Monday, February 5, 1996
MARKET CLOSE

INDEX:

I. Market News: NASDAQ Tech Rally Drives Market
II. Heroes: Aviall, Greenwich Air Services, Texas Instruments, Micron, PRI Automation, Creative Technologies, Hilton Hotels
III. Goats: Hayes Wheels, Exogen, Echostar Communications, Coors, U.S. Healthcare
IV. Investment Perspective: Mass Confusion Over Mass Storage

MARKET CLOSE

DJIA: 5407.59 (+ 33.60) -- RECORD
S&P 500: 641.43 (+ 5.58) -- RECORD
NASDAQ: 1069.46 (+ 11.19) -- RECORD

MARKET NEWS

A rally in the NASDAQ Composite pulled the other indices up today as so-called "technology" shares attracted hordes of buyers. All those networking, semiconductor and semiconductor equipment stocks that hurt your portfolio over December and January seem to be coming back in favor in February. Perhaps a February rally? The big news in Fooldom today was Iomega, which we cover in our Investment Perspective.

The latest word on the Fool World Book Tour: The Brothers Gardner will have an "electronic book signing" at 11:00 PM EST next Monday, the 12th of February, right here on America Online! You can buy the book then at a 10% discount and have both of the Hermanos Motley scrawl their names across the frontpiece, with up to a 15-word inscription. The total price? $20.70 plus $4.00 shipping and handling, as well as applicable sales tax depending on where you want the book shipped.

HEROES

The news that Aviall <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:AVL)") else Response.Write("(NYSE:AVL)") end if %> was exiting the airline engine and component repair business sent the stock plummeting last week. When Greenwich Air Services <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:GASI)") else Response.Write("(NASDAQ:GASI)") end if %> announced they were buying the unit for $260-280 million, Aviall shares rallied $1 3/8 to $6 3/8 on the news, recovering most of what it had lost. Greenwich has benefited from the major airlines outsourcing their repairs and the Aviall unit fits right in with their core operations. The Street must like those "synergies" as well, as it sent Greenwich shares into higher altitude today, rising $5 to $27 3/4. Aviall gets much needed cash and Greenwich gets a nice new subsidiary---who could be unhappy with that?

News that Fujitsu and Texas Instruments <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:TXN)") else Response.Write("(NYSE:TXN)") end if %> had agreed to a broad cross-licensing agreement that expires in 2005 apparently reminded investors that Texas Instruments is far more than a DRAM company. Shares of Texas Instruments rose $5 1/8 to $53 1/8 today amidst a broad rally in semiconductor and semiconductor equipment shares. Micron Technology, beaten to within an inch of $30, recovered $1 3/8 to $37 3/8 today, despite Rick Whittington's recent pronouncement that DRAM prices could fall as much as 80-90% this year. Perhaps the Street is no longer asking "how high" every time that Soundview Financial says "Jump!"? PRI Automation <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:PRIA)") else Response.Write("(NASDAQ:PRIA)") end if %>, a representative of the beaten-down semiconductor equipment shares, recovered $4 1/8 to $32 1/8 today in light volume.

Creative Technologies's <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:CREAF)") else Response.Write("(NASDAQ:CREAF)") end if %> Friday afternoon earnings report caused the shares to rally today, rising $15/16 to $9. Creative Tech made $0.31 EPS versus $0.24 EPS in the year ago period---a sharp contrast from the losses it had been reporting on 100% revenue gains for the last two quarters. The maker of the SoundBlaster card had a rough go of it in the up market for technology stocks, but seems to be catching its second wind now. The company's 3D-Blaster product offers a nice new niche to dominate.

Hilton Hotels Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:HLT)") else Response.Write("(NYSE:HLT)") end if %> saw shares rise $9 5/8 to $83 1/2 after Stephen Bollenbach was hired as its President and CEO. Bollenbach, who had been the CFO of Walt Disney Co. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:DIS)") else Response.Write("(NYSE:DIS)") end if %>, put together the Capital Cities/ABC-Disney merger. Bollenbach's credentials include being the architect of restructuring at Promus (the old Holiday Inn) and Marriott where he substantially increased valuations. Many institutional investors expect Bollenbach to work his magic again.

