Tuesday, January 26, 1999
DJIA            9324.58     +121.26     (+1.32%)
S&P 500         1252.31      +18.33     (+1.49%)
Nasdaq          2433.41      +64.10     (+2.71%)
Russell 2000     425.33       +3.22     (+0.76%)
30-Year Bond  101 27/32       -5/32  5.13 Yield


Document processing company Xerox Corp. (NYSE: XRX) gained $10 15/16 to $116 5/16 after reporting Q4 EPS of $1.69, up from $1.46 a year ago and ahead of the First Call mean estimate of $1.67. The positive Q4 results were due in part to a 33% increase in sales of digital products, which accounted for more than half of total revenues for the first time ever. Meanwhile, operating margins rose by more than one full percentage point to just over 16%, and the company was able to cut costs by shedding another 2,200 employees as part of its ongoing restructuring during the period. Improving currency conditions in Europe and Japan should help the firm reach its goal of EPS growth in the mid- to high-teens this year and in future periods, the company reiterated in a statement last night. Xerox also announced a two-for-one stock split, payable on Feb. 23.

Shares of teen apparel direct marketer dELiA*s Inc. (Nasdaq: DLIA) like, you know, rose $2 11/16 to $17 3/4 today after the company announced that its Internet subsidiary, iTurf Inc., had filed a registration statement with the SEC -- laying the groundwork for an initial public offering. dELiA*s is definitely way ahead of the pack in terms of online teen marketing, thanks in part to its early development of gURL.com -- a website dedicated to teenage girls. The firm has expanded its Net presence to six sites since turning on its main site last May, and attendance is soaring (800,000 to 22 million page impressions at iTurf from February to December of last year). Now that's Girl Power. For more details on the company, see this afternoon's Fool Plate Special.

Cardiac laser surgery technologies developer PLC Systems (AMEX: PLC) beamed up $1 5/16 to $6 13/16 after a Health Care Financing Administration panel recommended that transmyocardial revascularization (TMR) procedures, an alternative to heart bypass surgeries, should be covered under Medicare so long as they are performed with FDA-approved devices. So far, PLC's CO2 HeartLaser is the only device approved by the FDA for TMR procedures, explaining today's pop in the company's share price. However, a final decision by the HCFA is still forthcoming and, indeed, may be months away. Meanwhile, rival heart laser maker Eclipse Surgical Technologies (Nasdaq: ESTI) gained $1 15/16 to $12 11/16 today, even though it is still awaiting the green light from the FDA to enter into the ER and get down to operating (profits).

QUICK TAKES: Anti-HIV and cancer drug developer Agouron Pharmaceuticals (Nasdaq: AGPH) ran up $3 21/32 to $56 13/16 today before being halted at around 3 p.m. Eastern time. At the close, drug maker Warner Lambert (NYSE: WLA) announced it will acquire Agouron for $2.1 billion in stock, or roughly $60 per share... Fast food giant McDonald's (NYSE: MCD) shaked its way $3 1/16 higher to $78 15/16 after reporting Q4 EPS of $0.64 (excluding costs for its Made For You program), in line with the First Call mean estimate. The company also set a two-for-one stock split, which will be paid March 5... Help desk software maker Remedy Corp. (Nasdaq: RMDY) gained $6 3/16 to $22 15/16 after reporting Q4 EPS of $0.26 (excluding charges), a penny less than last year's results but $0.02 ahead of the Zacks mean estimate. At least four brokerages raised their ratings on the company today.

News integrator and provider NewzEdge Corp. (Nasdaq: NEWZ) jumped $2 5/16 to $12 15/16 after IBM (NYSE: IBM) said it will integrate the firm's Review Topics product into Big Blue's own internal online news service... International broadband communications provider United International Holdings (Nasdaq: UIHIA) rose $9 3/8 to $47, adding to yesterday's 10% advance, on news that Microsoft (Nasdaq: MSFT) will take part in a series of joint projects with the company's United Pan-Europe Communications (UPC) subsidiary to offer online, telephone, and interactive video services to European broadband customers... Fiber optic telecom components maker Uniphase Corp. (Nasdaq: UNPH) moved up $12 to $81 3/4 after posting fiscal Q2 EPS of $0.27 (excluding charges), beating the First Call mean estimate by a penny.

