<THE EVENING NEWS>
Thursday, July 16, 1998
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HEROES

Computer products maker Apple Computer (Nasdaq: AAPL) triggered a continuation of its 1998 rally, rising $3 1/16 to $37 1/2 after reporting fiscal third quarter net income of $101 million, or $0.65 a share, on revenues of $1.4 billion. Excluding one-time items, net profits were $75 million or $0.50 per share, a figure that made sauce out of the $0.33 per share consensus analyst estimate. While sales were flat sequentially and down 19% from the year-ago period, gross margins reached their highest level in three years, climbing to 25.7% from 24.8% in the second quarter. That was due to a sequential increase in the average Mac selling price to $2,130 from $2,089.

Mattel Inc. (NYSE: MAT) picked up $2 11/16 to $40 15/16 after the maker of Barbies, Hot Wheels, and other toys reported fiscal Q2 earnings of $0.20, which was in line with the Street's estimate and a warning from the company on June 15. Revenues slid 13% from a year ago to $861.5 million due to a $72 million reduction in sales to toy retailer Toys R Us (NYSE: TOY), a $16 million reduction tied to unfavorable foreign exchange conversion rates, and a $28 million decrease related to discontinued product lines. However, CEO Jill Barad said she is "confident" that the company will hit its planned 18% earnings per share growth for fiscal 1998, meeting full-year estimates of $1.95 per share. Additionally, second half shipments to Toys R Us are expected to be higher than during the same period a year ago, supported by tie-in products related to Walt Disney's (NYSE: DIS) upcoming movie A Bug's Life and The Rugrats Movie from Viacom's (NYSE: VIA) Nickelodeon unit.

Biotechnology company and cancer cure researcher EntreMed Inc. (Nasdaq: ENMD) gained $1 7/8 to $32 1/4, benefiting from today's decision by the Food and Drug Administration to allow Celgene Corp. (Nasdaq: CELG) to market the drug thalidomide as a treatment for a rare form of leprosy. Celgene actually lost $1 5/8 to $12 1/2 on the announcement -- possibly as investors moved their money into EntreMed, which hopes to receive FDA approval to sell thalidomide as an anti-cancer agent. That approval, while potentially more lucrative than the leprosy green light, is still at least two years away, according to EntreMed. Today's approval is a first for the FDA -- thalidomide was never approved in the U.S. in the 1960s when it was used in several foreign countries as a sedative for pregnant women. The drug caused thousands of birth defects, however, and was ultimately banned worldwide.

QUICK TAKES: Photo film company Eastman Kodak (NYSE: EK) rose another $4 1/2 to $87 after reporting Q2 EPS of $1.51 yesterday, spanking estimates of $1.13... Software giant Microsoft Corp. (Nasdaq: MSFT) stayed at $117 3/8 today prior to reporting fiscal Q4 EPS of $0.50 after the bell, up from $0.40 last year and beating the Street's estimate of $0.48.... Workstations and Java programming language developer Sun Microsystems (Nasdaq: SUNW) gained $9/16 to $49 15/16. After the close, the company reported Q4 EPS of $0.73 (excluding a charge) compared to $0.61 last year, beating estimates by a penny.

Telecommunications transmission and network access systems maker Tellabs (Nasdaq: TLAB) climbed $6 1/16 to $84 3/4 after reporting fiscal Q2 EPS of $0.46 (excluding gains and write-offs), which was $0.04 ahead of the Street's expectations. A replay of today's conference call is available at (800) 633-8284, access number 4486331... Data and multimedia network operator Qwest Communications (Nasdaq: QWST) advanced $2 1/8 to $42 1/8 on speculation that the company may be an acquisition target in the eyes of telecommunications services company British Telecommunications (NYSE: BTY)... Direct PC marketer Gateway (NYSE: GTW) gained $4 1/8 to $67 1/16 after setting new prices for its G-Series line of PCs between $1,568 and $3,499.

