Thursday, February 1, 1996
MARKET CLOSE

INDEX:

I. Market News: Techs Hot For a Change
II. Heroes: Applied Signal Tech, BroadBand Tech, Trion, ARV
III. Goats: Circon, Open Environment, Peak Tech, Cornerstone Imaging
IV. Investment Perspective: The Digital World---Part Eight
V. Calendar: Friday's Economic Events

MARKET CLOSE

DJIA: 5405.06 +9.76 (+0.18%) -- RECORD
S&P 500: 638.46 +2.44 (+0.38%) -- RECORD
NASDAQ: 1069.46 +9.67 (+0.91%) -- almost a record

MARKET NEWS

After a month of trailing the other market indices, the Nasdaq Composite raced ahead today, closing just shy of its all-time high. The market didn't quite know what to do after the Fed eased rates yesterday. Do we celebrate? Do we complain that it wasn't more? Do we go get a cup of coffee to warm the heck up? After a confused day of trading, the Dow posted a modest gain.

HEROES

Applied Signal Technology <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:APSG)") else Response.Write("(NASDAQ:APSG)") end if %> has been going nuts, up $2 to $6 today. The problem is no one seems to know why. The company went so far today as to make a warning announcement cautioning investors with regard to the heavy trading and big price swings. The company says its core business is fine, but the management has no explanation for the unusual trading activity. Applied Signal Technology designs, develops, manufactures and markets signal processing equipment to collect and process a wide range of telecommunications signals for commercial and government applications.

BroadBand Technologies <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:BBTK)") else Response.Write("(NASDAQ:BBTK)") end if %> rose $4 11/16 to $23 11/16 as a result of an upgrade from UBS Securities. The stock's rating was raised from "hold" to "buy" based on UBS's "view that switched digital video technology will receive more visibility in the next six months." BroadBand designs telecommunication electronics and software products that allow the transmission of voice, video, and data through local telephone networks.

Trion <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:TRON)") else Response.Write("(NASDAQ:TRON)") end if %> posted impressive earnings and was rewarded today, up $1 1/4 to $6 1/2. Trion specializes in the design, manufacture and sale of high-performance air cleaning and filtration products. For the fourth quarter, the company posted a sales increase of 65% and an increase in net income of 64% over the year-ago period. With sales improving and the acquisition of Envirco, Trion's backlog climbed to $9.3 million, 131% high than last year's figure. Earnings per share for the year were $0.38 compared to 1994's $0.28. For the fourth quarter, Trion earned $0.11 per share versus $0.07 in the year-ago quarter.

ARV Assisted Living <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:ARVI)") else Response.Write("(NASDAQ:ARVI)") end if %> jumped $2 5/8 to $13 3/4 today after announcing that acquisition of a 217-unit assisted living facility in Bedford, Ohio. The deal, valued at $8.85 million, gives ARV its third assisted living facility in Ohio, the others a 121-unit facility in Sharonville and a 127-unit facility in Cincinnati. Since the company went public in October, it has acquired six facilities in its plan to set up clusters around major metropolitan areas across the country. ARV currently operates 34 facilities throughout the United States, one of the largest assisted living companies in the country.

GOATS

Circon <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:CCON)") else Response.Write("(NASDAQ:CCON)") end if %> announced disappointing earnings today and paid the price, losing $4 3/8 to $11 3/8. Richard A. Auhll, chairman and president, announced that Circon's sales in 1995 set a record of $160.4 million, but net income and earnings per share were down from 1994 levels. Circon earned $0.08 per share for the quarter, down from $0.14 in the year-ago period. The Street, however, was looking for $0.21 a share. Oof!

Open Environment <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:OPEN)") else Response.Write("(NASDAQ:OPEN)") end if %> shed $3 3/4 to $10 1/4, even after posting earnings in line with Street expectations. Open Environment is a leading provider of three-tiered client/server technology. For the fourth quarter, the company posted a revenue increase of 55% and a net earnings increase (before non-recurring special charges for acquisitions of technology) of 145%---or $0.13 a share. Cowen & Co. downgraded Open Environment, however, from "strong buy" to "buy." The Cowen analyst cited higher research and development costs will pressure Open Environment as they shift toward more Internet related products.

