Is Growth Weakening at DexCom (DXCM)?
Highlighting a key accrual to watch closely in upcoming quarters
We live to find cases where unsustainable accounting-related benefits are propelling a company’s growth. Along the way, we often uncover instances where allowances appear to have been built to unusually high levels that set the stage for a company to benefit from reversing the allowance into earnings in upcoming quarters. Our review of DXCM’s recent results revealed evidence that we believe indicates the company is an example of both situations at once.
For a closer look, let’s get behind the numbers…
DXCM beat its earnings forecast by 5 cents in 1Q24 and 7 cents in 4Q23. What caught our eye while reviewing the 1Q24 numbers was the huge increase in accounts receivable which we believe could have provided an artificial boost to revenue growth. The recent decline in the warranty accrual has also boosted the bottom line. However, we believe investors should be paying especially close attention to the accrual for rebates in the future as it has the potential to have a huge impact on both top and bottom-line growth that many investors are likely not considering.
Big Jump in receivables
The following table shows DXCM’s accounts receivables DSOs for the last eight quarters:
Points to note:
DSOs jumped by 18 days y/y. This is an acceleration from the 6-day increases seen in the previous two quarters. Also, note that DSOs jumped by 11 days sequentially from 4Q23 to 1Q24 compared to a 1-day decline in the comparable year-ago period.
However, sales growth remained constant over the last several quarters and we saw no other factors such as acquisitions which would have altered the relationship between sales and receivables growth.
Foreign accounts pay more slowly than domestic accounts, but the sales mix between the two is not materially shifting. Foreign sales only rose from 26% of sales in 2022 to 28% in 2023.
DXCM says that receivables are normally collected in 30-90 days. The company is already well above its maximum collection time.
The sharp jump in receivables looks very out of place and may indicate that the company offered more generous payment terms to pull sales into the quarter, and/or that it is experiencing longer collection times.
DXCM only reports an allowance for credit losses in the 10-K. It was $9.3 million for December 2023 (up only $2 million y/y) or 0.95% of receivables vs. $7.3 million or 0.97% of receivables in December 2022. That is after the age of receivables increased. We believe DXCM may have to increase its allowance for doubtful accounts in upcoming quarters which could be an unexpected drain on earnings growth.
Warranty allowance cut in half
The table below shows DXCM’s accrual for future warranty claims on a days-of-sales basis for the last eight quarters:
Points to note:
Despite the rapid sales growth, the warranty allowance has been cut in half.
DXCM does not disclose warranty expense or claims paid quarterly so we can’t calculate the exact impact on earnings. However, if DXCM had to boost the allowance back to 1.9 days, it would be a 2-cent headwind for EPS.
Keep an eye on the allowance for rebates
The company records allowances for rebates, price cuts, returns, and quick payments that reduce sales and receivables. It does not give the expense amount of this variable consideration, only the period-ending allowance figure. The allowance has grown rapidly and is now larger than the net receivable figure:
The allowance used to be 40%-45% of receivables – it rose quickly above 50%.
If the company is accruing the rebate allowance faster than sales, it is a drag on both sales growth and profits. On the surface, the rapid increase in the rebate allowance would seem to have been holding back growth in recent quarters. However, it is difficult to determine the impact on a given quarter as the ending allowance balance is a product of both new allowances accrued and existing allowances utilized during the period. The allowance rose by $100 million sequentially in 1Q24. This could have been the result of DXCM booking $150 million in new rebate expense and using $50 million of the reserve, or possibly booking $200 million and using $100 million. The point is that the size of the expense could be much larger than what the change in allowance alone might indicate.
It is important to realize that the expense for new rebates is likely in the $100 million range in any given quarter compared to the company's recent revenue beats in the $10-$12 million range.
It is also important to consider the impact on the bottom line. Operating expenses are driven by the volume of product built and shipped and would be the same if DXCM recorded a rebate expense of $50 million for new allowances or $200 million. Using a 25% tax rate, we estimate that every $10 million change in the rebate expense is worth 2 cents in EPS. That compares to DXCM’s EPS beats of 5 cents and 7 cents in the 1Q24 and 4Q23.
We also believe this huge reserve could decline at some point. DXCM really does not discuss the topic much at all beyond describing how the process impacts revenue recognition. It has grown from 40% to 52% of gross receivables in a short time. That has been a sizeable headwind on sales. If this reserve declines, it likely means DXCM would be reporting a smaller expense to net against sales, and sales growth would suddenly improve. A 1% decline would add $21 million to sales and 4 cents to EPS. Our advice is to track the size and direction of this allowance as it has a much larger impact on sales than the headline numbers of “beat by $10 million.”
When seeing the size of this accrual against receivables, investors should be more concerned with the DSO figure approaching 100 days. DXCM has already built an allowance against more than half the total receivables.
Lower tax rate boosting growth
A lower tax rate has been helping results by about 1 cent per quarter. DXCM has forecast this, but it is not likely a sustainable source of EPS growth.
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Disclosure:
This article is intended for educational purposes and is not investment advice.
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