U.S. Treasuries, and money market accounts.

Other expense of $1.7 million for the quarter includes $609,000 of interest expense on our convertible notes, one-time charges related to a proposed settlement of the net NetRatings patent litigation, and a write-down of intangible assets related to the Bitpass asset acquisition in 2007. As our teams progressed on their Micropayments initiative this year, it became apparent that we were going to develop technology from what we acquired from Bitpass, leading to the write-down.

Our GAAP tax rate in the second quarter was 21.7%, well below our guided rate of 30% due to a one-time benefit recorded in the quarter related to our recent IRS audit. The benefit was related to an allowance carried on our books for R&D tax credits.

Turning to the cash flow statement, net cash provided by operating activities for the six months ending June 30, 2008, totaled approximately $40.0 million compared to $48.0 million in the similar period for 2007. The primary differences between the two periods are tax-related items. Excluding changes in assets, operating assets, and liabilities, net cash flow from operations for the six-month period was $55.7 million compared to $54.8 million for the similar period of 2007.

CapEx was on plan at $5.3 million in the second quarter, with the bulk of the investment related to our data center infrastructure and third party software licensing. We now have invested $9.5 million through the end of June against our original $25.0 million plan. However, given changes in the company’s strategy related to our data management initiatives, we now expect CapEx for the year to be $2.0 million to $3.0 million lower.

As Joel mentioned, we selected SAP as our ERP partner, which we licensed in the second quarter. This decision will have two financial impacts. One, our anticipated capital requirement and total cost of ownership for the solutions will be reduced as partially reflected in the 2008 CapEx budget reductions, and the final schedules will add close to $1.0 million to operating expense in the second half of the year.

Turning to the balance sheet, you will note that we have reclassified approximately $109.0 million of our student loan-based auction rate securities to long-term investments, given the current liquidity issues in the market. As we mentioned on the prior call, all of these securities are felt guaranteed and over-collateralized. We ended the quarter with approximately $587.0 million in cash and investments.

Now, on to guidance: For the third quarter of 2008 we currently expect revenue of $98.5 million, GAAP net income of $0.37 per share, assuming a 29% tax rate, and non-GAAP net income of $0.47 per share, assuming a 27% tax rate.

For the full year, we currently expect revenue of $410.0 million, GAAP net income of $1.63 per share, assuming a full-year tax rate of 28%, and non-GAAP net income of $2.00 per share, assuming a full-year tax rate of 27%.

A few comments related to the guidance: Consistent with the first half of the year, we remain cautious on our second half outlook due to the state of the macro economy, particularly in the fourth quarter. In addition, we still continue to expect attrition in Europe, which we currently believe will impact the seasonal lift we generally see from the second to the third quarter. We now expect third quarter operating margins to be up sequentially, almost 3% from the second quarter but flat to slightly down on a year-over-year basis. In the fourth quarter we expect to see flat to slightly improved margins on a year-over-year basis. Our revised schedule and timing of infrastructure investments and some caution, given the state of the macro economy, have contributed to this change.

Spending is anticipated to be down sequentially from Q2 to Q3 in some areas, including lower payment processing costs from recent contract negotiations and changes in the interchange model in Europe, as well as lower G&A expenses due to lower outside professional services. We will also begin to capitalize our ERP and data warehousing efforts, offset in part by increased spending levels related to the final project plans and accelerated schedules.

Interest income is expected to be $4.9 million for the third quarter and includes $1.1 million in gains related to portfolio changes. For the fourth quarter interest income is expected to be about $4.0 million.

Now that the buyback is complete, our share count assumptions are 41.8 million in the third quarter and about 42.2 million in the fourth.

With that, I will turn the call back over to Joel.

Joel A. Ronning

In summary, we are pleased with our second quarter results as we saw strong performance across all areas of our business. Our core business continues to perform well and we continue to see positive traction in the consumer electronics and the games market, with pipeline for potential new clients growing at a really good pace. We continue to believe we have a right strategy in place and their continued focus on execution will deliver compelling results for the foreseeable future.

With that, let’s open it up for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Colin Sebastian with Lazard Capital Markets.

Colin Sebastian - Lazard Capital Markets

We’ve seen some pretty healthy results from not only you guys but other e-commerce outsourcing companies. With the numbers you just reported do you think the tougher macro environment is helping out on the business development side, given that companies may be looking more aggressively for pockets of growth? Retailers and manufacturers.

