Young Company Suffers A Hit, Takes High Road To Tomorrow

"Disillusion can become itself an illusion If we rest in it."

- T. S. Eliot

The situation of which you are about to read is true. The names have not been changed. The company, whose identity will be revealed, is not a household name. But it is a rapidly growing enterprise that has mushroomed beyond the development stage.

Pretend it is 1979 and you're tinkering in your basement. You've hit upon a product idea, and it's coming together. You start nosing around, knowing you need outside money and heady business people to get this thing to another level.

Years pass before your idea is converted well enough that profits flow regularly.

Now it is 1987. Orders are coming in and the cash register is ringing. You begin a string of profitable quarters that stretches as far as the eye can see. You are still a relatively small company, but by 1988, sales have burst past the $12 million mark.

To get to the next step, and to make it possible for you and your financial angels to be better able to convert your investment to cash, you map plans to go public, to sell common stock to people you don't know.

By 1990, it happens. That little idea in your basement 11 years ago is sold to the public. It suddenly has a market value - total shares times market price - of more than $150 million. You started it with $15,000.

What could be better? The profits continue to roll in. The shares ease off a bit, with a weakening economy, but the future is bright.

Profitability widens. You invest much of it for the future. Your profits ebb a bit because of that. At the same time, you realize order rates, at least for this quarter, are showing a downturn.

Observing federal securities law, you issue a statement. The statement does not say you will experience losses this quarter. It does not say business is in the dumpster. It states that higher development spending and what amounts to a modest order deferral will mean that instead of a doubling of profits from a year ago, your 19th-straight profitable quarter will equal, or underperform by a few pennies a share, last year's results.

How does Wall Street ingest such news? In its time-honored tradition of excess, Wall Street ransacks your stock.

Quicker than a heartbeat, nearly $60 million of your company disappears from the map. A company worth $143 million on Wednesday, Sept. 11, is worth less than $85 million - a 42 percent haircut, as the Wall Street wags put it - 24 hours later.

Not because you are going broke. Not because customers took a walk. But because profits will be a bit less cheery when you announce them the last week of October.

Meet Digital Systems International, a Redmond company in the computerized phone-calling business that became the Street's latest punching bag.

The biggest loser of all was Michael Darland. He is a guy who can come up with a good idea in his basement. He is Digital's co-founder and president. The value of Darland's own stock, in that one fateful day a week ago, plummeted $10 million. That's a bad day.

"I got hurt big time," a plaintive Darland said. "I'm not going to tolerate that."

In other words, the orchestration of a stock drop was not in Mike Darland's best interests.

"I don't want this ever to happen again," Darland said.

But Darland, who knows how the stock market works, concedes his control of some market elements is negligible. Large institutions - mutual funds, banks, pension funds - are lemmings. If they see a potential problem, unlike an individual willing to hold for the long term, they flee.

In two days, a week ago Thursday and Friday, about half of all available Digital stock changed hands. More than 2 million shares found new homes.

"For every sale there's a buyer," the wistful Darland said. As some big hitters cashed out of his tumbling stock, Darland preferred to look at the opportunity presented to those just getting in.

Digital makes gear that automatically dials numbers. But not consecutive numbers, company officials quickly note. These are numbers you program in. For example, many University of Washington alums received phone calls last week asking for money. That was a Digital system.

Customers read like a Fortune 500 Who's Who: Sears, J.C. Penney, American Express, Mobil, McCaw Communications, US West, Chase Manhattan.

Systems automatically disconnect, unless otherwise requested, phone-answering machines. They quickly disconnect when they reach a busy signal. Such automation, Digital said, increases efficiency by three to five times. In a normal business phone-dialing environment, 44 minutes an hour are nonproductive, Darland said. With Digital Systems, 54 minutes an hour are productive.

A concern for securities analysts has been saturation. Is there a point, they wonder, when most companies will have all the telephone efficiencies they need? (That's similar to the first questions asked of IBM and Xerox: How many computers or copiers does one need?)

Darland's response, essentially, is no. That's why the company is devoted to research, finding high-tech solutions to problems.

Darland said he's opposed to systems that randomly call.

"You've got a brick house and you get a call for aluminum siding," Darland said. "It doesn't make you happy and it doesn't make them happy. I think cold-call telemarketing is going to go away."

Digital has a 35 percent market share, double its nearest competitor. Darland is confident Digital can parlay its position and research and development expertise into further gains.

But even the most confident entrepreneur must have to take a deep breath after the week-ago nightmare.

Darland said Digital informed analysts late that Wednesday that profits, instead of the 30-35 cents the analysts predicted for the quarter, would be 9-13 cents. The year-ago produced 13 cents. Darland said securities law obligates a company to inform the public when expectations will be widely missed. He said determining when an order will or won't reach fruition is somewhat of an art, and it was only in the first two weeks of September that Digital could be sure the order rate for this quarter, ending Sept. 30, had seriously slowed.

The reasons for the slowing, Darland said, were, in order of importance:

-- The slower economy was slowing down decision makers; deals were essentially set, but couldn't be booked until final agreements were signed.

-- The summer season interrupted the agreement-signing process.

-- With six of the best sales people promoted to higher positions, a lag existed in training new people. Higher expenses related to that and research and development impinged results.

Wall Street wasn't interested in reasons. The next morning, once the stock started trading, it was down 40 percent. A stock that less than 15 months ago was in the $24 range had dipped below $9.

Looked at in the harshest light - high to low - investors had lost $132 million.

Darland could have whined and dwelled on the past when he outlined some of the above at a Piper, Jaffray & Hopwood investment conference Thursday. He didn't do either. More than 50 people crammed into the small room. When he completed his presentation, the audience - many of them Wall Street money managers - applauded.

At day's end, the stock was up two bits, at $9.25. By Friday's close, it was up 50 cents more, to $9.75.

The Dow Jones industrial average of 30 blue-chip stocks climbed 33.54 points to 3,019.23.

The Murphey Favre Northwest 50, 50 stocks weighted by their regional economic impact, gained 15.85 points to 2,142.61.

Bonds traded quietly, edging up about $5 per $1,000 of face value to close at $1,026. That was priced to yield 7.90 percent, said Mike Drummond of Seattle-Northwest Securities. Drummond said bonds were in a holding pattern. They await evidence another interest-rate cut is coming. He said odds are about 60-40 of another cut this year.

"What goes up will go up," was Judith Cochrane's description of the buoyant municipal-bond market. The Security Pacific first vice president noted about a $5-per-$1,000 improvement in tax-exempts. She said this week's sale of $400 million in Washington Public Power Supply System bonds is expected to go quickly.

On portfolios: Here are percentage gains since the start of the year for two sets of stocks:

Readers' Portfolio (10 NW stocks preferred by readers) - Alaska Air +28.6 percent, Boeing +9.6, Costco +87.6, Immunex +26.6, Intermec +60.0, Microsoft +72.4, Nike +28.0, Nordstrom +110.1, QFC +72.2, Washington Federal S&L +46.1. Average: +54.1 percent. What $1,000 invested in those stocks would be today: $1,541.

Readers' Non-Portfolio (10 NW stocks picked randomly, excluding the readers' top 10) - Arctic Alaska Fisheries +17.9 percent, Bohemia +113.6, Data I/O +72.2, Hecla Mining +19.1, McCaw Cellular +59.4, Momentum Distribution -10.7, Plum Creek Timber L.P. +42.4, ProCyte -2.4, Puget Power +20.2, U.S. Bancorp +47.2. Average: +37.9 percent. What $1,000 invested in those stocks would be today: $1,379.

Wall Street Recap appears Sundays in the Business section.