Ups and Downs Plus Top News (QuickNews) August 31, 1999

Motley Fool QuickNews
Tuesday 8/31/99

Editor's Note: One of the things readers have said they miss with our new news format is a single page with a daily market review and other Fool news and commentary. In response to that, this week we introduce The Motley Fool's QuickNews, where you'll find our mainstay Ups and Downs and the day's top news stories in one easy-to-read composite. Of course, don't forget to check out the links to the rest of our news features, published throughout the day. Comments or questions? E-mail the Fool News team at

Closing Market Numbers

DJIA           10829.28    -84.85    (-0.78%)
S&P 500         1320.41     -3.61    (-0.27%)
Nasdaq          2739.35    +26.66    (-0.98%)
Russell 2000     427.83     -0.47    (-0.11%)
30-Year Bond  100 23/32    -06/32  6.07 Yield

Today's Market Movers:


Communications network provider Coyote Network Systems (Nasdaq: CYOE) stalked up $13/32 to $6 13/16 after subsidiary Coyote Technologies signed a distribution agreement with telecommunications equipment maker Ericsson (Nasdaq: ERICY). Under the agreement, Coyote will sell a networked Internet protocol device using Ericsson gear.

Data storage server manufacturer MTI Technology (Nasdaq: MTIC) surged $2 11/16 to $22 5/16 after the company announced plans to beef up its direct sales force to better market its expanded product line.

Internet telephone company Net2Phone (Nasdaq: NTOP) extended its August hot streak, adding $12 3/8 to $85 after landing a contract with AT&T (NYSE: T). Under terms of the agreement, AT&T will provide network and colocation services that will allow Net2Phone to expand its international reach to 17 countries.

Surgical sealant manufacturer Focal Inc. (Nasdaq: FOCL) stepped up $1 5/8 to $5 3/4 on news that the FDA granted exemption approval for the company to initiate a clinical trial of its FocalSeal-S product, used to seal leaks following neurosurgical procedures.

Automated data storage company Advanced Digital Information (Nasdaq: ADIC) lofted $5 5/8 to $32 1/4 after announcing an upgrade to its software that will allow its products to support smaller tape libraries and certain high-end servers.


Network processor maker MMC Networks (Nasdaq: MMCN) plunged $19 1/8 to $30 7/8 after two of the company's biggest customers, Cisco (Nasdaq: CSCO) and IBM (NYSE: IBM), reached an agreement some think could reduce the two giants' dependency on MMC.

Liquid waste disposal specialist US Liquids (AMEX: USL) lost $10 1/4 to $7 1/2 -- a 58% drop -- after law firm Wolf Popper filed a class action lawsuit on behalf of people who bought the stock from May 28, 1998, to August 25, 1999. The lawsuit alleges that the company issued false and misleading statements. Liquid announced plans to repurchase up to $3 million shares of stock based on the belief that the stock is undervalued.

Telecommunications engineering services company Dycom Industries (NYSE: DY) plummeted $8 11/16 to $31 1/16 -- the second time in a week the stock has tumbled -- as a result of a trade journal article that questioned the company's accounting practices. The company issued a statement today calling the comments false and misleading.

Power amplifier and subsystem maker Microwave Power Devices (Nasdaq: MPDI) dropped $1 13/16 to $8 7/16 after the company said third-quarter earnings would suffer after one of its customers put a hold on further deliveries. The hold order was lifted after a technical problem was resolved but not in time to book the sales.

Today's Top Stories:

Office Depot Taking It On the Chin
By Richard McCaffery (TMF Gibson) (TMF Gibson)

Office Depot (NYSE: ODP) announced this morning that earnings for the second half of 1999 would come in around $0.39 per share, 24% less than investors were expecting.

The Delray Beach, Florida chain, the world's largest supplier of office products, said weak sales and price pressures are to blame for the expected shortfall. Competition has increased and rising paper prices have cut into profitability. Adding to the shortfall, the company announced plans to take a $28.3 million charge in the third quarter as part of its plan to close underperforming stores. It will also take a $34.2 million charge to write down inventory that's not selling, most of it out-of-date technology products. At the same time, the company continues an aggressive expansion campaign, expecting to open 140 new stores this year.

After getting hit hard yesterday, the company's shares fell 23% this morning before rebounding later in the day to end at $10 5/8 . But the shares have been sliding from about $22 since early July, in part because of second-quarter warnings from the company. Also, Merrill Lynch analysts cut their recommendation on the firm to "accumulate" from "buy" last month based on an in-house study that the office products industry is reaching saturation. Long term, Merrill expects the company to grow its earnings about 12% annually.