Pharmaceutical product technologies developer Vical Inc. (Nasdaq: VICL) gained $2 to $16 1/4 after saying Pfizer (NYSE: PFE) will use the firm's naked DNA gene delivery technologies for certain therapies for animals. As part of the deal, Pfizer will buy $6 million of Vical stock and fund $1.5 million in Vical research over the next three years... Property and casualty insurer Horace Mann Educators Corp. (NYSE: HMN) picked up $3/4 to $26 5/8 on news that it will be added to the S&P MidCap 400 Index in place of First Brands (NYSE: FBR), which is merging with Clorox (NYSE: CLX). Rational Software (Nasdaq: RATL), which will replace Allegiance Corp. (NYSE: AEH) on the same index, added $2 3/16 to $31 7/8... Telecom equipment biggie Lucent Technologies (NYSE: LU) added $7 15/16 to $110 on an A.G. Edwards upgrade to "accumulate" from "maintain."

Healthcare heavyweight Johnson & Johnson (NYSE: JNJ) gained $3 13/16 to $82 9/16 after reporting Q4 EPS of $0.50 (before charges), matching the First Call mean estimate. For more details, see tonight's Drip Port report... German enterprise software powerhouse SAP AG (NYSE: SAP) moved up $4 1/4 to $37 after reporting that its fiscal 1998 net income rose 14% year-on-year to about $621 million, which was reportedly within analysts' expectations... Internet-related software developer ImaginOn Inc. (Nasdaq: IMON) jumped $2 1/16 to $11 11/16 on rumors of a possible deal with America Online (NYSE: AOL). ImaginOn denied the accuracy of the rumors late in the trading day, however.

Mobile satellite personal communications services (PCS) provider Globalstar (Nasdaq: GSTRF) was launched $1 13/16 to $19 7/8 after an agreement between the governments of Russia, Kazakhstan, and the U.S. cleared the way for the company to resume its launch schedule of four satellites every month starting next month. Globalstar lead partner Loral Space & Communications (NYSE: LOR) picked up $2 1/8 to $21 15/16... Wavelength division multiplexing components maker E-TEK Dynamics (Nasdaq: ETEK) jumped $6 3/32 to $31 after Donaldson, Lufkin & Jenrette started coverage with a "top pick" rating and a 12-month price target of $40 per share... Semiconductor equipment maker Asyst Technologies (Nasdaq: ASYT) picked up $2 3/8 to $26 after Adams, Harkness & Hill raised its rating to "accumulate" from "market perform."

Earnings Movers

Action Performance
(Nasdaq: ACTN) up $5 3/4 to $42 3/8; fiscal Q1 EPS: $0.29 vs. $0.22 last year; estimate: $0.27

Amdocs Ltd.
(NYSE: DOX) up $4 1/8 to $20 7/8; fiscal Q1 EPS: $0.10 vs. $0.06 last year; estimate: $0.08

Cytec Industries
(NYSE: CYT) up $1 7/8 to $22 1/16; Q4 EPS: $0.65 (before gain) vs. $0.62 last year; estimate: $0.57

International Speedway Corp. (Nasdaq: ISCA) up $1 3/4 to $40 5/8; Q4 EPS: $0.37 vs. $0.05 last year; estimate: $0.35

Kulicke & Soffa Industries (Nasdaq: KLIC) up $5 3/16 to $26 7/8; fiscal Q1 EPS: loss of $0.38 vs. gain of $0.29 last year; estimate: loss of $0.40

