The Motley Fool, 05/27/97: The Evening News

HEROES

AT&T <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: T)") else Response.Write("(NYSE: T)") end if %> added $1 1/8 to $37 1/4 on reports from the Wall Street Journal that the telecom colossus and SBC COMMUNICATIONS <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: SBC)") else Response.Write("(NYSE: SBC)") end if %> are conducting merger talks, which the paper valued at over $50 billion. Telecom billing software provider LHS GROUP <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: LHSG)") else Response.Write("(Nasdaq: LHSG)") end if %> moved up $3 7/8 to $34 1/4 on the reasoning that an integrated company with 60% of the country's long-distance revenues would help the software firm. Meanwhile, PREMIERE TECHNOLOGIES <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: PTEK)") else Response.Write("(Nasdaq: PTEK)") end if %>, a company that provides value-added services to telcos and is more closely associated with WORLDCOM <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: WCOM)") else Response.Write("(Nasdaq: WCOM)") end if %> these days, stayed flat. Other long-distance carriers moved up on the news, including SPRINT <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: FON)") else Response.Write("(NYSE: FON)") end if %>, rising $1 1/4 to $48 7/8, and FRONTIER COMMUNICATIONS <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: FRO)") else Response.Write("(NYSE: FRO)") end if %>, which gained $3/4 to $17 3/4 on the day.

MICRON TECHNOLOGY <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: MU)") else Response.Write("(NYSE: MU)") end if %> climbed $4 1/4 to $42 1/2 on heavy volume as Merrill Lynch reiterated its bullish outlook on the memory chip manufacturer. Micron still lags other DRAM companies in 64 megabit chip development, but has been able to squeeze cash flow out of trailing-edge 4 Mb and 16 Mb DRAM chips. This strategy has been validated elsewhere by the likes of WESTERN DIGITAL <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: WDC)") else Response.Write("(NYSE: WDC)") end if %>, which has waited on making drives with magnetoresistive heads that have been the technology du jour in that industry. However, Western Digital purchases the leading-edge components from companies that make capital expenditures for new equipment, while Micron has to lay out its cash just to get going in the rush to 64 Mb chips and 300mm wafers. Micron will generate less than $1 per share in free cash flow this year if it makes earnings estimates, and the company is ready to sell more stock or debt (with its $1 billion shelf registration still outstanding) if it feels the time is right.

Embedded systems software company WIND RIVER SYSTEMS <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: WIND)") else Response.Write("(Nasdaq: WIND)") end if %> rebounded $3 7/8 to $34 following last week's decline after reporting EPS of $0.11, beating estimates of $0.09. Initially, the stock sold off, as it might not have hit the whisper number or as some business reality was mentioned in the conference call. Possibly helping today, the company said its VxWorks operating system software is being used on a Mars probe set to reach the red planet on July 4. Wind River now trades at 47 times estimated 1999 earnings while RADISYS <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: RSYS)") else Response.Write("(Nasdaq: RSYS)") end if %>, another embedded systems company, which has been the subject of a few bearish pieces in Barron's, trades at 16.6 times 1998 EPS estimates. INTEGRATED SYSTEMS <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: INTS)") else Response.Write("(Nasdaq: INTS)") end if %>, which gained $1 3/4 to $13 3/4 today, only trades at 14 times 1999 estimates. We hope we haven't given any bearish editors a story idea.

WESTERN DIGITAL <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: WDC)") else Response.Write("(NYSE: WDC)") end if %> gained $4 to $56 7/8 as investors sort out normal price declines in the PC industry from extraordinary price declines, which is what the industry claims is the current condition. Analyst Roxanne Googin of Gruntal & Co. disagreed, telling Dow Jones last week that she sees a "protracted problem" in the high-end of the disk drive market. SEAGATE TECHNOLOGY <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: SEG)") else Response.Write("(NYSE: SEG)") end if %> rose $2 5/8 to $42 7/8, recovering from last week's slide, as did READ-RITE <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: RDRT)") else Response.Write("(Nasdaq: RDRT)") end if %> and supplier HUTCHINSON TECHNOLOGY <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: HTCH)") else Response.Write("(Nasdaq: HTCH)") end if %>. INNOVEX <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: INVX)") else Response.Write("(Nasdaq: INVX)") end if %> added $1 1/4 to $30 and APPLIED MAGNETICS <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: APM)") else Response.Write("(NYSE: APM)") end if %> rose $2 3/8 to $26 3/8. Institutional investors, who set the tone in this market, will have to learn that pricing is usually stronger in the third and fourth calendar quarters and that inventory adjustments going into the weakest part of the year don't necessarily mean that the whole industry is cracking.

