Monday, November 29, 2010

1,359 Words for “Caveat Emptor”

“We’re nothing but a mirror of our consistent thoughts. You tend to manifest what you focus on. If you look around for what’s wrong, you’ll find it. But as all we know up here in San Francisco, when you focus on what’s right, you see it all around you. … There is absolutely nothing wrong with California that can’t be fixed by what’s right with California. … If you’re from another state, you’d love to have the problems of California.”

–California Lieutenant Governor-elect Gavin Newsom

Leaving aside the new-age psycho-babble, as well as the fact the more than a few states do have “the problems of California,” we couldn’t help think of the San Francisco Mayor’s recent election-eve musings as we listened to the earnings call of a company that, we submit, gave a pretty good demonstration, if inadvertently, of something that is wrong not merely with California but with all of America.

Now, this large retailing success story has its detractors—zillions of them, if you were to believe the mainstream media, although when you scratch the surface of that mistrust, you find mainly disgruntled union bosses and superficially populist politicians (including our current Vice President, who once actually campaigned against the company’s expansion), scared by the company’s hyper-efficient operating methods, not to mention the fact that it isn’t a union shop.

Thus do people with one agenda look for whatever dark clouds they can find in the silver lining of a company that brings, by our brief calculations, more than ten billion dollars worth of reduced living costs to the American consumer each year.

The company is Wal-Mart, and fully 60% of American adults shop at one of their stores at least once a month. (By way of comparison, Target is shopped by 25% of American adults monthly).

It goes without saying that those 120 million or so monthly visitors to Wal-Mart are hardly a uniform picture of American poverty, as the mainstream media would have us believe. But, then, mainstream media types—not to mention Vice Presidents—don’t shop there, so what would they know?

If they did shop at Wal-Mart, however, what they would know is that a basket of typical good purchased at Wal-Mart costs anywhere from 2% less than the competition in the company’s original mass merchandise business (think Sears), to 10% less than the competition in the case of groceries, which now account for half the company’s U.S. sales.


Applying those savings to the company’s $300 million-plus in U.S. sales, you arrive at roughly $18 billion in savings Wal-Mart provides its customers. Each year.

Now you would think that a company that helps consumers save $18 billion a year would be justly celebrated and encouraged to flourish—within the bounds of legal competitive behavior and the rule of law.

But this is America, and America is now governed by trial lawyers—and that’s one thing that’s wrong with America, which Wal-Mart’s latest earnings call illustrated as well as anything we’ve seen since Congress passed so-called healthcare “reform” legislation without bothering to reform the tort system.

(Hey, when 56 Senators are lawyers—not to mention the President, Vice-President, and 36% of Congresspersons—while only two Senators are doctors, well, the fix on tort reform was in from the start.)

Now, it wasn’t so much the earnings discussion, which involved, as it usually does, Wal-Mart’s extensive retail operations—from Bentonville to Leeds—that shed a light on the trial lawyer problem in America.

It was the preamble—the so-called “Reg. FD” disclosure statement that public company executives make before launching into a discussion of business.

For the record, we’ve long thought Reg. FD was one of the really good rules promulgated by the Feds, eliminating, as it did, the kind of selective disclosures companies used to make to Wall Street’s Finest.

(We remember well the pre-Reg. FD days when conference calls were restricted to specific Wall Street analysts and specific buy-side investors. The chosen few would, for example, get on the Hewlett Packard earnings call not because they cared a whit about Hewlett Packard: they got on so they could find out what was happening to DRAM pricing—this was in the days before DRAM prices were instantly available on what Tracy Jordan calls “The Interweb”—and then would, while the HP call was still ongoing, trade shares of Micron and other various memory makers.)

The one downside of Reg. FD is that companies use part of the discussion to point out—strictly for the legal record—the obvious: that stuff they are going to talk about on their earnings call could change down the road, thanks to the fact that, well, stuff changes.

You might think this notion is fairly obvious, but whenever a public company announces a sudden, unexpected negative situation, like bad earnings or a lawsuit or an investigation of some sort, the company is invariably hit with lawsuits from trial lawyers looking to dredge up some cash flow.

