Sonoma County: News and Notes

Well, it hailing here today. I just looked outside at what was coming down and it was hail. I lived in Florida for almost 15 years so I am familiar with it. Just rare to see this stuff in California. Probably means that it will snow at lower elevations in the Sierra’s. But we are not here to talk about the weather. We are here to talk about Keysight’s Earnings. This was the blandest call given that they just did a $1.6B acquisition and that will be the focus of much of what we talk about. But the numbers are straightforward. The company had $726M in Revenue and $0.63 per share earnings. If you switch to the non-GAAP number, they are essentially flat year over year. The company is profitable and stable. The market it is in is about the same. The question for you as an investor is all about the deal.

Let’s talk about using cash in acquisitions, especially since this is going to be borrowed cash. The borrowing does not bother me, but it does up the purchase price slightly. The thing is that Ixia shareholders (the shareholders of the company that Keysight is purchasing) are getting cash for their stock. There was a slight uptick in the stock prices of both Ixia and Keysight. Ixia’s share price is quite close to the offered cash value. That means people are pretty sure the deal will go through. The question is what does it mean to shareholders.

Now, the truth is that the PROFIT that Keysight derives from the deal must exceed the cost of the deal. Think of it this way. I give you $100 and you pay me back over time. I don’t make a profit until I get my $100 back from you. Revenue is not what you get to give me, it is profit. So, if you use that money to build a business that makes $10 a month, then I get my money back in 10 months at best. Ixia made $5.4M in profit last quarter. Even if I round this up to $6M, it will take over 250 quarters to pay back which is more than 60 years. As an investment, that is a terrible deal on the face of it.

The question comes down to what are called “synergies” and this is where acquisitions make it or break it. There are cost synergies and revenue synergies. The cost ones are easier to understand. You don’t need 2 CEOs. So, there are a number of people that will be let go once this deal is complete. At a minimum, that will include Executives and G&A (HR, Accounting, etc.). There may be other gains as well, but let’s stop there for the moment. Then there are revenue synergies. This is the notion that you can increase sales by selling one company’s products into the other’s customers. This is a lot riskier than cost synergies and is the place that most deals don’t work. I generally like to think that any revenue synergy is a bonus to the deal and that is the way it was discussed on the quarterly call.

So, what you should be looking for is if you take the P&L statement of both companies and add them together that the combined company beats that business. My experience is that it is a lot harder than it looks. Think of the Anite deal. Keysight spent $607M of shareholder money. Profits have not appreciably grown. So, what will be different this time? We shall see.

Have a great day!
Jim Sackman
Focal Point Business Coaching
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Time and Complexity

Complexity is an interesting issue when it comes to Time and Efficient use of Time. I will go back into my work history to explain. When I worked at AFC, we had built a product that was optimized for use by the Small Telephone Companies often called the IOCs. The way that the product was organized and worked made their life better. The group that did not have that same view was the Large Telephone companies then called the RBOCs. I want to talk about complexity as we saw it and then as the RBOCs saw it.

From AFC’s standpoint, we wanted everybody to adopt the same models of the product. We didn’t want to have separate versions of the product for different customers. The challenge for us was that this was the way that the RBOCs wanted things. They approved specific versions and wanted only those versions shipped to them. From AFC’s standpoint, this meant that we had to hold inventory for those customers separately. On top of that, we had to test multiple versions and we had to apply bug fixes to different software for each group of customers.

This changed greatly when we won the FiOS business at Verizon. They bought two “models” of the product. These configurations were the only thing they bought and they bought them in great quantity. So we treated this as a completely separate product and didn’t worry about how things were getting different between the older product and the FiOS product. The difference here was scale. AFC (up until FiOS) was a $350M/year business. Of that, we did about 15% with the RBOCs. That meant the special versions of them were in relatively low quantity. But FiOS was a $600M/year business on its own. That meant that any special procedures and versions were in relatively high quantity. The Time to create and manage the difference were done over large numbers so were easy to justify.

The RBOCs had their own version of that problem and let me look at it in today’s view. They have a large amount of legacy equipment in the network that works to very old standards. The problem is that they can no longer buy replacements – even used replacements for some of that equipment it is so old. They also don’t want to approve new vendors for the legacy network. It is expensive to do so in both resources and Time. I was told once that approving a new product for them was a $30M project and took 2 years. If you want to retire the legacy gear, why would you spend the time and money to find new versions?

But think about this more broadly. These are huge organizations with 10s of thousands of employees. The cost to keep the legacy network going is great and at the same time, they have to build a new, more efficient network. People will need retraining. Spares will have to be kept. Processes will need updating. I often see small companies unhappy with the Large Telephone Companies speed in change. Can you imagine how complex it is to manage a network that can still interface with 100-year-old equipment and yet be the most modern in the world? It is this that is complex and adds cost to their business.

