10 Questions With Gartmore Millennium Growth's Aaron Harris

If Aaron Harris is out to prove he's not a flash in the pan, he's making a strong case.

In 1999, he helped manage the (NGTIX)Nicholas Applegate Global Technology fund to a stunning 494% return. Now he's joined Villanova Capital and runs the (NMGAX)Gartmore Millennium Growth fund.

He took the reins in April and has trounced his peers ever since. Last week Gartmore launched two new funds with Harris at the helm: Gartmore Technology & Communications and Gartmore Growth 20.

Given his knack for finding the next big tech trends and the shakiness in the sector these days, it's a great time to huddle with him.

Manager: Aaron Harris
Fund: (NMGAX)Gartmore Millennium Growth
Managed Fund Since: April 15
Assets: $75 million
YTD Return/Rank in Category: 50.2%/Top 1%
Load/Expenses: 5.75%/1.25% (Class A shares)
Top Holdings: Extreme Networks (EXTR) Juniper Networks(JNPR) Quest Software(QSFT)
Source: Villanova Capital and Morningstar. Holdings as of Oct. 2.

1. McDonald: Part of your past success has been figuring out what looked good in the burgeoning Internet sector. Looking forward, what kind of Net companies look good to you?

Harris: Last year, one of the themes was the Internet, and another theme was wireless. Qualcomm (QCOM) was our largest holding. We had the luxury of having to keep trimming it back because it got to be such a big percentage just through performance. I think it was up around 650%. It was the best performing large-cap Nasdaq stock.

We were early in recognizing the new dynamics within Qualcomm: management restructuring; laying off handset division; infrastructure division; concentrating on their semis and their patents on CD-made technology.

The thing that we really look at is early recognition of unrealized growth, and I think at the beginning of '99 the out-year earnings per share estimate was at $1. After they divested and mainstreamed their products, their earnings per share went to over $3.

Now, let's fast forward. Continuing to focus on the bottleneck is the theme. What that means is there's so much traffic being generated -- there's six billion email messages sent a day, Internet traffic around the world is doubling every four to five months. All these major carriers are trying to make their networks more data-specific as opposed to voice. You're talking about mobile-wireless connectivity, pagers, Palm Pilots, Internet access on your cell -- the networks aren't built for that, you know?

So, we're looking for those companies that are solving that problem with the bottleneck. The two that are my largest holdings and that I think are great examples of what we're looking for are Extreme Networks(EXTR) and Juniper Networks(JNPR).

Another one -- to answer the Internet one -- is Art Technology Group(RTG).

2. McDonald: Can you give a thumbnail of what these companies do and why they are in the sweet spot?

Harris: Extreme makes a layer III switch. They're taking a market share -- they've got this Black Diamond Switch, which is really quickly being accepted in the enterprise. They are starting to pick up some service providers like PSI or Qwest or Level III, but they're competing and doing a pretty good job of warding off Cisco's(CSCO) domination in the enterprise. So, that's been a big one.

Juniper is a little bit more outside the network. They're a router, and they are selling directly to the service providers. They have about 22% market share in the core routing business, and I think we're going to see that accelerate.

In the buildouts the industry is so dynamic, and in technology it's so fierce and competitive. These guys continue to have new products. Juniper has the M5N10, which are basically boxes with their Juno operating system in it. Very high profitable margin business, so I think we're going to continue to see some good business momentum there.

Art Technology helps personalize your Web site to make it a functional, wholly integrated suite. They are one of the few that has written a full software platform using Java.

They've got over 400 clients -- (they're) growing like a weed. Their new software platform -- it's called the Dynamo -- is picking up; I think it's taking customers from a company like Broadvision(BRVN).

3. McDonald: And part of that model, when we talk about folks that are in consultative roles -- a big part of that -- is once you get your foot in the door and solve one problem, you might have a better chance at growing with the business as they encounter other hurdles, right?

