Friday, January 22, 1999
DJIA 9144.62 -119.46 (-1.29%) S&P 500 1226.38 -8.78 (-0.71%) Nasdaq 2338.86 -5.86 (-0.25%) Russell 2000 421.76 -2.29 (-0.54%) 30-Year Bond 102 10/32 +18/32 5.10 Yield

An Investment Opinion
by Dale Wettlaufer

Gateway Q4: It Gets Even Better

Gateway 2000 Inc. (NYSE: GTW) inched ahead $1 to $59 this morning after posting very impressive fourth quarter results last night after the bell. The South Dakota PC company reported fourth quarter revenues of $2.31 billion, up 16.6% year-over-year. EPS grew 37%, however, as gross profit shot up 40.3% and gross margin expanded 3.65 percentage points year-over-year and 80 basis points sequentially. That allowed the company to expand sales, general, and administrative expenses by 44.1% and still bring about a 34.5% increase in operating profit. Paying attention here to absolute dollar spending and gross profits available for operating expenditures is more instructive than looking purely at SG&A expenses as a percentage of sales. Looking at operating income, the quality of these earnings is very high and speaks to a number of accomplishments at Gateway this year.

First, the company's Gateway Country Stores concept is quite interesting. Though the connotation might be cheesy, the Gateway stores could be compared to a catalog showroom, where inventory investment in demonstration models per square foot is minimal and sales per square foot are incredibly good. These stores will also be the base for a number of outbound salespeople targeting small- and medium-size businesses. Productivity gains were driven by four key factors, some straight blocking and tackling and some strategic: 1) Better pricing discipline across product line; 2) recutting some contracts and holding vendors to contract prices; 3) better job at manufacturing execution, reducing waste and increasing margins; and 4) better product mix.

The better product mix is one of the most attractive features of Gateway and harkens back to the days of Dell (Nasdaq: DELL) richening its product mix and thus growing profits and cash flow much faster than the rest of the industry. This quarter, Gateway's average unit price declined only 2% sequentially versus 9% for the rest of the industry, according to Gateway. On an annualized basis, that's a big difference and points to solid performance in increasing sales of portables and servers. Asset management also improved greatly once again. Inventory investment was negative sequentially and was even better year-over-year. For the year, inventory investment was negative $81.3 million, coming from a quarterly improvement in inventory turns for three out of the four quarters this year.

Quarterly inventory turnover (annualized):
Q1: 25.6
Q2: 30.2
Q3: 32.6
Q4: 39.5
source: Motley Fool data

Through three quarters, net cash flow from operations equaled 228% of net income. For the fourth quarter, based on our look at the data, that trend accelerated, with cash flow from operations for the year equaling around 275% of net income. Return on invested capital flows from the basic fact that invested capital was flat sequentially (treating 5% of revenues as required cash) while after-tax operating profit was up 65.5%. That resulted in a return on capital performance of 79%, annualized for the quarter, up from a still very strong 48% last quarter. With excellent fundamentals as far as strategy, products, and production and financial execution go, the company's valuation is way too low at a multiple of less than 9 times enterprise value to net cash flow from operations.


Programmable logic device maker Lattice Semiconductor (Nasdaq: LSCC) climbed $4 to $51 7/8 after reporting fiscal Q3 EPS of $0.45, down from last year's $0.57 but ahead of the Zacks mean estimate of $0.43. The company said it is "cautiously optimistic" that the turmoil in the chip industry brought on by the Asian financial crisis last year has subsided. Donaldson, Lufkin & Jenrette raised its rating to "buy" from "market perform."

Satellite systems maker and DirecTV direct broadcast satellite (DBS) operator Hughes Electronics Corp. (NYSE: GMH) rose $2 1/8 to $46 7/8 after agreeing to buy the DBS medium-power business of rival Primestar Inc. for $1.82 billion in cash and stock. Hughes will also receive Primestar's rights to the Tempo high-power satellite assets. Hughes and DirecTV will hold a conference call today at 11 a.m. ET -- (800) 621-5344. A replay will be available from 1 p.m. ET today through 5 p.m. Monday -- (800) 633-8284, reservation # 11589806.

