A Look Into The Anatomy Of BlackBerry's $1 Billion Loss: More Like An Autopsy Than A Diagnosis

Oct. 2.13 | About: BlackBerry Ltd. (BBRY)

BlackBerry (NASDAQ:BBRY) released is Management Discussion and Analysis (MD&A) and it is posted on SEDAR.com for anyone who wants a copy.

The document is interesting reading for anyone following the BlackBerry saga and gives a bit more detail than the somewhat cryptic disclosure made in the company's earnings pre-release and final release for the second quarter.

The first point worth a comment is disclosure that in Q1 when BlackBerry recognized 6.8 million smartphones in revenue the actual number sold to end users was 6.4 million. The difference of 0.4 million is not material. In the Q1 conference call BlackBerry reported that 40% of the 6.8 million recognized in revenue were BB10 devices. At that time BlackBerry management gave no information on the sell-through to end users and left investors with the impression that it had sold 2.8 million BB10 phones in Q1. As we know now, it had not. We also now know that 2.2 million BB10 devices booked to revenue in Q1 were not sold to end users in that quarter, suggesting that end user demand exceeded shipments of BB7 devices.

In the Q2 report, BlackBerry disclosed that 5.9 million smartphones were delivered to end users in the quarter but only 3.7 million were recognized in revenue because of the 2.2 million devices recorded in revenue in Q1 but not shipped until Q2. At that time I assumed that the 2.2 million unit difference comprised primarily BB10 devices and it now seems that assumption was correct.

In the Q2 MD&A, BlackBerry disclosed that the mix of devices sold through to end users in Q2 was 4.2 million BB7 devices leaving a balance of 1.7 million which must have been BB10 devices.

If it is so, then Q1 actually saw something like 600,000 BB10 sales to end users and Q2 saw that figure rise to 1.7 million. A further 1.0 million Z10's were sold in Q4 of BlackBerry's last fiscal year. Adding it all up, a total of about 3.3 million BB10 devices had been sold to end users by August 31, 2013. That is pretty close to 500,000 units a month since the devices were launched in Canada on February 5, 2013.

Early reports suggested that BlackBerry had placed orders to build 1.5 to 2 million BB10 devices a month starting last February. In May 2013, Jim Faucette of Pac Crest Securities reported that sales of the devices appeared to be running at about 500,000 a month and warned that a major inventory write down was likely.

Faucette pretty well nailed it. Production of 1.5 million to 2 million devices a month for 7 months results in a build of from 10.5 million to 14 million units. Deduct the approximately 3.3 million units sold to end users and another 0.5 million (a one month sales rate) for normal channel inventories and you get an excess of 6.7 to 10.2 million units. If you assume an inventory cost of about $200 a device you have excess inventory of from $1.3 billion to $2 billion. BlackBerry had a reserve for excess inventory of $463 million in its Q1 financial statements (note 4 to the statements) and took a $934 million charge in the current quarter, a total of $1.4 billion. Hats off to Jim Faucette.

The question for the BlackBerry board and audit committee is a simple one. Where were you while all this was going on? And, why not simply tell investors the unvarnished truth about the slow start for BB10. Surely, the company and investors would all be better off if from the outset they were dealing with facts. While the sale of 3.3 million BB10 devices in 7 months is a lot less than management hoped for, it is not a disaster. What is a disaster is a surprise billion dollar write down and an exodus of former BlackBerry supporters including both customers and investors who feel betrayed.

In my view, the lack of forthright disclosure will be apparent to prospective bankers and is more likely to dissuade them than encourage them to lend to a takeover. BlackBerry's current MD&A discloses $3.1 billion of purchase commitments which includes $1.5 billion committed to contract manufacturers. Those commitments could add another 7.5 million devices to the already massive inventory excess. At 500,000 units a month disposal of this inventory would take 2 or 3 years, so it is pretty clear they need to be heavily discounted to move. BlackBerry could negotiate to pay suppliers their profit on the device assembly as a penalty and try to curtail the build, if it can get agreement. If not, a lot of users are going to be able to get a pretty good phone for not much money.

Without a takeover and with a mountain of inventory to move, BlackBerry is unlikely to move higher in share price any time soon. Oddly enough, it is likely to survive. The phones will be sold and its user base will grow. Its network operations will continue to add value. And, perhaps and at long last, it will in fact make its BBM messaging system available on iOS and Android platforms.

I am betting the takeover talks die out, the company muddles along and the stock price sinks well below $5 a share and languishes there for a few years while the board finds a new Chief Executive Office more up to the task and gets on with the business of running the company.

I am long BlackBerry calls, a legacy of my former support for the company and its products, and long BlackBerry puts which reflect my current view that there is little hope for recovery when you cannot trust either the board or management to give investors the full, plain and true disclosure they are entitled to receive.

Disclosure: I am short BBRY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I hold calls and puts on BlackBerry. The calls are legacy holdings and the puts reflect my current views.