A while back I complained that several stocks I had been bearish about had gotten boosts from takeout offers. Namely, Diebold (DBD), Delta Airlines (DAL) and Yahoo! (YHOO).

Delta stock finally broke down, and then agreed to a merger at much lower share prices.

Today I look less stupid about Yahoo, though the stock is still up 5% from the date of my bearish article, compared to a 4.3% decline in the S&P 500.

So that’s two down and one to go.  Each reduction in my apparent stupidity is welcome.

Disclosure: At time of publication, William Trent has no financial position in the companies mentioned in this article.

I should probably learn to take the money and run more quickly. Back in December I wrote about Diebold (DBD) at about $33 per share and said investors should probably look elsewhere due to earnings quality concerns and what I considered to be unsustainable cash flows. That looked good until this morning, when the takeover offer from United Technologies (UTX) sent the shares up from $25 to $39.

In the interest of full disclosure, this is the third time in as many months that a takeover bid has made one of my bearish calls look stupid (at least temporarily.) In September I wrote bearish pieces on both Yahoo (YHOO) and Delta Airlines (DAL) at prices of $23.30 and $17.65, respectively. I no longer look stupid on Delta since their deal appears to have run aground.

Interestingly, of the three Delta was the only one whose management actually wanted the deal. We’ll have to see whether the Yahoo and Diebold hostile bids suffer the same fate.

Position: No financial positions in the stocks mentioned

My long-term orientation doesn’t typically fare so well in short term stock picking contests. Nonetheless, I have decided to enter the blogger face-off over at SINLetter. You can check in to see which of us are making the best picks between now and the end of March.

My picks were long SMH, short Diebold (DBD) and long CSG Systems (CSGS).

The following is a reprint of my December 13, 2007 RealMoney column.

Diebold (DBD), the maker of ATM machines and much-criticized automated voting machines, never seems far from controversy. It also has developed a habit over the last ten years or so of its share price swinging wildly back and forth between the $30’s and $50’s every couple of years. With the pendulum now back at the low end, traders may be tempted to hop on for the ride. Investors, however, should probably look elsewhere.

The Latest Controversy

Diebold topped out at $54.50 in late July, when it announced it would miss the deadline for filing its 10Q for the June quarter “while it seeks guidance from the Office of the Chief Accountant (the “OCA”) of the Securities and Exchange Commission with regard to its revenue recognition policy.”

After receiving said guidance, Diebold announced on October 2 that it would cease using the “bill and hold” method to record sales. The company helpfully added that:

The change in the company’s revenue recognition practice, and the potential amendment of prior financial statements, would only affect the timing of recognition of certain revenue. While the percentage of the company’s global bill and hold revenue varied from period to period, it represented 11 percent of Diebold’s total consolidated revenue in 2006. The company does not anticipate that the change in the timing of revenue recognition would impact previously reported cash provided by operating activities or the company’s net cash position.

Diebold will provide further information once it has completed an in-depth analysis of the most appropriate revenue recognition method and has reviewed it with its independent auditors and its audit committee. While the company cannot predict with certainty the length of time it will take to complete this analysis and review, it anticipates the process will take at least 30 days. Upon completing this process, Diebold will be in a position to provide updated revenue and earnings guidance for the full-year 2007.

At least 30 days later, the company announced its September quarter 10Q would also be delayed, as it is “in the process of determining the most appropriate method to replace its bill and hold practice, and has sought additional guidance from the OCA.”

Bill and Huh?

For the uninitiated, an SEC document describes what they are looking for:

Improper accounting for bill-and-hold transactions usually involves the recording of revenue from a sale, even though the customer has not taken title of the product and assumed the risks and rewards of ownership of the products specified in the customer’s purchase order or sales agreement. In a typical bill-and-hold transaction, the seller does not ship the product or ships it to a delivery site other than the customer’s site.

Diebold’s revenue growth rate in 2007 was 12.3%, and may have been mostly due to this questionable revenue recognition practice (as bill and hold sales were approximately 11% of total revenue in 2006.) Furthermore, since half the recorded revenue was service-related, the actual product sales may have even declined year/year.

