Saturday, May 31, 2008

Mark Cuban on CEO Pay

Here is one more reason Mark Cuban should get more credit--besides the day spent working at Dairy Queen, besides his rabblerousing to make the NBA a better league, and besides transforming the Mavericks franchise into a contender--he has a delightful blog:

http://www.blogmaverick.com/2008/04/15/my-2-cents-on-ceo-pay/

The above entry is his take on CEO pay, and Mr. Cuban's idea is absolutely ingenious. It wasn't too long ago that companies were refusing to include the true cost of any stock option grants in their accounting reports. Mr. Cuban's idea makes the ability to fudge the numbers even more difficult, because it's hard to miss money coming out of the cash flow till. His idea would probably also accomplish what many shareholder compensation resolutions are trying to do--lower the ratio between the CEO's pay and the average worker. Here is Mr. Cuban's idea, in his words:

Make companies generate 100pct of their compensation in cash that is 100pct expensable in the quarter paid. Thats not to say they cant own stock. Hell yes they can own stock. But make them buy it either on the open market, or as part of the programs that make stock available to every company employee, on the same terms. They are getting paid enough in cash and if they believe in their ability to run the company, they can put their money where their mouth is. Eliminate all the free lottery tickets. Make them buy stock, options, warrants, whatever, on the same terms as everyone else can.

Shareholders tend to ignore how much stock is given to management, they don't ignore cash. Companies will always be a lot more stringent with their cash, whether its paid to the CEO or anyone else. CEO cash compensation will go way up, but total compensation will come way down. More importantly , CEOs getting paid huge sums in cash will stand out like a sore thumb when things arent going so well. They will be treated like everyone else in the cash zone and held far more accountable for their work.

I naively believed that this kind of out-of-control compensation would not happen after 2002, when E-Trade's CEO, Christos Cotsakos, received 77 million dollars at a time when his company lost 242 million dollars. The resulting outrage caused him to pay back some of the money, but obviously, no lasting changes occurred. Here is a link about that incident:

http://www.businessweek.com/bwdaily/dnflash/may2002/nf20020517_7164.htm

Friday, May 30, 2008

Stocks Update

Big pharma looks like one of the cheaper sectors in the market. Today, I bought

60 shares of PFE (Pfizer) at 19.33
50 shares of MRK (Merck) at 38.61
65 shares of WYE (Wyeth) at 44.41

In my tiny, self-made pharma fund, I like WYE the most. MRK will issue a dividend soon, which is one reason I wanted to own it. I bought 100 shares of PFE before (at around 20.70) and am averaging down. It will probably take years for the pharmas to get out of the doldrums. In the meantime, I am sure it will be a bumpy ride. If a Democratic president is elected, chances are that any universal health care plan will squeeze big pharma. In addition, Congress may decide to cut consumer prescription costs by supporting generics and reducing patent rights. But with money market yields at around 2%, I could do worse than put my money in these dividend-generating stocks. I am not necessarily a long-term investor--once MRK pays its dividend, for example, I will look to get out.

Update on June 2, 2008: Bought 50 MRK @ 38.12 (have 100 shares total now)

The information on this site is provided for discussion purposes only and does not constitute investing recommendations. Under no circumstances does this information represent a recommendation to buy or sell securities or make any kind of an investment. You are responsible for your own due diligence.

Thursday, May 29, 2008

Federal Reserve President Richard Fisher at the Commonwealth Club

Richard Fisher, the CEO and President of the Federal Reserve Bank of Dallas, spoke at San Francisco's Commonwealth Club (595 Market St.) on May 29, 2008. Some highlights:

1. Mr. Fisher is a big fan of Bill [McChesney] Martin, known for his statement that the job of a central banker is to "take away the punch bowl just as the party gets going."

2. Mr. Fisher said that the Dallas Federal Reserve's inflation numbers incorporate food and energy/gas prices. See http://dallasfed.org/research/ for more information. I believe that what Mr. Fisher was referring to is the the "trimmed mean PCE" numbers, but I could be incorrect. What seems clear, however, is that the PCE numbers are probably more accurate than the CPI numbers, which are usually "excluding food and energy." As you can see in the next link, the PCE numbers are usually at least one percentage point higher than the CPI numbers. See http://www.dallasfed.org/data/pce/index.html

Mr. Fisher indicated that only his bank and the Cleveland Federal Reserve Bank published these more comprehensive numbers.

3. Mr. Fisher's speech sounded like a more number-heavy speech that the former Comptroller David Walker would give. He warned us to do something about government spending, saying that we are "falling victim to complacency and recklessness." He mentioned the "frightful storm of untethered government debt." [He probably meant to say, "unfettered," not "untethered."]

8 years ago, we had a surplus of 236 billion dollars, with a Republican Congress and Democratic president (Mr. Fisher emphasized that these issues were non-partisan.)

Today, the expected deficit in 2008 is at least 410 billion dollars.

Our underfunded liabilities, using an infinite horizon discounted value, is 13.6 trillion dollars for social services.

[Now, I don't pretend to know what an infinite horizon discounted value is. For more information on infinite horizon projections, see

http://www.factcheck.org/article302.html

That article says that an infinite horizon model is misleading, but Mr. Fisher mentioned an infinite horizon "discounted value," which may be different.]

Mr. Fisher said that Medicare was the biggest problem. Medicare has three parts, A (hospitals), B (doctor visits), and D (drug benefits/prescriptions). He estimated a projected deficit of 85.6 trillion dollars for Medicare. Including the projected deficit of Social Security benefits, Mr. Fisher expects a 99.2 trillion dollar deficit in unfunded portions of entitlement programs. He said that this debt works out to be more than 300,000 dollars per person, assuming a population of 304 million, which includes nonworking adults and children. Income taxes have to increase 68%(?) to cover deficits, which is basically reaches confiscatory levels.

What to do about all this? Well, he didn't have much to say, other than it was our responsibility, because we elect the people who run the government.

4. Mr. Fisher dissented in the last three interest rate cuts. He is an inflation hawk and said that "inflation is the most insidious enemy of capitalism and prosperity." He also said that "running the printing press" [of money] is the worst option, because that causes inflation, and stable prices are necessary for growth.

5. Mr. Fisher mentioned a humorous story where someone asked a researcher, "Is there a difference between the Republicans or Democrats [Congresses] in terms of who spends more money?" The answer was, "There's only one difference--Democrats enjoy it more."

6. Mr. Fisher was more relaxed during the Q&A session.

When asked what his bank does, he said that among other things, the Federal Reserve lends money at the discount window; clears checks (which is a declining function--he said his children had never used a paper check--people are moving to online banking); assists the U.S. Treasury; and processes cash (his bank recently processed 12 billion dollars--cash is used more in TX).

Mr. Fisher ran for a U.S. Senate seat and lost. In his funniest remark, he said he calls the legislative branch "the lower intestine." This was after he said the best part of his job was that he was allowed to speak the truth, and most government officials could not do that because they had to get elected, or balance competing interests. The difference between his position and the other branches was that he "could tell the truth."

He said that the FOMC meetings were a civil deliberation and a process that emphasized civility.

Comparing Greenspan and Bernanke, he said both of them had a great sense of humor. Bernanke was "perditiously smart," understanding the Depression more than any other living human being. He said Bernanke's best experience was serving on the local school board in Pennsylvania. On Greenspan: he "listened very well," perhaps because he played the saxophone.

Mr. Fisher said we are in for a period of "anemic economic activity," but said he would not call it a recession. He said the "debauching of our credit system" hurts small businesses, which create jobs in America.

He also said that we are experiencing inflation and our current economic climate because "we won." In his most passionate remarks, Mr. Fisher commented that "Chairman Mao is dead--I won't say God bless his soul. Hồ Chí Minh is dead. In November 1989, the Soviet Union filed for bankruptcy. We won." Everyone wants to imitate our lifestyle, which raises prices and leads to a period of more competition as other countries adopt our successful capitalist model.

A question was asked about implementation of the Basel II Accord, but Mr. Fisher said the writer of that question should come up to him afterwards and speak to him about it directly, because it was a technical question.

Mr. Fisher said he was instrumental in getting NAFTA passed and was "proud of NAFTA." He referred to Joseph Schumpeter and "creative destruction," saying that it drove each of us to our "competitive advantage." but said that the media was skewed in its reporting. If a company shut down, the media was there, but it wasn't there to record an instance when a completely new job opened for that person who was laid off or in general. He said that only 1% of our economy was based on agriculture; 5% on mining; 11% on manufacturing; and the rest (84%) was services. To give us an idea of how the economy has changed, Mr. Fisher said that lawyers "produced" more GDP than auto manufacturers [a sure sign of over-legislation].

A question was asked about whether he believed that the numbers from the BLS were accurate. He said that he was more concerned about sufficiency of the data than its accuracy. There are apparently large swathes of the economy that aren't reflected in the numbers he receives.

Overall, it was a fun experience. I asked him a question privately, about which currency he believed would be the most stable over the next five years. Mr. Fisher said that he couldn't predict that far out, and a basket of currencies would be the most stable way of managing risk. He did say that the European Central Bank had only one mandate, which was to control inflation, while the Fed had a dual mandate [maximum sustainable employment and price stability]. His comments seemed to imply that the Euro might be the most stable currency, but for the long term, he said he favored the U.S. dollar. His refusal to give me a clear answer was astute. To give you an idea of just how quickly things can change, remember than as recently as November 2003, Mr. Bernanke is on record as saying that "the current risk of increased inflation is, for the time being at least, quite small." See

http://www.federalreserve.gov/BoardDocs/Speeches/2003/
200311062/default.htm

The job of American central bankers--especially given their recent inability to predict bubbles and busts--is to respect savers while minimizing unemployment. Hopefully, Mr. Bernanke will get back to the "respecting savers" part of the mandate by raising interest rates at the next FOMC meeting.

FYI: The San Francisco Federal Reserve is right up the street from the Commonwealth. Call ahead of time, but for now, they have tours open to the public on Fridays at noon. Otherwise, they are closed to the public.

