KG: Looking ahead to 2Q results

King Pharmaceuticals (KG) will report its second-quarter earnings before the market opens on 7 August.

If one views a graph showing the price of King shares over time, it would be easy to assume King is a dot-com company that survived. The price peaked in July 2001 at $46.05 per share, and then it fell 84 percent over the next four years. The lowest closing price was $7.55 in April 2005. The shares bounced back up over $20 fairly quickly, but they have been trading in a range between $16 and $21 for the last year and three-quarters.

Of course, King is not a dot-com company. It sells brand-name prescription pharmaceuticals, most notably Altace®. This ACE inhibitor, which is used to treat patients with cardiovascular risks, accounts for about 1/3 of King's net sales. Many problems led to King's difficulties in the early years of this decade, including disappointing sales, Medicaid overcharge allegations, and inventory management challenges.

King has put, as far as we know, these problems behind it. But, it now faces a challenge that could be more difficult to surmount: the looming loss of patent protection on Altace and other key products.

King has been achieving good scores on our gauges of late. After the first quarter of the year, the Overall Gauge read a strong 59 points. In our accompanying analysis, we fretted that the gauges were giving too much credit to the company for the rebound that had already occurred. We noted that earning increases were more attributable to lower "special charges" (e.g., asset impairment) than improving core operations.

As a result, we will carefully examine the second quarter results to get another read on how well the company is really performing. We will also be looking for clues to their strategy for dealing with the patent expiration concerns.

The 2005-2006 recovery resulted in strong Revenue growths, which have since abated. Revenue in the four quarters that ended in March 2007 was only 7 percent greater than in the four preceding quarters. We're assuming growth won't slow much more until patents actually start to expire. Therefore, our estimate for the second quarter Revenue is $535 million. This value is 7 percent greater than revenues in the June 2006 quarters. Coincidently, it also equates to year-over-year revenue growth of 7 percent.

Like most specialty drug manufacturers, King achieves eye-popping Gross Margin figures: values over 80 percent of revenue are not unusual. Recently, the Gross Margin has been somewhat below 80 percent, and our expectation for the second quarter is a still-lucrative 77 percent. This would result in a Cost of Goods Sold (CGS) of 23 percent of $535 million, or $123 million.

It seems reasonable to assume that Depreciation and Research and Development (R&D) expenses will each be about 7 percent of revenue, or $37.5 million apiece. Depreciation as percentage of revenue has been slowly declining, and R&D has been slowly increasing, and the two figures, for whatever reason, seem to have met in the middle.

Sales, General, and Administrative (SG&A) expenses seem have stabilized at 35 percent of revenue, which would be $187 million if our revenue estimate stands up.

King often has takes special operating charges that determine the quarter's success. The charges range, in no particular pattern, between negligible and huge. We're going to assume a $20 million charge in the second quarter, which is significant, but not even half the charge as recently as December 2006. (Note: many earnings estimates do not take these charges into account.)

Our estimates would lead to Operating Income of $130 million.

Non-operating income has recently been about $7 million per quarter. If the Income Tax Rate (another fluctuating parameter) is 33 percent, Net Income would be $92 million.

($ M)		June 2007 (predicted)	June 2006 (actual)
Revenue		535	500
Op expenses
	CGS	(123)	(107)
	Depreciation	(37)	(39)
	R&D	(37)	(35)
	SG&A	(187)	(154)
	Other	(20)	(0)
Operating Income		130	165
Other income
	Investments	0	0
	Interest, etc.	7	5
Pretax income		137	170
Income tax		(45)	(59)
Net Income		92	111
		0.37/sh	0.46/sh

WPI: Look Ahead to 2Q Results

Watson Pharmaceuticals (WPI) will report its results for second quarter of the year on 2 August 2007.

This company develops, manufactures, and sells generic and, to a lesser extent, branded pharmaceutical products. Watson had been expanding beyond its roots a generic drug manufacturer into higher-margin branded pharmaceuticals. However, the $1.9 billion acquisition of Andrx Corporation increased Watson's concentration in generics, which are now responsible for over 75 percent of revenues.

