Tuesday, October 6, 1998
DJIA            7742.98    +16.74      (+0.22%) 
 S&P 500          984.59     -3.97      (-0.40%) 
 Nasdaq          1510.89    -25.80      (-1.68%) 
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 30-Year Bond   112 9/32     -6/32  4.73% Yield 


Cellular phone and telecommunications equipment company Motorola (NYSE: MOT) rolled $3 1/4 higher to $41 13/16 after reporting fiscal Q3 EPS of $0.07 before charges, down from the $0.51 earned last year but $0.06 above the Street's downwardly revised mean estimate. The company said it is beginning to see "some early signs of progress" from its ongoing restructuring program, adding that it is "on track to achieve its goal of an annualized savings rate of at least $750 million by mid-1999." The firm also took out its crystal ball and predicted that its chip sales will pick up next year and that its fourth quarter earnings will be at least even with analysts' expectations of $0.22 per share. The rosy forecasts suit Motorola shareholders to a "T," which in this case stands for "Turnaround." More details on the Q3 report are available in today's Breakfast With the Fool.

Enterprise Year 2000 problem solver Data Dimensions (Nasdaq: DDIM) rose $2 9/16 to $12 13/16 after bucking the recent general earnings warning trend by saying it expects its fiscal Q3 EPS will come in about 40% above analysts' estimates of $0.19. Revenues are expected to post a 90% increase from the $17.6 million figure recorded last year, thanks largely to strong demand for the company's information technology consulting services. The firm said business is "strong across the board" and that it expects further revenue and earnings growth in Q4. The results and guidance are good news for the Bellevue, Washington-based firm's shareholders, who have watched Data Dimensions' share price steadily drop from its perch at $35 1/4 per share exactly one year ago. Fellow millennium bug exterminator Keane Inc. (AMEX: KEA) rose $2 3/8 to $30 1/2 today, as well.

QUICK TAKES: Electronics and used car retailer Circuit City Stores (NYSE: CC) tacked on $2 9/16 to $33 5/16 after reporting an 11% increase in September same-store sales at its namesake electronic and appliance outlets. Meanwhile, same-store sales at its CarMax stores slid 3% during the month compared to a year ago... Retailing giant Wal-Mart Stores (NYSE: WMT) gained $2 1/4 to $59 1/4 after reporting a 9% increase in same-store sales at its namesake outlets during September compared to the same month a year ago. Same-store sales at its Sam's Clubs outlets rose 11.4% year-over-year during the month... Programmable logic chip maker Xilinx Inc. (Nasdaq: XLNX) rose $2 1/16 to $33 15/16 after PaineWebber started coverage with a "buy" rating.

Aftermarket car retail and service chain Pep Boys - Manny, Moe & Jack (NYSE: PBY) drove $11/16 higher to $14 1/16 after saying it will sell 100 of its nonservice/nontire format Express stores to rival AutoZone (NYSE: AZO) for $108 million in cash. The Boys also reported a 9.5% increase in comparable store sales for the third quarter... Electronic enclosure, thermal management, and industrial tool products firm Applied Power (NYSE: APW) charged ahead $2 5/8 to $23 3/8 after reporting fiscal Q4 EPS of $0.53, up from $0.41 a year ago and $0.03 ahead of the Street's mean estimate... Aluminum and alumina producer Alcoa (NYSE: AA) stamped out a $4 5/16 gain to $72 1/2 after reporting fiscal Q3 EPS of $1.22, beating the First Call mean estimate of $1.06.

Glaxo Wellcome (NYSE: GLX) gained $1 5/8 to $54 1/16 as the drugmaker's lamivudine drug was recommend for approval by an FDA advisory panel today as a once-a-day treatment for patients with chronic hepatitis B virus... Biotechnology firm Biogen Inc. (Nasdaq: BGEN) climbed $3 3/16 to $68 3/8 after reporting fiscal Q3 EPS of $0.49, matching the Street's mean estimate... Gene discovery and testing services firm Myriad Genetics (Nasdaq: MYGN) added $1 1/2 to $11 3/8 after Germany's Schering AG signed a five-year agreement to use Myriad's protein interaction technology to develop new drugs, which could be worth a total of $51 million in fees to Myriad.

Telecommunications construction and maintenance services provider Dycom Industries (NYSE: DY) tacked on $3 7/16 to $30 1/4 after withdrawing a proposed 3 million share secondary offering due to "current market conditions"... Coronary stent maker Boston Scientific Corp. (NYSE: BSX) picked up $2 5/8 to $52 5/8 despite recalling its "NIR ON Ranger with Sox" stent due to reports of balloon leakage in the system. Rival Guidant (NYSE: GDT) gained $2 5/8 to $70 3/16 and Arterial Vascular Engineering (Nasdaq: AVEI) rose $1 7/8 to $37 5/8... Network security products maker Network Associates (Nasdaq: NETA) added $1 3/8 to $28 after announcing it will offer free upgrades of its Total Virus Defense product suite to users of Intel's (Nasdaq: INTC) LANDesk Virus Protect products, which were recently sold to Network Associates rival Symantec (Nasdaq: SYMC).


