Charlie Munger's Wisdom

The thoughts of others

Were light and fleeting,
Of lovers’ meeting
Or luck or fame.
Mine were of trouble,
And mine were steady,
So I was ready
When trouble came.

-- A.E. Housman

Charlie Munger: "You can say, who wants to go through life anticipating trouble? Well, I did. All my life I’ve gone through life anticipating trouble. And here I am, going along in my 84th year and like Epictetus, I've had a favored life. It didn’t make me unhappy to anticipate trouble all the time and be ready to perform adequately if trouble came. It didn’t hurt me at all. In fact it helped me." More here and here.

California Water Service Group Annual Meeting (2010)

California Water Service Group (CWT) held its annual meeting on May 25, 2010 at a downtown San Jose hotel. Chairman Robert Foy, looking dapper in a bowtie, commemorated Dr. Edward Day Harris, Jr., a board member who recently passed away.

Mr. Foy then formally began the meeting by introducing California Water Service Group's executive team. Mr. Foy explained that CWT was holding its annual meeting in a hotel because of new construction on its nearby campus. After completing the formal portion of the meeting, he began a slideshow presentation. The first slide was a Vince Lombardi quote: "Individual commitment to a group effort is what makes a team work." Mr. Foy provided detailed background information on the Board's members and showed several comments praising them ("integrity," "beacon of consistency," etc.). After praising the Board, Mr. Foy turned the meeting over to CEO Pete Nelson.

Mr. Nelson complimented Mr. Foy for his service to the company and elsewhere, noting that the city of Stockton had recently awarded Mr. Foy "Stocktonian of the Year." Mr. Foy--clearly the most charismatic man in the room--was the CEO of Pacific Storage before he came to CWT. In addition, he is involved with numerous community, religious, political and charitable groups.

Mr. Nelson focused on the employees of the company, reminding us that there are "a thousand employees behind one glass of water." He explained that the company has meter readers (52 employees), customer service agents (119 employees), district managers, and many other employees who ensure safe and reliable drinking water. Customer service is a top priority--"96% of calls" get resolved on the first call. Meter readers, who handle five million reads a year, are also trained to be "field ambassadors."

Mr. Nelson said CWT values employee feedback. He said that "the people who do the work are best able to say how to do the work," i.e., "decisions must be local." He ended the meeting by saying that "each individual employee is important to the company."

I asked why someone would want to own CWT over San Jose Water Company (SJW). Mr. Nelson said that the companies were "sister utilities" and cooperated with each other. While different, they are "both good companies." (SJW owns some of CWT, and the Chairman of SJW's Board was present at the meeting.)

I also asked about the financial status of the company's pension plan. The CFO, Martin Kropelnicki aka "Marty," provided a delightfully detailed answer, mentioning the applicable IRS/FASB code sections from memory. The condensed answer is that the plan is over 80% funded, which is a reasonable amount.

Another shareholder complained about the service he was receiving from Delaware Water Company and asked CWT to buy them out. Mr. Nelson said he did not comment on acquisitions.

Another shareholder asked about desalination. Mr. Nelson indicated that "as a supply source, desalination is not economic yet," and there are also "environmental issues" associated with it.

Finally, a shareholder (and retired employee) complained about his medical care benefits and pension checks. Mr. Nelson said that the company had "dropped the ball" and planned on communicating with retirees better.

After the meeting, shareholders received a complimentary box that included a shower head and other water-saving tools.

As an investor, it's difficult to differentiate between publicly traded water companies such as SJW, CWT, AWR, AWK, and SWWC. They all know each other, so no one seems willing to badmouth anyone else. Also, much of the revenue is based on unpredictable political factors, such as the willingness of a water board to grant rate increases. Having a charismatic Chairman like Mr. Foy may give CWT an advantage over its competitors when it comes to political schmoozing, but it's still hard to predict which water companies will outperform. One interesting issue with water companies is that conservation may work against them; in other words, the more users conserve and cut back on water use, the less money water companies make. Overall, I enjoyed meeting Mr. Foy and the rest of the SJW team, especially Mr. Kropelnicki.

Disclosure: I own an insignificant number of shares of CWT, AWK, and SJW. Of the aforementioned holdings, I own the most number of shares in AWK.

Update: a reader on a different site left an interesting comment. See below:

I started following Water Utilities in 1997 and have been an investor in various ones ever since. However, I sold all CA water utilities after the electric crisis a few years back, and vowed never to own another CA utilities again. The cost of electricity spiked during the crisis and the largest operating cost of a water utility is energy to power the distribution pumps. These are operating costs that should be part of rate relief, but the CA PUC refused to allow the water utilities to recoup these higher operating costs, instead making shareholders eat the difference. This is like changing the rules mid-stream.

Callidus Software Annual Meeting (2010)

Callidus Software (CALD) held its annual meeting in the heart of downtown San Jose. Around nine people attended the meeting, including only two non-employee shareholders. The company offered shareholders a small box of donuts, water, and coffee.