Just last month, for example, Green Mountain Coffee Roasters was hit with lawsuits from a whole batch of trial lawyers a few days after announcing an SEC investigation into the company’s accounting.

Green Mountain made its announcement on Tuesday, September 28. On Friday, October 1, seven law firms announced “investigations” or “securities fraud class action lawsuits.” On Monday, three more jumped into the lottery sweepstakes, and by week’s end a few more joined in, including one firm that issued a press release with the following headline, which we are not making up:

“….Encourages Investors Who Have Losses in Excess of $500,000 From Investment in Green Mountain Coffee Roasters, Inc. to Inquire About the Lead Plaintiff Position in Securities Fraud Class Action Lawsuit Before the November 29, 2010 Lead Plaintiff Deadline”

Now, we’re all for good corporate governance, and for companies keeping things on the up-and-up. Short-selling is an investment tool we employ frequently, so it is a part of our business model to find companies that may not be doing all the things they like to say they’re doing on earnings calls. Few things in this business are as satisfying as spotting a public company masquerading as something it is not—and making money when the chickens come home to roost and things go kablooey.

The problem with trial lawyers, of course, is that they rarely spot frauds before the frauds go kablooey. They spot the frauds after they go kablooey.

Thus it is that public companies feel pressured to offer Reg. FD “disclaimers” that can be a few short sentences or can verge into Gravity’s Rainbow-length missives, and Wal-Mart, being a target anyway, thanks to its fantastically successful non-union operation, goes to great lengths to cover all the bases.

To such great lengths does Wal-Mart go, in fact, that the disclaimer goes on for more than a few minutes: it goes on for more than ten minutes.

We are not making that up: of the 11,369 words spoken on the recent Wal-Mart earnings call, 1,359 of them—12%—came in the disclaimer section.

And if there was ever an example of something wrong with America, we think it is the notion that one of the world’s great corporate successes must waste 12% of its time on a prophylactic, legalistic mush of words, not one of which contributes to the general welfare of anyone.

But judge for yourself! Here’s the entire legal disclosure, thanks to the indispensible Briefing.com:

Welcome to the Wal-Mart earnings call for the third quarter of fiscal year 2011. The date of this call is November 16, 2010. This call is the property of Wal-Mart Stores, Inc. and intended solely for the use of Wal-Mart shareholders. It should not be reproduced in any way.

This call will contain statements that Wal-Mart believes are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, as amended, and intended to enjoy the protection of the safe harbor for forward-looking statements provided by that Act.

These forward-looking statements generally are identified by the use of the words or phrases anticipate, are anticipating, are expecting, assume, could be, expect, forecasting, goal, guidance, guided, is expected, is planning, may affect, plan, will accelerate, will add, will be, could save, will drive, will ring, will be growing, will come, will continue, will cost, will experience, will generate, will grow, will improve, will not continue, will remodel, will see, will spend, will take, would represent, or a variation of one of those words or phrases in those statements or by the use of words and phrases of similar import.

Similarly, descriptions of our objectives, plans, goals, targets, or expectations are forward-looking statements. The forward-looking statements made in this call discuss, among other things, management's forecasts of our diluted earnings per share from continuing operations attributable to Wal-Mart for the fourth quarter of fiscal year 2011 and for all of fiscal year 2011; the assumption underlying those forecasts that currency exchange rates will remain at current levels; management's forecasts for the comparable store sales for our Wal-Mart U.S. segment and comparable club sales, without fuel, for our Sam's Club segment, in each case, for the current 13-week period; management's expectation that the comparable store sales of our Wal-Mart U.S. segment will be positive for the holidays and the fourth quarter of fiscal year 2011 and that the fourth quarter of fiscal year 2011 will be another quarter of sequentially improving comparable store sales for our Wal-Mart U.S. segment; management's expectations as to our anticipated tax rate for fiscal year 2011, quarterly fluctuations in that tax rate and factors that will affect that tax rate; management's forecasts for Wal-Mart's capital expenditures in fiscal year 2011 and fiscal year 2012; management's goal for return on investment being maintaining a stable return and management's expectations that Wal-Mart will continue to manage its inventory to be in line with its current business needs; although Wal-Mart will see year-over-year pressure from higher inventories in the fourth quarter of fiscal year 2011, that our Wal-Mart U.S. segment will be the price leader throughout the holidays; that inventory levels at our Wal-Mart U.S. segment will stabilize and Wal-Mart will once again generate even more cash flow; that our operations in Brazil will improve, growth in Wal-Mart's operations in China and India will accelerate, growth in Wal-Mart's Mexican operations will continue and supercentres will be added in Canada; and that the sales momentum of Wal-Mart's Sam's Club segment will continue into the fourth quarter of fiscal year 2011 and into fiscal year 2012; and the Sam's Club segment will leverage expenses in fiscal year 2012.

