This Metric Says You're Smart to Own Digital River

There's no foolproof way to know the future for Digital River (Nasdaq: DRIV  ) or any other company. However, certain clues may help you see potential stumbles before they happen -- and before your stock craters as a result.

A cloudy crystal ball
In this series, we use accounts receivable and days sales outstanding to judge a company's current health and future prospects. It's an important step in separating the pretenders from the market's best stocks. Alone, AR -- the amount of money owed the company -- and DSO -- the number of days' worth of sales owed to the company -- don't tell you much. However, by considering the trends in AR and DSO, you can sometimes get a window onto the future.

Sometimes, problems with AR or DSO simply indicate a change in the business (like an acquisition), or lax collections. However, AR that grows more quickly than revenue, or ballooning DSO, can, at times, suggest a desperate company that's trying to boost sales by giving its customers overly generous payment terms. Alternately, it can indicate that the company sprinted to book a load of sales at the end of the quarter, like used-car dealers on the 29th of the month. (Sometimes, companies do both.)

Why might an upstanding firm like Digital River do this? For the same reason any other company might: to make the numbers. Investors don't like revenue shortfalls, and employees don't like reporting them to their superiors.

Is Digital River sending any potential warning signs? Take a look at the chart below, which plots revenue growth against AR growth, and DSO:

Source: S&P Capital IQ. Data is current as of last fully reported fiscal quarter. FQ = fiscal quarter.

The standard way to calculate DSO uses average accounts receivable. I prefer to look at end-of-quarter receivables, but I've plotted both above.

Watching the trends
When that red line (AR growth) crosses above the green line (revenue growth), I know I need to consult the filings. Similarly, a spike in the blue bars indicates a trend worth worrying about. Digital River's latest average DSO stands at 61.7 days, and the end-of-quarter figure is 55.1 days. Differences in business models can generate variations in DSO, and business needs can require occasional fluctuations, but all things being equal, I like to see this figure stay steady. So, let's get back to our original question: Based on DSO and sales, does Digital River look like it might miss its numbers in the next quarter or two?

I don't think so. AR and DSO look healthy. For the last fully reported fiscal quarter, Digital River's year-over-year revenue shrank 9.5%, and its AR dropped 6.4%. That looks OK. End-of-quarter DSO increased 3.5% over the prior-year quarter. It was down 27.1% versus the prior quarter. Still, I'm no fortuneteller, and these are just numbers. Investors putting their money on the line always need to dig into the filings for the root causes and draw their own conclusions.

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Seth Jayson had no position in any company mentioned here at the time of publication. You can view his stock holdings here. He is co-advisor of Motley Fool Hidden Gems, which provides new small-cap ideas every month, backed by a real-money portfolio. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


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  • Report this Comment On May 03, 2013, at 10:47 AM, minnwinn wrote:

    Seth, I'm sorry ... but your analysis is not correct. First, Digital River reports net sales. That is, it only reports the portion of the gross sales that it has earned (let's say for illustration purposes it's sub-10% on average). The remainder (or 90%+ in our example on average) is the owner of the products its selling. So 10% or less is reported as net revenue essentially net of the 90%+ cost of sales going to their clients. However, because Digital River generally collects most of gross revenue from credit cards and other payment types that are guaranteed to be settled within a day or two and they will only pay clients on sales for which they've collected, they are never out the funds. Receivables are 100% of gross sales for a two to three day window while revenues are less than 10%.

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