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In its latest communication fumble, Google Inc. accidentally revealed an internal financial target for 2006 on its Web site but said it didn’t constitute financial guidance.

—Wall Street Journal, Wednesday

Google Inc. said it agreed to pay as much as $90 million in legal fees and advertising credits to settle a lawsuit filed against it and other Internet companies last year alleging that the companies knowingly overcharged for online advertisements and conspired to continue doing so.

—Wall Street Journal, Thursday

The Cover Story Curse still holds: just three weeks after Time Magazine featured “The Google Guys” on its cover, those same Google Guys appear no more adept at running a public company than my dog Lucy.

Funny how perceptions change, and change quickly.

During the IPO process two short years ago, The Mainstream Press could not have been more dismissive of The Google Guys, their “Do No Evil” ethics, and the ad-driven search-engine business they had created.

A year later, after that same ad-driven search-engine business model had blown through pre-IPO earnings forecasts on the heals of some terrific new products—including Google Maps and Google Mail—and the stock had tripled, The Mainstream Press jumped on board the Mountain View Express.

Even CNBC, chastised into sobriety after its Bubble-Era cheerleading had come to grief, finally joined the caboose, giving full exposure to an analyst expounding a Bubble-Era, $2,000-a-share theoretical future Google stock price in the first days of 2006—which coincided precisely with the peak in Google’s stock.

Then came a disappointing quarter, and now comes word of two more Google Gaffes, straight on the heals of last week’s miscue by CFO George Reyes, a straight-arrow guy if ever there was one, who triggered panic-selling in the stock by making very rational comments about the likely diminution of Google’s growth rate.

Reyes’ comments should have surprised nobody who has been paying attention to the public comments of Google customers such as Blue Nile and FTD Group regarding the diminishing value of Google search—but Wall Street’s Finest, no doubt feel embarrassed to have finally embraced the Googlephoria at the moment it was about to evaporate, have not been mollified.

Somewhat obscured by the Google miscues was Tuesday’s excellent Wall Street Journal piece by Mylene Mangalindan regarding the heavy investment spending required by internet-based companies:

As the big survivors among Internet companies mature, they are learning a painful — and unexpected — lesson: Staying in the online game requires heavy, constant spending.

That is something Amazon.com has been dealing with for some time, and it triggered an excellent question on that company’s last conference call, when Mark Rowen of Prudential asked what I thought was very interesting question, foreshadowing the Wall Street Journal story:

“Jeff [Bezos, Amazon CEO], you have said for a long time that your model is more efficient that the traditional retail model because you don’t have to invest in real estate, which always goes up. Instead you can invest in technology, which goes down.

“But if I add up all of your expenses as a percent of revenue, and add in free shipping…I think in 2005 it was a little over 20% in the fourth quarter…which is 200 or 300 basis points higher than a company like Wal-Mart.

“So could you just sort of give us an idea…why is it that we are not seeing more efficiency, if, in fact, the model is more efficient?”

Mr. Rowen was not making his numbers up.

In calendar 2005, both Amazon and Wal-Mart generated roughly the same gross margin (24% and 23%, respectively) while Wal-Mart’s pre-tax margin came in half a basis-point above Amazon’s 5.04% pre-tax margin.

The difference between gross margin and pre-tax margin is cost-structure, and since Wal-Mart starts out with a lower markup to consumers but ends up with a higher piece of the gross profit dollars, it would appear that Wal-Mart—stodgy old brick-and-mortar Wal-Mart—is more efficient than technology-savvy Amazon.com.

To Rowen’s perceptive question, Jeff Bezos gave a bland answer:

“Well, I think one thing to keep in mind is that if we were not investing in some of these new initiatives such as digital and Web Services, our cost structure would be different today. So if we were totally optimizing our cost structure for a kind of steady-state business, you would see a different cost structure…”

“If you look at the return on invested capital, the dynamics between our business and traditional retail are very different in large part because of the efficiency of our capital model, high inventory turns, low PP&E.”

