Motley Fool QuickNews

Tuesday 9/14/99

Closing Market Numbers

DJIA           10910.33    -120.00    (-1.09%) 
S&P 500         1336.29      -7.84    (-0.58%)
Nasdaq          2868.29     +23.52    (+0.83%)
Russell 2000     438.24      -1.41    (-0.32%)
30-Year Bond   100 2/32     -30/32  6.12 Yield

Today's Market Movers:


Semiconductor fabrication equipment big daddy Applied Materials (Nasdaq: AMAT) moved up $5 9/16 to $81 9/16 today after chairman and CEO Jim Morgan reportedly told an industry conference that he sees a "continuous rise in chip demand worldwide" over the coming years, which is good news for firms throughout the sector. Fellow capital equipment maker KLA-Tencor (Nasdaq: KLAC) added $6 9/16 to $73 3/8, Novellus Systems (Nasdaq: NVLS) rose $5 13/16 to $67 3/4, Teradyne (NYSE: TER) advanced $3 7/8 to $41 7/8, and Lam Research (Nasdaq: LRCX) picked up $7 1/2 to $65 5/16.

Networking products company Cabletron Systems (NYSE: CS) moved up $1 5/16 to $19 5/8 after SG Cowen analyst Chris Stix raised the company's fiscal 2001 earnings estimate to $0.85 per share from $0.65 per share based on optimism about growth prospects from new products. Stix also boosted the firm's price target to $25 - $30 per share from $15 to $20 per share.

Online health information services firm Healtheon (Nasdaq: HLTH) climbed $3 5/16 to $37 11/16 after signing a $50 million strategic agreement with merger mate WebMD and rehabilitation and outpatient surgery centers operator HEALTHSOUTH (NYSE: HRC) to develop an online sports medicine channel. The deal includes revenue sharing from all sponsorships, e-commerce, and advertising derived from the channel. HEALTHSOUTH, which was battered last week, gained $5/16 to $6 1/16 on the news.

Business-to-business e-commerce services provider (Nasdaq: PPRO) jumped $14 1/8 to $26 1/8 in its first day of trading after selling 4 million shares in an initial public offering at a price of $12 per share.

Internet telecommunications products maker and recent StockTalk subject Net2Phone (Nasdaq: NTOP) rang up $6 15/16 to $63 3/4 after announcing product reselling agreements with Web hosting companies, 9Net Avenue, and Advanced Internet Technologies.

Nutritional and weight management products marketer Herbalife International (Nasdaq: HERBB) sprouted $5 17/32 to $14 11/16 after its board agreed to a $17 per share offer from founder, chairman, president, and CEO Mark Hughes to take the company private.


Auto parts maker Federal-Mogul (NYSE: FMO) was throttled for a $9 loss to $30 3/8 after saying a weak global parts aftermarket, a poor sales mix, and productivity shortfalls from the start-up of its camshaft business will lead to Q3 EPS between $1.00 and $1.05 and full-year EPS between $4.20 and $4.30. The First Call mean estimate had called for EPS of $1.25 and $4.73, respectively.

Banking giant Bank of America Corp. (NYSE: BAC) was knocked down $2 11/16 to $56 1/2 after Credit Suisse First Boston analyst Michael Mayo cut his 1999 earnings estimate for the company to $4.70 per share from $4.85 per share, citing recent trading softness that may continue as Y2K approaches.

Oil and gas services firm Baker Hughes (NYSE: BHI) was drilled for a $2 3/8 loss to $31 3/4 as a spokesperson told Bloomberg News that the company's Q3 EPS will fall $0.02 to $0.03 short of the First Call mean estimate of $0.06 due to continued lower spending by the firm's oil and gas producing clients.

Fire and rescue vehicles, streetsweepers, and signage maker Federal Signal Corp. (NYSE: FSS) sank $1 1/16 to $19 1/2 after saying production problems and lower margins in some of its business segments will result in Q3 EPS between $0.30 and $0.32, down from last year's $0.36 and shy of the First Call mean estimate of $0.37.

Several property and casualty insurers lost ground today as Hurricane Floyd draws nearer to the Florida coast, threatening to do as much if not more damage than the costliest hurricane ever, 1992's Hurricane Andrew. Allstate (NYSE: ALL) lost $1 7/16 to $32 1/8, Travelers Property Casualty (NYSE: TAP) slipped $1 3/8 to $33 7/8, and St. Paul Companies (NYSE: SPC) slid $1 to $31 5/8.

