<THE EVENING NEWS>
Tuesday, February 2, 1999
DJIA 9274.12 -71.58 (-0.77%) S&P 500 1261.99 -11.05 (-0.87%) Nasdaq 2463.42 -46.67 (-1.86%) Russell 2000 421.73 -4.35 (-1.02%) 30-Year Bond 100 5/32 -27/32 5.24 Yield
The other shoe finally dropped today, allowing Nine West Group (NYSE: NIN) shareholders to relax a little. The shoe retailer's stock kicked up $1 9/16 to $15 5/8 following last night's announcement that an SEC probe (initiated in May 1996) into the company's revenue reporting and importation policies ended with no action taken. That removes the second of two lingering regulatory clouds from Nine West's horizon, as last April the U.S. Customs Service ended without action a related investigation into the prices and duties on products the company bought from Brazil beginning in 1994. Nine West still isn't a perfect fit, however, as the company last week expanded its restructuring efforts by cutting 144 jobs, which will affix a $3.2 million charge to fourth-quarter earnings. Merrill Lynch led the upgrade brigade, boosting its long-term rating to "accumulate" from "neutral" this morning on the SEC news, but holding off on a near-term change on uncertainty about the demand for footwear.
No more waiting around breathlessly, hoping to hear the three little words "You've got mail?" Despite the potentially disastrous effects such a development could have on modern romance, computer telephony products maker Notify Technology Corp. (Nasdaq: NTFY) is forging ahead with the development of visual "Got Mail" technology that allows computer users to check their online mailboxes without turning on their machines. Notify Technology's stock raced ahead $7 7/16, a whopping 384%, to $9 3/8 today as the company announced it is marketing the product to telephone companies and Internet service providers (ISPs), its traditional modus operandi. Among the current licensees of the company's products are wireless electronics company Uniden America Corp. and Baby Bell SBC Communications (NYSE: SBC).
QUICK TAKES: Movie listing and ticketing service provider MovieFone Inc. (Nasdaq: MOFN) ran ahead $4 to $30 1/2 after America Online (NYSE: AOL) said it will acquire the company for roughly $388 million in stock. AOL intends to rebrand the business as AOL MovieFone, making it a key anchor tenant on AOL's online service. AOL lost $3 11/16 to $167 1/2. For more on the deal, dial up this morning's Breakfast With the Fool... Former presidential hopeful Ross Perot's information technology consulting company Perot Systems (NYSE: PER) raced ahead $27 1/2 to $43 1/2 in its first day of trading. The company sold 6.5 million shares at an initial price of $16 each... Healthcare data interchange products provider Mede America Corp. (Nasdaq: MEDE), itself trading for the first day after selling 4.6 million shares yesterday at $13 each, rose $6 5/8 to $19 5/8 today.
Construction cements maker Giant Cement Holding (Nasdaq: GCHI) hardened $1 15/16 to $19 1/2 after saying last night it expects earnings growth of about 25% for full-year 1999. The company also said it anticipates Q4 EPS of $0.46 or $0.47, short First Call's four-analyst consensus estimate... Leading Irish bank Allied Irish Banks PLC's (NYSE: AIB) American depositary receipts took on $4 9/16 to $121 5/8, reportedly on speculation that European banking giant Deutsche Bank AG might bid for the company... Business Internet services provider PSINet Inc. (Nasdaq: PSIX) won $4 13/16 to $40 after announcing plans to expand the availability of its InterSky Internet access service into 50 new markets in the U.S. and abroad in 1999.
