Fed Hands Out Treats
Iomega, 3Dfx, and KLA-Tencor report earnings
by Louis Corrigan (TMFSeymor@aol.com)
ATLANTA, GA (Oct. 15, 1998) -- The Federal Reserve passed out early Halloween treats to investors today in the form of a quarter point cut in the discount rate, which now stands at 4.75%, and another quarter point cut in the Fed funds rate, now at 5%. Rumored since last week and talked up as a partial panacea for continued international economic uncertainty and an inoculation against a potential U.S. recession in 1999, the moves not only took the sour look off investors' faces but left them with a sugar high.
The Dow Jones Industrial Average sprinted ahead 4.15% while the S&P soared 4.17%, the Naz popped 4.55%, and joy spread throughout the land despite the fact that the Atlanta Braves have been knocked out of the playoffs. The Fool Port was no slouch, dancing to a 5.54% gain on Fed Chair Greenspan's party tape as America Online (NYSE: AOL) played that funky music for $10 1/16 to $105 11/16, Lucent (NYSE: LU) boogied up $4 1/16 to $70 13/16, and Starbucks (Nasdaq: SBUX) jolted ahead $2 3/16 to $36 7/16. But the action wasn't all dominated by the G-man's bust-a-moves. Three Foolish stocks reported earnings.
After the close, Iomega (NYSE: IOM) announced third quarter sales of $392 million, down 9% from the year-ago period and good for (yes, good for) a net operating loss of $7.6 million or $0.03 a share, before a non-cash special charge. I/B/E/S shows analysts looking for a loss of $0.05 per share. Also, the reported figure includes a $3 million after-tax loss related to Nomai, the money-losing French competitor Iomega had acquired in July as the easiest way to end a patent battle. Iomega also booked a special $11.1 million non-cash charge as part of the deal so that the total reported loss for the quarter was $14.8 million or $0.06 per share. Last year, Iomega earned $30 million or $0.11 per share in the third quarter.
The company appears to making progress on its turnaround, too. CEO James Sierk had been looking to cut expenses by $50 million in the second half of the year, and in the third quarter alone he delivered $49 million in savings versus the second quarter thanks to reduced headcount, lower marketing and ad spending, and a 22% drop in R&D versus the second quarter. Selling, general and administrative (SG&A) expenses dropped to 19% of sales from 29% of sales in the second quarter. They were flat on a dollar basis when compared to the year-ago period.
The SG&A percentages are even more impressive since price cuts left Zip revenues flat with the year-ago period at $279 million while Jaz revenues fell by 25% to $95 million. Such price-cutting trimmed gross margins to 22.4% from 32.5% in the third quarter of 1997. Zip drive sales increased 39% in the period to 2.4 million while Zip disk shipments rose 30%. Iomega will soon ship its 18 millionth Zip drive.
Sierk said Iomega is "on track to return to profitability in the fourth quarter." While cash flow for the third quarter was negative $21 million before the Nomai acquisition, Iomega should (as expected) be cash flow positive in the fourth quarter though not for the year. For more information, listen to the company's conference call through Saturday at 800-446-4927 or online at www.vcall.com. Jeff Fischer should have a Foolish summary by tomorrow. Iomega closed the day up $1/16 at $3 11/16.
Also after the close, 3Dfx (Nasdaq: TDFX) reported earnings, but it didn't bother to make anyone's job easier by giving a little 3D expansion of the numbers, which showed revenues of $33.2 million, net income of $3.1 million, and EPS of $0.20. Those figures, though, include a one-time gain from a litigation settlement with Sega that gets figured in as part of the $13 million in "interest and other income," so I'm not sure how they compare with the I/B/E/S estimate for a loss of $0.08.
Why didn't the company break things out more clearly? Beats me, but it could be because the pre-tax operating loss of $8.8 million looks worse than expected given the company's September 14 press release in which management said the firm anticipated "losing several million dollars at the pre-tax operating level" for the quarter. The earnings report did note an increase in inventory reserves "due to an exceptionally rapid rate of product lifecycle obsolescence." I'll let Jeff dissect that further, but it doesn't sound so great. For more, try the conference call at 800-633-8284 (password 1596411). Or wait for Jeff to do his magic on the call summary. 3Dfx closed up $1/2 on the day at $10 1/2.