QUICK TAKES: TALX CORP. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: TALX)") else Response.Write("(Nasdaq: TALX)") end if %> added back $1 1/4 to $6 after the computer telephony products company fell following last week's earnings report... CYBERMEDIA INC. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: CYBR)") else Response.Write("(Nasdaq: CYBR)") end if %> jumped $4 3/8 to $19 1/8 after the software company said that its Oil Change software updating application will be included in every CompUSA extended service agreement... Modem company DATA RACE <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: RACE)") else Response.Write("(Nasdaq: RACE)") end if %> regained $1 3/4 to $14 1/2 after slipping last week on concerns over distribution for a "key product," according to Southcoast Capital... GLENAYRE TECHNOLOGIES <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: GEMS)") else Response.Write("(Nasdaq: GEMS)") end if %> gained $1 7/16 to $14 7/16 after the downtrodden wireless systems company announced last week that it has instituted a poison pill plan... Upon announcing copyright-protection features for its video chips, C-CUBE MICROSYSTEMS <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: CUBE)") else Response.Write("(Nasdaq: CUBE)") end if %> gained $2 3/8 to $20 3/8. Competitor ESS TECHNOLOGY <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: ESST)") else Response.Write("(Nasdaq: ESST)") end if %> also rose $1 19/32 to $15 31/32... VISHAY INTERTECHNOLOGY <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: VSH)") else Response.Write("(NYSE: VSH)") end if %> rose $3 3/8 to $32 after Alex. Brown rated the maker of capacitors and resistors a "strong buy," up from a "buy" rating... Direct PC marketer DELL COMPUTER <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: DELL)") else Response.Write("(Nasdaq: DELL)") end if %> picked up $6 to $113 1/4 on announcing product features that it says will lower the cost of PC ownership for enterprise users... GATEWAY 2000 <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: GTW)") else Response.Write("(NYSE: GTW)") end if %>, settling in at its New York Stock Exchange post, gained $5 7/8 to $74 3/4... VANGUARD CELLULAR SYSTEMS <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: VCELA)") else Response.Write("(Nasdaq: VCELA)") end if %> added $1 to $13, 360 COMMUNICATIONS <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: XO)") else Response.Write("(NYSE: XO)") end if %> rose $1 3/8 to $18, and former PacTel cell phone company AIRTOUCH COMMUNICATIONS <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: ATI)") else Response.Write("(NYSE: ATI)") end if %> moved up $1 1/4 to $26 1/2 as investors re-value cellular telephone properties in the wake of the announced acquisition of PALMER WIRELESS <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: PWIR)") else Response.Write("(Nasdaq: PWIR)") end if %> by PRICE COMMUNICATIONS <% if gsSubBrand = "aolsnapshot" then Response.Write("(AMEX: PR)") else Response.Write("(AMEX: PR)") end if %>... Application-specific integrated circuit (ASIC) manufacturer ZILOG INC. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: ZLG)") else Response.Write("(NYSE: ZLG)") end if %> rose $1 3/4 to $22 1/2 after Delphi Management President Scott Black said in this weekend's Barron's that he likes the company's leading position and customer relationships... GAYLORD CONTAINER CORP. <% if gsSubBrand = "aolsnapshot" then Response.Write("(AMEX: GCR)") else Response.Write("(AMEX: GCR)") end if %> wrapped up a $1 gain to $8 1/8 after CS First Boston raised its rating on the company to "buy" from "hold"... U.S. ROBOTICS <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: USRX)") else Response.Write("(Nasdaq: USRX)") end if %> surged $6 to $80 3/4 and ASCEND COMMUNICATIONS <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: ASND)") else Response.Write("(Nasdaq: ASND)") end if %> rose $4 to $55 1/2, possibly as a result of the AT&T-SBC merger talk, which would accelerate remote access demand.

