Photographer: Pau Barrena/Bloomberg

One Tiny Number Can Reveal Big Problems at a Global Smartphone Maker

Steve Jobs learned in 1997 what HTC is facing today: Too many products sitting in warehouses can mean big trouble

Tucked away in a corporate earnings report—past the data on profit margins and revenue growth, hidden deep inside a balance sheet—is a number that can tell you a lot about a mobile phone maker's health. In the global smartphone war, brands are routinely measured by market share, revenue, profit, and the coolness of their ads. But one line item called finished goods inventory, which refers to the percentage of materials that were manufactured into phones but went unsold, can give insight into whether a company's fortunes are changing.

The latest company to let phones pile up in warehouses and on store shelves is HTC. The Taiwanese company's stock just fell to its lowest point in a decade after lowering its sales forecast on June 5 and announcing a NT$2.9 billion ($93 million) writedown, though it's recovered some of that loss amid speculation the decline could make it a buyout target. HTC's finished goods inventory had climbed to a record high 2.35 percent of total assets at the end of last quarter. During the company's heyday, that figure rarely nudged above 1 percent.

“The rise in finished goods inventory could be a sign that HTC's latest high-end phone, the M9, is not selling as well as expected,” says John Butler, an analyst at Bloomberg Intelligence. “The phone has received rather negative reviews from tech critics and may not be faring well against some very competitive, feature-rich phones on the market from rivals like Samsung with the S6 and Apple's iPhone 6 and 6 Plus.”

This annotated chart shows HTC's rising finished goods inventory as a percentage of assets. 
Author: Tim Culpan
This annotated chart shows HTC's rising finished goods inventory as a percentage of assets. Author: Tim Culpan

Inventory, sometimes used by data divers to peek into the bowels of a company, is generally divided into three types: raw materials, which are the bits and pieces that get fed into the production line; unfinished goods, the stuff still in production; and finished goods, the devices sitting in warehouses, on trucks, or even on store shelves. The distinctions are important. Having a ton of materials or unfinished goods isn't necessarily a disaster. Many materials can be switched around between products, so even if one incarnation of a smartphone faces low demand, the components can be swapped into another product pretty easily.

Leaving unsold products lying around, however, is an especially bad sin in the consumer electronics industry. Once a smartphone is assembled and leaves the production line, the clock starts ticking. In the high-paced technology business, consumer devices lose their luster fast, which makes the chance of actually selling the product decline with each passing day as newer models come onto the market. Steve Jobs saw this when he returned to Apple in 1997—at a time, he had said, when it was near bankruptcy—to find that finished goods inventory had climbed to 7.7 percent of assets. Jobs hired an operations guru from IBM named Tim Cook to clean up the mess. A year later, in June 1998, the number had dropped to 1.7 percent—and hasn't crossed 0.9 percent in the past few years.

When Motorola got into trouble at the end of 2008, its finished goods inventory peaked at 6.1 percent. That same quarter, it posted a record $3.6 billion loss that precipitated large-scale layoffs and the eventual breakup of the 80-year-old company. Having lots of unsold stock isn’t always a bad sign, though. Nokia's figure climbed above 14 percent in 1995 before it kicked off a decade of exploding sales—creating, for a time, the world's biggest mobile phone maker. But HTC isn't seeing explosive growth, which makes its record inventory figure a red flag for investors. HTC declined to comment.

Too low a stockpile, coupled with insufficient production capacity, can also be a problem. Qualcomm ran into this three years ago, forcing various smartphone makers to push back their product launches due to a lack of available chips. HTC faced a shortage of components in 2011—when it was topping even Apple in the U.S.—prompting the company to sign long-term supply contracts to secure supply and favorable pricing. In an expensive display of irony, this month's writedown was a response to some of those 2011 supply contracts. None of it was for unfinished goods. Yet.

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