Tuesday, February 10, 1998
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United States Filter Corp. (NYSE: USF), a global provider of industrial and municipal water and wastewater treatment systems and related products and services, announced yesterday that it will purchase Culligan Water Technologies (NYSE: CUL) for approximately $1.5 billion. Culligan gained $15 1/8 to $54 today. Culligan shareholders will get 1.714 shares of U.S. Filter for each Culligan share. With the pooling transaction expected to close in late May, the deal values Culligan at $59.24 per share (a 52% premium) as of last night's close. This puts Culligan's buy-out price at 3.8 times its trailing sales. Before the merger announcement, Culligan traded at 2.6 times enterprise value-to-sales. The deal will add roughly 43 million shares, which will be softened by Culligan's $0.77 in annual cash flow per share, valued at roughly one-third (55 times) U.S. Filter's $0.22 annual cash flow per share (at 155 times). Thanks to its higher-margin home water purification products, Culligan's operating margins are 42% higher than U.S. Filter's (at 9.16%), which in conjunction with a number of cost saving combinations will help U.S. Filter wash down the acquisition.

Reliability Inc. (Nasdaq: REAL), a manufacturer of "burn-in" equipment used to test the performance of memory chips, gained $1 13/16 to $14 9/16 after announcing a 122% jump in Q4 EPS to $0.40 versus $0.18 a year ago, crushing the Zacks estimate of $0.29 from a single analyst. For the year, net profit margins expanded to 17.2% from 13.6% the year before, while the order backlog for the company's two main testing products grew 64% to $11.2 million. The size of the backlog underscores the popularity of the company's Intersect functional memory tester and Criteria micrologic system, since they represent 79% of Reliability's total backlog of $14.1 million. Despite announcing on Jan. 15 that it was closing its Durham, N.C., plant because of declining memory chip prices, the company is forecasting EPS to increase 78% in Q1 from $0.09 a year ago to $0.16. And that's including a $0.05 per share reserve to cover costs related to shuttering the plant. Ironically, the company's gain comes on a day when one of its major customers, Texas Instruments (NYSE: TXN), is being rewarded $2 1/8 to $55 3/4 for announcing its plan to terminate its joint venture with Hitachi for the production of memory chips (eliminating production of an estimated 3 million DRAM chips per month).

Pioneer Natural Resources (NYSE: PXD), a firm formed last August when Parker & Parsley Petroleum merged with T. Boone Picken's MESA Inc., reported a Q4 loss of $11.58 per share, which was much worse than the loss of $0.19 per share expected by First Call. However, Pioneer is up $1 1/16 to $23 1/8 today on the strength of some announced changes that investors hope will return the company to profitability. The eye-popping Q4 loss includes an $863 million write-down (due to falling oil and natural gas prices) to reflect the fair market value of the oil and gas properties acquired from MESA. Separately, Pioneer expects to generate $375 million to $550 million in cold, hard cash by selling more than 400 fields -- or 95% of its total acreage, which only accounts for 15% of the company's total cash flow and constitutes 10-12% of its reserves. The company hopes to allocate the capital generated from the sale into higher return investments, like its stock buyback program, which it plans to double from $100 million to $200 million. Pioneer also announced that it will pare back its 1998 capital spending by $100 million to $500 million and cut the number of its operating divisions from eight to five. This restructuring will result in a $20 million charge to fiscal 1998 earnings while trimming operating and administrative expenses by 12%.

QUICK TAKES: Wainoco Oil Corp. (NYSE: WOL) rose $13/16 to $8 1/8 after announcing that it has called for redemption of the remaining $24.8 million of its 12% Senior Notes due 2002 and $46 million of its 7 3/4% Convertible Subordinated Debentures due 2014. The oil refinery plans to fund the redemptions with the proceeds from a recently completed private sale of $70 million of 9 1/8% Senior Notes due 2006 and other cash... Personal-care products manufacturer Playtex Products (NYSE: PYX) gained $15/16 to $12 15/16 after reporting Q4 EPS of $0.03, matching EPS from the year before. For the year, Playtex earned $0.37 per share before taking an extraordinary loss of $0.08 per share related to a refinancing, compared with $0.36 per share in 1996.

