HEROES

ZYGO CORP. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: ZIGO)") else Response.Write("(NASDAQ: ZIGO)") end if %> surged $8 to $35 1/2 today after reporting a 56% increase in sales, from which a 165% increase in per-share earnings flowed. The company sells its guidance systems to equipment suppliers. For instance, it sells $225,000 units to the disk-drive industry, where its machines are used to verify flying heights of a disk head. In the photolithography process of building semiconductors, its vision systems guide machines to distances of 1.24 nanometers, or 1.24 billionths of a meter. Though the semiconductor capital equipment slowdown has hurt some companies, even small caps here can generate surplus cash flow to set industrial tongues wagging. Zygo's free-cash flow-to-sales ratio (earnings plus depreciation and amortization minus capital expenditures) belies its small size and its association with semiconductors. It sits at 12.4% for the last year. And that's small for the industry.

Laser manufacturer COHERENT <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: COHR)") else Response.Write("(NASDAQ: COHR)") end if %> spun out a $6 gain to finish at $39. The company reported a 19.8% increase in quarterly revenues and a 32% increase in EPS, compared with last year's fourth quarter. The company's lasers are used in fields ranging from medicine, where its lasers are used for vascular problems or glaucoma, to the disk-drive industry, where its products are used in treating hard-disk media. On a sequential basis, comparing this quarter with the one that ended a little more than 90 days ago, sales grew 12.9% and EPS grew 8.8%. In addition to the company's introduction of new medical lasers, the disk-drive industry is adding capacity -- moving into what might be a sweet spot of a product cycle.

The prayers of THOMAS NELSON <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: TNM)") else Response.Write("(NYSE: TNM)") end if %> investors have finally been answered with today's $2 surge to $12 1/4. The firm surpassed consensus estimates of $0.24 EPS by six cents, showing positive operating earnings growth for the first time in more than a year. The leading publisher, producer and distributor of Christian books and music has been pummeled over the past year after missing estimates last October and continuing to underperform. Although the company is experiencing a continued drought in sales of books and music, the gift division it bought from C.R. Gibson is seeing strong growth. Thomas Nelson continues to suffer from poor financial controls on sales, general and administrative (SGA) expenses. The company currently spends 39.6% of revenues just to cover these costs, only down 1.4% from last year's levels. By way of comparison, SGA for TIME-WARNER <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: TWX)") else Response.Write("(NYSE: TWX)") end if %> is 32% and SGA for POLYGRAM <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: PLG)") else Response.Write("(NYSE: PLG)") end if %> is 36%.

QUICK TAKES: Disk drive head-maker READ-RITE <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: RDRT)") else Response.Write("(NASDAQ: RDRT)") end if %> added $1 to $17 3/4 after formally announcing a product that would help its customers improve the state of their art... Disk drive component-maker HUTCHINSON TECHNOLOGY <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: HTCH)") else Response.Write("(NASDAQ: HTCH)") end if %> spun out a $3 1/4 to $44 3/4 gain as investors look forward to the company's earnings release... NEXSTAR PHARMACEUTICALS <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: NXTR)") else Response.Write("(NASDAQ: NXTR)") end if %> added $2 9/16 to $15 5/8 after making presentations this week in which it discussed efficacy data for its MiKasome antibiotics... Arterial stent maker ARTERIAL VASCULAR ENGINEERING <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: AVEI)") else Response.Write("(NASDAQ: AVEI)") end if %> rebounded $2 1/4 to $15 1/2 after commenting on the recent volatility in its stock price and announcing that its board has authorized a $10 million stock buy-back... US ROBOTICS <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: USRX)") else Response.Write("(NASDAQ: USRX)") end if %> dropped $3 3/4 to $62 7/8 on more than twice its 30-day average trading volume after a Robertson Stephens analyst expressed angst over next week's earnings release. Other analysts pooh-poohed such worries.