Along with issuing its third earnings warning in as many quarters, Sports Authority (NYSE: TSA) announced a change in its game plan this morning, opting to cut from its roster 18 stores that the sporting goods retailer says have been holding back the team's annual earnings per share by $0.18 to $0.20. But this means the company will take an after-tax third quarter charge of $55 million, or $1.72 a share, to cover the closings as well as asset impairments for six stores that will stay open, inventory writedowns, severance pay, tax restructuring costs, and other corporate charges. Including the hefty charge, Sports Authority expects a loss of $1.99 to $2.04 per share for the quarter. Before the charge, the company anticipates a smaller loss -- though a loss nonetheless -- of $0.27 to $0.32 a share, wider than the analysts' mean EPS estimate of a loss of $0.02 a share. Last year, the retailer made $0.06 a share in profit during the same period. The company also forecasts a 5% to 5.5% decline in comparable store sales for the quarter as business continues to suffer because of the "difficult" footwear environment. Sports Authority was slammed for a $1 1/16 loss to $5 11/16.

Storage management software developer Veritas Software Corp. (Nasdaq: VRTS) announced it will acquire the Network and Storage Management Group (NSMG) of computer disk drive manufacturing giant Seagate Technology's (NYSE: SEG) software division. In exchange, Veritas will issue about 33 million shares, valued at around $1.6 billion, to Seagate, giving it a 35% stake in Veritas. Investors pummeled Veritas shares, which plunged $19 3/16 to $26 3/16, on concern that it may be paying too high a price and may not be able to write off much of it as one-time in-process research and development (R&D). The company reportedly told analysts yesterday that it plans to write off $500 million as R&D and amortize $1 billion over three to five years, or roughly $80 million a quarter. Veritas rival Legato Systems (Nasdaq: LGTO) sank $8 7/8 to $31 1/8 after Warburg Dillon Read lowered its rating on the company to "hold" from "buy," saying that Legato's market position could be limited with Veritas more than tripling the estimated size of its 1999 business with the planned acquisition. To listen to a replay of Seagate's conference call last night, dial (800) 475-6701 and use access code 409401.

QUICK CUTS: Pfizer (NYSE: PFE) fell $5 1/2 to $89 1/4 on market research showing that U.S. new prescriptions for its popular impotence drug Viagra dropped 6% in the week ending September 25, while refills were down 5%... Lucent Technologies (NYSE: LU) slipped $1 5/16 to $57 9/16 after announcing it has acquired privately held Quadritek Systems Inc., which develops next-generation Internet Protocol (IP) network administration software, for about $50 million in cash... America Online (NYSE: AOL) was cut $5 1/2 to $97 1/2 after announcing the resignation of its chief technical executive, Michael Connors, who is credited with building the company's network during six years of rapid subscriber growth -- from about 100,000 in 1992 to more than 13 million members today.

Office supplies retailer OfficeMax (NYSE: OMX) slid $7/8 to $7 7/8 after warning it expects Q3 operating income will fall short of the analysts' consensus estimate of $0.31 per share due to lower-than-expected computer and business machine sales... Columbia/HCA Healthcare (NYSE: COL) fell $1 3/8 to $17 7/8 on news that the Justice Department has joined a whistleblower lawsuit against the healthcare company and Quorum Health Group (Nasdaq: QHGI) that alleges widespread Medicare fraud... Financial services firm Conseco (NYSE: CNC) shed $1 3/4 to $27 as the company said in a statement in response to questions from investors that it remains "comfortable" with analysts' mean EPS estimate for the third quarter.

Internet commerce application software company Open Market (Nasdaq: OMKT) plunged $2 3/8 to $6 after pre-announcing a Q3 loss of $0.17 to $0.20 per share due to revenue shortfalls in Asia and lower-than-anticipated sales of its Folio products... IndyMac Mortgage Holdings (NYSE: NDE) tumbled $6, or 37.5%, to $10 as Fitch IBCA placed the mortgage real estate investment trust's credit ratings on RatingAlert negative, indicating that they could be lowered. Fitch IBCA voiced concerns about IndyMac's reliance on short-term collateralized funding... CD, DVD, and diskette manufacturer Zomax Optical Media (Nasdaq: ZOMX) was cut $5 7/16 to $4 11/16 after warning that it expects Q3 EPS of $0.10 to $0.12, short of analysts' mean estimate of $0.21. The company blamed the shortfall on a product mix change and a 70% drop in diskette sales as CD sales increased.

Gatorade, oatmeal, and Rice-a-Roni maker Quaker Oats Co. (NYSE: OAT) fell $3 3/8 to $61 1/8 after Donaldson, Lufkin & Jenrette lowered its rating on the company to "market perform" from "buy," saying that sales growth in the last two quarters was driven by strong Gatorade sales this summer and isn't sustainable... Life insurance and annuity products company AmerUs Life Holdings (NYSE: AMH) tanked $3 15/16 to $14 3/4 after saying it expects Q3 operating EPS of $0.33 to $0.37, below the consensus estimate of $0.59. The company also announced plans to buy back up to an additional $25 million in stock... Olicom A/S (Nasdaq: OLCMF) American depositary receipts plunged $4 15/16, or 35.1%, to $9 1/8 after the Danish computer network equipment maker said Q3 EPS missed estimates because of lower prices for PC networks.