Joel A. Ronning

I think that’s a good question, Colin, and I think that’s a possibility. We’ve been through a couple of recessions and it seems that clients are more skittish about making investments in their internal infrastructure. But at the same time, recognizing that our ultimate customer, we’re representing our client to the consumer, and we take a portion of that compensation. If our ultimate customer is not buying, it’s a problem for us, so we’re paying a lot of attention to that.

But, yes, I think that our clients are paying a lot of attention to their IT budgets and being a little more prudent.

Colin Sebastian - Lazard Capital Markets

And that said, just to follow up on the comments on the economy, just curious if there were any specific areas of your business that prompt the cautionary comments, or if you’re just reiterating what you had previously said about the second half of the year.

Joel A. Ronning

Well, I think part of our concern is the concern that our clients have, in the consumer electronics arena and certainly in the software arena. So we’re just paying attention to some of the direction, some of the guidance and the things we’re hearing from them.

So I think it’s prudent to be a little thoughtful about this environment.

Colin Sebastian - Lazard Capital Markets

And that’s reflected to the extent that you can in your outlook for the second half of the year? The caution?

Joel A. Ronning

Definitely. Yes.

Operator

Your next question comes from Phil Winslow with Credit Suisse.

Philip Winslow - Credit Suisse

One of the things Tom mentioned was lower attrition in your customer base. Last quarter you mentioned one of your large European customers that was supposed to move off the platform in Q1. Still hadn’t. Wondering if you could give us an update on that on in Q2, but also just what you’re generally seeing across the customer base.

Joel A. Ronning

I think customers view this as an easy shift and they get the smaller organizations coming in with the little bit parts that are needed and saying, “Gee, if you had just attached A to B and C to D and E to F and F to G, and etc. it will all come together and will be smooth as silk and you’ll save gobs of money.” I think once they start connecting all those little Lego pieces they realize that they’re missing pieces and the pieces don’t necessarily connect well and they don’t have the infrastructure nor the domain experience to expertise to understand what needs to be done.

And we see this, it’s kind of a common circumstance where clients give us notice that they’re moving in a direction and they find it’s much more difficult to move. And I’ve said this in the past that we’re also not surprised when they make the move and do it for a while and end up calling us up and saying, “Gee, this is really pretty hard and our revenues are down and can you give us a hand?” I fully expect these clients to be in conversations with us again in the future, because this is hard to do.

So I think there is some caution from those clients as they start what they thought was going to be a fast switch over to an internal system is a little more complex than they thought.

Philip Winslow - Credit Suisse

And then also if you would just give us a sense over the course of the quarter, maybe you saw just sort of continued stability throughout each month or were there any changes as we got towards June?

Joel A. Ronning

Just in terms of velocity?

Philip Winslow - Credit Suisse

Yes, just overall business environment.

Joel A. Ronning

It just was a solid quarter. We usually expect a little bit more of a tail-off towards the end of the quarter and we didn’t see as much of that as what we’ve seen in the past. But I don’t think there was any real blip at the end of the quarter or at the beginning of the quarter. It performed like other quarters have. There was just more of it.

Operator

Your next question comes from Daniel Ives with Friedman, Billings, Ramsay.

Michael Bahl for Daniel Ives - Friedman, Billings, Ramsey & Co.

Can you advise us on what the contribution from Netgiro in the quarter was?

Joel A. Ronning

We don’t break that out separately. Sorry about that.

Michael Bahl for Daniel Ives - Friedman, Billings, Ramsey & Co.

And can you also just comment, give a little color, on the gaming and consumer electronics part? I mean, can you speak of how that revenue has been ramping in those segments and maybe give an idea of what type of percentage of those revenues can be, can we look at in terms of percent of total revenues in coming quarters? Or maybe a little color on the pipeline?

Thomas M. Donnelly

Again, we don’t break out revenue. That would be a very complicated and interesting effort to do that. Both segments, if you will, as we view them, are growing. Clearly the big elephant that got gaming out of the gate is EA and they’re performing well and we’re very much looking forward to the Madden and Spore launches coming up and supporting our client in those efforts.

And these new wins, we had two large wins in the first quarter and in the second quarter we don’t have the ink dry but we’re in contract negotiations with two more very large consumer electronics clients. So there are going to be nice drivers to next year’s growth, I’m sure.

