Archive: Fundies

DAL: Delta Looks Better When You Don’t Look Too Closely

This article was originally published at RealMoney on September 17, 2007.

When I saw out-of-the-money calls Delta Airlines (DAL) on StockPickr’s stocks with heavy option volume my first thought was that it must have been one of the short squeeze airline plays also mentioned on StockPickr. Nope. So that got me thinking. I typically don’t want to touch airlines with a 10-foot pole, but they do make for the occasional good trade. Is this one of those occasions?

For me, even a speculative trade has to have something underneath it for support. At first glance, it looks like Delta has that. 2008 EPS estimates are at $1.80 and have been marching up steadily, now giving the company a single-digit P/E multiple. Price/Book is also low, but only because they exited bankruptcy with a load of goodwill on the balance sheet. Excluding that, the book value is negative. They have a fair amount of cash, but plenty of near-term liabilities on which to spend it. All in, their total net debt is more than $5 billion, resulting in an enterprise value of $9.7 billion. If they keep generating the cash flow they did during the first half of 2007, the double-digit free cash flow yield could be enticing.

The problem with those valuations, though, is that they rely on the accounting numbers on the face of the financial statements. The last 10Q disclosed that after the June 30 financial statement dates but before July 31, the company issued another $66 million in debt and paid $303 million cash to terminate pension plans and settle some other obligations. Then, on August 28 they were required to issue $650 million in debt to their pilots in exchange for salary concessions they had made. The company has settled $11.4 billion of bankruptcy claims by issuing common stock, but “currently estimate that the total allowed general, unsecured claims in our Chapter 11 proceedings will be approximately $15 billion, including claims with respect to which we have issued or commenced distributions of common stock.” That means that another $3.6 billion are not yet on the books, even assuming their estimate is correct. That brings the enterprise value to $14.3 billion, and the free cash flow yield below 7%. Who knows how many shares will have to be issued to settle the claims, so I won’t even talk about the P/E.

What’s more, airlines are notorious for off-balance sheet and other obligations. Delta has 136 aircraft under operating leases, which make up about a quarter of its fleet but do not appear on the balance sheet. If these were treated as company-owned aircraft, the assets and liabilities would each increase by about $3.5 billion (assuming the leased aircraft are worth about as much, on average, as those that are owned.) Now we’re down to a 5.4% yield on an adjusted enterprise valuation of $18.8 billion.

How quickly we get from something that looks enticing to something that looks like it came out of bankruptcy five months ago. Which, of course, it did. Bottom line, if you want to take a flier on an airline, I’d stick with one of the short squeeze plays. The majors still look like they can cause a major league stomachache.

Topics: Airline, Delta Air Lines (DAL), Forensic Accounting, Fundies, Stock Market, Transportation | 1 Comment

ADBE: Adobe’s Pride in its Headquarters Building Doesn’t Extend to the Balance Sheet

Design software maker Adobe Systems (ADBE) is rightly proud of its headquarters building, which it lauded last December in a press release:

Adobe Systems Incorporated today announced the U.S. Green Building Council (USGBC) has awarded Leadership in Energy and Environmental Design-Existing Building (LEED®) Platinum certifications for Adobe’s East and Almaden headquarters towers in downtown San Jose, distinguishing Adobe as the world’s first commercial enterprise to achieve a total of three Platinum certifications under the LEED program.

However, the pride in its building is more muted when it comes to showing the property and its associated debt on the balance sheet, as disclosed in a recent SEC filing:

On March 26, 2007, Adobe Systems Incorporated (the “Company”) renewed its lease arrangement for one of three buildings the Company occupies as part of its corporate headquarters, known as the Almaden Tower, located in San Jose, California (the “Property”).

Pursuant to a lease agreement (the “Lease”), dated March 26, 2007, between the Company as Lessee and SELCO Service Corporation as Lessor, the Company has leased the Property for a new five year term that extends to March 26, 2012, with an option to extend for an additional five years at the Company’s sole discretion. Rent payments under the Lease are a function of LIBOR; payments for the initial term are currently estimated to be $29.7 million. The Company has the option to purchase the Property at any time during the term of the Lease for approximately $103.6 million. The maximum recourse amount (or residual value guarantee) under this obligation is approximately $89.5 million. The Lease will continue to qualify for operating lease treatment under Statement of Financial Accounting Standards No. 13, “Accounting for Leases,” and as such, the Property and related obligations will not be included on the Company’s consolidated balance sheet.

