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Earnings and Pink Slips

Earnings season is in full force with mixed results. Several companies are meeting or beating lowered estimates. While the market is focusing on a couple pennies here or there, it is important to step back and focus on what companies are forecasting for the economy for the rest of the year and next year. Not surprisingly, most companies believe the third or fourth quarter will be the bottom on the earnings slide. Historically, companies find it impossible to cut costs as fast as revenues decline during recessions. So far, companies have been very aggressive in cutting costs. However, the degree of excess is much greater that most realize, for corporate fat and sales during the bubble economy.

Here are a few highlights of earnings reports from companies this week.

Amazon still was unable to configure its income statement to create a pro-forma profit, but please don’t worry, one will be there next quarter. Amazon also lowered its revenue expectations for the fourth quarter. Amazon now expects holiday sales to be flat to up 10%, from 10%-20% growth.

Fujitsu is cutting 4,500 jobs worldwide. Fujitsu also lowered its forecast of its chip output to 425 billion yen, 30% lower than last year, and 50 billion yen lower than its revised forecast in July. It admitted that flash memory for mobile phone have been particularly impacted by the slowdown in handset sales.

NEC is cutting back the hours of all its 9,000 while-collar employees. Workers will only work 4 days a week, however, employees will still receive 80% of their pay during their day-off.

Black & Decker reported earnings inline with estimates, but guided down fourth quarter earnings by about 30%.

Compaq announced that between the slowing economy, a typhoon, and the September 11 attack the third quarter was "almost the perfect storm." Its sales declined 33% from last year and the company expects a slight sequential increase in the fourth quarter. Compaq’s third quarter revenue is 14% below 1998 levels.

Vitesse Semiconductor: Sales fell 73% in its fourth quarter vs. last year and posted a $59 million loss compared to a profit of $11.6 million last year. Fourth quarter sales are up only 8.4% from results posted in 1998. Vitesse is still trading at 4 times revenue, and those revenues are falling.

Altera: Third quarter sales declined 56% compared to last year and 19% sequentially. Income fared worse, but at least it did post a profit, declining 82% to $21 million. Revenues are only 6% ahead of 1998 levels. Altera is trading at 6.4 times sales.

SBC caught investors off guard with its third-quarter results. Edward E. Whitacre, chairman and CEO, commented that, "Overall conditions have worsened in recent months, making for one of he most challenging business environments in recent memory." SBC announced that it will reduce its workforce by "several thousand" and cut capital spending "by approximately 20 percent in 2002." The 20% cut in capital spending equals about $2.4 billion, pouring more cold water on beleaguered telecom sector.

One of the more interesting earnings report was released by 360Networks. For the quarter ending June 30, 2001, 360Networks reported revenue of NEGATIVE $63 million. The company reported negative revenue due to contracts that were renegotiated. The contracts were accounted for on a percentage of completion basis and when the contracts were renegotiated the previously booked revenue had to be adjusted. As you can guess the bottom line didn’t fare too well either. The net loss for the quarter of $5 billion was impacted by several charges including a $4.4 billion asset impairment charge. 360Networks is currently under the protection of the U.S. Bankruptcy Court.

Lucent: Sales fell 28% in the third quarter compared to last year and Lucent expects telecom spending to decline 15%-20% in 2002.

AMR: Slashing capital expenditure by 60%. Taking delivery of only 16 planes from 45 previously expected.

Layoffs continue to mount as companies announce restructuring plans along with third quarter results.

-AT&T announced it is reducing its staff by an additional 2400 jobs.
-B/E Aerospace is laying-off 1,000 of its 4,650 employees.
-MetLife eliminating 1,900 workers, or 4%.
-Phelps Dodge laying off 1,500.
-Merrill Lynch is asking employees to quit. Looking for up to 10,000 employees to accept. Over 6,000 that have already been eliminated.
-Lexmark: 12% reduction.
-Sears is eliminating 4,900 workers
-Eastman Kodak is cutting 4,000 jobs, 5% of its workforce.

Silicon Valley continues to be gravely affected by the technology fallout. There have been 181 companies that have announced third quarter results so far. Collectively these companies have experienced a 22% revenue decline compared to last year’s results. Including charges and other write-downs, profits have disappeared. Last year these companies posted a $3.4 billion gain compared to a $9.3 billion loss this year. These companies have caused the worse job loss situation since 1992, when the area was in the middle of a five-year slump.

