RIM's inventory overhang could crimp future results

TECHNOLOGY

RIM's inventory overhang could crimp future results

DAVID MILSTEAD | Columnist profile | E-mail

From Tuesday's Globe and Mail

Published Monday, Nov. 21, 2011 6:32PM EST

Last updated Monday, Nov. 21, 2011 6:54PM EST

Research In Motion (RIMM-Q17.36-0.83-4.56%) has had some difficulty selling its products this year, to put it mildly; that has, in turn, provided investors with a couple of deeply disappointing quarters.

RIM optimists who hope to put the last six months behind them, however, should be warned: Lurking in RIM's financial statements are warnings that this summer's dismal performance is creating an overhang that could further crimp RIM's future results.

The chief warning sign are the ballooning inventories at RIM, which have doubled in just two quarters from $600-million (U.S.) in late February to almost $1.4-billion in late August.

Much of that inventory are the raw materials need to make BlackBerrys and PlayBooks. But “finished goods” inventory – products ready to sell, but unsold – tripled in that time to $298-million from $94-million.

RIM's accounting policies suggest most of that finished-goods inventory is PlayBooks. (Last week's announcement that the first-generation PlayBook will now be sold for as little as $199 seems to be further evidence.)

RIM, in keeping with industry practice, has traditionally booked revenue for its products when they were sold to retailers and wireless carriers – not when those products were ultimately sold to the end user.

RIM then subtracted from revenue an allowance for future discounts and sales incentives used to get BlackBerrys into consumers' hands.

This was not a big deal when BlackBerrys flew off the shelves. But, according to disclosures in the company's securities filings, RIM changed its accounting policy this fiscal year to recognize that a retailer or carrier has the right to return unsold products.

RIM also disclosed that now, if it cannot “reasonably and reliably” estimate product returns “based on historical experience,” it waits to recognize revenue when a product “sells through the distribution channel” to the end user.

A logical interpretation of that: Since the brand-new PlayBook has no historical sales and return data, RIM isn't recognizing revenue on the PlayBooks until they're sold to the end user.

BlackBerrys, on which revenue is recognized when they pass to retailers, wouldn't be counted on the financial statements as inventory, but the PlayBooks would. And that would explain the tripling of finished-goods inventory levels.

What does RIM say about this? I don't know. I first approached the company Oct. 10 with my questions. After a series of phone calls and e-mails, a RIM spokeswoman now seems unwilling or unable to answer the queries.

But there are a couple more things I can observe: If RIM is delaying booking PlayBook revenue, it deserves credit for a conservative accounting policy. However, it also has created a situation in which it may have to take a writedown on some amount of that $298-million in finished goods inventory if it cannot clear out the piled-up PlayBooks at the new discount prices.

Analyst Jeff Fidacaro of Susquehanna Financial Group notes that at discount prices of around $199 for the PlayBook, RIM will be taking a loss on the tablet's hardware compared to the $205 that IHS iSuppli estimates the components cost.

That means RIM's gross margins, already under pressure, could decline further as devices are sold at a discount. Any of the unsold PlayBooks would have to be written off in a non-cash charge that flows directly to RIM's bottom line.

“I think there is a chance of a writedown given the obvious efforts to clear product out of the channels,” says analyst Barry Richards of Paradigm Capital.

However, Mr. Richards believes some of the impact of potential PlayBook clearance sales were already built into the company's guidance for the quarter that ends this month. Excluding these discount sales, RIM's margins “might actually be better than we expected.”

The future earnings hazards are not all PlayBook-related. If RIM is applying historical estimates of incentives and returns for BlackBerrys in calculating its revenue-netting number – and the current experience turns out to be worse than RIM's estimates – there is the potential for additional downward adjustments to revenue and income.

To be clear: These issues won't be the key driver of RIM's stock price; the company's latest sales, profit and BlackBerry-shipment numbers will make the headlines.