The Financial Impact of the Note 7 Recall

Samsung reported its earnings for the third quarter last week and the impact of the Note7 recall was understandably a major focus. Since I track Samsung’s financials on an ongoing basis and, since I haven’t seen a lot of coverage of what Samsung reported last week on this topic, I thought I’d share some of the details with Tech.pinions Insiders and put the impact in the context of Samsung’s broader business.

Samsung’s reporting structure

Samsung Electronics has three main business divisions:

  • CE (Consumer Electronics) – TVs, printers, AC units, fridges, and other consumer and medical devices
  • IM (IT & Mobile) – phones and tablets, but also PCs, digital cameras, and mobile network infrastructure
  • DS (Device Solutions) – components for consumer devices, including DRAM, NAND flash, modems, displays using LCD and OLED technologies, and more.

From a financial perspective, Samsung reports these three but also breaks out some of the constituent parts:

  • CE – Samsung reports divisional results but also breaks out TV sales specifically
  • IM – reports at a divisional level but also Mobile revenues specifically (though not margins)
  • DS – split into two parts: semiconductor (of which memory is again broken out separately) and display panels.

Impact on the IM division

The IM division is where smartphone sales are reported and it’s here the impact of the Note7 recall was greatest. The chart below shows revenues and profits (in trillions of Korean Won) for this division):

screenshot-2016-10-31-14-56-32

Note the dark gray bar for Q3 2016 isn’t missing – it’s just so tiny you can’t see it. In other words, the Note7 recall basically wiped out profits for the quarter for the division. Technically, they were 0.1 trillion Won, or about $87 million, compared with over $2 billion profits a year earlier — nearly $4 billion in profit in Q2. You can also see a revenue dip there, from 26.6 trillion Won both a year earlier and in Q2 to 22.5 trillion Won ($19 billion). That drop is about $3.5 billion, approximately the size of the gap in revenues left by the recall. When Samsung decided to fully recall all Note7 devices, it revised its earnings guidance downwards by around 2 trillion Won, so roughly that much of the impact was from reversing the revenue recognition for those devices which had actually been sold and not recalled at that point. The rest is from sales which had been expected but never happened because of the recall. Interestingly, the impact on profits was even higher – those dropped by almost $4 billion in the financials, as we’ve already seen. The reason is revenues were only impacted by foregone sales, whereas profits were impacted by the cost of the devices sold and the additional costs associated with the recall itself. Samsung doesn’t report expenses by business line, but its Selling, General and Administrative expenses overall rose by around 600 billion Won, or $525 million, year on year, and the company largely attributed this to the cost of the recall.

Overall impact

However, the overall impact of the recall on Samsung Electronics was much more muted, in part because other parts of the business performed well in Q3 and in part because Samsung sold some assets in the quarter in anticipation of the early phases of the recall. A summary of Samsung’s overall financial performance is shown below:

Samsung overall performance

As you can see, while there certainly was a dip in operating margin in the quarter, it was much less dramatic than in the IM division, where margins dropped effectively to zero. A large part of that is because the IM division accounts for less than half of the company’s overall revenues and only around a third of its operating profits. The semiconductor segment of the components division actually accounts for the largest chunk of operating profits and happens to have done particularly well this quarter, which helped offset some of the drop in the IM division. But Samsung also sold some of its stake in components vendor ASML in the quarter, which basically offset the increase in SG&A driven by the cost of the recall when it came to net margins. As a result, Samsung’s net margin was only slightly lower year on year and quarter on quarter.

Guidance for the future

Samsung has provided some rough guidance for the future impact of the Note7 recall as well. In essence, Samsung is expecting the impact to run through the current quarter (Q4 2016) and the next quarter (Q1 2017). In the current quarter, the impact is expected to be around 2 trillion Won, while in Q1 it’s expected to be around 1 trillion Won. Of the 2 trillion in Q4, around 1.5 trillion of the impact will hit the IM division, while the other 500 billion will hit the semiconductor division, which would make some of the components used in the Note7. In the grand scheme of things, this roughly $2.6 billion hit isn’t enormous, though it’s not nothing. But, of course, Samsung will also seek to replace many of these would-be Note7 sales with Galaxy S7 or S7 Edge sales instead, which will help mitigate the impact on overall sales, though the costs already incurred for manufacturing devices which will not now be sold along with the ongoing costs of the recall will still be felt.

It’s worth looking at Samsung’s overall guidance for the fourth quarter as it relates to smartphone sales, too. It sold around 89 million total handsets (including feature phones) in Q3 and expects to sell a similar number in Q4. Of that total, around 75 million were apparently smartphones and the company expects to sell a similar number of those in Q4 as well. As with Q3, that would be down significantly on last year, when the company sold 80-85 million smartphones in the fourth quarter. Interestingly, this also puts the likely total within touching distance for Apple, whose guidance suggests it will sell somewhere in the high 70 million range. We could therefore see Apple outsell Samsung in a quarter for only the second time ever (the first was Q4 2014, when the iPhone 6 began selling in volume).

Published by

Jan Dawson

Jan Dawson is Founder and Chief Analyst at Jackdaw Research, a technology research and consulting firm focused on consumer technology. During his sixteen years as a technology analyst, Jan has covered everything from DSL to LTE, and from policy and regulation to smartphones and tablets. As such, he brings a unique perspective to the consumer technology space, pulling together insights on communications and content services, device hardware and software, and online services to provide big-picture market analysis and strategic advice to his clients. Jan has worked with many of the world’s largest operators, device and infrastructure vendors, online service providers and others to shape their strategies and help them understand the market. Prior to founding Jackdaw, Jan worked at Ovum for a number of years, most recently as Chief Telecoms Analyst, responsible for Ovum’s telecoms research agenda globally.

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