Two Ships Pass
Friday, April 17, 1998
by Jeff Fischer (JeffF@fool.com)

ALEXANDRIA, VA (April 17, 1998) -- Like two ships passing in the night, Iomega and 3Dfx Interactive reported earnings on Thursday evening that were headed in opposite directions. 3Dfx trounced the earnings estimate of $0.24, more than doubling that number as the company reported earnings of $0.50 per share. While Iomega -- a company that in the past was growing much like 3Dfx is growing now -- reported its first loss in over two years as its business took a swim down a darker channel.

The captains of both these ships had volumes to say in their respective conference calls, which are available at the Fool and the highlights of which we'll touch upon here.

First, the Fool Port enjoyed a strong week, rising 3.52% while the S&P gained only 1.08%, allowing the Fool to increase its annual and historical lead against the benchmark that 90% of the professionals can't match.

Deep in the heart of earnings season, this week we received numbers from International Paper, KLA-Tencor and, of course, Iomega and 3Dfx. International Paper (NYSE: IP) rose because inventories in the paper industry are thought to be low, while KLA-Tencor (Nasdaq: KLAC) reported earnings in line with its pre-announcement. Earnings were lower than what was expected at the beginning of the year due to a slowdown in Asia. Paul Larson covered the KLA earnings report well on Thursday.

The most interesting report came from 3Dfx (Nasdaq: TDFX), and on Friday the stock set a new high, up 12%. Though the company's conference call had few surprises, it was upbeat and concise, while the numbers for the quarter speak for themselves. Revenue jumped 861% from the same quarter in the prior year to $50 million -- up 125% from the fourth quarter that ended just three months ago. The company launched its new Voodoo II product in February, and it shipped in volume in March. Management calls the product an "unqualified hit." Nothing in the industry comes close to matching its performance.

During the conference call, 3Dfx stated that it expects Voodoo II to constitute 75% to 80% of revenue in the current quarter, up from 35% last quarter. The company is lowering its prices on older technology in order to reach new markets, a move that will increase volume but decrease the average selling price per unit. 3Dfx expects revenue to grow 15% to 20% during the next few quarters, with earnings per share growing at about that rate to slightly lower. Gross margins of 50% might be pressured modestly as prices decline on older products. This was expected.

Having earned $0.50 per share in the first quarter and expecting growth over the next three quarters, the company might be on track to earn over $2.00 per share this year. There is at least one analyst who is expecting earnings below that number, though, putting out estimates of $1.69 per share for the year today and claiming that the high-end 3D gaming market will become saturated by year-end. But he's been downbeat on 3Dfx from the start and he has been too conservative to date. Other than business changes, there are only a few things that could impact earnings per share growth in subsequent quarters.

For the quarter just ended, 3Dfx used 15 million shares as its number of shares outstanding. The company uses a moving weighted average for its share count, meaning that the number of shares used in the earnings per share count will be 17 million next quarter -- taking into account the recent secondary offering. So, there will be more shares existing next quarter. Also, the company is now paying taxes. It paid a 20% tax rate this quarter and will be paying closer to 28% for the rest of the year. But as long as demand remains constant or grows, and with Banshee -- the company's much-anticipated 2D/3D product expected in the third quarter -- 3Dfx is still on track to possibly earn more than double the previous earnings estimate of $1.00 per share.

Following first quarter revenue of $50 million, and with 15% to 20% sales growth projected, 3Dfx could achieve 1998 revenue of over $250 million (that's if revenue grows 15% per quarter in each of the next three quarters). With a current market cap of $540 million, the stock trades at 2.1 times the potential sales number, and at 15 times the possible earnings per share of about $2.00.

3Dfx is up 60% since the Fool issued its buy report in January at $20 per share, and up 25% for us -- from the price that we were able to buy it. The 3Dfx conference call synopsis is available in our earnings central area. All told, the company has clobbered our estimates so far. We felt that the current estimates were low when we bought the stock, but this is a nice upside surprise to our expectations.

The Iomega (NYSE: IOM) conference call was considerably longer than 3Dfx's and not nearly as upbeat. It was far from dismal, but management seemed less certain than did the management at 3Dfx. That's not surprising considering the recent shakeup at Iomega.

The most important admission is that the next two quarters should be breakeven or again show a slight loss. The company reported a loss of $0.07 per share in this quarter, though revenue grew 13% from last year to $408 million. The bulk of Iomega's loss was due to sales and marketing expenses, which doubled from last year to over $100 million. About $20 million was spent on advertising, and $10 million was spent on a new Oracle (Nasdaq: ORCL) system. Generally, management admits that its SG&A expense must drop again. It wants this expense to be 15% to 19% of sales. It was 26% last quarter -- too high.

That said, Iomega is committed to more advertising expenditures during the current second quarter. These expenses were booked during the first quarter. Following these obligations, the company plans to lower its advertising costs. By the fourth quarter of this year Iomega hopes to be profitable again, though for the year as a whole it expects to be cash flow negative.