With this in mind, it will be critical for the company to manage its assets and other balance sheet accounts effectively, thereby generating cash for investors even as sales growth slows. How has the company done recently? Return on equity (ROE) is one way to measure management's ability in this regard. It calculates the amount of earnings the company generates from its equity capital. In 1998, Office Depot increased its ROE to 15.8%, up from 14.2% a year earlier, meaning the company is generating $0.16 of earnings for every dollar of equity capital. It's good to see this number trending up, though this morning's announcement will make it tough for that trend to continue.

How does its ROE stack up? If you compare Office Depot's ROE to a super-efficient retail giant such as Home Depot (NYSE: HD), you see that the company has room for improvement: Home Depot's 1998 ROE is 18.5%. It's not an apples-to-apples comparison since Home Depot's merchandise is not under the same price pressure Office Depot is facing, but it does provide a look at the kind of return a retailer of comparative size can squeeze out of its equity.

Office Depot's sales for each dollar of assets provides another look at this, focusing on how much in sales the company generates for each dollar originally invested. Office Depot's sales-to-assets ratio improved to an impressive $2.18 for the 12 months ended in June, up a scratch from $2.17 for the 12 months ended in December.

Looking at some of Office Depot's other margins, it's clear that the company doesn't operate in a very profitable sector. Gross margins improved to 28.2% in the first half of 1999, up from 26.6% in the first half of last year. The good news, again, is that the company is moving its numbers in the right direction. However, comparable store sales for the first half of 1999 grew just 1%.

The company's bad news this morning didn't come without a little sweetener -- a plan to repurchase $500 million in stock. Every little bit helps. But in an increasingly competitive industry, and perhaps a maturing sector, Office Depot will have to work hard to reward shareholders. Investors that think the company has demonstrated its ability to do this for the long term should take a closer look: the company is trading at a 1999 P/E of 12.7.

FOOL PLATE SPECIAL An Investment Opinion
Sega & the Sonic Boom
By Rick Aristotle Munarriz (TMF Edible)

Am I dating myself if I confess to once being impressed by video game pioneer Pong? Sure, it was colorless flat-paddle ping pong, but it took a medium which everyone accepted as a means of entertainment and information and made it interactive overnight. A genre was born.

Next week the cries of "I want it" will crescendo as Sega's Dreamcast gets plugged into a television set near you. Last night Sega announced that toy stores had logged 300,000 pre-orders, three times what Sony (NYSE: SNE) garnered with its 1994 PlayStation debut.

The arrival of a newer, more powerful kid on the block should not alarm video game console historians. The Atari, Colecovision, and Intellivision of the 1970s gave way to the 8-bit wonders of Sega and Nintendo in the 1980s. Both companies, heeding the call for better systems, raced toward 16-bit systems as the 1990s rolled in.

It seemed as if the two Japanese competitors would own the market forever. Then, some pesky upstarts crashed the party. In 1993, 3DO (Nasdaq: THDO) and Atari's attempted revival in its Jaguar system hit the market. While both machines met a quiet demise, they did whet the consumer appetite for the PlayStation release a year later.

Running on CDs that were cheaper to produce than Super Nintendo and Sega Genesis cartridges, and toting a superior spec sheet, Sony began to wrest market share from its lowly 16-bit competitors. It also charged developers lower royalties than its peers -- securing plenty of available titles and at lower price points.

Sega attempted an immediate attack but sputtered. Nintendo took to tarrying while it readied its Nintendo 64 system. The cartridge-based N64 has fared well but still trails the PlayStation in popularity. Still, the console industry is booming. According technology market-watcher Ziff-Davis, 21 million stateside households owned at least one video game system last year. This year -- 43 million. The staggering growth, more than doubling over the course of a single year, can be attributed to falling system and software prices. Sony and Nintendo slashed the console retail prices to just $99 earlier this month -- having gone from $149 to $129 over the past year. Individual game titles are also more attractively priced.

The latest reductions are clearly a preemptive strike at Sega's $199 asking price for the Dreamcast. It might not be enough. Sega has suffered through four holiday seasons, written off by many during that time. But it has been an astute pupil of history. It has seen new machines fail because of high initial prices (the 3DO was launched at $700), lack of software support (the 3DO system hit the shelves with just one available title; Sega has lined up more than a dozen, including the arcade favorite House of the Dead 2), and incomplete distribution channels (every major retailer seems to be stocking the Dreamcast).