GOATS

French insurance and financial services company AXA <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: AXA)") else Response.Write("(NYSE: AXA)") end if %>, which owns the Equitable and chunks of Donaldson, Lufkin & Jenrette and Alliance Capital Management, lost $1 5/8 to $32 7/8 after French Prime Minister Alain Juppe announced his resignation amid political gains being made by Socialists in the French national elections. Hard money advocates in the European Union fear that the French left will try to alleviate the country's double-digit unemployment rate with monetary easing or fiscal leniency, reversing the currently more hawkish monetary stance of the government. French telecom equipment ALCATEL ALSTHOM <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: ALA)") else Response.Write("(NYSE: ALA)") end if %> also fell $1 to $23 5/8.

Optoelectronics company CIENA CORP. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: CIEN)") else Response.Write("(Nasdaq: CIEN)") end if %> lost $3 3/4 to $42 1/4 as the post-initial public offering lockup on insiders' holdings expired today, leaving 8 million+ more shares of the company's outstanding shares free to be traded. That amounts to only 10% of the 88 million shares covered by the lockup, which expires in August of this year, according to Dow Jones. The company's wave division multiplexing systems allow telecom backbone carriers to "stop digging around for bandwidth." These systems essentially act as modems (modulators/demodulators). They take a signal input, split up the signal into finer parts than competitors' equipment can, and then put the signal back together at the other end of the fiber cable. By increasing the bandwidth of current backbones by a factor of 16, Ciena's customers have been pretty much beating a path to its door.

QUICK CUTS: CROWN VANTAGE INC. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: CVAN)") else Response.Write("(Nasdaq: CVAN)") end if %> fell $1 1/4 to $7 3/4 as the paper products company will have to wait two years until it can bid on the job of making paper stock for U.S. currency... CADENCE DESIGN SYSTEMS <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CDN)") else Response.Write("(NYSE: CDN)") end if %> lost $2 1/4 to $33 3/4 as Goldman Sachs re-jiggered its rating on the semiconductor and circuit board design software firm.

FOOL ON THE HILL
An Investment Opinion by Randy Befumo

Financial Statement Minutiae

How much about accounting does an investor need to know? Although some might try to soft-pedal the relative importance of balance sheet minutiae, for many companies, paying attention to the balance sheet as well as the income statement is crucial to ascertaining the quality of the investment. Investors in dental benefits company UNITED DENTAL CARE <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: UDCI)") else Response.Write("(Nasdaq: UDCI)") end if %> discovered the importance the balance sheet entry called "reserves" this morning when the stock decayed $8 to $16 1/2. United Dental will come in "significantly below" analyst expectations in the upcoming quarter due to inadequate loss reserves. Competitor COMPDENT <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: CPDN)") else Response.Write("(Nasdaq: CPDN)") end if %> was knocked down $1 7/8 to $18 1/4 in a classic guilt by association sell-off.

United Dental Care snuck a press release out on Friday after market close announcing that it would not meet expectations of $0.33 per share in the fiscal second quarter. Although revenues for the month of April were right on-target, costs related to a substantial loss on a Medicaid contract in Arizona and "substantially greater-than-anticipated" indemnity claims activity will hurt earnings. The company is not clear at this time what earnings for the second quarter will be, but it is currently reviewing all appropriate accounting adjustments, including the possibility of taking a significant one-time charge. Shares of United Dental plunged well past their prior 52-week low of $21 7/8 on more than 82 times normal volume, indicating that some institutions were large sellers of the shares.

United Dental is a health maintenance organization (HMO) that provides dental coverage to 1.9 million members in the U.S. The company is attempting to replicate the success of medical HMOs in the dental market. Although the company actively provides dental benefit programs to employers, the accounting structure is exactly like that of an insurance company. Because an insurance company receives payment for a policy in advance of giving coverage for specified risks over a given period, information on the balance sheet becomes vital to interpreting the level of risk inherent in the investment. An insurance company accepts the money up-front and uses part of that payment to set up a "reserve" against future claims, the size of which is dependent on past loss experience and management's assessment of future risks.

When United Dental talks about "substantially greater-than-anticipated" indemnity claims activity, it means that the folks they are covering are making claims at a much higher rate than it assumed. When it affects the company's earnings as it has in the case of United Dental, it means the company has not put enough money in its reserves. Any payments that are not covered in the reserves come straight out of earnings, which is why an insurance company can report a single, devastating quarter of losses that wipes out many quarters of prior gains.