With a value of $104 million and annual lease payments of approximately $6 million, the payments do not appear all that different from those the company would pay in a mortgage. It’s not like Adobe needs creative financing arrangements, either. With $2.2 billion in cash and short-term investments as of December, they could buy 20 such buildings without taking out a mortgage against any of them. We’re actually more concerned that management is spending time drafting arrangements like this than we are about the arrangement itself. But that’s not the least of it:

As part of the financing of the Lease, the Company purchased a portion of the Lessor’s receivable under the Lease for approximately $80.4 million, which will be recorded as an investment in lease receivable on the Company’s consolidated balance sheet for the quarter ended June 1, 2007. This purchase may be credited against the purchase price if the Company purchases the Property, or may be repaid from the sale proceeds if the Property is sold to a third party.

So rather than carrying the property on the balance sheet and taking a charge for depreciation and interest expense, the company keeps it off the balance sheet and pays rent. With the investment in the lease receivable, it makes us wonder why they even bothered.

Topics: Adobe Systems (ADBE), Forensic Accounting, Fundies, Investing 101, Stock Market | No Comments

MMM: 3M Buying Back Shares, But With What?

Stock Market Beat Large Cap Watch List (Track at Marketocracy) member 3M Company (MMM) announced a large share repurchase program yesterday:

3M today announced that its Board of Directors approved a new $7 billion two-year share repurchase authorization between Feb. 12, 2007, and Feb. 28, 2009, the largest in 3M’s history.”While our first priority remains investing for growth, returning cash to our shareholders remains an integral part of our strategy,” said George W. Buckley, 3M chairman, president and CEO. “The strength of our operations and our confidence in 3M’s future continue to afford us the flexibility to do both.”

During the calendar years 2004-2006, the company returned more than $10 billion in cash to shareholders through the combination of share repurchases and cash dividends.

The press release was mum on how, exactly, the company would pay for the shares. 3M has about $2 billion in cash on hand, and generated about $4 billion in operating cash flow in each of the last two years. However, replenishing equipment and making acquisitions ate up about $2 billion each year, while dividends eat up another $1-$1.5 billion. That leaves $0.5-$1.0 billion in cash flow each year for repurchases. Combined with existing cash, the company comes up about $3.5 billion short of the $7 billion they plan to buy back over the next two years.

So where will they come up with the money? By issuing debt, of course. (They could also defeat the purpose of the buybacks by issuing new shares, but we’ll assume for now that they aren’t pulling the switcheroo.) Indeed, total debt rose by $1.5 billion in 2006 as part of their return of “more than $10 billion in cash to shareholders” over the last two years.

Now, we aren’t criticizing debt per se, particularly at the low low interest rates companies can borrow today. If the company doesn’t borrow to buy its own shares, a private equity buyer may well come along and do the same thing anyway. Furthermore, 3M’s current debt load of $3.5 billion ($1.5 billion net of cash) is hardly budget busting against $21 billion of assets at book value and a $55 billion market cap. In fact, many would likely argue that a recapitalization from debt to equity is the wisest thing to do for 3M.

But you won’t, apparently, catch management saying that.

Topics: 3M (MMM), Fundies, Stock Market | 1 Comment

Is Silicon Labs’ Board Independent Enough?

When you own your own business you can make sure that any managers working for you are acting in your interest. It is different for public companies, where management is not directly answerable to shareholders. In corporate governance terms, this is called the agency problem. How can a shareholder be sure management, who acts as the shareholder’s agent, is acting in the shareholder’s interest? In theory this is done through the Board of Directors.

For the board to be an effective guardian of shareholder interests, it should strive to mitigate conflicts of interest between stakeholders, and in particular between management and shareholders. Managers left to pursue their own agendas unchecked can grant themselves excessive pay, use shareholder funds wastefully, engage in nepotism and do many other things that could potentially be harmful to the shareholders. More »

Topics: Bowater (BOW), Fundies, Governance, Investing 101, Silicon Laboratories (SLAB), Stock Market, The Buckle (BKE) | No Comments

Plantronics (PLT) and Oracle (ORCL) Scratch Each Other’s Backs

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

Oracle Standardizes on Plantronics Wireless Headset Systems to Optimize VoIP Communications

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

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

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

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

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

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

Later, Schilit elaborates:

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

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

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

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

Or, as we suggested earlier, it could all simply be PR fluffery. But even in that case it is best if investors know all the details.
Disclosure: Author is long Plantronics (PLT) call options and short Plantronics put options.