The Dreamcast's power is jaw-dropping. Catch a display model running the return of Sega's Sonic the Hedgehog to see what I mean. The Dreamcast also offers something new -- a 56k modem -- with limitless possibilities. While 300,000 early adopters might seem insignificant in light of 43 million game-playing homes, Sega is back -- and there are some investing implications to ponder.

Before Wall Street as a whole figures it out, there seem to be clear winners and losers beyond the console makers. Destined to have a rocky road this holiday shopping season are traditional toymakers like Mattel (NYSE: MAT) and Hasbro (NYSE: HAS). Between the bargain-hunters stockpiling PlayStations and N64s to the mad rush for Dreamcast titles, there won't be much stocking left to stock. Yes, Mattel and Hasbro are alive in the realm of software, but not significantly enough to offset the gamer defections. The big-ticket Dreamcast might spoil the hype for what could have been a great Star Wars selling season for Hasbro in particular. Next year might be more of the same as Sony rolls out its PlayStation 2.

There will be winners, too. Retailers, like leading toy vendor Wal-Mart (NYSE: WMT), and toy-specific players like Toys 'R' Us (NYSE: TOY), might enjoy the inventory advantage of storing smaller game boxes, with whirlwind turnover, over bulkier play fare. Online toy merchants like eToys (Nasdaq: ETYS) and (Nasdaq: AMZN) should flourish given the convenience of specific title requests rather than vague action figure and Barbie wishlist references often best filled in person. Sega is back, and to some, it's a Dreamcast come true

More of Today's Best:

FOOL ON THE HILL An Investment Opinion
Retail Markdown
By Warren Gump (TMF Gump)
-- This year hasn't been too rosy for the stocks of retailers. Despite a buoyant economy, many companies have suffered from missteps or changes in market dynamics. Neiman Marcus (NYSE: NMG) released Q4 earnings of $0.06 per share, compared to $0.33 last year. Office Depot (NYSE: ODP) warned last night that second-half profits would fall shy of analyst projections because of weak sales and margin pressures. Last week, The Wet Seal (Nasdaq: WTSLA) announced earnings that were below the level achieved one year earlier. Two weeks ago, Saks Inc. (NYSE: SKS) warned that it would not achieve expected yearly earnings. All of these companies have seen their stocks turn south as their estimates tumbled.

War and Peace On a PalmPilot?
By Dave Marino-Nachison (TMF Braden)
-- Online professional bookstore (Nasdaq: FATB) thinks it has the answer, taking a cue from virtual auctioneer eBay (Nasdaq: EBAY) with today's launch of its eMatter secure digital publishing system.

Fruit of the Loom In a Sticky Situation
By Dave Marino-Nachison (TMF Braden)
-- The rot in the fruit basket continued as underwear maker Fruit of the Loom (NYSE: FTL) rounded off a disappointing first half by saying after the bell that it expects full-year earnings to come in "significantly below analysts' expectations." Seven analysts surveyed by First Call were looking for a loss of $0.03 per share.

Guidant Buys CardioThoracic Systems
By Brian Graney (TMF Panic)
-- Medical devices maker Guidant (NYSE: GDT) has agreed to acquire coronary artery bypass grafting (CABG) products maker CardioThoracic Systems (Nasdaq: CTSI) for $313 million in stock. The purchase price works out to $19.50 per share, a 3% premium to CardioThoracic's closing price of $19 per share yesterday and not much higher than the shares' $18 initial public offering price in 1996 -- not the best example of building shareholder value in the world. The deal is expected to be neutral to earnings in 2000 and accretive in 2001. One-time acquisition-related charges will be recorded in Guidant's Q4, when the deal is expected to close.

McLeodUSA Gets $1 Billion Infusion
By Brian Graney (TMF Panic)
-- Confirming a report in this morning's Wall Street Journal, private investment firm Forstmann Little & Co. has agreed to invest $1 billion in Cedar Rapids, Iowa-based competitive local exchange carrier (CLEC) McLeodUSA (Nasdaq: MCLD). Under the deal, Forstmann Little will buy convertible preferred shares representing a 12% stake in the company, which had needed a capital infusion to fully fund its business plan. In return, Forstmann Little senior partner Ted Forstmann and another partner plan to join the company's board.