<THE EVENING NEWS>
Wednesday, March 3, 1999
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HEROES

Online computer products retailer Cyberian Outpost (Nasdaq: COOL) raced ahead $6 3/8, or 40%, to $22 1/2 today after it said fiscal Q4 (ended Feb. 28) revenues are seen coming in around $33 million when the company reports results in early April, about four times the year-ago level. Probably equally important to investors, however, are the sequential numbers, key in evaluating the legitimacy of online growth: revenues were 40% above the Q3 mark, while customer growth over the three-month period was about 33%. In the three quarters reported since the company's August IPO, sequential sales growth numbers have been uniformly strong but have trended slightly downward from 38% in Q3 and 47% in Q2. Cyberian didn't pre-announce any earnings numbers today -- the company plans to report in the first week of April, with three analysts giving First Call a $0.39 per share loss estimate.

In the cutthroat video-game console market, being an early mover with a next-generation system can be a risky move. Just ask Sega Enterprises, which saw its 32-bit Genesis system forced out of the American market by Sony Corp.'s (NYSE: SNE) PlayStation and Nintendo Co.'s N64. Sony, which unveiled the widely anticipated "Version 2.0" of the PlayStation console, moved ahead $3 to $76 11/16 today. With a 128-bit microprocessor, four times the power of the current 32-bit model, PlayStation II can produce three-dimensional characters reminiscent of those in the movie "Toy Story," connect users to the Internet and a PC, and play music and movies using CD-ROMs. Sega launched its 128-bit Dreamcast system in Japan last November with a fall 1999 North American debut in mind. Several of the early releases -- including a supercharged extension of the "Sonic the Hedgehog" franchise -- have garnered rave reviews for graphics and gameplay. Sony struck gold with the 50 million unit-selling PlayStation, its maiden voyage in home gaming's waters. The upcoming battle with Dreamcast -- PlayStation II is expected in Japan by March 2000 and here by the fall of 2000 -- is certain to be fierce.

QUICK TAKES:PC giant Compaq (NYSE: CPQ), whose products retailer OfficeMax (NYSE: OMX) selected for its computer "store within a store" concept, advanced $1 15/16 to $33 7/8 today... Compaq competitor Dell Computer (Nasdaq: DELL) announced the launch of an on-line computer products superstore today, a move the Fool's Warren Gump analyzed this afternoon. The stock rose $2 7/8 to $80 15/16... Chip giant Intel (Nasdaq: INTC) added $4 7/8 to $114 11/16 as CNBC reportedly said the company's fundamentals are unchanged since January and the technology sector is oversold... Life sciences company Monsanto (NYSE: MTC) gained $2 1/4 to $46 5/8 following reports in The New York Times that the company held preliminary talks to be acquired by chemicals giant DuPont (NYSE: DD).

Casual restaurant operator Outback Steakhouse (Nasdaq: OSSI), which split its stock 3-for-2 after the bell last night, grilled its way ahead $11/16 to $32 3/8. CFO Robert Merritt said yesterday that the company plans to add takeout at its stores this year in hopes of yielding an additional $300,000 in sales per restaurant... French telecommunications giant Alcatel SA (NYSE: ALA) rose $2 1/4 to $24 1/8. The company, which said yesterday it would buy data networking firm Xylan (Nasdaq: XYLN), this morning announced plans to develop an integrated communications server in tandem with computer telephony company Dialogic Corp.

Telecommunications operation support systems provider Architel Systems Corp. (Nasdaq: ASYCF) dialed up a gain of $4 1/32 to $19 11/16 after Amdocs Ltd. (NYSE: DOX) agreed to buy the company in a stock deal valuing Architel at $24.52 per share, about a 57% premium to yesterday's closing price. Amdocs shed $3 5/8 to $22 3/16 on the news... Shares of Concentra Managed Care (Nasdaq: CCMC), which agreed to merge with 14.9% owner and New York investment firm Welsh, Carson, Anderson & Stowe, rose $3 1/16 to $14 11/16 today. The buyout group agreed to buy all but 7% of the company's shares for $16.50 each, a 42% premium over yesterday's closing price. It will also seek a buyer for the remaining 7% at the same price.

Microwave and radio frequency wireless communications products maker Alpha Industries (Nasdaq: AHAA) warmed up $4 to $18 1/4 after it said it expects to report fiscal Q4 EPS of $0.51. That figure includes a $0.20 per share tax benefit, without which the number is closer to the $0.22 estimate three analysts gave First Call... Internet advertising company DoubleClick Inc. (Nasdaq: DCLK), which said 15 companies agreed to use its "DART For Advertisers" ad serving system, won $4 7/8 to $95 3/8... Unmentionables retailer Intimate Brands (NYSE: IBI) snagged $2 3/16 to $43 1/8 after the company said February same-store sales were up 10% from last year's levels.

