October 15, 1998
Inside Business Week's "Inside Wall Street"
by Louis Corrigan (TMF Seymor)

Lessons From EquiMed

In April '96, New York Times reporter Kurt Eichenwald laid out Dr. Douglas Colkitt's long and astonishing history of self-dealing that started years before he became Chair and CEO of the publicly traded EquiMed (OTC Bulletin Board: EQMD) and National Medical Financial Services <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: NMFS)") else Response.Write("(Nasdaq: NMFS)") end if %>. As Eichenwald put it, if a conflict of interest is a tree, Colkitt had created an overgrown forest.

This forest grew on land Colkitt reportedly gained by outmaneuvering investors who held minority stakes in his businesses. Indeed, some have sued him. Although Times reporters usually don't give specific investment advice, Eichenwald's findings compelled him to offer this decisive conclusion: "Sell both stocks."

In July 1996, just three months later, Gene Marcial's "Inside Wall Street" column in Business Week featured Colkitt's EquiMed in a glowing light. The company then owned or managed 30 radiation oncology treatment centers as well as 18 ophthalmology clinics. Its stock traded on the Nasdaq national market for $7 a share. One unnamed investment manager told Marcial that EquiMed, which then had annual revenue of about $100 million, would soon be raking in up to $50 million in additional sales thanks to a new chain of cosmetic laser surgery centers. Craig Dickson of Everen Securities said EquiMed was worth $20 a share even without these centers.

Since then, EquiMed has sold the ophthalmology clinics, and the cosmetic laser centers never really got off the ground. No chart that I can find adequately presents what's happened to the stock since then. None are ugly enough to tell the real story.

That's because by July 1997, EquiMed had plunged to $1 3/4. Since Colkitt owned over 75% of the stock, he could do as he wished. So he orchestrated a 1-for-6 reverse stock split. That immediately plucked EquiMed out of penny stock purgatory. It also recalibrated the July '96 price to $42 and the price target mentioned in Business Week to $120. Even so, the post-split shares have once again fallen back to $1/8, leaving the stock down 99.99% since Marcial wrote positively about the company.

Nasdaq delisted EquiMed in June for failing to file its 10-K annual report (due March 31) and its first quarter 10-Q report (due May 15). It now trades on the OTC Bulletin Board. In posts dating back to January, short-sellers on the Fool's AOL message board argued that the reason for the delayed filings was that EquiMed's house of cards had collapsed, and Colkitt simply hasn't been able to superglue the financials together so that they have any form at all.

Indeed, Ernst & Young sent a letter to EquiMed in May 21, 1997, charging that "[p]rocedures are not in place to assure all adjustments to the Registrant's accounting records, including general journal entries, are reviewed, approved, and supported with documentation or appropriate explanation." Nor were procedures in place "to assure that routine reconciliations, reviews and analyses of the Registrant's significant account balances are performed on a timely basis."

On July 21 of this year, EquiMed issued a press release indicating that its quarterly financial statements for 1997 "will be restated and should no longer be relied upon." On August 11, EquiMed announced it had filed a $75 million lawsuit against Ernst & Young. The company said there had been no material "disagreements" with its auditors and charged that the auditors had refused to issue a final report simply because of a fee dispute. Ernst & Young rejected this claim, referencing the earlier May 21, 1997, letter in an August 1998 letter to the SEC.

Short-sellers on the Fool message board have speculated that EquiMed's problems might be related to the quality of the accounts receivable at companies once owned by Colkitt but acquired by EquiMed in the last two years. Even the now discredited third quarter 199710-Q filing indicates that accounts receivable more than doubled to $13.6 million by September 30, 1997, from $6.3 million at the end of 1996. Moreover, receivables from affiliates soared to $23.1 million from $9.7 million over this same period.