Ronald Reagan on Libertarianism

If you analyze it I believe the very heart and soul of conservatism is libertarianism. I think conservatism is really a misnomer just as liberalism is a misnomer for the liberals — if we were back in the days of the Revolution, so-called conservatives today would be the Liberals and the liberals would be the Tories. The basis of conservatism is a desire for less government interference or less centralized authority or more individual freedom and this is a pretty general description also of what libertarianism is. Now, I can’t say that I will agree with all the things that the present group who call themselves Libertarians in the sense of a party say, because I think that like in any political movement there are shades, and there are libertarians who are almost over at the point of wanting no government at all or anarchy.

From Interview with President Reagan, published in Reason July 1975

http://en.wikiquote.org/wiki/Ronald_Reagan

One of the American public's worst misconceptions is that libertarianism calls for no laws. As I explained in my review of Milton Friedman's Capitalism and Freedom, Mr. Friedman himself stated the need for government: "The existence of a free market does not of course eliminate the need for government. On the contrary, government is essential both as a forum for determining the 'rules of the game' and as an umpire to interpret and enforce the rules decided on." See

http://willworkforjustice.blogspot.com/2007/08/capitalism-and-freedom-by-milton.html

Thus, anyone who states that libertarianism means anarchy or no laws is incorrect. Libertarianism merely means that you agree that interference with your ability to lead your life as you see fit--assuming your actions do not interfere with others' freedom--should be reduced as much possible.

More on government debt and the money we pay to the government: Richard Carmona, former U.S. Surgeon General (2002-2008), says that "75 cents of every tax dollar that you contribute [to health care] is spent on chronic disease, much of which is preventable" (The Commonwealth magazine, June 2008, page 44). Mr. Carmona singles out smoking and obesity as two of the largest scourges of health. One issue with having universal health care is how we regulate chronic disease--does an obese man get a free gastric bypass, or a free diet book? I wish I knew the answer.

One way to reduce the burden on a national healthcare system is to have government workers use the old, pay-as-you system, while non-government workers use a separate, heavily subsidized health care system. This way, only government workers would pay healthcare premiums out-of-pocket through HMOs or some other private programs. With most government workers not being "at-will" and therefore harder to terminate, they are best positioned to budget and pay monthly premiums to private hospitals. This type of carve-out is not unprecedented--postal and other federal workers, for example, do not get the same federal retirement benefits private citizens do because federal workers don't pay certain taxes. With more than 1.8 million civilian employees, the Federal Government, excluding the Postal Service is the Nation’s largest employer. If you add in local and state government, teachers, professors, and other government workers, you would have enough members to incorporate into a private hospital system. In fact, you could probably leave the current HMO/PPO system intact, and then work with existing hospitals to provide free health care to private citizens or invest in new hospitals. The out-of-pocket and insurance reimbursement system would shift to government members rather than private citizens, who are the ones most required to be healthy so that they can be productive and pay taxes to sustain the government.

Zazzle dazzles!

I bought one custom-made shirt from Zazzle a few days ago, and it arrived today. I am very happy with the product. Many other custom shirt-printers require their customers to buy multiple (e.g., six or more) shirts before placing an order. Zazzle is more flexible. If you are interesting in buying a custom-made shirt or just want to buy a quality shirt, check out Zazzle:

http://www.zazzle.com/

Home Prices Nationwide and in Select Markets, Inflation-Adjusted and Actual Growth and Fall

From Barry Ritholtz at http://bigpicture.typepad.com/

http://www.nytimes.com/interactive/2008/05/28/business/
20071031_HOUSING_GRAPHIC.html

It's an interactive chart from the New York Times showing the decline and incline of housing prices over the past 20 years, both locally and nationally.

Stocks Update

Last week, I bought MMM, IF, and SCUR on May 23, 2008.

I sold MMM this week, making around 0.5%.

SCUR was much better. I sold today, making a 15% gain in less than a week (May 23, 2007 to May 29, 2008).

IF is basically flat so far. No worries--that is a long term hold.

So here is my track record thus far in terms of round-trips:

MMM = 0.5% (less than seven calendar days)
SCUR = 15% (less than seven calendar days)
IF = (bought on May 23, 2008--not sold yet)

Keep in mind, most of these trades were in a Roth IRA, so I won't pay taxes on the transactions until I withdraw the money in my (hopefully) old age. My trades will not generally incorporate any tax analysis.

The information on this site is provided for discussion purposes only and does not constitute investing recommendations. Under no circumstances does this information represent a recommendation to buy or sell securities or make any kind of an investment. You are responsible for your own due diligence.

Jamba, Inc. Shareholder's Meeting, May 28, 2008

Jamba Juice's (JMBA) shareholder meeting took place near the beautiful Berkeley marina at the Doubletree Hotel (Berkeley Marina). I attended Jamba's first ever meeting last year, and the same issues concern me today that concerned me then. See

Jamba Juice Shareholder Meeting (2007)

In that earlier post, I talked about futures contracts (for oranges), as well as a possible partnership with a major company. As we know, Jamba now partners with Nestle to produce read-made beverages sold in stores. As for future contracts, well, the CFO is opposed to it for reasons I think are illogical. At the same time, with all commodity prices being so high now, perhaps futures contracts are not currently a great idea. It's a CFO's job to monitor futures markets to increase price stability of key ingredients, and it deeply disappointed me to hear him almost reject outright the possibility of using futures contracts.

But back to the present. In contrast to last year, Jamba offered its products to shareholders at the meeting. It more than made up for last year. This year, shareholders got to sample the new ready-made juicies and smoothies, as well as "granola poppers," a yogurt-like smoothie with granola on top. At the end of the meeting, Jamba caps were given out, with a coupon for a free smoothie in the in-seam of the cap's tongue (a nice touch). I suppose when your stock goes from $10 dollars a share to around $2.50, public relations feels the need to upgrade the shareholder experience. Some may say that's pandering, but I am all for it. Despite my losses in this stock, I actually came out of the meeting with my bloodlust for management somewhat satiated. The fact that I had to cross the beautiful S.F.-Oakland Bay Bridge and spend some time near the water in Berkeley might have had something to do with the soothing feeling as well.

First, let's talk about the new products. Nestle's alliance with Jamba has produced two kinds of drinks: juicies and smoothies. Juicies are basically a little silkier (in Jamba-speak, "refreshing"), while smoothies are more filling (in Jamba-speak, "nourishing"). This is because smoothies use some low-fat milk, while juicies use some non-fat milk. On the smoothie side, Jamba had "strawberries wild" and "banana berry" flavors, and on the juicie side, "very berry" and "mango orange peach. " I liked the juicies better--they were more refreshing.

Attending the meeting were about 25 people, mostly management, and an African-American team of teenagers called "The Wall Street Wizards." (Se http://wallstreetwizards.org/) Mr. Thomason, the founder of the program, was there and ran a tight, professional ship. One of his students fell asleep during one presentation (no one seemed to notice except Mr. Thomason), and he asked a classmate to wake up the student. His students seemed to have quite a bit of fun and asked several intelligent questions, including one about hedging (apparently a high school student and I can figure out that hedging could be an important tool for this business, but not Jamba's CFO, Donald Breen. But to be fair, most formally educated economists agree that hedging does create more volatility in earnings).

Paul Clayton, President and CEO, and Paul Colletta, Marketing and Brand Development, had presentations. Mr. Coletta is the person responsible for changing the cluttered Jamba menu into the easy-to-peruse current menu--probably the single best accomplishment to date in terms of Jamba's consumer-friendliness. I would get headaches reading the old menu, trying to decide what to order.

Mr. Clayton is a consummate professional. I am happy he is the CEO of this company, and he truly seems to care about the company and consumers.

The meeting started inauspiciously when a shareholder asked why there weren't any female directors on the Board. Ouch. I hadn't realized there were no female directors on the Board, but having no female directors is not a good sign for a California company trying to appeal to progressive types. In all fairness, Apple, Inc. had the same complaint two years ago, and finally put Susan Decker on its Board. Steve Jobs responded at the time that women were smarter than men and thus didn't want the liability of being on a Board, so it was harder to find them. Mr. Clayton could have used a play from Mr. Jobs' book. For the time being, Mr. Jobs is correct--other than Susan Decker--a person who I respect a great deal and who adds instant credibility to any company that is lucky enough to hire her--there isn't a ready pool of female candidates to choose from in terms of Board participation. Jamba should start looking for female directors--it would add a nice boost to their image if by 2010, their Board was 1/2 female.

The formal part of the presentation included a comment that approximately 36 million shares were present out of the 52 million outstanding shares. This is a small company, in other words.

CEO Clayton's presentation was done by slides, along with extensive comments assisting the audience in understanding the material. First, probably due to more stores opened, Jamba's revenue has been increasing every year since 2003. Jamba is also into a joint venture with a Hawaiian company that is doing well, but Jamba owns only a 5% stake. Any good news, though, is nice at this point for suffering shareholders.

CEO Clayton's presentation included a detailed chart showing why margins, and therefore profits, had declined. Here is a breakdown of the basic margins in 2007:

COGS (ingredients, cups, etc.) = 27.5%
Labor (increases in minimum wage, worker's comp insurance, etc.) = 33.5%
Occupancy (rent, lease obligations, etc.) = 12.2%
Other (mainly marketing) = 13.2%
Profit Margins = 13.6% (last year = 18.6%--substantial decrease)

If you did the math, you'll see that 1% is somehow lost in these numbers, probably due to some rounding off. In any case, as a result of the increase in overhead, cash flow decreased from 18.6% to 13.5%. The main culprits were minimum wage increases (including an even higher local minimum wage in S.F.) and new store leases.