Merck & Co. (NYSE: MRK) up $6 1/2 to $144; Q4 EPS: $1.16 vs. $1.01 last year; estimate: $1.16

Nortel Networks (NYSE: NT) up $3 to $58 7/16; Q4 EPS: $0.72 vs. 0.74 last year; estimate: $0.70

PathoGenesis Corp. (Nasdaq: PGNS) up $5 5/16 to $50 1/4; Q4 EPS: $0.17 vs. loss of $0.73 last year; estimate: $0.15

SanDisk Corp. (Nasdaq: SNDK) up $5 5/8 to $29; Q4 EPS: $0.13 vs. $0.27 last year; estimate: $0.10

VeriSign Inc. (Nasdaq: VRSN) up $4 3/16 to $81 1/2; Q4 EPS: loss of $0.11 vs. loss of $0.72 last year; estimate: loss of $0.14


Investors were gloomy today after funeral and cemetery company Service Corp. International (NYSE: SRV) stock heard something scary knocking at its door. Service Corp., cut by $15 5/16, or 44.5%, to $19 1/8, said it expects fourth-quarter earnings of between $0.22 and $0.24 per share, nearly six feet under First Call's $0.42 consensus estimate. Today's mid-session share price of $18 3/8 represented the stock's lowest point since 1995. Slowing death rates in key markets, high integration expenses for recent acquisitions, and killer high costs for potential acquisition targets were among the reasons for the projected shortfall. EPS for 1999 could approximate 1998 levels, pegged at between $1.31 and $1.33 per share after today's announcement, according to COO L. William Heiligbrodt, whose quote bears reprinting: "Declining death rates pose a challenge for the industry." Indeed. Competitor Stewart Enterprises (Nasdaq: STEI) lost $3 7/16 to $18 in sympathy, while Loewen Group (NYSE: LWN) dropped $3/4 to $4 1/4.

Also disappointed today were investors in Inktomi Corp. (Nasdaq: INKT). Shares of the developer of scalable software for the Internet lost $18 7/16 to $129 13/16 on news that software powerhouse Microsoft (Nasdaq: MSFT) will drop Inktomi as the primary search engine on the Microsoft Network. Inktomi still has plenty of clients, powering the search engines of Lycos' (Nasdaq: LCOS) HotBot, GeoCities (Nasdaq: GCTY), and @Home (Nasdaq: ATHM), among others, and CEO David Peterschmidt reportedly advised Wall Street that the contract counts for less than 5% of revenue. Microsoft has a good excuse for excusing itself, as it announced plans to sign on AltaVista, the popular search site Compaq Computer (NYSE: CPQ) said today it will at least partially spin-off, perhaps this year. AltaVista's site will feature e-commerce from recent Compaq acquisition Shopping.com (Nasdaq: IBUY) and Microsoft's HotMail e-mail technology. Microsoft advanced $9 11/16 to $171 9/16 today, while Compaq moved ahead $2 9/16 to $49 1/4.

QUICK CUTS: Healthcare services giant McKesson HBOC (NYSE: MCK) lost $7 5/8 to $74 3/8 after it said fiscal Q3 EPS was $0.56, ahead of last year's $0.43 figure and flat with market projections. The company said it should be able to meet its fiscal 2000 EPS goal of $3.00 per share, a penny below the Street's current earnings estimate... Number-one Pepsi bottler Whitman Corp. (NYSE: WH) drained $3 15/16 to $19 9/16 after reporting Q4 EPS of $0.12, well above last year's $0.11 loss but flat with market estimates. The company also announced a deal with PepsiCo (NYSE: PEP) that involves swapping domestic and international territories that Whitman says will boost its annual sales by nearly 40% annually on a pro-forma basis. PepsiCo, meanwhile, fizzled $3/4 to $39 1/2 as the company said it expects to report Q4 EPS of about $0.24 when it hands in results next week.

