<THE EVENING NEWS>
Friday, March 5, 1999
MARKET CLOSE
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30-Year Bond        95    1 12/32  5.59 Yield

HEROES

Beaten-down information technology and staffing services provider Metamor Worldwide (Nasdaq: MMWW) rallied a bit today, grabbing $1 5/8 to $16 3/4 after announcing the purchase of GE Capital Consulting -- a division of GE Capital Corp., itself a subsidiary of General Electric (NYSE: GE) -- for $115 million in stock and cash. Metamor, which also struck a three-year $105 million arrangement to provide information services to GE Capital Corp., expects the deal to help earnings in fiscal 1999. GE Capital Consulting has projected revenues in excess of $90 million for 1999. The deal also includes a half-interest in a consulting joint venture with a New York investment bank that should bring in another $6 million in revenues. Add that to January's purchase of Chicago IT services company SPR Inc. (Nasdaq: SPRI) -- itself expected to tally $100 million in revenues this year -- and Metamor could be poised to reverse a yearlong slide. SPR picked up $1 1/2 to $13 1/16 today in active trading.

Computer telephony products maker Notify Technology Corp. (Nasdaq: NTFY) earned a vote of confidence from David Brewer, better known as the co-founder of search engines and network caching solutions provider Inktomi Corp. (Nasdaq: INKT). Brewer agreed to buy 850,000 shares of the company for $3.50 a pop -- a 14% discount to yesterday's closing price -- as well as warrants to buy another 1.3 million shares for $3.60 each over the next four years. Today's purchase alone gives Brewer nearly a quarter of the shares currently outstanding, suggesting that he has quite a bit of confidence in Notify's technologies, which include visual "Got Mail" technology that allows computer users to check their online mailboxes without turning on their machines. Brewer will join Notify's board in connection with the deal and, according to a mid-January proxy filing, become the company's largest individual shareholder. The shares snagged $1 15/16, or 47.7%, to $6 today, trading more than 6 times their 30-day average volume.

QUICK TAKES: Networking chip maker Level One Communications (Nasdaq: LEVL) raced ahead $17 7/8, or 66%, to $45 following last night's news that Intel (Nasdaq: INTC) agreed to buy the company for approximately $2.2 billion -- about $48 3/4 a share -- in stock, an 80% premium over Level One's closing price yesterday. For more on the deal, click on today's Breakfast With the Fool... Disk drive maker Seagate Technology (NYSE: SEG) picked up $1 7/8 to $29 7/8. A Seagate spokesman told Reuters yesterday evening that nothing about its business outlook changed because of yesterday's deal between IBM (NYSE: IBM) and Dell Computer (Nasdaq: DELL). IBM picked up a new "buy" rating from Credit Suisse First Boston, which expects the shares to hit $230 within a year, and the stock rose $7 1/4 to $178 1/4.

Semiconductors and electronics manufacturer Texas Instruments (NYSE: TXN) lassoed $8 1/8 to $100 5/8 following reports that CFO Bill Aylesworth said Q1 operating margins should be about 16%, moving toward 20% later this year... Retail behemoth Wal-Mart Stores (NYSE: WMT) boosted an existing share buyback plan by $1.2 billion today and also reported plans to split its stock 2-for-1 effective April 19. The shares gained $3 7/8 to $93 1/4... Shares of Internet portal company Yahoo! (Nasdaq: YHOO) hooted up $8 5/16 to $159 13/16 following an upgrade to "buy" from "hold" by Paul Noglows at Hambrecht & Quist... NEON Systems (Nasdaq: NESY), which makes and sells software that integrates computer systems, shone $10 1/16 to $25 1/16 in its first day of trading. The company sold 2.7 million shares for $15 each.

@Home Corp. (Nasdaq: ATHM) moved up $2 1/2 to $117 3/4 today. The high-speed Internet access company will join the Nasdaq 100 Index after the close of trading Tuesday (March 9), replacing Tele-Communications Inc. (Nasdaq: TCOMA), which is being acquired by AT&T (NYSE: T). California's public utilities commission signed off on the deal today. AT&T's shares moved up $3 1/16 to $87 1/2... Satellite systems designer Orbital Sciences Corp. (NYSE: ORB), which successfully launched a satellite for NASA last night, rocketed up $1 to $25 1/2... Insurance company American Indemnity Financial (Nasdaq: AIFC) blazed ahead $2 5/8 to $13 5/8 after property, casualty, and life insurer United Fire & Casualty Co. (Nasdaq: UFCS) agreed to buy the company for $14.60 per share in cash, about a 33% premium over yesterday's closing price, and deferred consideration of $1 per share in two years.

