Yesterday, Digital River, Inc. (DRIV), reported revenues of $96.6 million, down 1.8% year over year and 6.1% sequentially and in line with consensus estimate of $96.5 million. Revenues came in towards the high end of the management’s guidance of $95 million – $97 million. Quarterly sales would have been higher but for unfavorable exchange rates that hurt year-over-year revenue by about $4.6 million.

DRIV provides e-commerce solutions to software publishers and retailers around the world.

Sales and marketing expenses declined 1.1% year over year. However, sales and marketing costs are projected to increase in the second half of 2009 due to increases in headcount. Product R&D expense declined 1.8% year over year. R&D expense is also estimated to increase in the second half of the year as DRIV hires additional development resources to deliver new products and services. G&A costs were down almost 18% year over year.

GAAP operating margin came in at 13.4%. Non-GAAP operating margin (excluding stock compensation expense, amortization of acquisition related intangibles) came in at 20.5%, compared to 20.2% in the year-ago quarter and 27.8% in the previous quarter.

GAAP EPS came in at $0.31. Non-GAAP EPS of $0.42 beat the consensus estimate by a penny and were consistent with management’s second quarter guidance of $0.39 – $0.42.

Going forward, management expects revenues between $96.5 million and $98.5 million, in the third quarter of 2009, against consensus forecast of $97.8 million. Non-GAAP EPS is projected between $0.38 and $0.41, against consensus estimate of $0.45. Management is cautiously optimistic for the remainder of 2009 and is encouraged by the growth in sales pipeline, new product roadmap and recent wins in the business to business software market.

Earlier this month, DRIV announced its plans to outsource its global customer service operations to Tennessee-based Sitel, a leading global business process outsourcing provider. The company also plans to realign resources across the company. Both these actions will result in eliminate120 positions globally primarily related to the outsourcing of customer service operations.

This organizational change is expected to drive efficiencies for the company in 2010. The company also plans to hire experienced sales professionals accustomed to working with top management and large global enterprises.

DRIV is currently diversifying its software business into complementary markets, which include consumer electronics and games. DRIV also plans to invest in new technologies to unlock opportunities in horizontal markets such as subscriptions and business-to-business software market.

The stock has more than doubled after touching a low of $18 in the crash of November 2008, in part due to a broader market rally. Although outsourcing will improve margins by reducing costs, we expect margins to remain under pressure due to the initial ramp up of new consumer electronic and business to business software customers. We maintain our HOLD on the stock.

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