Back in February, Watson issued guidance for 2007 that fell below Wall Street expectations at that time. Nevertheless, generic drug manufacturers became more attractive to investors, who realized that large numbers of pharmaceutical products will be losing their patent protection over the next several years. Watson stock hit a series of 52-week highs within the last two weeks, before giving some of the gain back in the recent market downturn.

Watson stated that they expect Revenue for 2007 to be between $2.5 and $2.6 billion. Since this announcement coincided with the report that first quarter revenues were $672 million, which would scale to $2.688 billion, Watson was signaling that the average revenue in the three final quarters would be somewhat less than $650 million. For our purposes, we will assume that Revenue in the second quarter will equal $650 million, and we will worry later about the September and December quarters.

The increased proportion of generics in the product mix, as a result of the Andrx acquisition, has lowered Watson's Gross Margin below its historic levels. We'll assume the gross margin in the second quarter, as a percentage of revenue, will match the 35.5 percent average of the two preceding quarters. Therefore, the estimate for the Cost of Goods Sold (CGS) is 64.5 percent of $650 million, or a little over $419 million.

We will also use recent results and company forecasts to estimate the Depreciation expense at 7 percent of revenue ($45.5 million), and the Research and Development (R&D) expense, which is usually a little less, at 6 percent of revenue ($39 million).

In the last year, Watson has reduced Sales, General, and Administrative (SG&A) expenses to 16 percent of revenue, which we'll use as our estimate. This works out to be $104 million.

These estimates would result in an Operating Income of $42 million.

Watson's non-operating income and expenses are not typically significant. We'll assume a $5 million expense.

With a 37 percent Income Tax Rate, Net Income would be $23 million.

($ M)		June 2007 (predicted)	June 2006 (actual)
Revenue		650	510
Op expenses
	CGS	(419)	(331)
	Depreciation	(46)	(41)
	R&D	(39)	(311)
	SG&A	(104)	(71)
	Other	0	(67)
Operating Income		42	(30)
Other income
	Investments	0	0
	Interest, etc.	(5)	5
Pretax income		37	(25)
Income tax		14	(10)
Net Income		23	(15)
		0.20/sh	(0.15)/sh

BP: Financial Analysis through June 2007

We have analyzed BP p.l.c.'s (BP) financial results for the quarter that ended on 30 June 2007.

BP, the former British Petroleum, is the Integrated Oil and Gas company with the third-most sales and the fourth largest market capitalization in the world. BP became a behemoth by acquiring Amoco, Arco, and other companies. Significant problems over the last two years have cast a negative light on the company. A fatal explosion in 2005 at a BP refinery in Texas was followed by a major leak and pipeline corrosion in Alaska, where BP operates the Prudhoe Bay field. These events led to fears BP was not safely maintaining its properties and equipment. The bad news also did much damage to the green image the company has been cultivating in its marketing.

In 2006, BP began reporting its results in accordance with International Financial Reporting Standards (IFRS) as adopted for use by the European Union. Previous finance statements complied with UK Generally Accepted Accounting Principles. The differences between these two approaches makes it difficult to identify historic norms to which current results can reasonably be contrasted. Comparability is also complicated by significant corporate acquisitions and divestitures, such as the $9 billion sale in December 2005 of a chemical business. However, we have to give credit to BP for making a three-year set of consistent financial data available on their web site.

When we analyzed BP after the March quarter, the Overall score was 26 points. Of the four individual gauges that fed into this composite result, Value was the strongest at 8 points. Growth was weakest at 2 points. [Note that recent algorithm tweaks led to minor changes in the previously reported scores.]

Now, with the available data from the June 2007 quarter, our gauges display the following scores:

• Cash Management: 5 of 25
• Growth: 0 of 25
• Profitability: 4 of 25
• Value: 4 of 25
  

• Overall: 15 of 100

Before we examine the factors that affected each gauge, let's look at the latest quarterly Income Statement. [Note: we had not made any predictions for BP in this quarter.]

