CPY – “Da Bulls” Part II

The second bullish aspect of this stock is that they seem to have a clear business strategy and more importantly have the balance sheet to execute their plans.

As it stands now, two major tiers have emerged in the professional photo industry with the bottom of the group competing solely on price mainly by offering larger/more prints at discounted prices as well as instituting “no session fee” policies. The top of the group is competing more on quality, service, and number of choices but at higher prices.

Reading through the last 2 annual letters to shareholders penned by David Meyer who is the Chairman of the Board as well as the co-founder of the investment firm that led the hostile takeover in 2004, it becomes obvious that the key CPY’s long-term strategy is to be in the top tier by preventing the commoditization of their products. While digital photography has caused some pain for the company, it is now seen as the best way to achieve long term growth and profitability. Pretty ballsy ……

I am not going to quote extensively from the Chairman’s annual letters but they are important to read to understand what the guy calling the shots is thinking, they are also refreshing compared what these letters usually sound like. Here are what I feel are the most notable quotes:

2004 letter: “digital has arrived, and there is no looking back”
2004 letter: “our customers are not inherently price sensitive when it comes to genuine
differentiation”
2005 letter: “despite facing an aggressive promotional environment, we will not
participate in the commoditization of our valuable service”
2005 letter: “I am frequently asked if I am concerned about our sittings declines. The
answer, candidly, is no.”

(link to annual letters: http://phx.corporate-ir.net/phoenix.zhtml?c=103013&p=irol-reportsannual ….. the 2003 letter is missing for some reason)

I think these give a pretty clear indication of what direction management is going to take this company. I did not spend much time reading the letters from the pre-2004 management, but one quote did jump out at me and highlights the 180 degree turn in the direction of this company:

2002 letter: “In 2003 we will continue to focus on the fair price for the value and service
we provide, but we must also recognize that over the long-term, we need to get new Moms to try us.”

To me this is a nice way of saying that we are going to slash prices to get more people through the door and worry about profitability later. Oh yeh, the only operating target offered as a company stated goal for the following year was a revenue target with no mention of profitability.

Looking over the last 2 years operating results, it looks like management is doing what they said they would and is having some initial success. In 2006 and 2005 sitting volume (the number of customers walking through the door) declined 17.7% and 16% compared to the previous year. However, total revenue showed a small positive increase in both years due to a 22.4% and 22.9% increase in sales per customer due to introduction of new digital products and a price increase instituted in 2005. Yes, this company actually increased prices and customers came back!

Looking at the balance sheet, it also looks like the company has the financial wherewithal to fund its long term plans. AFTER spending $32 million buying back stock and roughly $35 million to upgrade its studios to digital the company is still virtually debt free with $27M in free cash and $16M in debt outstanding that will be paid off by 2009 and $23M in long term liabilities for legacy pensions. The company can generate roughly $25M in free cash flow (see next post for calculations), so if things stay as they are the company will have roughly $70-$75M in free cash on the balance sheet and no debt by the end of 2009.


* DISCLOSURE: I or accounts I manage may be long or short any and/or all stocks mentioned in this post. This is not a recommendation to buy or sell any security. For informational and educational purposes only.