On Thursday, Electronics for Imaging (EFII), a copier company I knew well twenty years ago, issued a press release which it filed as an 8-K with the SEC. The release reads in part:
“Electronics For Imaging, Inc. (Nasdaq:EFII), a world leader in customer-focused digital printing innovation, is postponing the conference call at which it anticipated discussing second quarter 2017 preliminary results in order to enable the Company to complete an assessment of the timing of recognition of revenue. The assessment is related to certain transactions where a customer signed a sales contract for one or more large format printers and was invoiced, and the printer(s) were stored at a third party in-transit warehouse prior to delivery to the end user.
In addition, EFI is in the process of completing an assessment of the effectiveness of EFI’s current and historical disclosure controls and internal control over financial reporting. EFI expects to report a material weakness in internal control over financial reporting related to this matter. EFI also expects to report that EFI’s disclosure controls were not effective in prior periods.
The Company currently expects that the total aggregate revenue for the periods under review will not be materially different from the aggregate revenue that was previously reported for those periods, taking into account any revenue from the prior periods that may be moved into the current or upcoming periods.”
The stock lost 45% of its market value in Friday trading.
What’s this about?
While the situation is still pretty muddy, the basic issue is what counts as a sale–how an order for a company’s products ends up being counted as revenue in the company’s income statement.
In the case of large, expensive precision equipment (think: multi-million dollar semiconductor production machines), an order doesn’t become a sale until the unit is delivered to the plant and is installed and working to the satisfaction of the receiving company’s engineers. This process can take weeks from the time the equipment leaves the factory.
For just about everything else, an item is considered sold the second it leaves the factory–whether in the mail or a UPS van, or in a truck owned by either party to the transaction–and a bill is sent. Initiating delivery allows the sender to book the associated revenue on the income statement. (Returns? Companies typically reduce reported revenue by an estimate–based on their past experience–of likely returns. The estimate is usually not disclosed. Returns only become an issue if they’re much larger than the return provision.)
In the EFII case, in contrast, it sounds like items were shipped, a bill was sent and revenue was recorded on the income statement, even though no one had actually ordered the shipped merchandise. The merchandise was then held in a third-party warehouse until an actual customer order came in–at which point the items were shipped.
Why do this? …to make current earnings look better than they actually were.
What’s still unclear:
–who knew about this
–how long the practice was going on
–how large the phantom sales had grown
–how it was discovered.
The press release, which I’m regarding as having been carefully crafted by EFII’s lawyers, suggests to me that the revenue overstatements:
–have been going on for a long time (“controls were not effective in prior periods”), and
–the amounts involved may be large (“revenue from the prior periods…may be moved into…upcoming periods” (emphasis mine)).
Yes, the warehoused merchandise may eventually be sold (that’s my reading of the third press release paragraph above). The biggest issue for investors is that the company may have been overstating its growth rate for some time through phantom “sales.”