Merrill Lynch boosted their forecasts for handset sales in 2006 and 2007.  The increases are a bit out of synch with recent disappointing reports from the handset channel. Cellular-news.com reports:

Merrill Lynch has upgraded their forecasts for handset sales next year to 1,067 million, in a research note from their analysts. Their 2006 handset estimate has also increased from 918 million to 970 million. In their view, 2006 could be the peak year for global and emerging market net adds at 440 million and 387 million.

They expect the annual growth rate of handset unit shipments to slow from 20-30% seen in 2003-06 to 10% or less in 2007-10, mainly driven by a slowdown in emerging markets subscriber growth from 28% YoY in 2006 to 18% YoY in 2007. However replacement handsets in emerging markets will grow at 66% in 2007 and provide the impetus for industry unit growth.

WCDMA handset market should accelerate, driven by HSDPA adoption, to 67% YoY to 168 million, up from 10% to 15% of the market in 2007.

The Cellular-news article has a decent chart showing the specific forecast changes, for those tracking such things.

We have discussed Oracle’s (ORCL - Annual Report) acquisition strategy several times, and believe it is the correct path for the company. However, the devil is always in the details, and with an acquisition strategy the details include making sure customers of both the parent and the acquired company remain satisfied. As ComputerWorld reports, Oracle is having mixed success on that front.

Some Siebel CRM users interviewed at the Oracle OpenWorld user conference here last week said Oracle has been slow to provide details on its pledge to integrate Siebel and Oracle products and to reveal its long-term plans for its CRM product lines.

She said Oracle executives have given mixed messages about the future of the Siebel middleware products. Depending on Oracle’s plans, EDS may have to replace the Siebel middleware with software from Oracle, [Julie Reeves, CRM leader for the office of the CIO at Electronic Data Systems Corp.] noted. “It’s an open question for the future,” she said.

Reeves said she hopes that Oracle moves to ease the migration to new versions of its tools. The process is now quite costly, mostly because EDS has to customize each new version, she said.

“Easing that migration and helping customers upgrade without significant financial drain is very important,” Reeves said.

At this point, it sounds like they aren’t so much ready to switch vendors as anxious to learn what improvements may be planned and how that might affect their own implementation plans. However, integrating software is a complicated process (IBM, Accenture and others make billions each year helping companies do it) and it may be unfair to expect a detailed roadmap so quickly. On the day-to-day service front, Oracle appears to be doing a much better job.

A couple of Siebel users said that Oracle’s services operation has equaled and in some cases exceeded that of the former Siebel Systems Inc.

Richard Napier, business development manager at InFact Group, a software consulting firm and systems integrator in Plano, Texas, said software patches and upgrades are easier to locate on the Oracle Web site than they had been on Siebel’s.

“In all our dealings with Oracle, we notice better communication, more efficiently handled service requests and basically more information” than Siebel offered, he said.

As long as the integration road map is worth the wait, Oracle should manage to pull everything together.

As “fans” of David Lereah well know, the purpose of industry trade groups is to… well… promote the industry. While they typically provide solid data that can be used in analysis, one always has to keep an eye out for their spin. Not surprisingly, the forecasts provided by industry groups tend to be on the optimistic side. The problem is, years don’t go on forever, and at some point the forecast has to be reconciled with reality. For the World Semiconductor Trade Statistics (WSTS) organization, that point was today.
Global chip makers cut 2006 sales outlook | Reuters.com

The global semiconductor market is now expected to grow by 8.5 percent to $247 billion in 2006, according to World Semiconductor Trade Statistics (WSTS) which groups the world’s main semiconductor manufacturers. In May it still expected growth of 10.1 percent.The WSTS group also trimmed its 2007 growth estimate for the worldwide semiconductor market to 8.6 percent from an earlier expectation of 11 percent growth. For 2008 it sees 12.1 percent growth, it added in its bi-annual market forecast. The adjusted forecast comes after a few important chip categories lagged behind initial expectations.

As you may guess, we are not surprised. But what’s done is done, and while 2006 is essentially in the bag what about the forecasts for 2007 and 2008? The chart below shows the year/year growth rate in semiconductor sales for each month going back to 1998. Data is courtesy of the Semiconductor Industry Association (SIA).