GOATS

Hayes Wheels International <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:HAY)") else Response.Write("(NYSE:HAY)") end if %> went flat today, slipping $4 5/8 to $19 3/8, after Varity Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:VAT)") else Response.Write("(NYSE:VAT)") end if %> withdrew its $25 cash buy-out offer. Varity, which already owns 46% of Hayes Wheels, stated that it doesn't want to buy more shares and it does not want to take Hayes private. Hayes, which makes aluminum and steel wheels, has suffered from weak earnings over the past few years.

"Profit-taking" was the explanation that Exogen <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:EXGN)") else Response.Write("(NASDAQ:EXGN)") end if %> offered today when asked why the stock fell more than 13%, losing $3 1/2 to close at $22. The company, which went public back in July at $11, hit a 52-week high on Friday. Exogen makes medical devices that use ultrasound and mechanical stress technologies to heal fractures. The stock price surged on Friday when two market makers received large end-of-day buy orders that caused a decrease in liquidity and a pop in the share price. Echostar Communications <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:DISH)") else Response.Write("(NASDAQ:DISH)") end if %> was also off $4 3/4 to $33 1/4 in a reported bout of profit-taking after a positive Heard On The Street article.

Brown Brothers downgraded Coors to short-term avoid, long-term underperform today. Reportedly, the analyst was forced to try Zima and then wash that down with Red Elk, Coors's stealth micro-brewery offering. Coors <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:ACCOB)") else Response.Write("(NASDAQ:ACCOB)") end if %> fizzled down $3 1/4 to $18 3/4, despite rumors that the Aryan Nation and the Silver Bullets female baseball team would assault the brokerage's research department.

US Healthcare <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:USHC)") else Response.Write("(NASDAQ:USHC)") end if %> got sent to the Emergency Room today, losing $4 1/8 to fall to $44 3/4 after reporting fourth quarter earnings above expectations. During the conference call, the company suggested that its medical loss ratio could raise 250 basis points in the next year. The medical loss ratio is a measure of how much of every dollar in premiums it spends delivering care. A basis point is 1/100th of a percentage point, meaning that the medical loss ratio could increase 2.5%. Increasing medical loss ratios have haunted the HMO stocks all year as they take on more and more Medicaid/Medicare business in order to keep revenue growth high. Medicaid/Medicare business tends to increase the medical loss ratio and decrease profit margins because unless it is capitated the program is designed to give no profits to the caregiver. (Capitation is when someone agrees to pay a set fee and the care provider gets to keep any of that fee it does not spend.)

INVESTMENT PERSPECTIVE: Mass Confusion Over Mass Storage

I. Introduction

The past few days have seen a flurry of activity in the shares of Iomega <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:IOMG)") else Response.Write("(NASDAQ:IOMG)") end if %>. The company, reporters, professional money managers and the public (via the Motley Fool's Iomega message board) have all chimed in vociferously about the company, its "postponed" secondary offering and its future. The volatility that accompanies increased uncertainty has caused temperatures to rise on the message boards and volume to rise at the stock exchange.

The distinction between the actual facts and the interpretations of the facts has blurred for many investors. The actual concrete events of the past two weeks are Iomega's fourth quarter earnings announcement (January 24th), the announcement that a secondary offering was put on hold (Febuary 1st), and the message from the company to shareholders released today (Febuary 5th). Comments about Iomega appearing on Dow Jones wires, in Barron's, in Herb Greenberg's Business Insider column (Keyword:Bizinsider) and on CNBC's Dorfman spot have been mixed in with these concrete facts, creating one heck of a lot of confusion. Shareholders have been left dismayed and paranoid as a result, thrust into a world of investing that was never clearly explained---the politics of a secondary offering.

