Fool Portfolio Report
Thursday, October 31, 1996

by David Gardner (MotleyFool)
and Jeff Fischer (MF BudFox)

ALEXANDRIA, VA, October 31, 1996 -- Well, first off I have to say that the market's reaction to ATC Communications's earnings released this morning are very similar to my own: short-term disappointment. ATCT dropped $4 7/8, or 20.5%, closing at a bid of $18 7/8.

Insofar as our company had announced earnings of 12 cents per share in its previous quarter, I am bummed out that the guys in Dallas couldn't ring up a similar amount this quarter. My own projections -- admittedly guesswork (as stated in our initial purchase report) -- were for a similar performance to the company's strong June fiscal fourth quarter. However, the grand old world of American business does not always perform according to our humble forecasts; this is only the latest in a long string of instances that I expect to continue ad infinitum.

A key observation about the company's first quarter fiscal '97 performance comes down to a two-paragraph section included in our initial purchase report. To wit:

Another potential risk: the company's call centers can have a significant amount of idle capacity during day-time hours. It's difficult to call people (or receive calls) when nobody is home, but working. As such, any additional calling volume taken during daytime hours can impact gross margins substantially -- in ATC's favor! This is believed to have happened in the most recent quarter. But the point is, if such volume isn't up next quarter, margins could go lower.

Additionally, analysts estimate that some of the strong growth in revenues during the recently completed fourth quarter resulted from a significant one-time piece of daytime inbound business received from one client. ATC won't say who that client was, or the amount of business, or if it could happen again in the next and subsequent quarters. Therefore, the last quarter completed MAY present the company in a stronger light than can normally be achieved. We obviously hope not, but that remains a risk. On the plus side, one could reasonably suspect in the current industry environment that lightning may strike more than once.

Indeed, sales growth -- 47% over the first quarter last year -- declined slightly percentage-wise from last quarter, suggesting that lightning didn't strike again (this period, anyway). And margins, which were a respectable 8.0%, do seem to have been affected by a lower amount of day-time calls, since last quarter margins were 9.3%.

So what we have up to this point in our summary is a company that has continued to execute its business plan, cranked out a respectable quarter, but disappointed the market because it was unable to maintain quarter-over-quarter momentum. In a high-risk, high-volatility situation like this one, that'll whack your stock a few points the day of the announcement. We expected as much, if the company didn't meet the market's expectations. It didn't.

Ironically, the few Wall Street analysts following ATCT hit the number right on: nine cents was the consensus First Call estimate. But since lots of momentum investors out there (and really, the market in general) count on a company like this one beating estimates, only hitting estimates head on doesn't feed the hungry beast. So the beast roars.

OK, now let's get away from the somewhat unFoolish bowling-for-dollars world of short-term price movement focus and instead look at the business.

Sales rose 47% to $26.5 million for fiscal 1997's first quarter. Fully taxed net income was $2.1 million, or $0.09 per share, versus $0.8 million, or $0.04 per share in last year's September quarter. Net profit margins -- that key figure we write about in our Motley Fool Investment Guide -- came in at 8.0%... very nice when compared to where the company was a year ago, sporting 4.5%, but still down sequentially from the previous quarter's 9.3%.

OK, let's look forward from here, and let's first err on the conservative side. Trailing earnings are now 30 cents per share, so the P/E ratio is now 63. Based on current earnings estimates of 40 cents for this year, and 64 cents for next (ended 6/30/98), you have an annualized growth rate of 54%. Our Fool Ratio suggests the P/E at fair value should lie in line with the growth rate. A P/E of 54 on trailing earnings would put the stock at $16 1/4, a couple points below where it is now. That's our most conservative model, which assumes the company doesn't capitalize on its booming industry, can't strike up enough business to beat estimates, and merely soaks up enough in sales each quarter to make estimates. We of course feel the company has more ambition and talent than that, though.