All of which is very true but ignores the fact that Wal-Mart is always investing heavily in “new initiatives” and does not operate “a kind of steady-state business,” despite the fact that Wal-Mart came public back in 1970.

What does this have to do with Google? Well, Google management highlighted big capital expenditure plans at last week’s analyst meeting—which at a minimum would equal 19% of net sales.

Just for comparison’s sake, Caterpillar Tractor’s capital spending amounted to roughly 8% of sales last year.

How could a search-engine company dealing in bytes be spending more heavily, relative to its sales, than a brick-and-mortar manufacturer of earth-moving equipment?

When I first started using Gmail, which encourages users to never delete an email (see “Plastics” from January 9), I could literally watch the storage space available in my Gmail account rise, like a population count in Times Square, as Google added the servers and storage to accommodate all the data piling up from Gmail accounts around the world.

Then, about two months ago, that storage counter slowed to a crawl, and now increases modestly only every few days.

As a result, my use of the Gmail storage space allocated to my account has ballooned from 1% of my storage capacity to 24%.

24% is not sustainable: at the rate I’m going, it’ll be at 50% by summer and 100% by December.

Sure, I can revert to MSN methods of deleting all the emails I don’t especially need—and I’ll do it if I have to. But that wastes time.

Could it be the dot-coms have underestimated the long-term capital required to maintain, let alone grow, in the online world?

I don’t know the answer to that question: but having trained its customers to expect “limitless storage,” Google needs to deliver precisely that, otherwise, it will start losing customers.

And if it starts losing customers, the “Do No Evil” Google Guys will not be able to do much good, for themselves or their fellow shareholders.

Jeff Matthews
I Am Not Making This Up

© 2005 Jeff Matthews

The content contained in this blog represents 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.

For particularly crucial meetings, Intel has a special team of six full-time facilitators who guide participants through intensive sessions in a 5,000-square-foot building in Oregon.—Wall Street Journal

So this is what it’s come to at one of America’s great companies: meetings to get ready for meetings?

The facilitators can tap a database of techniques ranging from good icebreakers, to how to evaluate competitive threats.

“Good icebreakers?” What—like, “Business is so bad at Intel…”?

I mean no disrespect here: I’m writing these words on a computer powered by a microprocessor made by Intel (at least I think it’s Intel—although given the recent market share losses to AMD, who knows), and my life has benefited immensely from the computer revolution.

But a 5,000 square-foot building to get ready for meetings?

And they can draw on an armory of tailor-made equipment, including hand-held voting pads for quick, anonymous polling of the meeting members, rolling 6-foot-by-6-foot white boards that can double as space dividers and a 42-foot-long white board.

I admit, I’m not a big Meeting Guy—maybe because the smartest guy I ever worked for had his staff meetings right in his office, at his desk.

And since he worked at a specially-made stand-up desk, we all stood while we talked. No coffee, no doughnuts, no icebreakers or 42-foot white boards or hand-held voting pads. We talked about whatever we had to talk about and then left.

Of course, we weren’t running a huge multinational manufacturing enterprise. Still, after reading today’s Journal, it makes me wonder: I always thought the guy who started Dilbert worked at the phone company, not Intel…

Jeff Matthews
I Am Not Making This Up

© 2005 Jeff Matthews

The content contained in this blog represents 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.

“All great popular music is based on cool riffs.”—Dave Davies.

So the Kinks lead guitarist (and less famous brother of lead singer Ray Davies), now in his 60’s and slowed by a stroke, tells this month’s Mojo, the British music magazine that does what Rolling Stone long ago stopped doing: it actually covers what’s going on in the music world.

Dave, the unheralded co-leader of one of the 60’s most adaptable and long-lived bands makes that profoundly simple observation when discussing the origin of “You Really Got Me,” the Kinks’ first hit single 40 years ago—yes, forty years ago.

The way Dave tells Mojo, his teenage brother Ray walked into the room at their sister’s house where Dave was practicing guitar chords, said “What about this?” to his brother, and played, one fingered on the piano, “Da-da-da-da-da.”

