Digital River's Torrential Prospects

Last night, e-commerce support specialist DigitalRiver (NASDAQ:DRIV) reported third-quarter earnings, and it was a good quarter. Revenues rocketed 42% year over year, and GAAP EPS saw a 10% boost even after a generous helping of share dilution. The company would like to spin GAAP earnings per share to $0.33 for the 2006 period and $0.31 in 2005 by backing out a couple of cents' worth of costs in each reporting period. That's fine if you want to call it pro forma, though Digital River thinks it's an "adjusted GAAP" measurement. Me, I'm sticking to plain GAAP, at $0.32 per share now and $0.29 last year -- you can see the full rundown in my Fool by Numbers.

Moving past that slightly disturbing oddity, part of the sales improvement came by way of acquisition, with the Commerce5 stock-swap buyout in last year's fourth quarter bringing substantial customers on board, including Hewlett-Packard (NYSE:HPQ) and Gateway (NYSE:GTW). But some of it was organic growth, as Digital River continues to work hard to land new customers by merit of its quality services.

The company has been running other companies' e-commerce websites and download solutions for about a decade now, and has gotten quite good at it. So good, in fact, that industry heavyweights Symantec (NASDAQ:SYMC) and Microsoft (NASDAQ:MSFT) just signed multiyear contracts expanding their reliance on Digital River. For the first time, Microsoft will sell its Office suite via direct download, handled by -- yep, Digital River. That relationship is expected to make Microsoft the source of at least 10% of Digital River's revenues, maybe as early as 2007.

"Our ability to execute on our business objectives contributed to our solid third-quarter financial performance and strong cash flows," said CEO Joel Ronning. "We believe we are well-positioned to capitalize on growth opportunities before us in 2007."

And the company's capital structure is well-suited to rapid expansion, with low debt, hardly any receivables, and costs pushed into the future by way of a large accounts payable line item. Digital River likes to buy smaller competitors to get access to their customers, and the company likes to do so entirely in stock. Fellow Fool Rich Duprey noted the shareholder-unfriendliness of this practice back in the spring, but thought the company's opportunities outweighed the downsides.

If you read my takedown of Sun Microsystems (NASDAQ:SUNW) yesterday, you might think I'm hypocritical for praising Digital River's client announcements while bashing Sun for the same thing. But the difference is that Sun's announcements seemed to be mere window-dressing, seemingly inconsequential to the company's continued fortunes, and really quite predictable. And they seemed to be designed to draw attention away from the real story -- a disappointing earnings report. Digital River's client upgrades have a real, measurable impact on the top and bottom lines, and a partner like Microsoft can become a tentpole that supports lots of business as smaller customers flock to a proven solution. Apples and oranges, guys.

Management hinted at more large deals to be announced over the next few months, though nothing as big as the Microsoft contract. It's taking its software expertise and moving into the consumer electronics field now, giving us a chance to speculate who the new partners might be -- Samsung? Philips?Toshiba? Only time will tell. But when the news comes, it should be good.

Further Foolishness:

• Digital River Wants the World
• Digital River's Profitable Sell-Off
• Making a Million Over Coffee
• Riding Technology to a Triple

Microsoft and Symantec are Motley Fool Inside Value recommendations, and a free 30-day trial to that service is but a mouse click away. However, if companies like Digital River float your boat, ourRule Breakersservice might be more up your alley, as David Gardner and his team searches for tomorrow's leaders today. That's another free trial waiting for you.

Fool contributor Anders Bylund holds no position in any of the companies discussed here. You can check out Anders' holdings if you like. Foolish disclosure is poised for long-term success.