Friday, July 30, 1999
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Fool News Evolution

Next Monday (Aug. 2) you'll see some changes in the Motley Fool's News area with the debut of NewsWorld. We've received hundreds -- maybe thousands -- of suggestions and comments from you asking us to provide more commentary and in-depth looks at top stories throughout the day -- and that's what NewsWorld is all about.

Breakfast With the Fool will be back as usual, but the Lunchtime News and the Evening News will be gone -- but we'll be improving our daily news coverage by providing in-depth Foolish looks at key news stories and market happenings throughout the day. We'll also provide useful links to top stories on our site and other websites.

Stop in anytime throughout the day to get a Foolish perspective on what's happening in the market.

We'll also be trying some new stuff here, and we look forward to hearing your opinions and ideas as the Fool's NewsWorld continues to evolve.

See you Monday, Fool!


Business Web hosting company Digex (Nasdaq: DIGX) rose $5 5/16 to $22 5/16 after selling 10 million shares in an initial public offering at a price of $17 per share. This is actually the second IPO in less than three years for the Beltsville, Maryland-based firm, which was gobbled up by competitive local exchange carrier Intermedia Communications (Nasdaq: ICIX) in 1997 after only eight short months as a public company. Intermedia is retaining an 83% stake, which is valued at about $1.1 billion following today's sale. Intermedia comes out looking like a genius, considering it paid a whopping $171 million for all of Digex just a little more than two years ago. That's almost a seven-bagger (on paper) over that span -- not all that spectacular in these days of mammoth Internet-related returns, but pretty darn good considering the old Digex brought with it scads of fiber that has since been folded into Intermedia's network infrastructure.

Wafer fabrication equipment supplier Lam Research Corp. (Nasdaq: LRCX) marched ahead $9 to $55 3/8 after reporting fiscal Q4 EPS of $0.28 versus $0.05 (excluding charges) a year ago, more than doubling the First Call mean estimate of $0.12. The company said its book-to-bill ratio was above 1.2 to 1 during the quarter, and gross margin improved to 38.8% from 35.5%. Revenues of $211 million roughly matched expectations, despite being down 8.5% from 1998 and down 20% from 1997. The big surprise was the company's operating margin, which at 5.2% was twice what some analysts had been anticipating. Of course, firing half of your workforce (as Lam has done over the past year) will do that, and selling, general, and administrative expenses, not surprisingly, dropped 31%. However, a 23% slide in R&D expense is worrisome, since it suggests the company's long-term growth potential is being sacrificed in the name of near-term earnings performance. Advest, Goldman Sachs, and Warburg Dillon Read appear unconcerned, though, and showered the firm with upgrades.

QUICK TAKES: Muncie, Indiana-based bank holding company ANB Corp. (Nasdaq: ANBC) jumped $4 1/8 to $32 3/8 after agreeing to be acquired by Evansville, Indiana-based Old National Bancorp (Nasdaq: OLDB) in a $212.4 million stock swap. Old National fell $1 1/4 to $28 13/16... Real estate services firm Chicago Title Corp. (NYSE: CTZ) gained $6 1/16 to $42 3/4 after confirming that it is in talks to merge with California rival Fidelity National Financial (NYSE: FNF). Digital telecommunications network deployment and access products provider Adtran Inc. (Nasdaq: ADTN) advanced $1 13/16 to $37 13/16 on news it will replace General Nutrition Centers (Nasdaq: GNCI) on the Standard & Poor's MidCap 400 Index.

Online advertising agency Modem Media.Poppe Tyson (Nasdaq: MMPT) tacked on $7 7/8 to $29 1/8 after reporting Q2 EPS of $0.05 compared to a loss of $0.11 last year, whomping the First Call mean estimate of a $0.06 loss. BancBoston Robertson Stephens raised its rating on the firm to "strong buy" from "buy"... Infectious disease and cancer treatments developer Gilead Sciences (Nasdaq: GILD) rose $9 3/16 to $77 1/2 after posting a Q2 loss of $0.48 per share versus a loss of $0.49 per share a year ago. Total revenues increased 24% from a year ago to $8.7 million... Enterprise application software company BMC Software (Nasdaq: BMCS) climbed $5 1/2 to $53 7/8 after reporting fiscal Q1 EPS of $0.42 (excluding charges), beating the First Call mean estimate by $0.02.

