Stock Analysis: Intuit (INTU)

Company description:

Intuit Inc., incorporated in March 1984, is a provider of business, financial management solutions for small and medium sized businesses, financial institutions, including banks and credit unions, consumers and accounting professionals. The company's flagship products and services, including QuickBooks, Quicken and TurboTax software, enable small business management and payroll processing, personal finance, and tax preparation and filing. It has six business segments: QuickBooks, Payroll and Payments, Consumer Tax, Professional Tax, Financial Institutions and Other Businesses.

The company's Small Business division consists of two segments: QuickBooks segment and Payroll and Payments segment. The QuickBooks segment includes QuickBooks accounting and business management software and technical support, as well as financial supplies for small businesses. The Payroll and Payments segment includes payroll products and services and merchant services for small businesses.

The Consumer Tax segment includes its TurboTax consumer and small business tax return preparation products and services. The Professional Tax segment includes its Lacerte and ProSeries professional tax products and services.

The Financial Institutions consists primarily of outsourced online banking applications and services for banks and credit unions. The Other Businesses segment includes its Quicken personal finance products and services, Intuit Real Estate Solutions and its business in Canada and the United Kingdom.

In August 2006, Intuit acquired StepUp Commerce, Inc. StepUp provides services that allow small businesses to present their product information and images to online shoppers. StepUp became part of its QuickBooks segment. On February 6, 2007, the Company completed the acquisition of Digital Insight Corp. Digital Insight is a provider of outsourced online banking applications and services to banks, credit unions, and savings and loan associations. In August 2007, the Company sold its Intuit Distribution Management Solutions (IDMS) business. In March 2007, the Company sold certain assets related to its Complete Payroll and Premier Payroll Service businesses to Automatic Data Processing, Inc. (ADP).

Click here for a full description of the company’s operations.

Annual report highlights (latest report is for the period ending 7/31/07):

General

Intuit Inc. is a leading provider of business and financial management solutions for small and medium sized businesses; financial institutions, including banks and credit unions; consumers; and accounting professionals. Flagship products and services, including QuickBooks, Quicken and TurboTax software, simplify small business management and payroll processing, personal finance, and tax preparation and filing. ProSeries and Lacerte are Intuit’s leading tax preparation software suites for professional accountants. Financial institutions division, anchored by Digital Insight Corporation, provides on-demand banking services to help banks and credit unions serve businesses and consumers with innovative solutions. Founded in 1983 and based in Mountain View, California, company had revenue of $2.7 billion in the fiscal year ended July 31, 2007.

Company had approximately 8,200 employees in major offices in the United States, Canada, the United Kingdom and other locations as of July 31, 2007.

Intuit’s Mission

Intuit’s mission is to revolutionize people’s lives by solving important problems. Company’s goal is to create solutions so profound and simple that customers wouldn’t dream of going back to their old ways of keeping their books, managing their businesses, preparing their or their clients’ taxes, or organizing their finances.

Company Growth Strategy

Intuit’s strategy is to be in growth businesses, high-profit businesses and attractive new markets with large unmet or underserved needs that they can solve well. Company’s core competency is customer-driven innovation applied to solve important customer problems simply. Company seeks to continuously improve its existing solutions to delight customers by creating product and service experiences that are dramatically better than the alternatives.

Company approaches new opportunities by developing products and services designed to attract customers who do not use software products (non-consumption) and by offering solutions that have better value compared with higher-priced alternatives (disruption). This strategy helps the company to build large user bases and create durable competitive advantage.

Company’s offerings serve consumers, small business and tax customers, and accounting professionals, who are both customers and recommenders of our products and services. Potential customers are divided into three groups:

• “Self-Directed” Customers: These customers are comfortable using software and doing the work themselves. They are likely to use products such as QuickBooks, QuickBooks Standard Payroll, TurboTax and online banking applications that Intuit provides through financial institutions.

• “Self-Directed with Assistance” Customers: These customers are comfortable doing much of the work themselves, but want some assistance and assurance that they have done it right. They are likely to use services such as QuickBooks support and QuickBooks Assisted Payroll. Intuit is increasing their focus on serving these customers – particularly in their consumer tax and payroll businesses. Company believes that this customer segment offers significant potential for Intuit as many of these customers are served today either by fully self-directed solutions or by full-service solutions that are more expensive and complicated than they need.

• “Can’t Be Bothered” Customers: These customers want lots of human assistance and are likely to use full-service providers. Intuit does not focus on these customers.

