Thursday, April 16, 1998
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Texas Instruments (NYSE: TXN) gained $1 11/16 to $58 1/4 after the semiconductor and electronics manufacturer reported first quarter earnings of $0.44 per share (before a $0.41 charge primarily to cover the cost of discontinuing a joint venture with Hitachi), up from $0.35 in Q1 1997 and in line with analysts' estimates. Intense competition and severe price cuts -- 60% from Q1 1997 -- on dynamic random access memory (DRAM) chips drove the company's overall orders down 14.5% and revenues down 1% (excluding sold businesses). But thanks to TI's diversified product portfolio, especially its digital signal processors line, the company was able to improve gross profit margins both year-on-year and from the fourth quarter. TI now expects that the semiconductor industry will grow just 5% or less this year, down from its previous projection of 10%. It anticipates continued pressure on its semiconductor sales and margins in Q2, but in its most important segments, TI expects 20% growth in mixed signal chips and 30% growth in digital signal processing -- with 45% growth in digital cellular chips. The company is banking on the rapidly growing wireless communications industry, where it is the market leader (one out of two digital cell phones produced has TI chips).

Apple Computer (Nasdaq: AAPL) jumped $1 3/16 to $28 5/8 after reporting second quarter earnings of $0.38 a share, compared with a loss of $1.42 (before charges) for the year-earlier quarter and the First Call mean estimate of $0.16. Q2 earnings also beat the $0.33 a share recorded for the first quarter. Gross margins improved to 25% versus 19% in the year-ago period and 22% in the first quarter. Strong demand for Apple's Power Macintosh G3 computers, which sell for $1,700 and up without a monitor and yield higher margins, helped propel the company's earnings. The company also benefited from further cost-cutting and consolidation of internal operating units. Investors should note that Apple's bottom line was enhanced by the use of tax loss carryforwards that resulted in an effective tax rate of 6.8% this quarter. Still, applying a full tax rate to the company's pre-tax earnings of $55 million, EPS would have come in at $0.26, well above the $0.16 estimate.

QUICK TAKES: Oil companies moved up today as crude oil prices gained more than 3% on expectations of strong demand for gasoline and concern that supply could be disrupted by renewed tensions between the United Nations and Iraq over weapons inspections. Exxon (NYSE: XON) fueled up $1 5/8 to $70 5/16; Amoco (NYSE: AN) was pumped up $3 3/16 to $87 5/16; Chevron (NYSE: CHV) jumped $3 11/16 to $83 3/4; Mobil (NYSE: MOB) added $1 5/8 to $77 1/8; Texaco (NYSE: TX) climbed $1 9/16 to $62 1/2; and British Petroleum (NYSE: BP) gained $1 3/4 to $91... American Airlines parent AMR Corp. (NYSE: AMR) took off for another $4 3/8 to land at $158 1/4 in the wake of announcing higher-than-expected Q1 earnings and a 2-for-1 stock split.

Internet-related companies continued to rise in the wake of Yahoo! Inc.'s (Nasdaq: YHOO) higher-than-expected Q1 earnings announcement. While Yahoo! added another $10 9/16 to $128 3/4, competitor Infoseek Corp. (Nasdaq: SEEK) soared $9 11/16 to $44 3/16 in the wake of the company's announcement that it will acquire privately held online community and "chat room" operator WebChat Broadcasting System. Netscape Communications (Nasdaq: NSCP) surged $5 13/16 to $25 9/16, Excite Inc. (Nasdaq: XCIT) leapt $8 1/8 to $91 1/8, and Lycos Inc. (Nasdaq: LCOS) jumped $6 13/16 to $78 7/16 after announcing plans to create a Japanese version of its search directory with Sumitomo Corp.