Diebold’s chief rival, NCR (NCR) has noted that the upgrade cycle for ATM machines is in a lull. This is before any potential spending cutbacks by banks needing to conserve cash in the wake of the subprime crisis. It is hard to imagine the revenue growth getting much better.

Somebody Buy Them A Clue

As for “the most appropriate method to replace its bill and hold practice,” I don’t see why the company requires additional guidance from the OCA. They should recognize revenue when the customer accepts delivery of the product or service in question. In their own 10K they tell investors “for product sales, the company determines that the earnings process is complete when the customer has assumed risk of loss of the goods sold and all performance requirements are substantially complete.”

The fact that the company needs additional guidance when its own 10K describes the appropriate policy is troubling. Just as the previous CEO’s massive fund-raising activities for one political party cast doubt on the company’s objectivity when providing election equipment, the company appears to keep making mistakes that should be easily avoidable.

Shares are No Bargain

Now, just because the company keeps shooting itself in the foot doesn’t mean its stock is overpriced. Down 40% from the recent peak, it is worth asking whether the bad news is all priced in. Unfortunately, I don’t think it is.

For one thing, the stock is trading at 26x the 2006 earnings per share. Those are the most recent earnings figures available since the company is late filing its reports, and even they are likely to be revised lower following the restatements. The existing 2007 and 2008 consensus EPS estimates are most likely wishful thinking.

So how about cash flow? After all, as the company points out, changing from the bill-and-hold method shouldn’t affect the reported cash flow from operating activities. Measuring free cash flow as cash from operating activities less capital expenditures, the $206 million in 2006 free cash flow represents an 8% yield on the current enterprise value. I would normally consider such a yield worth pursuing.

The problem is, I don’t think that cash flow is sustainable. A good chunk of it was due to the company reducing working capital, a strategy that can be taken only so far. I peg the sustainable rate of cash from operations at about $90 million less than was reported, and I also have questions about the rise in “certain other assets.”

Making these adjustments, the free cash flow starts looking more like $80 million, for a yield of just 3.1%.

With the financial statements raising more questions than answers, likely slowing and the valuation mediocre at best, Diebold looks like a stock to avoid.

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William Trent currently has a short position in put options related to Office Depot (ODP).

The following is a reprint of my December 12, 2007 RealMoney column

Printer manufacturer Lexmark, Inc. (LXK) started out this year at $73 and hasn’t looked back. Unfortunately, its motion has all been to the downside. Now less than half the stock it used to be, is it time to consider a nibble?

The stock is certainly cheap enough. Not only is it trading at a mere 12x expected earnings, $6.60 of the $34.50 current valuation is literally cash in the bank.

Over the last 12 months, Lexmark has brought in cash from operating activities totaling nearly $500 million and used less than $200 million for capital expenditures, resulting in free cash flow of $309 million and a FCF/Enterprise value yield of 11% - a very juicy premium to the current Treasury yield.

Of course, any juicy reward is bound to come with some risks, so let’s take a good hard look at those.

Second Fiddle

Even before Hewlett Packard’s (HPQ - Annual Report) recent resurgence, Lexmark was a distant runner-up in the printer business. Lexmark countered this position by forging an alliance with Dell (DELL) under which Lexmark makes all of the Dell-branded inkjet printers and half of their laser printers. Unfortunately for Lexmark, they inked that deal just in time for Dell to start its own tailspin.

Then, even if Hewlett Packard were to falter there are plenty of other competitors in the wings. First there are the traditional rivals like Seiko Epson (SEKE.Y) and Canon (CAJ), and Brother (BRTHY). Then, converging technologies have made competitors out of Ricoh (RICOY), Xerox (XRX), Samsung, and Kyocera Mita (KYO).

Declining Business

Everyone knows that obsolescence is a key risk for technology companies, and Lexmark is currently feeling the pain of the industry’s ongoing shift from inkjet to laser technology. I’ll let Lexmark explain it themselves (courtesy of the latest 10Q filing:)

Lexmark believes it is experiencing shrinkage in its installed base of inkjet products and an associated decline in end-user demand for inkjet supplies. The Company sees the potential for continued erosion in end-user inkjet supplies demand due to the reduction in inkjet hardware unit sales reflecting the Company’s decision to focus on more profitable printer placements, a mix shift between cartridges resulting in a higher percentage of moderate use cartridges and the weakness the Company is experiencing in its OEM business. Additionally, Lexmark expects to see continued declines in OEM unit sales, aggressive pricing and promotion activities in the inkjet and laser markets….