CEO Leslie Stretch handled most of the meeting telephonically, along with CFO Ron Fior, who was present in person. CEO Stretch has a delightful English accent, which was fun to hear. There was no presentation, so we went straight to Q&A after concluding the formal portion of the meeting.

A shareholder asked several questions, focusing on the company's top line growth. He asked, "What improvement in gross margins can we expect by the end of the year?" CFO Fior responded that he expected gradual improvement. Over time, he was hoping that some technological improvements, along with scale, would improve on-demand margins. [Note: page 10 of CALD's 10K states, "our overall gross margin declined from 43% to 39% from 2008 to 2009, and "revenue declined by 24%" during the same period.]

The same shareholder also asked how the company expected to get to "cash flow positive" or "break-even." CFO Fior answered that he expected a "gradual increase" in revenues and margins.

I asked about page 14 of the 10K, which shows a shift in Callidus' business model from consulting/professional services to on-demand. I asked why the company made the shift, especially when its own 10K stated that a "substantial portion of [its] revenues are derived from the performance of professional services." (See page 16, 10K)

CEO Stretch and CFO Fior responded that services revenue had been declining for years and switching from legacy licenses business to a recurring on-demand business model with much shorter implementation times resulted in much lower services revenues. For example, a legacy on-premises license might take a year to two years to implement whereas now, in the on-demand center, a new customer can be up and running in 3 to 6 months.

I then asked about the company's "wide moat." People looked confused, so I explained that a wide moat refers to something that protects a company from being conquered or beaten by competitors. For example, Oracle's software, once installed, becomes an integral part of a company's operations. In short, Oracle's wide moat is the "stickiness" of its software. CEO Stretch responded that "no one can do what we do for insurance companies," noting that Callidus' customers include some of the biggest insurance companies in the world, such as Allianz North American and Allstate. He also highlighted Callidus' "90% renewal rate," which indicates customer satisfaction and/or "stickiness."

I wanted to know more about the reasons Callidus' product is especially suited for insurance companies, so I sent a follow-up email. The company was kind enough to send me some of its thoughts: "Our product is especially suited to companies that have large distribution channels (agents), complex plans, and large data volumes from multiple data sources. It allows industries such as the telecom and insurance industries where these conditions exist to simplify the complexity through our rule-based engine and at the same time have flexibility to change quickly. We solve a difficult problem and make it easier for these companies to implement new incentive plans on a much more timely basis. With our acquisition of Actek, Callidus accounts for 2 of the 3 companies Gartner Research ranked positive in the insurance space."

On a side note, when I asked questions about the 10K, someone interrupted me, demanding my name and how I held my shares. At that time, this person hadn't asked the previous shareholder any of these questions, so I was caught off-guard. I repeated my name and disclosed the name of my brokerage. I asked if he was general counsel (i.e., a lawyer who is an employee of the company). It turns out that he was outside counsel (i.e., a lawyer who bills the company for legal services but is not an employee).

I always get concerned when outside counsel takes over meetings, even if only temporarily. First, the general counsel usually attends annual meetings (as in this case), so if there really is a problem, the general counsel can step in. Also, why pay an outside lawyer to sit at meetings when the corporation's own general counsel should be able to handle any legal issues that arise? To me, paying outside counsel to sit at annual meetings seems like a waste of money, but that's just me.

Second, anytime outside lawyers feel entitled enough to direct questions to shareholders, it tells you that the company may be placing too much trust and discretion in an outside law firm. Such faith can be an expensive proposition at 200 to 500 dollars an hour. Personally, I prefer to see strong CEOs and management and weak lawyers--not the other way around.

Third, outside lawyers have directed questions to me at meetings only at small companies where performance has lagged. Perhaps the company's inability to make the numbers emboldens the lawyers, who feel the need to assert themselves; however, successful businesses rarely do well when management is taking directions from lawyers. This is because lawyers tend to be risk-averse, and winning in the business world requires risk and gusto. (I can't help but remember the following words about Citigroup, spoken by its largest individual shareholder: "My recommendation and advice for them is they don't hire anyone unless this guy has expertise in banking. I told them, next time no lawyer, please." See here for more.)

In any case, here is my advice: to the extent a company or lawyer wants to know the names and status of shareholders at the meeting, it's really simple--just have a sign-in sheet outside the meeting room and have someone check the information on the sheet before admitting someone to the meeting. If you can't handle that basic protocol, the solution isn't to interrogate someone during the meeting itself. That's just basic common sense. What if I was a major shareholder?

[Update: the CFO wrote to me and apologized if I felt singled out. It turns out the other person asking questions at the meeting represented a major shareholder and was already well-known to the company.]

Callidus looks like an interesting company. I don't usually invest in software companies, but if you believe insurance companies are growing and will continue to need sales performance management software, you may want to take a look at Callidus.

