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To: Sam Citron who wrote (596)	2/11/2002 2:56:37 PM
From: Sam Citron	Read Replies (1) \| Respond to of 786

Channel stuffing for beginners from WSJ 2/7/02 THE NUMBERS GAME By TRACY BYRNES Too Many Thin Mints: Spotting The Practice of 'Channel Stuffing' With financial chicanery popping up everywhere these days, it's painful to read a newspaper or turn on the TV. To make matters worse, the financial pundits, who spend their days dissecting this stuff, seem to have their own language. They claim companies "massage earnings" or "cook the books." Or how about this: They even talk about companies "stuffing the channel." Well, what the heck does that mean? Stuffing the channel refers to getting customers to buy more than they really need now to pump up sales figures. Take the Girl Scout that comes to the door hawking cookies. I ordered three boxes of Thin Mints and paid her. But when she got home she tallied all the boxes she sold and realized that she needed 10 more boxes to win those free tickets to Six Flags Great Adventure. So what does she do? She doubles my Thin Mints order, along with a few other customers', unbeknownst to all of us. She just knows this won't be an issue since everyone loves Thin Mints. Two problems though. She's got to come back and sell more cookies and get more money from me -- and it could take me weeks to scrape up another $3 for the box. And if I do come through, by the time she shows up in March to sell me Easter candy, I'll still be eating Thin Mints and won't buy a thing from her. She stuffed the channel -- and my face for that matter. When companies do this, once the merchandise is shipped, they record it as a sale in their books, regardless of whether the products are paid for or not. This makes sales appear much higher and that translates into higher earnings. And that makes the analysts happy. But when stretched, it makes sales figures misleading and regulators unhappy. To be sure, recording a sale as it ships is not illegal. It is the revenue-recognition policy for many companies, especially manufacturing ones. It is just much easier for these companies to stuff the channel. But be aware that companies with different revenue-recognition policies can just as easy take a gamble at channel stuffing. Picture it. It's the end of December, and a salesperson who sells heated stadium pillows has to make his sales quota for the year. So he ships out extra pillows. He makes his number, not worrying that his customer will not need so many pillows in January. He'll worry about that then. He'll just steal from February to make his January sales number. He has becomes a serial stuffer. And since his company wants growth, by March he's trying to sell his customer three months of pillows in one month. Eventually this will catch up with him as customers groan under mountains of unused or unsold pillows. In real life, stuffing can have grave consequences. Lucent Technologies, for instance, came under Securities and Exchange Commission investigation in February 2001 for several issues, including stuffing the channel with its telecommunications equipment. For that and several other reasons, its stock now trades below $6 from around $20 when the stuffing issue arose. Sunbeam famously stuffed the channel with barbecue grills and other outdoor items, and that aggressive practice contributed to the company's demise. Personal-computer makers have also had brushes with channel stuffing. It's possible to spot channel stuffing. You can look for evidence of this practice in the financial statements. First read the summary of accounting policies footnote near the end of the financial statements to determine the company's revenue-recognition policy. Remember, recording revenue at shipment is not necessarily bad, it just may be a tip-off to some aggressive behavior. Then check out the receivable balance on the balance sheet. That shows how much money the company is still owed from products shipped or services rendered. Is it higher than last quarter? Last year? Figure out an easy ratio: days to sales outstanding. That's the amount of time a customer takes to pay. Just divide the total balance in accounts receivable, found on the balance sheet, by the average sales per day (which is annual sales divided by 365). Compare to last year. Is it getting longer? That could indicate that the sales team offered an extended payment plan in effort to get the customer to buy more goods. If so, now the company has to wait longer to get paid. That's bad news. Then look at the inventory number. Is that growing too? Too much inventory in the warehouse means no one is buying anything. That could mean that customers have everything they need thanks to a build up in supplies from previous months. And that scenario is precisely why channel stuffing is more than just a funny accounting phrase. It's a potentially toxic situation. Which reminds me. Want a thin mint? I've got plenty. online.wsj.com Send your queries, comments and story ideas by e-mail to Tracy at tracy_byrnes@yahoo.com. While she can't respond to all questions, she will read every e-mail and will use this column to answer those with the broadest reader interest. Please include your name, address and daytime phone number. Questions may be edited for clarity and brevity.