Newark, N.J.-based bank holding company Broad National Bancorp. (Nasdaq: BNBC) broadened $1 1/2 to $24 1/4 after Independence Community Bank Corp. (Nasdaq: ICBC) agreed to buy Broad for $26.50 per share, a 16.5% premium on yesterday's closing price...Telecommunications customer service and billing outsourcer Convergys Corp. (NYSE: CVG) added $3 1/4 to $21 3/4 after Merrill Lynch upgraded the stock to "near-term buy" from "accumulate" citing a clearer outlook for 1999... Information technology outsourcer and Y2K problem-solver IMRglobal Corp. (Nasdaq: IMRS) improved $1 9/16 to $26 1/4 after Adams, Harkness & Hill boosted its rating on the stock to "strong buy" from "accumulate," setting a 12-month price target of $40 per share... Chip-to-chip interface technology company Rambus (Nasdaq: RMBS) moved up $6 1/4 to $81 1/8 after Morgan Stanley Dean Witter upgraded the stock to "outperform" from "neutral."
Financial information publisher Individual Investor Group (Nasdaq: INDI) ran ahead $1 5/16 to $7 3/8 after it said total advertising impressions on its Individual Investor and Insider Trader websites for January were 63% above December levels... Oil and natural gas pipeline company Lakehead Pipe Line Partners (NYSE: LHP) ran up $2 3/4 to $44 5/8 after Merrill Lynch boosted its short-term rating to "accumulate" from "neutral" and its long-term rating to "buy" from "accumulate," calling the company's units undervalued... Senior citizen living facility operator Assisted Living Concepts (AMEX: ALF) gained $13/16 to $6 13/16 after slumping $6 5/8 yesterday on news that American Retirement Corp. (NYSE: ACR) agreed to end its proposed $500 million merger with Assisted Living, which will restate earnings for fiscal 1997 and the first three quarters of fiscal 1998.
Internet software developer Spyglass Inc. (Nasdaq: SPYG), which said last night it plans to defend itself against a class action lawsuit launched by disgruntled shareholders Friday, peered up $2 1/4 to $13 1/8 today... Network software company Citrix Systems (Nasdaq: CTXS) ripened $1 to $87 11/16 after Lehman Brothers reiterated a "buy" rating on the stock, setting a $125 per share 12-month price target... Drug developer Merck & Co. (NYSE: MRK) popped up $3 3/8 to $150 5/16 following an upgrade to "attractive" from "neutral" by PaineWebber... RV and bus manufacturer Thor Industries (NYSE: THO) rolled up $2 3/8 to $28 1/4 after the company said fiscal Q2 operating income is expected to be about double last year's total.
ACNielsen Corp. (NYSE: ART) up $2 15/16 to $26 7/16; Q4 EPS: $0.36 vs. $0.27 last year; estimate: $0.33
Airborne Freight (NYSE: ABF) up $1 3/16 to $38 1/16; Q4 EPS: $0.78 vs. $0.60 last year; estimate $0.66
HON Industries (NYSE: HNI) up $1 3/16 to $21 1/16; Q4 EPS $0.48 vs. $0.42 last year; estimate: $0.47
MicroTouch Systems (Nasdaq: MTSI) up $2 13/16 to $19 9/16; Q4 EPS $0.33 vs. $0.24 last year; estimate: $0.30
PepsiCo (NYSE: PEP) up $13/16 to $38 15/16; Q4 EPS $0.24 vs. $0.29 last year; estimate: $0.23
Rent-Way (NYSE: RWY) up $1 11/16 to $27; fiscal Q1 EPS $0.18 (before charges) vs. loss of $0.17 last year; estimate: $0.17
U.S. Filter (NYSE: USF) up $1 7/8 to $26 1/8; fiscal Q3 EPS: $0.36 vs. $0.31 last year; estimate: $0.36
Wild Oats Markets (Nasdaq: OATS) up $3 7/16 to $27 3/16; Q4 EPS $0.25 vs. $0.17 last year; estimate: $0.25
Coronary stent and medical devices maker Guidant (NYSE: GDT) slumped $3 11/16 to $54 11/16 after rival Medtronic (NYSE: MDT) received FDA marketing approval for its new Gem II DR dual-chamber implanted defibrillator, putting the screws to Guidant's efforts in the fast-growing segment of the coronary care market. Medtronic rose $4 to $85 on the news. The new product is a smaller device than Medtronic's earlier Gem DR, which originally broke Guidant's short-lived monopoly of the dual-chamber pacing business last October. The approval, which will likely take away some revenues from Guidant in the short term, also places the Indianapolis-based company in an unusual position -- playing catch-up. Previously, Guidant had made a name for itself by getting its updated and innovative pacing and stent products to market before everyone else. In this case, it seems Medtronic has beaten Guidant at its own game.