Hearst-Argyle Television (NYSE: HTV) was tuned out for a $2 9/16 loss to $28 7/16 as Merrill Lynch downgraded its long-term rating on the broadcaster, along with A.H. Belo Corp. (NYSE: BLC), to "accumulate" from "buy," calling the stocks expensive... Continued softness in its U.S. financial services business has led consumer marketing information company NFO Worldwide (NYSE: NFO) to warn that it expects Q3 EPS of $0.11 to $0.13, lower than last year's $0.19 and analysts' expectations of $0.25. The company's shares lost $2 1/8 to $5 3/4.

An Investment Opinion
by Dale Wettlaufer

Asset-Backed Carnage

The carnage continues to spread in the mortgage investing sector and among companies involved in the securitization of loans. Yesterday, mortgage real estate investment trust Criimi Mae (NYSE: CMM) declared chapter 11 bankruptcy, having been caught in a severe balance sheet squeeze play. With recent conditions in the fixed income markets, many companies with low-quality credits on the balance sheet or business models that rely on low-quality credits passing through the balance sheet have been totally blown out of the water.

This isn't a new development, though. Green Tree Financial has been flailing for just about a year now, thanks to prepayments customers make on loans coming in at a more rapid rate than the company had modeled in its earnings assumptions. Again we face the fact that Generally Accepted Accounting Principles inject earnings with all sorts of assumptions as to what might likely happen. What is likely is only a strong possibility, or else it would be a certainty -- a cash stream of earnings now, today. If it's likely to happen, then there is a possibility that it won't happen. You can write some of these things off as "one-time events," but the hits to owners' equity on recording those one-time events go down to the retained earnings line, wiping out earnings that have been booked in past periods.

Cash flow statements cover this stuff well enough, though, that one can figure out what is happening on the basis of cash going in and cash going out. Criimi Mae actually had shown positive cash flow from operations through the first six months of 1998, unlike many companies involved in the subprime lending and securitization game. And its cash income wasn't that far off from its reported income. But the problem was the company's accelerating investment in loans and subordinated collateralized mortgage-backed securities this summer -- the worst time over the last five years that you could have chosen to step on the gas pedal.

Total assets on the balance sheet increased just under $1 billion through the end of the first half of the year, while total liabilities increased just over $700 million. Meanwhile, cash flow from operations declined 32% year-over-year through the first six months of the year. Here's the company's condensed cash flow statement through June:

                                1998          1997 
 Net income...............$59,239,811   $29,511,726 
 Net cash provided  
 by operating activities...16,482,103    24,168,832 
 Net cash (used in)  
 investing activities....(905,018,750)  (16,506,126) 
 Cash flows from  
 financing activities: 
 Net cash provided by  
 (used in) financing  
 activities...............906,851,021    (1,745,451)
This is a lot of cash going into the business without much coming out as a return on capital. On average assets in the neighborhood of $2.36 billion, the company's cash return on assets of 1.4% wouldn't be bad if the asset quality was there. But as we can see below, the company's asset base consisted largely of subordinated interests in mortgage securities, which like any other fixed income instruments are priced off the net present value of expected cash flows of the security. And the pricing mechanism that rules the market is the required rate of return of the buyers in the market. Confident buyers will pay up and less confident market participants won't. When the market dries up and blows away, though, there isn't anyone to fulfill the company's liquidity needs. (AOL users please expand screen to view table)
                                         June 30, 1998        Dec. 31, 1997 
 Mortgage Assets:  
 Subordinated CMBS, at fair value        $1,566,016,034       $   35,424,387 
 Subordinated CMBS, at amortized cost          --              1,079,055,459 
 Mortgage securities, insured loans, at 
  fair value                                587,031,839           18,888,883 
 Mortgage securities, insured loans, at 
  amortized cost                               --                586,224,858 
 Investment in originated loans, at  
  amortized cost                            503,643,362               -- 
 Equity Investments                          44,731,988           46,234,269 
 Receivables and other assets               120,209,124          105,368,838 
 Cash and cash equivalents                   20,423,168            2,108,794 
 Total assets                            $2,842,055,515       $1,873,305,488 
 Total shareholders' equity                 701,576,313          444,980,987 
                                           ============         ============
As far as bonds go, subordinated interests that suck up losses before senior interests are much more risky. The portfolio above isn't that different from a margin account, where the value of the liabilities is fairly constant and the equity in the account drops at a faster rate than a drop in the value of assets, depending on leverage. The more leverage, a smaller amount of an asset decline is needed to bring about an illiquidity situation. Match up the subordinated assets and their relation in value to the value of shareholders' equity and you can see how quickly things can go awry. More on that in Friday's Fool on the Hill.


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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

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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