Textile products maker Burlington Industries (NYSE: BUR) lost $1 7/16 to $8 1/4 after announcing a broad reorganization of its apparel fabrics business, closing seven plants and cutting 2,900 jobs. Fiscal Q1 EPS was $0.14, down from $0.22 last year and flat with Street projections... Integrated oil giant BP Amoco lost $11/16 to $85 5/16 (NYSE: BPA) after reporting a restructuring that will mean up to 1,600 job cuts in Texas. The company is also relocating some operations. Meanwhile, Texaco (NYSE: TX) leaked $2 1/8 to $48 1/2 after reporting EPS of $0.14 for Q4, off from last year's $0.85 mark and Wall Street's $0.25 projection.

Predictive software firm HNC Software (Nasdaq: HNCS) lost $3 3/16 to $27 1/16 as it said it is dropping plans to merge with privately held Open Solutions, which develops software for banks and credit unions, in favor of a strategic alliance with the company. The company also reported Q4 EPS of $0.27, up from $0.18 last year and a penny ahead of Wall Street's consensus earnings estimate... Automated cell and tissue testing technologies developer Ventana Medical Systems (Nasdaq: VMSI) softened $1 13/16 to $17 7/8 after saying Q4 EPS will be "slightly below" the market's $0.13 consensus estimate... Turfgrass and forage seed developer AgriBioTech (Nasdaq: ABTX) was reaped for a loss of $1 to $7 15/16 after losing $3 1/8 yesterday on Friday's news that it has ended its three-month search for a strategic partner and will remain independent.

Hospital and healthcare systems operator Quorum Health Group (Nasdaq: QHGI) moved back $2 15/32 to $9 1/16 after saying it expects full-year fiscal 1999 EPS of between $0.80 and $0.90, missing First Call's $1.10 consensus projection. The company reported fiscal Q2 EPS of $0.05 (before items), down from $0.32 a year ago and well off the market's $0.20 mean expectation... Power conversion product manufacturer Artesyn Technologies (Nasdaq: ATSN) was shocked for a $3 1/4 loss to $15 3/16 after it said it expects Q1 EPS of between $0.15 and $0.18, below First Call's $0.23 projection, but is still confident with the Street's full-year range of between $1.05 and $1.15 (the mean is $1.12). Q4 EPS was $0.24, up from $0.10 last year and a penny above analyst projections... Contract staffing and outsourcing services concern AHL Services (Nasdaq: AHLS) slipped $1 3/4 to $30 15/16 after pricing 3.5 million new common shares at $31 apiece.

Telecommunications services provider Frontier Corp. (NYSE: FRO) retreated $2 1/2 to $33 5/8 after it cut its annual dividend to save up to $118 million annually and fund growth initiatives... Fiber-optic network operator Qwest Communications International (Nasdaq: QWST) fell $2 9/16 to $56 1/8 as Lehman Brothers cut its rating on the stock to "outperform" from "buy"... Giant-screen projection technology maker Imax Corp. (Nasdaq: IMAXF) shrunk $1 25/32 to $24 after S.G. Cowen & Co. downgraded the firm to "buy" from "strong buy" and Goldman, Sachs & Co. cut its rating from the "select list" to "market outperform."

Earnings Movers

Banyan Systems (Nasdaq: BNYN) down $2 5/8 to $12 3/4; Q4 EPS $0.04 vs. $0.13 last year; estimate: $0.03

Black & Decker (NYSE: BDK) down $4 1/4 to $53 5/8; Q4 EPS: $1.10 (excluding one-time items) vs. $1.00 last year; estimate: $1.10

(NYSE: KO) down $3/8 to $62 9/16; Q4 EPS $0.24 vs. $0.33 last year; estimate: $0.24

Consolidated Freightways (Nasdaq: CFWY) down $1 5/8 to $16 9/16; Q4 EPS: $0.53 (before charges) vs. $0.31 last year; estimate: $0.48

