Fool Portfolio Report
Thursday, February 12, 1998
by Dale Wettlaufer (TMFRalegh@aol.com)

ALEXANDRIA, VA (Feb. 12, 1998) -- OK, show of hands. How many people thought 3Dfx Interactive (Nasdaq: TDFX) earned $0.15 per share last quarter? That's what all the headlines said and that's what the earnings report said, right? You bet. But does that necessarily make it true? I would argue no and I would argue that the company earned $0.10 per share last quarter.

Hey, fun to open with a seemingly inflammatory comment, huh? The thing about 3Dfx is that the company hasn't paid taxes since I don't know when. As of the end of last quarter, 3Dfx had net operating loss carry-forwards of $18.5 million. Based on tax rates for similar California companies, that's worth about $6.3 million in corporate income tax the company will be able to forgo. Last quarter's income statement looks thusly to me:

Three Months Ended
December 1997

Income/(loss) from operations $1,699 Interest and other income, net 375 Pre-tax income 2,074 Income tax expense 705 Net income/(loss) $1,369 Net income/(loss) per share $0.10 Shares used in computing net income/(loss) per share 14,127

By my count, 3Dfx earned $0.10 per share last quarter. Am I a fool or a Fool?

The reason why I would assume the company paid taxes on the pre-tax income it generated this quarter is because I want to compare apples with apples in future periods and in comparing how the company did this quarter compared with past quarters. If the company generates $0.20 in two years and is paying a 34% tax rate, I wouldn't be disappointed with the earnings growth the company has achieved. Why?

If I find myself two years down the road, looking at Q4 1999 earnings of $0.20 per share, I would be very pleased that I was conservative with my assumptions in 1997. That's because I didn't take for granted the non-taxed Q4 1997 EPS of $0.15, but instead assumed Q4 1997 EPS of $0.10. If it's 1999 and 3Dfx just earned $0.20 per share in the fourth quarter, that means they have generated 41% annual growth in EPS. Not bad, huh? But if I assume $0.15 per share for Q4 1997 today and look back from Q4 1999 -- when the company has generated EPS of $0.20 -- that's only 15.5% compounded annual EPS growth. That's not all that great for a riskier, small-cap growth company.

Part of being Foolish is thinking for yourself (contrary to the assumptions of all sorts of writers and other Wise people that think that you, the reader of this, is an unthinking automaton that mindlessly mimics the Fool's Port's every move -- more on this later). The other part of being Foolish, in my mind, is being conservative with accounting assumptions. Don't get me wrong, 3Dfx did nothing wrong reporting EPS of $0.15. It's just that, as an investor, you want to assess the true earnings power of a company you own or are looking at. By assuming that the full earnings power of the company was $0.10 today, I won't be disappointed down the line when the real tax man asserts his 34% interest in the earnings of our enterprise (I don't own 3Dfx, I just say "our" for the sake of conversation).

I suspect the Fool Port guys will have more to report on the product front and the revenue growth front for 3Dfx when they talk more about the company in future reports. In fact, Jeff Fischer promised a close look at the earnings but he hasn't gotten to it yet. Either way, it's up to you as Fools to do your own homework, of course.

3Dfx lost $1 3/8 to close at $22 7/8 on the day. Yesterday, the company said that it will sell shares in a firm underwriting (meaning, the underwriter has committed to do the deal, whether they can scare up enough demand for the issue or not). Two million shares will be offered. Insiders will sell 300,000 shares in the offering, but the issuance of shares looks like it will be limited to two million shares, adding 14.2% more shares to the above share count. Considering 3Dfx was only down 5.7% today (though it was down yesterday, too), the stock fared fairly well. Investors are balancing the dilution in their ownership and the additional $42 million or so in cash that will be added to the company's coffers.

3Com (Nasdaq: COMS) added $1 3/8 to close at $35 1/8 today after announcing a big order from international long distance telecom company USA Global Link. You may have heard of this company -- it's the one that spoofs monopoly phone companies in other countries by providing "call back" services to the poor souls in these over-regulated countries. A person calls a Global Link number in the U.S. and then waits for the call back. They then get a dial-tone and make their international call, avoiding the ridiculous tariff because the call originated in the United States. Pretty Foolish. US Global Link says 3Com will sell Total Control platforms for a voice-over-internet protocol long distance network. The planned expenditure is $1.2 billion and 3Com looks like it will win a nice chunk of that business.

What's nice, too, is that Fools abroad will have another way to defeat the distortions of monopoly telecom service. What's great for Fools isn't so great for the global internet backbone, though. Look for more spending for fiberoptics and ATM switches from companies such as Lucent (NYSE: LU), Cisco Systems (Nasdaq: CSCO), Ascend Communications (Nasdaq: ASND), Newbridge Networks (NYSE: NN), and 3Com partner Siemens.

Hey, know what? Have you been paying attention to GM (NYSE: GM)? GM shares alone are up 27.8% since the Fool bought them in the Fool 4 switch. That's 18% annualized, including dividends, but not even including the Raytheon (NYSE: RTN.A) shares GM shareholders received from the Hughes defense electronics transaction. 18% per year may not beat the market, but that beats my personal goal of 15% annual return, rain or shine, in the market. It's not easy making money in auto company investing, either. I think the Fool 4 methodology worked quite well in this instance, as it indeed has over the decades.