Real-time digital signal and image processing systems developer Mercury Computer Systems (Nasdaq: MRCY) was launched $4 5/8 to $28 5/8 after reporting fiscal Q4 EPS of $0.41, ahead of the Zacks mean estimate of $0.33. The company said revenues should continue to grow in the 25% to 30% range in fiscal 2000, although Q1 revenue growth will be "substantially higher" than the yearly rate... Pharmaceutical product technologies developer Vical Inc. (Nasdaq: VICL) jumped $3 11/16 to $14 3/4 after The Wall Street Journal reported that scientists at drug giant Merck (NYSE: MRK) are preparing to start human tests of two potential AIDS vaccines developed using Vical naked DNA gene delivery technology... Programmable logic chip maker Xilinx (Nasdaq: XLNX) jumped $ 2 5/8 to $62 3/8 after impressing analysts with its new products roadmap at a meeting today, according to Reuters.

Drug distributor Cardinal Health (NYSE: CAH) tacked on $3 7/8 to $68 1/4 after reporting fiscal Q4 EPS of $0.58 (excluding charges), up from $0.46 last year and a penny ahead of the First Call mean estimate... Medical malpractice insurer MIIX Group Inc. (NYSE: MHU) moved up $4 1/2 to $18 in its first day of trading after selling 3 million shares in an initial public offering at a price of $13.50 per share... Windows NT-based applications management software firm NetIQ Corp. (Nasdaq: NTIQ) gained $3 3/4 to $16 3/4 after selling 3 million shares at an IPO price of $13 per share.


"People still want those things?" Apparently. But educational toy retailer Noodle Kidoodle (Nasdaq: NKID) expects to report a Q2 loss of between $0.28 and $0.30 per share -- Wall Street was looking for $0.15 per share loss. Included among the culprits: the scarcity of Beanie Babies, which hurt sales. Nothing cute and cuddly about that! Noodle Kidoodle, recently a Foolish Trouble -- apparently because of investors' indecision about whether to value the company as a toy retailer, an Internet stock, or some combination of both -- also said results would be hurt by costs associated with a just-announced joint venture to set up its Internet division. Coming on to help with the online effort -- and getting a 20% stake for his efforts -- will be former NetGrocer CEO Daniel Nissan. The company expects to post sales of $20 to $21 million for the quarter, up from $18.4 million a year ago, but same-store sales will be off 9% to 10% for the quarter. The shares lost $1 7/8 to $4 7/16 today on the news. They're down some 60% in 1999, about as much fun for investors as Rocket the beanie blue jay with a split seam.

Bedroom slippers and thermal retention products maker R.G. Barry Corp. (NYSE: RGB), which reported a Q2 loss of $0.55 per share, down again from last year's $0.16 loss, lost $2 1/4 to $5 1/2 today. "We now anticipate 1999 sales will be approximately flat with last year," said Chairman and CEO Gordon Zacks, "and that our diluted per share earnings will be in the $0.25 to $0.45 range." Last year, the company reported revenues of just under $151 million, approximately 93% of which was generated by the company's footwear division. Fargeot, a French slipper and casual shoe maker with 1998 sales of $10 million that R.G. Barry bought an 80% interest in for $4 million in cash earlier this month, probably won't figure much into the company's results. Zacks said the company was hurt by retailers' increased reliance on private label products over brand names, retailers going out of business, and cautious ordering driven by last year's warm winter.

QUICK CUTS: Charlotte-based bank First Union (NYSE: FTU) withdrew $2 to $46. The company announced that President John Georgius will retire from that post at the end of the year after 24 years at First Union and 36 years in the banking business. He will be replaced by G. Kennedy Thompson, vice chairman for global capital markets... Retirement savings and investment products company Arm Financial Group (NYSE: ARM), which turned in operating EPS of $0.67 for Q2, was dumped for a loss of $4 3/4 to $5. Wall Street expected a $0.55 per share profit. Net loss per share was $7.30... Website co-location services and direct access provider AboveNet Communications (Nasdaq: ABOV) lost $11/32 to $35 13/32 after turning in a fiscal Q4 loss of $0.38, well ahead of last year's $3.90 loss but $0.09 worse then estimates.