This tells us a few things:

• The semiconductor sales growth rate has been more consistent since 2005 (in the mid-high single digits.)
• The forecast calls for that to essentially continue for two more years.
• The chart tells us that is pretty dadgum unlikely.

Sales growth is likely to be either much higher or much lower than 8.6% next year. The million dollar question (or however much you may have at stake – for us it’s more like a couple thousand) is which direction. We’re betting it is lower.

For one thing, this is the longest the semi industry has ever gone without a year/year decline. By itself that doesn’t mean much – due to the fabless/foundry model and general tech industry maturity sales growth should be less volatile.

However, when you combine low volatility in sales growth with huge orders for new manufacturing equipment you end up with oversupply. Oversupply in a cyclical industry means sharper than normal price reductions. If the prices fall faster than unit demand rises – you get a decline in sales.

The other reason we expect semiconductor sales to be less than the industry predicts next year is summed up in the following chart, which tracks the total sales (rather than growth) over the preceding twelve months. There has been a definite change in the overall growth rate, going back to about 1995 or 1996, depending on where you want to draw the lines. For simplicity, we’ll just use the last 10 years (September 1996 – August 2006). Over that time frame, the average growth rate has been 6.3%. However, it is easy to see that that rate is toward the top of the new range (the trendline represents resistance in this case.)

So, given overcapacity, volatility and resistance we think 8.6% growth in 2007 is on the optimistic side. Perhaps even the wildly optimistic side.

Disclosure: William Trent has a long position in SMH.

Merrill Lynch recently said tech should outperform, based on:

1. A pickup in tech industrial production
2. Firming order books
3. Improving capacity utilization
4. Global exposure
5. 70% of earnings reports beating estimates

While we don’t dispute any of the points Merrill makes, we would note that the capacity utilization is likely to drop when all of the semiconductor equipment on order starts getting installed.

However, the bearish argument goes beyond nit-picking to the data Merrill chose to ignore. For example, Friday’s GDP report shows a continued slide in spending on equipment and software.

Likewise, while Thursday’s durable goods report showed a modest uptick in orders for computers and electronic products, shipments were down from a year ago.

And the decline is being led by semiconductors, as we have been predicting (and which further supports our assertion that the new equipment will hurt capacity utilization. What’s more, semiconductors are the only reported segment that does not report orders, backlog or inventory. So the overall order pickup may be misleading if semiconductor orders are tailing off.

Bulls will counter that the US GDP and durables reports do not reflect the global economy (see Merrill’s fourth point.) But the counter-argument to that is that they reflect a very large portion of the global economy, and the portion that typically leads the way when it comes to the economy.

We are still hopeful that Microsoft’s Vista operating system will spur overall tech spending. But we also think it is important to listen to both sides of the story.

Disclosure: William Trent has a long position in SMH.

The latest GDP report shows that the U.S. economy continues to be almost exclusively driven by consumer spending. In fact, the net effects of government, investment and trade are negative.

Since private domestic investment is often equated to business spending, it is important to note here that that segment is negative due to falling residential fixed investment. All of the business related spending categories were additive to GDP. Digging deeper into the residential component, here is the year/year change:

And here is how that impacts the total reported GDP growth:

The only thing left to see is whether the slowdown in housing starts to affect the rest of consumer spending. If so, we will probably see a recession.

We told you now is not the time to own a truck.  Continuing the trend this earnings season, truck-owning YRC Worldwide (formerly known as Yellow) expects margins to be hurt by a slowdown in shipping.
YRC Worldwide 3Q Profit Rises 12 Percent: Financial News – Yahoo! Finance

Transportation company YRC Worldwide Inc., whose brands include Yellow Transportation and Roadway, said Thursday its third-quarter profit rose 12 percent on lower expenses, as revenue edged up 3 percent.But the company issued a disappointing outlook, sending its shares down 41 cents to $38.79 in aftermarket trading. They closed up 39 cents at $39.20 in regular Nasdaq trading.

For the full year, YRC projects a profit of $5.45 to $5.55 per share on revenue of about $10 billion. In July the company had projected year earnings of $5.65 to $5.85 per share on revenue of $10 billion.

That is a $0.20 per share guidance reduction with just one quarter left in the year. Next year’s EPS could be $1.00 or more less than current estimates bake in. As we said before, trucks cost money even when they aren’t being used. As the economy slows, those companies like CH Robinson (CHRW - Annual Report) and Landstar (LSTR - Annual Report) that get their capacity from independent contractors on an as-needed basis have lower overhead expenses and remain profitable. If the economy slows much further, Yellow’s guidance reductions will be even larger.