So, think about the models that you have. Especially those that are rarely used. Ask yourself, can I simplify my business and sell more of the more popular items? It might be a great way to make more time!
Jim Sackman
Focal Point Business Coaching
Business Coaching, Executive Training, Sales Training, Marketing

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Sonoma County: News and Notes Update

Two quick things. Enphase just got an updated loan. I am analyzing the loan terms and will write more about that after the conference call. The terms of the loan are complicated and I will need to study them.

The other thing is I wanted to make one note about yesterday’s Column. I thought of another possibility for the reduction in Gross Margins for Q1 of 2017. There could be a significant component of Deferred Revenue. What this would mean in practical terms is that the company would make a significant shipment of products for which it could not claim revenue. There are 2 ways that this could happen as I see it. First, Calix is planning to do some installations in late-Q1 that will not be approved until Q2. Alternately, there could be a new contract (Verizon) where early shipments were dependent upon R&D items. In this case, the product would be not considered Revenue under Sarbanes-Oxley. This would be true even if the company received payment for them in either case.

The challenge to the Deferred Revenue possibility is that it would have made sense to make this part of the announcement if it were true. But it is a possibility.

Jim Sackman
Focal Point Business Coaching
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Sonoma County: News and Notes

We have formally entered Earnings Season and this week we look at the Earnings of Calix. Quarterly Revenue was a record $131.8M and Earnings were a loss of $0.23 per share. There was also a loss (smaller) in non-GaaP results. The stock has been taking a beating on these results with the share price as I type of $6.90 per share down about 9.8%.

So, what is going on and why is the company being beat up so much? The up front problem is in Gross Margins but there is a secondary problem with Operating Expenses (OPEX). We will look at both.

On the Gross Margin Front, the company averages in the mid-40% gross margin range (44% – 46%). Q4 ended with Gross Margins of just over 40%. This gap (let’s call it 5% for round numbers) equated to about $6.6M of loss earnings. Now, this is not enough to make the company profitable, but it would be close to breaking even with this additional money. The company said most of the change in Gross Margins was attributable to Services. Services are people working to engineer, install, and maintain the product. Most of the salaries of those involved are part of Gross Margin so these tend to be lower margin than Products. We also know that the absolute maximum revenue for Services is $13.2M. The CFO claimed they would break out the Gross Margin numbers if Services was 10% of Revenue. If we assume at least $3.3M of this gap is attributable to Service then this implies a Gross Margin of no more than 20% for these Services. Not great, but if there is little to no additional OPEX associated with this work then they are still bringing value to the bottom line.

The problem is that in the Q1 guidance the CFO was revenue of $110M to $114M Revenue and 30% to 34% Gross Margin. I will use mid-point range numbers to elaborate here as the Gross Margin change is significant. If I used 45% as the normal Gross Margin, the gap created is $14.56M in Gross Margin. If Service remains below 10%, this implies that these Services are being sold at an absolute loss. George Notter questioned this on the call but received a non-answer for it. The implication behind it is that we have entered a period of somewhat lower Product Margins and that this may extend for a time into the future. All of this does not include Verizon, which was silent during this period.

But there is a second problem and that is Operating Expense. In Q4, OPEX grew annually over $8M or about 12.5%. This is troubling because it means that the company is becoming less efficient in order to win the business it is trying to pursue. Think of it this way. It is having to charge less (or deliver more value) for its products and it is having to spend more money to run the company. This is a bad position. It may not be permanent, but this is what the market is reacting to.

Outside of the activity in Verizon, there are technical issues that the company is claiming are making it more competitive. Well, it will have to show better results if it wants the investing world to buy into that notion.
Jim Sackman
Focal Point Business Coaching
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Time and Your Participation

There are a lot of Time Management tools out there. A couple of the more famous are the Urgent and Important method popularized by Steven Covey. There is also the ABCDE method that I have taught. I want to give you another, Your Participation.

I am working with a client that is doing a lot of work on Time Management for himself. The challenge he had was that all the A items overfilled his schedule. We went through the list and he explained to me all the things that must get done each time period. We also talked about all the things that he is not doing that he should be doing. I set up a goal beyond what he needed to hit to go back over the list. I figured that if I pressed harder than I needed to then something good would happen.

Then, I asked a rather salient question…”How many of these activities require you to do them?” That is different than do they need to be done, but it is about who has the skill to do them. I started with administrative and rote tasks and wanted to make a list of them. That list alone made a good chunk of the overflow of work. We talked about who these tasks could be delegated to or outsourced to and made a plan around that.

After that, we made an attack by trying to break the bigger chunks into parts that absolutely require his time but parts can be done by others. This provided the rest of the time required. This meant that he was going to have to change how the tasks were done so that others could participate more directly. One other thing that was key was a single technological thought that allowed him to make a specific task easier to manage. That leads to my next challenge for him (and others).

