Intuit, Inc. 2017 Shareholder Meeting

Intuit, Inc. (INTU) held its annual shareholder meeting on January 19, 2017.  As always, Intuit's meeting is one of the best to attend in the Bay Area because of CEO Brad Smith's preparation and ambassador-like demeanor. This year, Intuit's food spread included a delicious coffee brand I'd never seen before--Equator Coffees and Teas--literally a nice perk.

CEO Smith's presentation followed his pattern of guiding Intuit--a 34-year old company "born in the era of DOS"--into his long-term vision of becoming a services-based, global company.  The company's focus continues to be in the U.S. and Canada, where 95% of the profits are generated.  Of all the goals in Intuit's game plan, this figure is disappointing after years of hearing Intuit's desire to expand internationally.  Its technical staff continues to be based primarily in California and India (pp. 19, 10K), but it seems unable to get a business foothold in other countries.  CEO Smith, ever the optimist, said Intuit continues to be "constructively dissatisfied" and is "starting to get momentum outside the U.S."

Curiously, on February 1, 2016, Intuit gained access to a five-year credit line of $1.5 billion, leaving $1 billion in "ammunition" after retiring debentures issued in 2007 (pp. 23, 10K). On this particular banking deal, Intuit did very well--its 5.75% bonds are being retired with a 2% credit line (about 0.5% above LIBOR). I predict Intuit will buy a smaller company, perhaps Palo Alto-based Adaptive Insights, or a private company specializing in machine learning.  It currently has the option of leasing IBM products for machine learning without disclosing PII to third parties, but if all of their other algorithms are in-house, it seems Intuit would want its machine learning (i.e., "personal, anticipate, populate") and business intelligence programs to be wholly owned as well.  The most interesting data point I heard this year was that the chances of a small business surviving in its first few years increases by 89% if the business owner is linked to an accountant.

Intuit's goal of moving into a services-based, subscription model seems to require it to boost its accounting expertise portfolio, especially with regards to improving Quickbooks Online.  ("As we continue to transition our business to more connected services, we become more dependent on the continuing operation and availability of our information technology and communication systems and those of our external service providers." -- pp. 15, 10K.) Intuit's transition to the "cloud" (rather than just CD-ROMs sold through third-party retailers) has led it to divest Quicken--which was only about 2% of its profits--and focus on integrating all of its products across platforms within a broad, diverse ecosystem.

The Q&A session was excellent.  CEO Smith did not limit people who asked questions and involved members of his executive team when appropriate.  One person asked why he had to pay an additional 20 to 30 dollars to file his state taxes when the transmission cost of his federal return was zero to the federal government.

It turns out that the cost goes directly to Intuit, not a third party transmitter or entity.  Why?  Complying with each state's tax rules involves new work for Intuit.  CEO Smith explained that 44 states had their own tax codes, and the value came from Intuit's work trying to maximize tax credits and deductions based on each state's individual tax codes--which change each year.

I was concerned about privacy and third party security in the era of "big data."  I asked what Intuit did with customer data, and whether it shared that data with third parties without full anonymizing.  I expected to hear that Intuit sold some of the insights it gained from its data to third parties because doing so would be highly profitable; however, CEO Smith firmly stated that Intuit did not sell any customer data and did not share any customer data without express permission.  It's "not our data, it's the customer's" and Intuit does "not sell that data."  Moreover, it complies not only with U.S. laws but also EU laws relating to privacy coming from Brussels.

I wanted to be absolutely sure CEO Smith wasn't putting me on, even though his statements were unequivocally pro-consumer and pro-privacy.  (Data is the new gold in Silicon Valley, after all.)  I asked a similar question about privacy and data sharing in a follow-up question.  He reiterated his stance, and then asked Intuit's general counsel, Laura Fennell, to confirm that no third parties gain access to Intuit's data without express user consent.  She immediately confirmed his statements and later explained to me after the meeting that although IBM's Watson was mentioned during the presentation, Intuit can rent IBM's Watson and extract its own insights without sharing any data with IBM.

