Posted by: John Gilmore | September 16, 2006

2nd Quarter 2009 Earnings – Profit Surprises or Revenue Declines?

The stock market has risen over the past week as many company’s 2nd quarter earnings beat Wall Street ‘expectations’. I mentioned in a previous post that although many companies are beating lowered Wall Street expectations – this is not an indication of ‘green shoots’ or that the economy is somehow stabilizing.

In this economic environment where sales and revenue are declining significantly, most companies are trimming costs wherever possible – headcount, travel, inventories, etc. to offset the reduction in revenue. This, in turn, reduces expenses and obviously helps their profit/earnings. Any good manager must do this – you can’t survive if your expenditures don’t line-up with your volume of sales – management 101 stuff. So, we see that many companies have reduced expenses and have managed to beat their earnings expectations. This, in turn, has led the stock market higher.

If we want to look at our economy from a high level (macro-economic level) and determine if things are actually turning around – the best way to do this is to look at the top line revenue of some of our biggest companies – and ignore what they’re doing to offset any reduction in sales/revenue. In an economy based on exponential growth, sales/revenue growth is essential for the system to continue to function.

Let’s start by looking at UPS and FedEx’s recent quarterly results (June/July 2009). Many economists/analysts look at these companies because of the large volume of goods they transport. It stands to reason that if the economy is in good shape or stabilizing – package volume will increase or – at a minimum – remain in line with previous quarters.

United Parcel Service Inc.’s second-quarter income fell 49% on continued weak demand, with the shipping bellwether warning that conditions have yet to improve substantially and forecasting discouraging third-quarter results.

Revenue decreased 17% to $10.83 billion. Operating margin fell to 8.3% from 11.2%, while average revenue per package fell 11%.

U.S. package revenue fell 12%, while international package segment revenue dropped 24%. In a post-earnings conference call, Mr. Kuehn said the “stagnant economic activity around the world negatively impacted all of our business segments” in the second quarter. He added that the company is bracing for more of the same until it sees clear indications of improvement.

As a diversified transportation company that moves everything from documents to building materials, UPS, along with rival FedEx, is considered a barometer for the state of the U.S. economy.”

We see UPS package revenue/volume falling 12-24% – and the forecast is for more of the same for the remainder of 2009. It doesn’t take an economics professor to see that one of the barometers for the current state of the U.S. economy – is not good.

“For the fiscal year ended May 31, [FedEx] the Memphis, Tenn.-based shipping company, and Atlanta-based United Parcel Service Inc.‘s chief rival, posted net income of $98 million, or 31 cents per share. That compares to net income of $1.12 billion, or $3.60 per share, for full-year 2008. Revenue fell 20 percent to $7.85 billion” (June 2009)

Federal Express has a similar story as UPS – volume/revenue down – in the 20% range. Two very big barometers of our economy are telling us that things are not improving.

Let’s move on and take a look at some other large company’s recent earnings reports. Take note of the their sales and revenue declines.

AT&T Inc.’s second-quarter profit fell 15% on continuing weakness in the landline business despite continued growth in wireless data revenue and subscriber totals. Revenue slipped 0.4% to $30.73 billion. Profit from the wireline segment fell 6.1% on a 36% drop in revenues.

McDonald’s second-quarter profit came in at $1.09 billion or 98 cents a share, including a one cent benefit from an asset sale, down from $1.19 billion, or 1.04 a share, a year earlier. Revenue decreased 7% to $5.65 billion.

3M Co.’s second-quarter earnings fell 17% as weak demand pushed sales lower. The company’s results, however, still beat Wall Street expectations. The diversified manufacturer has cut costs but still faces significant declines in manufacturing and transportation markets. In early April 3M offered early retirement to 3,600 nonunion employees, or about 11% of its U.S. work force. It cut 1,200 workers in the first quarter. In the latest quarter, the company reported earnings of $783 million, or $1.12 a share, compared with $945 million, or $1.33 a share, a year earlier. Excluding items such as restructuring-related expenses, earnings came to $1.20 a share from $1.39 a share a year earlier. Net sales fell 15% to $5.7 billion.