Zip and Jaz drive maker Iomega Corp. (NYSE: IOM) added $3/8 to $6 1/16 ahead of its fiscal Q2 earnings release. After the close the company reported a loss of $0.13 per share. A conference call with analysts regarding the release is accessible via this link... PC maker Micron Electronics (Nasdaq: MUEI) gained $1 1/4 to $14 3/4 after being upgraded by BancAmerica Robertson Stephens to "buy" from "long-term attractive"... Internet software and portal company Netscape Communications (Nasdaq: NSCP) advanced $1 13/16 to $33 1/4 after launching a public beta test version of its Communicator 4.5 Internet browser... Gallium arsenide chip maker Anadigics Inc. (Nasdaq: ANAD) tacked on $4 5/16 to $17 3/4 after reporting fiscal Q2 EPS of $0.02, beating the Street's estimate by a penny. Sales of chips for fiber optics products rose 52% from year ago levels, while cable TV chip sales increased 37% in the period.

Trash hauler Waste Management (NYSE: WMX) picked up $1 13/16 to $41 11/16 after the Justice Department cleared the firm's merger with USA Waste Services as long as the companies divest about $275 million of waste disposal, transfer, and collection services assets in some metropolitan markets... Eye care and specialty pharmaceuticals maker Allergan Inc. (NYSE: AGN) moved up $4 7/16 to $54 1/2 after reporting fiscal Q2 EPS of $0.52 (excluding gains and charges), walloping the Street's estimate of $0.37... Software support services and engineering tools developer Rational Software Corp. (Nasdaq: RATL) rose $15/16 to $17 3/16 after reporting fiscal Q1 EPS of $0.09, which was in line with the Street's estimate. Net income increased 56% to $8 million.

Regional Bell operating company SBC Communications (Nasdaq: SBC) advanced $1 1/8 to $40 3/4 after reporting fiscal Q2 EPS of $0.52, beating the First Call mean estimate by $0.02. BT Alex. Brown started coverage of the company with a "market perform" rating... Local exchange carrier Allegiance Telecom (Nasdaq: ALGX) added $5/8 to $15 1/16 after Goldman Sachs placed the company on its "recommended list"... Cardiac and vascular surgical products maker Guidant Corp. (NYSE: GDT) was pumped up $6 1/4 to $87 7/16 after SG Cowen started the company with a "strong buy" rating. J.P. Morgan and Morgan Stanley Dean Witter also raised their fiscal 1998 earnings estimates... Greensburg, Pennsylvania-based bank Southwest National Corp. (Nasdaq: SWPA) zoomed $19 1/4 to $74 1/4 after agreeing to be acquired by First Commonwealth Financial (NYSE: FCF) in a $268 million stock swap. First Commonwealth fell $2 15/16 to $27 5/8.

Earnings Movers

Altera Corp. (Nasdaq: ALTR) up $2 1/8 to $38 7/8; Q2 EPS: $0.38 vs. $0.41 last year; Estimate: $0.38

Ameritech Corp. (NYSE: AIT) up $2 to $49 3/4; Q2 EPS: $0.63 vs. $0.57 last year; Estimate: $0.62

Cincinnati Bell (NYSE: CSN) up $1 9/16 to $32 13/16; Q2 EPS: $0.31 vs. $0.39 last year; Estimate: $0.28

Cummins Engine Co. (NYSE: CUM) up $3 5/16 to $54 3/4; Q2 EPS: $1.38 vs. $1.38 last year; Estimate: $1.35

International Game Technology (NYSE: IGT) up $1 13/16 to $25 7/8; Q3 EPS: $0.40 vs. $0.29 last year; Estimate: $0.34

Legato Systems (Nasdaq: LGTO) up $5 1/8 to $44 3/4; Q2 EPS: $0.15 vs. $0.08 last year; Estimate: $0.14

National Data Corp. (NYSE: NDC) up $3 1/2 to $43 13/16; Q4 EPS: $0.47 vs. $0.36 last year; Estimate: $0.46

Navarre Corp. (Nasdaq: NAVR) up $1 1/16 to $6 3/16; Q1 EPS: Breakeven vs. $0.15 loss last year

Tower Automotive (NYSE: TWR) up $2 1/16 to $24 13/16; Q2 EPS: $0.46 vs. $0.25 last year; Estimate: $0.45