As the Company analyzes the situation, it sees the following:

• Some of its unit sales are not generating adequate lifetime profitability due to lower prices, higher costs and supplies usage below its model.
• Some markets and channels are on the low-end of the supplies generation distribution curve.
• Its business is too skewed to the low-end versus the market, resulting in lower supplies generation per unit.

Cheap Enough?If the risks haven’t sent you running for the hills, you are probably wondering whether the current share price is cheap enough to justify taking those risks. With the prospects for a decline in sales, earnings and cash flow being more than a distinct possibility, any price paid is going to have to be justified for a declining business.

The traditional valuation model says that value is equal to the cash flow in the coming year, divided by the difference between the company’s cost of capital and its growth rate. The 11% free cash flow yield I calculated above is a version of this model, and it provides the denominator in the equation: lexmark’s return, less its growth rate, should equal 11%.

Since the growth rate is negative, the return will be something less than 11%. If the current declines of approximately 3%, the implied return works out to 8%. That probably doesn’t sound like a huge payoff for many investors, but it is still a nice premium to Treasuries. Depending on the outlook for the rest of the market, value investors might find it worth a shot.

I recently looked at some of the enterprise software calls to get a check on tech spending. Today I take a look at hardware. The big (and most recent) news came from Cisco (CSCO):

Our balanced product momentum across our core technologies and advanced technologies continues to be the best I have seen in a number of quarters….
Let me approach it from a broad perspective. First is what we are seeing is the importance of balance on a global basis. I have been in this business for 30 years — Jim, I think you have been there that long or maybe a hair longer. It’s the strongest global economy I have been a part of.

(Excerpt from full CSCO conference call transcript)

It was funny that nobody challenged him on this, as anyone who has been in the business for long must surely remember Chambers’ comments in 2000. According to a CIO Magazine case study called “What Went Wrong at Cisco:”

Xilinx’s Wall Street warning came two months before Cisco Chief Strategy Officer Mike Volpi told The Wall Street Journal in November, “We haven’t seen any sign of a slowdown.” Volpi told The Journal that Cisco hadn’t changed its internal plans since the beginning of its fiscal year in August. “We have guided [Wall Street] accurately, and we can execute to plan.”
On Dec. 4, CEO Chambers crowed to analysts, “I have never been more optimistic about the future of our industry as a whole or of Cisco.”
Eleven days later, CIO Solvik says, the company saw the problem for the first time.

In case you were wondering, Xilinx (XLNX) lowered its guidance in June, then missed the lower estimate. However, they didn’t pin the blame on Cisco. On their call, they said:

During last quarters’ call, we forecasted that all geographies extension plan would be up sequentially. Japan was down sequentially as planned, but so was Europe, which turned out to be surprise. This quarter our top 10 European accounts, which represent 45% of total European sales were up 16%, but the main remaining channel accounts were down 19%. The weakness was mainly in the distribution channel across a few end markets including industrial, audio and video broadcast and data processing.

(Excerpt from full XLNX conference call transcript)

Turning to some other companies, EMC (EMC - Annual Report) is certainly having no trouble.

Looking quickly at the IT spending outlook for 2007, we see a positive environment in all major geographies and we believe there is opportunity for us to beat our annual financial targets for revenue, earnings per share and cash flow. EMC’s positive results and momentum are obviously only possible because customers are embracing our strategy, our leading products, our services and our solution sets at each of our four businesses — storage, content management and archiving, RSA security and VMware.

(Excerpt from full EMC conference call transcript)

Other tech companies aren’t so lucky. Sun (a href="http://stockmarketbeat.com/blog1/category/tech/sunw/">SUNW - Annual Report) said:

Sun’s total revenues for the fourth quarter of fiscal year 2007 were $3.835 billion, an increase of 0.2% as compared with $3.828 billion in revenue reported for the fourth quarter of fiscal year 2006.