The rest of the slides focused on Jamba's brand name recognition. The MTO (made to order) market is a 2.29 billion dollar market. Jamba has a 19% market share in this market, with the next individual competitor, Freshens, being at only 6%. The category of "Other," or mom and pop stores and Hobee's, equaled 70% of the market share, which shows that Jamba doesn't have a high market penetration and will keep improving its market share. The ready to drink market--which Jamba is now entering--is only a 655 million dollar market, with Odwalla (owned by Coke) being the market leader. Nestle obviously wants a share of this increasing market and that's why it has partnered with Jamba.

Unfortunately for Jamba, outside of California, DQ/Orange Julius dominates in the public perception of MTO smoothies. Next in line, nationally, are Sonic and Starbucks. In California, however, Jamba is the leader with 86% brand name recognition (only 33% outside of California).

Jamba seems to be focusing on opening new stores in airports, colleges, and grocery stores.

Paul Coletta, Sr. VP of Brand Development, did the next presentation. He indicated he wanted to improve frequency of store visits and sales. His slide had a term, "J6 Store experience," which he did not explain. Mr. Coletta said that Jamba is a "healthy living company," with no high fructose corn syrup and no trans fat in any of its products. The healthy living pillars Jamba abides by include an all natural, balanced life and an emphasis on the goodness of whole fruit.

With respect to its athletic, balanced life image, Jamba is partnering with Nike in running events. I don't see any significant revenue from this alliance, however--it's more of an advertising move.

Mr. Coletta mentioned that he wanted to "innovate beyond the smoothie" into teas, juices, and meals in a blender. He said that advertising strategy had been flipped from in-the-store marketing to "sampling," which is giving away free samples to the public. Now, most of Jamba's "communication strategy" was marketing, which included billboards (I saw a huge Jamba wall-billboard in S.F. after the meeting--it was very well-placed--you can't miss it if you're driving down a particular highway exit in S.F.) and radio ads (Mr. Coletta indicated he wasn't too bullish on this method), in addition to sampling.

Jamba wants to become a "part of pop culture." What Mr. Coletta really means is that becoming a part of pop culture gets a company free advertising. For example, Campbell's Soup didn't have to pay anything to Mr. Warhol for its famous pictures. He ran a video showing some tv ads, including a hilarious SNL skit starring Keira Knightley as an energetic, enthusiastic employee who couldn't stop moving. Only when a customer, Amy Poehler, said she didn't want a free boost did the employee stop moving, even calling over other employees. (Ms. Poehler eventually changed her mind and did get the free boost.) Letterman is a fan of Jamba Juice and has incorporated some skits in his Late Show using Jamba Juice. A montage of stars caught with Jamba Juice products in their hands was shown, mainly from Hollywood-type and "People" magazines. One piece of bad news is that some of the images were taken from last year's meeting, but there were plenty of new images.

Mr. Coletta mentioned that Jamba had been featured in the new film, "Baby Mama."

A gentleman from the Wall Street Wizard group asked about hedging. The CEO deferred to the CFO, who talked about how Jamba had contracted with a blueberry grower to get a consistent supply of blueberries. The CFO said that there was a "force majeure" clause in contracts relating to seasonal fruit contracts, so it was hard to hedge, and he preferred a "contracted price" directly with a supplier. I call tomfoolery on this answer. Southwest Airlines did a great job hedging its exposure to the volatile commodities market, and Peet's also uses futures contracts for its coffee and tea. As I indicated last year and again this year, had Jamba bought futures contracts for oranges, it would have avoided the debacle of January 2007 and onward, where it passed on the cost of higher orange prices to its consumers in the form of a 50+ cent increase. I can't tell you how unprofessional Jamba's stores felt in the past when I went there and was told if I wanted a drink with oranges, I had to pay more. The CFO wasn't done, however. In response to my question, "Wouldn't Jamba have avoided the debacle of January 2007 if it had hedged?," he actually said that Jamba would experience "more volatility" if it engaged in futures contracts because if the prices decreased, it would have to mark-to-market the contracts. This response upset me so much, I almost began to personally blame the CFO for the decrease in Jamba's stock price. I said it was the CFO's job to ensure a steady and stable business environment if possible, and if Jamba had a major ingredient like oranges it needed, the natural course would be to selectively use the futures market and then hedge further by contracting with local suppliers or even owning suppliers of fruits outright. The idea that futures contracts cause "more volatility" for a business seems just plain wrong [but see the comments section--an intelligent writer indicates that using futures would indeed increase volatility in a mark-to-market scenario with respect to earnings. I now understand the CFO was technically correct. I maintain that guaranteeing an actual delivery and price of a hedged product would increase stability, because it is easier to plan ahead when you lock in a major cost of doing business over the next 9 to 12 months. In this case, JMBA probably believes it can always get its ingredients somewhere, at some price, and won't ever be faced with an actual shortage of a fruit to the point where actual delivery on a futures contract becomes necessary. It must also believe that even higher prices of oranges will not disrupt its business, profits, or image, which is the sticking point between Jamba and myself]. Even if the price of the contracts decreased, many shareholders might consider that an acceptable risk because of the importance of delivery of an essential ingredient. In fairness, most of the fruit ingredients Jamba uses heavily don't seem to have an American futures market, like strawberries (Spain does have a futures market in strawberries, however). Still, it boggles my mind that Jamba's management hasn't explored all possible hedging strategies in depth. If it doesn't think that the orange price increase it passed on to consumers before hurt its image, Jamba is out-of-touch. There just isn't a culture of fear at the company, and that's a strange thing when the stock price is around 2 dollars a share.

The CEO took over the rest of the Q&A session. He said that Nestle was the one spending the money on advertising the new ready-made drinks. In response to another question, the CEO indicated that Jamba hadn't put more stores in the South because the key metric was "average unit sales," and most Southern cities didn't have the required "density" (of population) to make it a profitable venture. He expanded by saying that average unit sales were better in smaller cities, like Seattle, and even Chicago took some time to ramp up sales. He said the lower average unit sales were in Texas, a large state. This emphasis on finding the highest average unit means that the CEO is looking to expand not just in warm climates, but in areas where he believes consumers are "early adaptors," a neat phrase. He basically means he wants people who are fitness conscious and willing to try new things--which means that he will look to expand in cities with a high young population, which will also produce teenage employees willing to work for minimum wage. It's a smart move, but it still doesn't explain why Jamba only has 28 (twenty eight) stores in the entire state of Florida. That failure to expand in Florida is one indicator that Jamba just isn't focusing enough on location as a key metric in opening stores. A shareholder pointed out that Jamba had a store in Idaho, but no stores in several Southern states, where it was warmer. The CEO said that the "seasonality curve is the same," and referred back to his density (of population) issue. He said that he wants to open stores in D.C. Anyone who has spent a summer in D.C. knows that Jamba is correct in wanting to open stores there.

I asked about the impact of the outstanding warrants (derivative liabilities) on the diluted earnings per share, and whether they had any impact if the stock price stayed below 6 dollars a share. (See page 25-26 of the 10K.) The CFO said that it was better to view the warrants as increasing or decreasing revenue. As I understood his response, for every dollar reduction in the stock price, Jamba loses 17 million dollars; for every dollar increase in the stock price, Jamba gains 17 million dollars. You can see the problem when Jamba stock has decreased from $10 to $2.50 over the past year.

I asked why Jamba had bought back 34 stores from its franchisees (see page 34 of the annual report). The CEO said that he had expected same store sales to increase and had he known that profit margins would deteriorate, he may not have made the same decision. He said that "2008 is going to be a bumpy year" as Jamba tries to drive down costs and increase foot traffic in its stores. That's not something a shareholder wants to hear, but he gets points for being honest. He said Jamba would be focusing on improving margins to "drive top line sales." With 99 new stores, which will probably take about two to three years to recoup their investment and bring steady income, Jamba has quite a bit on its plate and seems to be re-trenching.

Someone asked whether Jamba wanted to expand internationally. The CEO answered that he had a staff of one person doing due diligence on international expansion. He prefaced that comment by joking that it was fun to imagine us going into different countries and planting our flag, sticking out his chest, but that other considerations warranted more due diligence. He got a laugh from that animated response.

I said that Jamba wasn't focusing enough on location, and that while I enjoyed Mr. Coletta's presentation (it was much better than last year's), a store could have the best product, but would go out of business if it didn't have a good location. I said Jamba might go bankrupt if it didn't focus on location over brand recognition. Here is my highlight of the meeting--the CEO said, "I promise you we are not going out of business." Shareholders, take note--Mr. Paul Clayton has put his own personal reputation on the line. I hope it works out.

Mr. Coletta took the last few questions. He said that Jamba needed to stay below 5 dollars for products--the consumer resistance point is five dollars. He was open to introducing hot products, and he was testing them, but they had to be complementary to the Jamba experience. In response to a question that Jamba stores were packed in the summertime, but dead in the winter, Mr. Coletta said that he understood that, and he was planning on 1) year round drinks (like the "Coldbuster," which had less of a seasonality problem), 2) hot (drinks and food); and 3) meals.

The CEO was friendly to me after the meeting, despite my tough questions. It looks like Jamba needs to focus more on the details, like location and menu items, rather than brand recognition, but overall, at $2.50 a share, it might be a value play. I do not plan on adding any new shares. Peet's just came out today with an email coupon advertising its new Berry Pomegranate Tea Freddo. It looks scrumptious. While Jamba is sitting on its hands and thinking about what new drinks to serve, and whether it should diversify its menu into hot and cold drinks, its competitors are adapting more rapidly to the market. You can have all the brand recognition in the world, but at the end of the day, what counts is your product and your ability to get that product into customers' hands.

