Friday, January 5, 1996
MARKET CLOSE

INDEX:

I. Market News: Up and Down to Nowhere
II. Heroes: Adv. Micro, Sunrise, BTU, Somatagen, Silicon Graphics, Data Broadcasting
III. Goats: Duracell, Ahmanson, Summa Four, Manugistics, Pioneer Std, DSC Comm
IV. Investment Perspective: Adobe Disappoints, Pays Dearly
V. Calendar: Monday's Economic Events

MARKET CLOSE

DJIA: 5181.43, up 7.59 (+0.15%)
S&P 500: 616.71, down 0.99 (-0.16%)
NASDAQ: 1033.47, up 3.65 (+0.35%)

MARKET NEWS

Another wild ride for the markets, with the indices ending up essentially flat. With the bond market in a bit of turmoil about the budget battle, even blue chips whipped back and forth during the day. Despite the collapse of Adobe Systems <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:ADBE)") else Response.Write("(NASDAQ:ADBE)") end if %> after posting poor earnings last night, the tech sector finally passed a day without losing more ground, the first such day in some time.

HEROES

Advanced Micro Devices <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:AMD)") else Response.Write("(NYSE:AMD)") end if %> surged $1 1/8 to $17 7/8 today after it announced a five-year patent cross-license agreement with Intel Corp. The two companies previously reported they would negotiate patents after litigation surrounding them was settled early in 1995. All this agreement entails is an extension of a previous pact to have both companies utilize one another's patents. Although AMD apparently will receive some royalty payments from Intel under the agreement, it is still limited to using only "microcode" up to Intel486 processors. AMD is best known for manufacturing 486 central-processing units and recently acquired NexGen in order to accelerate its development of 586-compatible and faster CISC-based microprocessors. Today's reaction to an expected agreement seems a little out of whack with the fundamentals of the situation.

Sunrise Medical <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:SMD)") else Response.Write("(NYSE:SMD)") end if %> rebounded $2 to $18 3/4 today after dropping slightly more yesterday. The company announced yesterday that it would restate its 1994 and 1995 financial statements for its Bio Clinic Corp. unit after completing an internal investigation. The restatement reduces net income by $4 million for fiscal 1994 and $11.2 million for fiscal 1995. As a result, the company reported that it would initiate an aggressive restructuring plan called "Operation Rebound." Although this was not enough to salvage shares of the medical products company yesterday, it was enough to convince Dillon Read to upgrade the company's stock to "outperform" today from "neutral." The analyst stated that the financial problems seemed limited to a single unit and that the management appears to have aggressively dealt with it, suggesting that most of the bad news is behind it.

BTU International <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:BTUI)") else Response.Write("(NASDAQ:BTUI)") end if %> clawed ahead $1 5/8 today to reach $6 7/16---the first time the stock has moved significantly since a December announcement of lower-than-expected profits for the next fiscal quarter. BTU management felt the stock was unjustly slaughtered after it reported that an order delay from a Central European company for nuclear furnaces would hamper profit growth in the near term. As a result, they have authorized a buyback of up to 4% of the common stock, or about 300,000 shares. The supplier of thermal processing systems for electronics manufacturers still expects record 1995 earnings and is hopeful about a number of new products. Analyst consensus expectations are for $0.83 a share, growing at 10% to 15% a year, which implies a fair value in the $8 to $12 range if the company can carry a multiple equal to its rate of growth.

CNBC's "financial correspondent" Daniel Dorfman cited Jim McCamant of the Medical Technology Stock Letter who claims that shares of Somatogen <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:SMTG)") else Response.Write("(NASDAQ:SMTG)") end if %> could go to $50 within 12 months. This was apparently enough to cause the stock to rally $3 1/4 to $22 on 4.5 times normal volume. The company's blood substitute product, if approved, would have a "billion dollar market." Without going into the specifics of how many *other* companies are working on similar products or that Somatogen is only in Phase II trials, implying years could pass before they generate any significant revenues, we must express some surprise that investors give Dorfman the power than he appears to have. No record was cited for Mr. McCamant or his Medical Technology Stock Letter and no thought was given to the fact that cash-flow negative Somatogen will have to continue to issue more shares to get its product through Phase II and Phase III trials.

