HEROES
KINDER-CARE LEARNING CENTERS <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: KCLC)") else Response.Write("(NASDAQ: KCLC)") end if %> jumped $3 1/2, or 21%, to $19 3/4 as Kohlberg Kravis Roberts, best known for their leveraged buyout of RJR Nabisco, announced a merger agreement between a KKR affiliate and the child-care company. After the announcement, Standard & Poors put Kinder-Care on credit watch with negative implications. At $20.25 per Kinder Care share, plus the assumption of debt, the deal is worth more than $600 million. Shareholders have the option of holding their Kinder Care stock. And given demographic trends, industry profit margins, and KKR's overall great record, that's not an idea to be totally overlooked.
STRATUS COMPUTER <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: SRA)") else Response.Write("(NYSE: SRA)") end if %> jumped $3 3/8 to $23 1/8 after being upgraded to "strong buy" from "buy" by Salomon Brothers. The firm's analyst believes that the company can return its software unit to profitability. Stephen Smith at PaineWebber recently pointed to the company's telco business as a strong performer, with international telco revenues up 65%. Stratus makes fault-tolerant hardware and middleware. With the increased demand for online transactions and fault-tolerant/mission-critical enterprise systems, the leading companies in these markets are looking at excellent prospects for revenue gains over the next five years.
Continuing its recent strength, READ-RITE <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: RDRT)") else Response.Write("(NASDAQ: RDRT)") end if %> surged $1 13/16 to $17 5/16. Battered about since the third quarter of 1995, when peripherals maker Conner was acquired by SEAGATE <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: SEG)") else Response.Write("(NYSE: SEG)") end if %>, this is the first time in a while that these shares have shown any sort of persistant strength. The company has been troubled in its transition to MR (magneto resistive) heads and therefore lost market share in the ultra-competitive disk drive industry. With some signs of life at QUANTUM <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: QNTM)") else Response.Write("(NASDAQ: QNTM)") end if %> and excellent news since summer from customer WESTERN DIGITAL <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: WDC)") else Response.Write("(NYSE: WDC)") end if %>, Read-Rite's fortunes may be reviving.
QUICK TAKES: SEAGATE <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: SEG)") else Response.Write("(NYSE: SEG)") end if %> was the other big mover in the disk drive industry today. America's largest storage company announced an OEM agreement with LOCKHEED MARTIN <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: LMT)") else Response.Write("(NYSE: LMT)") end if %> today and tacked on almost half a billion dollars in market cap in moving up $4 to $58 7/8...
GOATS
Though the furnaces burned bright along the Great Lakes this summer, the stock of BETHLEHEM STEEL <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: BS)") else Response.Write("(NYSE: BS)") end if %> is floundering, dropping $1 to a new 52-week low of $8 5/8. The company recently issued bonds in the range of junk, or high-yield, and is contemplating various solutions for dealing with money-losing units. Bethlehem has multiple problems. One big one: the lack of a competitive cost structure to deal with industry innovators such as NUCOR <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: NUE)") else Response.Write("(NYSE: NUE)") end if %>, which is now working on a iron-carbide process that should strengthen its lead in areas where Bethlehem now struggles. Another problem: Bethlehem's pension liabilities are huge. Shutting down now could trigger contingent liabilities which are larger than the company's total market capitalization. The death of another American icon may be upon us, which is tragic.
REDHOOK ALE BREWERY <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: HOOK)") else Response.Write("(NASDAQ: HOOK)") end if %> dropped $4 1/16 to $17, committing the Wall Street equivalent of a party foul: the company will miss analysts' EPS estimates of $0.15 for the quarter. The Seattle Brewer of craft beer reported quarterly earnings of $0.10 to $0.11 per share -- below last year's third quarter EPS results of $0.12. In addition, revenues were smaller than expected. Though some might take it as a bad sign that sales were down in the summer quarter, craft beer companies are becoming extremely specialized (if one company has the best Octoberfest beer, for example, sales will skew toward the fourth quarter). Though earnings valuations might look pricey throughout the sector (see BOSTON BEER CO. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: SAM)") else Response.Write("(NYSE: SAM)") end if %>), assessing the valuations from a brand-equity or price/sales standpoint might clarify their complexions somewhat.
Though they recovered pretty strongly from their daily low of $11 7/8, the shares of GTS DURATEK <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: DRTK)") else Response.Write("(NASDAQ: DRTK)") end if %> took a 10.6% hit in dropping $1 5/8 to $13 3/4. This, after Deutsche Morgan Grenfell adjusted earnings estimates for 1996 downward from $0.14 to $0.05 per share. Duratek is a Maryland company that holds multiple patents on its processes for turning low-level nuclear waste into glass-like beads. The company has much to look forward to in the way of remediating environmental hazards in the US and especially in places like Russia (if that country ever has the money to take care of such things). This morning's drop and rebound in the share price illustrates the importance of knowing how to value small-cap companies on forward-earnings, as earnings flow shouldn't really happen until 1997. Congratulations to the technical analysts if they saw it bounce off of "support," but multo-congratulations to those who know how to value the company and who seized an opportunity to exploit the short-term market inefficiency.
QUICK CUTS: GENSYM <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: GNSM)") else Response.Write("(NASDAQ: GNSM)") end if %> shed $8 1/2 to close at $12 1/2 as the quality control software company revealed that it missed closing on some sales before the books closed on the third quarter... AU BON PAIN (NASDAQA: ABPCA) fell $3/4 to $6 1/4 as the company pre-announced a third quarter loss of $0.15 to $0.20 per share and same-store-sales shrinkage of 3%. We're wondering if Peter Lynch still eats here, whether he owns the stock, and whether he's going to talk about it again in this year's Barron's Roundtable.