(Excerpt from full SUNW conference call transcript)

The largest technology distributor, Ingram Micro (IM) had a mixed quarter - overall sales were reasonably strong but currency fluctuations played a big role:

On a regional basis, North America sales where $3.3 billion, essentially, flat versus the prior year or 40% of total revenues. As we described at last quarter warranty sales on behalf of our vendors are now recognized as net fees rather than gross revenues in cost of sales as reported in the prior year period. We saw a negative impact on year-over-year sales comparisons of approximately 5%. European sales were $2.78 billion or 34% of total revenues, an increase of 16% versus a year ago. The translation impact of relatively strong European currencies contributed an 8 percentage point positive impact on comparisons to the prior year.

Asia pacific sales were $1.76 billion, an increase of 31% over the prior year and 22% of our total sales. Finally Latin America sales were up 4% versus last year to $344 million representing 4% of our total sales.

(Excerpt from full IM conference call transcript)

Much like the software conference calls, the outlook appears reasonably positive. However, I’m not ready to break out the champagne and say were past the tech spending doldrums. Results are mixed, the financial sector is very important to tech spending, and Cisco’s forecasting track record doesn’t help my confidence level. While I’d love to see tech spending improve, I’ll have to see it to believe it.

Disclosure: Author is long IShares MSCI Japan Index (EWJ) at time of publication.

Xerox Corporation (XRX) announced today second-quarter 2007 earnings per share of 28 cents. When I previewed the report I said “can they make the numbers without asking investors to ignore a bunch of stuff? I don’t doubt they will earn $0.27 as expected but wonder how they’ll get there.”

Well, as it turns out they didn’t ask investors to ignore a bunch of stuff. Unfortunately, however, the report still didn’t strike me as being particularly strong. I’ll run down a few of my observations.

Total revenue of $4.2 billion grew 6 percent in the quarter. Post-sale and financing revenue - Xerox’s annuity streams that represent more than 70 percent of total revenue - increased 7 percent. Both total revenue and post-sale revenue included a currency benefit of 2 percentage points as well as the benefit from Xerox’s acquisition of Global Imaging Systems, which was completed in early May.

So… 4% growth excluding the currency benefit and $100-$200 million from Global Imaging, the sales looked about flat. With Global Imaging having clocked in $1 billion in sales last year, it should be expected to boost sales by 6.25% in its first full quarter as a Xerox subsidiary, or slightly more than half that in the partial quarter just completed. Xerox is spending billions of dollars on acquisitions not to grow but to stay in place.

A fundamental measure of Xerox’s business is increasing the number of Xerox systems installed in customers’ workplaces. This install activity generates sales of supplies and services that are expected to drive gains in post-sale revenue.

They keep saying that. I’m still waiting for them to prove it. For example, during the second quarter, install activity increased 54 percent for the company’s color multifunction devices that print, copy, fax and scan. But revenue from color grew 12 percent in the second quarter and now represents 38 percent of Xerox’s total revenue, up 4 points from the second quarter of 2006. Why isn’t the sales keeping up with the install rate? Shouldn’t all those installs be generating post-sale revenue by now?

Gross margins were 40.3 percent, a less than one point decline from second quarter of 2006.

I don’t need to add anything there.

Xerox expects third-quarter 2007 earnings in the range of 24-26 cents per share. The company increased its range of earnings expectations for full-year 2007 to $1.16 - $1.18.

After beating in the current quarter, the high end of the guidance range for the rest of the year only matches consensus. That is the equivalent of cutting guidance in the coming quarters.

With sales up just 7% (including all the aforementioned benefits) accounts receivable and inventories are up 11% year to date. Some of that increase, however, may be seasonal.

Cash flow from operations were up for the quarter and year-to-date, but only because the company contributed less to its underfunded pension plan than it did last year. Excluding pension contributions (which are discretionary) the cash flow would have been down.

Long story short, there is nothing to shout about with Xerox’s earnings.

The Economic Calendar is quiet in the early part of this week but there are important reports at the end of the week. On Thursday is the Durable Goods report, for which the consensus estimates a 2.0% increase. On Friday is the Preliminary Estimate of 2Q GDP, which the consensus has pegged at 3.2%. That sounds a little high to me based on the economic data table I’ve been compiling.