We bought this stock because we believed the company would beat earnings estimates consistently, but still now that it has failed to in its first effort, we have to readjust our sights -- at least for now. The story has changed -- though not permanently, I don't think -- but the first chapter now has a different cast to it. And without the ability to look into next quarter's crystal ball, we must prudently assume -- in one scenario -- that the company may only meet, not exceed, estimates, which gives the fair value which falls below our value figured upon ambitious, estimate-beating growth in the future. In other words, the stock needs to start beating earnings again for the earnings to catch up and merit a much higher valuation. Of course, estimate-beating performance is what the Fool banked on when purchasing this small high growth company -- and is what nearly all investors hope for when purchasing such companies.

You take on added risk in a small cap investment, whereby quarterly sales and earnings numbers can be greatly affected by just one or two large contracts in the quarter -- or lack of contracts. This appears to have happened with ATC Communications. This quarter was successful, strong, impressive. The company is healthy -- is very far from ailing. But last quarter was an all-out, rock 'em, sock 'em, blow-out quarter, and so the company in effect has "disappointed" short-term or momentum investors, alongside with Fools hoping for more in this quarter's showing following the last quarter. But does that mean the company won't ever have another blow-out quarter again? Heck, no. It's still a leading company in a booming industry, an exploding industry, and ATC Communcations is in the right place and right time to capitalize on that growth. The potential is still very much there. We wouldn't have bought the stock if the only potential was short-term potential. Who ya kiddin,' Fool!

That said, it is prudent to state that, cautiously considered, if the company can't meet our expectations in the future -- if the company can't live up to the hopes we had for it when we first bought the dang thing -- then of course we will re-evaluate and reach for the appropriate response. But to do so now, or even think of it, after only one quarterly report -- and a good report at that, just not Stupendous -- would be very unFoolish. We bought the stock hoping to capitalize on a multi-billion dollar industry which is booming. That industry is still booming, and ATC is still in that industry (they didn't change businesses and start selling pumpkins in the last few weeks, though it would have been good timing.) But nope, they're still in the trenches of the $80 billion dollar per year telemarketing industry; and ATC Communications is still estimated to grow around 50% per year annualized. This quarter is past and was solid. But we'll be Foolishly ready to analyze next quarter when it comes, and we'll hope to see more impressive growth -- estimate beating growth. The estimate for next quarter stands at 10 cents. ATC Communications just earned 9 cents.

Ah, finally, but then look at others in its field -- they all have substantial premiums to normal valuations, and have enjoyed premium pricing all the way up. Take a quick look at ATCT compared to industry peer APAC TeleServices (Nasdaq:APAC):

Sales Market Cap Cap/Sales ATCT $102.8 $422.8 4.1 APAC $225.5 $2,135.6 9.5 EPS Growth* P/E ATCT 125% 63 APAC 514% 94 *most recent quarter

As you can see, the market right now really values growth rates. ATC is priced at four times sales, vs. APAC's 10 times sales! However, APAC racked up the big numbers this quarter 'round. So going forward, I think we can conclude that the market still likes this industry, and pays up for growth rate (to the extent that it may ignore cash flow -- APAC's was negative through the June quarter). We'll keep our fingers crossed that ATC can re-juice its growth. It's a fine company, regardless.

What we found particularly impressive was the tenor of our Motley Fool ATCT message folder on AOL. Most investors took their lumps rationally and patiently, recognizing that speculative momentum play focused on the short-term gain, and probably sold out of the stock this morning. As Aprato wrote in the folder, "people looking for a quick kill based on earnings" didn't get it, and are probably mostly gone. What's left is less speculation.

Also, for one reason I'm glad we were wrong. As the eminently unWise MF TallTim wrote, "Don't forget that even Fools can be wrong -- as they are quick to point out. Maybe they were wrong on this one, but I wouldn't draw that conclusion from one day's results."

JLund1609: "I just wanted to thank all those in a mad dash for the exits who tossed their ATCT shares down like worthless tickets after the twelfth at Hialeah."

One contributor to our ATCT message folder on AOL wrote, "Why [did the Fools] buy so close to the earnings announcement unless they thought the numbers would be beaten? Big disappointment!"