Four fundamentals support company’s growth strategy:

• It carefully chooses the businesses it is in, focusing on businesses with large unmet or underserved market opportunities where company believes it can build a strategic and durable advantage.

• It actively looks for significant new customer problems and applies its core competency of customer-driven innovation to solve those problems with simple, easy-to-use solutions.

• It solicits and acts on feedback from its customers so that it can continually improve its existing products and services. Company’s goal is customers who are so happy with their products and services that they actively recommend them to others.

• It applies operational rigor and process excellence principles to execute more effectively on a daily basis. Company’s goal is to provide better customer experiences at lower cost.

Right for Me Initiatives

Company’s focus on customer needs is embodied in Right for Me initiatives. Rather than approach its targeted markets with a “one size fits all” mentality, they dig deeper to understand the many different needs of various customer segments. Company then uses this knowledge to develop products and services to meet those different needs. Over the past several years, for example, they have gone from offering just two versions of QuickBooks to offering many QuickBooks solutions that address different needs.

Product Development

Since the personal computer and software industries are characterized by rapid technological change, shifting customer needs and frequent new product introductions and enhancements, a continuous high level of investment is required for the enhancement of existing products and the development of new products. Intuit develops the majority of its products internally. Company may also supplement its internal development efforts by acquiring strategically important products and technology from third parties, or establishing other relationships that enable it to enhance or expand its offerings more rapidly. Company has a number of United States patents and pending applications that relate to various aspects of its products and technology.

Intuit’s traditional core desktop software products – QuickBooks, Quicken, TurboTax, Lacerte and ProSeries – tend to have fairly predictable, structured development cycles of about a year, with annual product releases. Company also develops new products for which development cycles are less predictable. Developing consumer and professional tax software presents unique challenges because of the demanding development cycle required to accurately incorporate tax law and tax form changes within a rigid timetable. The development timing for company’s other small business and financial institutions offerings varies with business needs and regulatory requirements and the length of the development cycle depends on the scope and complexity of each particular project.

In company’s Financial Institutions business, it has relationships and has developed interfaces with most of the major vendors of core processing software and outsourced core processing services to financial institutions. These system interfaces allow company to access a financial institution’s host system to provide end users access to their account data. In addition to developing new interfaces, company continues to significantly enhance its many existing interfaces in order to deliver more robust connectivity and increase operating efficiencies.

Research & Development

Intuit continues to make substantial investments in research and development. Company’s future research and development efforts will be focused on enhancing existing products and services and on developing new products and services to address customer needs in existing and new markets.

Company anticipates that the products it develops in the future will offer increased ease of use, be customized for specific customer categories, be Web-integrated or Web-based, and feature improved integration with other Intuit and third party products and services and with our internal information systems. Company also expects to continue to focus significant research and development efforts on multi-year projects to modernize the technology platforms for many of our products.

Intuit’s research and development expenses were $472.5 million or 17% of total net revenue in fiscal 2007, $385.8 million or 17% of total net revenue in fiscal 2006, and $292.6 million or 15% of total net revenue in fiscal 2005.

Seasonality

Company’s QuickBooks, Consumer Tax and Professional Tax businesses are highly seasonal. Some of its other offerings are also seasonal, but to a lesser extent.

Revenue from many of company’s small business software products, including QuickBooks, tends to be at its peak around calendar year end, although the timing of new product releases or changes in company’s offerings can materially shift revenue between quarters. Sales of income tax preparation products and services are heavily concentrated in the period from November through April. In the Consumer Tax business, a greater proportion of company’s revenue has been occurring later in this seasonal period due in part to the growth in sales of TurboTax Online, for which revenue is recognized upon filing.

These seasonal patterns mean that company’s total net revenue is usually highest during its second quarter ending January 31 and third quarter ending April 30. Intuit typically reports losses in its first quarter ending October 31 and fourth quarter ending July 31, when revenue from the tax businesses is minimal while operating expenses continue at relatively consistent levels.

Markets

Intuit’s primary target customers are small and medium sized businesses, consumers, accounting professionals, and small and medium sized financial institutions. The markets in which company competes have always been characterized by rapid technological change, shifting customer needs, and frequent new product introductions and enhancements by competitors.

Market and industry changes are quickly rendering existing products and services obsolete, so Intuit’s success depends on its ability to respond rapidly to these changes with new business models, updated competitive strategies, new or enhanced products and services, alternative distribution methods and other changes in the way we do business.