My final question related to the Free File Alliance, an agreement with the federal government.  Intuit's 10K makes this program sound as if it's preventing the IRS from directly competing with Intuit's software: "The current agreement with the Free File Alliance is scheduled to expire in October 2020. We anticipate that governmental encroachment at both the federal and state levels may present a continued competitive threat to our business for the foreseeable future" (pp. 14, 10K).  However, when I asked CEO Smith about the Alliance (no Star Wars figures included, unfortunately), he said it was merely a way to give taxpayers below a certain income threshold the ability to get online and do their taxes more efficiently.  "Voluntary compliance" is the goal from Intuit's standpoint, and it is working with the IRS to assist taxpayers who would otherwise use pen and paper or not file at all.  He added that the idea of assisting lower income taxpayers fits into Intuit's mission, which is to serve the community and the nation.  Stirring words, indeed, but I suspect there's much more behind the scenes between government agencies and Intuit.  Many years ago, I remember seeing a former CEO become almost frothy when asked about the government's encroachment into Intuit's business.

Overall, Intuit continues to focus on serving consumers and adapting to technological change. Having beaten Microsoft's attempts to win away its customers, its biggest challenge now is adapting to the cloud and its new ways of doing business--at least until it figures out how to expand internationally at a faster pace.

Disclosures: I like Intuit's corporate culture and may apply for employment.  As of January 20, 2017, I own an insignificant number of Intuit shares, but my holdings may change at any time. Nothing herein constitutes investment advice.  You are responsible for your own due diligence.

Modern Capitalism, or How to Guarantee a Military-Industrial Complex

My uncle once told me, "In the future, there will be five companies, and they'll own everything."  We needn't go into the future to see such a reality--in most important ways, the aforementioned scenario is already here if you add two zeros to the end of the number above.

Where does innovation come from after a company achieves multinational status, starts paying a dividend, but still has to grow by x% annually to please Wall Street? Some people may know that such growth comes from buy-outs and mergers. Indeed, after a certain size, large companies succeed based on how adept they are at incorporating a newly bought company's products and remaining employees into their own pre-configured business and legal systems. In short, scalability, supply chain management, and risk controls drive value in a major corporation if it survives long enough. What about innovation?

Under the current merger-and-acquisition system, major companies will "buy" innovation and pay premiums--sometimes obscene ones--to avoid having large and unpredictable R&D budgets. In such a dynamic, large companies can pay a small percentage of their revenue to attract a smaller company, but without taking the risk of having larger or recurring R&D costs on the books that don't produce consistent ROI. Smart, right?

Yet, it is precisely the large companies, with their established products and revenue streams, that are best able to take the risks necessary to produce great ideas. If only smaller companies are taking bank loans or SBA loans to try new ideas, then the banks become the primary risk-takers and consequently demand greater influence and political power to take on such risk. If the big banks' investment banking, consulting, and M&A groups are the major players backing smaller companies or venture capital firms, then most innovation not linked to academia is supported by the banking sector.

Guess who supports the banking sector? The FDIC and your deposits.  In other words, under America's current capitalist system, taxpayers are back-stopping the risks of innovation under "too big to fail" because many larger corporations aren't investing enough in R&D, which is seen as an unpredictable cost by Wall Street. Today, only Tesla (TSLA) appears to be choosing innovation over steadily increasing share price. Other companies like General Electric have large R&D budgets, but as a percentage of gross revenue, they're actually minuscule--usually no more than 7%.

Seen this way, of course America's banking and insurance sectors will have the most influence in Congress--they're the ones driving innovation by funding R&D that larger companies should be funding but won't. Not only will large banks and insurance companies demand favorable tax policy for their risk-taking (witness Warren Buffett asking for and receiving a "terrorism" exemption post-9/11), they get their funding directly from the Federal Reserve or indirectly by convincing the Federal Reserve to lower interest rates. What are you, the taxpayer, getting in exchange for stricter personal deductions than businesses; receiving low interest rates on your deposits; and being the insurer of last resort?

You probably won't guess the correct answer: a military with a budget not subject to audits that does the R&D for you, but with the higher risk of pursuing war as a testing ground for new weapons and strategies, and with debt that could sink or split the entire country if mismanaged. If the larger companies have external checks and balances that mitigate R&D risk-taking, and the banks are being back-stopped by the government (and therefore taxpayers) when they make loans that support R&D, big banks and the military become the two groups not subject to checks and balances but necessary for innovation. Under such incentives, it's only a matter of time before the military and banking sectors dominate the entire country and become powerful enough to ignore President Eisenhower rolling in his grave.

And so it goes.