Chipmaker VLSI Technology (Nasdaq: VLSI) moved up $3/4 to $17 3/8 following reports that Dutch semiconductor and consumer electronics company Philips Electronics NV (NYSE: PHG) will pursue a hostile takeover of VLSI if the California firm doesn't play ball. News of Philips' overtures hit the stands Feb. 26; the company wanted a response by today... Pacific Gateway Exchange (Nasdaq: PGEX), a facilities-based provider of international telecommunications services, advanced $2 7/16 to $24 15/16 after reporting Q4 EPS of $0.25, up from $0.19 last year and a penny above estimates... Biopharmaceutical company Biogen (Nasdaq: BGEN), which earned a reiterated "buy" rating from Salomon Smith Barney today, took $1 7/16 to $105 1/16.

Young adult fashion retailer Pacific Sunwear of California (Nasdaq: PSUN) shined this morning, taking on $2 1/16 to $32 1/16 after BT Alex. Brown upgraded the stock to "strong buy" from "buy"... Linear integrated circuits maker Linear Technology (Nasdaq: LLTC) ran ahead $1 9/16 to $44 1/16 as Morgan Stanley Dean Witter boosted its rating on the company to "strong buy" from "outperform"... Parexel International (Nasdaq: PRXL), a top provider of contract research for the pharmaceutical and biotech industry, got a reiterated "buy" rating from Hambrecht & Quist. The stock ran up $2 1/8 to $24 5/8... Semiconductors and electronics manufacturer Texas Instruments (NYSE: TXN) moved up $5 3/8 to $91 7/8 on the strength of a reiterated "strong buy" rating from BancBoston Robertson Stephens. Click here for a recent Foolish interview with TI's CEO, Tom Engibous.

GOATS

Networking products company 3Com (Nasdaq: COMS) dropped $2 7/16 to $24 9/16 after it warned that its fiscal Q3 (ended Feb. 26) earnings will not meet analysts' expectations due to an unexpected slowdown in the U.S. and Latin American enterprise markets, weakness in the traditional two-tier distribution channel, and lower-than-expected PC original equipment manufacturer (OEM) sales. The company said it expects earnings from ongoing operations of $0.23 a share, below the analysts' mean forecast of $0.36. The sales slump came at a bad time for 3Com, which had already implemented a price cut for its network interface cards (NIC) during the quarter. Typically, the cards represent about a third of 3Com's revenues. While the company has been gaining NIC market share, that provides little protection from the double-edged whammy of lower sales and declining average selling prices. At least eight brokerages downgraded the company today.

Women's clothing designer Jones Apparel Group (NYSE: JNY) was ripped for a $3 3/16 loss to $22 3/4 after announcing it will buy women's shoe designer Nine West Group (NYSE: NIN) for about $1.4 billion in cash, stock, and assumed debt. Under the deal, Nine West shareholders will end up with 0.5011 of a Jones share and $13 in cash for each Nine West share owned, which works out to about $26 per share based on yesterday's closing price. At that price, Jones is picking up Nine West at just over 20 times estimated 1999 earnings of $1.27 per share and a little more than 0.72 times the firm's trailing 12-month sales of $1.93 billion. That seems like a pretty cheap buy, but some Jones shareholders are reportedly worried about the company's move into a new product category. Also, Nine West carries some leather-coated baggage into the marriage, especially after some poor fashion decisions helped lead to a 40% decline in the firm's shares last year.

QUICK CUTS: Professional staffing services firm StaffMark (Nasdaq: STAF) tanked $4 5/16 to $8 1/8 after saying a spending slowdown by some clients and lower growth at its domestic information technology staffing unit will lead to Q1 EPS between $0.22 and $0.25, short of the IBES mean estimate of $0.35... Industrial fluid filter and separation devices maker Pall Corp. (NYSE: PLL) fell $4 13/16 to $16 1/2 after saying lower margins resulted in fiscal Q2 EPS of $0.15, down from $0.22 a year ago and $0.04 shy of the First Call mean estimate. For fiscal 1999, the company expects EPS before charges to come in 10% to 15% below the $0.92 earned last year... Women and children's shoe maker Maxwell Shoe Co. (Nasdaq: MAXS) was stomped for a $1 3/8 loss to $9 3/8 after reporting fiscal Q1 EPS of $0.23, which was $0.03 short of the First Call mean estimate.

Elsewhere in shoe land, discount retailer Payless ShoeSource (NYSE: PSS) tripped $4 3/4 to $50 5/8 after saying its same-store sales declined 4.5% year-over-year in February on the back of a 1.5% decline in total revenues during the month to $160.4 million... Enterprise resource planning (ERP) software developer SAP A.G. (NYSE: SAP) slid $1 1/2 to $29 5/16 after the company announced that Jeremy Coote has resigned as President of its SAP America unit... Disposable specialty medical products maker Maxxim Medical (NYSE: MAM) dropped $3 11/16 to $16 15/16 after posting fiscal Q1 EPS of $0.40 (excluding charges), up from $0.37 a year ago but shy of the First Call mean estimate of $0.42.