Horsham, Pa.-based biotechnology company Cell Pathways (Nasdaq: CLPA) forged a path straight down today, tumbling $18 1/4 to $9 after trading was halted yesterday around 2:30 p.m. Eastern time. Triggering the halt was the announcement that the company's Phase III clinical trial for Prevatec (an anti-cancer drug) "suggests that the study did not achieve a statistically significant clinical response when compared to placebo." The drug is being tested as a treatment for the condition known as adenomatous polyposis coli. As a result, the firm expects to delay the filing of its New Drug Application with the Food and Drug Administration, which had been originally expected in March. While the unexpected development is a punch in the stomach for Cell Pathways, it also happens to underscore the many risks inherent in biotech investing.
QUICK CUTS: Telecommunications services provider Sprint Corp. (NYSE: FON) tripped $2 1/4 to $81 15/16 after posting Q4 EPS from continuing operations of $0.79, ahead of last year's $0.72 but short of the First Call mean estimate of $0.85. Meanwhile, wireless unit Sprint PCS (NYSE: PCS) fell $1 9/16 to $30 despite adding 836,000 new subscribers in the quarter... Healthcare and contract rehabilitative services firm Integrated Health Services (NYSE: IHS) slumped $1 1/2 to $11 3/16 after selling its home health nursing business to an affiliate of privately owned Medshares Inc. for undisclosed terms... Equine apparel designer Polo Ralph Lauren Corp. (NYSE: RL) was thrown for a $1 5/16 loss to $23 1/4 after saying it will take a $65 million pre-tax charge in fiscal Q4 to close nine of its free-standing stores and lay off about 250 employees. The company also reported Q3 EPS of $0.25, down from last year's $0.29 but in line with the First Call mean estimate.
Neuropsychiatric drug developer Neurogen Corp. (Nasdaq: NRGN) slid $5 1/16 to $12 3/16 after interim results from the Phase I study of its NGD 91-2 anxiety treatment showed that its use had a statistically insignificant effect on about 40% of the subjects in the trial, which will extend the treatment's clinical development time line... Engineering software products developer Summit Design (Nasdaq: SMMT) sank $2 1/4 to $4 7/8 after saying slow U.S. sales will result in lower-than-expected Q4 revenues of about $10.9 million. The company said it has agreed to terminate its proposed merger with OrCAD Inc. (Nasdaq: OCAD) after both companies determined it was no longer in the best interests of shareholders. OrCAD fell $1/2 to $6 13/16.
Publishing tools company Inso Corp. (Nasdaq: INSO) dropped another $1 11/32 to $8 1/16 as several shareholder lawsuits were filed against the company following yesterday's announcement that it will restate its financial results for the first three quarters of 1998 due to revenue recognition problems... Secure electronic transactions products company Entrust Technologies (Nasdaq: ENTU) lost $4 1/2 to $30 1/8 as Goldman Sachs said it would release about 38.7 million of the company's shares from the lock-up associated with the company's initial public offering on Feb. 4, 12 days ahead of schedule... Drug developer Vertex Pharmaceuticals (Nasdaq: VRTX) slid $3 to $28 5/8 after Lehman Brothers lowered its rating to "neutral" from "outperform" based on competition concerns for the company's protease inhibitor.
