CPY Q2:2007 Earnings Analysis

By just about any measure, CPY has been a pig of a stock. I first posted about it on 6/11/07 when the share price was $71. I have bought shares for the Marketocracy Best Ideas portfolio at an average price of $40.75 and the position now makes up 5% of that portfolio. I have bought shares for my personal account at $45, $40, and $30.5. Any way you look at it, this has been a bad investment thus far.

Obviously, at this point the question is do I cut my losses, do I add to my position or do I hold on. The next few posts will concentrate on CPY and I hope that I can come up with a reasonable answer.

First, the latest quarterly earnings analysis …….

The company reported fiscal Q2 earnings on 8/28/07 with this being the first quarter that included 6 weeks of results from the acquired Wal-Mart business. In their fillings, the company is calling the Wal-Mart business “Picture Me” and the legacy Sears business is called “SPS.”

GAAP reported net income in the quarter is NEGATIVE $3.4M vs. +$0.64M last year. However, it looks like the reported GAAP numbers are substantially understated. As I understand it, the company essentially booked 3 weeks worth of revenue from Picture Me--deferring $8.1M worth of revenue--but full 6 weeks worth of expenses.

Below is a breakdown by business line and what actual EBITDA looks like once the $8.1M deferral is added back:

The real bad news is that Sears continuous to see declining sales with sittings down 9.4% while avg price per order was up 4.8% for a net Sears revenue decline of 5.6%.

The good news is that despite the sales decline management is finding more costs to cut and EBITDA is still growing. Sears EBITDA was up $2M in absolute terms. Sears EBITDA margin up to 14.5% from 10.1% in Q2:2006. Margin improvement came from BOTH GROSS AND SG&A MARGINS.

Interest expense increased as the company is now carrying $115M in debt. D&A increased due to the acquisition. The 10Q stated that D&A from the PCA acquisition will be $14M annually.

From a purely financial perspective, I would say this quarter was substantially better than it looks. The Picture Me business will probably continue to distort earnings for another few quarters as CPY’s management starts to upgrade to digital, raise prices, and starts cutting costs – basically they will follow their Sears game plan from a few years ago. Negative sitting continues to be a concern, however average prices per customer are still rising and EBITDA is still growing.

In the next few posts I will highlight key points from the conference call, talk about the massive insider buying activity, and how I am looking at valuation.

* 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.