Aerospace components and semiconductor equipment maker Fairchild Corp. (NYSE: FA) rose $1 1/2 to $22 5/8 after announcing that it will realize a pre-tax gain of around $60 million from its sale of the Hardware Group and PacAero units of Banner Aerospace (NYSE: BAR) to AlliedSignal (NYSE: ALD) for $345 million in stock. Fairchild owns about 67% of Banner, an aerospace components company, which gained $1 to $12... Cervical cancer screening technologies developer AutoCyte Inc. (Nasdaq: ACYT) jumped $1 15/16 to $6 1/16 after the FDA said it will not require additional clinical trials for the company's PREP sample preparation system... Infectious disease testing materials provider Boston Biomedica (Nasdaq: BBII) gained $2 1/16 to $7 7/16 after receiving three patents for chemical compounds that inhibit the replication of the HIV virus.

Computer simulation software developer Simulations Plus (Nasdaq: SIMU) continued rising, finishing up $1 13/16 to $7 5/8 after announcing yesterday that it has signed an agreement with Parke-Davis, a division of Warner-Lambert (NYSE: WLA), to test its new GastroPlus simulation software... Norland Medical Systems (Nasdaq: NRLD), which makes sensors to determine bone density, ratcheted up $1 11/16 to $8 1/2 after receiving FDA clearance to market its pDEXA bone fracture risk assessment product... Oncology practice management company Physician Reliance Network (Nasdaq: PHYN) advanced $2 1/4 to $11 3/4 in the wake of its Q4 earnings announcement yesterday. Earnings for the quarter, before a one-time pre-tax charge of $1.0 million for severance payments, were $0.11 per share, compared with $0.09 for the prior-year period.

Ryan, Beck & Co. (Nasdaq: RBCO) added $1 1/4 to $9 1/8 after Fort Lauderdale, Florida-based BankAtlantic Bancorp (NYSE: BBX) said it would acquire the brokerage firm, which specializes in bank and thrift issues, in a stock swap valued around $38 million... Computer software company Wiztec Solutions (Nasdaq: WIZTF) surged $1 3/8 to $10 3/4 on announcing an agreement with @Entertainment, Inc. (Nasdaq: ATEN), a multi-channel pay TV operator in Poland. @Entertainment will use Wiztec's WIZARD Subscriber Management and Billing System to support all customer care and billing services for its subscribers.

Internet access provider EarthLink Network (Nasdaq: ELNK) climbed $4 5/8 to $38 5/8 after announcing a "Get Out of AOL Free" program, which is intended to lure customers away from rival America Online (NYSE: AOL)... VMARK Software (Nasdaq: VMRK) and Unidata Inc. announced that their shareholders have approved the merger of the two companies. The name of the new company is Ardent Software, which expects to begin trading on Nasdaq on February 12 under the symbol ARDT. VMARK ended up $1 3/8 to $11 3/4... Internet services firm USWeb Corp. (Nasdaq: USWB) jumped $1 5/8 to $14 3/8 after announcing the launch of a private, independent company called USWeb Learning, which aims to become the leading provider of Internet-related education and certification services.


Israeli "generic" pharmaceutical company Teva Pharmaceutical Industries (Nasdaq: TEVIY) fell $9 9/16 to $37 1/2 after pre-announcing lower-than-expected Q4 results. Teva expects to report Q4 EPS between $0.30 and $0.34 before a one-time charge resulting from its recent marketing agreement with Biovail Corp. Even before the one-time charge, Teva will fall far short of estimates of $0.64. The company attributed the shortfall to a decline in sales in Israel, in part due to inventory adjustments at General Health Fund, which is Israel's largest healthcare provider and accounts for 25% of Teva's sales. The company also made significant expenditures in the global marketing and R&D for Copaxone, its new treatment for multiple sclerosis. Finally, a higher tax rate is also expected to drag down Q4 results, coming in at 26%-28% compared with roughly 23% in previous quarters. Teva said that several of these factors were "particular to the fourth quarter" and that in 1998 it "expects to return to its historical growth rates and trends."

