Closer Look at Tellabs
The importance of flow
by Phil Weiss (firstname.lastname@example.org)
At the time that I wrote my column on Tellabs I wondered if the increase in the Flow Ratio from the first quarter (1.55) to the second quarter (2.01) of this year could have been a foreshadowing of the precipitous decline in the company's stock price that followed a little while later. When third quarter earnings were released in October, the company's flowie continued to increase as it went up to 2.64.
Although Tellabs represents a relatively small portion of my portfolio, I decided to see whether or not I could learn more about the change in the company's flowie. I did this because of my strong belief that you can often learn much more from things that don't work out as you planned than you can from those that go smoothly from the get go.
Since I needed to get "underneath" the numbers on the balance sheet and income statement, I decided to contact the company's investor relations department to see what I could find. I had the good fortune of being put in touch with Tellabs' Vice President of Finance & Treasury, Pete Johnson. I have to say that I was pleasantly surprised by how willing Mr. Johnson was to help me to better understand the situation.
Before calling I had decided that the best way to approach the conversation would be to attack the individual components of Tellabs' flowie rather than try to look at everything collectively. So, we started with a discussion about why the time it has been taking the company to collect its accounts receivable has increased each of the last four quarters ï¿½ for those of you that are not familiar with this calculation it is calculated by using the following formula:
Accounts Receivable ------------------- Sales/360
I spoke to Mr. Johnson on two different occasions. By the time I finished the second phone call I had a much greater understanding of the numbers that can be found in the current assets and current liabilities section of Tellabs' balance sheet. I also had a better feel for how much importance the company places on the elements that make up this financial statement.
This call also left me with a smile on my face. You see, Mr. Johnson told me that none of the analysts that follow the company had EVER called to discuss this issue with him. This is something that surprised him. It also goes to show how much today's analyst is focused on things like earnings momentum rather than the underlying numbers that give us the most insight into how management runs its business.
Another thing I appreciated hearing Mr. Johnson say was that he couldn't understand how analysts could rate the stock a "buy" at $93, and a "hold" after it had fallen from its highs despite the fact that there had been no fundamental changes in how its business was performing. Many a Fool has asked that very same question over and over again. He also laughed about the way companies see their prices crushed due to missing earnings by a penny or two. He said that when it comes to dealing with most analysts you have to, in essence, manage their morale and orientation.
Okay, back to the issue at hand. I learned that there were three primary reasons for the slowdown in the collection of accounts receivable. The first relates to the significant problems Tellabs has had since it converted its accounting systems to SAP AG's (NYSE: SAP) software in October 1997. It seems as if SAP can't issue bills that Tellabs clients can understand. The problem with the bills is a result of the complexity of the work that Tellabs does for its customers as products manufactured by Tellabs generally account for only about 8% of Tellabs' revenues. The rest relates to configurable software and other special work done during the installation process. Needless to say the company is quite disappointed with SAP -- Mr. Johnson's actual comment was a bit stronger than that, but he asked that it not be quoted.
The problems with the bills generated by SAP's software is that they result in a delay in payment to Tellabs. The company has tried to fix the problem, but the number of consultants in the U.S. that can reconfigure SAP the way that Tellabs needs it done is extremely limited. It is hoped that this problem will be alleviated when SAP comes out with its next software upgrade -- it's due in another three to six months. In the meantime the company is continuing its efforts to improve in this area. Its goal is to bring unpaid accounts receivable down by half by year-end. That sounds like an admirable goal. This Fool certainly hopes that it is met.
The second reason given for the slowdown in collection is that Tellabs is making more sales in regions like Africa and the Middle East. Since it takes longer to deliver products to these regions, Tellabs often grants longer payment terms to these customers. I asked if the Company ever tried to shorten payment terms for its more popular products. I was told that Tellabs often has a choice between longer collection terms or higher revenues. It usually chooses higher revenues.
My reaction to his comment about choosing higher revenues over a longer collection period is that, unfortunately, it's at least partially tied to what the analysts are looking for (i.e., better earnings). However, I also believe that getting a higher price for a sale is worthless if you don't collect the receivable (though I will say that Tellabs has had little, if any, write-offs).