When Dave played back the riff on his fuzzy electric guitar, he says, “The hairs just stood up.” He knew they had created a hit song.

Lest grey-hairs like me bemoan the passing of time and the decline of music “today” from those fertile years of our youth by insisting that no two teenage kids from nowhere could create a song and a sound like that ever again, I’m happy to report that not only can it happen again, but it just did, in Sheffield, of all places.

The teenagers call themselves The Arctic Monkeys, and I’d read about them in a flattering New York Times story a couple of weeks ago.

They sounded interesting, but when I asked my younger daughter if she’d ever heard about them, she said no, and I forgot about it—until the next day, when she dragged me upstairs to her computer, saying “Dad, the Arctic Monkeys are great.”

She played me the four or five songs she’d downloaded the previous night after checking them out thanks to the magic of iTunes, and the very first, “I Bet You Look Good on the Dance Floor,” made, as Dave Davies says, the hairs stand up.

Better yet, the band’s first CD just came out, and proves the Monkeys have a lot more in them than those first few songs that appeared on iTunes.

The singer, Alex Turner, has a voice that sounds like early David Bowie at times, only ragged and with a thick accent which makes the very sharp and often funny lyrics that much more interesting. (I’m willing to bet there aren’t too many songs in your own personal archives with the line, “’Cos he’s a scumbag, don’t you know?”)

The music is mostly fast and has a sort of sloppy Nirvana-type feel of guys actually playing instruments as opposed to session men covering songs for a producer attempting to create a Sound.

You can hear influences ranging from The Pretenders to Squeeze to Rage Against the Machine to early Beatles and even very early Genesis, but the minute you think the song settles into a certain style the music shifts direction and goes somewhere else.

Maybe the most interesting and encouraging thing about the CD itself, from the point of view of good things to come—is the narrowness of the songs’ subject range: it’s about what happens at night in Sheffield, England, involving pubs and bouncers and dance floors and under-aged drinking and birds and blokes and toffs, and not much else.

It will be very interesting to hear what they’re writing about when their horizons open up—say, after the coming tour of the United States.

Unfortunately for the Monkeys, word-of-mouth about the band exploded after the tour was planned, and tickets that went for $12.50 at the Paradise Lounge in Boston—a Dive with a capital D—are now offered at $110 online.

(Lest the Paradise consider legal action for that remark, let me state unequivocally that the Paradise is, in fact, one of the all-time great places to see a band play, and I’ll be bringing my daughter up early so we can get a good spot at the edge of the stage, which is not hard because almost anywhere you stand you’re ten feet from the drummer.)

My prediction—and I hope the SEC understands that I make this forecast without having received any illicit payments from journalists or stockbrokers or record companies—is that the Monkeys take America by storm.

Jeff Matthews
I Am Not Making This Up

© 2005 Jeff Matthews

The content contained in this blog represents 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.

Editor’s Note: Given the current state of government oversight over our public capital markets, in which attorneys working for the SEC issue subpoenas for phone records of investigative journalists who dare investigate publicly traded corporations—as opposed to those attorneys going after the phone records, for example, of message board stock manipulators or corporate executive stock manipulators—the writer of this blog is no longer willing to speak his unadulterated mind.

The following reflects the New, Always-Upbeat World of Free Speech which seems to be preferred by the same SEC that regularly shuts down hedge funds after the principals have absconded with the cash and which was unable to detect and prevent the collapse of numerous Bubble-Era companies, including Enron, whose former Chairman and former Chief Operating Officer are now on trial for allegedly hiding that collapse from public investors whom the SEC was supposed to protect, following the Hovnanian conference call yesterday.

“We are projecting margins to be lower than we have had for the last few years,” a very savvy member of the top-flight home-builder Hovnanian’s management team said on yesterday’s superb and highly upbeat conference call.

“Although it’s too early for a formal EPS projection for fiscal ’07,” the superlative management executive continued, “we expect to see a similar trend to what we are projecting this year—further reductions in gross margins offset by further gains in deliveries and revenues, resulting in an increased EPS.”