($M)		June 2007 (actual)	June 2006 (actual)
Revenue (1)		71872	72132
Op expenses
	CGS (2)	(57086)	(57158)
	Depreciation (3)	(2535)	(2309)
	Exploration	(155)	(97)
	SG&A (4)	(3565)	(3516)
	Other (5)	(172)	182
Operating Income		8359	9234
Other income
	Investments (6)	1083	932
	Asset sales (7)	1309	541
	Interest, etc. (8)	(27)	(1)
Pretax income		10734	10706
Income tax		(3283)	(3441)
Net Income		7441	7265
		2.33/ADS	2.16/ADS

<sup>1. Sales and other operating revenues
2. Purchases + Production and manufacturing expenses + Production and similar taxes
3. Depreciation, depletion and amortization
4. Distribution and administration expenses
5. Impairment and losses on sale of businesses and fixed assets + Fair value (gain) loss on embedded derivatives
6. Earnings from jointly controlled entities + Earnings from associates
7. Gain on sale of businesses and fixed assets
8. Interest and other revenues - Finance costs + Other finance income</sup>


Revenue was 0.4 percent less than in the year-earlier quarter (with high oil prices!). The Cost of Goods Sold (CGS) was 79.4 percent of Revenue, compared to 79.2 percent last year. Depreciation was 3.5 percent of Revenue, compared to 3.2 percent last year. Sales, General, and Administrative (SG&A) expenses were 5.0 percent of Revenue, compared to 4.9 percent last year

The net effect of slightly lower Revenue and higher costs was Operating Income 9.5 percent below last year's value.

The lower Operating Income was balanced by higher non-operating income, especially gains due to asset sales. As a result, pre-tax income in the two quarters was essentially the same. With a lower Income Tax Rate, Net Income actually exceeded last year's value by 2.4 percent. We think it is noteworthy, however, that the increase was driven by investment income, asset sales, and a lower tax rate.


Cash Management. This gauge decreased from 7 points in March to 5 points.

The measures that helped the gauge were:

• LTD/Equity = 13.8%; insignificant, but up a couple points from last year
• Days of Sales Outstanding (DSO) = 54.3 days, less than the 58.6-day level one year earlier
  

Note that the DSO change indicates the company is having more success getting its customers to pay their bills; rapid collection is a sign of efficiency because the payments received can be re-invested sooner.

The measures that hurt the gauge were:

• Current Ratio =1.0; weaker than we like, but typical
• Debt/CFO = 1.0 year, up from 0.7 years 12 months ago
  
• Inventory/CGS = 35.3 days, compared to 33.0 and 33.8 days 3 and 12 months ago, respectively
• Working Capital/Market Capitalization = 0.4 percent, down from 1.5 percent
• Cash Conversion Cycle Time (CCCT) = 16.2 days, up from 10.6 days, for this measure of efficiency.

Growth. This gauge decreased from 2 points in March to 0 points.

None of these measures helped this gauge:

• Revenue growth = -0.3 percent, down from 29 percent in a year
• Revenue/Assets = 119 percent, down from 125 percent in a year; sales efficiency is worsening
• Net Income growth = -9 percent, down from 15 percent in a year
• CFO growth = -16 percent, down from 5 percent in a year

Net income was slowed by a change in the income tax rate from 32 to 35 percent

Profitability. This gauge decreased from 6 points in March to 4 points.

The measures that helped the gauge were:

• ROIC = 14.4 percent, decent but down from 22.3 percent in a year
  

The measures that hurt the gauge were:

• FCF/Equity = 9 percent, down from 19 percent in a year
• Accrual Ratio = 6 percent, up from 4 percent in a year
• Operating Expenses/Revenue = 91 percent, up from 88 percent in a year
  

The increase in operating expenses was primarily the result of a decrease in Gross Margin.

The increasing Accrual Ratio tells us that less of the company's Net Income is due to CFO, and, therefore, more is due to changes in non-operational Balance Sheet accruals.

Value. Despite the less-than-thrilling performance, BP's stock price followed the price of oil and rose over the course of the quarter from $64.75 to $72.14. The Value gauge, based on the latter price, was sliced in half from 8 points in March to 4 points now.