Alhough EquiMed itself attributed the rising receivables to a reduction in receivables sold under a factoring agreement, the short-sellers may be right, especially given that EquiMed appears to have acquired nine companies from Colkitt during 1997 alone. EquiMed bought three Colkitt companies in January 1997. It paid Colkitt $0.4 million for Nixon Equipment, a firm with $2.3 million in 1996 revenue, part of which came from leasing medical equipment to EquiMed's oncology centers. The other two firms were George Washington Real Estate Corp. and Thomas Jefferson Real Estate Corp. EquiMed paid Colkitt $2.3 million for these companies, which had $0.67 million in 1996 revenues mostly from leasing seven of the eight buildings they owned to EquiMed's oncology centers.

In April 1997, EquiMed purchased a group of management services companies belonging to Colkitt, including Russell Data Services, Billing Services Inc., Trident International Accounting, Tiger Communications International, and an 80% interest in Nittany Decisions Services. Half of the $9.6 million in revenues generated by these companies in 1996 came from EquiMed, which paid Colkitt $6 million in cash plus a possible earn-out of $9.3 million for these firms.

On June 19, 1998, EquiMed's Anesthesia Solutions subsidiary, which was acquired from Colkitt for an undisclosed price less than a year earlier, filed for chapter 11 bankruptcy protection. EquiMed had never issued an amended 8-K filing offering detailed financials for Anesthesia, though the law requires such disclosure.

Allegedly bogus bookkeeping has inflicted other Colkitt-run businesses. For example, Physicians Resources Group <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: PRG)") else Response.Write("(NYSE: PRG)") end if %> acquired EquiMed's ophthalmology division in late 1996 for $55 million in cash plus the assumption of debt. Physicians Resources almost immediately determined the company wasn't worth that amount; it has since sued EquiMed, with EquiMed returning the favor.

EquiMed no doubt has other troubles, too. For instance, the former Colkitt business, Russell Data, which was acquired by EquiMed last year, apparently still owes over $2 million to National Medical, whose own business came mostly from contract work for EquiMed, which it parceled out to Russell Data. Yes, that's as circular as it sounds. Indeed, looking at the related-party transactions over the years suggests that Colkitt may have used the public companies he has controlled to cash out his own private investments or perhaps to prop up those private companies when necessary.

Unsurprisingly, National Medical has seen its own share of troubles. It was booted from Nasdaq's national market to the Nasdaq smallcap market on June 22 for failing to meet listing requirements. After undertaking its own 1-for-10 reverse split in February, the company now trades for $3/8 a share, down from the split-adjusted 1996 high of $67 1/2.

The EquiMed story has surely only gotten uglier since Marcial profiled the company, but the writing was on the wall well before the Business Week article appeared. The EquiMed story provides a number of important lessons. Perhaps the most obvious is that Marcial apparently doesn't do much independent research on the companies he features in the "Inside Wall Street" column. Marcial's piece on EquiMed (July 29, 1996), for example, doesn't even mention Colkitt's troubling history, though one would think that Marcial should have run across Eichenwald's Times piece in any cursory news search.

Instead, Marcial apparently relies completely on comments from Wall Street analysts or money managers (many of whom go unnamed) under the theory that they have the inside scoop. He's just reporting what they think. Yet often they're just plain wrong. Sometimes they're so wrong one must wonder whether they're using Marcial's column to hype a story so they can cash out their own positions. When they're wrong on a smallcap stock, look out below! While EquiMed is an especially ugly disaster, it's hardly the only loser to be temporarily pumped up by Marcial's column.

The EquiMed story offers broader lessons, too.

Avoid Companies That Engage in Lots of Related-Party Transactions

In 1996, EquiMed paid $134,000 to Colkitt's sister Marcy Colkitt to serve as the company's general counsel. Marcy's law firm pocketed another $132,000. In 1995, Marcy gained another $264,500. Also in 1996, a firm owned by the wife of one of EquiMed's directors made $150,000 for assisting in the sale of the ophthalmic practices. Moreover, former minority partners in Onco Tech, a forerunner of EquiMed's oncology business, also claim that Colkitt arranged for the firm to lease equipment from Colkitt's parents back in 1988. The equipment, valued at $175,000, was leased at $9,275 per month, allowing Colkitt's parents to be paid $769,825 in just a few years, according to the New York Times.