Other Internet companies rising today included K-tel International (Nasdaq: KTEL), which earlier this week announced plans to open an online music store in May, gained $1 15/32 to $21 1/8. Online bookstore Amazon.com (Nasdaq: AMZN) added $2 3/8 to $98 1/2, and online travel agency Preview Travel (Nasdaq: PTVL) climbed $1 11/16 to $35 15/16... Refractive laser technology developer VISX Inc. (Nasdaq: VISX) shot up $8 5/16 to $40 1/4, changing hands at roughly 10 times its 30-day average volume, after reporting late yesterday Q1 EPS of $0.58 compared with $0.17 for the year-earlier period. The First Call mean estimate was $0.28... Capital One Financial (NYSE: COF) leapt $9 1/16 to $97 5/16 after reporting Q1 EPS of $0.96 versus $0.63 for the year-earlier period. The First Call mean estimate was $0.88. The company is now targeting its 1998 EPS at $3.90, which is significantly higher than the analysts' average projection of $3.47.

Long-term care and medical services provider Harborside Healthcare (NYSE: HBR) jumped $2 7/16 to $23 15/16 after announcing that it has agreed to be acquired by Investcorp, an international investment firm, for $25 per share in cash in a deal valued at $291 million... Xylan Corp. (Nasdaq: XYLN) charged up $1 7/16 to $30 after the networking equipment company reported late yesterday Q1 EPS of $0.18 versus $0.13 for the prior-year quarter. Analysts had expected EPS of $0.16... Real estate developer and railway operator Florida East Coast Industries (NYSE: FLA) surged $4 15/16 to $116 7/8 after announcing a proposed 4-for-1 stock split... AmerUs Life Holdings (NYSE: AMH) picked up $1 15/16 to $33 1/16 after announcing a buyback of up to $75 million of the company's Class A common stock, expected to begin in early May, as well as its intention to pay down $250 million in debt.

S3 Inc. (Nasdaq: SIII) climbed $21/32 to $7 1/16 after announcing that Compaq Computer (NYSE: CPQ) has picked its ViRGE/MX accelerator for Compaq's new Armada 7800 notebook PC, while Toshiba has chosen the accelerator to power the graphics and video applications for its new series of Pentium II-based notebook PCs... Powerwave Technologies (Nasdaq: PWAV), which supplies RF power amplifiers for wireless communications networks, gained another $1 11/16 to $19 1/16 after reporting higher-than-expected Q1 EPS of $0.13... Dental practice management firm American Dental Partners (Nasdaq: ADPI) moved up $1 7/16 to $17 7/16 from an initial public offering price of $15.

Home furnishings retailer Ethan Allen Interiors (NYSE: ETH) added $1 7/8 to $53 7/8 after Merrill Lynch raised its rating on the company to near-term "buy" from "accumulate," while keeping its rating of long-term "buy"... Comcast (Nasdaq: CMCSK) gained $2 1/4 to $37 after Merrill Lynch reiterated it as a near-term "buy" with a 12-month target of $43... Transkaryotic Therapies (Nasdaq: TKTX) gained $7 3/4 to $36 after the drug company, along with Hoechst Marion Roussel, announced that a U.S. District Court has ruled they did not infringe on Amgen's (Nasdaq: AMGN) patent for anemia drug Epogen... Software and information technology company Systems & Computer Technology (Nasdaq: SCTC) rose $3 5/8 to $51 3/4 after announcing a 2-for-1 stock split payable May 15.

Earnings Movers

BF Goodrich (NYSE: GR) up $2 1/4 to $53 1/2; Q1 EPS (from continuing operations): $0.72 vs. $0.40 last year; Estimate: $0.62

Coastcast Corp. (NYSE: PAR) up $1 9/16 to $24; Q1 EPS: $0.44 vs. $0.13 last year; Estimate: $0.32

Yurie Systems (Nasdaq: YURI) up $2 7/8 to $31; Q1 EPS: $0.14 vs. $0.03 last year; Estimate: $0.11

Northrim Bank (Nasdaq: NRIM) up $3 to $18 3/8; Q1 EPS: $0.25 vs. $0.17 last year; Estimate: $0.19

Interphase Corp. (Nasdaq: INPH) up $2 3/8 to $9 1/2; Q1 EPS: $0.13 vs. $0.02 last year

Parametric Technology (Nasdaq: PMTC) up $3 5/8 to $34 15/16; Q2 EPS: $0.24 vs. $0.14; Estimate: $0.24