Enterprise application software company BMC Software (Nasdaq: BMCS) gained $5 1/8 to $43 11/16 after reporting fiscal Q3 EPS of $0.44 versus $0.30 a year ago, beating the First Call mean estimate of $0.39. Total revenues increased 45% to $283.4 million from the same quarter last year, driven by "strong" license revenue growth and "very strong" mainframe product sales.

Database software vendor Sybase Inc. (Nasdaq: SYBS) jumped $2 1/16 to $10 5/8 after posting Q4 EPS of $0.10 (excluding a restructuring charge), double the First Call mean estimate. Server license revenues climbed 32% sequentially and 20% year-on-year during the quarter.

Women's apparel designer Jones Apparel Group (NYSE: JNY) advanced $3 5/16 to $27 5/16 following an upgrade from Morgan Stanley Dean Witter to "strong buy" from "outperform." Credit Suisse First Boston also started coverage this morning with a "strong buy" rating and a 12-month price target of $33 per share.

Natural gas pipeline company and fiber optic telecommunications network operator Williams Companies (NYSE: WMB) picked up $2 5/16 to $32 13/16 after saying its Williams Communications unit has doubled the size of its five-year contract for equipment from Nortel Networks (NYSE: NT) to $600 million from $300 million due to "boomin'" long-haul telecom traffic carriage and business growth.

Auction house Sotheby's Holdings (NYSE: BID) was raised $1 15/16 to $38 7/16 thanks to a Morgan Stanley Dean Witter upgrade to "outperform" from "neutral."

Online retailer Amazon.com (Nasdaq: AMZN) gained $8 3/4 to $114 3/4 after BancBoston Robertson Stephens reiterated its "buy" rating on the stock, saying recent investor concerns regarding possible Internet pricing battles are "overblown" and have created "an attractive market opportunity to buy shares."

Cable-based online services provider @Home Corp. (Nasdaq; ATHM) added $3 3/8 to $100 3/4 after The Wall Street Journal reported that AT&T (NYSE: T) may sell its Internet-access business, including its WorldNet Internet dial-up service, to @Home for $1 billion in stock. For more details, see this morning's Breakfast With the Fool.

Earnings Movers

Arkansas Best Corp. (Nasdaq: ABFS) up $1 5/8 to $7 1/2; Q4 EPS: $0.30 (excluding settlement gain) vs. $0.19 last year; estimate: $0.17

Atmel Corp. (Nasdaq: ATML) up $2 3/4 to $18 3/4; Q4 EPS: $0.09 vs. loss of $0.95 last year (including charges); estimate: $0.07

Carrier Access Corp. (Nasdaq: CACS) up $9 3/8 to $47 7/8; Q4 EPS: $0.13 vs. loss of $0.01 last year; estimate: $0.07

Commonwealth Industries (Nasdaq: CMIN) up $1 1/8 to $10 15/16; Q4 EPS: $0.13 vs. $0.08 last year; estimate: loss of $0.01


IBM (NYSE: IBM) shareholders were blue this morning, as the stock sagged $13 1/4 to $183 3/4 after the company reported Q4 EPS of $2.47, up from $2.11 in the same year-earlier period and ahead of analysts' mean estimate of $2.45. The PC maker missed the most optimistic forecasts amid a 2% decline in hardware sales and a 3% drop in maintenance revenues, ongoing softness in memory chip prices, and continued weakness in Asia and Latin America. The company's gross profit margin fell to 39% from 40.1% a year ago.

Digital video compression systems maker C-Cube Microsystems (Nasdaq: CUBE) lost $5 1/8 to $24 9/16 after it said Q4 EPS was $0.31, a penny ahead of last year's figure and in line with market estimates. The company also announced the purchase of communication technology, patents, and personnel for implementing interactive cable and satellite digital set-top boxes from TV/Com International.

Barnes & Noble (NYSE: BKS) slid $9/16 to $38 13/16 following reports in Business Week's "Up Front" section that it will revamp efforts next month for an initial public offering of its online bookstore. The Fool talked to barnesandnoble.com CEO Jonathan Bulkeley in this week's StockTalk interview -- check it out.