Finally, the mostly forgotten KLA-Tencor (Nasdaq: KLAC) will be mostly ignored by me. The stock fell $5/8 to $26 13/16 after reporting that revenue plunged to $205 million from $312 million last year. That led to net income of $10.2 million, or $0.11 per share, a mile of heartache away from the $49.7 million or $0.56 per share reported for the third quarter of 1997. Bloomberg reports First Call consensus estimates of $0.12, while I/B/E/S says analysts were expecting $0.14. No matter how you slice it, seems like the crack at KLAC left it on the rack on a day when most investors made lots of hay.
But enough about earnings. Let's talk baseball. As an Atlanta Braves fan, I'm spending a day suffering from woulda-coulda-shouldas. Yet even though the San Diego Padres walked away victorious from the recent championship series (hey, they deserved it), it's worth taking a moment to celebrate how this often brilliant series highlighted how amazing baseball can be. Indeed, while I've recently pointed to the similarities between poker and investing, I'm convinced that baseball can also school you and even wire you to become a better investor.
After all, baseball is a game ruled by stats, by probabilities, by maxims based on probabilities. For instance, good pitching beats good hitting. Or, left-handed batters do better than right-handed batters against right-handed pitching (and righties better than lefties against left-handed pitchers). Or, leadoff walks tend to produce runs. And so on. People passionate about baseball have a nuanced understanding of how stats influence the most minute decisions in a game, from what pitch to throw a certain hitter to what's the best count for a runner to try to steal second base on. Playing the probabilities produces good results, all other things (like talent) being equal.
On the other hand, teams win championships by rising above or confounding the probabilities, by individuals turning in spectacular performances in the clutch or by managers using their intuition to ignore the stats, to determine when they should stick with a player in a groove even when the stats say make a change. Baseball teams move from good to excellent when they can embrace the often radical and fast-changing contingencies of the game with an artfulness that takes note of the probabilities but isn't prisoner to them.
Take the brilliant game 5 of this series. Down 3 games to none and playing in San Diego, Atlanta had salvaged game 4 on a grand slam homerun. But no team in the history of baseball down 3 games to none in a 7 game series had ever forced a game 6. Padres manager Bruce Bochy pulled out all stops to ensure that the Braves would not be the first. In a bold, almost shocking move that would be second-guessed repeatedly over the next two days, he brought in his ace starter Kevin Brown in the sixth inning of game 5, with the Padres up 4 to 2. Brown is one of the hottest, most dominating pitchers in baseball and he had owned the Braves over the last two years. He came in with fire-spitting determination and a 96 mile per hour fastball. But he'd come in as a relief pitcher only three times in his career. Moreover, he was supposed to pitch in game 6, if necessary. If he threw more than maybe two dozen pitches, that would be impossible. Bochy was arguably taking a huge gamble.
As it turned out, it backfired spectacularly. Braves left-fielder Michael Tucker had batted a dismal .186 the latter half of the year and had a pathetic ten runs batted in during that period. Yet he had a theoretical edge as a leftie batting against the right-handed Brown. Plus, he had already managed two run-scoring hits earlier in the game. Moreover, while he was 0-for-3 against Brown in game 2, he had been a spectacular 6-for-11 (.545 average) against Brown lifetime prior to game 2. Tucker waited for his pitch and hit a mind-blowing three-run homer to give the Braves the lead.
As astonishing, the victory was sealed for the Braves by their ace starter and four-time Cy Young award winner Greg Maddux, who came on in relief in the ninth inning despite the fact that his last appearance in relief came in 1987. While Maddux is probably the best pitcher in baseball, he had to face Tony Gwynn, who is probably the best hitter. And as the stats show, Gwynn has dominated Maddux like no one else, hitting an unbelievable .435 off the guy. Yet, the game ends when Gwynn grounds to the first baseman!
One could go through the series, taking some innings almost pitch-by-pitch, but what the game repeatedly shows is that probability only takes you so far. In yesterday's game 6, Atlanta featured its less powerful right-handed line-up against the left-handed Padres pitcher Sterling Hitchcock. Braves manager played the leftie-rightie odds, ignoring the fact that lefties, oddly, have actually hit Hitchcock slightly better. Meanwhile, the decisive sixth inning, in which the Padres scored all five of their runs, depended on another Bochy gamble.