EconomicData

The Earnings Calendar is as busy as it can get. Some of the names I’ll be watching:

Monday

• Altera (ALTR) - Xilinx (XLNX)  filed an awful report. Can Altera do any better? Consensus is $0.19 EPS on sales of $314 million.
• Hexcel (HXL) - This Small Cap Watch List (Track at Marketocracy) member was seeing rising estimates until last month, when they were cut from $0.20 to the current $0.17.
• Steel Dynamics (STLD - Annual Report) - The Mid Cap Watch List (Track at Marketocracy) member is expected to earn $1.04 on sales of $948 million.
• Texas Instruments (TXN - Annual Report) - expected to earn $0.42 on $3.45 billion in sales.

Tuesday

• CH Robinson (CHRW - Annual Report) - estimates have been rising and now stand at $0.47, but Landstar (LSTR - Annual Report) disappointed.
• CDW Corporation (CDWC) - stellar monthly sales reports have kept estimates rising. They now stand at $0.97.
• EMC Corporation (EMC - Annual Report) - The big news is still the VMWare IPO, but it is also a decent look at enterprise tech spend.
• Laboratory Corporation of America (LH) - The Mid Cap and Large Cap Watch List (Track at Marketocracy) member has been seeing positive earnings revisions and is now expected to earn $1.09 on $1.03 billion in revenue.
• Lexmark (LXK) preannounced and will probably offer poor guidance.
• Linear Technology (LLTC) - expected to earn $0.35 on $267 million in sales.
• Norsk Hydro (NHY) - The Large Cap Watch List (Track at Marketocracy) member has no analyst coverage right now.
• Plantronics (PLT) - my covered call position is now being cashed out so I’ve no skin in this one. But it is often volatile.
• United Parcel Services (UPS) is a great read on the health of the economy. Expectations are $1.03 on $12.23 billion in revenue.

Wednesday

• Arkansas Best (ABFS) - after Landstar’s (LSTR - Annual Report) weak quarter I’m expecting a poor showing. Estimates have come down to $0.67, but may not have come down enough.
• Colgate Palmolive (CL) - Large Cap Watch List (Track at Marketocracy) member unlikely to surprise much. Consensus is $0.83 on $3.31 billion.
• Corning (GLW - Annual Report) - is LCD supply/demand back in balance?
• Freeport McMoRan Copper & Gold (FCX - Annual Report) -Another Large Cap Watch List (Track at Marketocracy) member with dramatic positive earnings revisions, now standing at $2.71.
• Graco (GGG) is another Large Cap Watch List (Track at Marketocracy) member. Estimates have been coming down and are now at $0.61.
• MEMC Electronic Materials (WFR) - Is polysilicon supply catching up to demand for this Large Cap Watch List (Track at Marketocracy) member?
• Xerox (XRX) - can they make the numbers without asking investors to ignore a bunch of stuff? I don’t doubt they will earn $0.27 as expected but wonder how they’ll get there.

Thursday

• Federated Investors (FII) is on the Large Cap Watch List (Track at Marketocracy) and expected to earn $0.54.
• Ingram Micro (IM) is on the Small Cap Watch List (Track at Marketocracy) and expected to earn $0.36.
• KLA-Tencor (KLAC) - I know the semiconductor equipment fundamentals stink. I want to know how much and whether it is priced in.
• NII Holdings (NIHD) is on the Large Cap Watch List (Track at Marketocracy) and expected to earn $0.49.
• Western Digital (WDC) is on the Large Cap Watch List (Track at Marketocracy) and expected to earn $0.36.

Disclosure: William Trent has a long position in SMH.

There have been several indications that U.S. businesses may be cutting back spending in recent months. We review some of the recent conference call transcripts to see how leading technology companies answer the question: “How’s business?”

Leo Apotheker

Let me maybe try to answer your two questions on Germany and the U.S. Let me start with the U.S. first. We did not see any material change in the spending environment in the U.S. It was as expected, not better, not worse — steady as it goes. We have no reason to believe that that will change.