MORE QUICK TAKES: ELJER INDUSTRIES <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: ELJ)") else Response.Write("(NYSE: ELJ)") end if %> rose $1 1/4 to $11 1/8 after the building products company reported a 17.8% increase in quarterly operating profits... Temp-help company CORESTAFF <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: CSTF)") else Response.Write("(NASDAQ: CSTF)") end if %> added $2 3/8 to $25 1/2 after reporting investor-pleasing quarterly earnings earlier this week... Thoroughbred racing facility BAY MEADOWS <% if gsSubBrand = "aolsnapshot" then Response.Write("(AMEX: CJ)") else Response.Write("(AMEX: CJ)") end if %> galloped $8 3/8 higher to close at $33 1/4 after agreeing to be acquired by PATRIOT AMERICAN HOSPITALITY <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: PAH)") else Response.Write("(NYSE: PAH)") end if %>... Broadcaster CLEAR CHANNEL COMMUNICATIONS <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CCU)") else Response.Write("(NYSE: CCU)") end if %> moved up $6 1/2 to $73 on the lingering strength of a Morgan Stanley upgrade earlier in the week... NEW DIMENSION SOFTWARE <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: DDDDF)") else Response.Write("(NASDAQ: DDDDF)") end if %> jumped $1 1/16 to $6 15/16 upon reporting record revenues and a 200% increase in EPS for its third quarter. The company makes software for information technology services administrators... WARRANTECH <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: WTEC)") else Response.Write("(NASDAQ: WTEC)") end if %> rose $2 to $12 1/4 after signing a three year, $26 million warranty service contract with the Lechmere subsidiaries of Montgomery Ward.

GOATS

ODWALLA <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: ODWA)") else Response.Write("(NASDAQ: ODWA)") end if %> lost some of its freshness today as the stock plummeted $6 1/4 to close at $12 1/8. The company's products were linked to 10 of 13 cases of E. coli food poisoning, a mini-outbreak of which has occurred on the West coast. The specific ingredient identified, apple juice, can be found in a good deal of the company's products, since the company sells a wide variety of blended juices in addition to its "single strength" products. Odwalla is unique in that it is one of the few producers of packaged drinks that are not pasteurized. While Louis Pasteur might have had a good idea, pasteurization does kill certain enzymes which are lacking in the diets of many Americans. Odwalla will revisit its policy of non-pasteurization as health officials sort out the matter.

Retailer STRAWBRIDGE & CLOTHIER <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: STRWA)") else Response.Write("(NASDAQ: STRWA)") end if %> fell $2 5/8 to $17 after announcing that it is postponing a distribution of shares in MAY COMPANY <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: MAY)") else Response.Write("(NYSE: MAY)") end if %> until 1997. The company's shareholders voted in July to reorganize and liquidate the company, at which point May took over a large chunk of Strawbridge's assets and liabilities. In exchange, Strawbridge will receive up to 4.5 million May Company shares, which will eventually go to the almost-defunct retailer's shareholders. Earlier this year, the shareholders believed that they would receive between 0.41 and 0.45 May shares for each of their Strawbridge shares. With the postponement announcement this morning, the company threw these owners a $0.25-to-$0.275 dividend bone, but said that the amount of the distribution will decrease to a range of 0.37 to 0.41 May shares. At about $47 per May share, that's $17.39 to $19.27.

GENERAL ACCEPTANCE CORP. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: GACC)") else Response.Write("(NASDAQ: GACC)") end if %> discovered this morning that its credit-worthiness was not generally accepted, dropping $2 1/4 to $3 1/4 on more than fifty times normal volume. The specialized finance firm revealed today that it would curtail growth in the first half rather than amending and increasing its line of credit as it works toward its first securitization of debt. A debt securitization is when a finance company sells a bunch of loans it has made to other investors and takes the cash, freeing itself up to make more loans. General Acceptance has had a rough year after it became one of the first used-car financers to implode late last year when consumer credit quality started to decay. It joins peer TFC ENTERPRISES <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: TFCE)") else Response.Write("(NASDAQ: TFCE)") end if %> in the dubious growth-stocks-turned-into-penny-stocks category.

QUICK CUTS: Managed care and medical services company RISCORP (NASAQ: RISC) plunged $3 7/8 to $5 as two of the company's officers have been served with grand jury subpoenas related to an investigation of campaign contributions... STARBUCKS <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: SBUX)") else Response.Write("(NASDAQ: SBUX)") end if %> lost $2 1/2 to $32 1/2 after reporting a 5% increase in same-store-sales in October and noting that the company will open 295 additional company-owned stores in the remainder of fiscal 1997... Former QUARTERDECK <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: QDEK)") else Response.Write("(NASDAQ: QDEK)") end if %> CEO Gaston Bastiaens is seeing some of his magic rub off at LERNOUT & HAUSPIE SPEECH PRODUCTS <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: LHSPF)") else Response.Write("(NASDAQ: LHSPF)") end if %>, which was down $3 1/8 at $16 3/4 today... INFERENCE CORP. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: INFR)") else Response.Write("(NASDAQ: INFR)") end if %> dropped another $3 1/4 to $12 1/4 after the help-desk software company suffered a substantial and as-yet unexplained decline yesterday.

