By most measures Research in Motion’s (RIMM: Nasdaq) balance sheet is solid. Investors concerned about slipping market share for RIMMs iconic Blackberry against Apple’s (AAPL: Nasdaq) sexy iPhone take comfort in a growing cash balances. Indeed, at the end of August 2011, the company held $851 million in cash and another $298 million in short-term investments. One of the reasons RIMM has that nice bank roll is its history of generating strong cash flow from operations. The company converted 20% of sales to operating cash flow in both fiscal years 2010 and 2011.
RIMM has no debt and net working capital remains near $3.6 billion. By all appearances the company is well fortified despite the fact that profit margins have slipped and sales growth has all but stalled.
That assessment might be a bit premature. I often screen stocks for strong cash flows and measure the conversion of sales to operating cash flow. Although RIMM converted every fifth dollar of sales to cash in the previous two fiscal years, in the last six months that rate slipped to one dollar of cash for every ten dollars of sales.
So I took a closer look at RIMM’s working capital situation - much deeper than the popular measure of current assets against current liabilities. A company basically operates with three balance sheet accounts. It buys Inventory and sells it to customers. Often a company buys on credit and has Accounts Payable. It also gives its customers credit, which comprise Accounts Receivable. Companies strive to keep in line outflows of capital for inventory purchases and inflows of cash from customers.
RIMM had been relatively successful at this balancing act. In Fiscal Year 2010 Inventory on the balance sheet represented 29 days of costs. Collections on Accounts Receivable required another 63 days. That meant the company had to finance operations for approximately 92 days (29 days plus 63 days). It got some help from suppliers by buying on account for an average of 27 days. So RIMM had to pony up working capital for approximately 65 days of production and sales activity (92 days minus 27 days).
The story was largely unchanged a year later at the end of Fiscal Year 2011. Inventory days actually shrank to 20 days. Collections had slowed to 73 days, but the company was still taking advantage of suppliers’ goodwill for an average of 27 days.
The most recently reported quarter ending August 2011, presents a whole new picture. Days in Payables had lengthened to 41 days, but that was not enough to make up for a slower pace in getting cash back in the door after investing in inventory and selling products to customers. That is because Inventory is sitting on the shelf a quite a bit longer - 47 days. Collections from customers have improved very little and are still taking an average of 71 days.
The bills are just flat out coming in faster than cash is coming in the door. The working capital investment required lengthened to 77 days or just over two and a half months.
I thought it might be interesting to project what the working capital investment interval might be by the end of the current fiscal year. I assumed no change in the closing value of working capital accounts from the current levels. I also used the consensus sales estimate for FY2012 of $20 billion and the most recently profit margin of 38.7%. Under these assumptions the working capital interval stretches out even further to three months. RIMM is clearly headed in the wrong direction as far as cash conversion is concerned.
Research in Motion has plenty of cash to sustain its operations and there are certainly no credit quality issues for the company. Yet its working capital accounts point to a deteriorating situation that is not disclosed by simply looking at total cash on the balance sheet or calculating net working capital. If the competitive situation is as dire as many of the analysts and pundits suggest, RIMM will need every penny on its balance sheet to inject new life into its product line and maintain its market share. Increased working capital investment would be a distraction.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.