Marketing and Distribution

To market its products company uses marketing programs such as direct-response mail and email campaigns; Web marketing, including purchasing key words from major search engine companies; telephone solicitations; newspaper, magazine, billboard, radio and television advertising; and promotional offers that they coordinate with major retailers and computer original equipment manufacturers, or OEMs.

Intuit is exclusively endorsed by the American Bankers Association (ABA) for its Internet banking product and it has promotional arrangements with several state banking associations that promote Intuit’s products to their constituents.

Company sells many of its products and services geared towards small businesses, consumers and accounting professionals directly through its Web sites and call centers. Intuit’s other major distribution channels are: PC makers, office supply superstores, consumer electronics stores and other retailers.

In the Financial Institutions business, company sells its products and services to financial institutions using a direct sales model and, to a lesser extent, in cooperation with core processing partners.

Competition

As company implements its customer-driven strategies, it faces increased competitive threats from larger companies than it has historically faced. In addition, the competitive landscape can shift rapidly as new companies enter markets in which Intuit competes. This is particularly true for Web-based products and services, where the barriers to entry are lower than they are for more traditional software products and services.

Intuit’s most obvious competition comes from other companies that offer technology solutions similar to ours. However, for many of its products and services, other important competitive alternatives for customers are manual tools and processes, or general-purpose software. Many of company’s new customers have used pencil and paper or software such as word processors and spreadsheets, rather than competitors’ software and services, to perform financial tasks. For example, many taxpayers prepared their tax returns manually before using TurboTax; a large number of small businesses used spreadsheets to keep their books and calculate their payrolls before purchasing QuickBooks; and many end user customers used paper checkbooks to track their bank accounts and pay their bills before using online banking software. Company believes that there is a long-term trend away from manual methods and toward the use of both online and desktop software to accomplish these tasks that will provide it with future growth opportunities.

QuickBooks is the leading product in the retail sales channel for its category. Intuit faces significant competitive challenges in its QuickBooks and Payroll and Payments businesses from Microsoft, which in September 2005 launched accounting software and associated services that directly target small business customers. Increasingly, company’s small business products and services also face competition from free online banking and payment services offered by financial institutions and others.

In the private sector company faces intense competition primarily from H&R Block, the makers of TaxCut software, and increasingly from Web-based offerings such as 2nd Story Software’s TaxACT, where company is subject to significant and increasing price pressure. Company also competes for customers with assisted tax preparation businesses such as H&R Block.

Intuit also faces potential competitive challenges in the Consumer Tax business from publicly funded government entities that offer electronic tax preparation and filing services at no cost to individual taxpayers.

The market for Internet banking services is highly competitive. In the area of retail Internet banking, Intuit primarily competes with other companies that provide outsourced online banking services to financial institutions, including Online Resources, S1 Corporation and FundsXpress (a subsidiary of First Data Corporation).

Company believes that the most important competitive factors for its core software products – QuickBooks, Quicken, TurboTax, Lacerte and ProSeries – are ease of use, product features, size of the installed customer base, brand name recognition, value, and product and support quality.

In addition, the ability for customers to upgrade within product families as their businesses grow is a significant competitive factor for company’s QuickBooks products. Productivity is also an important competitive factor for the full-service accounting firms to which company markets its Lacerte products.

Intuit competes effectively on these factors as its QuickBooks, Quicken and TurboTax products are the leading products in the retail sales channel for their respective categories.

Dividends

Intuit has never paid any cash dividends on its common stock. From time to time company considers the advisability of paying a cash dividend. Company currently anticipates that it will retain all future earnings for use in its business and for repurchases under its stock repurchase programs. Company does not anticipate paying any cash dividends in the foreseeable future.

Stock Repurchase Programs

Intuit’s Board of Directors has authorized a series of common stock repurchase programs. During fiscal 2007 company repurchased 17.1 million shares of its common stock for $506.6 million under its repurchase programs. From the inception of these programs in May 2001 through the end of fiscal 2007, company repurchased 158.7 million shares of its common stock for $3.8 billion. At July 31, 2007, company had authorization from its Board to expend $800 million for future stock repurchases.

Overview of Financial Results

Total net revenue for fiscal 2007 was $2.7 billion, up 17% compared with fiscal 2006. Intuit acquired Digital Insight and created a new Financial Institutions segment in February 2007. Excluding revenue from the Financial Institutions segment, fiscal 2007 total net revenue increased 11% compared with fiscal 2006. Almost 30% of the fiscal 2007 revenue increase was due to 15% higher revenue in the Consumer Tax segment. QuickBooks segment and Payroll and Payments segment each contributed about 15% of the fiscal 2007 revenue increase.

