<THE EVENING NEWS>
Friday, July 16, 1999
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HEROES

Software giant Microsoft (Nasdaq: MSFT) had a good day today, rising $5 1/16 to $99 7/16 to become the first company to ever top the half-trillion dollar market capitalization mark. While that may be greatly significant to a guy like Bill Gates, who is now on the verge of becoming the world's first $100 billion man, the smaller Microsoft shareholders out there had other developments to digest today. First up was the possibility that the company may try to unlock some value by jumping aboard the tracking stock bandwagon and offering shares of its Microsoft Network (MSN) properties. (For more details, see today's Breakfast With the Fool). On the legal front, the company's federal antitrust defense got a boost after a Connecticut jury found in favor of the company in an unfair trade practices dispute with privately held Bristol Technology. And finally, hopes are high that the company will turn in strong numbers when it releases its fiscal Q4 earnings after Monday's close.

Razor blades and batteries maker Gillette (NYSE: G) marched up $2 1/2 to $47 1/4 following its Q2 earnings report. While EPS of $0.26 was down $0.07 year-over-year and in line with analysts' lowered expectations, investors were heartened by a 3.8% rise in sales to $2.41 billion, which was twice the rate analysts had been expecting. Backing out currency effects and the divestiture of its Jafra Cosmetics International, Gillette's sales were up an impressive 9% for the quarter and 6% for the first six months, setting the stage for a bright second half. "We look for improvement in our business throughout the last half of the year as we return to our more traditional sales and earnings growth rates by the end of 1999,'' chairman and CEO Michael Hawley said. For more on the Boston behemoth, see yesterday's Drip Port report.

Broadband infrastructure chip supplier PMC-Sierra (Nasdaq: PMCS) jumped $12 1/2 to $82 1/2 after reporting Q2 EPS of $0.22 this morning (excluding gains and charges), up from $0.14 a year ago and ahead of the First Call mean estimate of $0.19. PMC-Sierra is a classic example for investors of how high margins combined with sales growth correlates into higher share prices over time. Gross profit margins for the company's networking products, such as chips for asynchronous transfer mode (ATM) and synchronized optical network (Sonet) gear, have been pegged at an astounding 80% to 81% range for the past year. But what has propelled PMC-Sierra's stock 260% over the same span has been coupling those high margins with networking products sales growth like the 16% sequential and 67% year-over-year growth exhibited in Q2. That potent combination looks set to continue, especially now that networking-related sales represent 92% of net revenues, up from 82% a year ago.

QUICK TAKES: Broadband play-of-the-day Paradyne Networks (Nasdaq: PDYN) soared $39 1/4 to $56 1/4 after selling 6 million shares in an initial public offering at a price of $17 per share. Fellow broadband access equipment cohort Efficient Networks (Nasdaq: EFNT) added $7 1/2 to $58 5/8 in its second day of trading, after gaining 241% in its debut yesterday... Internet-based electronic government services company National Information Consortium (Nasdaq: EGOV) also continued to rise in its second day of trading, moving up $4 3/4 to $22 1/16. Yesterday, the company sold 13 million shares to the public for $12 each... Drugstore operator Rite Aid Corp. (NYSE: RAD) picked up $1 1/2 to $23 3/8 on rumors it may be acquired by Wal-Mart (NYSE: WMT). Just a thought, but does Sam's Drug Club sound like a good idea to you?

Enterprise application testing company Mercury Interactive (Nasdaq: MERQ) rose $7 3/8 to $43 7/8 after turning in Q2 EPS of $0.18, better than last year's dime profit and $0.02 ahead of estimates. The company named Amnon Landan, a company co-founder, its chairman, replacing Aryeh Finegold, who also helped start Mercury...
Real-time e-commerce transaction services firm CyberSource Corp. (Nasdaq: CYBS) rose $3 5/16 to $30 after Business Week's "Inside Wall Street" column said the company was likely to become a takeover target. Gene Marcial's famous unnamed New York money manager said Visa or another credit card company might be a likely buyer... General construction firm Turner Corp. (NYSE: TUR) fabricated a $3 3/4 gain to $21 1/4 after confirming it has received and is evaluating a buyout offer from an outside group.