Aldila Inc. (Nasdaq: ALDA) up $1 9/16 to $7 15/16; Q1 EPS: $0.07 vs. $0.06 last year; Estimate: $0.03

Right Management Consultants (Nasdaq: RMCI) up $2 1/8 to $13 3/4; Q1 EPS: $0.22 vs. $0.11 last year; Estimate: $0.17

Durakon Industries (Nasdaq: DRKN) up $1 1/2 to $11; Q1 EPS: $0.22 vs. $0.04 last year; Estimate: $0.06

Davox Corp. (Nasdaq: DAVX) up $1 3/8 to $29 1/8; Q1 EPS: $0.35 vs. $0.31 last year; Estimate: $0.30

Equitrac Corp. (Nasdaq: ETRC) up $2 to $21 1/4; Q4 EPS: $0.24 vs. $0.20 last year; Estimate: $0.24

Aspect Telecommunications (Nasdaq: ASPT) up $2 1/8 to $31 1/8; Q1 EPS: $0.26 vs. $0.21 last year; Estimate: $0.26

Allergan Inc. (NYSE: AGN) up $2 1/4 to $39 7/8; Q1 EPS: $0.35 (before charges) vs. $0.27 last year; Estimate: $0.29


Gen-X clothing retailer Wet Seal Inc. (Nasdaq: WTSLA) tanked $3 1/2 to $32 1/4 after telling analysts that its fiscal Q1 earnings may miss estimates due to colder-than-expected March weather in California, where more than a third of its 404 stores are located. The First Call mean estimate calls for earnings of $0.27 per share in the quarter. The development was a bummer for a company that has beaten earnings estimates by an average of 42% over the four most recent quarters while operating with only slight leverage. Wet Seal had $1.8 million in long-term debt as of last November, resulting in a total debt-to-common equity ratio of only 3.6%. With lower leverage and lower margins than rivals, though, turning inventory quickly becomes even more important to generating a satisfactory return on shareholders' equity. This quarter's warning puts margins into jeopardy, due to the potential for markdowns and asset turnover. Both of those, in turn, jeopardize next quarter's results, which affects the first half of the year and estimates for the entire year, though followers of the company believe it can recover quickly from this quarter's potential stumble.

Gallium arsenide chip maker TriQuint Semiconductor (Nasdaq: TQNT) lost $2 7/16 to $21 9/16 after reporting a fiscal Q1 loss of $1.33 per share versus earnings of $0.20 per share a year ago, missing the First Call mean estimate of $0.03 per share. The company said the shortfall was due to a $1.4 million charge to settle a class action lawsuit by shareholders, integration costs related to its acquisition of Raytheon's (NYSE: RTN) MMIC unit, and problems moving its wafer fabrication business to a new facility. Unimpressed by the results, Adams, Harkness & Hill lowered its rating on the stock to "underperform" from "market perform." Last week, the company pre-announced that it would miss estimates. Traders shook off the warning and added 9% to the stock price by yesterday's close, deciding to deep-six the stock only after the final numbers rolled in and analysts failed to give the company a thumbs-up for institutional investors.

QUICK CUTS: Shaving products and batteries maker Gillette Co. (NYSE: G) lost $2 5/8 to $115 1/8 after reporting Q1 EPS of $0.47, missing the Street estimate by $0.02. The company also set a two-for-one stock split... Automaker Chrysler Corp. (NYSE: C) slid $1 11/16 to $44 3/16 after saying it will cut production of its Jeep Cherokee sport-utility vehicle at its plant in China due to lower demand... Disk drive maker Seagate Technology (Nasdaq: SEG) slipped $1 1/4 to $26 11/16 after Moody's cut its rating on the firm's senior debt to "Ba1" to "Baa3"... Drug maker Merck and Co. (NYSE: MRK) lost $4 1/16 to $119 7/16 after reporting Q1 EPS of $0.95 compared to $0.82 a year ago, which missed the First Call mean estimate by a penny.

