Archive for February, 2007

Analyzing Company Press Releases: Reading Between the Lines

Companies frequently put out news releases, and these can often send clues to the investor who reads between the lines. One example of this type of work originally appeared at Stock Market Beat and is reprinted here with the author’s permission.

We’d venture to guess that not too many people follow both small-cap headset maker Plantronics (PLT) and large-cap enterprise software vendor Oracle (ORCL.) We do, which is probably the only reason we noticed this little gem. Both companies recently issued remarkably similar press releases, each extolling the other’s virtues.

Oracle Standardizes on Plantronics Wireless Headset Systems to Optimize VoIP Communications

“We evaluated numerous headset offerings to complement Oracle’s VoIP deployment, and the Plantronics Voyager 510-USB is clearly ahead of the pack for audio performance, ease of use and style and comfort,” said Mark Sunday, Senior Vice President and CIO, Oracle. “We are also very impressed with Voyager’s performance with Oracle Collaboration Suite. Now employees have a single wireless headset for all of their voice and data communications.”

Plantronics Standardizes Global Operations on Oracle(R) … – Yahoo! News (press release)

“We get a great deal of value and cost savings out of the Oracle system,” said Plantronics Vice President of Finance and Worldwide Corporate Controller Susan Fox. “The external auditors we work with have experience using the Oracle E-Business Suite and have developed proven methodologies for testing and verification. That expertise allows us to reap the benefits of economies of scale and avoid the process of educating auditors on the nuances of our system.”

Now, it’s quite likely that this was simply a way to share cost-free favors (talking each other up in a press release) as each business negotiated a standard supply contract. However, it is always something that should draw attention when two parties enter an agreement that may not be arms-length. It would be better to look at it and decide nothing is wrong than to overlook something that could potentially be a warning.

In Financial Shenanigans: How to Detect Accounting Gimmicks & Fraud in Financial Reports, Second Edition (aff. link) Howard Schilit has this to say about such deals:

On October 5, 1999 Microstrategy (MSTR) announced in a press release that it had signed a deal with NCR Corporation…. Under the agreement, MSTR invested in an NCR partnership and NCR returned the favor and purchased MSTR’s products. We refer to that practice as a “boomerang.” (p. 44)

Later, Schilit elaborates:

A two-way transaction means that you both buy from and sell to the same party. Questions should be raised about the quality of the revenue recorded on such transactions….

If, as a condition of making a sale, the buyer receives something of value from the seller (in addition to the product) the amount of revenue recorded becomes suspect. This may involve a barter exchange, offering the customer stock or stock warrants, or investing in a partnership with the buyer. (p. 80).

In the cases of Plantronics and Oracle, there were no specifics regarding the size of the deals or time frame over which they extend. Neither is a major (10%) customer of the other, so there is some limit as to how much the deal could help one or the other. Questions investors may want to pursue include:

  1. Were the agreements similar in size? Revenue recognized from barter agreement is of lower quality (less likely to recur) than cash revenue.
  2. Given that Oracle’s fiscal quarter ends in November, the arrangement could have allowed them to book last-minute revenue. If their revenue for the quarter misses or only slightly exceeds analyst estimates when they report next Monday, a good conference call questioner could ask how much this agreement contributed (particularly with respect to license revenue.)
  3. Given that Plantronics is much smaller, they could potentially benefit more from the deal than Oracle but they are potentially in a less favorable bargaining position. Their investors might want more information regarding the size of the agreement for that reason.

Or, as we suggested earlier, it could all simply be PR fluffery. But even in that case it is best if investors know all the details.

Disclosure: At time of publication author is long Plantronics (PLT) call options and short Plantronics put options.

Posted on 28th February 2007
Under: Analyzing Press Releases, Case Studies, Fundamental Analysis, Investing in Stocks | No Comments »

Revenue Recognition from Barter Transactions

One earnings quality issue arises from barter transactions. A good example of this is provided in Financial Statement Analysis : A Global Perspective and excerpted below.