The only measure that helped the gauge was:

• Price/Revenue ratio = 0.9, about the same as its three-year median

The measures that hurt the gauge were:

• Enterprise Value/Cash Flow = 10.4, up from 8.7 in June 2006
• P/E = 10.8, up from 9.9
  
• P/E to S&P 500 average P/E = 35 percent discount, about the same as its thee-year median
  

The average P/E for the Integrated Oil and Gas industry is 12. The average Price/Revenue for the industry is currently 1.2.

These results warrant some explanation. The value measures in other circumstances could be interpreted as indicative of an inexpensive, even cheap, stock. The problem is that the measures have inflated somewhat, yet there hasn't been any signs of better operational performance.


Now at a disappointing 15 out of 100 possible points, the Overall gauge has been weakening. Revenue is down, even though the company can charge higher amounts for its output. Income gains have been due to non-operational factors. The Growth gauge is at 0, and it would be negative if we allowed that possibility. And, yet, the stock price is up. If the company could turn around its operational performance, there is plenty of upside potential. But, there aren't signs of this turnaround in the recent results.

TDW: Review of June Income Statement

We have analyzed Tidewater's (TDW) preliminary financial results for the quarter that ended on 30 June 2007. Tidewater published an Income Statement and supplemental information (e.g., vessel utilization and delivery rates) for the quarter, but they didn't provide a Balance Sheet or a Cash Flow Statement. With this paucity of data, we are not able to update the gauge scores. New scores will be computed after the company submits a 10-Q report to the SEC.

Tidewater owns a large fleet of vessels serving the global offshore energy industry. Once focused on the Gulf of Mexico, international operations comprised almost 80 percent of Tidewater's business in fiscal 2007.

With energy prices high, as they are now, offshore production becomes increasingly profitable. The demand for maritime services has gone up correspondingly, along with the leasing rates that Tidewater charges for its vessels. If changing economic conditions cause energy demand to soften and production to slow, rates will obviously decline and some vessels might have to be idled. Because each area has its own unique challenges, which change over time, production rises and falls in these areas. Since Tidewater's assets are mobile, the company can respond by shifting vessels to the regions where activity is greatest and leasing rates are highest.

Revenue started to surge at Tidewater in late 2004, after a couple years of flat (or declining) performance. The growth peak was in June 2006, when quarterly revenues were 40 percent greater than the year-earlier period. The pace of growth has already started to slow, which is natural given that the earlier increases were built on a much smaller base. Also, there are practical ceilings on how fast new ships can be deployed, how much lease rates can rise, and how close the utilization rate can get to 100 percent.

When we analyzed Tidewater after the March quarter, the Overall score was a very good 61 points. Of the four individual gauges that fed into this composite result, Growth was the strongest at 23 points. Profitability was weakest at 13 points. [Note that recent algorithm tweaks led to minor changes in the previously reported scores.]

Let's compare the latest quarterly Income Statement to our previously announced expectations.

($M)		June 2007 (actual)	June 2007 (predicted)	June 2006 (actual)
Revenue		305	309	270
Op expenses
	CGS (1)	(150)	(142)	(130)
	Depreciation	(28)	(34)	(28)
	SG&A	(32)	(28)	(24)
	Other	0	0	0
Operating Income		95	105	89
Other income
	Asset sales	7	5	3
	Interest, etc.	6	5	4
Pretax income		108	115	95
Income tax		(21)	(24)	(24)
Net Income		88	91	71
		1.55/sh	1.62/sh	1.23/sh

_{1. CGS=Vessel operating costs + Costs of other marine revenues}

Revenue was 1.3 percent below our estimate. We expected Revenue to be 14.4 percent greater than in the year-earlier quarter, and the actual increase was 13.0 percent. In addition, we thought the Cost of Goods Sold (CGS) would be 46 percent of Revenue, and the actual value was a heftier 49 percent. Depreciation expenses were 9.2 percent of Revenue, a little less than our 11 percent estimate. Sales, General, and Administrative (SG&A) expenses were 10.5 percent of Revenue, compared to our forecast of 9 percent.