You can write to Jamba's Board of Directors at the following address:

Board of Directors (or Chairperson)
c/o Corporate Secretary
Jamba, Inc.
6475 Christie Avenue, Suite 150
Emeryville, CA 94608

Long's Drugs Stores Corporation Shareholder Meeting, May 29, 2008

The Longs Drugs Stores shareholder meeting (LDG, 2008) took place at the Shadelands Arts Center in Walnut Creek, CA. Walnut Creek is a storybook kind of city, with trees, churches, and friendly people seemingly on every corner. The Shadelands Center in Walnut Creek is a room that is part of an overall community center. There were about 160 chairs in the room. Food was practically non-existent. Pepperidge Farm's basic "Milano" cookies were served with some coffee and water. (Of all the Pepperidge Farm products to bring, why, oh why, did it have to be the basic Milano?) Needless to say, I was not impressed with the food offerings, and with the meeting being held in a community center, and no company products being given away, I was ready to call "cheapo" on Longs. I was pleasantly surprised, however, by the quality of the presentation. Longs is an old-school company, but if you're dealing with drugs, maybe old-school is just fine.

First, some definitions: PDP = prescription drug plan; PBM = pharmacy benefit management services; and front-end sales...we'll get to that later.

Longs Drugs first began by introducing its Board. The actual presentation was done by slides. Longs' CEO, Warren Bryant, talked about "superior customer service" being an "important differentiator." He seemed bullish on Hawaii. Longs opened six new stores there, while shutting down stores in other states. A slide indicated that Longs opened its first store in Hawaii in 1954.

Rx America, LLC (http://www.rxamerica.com/) is Longs' real jewel. Longs doubled its Medicare beneficiaries from the previous year.

Longs touted its share buybacks and community service (local charities and Governor's Council on Fitness and Sports).

The Q&A session had exactly one person who asked questions, and yes, it was yours truly. I asked what "front end sales" and "front end merchandise" meant. (See 21-23 of 10K, etc.) The CFO said it basically meant "everything other than prescription sales." This is an important term and should be defined more clearly in the 10K--other drug stores (e.g., Rite Aid) have been hit with accounting scandals, so drug companies need to be as clear as possible in their accounting terminology.

I asked the CEO about Longs' reliance on AmerisourceBergen (Symbol: ABC), which supplies them with most of their drugs (http://www.amerisourcebergen.com/cp/1/). (ABC's numbers are difficult to decipher because of the acquisition of Bellco in October 2007 as well as its share buybacks.) I asked why Longs didn't take a minority stake in such an important partner, and only did a 50% joint venture with them. CEO Bryant said that ABC was a publicly traded company and that Longs had no investment stake in it. He deferred the joint venture question to the CFO, who said that about eight years ago, ABC and Longs started a joint venture to open a "central fill operation" in Sacramento, CA, which was completed about three(?) years ago.

I asked whether Longs had a "poison pill" provision to prevent a takeover from CVS or Walgreen's. The CEO made some comments but basically said that it was a matter for the Board of Directors. The general counsel chimed in and said that after a stockholder's rights plan amendment a few years ago, there was no "poison pill" as the term is generally understood. I am betting CVS eventually makes a bid for Longs.

Before I get to the annual report, one interesting tidbit--I heard some directors talk about Dubai. One said, "I was just in Dubai--fabulous." Dubai is getting a good reputation among businesspeople.

Here are the highlights from the 10K:

Pages 14-38 are about compensation. (The first part of the 10K pamphlet is a compensation audit.)

The actual 10K report begins on a separate page 1 after the compensation audit. Longs was founded in Oakland, CA in 1938 (page 1).

Pages 39-40 would be fun to read for employment lawyers. Longs talks about what a "for cause" departure is for severance package purposes.

Longs has 510 stores, mainly on the West Coast and Hawaii (447 stores in CA: see pages 6, 13).

Here's an interesting part: RxAmerica, Longs prescription benefit subsidiary, is buying an insurance company (which it openly refers to as a "shell" company). Longs has to buy such a company because the new Medicare rules require all prescription plan providers to do so--although I can't figure out why, other than the reference to plan providers shouldering some of the risk and the expiration of Medicare and Medicaid waivers. The company is Accendo (page 2), which used to be Nutmeg Life Insurance (page 5). Now, here's the issue--presumably, these insurance companies have issued policies to customers. What happened to all those policies, especially the life insurance ones? I should have asked this question at the meeting, but I really didn't have much information about the insurance company transaction, so I refrained.

See also pages 11-12: For 2009 and forward, "in accordance with the federal statutory mandate [Medicare Prescription Drug, Improvement, and Modernization Act of 2003], the insurance company [Accendo] will provide the Medicare prescription drug plans." Apparently, Accendo has to make a bid to CMS (Center for Medicare) for 2009. Seriously, could Longs be more vague?

Longs completed a distribution center in Patterson, CA (I've never heard of that city before).

Longs has 21,900 employees, with 55% being part time, and non-union (page 5).

Medicare and Medicaid = 24% of pharmacy sales (page 6).

Longs 4Q sales increase not only generally because of the holidays, but because of the cold and flu season--when people need drugs and flu shots (see page 6). I had forgotten that Longs and other drug makers love it when we get the flu. What's also interesting is that the report implies that the fourth quarter seems to be when Longs does much of its non-pharmacy business, but that reading could be a mistake on my part. I need to see the quarterly reports to confirm this overall 4Q-concentration, because it seems counterintuitive.

As indicated previously, AmerisourceBergen (ABC) is Longs major supplier of drugs (page 6). A joint venture is mentioned on page 28.

Page 7 indicates that Longs fears competition from mail order services. (Really? I wouldn't want to get my drugs by mail from an unknown company. Perhaps Canada is operating reputable mail order facilities?)

Page 5--no international sales.

Page 8--Longs plans on closing 31 stores in 2008.

For all you job-seekers and college hopefuls--on page 9, Longs says there is a "shortage of licensed pharmacists."

Page 14: this is why people hate lawyers. See Rankin v. Longs Drugs Stores California, Inc. (legal name). Basically, the lawsuit alleged that Longs employment application violated Labor Code 432.8 by inquiring about criminal convictions over the last seven years, without carving out an exception for marijuana use more than 2 years old.

LC 432.7, which is where 432.8 derives from:
(a) No employer, whether a public agency or private individual
or corporation, shall ask an applicant for employment to
disclose, through any written form or verbally, information
concerning an arrest or detention that did not result in
conviction...
So the lawsuit alleged that job applications must specify that a company is asking for non-Mary -Jane-related convictions. Can you say, "technicality"? Unfortunately, that's how many (most?) lawyers make money in state court--by doing what they were taught in law school, which is to parse everything and abuse technicalities. (State court is far more nurturing of the technical than federal court, which tends to look at the substance of a complaint.) Go legislators! Don't stop until you've made it impossible for any small business to survive in California without having an army of lawyers. (If this were a Tom Toles cartoon, the bottom right hand side of this piece would say, "You're almost there...")

But enough against lawyers--how else would a bloke like me make money?

Longs has properties located in CA, UT (pharmacy benefits), and NV (call center).

Page 19--Longs expanded in Reno by buying out some other company's stores. Nice move--with all the hangovers from gamblers and revelers, Longs should do good business there.

Page 24--more generics lead to better profit margins for Longs. Retail drug store gross profit was 26% of retail drug store sales in 2008.

See page 24-25: as a result of the way Medicare Part D works, Medicare doesn't actually provide any fees to the drug company until after a Medicare recipient spends more than $2,510 on prescriptions. Then, from $2510 to $5726, the recipient covers all costs. Then, from $5726 onward, the drug provider is responsible for 15% of the drug costs. So basically, until grandma spends $5726, Medicare isn't very profitable for a drug provider, and it takes several months to get there--another reason why Longs makes much of its money in Q4.

So there you have it--Longs is going to be a good company and attractive takeover target, assuming its insurance company purchase works out. It's too difficult for new entrants to get into the pharmacy business, so there seems to be a wide moat here. Also, no one (except maybe Walgreen's) has the stores in California that Long's has, so CVS is going to be knocking one of these days. As long as anti-trust issues don't harm any possible deal, Longs should be a decent long term investment. I will look to add shares if Longs falls to the low 40's and will also be looking at AmerisourceBergen (ABC).

Tuesday, May 27, 2008

CNBC "Stalks" Warren Buffett

In case you missed it, CNBC posted a page dedicated to Warren Buffett:

http://www.cnbc.com/id/19206666/

If the above link doesn't work or becomes outdated, google "CNBC Warren Buffett Watch."

Here are two transcripts relating to the 2008 Berkshire Meeting:

http://www.cnbc.com/id/24466954/

http://www.cnbc.com/id/24427682/

Jamba Juice, Inc. (JMBA)

Jamba Juice, Inc. reported earnings today, or, perhaps more accurately, no earnings--it lost 0.21 cents a share in Q1. JMBA is currently selling below book value, but that may not necessarily indicate that it's a good value play. Its products appeal mainly in the summertime, and outside of the West Coast and the South, the weather isn't sufficiently warm to increase demand for cold fruit smoothies year-round. The breakfast shakes it introduced earlier this year were a good idea, but they haven't caught on like the Frappuccino. Perhaps due to the lack of advertising of its new products, same-store sales declined. Jamba continues to have one of my favorite drinks, the Matcha Green Tea Blast. The key for selling drinks seems to be to make them sweet with whipped cream and include chocolate. Jamba, unfortunately, doesn't really have too many chocolate drinks.

But the problem isn't with Jamba's products--its smoothies taste good, and its stores are packed when the weather is hot. Jamba's issue is that consumers think of the company only when the weather gets warm. In order to convince consumers that Jamba smoothies should be a daily addition to one's diet, Jamba needs to add drive-thrus or get locations that aren't in strip malls to encourage time-strapped workers to go to Jamba in the morning. (Do you know a lot of people who regularly go to suburban strip malls--where Jamba has many of its stores--in the morning? I certainly don't.) To give you an example, I work in downtown San Jose, and there are two Starbucks and one Peet's within walking distance, but no Jamba Juice store. If there was a Jamba nearby, I would go almost every single day. A Popeye's Chicken store is opening nearby my office--and still, no Jamba. Jamba's failure to seek out good locations is mind-boggling. By focusing on strip malls, Jamba is robbing itself and its shareholders of the lunchtime and business crowd. It's a very costly mistake, and many a store has gone out of business because it failed to properly choose its location.