The third reason given for the slowdown in receivable collection is that Tellabs has given Telefonos de Mexico (NYSE: TMX) extended payment terms under a large contract that the two parties have. It certainly seems to me that in this case TelMex is the party that is exhibiting its strength over Tellabs rather than the other way around.
We finished our discussion of receivables with a talk about how Mr. Johnson approaches due diligence. He said that the first place that he looks is the balance sheet, and in particular Accounts Receivable, because it contains all he needs to learn about a company, its management, and the way it does business. I was quite intrigued by his statement that the Ciena deal first began to fall apart when he had some questions about a receivable that made him start to wonder whether the company had started to lose its competitive position in the marketplace. He found some strange abnormalities in customer patterns. It ended up that his reactions were quite perceptive.
That's all that we have time for tonight. I'll be back tomorrow to finish up the discussion with some thoughts on the changes to the current liabilities section of the balance sheet and what all this means to the Flow Ratio.
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Stock Change Bid AXP + 7/8 94.88 CHV +1 7/16 81.06 CSCO +2 1/4 67.81 KO + 9/16 72.69 GPS +1 7/16 65.63 EK + 3/16 76.69 XON + 3/4 72.75 GM - 1/4 66.75 INTC - 13/16 94.00 MSFT + 7/8 106.38 PFE +1 7/16 107.44 SGP + 5/8 105.06 TROW + 1/4 36.00
Day Month Year History C-K +1.04% 3.63% 15.19% 15.19% S&P: +1.36% 3.20% 12.71% 12.71% NASDAQ: +0.74% 3.71% 10.25% 10.25% Cash-King Stocks Rec'd # Security In At Now Change 2/3/98 24 Microsoft 78.27 106.38 35.91% 2/3/98 22 Pfizer 82.30 107.44 30.55% 5/1/98 37 Gap Inc. 51.09 65.63 28.45% 6/23/98 34 Cisco Syst 58.41 67.81 16.10% 2/13/98 22 Intel 84.67 94.00 11.01% 8/21/98 22 Schering-P 95.99 105.06 9.46% 2/6/98 56 T. Rowe Pr 33.67 36.00 6.91% 2/27/98 27 Coca-Cola 69.11 72.69 5.18% 5/26/98 18 AmExpress 104.07 94.88 -8.83% Foolish Four Stocks Rec'd # Security In At Value Change 3/12/98 20 Eastman Ko 63.15 76.69 21.44% 3/12/98 20 Exxon 64.34 72.75 13.08% 3/12/98 15 Chevron 83.34 81.06 -2.74% 3/12/98 17 General Mo 72.41 66.75 -7.81% Cash-King Stocks Rec'd # Security In At Value Change 2/3/98 24 Microsoft 1878.45 2553.00 $674.55 2/3/98 22 Pfizer 1810.58 2363.63 $553.05 5/1/98 37 Gap Inc. 1890.33 2428.13 $537.80 6/23/98 34 Cisco Syst 1985.95 2305.63 $319.68 2/13/98 22 Intel 1862.83 2068.00 $205.17 8/21/98 22 Schering-P 2111.7 2311.38 $199.68 2/6/98 56 T. Rowe Pr 1885.70 2016.00 $130.30 2/27/98 27 Coca-Cola 1865.89 1962.56 $96.67 5/26/98 18 AmExpress 1873.20 1707.75 -$165.45 Foolish Four Stocks Rec'd # Security In At Value Change 3/12/98 20 Eastman Ko 1262.95 1533.75 $270.80 3/12/98 20 Exxon 1286.70 1455.00 $168.30 3/12/98 15 Chevron 1250.14 1215.94 -$34.20 3/12/98 17 General Mo 1230.89 1134.75 -$96.14 CASH $120.62 TOTAL $25176.12 *Please note: On 8/4/98 $2,000 cash was added to the
portfolio. $2,000 will be added every six months.
*The year for the S&P and Nasdaq is as of 02/03/98