Much of the cash flow problem in the first quarter was due to inventory problems. All of management is now focused on improving the company's inventory practices. Iomega is moving to a demand-pull inventory model that should tighten its efficiency and keep inventory much lower. Inventory components on hand are at considerably higher levels than in previous quarters, while Zip drives are filling the inventory channel more than the company wishes. Iomega will work to lower the Zip drive channel inventory this quarter.

Finally, Iomega's new Click product prototype is shipping and should be available during the third quarter. Iomega is working with Citizen Watch company to produce Clicks for the OEM market.

Speaking of the OEM market -- more than 50% of Zips sold were to OEMs (computer manufacturers), with Dell, Compaq, Apple, Gateway and Micron being the top five clients. Selling to OEMs means lower margins, but it is also a key step to becoming a standard and, obviously, to selling more Zip disks. If Iomega can lower costs and push OEM sales to the point where a PC without a Zip drive or better wouldn't even sell, then the company could be in a sweet spot for selling its trademarked Zip disks for years to come. Our argument might be that Iomega should stop advertising so much except in the direct consumer channel, and perhaps lower prices to push more sales. On that note, Iomega stated that it was satisfied with its current Zip and Jaz prices, but the company will consider lowering prices if the market calls for it.

There is much more in our Foolish conference call synopsis for Iomega.

To Close: The Fool Port touched a record all-time high on Thursday, but it couldn't hold it. We're officially on an ALL-TIME HIGH WATCH. On Friday, all of our Foolish Four stocks rose, but our Internet stocks -- volatile monsters -- sunk us. The Investor's Business Daily index of Internet stocks has gained a giant 71% since January 1. It's not surprising to see volatility and a decline for any or absolutely no reason. Friday Internet stocks sold lower following the earnings report from Excite (Nasdaq: XCIT), which was a loss as expected.

We'll see many more earnings reports next week. On Tuesday we listed the coming announcement dates of Fool stocks, and next week we should see reports from Innovex, AT&T, Lucent, and Exxon.

Please be sure to visit and bookmark our new Fools and Their Money area -- it's personal finance done Foolishly, from buying a car or a house to taking care of debt, and much more. Have a great weekend... and stay Foolish!

--Jeff Fischer

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TODAY'S NUMBERS

Stock Change Bid ---------------- AMZN -3 3/4 94.75 AOL -1 11/16 73.56 T + 7/8 67.13 DD +1 1/2 77.00 DJT + 1/4 8.88 XON +1 13/16 72.13 INVX - 1/16 26.81 IP + 11/16 54.56 IOM - 1/16 7.06 KLAC - 3/8 38.94 LU +1 1/16 69.31 COMS - 1/4 33.13 TDFX +3 7/16 32.13 SPY +1 15/32 112.28
Day Month Year History FOOL -0.06% 7.92% 21.15% 306.56% S&P: +1.31% 1.90% 15.69% 144.92% NASDAQ: +0.45% 1.68% 18.87% 159.19% Rec'd # Security In At Now Change 8/5/94 710 AmOnline 3.64 73.56 1922.93% 5/17/95 1960 Iomega Cor 1.28 7.06 451.58% 10/1/96 84 LucentTech 23.81 69.31 191.13% 9/9/97 290 Amazon.com 38.22 94.75 147.90% 8/12/96 130 AT&T 39.58 67.13 69.60% 2/20/98 215 DuPont 59.83 77.00 28.69% 1/8/98 425 3Dfx 25.67 32.13 25.16% 1/8/98 115 S&P Depos. 95.91 112.28 17.07% 2/20/98 270 Int'l Pape 47.69 54.56 14.41% 2/20/98 200 Exxon 64.09 72.13 12.54% 6/26/97 325 Innovex 27.71 26.81 -3.24% 4/30/97 -1170*Trump* 8.47 8.88 -4.80% 8/24/95 130 KLA-Tencor 44.71 38.94 -12.91% 8/13/96 250 3Com Corp. 46.86 33.13 -29.32% Rec'd # Security In At Value Change 8/5/94 710 AmOnline 2581.87 52229.38 $49647.51 9/9/97 290 Amazon.com 11084.24 27477.50 $16393.26 5/17/95 1960 Iomega Cor 2509.60 13842.50 $11332.90 10/1/96 84 LucentTech 1999.88 5822.25 $3822.37 2/20/98 215 DuPont 12864.25 16555.00 $3690.75 8/12/96 130 AT&T 5145.11 8726.25 $3581.14 1/8/98 425 3Dfx 10908.63 13653.13 $2744.50 1/8/98 115 S&P Depos. 11029.25 12912.34 $1883.09 2/20/98 270 Int'l Pape 12876.75 14731.88 $1855.13 2/20/98 200 Exxon 12818.00 14425.00 $1607.00 6/26/97 325 Innovex 9005.62 8714.06 -$291.56 4/30/97 -1170*Trump* -9908.50 -10383.75 -$475.25 8/24/95 130 KLA-Tencor 5812.49 5061.88 -$750.62 8/13/96 250 3Com Corp. 11715.99 8281.25 -$3434.74 CASH $11233.54 TOTAL $203282.20

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