I have no doubt that this strategy—of homebuilders seeking to make up in volume what they are losing in price—will have the most salutary and beneficial impact on the current housing situation in the United States, which, in the New, Always-Upbeat World of Free Speech, I should describe as not a bubble but more a nice warm bath.

Jeff Matthews
I Am Not Making This Up

© 2005 Jeff Matthews

The content contained in this blog represents 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.

Tough as Nails!

That’s the headline on the cover of the new Business Week, over a photograph of a crew-cut, orange-apron-wearing Home Depot employee, crisply saluting with his right hand while his left holds a shovel, rifle-style.

“Skip the touchy-feely stuff,” the text informs us: “The Big Box retailer is thriving under CEO Bob Nardelli’s military-style rule.”

But what looks on the cover to be a glowing review of GE veteran Nardelli’s military-infused makeover of one of the most successful companies in American retailing history offers a cautionary tale about the downside to managing-by-numbers when it comes to the “touchy-feely” world of retail.

“Nardelli,” the article begins by telling us, “loves to hire soldiers.” And it’s not kidding: almost half the 1,100 store leadership trainees hired since 2002 have been “junior military officers.” One Home Depot manager actually describes Nardelli as “the general.”

Now, my nephew is a soldier. He just came back from Iraq. And I’d love to see him get into a training program like Home Depot’s when the time comes for him to transition to civilian life.

But if you’re wondering whether a military-style organization is the best way to run a home improvement retailer, the Business Week article will not entirely answer your question.

After starting out with the usual hoopla and glowing factoids of the Nardelli-inspired revival at the world’s largest home center, the article describes the Nardelli culture as paralyzed with fear; quotes an ex-manager who calls the company “a factory”; and reports that “Home Despot” is the nickname given by some insiders. My favorite, “Bobaganda,” is what others call the television programming in the break rooms owing to “its constant drone of tips, warnings, and executive messages.”

Me, I have no insider’s knowledge of whether such “Bobaganda” is in fact helping the company “thrive.” But I know at least one customer who’s seen the short-run impact of Nardelli’s “military-style rule” at the store level.

A friend called recently about a weird experience at the local Home Depot: he was looking for carpet, but when the sales lady pulled out those big rolling carpet-holders, there wasn’t much carpet on them.

“I’m sorry,” she told him. “We’ve been running low.” She blamed it on problems “with the trucking company,” and said new carpet inventory would be on its way.

I told my friend that knowing the problems truckers have been having holding onto drivers in this tight labor market, maybe that was in fact the problem—but just to make sure called a friend who used to run a Home Depot store and is now at a competitor.

Even before I finished telling the story, he began to laugh. “It’s not the trucks. It’s some bean-counter at corporate,” he said. The way he’d heard it, Home Depot’s fiscal year was coming up, and corporate had cut back store-level inventory—he supposed to show Wall Street’s Finest how well the company was managing inventory.

“There’s only one problem with that,” he said with deep irony. “You run out of what you sell.”

Interestingly, just last week Home Depot reported its fiscal year end, and Wall Street’s Finest did indeed take note of the company’s crisp inventory management. As Morgan Stanley wrote:

“Inventory levels…grew slower than sales…. We note that inventory growing slower than sales is consistent with comments from suppliers who cited strong sell-through but slower sell-in particularly towards the end of the quarter [emphasis added].”

Now, I’ve walked Home Depot stores with its founders, Bernie Marcus and Art Blank. It was their baby: they lived and breathed Home Depot. Bernie especially wore his heart on his sleeve—he’d get choked up just talking about how a particular employee had gone out of his way to help a customer install a sink.

And to their credit, both founders knew the business had outgrown the highly decentralized way they had managed the business—hence, the GE-trained, Six-Sigma promoting Nardelli.

But retail is not just about computer-generated numbers. Home Depot stores sell GE light-bulbs—they don’t manufacture those light-bulbs…and if a nearby Lowes does at least as good a job selling the same light-bulbs, not to mention carpets, then the Home Depot customer has a choice.