Network Solutions (Nasdaq: NSOL) lost $1 1/4 to $170 1/2 following reports in the New York Times that the Internet Corporation for Assigned Names and Numbers (ICANN), a non-profit board charged with opening the Web's domain-name registration business to competition, may use an international lottery to pick the first five companies to end Network Solutions' government-sanctioned monopoly on the industry.

Telecommunications equipment giant Lucent Technologies (NYSE: LU) fell $2 1/16 to $104 7/8 this morning, extending yesterday's loss driven by worries about revenue growth. Lucent's betrothed, data networking equipment company Ascend Communications (Nasdaq: ASND), dipped $2 1/16 to $79 11/16.

Athletic shoe retailer Just For Feet (Nasdaq: FEET) ran down $2 3/8 to $15 after the company said lower-than-anticipated sales and higher store opening expenses are expected to pull Q4 EPS below Wall Street's $0.25 consensus estimate. The higher costs, paired with slumping same-store sales at the company's specialty-store division, offset better same-store sales growth at its superstores.

Next generation Internet video company FVC.COM (Nasdaq: FVCX) dropped $2 1/16 to $10 13/16 as the company said it sees Q4 EPS missing the $0.05 consensus estimate five analysts gave First Call. "Orders were heavily back-end loaded during the quarter and we were unable to fully ship all orders," said CEO Rich Beyer.

Broadband cable modem systems maker Terayon Communication Systems (Nasdaq: TERN) shed $3 5/16 to $38 15/16 after the company announced plans to sell 3.25 million shares of common stock for $38 per share, about a 10% discount to yesterday's closing price. The new shares would increase the total outstanding by nearly 20%.

Home healthcare medical products manufacturer Sunrise Medical (NYSE: SMD) set for $2 1/8 to $7 13/16 after reporting fiscal Q2 EPS of $0.08, twice the year-ago figure but well short of First Call's five-analyst estimate of $0.17. "The second quarter is traditionally our weakest, but results this year were particularly disappointing," said Chairman Richard Chandler, but he added, "we expect to show improving sales and earnings trends in the second half of the fiscal year."

Earnings Movers

Anchor Gaming (Nasdaq: SLOT) down $1 9/16 to $57; fiscal Q2 EPS: $1.34 vs. $1.20 last year; estimate: $1.34

Becton Dickinson (NYSE: BDX) down $2 13/16 to $34; fiscal Q1 EPS $0.29 vs. $0.25 last year; estimate:

CDW Computer Centers (Nasdaq: CDWC) down $4 5/8 to $88 5/8; Q4 EPS: $0.84 vs. $0.64 last year; estimate: $0.81

C.P. Clare (Nasdaq: CPCL) down $1 1/2 to $6 1/4; fiscal Q3 EPS $0.01 vs. $0.22 last year; estimate: $0.01

Forte Software (Nasdaq: FRTE) down $7/16 to $7 3/4; fiscal Q3 EPS: profit of $0.03 vs. loss of $0.32 last year; estimate: $0.03

Iomega (NYSE: IOM) down $1 1/8 to $7 7/8; Q4 EPS: $0.07 vs. $0.13 last year; estimate: $0.05

Preview Travel (Nasdaq: PTVL) down $1 to $22 1/4; Q4 EPS loss of $0.61 (before charges) vs. loss of $0.63 last year; estimate: loss of $0.66

QLogic Corp. (Nasdaq: QLGC) down $8 to $142 3/4; fiscal Q3 EPS: $0.76 vs. $0.43 last year; estimate: $0.70

Starbucks Corp. (Nasdaq: SBUX) down $1 1/16 to $51 11/16; fiscal Q1 EPS: $0.29 vs. $0.23 last year; estimate: $0.29

Tribune Co. (NYSE: TRB) down $1 3/8 to $64; Q4 EPS: $0.72 (before one-time items) vs. $0.62 last year; estimate: $0.70

USX-U.S. Steel Group (NYSE: X) down $5/8 to $26 3/8; Q4 EPS: $0.63 (before one-time items) vs. $1.52 last year; estimate: $0.32


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