Internet companies often exchange rights to place advertisements on each other’s Websites (that is, barter). Should the company record the revenue based on the fair market value of the space and a related expense of the same amount? Or should both be ignored since they offset each other? The net result has no impact on earnings, but early stage companies are often valued based on revenues rather than earnings or cash flow (often because they have no earnings or cash flow). Companies could inflate their values by recording barter transactions as “revenue” even if these arrangements did not produce earnings or cash flow for the respective entities.

In 1999, the FASB Emerging Issues Task Force (EITF) declared that revenue from such barter transactions should be reported only if the fair value of the advertising surrendered in the transaction is determinable based on the entity’s own historical practice of receiving cash, marketable securities, or other consideration that is readily convertible to a known amount of cash for similar advertising from buyers unrelated to the counterparty to the barter transaction.

Analysts may go further, and consider whether other transactions between companies are barter-like and whether the financial statements should be adjusted to treat them as such.

Posted on 28th February 2007
Under: Adjusting Reported Financial Statements, Financial Statement Analysis, Fundamental Analysis, Securities Regulation | No Comments »

Adjusting Net Income for Unconsolidated Affiliates

Our article on equity income from affiliates described the income statement treatment for investments a company makes that result in it owning a significant amount of the investee, but not enough to treat it as a subsidiary. In accounting for business combinations we showed what can happen when companies report similar investments using different accounting methods. What follows is an excerpt from an article originally posted at Stock Market Beat discussing generally how to analyze the income statement of a company that has unconsolidated affiliates.

Xerox’ participation in the Fuji Xerox JV is accounted for using what is known as the equity method. According to the company’s latest 10K, “Equity in net income of unconsolidated affiliates of $114 million, principally related to our 25% share of Fuji Xerox income, which increased by $16 million in 2006 as compared to 2005, primarily due to improved operational performance.” In both 2005 and 2006 the Fuji Xerox venture contributed nearly 10% of the net income reported by Xerox, without muddying up the “revenue” or “expense” lines.

It is a simple adjustment, however, to see how net margin would be affected by looking at only the operations for which Xerox fully reports results. All that is needed is to subtract “equity in net income of unconsolidated affiliates” from net income, which we do in the table below.

As expected, net margin is lower when you take out portions that are treated as 100% profit (all costs are off the financial statements.) There is also a smaller improvement in margin (130 basis points rather than the 140 reported) in 2006, but a larger one in 2005 when adjusted numbers are used. In addition, the growth in net income is higher in both periods when using the adjusted number. Overall, this analysis tells us that the company’s non-JV business was starting in worse condition that was apparent, but showed more significant improvement relative to taking the numbers at face value.

By understanding how the accounting requirements as well as any management discretion used when applying them, investors can piece together more of the puzzle.

Posted on 27th February 2007
Under: Accounting, Adjusting Reported Financial Statements, Common Size Analysis, Financial Statement Analysis, Fundamental Analysis, Investing in Stocks, Ratio Analysis | No Comments »

The Accounting Equation

The basic accounting equation is Assets = Claims

Assets are the cash, physical property, and other resources the entity controls that can be used to generate cash, provide future economic benefits or settle obligations.

Claims are the firm’s contractual and other obligations. There are two basic types of claims. Non-owners’ (creditors) claims are called liabilities. Claims held by the firm’s owners are called owners’ equity. Creditors have the primary legal claim against assets. Equity is a residual claim; should the company liquidate the business, anything remaining after obligations to creditors are settled belongs to the owners. For different types of entities, owners’ equity takes different forms. Corporations generally refer to it as stockholders’ equity. Unincorporated business with may call it proprietor’s capital or partners’ capital.

An expanded version of the basic accounting equation is often used to distinguish the two types of claims:

accountingequation.jpg

This is the essence of a balance sheet. The statement must always be “in balance” regarding the assets and claims against them.