Pipeline company Kinder Morgan Energy Partners, L.P. (NYSE: ENP) moved up $2 1/4 to $39 3/4 after reporting Q2 EPS of $0.61, up from $0.50 a year ago and a nickel better than the Zacks mean estimate. Merger mate KN Energy (NYSE: KNE) rose $1 7/16 to $21 7/8 following upgrades from Banc of America Securities and Salomon Smith Barney... Canadian land drilling and oil field services firm Precision Drilling Corp. (NYSE: PDS) picked up $1 1/16 to $23 5/16 after cleaning house and announcing an entirely new board of directors. The company also said a new chairman and CEO has been appointed at recent tender offer target Computalog Ltd. (Nasdaq: CLTDF). Computalog rose $9/16 to $8 9/16 on the news... Baby Bell SBC Communications (NYSE: SBC) rang up $2 3/16 to $59 3/16 on word it will form a marketing and distribution alliance with Hughes Electronics' (NYSE: GMH) DirecTV unit, according to Bloomberg News.

Semiconductor test handling equipment maker Cohu Inc. (Nasdaq: COHU) gained $3 1/16 to $42 after reporting Q2 EPS of $0.48, down from last year's $0.53 but well ahead of First Call's $0.24 two-analyst consensus. The company said William Ivans, chairman since 1983, died in a glider accident Tuesday. President and CEO Charles Schwan will succeed him... Wireless firm Nextel Communications (Nasdaq: NXTL) moved up $2 15/16 to $57 5/8 after Warburg Dillon Read started coverage with a "buy" rating... Diversified plastics, apparel, and electronics manufacturer Raven Industries (Nasdaq: RAVN) flew up $1 3/8 to $17 7/8 after saying its Q2 EPS should be about 25% higher than a year ago, rather than the "slightly higher" increase the company had previously expected.

Online audio content provider Audible Inc. (Nasdaq: ADBL) screamed ahead $12 to $21 after selling 4 million shares in an initial public offering at a price of $9 per share... Multimedia compression and playback technologies firm Ravisent Technologies (Nasdaq: RVST) picked up $5 5/8 to $17 5/8 in its first day of trading after selling 5 million shares at an IPO price of $12 per stub.

Earnings Movers


Allaire Corp. (Nasdaq: ALLR) up $4 to $67; Q2 EPS: loss of $0.02 (excluding charges) vs. loss of $0.49 last year; estimate: loss of $0.04

Eclipse Surgical Technologies (Nasdaq: ESTI) up $2 13/16 to $14 5/8; Q2 EPS loss of $0.15 vs. loss of $0.47 last year; estimate: loss of $0.18

QLogic Corp. (Nasdaq: QLGC) up $7 5/8 to $147 1/2; fiscal Q1 EPS: $0.60 vs. $0.26 last year; estimate: $0.49

Sawtek Inc. (Nasdaq: SAWS) up $7 3/8 to $66 1/8; fiscal Q3 EPS: $0.38 vs. $0.32 last year; estimate: $0.34

Veritas Software (Nasdaq: VRTS) up $7 7/8 to $61 3/16; Q2 EPS $0.16 vs. $0.08 last year; estimate: $0.14

GOATS

Medical tissue cohesive products maker Closure Medical Corp. (Nasdaq: CLSR) tumbled $10 1/4 to $18 after saying second-half revenues and EPS will be below analysts' expectations because Johnson & Johnson's (NYSE: JNJ) Ethicon unit has cut its orders for Closure's Dermabond wound glue for the remainder of the year due to "excess inventory levels." The company broke even in Q2, better than last year's $0.17 per share loss and in line with market projections, but that could be the last good news the firm's investors get for a little while. Dermabond's near-term success is heavily dependent on gaining acceptance in emergency rooms and operating rooms, where old-fashioned sutures have been the wound closing method of choice for centuries. That acceptance is taking longer than expected. But having Ethicon, the dominant suture company, in its corner as its committed worldwide distribution partner is a major business advantage that risks being priced right out of Closure's $250 million market capitalization with today's drop. At these levels, medically inclined investors with a longer time frame may want to take a closer look.

Discount broker Charles Schwab (NYSE: SCH) traded down $2 15/16 to $52 7/16 after reporting Q2 EPS of $0.18, doubling last year's $0.09 and coming in a penny ahead of the First Call mean estimate. Net profit margins increased to 15.4% from 12% a year ago, but founder Charles Schwab himself cautioned that margins will fall back to historical levels in the coming quarters as it invests in its people, its technology, and its brand name. What will be interesting for Schwab investors to track over the coming quarters is how much it spends on each of the three elements. As fellow Fool Louis Corrigan has pointed out, updating technology to keep pace with rapid account growth offers a higher potential return on investment for online brokers than the other two options. Considering Chuck & Co.'s already well-entrenched brand name vis-a-vis other online brokers, and the high cost of training more employees, sacrificing margins for servers right now seems like the correct choice.