Today, I thought it would be helpful to summarize the events of the past few weeks with Iomega and to separate fact from fiction in an effort to figure out just what the heck is going on with Fooldom's most famous stock. The story begins with Iomega's fourth quarter earnings. (All of these per share numbers are adjusted for the recent 3-for-1 split.) Iomega reported earnings of $0.166 EPS versus $0.023 EPS in the year ago period, a dynamic increase fueled by rapid sales growth for its Ditto, Zip and Jaz products---attractively-priced mass storage devices that hold quite a bit more information that the conventional disk drive.

II. Herb Greenberg's Business Insider

Allegations about "aggressive" accounting and "irregularities" focus on this fourth quarter's earnings report relative to the third quarter, meaning any individual investor's quest for the facts should begin here. This is indeed where Herb Greenberg started, in his series of articles written about Iomega over the past week for the San Francisco Chronicle. Greenberg began writing about Iomega on January 29th and has not been able to pull himself away from the topic yet. This comes as no great surprise, given that Greenberg is right on the money when he says: "This is more than just a story about a controversial Utah maker of removable disk drives ... This is also the story of the Internet..."

Greenberg repeats allegations of "aggressive" accounting in his first column, citing a decrease in the reserves against receivables as a percentage of receivables from 6% in the third quarter to 1.8% in the fourth quarter. Tinkering with this discretionary item is what many suggest allowed Iomega to come even close to their expected quarterly numbers. The claim is that Iomega would have only made $0.097 EPS rather than $0.166 EPS if they had kept the percentage constant, disappointing consensus estimates right before their secondary offering.

This is a fairly confusing issue, as Iomega labeled $3.5 million as "allowances" against receivables in its third quarter 10-Q. (You can get to this 10-Q by typing: "http://www.sec.gov/Archives/edgar/data/352789/0000352789-95-000004.txt" in your web browser.) Greenberg maintains that in this filing they labeled $3.5 million as "allowances" against receivables, but I'll be darned if I can find what he is referring to. The company states in their filing with the SEC for the 5.25 million share offering that the allowances against receivables was $1.45 million in the third quarter and they led analysts to believe the number for the fourth quarter was $1.9 million in the fourth quarter, numbers that do not coincide with the ambiguous $3.5 million in "allowances against receivables."

Iomega's explanation is that the reserves against receivables in the third quarter 10-Q covered part bad debt and part rebates already issued to retailers, meaning that the $3.5 million is there somewhere. The retort from the bears is that the adjusted numbers are still below 3.0% even if they did rise, less than the current industry average. Suffice to say that this all is a pretty confusing piece of fiscal legerdemain that can be explained in two possible ways: 1) the company is hiding something and boosting their current earnings by keeping their reserves too low, thus accounting "aggressively,"; 2) those who are negative on the stock are confused by ambiguous information given in the 3-Q and are not listening to the explanations from the company.

Greenberg's reiteration of these charges also includes a shot at Iomega versus its Fremont, California rival, Syquest, as he compares market capitalizations. Greenberg suggests that these two storage companies have similar products and similar revenues, thus the disparity between their market caps points to an overvaluation in Iomega. Syquest, which has shrunk to being worth $57.5 million from being worth $180 million a few months back, does not compare very well to Iomega's $853 million. This disparity might have more to do with factors specific to Syquest, however, like the fact that it is not making any money on its competing product and has reported huge, unexpected losses two quarters running.

III. Dow Jones and Dorfman

Carmen Fleetwood of Dow Jones was next to write on Iomega, right after it pulled its secondary offering. Fleetwood suggested from the start that canceled secondaries normally lead to higher prices, an incorrect assertion shareholders of Kulicke & Soffa <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:KLIC)") else Response.Write("(NASDAQ:KLIC)") end if %> and Chips & Technologies <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:CHPS)") else Response.Write("(NASDAQ:CHPS)") end if %> know all too well. The reaction to the secondary offering depends substantially on *why* it was pulled. Reasons were only made available today, in CEO Kim Edward's letter to shareholders. The stock got killed after they pulled the offering late Thursday because no one knew why, but there were some ugly allegations about accounting on the table upon which all eyes were fixed.

