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Margins Pick: Equitrac

by Louis Corrigan (TMF Seymor)

Atlanta, GA. (Jan. 5, 1999) -- Very slim pickings this week on our Rising Margins screen. We'll forget the penny stocks and ignore one contender, online broker National Discount Broker <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: NDB)") else Response.Write("(Nasdaq: NDB)") end if %>, to focus on an obscure small cap with a low float, low daily trading volume, and no analyst coverage. In other words, high risk and potentially high reward. And best of all, it's boring.

Equitrac <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: ETRC)") else Response.Write("(Nasdaq: ETRC)") end if %> sells computer system products that automatically track, record and report usage of office equipment. For example, its wireless meter-reading products allow copier dealers and manufacturers to collect meter readings for photocopier lease and maintenance programs based on cost per copy contracts. Sounds odd, but it sells its gear directly to professional service firms (like law, design, and advertising firms) and on an OEM basis to giant Pitney Bowes <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: PBI)") else Response.Write("(NYSE: PBI)") end if %>, which means Equitrac's stuff is probably pretty good.

Last week, Equitrac delivered an impressive 41% jump in EPS to $0.31 (before a one-time gain of $0.8 million pumped up reported EPS to $0.45) on just a 16% rise in revenue to $14.4 million. Operating income actually soared 46%. Sounds great. So how'd they do it?

Over $1 million of the $2 million worth of sales growth came from sales to service firms, a market that "continues to be strong," while CEO George Wilson says he's "very pleased" with the "growing relationship" with Pitney. Okay. Sales and service revenue increased 13% while rental revenues were steady. Looks like the real growth is coming in sales, with sales to office equipment dealers and manufacturers the target area.

Two margin-improving areas: 1) Equitrac "replaced low margin sales of third-party computer equipment by its computer services division with higher margin sales of Company manufactured products." 2) The one-time gain came from the sale of its third-party computer maintenance division, which had revenues for the first nine months of FY99 of $4 million ($2.4 million in service contract revenues and $1.6 million of sales of third-party equipment) but an operating loss of $0.22 million.

It's worth pausing over this to think about what it means. Tossing that division out, we should back out $4 million from the $42.7 million in YTD sales to get $38.7 million. YTD operating income is $4.67 million, but the division sale means we can now add back $0.22 million there to get $4.89 million. So operating margins were 10.9%, but on a pro forma basis after the sale, they would really be 12.6%. Just by dumping a lousy non-core business, Equitrac has increased its operating margins by about 16%. Sounds smart.

The Fool Snapshot reveals the company has no debt, $2.44 per share in cash, and a mediocre (but, we know, improving) return on equity of 13.5%. Jumping to Yahoo!, we see a bunch of small insider sales (and no buys), the most significant of which was Wilson's sale of 34,500 shares on May 20 at $20.44, which looks like part of a pattern of periodic selling. That was about 7% of his total holdings. I'd want to take a closer look at this. Regular portfolio-diversifying sales by the CEO are okay, but not great.

Going to the company's 10-K, I see that over the last three years, Equitrac has grown sales by 16.9% per year and EPS by 35.7%. During that time, the stock has tripled. Pretty terrific!

Assuming this non-seasonal biz can deliver $0.30 per share in Q4, FY99 earnings excluding the one-time gain would be $1.16. With the stock around $18, it trades at just 15.5 times earnings three months away. Moreover, those earnings have been held down some by the jettisoned division. Plus, the company actually had about $1 per share in long-term investment securities, a total of about $3.44 per share in cash. So, net of cash, the P/E is about 12.6.

Though the 10-K and recent 10-Qs don't provide a lot of detail into competitors, they do mention plans to roll out new Oracle software soon, which should help Equitrac become more efficient with its new manufacturing facility. This looks like a sleepy stock and a boring business, but one worth further investigation.

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