July 27 was a busy day for Biolase (NASDAQ:BLTI). It accepted its current chief financial officer's resignation, appointed an interim CFO, declared a dividend, and confirmed disappointing earnings of $0.03 per share.
Fool contributor Rich Duprey recently questioned Biolase's focus. With distributors replete with inventory, growth was apparently stalling, and earnings were going to be half of expectations for the second quarter.
Instead of earnings of $0.06 per share expected by analysts, Biolase warned that earnings were likely to be $0.03 per share in an after-market press release on July 16. As is typical with a warning, Biolase's stock was dropped off the edge of a cliff and lost 27% of its share price. Biolase now trades around $9.00 -- a long way from the 52-week high of $21.52 and the glory days of high growth.
When these things happen, I ask myself if investors might have had some warning of things to come and dropped the stock before the market cut down the company. As it turns out, Biolase was sending signals that all was not high-growth and laser-sharp business in the arena of dental lasers.
I looked at the company in May, and the big news at that time was the huge number of short sellers and some negative press from Herb Greenberg at CBS MarketWatch. Greenberg was opining that the reason for all the short interest was an inventory issue and possible channel stuffing. The short action was interesting. Short positions increased from 8.3 million shares in March to 9.2 million in April. In June, shares shorted were still at 9.2 million. This is a stunning 38% short ratio. Do the shorts suspect foul play? They have been right to be short up until now with the declining share price.
The company has vigorously denied any manipulation of inventory, and distributors claim they order just what they need. What do the numbers say? If we suspected that Biolase was not moving lasers at warp speed, we might look for rising inventory levels, rising days sales outstanding, stagnating revenue, and declining margins. Here is what the numbers say.
| June 04 | Mar 04 | Dec 03 | Sep 03 | June 03 | |
|---|---|---|---|---|---|
| Growth in revenue | 3% | -11% | 20% | 29% | 20% |
| Gross margin | 65% | 65% | 69% | 63% | 63% |
| Growth in operating income | 8% | 8% | 18% | 19% | 13% |
| A/R growth | 42% | 7% | -22% | 37% | 46% |
| Inventory growth | 28% | 5% | 3% | 0% | 0% |
| DSO | 54 | 39 | 32 | 49 | 46 |
| Inventory turnover in days | 90 | 72 | 68 | 68 | 85 |
We can see some trends that tell us all may not be smiles in laser sales:
- Revenue and operating income growth has been declining since September 2003, and margins declined in March 2004.
- Inventory levels were climbing and were increasing at faster rates in March than revenue levels were.
- The number of days it took to turn over inventory increased by 2 1/2 weeks in the June quarter -- a trend that started in the first quarter of 2004.
- Biolase was slow collecting its debts, with accounts receivable growth outstripping revenue every quarter except the fourth quarter of 2003.
- Days sales outstanding increased by almost a week in March 2004.
- The firm does not report a backlog of orders in the 2003 10-K.
All this points to distributors not ordering inventory at as rapid a clip and possibly being given price breaks and extended payment terms to buy at all. Both 2003 and the first half of 2004 appear to be times of decreasing demand for lasers. By June, when earnings expectations were cut in half, most of these trends were magnified and increasing. In March, when the first signs of weakness were beginning to gel, the stock was an unattractive purchase or hold.
I combed the 2003 and 2002 financial statements looking for reports of a backlog. Backlog can give you an idea of future sales commitments. There was no backlog, and Biolase declined to answer my email asking why.
Biolase is trying to shore up investor confidence by declaring a dividend and shaking up management, but it's the little things that will keep me out of the stock for now -- those pesky numbers, no back log, and the ignored email.
Fool contributor J. Graham does not own shares of Biolase.
