Blackberry – The Real Story

Blackberry’s fiscal Q1 earnings came out last Thursday. The analysts were shocked to see a surprising profit from the same company who lost $ 4.4 billion just 2 quarters ago. Investors reacted positively to Blackberry’s results, which sent the shares higher since the earnings release. Everything seems to be on track for John Chen’s turnaround plan. “Our performance in fiscal Q1 demonstrates that we are firmly on track to achieve important milestones, including our financial objectives and delivering a strong product portfolio,” said John Chen, Executive Chairman and Chief Executive Officer of BlackBerry. “Over the past six months, we have focused on improving efficiency in all aspects of our operations to drive cost reductions and margin improvement. Looking forward, we are focusing on our growth plan to enable our return to profitability.”

First of all, I want to give credit to Mr. Chen for what he has achieved during such a short period of time. He executed quickly and well and the balance sheet has seemingly stabilized.

While in GAAP terms, the business seems to be doing much better than it was 6 months ago, the earning’s quality of Blackberry deserves some serious attention because in my opinion, Blackberry embarked upon a massive financial engineering started with Thorsten Heins and John Chen took it to another level.

In simple terms, the trick John Chen and his team deployed involved shifting future expenses to a specific quarter and took a big one-time charge. This includes the massive inventory write-off, PP&E impairment and intangibles write-off. On a smaller scale, Blackberry’s management team also conveniently used restructuring charge to mask some real operating expenses.

• Inventory write-off – this served the purpose of lowering Q3 2014’s GAAP income but improving BBRY’s gross margins going forward as inventories were being carried on the balance sheet on a lower cost.
• PP&E and Intangibles write-off – again, this lowered the Q3 2014 GAAP income but future quarterly depreciation charges would be lower.
• Restructuring charge: while used properly, this should give investor a better picture of what’s recurring versus what’s not. But I suspect that Blackberry’s management has abused the use of restructuring charges by throwing in normal operating expenses into restructuring charges.

So, what’s Blackberry’s normal earnings? Here I’ve prepared a table which shows the GAAP numbers and estimated real numbers with explanations.

Now we can tell that without the financial engineering, Blackberry could have been reporting a close to $ 700 million quarterly loss instead of a $ 20 million GAAP income. This is without considering the effect of restructuring charge, which would increase operating expenses and lower operating income even further. Such is the shortcomings of GAAP and reported numbers.

Let’s not forget about the real cash flows. Here Blackberry acknowledged that without the tax refunds and real estate sales, it actually used $ 255 million of cash instead of an increase of $ 429 million. The difference is $ 684 million, which is fairly close to the difference between GAAP earnings and normalized earnings. I don’t think this is a pure coincidence.

John Chen’s financial engineering has made it a lot easier for him to report good numbers in the following quarters. If you are a Blackberry shareholder, you should do this exercise every quarter to understand the real progress of the turnaround.