Posted on 25th February 2007
Under: Accounting, Financial Statement Analysis, Fundamental Analysis | 5 Comments »

Reminiscences of A Stock Operator

The following is an excerpt from Jesse Livermore’s “Reminiscensces of a Stock Operator,” which is available in our public domain library.

Another lesson I learned early is that there is nothing new in Wall Street. There can’t be because speculation is as old as the hills. Whatever happens in the stock market today has happened before and will happen again. I’ve never forgotten that. I suppose I really manage to remember when and how it happened. The fact that I remember that way is my way of capitalizing experience.
I got so interested in my game and so anxious to anticipate advances and declines in all the active stocks that I got a little book. I put down my observations in it. It was not a record of imaginary transactions such as so many people keep merely to make or lose millions of dollars without getting the swelled head or going to the poorhouse. It was rather a sort of record of my hits and misses, and next to the determination of probable movements I was most interested in verifying whether I had observed accurately; in other words, whether I was right.
Say that after studying every fluctuation of the day in an active stock I would conclude that it was behaving as it always did before it broke eight or ten points. Well, I would jot down the stock and the price on Monday, and remembering past performances I would write down what it ought to do on Tuesday and Wednesday. Later I would check up with actual transcriptions from the tape.
That is how I first came to take an interest in the message of the tape. The fluctuations were from the first associated in my mind with upward or downward movements. Of course there is always a reason for fluctuations, but the tape does not concern itself with the why and wherefore. It doesn’t go into explanations. I didn’t ask the tape why when I was fourteen, and I don’t ask it today, at forty. The reason for what a certain stock does today may not be known for two or three days, or weeks, or months. But what the dickens does that matter? Your business with the tape is now — not tomorrow. The reason can wait. But you must act instantly or be left. Time and again I see this happen. You’ll remember that Hollow Tube went down three points the other day while the rest of the market rallied sharply. That was the fact. On the following Monday you saw that the directors passed the dividend. That was the reason. They knew what they were going to do, and even if they didn’t sell the stock themselves they at least didn’t buy it. There was no inside buying; no reason why it should not break.

Posted on 25th February 2007
Under: Library | No Comments »

Community Project: Public Domain Financial Library

We’d like to build a resource library of financial texts that have entered the public domain. Right now we have one: Jesse Livermore’s Reminisces of a Stock Operator. (Sorry – we wish we could remember where we found it to give proper credit but we can’t.)

At any rate, we hope the Internet community can help us find other useful financial books that can be uploaded as pdf or word documents for everyone to enjoy. If you know of any, please contact us.

Posted on 25th February 2007
Under: Uncategorized | 2 Comments »

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Posted on 25th February 2007
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Library

Many of the classic financial texts have entered the public domain. With any luck, we’ll be able to collect them here as a free reference guide. If you know of any other available public domain classics, please let us know and we’ll try to get them up here.

Reminiscenses of a Stock Operator, by Jesse Livermore (writing as Edwin Lefevre)

Posted on 25th February 2007
Under: Uncategorized | 4 Comments »

Kiplinger’s Reviews Finding the Next Starbucks


Kiplinger’s March 2007 issue included a review of “Finding the Next Starbucks” by Michael Moe. They liked the book – after the first 200 pages, which they found to be a boring rehash of the obvious.

Posted on 25th February 2007
Under: Book Reviews | No Comments »

Pensions: The Impact of Pension Assumptions on Earnings

Pension plans promise employees a benefit that will be received at a future time. Estimating the cost of these benefits requires many discretionary assumptions. These include an appropriate discount rate to determining the present value of future benefits, the estimated rate of future compensation increases, and the expected return on plan assets. The primary impact of these assumptions is illustrated in the table below.

pensionestimates.jpg

Posted on 22nd February 2007
Under: Accounting, Adjusting Reported Financial Statements, Financial Statement Analysis, Fundamental Analysis | No Comments »