Enterprise software company Smith Gardner & Associates (Nasdaq: SGAI) locked up $3 7/16 to $16 1/2 after reporting Q4 EPS of $0.11. Two analysts polled by First Call expected an $0.11 per share loss... ABR Information Services (Nasdaq: ABRX), which provides benefits administration, payroll, and human resource outsourcing services to employers, signed up gains of $1 11/16 to $20 13/16 after it turned in fiscal Q2 EPS of $0.20, a nickel better than a year ago and $0.02 better than market projections... Missouri utility company St. Joseph Light & Power Co. (NYSE: SAJ) switched on gains of $3 1/2 to $20 3/8 after UtiliCorp United (NYSE: UCU) agreed to buy the company for $23 per share, about a 36% premium on yesterday's closing price for St. Joe stock... Real estate investment trust Berkshire Realty Co. (NYSE: BRI) moved ahead $1 to $10 11/16 after reporting several buyout offers, including an $11.05 per share overture from Aptco LLC that the company deemed insufficient. Berkshire didn't reveal the other offers.

Consumer electronics stores Circuit City Stores (NYSE: CC) connected for $5 1/2 to $68 3/4 as Donaldson, Lufkin & Jenrette analyst Gary Balter raised his target price for the stock to $90 per share from $75... Bank holding company Comerica Inc. (NYSE: CMA) stepped up $2 5/16 to $69 3/4 after Chairman Eugene Miller said in an interview that the company is looking at acquisition opportunities in California... Specialty semiconductor company Microchip Technology (Nasdaq: MCHP), upgraded to "strong buy" from "outperform" by Morgan Stanley Dean Witter today, added $3 9/16 to $32. The broker made an identical ratings change for chipmaker Altera (Nasdaq: ALTR), which moved up $3 5/8 to $57 9/16... Telecommunications billing and customer service software maker LHS Group (Nasdaq: LHSG), which withdrew a secondary stock offering of 3.4 million shares citing unfavorable market conditions, picked up $1 15/16 to $40 11/16 today.

Insurance holding company Everest Reinsurance (NYSE: RE), which J.P. Morgan started today with a "market perform" rating, climbed $7/8 to $34 15/16... Finnish wireless telecom equipment company Nokia (NYSE: NOK.A), a December Foolish Daily Double, added $7 11/16 to $145 15/16 as Thomas Weisel Partners started coverage of the company with a "buy" rating... Insurance giant American International Group (NYSE: AIG), started at "buy" by JP Morgan Securities, socked away $2 7/8 to $118 5/16. The brokerage expects the stock to hit $138 per share within a year... Banking power Chase Manhattan Bank (NYSE: CMB) advanced $3 1/2 to $86 7/8 as a Salomon Smith Barney analyst reiterated a "buy" rating on the stock... Cola warrior PepsiCo (NYSE: PEP), reiterated as a "top pick" at Donaldson, Lufkin & Jenrette, foamed up $2 1/8 to $39 7/8 today.

GOATS

Computer superstore company CompUSA (NYSE: CPU) got clocked today for a $1 3/4 loss to $6 3/8 after announcing that third quarter same-store sales will decline in the high single-digit percentage range. Combined with the cost of other initiatives, the company expects to report a loss of a few pennies per share for the quarter. Additionally, CompUSA is forecasting a loss in the fourth quarter "based on current business trends." Analysts, believing one of those trends is a slowdown in corporate computing products spending, lowered their opinions of the company today, with at least four brokerages issuing downgrades. However, the array of assets the company has -- both virtual and hard assets -- is of interest to at least one Fool, as described in today's Fool Plate Special

Healthcare information systems developer IDX Systems Corp. (Nasdaq: IDXC) dropped $11 1/2 to $14 1/2 after saying unexpected delayed purchasing decisions by some of its clients will result in a Q1 loss of $0.22 to $0.28 per share. Analysts, some of whom had affixed a "first-mover" crown on IDX in the emerging Internet-related systems segment, had been expecting earnings of $0.35 per share, according to the company. First-mover status may sound great, but it can also be a hindrance for a company like IDX that must contend with the ever-changing playing field of healthcare. Healthcare purchasing managers seem to have a lot on their minds these days, starting with making sure their systems are Y2K compliant. Purchases of snazzy new software, such as the IDX's IDXtendR product, will have to wait. In response, at least six brokerage firms lowered their ratings on IDX today.