One of the big problems is how to manage interruptions and the Urgent/Important matrix is good with that. But just being able to block out some time in significant chunks is very handy separately. The best way to do that is pro-active communications. By informing people before they call you about a problem you get to communicate on your terms. Even better, you can set expectations on updates and thus clear your time to get the work done that they want. By improving communications and setting the timeframe for an update, you can take additional control of your calendar.

So, there are several ways beyond the traditional metrics to be able to help move things to help make your Time more under your control. The best part of this is that control is a major stress reducer. So, you can spend less time worrying about your time and more time taking care of what you need to do.

Have a great day!
Jim Sackman
Focal Point Business Coaching
Business Coaching, Executive Training, Sales Training, Marketing

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Net Neutrality Friday

Well, it has been relatively quiet so far this year. I know some folks that have started pushing an old idea again, trying to make it new. This is what is called Open Access. Access is good. Open is good. Open Access is not so good, at least in this new flavor.

Open Access is the idea to separate your services from your physical access and be able to have multiple service providers bid for your services on a network produced by someone else. The latest twist on this comes from the Metro Ethernet Forum (MEF), which is trying to find a reason to stay in business. The MEF built standards and got them adopted. The technology and standards are widely used and essentially won. The problem with winning is that there is no reason for your group to exist. So, the MEF is trying to create another battle.

Here is the problem. The old days of Open Access were all about different kinds of services. This is particularly true with video. The video is the one service that takes lots of bandwidths. If you go back 10 years, it was not common to find streaming services. In some places, you could have multiple video providers. That setup was not common, but Project Utopia was an example of that.

Here is the thing. Bandwidth has grown tremendously and all services are now becoming purely Internet Based. There are use cases for non-Internet Services in the Business World. But in the consumer market, we can all see the convergence of all services heading to being Internet Services. Yes, there are still a phone and video services that are not based on the Internet. We can all see that in the future this will not be true.

So, why would the MEF try to resurrect a model that is no longer relevant? I know they are trying to keep themselves around, but seriously the Internet is our common bandwidth utility. You can no longer build a service of any scale without it. So, making non-Internet Services for consumers makes almost no sense for the Service Owner.

I find this whole thing very odd and hope the MEF realizes that this is a battle that is already won and there is no point in continuing.

Jim Sackman
Focal Point Business Coaching
Business Coaching, Executive Training, Sales Training, Marketing

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Sonoma County: News and Notes

I will try to type this between rain drops.

Although it is not quite earning season, I wanted to comment on the proposed purchase of Ixia by Keysight for $1.6B. Although it was not in response to my posts, in spirit the move was in response to what I was saying. The purchase was made with Cash. That is very unusual by itself. Here I want to talk about why too much cash is a big deal to investors and what the responses are to it.

Companies need cash for day to day operations and paying the bills. They definitely need to have a reserve as well to be able to handle extraordinary expenses. Beyond that, you really want the companies that you invest in to limit the amount of cash that they have. There are reasons that they don’t and it is something to consider while you are investing.

There are 2 values for a company that is important here. First is Market Capitalization and the second is Enterprise Value. Market Capitalization is the total value of the stock of a company. Enterprise Value removes any Net Cash from the Balance Sheet and removes it from the value of the company. Now, I suspect that was not clear and so I will explain. Imagine you were selling a wallet and a guy offers you a dollar. The wallet is worth a dollar. Now, put a $100 bill in the wallet and offer it for sale. The same guy should offer you $101 – $1 for the wallet and $100 to cover the cash. The value of the wallet has not changed. The wallet is like Enterprise Value and the Market Capitalization is like the $101. The stock price is higher, but it is all about cash.

Companies are not generally allowed to directly invest in the large scale unless they are an investment firm. An operating firm is supposed to deploy its cash to make itself more valuable. That means that the ROI on the cash is not high. The main job of a company is to not lose the cash. Because of that, you are not making very good returns on the cash part of the Market Capitalization (right now 1% or less). That is not why you invested and you should be asking the company to give you the cash (if it has too much) so that you can invest it and get a better ROI.

Now if the company does so, it has 3 basic choices. The first is a dividend. This can be one-time or a long term payment of cash to the shareholders. The stock price will decline to compensate, but you will now have the cash to do what you want. The second is a stock buyback. In this case, a company buys its own stock with its cash. This lowers the number of shares outstanding and should drive up the value of the stock. Finally, the company can invest in a new initiative – in Keysight’s case the purchase of Ixia.

We will ultimately judge the investment through the growth of Keysight stock in the future. The company is telling you something by doing the purchase. They are telling you that you will get a better ROI from letting them invest the money in Ixia than you will be able to do somewhere else. You will be the judge of that and we will see how things proceed.

Thanks and have a great day!
Jim Sackman
Focal Point Business Coaching
Business Coaching, Executive Training, Sales Training, Marketing

Change Your Business – Change Your Life!

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