Secondary offerings require increased disclosure from a company, above and beyond the normal levels. Whenever a stock offering is pulled, it immediately raises the question of whether or not the company is choosing to not have to disclose something. This could be as bad as monkeying with the numbers, since accountants have to go through them prior to the secondary, or as good as a takeover offer that the company is not prepared to make public. In Iomega's case the secondary offering appears to have not been pulled for disclosure reasons, but because of timing. All these allegations about "cooking the books" would have been the first thing that Kim Edwards talked about in the "road show", where company executives go from institution to institution, persuading them to buy shares.

Fleetwood also reported another rumor which has been festering for weeks---that Hambrecht & Quist and Montgomery Securities, the underwriters for the offering, were all set to publish numbers far below current Street consensus and that neither company could justify the stock's valuation. This seems ridiculous given that if the companies had really felt this way from the start, they never would have gotten involved with the offering. The final rumor she reiterated was the one that Herb Greenberg had spent two days discussing---that allowances were altered to let the company make its quarterly earnings numbers.

Today, Dan Dorfman got into the fray, commenting on Iomega in a segment titled "Iomega in a Pickle." The pulled secondary offering, the balance sheet and future competition were what Dorfman focused on, calling Iomega "Yesterday's Technology." Today's letter to shareholders (available in a special Motley Fool Iomega collection in the main listbox) discusses component shortages at Iomega which Dorfman honed in on. The secondary offering was supposed to remove Iomega's cash-crunch and alleviate the component shortage, but with its cancellation this is not going to happen, leaving Iomega to tap the debt markets again or find some other form of financing. If capacity constraint does not allow them to fulfill all of their orders, the resultant gap between supply and demand could conceivably be filled by a competing technology. Dorfman asserted that Matshushita Electric Industrial Co. had a product that it was set to launch, as did Panasonic and Plasom Data. Iomega shareholders have heard this one before, however, when another company tried to launch a CD-ROM based product last year.

IV. A Useful Parallel

Greenberg, Fleetwood and Dorfman have all received information about Iomega from "interested parties," both long and short, in writing their pieces---although it appears, given the spin, that the bears have been contributing a heck of a lot more. There is a parallel that I want to draw that will be helpful for many investors. The similarities between Iomega's alleged ails and those of America Online <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:AMER)") else Response.Write("(NASDAQ:AMER)") end if %> are stunning, actually. You have allegations of poor accounting standards bordering on criminal manipulation to make quarterly numbers. You have capacity constraint delivering product to consumers in a reasonable way. You have a cash crunch caused by high costs in the middle of a rapid ramp-up. You have supposed emerging products that will make the current product obsolete. The only difference is that America Online did not pull its secondary because of the bad news, whereas Iomega did.

The share price of a stock reflects the amount of uncertainty in it at any given moment in time. When the amount of uncertainty increases due to new markets and unknowns about the current business, like with America Online and Iomega, the share price can get very volatile. Seeing 50% moves up or down in the space of a few days is not uncommon, as various market participants seek to discount the risk versus the reward of earnings growth and share price appreciation to come up with a fair price given available information. Although it might be convenient to believe that "multiposters" putting up "misinformation" on the Iomega stock boards drive the price, the fact that the negative side to the story has been put out by major media outlets probably has far more to do with recent volatility than posts in a *very* difficult-to-follow message board on America Online. Conspiracy theories that lead to one source for traumatic events allow people to believe they understand complex events that actually probably have no single explanation---assassinations and major political events normally spark the same sort of behavior.

For Iomega, like America Online, nothing is certain. It is a new technology that could be wildly successful or surpassed by another in a few months. Everyone has an opinion about what will happen, including me, but those opinions are all mixed together to determine the stock price at any given moment. This is the discounting mechanism of the market that creates opportunity and although it can cause temporary setbacks in your portfolio, it is the very thing that allows you to profit over the long term. Don't curse volatility -- rather embrace it and recognize it as what allows individual investors to succeed in a market dominated by anxious giants. For Iomega, all of the conflicting information simply gives those with the best understanding of the facts the potential to make more money, short or long.

Byline: Randy Befumo (MF Templar)