The net effect of the lower Revenue, higher CGS, lower depreciation, and higher SG&A expenses was Operating Income 9.5 percent below the forecast value.

The gap was partially closed on below-the-line items. Non-operating income was $3 million greater than expected. Equally significant, the effective Income Tax Rate was 19.4 percent, instead of the predicted 21 percent. As a result, Net Income fell short of our prediction by only 3.3 percent.

Non-recurring, after-tax charges of $3.5 million ($0.06/share) are included in these results. These charges might explain some part of the higher-than-expected CGS or SG&A expenses.

BUD: Financial Analysis through June 2007

We have analyzed Anheuser-Busch's (BUD) preliminary financial results for the quarter that ended on 30 June 2007. Our evaluation will be updated after the company formally submits a complete 10-Q report to the SEC.

Company Description

BUD is the well-known brewer and, yes, theme park operator. The company is making a determined effort to expand its "Rest of World (ROW)" non-U.S. operations, most notably including China. Some say that BUD might buy Belgian brewer InBev (INB) as part of this strategy.

If not the acquirer, there has been speculation that BUD could be the target. A buyout would probably please Warren Buffett, whose Berkshire Hathaway (BRK-A) owned almost 36 million BUD shares as of 31 December 2006.


Previous Results

When we analyzed BUD after the March quarter, the Overall score was a mere 24 points. Of the four individual gauges that fed into this composite result, Growth was the strongest at 13 points. Value was weakest at 1 point. [Note that recent algorithm tweaks led to minor changes in the previously reported scores.]


New Scores

Now, with the available data from the June 2007 quarter, our gauges display the following scores:

• Cash Management: 4 of 25
• Growth: 12 of 25
• Profitability: 12 of 25
• Value: 0 of 25
  

• Overall: 23 of 100
  

Income vs. Expectations

Before we examine the factors that affected each gauge, let's compare the latest quarterly Income Statement to our previously announced expectations.

($M)		June 2007 (actual)	June 2007 (predicted)	June 2006 (actual)
Revenue		4515	4518	4256
Op expenses
	CGS	(2858)	(2892)	(2601)
	SG&A	(756)	(791)	(714)
	Other	0	0	0
Operating Income		901	836	881
Other income
	Equity income	195	204	170
	Interest, etc.	(104)	(110)	(117)
Pretax income		992	930	935
Income tax		(315)	(288)	(297)
Net Income		677	642	638
		0.88/share	0.83/sh	0.82/sh

Revenue was spot-on our estimate, at about 6 percent greater than in the year-earlier quarter. In addition, we thought the Cost of Goods Sold (CGS) would be 64 percent of Revenue, and the actual value was 63.3 percent. Sales, General, and Administrative (SG&A) expenses were 16.7 percent of Revenue, compared to our forecast of 17.5 percent.

Lower SG&A expenses resulted in Operating Income 7.8 percent above the forecast value.

Non-operating income was a minuscule $3 million below our estimate. The Income Tax Rate was 31.8 percent, instead of the predicted 31 percent. As a result, Net Income exceeded our prediction by 5.5 percent. The lower SG&A expenses explain most of the out-performance.


Gauge Review

Cash Management. This gauge was unchanged from March at 4 points.

The measures that helped the gauge were:

• Cash Conversion Cycle Time (CCCT) = 0.3 days, down from 3.5 days, for this measure of efficiency
• Debt/CFO = 2.7 years, compared to 3.3 and 2.9 years 3 and 12 months ago, respectively
  
• Inventory/CGS = 24 days, compared to 27 and 25 days 3 and 12 months ago, respectively
  

The measures that hurt the gauge were:

• Current Ratio =0.9; weaker than we like, but matching the 5-year median value
• LTD/Equity = 204%; highly leveraged, but down 1% from a year ago
• Days of Sales Outstanding (DSO) = 23 days, about the same as one year earlier
• Working Capital/Market Capitalization = -0.4 percent, about the same as one year earlier.
  

Growth. This gauge decreased from 13 in March to 12 points.

