Subject: Deferred Revenue
Here is my understanding of accounting for deferred revenue:
When product is shipped to a distributor, Xicor records an accounts
receivable from the customer for the sale, they relieve inventory for
the product shipped, and they record deferred revenue which represents
the gross profit on the sale.
Here is an example of how this would work:
Sale to distributor $10,000
Cost of Sale $6,000
Gross Profit $4,000
No entries are made which affect the income statement. The
balance sheet would show a $10,000 receivable, a reduction of
inventory of $6,000 and a deferred revenue of $4,000.
The distributor then pays the invoice for $10,000 which
eliminates the receivable and increases cash.
When the distributor reports that they have shipped the
product the Company eliminates the deferred revenue of $4,000, they
record a sale of $10,000 and they record the cost of sales of $6,000.
At this point, the $4,000 of profit is recorded in the income
statement.
Now if there were no other factors involved, it would appear that the
decrease in deferred revenue from the 1st quarter would mean that
sales in the second quarter benefited and that actual shipments were
down in the second quarter (since Q1 had a large increase in deferred
revenue of $2.8 million). However, another part of the equation is
that the Company could record allowances for returns and price
adjustments. This reserve would decrease deferred revenue and
decrease accounts receivable. The actual accounts receivable balance
decreased by $2.5 million from Q1 to Q2 while deferred revenue
decreased by $1.9 million. This seems a little odd considering that
the Company has indicated that shipments have been increasing. So it
appears that either the Company hired a great collector who has
speeded up the payment process or the Company recorded a reserve
against the balance which it didn't have at Q1.
Based on the above, here is what I think happened during this quarter:
Shipments continued to increase as a result of additional equipment
purchased and strong demand for products. In fact, it appears that
their main problem is they cannot produce enough to meet demand,
something that other semiconductor companies can only wish for.
Because of this increase in shipments, the Company's deferred revenue
account was growing. Since most people do not understand this account
and just assume that any liability must be bad, the Company needed to
do something to bring it down. The answer was to either start
recording a reserve against the deferred revenue, if they weren't
already, or to change the methodology used in estimating the reserve.
Since deferred revenue represents the profit on sales which have not
yet been recorded, it means that the Company has $.72 per share of net
income recorded on the balance sheet which will be realized in future
quarters. Remember, when the deferred revenue is determined to be a
sale, it has no additional costs associated and basically drops to the
net income line dollar for dollar. In addition, the Company has
probably recorded a very conservative reserve against this balance and
will actually realize more than this amount. When you consider that
analyst's expect EPS for 1996 to be around $.70 - .80 you can see that
deferred revenue is a very significant account.
This method of accounting is very conservative. Many companies record
the sale at the time of shipment to the distributor and then record a
reserve for returns and allowances. If Xicor had done this, an
additional $.72 of EPS would have been realized in past quarters, with
a great deal of it benefiting the most recent quarters.
As a result of all this, Xicor's stock is now priced at a ridiculous
level which we may have to live with for a little while. In addition,
it is impossible to determine from the financial statements how well
the Company is actually doing (which I suspect is much better than
their #'s indicate). |