Automaker DaimlerChrysler (NYSE: DCX) braked $5 7/16 to $72 1/8 today as several brokerages downgraded the stock following Thursday's disappointing second quarter earnings news... Clothes designer Tommy Hilfiger (NYSE: TOM) traded down $1 11/16 to $36 15/16 after reporting strong Q1 2000 earnings of $0.40 per diluted share, three cents ahead of First Call estimates. For more on the news, look at today's Fool Plate Special... Ford Motor Co. (NYSE: F) slowed $3 1/2 to $48 1/2 following reports that the company will suspend production at its Wixom, Mich., plant next week because it couldn't get enough parts for its new Lincoln LS entry-level luxury sedan.

Marketing communications services company Snyder Communications Inc. (NYSE: SNC) tuned out $7 11/16 to $19 3/8 following news that Q2 EPS was $0.31, better than last year's $0.25 but flat with estimates... Wireless local area networking technology company Aironet Wireless Communications Inc. (Nasdaq: AIRO) dropped $1/2 to $10 1/2 in its first day of trading. The company sold 6 million shares to the public yesterday for $11 each... Compound semiconductors maker Cree Research (Nasdaq: CREE), which will split its stock 2 for 1 after the market's close today, retreated $3/4 to $61 7/8. TheStreet.com's Herb Greenberg has been poking into the company's relationship with diamond substitute manufacturer C3 Inc. (Nasdaq: CTHR) in recent columns.

Pharmaceutical development services firm Applied Analytical Industries (Nasdaq: AAII), which said it expects to turn in a Q2 loss of $0.17 per share, lost $4 1/2 to $6 5/8. Wall Street was expecting an $0.12 per share profit... Manufactured housing company Champion Enterprises (NYSE: CHB) rusted $2 13/16 to $13 1/2 after reporting that the bankruptcy of one of its independent retailers is expected to result in an after-tax Q3 charge of $0.41 per share... Enterprise content management and publishing software company Interleaf (Nasdaq: LEAF) ended down $1 7/32 to $8 13/16 today. The company late yesterday afternoon reported fiscal Q1 EPS of $0.02.

Earnings Movers

AGL Resources Inc. (NYSE: ATG) down $1 5/16 to $18 7/8; fiscal Q3 EPS $0.12 vs. loss of $0.02 last year; estimate: $0.34

Allmerica Financial (NYSE: AFC) down $2 to $59 3/16; Q2 EPS $1.32 (continuing operations) vs. $0.91 last year; estimate: $1.15

Atrix Laboratories Inc.
(Nasdaq: ATRX) down $1 1/8 to $6 7/8; Q2 EPS loss of $0.47 vs. gain of $0.33 last year; estimate: loss of $0.23

First Years Inc. (Nasdaq: KIDD) down $2 3/4 to $10 3/8; Q2 EPS $0.25 vs. $0.25 last year; estimate: $0.28

GPU Inc. (NYSE: GPU) up $1 11/16 to $38 3/8; Q2 EPS $0.84 vs. $0.62 (both before charges) last year; estimate: $0.66

Steris Corp. (NYSE: STE) down $2 11/16 to $13 7/16; fiscal Q1 EPS $0.14 vs. $0.20 last year; estimate: $0.23

An Investment Opinion
by Warren Gump

Extrapolation Fallacy

We're preparing to wrap up a terrific second quarter earnings season, with overall profit (before restructuring and other "one-time" charges) looking to be up about 15% from the prior year, based on combination of actual and projected results. Almost two thirds of S&P 500 companies have reported results; estimates for the remaining third are based on First Call Director of Research Chuck Hill's expectation that they will come in slightly better than published estimates. This assumption takes into account the fact that security analysts have a tendency to low-ball projections to enable companies, which are often clients of the analysts' firms, to beat expectations.

This projected earnings growth is great news for investors, as it indicates the fundamental value of their holdings is also rising. I do, however, want to caution you about headlines that are likely to sprout forth based on earnings news that will be released over the next six months. Over this period, earnings growth will likely be even higher than the 16% reported during Q2. According to Hill's projections, the number is likely to hit 21% in Q3, trailing off slightly to 18% in Q4.

While this news should be heartening, be sure not to become so excited that you extrapolate such massive percentage gains into future expectations. In a way, it's hard not to do this. The tendency of many stock market observers it to take recent trends and project their continuation indefinitely into the future, ignoring shifts that often emerge, turning those projections on their tail.