CyberCash Inc. (Nasdaq: CYCH) down $1 15/16 to $16 3/8; Q4 loss of $0.46 vs. loss of $0.49 last year; estimate: loss of $0.48

Halliburton Co. (NYSE: HAL) down $3/16 to $30 5/16; Q4 EPS: $0.20 (before charges) vs. $0.58 last year; estimate: $0.20

MemberWorks Inc. (Nasdaq: MBRS) down $7/32 to $33 3/16; fiscal Q2 EPS $0.10 vs. $0.03 last year; estimate: $0.10

PathoGenesis Corp. (Nasdaq: PGNS) down $5 5/16 to $50 1/4; Q4 EPS $0.17 vs. loss of $0.73 last year; estimate: $0.15

Progressive Corp.
(NYSE: PGR) down $29 1/16 to $124 9/16; Q4 EPS $1.38 vs. $1.13 last year; estimate: $1.54

S3 Inc. (Nasdaq: SIII) down $7/8 to $6 1/2; Q4 EPS: loss of $0.56 vs. profit of $0.03 last year; estimate: loss of $0.32

STMicroelectronics (NYSE: STM) down $2 1/2 to $96 13/16; Q4 EPS: $0.84 vs. $0.90 last year; estimate: $0.81

Sybron International (NYSE: SYB) down $1/16 to $27 1/16; fiscal Q1 EPS: $0.24 vs. $0.18 last year; estimate: $0.24

Technitrol Inc. (NYSE: TNL) down $2 to $26 3/8; Q4 EPS $0.50 vs. $0.46 last year; estimate: $0.49

Terra Nitrogen Co. (NYSE: TNH) down $1 1/8 to $9 3/4; Q4 EPS $0.01 vs. $0.71 last year; no estimate

Union Pacific Resources Group (NYSE: UPR) down $7/8 to $8 3/8; Q4 EPS: loss of $3.48 (from continuing operations) vs. profit of $0.31 last year; estimate: loss of $0.33

An Investment Opinion
by Warren Gump

Should Management Profit from Screwing Up?

Many companies have jumped on the bandwagon of offering employee stock options (ESOs). Generally, these plans are touted for their ability to align management's interests with those of shareholders. The theory goes that if management has exposure to stock options, they will be monetarily rewarded as the company's stock price increases. Such incentives make intuitive sense. Unfortunately, a nefarious twist to these options plans is becoming increasingly popular. Several companies have been taking the risk out of their options plans by "repricing" the options if the stock price falls.

An option provides the owner the right, but not the obligation, to purchase a security over a specified period of time. Upon grant, the employees are notified of the exercise price, or the price at which the stock can be purchased. Most of the time, ESOs have an exercise price at or above the current market price of the company's stock and are valid for several years.

If the stock price of the company rises, the employee gets to benefit from this increase through the stock options. Let's say that the fictitious Options'R'Us issues its employees 5-year options at the current stock price of $20. The employee receiving these options would be able to purchase a share of the company for $20, regardless of what price the stock was trading.

If the stock falls under $20 after five years, the option is basically worthless because it is cheaper to go out and buy the stock on the open market. If the stock was trading above $20, the option would be worth at least the difference between the stock trading price and $20. For example, if the stock were trading at $25, each option would be worth at least $5 ($25 - $20). If the company gets really hot (you know, changes its name to Options'R'Us.com) and soars to $100, each option is worth at least $80 ($100 - $20).

Providing ESOs helps employers motivate employees to work toward the better good of the entire company. Producing overall results that are well received by the stock market results in a higher option value. On the other hand, if the company's stock price performs poorly, the options do not gain any value. Such a system obviously increases employee awareness of the company's stock price. (Another benefit for the company is that options aren't charged against net income, but that's the subject of a Fool on the Hill column for later this spring.)