• Revenue growth = 4 percent, up from 3 percent in a year
• Revenue/Assets = 95.3 percent, up from 92.2 percent in a year; sales efficiency is improving
• Net Income growth = 9 percent, up from -12.6 percent in a year

• CFO growth = 7 percent, up from 1.4 percent in a year

Net income benefited a little from a change in the income tax rate from 32 to 31 percent

Profitability. This gauge remained at March's 12 points.

The measures that helped the gauge were:

• FCF/Equity = 54 percent, up from 49 percent in a year
• ROIC = 16.1 percent, equating last year's value
  

The measures that hurt the gauge were:

• Accrual Ratio = -0.5 percent, down from 0.0 percent in a year
  
• Operating Expenses/Revenue = 83 percent, up from 82.2 percent in a year
  

Value. BUD's stock price rose over the course of the quarter from $50.46 to $52.16. The Value gauge, based on the latter price, dropped to 0 points, compared to 1 point three months ago (and 5 points twelve months ago).

The measures that helped the gauge were:

• Enterprise Value/Cash Flow = 16.2, up from 15.7 in June 2006
• P/E = 19.7, up from 19
  
• P/E to S&P 500 average P/E = 18.5 percent premium, higher than its five-year median of 10 percent premium
  
• Price/Revenue ratio = 2.5, a little higher than its five-year median of 2.4
  

The average P/E for the Alcoholic Beverages industry is 20. The average Price/Revenue for the industry is currently 2.25.

Now at 23 out of 100 possible points, the Overall gauge is low and getting lower. The growth and profitability scores are encouraging, but we don't see why this company trades at a premium to the market multiple.

COP: Financial Analysis through June 2007

We have analyzed ConocoPhillips's (COP) preliminary financial results for the quarter that ended on 30 June 2007. Since Conoco didn't provide a new Balance Sheet, our evaluation is incomplete. To estimate the gauge scores, we simply assumed that the Balance Sheet didn't change from March. This assumption is unsatisfying given the $4.5 billion charge recorded in the second quarter for expropriated assets. We will have to wait for a 10-Q submittal to complete our analysis.

With worldwide oil, gas, and chemical operations, ConocoPhillips is the third-largest integrated energy company based in the U.S. Among international energy giants, it ranks fifth by Revenue and eighth by Market_Capitalization.

Holding the sixth spot on the Fortune 500, Conoco's heft is the product of mergers and acquisitions. Conoco, Inc., and Phillips Petroleum combined in August 2002. The resulting behemoth purchased Burlington Resources for $33.9 billion in March 2006 for its extensive natural gas operations in North America.

Conoco's international holdings have become problematic, given the nationalistic trends in Russia, where it owns a chunk of Lukoil, and Venezuela. A disagreement with the Venezuelan government has caused Conoco to record in its second-quarter financial results "a complete impairment of its entire interest in its oil projects in Venezuela of approximately $4.5 billion, before- and after-tax." A $4.5 billion write-off for a company with $173 billion in assets is not a cause for panic, but it is worrisome.

Conoco shares have been surging, which must please super-investor Warren Buffett since the company he runs, Berkshire Hathaway, owns about 18 million shares of Conoco. Of course, $70 for a barrel of oil didn't hurt. A new $15 billion program to repurchase company stock through 2008 definitely helped the stock.

When we analyzed Conoco after the March quarter, the Overall score was a so-so 33 points. [We didn't foresee the impending big gain in the share prices. Was it because the surging price of oil outweighed all other consideration? Was it because the company's mergers have made historic data irrelevant?] Of the four individual gauges that fed into this composite result, Cash Management was the strongest at 15 points. Value was weakest at 3 points, which really worried us at the time. [Note that recent algorithm tweaks led to minor changes in the previously reported scores.]

Now, with the available data from the June 2007 quarter, our gauges display the following scores:

• Cash Management: 13 of 25 (primarily based on old data)
• Growth: 3 of 25
• Profitability: 10 of 25
• Value: 0 of 25
  

• Overall: 24 of 100
  

Before we examine the factors that affected each gauge, let's compare the latest quarterly Income Statement to our previously announced expectations. In the table below, we have excluded the $4.588 billion charge for expropriated assets.