Mortgage lender New Century Financial Corp. (Nasdaq: NCEN) dropped $2 1/4 to $9 1/2 after reporting Q4 earnings of $0.22 per share compared with estimates for $0.56 and prior period results of $0.23. The results reflected a decrease in recorded gains on the sale of various securities, including a $5.2 million reduction in the value of the company's residual securities (which are leftovers from past securitizations) and a $3 million "allowance" against loans due to concerns about continuing accelerated pre-payment trends in the business. A little over a month ago New Century tumbled 13% due to investor concern that subprime loan companies in general would not survive the auditing season without resorting to significant write-downs due to revised assumptions used in the recording of the value of securities on the books. Apparently these concerns were not fully priced into New Century, for today's loss put the stock near its 52-week low.

QUICK CUTS: Wastewater treatment firm U.S. Filter Corp. (NYSE: USF) fell $3 to $31 9/16 after announcing a deal to acquire Culligan Water Technologies (NYSE: CUL)... Software maker Data Dimensions (Nasdaq: DDIM) dropped $2 1/4 to $16 1/8 after the stock was downgraded by Ladenburg Thalmann to "hold" from "buy"... Ambulatory surgical center operator National Surgery Centers (Nasdaq: NSCI) fell $2 1/2 to $22 1/4 after reporting Q4 EPS of $0.18, lower than the $0.19 expected by First Call. BT Alex. Brown downgraded the stock from "strong buy" to "buy"... Coast Dental Services (Nasdaq: CDEN) was drilled for $2 5/8 to $25 3/4 even though the dental management company reported Q4 EPS of $0.16, in line with the First Call consensus estimate.

GT Interactive Software Corp. (Nasdaq: GTIS) fell $5/8 to $6 3/8 after a class action lawsuit was filed against the company in New York District Court. The suit alleges that the software developer inflated earnings and, consequently, its share price by reporting R&D expenses for discontinued and/or technologically infeasible projects in statements to the SEC... Food distributor Performance Food Group (Nasdaq: PFGC) dropped $1 1/2 to $18 1/4 after reporting Q4 EPS of $0.27, just shy of the First Call estimate of $0.28. The company's CEO said recruiting and training additional personnel is "a major challenge," leading to higher costs that may negatively impact fiscal 1998 earnings.

Cardiac monitoring and testing services provider Raytel Medical Corp. (Nasdaq: RTEL) slipped $3 7/32 to $8 25/32 after announcing yesterday that it expects to report Q1 EPS between $0.12 and $0.15 due to a slower-than-anticipated holiday season. That's far lower than the First Call consensus earnings estimate of $0.23... Sykes Enterprises (Nasdaq: SYKE) slid $4 3/8 to $18 1/2 after CS First Boston lowered its rating on the computer technical support provider to "hold" from "buy"... Computer-aided production engineering software company Tecnomatix Technologies (Nasdaq: TCNOF) bumped down $2 1/4 to $31 3/4 after announcing a fourth-quarter loss of $0.48 per share including a one-time charge of $9.6 million related to the acquisition of AESOP, the developer of Simple++. Excluding the charge, Q4 EPS would have totaled $0.41 compared with $0.28 the year before. The First Call consensus earnings estimate was $0.37.

An Investment Opinion
by Dale Wettlaufer

Research What You Know

Boston Market restaurant operator Boston Chicken (Nasdaq: BOST) has been skinned over the course of the last year as a number of problems with the business model came home to roost. Over the last two days, the stock has fallen 11% to $7 1/32 after the company said it will take charges of $250-350 million to write down the value of developer debt it holds as well as to prepare the company to take over the interests of two large developers of Boston Market franchises. That decision doesn't come about because Boston Market's concept and menu aren't really good, or because Boston Chicken wants to hoard its huge profits for shareholders. And it doesn't come about due to funny accounting practices that some in the media are so pleased with themselves for pointing out. It comes about because the company wasn't absolutely fanatical about operations and partly because it didn't think like private owners would about accounting for the economic results of the business. Investors aren't blameless in this thing, either. If "buy what you know" merely means to you, "buy what you eat," then here is a clarification. Research what you know before buying.

Comparing Boston Market's store-level sales in 1996 to McDonald's (NYSE: MCD) 1996 results showed an encouraging result. Per-store weekly sales were $24,000 in 1996 versus $26,800 per week for McDonald's U.S. units in 1996. Since each McDonald's store occupies more real estate, the sales per square foot actually looked very good. The attractiveness of store results started to fall early last year, though, as the cost of discounts and promotions as a percentage of revenues more than doubled to 7% of sales from 3% in the year-earlier period. Just as rebate activity is horrible for auto companies and promotional pricing hurts PC retailers, it's not good for restaurants.