Harris: Exactly. And that's explains our investments in other companies -- Commerce One(CMRC), i2 Technologies(ITWO), Manugistics(MANU).

4. McDonald: Coming into fourth quarter, we're looking at some dicey issues: a weak euro and some earnings warnings from some of the bigger bellwether tech outfits. A lot of people are saying this is going to be tough this quarter in terms of knowing where put money and feeling confident. Apart from what you've already mentioned, where do you see opportunities in a somewhat challenging environment?

Harris: I think that's a great question, because there's been a lot of noise in, like you said, the bellwethers -- Intel(INTC), Apple(AAPL), SCI(SCI), which makes boxes for Hewlett-Packard preannounced. The thing that I focus on is the dynamic nature of IT spending.

Where is the spending going on the service level -- the AT&Ts of the world, the Qwests to the enterprise -- that's your company, my company. Where are our IT managers spending money, what are the patterns and what are the solutions that are being sought after?

There's been a lot of noise on the big telecommunications spending. Sanford Bernstein brokerage made the comment that there's kind of a disconnect between the large telco and the service provider. They're talking about a 10% capex (capital expenditure) increase next year, while the telecom equipment guys are talking about 30% demand from their customers, so there's a disconnect at 10% vs. 30%.

I think that you have to focus on where in the enterprise are the needs. Obviously, I think optical is going to continue to be a very strong focus for companies.

The thing about optical I think a lot of people don't understand is how much more efficient you become. With these heavy networks that we have in the ground, it's cheaper to build out an optical network now. Your return on investment is so much quicker, so I think that's going to continue to be a play.

Another sector we haven't talked about is oil services -- oil and gas services -- where I have about 18% of the millennium growth fund.

The thesis is: We haven't seen this type of structural imbalance between supply and demand. And that's both on the oil level as well as the gas level. Obviously, everyone knows oil has gone up about $30, but gas inventories are as low as they've been in years, and demand is picking up as we're becoming so much more industrialized.

So, I'm focusing on R&B Falcon(FLC), Pride International(PDE). These guys are solving the challenging industry dynamics, such as the Juniper and the Extremes in their areas. These guys are providing services such as rigs, drillers, and platforms that are being sold to the Chevrons, the Exxons and Shells of the world.

Again, it's companies that are coming up with solutions.

That's why it's so important to kind of understand the vision of management. I think one of the things we do very well is that we stick true to our philosophy of holding management accountable. Can they execute? We believe in the cockroach theory; if they miss one quarter, there's probably more bad news coming.

I still think there's a lot of spending going on we're going to see in mid-October through November for the major energy companies. I think you're going to see some healthy pickup in activity there.

5. McDonald: On the flip side, where are the traps in the fourth quarter?

Harris: I think you're going to probably see some of the Internet content names are going to start to trade a little bit like retail. Again, back to the whole visibility -- are these guys making money, do they have sustainable business models? Also, Internet advertising is a little bit dangerous.

McDonald: Clearly, Yahoo!(YHOO) told us that.

Harris: And if Yahoo! is telling you that, then advertising's in trouble. They're the king. They've been the metric in terms of CPMs, which stands for click per thousand impressions. It's an advertising model, so if you're Nike, you're going to charge them $22 for 1000 impressions to be guaranteed.

They were the only ones where, because they had so much scale, their CPM was sustainable at that level. I think you're going to start to see that pricing coming under pressure. And if they're having problems, I think a lot of Internet advertising companies are going to have problems.

McDonald: So, we're talking about the DoubleClicks(DCLK) and the like?

Harris: Yeah, those second- and third-tier guys don't have the scale and maybe the brand of Yahoo!. Beyond that, I don't know about other sectors that are a "must miss." Right now, what's going on with PC sell through ... people are talking about Windows 2000. I think Windows 2000's rollout and the acceptance has been sluggish and disappointing. It has not sparked the hardware upgrade that people were talking about. I think we're going to need to watch commodity memory, DRAM pricing as an indicator for what's going on.

