This was in the Motley Fool's "Daily Trouble" article today:
The Daily Trouble (Archive)
Sep 24, 1997
Document Sciences Corp.
(Nasdaq:DOCX)
Phone: 619-625-2000
Website: docscience.com
Price (9/23/97): $3 3/4
HOW DID IT FIND TROUBLE?
After going public last September at $12 a share, this Xerox spin-off made a brief advance to $16 3/8. Brief is the word, because investors suffered one heck of a wedgie on Jan. 7 when the company said it would miss fourth quarter estimates by four cents a share.
Already down to $10 1/8, the stock dropped another $4 1/4 that day. And though the shares recently rallied for a near double off the lows of $2 7/8, investors have mainly been looking for ways to dump their stock and shed their losses.
Last fall, a glowing article in Investor's Business Daily said this software company was well-positioned to benefit from the booming information economy. In the last three years, Document Sciences has churned out 64% annual sales and 33% EPS growth. Business Week's May 26 edition ranked the firm #19 on its list of hot growth companies, with a 3-year average annual return on invested capital of 50%.
But the Document feeder has been jammed of late by flat results from first time licensing fees, the key to long-term sales growth. In the second quarter, these fees fell slightly versus the year-ago period. Renewal licenses for the company's software are increasing, but support services needed to land and keep contracts are soaring, raising the cost of sales significantly. Support services cost 13% of total revenue in the latest quarter, up from just 5% a year ago.
As a result, the still terrific gross margins have dropped from 86% to 78%. Add in rising selling, general and administrative (SG&A) expenses, and it becomes clear that Document Sciences is only profitable because of the interest income from its huge cash stash.
BUSINESS DESCRIPTION
Located in San Diego, Document Sciences was created in 1992 out of a former unit of Xerox. The company develops and supports document automation software used in high-volume electronic publishing of individually customized documents.
One advantage of this software is that it automatically tags important data from a company's enterprise database and uses this information in documents that it cranks out automatically at a rate of 50 pages per second. For example, a customer's product purchase at a drug store will lead the firm's software to target that customer with follow-up direct mail offering discounts on related products.
The company's CompuSet software sells for about $75,000 plus $25,000 in professional services. Such first-time fees accounted for about 56% of revenue in 1996 but only 41% of sales in the latest quarter. Annual renewal fees run about 15% of the initial fees. The insurance and commercial print services industries accounted for 55% of the firm's revenue last year, with international sales making up 34%.
Document Sciences' more than 500 customers include R.R. Donnelley, Vanguard, Wells Fargo, Caterpillar, Circuit City, Automated Data Processing, First USA Bank, National Data Services, and Reliance Insurance. In addition to companies' in-house information technology divisions, competitors include Image Sciences (partly owned by Xerox), FormMaker Software in insurance, M&I Data Services in financial services, and Group 1 in commercial direct mail.
Document Sciences has derived nearly a third of revenue from relationships with Xerox, which owns a 63% stake in the company.
FINANCIAL FACTS
Income Statement
12-month sales: $17.7 million
12-month income: $1.4 million
12-month EPS: $0.13
Profit Margin: 7.9%
Market Cap: $41.6 million
Balance Sheet
Cash & Securities: $22.4 million
Current Assets: $28.5 million
Current Liabilities: $4.5 million
Long-term Debt: $0.1 million
Ratios
Price-to-earnings: 28.8
Price-to-sales: 2.4
HOW COULD YOU HAVE SEEN IT COMING?
First-time fees doubled in the third quarter of 1996. Although service fees also nearly doubled (and costs more than doubled), there were no obvious signs of impending doom. The company's track record was also quite impressive, though its tiny size meant that increasing the number of service personnel would likely pressure margins.
WHERE TO FROM HERE?
Deutsche Morgan Grenfell analyst Rudolf Hokanson estimated the market for document automation software could grow by 36% a year, to $1 billion by 2000 from $300 million in 1996. According to the article in IBD, Hokanson saw Document Sciences growing by 40% to 45% a year over the same period.
But Grenfell was one of the company's underwriters, and these merry forecasts have just missed the mark. Total revenue is up 37% for the first six months of the year, but just 28% in the second quarter. Plus, the company has had operating losses both quarters. The lone analyst reporting to First Call expects earnings of $0.15 per share this year and $0.25 in FY98, for 55% annual growth over the next six quarters. The stock now trades at just 14.5 times FY98 estimates. Using the 22% industry growth rate gives us a YPEG fair value of $5 1/2.
Document Sciences does have a first-rate list of customers. Plus, the company is sitting on a wad of cash, good for 70% of total assets, or about $2 a share. If the company can show some growth in first-time licenses, its stock might be in for a nice turnaround. |