How that customer chooses in the future will determine the success or failure of “Bobaganda,” not whether the CEO and the soldiers carrying out their marching orders are “tough as nails.”

Jeff Matthews
I Am Not Making This Up

© 2005 Jeff Matthews

The content contained in this blog represents 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.

Ms. Rieker, who joined Enron in 1990, clarified testimony from Mr. Koenig that as far back as January 2000, Mr. Skilling had directed last-minute changes to earnings results to put them in line with analysts’ expectations.—New York Times


Thanks to Paula Rieker, the former board secretary of the former Wall Street Favorite known as Enron, the world now knows how certain large, complex, multinational companies manage to “beat the number” by a penny or two, quarter after quarter after quarter, until they don’t.

When the consensus expectation of analysts suddenly rose by 1 cent a share, to 31 cents, she said she “panicked.” But a day later, when she was told that Enron would report 31 cents a share, Mr. Koenig explained that Mr. Skilling and the chief accounting officer, Richard A. Causey, had decided that the numbers should be changed. She modified the news release that went out that day.

Anybody who has ever worked at a real company—as opposed to the bright bean-counters who move straight from grad school into the ranks of Wall Street’s Finest—knows that companies are inherently messy affairs, what with people to manage and budgets to meet and judgment calls to make and accounting rules to bend…not to mention currency swings and interest rate movements and hurricanes, droughts, wars and government policy changes.

But to Wall Street’s Finest, who view nearly everything through the prism of a quarterly earnings-per-share number that is almost as meaningless as the paper on which it is printed, the messiness vanishes, its place taken by a “Number” that becomes the all-encompassing target, almost regardless of how that “Number” is reached or exceeded.

Take Dell, for example: Dell “made the number” last week thanks entirely to a lower-than-expected tax rate. Wall Street’s Finest, as reported here, liked “the number” but not Dell’s forward guidance, which seemed light to the so-called analysts whose job it is, presumably, to divine trends before they are glaringly evident and already priced into their stocks.

Where, the readers of this blog who have experienced terrible service problems at the hands of that once-great company might ask, have those analysts been for the last year? How can they be surprised at Dell’s weak revenue growth, the declining earnings growth rate, and the lack of a full year forecast?

They’ve been spending too much time on useless models and not enough time talking to customers, that’s how.

Every investor should read carefully the account in today’s New York Times of how one complex multi-national corporation “beat the number,” according to Enron’s Ms. Rieker in yesterday’s testimony:

Then in June 2000, with Enron prepared to meet analysts’ earnings expectations of 32 cents a share, Ms. Rieker recalled that Mr. Koenig came into her office and said he had “just come back from a meeting with Skilling where he had said he wanted to beat earnings by 2 or 3 cents.”

Four days later, Enron reported 34 cents a share. Analysts were never told about the sudden change.

The next time a company “beats the quarter” by a penny or two, think about how Enron used to “beat the number.”

And ignore the analysts who actually care about it.

Jeff Matthews
I Am Not Making This Up

© 2005 Jeff Matthews

The content contained in this blog represents 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.

Disney Shopping, a $160 million a year direct-to-consumer purveyor of Disney merchandise, announced a change in its business model that to anybody on Wall Street—and to consumers under the age of 30—should come as no surprise: it is eliminating its paper catalogue.

According to an interesting article in this weekend’s New York Times, “Disney spent $18 million to mail 30 million catalogs last year,” with half the catalogs going out in the fourth quarter holiday season.

The result was a whopping 45% decline in peak season telephone orders.

Now, you might expect that a 45% decline in telephone orders from a catalogue mailing would lead to a fairly big decline in overall sales for the Disney Shopping business, but thanks to the overwhelming proportion of internet-based orders, sales actually increased 5% for the year.

You don’t have to be a math whiz to figure out the general direction of the variables in the equation embedded in this discussion: catalogue-based sales down, internet-based sales up.

