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Monday, November 03, 1997

Neuromedical Systems Inc.
(Nasdaq: NSIX)
Phone: 800-PAPNET4
Price (10/31/97): $4 5/8
Website: http://www.nsix.com

HOW DID IT FIND TROUBLE?

It has been a tough year for Neuromedical Systems. Mounting losses, missed earnings estimates, and the resignation of the CEO could have been enough to put this medical products company in trouble. However, that's only part of the story.

Neuromedical's PAPNET system for the automated screening of Pap smears is locked in a dog-eat-dog battle with several competitors, and lawyers are feasting on the controversy. Neuromedical has sued Neopath, another company with a Pap screening device, for patent infringement and Neopath has sued right back. Cytyc has developed an alternative means to perform Pap testing that was approved by the FDA last fall. A PAPNET distributor has asked the FDA to re-review Cytyc's thin-prep technique, alleging that it isn't all it was cracked up to be. Cytyc has sued Neuromedical for defamation. The uncertainty over the future of Pap screening and the dismal financial performance of Neuromedical has led to Trouble.

BUSINESS DESCRIPTION

Neuromedical Systems manufactures a computer-assisted system for Pap smear testing for cervical cancer screening. The system is designed to reduce the number of false negative tests, meaning greater accuracy and potentially life-saving diagnoses.

The PAPNET system screens slides for abnormal cells and identifies those slides with a high probability of having abnormal cells.

The company has the backing of Goldman Sachs through GS Capital Partners. Competitors in the business include Neopath and Autocyte, both of which do automated testing, and Cytyc, which has an alternative to Pap testing. If the Cytyc thin-prep becomes the standard test for cervical cancer screening, Neuromedical Systems and Neopath may be in trouble. Autocyte's machine can screen the thin-prep specimens; Neuromedical's cannot.

FINANCIAL FACTS

     Income Statement
      12-month sales: $8.2 million
      12-month income: ($38.1 million)
      12-month EPS: ($1.25)
      Profit Margin: N/A
      Market Cap: $142.9 million

      Balance Sheet
      Cash: $52.8 million
      Current Assets: $56.6 million
      Current Liabilities: $9.7 million
      Long-term Debt: $9.5 million

      Ratios
      Price-to-earnings: N/A
      Price-to-sales: 17.4

HOW COULD YOU HAVE SEEN IT COMING?

The decline in Neuromedical's stock has coincided with the FDA approval of Cytyc's new screening test. While investing in any development stage company is risky, the stakes go even higher if that company has a significant competitor.

While at first glance the Cytyc technique and Neuromedical's screening system would appear to be complementary, in fact the PAPNET is not designed to read the thin-prep. An investor realizing the risk that Cytyc posed to Neuromedical might have stepped aside. The spate of legal tangles is an unnecessary distraction as well.

Even if an investor decided that Neuromedical would win the day, the mounting losses that were worse than estimates were also a sign of trouble. The company missed estimates by 21% in the December 1996 quarter and by 10% in the March quarter.

WHERE TO FROM HERE?

Neuromedical has some powerful backers in Goldman Sachs. At this point, the jury is still out on the future of Pap testing. The company has announced new installations of the PAPNET system in the past month.

Earnings estimates for the company are for losses as far as the eye can see. The price-to-sales ratio is distorted by the absence of significant sales. The price-to-R&D ratio is 22, which is a bit rich. Companies trading at a price-to-R&D less than 15 are considered more attractive.

Any investment in Neuromedical Systems would have to be considered an abject speculation. There is no way that the future of the company's PAPNET system can be determined with any certainty. If Neuromedical wins the Pap test wars, there will be ample time to make an investment in the company.

- Mark Weaver, MD, MWEAV@aol.com


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