MORE QUICK CUTS: PHARMACIA & UPJOHN INC. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: PNU)") else Response.Write("(NYSE: PNU)") end if %> dropped $1 3/4 to $36 as the company is guiding down fiscal 1997 estimates to the $2.25 area... Telecommunications marketer/outsourcing servicer and Fool Portfolio holding ATC COMMUNICATIONS <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: ATCT)") else Response.Write("(NASDAQ: ATCT)") end if %> tumbled $4 13/16 to $19 after the company reported estimate-meeting earnings of $0.09 per share in its first quarter. The highest "street" estimate was $0.11 per share and the lowest was $0.06, according to First Call (available on AOL at keyword: FirstCall)... LSI INDUSTRIES <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: LYTS)") else Response.Write("(NASDAQ: LYTS)") end if %> was dimmed for $1 1/8 to trade at $10 after the sign-maker (which sells to companies such as gas stations and convenience stores) reported an 18% decrease in quarterly per-share profits... WENDY'S <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: WEN)") else Response.Write("(NYSE: WEN)") end if %> was fried for $1 1/4 to close at $20 5/8 after investors expressed disappointment with the company's 30% year-over-year EPS increase, which missed estimates by $2.5 million.

FOOL ON THE HILL
An Investment Opinion by MF Templar

A Certain Knot in Gordia

AMERICA ONLINE <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: AOL)") else Response.Write("(NYSE: AOL)") end if %> has kindly provided regular fodder for commentary in this space, and this week was no exception. In a bold series of moves to reposition the business, the company has again taken the media high-ground and knocked commentators of all stripes off balance for a change. Confounding the expectations of most of the securities analysts who cover the stock, shares have moved strongly upward in the days following the announcement of flat-fee access, "gold-standard" cash accounting and the most significant management restructuring ever to happen to the Reston, VA-based online service.

The story of Rolando de Orco in Machiavelli's The Prince goes a long way toward explaining why the reaction to this radical series of moves has been so well received. Cesare Borgia charged his lieutenant de Orco with the unpleasant task of suppressing the populace of a territory he had recently captured. De Orco went about his duties with a missionary zeal, killing husbands, imprisoning relatives, and generally giving everyone a really hard time. As a result, de Orco earned the enmity of many of the citizens and was hated and feared by all. After de Orco had finished his work, Borgia decided it was necessary to deal with the discontent de Orco had generated in following his orders. One bright Italian morning, the citizens of the province awoke to see de Orco cut in half, laying out in the town square. With an economy of violence, Borgia had completed an act so bold that it left the people in awe -- still oppressed, yet suddenly strangely grateful to the man who had ordered their original pacification.

On Tuesday, America Online left the arguments of media critics and short sellers cut in half in the town square, with investors awed by the economy of violence it had committed on itself. In one fell swoop, the cagey management team removed two of the crucial pillars in the short-sellers arguments -- "the Internet will kill AOL with pricing" and "the accounting is all screwy." In a few hours on Tuesday, the financial community and the press learned that America Online was going to compete head-on with Internet Service Providers (ISPs) on pricing and that it would convert to the strictest form of expense accounting possible, in order to restore confidence in its financial story. The subsequent shocked and muted reaction from the company's many critics simply left them reporting the news and struggling to understand, with the exception of the firm's hometown newspaper, which ran another in a series of skeptical articles.

With the new flat-fee access package, America Online is easily competitive with the major national ISPs. If a customer is willing to pre-pay a year or two out, the price falls below the $20 level that rival NETCOM ON-LINE COMMUNICATIONS <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: NETC)") else Response.Write("(NASDAQ: NETC)") end if %> suggested two quarters ago was the lowest it could possibly go. How can America Online undercut all but a select group of regional ISPs with more aggressive pricing? A massive high-speed, fixed-cost network that has already been built by its subsidiary ANS Communications and BBN CORP. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: BBN)") else Response.Write("(NYSE: BBN)") end if %> -- the team that designed the Internet. With the average user limited to about 20 to 30 hours of Internet use a month due to work schedules, the move to unlimited pricing fulfills a critical psychological need without blowing out their network -- a concern that the company had grappled with when it previously considered such a move.