The fallout from IDX's warning today tore its way through the rest of the healthcare information sector, trashing stock prices quicker than Mike Tyson can destroy a jail cell television. Cerner Corp. (Nasdaq: CERN), which was beat up on delayed contract concerns a month ago, fell $1 5/16 to $14 3/8; Shared Medical Systems (NYSE: SMS) slumped $3 13/16 to $49 7/16; and QuadraMed (Nasdaq: QMDC) shed $4 3/8 to $11 7/16. Also, physician practice management software maker Medical Manager (Nasdaq: MMGR) was downsized $3 15/16 to $24 7/8, Eclipsys Corp. (Nasdaq: ECLP) lost $3 to $25 1/2, and healthcare IT consultant Superior Consultant (Nasdaq: SUPC) slid $3 7/8 to $31 5/8. McKesson HBOC (NYSE: MCK), which received a Morgan Stanley Dean Witter downgrade to "outperform" from "strong buy," dropped $4 5/8 to $61 1/4.

QUICK CUTS: Apparel marketer The North Face (Nasdaq: TNFI) did an about-face and fell $3 7/16 to $13 1/16 after saying it has withdrawn its tender offer for all of its outstanding shares, which was announced earlier this week, due to "unexpected delays" in preparing its audited 1998 financial statements. Those delays may end up affecting the firm's 1997 results, the company said. In a confusing twist, the company added that the previously announced transaction agreement with TNF Acquisition LLC "remains in full force and effect"... Baseball gloves and basketballs maker Rawlings Sporting Goods (Nasdaq: RAWL) was spiked for a $1 5/8 loss to $10 after saying delayed orders by several retailers will lead to fiscal Q2 EPS between $0.38 and $0.43, short of the Zacks mean estimate of $0.66.

After yesterday's fall by International Gaming Technology (NYSE: IGT), slot machine maker Anchor Gaming (Nasdaq: SLOT) threw snake-eyes today and lost $4 9/16 to $35 15/16 after saying that the same potential Nevada legislation that is worrying IGT may also hamper Anchor's future earnings. Further, Anchor said its fiscal Q3 EPS will come in $0.13 to $0.23 below the First Call mean estimate of $1.33... Group employee benefits provider Delphi Financial Group (NYSE: DFG) slipped $12 3/8 to $28. Since Feb. 23, Delphi's shares have tumbled 30% after Berkshire Hathaway's (NYSE: BRK.A) Cologne Re unit said it will add $275 million to its reserves to cover workers' compensation claims, prompting speculation that a similar move is forthcoming from Delphi's Unicover subsidiary. Goldman Sachs cut its rating on Delphi to "market perform" from "recommended list" today.

Trash hauler Allied Waste Industries (NYSE: AW) was dumped $5 to $15 after reporting pro forma Q4 EPS of $0.25 (excluding charges), up from last year's $0.12 and in line with the Zacks mean estimate. However, Merrill Lynch cut its near-term rating on the company to "accumulate" from "buy"... Set-top box maker Scientific-Atlanta (NYSE: SFA) slid $3 1/4 to $27 1/8. In a press release, the company said it knew of no news to explain the stock's drop... Business-to-business e-commerce software provider Sterling Commerce (NYSE: SE), which dropped $3 5/8 to $26 7/16 today, said "no comment" to requests from the NYSE to explain its stock's recent activity... Staffing services provider Norrell Corp. (NYSE: NRL) slid $1 3/16 to $13 13/16 on downgrades from Legg Mason and Dain Rauscher Wessels.

Specialty railroad trackwork maker ABC-NACO (Nasdaq: ABCR), formed by the merger of ABC Rail Products and NACO last year, derailed for a $9/16 loss to $14 after saying a falloff in sales and margins at its track products business resulted in pro forma fiscal Q2 EPS of $0.05, lower than the $0.12 expected by the five analysts surveyed by First Call... Engineering and construction services company Michael Baker Corp. (AMEX: BKR) was knocked down $3/4 to $7 1/2 after saying problems at a large construction project being performed by one of its subsidiaries at Universal Studios in Florida will have a "material adverse effect" on the company's 1998 earnings... Biotechnology company Biogen (Nasdaq: BGEN) lost $1 9/16 to $103 7/16 following a Morgan Stanley Dean Witter downgrade to "outperform" from "strong buy."

FOOL ON THE HILL
An Investment Opinion
by Warren Gump

Keep Your Eye on Ionics

I have been intrigued by the prospects for companies associated with the water industry for quite a while. This fascination comes from the prospects of the increasing need of high purity water for manufacturers in the semiconductor and pharmaceutical industries. In addition, as clean fresh water becomes a scarcer resource, national and local governments will need to spend massive amounts of money to upgrade their water and wastewater system infrastructures. Rounding out the opportunities for growth is the soaring demand for bottled water.