QUICK CUTS: Disk drive maker and bad news broken record Seagate Technology (NYSE: SEG) slumped $3 7/16 to $26 9/16 after posting fiscal Q4 EPS of $0.30, excluding unusual items. That was up from $0.09 a year ago but short of analysts' expectations of $0.34 a share and the company's recently lowered guidance of $0.32 to $0.37. In a conference call, Seagate reportedly said it would be "very difficult" to be profitable during the current quarter... Private label contract apparel manufacturer Tarrant Apparel Group (Nasdaq: TAGS) was torn for a loss of $2 1/4 to $17 13/16 after saying it expects Q2 EPS of between $0.30 and $0.33, well below Wall Street's $0.54 consensus estimate... Programmable logic devices (PLD) maker Altera Corp. (Nasdaq: ALTR) sank $4 1/16 to $41 1/16 after Morgan Stanley Dean Witter analyst Mark Edelstone cut his rating on the firm to "outperform" from "strong buy."

Enterprise network and data security products firm Security Dynamics Technologies (Nasdaq: SDTI) was shot down $3 1/4 to $20 3/4 after posting Q2 EPS of $0.15, even with the Street's mean estimate. However, the company also reportedly said in its conference call that sales of a new security product may be slower than expected due to Y2K concerns from customers... Midsize business financing company Finova Group (NYSE: FNV) fell $3 3/4 to $48 11/16 as fears of higher loan prepayment rates prompted a J.P. Morgan downgrade today to "long-term buy" from "buy"... Electronics manufacturing services (EMS) firm Flextronics (Nasdaq: FLEX) stumbled $5 3/8 to $54 7/16 after posting fiscal Q1 EPS of $0.34, in line with the Zacks mean estimate. However, Needham & Co. and SoundView Technology Group both cut their ratings on the firm.

Nonlaser vision treatment company KeraVision (Nasdaq: KERA) blurred $3 3/8 to $19 on dilution fears after saying it has filed to sell 4 million shares of company stock, which would boost the total outstanding more than 28%. The company also reported a Q2 loss of $0.45 per share, $0.04 ahead of First Call's four-analyst consensus estimate... Bike maker Cannondale Corp. (Nasdaq: BIKE) braked $7/8 to $10 1/8 after warning that it expects earnings for its fiscal Q4 ended July 3 to be around $0.10 a share, substantially below analysts' mean estimate of $0.28... Electronics contract designer and manufacturer Plexus Corp. (Nasdaq: PLXS) shed $2 5/8 to $31 1/4 after saying fiscal Q3 EPS was $0.39, a penny off Wall Street's consensus projection.

Property and casualty insurer Horace Mann Educators Corp. (NYSE: HMN) fell $2 7/16 to $26 1/2 after announcing that Q2 EPS is expected to come in at approximately $0.34, well off Wall Street's $0.50 consensus. Catastrophe losses were unusually heavy during the quarter, while higher-than-expected noncatastrophe property and automobile claims also hurt results... Industrial gases company Air Products & Chemicals (NYSE: APD) leaked $4 3/8 to $36 15/16 after directing investors toward fiscal Q3 EPS of $0.48 before a $0.04 per share workforce reduction charge, missing the market's $0.13 mean estimate... Office products superstore operator Office Depot (NYSE: ODP) was shredded $1 1/2 to $18 13/16 after posting Q2 EPS of $0.21, in line with the Zacks mean estimate. The company said that although it faces challenges in the second half, it believes its financial goals are "achievable." Merrill Lynch was not so sure and lowered the firm's near-term rating to "accumulate" from "buy."

Auto and renter's insurance provider Unistar Financial Service Corp. (AMEX: UAI) tumbled $14 1/16 to $27, adding to yesterday's 27% decline. In an interview with Reuters, the company's CEO blamed short-sellers for the drop, saying the company is under a "malicious attack"... Food store equipment and commercial refrigeration products maker Hussmann International (NYSE: HSM) spoiled $1 1/4 to $17 1/16 after saying weak demand for its beverage coolers will trim second-half earnings by about $0.10 per share. A.G. Edwards cut its rating on the firm to "accumulate" from "buy"... Pinball and video gaming devices maker WMS Industries (NYSE: WMS) dropped $1 to $14 11/16 after filing a registration statement with the SEC to sell up to 3.5 million primary shares.

FOOL ON THE HILL
An Investment Opinion
by Warren Gump

Learning About Warner-Lambert

Those of you have followed my writings probably know that I am quite fond of the biotechnology industry. With the innovations likely to emerge from this industry as genome research expands exponentially, I find few areas more attractive for long-term shareholders willing to endure stock price volatility inherent with companies working on revolutionary discoveries. Up to this point, most of my writing has been on pure-play biotech companies like Amgen (Nasdaq: AMGN), Biogen (Nasdaq: BGEN), and Immunex (Nasdaq: IMNX). But these firms aren't the only way to gain exposure to the industry. Traditional pharmaceutical companies are also quite involved in the sector.