McDonald: There is that line between old tech and new tech; PCs are pretty mature.

Harris: Yeah, you still hear 15% to 18% PC growth. That's not what it has been historically, but there is still growth. You talk about Handspring(HAND). These guys are having some good quarters. I find it very difficult to monitor consumer spending habits, but there is definitely a trend going on where people want to get online -- maybe the PC isn't the only way to do it any more?

So, PCs marks a percent of market share of people getting online. It's more competitive ...

McDonald: Every dollar that goes to a Palm is a dollar not going to a PC.

Harris: Exactly.

6. McDonald: This is a good segue, actually. What's your take on the bellwether, maturing tech stocks? For example, let's look at Microsoft(MSFT), Cisco and Intel. A lot of folks own those stocks. They've made an awful lot of money on them in recent years, but there are some tough questions going forward.

Harris: Well, Microsoft and Intel -- let's talk about them, because I think they're somewhat related. I think you have to see Windows operating systems -- Windows 2000 operating system -- really being digested. That is going to drive PC demand, and that is going to drive Intel. So, those two are somewhat tied.

I still think they're phenomenal companies. One thing about Intel is that it is so PC-oriented that you're going to need to see the company make some moves outside of that -- be it in wireless or in other types of semiconductors. Maybe they need to look more like Broadcom(BRCM) -- more diversified outside of being a pure PC name. So, those are things to monitor; where is management taking Intel?

The other thing with Intel -- the Athlon Processor, which is AMD's(AMD) higher-end microprocessor that's actually picked up some good share. The competition from AMD has surprised some people.

Microsoft has regulatory issues going on. It's a distraction for management and it's keeps a cloud overhanging Microsoft.

I like Cisco. I like Cisco a lot. There have been concerns about the quarter. I think that these guys have great visibility. You look in their backlog, I think their quarter is done, I think they're probably 3/4 of the way done for fourth quarter -- deferred revenues are up. I think these guys are winning 70% of all network buildouts. They've got some new products coming out, a LAN switch called the Constellation -- I won't get into that too much, but I think Cisco is the networking company to own.

I don't think it's a Cisco wins, everybody else loses, or other people win, Cisco loses. I think Cisco's going to continue to grow. There are companies like Juniper and Extreme that are also growing and picking up market share. I think Cisco's got a very broad product portfolio. It's doing great.

I also own Nortel Networks(NT). I think Nortel is doing great. Actually there was news about them winning some business from Cable & Wireless in Europe.

I own Alteon Websystems(ATON). They're a hardware/software switching company. So, as data comes into your server, it can prioritize (it): Is Ian a first-time browser on Amazon.com's(AMZN) site, or has Ian been on Amazon.com 10 different times and bought about 10 different books, so (he's) going to get priority packaging. That's why I own Alteon.

7. McDonald: One sector we haven't discussed is health care. Do you have interest there?

Harris: I have interest there. I do own a little bit of health care. I own Allergen(AGN). They're about a $10 billion market-cap company that's been a really strong performer.

I haven't had a lot of focus here for a couple of reasons. I think that there's more regulatory issues going on there than technology. It's about 5% of the fund right now. That's very likely to change as we kind of broaden the prospectus parameters. It could be higher. Let me put it this way: It's a place that I'm focusing on.

I'm doing research, talking to analysts, talking to companies; it's really kind of a wait-and-see in terms of certain sectors.

8. McDonald: What do you see in the wireless area? Obviously, Qualcomm had that stunning year last year, and things can't keep going up, but what do you see as a wireless plays?

Harris: I think Qualcomm's a great example of what we're doing. It's capturing change early in its effect on numbers. I would make the argument that this year, I think Qualcomm is gone from (around) $150 to $65 to $70. It's down probably 70%, whatever that percentage is. I'd make the argument that Qualcomm is a better company this year than it was last year.

