The vital signs are improving at
When this medical technology company reached the brink of implosion last year, management got tough. The company eliminated 21 of 25 offices, cut its workforce in half and reduced the number of product offerings, with an eye toward profitability.
It was just what the doctor ordered. The company saw a swing in earnings before interest, taxes and depreciation, or EBITDA, of $9 million in just a year, trimming its second-quarter loss to $3.2 million this year from a $5.7 million loss in the year-ago period.
More important, the specialty focus will help expand margins and profits. In 2000, the company's EBITDA margin was a negative 12%. This year, the company should see margins of 12% to 14% with "mid- to high teens in 2002," according to Alexander Draper, health care information systems analyst at SunTrust Robinson Humphrey. "Longer term, we think that the business model can sustain a mid-20% EBITDA margin," he noted.
Though VitalWorks will report a net loss in 2001, it should post a profit in 2002. If revenue can grow in the midteens, compound earnings growth could reach 20% to 25% over the next five years.
What I like most about VitalWorks is that nearly 70% of its revenue is now from recurring service and maintenance contracts. For a company looking to grow, that kind of stable base can't be underestimated.
VitalWorks insiders certainly like the thesis. In July, CEO Joe Walsh acquired 635,000 shares by exercising options at $2.10 per share, and independent board members snapped up an additional 11,000 shares in August. There have been no insider sales in the past six months.
As with any small-cap company, there are risks: Small daily volume means potentially volatile swings in stock prices, and small-cap companies have limited financial flexibility if times get tough. Because VitalWorks has a market cap of around $150 million and a float of just 32.8 million shares, getting in or out of it could be difficult.
VitalWorks did all that without a meaningful customer loss. In fact, the company actually increased service revenue -- a good indicator of customer retention -- by more than 4% in the past year.
That suggests the restructuring will pay off. Draper of SunTrust Robinson Humphrey told clients on Monday, "We believe that management has successfully completed its restructuring and has placed the company on a solid foundation for growth." He rates the company a buy, and his firm has provided banking services for VitalWorks.
A Healthy Focus
VitalWorks develops and services management software for clinic-based and hospital-based medical specialties. More than 70,000 physicians in 10,000 locations use its products.
But unlike other medical system companies, VitalWorks has positioned itself as a niche provider to medical specialties. Its largest focus is radiology, with more than 500 locations. It also has a strong presence in two hospital-based practices: anesthesiology and emergency medicine. VitalWorks' office-based products center on ophthalmology, dermatology and plastic surgery.
This niche approach provides VitalWorks with two important advantages: focus and better margins. A "niche specialty focus reduces competition and allows for market leadership," notes Draper. "By taking on a market leadership role, the company can command better pricing, reduce competition and become the de facto standard for these specialty providers."
Operating on the Mend
Admittedly, VitalWorks, formerly known as Infocure, was a mess until a new management team and board took control late last year. Revenue was off 32% in 2000, and its stock slid 90% that year. The company faced a number of lawsuits related to securities violations and contract breaches, and they pushed VitalWorks into the ICU.
Now, a new management team and an independent board have positioned the company to rebound and excel. The company estimates it will post revenue growth of 5% this year amid restructuring, and 12% in 2002. Longer term, the company should achieve 15% top-line growth.
While the company's balance sheet continues to improve as a result of the restructuring and a pending sale of its former headquarters building, which should reduce debt by $5 million to $10 million, the company still carries a debt-to-market-cap ratio of 58%, with nearly $38 million in long-term debt.
The medical-technology business is a tough enterprise. Everyone needed systems leading into Y2K, but now that almost every physician has made a purchase, growth has slowed dramatically. Hence, for VitalWorks to prosper, execution of its core focus on specialties and recurring revenue is key.
VitalWorks has settled a large lawsuit with
, but it still faces lawsuits claiming the company failed to register shares issued in acquisitions. While the lawsuits are unlikely to materially impact the company's operations, settlements could slightly dilute current shareholders.
Still, I like what's beginning to emerge from VitalWorks as it completes its restructuring. I like the niche focus and the potential for profitability early next year. While the lack of current profits keeps me from providing that extra barrel reserved for the healthiest small-caps, I give VitalWorks two-and-a-half barrels.
For an explanation of our barrel rating system, see our recent description.
A Barrel Full of Profits
My weekly review of previous picks provides a reason to give thanks. While
remains under water, a 30% gain in
and an 11% rise in
will provide some turkey for the table.
I'll continue to review the progress here each week.
Do you have candidates for Bottom of the Barrel? If so, shoot me an email with the company's name, why you think it qualifies and your full name and hometown. If we profile your suggestion, we'll send you a TSC gift to commemorate your pick.
Christopher S. Edmonds is president of Resource Dynamics, a private financial consulting firm based in Atlanta. At time of publication, Edmonds' firm had no positions in any of the securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. While Edmonds cannot provide investment advice or recommendations, he welcomes your feedback and invites you to send it to