Ucar International (NYSE: UCR) up $2 3/8 to $30 1/4; Q2 EPS: $0.67 vs. $0.89 last year; Estimate: $0.66

GOATS

American Airlines parent AMR Corp. (NYSE: AMR) dropped another $4 13/16 to $78 11/16 after yesterday beating second quarter EPS estimates by a nickel. Apparently some investors had hoped that the company would top even the highest expectations and repeat its performance from the first quarter, when profit had increased 91%. AMR also said it has seen increasing pressure in its Asia and Latin America markets, which it expects will continue in the second half of the year. Donaldson, Lufkin & Jenrette cut its rating on the company to "market perform" from "buy," while Gruntal & Co. lowered its rating to "hold" from "buy." Other airlines, which have yet to report earnings, fell as well today. United Airlines parent UAL Corp. (NYSE: UAL) lost $9/16 to $87 13/16; US Airways Group (NYSE: U) slipped $1/2 to $76 5/16; and Delta Air Lines (NYSE: DAL) dropped $1 5/8 to $135 1/2.

PC graphics accelerator firm 3Dfx Interactive (Nasdaq: TDFX) sank $3 15/16 to $17 3/8 on nearly four times its 30-day average trading volume despite reporting late yesterday second quarter earnings of $0.54 a share compared with a loss of $0.19 a year ago and topping the mean estimate of $0.48. Last quarter, 3Dfx reported EPS that was more than twice what analysts had predicted, so investors may have been counting on a huge earnings surprise. According to one poster on the Fool's 3Dfx message board on the Web, the "whisper number" may have been around $0.82 a share. The company's shares had run up almost $5, or 30%, in just over a week in advance of this earnings report. The company today announced partnerships with six advertising and PR agencies in the U.S. and Europe to develop the company's global branding campaign.

QUICK CUTS: Coca-Cola Co. (NYSE: KO) slipped $5/8 to $87 3/16 after reporting Q2 EPS of $0.47 (excluding unusual items), compared with $0.45 in the year-ago period and in line with analysts' estimates. Lehman Brothers cut its rating on the Atlanta-based company to "outperform" from "buy"... Defense contractor Northrop Grumman (NYSE: NOC) fell $5 11/16 to $97 3/8 on news of a breakdown in talks to overcome the government's objections of Lockheed Martin's (NYSE: LMT) proposed $10.7 billion bid to acquire the company... Buildings, industrial, space, and aviation controls manufacturer Honeywell Inc. (NYSE: HON) dropped $4 3/8 to $85 5/8 after reporting Q2 EPS of $0.89 (before unusual gains), missing the analysts' mean estimate of $0.93... System-level integrated circuits maker Cirrus Logic (Nasdaq: CRUS) lost $1 13/16 to $10 5/8 after reporting Q1 EPS of $0.01, down from $0.04 last year and a penny ahead of estimates. The company said it anticipates a further decline in its storage business and reduced revenues for the next quarter.

Biotechnology and drug company ICN Pharmaceuticals (NYSE: ICN) tanked $5 to $33 5/8 after announcing late yesterday that it plans to take a Q2 charge of around $172 million, or $1.65 a share, to cover a default on notes receivable due to the company from an agency of the government of Yugoslavia. Excluding the charge, the company expects to meet current Q2 estimates... Internet advertising company DoubleClick (Nasdaq: DCLK) dropped $4 1/4 to $48 7/8 after reporting a Q2 loss of $0.28, worse than last year's loss of $0.11 but in line with estimates... Vanstar Corp. (NYSE: VST), which provides services and products to design and manage computer network infrastructures, sank $3 3/16, or 21%, to $12 after announcing it anticipates Q1 earnings from continuing operations to be between a loss of $0.05 per share and a profit of $0.05, far short of analysts' estimates of $0.21 per share.

Automated semiconductor wafer fabrication systems maker Novellus Systems (Nasdaq: NVLS) slipped $1/2 to $37 1/2 after reporting fiscal Q2 EPS of $0.46 compared to $0.50 (excluding one-time charges) a year ago, which was in line with the Zacks mean estimate... Printer manufacturer Electronics for Imaging (Nasdaq: EFII) lost $3 7/16 to $18 11/16 after reporting Q2 EPS of $0.13, down from $0.41 a year ago but meeting estimates... Enterprise network management and security company Check Point Software Technologies (Nasdaq: CHKPF) tumbled $3 5/8 to $27 5/8 despite reporting Q2 EPS of $0.43, up from $0.20 a year ago and beating estimates of $0.36. Investors are reportedly worried that the company may be facing a revenue shortfall.

