<THE EVENING NEWS>
Wednesday, April 21, 1999
DJIA 10581.42 +132.87 (+1.27%) S&P 500 1336.12 +29.95 (+2.29%) Nasdaq 2489.08 +79.44 (+3.30%) Russell 2000 426.57 +11.23 (+2.70%) 30-Year Bond 96 -5/32 5.53 Yield
Shares of Network Solutions (Nasdaq: NSOL) reversed a lengthy slide today as the market learned the identity of the first five companies to compete with it in the once monopolistic web domain name registrar business. First into the fray are online services giant America Online (NYSE: AOL) and a unit of France Telecom (NYSE: FTE), the only two publicly traded entries in the group. AT&T (NYSE: T) made the "B" list, a group of 28 organizations expected to join the fray within two months. Network Solutions, which has been battered recently in part because of uncertainty about its new market environment, picked up $32, or 53.3%, to $92 today. The company will get to charge the competing registrars $9 per year for each new address added to the master database of .coms, .nets, and .orgs, lower than originally hoped. But Network Solutions, which has expanded its service offerings and marketing efforts in recent months, still leads the leadership position in the domain name business and will be loathe to relinquish it. Collecting revenue from its competitors, particularly powerful companies like AOL, isn't a bad start.
Wireless communications technologies firm Qualcomm (Nasdaq: QCOM), which reported fiscal Q2 EPS of $0.82 before charges -- beating both last year's $0.25 mark and Wall Street's $0.59 estimate -- raced ahead $54 7/16 to $195 1/16, the stock's largest one-day point gain ever. Sales of its phones and chip sets were strong during the quarter; factor out one-time charges and the operating results of its network business -- set for sale to Ericsson (Nasdaq: ERICY) next month -- and results would be even stronger at $1.20 per share. Operating expenses -- which figure in research and development, selling and marketing, and general and administrative expenditures -- held firm at 22% of revenues excluding one-time charges. The refocused company, which has recently introduced new telephones and chips to the consumer market, has more than tripled this year and has plenty of fans on Wall Street: at least three brokerages upgraded Qualcomm today.
QUICK TAKES: Web portal operator Lycos (Nasdaq: LCOS) jumped $27 5/8 to $101 1/2 following news that its network of sites -- including the Hotbot search service and the Tripod community -- was the third most visited "web property" on the Internet in March. Fourth-place property Yahoo! (Nasdaq: YHOO) took $3 7/8 to $174 7/8... Shares of online brokerage E*Trade (Nasdaq: EGRP) were bid up $8 11/16 to $98 1/2 on news of a partnership to develop its E*Offering online investment bank site in cooperation with USWeb/CKS (Nasdaq: USWB) with eyes on a June launch. Yesterday, E*Trade reported a pro forma Q1 loss of $0.12 per share due, better than the projected $0.17 loss. USWeb grabbed $3 3/8 to end at $28 3/4. E*Trade competitor Ameritrade (Nasdaq: AMTD) took $17 11/16 to $128 13/16, while Charles Schwab Corp. (NYSE: SCH) got $8 1/4 to close at $115.
Component and supply management software company Aspect Development (Nasdaq: ASDV), which said it expects to be profitable in 1999, was up $2 1/4 to $9 3/4 while reporting a Q1 loss of $0.06 per share, a penny better than projected... Media streaming technologies developer RealNetworks (Nasdaq: RNWK) streamed up $9 1/4 to $190 5/16 after reporting a Q1 loss of $0.02, better than last year's $0.07 loss and First Call's $0.03 consensus estimate. The company also set a 2-for-1 stock split for May 10... Video transport and network access system maker Tellabs (Nasdaq: TLAB) moved up $5 to $102 9/16. After the market's close, the company announced plans for a 2-for-1 stock split on May 17, as well as the intent to triple sales by 2003.
Scalable Internet search and caching software developer Inktomi Corp. (Nasdaq: INKT), started at "strong buy" by CIBC Oppenheimer today, ascended $10 1/2 to $125 1/2... Telecommunications equipment company Lucent Technologies (NYSE: LU) dialed up a gain of $4 7/8 to $59 1/8 after Sprint (NYSE: PCS) awarded the company a three-year contract to million to supply equipment and services for the next phase of Sprint PCS's nationwide wireless network development and expansion worth at least $780 million... Regional phone company BellSouth Corp. (NYSE: BLS) advanced $2 5/8 to $44 this morning following news that it and AT&T successfully completed a series of joint tests to ensure that telephone calls will go through as usual during the changeover into Y2K.
Securities market maker Knight/Trimark Group (Nasdaq: NITE) gained $33 to $119 3/4 after reporting Q1 EPS of $0.67, up from $0.20 last year and $0.33 in Q4. Wall Street's estimate was $0.39. The company also said it will split its shares 2-for-1 after the market's close on May 14.... Drug developer Centocor (Nasdaq: CNTO) moved up $7 3/16 to $42 1/4, reportedly on acquisition-related rumors... Web-hosting company Verio Inc. (Nasdaq: VRIO), chosen to join the second wave of companies that will enter the Web address registrar business this summer, advanced $12 1/4 to $71 today. See above for more.
German enterprise software giant SAP A.G. (NYSE: SAP) picked up $6 1/4 to $30 7/8 after reporting Q1 net income flat with last year's Q1 levels at 98 million euros on 22% revenue growth... Network computing company Sun Microsystems (Nasdaq: SUNW) rose $5 1/8 to $59 1/2 this morning. The company said COO Edward Zander will become president as well, while CEO and Chairman Scott McNealy will remain in his current posts... Diversified manufacturing and service company Tyco International (NYSE: TYC) moved up $3 11/16 to $81 7/8 following an upgrade to "buy" from "add" at Credit Lyonnais, which set a 12- to 18-month price target of $101 per share.
Boston Scientific (NYSE: BSX) up $7 3/16 to $43 7/8; Q1 EPS: $0.25 vs. $0.15 last year; estimate: $0.21
Broadcom Corp. (Nasdaq: BRCM) up $8 3/4 to $73 1/8; Q1 EPS: $0.19 vs. $0.09 last year; estimate: $0.15
Coca-Cola (NYSE: KO) up $2 5/16 to $67 9/16; Q1 EPS: $0.30 vs. $0.34 last year; estimate: $0.29
Colgate-Palmolive (NYSE: CL) up $7 3/8 to $100 3/8; Q1 EPS: $0.65 vs. $0.60 last year; estimate: $0.64
DuPont Photomasks (Nasdaq: DPMI) up $5 1/2 to $48 1/2; fiscal Q3 EPS: $0.28 vs. $0.50 last year; estimate: $0.22
Encad Inc. (Nasdaq: ENCD) up $1/2 to $7 1/8; Q1 EPS: profit of $0.03 vs. loss of $0.06 last year; estimate: loss of $0.05
Ingersoll-Rand (NYSE: IR) up $1/8 to $64 7/8; Q1 EPS: $0.73 vs. $0.60 last year; estimate: $0.68
inTEST Corp. (Nasdaq: INTT) up $2 3/4 to $6 13/16; Q1 EPS $.03 vs. $0.19 last year; estimate: $0.01
Kimberly-Clark (NYSE: KMB) up $4 1/8 to $58 7/16; Q1 EPS: $0.72 (excluding gain) vs. $0.56 last year; estimate: $0.65
Legato Systems (Nasdaq: LGTO) up $7 to $42 1/8; Q1 EPS $0.25 vs. $0.13 last year; estimate: $0.22
Musicland Stores (NYSE: MLG) up $13/16 to $10 1/8; Q1 EPS: profit of $0.04 vs. loss of $0.11; estimate: loss of $0.04
Nautica Enterprises (Nasdaq: NAUT) up $3/16 to $13 3/16; fiscal Q4 EPS: $0.25 vs. $0.33 last year; estimate: $0.24
PeopleSoft Inc. (Nasdaq: PSFT) up $1 15/16 to $14 1/16; Q1 EPS $0.03 vs. $0.13 last year; estimate: $0.02
Qwest Communications International (Nasdaq: QWST) up $2 to $92 1/2; Q1 EPS: profit of $0.01 vs. loss of $0.06 last year (pro forma); estimate: breakeven
Xoom.com (Nasdaq: XMCM) up $6 1/2 to $76 3/4; Q1 EPS: loss of $0.24 vs. loss of $0.29 last year; estimate: loss of $0.26.
Electronic design automation (EDA) tools maker Cadence Design Systems (NYSE: CDN) was wrecked for $8 5/16, or 40%, to $12 1/2 after reporting Q1 EPS of $0.31 (excluding charges and goodwill amortization), a penny ahead of the Zacks mean estimate. However, the company said it sees its revenues and earnings growth slowing through the rest of the year. That guidance brought a flurry of downgrades from at least six brokerage firms today, who didn't buy the company's explanation that Cadence's chip customers are dragging their feet switching to the industry's new sub-0.18 micron chip geometries. In advance of tomorrow's earnings, rival Synopsys (Nasdaq: SNPS) dropped $4 1/4 to $42 1/8. Meanwhile Cadence's earnings lead investors to question whether the current valuations across the front-end semiconductor fabrication equipment world are justified. Companies like Applied Materials (Nasdaq: AMAT) jumped today on a good book-to-bill report from Semiconductor Equipment and Materials International (SEMI), but the fact is that billings are still down 19.5% since March 1997 and bookings are down 9%. Applied gained 8.2%, or $4 5/8 to $61 3/8, on the day and is up 44% for the year. The report from Synopsys tomorrow will certainly be helpful in clarifying the situation.
Bookseller Borders Group (NYSE: BGP) was burned for a $2 7/16 loss to $14 5/8 after Philip Pfeffer resigned as CEO after a mere five months at the helm. His duties will be assumed by current chairman and former CEO Robert DiRomualdo. The company also said it sees fiscal Q1 earnings of $0.04 to $0.05 per share for its retail stores and a loss of $0.05 to $0.06 per share for its Borders.com unit, excluding a $0.04 per share loss tied to Pfeffer's departure. Using Borders' diluted sharecount of 81.7 million shares and reported tax rate of 39% from Q4, Pfeffer's severance agreement works out to a cool $5.4 million pre-tax, or nearly $1.1 million per month. Considering Michael Jordan only made about $5 million per month in his final NBA season, that's not too shabby. As far as prospective CEO candidates go, it might just take a Jordan-caliber leader to turn around this troubled company.
QUICK CUTS: Paging company SkyTel Communications (Nasdaq: SKYT) tumbled $1 3/4 to $15 3/16 after saying "significantly" lower-than-expected subscriber growth in Q1 will continue and dampen earnings growth this year. Still, the company managed to earn $0.05 per share in Q1 (excluding a gain), meeting the First Call mean estimate...Network connectivity products maker Osicom Technologies (Nasdaq: FIBR) fell $8 3/8, or 44.4%, to $10 1/2 after saying it has not yet received any purchase orders from a Japanese client under a previously announced contract for a wireless personal data assistant (PDA) product. When the contract was announced last July, Osicom had projected $4 million in shipments per month over a two-year period starting in February 1999.
Digital and analog oscilloscopes maker LeCroy Corp. (Nasdaq: LCRY) was dumped $4 11/16 to $14 3/4 after posting fiscal Q3 EPS of $0.27 (excluding charges), in line with the Zacks mean estimate. However, the company said higher research and development expenditures and investments in networking products in Q4 will result in breakeven results, missing analysts' EPS expectations of $0.45... Telecom equipment company Advanced Fibre Communications (Nasdaq: AFCI) slid $15/16 to $7 3/32 after saying a slowdown in international sales led to Q1 EPS of $0.04 compared to $0.15 last year, which was still in line with the Zacks mean estimate. NationsBanc Montgomery Securities lowered its rating to "hold" from "buy."
Aluminum producer Kaiser Aluminum (NYSE: KLU) dropped $11/16 to $6 3/16 after saying low primary metal prices and shipment levels and an unfavorable product mix resulted in a Q1 loss of $0.48 per share, which was worse than the loss of $0.27 per share expected by analysts surveyed by First Call... Electrical and industrial equipment manufacturer Raychem Corp. (NYSE: RYC) fell $1 1/2 to $26 1/2 after Goldman Sachs lowered its rating on the company to "outperform" from "recommended list." Yesterday, the firm posted fiscal Q3 EPS of $0.43 versus $0.46 a year ago, which was in line with estimates... Dynamic random access memory (DRAM) chipmaker Micron Technology (NYSE: MU) slid $2 3/4 to $41 1/2 after BancBoston Robertson Stephens analyst Dan Niles cut his rating on the stock to "long-term attractive" from "strong buy."
Specialty staffing services firm Robert Half International (NYSE: RHI) was chopped down $10 1/8 to $24 7/8 after posting Q1 EPS of $0.38, matching the First Call mean estimate. However, at least six brokerages downgraded the stock on concerns over future earnings growth... Automated teller machines and data warehousing company NCR Corp. (NYSE: NCR) slipped $8 11/16 to $44 5/8 despite posting Q1 EPS of $0.03, topping analysts' estimates of a penny. However, the company reportedly warned that concern over the Year 2000 problem by customers may cut into future revenues... Biotechnology company Amgen (Nasdaq: AMGN) fell $5 to $64 on concern about a slowdown in sales of its key Epogen drug later this year. For more details, see today's Fool Plate Special.
Hotel and casino operator Starwood Hotels and Resorts (NYSE: HOT) slid $2 to $32 today. After the bell, COO and President Richard Nanula announced that he will resign... Packaged food products company Vlasic Foods International (NYSE: VL) was crunched $1 5/16 to $8 13/16 following a downgrade from J.P. Morgan to "market perform" from "long-term buy"... Enterprise software developer Project Software and Development (Nasdaq: PSDI) lost $2 7/8 to $21 despite reporting fiscal Q2 EPS of $0.42, beating the First Call mean estimate by $0.02. However, BancBoston Robertson Stephens cut its rating on the firm to "long-term attractive" from "buy"... Oral drug delivery systems developer DepoMed (AMEX: DMI) tanked $9 7/16, or 67.4%, to $4 9/16 after drug maker Bristol-Myers Squibb (NYSE: BMY) decided not to license the firm's Gastric Retention system for an unidentified drug candidate.
Compaq's Management Broke Compact
Morality tales leave us feeling a righteous satisfaction because things end as they should, with villainous characters getting their do. That's why I felt joyful when I first heard the news that leading PC and enterprise computing firm Compaq (NYSE: CPQ) had booted CEO Eckhard Pfeiffer and CFO Earl Mason from their jobs over the weekend. They deserved it.
The proximate cause of this shakeup was Compaq's surprise Q1 earnings disappointment, but that was simply the final shoe to fall. As I've said several times, these guys repeatedly exhibited disdain for individual investors by disclosing material news to a handful of analysts and money managers. The capricious and arrogant way they handled disclosure not only flouted the spirit of the securities laws but proved indicative of broader problems regarding these executives' integrity and judgment. Bottom line: the Pfeiffer-Mason regime had lost credibility. That's why investors initially bid up Compaq shares Monday morning. Whatever challenges the company faces -- and they're no doubt significant -- a change in leadership was simply long overdue.
Let's review a little history. In September 1997, a member of Compaq's top management appeared at an investment conference and told a small group of Wall Street professionals that the firm was raising its year 2000 revenue target by 25%, from $40 billion to $50 billion. With these institutional investors racing to the phones, the stock hopped to a 14% gain by the opening of trading the next day. No question, this was the kind of material information an investor would want to know before making an investment decision. The only trouble was, Compaq never bothered to issue a press release with this news. Investors had to rely on a secondhand account offered by Dow Jones, which got the news from an analyst attending the meeting. A day late, 14% short.
Of course, Compaq hasn't just kept good news confined to select investors. TheStreet.com reported last June that Mason told a closed-door meeting of professional investors at the PaineWebber Growth & Technology conference that the firm was "headed toward a money-losing quarter, according to two people who attended the session." At the time, analysts were looking for earnings of $0.01 a share, as Compaq was still suffering through an inventory glut. While many companies still close their "breakout Q&A sessions to reporters, few ever close their actual presentations, which Compaq did in this case.
More recently, Compaq shares got hit in February after another case of selective disclosure. According to a recent Bloomberg report, Credit Suisse First Boston analyst Michael Kwatinetz was touring Compaq's facility in February with a small group of investors when a Compaq executive (Mason, by some accounts) confessed that PC sales had shown "softness" in January. Kwatinetz immediately cut his estimates, with other analysts quickly following. This was basically an unannounced earnings warning.
This news becomes more interesting in light of the fact that Mason sold 265,000 shares of Compaq for more than $12 million on February 1. That's an average price of over $46 per share, nearly double today's close of $24. Did Mason already know Compaq would miss its Q1 earnings estimates? The attorneys behind a raft of shareowner lawsuits will certainly try to make the case. Although lawsuits are a dime a dozen following huge price declines in tech stocks, the plaintiffs here just might have a chance.
Of course, the credibility of both Mason and Pfeiffer has been in doubt for a while. On January 21, 1998, Pfeiffer said he expected a "strong 1998" with "improve[d] profitability." Yet, the firm was just six weeks away from pre-announcing an absolutely disastrous first quarter due to massive amounts of excess inventories in its reseller channel. Indeed, even as Compaq was talking up a move to a build-to-order model a la Dell (Nasdaq: DELL), with accompanying projected improvements in asset management, inventories were getting even more out of hand.