($M)		June 2007 (actual)	June 2007 (predicted)	June 2006 (actual)
Revenue (1)		47370	45000	47149
Op expenses
	CGS (2)	(33377)	(30150)	(32142)
	Depreciation	(2016)	(2025)	(1965)
	Exploration	(259)	(270)	(134)
	SG&A (3)	(5301)	(4950)	(5031)
	Other	0	(100)	(141)
Operating Income		6417	7505	7736
Other income
	Equity income (4)	1487	1000	1143
	Interest, etc. (5)	202	0	(197)
Pretax income		8106	8505	8682
Income tax		(3217)	(3742)	(3496)
Net Income		4889	4763	5186
		2.95/share	2.87/sh	3.09/sh

<sub>1. Revenue = Sales and other operating revenues.
2. CGS = Purchased crude oil, natural gas and products + Production and operating expenses
3. SG&A = SG&A expenses + Taxes other than income taxes
4. Equity income = Equity in earnings of affiliates - Minority interests
5. Interest, etc. = Other income - Interest and debt expense</sub>


Revenue was 5.3 percent above our estimate. We may have overweighted Conoco's guidance for the second quarter that maintenance and asset disposals would cut production, or maybe high oil prices are curative for many ills. We thought the Cost of Goods Sold (CGS) would be 67 percent of Revenue, and the actual value was 70.5 percent. Depreciation expenses were 4.3 percent of Revenue, a shade less than our 4.5 percent estimate. Sales, General, and Administrative (SG&A) expenses were 11.2 percent of Revenue, compared to our forecast of 11 percent.

The higher expenses outweighed the higher revenue to yield Operating Income 14.5 percent below the forecast value.

The gap was closed by Non-operating income $689 million greater than expected. The Income Tax Rate was 39.7 percent, instead of the predicted 44 percent. As a result, Net Income exceeded our prediction by 2.6 percent.

We find it a little trouble that the our-performance was due to non-operating factors.

Of course, the $4.5 billion charge, not included above, wiped out most of the net income in the quarter.


Cash Management. Since this gauge relies primarily on Balance Sheet data, which we don't have, we're going to omit a discussion of the various measures that drive the gauge.

Growth. This gauge decreased from 8 points in March to 3 points.

None of our measures helped the gauge that much.

• Revenue growth = -8.1 percent, down from 27 percent in a year
• Revenue/Assets = 103 percent, down from 120 percent in a year; sales efficiency is worsening
• Net Income growth = -32 percent, down from 52 percent in a year (killed by impairment charge)

• CFO growth = 15 percent; respectable, but down from 41 percent in a year.
  

Profitability. This gauge decreased from 11 points in March to 10 points.

The measures that helped the gauge were:

• FCF/Equity = 12 percent, up from 7.5 percent in a year
• Accrual Ratio = 0.3 percent, down from +6.3 percent in a year

The decreasing Accrual Ratio tells us that more of the company's Net Income is due to CFO, and, therefore, less is due to changes in non-operational Balance Sheet accruals.

The measures that hurt the gauge were:

• ROIC = 10 percent, down from 13.5 percent in a year
• Operating Expenses/Revenue = 86.5 percent, down just a bit from 87.3 percent in a year.
  

The increase in Gross Margin was matched by increases in R&D and SG&A expenses, which is why operating expense were basically unchanged as a percentage of revenue.

Value. Conoco's stock price rose over the course of the quarter from $68.35 to $78.50. The Value gauge, based on the latter price, dropped to 0 points, compared to 3 points three months ago (and 5 points twelve months ago).

• Enterprise Value/Cash Flow = 6.5, very inexpensive, and down from 6.8 in June 2006
• P/E = 12, up from 7
  
• P/E to S&P 500 average P/E = 28 percent discount, compared to a 56 percent discount one year ago
  
• Price/Revenue ratio = 0.7, compared to 0.6 one year ago
  

The average P/E for the Integrated Oil and Gas industry is also 12. The average Price/Revenue for the industry is currently 1.2.