On a regional basis, Ford North America narrowed its pre-tax loss to $851 million from a loss of $1.3 billion a year earlier while Ford Europe — traditionally its strongest segment — saw its pre-tax profit shrink to $138 million from $582 million a year earlier. Last quarter, the North America unit reported an operating loss of $637 million while Europe had a $550 million loss. Excluding items, the company’s loss came to 21 cents a share, which was narrower than the 50 cent average loss estimate of analysts surveyed by Thomson Financial. Revenue dropped to $27.2 billion, compared to $38.6 billion for the same time period a year earlier (decline of 29.5%).

Halliburton, the world’s second-largest oilfield-services company by revenue after Schlumberger Ltd., reported profit of $262 million, down 48% from a year earlier, though stronger than analysts had expected. Revenue fell 22% to $3.5 billion.

General Electric Co. said second-quarter net income fell 49% as the recession took a toll on both its industrial businesses and its struggling finance unit. Profit at the finance division, GE Capital, fell 80% to $590 million because of rising loan losses and a 29% decline in revenue. Without a $678 million tax benefit, the unit would have lost money. In its industrial units, GE said orders for equipment fell 42%.

Mattel Inc. reported an 82% jump in second-quarter earnings as cost cutting offset worse-than-expected sales that reflected consumers’ diminished spending and retailers’ efforts to curb inventories. The world’s largest toy maker reported a profit of $21.5 million, or six cents a share, up from $11.8 million, or three cents a share, a year earlier. Revenue fell 19% to $898.2 million.

International Business Machines Corp.’s second-quarter profit rose 12% as the company continued to hone its operations, but sales fell and the technology giant offered few signs businesses are prepared to resume spending. But weakness in the Armonk, N.Y., giant’s short-term consulting business and a 26% decline in hardware revenue compared with a year ago indicate that the technology business overall still faces stiff challenges. IBM is faring better than some other technology vendors because it exited the PC business and now focuses on computer services, software and hardware for businesses and governments. In the second quarter, IBM had a profit of $3.1 billion, or $2.32 a share, up from $2.77 billion, or $1.97 a share. Revenue fell 13% to $23.25 billion from $26.82 billion.

Google Inc.’s growth continued to slow in the second quarter, signaling the online ad market remains in a slump. The Internet search giant’s revenue inched up 2.9% from a year earlier to $5.52 billion, down from 6% growth in the first quarter, and far below the 39% growth Google saw in the second quarter last year. The results suggest there won’t be a rebound anytime soon for the $24.5 billion U.S. Internet advertising market, of which Google commands roughly a third of the market share.

Nokia’s net profit for the three months ended June 30 totaled €380 million ($537 million), down 66% from a year earlier, but ahead of analysts’ expectations for €316 million. Sales fell 25% to €9.91 billion.

In the second quarter, EMC’s earnings fell to $205.2 million, or 10 cents a share, from $360.1 million, or 17 cents a share, a year earlier. Revenue dropped 11% to $3.26 billion.

Southwest Airlines Co. returned to a profit after three straight quarterly losses but painted a bearish picture for the remainder of the year as two major competitors also highlighted continuing difficulties for the industry. Echoing comments by executives at UAL Corp.’s United Airlines and Continental Airlines Inc., which also announced second-quarter financial results on Tuesday, Southwest Chief Executive Gary Kelly said management is bracing for “continued weakness.” Despite signs of stronger demand in July, he added, the carrier “can’t confidently predict” another profit in the third quarter. “I don’t think the worst is behind us,” Mr. Kelly said during a conference call. “I think the worst is ahead.” After cutting its fleet of almost 550 aircraft by as many as 15 planes by the end of the year, the airline’s capacity will have dropped by as much as 6% in 2009.

John Tague, UAL’s chief operating officer, said United expects its overall capacity in the second half of this year to be down 12% and is prepared to trim more, if necessary. After Labor Day, as a response to the dramatic decline in international travel demand, the airline intends to cut international seats by another 7%, after a 7.7% reduction in the second quarter.