America Online's most important asset in making this shift -- its network -- remains a variable that Wall Street routinely fails to efficiently discount into the company's price. America Online plans to stop this by splitting the company into three operating units, leaving ex-British Telecommunications executive Bruce Bond in charge of moving ANS into the future. With what Bond describes as a $200 million revenue target this year, this puts ANS at just under the titan size of BBN Corp. (with a $500 million market capitalization) or UUNet Technologies (bought by MFS COMMUNICATIONS <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: MFST)") else Response.Write("(NASDAQ: MFST)") end if %> earlier this year for a cool $2 billion). Chief financial officer Len Leader anticipates reporting revenues for each of AOL's operating units on a separate basis within six months to a year, allowing the market to finally recognize the value of ANS implicit in America Online's online service business.

The shift in how America Online will account for its various operating units is nowhere near as significant as the company's bold move to completely change the way it recognizes marketing expenses. Previously, America Online amortized subscriber acquisition costs over the expected lifetime of the subscriber, attempting to match up costs with associated revenues. Although I still believe this approach was entirely appropriate, the company's move away from this legitimate accounting practice does allow it to stop wasting its time defending it and lets investors focus on the revenue growth story without getting their undies in a bundle over the way the company accounts for its earnings.

How is America Online going to make this change? A $385 million one-time, non-cash charge in the September quarter. Why non-cash? Because the company has already spent the money, according to the Statement of Cash Flows. All it will do is write off the $385 million asset on its balance sheet that it was already depreciating -- effectively restating past earnings for the shift in accounting. America Online's bank account balance will not change a single penny as a result of this one move and its cash-flow statements will not be shifted one iota. Furthermore, the company will take a $75 million charge in the December quarter to reorganize some acquisitions, to discontinue GNN while integrating the subscribers into its core AOL brand, and for some other organizational-related stuff to acheive a three-companies-within-one-company model.

So why is the stock going up? Two reasons. The first is that no one really paid any attention to America Online's earnings anyway -- they looked at the statement of cash-flows. The subscriber acquisition one-time amortization does nothing to change this and therefore cannot be negative construed. As for the pricing, the fact is that with 6.85 million subscribers as of October and a move toward low-price, flat-fee access, the online world faces an incredible competitor. AOL's assumptions are that more than half will choose the $20 price-point and the rest will opt for the $4.95-for-three-hours deal, keeping average revenue capture per subscriber at $17 a month. Many people view this as conservative and understand that if the company is not killed because of a network usage explosion, it actually could raise its average revenue per subscriber with a flat-fee deal -- at the same time squeezing the heck out of marginal ISP competitors who have much worse cash-flow problems.

Another benefit of the shift to flat-fee pricing is that it leaves America Online with a set amount of money with which to compensate its content generating partners, giving the company an impetus to clean up its confusing array of offerings by focusing on a few core brands on each channel. Previously, if a content provider was only marginally successful, it still could get its cut of usage and be fat and happy. Now content providers will start to need to generate hit shows or risk either getting canceled or receiving such a paltry amount of compensation that they might as well call it quits. By streamlining the proprietary portion of the service and opening the floodgates to the Web, AOL stops trying to recreate the Web and starts using the Web where the Web makes sense and AOL where AOL makes sense.

Now the question becomes... at what price AOL? Big Blue Triangle forecasts $70 million in positive cash-flow in its second half on the new accounting standard. This is without counting any service pre-payments from people opting to pay for one or two years in advance in order to get cheaper rates. Although the company estimates that about three percent of its users will do this, it would not be inconceivable to have five percent make this commitment, putting more than $100 million in cash in the company's bank account to be recognized as deferred revenues in the future. Unless the media gets bent out of shape about this form of accounting, this should swell the company's balance sheet, ensuring that it can remain cash-flow positive going forward, and making it dangerous to its universally cash-flow negative competition. The company forecasts about $1.7 billion in revenues this year and looks to be able to hit around $2.5 billion next year. With 111.3 million shares outstanding as of the last fiscal quarter, this gives the company a market cap of a cool $3.03 billion -- 3.0 times trailing sales, 1.8 times this year's sales and 1.2 times next year's sales with sequential revenue growth in excess of 10%. Taking into account the market value of the ANS assets and the potential of trading at 3.0 times sales next year, the math leaves you with a price somewhere in the $40s.

FOOLISH FEATURES

Double, double toil and trouble... Our Ghouls have cooked up their usual cauldron of midday market news in The Lunchtime News. In addition to eye of newt, toe of frog, wool of bat, and tongue of dog, there's are also interesting tidbits on Kimball International, Zygo, and Odwalla.

We've also got a bagful of tricks -- Ticker Treat & Scary Stocks. Some of our Ghouls have gotten together to spin some of the scariest stock stories out there. The scariest part about these stories is that they're true! Don't read this one right before bed.

CONFERENCE CALLS

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