With a slightly injured Greg Vaughn at first, a full count to the Padres Ken Caminiti, and one out, Bochy puts Vaughn in motion. Because Braves pitcher Tom Glavine is pitching Caminiti inside in hopes of getting a grounder to the left side of the field, the Braves second baseman Tony Graffanino goes to cover the base. Caminiti scoots a ball precisely to where Graffanino had been. So what might have proven a double play ball to end the inning with no scoring becomes a single that keeps the inning alive for the Padres.
Baseball, as the saying goes, is a game of inches. The truth, though, is that baseball is for the most part a game of probabilities. As the Braves have proved throughout the 1990s, good pitching tends to beat good hitting. But championships are won on the inches, on the slides made just ahead of the tag, on the gambles that pay off big.
I think there are analogies to investing. The Foolish Four approach is something like the Braves big three pitchers (Maddux, Glavine, and John Smoltz). You can't go wrong spending your money on these guys because, like good pitching, they keep you not just competitive with the market but, over time, well ahead of it. Yet in venturing away from the Foolish Four, especially into always volatile small-cap stocks, you need to understand that you're playing not just to be a contender but to win the championship. That means you have to be more attentive to risks, to be more adventurous in your gambles, to be more active in your management of the contingencies.
What's interesting is that while studies show that both individual investors and professional money managers produce generally bad results from actively trading their portfolios, professional investors in small-cap stocks generally do better with more active trading. While some suspect it's because small-caps permit well-placed investors to have an information edge over other investors, I think the real answer may have something to do with experience. The outdoor survival program Outward Bound was started after it was discovered that older sailors tended to have a better chance of surviving a shipwreck than did younger sailors with superior health because the older guys had greater experience and so knew how to survive. Similarly, as a fascinating New York Times piece noted this week, our bodies learn from previous experience how we should react to certain stimuli. In a sense, chemical changes in our brain based on remembered patterns influence our thinking as much as our thinking influences the chemical changes.
So are attentive fans of the San Diego Padres now wiring their brains to become pretty good small-cap investors? Maybe so.
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Day Month Year History Annualized FOOL +5.54% -4.29% 36.50% 358.11% 43.74% S&P: +4.17% 3.00% 7.94% 128.51% 21.78% NASDAQ: +4.55% -4.89% 2.59% 123.70% 21.16% Rec'd # Security In At Now Change 8/5/94 710 AmOnline 3.64 105.63 2804.63% 9/9/97 580 Amazon.com 19.11 97.06 407.89% 10/1/96 84 LucentTech 23.81 70.75 197.17% 5/17/95 1960 Iomega Cor 1.28 3.69 187.99% 4/30/97 -1170*Trump* 8.47 3.19 62.36% 8/12/96 130 AT&T 39.58 61.44 55.23% 2/20/98 200 Exxon 64.09 75.63 18.00% 2/20/98 215 DuPont 59.83 60.38 0.90% 2/20/98 270 Int'l Pape 47.69 45.94 -3.68% 8/13/96 250 3Com Corp. 46.86 30.94 -33.98% 7/2/98 235 Starbucks 55.91 36.44 -34.83% 8/24/95 130 KLA-Tencor 44.71 26.81 -40.03% 1/8/98 425 3Dfx 25.67 10.50 -59.09% 6/26/97 325 Innovex 27.71 11.00 -60.30% Rec'd # Security In At Value Change 8/5/94 710 AmOnline 2581.87 74993.75 $72411.88 9/9/97 580 Amazon.com 11084.24 56296.25 $45212.01 4/30/97 -1170*Trump* -9908.50 -3729.38 $6179.13 5/17/95 1960 Iomega Cor 2509.60 7227.50 $4717.90 10/1/96 84 LucentTech 1999.88 5943.00 $3943.12 8/12/96 130 AT&T 5145.11 7986.88 $2841.77 2/20/98 200 Exxon 12818.00 15125.00 $2307.00 2/20/98 215 DuPont 12864.25 12980.63 $116.38 2/20/98 270 Int'l Pape 12876.75 12403.13 -$473.63 8/24/95 130 KLA-Tencor 5812.49 3485.63 -$2326.87 8/13/96 250 3Com Corp. 11715.99 7734.38 -$3981.62 7/2/98 235 Starbucks 13138.63 8562.81 -$4575.81 6/26/97 325 Innovex 9005.62 3575.00 -$5430.62 1/8/98 425 3Dfx 10908.63 4462.50 -$6446.13 CASH $12005.75 TOTAL $229052.81