Continental, the fourth-largest U.S. airline, said its quarterly loss widened to $213 million, or $1.72 a share, compared with a loss of $5 million, or five cents a share, a year earlier. In addition to plunging demand for business travel, the airline’s earnings were battered by fears related to the H1N1 virus. Excluding charges of $44 million, the airline posted a loss of $169 million, or $1.36 a share.

American Airlines parent AMR Corp. on Wednesday reported a $390 million second-quarter loss as collapsing travel demand continued to erase gains from lower fuel costs. The results are the latest evidence that the airline industry is flying through one of its toughest summers ever. “We expect a tough ongoing revenue environment,” said AMR finance chief Tom Horton in a conference call. AMR, of Fort Worth, Texas, said second-quarter revenue fell 21% to $4.89 billion from a year earlier. Average fares fell 15%, even as the No.2 U.S. airline by traffic cut its capacity by 7.6% from the year-ago quarter as leisure and business travelers stayed home.

Microsoft Corp. said Thursday its profit in the last quarter plunged 29% because of weak computer sales, ending a fiscal year in which the software maker’s revenue fell for the first time since the company went public in 1986. “Our businesses continued to be negatively impacted by weakness in the global PC and server markets,” said Chief Financial Officer Chris Liddell. For the quarter ended June 30, the company reported earnings of $3.05 billion, or 34 cents a share, down from $4.3 billion, or 46 cents a share, a year earlier. Revenue decreased 17% to $13.1 billion.

American Express Co. second-quarter earnings fell 48% amid its preferred-stock repurchase as the credit-card issuer set aside less money for bad accounts amid falling customer balances. Like all financial companies, American Express has suffered in the economic downturn. After it posted its first-quarter results in April, both Moody’s and S&P downgraded American Express, citing worries about poor revenue trends, weak asset quality and long-term liquidity. Revenue, net of interest expense, decreased 18% to $6.09 billion.

Xerox said net income for the quarter fell 35% to $140 million, or 16 cents a share, from $215 million, or 24 cents a share, a year earlier. Revenue declined 18% to $3.73 billion. The revenue decline was led by a 29% drop in equipment sales.

Fortune Brands’s home and hardware segment sells products such as Moen faucets and Kitchen Craft cabinetry. The business — which provides about 45% of the company’s revenue — has been hit hard by the U.S. housing slump. Sales in the home and hardware segment dropped 25% though the unit swung to a profit, as expected, due to lowered costs and other restructuring moves by the Deerfield, Ill., company.

Another big player in the home-products business, Black & Decker Corp., said its second-quarter profit plunged 60% amid a continuing sales slump, though core earnings beat analyst expectations. Sales of power tools and accessories, by far its largest segment, fell 21%.

If we disregard all of the spin and ignore optimistic ‘forecasts’ that have no quantitative basis – I’m not sure how anyone can say that our economy is ‘stabilizing’ or that ‘green shoots’ are appearing. If you want to determine if the economy is stabilizing – simply looking at profits isn’t going to help you because of the massive expense reductions companies are implementing due to plunging sales and revenues. While reducing expenses will certainly help the bottom line – they contribute to our continued economic decline. You must look at sales and revenues and determine if business is increasing – to determine if the economy is really turning a corner. If we continue to see significant revenue declines and continued expense reductions from public companies – you’ll know that the economy continues to deteriorate.

But – as the mainstream media spin machine marches on – we see headlines like this in the Wall Street Journal (July 24th, 2009):

“Stocks Recapture 9000 on Profit Surprise”

It’s not hard to beat ‘expectations’ when you continue to lower the bar.

What we should see is a headline like this:

“Revenue Declines Signal a Deepening Recession”

I understand why all of these companies are reducing expenses in this environment of declining revenues, but it’s clear that these efforts are causing our unemployment rate to increase dramatically – to a much greater degree than is widely known.

The blue line above shows the U.S. unemployment rate according to how it was calculated in the 1980’s (before the government made changes to the calculation to show more favorable unemployment rates). As you can see, if we add in all of the people who have given up looking for work (discouraged workers) and all of the people who have taken part time jobs because they can’t find a permanent job – the actual unemployment rate is approximately 21%.