Last December, I commented on U.S. Filter (NYSE: USF), one of the leaders in the water infrastructure and distribution business. That company emerged into its leadership position through an acquisition spree over the past several years, culminating with last year's huge purchase of Culligan. While posting strong earnings excluding one-time charges, U.S. Filter's cash flow statement has not been quite so strong. During the quarter ending December 31, the company posted net income of $63 million, yet it only had cash flow from operations of $12 million -- and that was one of its better quarters from a cash flow perspective! The company also has a fairly leveraged balance sheet, with $1.9 billion in total debt and $1.7 billion in equity.

I've found another water purification company that does some of the same things U.S. Filter does, yet has much better cash flow and virtually no debt. This strong financial structure is a result of the company's focus on using internal growth rather than acquisitions as a primary driver of growth. Earnings for this company declined 24% last year, but that follows 12 consecutive years of record earnings and revenue. During this growth streak, the company grew revenues and earnings at a compound annual rate of 17% and 30%, respectively. The end of this streak was brought about by the severe downturn in the market for ultrapure water by semiconductor manufacturers.

Ionics (NYSE: ION), headquartered in (of course) Watertown, Mass., manufactures membranes and related equipment for the purification, concentration, treatment, and analysis of water and wastewater. The company also supplies purified water, food and chemical products, bottled water, and home water purifiers. Operationally, the company can be broken down into three business segments: Membranes and Related Equipment; Water, Food, and Chemical; and Consumer Products.

The Membranes and Related Equipment division, accounting for 47% of revenues and 44% of gross margin in 1997, makes membrane-based systems for the industrial and municipal markets. Systems sold by this division accomplish various tasks including water desalinization, wastewater processing, and ultrapure water filtering (where impurities are measured in terms of parts per billion or trillion!). During the first nine months of 1998, sales and gross margin for this division increased a modest 3%. Strength in wastewater treatment offset weakness in the ultrapure water segment. (Although full-year 1998 earnings have been reported, divisional results are only available through September 30.)

The Water, Food, and Chemical division uses Ionics' technology to produce products that are then sold to customers. In many cases, the company will set up and operate filtration systems at the customer's site. The water side of the business produces ultrapure water and drinking water. The division also produces chemicals and food products, such as demineralized whey, which utilize Ionics' membrane technology in their manufacturing process. Accounting for 32% of revenues and 28% of gross margin in 1997, this division was the laggard during the first three quarters of 1998. Revenue declined 23% and gross margin fell 21% because of reduced demand for ultrapure water.

The Consumer Products division sells bottled water under the Aqua Cool brand name, as well as home filtration systems under the HYgene brand. The bottled water business, which primarily sells 5 gallon bottles, has over 120,000 customers around the world. This segment accounted for 21% and 27% of 1997's sales and gross margin, respectively. During 1998, the division saw sales increase 10% and gross margin rise 11%. The year-over-year improvements reflect a growing customer base and higher average prices.

Earlier I mentioned that Ionics has significantly better cash flow relative to earnings than U.S. Filter. In 1997, the company had net income of $28 million and cash from operations of $48 million. The high level of cash flow is derived from large depreciation and amortization charges, as well as only modest increases in accounts receivable and inventory. During the first nine months of 1998, the company had net income of $16 million and cash from operations of $25 million. As noted earlier, U.S. Filter had net income of $63 million and cash flow of $12 million last quarter. These figures indicate that Ionics is a much better manager of working capital.

Another strategy of Ionics that I like is its continued focus on research and development (R&D). Many companies will reign in R&D spending dramatically during a downturn to help boost earnings. Despite the weakness of the first nine months of this year, Ionics increased R&D spending 24%. This indicates the company's management team recognizes the importance of R&D. I would much prefer a company to have weak earnings for a few quarters and continue to invest in worthwhile research projects than risk its leadership in technology by throttling back R&D expenditures to meet Wall Street expectations.

Ionics should be interesting to watch in the years ahead. While the First Call consensus EPS estimate for Q1 is down, a rebound to 20%+ growth off of last year's weak results are projected for the rest of the year. Analysts are projecting a long-term growth rate of 15%. With the increasing demand for cleaner water worldwide, such prospects seem reasonable, if not conservative. The earnings downturn over the past few quarters does remind investors that while enjoying long-term secular growth, this industry is affected by the economy. Investors in such a business should be rewarded by finding a company with strong management, a technological focus, and a solid financial structure. Ionics easily makes it through those filters.

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