What was with the volatility in Iomega's (NYSE: IOM) shares today? It was down nearly 6% at its lowest point before closing down 0.65%. Hey, Iomega, good idea on the split! Not. Why didn't they just get an authorization from shareholders to increase the share authorization? I think a $9 stock price is embarrassing, actually. Also, why is the company spending so much on advertising? I thought the plan was to get OEMs to adopt the Zip as a standard. I personally don't understand Iomega any longer and I think that too many companies, 3Dfx included, put way too much stock in Intel's strategy of branding the CPU. Intel branded the CPU after they had won a technology lock-down, not before.

Without a lock-down on the technology standard, Iomega might not supply highly-satisfying returns to shareholders going forward. I also believe the same of 3Dfx. (And the Fool is Foolish enough to let differences of opinion stand, especially in the Fool Port and when coming from guest columnists, because the portfolio is meant to be a real-money example, not something to blindly model.) Anyway, Intel's x86 architecture and then the Pentium locked down the standard and market share. They started the branding campaign to further lock down market share and because they were generating so much free cash flow they had to do something with that cash. I personally believe 3Dfx and Iomega have that whole cause-effect backwards, but I know you could argue quite effectively the other side of this argument, too.

Talk about lock-down, by the way, look at America Online (NYSE: AOL) now! A new high at $117 per share and over 13 million subscribers between the AOL and CompuServe brands. I wonder if Alan Abelson or his source for the valuation methodology pegging the value of AOL around $6 a share ever went short the company. The problem with ivory tower types, whether journalists or academics, is that they never have their money on the line. When your personal wealth is on the line, it's amazing what happens to the clarity of your thinking. It's easy to say something's a short when you're not willing to put your butt on the line, huh? (On a related note, behind this link are the Fool's top ten responses to a recent Forbes article.)

Well, with that curmudgeonly observation, I'll wrap up things here. Fool on!

--Dale Wettlaufer (TMF Ralegh)

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TODAY'S NUMBERS

Stock Change Bid ---------------- AMZN - 5/8 62.88 AOL +2 3/4 116.75 T +1 3/16 62.88 CHV + 13/16 77.13 DJT + 1/16 10.94 GM - 1/4 63.25 INVX + 1/16 24.38 IOM - 1/16 9.56 KLAC + 7/8 44.63 LU - 3/16 94.44 MMM + 13/16 88.69 RTN.A + 11/16 53.88 COMS +1 3/8 35.13 TDFX -1 1/16 22.94 SPY + 13/32 102.56
Day Month Year History FOOL +0.56% 8.25% 1.96% 242.19% S&P: +0.40% 4.47% 5.53% 123.42% NASDAQ: +0.34% 5.87% 9.17% 138.04% Rec'd # Security In At Now Change 8/5/94 355 AmOnline 7.27 116.75 1505.28% 5/17/95 1960 Iomega Cor 1.28 9.56 646.83% 10/1/96 42 LucentTech 47.62 94.44 98.33% 9/9/97 290 Amazon.com 38.22 62.88 64.50% 8/12/96 130 AT&T 39.58 62.88 58.86% 8/11/95 125 Chevron 50.28 77.13 53.38% 8/12/96 110 Minn M&M 65.68 88.69 35.04% 8/12/96 280 Gen'l Moto 48.74 63.25 29.76% 1/8/98 115 S&P Depos. 95.91 102.56 6.94% 12/19/97 17 Raytheon 53.21 53.88 1.25% 8/24/95 130 KLA-Tencor 44.71 44.63 -0.19% 1/8/98 425 3Dfx 25.67 22.94 -10.64% 6/26/97 325 Innovex 27.71 24.38 -12.03% 8/13/96 250 3Com Corp. 46.86 35.13 -25.05% 4/30/97 -1170 *Trump* 8.47 10.94 -29.15% Rec'd # Security In At Value Change 8/5/94 355 AmOnline 2581.87 41446.25 $38864.38 5/17/95 1960 Iomega Cor 2509.60 18742.50 $16232.90 9/9/97 290 Amazon.com 11084.24 18233.75 $7149.51 8/12/96 280 Gen'l Moto 13647.92 17710.00 $4062.08 8/11/95 125 Chevron 6285.61 9640.63 $3355.02 8/12/96 130 AT&T 5145.11 8173.75 $3028.64 8/12/96 110 Minn M&M 7224.44 9755.63 $2531.19 10/1/96 42 LucentTech 1999.88 3966.38 $1966.50 1/8/98 115 S&P Depos. 11029.25 11794.69 $765.44 12/19/97 17 Raytheon 904.57 915.88 $11.30 8/24/95 130 KLA-Tencor 5812.49 5801.25 -$11.24 6/26/97 325 Innovex 9005.62 7921.88 -$1083.75 1/8/98 425 3Dfx 10908.63 9748.44 -$1160.19 4/30/97 -1170*Trump* -9908.50 -12796.88 -$2888.38 8/13/96 250 3Com Corp. 11715.99 8781.25 -$2934.74 CASH $11259.61 TOTAL $171094.99