In other news, Jamba announced a deal with Nestle today, which pumped its stock 13%, or thirty cents; however, this appears to be old news, as Jamba already announced this deal several months ago. Jamba's shareholder meeting is tomorrow at the Doubletree Hotel. I will try to attend, but may not be able to make it because the Long's Drugs shareholder meeting is on the same day.

My three worst trades, percentage-wise, have been JMBA, SPCHB, and PCYC. I'm losing around 1,600 dollars total on these three stocks and refuse to sell them because once a stock hits the single digits, I figure either it's going to go back up in five years or go bankrupt, and I usually pull the risk trigger and wait and see. I don't have much money in these stocks anymore--but I am still frustrated with Jamba's management because it fails to understand that location is at least half the game in the food business.

3M Stock Trade (MMM)

To give readers an idea of just how jittery I am about the market--and who wouldn't be, with Buffett and Soros making their dire comments--I sold my MMM today and made a meager $138.41 in one business day. The trade occurred in my Roth IRA, so taxes won't be deducted. I will continue to keep an eye on MMM. Costco and Sears report earnings this week--the market will be watching closely.

Monday, May 26, 2008

Investors Looking for Income

Ben Stein has recommended DVM, a Cohen and Steers closed-end REIT fund (Dividend Majors Fund). I will keep my eye on this fund as well as EWM (Malaysia) for my retirement accounts. I am also looking at WES (Western Gas Partners), but not as a dividend or income play. As my readers know, I am concerned about making any investments until 2009 or beyond.

The information on this site is provided for discussion purposes only and does not constitute investing recommendations. Under no circumstances does this information represent a recommendation to buy or sell securities or make any kind of an investment. You are responsible for your own due diligence.

Las Vegas Sands Corp Annual Meeting and Report

The LV Sands' (LVS) annual report focuses on its expansion into Asia, more specifically Macau/Macao and the Cotai Strip (a term coined by LVS like the Vegas Strip, to identify the casino district of Macau).

One problem I have with its notice of meeting is that it doesn't tell you exactly where it is--just that it's at the Venetian 3355 Las Vegas Blvd South, Las Vegas, NV 89109. That's all very nice, but where in the Venetian? This sort of vague notice always activates my "welcome" sensors and makes me think that a company doesn't want to deal with individual shareholders, a sign of insularity. Lo and behold, page 25 of the 10K confirms my suspicions: "Mr. [Sheldon G.] Adelson and trusts for [his] benefit...beneficially own approximately 69% of our outstanding stock...we are considered a controlled company under the NYSE listing standards...The interests of Mr. Adelson may conflict with your interests." Really? You don't say.

But the situation in Macau isn't much better. Stanley Ho practically owned all the casino licenses and now "holds one of the three concessions." Guess who owns another concession/license to operate? His daughter: "MGM MIRAGE has entered into a joint venture agreement with Stanley Ho's daughter, Pansy Ho Chiu-king, to develop...two major hotels....in Macau." (page 8, 2007 annual report). Wynn owns the third concession.

Here are the rest of the 10K's highlights, at least from my perspective:

1. LVS's main geographic areas are in Vegas, Macao, and Singapore. The international expansion is a prodigious move, because Asian consumers are more flush with disposable income and have a non-Puritan culture that doesn't deem gambling sinful.

2. One issue I don't understand is why there are so few tables and slots at Sands Macau. The Sands Macao has 630 table games and 1,350 slot machines (page 2). The Pennsylvania license LVS received allows 3,000 to 5,000 slot machines (page 13), and the Venetian Macau has 1,150 table games and 2,650 slot machines. There is obviously a size difference involved (229,000 sq ft for the Sands Macau vs. 550,000 sq ft for the Venetian Macau), but it is hard to see why visitors will choose the Sands Macau over the Venetian. One reason may be its location near the waterfront, i.e. the casino just wanted a location near the waterfront and was willing to sacrifice amenities and space. Page 44 shows the difference in revenue--the Sands actually made more than twice the revenue of the Venetian Macau, but that's because the Venetian Macau opened in August 2007. Over time, I see a less prosperous future for the Sands Macau unless it can somehow differentiate itself.

3. If anyone is interested, the Vegas Venetian's table games win percentage was 22.3% in 2007, which means that players won slightly more than 1/5 of the time (page 44). Not good odds. For more on this issue, see

http://blogs.wsj.com/numbersguy/
lady-luck-didnt-visit-the-venetian-218/

For gamblers: http://www.straightdope.com/mailbag/mhouseodds.htm

4. At the MGM shareholder meeting, CEO Lanni implied that LVS's real estate development wasn't progressing smoothly. If that is the case, LVS's condos, set to open in late 2009, may impact LVS negatively up to 600 million dollars (page 3).

5. As cities lose manufacturing, they will turn to casinos to make up lost tax revenue. Witness the Sands Bethworks, a casino set to open in Bethlehem, PA in summer 2009. Brace yourself, Sean Thornton--Steeltown is now Gamingtown (page 3).

http://www.pbase.com/ckuhn55/bethlehem_pa

6. LVS may build a casino/resort in Kansas City, KS (page 5).

7. Macao's currency is called the "pataca," and it is linked to the Hong Kong dollar, which is pegged to the U.S. dollar (page 7).

8. There are apparently popular games called "pachinko" as well as "pachislot parlors" in Japan (page 8). I've never heard of these games, and I've played a round or two of Doppelkopf. Baccarat is the most popular game in Macao (page 7).

9. Nevada generally taxes gross revenues from casinos at a 6.75% rate (page 12).

10. The Nevada Board requires casinos to put 10,000 dollars into a revolving fund for any possible investigation "into their participation in such foreign gaming operation." (page 12) This struck me as hilarious, because the 10K doesn't really define what this investigation would entail, and the amount is too low for an adequate investigation.

11. One major problem with Macao is that Macao taxes gross revenue, but "gross gaming revenue does not include deductions for credit losses" (page 17). This means that if a player gets x million dollars in credit from the casino and fails to pay up, the casino still has to pay taxes on that x million dollars. As a result, casinos aren't going to be as willing to extend credit to their players, which could be a problem in the future, as some major players might feel disrespected.

12. Singapore seems to have the most fair taxation structure. See page 18: it taxes 15% of the gross gaming revenue, but reduces the tax to 5% for VIP players. Singapore protects its own citizens by disallowing LVS from extending credit except to "premium players and non-Singapore residents." I bet there's going to be some interesting discussions about who a premium or VIP player is for the purpose of calculating taxation. Singapore allows bad debts (credit extensions to players that are not paid) to offset corporate income tax. Once again, Singapore seems to be at the forefront internationally in how it deals with business.

13. LVS employs about 28,000 employees worldwide. The Venetian and Palazzo employees are non-union (page 18-19).

14. One the easiest sections in a casino operator's 10K is the IP section. There's practically no risk in having your intellectual property taken away from you except for someone mis-using your name.

15. Here's one interesting note for next quarter's numbers, and perhaps some good news for LVS investors: see page 20--LVS has most likely sold its Shoppes at the Palazzo on or around February 29, 2008 for around 700 million dollars, which will boost gross revenue as GGP pays off LVS. I can't see any specific one-time payments from GGP in the most recent quarterly reports (nothing in "Gain (Loss) on Sale of Assets" line on the Income Statement--maybe recorded under "Non-Cash Items" in the Cash Flow?), but it must be recorded somewhere. Here is more on this issue:

http://boombustblog.com/component/option,com_myblog/
show,Reader-commentary-on-GGP.html/Itemid,20/

16. For people who are unfamiliar with how real property transactions typically occur in China and places where there isn't much land (Side note: America's single greatest advantage is its vast land. Thank you, France--that was the best 23 million ever spent in the history of the world). Basically, you don't buy the land, you get long term renewable leases. Page 30 indicates that LVS has a long term lease for 25 years, with automatic extensions of 10 years. I don't know how "automatic" that renewal really is. The bottom line is that if LVS ticks off the Macau government, those investments on the land may revert back to the state.

17. Some bad news: LVS has been getting a corporate tax holiday in Macau--this tax break will continue only to the "end of 2008" (page 34).

18. We now come to the straight dope. See page 40: for 2006 and 2007, diluted earnings per share went from 1.24 to 0.33. Ouch.

As I indicated in my earlier post on the MGM shareholder meeting, I am neutral on gaming stocks.

No matter how its gaming stocks are performing, Vegas makes for a fun trip and will continue to benefit from Californians' love of a quick weekend getaway and cheap Southwest Airlines fares. If you get to Vegas and you're a sports fan, go to the sports book at the Wynn. If you love food, check out the buffet at the Rio. Personally, I wouldn't miss the Burger Bar at Mandalay Place. Get the buffalo burger (cook it medium) with an egg over easy as a topping and the sweet potato fries.

Economic Calendar

Economic Calendar:

http://biz.yahoo.com/c/e.html

Of course, one of the best ways to decide whether to buy a stock is reviewing similar companies that are reporting earnings and studying their earnings; however, it is also very important to see what economic numbers are being released, such as unemployment, new home sales, etc.

I have a feeling I may wake up early tomorrow.

Sunday, May 25, 2008

Walmart's (WMT) Annual Report

Walmart's (WMT) annual report is clear, concise, and so well-written, it could function as a lesson in basic accounting terminology. WMT actually explains why it includes one measure of accounting over another, and then provides both numbers, GAAP and non-GAAP. In providing more than the usual information, WMT ends up giving its readers some accounting definitions that make it easier to understand financial statements.

For example, what is the difference between diluted and basic earnings per share? "Diluted" earnings per share include options and share-based awards and therefore provide a more complete picture of how the company is doing.

On the very first page, Walmart actually tells you exactly what its free cash flow is, which is an important measure of a company's success. (If consumers aren't buying your products, your cash flow will decrease--and that one number can tell you if your products are in demand.) "Free cash flow" is basically net cash from operations. Walmart's cash flow increased 25% from the previous year. In addition, Walmart had more than $100 billion--yes, billion, with a "b"--in sales in just the fourth quarter alone.

