Digital River Easily Beats (DRIV) (MSFT)

On a reported basis, Digital River posted a net loss of $734 million or 2 cents per diluted share, toward the high end of management’s loss guidance of 9 cents – 2 cents. The reported figure deteriorated considerably from 15 cents earned in the year-ago quarter.

Revenues

Digital River generated revenues of $91.7 million in the third quarter of 2012, up 3.9% year over year and marginally ahead of management’s guidance of $88 million – $91 million.

The year-over-year growth in revenues was attributed to better-than-expected performance at Enterprise, driven primarily by new product launches from a few key clients. Enterprise revenue was $71.7 million, down 1% year over year. On a constant currency basis, Enterprise revenue increased 2% year over year.

Within Enterprise Commerce, Digital Commerce, which consists primarily of software and games, increased 2% year over year. Physical Commerce decreased 13% year over year as strong new business pipeline and some solid within Consumer Electronics was more than offset by client bankruptcies and some soft product launches by some key clients.

World Payments spiked 30% year over year. Digital River continues to see significant growth opportunities in the Payments space. The company recently announced that it will acquire LML Payments to bolster this segment.

Support revenue came in at $20 million, down 13% from a year ago.

In September, Digital River announced that it will acquire LML Payment Systems Inc. for $3.45 per share or $102.8 million. Digital River expects to complete the transaction by the fourth quarter of 2012 or the first quarter of 2013.

The acquisition is expected to be accretive to the bottom line in 2013 but no revenue contribution in 2013. After adjusting for cash on LML's balance sheet, the final acquisition cost will be around $72 million. The acquisition is expected to be accretive to the bottom line in 2013 but no revenue contribution in 2013.

During the third quarter, Digital River signed many new and expanded agreements. The company extended its relationship with Siemens, Novell, Corel, Individual Software and Grass Valley. The company also signed multi year extensions with two of its top clients, Trend Micro and Kaspersky. Meanwhile, Microsoft Corporation (MSFT) is the company’s largest customer and continues to be so.

On a geographical basis, international revenue decreased slightly to 45.8% from 46.2% in the year-ago quarter due to weak business in Europe.

Balance Sheet

During the first nine months of 2012, Digital River generated $24.3 million of cash from operations versus cash generation of $5.1 million in the year-ago quarter due to lower net income and changes in working capital. The company incurred $14.4 million in capital expenditures in the first nine months of 2012. Capital expenditures in the third quarter were $8.2 million and the company estimates to spend $25 million in 2012.

Digital River ended the quarter with cash and equivalents of $465.5 million, down from $497.1 million at the end of the 2011.

Guidance

In a separate development, Digital Rivera announced that founder Joel A. Ronning has stepped down as Chief Executive Officer. Mr. Ronning will continue to serve as Chairman of the Board until December 31, 2012, when he will retire from the board. He will be replaced by Thomas F. Madison, who has been named as the interim Chief Executive Officer.

Going forward, management expects to report revenues between $96 million and $100 million in the fourth quarter of 2012. On a segment basis, Enterprise Commerce would account for about $81 million and the support businesses about $19 million. The company expects to report EPS in the range of 8 cents – 15 cents. Excluding one-time items, net income per share is expected to come around 25 cents – 31 cents.

For 2012, Digital River projects revenues between $381 million and $385 million. The company expects to report EPS in the range of 20 cents – 27 cents. Excluding one-time items, net income per share is expected to come around 96 cents – $1.01.

The guidance for the year has been lowered based on one-time expenses related to a legal settlement and LML acquisition costs along with planned investments in technology infrastructure.

For 2013, the company is likely to face some headwinds due to macroeconomic conditions, client attrition and additional necessary ramp up in investments to ensure an updated technology infrastructure. Digital River forecasts that overall softness in the economy, especially in Europe coupled with recent decline in PC sales will make it challenging to post a growth in revenue. The company saw some client attrition in 2012 and expects the same in 2013 along with a decline in supporting business revenue.

We continue to maintain our long-term Neutral recommendation on Digital River. Our recommendation is supported by a Zacks #3 Rank, which translates into a short-term rating of Hold.