Peak Technologies <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:PEAK)") else Response.Write("(NASDAQ:PEAK)") end if %> plunged $6 1/2 to $18 1/2 on an earnings warning. Last week, analysts were cutting estimates on Peak, but today, the company fessed up. Peak expects fourth-quarter earnings to miss estimates which range from $0.30 to $0.33 a share. "Shortfalls in certain anticipated high margin service maintenance business and order delays in part related to one supplier" caused the disappointing results. How's that for vague? Peak is a distributor and systems integrator of bar-code data collection and wireless data transmission systems and information systems printing equipment.

Cornerstone Imaging <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:CRNR)") else Response.Write("(NASDAQ:CRNR)") end if %>, down $3 1/4 to $14 3/4, was whacked for announcing that its fourth quarter gross margin fell to 36%. Last quarter it was 36.2%, but last year it was 40.8%. The company says the slipping margin was expected and is related to the company's shift toward color image display products for Document Image Processing. Hmm. . . somehow the acronym DIP seems appropriate.

INVESTMENT PERSPECTIVE: The Digital World, VIII: Software and Services

I. Introduction

Software is as crucial in connecting to the digital world as the infrastructure made up of routers, switches and POPs that enable the electronic information to go from one place to another. Without the front-end software on computers to interpret the information and bring it to life, the Internet would be dead to the millions of people who currently access it. Software enables everything from on-screen animation to the bevy of services online and "nonline" companies are lining up to offer over the World Wide Web.

In Morgan Stanley's "Internet Report," Meeker, DuPeuy and McCuen compare the development of the Internet to the ramp-up of the personal computer industry in the 80s and early 90s. For personal computers, technology progressed from a focus on hardware to development of software and services. Sophisticated content was only possible after the earlier stages were completed. If the analogy holds for the Internet boom, then the next major wave of growth after the hardware is in place will be in software.

Internet software fits into four broad categories: front-end browsers, server/communications software, development/authoring tools, and back-end process and database applications. Let's look at each of these "clusters" of companies and the issues confronting them.

II. Software: The Front-End

The "browser wars" are being fought bitterly by a myriad of participants, vying for critical "mindshare" among the digital population. The Mosaic browser developed at the University of Illinois/Center for Supercomputing Applications is the grandfather of all browsers that currently grace the hard drives of personal computers throughout the world. Mosaic ended the first stage of browser development---text-based, non-interactive applications that were designed with power users in mind. With the advent of Mosaic, personal computers suddenly had the power to take advantage of the graphical fullness of the digital world.

It was companies like Netmanage <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:NETM)") else Response.Write("(NASDAQ:NETM)") end if %>, FTP Software <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:FTPS)") else Response.Write("(NASDAQ:FTPS)") end if %>, and Frontier Technology that rode the first wave, selling companies sophisticated IP-stack applications that allowed them to use e-mail, download files and connect to the Internet. These companies all got punched in the nose in August, however, when Microsoft began to offer crude versions of most of their applications as part of its Windows95 and WindowsNT operating systems; the market for low-end connectivity software suddenly dried up completely, leaving these three and others like them scrambling to develop even higher-end applications to maintain their market share.

The first stage for front-end software was completed the day Mosaic burst onto the scene, however. The mass consumer market for the Internet was suddenly laid wide open in a way that IP-stack vendors could never have achieved. Confronted with the free Mosaic browser, companies like IBM (with OS/2) and Microsoft <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:MSFT)") else Response.Write("(NASDAQ:MSFT)") end if %> had no choice but to offer similar free products with their operating systems. Online service providers (OSPs) like America Online and Prodigy had to offer connections to the Internet almost overnight in order to meet the surging demand and maintain their status as one-stop online solutions.

With browsers useful for accessing not only the Internet but also closed "intranets" created by corporations using the same httpd protocols, the market for a good browser goes far beyond the sticky fingers of individual computer owners. The main competitors in the browser market are Netscape <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:NSCP)") else Response.Write("(NASDAQ:NSCP)") end if %>, Spyglass <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:SPYG)") else Response.Write("(NASDAQ:SPYG)") end if %>, Microsoft <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:MSFT)") else Response.Write("(NASDAQ:MSFT)") end if %> and America Online <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:AMER)") else Response.Write("(NASDAQ:AMER)") end if %>.