There was also some discussion of ROI (return on investment, non-GAAP) vs. ROA (return on assets). Typically, GAAP numbers are more accurate, but that's not always the case. After the era of pro forma earnings, which allowed Enron to keep growing based on speculation about how it would do in the future, I always look at GAAP numbers. GAAP numbers can can still be fudged, but if I'm going to be fooled, at least I'm going to be fooled by looking at the most realistic numbers.

WMT has most of its stores in TX, FL, and CA. With the mortgage crisis, will WMT benefit from more traffic in its FL and CA stores as consumers become more price conscious?

I recommend that you read Walmart's annual report first if you've never read one before. I am still deciding whether I can go to the annual meeting in Fayetteville, AR. After all the hoopla in the press about Walmart, it was interesting to read about it in its own words. WMT's 10K front cover says, "We save people money so they can live better." It's interesting when a large, powerful retail company focuses its mission on saving consumers money rather than appealing to the quality of its products or some other non-concrete advantage, but it's hard to argue with more cash in your pocket at the end of the day.

Many economists have said that WMT helps the poor because the poor buy more fixed, or "hard" materials, like shampoo, cleaners, detergent, razors, clothing, etc., which are cheaper at WMT, while the rich buy more expensive items or high class services (like vacations and Gucci), which Walmart doesn't sell. I agree with that assessment, but the unresolved question is whether WMT negatively or positively affects the growth of a middle class in the areas it operates. At this point, I don't think that WMT affects the middle class in areas that have diversified economies. WMT may drive out smaller mom-and-pop retail stores, but when was the last time anyone in a large city bought their detergent or razors from a mom-and-pop shop? If smaller cities lose small businesses because they sell the same things WMT does, but at higher prices, does the benefit of cheaper prices offset the unemployment of the small business's employees (who now probably also lack health care)? It probably depends on how many small businesses are displaced.

Most likely, as long as WMT doesn't expand its offering of services, like haircuts, food service, gourmet coffee service, massages, cell phone sales and service, tax preparation, car repair, or other non-concrete products, the average small business won't suffer or will survive by competing based on quality. For example, I doubt the local Panera Bread franchise or the local gourmet coffee shop is concerned about WMT, even if WMT did decide to expand its food service operations. Large, less efficient corporations that sell products rather than services, like Circuit City, are the real entities who should be concerned about Walmart.

With its tens of thousands of employees, WMT might believe that if it offers full benefits to part timers, it might not be able to sustain its growth. Many have argued that WMT is a burden on local resources because its wages are too low and it doesn't offer medical benefits to all its employees, causing them to go on the dole. WMT may not be overly concerned about its employee benefits because its competitive advantage isn't based on its employees. (Sadly, lower level retail employees are not difficult to find, especially in the developing countries where WMT is expanding.) WMT's advantage is that no one its size has been able to replicate its handling of its worldwide supply chain and inventory management, which allows WMT to offer lower prices by being efficient and leveraging (arbitraging?) global operations. This is where the problem of capitalism comes to light--what is best for shareholders isn't always great for employees. The case of whether to criticize WMT for not offering full benefits is especially difficult, because WMT isn't polluting like Exxon Valdez or forcibly demanding its American employees work in dangerous conditions like coal mines. Therefore, you could argue that WMT deserves to be left alone, because if you don't like its products or way of doing business, you don't have to shop there, and WMT doesn't affect you directly unless you choose to work for them.

Also, at the end of the day, WMT's numbers don't lie--$100+ billion in sales in just four months means enough people believe in the company and its products to continue shopping there, and until that changes, WMT opponents are basically resorting to the argument that because a company is big and can afford it, it should offer more benefits to its employees.

I run a small business. If a non-customer came to my door and told me how to run my business, I'd feel that it was my right to choose my own path, because it was my money and time at stake. Why does that principle of the "right to be let alone" change just because Walmart makes more money than I do? I don't know Walmart's requirements for receiving benefits, but Walmart may want to offer its employees working at least 24 hours per week and with 6 months of tenure some kind of subsidized health care coverage. Costco (COST) demonstrates that you can grow and offer reasonable benefits to employees. At some point, Walmart's sales will decline if consumers gravitate to COST because of its presumably happier, more motivated employees, or better reputation. Few consumers want to save a few bucks by breaking the backs of local employees. At the same time, Walmart has many long time employees--by one count, they had 20,000 associates who had been with the company 20+ years. That's a reputation for retention not too many companies can boast.

See 2007 report of annual shareholder meeting:

http://www.bloggingstocks.com/2007/06/01/
liveblogging-wal-marts-annual-shareholders-meeting/

Panera Bread (PNRA) Annual Report Review

Panera Bread (PNRA) is one of my favorite places to hang out. I believe it has replaced Starbucks as a middle ground between home and work. (As PNRA says, it "competes on the basis of providing an entire experience rather than price only.") The "cobblestone"--a sweet apple pastry with cinnamon and frosting--is my favorite product, and most weekends, they sell out if you don't get to the bakery early enough. (It may have a lot of calories, but it also provides some fiber.)

The company's HQ are in Missouri, and I wasn't able to go to the annual meeting this year. Here are some interesting tidbits from the annual report.

PNRA used to be Au Bon Pain Co. (I wondered what happened to those stores--I'd seen them sprouting all over S.F. and had expected them to keep growing all over California.)

PNRA indicated its summer salads would be a big hit, and that it was able to hold off temporarily on some price increases. It did have to remove the Crispani (pizza) from its menu to save on labor costs.

To give you an idea of just how small Peet's is, with its 166 stores, PNRA opened 169 new stores in 2007. Of those stores, 89 were company-owned, and 80 were franchisees. (PNRA has 1,167 stores total.)

PNRA played its hand well in the futures market for wheat, so wheat costs won't impact its bottom line, at least not in 2008. (Wheat costs won't "materially impact earnings growth" in 2008.)

PNRA's Board of Directors has a Berkshire (Dairy Queen's COO) member, Charles Chapman III--it's always a good sign when Berkshire Hathaway is involved.

PNRA's franchisee situation is interesting. Its arrangement seems fair and requires less start-up costs than a McDonald's or many other franchises. A franchisee must put a small percentage
of its sales into a national advertising fund and spend a certain percentage on local marketing efforts. PNRA receives 4 to 5% of the franchise's sales, in addition to 35,000 dollars as a one time franchise fee.

It costs 1 million dollars to open a PNRA store.

PNRA also owns 51% of Paradise Bakery and Cafe, as well SLB and Pride. It appears to be acquiring companies as part of its efforts to continue growing.

Most of PNRA's stores are in FL, IL, CA, PA, MI, and VA, in that order.

I don't have an opinion on how well this stock will do in the future. Chipotle (CMG) might be the newer growth story, because PNRA stock has already appreciated 1000% for its long time shareholders. I am guessing that PNRA shareholders who bought and held for years aren't complaining. I won't either, as long as I get my cobblestone pastry in the morning.

Peet's Annual Report Review

Peet's 10K provides more information about the company. Here is my summary of the highlights:

First, Peet's currently has 166 stores. That means they plan on opening another 24 stores before the end of the year. The cost of opening those stores will drag down Peet's earnings in the near future. Once more time passes, Peet's will recoup its costs from a consistent stream of revenue from those new stores.

Peet's mentions a well-known fact--that arabica beans are known as the best quality beans. I point this out only because we can finally see the word arab receiving some positive connotation in America.

Peet's has only 687 full time employees. However, with 21 hours per week + 500 hours of work, employees can receive full benefits.

Peet's says that "green beans" are not highly perishable and are the largest cost of sales and raw materials. Green beans appear to be coffee beans that haven't been roasted yet.

I can't say I'm as bullish on Peet's stock as I am on the coffee, but I will keep an eye on the stock--especially if Peet's P/E becomes more reasonable.

A detailed review of the 2008 shareholder meeting is here:

http://willworkforjustice.blogspot.com/2008/05/peets-coffee-and-tea-shareholder.html

Broadcom 2007 Annual Report

Broadcom (BRCM) has an office in San Jose, but apparently their headquarters are located in Irvine, CA. I first confused Broadcom with Broadcast.com, which is famous for making Mark Cuban, owner of the Dallas Mavericks, rich. He wisely sold the online video company to Yahoo at the height of the bubble then turned around and used the proceeds to buy an NBA team (as close to a male version of a Disney fairytale as you can get). Broadcom, not to be confused with Broadcast.com, makes semiconductor chips.

Broadcom's annual report shows a difficult future for the company and an unusual ownership structure. Perhaps to divert attention away from its decreased sales, BRCM highlights its litigation success against Qualcomm in the report's first few pages. Whenever a technology company emphasizes litigation rather than business strategy or R&D, shareholders have to wonder whether their company's money is being wisely spent. For the most part, extended litigation is a black hole primarily benefiting lawyers. There is another issue here--while BRCM talks about its success against QCOM, it doesn't highlight its most recent litigation (SiRF is suing BRCM).

BRCM's revenue stream seems too concentrated on a few customers. BRCM states on pages 17 and 28 of its report that "sales to our five largest customers represented 39.7%...of our revenue in 2007." Later, on page F-41, it clarifies that its top two customers are Motorola and Cisco Systems. MOT isn't doing very well these days, and while I own shares of MOT, I bought them as purely a value play, not as a growth story. When your best customer is losing market share, that is a terrible portent for your company.

But it gets worse: BRCM, on page 40, states that company insiders and management "held 58.5% of the total voting power." BRCM also has anti-takeover provisions (see page 41). This double-whammy of unaccountable management and a moat to protect itself from outside interference may have created an insular culture.

Fans of Gordon Gekko might disagree with me: "The Carnegies, the Mellons, the men that built this great industrial empire, made sure of it because it was their money at stake. Today, management [of Teldar Paper] has no stake in the company! All together, these men sitting up here own less than three percent of the company. And where does Mr. Cromwell put his million-dollar salary? Not in Teldar stock; he owns less than one percent. You own the company. That's right, you, the stockholder. And you are all being royally screwed..."