Why, you might wonder, would anyone spend $18 million to contact consumers using a labor and resource-intensive method when the response to that method was a collapse in customer response at a near-50% annual rate?The answer is you wouldn’t—unless of course you happen to be a college professor.

While the folks at Disney have taken the highly logical step of paying attention to the data and putting an end to the $18 million catalogue operation, Donna Hoffman, a professor of marketing at Vanderbilt University, told the Times the move was “really short-sighted” and said the company ought to reconsider.

As if the trend is a momentary blip.

Ms. Hoffman, to her credit, provides a statistic to back up her point of view: the purported fact that consumers who use a retailers’ store, catalogue and web site spend 15% more at that retailer than customers who use only one shopping method. “Disney’s just leaving all of that on the table,” she told the Times.

But what, precisely, does “all that” amount to here?

Let’s assume Professor Hoffman is correct, and Disney is realizing a 15% sales lift from the shrinking base of customers who shop in Disney Stores, order online and peruse those catalogues—say, one quarter of the $160 million total Disney Shopping sales.

So perhaps $40 million out of those sales were boosted by Professor Hoffman’s 15% synergy number—implying Disney generated an extra $4 million of sales thanks to the catalogue mailings.

Now let’s try to figure out what it cost to get that extra $4 million in sales.

Without detailed access to Disney’s books we’ll have to guess, but there’s an interesting data point inside the article: 80%—or roughly $130 million—of Disney Shopping’s $160 million sales came from online customers.

Which means only about $30 million came from the telephone-based catalogue customers.

Assuming a 50% gross mark-up on $30 million of merchandise sales (a generous assumption), Disney Shopping’s catalogue might have generated $15 million in gross profits.

$15 million in gross profits which does not even cover $18 million in catalogue mailing costs.

Then there’s the call centers where operators take down the information and transform a customer order into a sale (Disney has closed one call center already), and Disney’s catalogue operations are clearly bleeding cash—I’d guess $5 to $10 million last year.

All for the sake of Professor Hoffman’s theoretical $4 million in extra sales lift Disney might experience by mailing 30 million catalogues straight to 30 million recycle bins around the United States.

Which is why the Disney Shopping VP told the Times there is no way Disney would ever revive the catalogue business, despite Professor Hoffman’s concern that Disney might eventually “decide it was a mistake.”

I give the Professor credit for taking a contrarian point of view. But when it comes to The Professor versus the Real World, my money’s on the Real World.

Jeff Matthews
I Am Not Making This Up

© 2005 Jeff Matthews

The content contained in this blog represents 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.

When one of Wall Street’s Finest begins a question on a conference call by saying “I’m struggling to understand…” you know there’s trouble brewing.

Wall Street analysts hate to express anything but goodwill towards the companies they follow—the better to retain access to the management of those companies. Especially those companies which generate banking fees.

Which is to say, of course, every public company in America.

Thus, when one of Dell’s biggest boosters began a question on last night’s Dell call that way, you knew it was going to be a long, ugly evening. And it was.

Among the questions asked by the disappointed analysts were the following:

“I’m struggling to understand why gross margins deteriorated so significantly, both sequentially and year-over-year…”

“Do you still feel the [direct] model has advantages [over HP]?”

“Should we assume that the new, lower operating margins are really part of a process of resetting the bar?”

“Why are the new lower margins not driving higher revenue…?”

“How would you assess your own execution this quarter?”

“When should we see the consumer business basically bottom out?”

“I’m a little bit puzzled by the effects of the 14th week [in the quarter]…”

“Is it fair to say that HP is making it a lot more difficult for you guys to grow on the printer side, and is it a really big disappointment for you?”

I must admit that, personally speaking, I’m struggling to understand why Wall Street’s Finest expected so much more than Dell delivered last night.

For one thing, Mark Hurd has clearly stopped the hemorrhaging at HP, which used to be the SPECTRE to Dell’s James Bond—grand plans of World Domination that always ended in failure, big explosions, and Bond getting the girl.