Last quarter, things really fell apart as Boston Market's weekly store-level sales fell to $19,500, down nearly 20% year-over-year. Compared with McDonald's U.S. unit weekly store-level sales results -- down one-half of one percent from 1996 levels in Q4 and down four-fifths of one percent from full-year 1997 levels -- Boston Chicken's business was looking very poor. Even ignoring the fact the American fast food and meal replacement categories were highly competitive this year, something obviously went wrong at Boston Chicken's operating level.

First of all, the unit-level economics at the early McDonald's restaurants were highly favorable. The cash-on-cash returns (the cash return from the restaurants after financing costs relative to the initial upfront cash investment) made early franchisees independent within a couple years of their taking out the franchise. People swamped McDonald's restaurants because the food was consistent, kids loved to go and watch the crews cook hamburgers, and the restaurants weren't loitering havens for teens with nothing to do.*

Compared to any restaurant, quick-serve or not, McDonald's was in a league of its own. Boston Chicken, on the other hand, misses part of the point. Its food is good, but nobody at Boston Chicken is the absolute operating freak that Ray Kroc and other McDonald's executives were. Like Walt Disney, Ray Kroc realized that people didn't want to see trash, even for a moment, anywhere in or near the store. Compare that with Boston Chicken. Does the cleanliness of each and every Boston Market strike you when you're there? How friendly is the help? Is there that same consistency at Boston Chicken that is seen at other successful quick-serve franchises?

Good food isn't the only thing in a restaurant. Atmosphere and service are at least as important. People have to want to come back, and unless there's something really compelling about it, a leveraged developer structure can fall flat on its face instead of just limping along like an unleveraged structure might do. By writing down a significant portion of the debt held on Boston Chicken's balance sheet, the company is indicating that it may never see a return on that asset. That does not bode well for the company's decision to purchase the flagging area developers, because the uneconomic return the developers are suffering will now be flowing through Boston Chicken's income statement. Furthermore, if no one at the corporate level is a die-hard stickler for cleanliness, service, and value, is that sort of deep-seated value going to pop up all of a sudden?

Some have tried to pin all of this on Boston Chicken's financing strategy and business model. There's nothing wrong with Boston Chicken's financing strategy if you can handle putting your high-risk money in a leveraged restaurant development company. The common mistake that people make looking back on the superior returns McDonald's has made over its lifetime is assuming that it was always this big, safe cash cow. Nothing can be further from the truth, because Ray Kroc was an absolute tiger who couldn't build fast enough to establish the brand name. At points in development in the '60s and the '70s, McDonald's was a highly leveraged company if you count capitalized lease obligations in long-term debt (which an investor should).

Speaking of debt, that's a major hang-up for some investors in Boston Chicken. It's not because debt is a problem or inherently evil, though. The problem lies in Boston Chicken's failure to understate profits. Those companies that are confident that they're building intrinsic value will understate, trusting that over a number of years the quality of their earnings stream will show itself. Not until this quarter, though, did Boston Chicken say it would take a reserve against the value of over $1 billion in developer debt the company holds. Rather than taking a loan loss reserve each quarter to conservatively account for the majority of the company's assets, even as the area developer economics and store-level economics were deteriorating, the company finally came out and made the now-expected announcement yesterday.

In the case of Boston Chicken, it's not debt that's bad and it's not even the company's disclosure that was bad. Anyone could have read these things in the 10-Qs or heard it on the conference call. The management of the company isn't going to jump off the page, slap you in the head, and say, "Hey, we should be taking loan loss reserves!" That's up to the investor to figure out for him or herself. Which brings us back to the maxim, "Research what you know, don't buy what you know." If your ongoing research indicates things have changed but the financials still paint a rosy picture, look at things two or three times before you're satisfied that things really are rosy. If the management doesn't look like it's acting like a private owner would, it's often time to move on.

*McDonald's: Behind the Arches, by John F. Love; Bantam Books, 1995


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Dale Wettlaufer (TMF Ralegh), Fool
Alex Schay (TMF Nexus6), Fool
Yi-Hsin Chang (TMF Puck), Fool
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