But one look at the financials shows that this company is experiencing lower growth, so ownership structure might be the least of its problems. Diluted earnings per share went from 0.64 cents a share to 0.37 cents from 2006 to 2007. Net cash from operations went lower from $891,659,000 in 2006 to $831,909,000 in 2007. In case I have somehow misinterpreted these numbers, see google's finance page, which contains a wonderful tool allowing anyone to view a company's balance sheet, cash flow, and income statement on a quarterly as well annual basis:

http://finance.google.com/finance?fstype=ii&q=NASDAQ:BRCM

To get another measure of how the company is doing, go to Annual Data, click on "Cash Flow," and compare numbers in "Net Change in Cash." Yup--it's not good.

Surprisingly, BRCM stock has rebounded considerably over the past several months. I am leaning towards selling my very small number of shares next week; however, I will keep this stock on my radar screen to see how Motorola--its largest customer--is doing.

WSJ, May 20, 2008

The Wall Street Journal's May 20th edition contained a lot of fabulous "infoporn," as Barry Ritholtz of the "The Big Picture" blog likes to say. ("Chartporn" is another one of his favorite expressions.) See http://bigpicture.typepad.com/

1. "Economies in states that produce oil, gas and other commodities are stronger than the rest of the U.S." April 2008 Unemployment rates for Montana: 3.8%; North Dakota: 3.1%; Oklahoma: 3.2%; Texas: 4.1%; Wyoming: 2.6%. Interestingly enough, based on some other information I've seen, South Dakota is apparently doing better overall than North Dakota in terms of bank deposits. Maybe North Dakotans are more optimistic and spending more money instead of saving it like their neighbors down south?

2. For all credit card company investors and lovers of the recent Visa (V) IPO, check this out:

Default Deluge: monthly credit card losses at credit-card companies are at 6%--a three year high. (Page C14). Say it with me: upcoming recession?

3. Nothing, however, topped the article on home prices (D3). Apparently, construction companies went overboard in building condos in Chicago, so you can buy a condo for $85,000 in Bronzeville. The areas with the most supply appear to be Wicker Park, Ukrainian Village, and Bucktown (why doesn't San Jose have cool neighborhood nicknames?). With a possible Olympic bid, Bronzeville might be an interesting location. South Side...the "baddest part of town" no more?

Median Single Family Home Prices:

Boston: 357K
Chicago: 249K
L.A.: 459K
NY: 445K
S.F.: 701K

Just Because: Golden State Warriors Stadium Picture


Just so you can see the view from the nosebleed seats. This was a good game against the Seattle Supersonics in March 2008. Kevin Durant is going to be a great player, if he spends more time playing defense.

Update on June 29, 2012: my thoughts on the 2012 NBA Finals are HERE.

Peter Peterson, a True American Hero

See CNBC interview with Mr. Peter Peterson, Blackstone Group founder, and David Walker, former U.S. Comptroller:

http://www.cnbc.com/id/15840232?video=751573252

Mr. Peterson has donated a billion dollars to raise awareness of how the American entitlement mentality is robbing the younger generation of the American dream.

Saturday, May 24, 2008

Thomas Jefferson

"A government big enough to give you everything you want is strong enough to take everything you have." - Thomas Jefferson

I don't know if Jefferson actually made the above statement, but it is absolutely correct. To counteract a growing government, we may have to consider creating a new independent branch of lawyers with the sole purpose of litigating against the government, essentially creating a Public Prosecutor's Office for all civil cases. This way, if the government wants to exercise eminent domain over your house, you would have access to a lawyer, or if a police officer used excessive force, you would be able to file a lawsuit and pay only the costs.

Ultimately, we should explore ways to reduce government middlemen by increasing direct benefits to the public that do not require a monopoly or an exertion of power over the public. Some ideas are rebates (the 600 dollars stimulus--which would have been perfect if we had a surplus) or free or subsidized health care (why should government workers be virtually the only persons to receive free health care for life?).

Friday, May 23, 2008

Stocks Update

Today, despite my concerns about the economy, I bought 50 shares of GE, 330 shares of MMM, 100 shares of IF, and some shares of SCUR.

GE: I don't believe I can completely time the market, so I will average down if GE drops to the mid-20's.

MMM: I missed the ex-dividend date for MMM, but this company still looks undervalued at these prices. I hope to sell MMM when it goes to anywhere from 78 to 84. Although I like this stock, I am just too concerned that an overall market correction will bring down good names along with bad ones.

IF: Indonesia is going to be a good investment in the long term. My plan is to hold this fund for many years.

SCUR: This is a value play that contains quite a bit of risk. Its balance sheet looks stronger than what its stock price indicates. It is also trading below its book value. I will revisit this stock in a year or two. If we are coming out of a recession, small caps will be the first stocks to lead the way.

The information on this site is provided for discussion purposes only and does not constitute investing recommendations. Under no circumstances does this information represent a recommendation to buy or sell securities or make any kind of an investment. You are responsible for your own due diligence.

Thursday, May 22, 2008

Trimble Navigation Systems Shareholder Meeting, May 22, 2008

I attended the Trimble Navigation Limited (TRMB) shareholder meeting, which was geared towards its employees rather than shareholders. Of the 100 or so people there, only about five of us were non-employee shareholders. There wasn't even a Q&A session at the end of the two hour meeting, which was highly unusual. The meeting seemed more like an internal company pow-wow, where the CEO was focused on motivating his employees, than an actual shareholder meeting.

I originally bought this stock a few months ago because it appeared to be the next GE and its price seemed too low (at the time). However, even to this day, I cannot understand the company's products very well. The CEO, Steven Berglund, spent the first part of the two hour meeting talking about how the company had "redefined" itself throughout the years and now focused on construction, advanced devices, mobile hardware, "ready-mix" solutions (just the first of very vague and confusing terms used throughout the evening), and precision agriculture. He said that TRMB does not have a growth strategy based on acquisitions, and only acquires companies to enter new markets. He focused on the fact that the "international marketplace is key to our success," and later referred to "aggressive internationalism" as the company's plan.

He indicated that he wanted to target customers in waste management, farming, forestry, and utilities. The CEO stated that in most of the markets Trimble was involved, the market penetration (a favorite phrase of CEOs) was low, and was usually around only 30%. Therefore, Trimble did not have to use words like "product life cycle" or "saturation." There was some pump-it-up phraseology of the "annihilation of complacency" and "humility and caution" being goals of the company.

Some very vague terms were used, such as saying that the company's products require "concept-selling capabilities," and Trimble "sells people things they don't know they need." For a value investor and Buffett acolyte such as myself, these phrases made me want to run for the hills.

After the CEO's presentation, there were several presenters, all of whom were touting some company product and who were unfortunately completely dull. I have heard of Six Sigma Black Belts, but now I got to hear about "Kaizen facilitators" and "customized improvement initiatives" and other terms only a business major could love. There were numerous graphs and pie charts showing how the company's products incorporated several different advantages for its customers. I felt like I was in a corporate Dilbert meeting.

But that's just it--Trimble is sort of like your Dilbert company. They are high-tech cost-saving consultants, like the guy who comes in your office and says you can save 100 million dollars by ordering fewer paper clips or by removing the olive from airplane meals. The difference is that Trimble sells high tech products that allow its customers to save money. There's no doubt that its product line is impressive--by having so many software and hardware engineers working in several different divisions, Trimble can deliver everything from its own IC Chip, boards that use other companies' IC chips, GPS systems (including ones that tell a farmer exactly where he is in his field), spatial imaging software, radios, antennas, GNSS sensors, and many other products.

There were some exhibits of the company's products, focusing on farmers, construction, GPS devices, highway projects, and reference design boards. Obviously, Trimble has a diverse product line and a diverse array of customers.

Because I still had a hard time understanding the business, and was very surprised at the lack of a Q&A session, and I went up to CEO Steven Berglund after the meeting to ask him some questions. I am not sure if it was the way I approached him, but he seemed upset that I questioned the lack of a Q&A session; to his credit, however, he did spend about 3 to 5 minutes answering my questions (in a defensive, brusque manner). I asked him about his employee breakdown. He asked which division I was talking about, but finally indicated that software engineers, then hardware engineers, then salespersons made up much of his workforce. I asked him who his major customers were. Again, he retorted that there wasn't any one big customer, not even the Caterpillar, CNH, and Nikon companies I mentioned (they were mentioned in the 10-K) . He replied that I should go read the 10-K. But he obviously hadn't read carefully all of the 10-K, because he would have known that I referred to CAT, Nikon, and CNH from page 20: "We believe that in certain business opportunities our success will depend on our ability to form and maintain alliances with industry participants, such as Caterpillar, Nikon and CNH Global."

By this time, CEO Steven Berglund was becoming more and more agitated, so I thought I'd ask him just one more question and move on. I had read in the 10-K that salespersons were paid in part on commissions, and asked him whether a significant number of his salesforce were independent contractors rather than employees. After some brusque comments asking me what I was talking about, he finally said that no, as far as he knew, the only independent contractors were "dealers," and that his salespersons were employees. That is a good sign, as it indicates that Trimble employees would be more loyal to the company as compared to independent contractors.

The food spread was fabulous, but lacked coffee and sweets. It was basically a buffett dinner style with shish kabobs, dips, bread, vegetables, and chicken entrees.

