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Friday, January 30, 1998
Remedy Corp.
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Phone: 650-903-5200
Website: http://www.remedy.com
Price (1/29/98): $15 3/8
HOW DID IT FIND TROUBLE?
After a life in the fast lane that gives new meaning to the term roller coaster ride, shareholders of help desk software king Remedy Corp. have called the doctor looking for an elixir, some strong painkillers, or maybe just a new Eagles record.
Just over a year ago, Remedy was sitting at an all-time high of $55 3/4. Then came the downhill ride on the great American scream machine as any hint of a sequential slowdown among its industry rivals led the entire group to experience vertigo. Remedy fell to around $22 by April, as first quarter earnings beat estimates by 23% but sales declined 21% from the fourth quarter due to a drop-off in software license revenues.
By July, Remedy was climbing again to $47, thanks to second quarter numbers coming in 11% ahead of estimates and other good news among industry players. The stock then dipped to $32 before bouncing back to $47 following third quarter earnings that beat estimates by 13%.
Fourth quarter results reported after the close on January 26 seemed to offer more of the same: record customer and site growth; an award from the META Group and another from integrators and valued-added resellers for best helpdesk software; and confirmation of an enviable 22% market share (twice that of its closest competitor). Operating margins were still an astounding 30% for the quarter. That was down from 33% a year ago, but the difference was more than made up for by the 17.8% of revenue churned back into R&D.
So why has Remedy flown off the track? The trouble began on December 23 when the stock dropped 34% to $21 9/16 after influential Goldman Sachs analyst Rick Sherlund cut his earnings estimates for the company, citing IBM's <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: IBM)") else Response.Write("(NYSE: IBM)") end if %> decision to acquire Remedy competitor Software Artistry <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: SWRT)") else Response.Write("(Nasdaq: SWRT)") end if %>. IBM had an informal deal to nudge customers Remedy's way, and Sherlund suspected this arrangement would end, hurting Remedy's sales.
Despite some good news, the fourth quarter earnings report actually confirmed fears that the momentum was indeed on the downside. Citing a transition in the leadership of its sales force, Remedy reported revenue of $38.8 million, up 31% but about $10 million short of analysts' original forecasts. The revenue shortfall plus higher R&D spending pushed EPS to $0.27, or 13% below already reduced estimates.
Then Bloomberg News reported that Remedy had lost "a number of senior sales people" during the quarter due to IBM's acquisition. The company apparently used its conference call to say that the first half of the year could be flat to down compared with 1997. The stock plunged as much as 34% before ending down 18% to $15 21/32.
BUSINESS DESCRIPTION
Remedy develops and sells adaptable client/server applications software. Its main Action Request System is used to run help desks, which track and resolve internal problems or other requests from a company's own employees. The software is also used to automate other "front office" business operations, including consolidating marketing information on customers to enhance customer support.
As of December, the firm had over 2,800 customers using its software in 5,260 sites in 61 countries. It markets its software through value-added resellers, systems integrators, original equipment manufacturers, and via its own direct sales force.
Remedy has ten publicly traded competitors, including dogs like Clarify <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: CLFY)") else Response.Write("(Nasdaq: CLFY)") end if %> and recent Trouble Scopus <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: SCOP)") else Response.Write("(Nasdaq: SCOP)") end if %>, and cheerier stories like The Vantive Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: VNTV)") else Response.Write("(Nasdaq: VNTV)") end if %> and Siebel Systems <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: SEBL)") else Response.Write("(Nasdaq: SEBL)") end if %>.
Insiders own over 20% of Remedy, with most held by Chairman Lawrence Garlick.
FINANCIAL FACTS
Income Statement
12-month sales: $129.2 million
12-month income: $27.3 million
12-month EPS: $0.89
Profit Margin: 21.1%
Market Cap: $480.5 million (Based on 30.69 million weighted shares)
Balance Sheet
Cash: $133.8 million
Current Assets: $171.1 million
Current Liabilities: $33 million
Long-term Debt: $0.5 million
Ratios
Price-to-earnings: 17.6
Price-to-sales: 3.72
HOW COULD YOU HAVE SEEN IT COMING?
It's tempting to be flip and say, "How could you have missed it?" Despite projections from the Gartner Group that the market for front-office applications software would grow from $600 million in 1997 to $3 billion in 2000, the help desk market is the kind that inspires analysts to say questionable things. Last July, even after Clarify's collapse, Edgar Bierdeman, a Dakin Securities analyst and one-time Remedy bull told The New York Times, "You don't value these companies on earnings. They're too young for that."
Yes and no. A year ago, Remedy traded at 100 times trailing earnings. Despite a terrific first half, the shares had dropped 28% to $40 a share but still traded at 55 times trailing earnings when he made those comments.
Sure, Remedy had a strong market position and stellar prospects, but few firms deserve to trade near their growth rates when that growth is so explosive. Investors should price a little risk into the shares, especially given widespread competition. And if Clarify wasn't enough to make an investor worry, there was always Scopus.
WHERE TO FROM HERE?
Because the company didn't bother to mention the cautious outlook for FY98 in its Q4 earnings press release and failed to issue a follow-up release after apparently making such comments on the conference call, my first reaction is to suggest you avoid this stock. If management doesn't want to deal squarely with the broad investment community as recommended by the National Investor Relations Institute (NIRI), then you probably don't want to have these guys in control of your money.
For investors willing to do the extra work to research this company, though, a check of the recent results shows a still solid business. Lower margin service and maintenance work accounted for 28% of revenue in the fourth quarter, up from 21% a year ago. Still, higher software sales protected the operating margins, thanks to the minuscule incremental cost of making more copies once the R&D work is finished.
Sure, EPS growth dropped to 22% in the fourth quarter versus 59% for the year as sales growth plummeted to 31% versus 60% for the year. First Call estimates of $1.30 per share for FY98 are sure to be cut, perhaps to the $1.00 range or below. The earnings disappointment and IBM news also make the recent volatility different from that seen on Remedy's previous rides up.
Yet, the stock's recent chaos has made this highly profitable business considerably more interesting, assuming its earnings slowdown proves temporary. It might also be a good time to examine some of Remedy's still highflying competitors for signs of impending trouble and to handicap which firms are likely to remain standing after an industry consolidation.
-- Louis Corrigan
([email protected])
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