(Excerpt from the full SAP conference call transcript)

Heather Bellini - UBS

Thank you and congratulations on a very good quarter. Safra, I was wondering if you could help us out with two questions. One, what do you think was behind the strength in new license sales this past quarter? How much of it do you think was related to changes in execution that you put in place post the November results?

The second thing would be many have been nervous about enterprise spending trends, given some of the missteps from some of the big software companies over the past few quarters. Can you give us your view on the macro environment right now? Thank you.

Safra A. Catz

Sure, and you know, Charles, you should add in on the first — on either question, actually. The reality is that the anomaly is not this quarter at all. It is really last quarter, and as we told you, we had a blockbuster Q4 in ’06 and Q1 was again fantastic. Q2, I think you basically saw that we felt we had some execution issues out in the field, really focused mostly around North America. Charles and Keith put in place — basically everyone is focusing back on what they need to be doing and they are really just back on track.

Today is not really the announcement of the anomaly. It was really last quarter when we talked about what went down in Q2. Charles, do you want to comment on that part?

Charles E. Phillips

Yes, and that is what we felt last quarter, what we said is that our destiny was in our control and the guys focused, did a great job and came through around the world, but North America especially.

(Excerpt from the full ORCL conference call transcript)

Anne Mulcahy

I think we would not highlight any difference or change in terms of enterprise spending that we certainly are aware of in Q1. We look at pipelines and activity and feel that there is a level of consistency that we are seeing with regard to our enterprise accounts. So I know that that has become a subject of certainly debate, but I don’t think we would share the view that there is any noticeable slowdown right now on the enterprise side in the US.

(Excerpt from full XRX conference call transcript)

Mark Loughridge

Well, you know, if you look at it, I am not going to make an economic forecast here. If you look at the U.S., however, we did see weakness, predominantly at the end of the quarter, in our enterprise space.

(Excerpt from full IBM conference call transcript)

It looks like the voting so far runs 3:1 in favor of “no slowdown.”

Xerox Reports First-Quarter Earnings of 24 Cents Per Share:

Xerox Corporation (XRX) announced today first-quarter 2007 earnings per share of 24 cents.The company’s earnings include a 2-cent charge to reflect its share of a restructuring charge recorded by Fuji Xerox Co., Ltd. This previously announced restructuring was initially expected to be a 3-cent charge to Xerox’s first-quarter earnings.

Total revenue of $3.8 billion grew 4 percent in the first quarter. Post-sale and financing revenue - Xerox’s annuity streams that represent more than 70 percent of total revenue - increased 6 percent. This growth was largely driven by a 7 percent increase in post-sale revenue from digital systems. Both total revenue and post-sale revenue included a currency benefit of 3 percentage points.

When we issued our earnings preview, we said: Xerox (XRX) - Consensus expects $0.20 on $3.82 billion this quarter and $0.27 on $4.09 next. The estimates have come down but are at the high end of revised guidance.

The new official guidance, which included the charge, was $0.18-$0.20. Since the charge was $0.02 instead of $0.03 it should have been $0.19-$0.21. Estimates properly came down after the guidance revision, so the earnings including the charge are the ones that matter. And on these, Xerox beat by $0.03. Guidance for next quarter was in line:

Xerox expects second-quarter 2007 earnings in the range of 26-28 cents per share.

What is amazing to us is how much glowing coverage the company received for mediocre 4% growth that was itself primarily due to currency effects rather than operational success. For example, “InPlay: Xerox beats by $0.05, ex items; guides in-line for Q2;” or even more laughably “[$$] Xerox’s Net Income Rises 17%, Boosted By Strong Sales.” Boosted by Strong Euro, they should say.

Still, the stock looks to rally on the news, which tells us management is good at managing expectations, anyway. Moving to the nitty gritty:

A fundamental measure of Xerox’s business is increasing the number of Xerox systems installed in customers’ workplaces. This install activity generates sales of supplies and services that are expected to drive gains in post-sale revenue. As Xerox accelerated activity in key markets during the first quarter, the continued impact of pricing declines put pressure on equipment sales, which were down 2 percent including a 2 point benefit from currency.

They are trying to say they are willing to lose money selling the razor in order to sell more blades. However, until they can produce overall growth in excess of nominal GDP we remain thoroughly unconvinced of the strategy.