Steve --
Re Reply #721
I understand where you're coming from in evaluating Magra's future prospects. I think the problem all investors face in interpreting Magra's financial statements is that management has offered so many generalities and so little hard information.
-- Will Magra ever make a profit??
When I look at Magra's financial results, I see a company that seems to have lost money on every sale, and that very well could go on increasing sales but still losing money.
I honestly can't say whether Magra will make money or not. But I do see some good reasons for skepticism.
First of all, Magra has spent something like 63 to 65 cents of every sales dollar just on the cost of goods sold. If you look at the "cost of sales" figures on the Magra financial statement, that same number shows up on Magra's inventory reporting. That is, I think "cost of sales" is simply how much Magra had to spend on the software (and hardware, if any) that it installed. I don't think "gross profit" includes ANY consideration of costs other than the costs of goods Magra sells.
Now, if Magra was just selling boxes of software, its expenses might not be that large as a percentage of sales. But as I understand its business, it is labor-intensive. That is, Magra seems to be involved in custom applications, meaning Magra computer people go out to various businesses, figure out what they need, and customize software applications for them. Then they probably do some training, show their customers how to run the systems, and continue to consult with the customers to work out bugs, develop new applications within the customer for the software, etc.
This means that a lot of the expenses that Magra incurs -- salaries, travel, phone calls, auto expenses, etc -- probably have to be incurred as an ordinary cost of Magra's sales. I don't think this is a case where Magra's sales involves simply shipping a set of disks to a customer.
If Magra's business involves sending computer people out to customers to work on the customers' systems -- or having computer people work in an office to design systems for customers -- it will be hard to get any "leverage" out of Magra's expenses. That is, if you increase sales 50%, you need to increase hiring of technical people by 50%, and your expenses for those people increase 50%. It seems quite possible that Magra could keep increasing its sales -- and still lost money!
HNLY's latest press release blames Magra's latest loss on "expansion" expenses. But the fact is that Magra, in the recent past, has been losing 7 to 9 cents of every dollar of sales. What would Magra's results have looked like without "expansion" expenses? Who can tell?
To get Magra to break-even for its last fiscal year -- that is, no profit, but no loss -- it would have needed expenses perhaps $175,000 to $225,000 lower than the $1.16 million in expenses it incurred. So what items in that $1.16 million were not needed to bring in the $2.5 million in revenue Magra had in last fiscal year? Could Magra have cut $200,000 from its spending and still have brought in $2.5 million in revenue?
The above figures are only for breaking even. For Magra's current sales to be truly profitable, Magra's "expansion" expenses would need to account for a lot more than $200,000 of its $1.16 million in fiscal year 1997 expenses. To have make a net return of even a modest 5% on sales (i.e., 5% of $2.5 million, or about $125,000), Magra's expenses related purely to "expansion" would have had to be between $300,000 and $450,000.
The real story here may be Magra's declining margins. For the 9 months ended 9/30/96, Magra had to spend only 57% of every sales dollar just on the goods it sold. For the year ended 9/30/97, this figure had increased to 63 cents. For the unaudited last quarter of calendar year 1997, the costs of goods sold was up to 65 cents.
This is just the cost of the stuff Magra sells; it has nothing to do with salaries, office expenses, etc.
If your costs of goods sold increases from 57 cents to 65 cents on the dollar, you need to cut other costs by 8 cents per dollar of sales just to avoid losing ground. That's why declining margins are not a recipe for booming profits. HNLY management ought to address the margins issue directly, rather than trying to blame "expansion" for all of Magra's losses.
-- Net Worth
I agree with you that tangible net worth is not everything when it comes to a non-manufacturing company. But it matters here in three respects.
First, a money-making company should at least be able to pay its bills. It looks as if Magra has had a hard time doing that. It has had little cash, and a lot of accounts payable. Also, where a company's main current asset is accounts receivable, you need to worry about bad debts. Magra's recent financial statements have had virtually zero expenses for bad debts, and I would bet a steak dinner that (1) some of its accounts receivable are at least 90 days old and (2) some of those old debts won't ever be collected.
Second, if Magra is "undervalued," it's not because of its tangible assets. In tangible terms, Magra is worth almost nothing. That means investors trying to figure out how much as share of Magra is worth should look exclusively to its likely earnings.
Third, HNLY makes a big deal of its supposedly high "book value."
But I doubt that "book value" consists of cash, property, or anything tangible. Instead, it likely consists -- at least in large part -- of intangibles such as "goodwill."
The concept of "book value" is almost meaningless unless you know
what type of numbers go into that "book value." When you look at the Magra numbers, you can see that Magra's "net worth" is simply a bookkeeping entry, with nothing physical behind it. I suspect HNLY's "net worth" is more of the same.
-- Capital structure
It's been almost a year since HNLY announced a "letter of intent" to acquire the controlling interest in Magra. I think it would be nice if HNLY would make a public release outlining the terms of the deal, and telling investors what HNLY's capital structure looks like now.
Both the Magra and MC deals involved "cash and stock," but there have been no public releases about how much cash, and how much stock.
I can think of no valid reason why HNLY can't disclose these basic facts immediately.
-- Jim
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