I was disappointed that CEO Steven Berglund was so brusque, as he appeared to be a good public speaker, but I suppose when you're in that position, and your stock has done well, you can afford to be that way. I am waiting on the sidelines on this stock because of its recent run-up. Many of the potential customers Trimble wants to sell to--such as local government and smaller businesses--may be cash-strapped if the economy doesn't rebound. If you believe that companies will be more likely to hire outside consultants to show them how to save money, you would probably like Trimble Navigation. There's nothing like seeing increased costs to make a CEO jump at the chance of finding more efficient ways of doing business. But if you believe that in a recession, all companies try to save money in ways that don't require paying for major products or new ways of doing things, then you may dislike Trimble's strategy. In addition, the company didn't seem to have any devices that relied on solar or nuclear power, or some other non-semiconductor-based environmental product. I kept thinking during the meeting that there must be some reason why there is such low market penetration in all of the areas Trimble is trying to sell into. Unless Trimble has re-invented the wheel--which it very well may have done, as I've never seen some of the products it offers--there will always be competitors going after the low-hanging fruit. It appears Trimble may be going after the more specialized, difficult-to-get rewards. A recession may not be kind to this company, but perhaps the big-ticket items Trimble sells will be recession-resistant. The CEO told me that his company "sells productivity." Personally, I am more of a skeptic, but if you like the sound of a company that is diversified and sells productivity, then this is the stock for you. I just wish CEO Steven Berglund hadn't been so brusque and understood that a shareholder meeting was also designed for non-employee shareholders to understand his company.

Shutterfly Shareholder Meeting, May 22, 2008

Shutterfly's (SFLY) meeting was as simple as Netflix's but with a completely different attitude. The first thing you notice is that the employees are happy and actually like being there. The vibe is absolutely wonderful, and if you are looking for a job in Redwood City, CA, you may want to apply at this company. I've never seen so many friendly people at a shareholder meeting. Of course, I was the only person there not on the payroll, so I did look out of place. Rather than ignore me, however, the staff approached me with interest.

The format of the meeting was exactly the same as NFLX's. No presentation, just the company logo in the back. As soon as the formal part of the meeting was over, we went straight to the Q&A session. I was the only one who asked questions.

The formal part of the presentation was well-organized. Specific employees had been trained beforehand to make motions and second them. They even began their motions with "Mr. Secretary," which added to the professional atmosphere. The food was standard--some fruit, some cookies, and coffee. These food items were near some company products, such as children's books, mugs, and other merchandise, showing SFLY's diverse product line.

First, I have to say that I was impressed with SFLY's CEO, Jeffrey Housenbold. Mr. Housenbold is one of the most articulate and prepared CEOs I have ever met. His responses to my questions were detailed and on point. My first question actually combined three issues, and he methodically responded to each issue with statistics and easy-to-understand responses that bolstered the company's image. Not once did I feel as if I was getting a prepared line--he was a breath of fresh air, especially after the NFLX CEO's terse responses. (SFLY's meeting, by the way, was held at 11AM, another indicator that the company wanted to welcome shareholders rather than drive them away by holding the meeting at 3PM.) SFLY's proxy statement also contains pictures and bios of the management team, which is an astute business move, because the pictures personalize the company more.

Some background from the company's Yahoo's Finance profile page: Shutterfly "produces and sells photo books; personalized calendars; greeting cards; photo-based merchandise, including mugs, mouse pads, coasters, tote bags, desk organizers, puzzles, playing cards, multi-media DVDs, magnets, and keepsake boxes; ancillary products, such as frames, photo albums, and scrapbooking accessories; and photo prints. It also produces customized children's books. "

My first question was what competitive advantage SFLY had over Flickr, whether the company was going to enter into partnerships like Flickr and Yahoo's, and what strategies the company had for growth.

Mr. Housenbold responded that SFLY manufactured its own products and was capitalizing on demand for various products, such as calendars, mugs, scrapbooking, and other merchandise. [from 10K: SFLY owns production facilities in Hayward, CA and Charlotte, NC, and may open more facilities in Charlotte.] He said that SFLY's business model was "permission-based sharing of memories," versus the less personal Flickr model. He indicated that less than 1% of Flickr's users generated about 40% of their content (my number may be incorrect, as I was quickly taking notes--but it was a very high number) and unlike SFLY, Flickr's revenue came from advertising rather than directly from its users and customers. Also, because SFLY controls its own manufacturing, they can enforce high quality standards, while Flickr cannot. The CEO continued to focus on how his company delivered quality. It was a flashback to Peet's vision, where Peet's CEO was basically saying that the company was going to focus on quality and let the product speak for itself through word of mouth.

Mr. Housenbold then talked about "customer centricity," a fun phrase. He said that his company offered 49 combinations of designs and its software and website were easy to use. On the other hand, Flickr did not have a direct e-commerce model and relied on advertising revenue, which implied that Flickr would be more beholden to its advertisers than its actual customers and consumers.

He said that Yahoo/Flickr had achieved [only] around 4 million dollars of revenue from 100 million accounts through ad-based generation (these numbers was be off due to my slow handwriting and attempt to capture all of his responses verbatim). In fact, Yahoo had actually shut down part of Flickr because it wasn't generating sufficient ad revenue. Meanwhile, with respect to growth, in 1999, SFLY started with 2 million customers and now had 9 million customers. The company was benefiting from a "viral marketing effect," where its brand name was entering the public sphere through its reputation and word of mouth on the internet.

As far as partnerships were concerned, his company has partnerships with Amazon.com, Border's, Target, and many other major companies. 78% of SFLY's revenue came from existing customers, which is impressive but indicates that the company isn't growing its customer base very quickly.

My second question was that I now understood how SFLY was different from Flickr (ad revenue business model vs. direct e-commerce model), but how was his company different from Snapfish? (a more similar competitor)

Mr. Housenbold first said that Snapfish (http://www.snapfish.com/) didn't own any manufacturing facilities, a hit on the quality of their products. He said that Snapfish has said they want to be the Walmart of online photos, and they are gearing their services towards consumers who are more "price-conscious." It was a very nice dig, i.e., if you're poor and dislike quality, you go to Snapfish, not us. He also politely attacked Snapfish's loyalty to its customers by saying that after 6 months of non-activity, Snapfish deletes all memory. Basically, SFLY was "Nordstrom," while Snapfish was Walmart. And if that style of polite dismantling of a competitor doesn't impress you, he ended with this riposte: as far as he knew, Snapfish has never been profitable, while SFLY has generated a profit. If I was Snapfish's CEO, I would have felt compelled to commit seppuku after hearing how different the companies were. Snapfish's own website states that it is the "best value in photography," which doesn't sound so great after hearing the comparison to Walmart. One wants a quality product when it comes to memories.

My friend, who has used SFLY's website, said that she was impressed with it. She said that the website, for free, allows users to modify their pictures, making them lighter, darker, etc. She said she was also impressed with the available products, such as the mugs. She hoped that SFLY would allow consumers to continue to keep their photos stored online for free. I indicated that the company had an incentive to allow free photo storage, because it would encourage consumers to buy SFLY's products in the future.

SFLY's 10K was one of the best-drafted 10Ks I've ever read. It had a great explanation of the U.S. Supreme Court ruling that established the principle of non-taxation for internet companies lacking a proper nexus with certain states. The 10K doesn't list any cases by name, but it is referring primarily to Quill v. North Dakota (1992). See the following webpage for more information on the list of other relevant cases, i.e. Oklahoma Tax Comm'n v Jefferson Lines (1995) and Complete Auto Transit v Brady (1977):

http://www.law.umkc.edu/faculty/projects/ftrials/conlaw/
interstatetax.htm

Basically, a company needs to have a sufficient nexus with a state before being able to tax the company. A physical presence, such as a warehouse with employees, is obviously sufficient to form the necessary connection because the company derives benefits from the state, but there are many gray areas. SFLY states that it is collecting sales and use taxes where it has "property and/or employees." (10K, page 25)

If it's not obvious by now, I am very impressed with this company. However, its share price hovers near a 52 week low. Is SFLY a value play? Here is my thinking:

1) Why does this company need to be public rather than private? There are no major liability issues or a need for money to expand or build stores. The CEO never mentioned that he wanted to build retail stores to sell directly to the public. It seems very strange that such a company would prefer to be public and endure Sarbanes-Oxley compliance and other issues that divert resources from serving its customers. I predict that at some point, perhaps within five years, if the stock price remains stagnant, this company will be bought out, merge, or go private.

2) Flickr actually does allow permission-based photo sharing--you can set certain photos to be seen only by your friends and family and can restrict permissions. But that's a minor issue, because Flickr obviously doesn't allow its users to modify photos and is clearly geared towards a different audience, just as the CEO indicated.

3) The majority (52%) of SFLY's revenue comes in the last quarter of the year, probably in X-Mas and Thanksgiving sales. (From 10K, page 14)

4) If it can convince Wall Street that it will be able to grow at double-digit rates, SFLY's stock price will increase. For now, however, I don't see how SFLY is going to achieve a high growth rate. It doesn't really advertise--and it seems like it's taking the Peet's grass roots marketing model, where word of mouth drives growth. But the problem with a company like SFLY using Peet's marketing strategy of "quality + reputation + product-sells-itself = success" (my words, not theirs) is that Peet's has retail stores, making it is easier for others to recognize its products. I am sure you can all recognize a Peet's paper cup instantly if you saw one. But SFLY's products won't enter the mainstream as readily as a food item. Instead, the growth will probably happen as family members, the ones most likely to pay for products like children's books, get introduced to the services and products. If SFLY's strategy is focused on families and grandparents, that's a slower way to grow than trying to get national brand name recognition through general advertising and by directing traffic to its website.

5) SFLY is currently being sued by Fotomedia and Parallel Networks in the Eastern District of Texas. (What's so special about the Eastern District of TX? There's definitely some forum shopping going on there.) I suspect it may be difficult to see future prospects clearly until these lawsuits get resolved.

I will keep my eye on this company. The CEO was friendly and humble and came up to me after the meeting to talk. He indicated that he was a user of SFLY before he became the CEO, which is another plus. Another shareholder came late to the meeting, and the CEO sought him out and went to speak to him. This is a friendly company that should continue to have a great reputation.

See also, Interview with Mr. Housenbold: http://sramanamitra.com/2008/03/20/
shutterflys-strategy-a-conversation-with-ceo-jeff-housenbold-part-1/