Those forward-looking statements also discuss management's expectations for the Wal-Mart U.S. segment relating bake centers driving the segment's sales in November and December 2010; supplier recalls in the health and wellness category remaining a headwind in the near term for the segment; a new Medicare Part D prescription drug plan driving incremental pharmacy traffic for the segment; the sales of Straight Talk by the segment in fiscal year 2011; and how the sales of that item could affect comparable store sales of the segment if the full transaction value for those sales was includable in the calculation of comparable store sales; the sales of Straight Talk and third party gift cards will ring through the Company's registers more than $2 billion for the full fiscal year; continued strong online sales in the 2010 holiday season for the segment and the factors to drive those sales; the number of new supercenters and other formats, including new units, to be opened in fiscal year 2012 by the segment; the number of the segment's stores to be remodeled in fiscal year 2012 and changes in the cost and time of those remodels; and the timing of Christmas spending in 2010.

Those forward-looking statements also address management's expectations that our Wal-Mart International segment will experience a very competitive fourth quarter in some of its markets; that such segment's sales will grow, although the segment will experience pressure on its overall gross margin; that the sales of that segment's operations in Mexico will grow by certain means; that such segment's Brazilian operations will continue to see pressure on those operations' results from the operating structure in Brazil, changes thereto and the effects of a conversion to an everyday low price approach, and regarding product offerings by that segment's ASDA subsidiary and the addition of new stores and square footage to that segment through an acquisition by ASDA and the timing for conversion of those new stores to a different format.

Those forward-looking statements also discuss management's expectations that Wal-Mart's Sam's Club segment will not continue to feel the effects of a credit card processing fee in the fourth quarter of fiscal year 2011; that such segment's small business memberships will continue to pressure net membership income in that fiscal quarter and regarding the occurrence of promotional events in the segment's units relating to the holiday season.

The forward-looking statements also discuss the anticipation and expectations of Wal-Mart and its management as to other future occurrences, objectives, goals, trends and results. All of these forward-looking statements are subject to risks, uncertainties and other factors, domestically and internationally, including general economic conditions; geopolitical events and conditions; the cost of goods; competitive pressures; levels of unemployment; levels of consumer disposable income; changes in laws and regulations; consumer credit availability; inflation; deflation; consumer spending patterns and debt levels; currency exchange rate fluctuations; trade restrictions; changes in tariff and freight rates; changes in costs of gasoline, diesel fuel, other energy, transportation, utilities, labor and health care, accident costs, casualty and other insurance costs, interest rate fluctuations, financial and capital market conditions; developments in litigation to which Wal-Mart is a party; weather conditions; damage to our facilities resulting from natural disasters; regulatory matters; and other risks.

We discuss certain of these matters more fully in our filings with the SEC, including our most recent Annual Report on Form 10-K and our most recent Quarterly Report on Form 10-Q, and the information on this call should be read in conjunction with that Annual Report on Form 10-K and Quarterly Report on Form 10-Q, and together with all our other filings, including current reports on Form 8-K, which we have made with the SEC through the date of this call. We urge you to consider all of these risks, uncertainties and other factors carefully in evaluating the forward-looking statements we make in this call.

Because of these factors, changes in facts, assumptions not being realized or other circumstances, our actual results may differ materially from anticipated results expressed or implied in these forward-looking statements. The forward-looking statements made in this call are made on and as of the date of this call, and we undertake no obligation to update these forward-looking statements to reflect subsequent events or circumstances.