Correction: The Motley Fool included a story on INTEGRATED PROCESS EQUIPMENT <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: IPEC)") else Response.Write("(NASDAQ: IPEC)") end if %> in last night's Evening News. The ticker symbol and the price quoted in the story were incorrect. We apologize for the error.
FOOL ON THE HILL
An Investment Opinion by MF Templar
Stomping on the Subscriber Acquisition Pedal
AMERICA ONLINE <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: AOL)") else Response.Write("(NYSE: AOL)") end if %> has been the subject of a lot of debate over the past few months. Today, America Online completed its annual report and released cash flow information for the fourth quarter to the public. I thought it would be an interesting exercise to go through that cash-flow statement and try to figure out what all the excitement was about and evaluate whether or not cash-flow improved in the fourth quarter versus the third quarter's arguably disastrous results.
The Statement of Cash Flows is a document that reconciles the Statement of Earnings with changes in the Balance Sheet, which measures assets and liabilities broadly. As many of you may know, just because a company's accounting says that it has earnings doesn't mean that it ends up adding any cash to its corporate coffers. Conversely, a company's accounting can say that it has taken a loss even when it has actually managed to increase the cash value of the company. When the Securities Exchange Commission wisely started to require companies to include the Statement of Cash Flows in the '80s, they did small investors everywhere a favor by forcing companies to make plain information that otherwise would have taken hours of dedicated analysis to figure out.
In America Online's case, cash flow is complicated by two main factors -- deferred subscriber acquisition costs and depreciation. I dealt with a definition of deferred subscriber acquisition costs at length in September 10th edition of the Evening News. America Online, in an effort to reconcile revenues with expenses, defers recognition of the costs associated with subscriber acquisition. By looking at the average length of time a subscriber of America Online uses the service, the company books the expenses over that entire period in regular monthly installments. In order to facilitate this sort of accounting, America Online has to capitalize those unrecognized subscriber costs on its balance sheet as an asset, which is depreciated on a monthly basis. You put the unrecognized expenses as an asset because a negative expense is a situation where two negatives cancel each other out, making a positive. Although many writers have called this accounting questionable, it remains valid under existing Financial Accounting Standards Board (FASB) rules.
The second element, depreciation, is important because of the large network that America Online owns with AOLNet and its ANS subsidiary. Because of these two factors, in order to understand the movements of America Online's stock, it is almost more important to look at the cash-flow statements than the income statement. Understanding the cash flow can be difficult because it is not reported quarterly but cumulatively, unlike earnings. This means that every quarter you see the cash flow for all the quarters since the end of the last fiscal year. For instance, the third quarter's Statement of Cash Flows is not just the third quarter, but the cumulative results of the first, second and third quarters. You can figure out the individual results for each quarter if you have each 10-Q, but unfortunately, this can be a hassle.
During the third quarter, America Online scared the bejeezus out of the financial community when it reported its cash flow results. Cash flow was extremely negative in the second quarter, much more negative than it had been in the previous few quarters. Cash flow had been deterioriating for some time. For instance, in the fiscal fourth quarter of 1995 AOL only added $253,000 in cash flow from operations, compared to the $17 million in operating cash flow that the company booked in the prior three quarters. Cash flow was negative for the first quarter of 1996, but it was not until the second and third quarters' glaring drop -- to a cumulative negative $47.4 million in cash flow from operations -- that the Street discarded their shares.
In today's just released Statement of Cash Flows, America Online posted a total 1996 cash flow from operations of negative $66.7 million. That's a $19.3 million decrease in the 4th quarter alone, and a 12-month run-rate of negative $80 million in cash flows. The largest debit increase for the quarter was the $86.4 million jump in deferred subscriber acquisition costs. This was actually a reduction from the amount the company spent acquiring subscriber in previous quarters.
Keep in mind that this was the 4th quarter where America Online announced it would purposefully put on the marketing brakes, looking to launch a major new campaign this Fall to tout the release of their new 3.0 software. (For readers who are curious, the third quarter is located on the Web in EDGAR and the 10-K, sans cash flow statement, is out there as well. Otherwise, you have to call and schmooze AOL's investor relations department to get today's annual report.)
What can be drawn from this cash-flow statement? America Online is really cash-flow negative. The company burned $66.7 million in cash for the fiscal year after bringing $17.3 million in cash to the bottom line in the prior year. The accelerated marketing campaign and subscriber acquisition program is an expensive bet on the online future. The question is, when are you spending too much to add a subscriber? How loyal are those subscriber going to be? How much can you expect to generate in profits from those subscribers immediately and in future years?
As I see it, if the company's 3.0 product is as compelling as it appears to be, and the online market ain't saturated, I think that the results over the next few quarters should teach us a lot about whether America Online's business model can work or not. It's do-or-die time. Chief Financial Officer Len Leader forecasts positive flow in the fourth quarter; I would say this is the make or break issue -- not the oft-publicized 10 million subscriber goal that chief executive Steve Case set a few months back.
Wall Street wants profitability and positive cash-flow.
FOOLISH FEATURES
As morbid as it sounds, today's Lunchtime News looks at the growth potential of deathcare companies, those that run funeral homes and cemeteries.
This weekend, we'll be thinking happier thoughts, as we contemplate Fool's Gold. As always, the Weekend Research Center provides a convenient recap of this week's news and research, while the Industry Updates give new insight to a number of Foolish sectors.
CONFERENCE CALLS
None
Dale Wettlaufer (MF Raleigh),
a Fool
A Fool Named Horse
Selena Maranjian (MF Selena),
a Fool
Heroes & Goats & Editing