Today's Top Stories:

Qualcomm Recovers From Latest Freak Out
By Brian Graney (TMF Panic)

Cell phone Code Division Multiple Access (CDMA) technology developer Qualcomm (Nasdaq: QCOM) moved up this morning after telling the world that it expects its current fiscal Q4 operating earnings will either meet or exceed the consensus estimate of $0.87 per share. The guidance came a day after the world (in this case, the World of the Wall Street Wise) freaked and assumed the worst when President Rich Sulpizio canceled a planned appearance at an SG Cowen investment conference in Boston, citing a scheduling conflict. Amid the confusion, the company's stock dropped 7% yesterday.

In the official analyst thesaurus, "scheduling conflict" is apparently synonymous with "quarterly earnings shortfall." It may be hard to determine precisely, but it's probably a fair bet that the dayplanner of an executive guiding a $30 billion company is a little bit more prone to a screw-up than the schedule of some Wall Street regurgitator whose livelihood depends on obsessing about quarterly earnings results. Maybe it's just me, but perhaps the executive in this case deserves to receive the benefit of the doubt.

In any event, investors should cheer whenever short-term irrationality gets the better of long-term common sense. Focusing on business fundamentals and ignoring business noise such as yesterday's cancellation over-reaction is what long-term investing is all about. Judging from today's calming press release from Qualcomm, the company agrees with this point of view. After dashing any lingering fears by saying that demand for its CDMA chipsets and phones has increased from the previous quarter, the firm shed some light on where its business focus will be in the future.

It's entirely possible that Sulpizio bagged yesterday's conference to meet with parties interested in Qualcomm's terrestrial-based CDMA handset business, which the company appears to be ready to divest. "With increased competition, parts shortages, and industry consolidation reducing margins in consumer products, Qualcomm desires to transition the business to a manufacturer that will support its customer base and employees while providing economies of scale, a strong purchasing base, and other operating efficiencies," the firm said today. An agreement relating to the handset business is expected before the end of the year.

In the meantime, Qualcomm said it may take a one-time charge to its earnings as it tries to position itself for future growth by undertaking initiatives to cut expenses and improve margins. This kind of talk usually comes from a company on its heels, not from a firm whose earnings last quarter blew away estimates by 19%. The company's operating margin (excluding one-time charges) expanded in fiscal Q3 to 21% from 6% a year ago as revenues from technology licenses, royalties, and development fees nearly doubled to $92.6 million. According to today's guidance, that figure will continue to expand in Q4.

With Qualcomm tweaking its CDMA technology-centric business model, return on invested capital (ROIC) should continue to march upward. In the most recent quarter, ROIC came in at 17.5%, up substantially from 8.7% at the end of fiscal 1999. Investors should expect Qualcomm's ongoing earnings growth to continue to grab the spotlight, but the firm's ability to lengthen the spread between its ROIC and its cost of capital will be the real driver of its share price performance over time. As long as the company can continue to earn more from every dollar invested in the business, short-term noise from meetings cancellations and such nonsense should be considered opportunities to hop aboard the Qualcomm growth train.

FOOL ON THE HILL An Investment Opinion
Digital Products Electrifying Best Buy
By Warren Gump (TMF Gump)

Consumer electronics retailer Best Buy (NYSE: BBY) announced another excellent quarter this morning, with earnings per share (EPS) up 33% on a 23% sales improvement. Same-store sales, a measure of store performance that excludes the impact of new locations, were up a strong 11.1%, driven by digital technologies such as DVD, digital camcorders, and Digital Broadcast Satellite Systems. This marks the seventh quarter in a row that the company has posted comp sales increases higher than 10%. In the wonderful traditional of often-illogical short-term stock price movements, Best Buy's stock fell $5 3/4 to $54 3/4 in trading today.

Best Buy has executed one of the most comprehensive turnarounds of any retailer over the past 2 1/2 years. Its stock price today is up from less than $2 per share in early 1997 as it overcame inventory control problems and the threat of bankruptcy by revamping supply management systems and rolling out a more consumer-friendly store prototype. Learning from its near-death experience, the company has been fanatically focused on controlling inventories and reducing debt.