Bottom-fishers came into the market today, picking up shares of battered technology stocks. Silicon Graphics <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:SGI)") else Response.Write("(NYSE:SGI)") end if %>, stricken in the last few days as a result of a disclosure that earnings would come in below expectations, came back $1 3/8 to close at $24 3/8. Network-equipment manufacturer Microdyne <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:MCDY)") else Response.Write("(NASDAQ:MCDY)") end if %>, which made a similar announcement yesterday, also bounced back $1 3/4 to close at $8 3/4. Microdyne hit a 52-week low yesterday and was trading at a mere seven times trailing earnings. Even if the company makes *nothing* next quarter, it would still trade at ten times trailing earnings. If the company can come close to achieving the 21.5% five-year growth rate analysts expect, this would suggest the stock is still really cheap after today. Check the Networking folder in the Industry Research Area (Keyword:SECTOR) for MF MOM's and MF Bogey's takes on Microdyne.

Data Broadcasting Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:DBCC)") else Response.Write("(NASDAQ:DBCC)") end if %> rose $1 3/8 to $12 1/2 on high hopes for its Internet real-time quote service announced on Wednesday. Data Broadcasting will offer real-time quotes as well as a host of fundamental information for only $29.95 a month. Not to be terribly skeptical here, but the company---which had a lot of one-time gains this year---is only expected to make $0.32 a share next year and $0.45 the year after, putting the multiple in the aggressive category to say the least. The fact that three of the last four quarters the company made *less* than it did the year before (after backing out one-time gains) does nothing to inspire confidence. Of the $29.95 ticket price, Data Broadcasting will pay $13 to the exchanges for the privilege of real-time quotes before it even starts to cover operations costs. With no sustained growth pattern, even if the company can grow earnings at the rate it has revenues going forward, (about 30% per annum), it still looks fairly priced in the $9 to $11 range over the next 52 weeks.

GOATS

Maybe it was all the money the company spent in its blitz of dumb commercials that did it in. Whatever it was, Duracell Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:DUR)") else Response.Write("(NYSE:DUR)") end if %> was down $3 7/8 to $47 7/8 after reporting to the "financial community" that its second-quarter earnings would come in below expectations. First Boston was quick with the sheers, slashing its rating from buy to hold without further comment. Ralston Purina Group <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:RAL)") else Response.Write("(NYSE:RAL)") end if %>, maker of Everready batteries, got hosed in sympathy with Duracell, losing $2 3/4 to close at $60. As batteries are 40% of Ralston's business, it is no surprise Duracell's talk of a soft holiday retail market, continued softness in Europe and weakness in Mexico got shareholders there dyspeptic.

HF Ahmanson <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:AHM)") else Response.Write("(NYSE:AHM)") end if %> slumped $1 1/8 to close at $25 1/8, leading banking stocks lower today in a broad-based sell-off. Whether it was shares of the holding company for Home Savings or shares of huge money-center bank J.P. Morgan <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:JPM)") else Response.Write("(NYSE:JPM)") end if %>, down $1 3/8 to $77 5/8, it was ugly as the 30-year Treasury stayed above the 6.0% yield mark. Traders were concerned with bank profits for the upcoming quarter should the yield stay above 6.0%. What is hurting the long bond? Growing skepticism that the current fiscal distress in Washington will end in any sort of compromise balanced budget.

Fool me once, shame on you. Fool me twice, shame on me. So said investors in telecommunications-equipment maker Summa Four <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:SUMA)") else Response.Write("(NASDAQ:SUMA)") end if %> today when they thrashed shares for $1 3/4, closing at $11. Higher costs due to an increased investment in engineering is the cause. Summa Four had the same problem in their last fiscal quarter which caused them to disappoint earnings then also. "Although our earnings performance was lower than expected, we continue to have a strong balance sheet and no debt. We also continue to pursue our stock repurchase plan," said President Edward Callahan today. Throw in some earnings increases and they actually have a future, too. They expect to make $0.10 a share, down from $0.24 a year ago and $0.08 below consensus estimates.

Well, at least they did not *pre-announce* bad earnings. Manugistics <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:MANU)") else Response.Write("(NASDAQ:MANU)") end if %> reported earnings of $0.10 per share last night---$0.02 light of consensus expectations. Down $3 1/8 to $10 3/4, they apparently picked a heck of a bad day to disappoint the Street. Manugistics makes software for supply-chain management. With the entire factory management and supply management segment of the software industry overpopulated, it is not surprising to see companies like Manugistics disappoint after high-profile disasters like Wonderware <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:WNDR)") else Response.Write("(NASDAQ:WNDR)") end if %>.

Pioneer Standard <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:PIOS)") else Response.Write("(NASDAQ:PIOS)") end if %> was another electronics company pre-reporting a bad quarter today. Down $1 7/8 to $11, Pioneer said that they would not match the year-ago level of $0.27 per share. Sales did improve over the period but a shift in product mix and increased operating expenses kept the lid on profits. When reported, Pioneer earnings will also reflect a $0.05 charge due to the acquisition of an affiliate. Pioneer distributes semiconductors, electronics and computer products.