Anyway, in the end our portfolio dropped 2.82% today. ATCT, as mentioned earlier, dropped 20%. It's my hope that other ATCT shareholders, Foolish or unFoolish, felt a decline more like 3% than 20% in their own holdings. ATC Communications is one of 11 stocks in our portfolio; diversification is the lesson here. While we will continue to hold the stock because of our belief in the business and company, we also recognize that we will be wrong from time to time. Who knows? Maybe this will end up being one such instance. But our portfolio, and hopefully your portfolio, is Foolish enough to withstand being wrong once, twice, or heck, even three times a year, and still put up market-smashing returns, as the Fool has the past two years and two months.

But enough of all this serious talk. As readers know, while Fools enjoy beating the market and making money, we just as much so enjoy being... well, just being Fools. And with Foolishness comes good spirits and humor and entertainment and, perhaps above all, community.

In that regard, I'm honored to give you this great Halloween picture of Fool Thom Unger (TMF Cutter). Thom is a Fool busy at Fool HQ each day of the week and often beyond the call of duty, but, like so many other Fools we appreciate each day, we don't get a chance to say it in this hectic, run-around world, and they don't get a chance to be as public about their Foolishness on a day-to-day online basis. He's one of the many Fools behind the scenes, and in the great spirit of... well, Halloween, we'd like to say thanks and share his Foolishness! Thom's costume, "Split-Personality," wins the Fool costume contest hands-down.

Also much in the spirit of Halloween, and enough to scare any investor to hide beneath their bed, Keith Pelczarski (MF Czar), skillfully carved together a dastardly array of terrifying stocks, with the help of other Motley Ghouls. Be sure to check out Ticker Treat and Scary Stocks. Bring your PEG calcalutor and be ready to run.

And, Finally, it wouldn't be Halloween without a frightening poem. While David wrote his half of this recap, Jeff created The Maven, a Foolish adaption to Poe's famous "Raven" poem, updated for the 1990's. Read it and creep!

Happy Halloween!

Today's Numbers

Stock Change Bid ------------------- AOL - 3/8 27.13 T - 1/4 34.88 ATCT -4 7/8 18.88 CHV - 1/2 65.75 GM + 5/8 53.88 IOMG - 5/8 21.50 KLAC + 1/2 24.25 LU - 3/8 47.00 MMM +1 1/4 76.63 QDEK + 1/8 5.19 COMS +1 5/8 67.63
Day Month Year History FOOL -2.78% -4.94% 45.10% 170.94% S&P 500 +0.62% 2.61% 14.50% 53.85% NASDAQ +1.27% -0.44% 16.10% 69.61% Rec'd # Security In At Now Change 5/17/95 2010 Iomega Cor 2.52 21.50 753.52% 8/5/94 680 AmOnline 7.27 27.13 272.96% 8/13/96 250 3Com Corp. 46.86 67.63 44.31% 8/11/95 125 Chevron 50.28 65.75 30.76% 9/27/96 -890 Quarterdec 7.08 5.19 26.77% 8/12/96 110 Minn M&M 65.68 76.63 16.67% 8/12/96 280 Gen'l Moto 51.97 53.88 3.66% 10/1/96 42 LucentTech 47.62 47.00 -1.29% 8/12/96 130 AT&T 39.58 34.88 -11.88% 10/22/96 600 ATC Comm. 22.94 18.88 -17.71% 8/24/95 130 KLA Instrm 44.71 24.25 -45.76% Rec'd # Security In At Value Change 5/17/95 2010 Iomega Cor 5063.13 43215.00 $38151.87 8/5/94 680 AmOnline 4945.56 18445.00 $13499.44 8/13/96 250 3Com Corp. 11714.99 16906.25 $5191.26 8/11/95 125 Chevron 6285.61 8218.75 $1933.14 9/27/96 -890 Quarterdec -6304.75 -4616.88 $1687.88 8/12/96 110 Minn M&M 7224.44 8428.75 $1204.31 8/12/96 280 Gen'l Moto 14552.49 15085.00 $532.51 10/1/96 42 LucentTech 1999.88 1974.00 -$25.88 8/12/96 130 AT&T 5145.11 4533.75 -$611.36 10/22/96 600 ATC Comm. 13761.50 11325.00 -$2436.50 8/24/95 130 KLA Instrm 5812.49 3152.50 -$2659.99 CASH $8801.62 TOTAL $135468.75