Reducing the amount of inventory maintained in its stores frees up the company's money to be spent on other uses like expansion, debt reduction, and share repurchases. The best measurement of inventory management is inventory turnover, which takes the company's sales and divides it by inventory. Best Buy has dramatically increased this number over the past three years and continued to do so in the latest quarter, where annualized turns were 8.4x, compared to 7.5x in last year's second quarter. Looking at longer-term trends, the company's inventory turns three years ago were only 4.9x.

All the numbers related to inventory turns may sound like mumbo-jumbo, but they represent a lot of real dollars. To get a better picture of what's being discussed, let's take a look at what would have happened to Best Buy if it had not improved its inventory practices. While in reality the company probably would have ended up in bankruptcy court if this improvement hadn't occurred, this exercise provides some perspective as to how operational improvements have helped the company's financial structure.

Best Buy's August 1996 balance sheet included merchandise inventory of $1.4 billion, which supported Q2 sales of $1.8 billion. During this year's just-reported second quarter, the company recorded sales of $2.7 billion. If Best Buy needed merchandise based on 1996 inventory turns, the company would have needed $2.2 billion worth of merchandise. Instead, its inventory stands at only $1.3 billion -- a savings of almost $900 million. Put another way, despite increasing sales 50% over the past three years, the company has reduced its level of inventory by $100 million.

Instead of plowing that $900 million into inventory, Best Buy has used those funds to clean up its balance sheet. It repaid about $400 million in debt and converted a convertible preferred security into equity, leaving it basically debt-free. The company used some of its remaining cash to buy back $100 million in stock over the past few months. In addition (this is like a luscious cherry topping off a sweet chocolate sundae), the company has amassed a cash horde of nearly a half billion dollars that can be used to fund expansion efforts or repurchase more stock.

Best Buy's operational improvement tells only half of the story of its recent success. The other part of the equation is the tremendous sales growth that the company has been able to achieve, thanks to effective merchandising and a booming economy. As mentioned previously, the company has seen same-store sales rise at double-digit levels for seven consecutive quarters. Part of this success has nothing to do with Best Buy management, but lies in the fact that consumers have gone gaga over purchasing electronics the past couple of years.

Nonetheless, a good portion can also be attributable to effective merchandising strategies and product selection. To get a rough idea of how much of the company's same-store sales improvement can be attributed to market conditions rather than management decisions, I compared same-store sales for Best Buy over the past six quarters with its main competitor, Circuit City Stores (NYSE: CC).
    Best Buy  Circuit City  Difference

Q1:98    15%          4%           11p.p.
Q2:98    18%          6%           12p.p.
Q3:98    12%          9%            3p.p.
Q4:98    11%         10%            1p.p.
Q1:99    13%          9%            4p.p.
Q2:99    11%         10%            1p.p.

(Notes: Although the quarters are listed as calendar quarters,
 the sales numbers are actually based on each company's respective
 fiscal quarters; p.p. stands for percentage points.)
This comparison indicates that Best Buy has been doing a better job than Circuit City of capitalizing on the overall improved environment for consumer electronic retailers. The tremendous relative gains reported in early 1998 are probably tied to the fact that Best Buy had easy comparisons due to its 1996-1997 operational problems. Outside of those two quarters, Best Buy has still maintained a 1 p.p. - 4 p.p. lead over its main competitor. In addition to higher sales gains, Best Buy also has beaten out Circuit City in inventory management practices. During the first quarter (the last reported period for both companies), Best Buy's annualized inventory turnover of 8.6x sales was significantly better than Circuit City's 6.5x sales ratio.

Best Buy is not resting on its recent laurels. It has been working hard to develop a prototype store that will allow it to enter many of the smaller markets that can't support a full-size store. In addition, it is breaking into the last few major cities where it doesn't have a presence. The company just entered the San Francisco market this year and plans to hit San Diego, Jacksonville, and Albany, NY during the third quarter. Next year it will begin opening stores in metropolitan New York City.

Acknowledging the importance of servicing customer needs over the Internet, the company announced yesterday that it created a new subsidiary to expand on its existing e-commerce initiatives. Some news reports attributed the stock's downward price movement today to the fact that the company's expanded Internet initiatives weren't going to be ready until after this year's holiday season. While this could be a modestly negative factor over the next couple of months, it shouldn't have that big of an impact over the long term, assuming the company creates a competitive site.