International microcomputer hardware and software products distributor Tech Data (Nasdaq: TECD) dropped $11 1/2 to $20 5/16 after warning that its Q4 EPS will come in between $0.61 and $0.64, shy of the First Call mean estimate of $0.69. In Q1, the firm is expecting EPS between $0.52 and $0.57, missing the current $0.61 estimate. Separately, rival Ingram Micro (NYSE: IM) fell $3 3/8 to $27... Home improvement warehouse retailer HomeBase Inc. (NYSE: HBI) was caught in a run-down and lost $1 3/16 to $5 9/16 after saying it will report Q4 EPS of $0.01, missing the First Call mean estimate by a penny... Router maker Cisco Systems (Nasdaq: CSCO) fell $2 5/8 to $112 3/8 in advance of its fiscal Q2 earnings report. After the bell, the firm reported EPS of $0.36 (before charges), up from $0.29 a year ago and a penny ahead of the First Call mean estimate.
Trane air conditioning and American Standard plumbing products maker American Standard Cos. (NYSE: ASD) was flushed for a $2 3/4 loss to $31 1/2 after agreeing to buy British plumbing products firm Blue Circle Industries PLC for about $417 million in cash... Dental practice management firm Coast Dental Services (Nasdaq: CDEN) was drilled $1 1/4 to $7 3/4 after reporting Q4 EPS of $0.18, missing the First Call mean estimate by $0.02... Semiconductor capital equipment maker Cymer (Nasdaq: CYMI) slid $2 1/2 to $25 1/2 after reportedly telling analysts in a conference call that sales and marketing expenses will rise in fiscal 1999, putting a squeeze on earnings. The firm posted a Q4 loss of $0.12 per share last night, which was not quite as bad as the loss of $0.16 per share expected by analysts.
A trio of homebuilders fell today on identical downgrades to "market perform" from "buy" by BT Alex. Brown, which cited concerns about the strength of the first-time homebuyer market. Beazer Homes USA (NYSE: BZH) lost $2 3/8 to $24 9/16, Centex (NYSE: CTX) fell $1 3/4 to $42 15/16, and Kaufman & Broad (NYSE: KBH) dropped $1 1/2 to $27 3/16... Vascular radiation therapies developer Novoste Corp. (Nasdaq: NOVT) was zapped $4 to $26 1/4 after saying higher R&D and production expenses resulted in a Q4 loss of $0.86 per share, worse than the loss of $0.74 per share expected by analysts surveyed by First Call... Computer reseller MicroAge (Nasdaq: MICA) slid $2 to $13 5/8 after Donaldson, Lufkin & Jenrette cut its rating to "market perform" from "buy."
Comparing Furniture Makers
Assembly required. Two words that strike fear in the furniture aisle of any discount store. Past experiences with these products likely conjure some type of nightmarish experience. Figuring out how to lug the 80-pound box from the store into your home or apartment. Trying to interpret instructions and diagrams that are poorly written. Assembling three-fourths of a bookshelf, only to realize that you mixed up the top and bottom panel and need to start over. Having strewn the various pieces of a home entertainment center across your home only to learn that a screw or connecting joint is missing. Does anyone remember how sore your arms were after twisting in 85 screws? Arghh!
Despite those drawbacks, it's hard not to notice that more and more of this ready-to-assemble (RTA) furniture is popping up in stores. You see it at Wal*Mart (NYSE: WMT), Home Depot (NYSE: HD), Costco (Nasdaq: COST), Office Depot (NYSE: ODP) and even Sears (NYSE: S). While I don't have any hard statistics, it seems as if an increasing amount of space is being devoted to these stores. Part of the reason for this raised prominence is the emergence of home offices, which need to be filled with some furniture. Because of reasonable prices and an increasing array of attractive decorative features, RTA is filling the bill.
The three largest companies in the business are Sauder Woodworking, O'Sullivan Industries (NYSE: OSU), and Bush Industries (NYSE: BSH). Sauder, the largest manufacturer, is a privately held company based in Archbold, Ohio. It's always disappointing when a category leader isn't publicly traded, but there are still two more players. Which one of the two remaining players is a more attractive investment option? I find O'Sullivan to be the more compelling story for the reasons outlined below.