The comp store sales for our total U.S. operations and comp club sales for our Sam's Club's segment and certain other financial measures relating to our Sam's Club segment discussed on this call exclude the impact of fuel sales of, and other amounts for, our Sam's Club segment. Those measures, our return on investment, free cash flow and amounts stated on a constant currency basis as discussed in this call may be considered non-GAAP financial measures. Reconciliations of certain non-GAAP financial measures to the most directly comparable GAAP measures are available for review on the Investor Relations portion of our corporate website at www.Wal-Martstores.com/investors, or in the information included in our current report on Form 8-K that we furnished to the SEC on November 16, 2010.


In other words, “Caveat Emptor.”


Which we already knew.



Jeff Matthews
I Am Not Making This Up

© 2010 NotMakingThisUp, LLC

The content contained in this blog represents only the opinions of Mr. Matthews.
Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews’ recommendations. This commentary in no way constitutes investment advice, and should never be relied on in making an investment decision, ever. Also, this blog is not a solicitation of business by Mr. Matthews: all inquiries will be ignored. The content herein is intended solely for the entertainment of the reader, and the author.

4 comments:

Kevin said...

I agree with the general sentiment expressed here, but Reg FD has nothing to do with the disclaimer above. The disclaimer exists because the Private Securities Litigation Reform Act of 1995 requires it. Otherwise, you don't get to enjoy the safe harbor provided by the act. (The PSLRA does not require this much detail, however. That is the result of the zealousness of lawyers trying to protect Walmart.) The safe harbor makes it much more difficult for plaintiff lawyers to successfully sue on a "10b5-1" fraud claim - it effectively places the burden of proof on plaintiffs to find material misstatements or omissions that cause the plaintiffs to suffer a loss. By identifying the forward looking statements, it makes it much more difficult for plaintiffs to do this. Of course, that doesn't stop them from trying - which means we've let the trial lawyers win - because they are going to get paid something no matter what (in other words, the defendant is going to settle rather than engage in a prolonged and costly litigation).

Reg FD simply requires Walmart to make that same disclosure to all investors at the same time (along with the rest of the details in the conference call.)

Anonymous said...

hey Jeff, I thought in the intro of your book you mentioned you didnt short stocks.. how come u are now saying you do? (Not that it makes a damn difference to me, I´m just curious whether you´ve recently changed the strategy)

Jeff Matthews said...

Kevin: Excellent, well said. Thank you.

Anonymous: We haven't changed a bit, we've always shorted as well as bought long. Now, checking the wording in the book, I can see now how you'd get that impression, but the intent was to say not that we only 'invest in stocks,' the intent was to say we deal only in stocks--as opposed to macro hedge funds that also trade currencies, bonds, commodities. Will be cleaning up that in the 2011 iPad Edition. So thanks, too.

JM

Aaron said...

Professor Jeff:

Very prescient post.

Just yesterday, the U.S. Supreme Court agreed to hear oral arguments in the Dukes vs. Wal-Mart class action lawsuit. At issue in the case is whether the plaintiffs, Dukes et al., met the necessary requirements for class certification. The case is emblematic of the many legal challenges a publically traded company like Wal-Mart faces (DISCLOSURE: I work for the company and I own the stock). I believe Reg FD is a “necessary evil” in that the law forces companies to disclose their known “risks” that could change the earnings outlook and, ultimately, their share price. Companies should make a best effort to educate investors of the challenges faced and Reg FD in my belief does a good job of that. Do I believe, however that every risk can be “identified” and acknowledged under Reg FD? Absolutely not!

P.S. – As an investor in Wal-Mart, I’d be more worried about currency risk given all the emerging markets WMT is recently investing in (India, South Africa, and Russia) to boost sales growth. A cursory glance at its latest quarterly earnings release shows how WMT International has driven the company’s sales growth over the last four quarters while sales here in the US has been anemic, to put it nicely. Inflation risk would also be near the top of my concerns as food processors attempt to pass through price increases to retailers and consumers due to increasing commodity and energy costs (hello, Kroger)! Keep an eye on COGS – if they start rocketing past net sales growth, look out!

I could be wrong, though…