In February 2007 Intuit acquired Digital Insight Corporation for a purchase price of approximately $1.34 billion and issued $1 billion in related debt. In July 2007 company signed a definitive agreement to sell its Intuit Distribution Management Solutions business and the sale was completed in August 2007. In addition, company sold its Intuit Information Technology Solutions business in fiscal 2006, its Intuit Public Sector Solutions business in fiscal 2005, and its wholly owned Japanese subsidiary, Intuit KK, in fiscal 2003.

Other:

• Intuit’s primary products and services are sold mainly in the United States: international total net revenue was less than 5% of consolidated total net revenue for fiscal 2007, 2006 and 2005.

• The Intuit Developer Network is an initiative that encourages third-party software developers to build applications that exchange data with QuickBooks and other Intuit products by giving them access to certain application programming interfaces. At the end of fiscal 2007, approximately 350 third-party applications were available for QuickBooks and other Intuit products on the company’s web site.

• Company is involved in the Intuit Tax Freedom Project whereas it provides online federal and state income tax return preparation and electronic filing services at no charge to eligible taxpayers. In fiscal 2007 company provided approximately 1.5 million free federal returns under this initiative.

• Majority of Wall Street analysts think this company is a “buy” and will “outperform” the market. But then again, I see that kind of sentiment given to a huge number of companies which basically renders it meaningless.

• 84% of shares are held by Institutional & Mutual Fund owners.

• There has been a lot of sporadic insider trading during the past 12 months, involving options exercises, buying and selling significant amounts of the company’s stock. I couldn’t see any pattern either way.

Financial highlights:

Revenue Growth (1-yr): 16.6%
Revenue Growth (4-yr average): 13.8%

Net Income Growth (1-yr): 16.5%
Net Income Growth (4-yr average): 14.7%

Free Cash Flow Growth (1-yr): 10.3%
Free Cash Flow Growth (4-yr average): 4.7%

Net Profit Margin (current): 16.6%
Net Profit Margin (5-yr average): 17.3%

Return On Equity (current): 23.5%
Return On Equity (5-yr average): 21.1%

Debt Ratio (current): 0.52
Current Ratio (current): 1.68

Discounted Cash Flow (DCF) Analysis:

I used discounted cash flow analysis to arrive at the intrinsic value of the company. I estimated that free cash flow would grow at an average rate of 8% per year for the next 10 years and at 3% (trailing GDP growth) perpetually after that.

I used a discount rate of 12% because, in my eyes, this company faces more risk and volatility than an average wide moat company.

Using the assumptions listed above, my intrinsic value of the stock came out to $28.36. My intrinsic value of Intuit is about 10% less than what Morningstar has listed as a “fair value” for this company. It is most likely due to the fact that I see this company as more risky than they do. Economic conditions are likely to not be conducive to a number of their products and net income will be affected adversely if the economy does slow down, which isn’t unlikely at this point.

Pros:

• Good company with several products that are market leaders (e.g. QuickBooks and TurboTax).
• Expanding its product line through acquisitions and entering new markets.
• High ROE, usually higher than 20%.
• Decent profit margin that’s consistently 16-19%.

Cons:

• Increasing pricing pressure of large competitors and innovating startups.
• Lack of diversification: more than 95% of the company’s sales are in U.S.
• Risk that new state and/or federal laws will provide more venues allowing citizens to file their tax returns at no charge.
• An economic slowdown would adversely affect its QuickBooks business when IT budgets at smaller companies (who are Intuit’s main customers) shrink.
• Spotty net income and stock return from year to year, occasionally dipping into red, is a concern even though overall business model is great.

Final decision:

At the price it currently trades at, I would pass on this company. Market price of $32 is higher than my intrinsic value of $28.36, which means that the stock is currently slightly overpriced according to my valuation. With the safety margin of 30-50%, my buying price range for Intuit is $14-$20. I do believe this is a great company with great franchises such as QuickBooks, Quicken, and TurboTax, but sporadic performance in terms of net income and stock return makes me want to demand a higher margin of safety than I would otherwise. Also, if you look at a 10-year chart of highs and lows, the stock consistently dips at 30-50% of its 52-week high at some point during every year. So, that’s another fact to consider.