Topics: Forensic Accounting, Fundies, Microstrategy (MSTR), NCR (NCR), Oracle (ORCL), Plantronics (PLT), Stock Market | 3 Comments

Is DELL Cooking the Books?

As accounting geeks, we are always on the lookout for examples of misleading company financial reports.  In particular, it is a neat find when a company has beaten earnings by a penny or two for several consecutive quarters due to accounting items over which management has discretion. Examples of such discretionary items include the allowance for doubtful accounts and warranty reserves.

Accounting rules require companies to recognize sales and the related expenses in the same period. However, if a product is warrantied for three years after the sale (as DELL products often are) this can be difficult. In such cases, management is required to estimate the future warranty expense and charge the estimated amount when the sale is made. The charge is accounted for as a warranty reserve, and future actual warranty costs act as a reduction to the reserve rather than showing up on the income statement directly. If management’s estimate turns out to be incorrect (intentionally or unintentionally) the amount reserved will be adjusted in the future periods when necessary.
Because management has a good deal of discretion when estimating the costs (especially during quarterly reports – which are not audited as are the annual ones) skeptical investors call reserve accounts “piggy banks.” If management has a good quarter and beats earnings by several cents they could estimate higher than normal warranty expenses, and smooth out the earnings by reporting less in the good time. Then, in a bad quarter they could estimate a lower warranty expense to take some of it back. Which leads us to the following article we found regarding DELL.
Research Firm: Dell Warranty Accounting ‘Troubling’ – Warranty Accruals – CRN

New questions are being raised about the way Dell accounts for its warranty accruals.Friedman, Billings, Ramsey Research (FBR), an Arlington, Va.-based research firm, on Friday said its study of Dell’s books “points to at least three troubling conclusions” in the way that the computer hardware giant has handled warranty accruals in its financial reports.

FBR said in its report that Dell’s accounting for warranty accruals “has caused [earnings per share] overstatement of 2 cents to 8 cents in five of the last 12 quarters for which data is available.” The study comes as Dell faces investigations by the U.S. Securities and Exchange Commission, the U.S. Attorney for the Southern District of New York and the audit committee of its board of directors.

“First, it appears that Dell regularly uses warranty accruals to materially manage margins and earnings, rendering the reported results less useful for gauging actual margin trends,” FBR said in the study. “Second, as of the last quarter for which a 10-Q [report with the SEC] is available, the cost of actual claims as a percentage of products sales was rising steadily — up 30 percent [year over year in Dell's 2006 fiscal year] and costs may be heading higher.

“FBR also said Dell’s way of disclosing how it manages the money it collects from product warranties, the money it sets aside in reserve for warranty expenses and how much it accrues in warranty funds, is unusual, making it difficult to identify the Round Rock, Texas-based company’s warranty accruals based on public financial reports alone. The research firm said Dell could be headed for a restatement of earnings if the SEC probe includes a focus on warranties.

Since that would be pretty serious manipulation, we decided to check things out for ourselves. We come away unconvinced.

We’ll take the last point first. In its reports DELL discloses its warranty costs and reserves using a table very similar to this one:

Accrualreporting.jpg

“Revenue deferred and costs accrued for new warranties” is the line management estimates. The obligations honored represent actual warranty expenses while the amortization of deferred revenue represents amounts DELL has collected for service agreements that it recognizes over the term of the agreement.

As FBR notes, by lumping deferred revenue and warranty estimates into a single line it is difficult to tell which is which. This can be important, as the warranty reserves are recognized as a product-related expense while the deferred revenues are recognized as service revenue. So we looked at several quarters of management estimates as a percentage of both total revenue and service revenue, which we condensed to the following chart:

Warrantyaccrualstosales.jpg

Other than the big spike up in Q306 (the quarter that ended in October 2005) there isn’t too much of a trend in either ratio. As a percentage of total revenue the accruals are rising over time, which actually means that the company is reporting lower profits than they would if the accruals were held constant. As a percentage of service revenue there may be a very mild case that the company is being more aggressive.