Joel A. Ronning

And I’ll take the pipeline. I have to say I’m excited about the size of the CE clients that we’re seeing in the pipeline. I think we’ve seen a shift here, pretty dramatic shift, over the past year and a half to two years, of the consumer electronics company standing on the sideline with e-commerce and now they really seem like they’re getting their head down and moving into this arena.

So we have a lot of conversations and a lot of interest and the pipeline with the larger players appears to be growing deeper and wider. So I’m excited about that. I think we’re also being a little more thoughtful on some of the smaller players.

In the games arena, it’s pretty deep. We seem to be in conversations with everybody that matters. And a number of up-and-coming companies as well. It’s a very complex delivery, subscription, and global model that they have and so we’re working pretty hard with all of these players. And specifically EA is helping us to find a whole bunch of new opportunities. So we’re putting more resources into that arena.

But I would say that they’re both pretty robust.

Michael Bahl for Daniel Ives - Friedman, Billings, Ramsey & Co.

And then because of lower interest income, can you give us any color on what your plans are for your growing cash? Maybe strategy around your cash, concerning like either buyback or acquisition strategy?

Joel A. Ronning

I think the cash is there to maintain flexibility, primarily for M&A. We were never really in the business of earning yield on cash balances but that has obviously impacted the company’s EPS on a year-over-year business, with yields going from 5% down to 2%, if you’re pretty good at blending things.

But as far as our capital strategy, we want to maintain flexibility, we want to maintain liquidity and we want to avoid risks. Kind of a cornerstone of the company’s business strategy has always been M&A and to have capital available to do M&A and what looks like it’s going to be a pretty attractive market over the next year and a half from a buyer’s perspective.

Operator

Your next question comes from Nat Schindler with Merrill Lynch.

Nat Schindler – Merrill Lynch

I wanted to see if you could give a little color on what’s been going on with the indirect business from Symantec? That’s largely, I believe, download insurance and other services you offer. But it’s been down the last five quarters. Could you go over that? And I believe it was down again, about 13% year-over-year this quarter. Can you explain a little bit on what’s happening in that business and what’s changed?

Thomas M. Donnelly

We’ve had that, actually, in the prepared remarks for a couple of quarters. There are two impacts. One is their auto renewals program, which impacts the upgrade business that we had historically done. Because we do not handle the auto renewals we’ve had a transaction drop on upgrade sales and therefore a drop on EDS sales, which is the biggest contributor there.

The other impact is where we took over the global subscription business, beginning in that late third, fourth quarter and even as Joel said, took over a few more sites in the second quarter. And there is no EDS on subscription renewals that we handle, at least at this point. That’s a future opportunity that we would certainly like to capitalize on, but it’s not assumed in our guidance and there aren’t any imminent plans to add that.

Nat Schindler – Merrill Lynch

So do you expect this part of the business to continue to decline then?

Thomas M. Donnelly

Well, one would expect as the impact of auto renewals, and with the fully ramped up subscription business, it should stabilize at some point here.

Operator

Your next question comes from Leland Westerfield with BMO Capital Markets.

Leland Westerfield - BMO Capital Markets

Joel, I was intrigued by your opening remarks on the consumer electronics pipeline and I wanted to make sure I understood it correctly. One Global 100, one Fortune 500 and then two more potentially before the holiday season. If we extrapolate that for 2009, the consumer electronics segment might, in very round numbers, represent what kind of revenue base within your overall total? I’m not quite sure about how much business you’re doing for those new clients.

Joel A. Ronning

We’re not giving 2009 guidance. And I think your calculation might be double counting there. The comments were we have a Fortune 100 and a Global 500 who have committed to us and we expect to contract with them the latter part of this year.

Leland Westerfield - BMO Capital Markets

Tom, what, if any, was the impact currency coming into U.S. denominated revenues in the current quarter?

Thomas M. Donnelly

Versus forecast, it as about $200,000 upside and about the same in detriment on the expense side, so it was pretty neutral. Year-over-year it’s about $2.9 million to revenue and $2.7 million to expense. So overall EPS benefit of about $200,000.

Operator

Your next question comes from Kyle Evans with Stephens, Inc.

Carter Malloy for Kyle Evans - Stephens Inc.

Can you talk about your goals with the online multi-player and casual game space? How far along are you with your Micropayment capabilities and what, if any, if the long-term impact to margins there?