Specialty chemicals maker Cabot Corp. (NYSE: CBT) dropped $2 15/16 to $22 after saying lower natural gas prices will result in fiscal Q2 earnings around $0.40, missing the First Call mean estimate of $0.53... Internet software firm Wall Data (Nasdaq: WALL) was stoned for a $4 3/4 loss to $14 1/2 after adjusting its recently reported fiscal Q3 EPS downward to $0.30 from $0.39 after discovering a contingency in an agreement with one of its resellers... Saville Systems PLC (Nasdaq: SAVLY) lost $2 7/16 to $16 15/16 after Jefferies & Co. lowered its rating on the provider of telecom billing and customer service software provider to "hold" from "accumulate"... Uninterruptible power supplies (UPS) provider American Power Conversion (Nasdaq: APCC) lost $5 5/8 to $29 5/16 following an Advest downgrade to "market perform" from "buy."

Nextlink Communications (Nasdaq: NXLK) was knocked down $4 15/16 to $46 9/16 after First Union Capital Markets cut its rating on the switched telecommunications services provider to "hold" from "outperform"... Electronic payment and collections systems maker CheckFree Corp. (Nasdaq: CKFR) moved down $3 3/8 to $35 1/2 after personal finance software developer Intuit (Nasdaq: INTU) sued the company for breach of contract related to an agreement signed last year. Under the arrangement, CheckFree agreed to support Intuit's online bill presentment products with its processing services and not offer a competing product of its own... Supply chain execution systems provider Manhattan Associates (Nasdaq: MANH) lost $6 7/8 to $9 following a pair of downgrades from Credit Suisse First Boston and Robinson-Humphrey.

FOOL ON THE HILL
An Investment Opinion
by Louis Corrigan

Trans World In a Web of Trouble?

It's hard to know what to make of Trans World Entertainment (Nasdaq: TWMC), a 501-store retailer of CDs and videos through its mall-based Record Town, Saturday Matinee, and F.Y.E. stores and strip mall-based Coconuts, Strawberries, and Planet Music chains. On the one hand, Trans World has been simply all world, the obvious winner in the recent multi-year consolidation of the music retailing space. After its pending acquisition of Camelot Music Holdings (OTC: CMHDA), Trans World should generate FY99 sales of $1.5 billion, or about 10% of U.S. music sales. Also, the FY98 results reported last week show the company just rocking, even if that's mostly thanks to mellow performers like Celine Dion and Jewel.

On the other hand, this company has got to be sitting in the middle of the old e-commerce superhighway, just waiting to become roadkill, right? As much as people like to browse through a store, who really will continue to pay $16.98 per CD when they can pay nearly the wholesale price via the Web? And what about all the industry talk about setting standards so consumers can download music from the Web and burn their own disks on their own writable CD recorder/players? That won't happen in the next year on any mass basis, but between improved compression technology and bandwidth enhancements via DSL and cable modems, it could happen soon enough to prove a meaningful threat. At $12 11/16, the stock currently reflects these serious cross currents.

Fourth quarter results announced last Wednesday showed revenue up 11% to $268 million on a 6% increase in same-store sales (SSS). Net income showed a titanic 44% gain to $30.7 million versus $21.3 million a year ago. Accounting for the dilution from the 6 million shares issued in a secondary offering last April (priced at $17.50, adjusted for splits), EPS increased 34% to $0.90 versus $0.67 a year ago. That crushed the consensus estimate of $0.81 per share.

Each major line of the income statement showed improvement. Gross margins jumped to 38.4% from 36.1%. Selling, general and administrative (SG&A) expenses remained nearly flat in real dollars and declined to 17.9% of sales from 19.6% last year. With money from the secondary offering, the small interest expense reported in FY97 turned into a small gain.

Since Trans World reported profits in the usually money-losing first two quarters of the year, overall FY98 results were even more impressive. Even after closing another 94 stores during FY98 (a net of 38 closings after acquisitions), sales still danced ahead 22% to $698 million on 8% stronger same-store sales. Excluding the one-time benefit, net income nearly doubled to $40.3 million from $20.6 million, spinning operating earnings up 96% to $1.19 per share versus $0.66 a year ago. Gross margins improved to 37.8% from 36.7%, while SG&A expenses dipped to 25.5% of sales from 27.2%. Interest expenses declined 69% to $1.5 million.