For another thing, Dell’s service problems appear to be so widespread that my own bad experience (see “Dell Screws Up a Good Thing”) is a pretty good reflection of the decline in Dell’s brand name.

Here’s how Dell CEO Kevin Rollins wrapped up the call last night:

“Our focus is going to be, as we mentioned at the outset, continuing to work on our customer experience…”

My advice—not that anybody at Dell is asking—is this: less time on conference calls with Wall Street’s Finest, more time on customer calls.

Jeff Matthews
I Am Not Making This Up

© 2005 Jeff Matthews

The content contained in this blog represents 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.

Inflation pressures increased in 2005….

Nevertheless, the increase in prices for personal consumption expenditures excluding food and energy, at just below 2 percent, remained moderate, and longer-term inflation expectations appear to have been contained.

—2/16/06 Bernanke testimony.

Shortly after the new Federal Reserve Chairman Ben Bernanke presented the above testimony to the Eco-1 dropouts in Congress, a far more relevant sort of testimony was presented to Wall Street’s Finest by a publicly traded company which, unlike the folks at the Fed, consumes food and energy and all kinds of materials that do not seem to appear in the government inflation statistics.

The company was Guitar Center, a large musical instrument retailer whose stores carry pretty much anything a musician could want to play—with high end guitars lining the walls and drums crowding the floors.

The stores are staffed with actual musicians, which is good except that these musical junkies tend to prefer playing their chosen instrument on the sales floor, which they do as much as possible, to actually ringing up a sale. So the stores can be a little intimidating to a novice, what with all the Hendrix-type guitar solos wailing in the background.

Whether the stock itself has merits is a different discussion, but, being a hack drummer myself, I can say that it is almost impossible to leave a Guitar Center without either buying something or craving an expensive new piece of equipment.

In any event, the company’s inflation ‘testimony’ came during yesterday’s fourth-quarter earnings call after the market close, when management discussed the real-world pressures many retailers are now seeing as a result of the higher costs of not only energy but building materials, labor and money itself.

According to Bruce Ross, the CFO:

In terms of the cost of building out the [Guitar Center] stores, we have seen a roughly 20% increase of [building out] a large format store…and roughly a 10 to 12% increase in the costs on the [smaller store] format.

So take Bernanke at his word: that inflation is well-contained. After all, Guitar Center is not raising prices on, say, Gibson Les Paul Classic guitars or Pearl MMX Masters drum kits by 20%.

Still, when costs go up 20%, somebody, somewhere, eats the cost. Somebody like Guitar Center.

Jeff Matthews
I Am Not Making This Up

© 2005 Jeff Matthews

The content contained in this blog represents 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.

“Our results to date in fiscal year 2006 reflect these broader market trends. In the first two months of the year, we experienced and increase in home order cancellations and a decline in net orders for new homes when compared to the same period last year.”—KB Homes 10K

One of the big headlines in today’s Wall Street Journal is that KB Homes is seeing a surge in order cancellations amidst a cooling real estate market.

Now, it’s only fair to point out that statement was made in a 10K filed on February 10th so this is not exactly breaking news.

But the change in direction is notable, particularly in comparison with KB’s optimistic outlook a mere 60 days ago.

Back in its December earnings call, KB Home’s management told Wall Street’s Finest all was well in the housing bubble.

“Housing demand remains solid in the vast majority of our markets,” CEO Bruce Karatz said on the call, despite a moderation in the overall housing market which he characterized “as expected.”

Asked for specifics, the KBH COO said the company was “still seeing incremental small [price] increases in both” Phoenix and Las Vegas. “We are not seeing a lot of buildup in the resale inventories.”

When asked if “there are any markets that you guys are maybe seeing very different slow conditions today versus what you were seeing maybe a few months ago…?” the company’s COO said this:

“No. As a matter of fact I would say—I mean you are comparing it to a few months ago. I would say generally improving conditions in the weaker markets.”

That was then. This is now.

Jeff Matthews
I Am Not Making This Up

© 2005 Jeff Matthews

The content contained in this blog represents 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.