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Wednesday, December 10, 1997

IMNET Systems, Inc.
(Nasdaq: IMNT)
Phone: 770-521-5600
Website: http//www.imnet.com
Price (12/9/97): $17 13/16


HOW DID IT FIND TROUBLE?

On September 30, IMNET Systems, a provider of healthcare information systems, said its annual 10-K filing would be delayed. The Securities and Exchange Commission (SEC) had made a "confidential informal inquiry" to the company's auditor because letters from an "anonymous party" (a.k.a. short-sellers) had raised concerns about IMNET's financial statements.

The mere hint that IMNET may have cooked its books sent the stock into free fall. Trading near its 52-week high of $42 1/2 at the time, the stock sold off 34% to $26 7/8.

A week later, the company announced it would miss the September first quarter earnings estimates of $0.17 per share and instead report a loss of $0.29 to $0.32 a share due to a fall-off in sales. Chair/CEO Kenneth Rardin said some significant new and add-on contacts weren't closed in the quarter due to the negative publicity surrounding the delayed filing. The company said it probably would not be able to make up for this shortfall in the remainder of the year. IMNET shares sank to a low of $17 on the news.

The next day, the SEC accepted IMNET's 10-K. Its auditors had rechecked the accounting and found no problems. The shares shot up to $24 3/4 on a relief rally likely abetted by short covering. The descent back into the teens followed the late October market turmoil.

BUSINESS DESCRIPTION

Atlanta-based IMNET Systems develops and markets electronic information and document management systems, primarily for the healthcare market.

Its Electronic Information Warehouse software can be integrated with offerings of other heathcare information systems (HCIS) providers such as HBO & Co. (Nasdaq: HBOC), Cerner (Nasdaq: CERN), and IDX Systems (Nasdaq: IDXC). The result is an enterprise-wide electronic medical record system that makes it possible for hospitals, for example, to access financial records and a patient's clinical records (such as X-rays) stored on a variety of media.

In FY97, two customers accounted for 47% of the company's $50.2 million in revenues. Its HCIS distributor alliances generated $18.2 million in sales, most by HBO. Insiders own 16% of the stock.

FINANCIAL FACTS

Income Statement*
12-month sales: $48.5 million
12-month income: $5.1 million
12-month EPS: $0.49
Profit Margin: 10.5%
Market Cap: $173.9 million
(*Excludes non-recurring charges)

Balance Sheet
Cash & Securities: $17 million
Current Assets: $54.3 million
Current Liabilities: $14.4 million
Long-term Debt: N/A

Ratios
Price-to-earnings: 36.4
Price-to-sales: 3.6

HOW COULD YOU HAVE SEEN IT COMING?

Several smaller vendors of healthcare management software have been whacked at various times this year, including IMNET, which lost 60% of its value between January and April. Small companies sporting high P/E ratios are very susceptible to business disappointments and shifts of investor psychology. At its September peak, IMNET was trading at 56 times the soon reported FY97 earnings and more than 41 times forward earnings estimates.

Companies in industries as diverse as aerospace, insurance, and publishing typically capitalize (rather than expense) the costs of developing new products and then amortize these costs over the life of the assets. Short-sellers often argue that this is a dubious practice when engaged in by software developers. Still, it would have been difficult to predict that such investors would be persuasive enough to get the SEC to raise these accounting concerns.

WHERE TO FROM HERE?

IMNET received $10.7 million in new orders during the first quarter, pushing the backlog of signed contracts to $53.7 million, up 94% from a year ago and 5% sequentially.

Yet the First Call consensus earnings estimate for the year ending next June has plummeted from $1.04 per share to just $0.34 in the past 60 days. Over the last 90 days, FY99 estimates have dropped from $1.42 to $1.16 a share. Even with the impact of recent problems, those numbers amount to 23.5% annualized growth in FY98 over FY96.

That estimate offers a reasonable middle ground between one analyst's projection of 50% long-term growth and the more prosaic 8% industry growth rate. It would give us an aggressive YPEG fair value of $27, suggesting some room to run over the next 18 months.

But concerns remain. The SEC didn't inquire of IMNET's auditors until mid-September, and the company didn't announce the matter until the last day of the third quarter. Corporate customers often delay orders from software vendors until the end of the quarter, hoping to get a better deal as companies worry about making earnings estimates. However, if IMNET is so dependent on the very last day of its quarter, an investor should worry about the quality of customer demand and the risks of paying a premium multiple for the stock.

On November 7, the company also announced a management shake-up. Chief operating officer James Gilbert reportedly requested early retirement; CEO Rardin has assumed his responsibilities. Meanwhile, former CFO Raymond Brown has become Senior VP of business development. And Scott Remley, a former Robinson-Humphrey analyst and vocal IMNET bull, has stepped in as the new CFO.

Despite IMNET's assurances that there is no problem with its financial statements, a new CFO often wants to clean up any problems during his first quarter on the job. Investors might do well to wait for IMNET's next earnings report before drawing any conclusions about the company's health.

-- Louis Corrigan
(TMFSeymor@aol.com)


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