The balance sheet is also terrific. The company has $116 million in cash, up from $95 million a year ago. Inventory is up 12% overall to $211 million, or just 8% on a square foot basis, thanks partly to a new point of sale inventory management system rolled out last year. The company has paid down all of its $35 million in long-term debt, ending the year with long-term lease obligations of just $16 million. So Trans World has $100 million cash net of long-term obligations, or $2.92 a share. Back that out of the current share price and you have a stock trading at 8.2 times trailing earnings. That's also just 7 times the $1.40 per share that Chair/CEO Robert Higgins says he's comfortable with for FY99. And that number assumes just 4% same-store sales growth for the first half of FY99 and 5% for the second half while excluding Camelot, which should prove accretive to earnings.

Trans World seems like a no-brainer bargain, a hot new release that somehow got thrown in the cut-out bin by mistake. But then there's the Internet. My main impression from listening to Higgins on last week's conference call is that he just doesn't get it.

In November, the company rolled out its TWEC.com online store to test the waters. Higgins said in last week's press release that the site's initial success "has proven to us that e-commerce will be an important complement to our highly successful retail store concepts. We believe that there are synergies between both formats and that the strong brand recognition that exists among customers of our traditional retail outlets will be key to the on-going success of our e-commerce site."

While Higgins said last week that Trans World is determined to be a dominant Web player and plans to spend the money to do so, don't expect big ad spending. He suggested on the call that CD e-tailers such as N2K (Nasdaq: NTKI), which runs MusicBoulevard, have probably been paying too much for prime real estate on America Online (NYSE: AOL) and the major portals. He said that the key is not when you get into a business (Trans World was a relative latecomer to music retailing) but how good you are getting into it.

Moreover, although online CD sales are projected to grow from about $200 million in 1998 to more than $1.6 billion by 2002, that will still represent just 10% of the industry. In the near term, he said the companies that will really be hurt by the Web are the mail order companies and music clubs, which together account for about 12% of industry sales. "We don't think it's really going to hurt the brick and mortar stores," he said on the call. Indeed, Higgins hopes to leverage the 500 million customer visits that the company's stores receive each year to cross-promote the online store. He talked about using the Web to "breathe new life into the vast catalog" of music that isn't sitting in the stores but that could be readily marketed and purchased via the Web. One analyst said Barnes & Noble (NYSE: BKS) has talked about reducing its store-level inventories as a competitive response to increased online book sales. Higgins said he thought that would be a mistake, noting that Trans World has actually been building bigger stores with broader selection, such as its F.Y.E. format, which will grow from 7 to 13 units this year.

Traditional retailers can use their stores to promote their websites. If you take a radical view of where the business is headed, you could even argue that the stores function as extremely cost-effective advertising for a website, even if the stores will eventually be shuttered or left to operate at a loss. But I think it's simply misguided to imagine that the Web will complement the stores and not cannibalize store sales. The typical customer who buys CDs at high prices from a mall-based retailer may be so extremely convenience-oriented and price-insensitive as to operate differently than the typical superstore book buyer, who's clearly already begun to change her buying habits. Still, I doubt it. The market does, too.

Trans World's game plan looks inadequate for a number of reasons. First, if you market the online store mainly to your existing customers, you're likely to cannibalize sales without expanding them by reaching new customers. Second, to reach those new customers, Trans World has to develop an online brand. Plugging in recordtown.com or coconuts.com takes you to the TWEC site. However, TWEC itself isn't a brand at all. And what seems true so far is that being early online, and in force, is far more important than being good. That's what Border's (NYSE: BGP) has taught us. Higgins is trying to extrapolate lessons from offline retailing (where, over time, operating efficiency can win out in a commodity business) to the online world where operations only matter if you already have the brand to draw in customers. Prime online real estate simply may never become available to Trans World because brand creates location on the Web. That's what Amazon (Nasdaq: AMZN) is teaching us.

Finally, Higgins seems oblivious to the coming online price wars. Now that I've embraced the view that the Web really will transform retailing, I look at Trans World's incredible 37.8% gross margin as a major liability. While the company's Camelot acquisition and perhaps future acquisitions will do much to keep this number high thanks to increased purchasing power and operating efficiencies, the figure has still got to come down in a world where someone will be willing to sell CDs at cost, or less. When that happens, Trans World's profits will disappear. If the company's gross margins had been 27.7% in FY98, its operating income before taxes or interest income would have plunged from $70.6 million to zero. For comparison, Amazon's FY98 gross margin was 21.9%.

Trans World may have a more compelling plan in the works. Higgins did say that in the next 90 days the company would make a major Web-related announcement that "would impress everybody." That may be behind his comments on CNBC last week that the stock should soon "be back to the $25 to $30 range," where it was just last fall. In my view, though, the only thing worse than a retailer without a solid strategy for dealing with the Web's competitive threat is one with a CEO who talks stock price targets. If nothing else, it's a signal that Higgins may be overconfident.

Related articles:
-- Trans World Still All World, Lunchtime News, 11/12/98

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