Still, there doesn’t have to be a trend in order for the quarterly fluctuations to affect earnings. So we took the average ratio of our nine quarters reported as a “normal” percentage of sales that should be accrued. We see that the fluctuations in accruals were indeed enough to affect EPS. Further, there were more quarters in which the adjustment would have reduced EPS than those in which it would have increased EPS. If the company beat estimates in those quarters by a smaller amount than the warranty accrual, there would be some cause for concern. For example, in the April 06 quarter (Q107) the company reported earnings that met consensus estimates, but normalizing warranty accruals to service revenue they would have missed by $0.02.
epseffect.jpg

However, Friedman’s second point (about the rising actual warranty expenses) seems somewhat frivolous. We noted that the reserve spiked in the October 2005 quarter. Looking at that filing, we learn that:

During the quarter, Dell recognized a product charge of $307 million for estimated warranty costs of servicing or replacing certain OptiPlextm systems that include a vendor part that failed to perform to Dell’s specifications. At October 28, 2005, $274 million of the accrued warranty obligation remains outstanding for servicing or replacing additional OptiPlextm systems.

Having a $307 million expected warranty expense is certainly unfortunate. However, as per the accounting requirements DELL recognized the charge as soon as the problem was discovered, and the higher current expenses at least partly relate to the remaining expenses associated with servicing and replacing those systems as needed. It is hard to argue that this is anything more than the accounting system functioning as it was intended to (matching the expenses to the associated revenues as much as possible.) The charge was taken in October 2005 and disclosed at the time as a way of covering the future expenses. Now, as the expenses are recognized they come out of the reserve rather than the income statement (since they were already charged to the income statement in October.) No big deal. In fact it seems to confirm that management is using the process appropriately. (It would be inappropriate for them to put a big deposit in the piggy bank if they weren’t going to have higher actual expenses.)
Furthermore, since the most recent cases of adjusted earnings falling below reported earnings are due to the timing of recognizing this specific issue, we are less concerned about the adjusted-earnings miss in the April quarter.

Topics: Dell (DELL), Forensic Accounting, Fundies, Investing 101, Stock Market | 9 Comments

What Finisar’s Note Exchange Means to Shareholders

Finisar’s (FNSR) announcement that it was exchanging some of its convertible notes for contingent convertible notes generated some interest in our case study on contingent converts. Given the interest, we figured we would reward it with a study of the specific Finisar transaction. We’ll start with the company’s spin:

Overall, the exchange provides the Company with more flexibility to utilize its cash flow from operations between now and 2010, while also minimizing dilution to shareholders.

If you think this sounds too good to be true, you would be correct. Let’s start by looking a little more closely:

The New Notes contain provisions known as net share settlement which require that, upon conversion of the New Notes, Finisar will pay holders in cash for up to the principal amount of the converted New Notes. Any amounts in excess of this cash amount will be settled in shares of Finisar common stock.

What this means is that the old notes were convertible into stock (270 shares per $1,000 of bond principal) or the company could settle in cash if it preferred. The new notes, by contrast, require the company to settle the first $1,000 of each bond’s ending value in cash rather than shares. This does not provide the company “more flexibility to utilize its cash flow.”  In fact, just the opposite. So we can surmise that some cash flow covenants were restricted “between now and 2010″ to give the company more flexibility in the short term. Specifically:

The New Notes do not contain the put option provisions of the Outstanding Notes which provide the holders of those notes the one-time option to require the Company to repurchase the Outstanding Notes on October 15, 2007.

So instead of being required to repurchase the notes next year, they get a reprieve until the notes expire in 2010.

Now let’s tackle the dilution aspect. The company tells us:

The New Notes also are convertible into 35 more shares of Finisar common stock per $1,000 principal amount than the Outstanding Notes.

Hmm. Instead of 270 shares, the bondholders can get 305 shares worth of value for their bonds. That doesn’t exactly sound like “minimizing dilution to shareholders” to us. What they really mean is that, because the principal will be settled in cash, the reported diluted share count will be lower. This is just accounting sleight-of-hand. The economic reality is that bondholders are getting more value for their money, and this value will come directly out of shareholder’s pockets.