The biggest name in browsers remains, without a doubt, Netscape. The Netscape browser, in fact, is a direct descendent of Mosaic. The product is essentially nonproprietary, given its reliance on the Mosaic codes that are available to almost anyone. Contrary to popular opinion, the browser is not the key to Netscape's future profitability; rather, Netscape is giving the browser away at a very low cost in the hope that it can set the standard for server software and secure transaction applications that will necessarily follow.

Microsoft is acutely aware of this fact, which is why the company has suddenly bombarded the world with its Internet Explorer. Microsoft recently put a free copy on every seat at the SuperBowl as part of its ongoing effort to take browser market share, an effort that is paying off. Microsoft Browser share went from 0% in June of 1995 to about 25% in October after the release of Windows 95 (measured by the browsers connecting to some popular music sites on the World Wide Web).

The funny thing is that Microsoft does not even own its browser entirely; it has Spyglass to thank for the basic code which made it possible. This is Spyglass's main strategy in the browser battles---to rent out its Enhanced Mosaic browser as a sort of mercenary army to any company who wants to add some value to it and grab browser market share. Spyglass strictly licenses its browser to companies who then bundle it with their software and counts among its clients Microsoft, CompuServe, Quarterdeck, Netmanage, Ventana and many others.

The recent talk of a strategic relationship between America Online and Netscape raises the possibility that the OSP is ready to dump the browser that it got from Booklink Technologies in late 1994, ridiculously underpaying for a product that---warts and all---kept them competitive in the OSP world at a crucial juncture. If Netscape could get America Online to offer its browser as part of its proprietary online service, it would further its own goal of capturing "mindshare" and create a powerful counter to the Microsoft/Spyglass partnership. The irony here is that Netscape stands to gain substantially more from this than America Online as it needs to grab a huge share of the browser market to execute the rest of its business strategy---server software and secure computing applications.

III. Servers and Secure Computing

The complexity of server software is daunting; you can get an idea of what it takes to have a server function by going out to Compaq's website (www.Compaq.com) and look at a diagram they have put up showing the components of an Internet server. The main players in the server software business are Netscape, Microsoft, O'Reilly & Associates, Open Market and the free NCSA daemon and CERNJ httpd products.

Netscape is a huge company when it comes to server software, a fact that many who are unremittingly negative about the company often exclude from their analysis. Netscape has its Netscape Commerce Server, Netscape Communications Server, Netscape News Server and Netscape Proxy Server, each filling a different market niche. The value Netscape adds to its servers is its secure transaction products; this company more than any other has benefited from the perception that commerce over the Internet is "unsafe" and requires a secure standard. The relationship between Netscape, Visa, Mastercard and Microsoft today regarding secure credit card transactions places Netscape in the catbird seat of this movement. The Netscape browser and the need for secure computing drive their high-margin and extremely profitable server software sales, allowing Netscape potentially to create the standards for the Internet.

Microsoft is not sitting idly by, however, as you can see from today's agreement. The Internet Information Server that is pending will fit right into Windows-NT and continue Microsoft's "Windows everywhere" strategy in the server market. This product will be shipped free with Windows NT, allegedly this quarter, and can potentially do to Netscape in the server market what Microsoft already did to Netmanage and its ilk in the IP-stack business---take out the low end of the market completely with a free product and forward its operating system domination goals at the same time.

Above the server software and supported by it is the multi-user applications environment. Netscape's acquisition of Collabra also creates the possibility that Netscape may be the one to provide the dominant communications software for businesses, striking at the market that was created by Lotus Notes, one that IBM apparently wants to cement by adding Tivoli Systems to its stable. Microsoft's "Notes-Killer," Exchange, suddenly looks a lot more like a "Keep Up With the Competition" product as things develop and it is still not on the shelves. The winner among these communications and multi-user applications competitors depends on the operating system that reigns supreme.