What's the advantage of investing in one of the old-line drug companies over a full-fledged biotech operation? Primarily the fact that these companies have a broad base of existing products that generate growth and help finance R&D efforts. The major biotech companies only have one or two major products currently on the market, whereas most of the big pharmaceutical companies are selling many drugs. Given their sheer size, the traditional drug companies also have more money to invest in R&D. Pfizer (NYSE: PFE) and Merck (NYSE: MRK) each will spend well over $2 billion on R&D this year, whereas Amgen, the biggest biotech company, will invest $850 million. On the other hand, those dollars are invested over a wider array of efforts and any individual new product must be bigger to have a material impact on the larger pharmaceutical firms.

I find many of the big drug companies interesting. One that really catches my eye, though, is Warner-Lambert (NYSE: WLA). Right now the company is achieving tremendous results with its Lipitor cholesterol drug and its aggressive move to expand its presence in the biotech arena. Earlier this year, the company issued stock worth $2.1 billion to acquire Agouron Pharmaceuticals, which uses genetic engineering extensively in its drug development process. Beyond its currently marketed Viracept protease inhibitor, Agouron has several drugs in its pipeline to help treat cancer and HIV/AIDS.

Before talking about the pharmaceutical side of Warner-Lambert, it is important to realize that the company has two other divisions. The consumer health care group sells products like Rolaids, Sudafed, Lubriderm, Benadryl, Listerine, and Schick shaving supplies. Last year, it achieved sales of $2.7 billion (27% of the company's total) and $510 million in income before taxes (24%). The confectionary business, marketers of items such as Chiclets, Dentyne, Certs, and Halls cough tablets sold $1.9 billion of products (18%) and earned $159 million before taxes (7%). These divisions have seen sales and earnings declines over the past two years, but they generate cash flow that helps fund the company's other operations.

Pharmaceuticals account for the majority of Warner-Lambert's business. Last year, this division had sales of $5.6 billion (55%) and income before taxes of $1.5 billion (69%). The phenomenal success of Lipitor and Rezulin, a diabetes drug that has likely seen revenue peak, have fueled a doubling of sales and a tripling of profits in the pharmaceutical segment.

Rezulin had been a hot shot, with sales moving up 78% to $748 million from $420 million in 1997. With the recent introduction of an effective competitive product, however, Rezulin has been made a second-line defense. In isolated instances, Warner-Lambert's drug has been associated with severe liver problems (including deaths). Although that drug now faces declining sales, soaring sales of Lipitor, which is co-promoted with Pfizer, should more than offset that downturn. After doubling last year to $2.2 billion, the company expects Lipitor's sales to reach $3.3 billion this year and $4 billion in 2000.

The company has additional drugs experiencing substantial sales growth. Revenue from anticonvulsant Neurontin shot up 76% to $514 million, while antihypertensive Accupril enjoyed 20% sales growth to $454 million. Viracept, the protease inhibitor picked up in the Agouron acquisition, should also boost sales. Over the past 12 months, the drug had $500 million in revenue -- with the latest quarter's sales still growing 30% over the prior year.

Sustaining the company's growth is highly dependent on finding new therapies. If recent history is any indication, things are looking good. In the past year, Warner-Lambert began co-promoting Celexa, a depression treatment, with Forest Laboratories (AMEX: FRX). Estimated sales for the year will be $300 million. The company also introduced a new antibiotic, Omnicef, which has been well received. To help ensure a healthy flow of new products, the Warner-Lambert is dramatically pumping up R&D spending. Current year expenditures for this line item are projected to rise 33% to $1.2 billion.

With pharmaceuticals comprising a major portion of the company's overall operations, Warner-Lambert's margins are quite impressive -- although not as high as other pure pharmaceutical firms due to the consumer health and confectionary operations. Gross margins were 74%, up from 68% two years ago as the positive impact of Lipitor and other drugs took effect. For the same reason, the company's operating margin increased from 16% to 17%. With strong cash flow, the company's balance sheet is pretty clean. Although $1.5 billion in debt sits on the balance sheet, this is mostly offset by $1.2 billion in cash.

With such a powerful lineup under its belt, Warner-Lambert might be worth investigating to gain exposure to the drug/biotech sector. If you are interested in learning about the company, you might want to check out its website. (They don't yet have an obvious link to the Agouron site, which gives you information on their novel drug discovery process.)

One nice aspect of Warner-Lambert is its investor-friendly dividend reinvestment program. In addition to allowing optional cash payments, you can avoid a broker altogether and purchase your first shares directly from the company for a $15 fee (the minimum initial investment is $250).

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