The Picture is Still Fuzzy At Syntax-Brillian

On Friday, December 1, Vincent Sollitto, Jr., CEO of Syntax-Brillian Corporation (BRLC), and Wayne Pratt, CFO of BRLC, held a conference call which addressed – among other items – inventory reserves. How did their talk affect the conclusion drawn in my prior article, namely that cost of sales for the quarter ended September 30, 2006 were understated by $5.3 million? Not at all. Here’s why.

During the conference call, Mr. Pratt estimated that inventory reserves were $7M as of June 30, 2006 and $2M as of September 30, 2006. He stated that the difference between the inventory reserves, $5.319M, was labeled as "provision for inventory reserves" in the cash flow statement for the September quarter. Mr. Sollitto earlier had commented that if prices have stabilized like they did in the September quarter, they didn't need to take as big of a reserve.

Utilizing the figures Mr. Pratt provided and information found in their Form 10-K and 10-Q, the net inventory and inventory reserves are calculated as follows [all numbers in thousands]:

click to enlarge

The inventory reserves as a percentage of inventory at cost went from 35% [$7M/$20.151M] as of June 30, 2006 to 5% [$2M/$42.704M] as of September 30, 2006. Why were the reserves so high at June 30, 2006? As Mr. Sollitto noted, prices stabilized in the September quarter, which would mean lower reserves were necessary for the June inventory since it would be sold in the September quarter. In fact, the $7M inventory reserves at June exceeded the inventory write-down for the entire year ended June 30, 2006 [$5.6M]. The $7M inventory reserves at June were over 4 times as high as the inventory write-down for the entire quarter ended September 30, 2006 [$1.7M]. The inventory write-down for the June inventory should have been well-known by September 13, 2006, when BRLC originally filed its June financial statements.

If the inventory reserves were more realistic at June 30, 2006, the increases [reductions] charged to costs and expenses would have been at least a positive $1.7M [the amount of the inventory write-down], not a negative $3.619M for the quarter ended September 30, 2006. This change increases the cost of sales by $5.319M [$1.7M + $3.619M] for the quarter ended September 30, 2006. The increased cost of sales reverses the net income of $3.8M to a net loss of $1.5M for the quarter ended September 30, 2006.

Are the prices right?

On Monday, December 4, BRLC announced that revenue would be at or above the high end of their prior revenue guidance for the quarter ended December 31, 2006. This announcement was similar to their announcement on October 12, when they stated that revenue will be above the high end of their prior revenue guidance for the quarter ended September 30, 2006. The question remains as to what the cost of sales will come in at for the quarter ended December 31, 2006, especially since the lower inventory reserves at September 30, 2006 leave little room for manipulation.

Disclosure: Author is short BRLC.