What Finisar has done is this:

  1. They agreed to settle the first $1,000 of each bond’s value in cash in exchange for being able to reduce the reported (not the economic) dilution to shareholders.
  2. They sweetened the notes by making them convertible into 35 additional shares (a $125 value per bond.)
  3. In exchange, bondholders have to wait until 2010 to cash in the bonds instead of having the option to do so next year.

Who do you think got the better end of this deal?

Topics: Ceradyne (CRDN), Finisar (FNSR), Forensic Accounting, Fundies, Investing 101, Stock Market | 2 Comments

Hewitt (Part 3) – The Fundies

Summary: In light of the ongoing audit it is difficult to interpret past results as a guide to future activity.

Income statement analysis

Sales growth accelerated from 11.3% in 2004 to 28.8% in 2005 on the back of the exult acquisition. However, in the first six months of 2006 sales declined 2%.

Sales quality – the need for a restatement and write-off related to contract costs suggests that sales were of poor quality and inadequate diligence was done regarding estimating future possibility. It is possible the market has become too competitive to be very profitable.

Revenue recognition – the percentage of completion method used carries the potential risk that costs and revenues will be (intentionally or unintentionally) estimated incorrectly, resulting in exactly the type of write-down the company is now quantifying. As they say in the 10K: “Our accounting for our long-term contracts requires using estimates and projections that may change over time; such changes may have a significant or adverse effect on our reported results of operations or consolidated balance sheet.

Projecting contract profitability on our long-term Outsourcing contracts requires us to make assumptions and estimates of future contract results. All estimates are inherently uncertain and subject to change to correct inaccurate assumptions and reflect changes in circumstances. In an effort to maintain appropriate estimates, we review each of our long-term Outsourcing contracts, the related contract reserves and intangible assets on a regular basis. If we determine that we need to change our estimates for a contract, we will change the estimates in the period in which the determination is made. These assumptions and estimates involve the exercise of judgment and discretion, which may also evolve over time in light of operational experience, regulatory direction, developments in accounting principles, and other factors. Further, initially foreseen effects could change over time as a result of changes in assumptions, estimates or developments in the business or the application of accounting principles related to long-term Outsourcing contracts. Application of, and changes in, assumptions, estimates and policies may adversely affect our financial results.”

· Customer financing – N/A

· Other

Seasonality – none apparent.

Earnings quality

· Capitalization of expenses – certain expenses are capitalized at the beginning of the contract to be recognized over the contract terms ($91 million in 2005), along with certain deferred revenue items. In addition, some software development costs are capitalized ($25 million in 2005).

· Operating margins – were declining even before the recent write-off announcement. A huge increase in “other operating expense” accounted for the deterioration. The company’s explanation was higher 3rd-party BPO services and higher “client service delivery expense.”

YTD 06

FY05

FY04

FY03

Operating margin

7.1

8.1

9.9

8.8

· Stock options – company accelerated vesting of out-of-money options to avoid expensing them, so the $0.35 per share pro-forma information reported is not a good guide to future expense.

· Pensions –Recurring (service + interest) costs exceed amount recorded on income statement by $6 million per year.

· Anomalous tax rates – no

· Other – following the Exult merger, certain expenses were reclassified from the consulting to the outsourcing segment, impairing comparability.

Balance sheet analysis

Debt load and maturity schedule

Amount

Interest Rate

Terms

$ 15,000

7.93

Repayable in June 2007

6,000

7.94

Repayable in five annual installments which began in March 2003

30,000

7.45

Repayable in five annual installments which began in May 2004

10,000

8.11

Repayable in June 2010

15,000

7.90

Repayable in October 2010

35,000

8.08

Repayable in five annual installments beginning in March 2008

$111,000

Exotic debt instruments “Subsequent to our merger with Exult, Hewitt became the sole obligor and assumed obligations on $110 million of 2.50% Convertible Senior Notes due October 1, 2010. The notes rank equally with all of our existing and future senior unsecured debt and are effectively subordinated to all liabilities of each of our subsidiaries. We recorded the notes at their estimated fair value of $102 million at the merger date and are accreting the value of the discount over the remaining term of the notes to their stated maturity value using a method that approximates the effective interest method. As of September 30, 2005 the outstanding balance on the notes was $104 million.