Where does all of this information put Best Buy from the perspective of an investor? Best Buy appears to have much better operations relative to its major competitor. In addition to higher sales and inventory turns, the company also boasts higher operating margins. These differences are known by the market, however, and Best Buy trades for a hefty 35x earnings estimates for the current year while Circuit City garners only a 24x price-to-earnings (P/E) ratio. Assuming that Best Buy maintains its operating advantages over competitors, I would be inclined to pay a higher multiple to get the industry's top player.

You can't forget, however, that market dynamics in electronics retailing can shift rapidly. Over the past 2 1/2 years, Best Buy has risen from its deathbed to achieve its current dominant position. Another retailer could come along and do the same thing. Before taking the plunge into Best Buy stock, an investor needs to be confident that the company's management will continue out-executing its competitors, and the robust growth in the overall consumer electronics will persist for many more years.

More of Today's Best:

Kroger Looking Sharp After Big Q2 Meal
By Richard McCaffery (TMF Gibson)
-- Grocery retail king Kroger (NYSE: KR) reported record Q2 diluted earnings per share (EPS), excluding all merger-related costs and an extraordinary item, of $0.24 today -- about 26% higher than last year's results and on par with analyst estimates.Chief Executive Joseph Pichler said manufacturing performance and new merchandising programs drove higher sales and earnings. Comparable store sales for the quarter jumped 3.6% and identical store sales, which only include stores that haven't been expanded or relocated, grew 2.6%. Total sales grew 6.2% to $10.3 billion.

FOOL PLATE SPECIAL An Investment Opinion
Pier 1 Takes a Long Walk
By Rick Aristotle Munarriz (TMF Edible)
-- Pier 1 (NYSE: PIR), purveyor of imported home furnishings and -- for the last year at least -- pessimism, announced quarterly earnings this morning. While sales rose 4% for the retailer, earnings fell by 32%. The $0.12 a share showing was a penny shy of analyst estimates. It's been a long walk unless you were short Pier since the shares peaked at $20 last year. Back then the company had come off a strong FY98. Same-store sales for the year ending in February were an amazing 15.6%. Plunging interest rates had fueled a real estate and refinancing boom. New homes, or old homes with cheaper mortgages, longed to be stocked with Pier 1 merchandise.

Solectron Gets Smart
By Richard McCaffery (TMF Gibson)
-- Electronics manufacturing contractor Solectron (NYSE: SLR) signed a $2 billion agreement to buy Smart Modular Technologies (Nasdaq: SMOD), a leading manufacturer of memory modules, memory cards, and embedded computers, in a move aimed at expanding Solectron's global reach and manufacturing capacity. The deal, the biggest ever in the fast-growing electronics manufacturing services industry, also gives Milpitas, California-based Solectron new products to offer customers such as Hewlett-Packard (NYSE: HWP), Cisco (Nasdaq: CSCO), and Compaq Computer (NYSE: CPQ), as well as added manufacturing and design centers in Puerto Rico, Scotland, Malaysia, India, California, and Boston.

Interstate Bakeries Poised For a Pleasant Trip?
By Dave Marino-Nachison (TMF Braden)
-- Leading baker and baked goods distributor Interstate Bakeries Corp. (NYSE: IBC) pulled fiscal Q1 earnings per share (EPS) out of the oven this morning, producing EPS flat with market estimates and last year's results at $0.87. Key profitability numbers were disappointing. Though revenues rose nearly 2.7% to more than $809 million, gross margins improved just two-tenths of a percentage point while both operating and net margins retreated by similar margins. The shares were off about 3% as of this writing.

Hi-Tech Jumps on DiabetiSweet "News"
By Dave Marino-Nachison (TMF Braden)
-- Shares of little-traded Hi-Tech Pharmacal (Nasdaq: HITK) jumped nearly 45% today on volume more than 200 times its daily average for the last 30 days after the company's Health Care Products division issued a press release describing its DiabetiSweet "Measure for Measure" product as "the first-ever bulk sweetener that can completely replace sugar in baking and cooking." Investors might be wondering where Hi-Tech came from; with a market capitalization of less than $30 million and less than 8,000 shares trading daily over the past 30 sessions, the company -- which today eclipsed its old 52-week high by a wide margin -- certainly snuck up on this Fool.