Recently, after significant drops in their stock prices, several companies have decided to "reprice" their options. This means that the exercise prices for the options are reduced because the stock has fallen dramatically. Let's say that the stock of Options'R'Us falls to $5 per share due to poor earnings. In a repricing, the company would exchange the old options that were issued and grant new ones with an exercise price of $5.

Once the repricing is complete, employees get to benefit from any gains in the stock price over $5. It's like when you are a kid playing a game and things didn't go as you expected so you say, "Do over." We messed up the first time, so we're going to start again. That's great for the employees and top management (which tends to own a disproportionately large share of options). On the other hand, shareholders don't have an opportunity to shout "Do over" and exorcise the losses experienced in the stock from their portfolios.

Several companies have recently disclosed the repricing of their employee options as described below.

Last September, Ciena Corp. (Nasdaq: CIEN) announced that it was repricing options with an exercise price above $12 3/8, the fair market value on Sept. 16, down to this level. All of those options that were issued when the company's stock was trading at $23 (its initial public offering price), $30, $50, or $92 (its peak this past July), were repriced at $12 3/8. At today's stock price, the repriced ESOs have an intrinsic value of about $22 million, despite the fact that the stock has fallen 63% in the last year.

Ciena commented in a press release that options held by the company's executive officers issued prior to the IPO would not be affected by the repricing. Such a statement indicates a punitive action on the leaders who led the firm when it experienced significant problems. As it turns out, however, that's not really the case. Most of these options wouldn't have been repriced under the program because well over 90% of them have exercise prices below $5.

Another recent repricing was that of Cendant (NYSE: CD), the company trying to recover from massive accounting fraud uncovered when management performed due diligence on a major acquisition. The company's stock plunged from a high of $42 in April to a low of $7 last October. On July 28, in the midst of the brouhaha, the company announced that it was going to reprice options for 4,000 middle managers that were granted between December and March because of the price decline.

At the time of the repricing, company president and CEO Henry R. Silverman commented, "We do not believe it is appropriate to, nor will we reset the terms of the options awarded as compensation to our most senior executives." Less than two months later the company announced a new equity ownership program for senior management.

Under this program, about 42% of the outstanding options were repriced to fair market value, 33% were repriced to levels above fair market value, and 25% were canceled. The board compensation committee apparently felt that senior management, those people most responsible for the debacle, deserved to have all of their options exchanged, not just those issued in one quarter. Once again, management and employees got a great deal while shareholders were stuck with their negative 42% one-year return.

One last example -- and there are plenty of other ones out there -- is FelCor Lodging Trust (NYSE: FCH). This company has apparently implemented a repricing program, but details are sketchy. FelCor didn't issue a press release discussing its repricing. Rather, we became aware of the issue because an astute Fool on our message boards read obscure Form 4 filings with the Securities and Exchange Commission (SEC).

According to these documents, outstanding options of the senior management team were canceled and replaced with a lesser number of new ones with a strike price of $22 1/8. Again, management is not subjected to the ramifications of decisions that caused shareholders to suffer a 31% loss over the past year.

Overall, ESOs are a good idea since they help motivate employees and allow them to participate in the growth of the company. Repricing previously issued options after a decline in the stock, however, is unfair to shareholders. Such action diminishes the incentive impact of the options while increasing the dilution in ownership among current owners.

A reasonable argument can be made that employees who did not have any influence on the decisions leading to the adverse stock movements should not bear the cost of the pain. My first response is tough luck, that's a risk assumed when receiving options as part of your compensation structure. A more realistic perspective given today's tight labor markets is that lower-level employees be offered a modest "retention" option grant. Such a grant would not be intended to replace previously issued options, but would allow employees to profit from increases in the stock from extraordinarily low levels.

What truly appalls me is seeing a senior management team -- those responsible for making the company's key strategic decisions -- have their options repriced. These people, already receiving a hefty salary, are granted options so that they benefit from guiding the company in a direction that boosts shareholders' returns. The system should not be redesigned to allow senior management to profit from screwing up.


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