If revenues are declining across many different industries throughout the world and this is causing a significant spike in unemployment, I’m not sure why anyone would feel confident that the recession is ending.

We’ve all been conditioned to focus on Wall St. earnings ‘expectations’ and we’re not looking at the bigger picture – that sales and revenues are declining by significant percentages across the entire system. What happens when sales and revenue continue to decline and companies have nothing left to cut from expenses? Eventually, your business model collapses and your business fails.

As we’ve learned – it’s not just corporate revenue that is giving us clues to what is happening. Government tax revenues (local, state federal), housing sales/prices, unemployment, individual/corporate/government debt, retail sales – things that are quantifiable – tell us the true nature of our economy.

What we are seeing is the continuing collapse of a debt-based monetary system. All of the Federal Reserve and Government ‘stimulus’ packages will only delay the inevitable end of this system.

jg – July 25, 2009

Update – July 31, 2009

A few days after writing the post above, Chris Martenson added some corporate revenue information (analysis) on his blog. This isn’t rocket science – it’s not hard to tell good data from bad – once you have a basic understanding of what can be manipulated easily.

Here’s a brief excerpt from Dr. Martenson’s blog post:

Also, into the “good” bucket I have now included corporate revenues because, unlike a corporate earnings statement (now in the murky bucket), there are many fewer games and shenanigans that can be played with revenue. Apart from sliding revenue forwards and backwards a quarter or two, it is relatively pure data. GAAP accounting assures as much.

Added up across all companies, revenue provides a nice, clean picture of where things are going. Perhaps the best we have.

Here’s the most recent picture of that (found here) :

What we see here is that for ALL companies in the S&P 500, a comprehensive enough sample that we can use this as a reliable measure of revenue across the entire corporate landscape, we find that revenues are down more than -15% in Q2 2009 compared to 2Q 2008.

Now, if you think about it, when people buy (or consume) anything, that transaction passes through a company somewhere, somehow. So we might use this -15% decline in corporate revenue as a pretty good approximation for how much less stuff is being consumed this year compared to last year.


Update – August 19, 2009

Chris Martenson added another blog post a couple of days ago relating to revenue declines and the games corporations are playing with earnings.

Target and Home Depot – “Beat by a Penny!”

Tuesday, August 18, 2009, 11:13 am, by cmartenson (Chris Martenson)

The gaming of our economic system and statistics is not the sole province of the government. Corporations have mastered the art as well.

Naturally, this is not much of a surprise, because with the government setting the tone for providing perpetually “better than expected” economic statistics, it stands to follow that corporations and Wall Street will gladly follow along.

Here are two separate examples from today to illustrate how the game is played. The game, for any new readers here, involves Wall Street analysts providing super-lowball estimates of earnings that a company can easily beat, and then trumpeting that result while conveniently glossing over the sordid details involving any worse-than-expected revenue shortfalls or accounting tricks used by the company to boost their earnings.

The first concerns the giant retailer Target (TGT), which announced their quarterly earnings this morning:

Target Second-Quarter Profit Tops Analysts’ Estimates (Correct)

Aug. 18 (Bloomberg) — Target Corp., the second-largest U.S. discount retailer, reported second-quarter profit that fell less than analysts estimated. The shares rose in early U.S. trading.

Net income declined to $594 million, or 79 cents a share, from $634 million, or 82 cents a share, a year earlier, Minneapolis-based Target said today in a Business Wire statement. Analysts estimated profit excluding some items of 66 cents, the average in a Bloomberg survey. The retailer said July 9 it would meet or exceed a median estimate of 64 cents.

Target said at the time that its gross margin, the revenue remaining after deducting the cost of goods sold, was better than expected and its credit-card group benefited from a modest improvement in risk trends. Sales in the retail unit declined 2.7 percent to $14.6 billion in the quarter ended Aug. 1.

“Despite continued pressure on discretionary items, Target continues to manage its inventories well, and gross margin has held up quite well year-to-date,” Robert Drbul, an analyst at Barclays Capital, wrote in an Aug. 11 report.