The operating systems that Web Servers run on are crucial to the future standards of the Web. With UNIX holding 69% (Sun counting for 31% of this and Silicon Graphics another chunk), open systems now rule the Net. However, Macintosh holds a surprising 17% share, emphasizing its nice spot in the graphics and publishing applications market, with Microsoft bringing up the rear with 14%. The word is that Microsoft's Windows NT is causing its share to rise, but should Sun snap up Apple anytime soon it suddenly has high-end and low-end server solutions with the potential eventually to dominate the market.

IV. Development/Authoring Tools

Why does Sun Microsystems want to dominate the operating system market for servers and why is Netscape willing to allow this to happen by not offering anything competitive? In fact, it was the Netscape adoption of Sun's Java programming language that initiated the massive surge in Sun stock a few months back. The reason is simple; Sun stands for open systems and open protocols, whereas Microsoft and its "Windows everywhere" strategy stands for closed systems and closed protocols. It is a testament to Sun's strength that Microsoft has been forced to license Java for the next version of its Internet Explorer.

So what is this Java thing? It is a set of development tools built into a programming language that allows Web pages to be fashioned as dynamic sites. Small applications (applets) can be executed over the Web when you connect to a site, allowing you to see something as fantastic as animation on a Web site or something as small as a changing stock quote. Until Java, Web sites were static and you had to re-enter one to see anything that might have changed.

Java is not the only set of development tools out there with implications for increased dynamism in Web pages. Netscape's LiveWire, America Online's Rainman, Macromedia's ShockWave and Adobe's Photoshop and Internet Studio are all absolutely crucial when it comes to "authoring" online content.

Two desktop publishing companies have moved their expertise to the 'Net. Adobe Systems <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:ADBE)") else Response.Write("(NASDAQ:ADBE)") end if %> now calls its desktop publishing stuff "authoring tools." Its Photoshop has about 80% of the digital imaging market, Illustrator has about 60% of the design market and PageMaker has about 42% of the PC-based desktop publishing world. With the recent acquisition of Frame Technologies, it suddenly has a huge share of the desktop publishing market for UNIX as well, making it *the* company to develop Internet publishing tools. Adobe's purchase of 4% of Netscape demonstrates Adobe's intentions to link up with Netscape in order to make its applications the standard for publishing on the Web, like Microsoft's applications are the standards for doing business.

Adobe's weakness lies in its heritage as a print-based document developer. The advantage of the Web over paper is that the Web as a medium can be dynamic, changing as the information changes. The company that has done more in this regard in the authoring tool segment is MacroMedia <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:MACR)") else Response.Write("(NASDAQ:MACR)") end if %>. MacroMedia's ShockWave is an add-on to its Director product that allows small "movies" to be viewed over the Internet via the Netscape Browser, version 2.0. This nifty feature was quickly adopted by Microsoft, America Online and Silicon Graphics for their Internet products.

V. Back-End and Database Products

The Web has implications for any company that currently has applications being used by businesses for commerce. Most of all the database companies are potentially transformed, as I have written about in the past. Companies like Oracle, Informix, Computer Associates and Sybase suddenly have huge potential markets opened to them that did not exist a year or two ago. As companies begin to come online to deliver goods and services, they will need custom-built database and back-end applications to achieve their goals.

Informix, more than any of its peers, has latched onto this possibility with its recent acquisition of Illustra Information Technologies, a company focused on Web databases as part of its core business. Today's slide in Informix because of questions about its fourth-quarter revenues might make a nice opportunity for those investors thinking about buying a stock involved in the Web-based market.

Companies as diverse as Microsoft (with its Back Office and FoxPro products) and Computer Associates will benefit peripherally from the Web as it drives the market for their products. The interface between the digital world and the more conventional PC world should shake a lot of the naysayers in this regard; with major companies like Oracle, Microsoft and Computer Associates looking toward the Web for their future growth, how "speculative" can some of this really be?

TOMORROW: The Digital World, IX: Services and A Conclusion

Friday's Economic Events

---January Employment Report (8:30)
---January University of Michigan Survey of Consumer Sentiment (10:00), tentative
---January Columbia University Leading Inflation Index (10:30)
---Weekly Commercial/Industrial Loans (4:15), tentative
---Federal Reserve releases minutes for FOMC meeting (4:30)

Byline: Randy Befumo (MF Templar)