An insurance company books earnings that are based in part on assumptions of future loss activity. It gets the money from the policy, puts part of it in reserve for future claims, expenses out any overhead fees, and calls the remainder earnings. If the assumptions about future claims are wrong, those prior earnings disappear immediately as the company covers the expenses out of its balance sheet. Although regulators pay more attention to insurance companies than to the garden variety industrial company, including making insurance companies report their results in statutory as well as traditional GAAP (generally agreed upon accounting principles) accounting, mistakes can still be made.

In the last quarter, United Dental Care revenues increased 82% while reserves for claims increased 16%. What this means is that in spite of the fact that United Dental collected 82% more in revenue from policies that it sold, it only increased its reserves for losses from those policies by 16%. Investors can see that the claims reserve as part of the current liabilities on the balance sheet on the 10-Q increased to $2.522 million from $2.172 in the prior year. Although United Dental has more than $50 million in cash in the bank it can use to absorb any losses, the market obviously does not appreciate the earnings volatility -- particularly when it comes as a result of an optimistic claims reserve. Management's statement in the press release about looking at one-time charges probably hints at the possibility of a charge to spiff up the anemic reserve.

Additionally, assumptions about future growth for United Dental will need to be trimmed back as the company increases the reserves it pulls out of future revenues. This is why a number of analysts covering the company lowered their estimates of fiscal 1998 earnings in spite of the fact that this news only purportedly affects this quarter. Volpe Welte, one of the company's underwriters, slashed its 1998 EPS estimate by 26%, to $1.25 per share. Consensus estimates for 1998 prior to today's implosion were $1.69 per share. If the company changes its reserves policy, assumptions about the rate of future earnings growth will decrease as well as the actual base from which those earnings will grow.

CompDent's slide today comes on all of this negative information surrounding United Dental's reserves policy as well as the falling earnings estimates. However, CompDent increased its reserves by 13.7% in the last quarter on a revenue increase of 15.6%, indicating that management there was much more conservative in their assumptions of future losses. Investors should not get too excited, though. Although CompDent's reserve is growing in line with revenues, it is reserving a slightly lower percentage of its total collected premiums. A quick ratio of the reserves to the earned premiums indicates that while CompDent's reserve is growing, if its loss activity starts to look at all like United Dental's, its reserves will probably prove insufficient.

As investors can plainly see, reported earnings on the income statement are not always the most important things to look at when valuing a stock. Much like when sub-prime auto insurer INTEGON CORP. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: IN)") else Response.Write("(NYSE: IN)") end if %> stalled out, investors who had only paid attention to the past earnings growth and future earnings estimates were blind-sided. Should an investor believe that owning an insurance company is something that is appropriate for their portfolio, taking the time to understand how the accounting works will probably save quite a bit of heartache should all of those previously reported earnings "disappear."

CONFERENCE CALLS

ROSS STORES INC. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: ROST)") else Response.Write("(Nasdaq: ROST)") end if %>
(402) 220-1007 -- replay available from 5:00 p.m. EDT through 5/27 @ 8:00 p.m. EDT

WIND RIVER SYSTEMS <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: WIND)") else Response.Write("(Nasdaq: WIND)") end if %>
(800) 633-8284 (reservation # 2748792, code: 2589) -- replay
(303) 248-1201 (reservation # 2748792, code: 2589) -- replay (Intl. callers)

05/28/97 (Wednesday)
MFRI <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: MFRI)") else Response.Write("(Nasdaq: MFRI)") end if %>
4:00 p.m. EDT
(800) 275-2442 -- live and replay available for 24 hours

05/29/97 (Thursday)
INTUIT <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: INTU)") else Response.Write("(Nasdaq: INTU)") end if %>
(800) 839-4232 -- replay available after 6:00 p.m. EDT
(402) 220-4869 -- replay available after 6:00 p.m. EDT

THIS WEEK'S CONFERENCE CALL SYNOPSES

DAYTON HUDSON <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: DH)") else Response.Write("(NYSE: DH)") end if %> Q1 Call
HOME DEPOT <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: HD)") else Response.Write("(NYSE: HD)") end if %> Q1 Call
URBAN OUTFITTERS <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: URBN)") else Response.Write("(Nasdaq: URBN)") end if %> Q1 Call
ROSS STORES <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: ROST)") else Response.Write("(Nasdaq: ROST)") end if %> Q1 Call

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Randy Befumo (TMF Templr), a Fool
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Brian Bauer (TMF Hoops), yet another Fool
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