Corning Q3 2006 Earnings Call Transcript – SeekingAlpha

Let me now update you on the supply chain as specifically the panel inventory situation in more detail. As I mentioned earlier, we believe there was an important improvement in the panel inventory levels during Q3. This improvement is a result of seasonal and market demand and strong annual shipments. I will table my comments on the end market just a moment. I’ll start with panel shipments, as a reminder our working assumption was been a substantial portion of the panel inventory in the supply chain, was a time when these panel makers although clearly LPL had also been public about their own inventory levels. Taiwanese panel makers have reported monthly panel shipment data through Q3 and the news has been very encouraging. Many have reported record shipments in July, August and September.Inventory levels have fallen in Q3, the number of day’s inventory and probably Q1. Inventory reduction combined with seasonal demand improved with Q3 as a result of the substantial improvement in materialization rates. We believe the Taiwanese on average increased their fab utilization rates which were in the 55% range in June, 70% in July, 85% in August, and 90% in September. Although clearly not every company is operating at that level, we believe that the average utilization rate for the Taiwanese panel makers is now equal to where it was in March. Obviously the most encouraging sign has been the strong last volume we experienced in the Q3 and our expectations for Q4 based on customer orders, which I’ll talk about a few minutes.

Now let me walk you though the end market trends in Q3. As always I would like to stress we don’t have perfect information. We use a variety of sources ranging from services that are available to use, such as display research, along with retail tracking vendors, our own discussions with customers as well as our own models. With that in mind you should also note that the following data has been derived from the aggregate of industry sources that are considered at this time to be preliminary estimates. Final data for Q3 will not be available for another month or so. Be clear the data we reference relates to shipments from PC manufacturers, television set makers to the retailers.

In summary the preliminary data indicates that the end market shipments were in line with our expectations for Q3 and on track for all three primary applications, notebooks, monitors and televisions.

Starting with notebooks, about 19.6 million were shipped in Q3, in line with our expectations. This was an 11% increase over the notebook shipments in Q2. We believe the penetration of notebook computers of all computer sold in Q3 was 36% and consistent with Q2.

Moving to LCD monitors, about 32 million were shipped in Q3 compared to 13 million in Q2. We believe the penetration of LCD monitors inched up from 79% in Q2 to 82% in Q3. For LCD televisions about 10 million were shipped in Q3 also in line with our expectations. This represents an 11% increase over Q2 shipments of 9 million. More importantly is that the penetration of LCD television into the color television market was an estimated 21% for Q3. As a reminder these percentages are preliminary at this time. You may recall during our last conference call, we estimated LCD television penetration to be 19% in Q2. After reviewing the final data we conclude the penetration was actually 21%. Based on this trend and the expected strong seasonal demand we believe LCD television penetration may be as high as 25% in Q4, an average of 22% this year.

Frankly, that television penetration is higher than we expected. While that may sound like good news, to us it indicates there is less room for further growth over the long term. At the current rate of capacity expansion the market could mature in a year or two. And given the 20% (or higher) annual price declines, the revenue growth won’t match the penetration gains.

Radio technology specialist Harris Communications (HRS) reported solid earnings and raised its full-year guidance. A review of the conference call indicates that the company is firing on all cylinders after nearly becoming a one-trick (defense) pony.

Harris started its new fiscal year with an excellent Q1. Posting outstanding revenue and earnings growth. Revenue for the Q1 was $947 million, a 25% increase compared to the prior year quarter. Organic revenue growth continued at a very strong 18%. Orders in the Q1 increased 53% to $1.1 billion significantly outpacing revenue and setting the stage for a continued growth throughout fiscal year 2007.

Government communication systems revenue was $459 million, 6% higher compared to the prior quarter as revenue increased across the department of defense, civil programs and technical services business areas.

RF communications. RF began 2007 with a very strong quarter, revenue was $264 million, an increase of 54% over the prior year.

Microwave had revenue and orders growth and strong operating performance once again in the quarter. Revenue increased to $94 million, 24% above the prior year. This is the seventh consecutive quarter that orders are been higher than sales and we continue to built order backlog.