DSC Communications <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:DIGI)") else Response.Write("(NASDAQ:DIGI)") end if %>, formerly Digital Switch, was down $2 1/2 to $30 7/8 as the telecommunications equipment company came under serious fire from two brokerages. Merrill Lynch moved the stock from short term "above average" to short term "neutral," keeping the long term "above average" rating while Cowen & Co. moved the stock down from "strong buy" to "buy." If you can tell us what either of those rating changes *really* means in 25 words or less, we will confer an honorary degree in analyst-speak to you.

INVESTING PERSPECTIVE: Adobe Systems' Thrashing

Adobe Systems stole the stage today, down $16 1/4 to close at $42 7/8 on 13 times normal volume. The company came in $0.17 per share light with its fiscal fourth-quarter earnings, making only $0.40 before a one-time charge for the acquisitions of Ceneca Communications and Frame Technology. Nearly one-third of the 71 million total shares traded---a little more than a third of the "float" (the float is the shares available to the public for buying and selling and thus not controlled by insiders or the company). Now that is volume!

Adobe Systems makes applications for desktop publishing, with its premiere products being PhotoShop and PageMaker---both used here at the Motley Fool to process pictures to be placed online and to format text for our publications. Its more speculative product is Acrobat, a publishing application designed specifically for the World Wide Web. The recent acquisition of Frame Technology, which also focused on document publishing software, served to cement Adobe's hegemony over this crucial product niche.

The company's earnings, excluding both the current charges for acquisitions and last year's charge for the acquisition of Aldus (note a trend here?) for its Freehand and Photostyler programs, were basically flat year-to-year. This undercuts an earnings trend that was spectacular---EPS was up 17% in last year's fourth quarter, 71% in the first quarter, 82% in the second quarter and 52% in the third quarter. It is not surprising that the company had a banner year in 1995---a year that the world discovered the Web and rushed online to do business there.

A look at the revenue increases over the last four quarters tells a slightly different story, however, one of a company getting its internal operations in line and increasing profits while revenues only increased marginally. A look at the current quarter's balance sheets shows that the trickling revenue continued to grow in an anemic fashion, up only 7% year-over-year. Although direct costs actually increased at a slower rate than revenues, improving the gross margin, it was the research and development increase of 17% and the sales, marketing and customer support increase of 12% that did in the company's bottom line.

The company's management agreed with this assessment in a press release that accompanied the earnings today: "The timing and effect of the Frame acquisition had a more substantial impact than anticipated and our expenses as a percent of sales were higher than our targets. It is our intent to correct this situation and bring operating margins in line with our business objectives," Chairman and CEO John Warnock said.

Today marks the first time since March of 1995 that shares of Adobe have gone below the $45 level, when it rocketed from the high $30s to the high $40s after reporting much better-than-expected first-quarter earnings. The shares were laggards after the fourth quarter last year was disappointing due to increased expenses after an acquisition---the same situation as this year.

Looking at Adobe's products, you have a desktop publishing monster with one of the dominant market shares in the Windows (PageMaker, PhotoShop), Macintosh (PhotoShop) and Unix (Frame Technology) markets for its products. Adobe's fall recalls, in fact, the troubles that Intuit <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:INTU)") else Response.Write("(NASDAQ:INTU)") end if %> had after the merger with Microsoft <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:MSFT)") else Response.Write("(NASDAQ:MSFT)") end if %>. Many investors said then that the Intuit's franchise in personal finance software was being undervalued due to short-term difficulties arising from a merger.

Mergers cost money and tend to create operational difficulties. To judge whether today represents disaster or opportunity in Adobe Systems requires one to think historically about what has happened before when this same management has swallowed a company that was a little too big to easily digest. One or two quarters of bumpy earnings and then a recovery. Should Adobe do the same this time, as it is likely, and come near the $2.54 -per-share target analysts have for fiscal 1997---say $2.10 for the sake of argument---today represents about 20 times that level for a company growing at 20% long term. Now, this was how Intuit looked too, but one also has to factor in dominant market share and look forward to what will happen as the World Wide Web and proprietary services like America Online become the dominant publishing environments. Adobe, in a sense, has a lock on the printing presses. A lot of graphics that you enjoy when viewing the Motley Fool's forums would not be possible without PhotoShop's software. Sometimes a multiple *equal* to the forward growth rate for a company with strong cash flow can be cheap if your holding periods are measured in years and not minutes.

Something to consider at least.

CALENDAR: Monday's Economic Events

---Treasury Auctions 13- & 26-Week Bills (2:00)
---November Consumer Installment Credit (3:00)

Byline: Randy Befumo (MF Templar)