Matthew Rafat (copyright 2017) 

Bonus: "In the past 30 years, America has had 13 wars at a cost of $14.2 trillion...what if they [had] spent part of the money on building up infrastructure?" -- Alibaba CEO Jack Ma

Bonus: below are the numbers supporting the arguments above:

People don't understand the difference between budgetary outlays and discretionary spending, or appropriations/expenditures, which is responsible for the inability to see eye-to-eye on fiscal responsibility debates.

Mandatory spending is federal spending based on existing laws. This budgetary spending is mainly entitlement programs, such as Social Security and Medicare, whose spending criteria are determined by who is eligible to apply for benefits and not by Congress, and includes items supposed to be relatively predictable. Discretionary spending, on the other hand, is the portion of the budget that the president requests and Congress appropriates every year through legislation. In the past, such spending was supposed to be for one-off, unusual and unpredictable items but has now become a slush fund for military adventurism, as we'll see.

Furthermore, when discussing military spending, it's debatable whether to include VA spending as part of the national defense budget, which creates further confusion. Let's try to clear up these issues.

Spending on national defense is estimated to be about 15% of all outlays in 2017. This is less than average when compared to budgets from other years. (Average proportion = 22%). That 15% is about $516 billion, not including VA funding.

The President’s 2017 budget includes $182.3 billion for the VA in 2017. This includes $78.7 billion in discretionary resources and $103.6 billion in mandatory funding (for veteran's disability benefits). Including national defense and VA budgetary amounts together, we have a total of $698 billion spent on military-related budget items. Technically, that's less than what we spend on Health and Human Services (e.g., Medicare) and Social Security (almost a trillion projected in 2017). However, the above figures do not include discretionary spending, which causes annual deficits funded partly by issuing debt to foreign countries. Let's look at those numbers.

For 2017, 49% of total discretionary spending is projected to go towards national defense, or about $500 billion. That means we spend about $1.2 trillion every year on the military and military-related items. Thus, the largest spending items in America in 2017 are the military and the VA; Social Security; and Medicare. Why is that a problem?

In 2017, the government is estimated to have a total debt of $17.7 trillion. At 104.4% of GDP, this percentage is extremely high when compared to other years (avg. 59.0%). Spending on SS is fine--that debt is owed to Americans. Spending money borrowed from future generations on unnecessary or inflated medical expenses like pharmaceuticals and on unnecessary wars or wars of choice is unconscionable. It guarantees fewer opportunities for younger generations. It means our intelligence agencies work overtime trying to justify illegal military invasions or are tempted to engage in false flag or psychological operations to justify security spending. It means millennials are called lazy or immature when they're anything but. In short, when you're going in debt for unnecessary items, and you need the jobs related to that unnecessary spending to get votes and stay in political office, you have to resort to fear and outliers to maintain the status quo. Such an approach is inadvisable in any era, but especially so in an era of increasing competition worldwide and against countries to which you owe money.

Bonus: The local level creates no reason for optimism, either.  In most major American cities, 50% to 70% of all local tax revenue is spent on "public safety" aka cops and firefighters. Many of these taxes go to pension obligations, i.e., paying gov employees who no longer work and who haven't paid into the retirement fund in sufficient amounts to sustain it without higher taxes or cutting other local programs.  Consequently, America's military budget is not subject to any real audits due to the federal gov's ability to borrow almost unlimited debt, while even local entities are forced to divert their taxes into strengthening a police state because by law, pension interests are vested and therefore untouchable. What could possibly go wrong?

Well, this is the kind of activity required in such a regime: http://www.post-gazette.com/news/nation/2015/11/06/Department-of-Defense-paid-53-million-to-pro-sports-for-military-tributes-report-says/stories/201511060140

Basically, the gov spends taxpayer monies to normalize the abnormal, then demands the entities continue its show at their own cost or be called unpatriotic.

Both parties are complicit, and both parties are locked into unsustainable programs that require more debt because neither party wants to impose any fiscal discipline. Why should they, when they can rely on more debt to maintain the status quo and their jobs? In the case of California Democrats, their allegiance is to an unsustainable K-12 system, teachers' unions, and the teachers' pension plan, which guarantees a return of 7.5%--even though the economy is growing about 2% to 3% a year.

Rather than take a common sense approach and reduce benefits for existing retirees--who negotiated an 8% ROI under much different economic conditions--it appears govs will reduce benefits for incoming, younger employees and wait a generation to try to balance their books without relying so much on debt.  It remains to be seen whether any system that depends on achieving consistent 7.5% ROI can be sustained in the "new normal."