Let me say, I don't own Qualcomm. And let me give you kind of the macro of what I think about wireless.

Nokia(NOK), Ericsson(ERICY), Motorola(MOT) -- all of the major wireless handset companies have guided down numbers.

We have seen in the last two years ingenious pricing plans to get consumer and corporate penetration up on the wireless. That's not new, you've heard about that; wireless penetration is picking up, you hear all the stories about how the Netherlands and Finland are 100% penetrated.

There was a lot of expectation at the beginning of the year for the continuing second acceleration of wireless demands, and that hasn't come through. And I think some of the reason is because people are saying you have a six-month life cycle on your handset. Well, when was the last time you bought a handset?

There are a lot of problems right now with wireless access in the U.S. Again, the networks aren't built out for it. So, why go out and spend $500 on a cell phone when you're not sure you're going to really get the functionality of the PC? Now, don't get me wrong -- I think that's something we're going to see, but it's been a little bit slower than people had hoped for.

So, you've got that, you've got the major wireless guys and infrastructure guys moderating expectations. And the other thing, too, is that China's a big wild card. China is so massive, with so many people. But there's a lot of regulatory problems with trying to introduce new technology in China.

So, that's my thesis. I actually don't own anything wireless right now. I own the Nortels and the Ciscos, which help provide some of the infrastructure, but I don't own Ericsson; I don't own Nokia; I don't own Motorola.

9. McDonald: If you had to buy three stocks and hold them for five years, what would they be?

Harris: I buy stocks for the reasons I talked about: management's ability to execute and to differentiate between a good company and a good stock. Ultimately, are we going to see the realized growth from these companies? So, I don't put a time horizon in terms of days, weeks, years.

Extreme, Juniper -- I think they're going to continue to be leading this technology revolution. That said, this is an aggressive growth fund, where this year the turnover's going to be probably 300% to 350%. But keep in mind, there are some names in there: Extreme and Juniper that are going to be core holdings of mine, and I might trade around the position a little bit if there's good news; (if there's) bad news I might trim or I might add to the names, but those are core holdings.

McDonald: Part of the turnover is probably driven by inheriting someone else's portfolio, right?

Harris: Exactly. That was my next point.

One company I haven't mentioned is a semiconductor company that makes silicon and puts their software on chips. It goes into DSL, and they're selling to Lucent and some of the DSL providers. It's a company called Globespan(GSPN). It's a little bit of a smaller cap (than) Extreme (or) Juniper. Actually, one I haven't mentioned -- if you put a gun to my head and say five years from now -- it'd probably be Flextronics(FLEX).

They're a contract manufacturer. So, they are outsourcing the hardware components of the product for Motorola, Cisco, Ericsson. If Cisco has a new product, they go to Flextronics and use their manufacturing capabilities, and they'll put Cisco's label on it and sell it. This company, five years ago, was the number 24 or 25 contract manufacturer in the world. They've done such a great job with people's products that now they're the number 3.

They've really been executing. They've made some acquisitions, but they're really focusing on outsourcing for networking and telecommunication equipment. That represents over half of their business. Motorola just recently signed a $30 billion deal over the next five years with Flex. This is interesting: I heard that the relationship between Cisco and Flex is so strong that every three days Flex produces a new Cisco product.

They've got about 150 or 200 products that Cisco has done with Flextronics. So, they continue to execute, visibility's great there. The trending for this type of outsourcing is going to continue, because the Motorolas, Ericssons, Ciscos don't want to be in manufacturing. They want to be in the technology business where they're focusing just on the core technology and outsourcing the actual manufacturing. So, that trend is going to continue.

10. McDonald: Lastly, what's the most recent new name added to the fund, and also to your personal portfolio?

Harris: Personally, I buy my fund. For the fund, I've been adding to my oil service names: Global Marine(GLM).

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