Joel A. Ronning

Casual games, it’s an interesting market. I think it’s a pretty well penetrated market. So we have clients that we’re doing that for and we’ll be happy to take on more of them. But I don’t look for that to be a multi-billion dollar opportunity.

The multi-player games clearly are. It’s a very complex series of needs there and we’re building out, it’s not just the Micropayments, but part of that is a wallet, which is what we talked about earlier. We’re doing some pretty good development there. We’re doing all kinds of complex things from a costing and a splitting of payments and global payments. A lot of in-game stuff that we’re working on. So, that’s where we’re really focusing a lot of energy. We find that to be a pretty exciting territory.

I do have to say it’s fairly complicated, we believe we’re starting to help set some standards there. What has historically happened is a lot of companies have had to develop their own internal standards and I think that’s hard to manage on a global basis. We like complexity and I think we’re solving a lot of problems. But we’ve got some work to do there. I think it’s going to take us through 2008 and 2009 to really help define, or help the industry define, a new approach to doing some of those things. And I hope that we’re the people that lead that. And I’m pretty confident that we will be.

But clearly the multi-player online game areas, and that’s one we’re watching very carefully and putting a lot of resources behind.

Carter Malloy for Kyle Evans - Stephens Inc.

And looking at your R&D line as a percent of revenue, obviously we have a pretty big bump this year from the unexpected expenses, but when do we expect that to return to a normalized rate?

Joel A. Ronning

I think in the out-year I would certainly expect some leverage to come back to that, given the amount of investment we have in games and consumer electronics. But that can also be opportunity driven. We’re not going to shy away from opportunities and I think not investing in R&D is probably not a prudent thing, particularly in some of these larger opportunities in consumer electronics and games, where we may need to add on additional functionality.

Operator

Your next question comes from Jeetil Patel with Deutsche Bank.

Herman Leung for Jeetil Patel - Deutsche Bank Securities

First, I guess if you look at your Symantec revenue last year, in the second quarter, it started to basically decline on both the direct and indirect side. I was wondering if you guys are up for a basic easy comparison over the next three quarters and the indirect basically has fallen significantly over the next, second to fourth quarters of 2007?

And then second, I was just wondering if you can talk about some of the drivers that are driving some of the existing client business that you’re seeing that is actually growing better than your expectations?

And lastly, your Fortune 100 client that you talked about that is in final contract negations, could that be closed sometime in the second half and is that factored somewhat into your guidance.

Joel A. Ronning

I will take the last two. The Fortune 100 client, yes, we fully expect that to be closed in the second half and we expect to be launching that in the second half.

The drivers for existing clients continue to be increased efficiency, global footprint, the complexity that they’re finding. But mostly it’s our marketForce and our marketing-related activities.

And, Tom, would you answer the first one, please?

Thomas M. Donnelly

I think I would answer it this way. We were certainly pleased with all the big business lines this quarter, which would include Symantec. I don’t think we’ve changed our overall outlook relative to having the concentration be in the low 30s this year. There’s a lot of different items at play there. I think, as we said on prior calls, could it be better? Yes. But we’re trying to be cautious to make sure we account for all the various impacts, new business models, various channel business that we handle, and the like. So it’s possible they could be easy compares but I don’t think our outlook for the year has changed a whole lot, but we were pleased, obviously, with the second quarter.

Herman Leung for Jeetil Patel - Deutsche Bank Securities

And I guess there was some European auto renewal launch that was closer to the back half of 2007. Could that be an opportunity for an easy comp as well?

Joel A. Ronning

I think the international auto renewal business started about a year ago and I think was fully, I don’t know for sure, but I believe it was pretty much fully launched toward the end of the year. So we are kind of in that first-year headwind again and second year in the U.S. and we get better data on the impact of that every quarter and we’ve been good about forecasting it. The team there is doing a good job.

Herman Leung for Jeetil Patel - Deutsche Bank Securities

Joel, I think you talked about deepening the relationship with Microsoft and expecting some kind of second half 2008 announcements. Is that more geared towards the marketing business or the core Microsoft download business?

Joel A. Ronning

Core business and marketing business. The projects we are engaging in are really interesting and they are really core.

Operator

Your next question comes from

Semik Benja [not verified]

So in terms of the European client that you had mentioned, that they were in the process of leaving, did that client leave in the second quarter, and if not, are you included expected revenues in the guidance from that client?