Healthcare management software developer HBO & Co. (Nasdaq: HBOC) plunged another $3 3/4 to $30 in the wake of healthcare supplies distributor McKesson Corp. (NYSE: MCK) calling off discussions with the company regarding a "potential business combination"... Golf sportswear designer Ashworth Inc. (Nasdaq: ASHW) plummeted $3 13/16 to $9 after warning that Q3 earnings will be flat or slightly above last year's due to quality-control problems with some of its styles made in other countries. The problems may also hurt Q4 earnings... Internet service provider At Home Corp. (Nasdaq: ATHM) lost $2 5/8 to $50 1/8 after reporting a Q2 loss of $0.10, in line with estimates.

VLSI Technology (Nasdaq: VLSI) was cut $1 5/16 to $19 3/16 after reporting a 19% drop in Q2 revenues and EPS of $0.14, down from $0.26 in the prior-year period... Able Telecom Holdings (Nasdaq: ABTE) dropped $2 3/4 to $11 5/8 after Asensio & Co. issued a "strong sell" and "short sell" recommendation on the telecommunications equipment maker... Computer security products firm Security Dynamics Technologies (Nasdaq: SDTI) fell $3 3/8 to $16 after announcing it expects sales to continue to slow this year to $177 million from $185 million last year... Software company Broadway & Seymour (Nasdaq: BSIS) dipped $3/4 to $6 7/8 as talks to sell its customer and financial services unit ended and it now expects a Q2 loss of $0.27 to $0.29 a share. Analysts had been predicting a penny loss.

FOOL ON THE HILL
An Investment Opinion
by Alex Schay

CAPacious Investing

The human desire for "certainty," in all of its elusive incarnations, places a premium on value that can be justified in a quantitative fashion. The million-dollar capital allocation decisions being made by money managers on a daily basis are rarely justified by an appeal to "feelings." However, in the absence of really concrete, helpful data, investors are forced to either concede that meaningful projections can simply not be made or that they are going to try anyway -- understanding that any conclusions that are reached are also subject to dramatic reappraisal.

To a certain extent, all "high-tech" initial public offerings dwell in this netherworld, where meaningful information -- of the kind that can provide an inkling about what is going to happen in the future -- is often elusive. As Graham & Dodd stressed in Security Analysis way before the technology explosion of recent years made the competitive landscape even more robust:

"Unseasoned companies in new fields of activity provide no sound basis for the determination of intrinsic value. The risks inherent in the business, an untested management, and uncertain access to additional capital combine to make an analytical determination of value unlikely if not impossible. The buyer of such securities is not making an investment but a bet on new technology, a new market, a new service, or an innovation in established product markets. Winning bets on such situations can produce very rich rewards, but they are an odds setting rather than a valuation process."

As noted in the opening, this doesn't mean that investors aren't going to try -- or at least construct justifications for building investment houses on untried foundations. When looking at the economic drivers of a business that really matter, one can begin with cash flow, which should be an assessment by the individual investor that more money will be taken out of the business over time than was initially put in. That is hardly controversial stuff. Another element is risk, which is commonly reflected in cost of capital calculations, where a determination is made about the return a company must earn on its existing assets in order to meet creditor and shareholder expectations -- and thus keep its share price constant.

The final, and most neglected variable in the economic driver calculation, is the company's competitive advantage period, or CAP (if it indeed has one). CAP is defined as the period of time during which a company is expected to generate returns on incremental investment that exceed its cost of capital, thereby creating value. A structured framework for assessing a company's CAP, which is measured in years, has been offered by Michael Porter in his book Competitive Strategy, as well as in a more recent high tech realm version provided by the authors of The Gorilla Game. One of the key determinants of CAP is a company's current return on invested capital (ROIC), where, generally speaking, the higher a company's ROIC (compared with other players in its business) the better it is situated in competitive terms -- because the ratio often reflects some form of competitive advantage, like economies of scale or superior management. Other factors that affect CAP include the overall rate of change in the company's industry (where high returns in a dynamic business like computer software are not valued as generously as high returns in say, the beverage business) and barriers to entry in the business.