Motor oil maker Quaker State Corp. (NYSE: KSF) was drilled for another $1 3/16 to $18 5/8 after being downgraded to "hold" from "buy" at CS First Boston. The move follows yesterday's announcement of the firm's proposed merger with the motor oil and franchise businesses of rival Pennzoil Co. (NYSE: PZL)... Specialty semiconductor company Altera Corp. (Nasdaq: ALTR) dropped $2 11/16 to $40 after reporting fiscal Q1 EPS (before an accounting change) of $0.37 versus $0.36 a year ago, which was in line with the First Call mean estimate... Open computer systems and server manufacturer Data General Corp. (NYSE: DGN) tumbled $5/8 to $16 13/16 after saying weak sales of its CLARiiON servers will result in a fiscal Q2 loss of between $0.05 and $0.15 per share. The First Call mean estimate called for earnings of $0.10 per share.

Property and casualty insurance holding company Allied Group (NYSE: GRP) fell $2 3/8 to $31 1/4 after the Wall Street Journal reported that Iowa insurance regulators are looking at transactions between the company and its Allied Mutual affiliate... Computer information systems maker Unisys Corp. (NYSE: UIS) gave back $13/16 to $20 15/16 after rising 12.5% yesterday on fiscal Q1 earnings of $0.14 per share versus a $0.06 per share loss a year ago... Guidant Corp. (NYSE: GDT) lost $5 3/4 to $67 3/16 after being downgraded to "buy" from "strong buy" at BT Alex. Brown. Yesterday, the medical devices company reported fiscal Q1 EPS of $0.62, beating the First Call mean estimate of $0.54... Darden Restaurants (NYSE: DRI) was cooked $11/16 to $17 after Lehman Brothers lowered its rating on the operator of Red Lobster and Olive Garden restaurants to "outperform" from "buy."

Offshore contract driller Ensco International (NYSE: ESV) declined $1 3/8 to $26 5/8 after reporting fiscal Q1 EPS of $0.61, beating the Street estimate of $0.58. However, the company said lower oil prices and other factors may have a negative impact on its near-term financial results... Medialink Worldwide (Nasdaq: MDLK) lost $3 3/8 to $24 3/8 after Loewenbaum & Co. downgraded the provider of audio and video production and distribution services to "buy" from "strong buy"... Quality assurance systems developer Thermedics Detection (AMEX: TDX) slid $1 7/8 to $8 1/8 after being downgraded to "hold" from "strong buy" at Gruntal & Co... Birmingham Steel Corp. (NYSE: BIR) was burned for a $13/16 loss to $16 3/16 as CS First Boston downgraded the operator of steel mini-mills to "hold" from "buy."

Earnings Movers

Lightbridge Inc. (Nasdaq: LTBG) down $2 9/16 to $11 11/16; Q1 EPS: $0.01 vs. $0.11 last year; Estimate: $0.07

Gartner Group (Nasdaq: GART) down $2 13/16 to $32 5/16; Q2 EPS: $0.19 vs. $0.18 last year; Estimate: $0.23

American Eco Corp. (Nasdaq: ECGOF) down $13/16 to $7 13/16; Q1 EPS: $0.11 vs. $0.21 last year; Estimate: $0.30

Maverick Tube Corp. (Nasdaq: MAVK) down $1 3/16 to $16 3/4; Q2 EPS: $0.30 vs. $0.19 last year; Estimate: $0.33

Parker-Hannifin Corp. (NYSE: PH) down $3 1/16 to $47 13/16; Q3 EPS: $0.75 vs. $0.70 last year; Estimate: $0.80

TCF Financial Corp. (NYSE: TCB) down $2 3/8 to $34 3/16; Q1 EPS: $0.43 vs. $0.40 last year; Estimate: $0.44

Cyberonics Inc. (Nasdaq: CYBX) down $3 5/16 to $26 1/4; Q3 EPS: $0.10 loss vs. $0.26 loss last year; Estimate: $0.12 loss

An Investment Opinion
by Alex Schay


At least for today, the company that was formed from last year's merger between HFS Inc. and CUC International will be dubbed D-Cendant. Yes, the "dominant" consumer services company Cendant Corp. (NYSE: CD), boasting more than 66 million customers through a dizzying array of shopping, travel, dining, and finance-related membership packages, dropped $16 9/16 to $19 1/16 today on roughly 22 times its average daily trading volume. The firm was pilloried by investors for "accounting irregularities" it had announced in an abbreviated conference call that it held with analysts after the bell yesterday.