We can look at the Japanese stock market in the late 1980s, when many investors had become convinced that the companies behind those equities had become such an impenetrable force that valuation didn't matter. After rising at astonishing rates in the years leading up to 1989, the Japanese market experienced a marked about-face that lingered throughout the past decade. Ten years after reaching its peak, the Nikkei stock market lost half its value.

The reality of that loss is actually much more painful than surrendering over 50% of invested capital to market forces. In addition to that actual loss, investors saw 10 years of time tick away. Money being invested at the market top was likely expected to earn at least compound annual growth of 10% over its investment horizon. Using a 10% growth assumption, $5,000 would have been parlayed into $12,950, a 10-year return of 159%. Of course, the value in the account 10 years later would have been less than $2,500, more than 80% lower than the projected ending value.

A look at events closer to home shows a similar, though positive, alteration to projections. In the 1980s, not too many people thought the United States would ever be able to balance the budget, much less end a year with a budget surplus. Fast-forwarding through a dizzying period of economic success, we find ourselves in 1999 not only projecting another year where the government is taking in more than its spending, but the President is talking about projections showing the deficit will be paid off in 15 years. My skepticism about the ability of our government to show such fiscal restraint aside, that's a mind-boggling shift in projections over just a little bit of time.

Returning to the financial discussion at hand, the projected earnings growth for the remainder of the year is real, but it should be put in context. Do you remember what happened last summer and in fall of 1998? Economies worldwide suffered the impact of currency devaluations and crises in numerous countries. Although our domestic economy emerged relatively unscathed, many multinational corporations suffered the ramifications of the international downturn. In fact, profits for companies in the S&P 500 actually fell during the year. Using First Call's tally, ongoing profits from these companies ended 1998 2% below the level achieved in 1997.

When being compared to last year's weak performance, this year's corporate earnings are naturally going to look strong since most economies are regaining lost ground. That being said, it is unlikely that growth rates will be sustained at such a rapid pace when comparisons represent normalized market conditions.

To better visualize what's happening, let's look at an interesting story from a local beach, Sunny Point. For several decades, the visitor count has been increasing at a pretty steady 3% per year, reaching a total of 930,000 in 1997. Last year, a bunch of folks decided to go to Sunny Peak instead of Sunny Point because a mudslide closed an access road, adding an hour to the trip to Sunny Point. The beach's 1998 visitor count fell to 902,000. Hoping to overcome this reduction in travelers, the Sunny Point Chamber of Commerce introducing a new ad campaign for 1999. Based on just-completed analysis of early season data, Sunny Point expects its visitor count to hit 987,000 people this year.

An eager second-year Chamber summer intern who helped devise the ad campaign was thrilled with this news. He concluded that his work helped accelerate visitor growth to 9%, six percentage points above its traditional growth rate. Before wrapping up his summer tasks, he was asked to create a decade-long projection for visitor growth. Although the intern was confident new twists on the current ad campaign would be successful for many years, he tempered the current year's 9% growth rate to 5%, wanting to be conservative and assuming some of the ad campaign's novelty might wear off. His projection called for 1.6 million visitors in 2009, although he pointed out that the number would reach 1.9 million if a 7% growth rate could be maintained.

Do you notice any problems in the intern's logic? While the ad campaign may have helped stoke extra interest in Sunny Point, a much more important reason for the jump in 1999 visitors was that the access road was reopened. Looking at the visitor count trend between 1997 and 1999, instead of between 1998 and 1999, the growth turns out to be exactly 3% per year, in line with the long-term trend. If that 3% growth rate were to end up being the actual growth experienced over the next 10 years, Sunny Point's 2009 visitor count would reach 1.3 million, quite a bit lower than the "conservative" 1.6 million estimated by the intern.

I don't want to diminish in any way the terrific prosperity that is now being experienced by Corporate America. The soaring increases in profits and profitability are truly remarkable feats, particularly considering we are so far into a period of economic prosperity. At the same time, as investors, we should not be lulled into expecting profitability growth rates similar to those projected for 1999. Over the next few months, many analysts will be talking about the tremendous growth in 1999 corporate profits, implying that they are sustainable. While there is a very remote chance that mid-teens profit growth can be maintained by S&P 500 companies in future years, that outcome will be much less likely when comparisons are no longer based on 1998's depressed results.


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