These CAP drivers are instructive when assessing the potential of a company like Broadcast.com Inc. (Nasdaq: BCST), a coming IPO that announced today that it will sell 2.5 million of its shares (a 15% stake) in a price range between $14 to $16, up from the $11 to $13 that it had initially forecast -- thanks to strong demand. The artist formerly known as AudioNet is an aggregator and broadcaster of media programming on the web. The company's websites offer a huge assortment of live and on-demand audio and video programming, including sports, talk and music radio, television, business events, full-length CDs, news, commentary, and full-length audio-books. As well as providing an enormous amount of content -- primarily through exclusive licensing arrangements -- the company provides business services, allowing companies to shoot all manner of business data to targeted desktops.

The company has yet to generate any operating earnings, which makes ROIC calculations impossible. For the three months ended March 31, Broadcast.com reported revenues of $3.2 million and a net operating loss of $2.997 million. It has an accumulated trailing operating deficit of $8.560 million, and plans to use its coming IPO funds (a potential $40 million) to expand its distribution network, increase marketing, acquire additional content, and upgrade its technology. Looking at the second CAP driver of overall industry competition, the company says it best in its boilerplate language (from its S-1 filing):

"The market for Internet broadcasting and services is highly competitive and the Company expects that competition will continue to intensify. The Company competes with (i) other Web sites and Internet broadcasters to acquire and provide content to attract users, (ii) videoconferencing companies, audio conferencing companies and Internet broadcasters, (iii) online services, other Web site operators and advertising networks, as well as traditional media such as television, radio and print, for a share of advertisers' total advertising budgets and (iv) local radio and television stations and national radio and television networks for sales of advertising spots... In addition, as the Company expands the scope of its content and services, it will compete directly with a greater number of Web sites and other media companies. Because the operations and strategic plans of existing and future competitors are undergoing rapid change, it is extremely difficult for the Company to anticipate which companies are likely to offer competitive services in the future."

Therein lies some fodder for the company's detractors. They maintain that the firm is essentially providing a commodity offering -- even most of the exclusive licenses are open for renegotiation after two years -- and that the technology barriers are not that high for its existing partners to go it on their own. "If media streaming technology and backbone bandwidth becomes more readily available to companies at low prices, the Company's customers may decide to broadcast their own programming. In particular, local exchange carriers, ISPs and other data communication service providers may compete in the future with a portion of or all of the Company's business services as technological advancements facilitate the ability of these providers to offer effectively these services."

Despite the theoretical low barriers to entry -- which were incidentally also mentioned by Amazon.com IPO commentators -- the company maintains that its early entrance into the Internet broadcasting market has enabled it to establish "strong brand recognition for its broadcasts and services" and to form relationships with a diverse range of content providers. However, in the cold light of CAP inputs, the company is by its own admission susceptible to competitive threats on multiple fronts. As well, the decision to change its name to Broadcast.com has some of us grizzled Internet veterans (of two whole years) scratching our heads -- this columnist's immediate reaction to its early year IPO announcment came in the form of a question, "Won't they compete with AudioNet?" Which may just reveal more ignorance on this columnist's part than any brand erosion.

So what portions of the previously mentioned economic drivers remain? Risk is out the window, or in theoretical terms too hard to quantify because the possible outcomes are dictated by a highly dynamic and unfamiliar landscape -- and cash flows end up being pure guesswork too. Does that mean investors shouldn't buy into Broadcast.com? Absolutely not... it just doesn't really qualify as an "investment" yet. To quote Graham & Dodd, it's a "bet on technology" that certainly, viewing recent history, isn't an unprofitable undertaking.

CONFERENCE CALLS

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Contributing Writers
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

Editing
Brian Bauer (TMF Hoops), another Fool
Bob Bobala (TMF Bobala), a Fool's Fool
Jennifer Silber (TMF Amused), Fool at last

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