State budgets are another casualty in the slowing economy, especially those states with high technology concentrations. California revenue for the past five months is $1 billion below budget, and expected to get worse. Last year, taxes on capital gains and stock options accounted for more than 20% of California’s $77 billion general fund.

Adding to the employment woes of technology workers is a survey from Matrix Resources indicating that the era of automatic wage increases is a relic from the past. The survey found that starting salaries declined by 2.1% for non-management IT jobs in the third quarter.

It does not look to get any better in the near future. Gartner Dataquest believes PC shipments declined 12% in the third quarter and forecasts a similar drop in the fourth quarter. The technology research firm only expects PC shipments to g row 3% at most next year.

The semiconductor book-to-bill for September showed a dramatic decline in both shipments and orders. Semiconductor orders declined 11% sequentially and 78% from last September. Since the peak last October, orders have fallen 78%, surpassing the 70% peak to trough decline registered in the 1998 downturn.

Goldman Sachs issued a report calling into question how strong the technology rebound will be. A booming economy, strong profits, and easy money fueled the technology bubble of the late 90s. Now each of these factors has reversed and Goldman calculates that "If a credit crunch forces companies to finance their investment with internal funds alone, capital spending could fall another 30 percent." The good times coupled with the "productivity miracle " blinded management in its capital spending decisions. According to the McKinsey report discussed last week, companies spend $350 billion too much on technology and much of that still needs to be worked off.

Retail sales have continued to pick up, but still remain below pre-September 11 levels. The Bank of Tokyo-Mitsubishi Chain Store Sales Snapshot increased 0.5% last week, but remains 2.6% below levels before the terrorist attacks. Additionally, September was the worst month on record since the Commerce Department started tracking the retail sales index in 1992. Adding insult to injury, analysts are starting to forecast Holiday sales. Merrill Lynch is looking for sales to decline 3%, this would be the worst holiday season since 1990.

Auto sales are humming in October, however it is not expected to lead to huge profits for the car companies. UBS Warburg issued a research report calculating that the 0% financing offers are costing the auto companies $1,000. Total incentives amount to $2,300 to $2,400 per car according to Autodata, up 72% from last October. It is also important to realize that the effect of the 0% financing is simple "pulling-forward" sales that would have been made in the future. These futures sales would have been made at higher prices as well, unless of course incentives remain at these high levels. If incentives stay at this level, there will be a whole host of problems auto companies will face. Besides the obvious lower profits, pricing in the used car market would fall. This would reduce residual values for the leased cars coming off lease and would push profits even lower.

The September National Association for Business Economics (NABE) survey showed that 75% of the economist surveyed believe the U.S. economy starting contracting in the second half. While, most economists have conceded a second half recession, other responses to the survey cause concern. Thirty-two percent expect job losses at their firms within the next six months, with 10% expecting "significant layoffs." Capital spending is expected to drop as well. While 20% expect to increase spending, 33% expect to reduce capital spending. The study indicates that the current economy is "just about the weakest economic performance and outlook" in the survey’s 19-year history, according to NABE President Harvey Rosenblum.

Too many economists are forecasting the future by simply looking at past statistics. How many times have you read or heard that the market has bottomed because the market starts up about six months before the economy recovers. Since the average recession is only eleven months long and the current slowdown started around June, now must be bottom. There are some economists that are expecting another bull market to erupt from current levels. However, the S&P 500 is trading just under 20 times next year’s earnings. Considering the average PE for the S&P 500 is in the mid-teen range, the market is far from "value" levels. Plus, it is highly likely that the current S&P 500 EPS estimate of 55.44 will prove quite high.

Merrill Lynch is bringing the hottest hedge fund strategy to the masses – convertible arbitrage. Yesterday, Merrill announced the offering of a 9% callable debt security tied to the share price of Sun Microsystems. The STRIDES (stock return income debt security) will be priced at the closing price of Sun on the date of issue and carry a 9% interest rate. At maturity, Merrill Lynch will deliver one share of Sun for each note, plus accrued interest.

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