It's a glorious day to continue our series on recently public companies (all the previous columns are in the box to the right), and today we look at a growing business that's cutting a wake in computer DVD and multimedia software: InterVideo (NASDAQ:IVII).

Founded in 1998, this young California firm grew sales by 36% last year, to $45 million, and had net income of $7.7 million -- reversing earlier losses. For the first three months of this year, sales topped $13 million, up 20% year over year, while net income rose 60%.

On July 16, the company raised $39 million by selling 2.8 million shares to the public at $14 each. The stock first traded at $19 and was lately priced at $20, giving InterVideo a market value of $250 million and a trailing P/E ratio of 29.

At first glance, this price might appear reasonable for a technology company that grew net income 60% last quarter, so after learning what it does, we'll learn what InterVideo is up against. Ultimately, you'll be the judge on the stock's potential.

How does the company make money?
InterVideo has sold more than 50 million copies of its leading software product, a DVD player for computers that you've probably heard of: WinDVD. You may even own a copy, whether you know it or not.

A majority of InterVideo's sales (84% last year) are made directly to computer manufacturers. In fact, WinDVD is bundled and sold by eight of the nation's 10 largest PC makers, including Dell (NASDAQ:DELL), Hewlett-Packard (NYSE:HPQ), and IBM (NYSE:IBM). Each pays InterVideo for WinDVD software on a contract volume basis.

Computers are becoming multimedia boxes (although at a slower rate than once expected), so PC makers are including DVD technology on more and more machines, and WinDVD is the leading solution. However, in order to continue growing (and avoid being a one-hit wonder), InterVideo needs to score other software hits and expand on its current winner.

New software products
The company's new software includes WinDVR (DVR stands for Digital Video Recorder), which sounds pretty cool. It allows you to record television shows on your computer or, among other features, watch and pause live TV. Using another InterVideo product, WinDVD Creator, you could burn your recorded shows (or anything else) onto a DVD and edit it however you wish.

The company also markets WinProducer, which lets you turn home movies into edit-ready Video CDs using MPEG-1 compression, or turn home movies into Mini-DVDs or MPEG-4 movies, all viewable online. InterVideo also sells software called XPacks, which, using Microsoft's (NASDAQ:MSFT) Media Player, allow you to encode MP3s from CDs, watch DVDs, and other uses.

A final product is called InterVideo Home Theater. This is a "media center suite" for managing and viewing digital media content (music, DVD, TV, etc.) on your PC. It's a category killer -- a "single solution" multimedia controller released early this year. There's more about these products and some others on the company's website.

The business strategy
As you might have guessed, InterVideo's strategy goes well beyond selling software to computer makers. Direct consumer sales over the Internet are a strong focus, with its packaged (or downloadable) software products selling for $9.99 and up.

Aside from online retail, InterVideo is selling its multimedia software to consumer electronics manufacturers, including Sony (NYSE:SNE), for use in DVD and DVR players; to PC peripheral manufacturers; and to consumers through 1,000 retail locations, including Best Buy (NYSE:BBY).

The overall objective is to continue to develop software that works in many different types of consumer electronic products, not just PCs, and therefore hit many new distribution channels. Key points to the unfolding business strategy include:

  • Serve a variety of product platforms with a single technology. InterVideo's software code can quickly be ported to new operating systems and new hardware, including Linux (many next-generation consumer electronic devices run Linux) and consumer electronics such as DVR players. InterVideo has signed contracts with three DVR makers.

  • Market a broad, integrated multimedia solution for the PC. InterVideo's software suite is meant to replace a PC's separate DVD player, Digital Video Recorder, MP3 player, CD player, and digital television set-top box all with one solution.

  • Continue to build software architecture than can rapidly be updated to include new features and technologies, because the industry is quickly evolving.

  • Maintain and improve strategic relationships, acquire relevant companies, and capitalize on emerging markets. As you might have assumed, InterVideo has strategic relationships with Microsoft and Intel (NASDAQ:INTC) that are key to its success.

Impressive financials
Take a slow look below at select financials from the last four years. There are some interesting things worth noting: The company has always had strong gross profits. Last year, when sales rose 34%, its cost of revenue actually declined, as did total operating costs, partly because it takes just pennies to replicate software once it's developed.

Also of note, research and development costs declined last year. Although this cost will likely rise this year because that's the spending plan for some of the IPO money, over the long run, R&D could remain in check because the company is developing products that should accept upgrades and additions rather easily.

    InterVideo's Annual Results ($000)
1999    2000     2001     2002 Revenue          3,036   15,426   33,763   45,494 Cost of Rev.     1,118    5,133   17,895   16,879 Gross Profit     1,918   10,293   15,868   28,615R&D              1,300    6,581    9,035    7,185 Sales & Market.  1,165    4,916    7,878    8,179Stock compen.      339    2,909    1,854    2,469Total oper. cost 3,570   17,247   24,165   23,319Operating Inc.  (1,652)  (6,954)  (8,297)   5,296Net income      (1,683)  (6,951)  (8,684)   7,729 Operating Cash Flow        (330)   1,384    6,924  Pur. of Prop. & Equip.   (1,976)    (712)   (700)  Free Cash Flow           (2,306)     672    6,224

On the bottom half of the table, we see that InterVideo first achieved free cash flow in 2001, due partly to the high margins of software and the company's low spending on property and equipment. In sharing a potential for strong free cash flow, InterVideo reminds me of last week's focus, iPayment (NASDAQ:IPMT).

We wrap up today's column with a summary of all that's good about InterVideo: It has a varied, scalable business strategy based on interrelated software products that are in a sweet spot as digital multimedia blossoms; it has the leading position in PC DVD technology; it's growing profitably and had $6.2 million in free cash flow last year, or about $0.50 per share. After the IPO, it had $52 million in cash and no debt, giving it an enterprise value of $200 million, or 32 times last year's free cash flow.

Given that free cash flow could increase rapidly in the next few years, the stock might make for an attractive investment. But what's missing from this entire column? That's right, the risks involved. And there are many. On Thursday, we'll pick up with that vital topic -- afterward, you can weigh the good against the bad, and decide if you like the stock.

Of companies mentioned, Jeff Fischer owns shares of Intel, and he shares this with you -- despite your justified "yawn" of a response -- due to the Fool's disclosurepolicy.