The notes are convertible into shares of Hewitt Class A common stock at any time before the close of business on the date of their maturity, unless the notes have previously been redeemed or repurchased, if (1) the price of Hewitt’s Class A common stock issuable upon conversion of a note reaches a specified threshold, (2) the notes are called for redemption, (3) specified corporate transactions occur or (4) the trading price of the notes falls below certain thresholds. The initial conversion rate is 17.0068 shares of Hewitt Class A common stock per each $1,000 principal amount of notes, subject to adjustment in certain circumstances. This is equivalent to an initial conversion price of approximately $58.80 per share. Based upon this conversion price, the notes if converted, would be convertible into 1,870,748 shares of Hewitt Class A common stock.

On or after October 5, 2008, we have the option to redeem all or a portion of the notes that have not been previously converted or repurchased at a redemption price of 100% of the principal amount of the notes plus accrued interest and liquidated damages owed, if any, to the redemption date. Similarly, the convertible debt note holders have the option, subject to certain conditions, to require Hewitt to repurchase any notes held by the holders on October 1, 2008 or upon a change in control at a price equal to 100% of the principal amount of the notes plus accrued interest and liquidated damages owed, if any, to the date of purchase.”

Value of unexercised options

Pension funding – unfunded liability of $65 million, of which only half is currently recognized on the balance sheet.

Accruals

· Doubtful accounts – rose by 10% compared to a 14% rise in receivables and a 29% rise in sales. Held at the same percentage of receivables would have reduced operating income by nearly $1 million.

· Other – substantial increase in cash flow from operations largely due to stock-option related tax deferrals

Receivables trends (DSO) – Declining

Long-term or unbilled receivables – stable

SPEs and other off-balance sheet items – $500 mm PV of operating leases, $150 mm in contractual obligations.

Cash flow analysis

Operating cash flow and net income trends – CFFO rose $90 million on a $2 million decline in net income for the first 6 months of 2006, primarily due to increased accrued compensation.

Growth indicators – out the window until the results of the restatement are known.

The proxy statement and other issues

Director independence – Three of 11 directors are employees and two have ties to Sara Lee.

Related party transactions – “In May and July 2005, FORE Holdings, our former parent company and a related party, sold properties and its rights as lessor for a number of the properties in which the Company leases space. As a result, our operating leases are all with third parties and there are no remaining operating leases with related parties (see Note 13 to the consolidated financial statements for additional information). In exchange for certain waivers and covenant changes stemming from the property sale, we received $3 million which is being amortized as a reduction of our rent expense over the remainder of the related leases.”

Other – multiple classes of stock: “As of September 30, 2005, our initial stockholders and their assignees owned shares of Class B and Class C common stock representing approximately 45% of the voting interest in Hewitt. Pursuant to the terms of our amended and restated certificate of incorporation, the Class B and Class C common stock are voted together in accordance with a majority of the votes cast by the holders of such stock, voting together as a group. As long as our initial stockholders continue to own or control a significant block of shares, our initial stockholders have a significant influence over the voting process. This will enable our initial stockholders, to have a significant influence over the election of the Board of Directors, control of management policies and determination of the outcome of most corporate transactions or other matters submitted to all the stockholders for approval, including mergers, consolidations or the sale of substantially all of our assets.

In addition, most of our initial stockholders are our employees and they may act in their own interest as employees, which may conflict with or not be the same as the interests of stockholders who are not employees.”

Topics: Fundies, Hewitt Associates (HEW), Stock Market | No Comments

The Fundies for Silicon Labs (SLAB): 10Q Review

Summary: Silicon Laboratories SLAB is an innovative, fabless analog chip designer. Its history of successful products has earned the company a premium valuation, but the long lead times necessary for customers to evaluate new products has resulted in lumpy fundamentals and a volatile stock price. Given that consensus estimates are at the high end or above management guidance, there may be a high risk of disappointment at the next earnings release. More »

Topics: Communications Services, Fundies, Semiconductors, Silicon Laboratories (SLAB), Stock Market, Technology, Wireless | 1 Comment

The Fundies for Ceradyne (CRDN) – 10Q Review

Summary: Ceradyne is trading at a relatively attractive valuation model, but we remain concerned about the growth prospects for military sales and the company’s use of convertible debt instruments. More »

Topics: Ceradyne (CRDN), Fundies, Stock Market | No Comments