Revenue in the broadcast communication segment was $140 million. And that’s up 59% compared to the same quarter a year ago. Revenue benefited from our prior year acquisitions of Leitch Technology, Optimal Solutions, and Aastra Digital Video. Excluding the acquisitions, revenue was about flat with the prior year.

The government communication systems and RF communications segments sell primarily to the Department of Defense, while the other two segments consist primarily of commercial customers. Back in 2000 the business was evenly split between government and commercial, but the communications bubble and 9/11 attacks shifted the mix to 80% government. Due largely to the acquisitions, the business is regaining some of its prior balance as commercial customers are back to 34% of total sales. The pending acquisition of Stratex Networks will further improve the balance.

After posting a solid quarter due to strong margins, headset maker Plantronics (PLT) shares were up more than 8%, despite issuing poor guidance for the December quarter.  Their EPS guidance of $0.25-$0.30 (after stock expense) on revenue of $205-$215 million compares to consensus estimates of $0.40 EPS on $228 million revenue. According to Yahoo! Finance:

Shares of Plantronics Inc. jumped more than 8 percent Wednesday, the day after the maker of communications headsets posted a solid fiscal second quarter with earnings above Wall Street’s expectations.Plantronics said the quarter’s earnings beat expectations thanks to a stronger product mix and lower expenses, even as revenue was in the middle of the company’s July outlook.

Baird analyst Reik W. Read upgraded the company despite its lower-than-expected third-quarter guidance.

Read upgraded Plantronics to “Outperform” from “Neutral,” thanks in part to “the positive revenue and margin trends” in the company’s call center and office segment, which accounts for 57 percent of total sales.Read said in a note to investors the company’s lower third-quarter guidance is due mainly to weakness in Altec.

We have also said that the key to Plantronics success lies in the office and call center market, which is why we (and the rest of the market) were so exasperated by their purchase of a consumer business (Altec) and excessive advertising spend, which management addressed in the conference call:

We did pull back; what we had found was that the overall adoption in the category was not appearing to rise as much as we had hoped….

So, we really scaled back a fair amount of that marketing, and put more effort into longer cycle innovation that we think can ultimately create a more compelling value offering, reduce some of the negatives. But having said that, there were still areas in the marketing that we thought were attractive… where we thought we were gaining some traction, and so we’ve narrowed our focus into those areas.

Which leads us to the crux of the issue: is now the time to buy? In our June valuation piece we said:

Therefore, although today’s valuation appears low, we will not be buyers again until it is lower still, or until we see evidence that the free cash flow is once again improving. A 3.6 percent free cash flow yield just doesn’t cut it when CDs are paying five percent.

With marketing spend down and margins up, the free cash flow improvement seems likely to follow. And with the ticker rising even on “bad” news, now probably isn’t the time to fight the tape.

Oracle (ORCL - Annual Report) CEO Larry Ellison announced the company will offer steeply discounted rates for the follow-on support customers need after installing (for free) the Linux operating system from vendors such as Red Hat (RHAT). Widely perceived as an attack on Red Hat, Yahoo! Finance notes:

The threat triggered a 16 percent decline in Red Hat’s stock price, reflecting investors worries that the pricing war will destroy one of the most successful businesses in the open-source software movement.

“Oracle has outsmarted Red Hat,” said industry analyst Trip Chowdhry of Global Equities Research.

Oracle’s challenge comes just a few months after Red Hat trumped the much larger company by buying open-source software maker JBoss Inc. for $350 million.

Ellison said he is more interested in accelerating the open-source movement than crushing Red Hat.

Because much of Oracle’s propriety software is designed to run on the Linux operating system, Ellison believes the company will make more money if more major corporate customers embrace open-source software.

For Oracle, taking a bite out of Red Hat’s few-hundred-million in annual sales is chicken feed. As CNet reported back in April, Oracle’s vision for the future is to control a complete software stack (complete set of software needed to implement solutions, from operating system to applications):

Oracle CEO Larry Ellison told the Financial Times that he would “like to have a complete stack.” Oracle makes billions of dollars selling databases and business applications. In recent years, the company has bought up many other companies, including rivals like PeopleSoft and Siebel Systems.

“We’re missing an operating system. You could argue that it makes a lot of sense for us to look at distributing and supporting Linux,” Ellison told the newspaper.

The CNet article also includes a table comparing how various software makers “stack” up: