Friday, April 30, 1999
DJIA          10789.04     -89.34    (-0.82%)
S&P 500        1335.18      -7.65    (-0.57%)
Nasdaq         2542.86     +14.42    (+0.57%)
Russell 2000    432.81      -0.04    (-0.01%)
30-Year Bond   94 3/32   -1 30/32   5.66 Yield


Direct marketing company MessageMedia (Nasdaq: MESG) grabbed $2 5/8 to $16 5/8 after the company said last night that Q1 losses were $0.17 per share, well ahead of last year's $0.38 loss. The company credits its impressive growth to a shift in focus to e-mail messaging, which accounted for most of the company's Q1 revenues this year. By comparison, last year's Q1 sales were about a third this year's and came primarily from a since-discontinued Internet payment system business. MessageMedia, which earlier this month signed on to provide e-mail messaging for Standard & Poor's online investment advisory service, today announced a pact with website community operator GeoCities (Nasdaq: GCTY) to deliver newsletters and other items to its members. Yesterday, the company named President Larry Jones its CEO.

Marketing information provider Market Facts Inc. (Nasdaq: MFAC) won $4 5/8 to $30 1/2 on news that London's Aegis Group agreed to buy the company for $31 per share in cash, a nearly 20% premium to yesterday's closing price. Aegis is getting Market Facts at its highest point in the company's trading history, as the merger-fueled rush pulled the shares past its September 1997 mark of just below $28. Market Facts on Monday reported Q1 EPS a penny better than expected at $0.22; the company cited a nearly 25% boost in revenue fired by both improving results at core operations and productive acquisitions. Perhaps fittingly, Market Facts has made two new investments just this month: a $4.1 million stake in Rochester, N.Y.-based Harris Black International, and the purchase of New York's Marketing Strategy and Planning for an undisclosed amount.

QUICK TAKES: Argentine oil company YPF SA (NYSE: YPF) jumped $5 7/8 to $41 13/16 after Repsol SA (NYSE: REP), Spain's giant oil, natural gas, and chemicals group, made an unsolicited $13.5 billion bid to buy the remaining 85.01% of YPF it doesn't already own. Repsol moved up $15/16 to $16 1/2 this morning; for more on the news, head back to this morning's Breakfast With the Fool... Commercial bank Mercantile Bancorp (NYSE: MTL) deposited $5 3/4 to $57 following reports that the company's board was to meet today to discuss the company's future and the possibility of a sale... Photodynamic therapy products QLT PhotoTherapeutics Inc. (Nasdaq: QLTI) took $2 to $45 11/16 after the company sold 2.75 million shares of company stock to the public at $43 5/8 each, a small discount to yesterday's $43 11/16 closing price.

Aerospace and aircraft giant Boeing (NYSE: BA) ascended $1/4 to $40 5/8 on news in The Wall Street Journal that it is in serious talks to acquire a controlling stake in the $2.4 billion Ellipso satellite mobile-phone project. Privately held Ellipso holds a Federal Communications Commission (FCC) license to launch a 17-satellite system... Information services company EDS (NYSE: EDS) got $2 7/16 to $53 3/4 after reporting first-quarter EPS of $0.36, before special charges and gains, down from $0.43 in the same year-earlier period but right in line with estimates... Telecommunications services provider GST Telecommunications (Nasdaq: GSTX) was lifted $3/4 to $12 5/8 after selling its multi-tenant residential services division to a group of undisclosed buyers. Q1 losses were $1.46 per share, a penny off First Call's mean estimate.

Power and energy management products company SatCon Technology Corp. (Nasdaq: SATC) powered up $1 15/32 to $8 1/8 after announcing that it received a second order for electric motors and controllers for use in fuel cell vehicles from Opel, General Motors' (NYSE: GM) German partner for alternative fuel vehicles... Recovery Engineering (Nasdaq: REIN), which sells water treatment systems under the PUR brand name, got $2 3/8 to $14 3/4 after it said it will sell its new purifying pitcher in Costco's (Nasdaq: COST) stores and said Q1 retail sell through was 36%, not 27% as previously reported... Laser eye surgery firm Summit Technology Corp. (Nasdaq: BEAM) jumped $2 5/8 to $17 7/16 following yesterday afternoon's news of Q1 EPS of $0.08, up from $0.01 last year and better than the nickel estimate one analyst gave First Call. Summit also said it closed the acquisition of Autonomous Technologies Corp. (Nasdaq: ATCI).

Media streaming technologies developer RealNetworks (Nasdaq: RNWK), reportedly preparing to launch a new compact disc track digitizer called "Jukebox," got $6 1/2 to $221 1/2 today... Airline operator Delta Air Lines (NYSE: DAL) rose $1 1/2 to $63 7/16 as the company denied rumors that CFO Warren Jensen may leave the company. The shares fell yesterday, but some watchers believe the fall was instead connected to labor negotiations... Internet networking giant Cisco Systems (Nasdaq: CSCO) added $4 7/8 to $114 1/16 today. Morgan Stanley analyst Chris DePuy reaffirmed his fiscal Q3 EPS estimate of $0.37 and said he's increasingly confident in the company's outlook for the second half of calendar 1999.

PC hard disk drive supplier Maxtor Corp. (Nasdaq: MXTR) picked up $13/32 to $5 21/32 after BT Alex. Brown started the stock with a new "buy" rating. The company made the news recently because of worrisome comments in its Q1 earnings report... Internet services company AppliedTheory Corp. (Nasdaq: ATHY) jumped $4 1/2 to $20 1/2 in its first day of trading after selling 4.5 million shares of company stock for $16 each... Credit card issuer and specialty finance company Capital One Financial (NYSE: COF), which approved a 3-for-1 stock split effective June 1, moved up $6 to $173 11/16 today... Radioactive and hazardous waste management company ATG Inc. (Nasdaq: ATGC) improved $15/16 to $8 after Prudential Securities started the company with a "strong buy" rating.

Earnings Movers

Adaptec Inc. (Nasdaq: ADPT) up $2 to $24 1/16; fiscal Q4 EPS $0.36 vs. $0.20 last year; estimate: $0.30

CompuCredit Corp. (Nasdaq: CCRT) up $2 to $16; Q1 EPS $0.57 vs. $0.15 last year; no estimate

Compuware Corp. (Nasdaq: CPWR) up $11/16 to $24 3/8; fiscal Q4 EPS $0.31 vs. $0.20 last year; estimate: $0.29

Corinthian Colleges (Nasdaq: COCO) up $3 5/8 to $16 3/8; fiscal Q3 EPS $0.25 (before charge) vs. $0.06 last year; estimate: $0.14

Cytyc Corp. (Nasdaq: CYTC) up $9/16 to $19 9/16; Q1 EPS $0.04 vs. loss of $0.37 last year; estimate: loss of $0.08

EarthWeb (Nasdaq: EWBX) up $2 to $53 1/8; Q1 EPS loss of $0.82 vs. loss of $0.27 last year; estimate: loss of $0.93

InfoSpace.com (Nasdaq: INSP) up $24 11/16 to $143 5/16; Q1 EPS loss of 0.03 vs. breakeven last year; estimate: loss of $0.14

Minnesota Mining & Manufacturing (NYSE: MMM) up $3 3/8 to $89; Q1 EPS $0.95 vs. $0.98 last year; estimate: $0.91

National Steel (NYSE: NS) up $3/8 to $9 3/8; Q1 EPS loss of $0.58 vs. profit of $0.14 last year; estimate: loss of $0.63

Penske Motorsports (Nasdaq: SPWY) up $1/4 to $36 1/4; Q1 EPS loss of $0.21 vs. loss of $0.16 last year; estimate: loss of $0.21

ThrustMaster Inc. (Nasdaq: TMSR) up $1 3/8 to $20 1/2; Q1 EPS loss of $0.05 vs. loss of $0.29 last year; estimate: loss of $0.10

W.R. Grace & Co. (NYSE: GRA) up $13/16 to $15 15/16; Q1 EPS $0.23 (before gain) vs. $0.15 last year; estimate: $0.21


High-end targeted home furnishings retailer Restoration Hardware (Nasdaq: RSTO) was tarnished by a $8 3/4 loss to $15 5/8 after NationsBanc Montgomery Securities cut its rating on the company to "hold" from "buy," citing concerns that the firm may fall short of analysts' Q1 and possibly even Q2 estimates. For Q1, the Zacks mean estimate calls for a loss of $0.04 per share. Goldman Sachs also lowered its rating today. The alarm was sounded by this statement in a federal filing by the firm yesterday: "We held our first off-price furniture sale event in the first quarter of 1999. While we expect that this event will have a positive impact on sales, we also expect that the sale event will put pressure on our merchandise margins, which could adversely affect our results from operations." If it sounds like a case of poor inventory management on the company's part, the numbers from the most recent year provided little warning. Inventory turnover for the year came in at 2.7 times, in the same showroom with Ethan Allen's (NYSE: ETH) figure of 3.3 times and Pier 1's (NYSE: PIR) 2.7 times for fiscal 1998.

Wall Street treated investors to a Tale of Two IPOs today as two companies that couldn't have more different business models took their initial baby steps into the world of the public markets and promptly traveled in opposite directions. While coal producer CONSOL Energy (NYSE: CNX) was shafted for a $1 3/4 loss to $14 1/4 after selling 22.6 million shares in an initial public offering at a price of $16 per stub, shares of Internet-based software management firm Marimba (Nasdaq: MRBA) danced up $40 3/4 to $60 3/4 after selling 4 million shares for $20 apiece. Coincidentally, the two companies ended the day with similar debutante market capitalizations -- $1.35 billion for Marimba and $1.15 billion for CONSOL. Of course, many single data-point obsessed observers will tear their hair out about the fact that Marimba had $17 million in fiscal 1998 revenues compared to CONSOL's $2.3 billion. That values Marimba at a cool 79 times trailing sales and CONSOL at a not-so-hot 0.5 times sales.

QUICK CUTS: Farm equipment manufacturer Deere & Co. (NYSE: DE) was ploughed under for a $2 3/8 loss to $42 3/4 after saying that aggressive discounting by rivals and reduced farm equipment demand caused by slumping commodity market prices will reduce year-over-year volume sales by 20%, worse than the 13% slide previously expected... Information technology consulting and software services firm Tier Technologies (Nasdaq: TIER) was knocked down $1 15/16 to $6 after posting fiscal Q2 EPS of $0.05, down from last year's $0.06 and below the First Call mean estimate of $0.16... Canadian biotechnology company BioChem Pharma (Nasdaq: BCHE) slid $1 1/4 to $20 3/4 after reporting that sales of its recently launched Zeffix/Epivir-HBV chronic hepatitis B treatment were $800,000 in the first quarter, less than one-tenth of what analysts had been anticipating.

Individual and group life insurer and reinsurer ReliaStar Financial Corp. (NYSE: RLR) slumped $4 11/16 to $36 3/4 after reporting Q1 operating EPS of $0.70, up from last year's $0.66 but below the First Call mean estimate of $0.77. The company blamed the shortfall on an "unfavorable claims experience" at its reinsurance business... Digital audio and video applications integrated circuit maker Zoran Corp. (Nasdaq: ZRAN) was zapped $2 9/16 to $10 13/16 after posting Q1 EPS of $0.01 versus $0.06 a year ago, missing the Zacks mean estimate of $0.05... Online live communities operator Mpath Interactive (Nasdaq: MPTH) gave back $11 1/4 to $39 3/8 after rising 181% in its first day of trading yesterday after the company sold 3.9 million shares in an initial public offering at a price of $18 per stub.

Console and PC video game developer Adrenalin Interactive (Nasdaq: ADRN) dropped $2 1/8 to $6 1/8 after agreeing to acquire privately-held McGlen Micro Inc., an online supplier of computer hardware to small businesses, for an unspecified amount of stock... Drug developer Abbot Laboratories (NYSE: ABT) slipped $2 1/4 to $48 3/8 after PaineWebber cut its rating on the company to "neutral" from "buy"... Security products and services firm Kroll-O'Gara Co. (Nasdaq: KROG) lost $2 3/4 to $23 15/16 after reporting Q1 EPS of $0.18 (before charges) versus $0.20 a year ago. The company said it will record an additional $3.5 to $4.5 million in restructuring charges in Q2... Securities custody and trust company and asset manager State Street Corp. (NYSE: STT) shed $6 to $87 1/2 following a PaineWebber downgrade to "attractive" from "buy."

Internet website co-location services and direct access provider AboveNet Communications (Nasdaq: ABOV) fell $7 3/8 to $85 5/8 after selling 4 million shares in a secondary offering at a price of $85 per share. Included in the sale were 1.18 million shares sold by selling stockholders... Document finishing, lamination, and shredding products maker General Binding Corp. (Nasdaq: GBND) unwound for $7 3/16 loss to $20 after saying weak results at its office products business and higher expenses in Europe resulted in Q1 EPS of $0.08 compared to $0.45 a year ago, falling far short of the First Call mean estimate of $0.42... Commercial and residential real estate services firm Insignia Financial Group (NYSE: IFS) was booted $1 9/16 lower to $12 9/16 after posting a Q1 loss of $0.06 per share, worse than the breakeven results expected by the sole analyst surveyed by Zacks.

An Investment Opinion
by Warren Gump


Over my next three Fool On The Hill (FOTH) columns, I'm going to look at the proliferation of option grants and how they affect (or really, don't affect) a company's financial statements. Very little attention is paid to this subject in the mass media or by investment professionals. At some point, however, people will likely consider the amount of options expended to be an important investment consideration. As Fools, we want to be ahead of the crowd, rather than fall behind it.

Employee stock options are pretty easy to understand. They provide employees the right, but not the obligation, to purchase shares of their employer's stock at a certain price for a certain period of time. Options are usually granted at the current market price of the stock and last for up to 10 years. To encourage employees to stick around and help the company grow, options typically carry a four to five year vesting period, but each company sets its own parameters. With the rousing gains in the stock market over the past two decades, options have become a highly sought after compensation mechanism. Many employees will not consider joining a company unless options are included.

Let's consider Sally, who's getting ready to graduate from college and is looking for a new job. She has offers from two companies, New Age Compensation and Old Line Compensation, for similar positions. The salary from New Age is $10,000 lower than the one from Old Line, but New Age dangles options on 2,000 shares as an incentive for Sally to join the firm. Sally decides to accept the job from New Age, believing that her total compensation, incorporating the probable ultimate value of her options, will be higher than the offer from Old Line.

The value Sally reaps from the option will not be determined until she disposes of the option through exercise or expiration. If New Age stock does well, she could make lots of dough. On the other hand, the stock price could go nowhere for ten years, resulting in her options being worthless. While the end result of the option is unknown, Sally must have valued the option grant at more than $10,000, or she wouldn't have decided to join New Age.

The Accounting Rules
Accounting regulators have struggled determining the best way to account for options. On the one hand, they obviously have some value to the employee. On the other hand, companies don't expend cash when they grant options. If an employee exercises an option, the company just issues a new share of stock. Instead of a cash outflow, the company actually has an inflow of cash from the exercise price of the stock (although that inflow is less than what would be provided if the share were issued on the open market). The company is basically using its ability to issue shares as a way to print shares and sell them at below-market prices.

Under old accounting rules, companies would only expense an options grant if it had "intrinsic value" on the date of issue. Intrinsic value is the extent to which an options exercise price is below the current market price. If Microsoft (NYSE: MSFT) were to issue options at an exercise price of $50 per share when the stock was trading at $81 per share, those options would have an intrinsic value of $31 ($81-$50) that would be expensed. If, on the other hand, Microsoft issued options with an $81 or higher exercise price, the options would have no intrinsic value and no expense would be recorded. Since most companies issue options at or above market prices, they do not record compensation expenses for these grants.

In 1995, accounting regulators issued a new pronouncement stating that it was preferable to use the "fair value" method of accounting for options rather than "intrinsic value." The fair value of an option can be calculated by using various pricing techniques developed on Wall Street to value traded options. While numerous assumptions must go into these calculations, they provide a rough approximation for what companies would expend to issue options.

Bowing to outside pressure, particularly from upstarts that rely heavily on options as a compensation tool, accounting regulators put a loophole into the 1995 pronouncement. Companies could continue using the "intrinsic value" method of accounting for options, so long as they included a footnote in their annual report stating the cost of options under the "fair value" method. With this loophole, very few (if any) companies have adopted the "fair value" method of accounting for options in their financial statements. Instead, they continue using the "intrinsic value" method, including a footnote in their annual statements describing how the implementation of "fair value" accounting would impact net income and earnings per share.

Going back to our example with Sally, the differing compensation structures would have differing effects on the income statements of the companies involved. As mentioned, New Age and Old Line are similar to each other. Both had prior year revenue and expenses of $1 million and $800,000, respectively. Over the next year, revenues rise 10% and expenses are flat at both companies, except for the cost of hiring an additional employee. New Age hires Sally for $25,000 and 2,000 stock options, while Old Line finds someone willing to accept a $35,000 offer with no options.

Below are the income statements for the two companies for the year after Sally's hire:

New Age Old Line
Revenue $1,100,000 $1,100,000
Expenses 800,000 800,000
New Hire 25,000 35,000
Net Income $275,000 $265,000

Earnings Per Share $2.74 $2.65

Diluted Shares 100,400 100,000

(A technical note that you can skip if you aren't detail oriented: Diluted shares outstanding increase by only 400 shares, rather than 2,000 shares, because they are accounted for under the treasury method. Under this technique, proceeds from option exercises are assumed to be used to acquire stock on the open market. In this example, the proceeds of Sally's options exercise would be used to repurchase 1,600 shares at the year-end stock price. Diluted shares would therefore increase by 400 (2,000-1,600) shares. Now back to our regularly scheduled programming.)

Looking at the income statement and reported earnings, New Age looks better than Old Line. The only difference between the two companies, however, is new hire compensation. While New Age is paying less cash compensation, we know that Sally decided to work for New Age because she believed she was receiving higher total pay. Is it fair for New Age to post higher earnings because it used its stock option printing press to pay part of Sally's salary?

Digging through New Age's 10-K, we will find disclosures regarding the value of stock options granted. Assuming Sally's options are worth $5 per share and they vest in the first year, this note would state that the fair value of option grants were $10,000. Incorporating that expense, this disclosure would detail that New Age's adjusted net income was $265,000 and earnings per share was $2.64 (the number or shares outstanding would remain 100,400). Someone using this disclosure would see that adjusted for option compensation, New Age is actually less profitable than Old Line.

Does the difference in reported earnings and option expense-adjusted earnings matter? I'll be tackling that issue and others in my next two FOTHs. In addition, I'll go beyond the hypothetical examples of New Age and Old Line to see what the footnotes from real companies say. How do option grants impact the income statements of Microsoft, Dell Computer (Nasdaq: DELL), T. Rowe Price (Nasdaq: TROW), and others? Stay tuned. Until then, have a Foolish weekend!


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