Yes, the jokes come easily when describing an organization that has the hubris to come up with a company name that is short for "ascendant" and synonymous with "superior" and "on-the-rise." However, the company is the world's largest franchiser, holding the top spot in the hotel industry with such names as Days Inn, Ramada (in the U.S.), Howard Johnson, Super 8, Travelodge, Villager Lodge, Knights Inn, and Wingate Inn. The firm also operates the second largest car-rental system in the world with Avis, tax preparation services through Jackson Hewitt, residential real estate brokerages through CENTURY 21, Coldwell Banker, and Electronic Realty Associates, as well as consumer software in various multimedia forms, information technology services, credit information services, and financial products.

Clearly, the company has some powerhouse brands, which helped the stock of the fomer HFS Inc. appreciate at an 80% compound rate since the end of 1992 and the shares of the former CUC International to attain a similar period growth rate of 37%. Together the two were expected -- (no, not dead yet) are expected -- to generate enormous combined cash flows as a result of the combination of their high incremental profit margin businesses. The tremendous cross marketing opportunities between and among their membership and franchise units has analysts salivating over an expected inflow of $30.80 in pure profit per customer by the end of 1998.

However, that figure depends on what expenses have been removed from the accounting numbers. Many investors have been leery of the quality of the company's earnings over the years. In fact, this morning Howard Schilit, author of Financial Shenanigans, described Cendant as "a train wreck waiting to happen." Cendant has engaged in dozens of mergers over the last ten years and the strategy of the business to date has been one where hard assets are spun-off and intangibles like brand names are retained and utilized to make the money. This strategy helped the firm generate a strong 20% return on equity in 1997 as well as forward expectations for EPS growth above 22%, despite being (past tense) one of only ten companies with a market capitalization over $20 billion. Such a large company with such high growth expectations attracted a host of institutional investors over the years -- all of which are in shell shock today.

A large company making many acquisitions incurs what can be referred to as an "abnormally large" number of one-time charges in the process. Cendant's 1997 results bear this out. For the year, Cendant reported EPS of $1.00 per share (a 49% increase over the $0.67 per share reported for 1996) excluding all one-time charges recognized in both 1996 and 1997. Net income for 1997 increased 61% to $872.2 million, again excluding one-time charges. When giving effect to one-time charges, the company reported $0.06 in diluted EPS for 1997. So the argument goes, if one-time charges become such a recurring part of the business plan, they are by definition no longer "one-time" charges. However, the great equalizer for the company is cash flow, which is, of course, the same as earnings except over sometimes radically different time frames. Whatever your position on earnings, the substance of cash has never been called into question, and Cendant generates enormous amounts of the stuff. The company currently trades at a tantalizing 13 times cash flow (adding back all amortization).

This brings us to the substance of yesterday's announcement. Cendant's CEO Henry Silverman reported that in the process of transferring the accounting functions from the former CUC to the former HFS in preparation for the company's Q1 1998 report, "irregularities" were uncovered. Hence the finger pointing at CUC. Silverman stated that the company will have to restate 1997 results, shaving off $100-115 million from the net income figure as well as a $0.11-$0.13 from the pre-one-time charge EPS. Accordingly, analysts have to take off a similar amount from expected 1998 earnings numbers. Silverman noted that two-thirds of the reduction relates to non-cash charges, leading many to believe that the problem stems from the company's amortization of marketing expenses.