That's one reason Compaq's stock could hardly get off the mat after being pummeled during the October 1997 market break. Potential trouble soon began registering not just with short-sellers but with analysts, too. The Wall Street Journal ran a "Heard on the Street" column on February 12, 1998 addressing two questionable transactions that had an air of deceit about them. Compaq had factored $732 million in receivables in both the third and fourth quarter of 1997. That is, it had sold to a third party, at a discount, some of its uncollected customer bills. Factoring allows a firm to collect cash now rather than later, thus reducing the days sales outstanding while improving cash flow. Although a legitimate asset management tool, factoring is rare in the PC industry. In this case, it seemed designed to spruce up Compaq's performance metrics while hiding the fact that channel inventories were actually getting worse rather than better.
Donaldson, Lufkin & Jenrette analyst Kevin McCarthy noted at the time that without these transactions, Compaq's return on invested capital (ROIC) "would have been essentially flat over the past three quarters instead of posting sequential improvement." In the summer of 1997, Mason had told analysts that a move toward a build-to-order model would push ROIC from 50% to over 100%, as inventories would fall from ten weeks to three. However, management was simply failing to deliver on its ambitious goals. To hide the extent of that failure, the firm was pumping inventory into the channel and thus off its books while giving resellers favorable terms to take it. Compaq was then factoring the huge receivables to hide what was really going on. None of this was illegal, but it was suspicious.
Pfeiffer took over the helm of Compaq in 1991, when the firm was in disarray. He's credited with turning the company into the top PC manufacturer by volume and a major technology success story of the 1990s. Yet, after Mason's arrival at Compaq from Inland Steel in May 1996, the company seemed to grow increasingly addicted to over-promising and under-delivering. Management has found it hard to be straight with investors. The recent Q1 earning warnings was another case in point. Compaq's management blamed the trouble mostly on weak overall demand for PCs. For its part, Dell immediately responded, "I don't think so." As Dale Wettlaufer has rightly pointed out, PCs represent a much smaller part of Compaq's business since it acquired Digital Equipment Corp. (DEC) and Tandem. So management's account again seemed inadequate.
There's no question that Pfeiffer and Mason have mismanaged Compaq. At the most basic level, Compaq is still building PCs for the channel while Dell is building to order and gobbling up market share. Moreover, Compaq has tried to maintain its channel partners while also selling direct, merely creating a confused business model rather than improved service. All of this has ensured that Compaq suffers from a price/profit disadvantage on the PC front, especially in an environment of falling component prices.
But Compaq hasn't just failed to address Dell's competitive advantage on the manufacturing/distribution end. It's tried to use DEC's service wing to refocus its entire business around providing enterprise computing solutions, a la IBM (NYSE: IBM). Digesting huge acquisitions are a challenge. Trying to refocus a company around acquired assets is doubly challenging. Yet to do so while a competitor is kicking your butt in your supposed core competency represents, at best, the hope that strategic bravado can compensate for operating inefficiencies. Yet, the strategy only compounded those inefficiencies.
The notion that such deal-making would answer the competitive threat from Dell was a case of managerial hubris. Yet, such hubris was apparent at every turn. Last summer, the company launched a pointless $300 million branding campaign that said, "Look how much money we're willing to blow." Compaq devoted more millions to high-speed cable outfit RoadRunner, which has stumbled along pretty aimlessly. It blew another $220 million in cash buying the suspect Shopping.com, part of a cynical strategy to repackage its Alta Vista search engine, which it has shown no more ability to exploit than DEC had, and cash in on the Internet. Wipe away all the hype, and it's clear that Compaq has been in trouble for over two years.
While money managers were angry that Compaq warned of the Q1 shortfall only after the quarter actually ended, that disclosure mistake simply reflects lots of others that were arguably more serious for being highly selective. Investors should simply run from companies that indulge in selective disclosure because it represents such a fundamental violation of the compact that exists between owner and manager. If you can't trust management to treat you like an owner, then you can't trust management. Period. It's a signal of fundamental troubles with a company's top leadership. That's why I always thought it laughable that Business Week would honor Compaq's board of directors as among the best. Let's be clear: the board was asleep. The problems with Pfeiffer and Mason have been a long time coming, and the board did nothing until had suffered plenty.
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