Beyond having a larger industry presence, the earnings outlook for O'Sullivan is much brighter. The company is already showing signs of recovering from a mild earnings downturn last year, whereas Bush is still experiencing a severe earnings squeeze. For the December quarter, O'Sullivan has already reported that earnings per share (EPS) increased 45% to $0.29 in the December quarter. After a December warning, analysts expect that Bush will earn $0.09 per share, down 79%. To be fair, O'Sullivan's prior year results were depressed, but the December 1998 results are still a couple of pennies ahead of those reported in December 1996.
The weakness in December 1997 was caused by lower than expected sales, as well as the rollout of new software and equipment at a factory. The recent earnings report suggests both of these problems have been resolved (sales were up 14% and gross margin increased to 28.7% from 27.3%). Analysts currently expect O'Sullivan to post earnings of $1.21 in calendar 1999, resulting in a price/earnings (P/E) ratio a bit under 13x. Long term growth is estimated at about 15%.
Bush's current problems sound eerily similar to those experienced by O'Sullivan, but more severe. Slower than expected revenue growth has been compounded by manufacturing issues at a recently acquired manufacturing facility. Revenue growth was up 23% because of acquisitions, but gross margin dropped to 27.0% from 29.3% and earnings plunged 81% to $0.07 from $0.36. Analysts expect earnings to continue falling for the next two quarters with a rebound in the latter half of 1999. While the stock is trading just under 11x current First Call estimates for 1999, those projections are more tenuous since they incorporate a turnaround that is not assured.
Investors should never stop at the income statement when looking at a company. Key information is also available on the balance sheet and statement of cash flows. Bush's October 3, 1998 balance sheet shows long-term debt of $125.6 million and shareholders equity of $122.8 million, resulting in a debt/equity ratio a tad over 1.0x (125.6/122.8).
While not absurdly high, I prefer seeing the number a little lower when a company is in a somewhat cyclical industry. (Yes, the furniture business -- even if the product category is relatively cheap -- is still cyclical.) In comparison, O'Sullivan has a fairly low debt/equity ratio of 0.2x based on its September 30, 1998 balance sheet shows debt of $39 million and shareholder's equity of $166.7 million. O'Sullivan definitely has a more favorable financial structure for investors.
I also checked out two balance sheet statistics for each company, days sales in inventory and days sales in receivables, to measure the efficiency with which working capital is managed. O'Sullivan had 51 days sales in inventory whereas Bush had a slightly higher 55 days. Both companies appear to maintain inventories at similar levels.
On the receivables front, however, O'Sullivan has a quite high 70 days sales in receivables, while Bush has a much more reasonable 38 days. I checked into this statistic further since they were so divergent. In the comparable prior year quarter, O'Sullivan had 73 days sales in receivables and Bush had 48 days. Both companies showed improvement, although Bush's was more impressive. O'Sullivan's reduction of this number over the past year alleviated some of my concern that its receivables were so high relative to sales.
Reading O'Sullivan's 10-K, I learned a probable reason for the high level of receivables. The company's top five customers account for about 58% of sales. In fact, its two largest customers, OfficeMax (NYSE: OMX) and Office Depot (NYSE: ODP), account for 20.1% and 11.6% of sales, respectively. Significant business with such powerful retailers likely means that O'Sullivan grants generous credit terms. Such a strategy is fine, but there is increased risk if one of those companies encounters financial problems.
Moving over to the cash flow statement, O'Sullivan has better operating cash flow than Bush. Through the first nine months of 1998, Bush had negative cash flow of $9 million. During the same period, O'Sullivan's operating cash flow was a positive $26.9 million. The biggest cause for this difference was a much higher investment in inventory for Bush.
Considering the various company characteristics described above, I believe O'Sullivan to be the better investment option. While its P/E multiple on 1999 estimates is slightly higher at 13x compared to 11x for Bush, O'Sullivan has a much stronger balance sheet. Because of this, O'Sullivan will have much more flexibility to address unforeseen opportunities and problems. Also noteworthy is the fact that O'Sullivan is reporting rising earnings, while Bush's earnings are falling. Obviously, investors tend to prefer placing their money into companies where earnings and cash flow are rising.
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