Disclosure: as of June 1, 2010, I owned an insignificant number of CALD shares.

Cadence Annual Shareholder Meeting (2010)

Around forty people attended Cadence's 2010 annual shareholder meeting. Coffee and some pastries were available. For some reason, the doors to the meeting room had been locked, which meant that if you were a few minutes late, someone with a key had to come by and give you access. (Cadence didn't intend to lock out anyone, and someone did come by within a few minutes to let everyone in.)

CEO and President Lip-Bu Tan (picture above) handled the informal portion of the meeting, which included a slideshow. Some highlights:

-- 46% of Cadence's revenue comes from the Americas, followed by Europe. Mr. Tan said that "last year [2009] we had to survive, but this year [2010] we are breaking out" and doing better.

-- Cadence has $619 million in cash (Q1 2010), with a 2009 backlog of $1.6 billion.

A shareholder asked questions about lost revenue due to overseas IP infringement. He wanted insight into business in China and licensing fraud. He said that he's heard small companies in China will buy one Cadence license and then allow multiple users or affiliates to use the license, costing Cadence additional customers and revenue. Mr. Tan said that Cadence was "making good progress in China," but IP issues would take time. [From what I've seen, it isn't unusual for tech companies to tolerate not maximizing revenue to gain a foothold or market share in China.]

Another shareholder asked about debt and upcoming debt payments. Cadence said it would consider all options but had plenty of money to make the upcoming payments.

I asked about Magma Design (LAVA), a competitor. Mr. Tan said that Cadence "will aggressively compete" against Magma Design. He referred my question about differences in the two companies' products to Dr. Chi-Ping Hsu, Sr. VP of the Products Group. Dr. Hsu said that Cadence was "doing quite well against" Magma Design and felt confident that Cadence's newer product lines would distance Cadence from Magma. Some people have mentioned that Cadence might buy out Magma; however, I saw no obvious signs that Cadence was actively thinking about acquiring Magma.

Mr. Tan also said that Cadence tries to be the full EDA (electronic design automation) solution for companies, referring to the "EDA 360" plan: 1) engage the customer early; 2) help the customer get to market first; and 3) use excellent customer service to prevent commodification. Mr. Tan emphasized that "time to market is essential" for Cadence's customers, because the faster Cadence helps them launch their products, the higher the premium/margin the company can charge in the marketplace. In short, Mr. Tan was saying that Cadence's customer service and complete solutions differentiate it from competitors such as Magma, Synopsys (SNPS), and Mentor Graphics (MENT).

I enjoyed meeting CEO Lip-Bu Tan and Sr. VP Chi-Ping Hsu. Both men carried themselves with confidence and yet without any trace of arrogance.

Disclosure: I own an insignificant number of Cadence (CDNS) and Magma Design (LAVA) shares. I do not plan on buying more shares of any EDA provider. Competition is intense, and companies must constantly innovate to survive. EDA is a very difficult business to be in.

Greenland's Importance to the World

Jim Folger, National Geographic, June 2010:

Greenland is warming twice as fast as most of the world. Satellite measurements show that its vast ice sheet, which holds nearly 7 percent of the world's fresh water, is shrinking by about 50 cubic miles each year. The melting ice accelerates the warming—newly exposed ocean and land absorb sunlight that the ice used to reflect into space. If all of Greenland's ice melts in the centuries ahead, sea level will rise by 24 feet, inundating coastlines around the planet.

Whoa.

Will Arizona be a Democratic State by 2035?

The GOP doesn't realize it yet, but Arizona will be a Democratic state within 25 years. Under our Constitution, every child born in Arizona is an American citizen, regardless of his/her parent's immigration status. Also, children are able to sponsor their parents for citizenship, so the parents that Arizona wants to deport will one day become citizens through their American-born children.

Later, when the children of Mexican immigrants grow up, they will be able to vote. American citizens won't support a political party that wanted to deport their parents. And don't forget: the children of Mexican immigrants go to public schools and will make numerous friends of all ethnicities. Anyone who thinks that second or third-generation American children who grow up playing with their Mexican-American friends will share the same thinking as their parents doesn't understand generational shifts. Put simply, new generations always rebel.

Just look at North Carolina--who would have thought the same state that elected Jesse Helms would one day elect John Edwards?

As for me, I keep wondering when Goldwater/Eisenhower Republicans will create the third party that America desperately needs. Wouldn't most Americans vote for a political party that supports fiscal conservatism, a humble executive branch, and non-interference in our private lives?

Bonus: according to the Brookings Institution, nearly 25% of Americans younger than 18 have at least one immigrant parent.

Film Rec: Wait Until Dark

Audrey Hepburn delivers an incredible performance in the thriller, Wait Until Dark. This film is an absolute must-see, especially for Alan Arkin fans. A very young Alan Arkin plays one of the best villains of all time, "Roat, Jr."