This topic has been a great bone for the popular business press to gnaw on in the past. Any expense that is not, well... immediately expensed, raises eyebrows outside the traditional financial community. However, GAAP accounting incorporates something called "the matching principle," whereby revenues need to be accompanied by their respective expenses. The problem arises when expenses are incurred for revenues that have yet to materialize. So let it be with America Online (NYSE: AOL), way back when it was amortizing its subscriber acquisition costs. All those disks that AOL sent out in its direct marketing efforts to gain subscribers cost money for which it often didn't see revenues until way down the road. So, AOL amortized those costs and was almost brought to its knees by the popular business press. The argument actually turned not on whether or not the practice was legal (it's de rigueur for accounting purposes), but over what period the company decides to amortize those costs. If the company is spreading those costs over too many years (more years than the actual revenue is coming in), it ends up reducing its expenses inordinately and pumping up its earnings.

So, how does Cendant account for its subscriber (read: membership in one of its 20 plans) acquisition costs? Here it is from the 10-K:


Membership acquisition costs are deferred and charged to operations as membership fees are recognized. These costs, which relate directly to membership solicitations (direct response advertising costs), principally include: postage, printing, kits, mailings, publications (including coupon books) and telemarketing costs. Substantially all of these costs are incurred for services performed by outside sources. Such costs are amortized on a straight-line basis as revenues are realized over the average membership period (generally one to three years)...Amortization of membership acquisition costs, including deferred renewal costs, which consist principally of charges from sponsoring institutions and publications, amounted to $617.6 million, $641.3 million and $556.6 million for the years ended December 31, 1997, 1996 and 1995, respectively.

So, the company sets up an asset account and slowly begins to boil it down according to whatever relevant schedule it has set up (AOL users, please expand screen to view tables):

December 31, 1997

ASSETS                                          1997       1996 
 Cash and cash equivalents                     $149.5     $633.9 
 Receivables, (net of allowance for doubtful 
 accounts of $108.0 and $106.9)               1,648.8    1,290.6 
 Deferred income taxes                          226.5      141.3 
 Other current assets                           550.5      463.8  
 TOTAL CURRENT ASSETS                         2,575.3    2,529.6 
 Deferred membership 
 acquisition costs                              424.5      401.6

Now, looking at the company's 1997 results including all charges it becomes clear how dramatic any fluctuation in these costs can be:
                                        1997        1996       1995 
 Membership and service fees--net    $4,589.0    $3,433.9   $2,606.2 
 Fleet leasing (net of depreciation 
 and interest costs of 
 $1,205.2, $1,132.4 and $1,089.0)        59.5        56.7       52.1 
 Other                                  666.2       418.2      333.8 
 NET REVENUES                         5,314.7     3,908.8    2,992.1
 Operating                            1,555.5     1,392.8    1,110.9  
 Marketing and reservation            1,266.3     1,089.5      875.2  
 General and administrative             727.2       339.6      279.5 
 Depreciation and amortization          256.8       167.9      112.9 
 Interest--net                           66.3        25.4       13.3 
 Merger-related costs and 
 other unusual charges                1,147.9       179.9       97.0 
 Total expenses                       5,020.0     3,195.1    2,488.8 
 INCOME BEFORE INCOME TAXES             294.7       713.7      503.3 
 Provision for income taxes             239.3       290.1      200.5  
 NET INCOME                             $55.4      $423.6     $302.8 

Anyway, much of this is pure speculation because the company has yet to report the exact nature of the restatement. In addition, the total amortization for the year reported in the 10-K passage is not reflected in the year-end amount highlighted here (they may be distributed through numerous accounts). A closer look at these issues can help investors assess the true impact of the coming adjustments. Assuming that the amounts quoted by Silverman are going to be the only adjustments that are made, Cendant's cash flow generating capabilities make the company very attractive at these levels. Dale Wettlaufer will take up these issues in tomorrow's Fool on the Hill as part of our Motley Fool tag-team extravaganza.


Please see the Motley Fool's Conference Calls page for call information and links to synopses.

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Yi-Hsin Chang (TMF Puck), a Fool
Brian Graney (TMF Panic), Fool Two
Alex Schay (TMF Nexus6), Fool, too
Dale Wettlaufer (TMF Ralegh), Final Fool
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Brian Bauer (TMF Hoops), another Fool
Jennifer Silber (TMF Amused), Fool at last

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