But this is minor stuff compared to the multi-million dollar transactions between EquiMed and Colkitt in 1997. Even though there may be nothing improper with these deals, they raise a red flag, especially given that these companies appear to have booked at least half their revenues from EquiMed itself.

It was also noteworthy that in June 1997, before the Anesthesia deal was closed, the board of directors experienced a mass exodus, with three of the four non-executive directors resigning. Among the three was Brian Smith, the only member of the audit committee. Smith was apparently replaced by Jerome Derdel, the lone remaining non-executive director. Related-party transactions are doubly suspect when they transpire in the absence of a strongly independent -- and multi-person -- audit committee.

Consider Management's History

Looking at the links between National Medical, EquiMed, and Colkitt's private companies, a careful observer might have spotted several potential or actual conflicts of interest for Colkitt. Moreover, National Medical's troubles were a good predictor of EquiMed's future.

Avoid Companies With a History of Legal Squabbles

EquiMed was formed in 1996 when the public company EquiVision (formerly Nasdaq: EQVN) merged with the private Colkitt Oncology Group. The Oncology Group had been created from an earlier merger involving Onco Tech,a firm in which Colkitt owned a 60% stake while a group of minority partners controlled the rest. As the New York Times reported, those partners should have received $20 million in the earlier merger, yet they walked away with just $6.2 million. So they sued Colkitt, asking for this earlier merger to be rescinded and for compensatory and/or rescissory damages. While Colkitt has said his actions were legal, he was required to pledge 0.8 million split-adjusted shares having a value of $16 million as of May 30, 1997, to indemnify the company against possible damages. The lawsuit apparently has not been settled yet.

If one were to believe Colkitt's former partners, this episode suggested he cared little about treating his fellow investors fairly. EquiMed's later feud with Physicians Resources also suggested that investors ought to wonder about the validity of EquiMed's financial filings. Though none of these disputes were clear-cut, they simply raised additional concerns about the quality of management, especially in light of the spate of related-party transactions.

Beware of Companies Providing Surprising Forward Estimates

From the start of 1997, EquiMed's press releases talked up a FY97 earnings target of $2.76 per share, making the stock look terribly cheap. But the company's reported income was being taxed at just 6% thanks to net operating loss carryforwards. More important, the company kept adding new operating units throughout 1997, making it simply unbelievable that the company could offer valid earnings guidance. If it sounds too good to be true, it probably is. In this case, it's impossible to say how close EquiMed came to this guidance because it still hasn't reported earnings for the year ended December 31, 1997.

Avoid Companies That Conduct a Reverse-Split

Reverse-splits tend to occur when a stock has been badly beaten down, almost always for good reason. Getting a stock above $5 may be necessary to attract institutional investors. Yet since few institutions are interested in such crummy companies, a reverse-split usually has a largely psychological affect, making a bad company look legit. Reverse-splits also can be used to help manipulate a stock by reducing the float.

Avoid Companies Late To File Regular Reports With the SEC

The Securities and Exchange Commission gives companies 90 days to put together a year-end filing and 45 days to do a quarterly filing. That's ample time. On rare occasion, an investment-worthy company may be late in filing a 10-K or 10-Q report. In general, though, a late filing indicates poor internal controls or perhaps something worse, such as a dispute with the auditors. Investors should usually just avoid any company that's recently been tardy turning in homework to the SEC. EquiMed's history of delayed filings goes back at least to the summer of '96 -- that is, as far back as can be tracked from online sources.

The bottom line is that EquiMed has been an absolute disaster for public investors since Marcial featured the stock in his column. Anyone doing a minimum amount of research should have realized that there were questions about the company and the way it was being managed. The fact that Marcial would consider EquiMed worthy of positive comment says a lot about the value of his "Inside Wall Street" column.