I'm excited to provide continuing coverage today of one of the best stories I've followed all year long, and by best stories I mean one of the worst stories. Of stocks that readily come to mind dating back the last few years, Imprivata, Inc. (NYSE:IMPR) has one of the most hopeless business models I've had the pleasure of shorting. I've laid out the short case twice prior for Seeking Alpha readers and despite some unexplainable moves higher the last few days - probably caused by the broader indexes going nuts to the topside - the trade remains one that has been very profitable.
Shares are down 24% from where I was able to get borrows initially and I think the action is just getting started. Operations have been a complete dumpster fire, the company is burning through cash faster and faster, and the company has apparently lost the ability to sell any product to customers who aren't already on the books. It's based on these factors that I continue to recommend professional short sellers load this name right here at support and unaware longs finally capitulate and sell.
The Bad Gets Worse
Today's article is really just a rehash of my previous two articles, as every single argument made then holds true now. Before getting to the major points of the short thesis I should probably explain the problem I have with the underlying business. I'm convinced that the commodity IMPR sells is impossible to sell at a profit - at least if this is the only revenue segment the underlying model has. This is the case at IMPR.
IMPR sells single sign-on service. Single sign-on basically boils down to having one singular password or access ability to multiple terminals. The benefits of this are quite obvious in environments like hospitals and those in the financial service industry. You can imagine in a mobile workplace the inefficiencies created from having to constantly log on and log off different workstations. Fortunately for IMPR this benefit is obvious to potential customers. Unfortunately, potential customers can get the service provided from incumbent IT, operating system, or security providers. Luckily for IMPR prospects they can get this at cost or free of charge from the incumbents.
I've also heard the argument from IMPR bulls that IMPR's service isn't simply single sign-on and that it's also about reducing risk of a data breach and reducing clinician admin time. This sounds good; however, IMPR operations tell a different story. To me, it would be different if IMPR was able to bring a different value prop to the table than those of incumbents or competitors offering single sign on at lower costs. It would have a much easier time selling product to those that aren't already customers; but currently, IMPR is deriving revenues almost entirely from leveraging its own incumbent advantage.
IMPR simply has not been able to bring that value prop. I believe this to be evidence that it's selling a highly commoditized product at an uncompetitive price. Clearly, this is not a recipe for long-term viability. I should also reiterate, as noted in the past, that I have personally called to add single sign-on service to terminals and operating systems and for employees during consulting jobs. Almost always this is provided free or at cost. Take that to mean what it may but, at least anecdotally, I'm convinced this is a widespread practice
Now, with that in mind I'll break down the operations that at least right now appear to support my theory. You should know what you're about to see gets very ugly. If you're long the stock you may want to walk away right now. With that disclosure out of the way we'll start with the good:
The one good statement IMPR has consistently brought to the table since its IPO is its balance sheet:
One of the very few tools that IMPR has is cash. It has a lot of cash. In fact cash comprises the majority of IMPR's balance sheet. It also has a $10 million revolver with zero balance. This provides the company with substantial liquidity and flexibility of operations. All of this would normally be a good thing. However, I don't believe IMPR has any productive outlets for the cash on hand. A more simple way of saying it would be that the cash on the balance sheet is a dead asset outside of trying to acquire a profitable business line. That's not exactly a bull case I would want to buy shares around.
All told the balance sheet is strong and does provide some options for IMPR. I just don't think it's enough to provide the type of momentum IMPR is going to need to see in hurry. Until I'm proven wrong I'll continue to roll the dice from the short side.
Operations themselves are a different story:
The top line growth isn't the problem; revenues grew 42% for Q3 and 37.3% for the 9M. We'll get to where those revenues came from in a moment, which is a huge problem, but IMPR is growing at attractive rates. This is a level of top line growth that would normally be attractive to technology investors.
However, when looking at the margins which I detailed in red you can see IMPR is essentially giving away its product when looking at a cost of revenues basis for its particular model. I want to be careful about how I phrase this because I just made the argument that IMPR is selling at a higher price than its competitors. I still believe this obviously. That theory is driven by data that I'll show shortly but for the most part the fact that IMPR can't seem to sell to new customers.
The driving force behind my theory that IMPR can never reach profitability is its margin compression. Margins have been compressing since 2012. Just looking at year-over-year results gross operating and net margins absolutely fell off a cliff. Gross margins contracted 890 bps on the quarter and 700 bps for the 9M; operating margins contracted 12.3% on the quarter and 16.5% for the 9M; and net margins contracted 710 bps for the quarter and 13.7% on the 9M. Equally as alarming is where the margins fell to: operating margins were (16.1%) and (21.2%) for the three and nine months reported and net margins were (17.6%) and (25.8%). IMPR's net margins are telling investors that for every dollar in revenue the company derives it is spending $1.26. That's the calling card of a severely broken model. If IMPR can't substantially raise prices to accommodate for its expenses, and I believe it can't, it won't be able to sustain its model longer term. It just can't. Even on an Adjusted basis IMPR's model is showing that most of the net loss increase on the income statement was coming from actual operations and not one-time and non-cash charges.
To further my argument that IMPR's current model is unsustainable I would like to note that these are the reflections of IMPR selling to already contracted business largely - meaning existing customers that it already has relationships with. Can you imagine what these figures would look like if IMPR was selling to new clients that wanted concessions on the front end?
The following graphics show IMPR's revenue composition and breakdown by customer (new or existing) and market segment (healthcare or non-healthcare) dating back to FY12. The results are extremely damning for the future of this model:
You can see a pretty clear trend of IMPR not being able to sell to new customers and with that not being able to sell outside of the healthcare vertical. I don't find this encouraging. How much longer can IMPR continue to drive revenues without adding new clients? At what point does its book become saturated? Does it even matter with the income statement looking the way it does? I mean really, IMPR isn't even close to being profitable and apparently has no plan to reach profitability and still can't move units to more than one vertical? I just don't see the bull thesis in this.
Finally, IMPR's cash burn has accelerated as of late and it's actually worse than it looks:
The boxes in yellow are line items that IMPR utilized to conserve cash burn. These are line items that will need to be reset in the future; just because IMPR was able to make this statement look better than it actually is doesn't mean it will be able to endlessly delay the outflows it saved. Even with that IMPR still burned ~$9.5 million during the first nine months of the year. I said during the balance sheet section that cash isn't a concern and even with this burn it isn't. But I did want to show that if losses continue to accelerate it could become a concern not that far down the road. Outside of the IPO raise there is nothing productive about this statement.
Where's the trade?
The bottom line with IMPR is that it has a broken model. It can't raise pricing on its product in the fear that it would push its existing book away. IMPR's existing book is its sole source of revenue derivation at this point as it has proven it can't generate revenue from new clients. If it doesn't raise pricing it will continue to grow net losses and cash burn. Both of these are at levels that aren't productive to the bull case, especially the net loss growth which has been the result of compressing margins from higher up in the income statement.
I'm convinced that there are no major risks to the short thesis. What that said, I'll continue to recommend a short position.
I look forward to providing continuing coverage. Good luck to all.
Disclosure: The author is short IMPR.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.