Joel A. Ronning

I think we do expect them to leave in the third quarter, in the second half. And that is in the guidance.

Semik Benja [not verified]

Have you given out a revenue number that they contributed towards in the second quarter?

Thomas M. Donnelly

No.

Semik Benja [not verified]

And can you give us more details about the marketForce? You mentioned a kind of momentum in that business a couple of times on the call. What are you seeing there? Obviously online advertising is seeing some headwind but you seem to be seeing some momentum, so can you talk about what you are seeing in terms of projects. And you also spoke about new products. Any specific products that are gaining traction there which are helping your overall business momentum?

Joel A. Ronning

I think in terms from a budget standpoint, what we’re running into is that the clients we’re working with are e-commerce-focused and so the online advertising, in a sense, is not directly related to the work that we’re doing. You know, our model is if you do these seven things you’ll close an order, or if you do these five things, or these three things. But if they follow our lead we can increase their revenue.

So we don’t tend to be very focused, at all, we do almost no work, maybe the answer is no work, on online advertising. We’re really merchants. We’re very focused on helping the client get the business. And that translates into very hard numbers. It’s either you win or you lose. It’s one of the things we love about this business is that there’s not a lot of ambiguity in it, that’s a blessing and a curse.

But we can walk into a client and say look, “We invested x amount of dollars here and we got a 3x revenue increase based on that investment.” And the response has been pretty good.

And so, marketForce continues to gain momentum as it’s very statistically-based, it’s easy to prove the success, and our clients, once they get a tan, our clients, once they get a taste of that, are interested in trying other programs. And generally we’re pretty successful in these programs.

And so I think we’re just going to continue to see traction in that service offering and it’s an incredibly sticky component of the relationship with our client, because we’re helping them to really increase revenue, drive their revenues. Their inclination to give us more business seems to be going up pretty significantly.

And in terms of new products, our multivariate testing is one that we continue to really work hard on and spend a lot of time on improving that. And then the Mass Dynamic Personalization, where essentially you can personalize an offer to a client, is another one that we think is going to be pretty exciting. We’ve got a bunch of other ones that have to do with data bases and what-not up our sleeves, so I think we’ll continue to bring out some pretty interesting products here over the next 18 months.

Semik Benja [not verified]

One final question, more longer-term oriented. Obviously your core business is soft or down, but how do you expect the landscape is going to evolve, especially with software as a service and reckon how Digital will play a role in that in that evolution?

Joel A. Ronning

We fully expect to be one of the leading players, if not the leading player, in terms of how to help companies optimize their Software As A Solution strategy. Although we have little to say and little to do with their internal development of the Software As A Solution offering, our belief is we will be enormously useful in terms of helping them to optimize the one-to-one relationship with the consumer, increase revenue, increase the lifetime value of that consumer. And so a lot of the things that we’re doing right now translate straight across into that. So we look at that with some pretty strong anticipation.

Operator

Your last question comes from Robert Breza with RBC Capital Markets.

Robert Breza - RBC Capital Markets

This is Joe in for Rob. In terms of pipeline, I was wondering if you could speak a little bit about the trends you’re seeing in terms of pipeline to customer and then customer to go live. If there’s any timing you guys have seen lengthening or shortening over the past couple of quarters.

Joel A. Ronning

I think it’s pretty consistent. The smaller clients come up pretty fast and the enterprise clients come up very slow. And so we haven’t seen any change on that. As I mentioned earlier, I’m excited by the large clients we’re seeing in the consumer electronics space. I’m also excited about the relationships that we have out there with current clients in the software arena. Those seem to be deepening at a pretty good pace. So that it’s not only a pipeline of new customers, but it’s a pipeline of current customers who are increasing their business with us.

Ed Merritt

Before we conclude our call today, I would like to mention that Digital River will be participating at the following upcoming investor conferences and events. On August 6 we will be in San Francisco at the RBC Technology, Media, and Communications Conference. On August 11 we will be in New York City celebrating our 10th anniversary as a publicly-traded company. Joel Ronning will be ringing the opening bell at the NASDAQ stock market with a few member of the Digital River team joining him at the event. And on September 10 we’re going to be in San Francisco at the Deutsche Bank 2008 Technology Conference.

Thanks for joining us on this call and that concludes the Digital River second quarter earnings call.

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Source: Digital River, Inc. Q2 2008 Earnings Call Transcript
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