That all sounds great; TGT beat estimates every which way, and it’s gross margin is holding up.

Look at the impact on the stock price – that’s a hefty pop (and that was the goal of the game):

But, wait a minute. What about revenues? Revenue is the driver of everything. And did TGT do anything unusual in its accounting to achieve these “better than expected” earnings? The article doesn’t say.

Digging a bit further into the financial reporting universe, we find this information:

[Target’s] total revenue fell 2.6% to $15.07 billion. The company said earlier this month same-store sales fell 6.2%. Analysts polled by Thomson Reuters expected revenue of $15.15 billion.

The credit-card segment’s profits slid 15% on the company’s reduced investment in the segment and lower interest rates. Bad-debt expenses rose 19%. The allowance for doubtful accounts was flat sequentially at $1 billion.

Accounts at least 60 days behind rose to 5.8% of receivables from 4.5% a year earlier, and the 90-day delinquency rate rose to 4.1% from 3.1%.

Hmmm…here we find that revenues fell more than expected and that those same store sales, the most important measure of them all for retailers, fell 6.2% yr/yr.

Profits, on the other hand, were greatly helped by the fact that even though bad-debt expenses rose 19%, the allowance for doubtful accounts (which detracts from earnings) stayed flat at $1 billion (yikes!).

As a thought experiment, what if the allowance for doubtful accounts had increased by 19%, in line with the bad debt expense (at a minimum) as one would have expected? Then that would have resulted in a $190M charge to earnings, TGT would have reported earnings that were some 31% lower, and they would have missed their earnings target by more than 10 cents/shr. Fiddling with the doubtful accounts line is pretty much just a straight-up 101-level accounting shenanigan, and it really shouldn’t fool anyone.

Because TGT held their doubtful accounts line steady, they were able to report better-than-expected earnings today, but will almost certainly have to report lower earnings in the future.

But the stock price is up today, and that is all that matters to TGT and Wall Street.

Okay, we’re going to play the same game with Home Depot (HD), who also reported this morning. See if you can spot the game on your own:

Home Depot Profit Falls Less Than Analysts Estimated

Aug. 18 (Bloomberg) — Home Depot Inc., the largest home- improvement retailer, reported second-quarter profit that fell less than analysts estimated and increased its full-year earnings forecast after reducing operating expenses.

Net income dropped 7.2 percent to $1.12 billion, or 66 cents a share, from $1.2 billion, or 71 cents, a year earlier, the Atlanta-based company said today in a statement. Excluding costs to close the company’s Expo business and a tax gain, earnings were about 64 cents a share. Analysts predicted 59 cents, the average of estimates compiled by Bloomberg.

Home Depot beat projections after rival Lowe’s Cos. yesterday reported profit and revenue that fell more than analysts anticipated. The companies are trying to counter sales declines with cost cutting as shoppers contend with sinking home values and job losses. Home Depot’s sales in the three months ended Aug. 2 decreased 9.1 percent to $19.1 billion.

“Home Depot’s ability to strongly manage inventory, and curb selling, general and administrative expenses, led to solid earnings performance that contrasts nicely with its peer’s results yesterday,” Joel Levington, an analyst at Hyperion Brookfield Asset Management Inc. in New York, said in an e-mail.

Digging a bit deeper into the financial reporting universe:

Quarterly results also included an approximately $50 million tax benefit related to a favorable foreign tax settlement. The tax benefited boosted earnings by about 3 cents per share.

Revenue dropped 9 percent to $19.07 billion from $21 billion, falling short of the $19.23 billion forecast of analysts polled.

Sales at stores open at least a year, known as same-store sales, slid 8.5 percent.

Same-store sales are a key indicator of retailer performance because they measure growth at existing stores rather than newly opened ones.

See the pattern? Promote the earnings, gloss over the revenue shortfalls, and ignore the accounting gimmicks.

Wash, rinse, repeat.

While I think that managing costs is a good thing for any business to do, it is not a sustainable path to earnings growth. Simply focusing on the bottom line results, as the mainstream press has done here, is ignoring important information about the true health and direction of TGT and HD.


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