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Holding Analysis - OCA Q3 10-Q Filing

Contributed by mm | November 14, 2003 4:43 PM PST

I spent an hour to read OCA's Q3 10-Q filing. I believe the worst is over and company is solidifying its fundamentals.

Here are my key takeaways:

- Most of the unfavorable YOY comparisons are due to the litigating practices. The worst is over and organic growth is happening. As an example, in page 30 of the 10-Q (PDF version) the company mentioned $10.8M organic growth in practices affiliated since Q3 2002, and it amounts to around 13% growth (10.8/(112.7-30.8), where $112.7M is Q3 2002 fee revenue and $30.8M is fee from litigating practices).

- Bad debt has a significant impact on the business. Company increased its uncollectible provision by $2.3M in Q3, which drives G&A higher.

- Apparently weak economy in the last few quarters affected both AR and bad debt. If economy can improve or hold, revenue shall pick up and YOY comparison should be easy after another two quarters.

- I expect to see lots of cash flow provided by account receivable decline in the next quarter. It appears to me that the account receivable is quite seasonable. In the history, AR declined 30% in Q4 2002 from $98.3M at Q3 2002 close to $68.5M at Q4 2002 close. In 2001, AR declined 32% from $50.8M at Q3 close to $34.6M at Q4 close. (However, this apparent seasonality is not discussed in the 10-Q.) This cash flow should allow company to pay off more debt and conduct meaningful stock buyback. (I can understand company is under cash pressure so it only bought back 100,000 shares in the first nine months of 2003.)

- The company is shifting its focus "from new affiliations to developing de novo practices and assisting existing affiliated practices to grow, which generally requires less capital investment." This may be a more cost-effective way to grow the business without massive cash outlay. I hope this can translate into revenue growth one year from now.

- One thing I could not find in the 10-Q is more disclosure on the buyout. I want to understand how much the company received out of the buyout. It should be significant enough (my guess is at least above $0.5M). Maybe the buyout contract specified that OCA cannot disclose the details of the settlement, or maybe OCA does not want to tip other litigators of the size of the deal.

Overall, I appreciate management's effort in providing meaningful disclosure. It's really admirable for a small cap to discuss all the ins and outs of the financial statements in such detail. While the litigation cloud may not be cleared for another 12 months, I have confidence that the company is turning the corner now.

From a valuation perspective, I believe the company can achieve an EPS for $1.00 a year for the next year (Q4 guidance is $0.18-$0.22 but Q4 is a seasonally weak quarter), and increase its EPS by at leat 10% YOY. Q4's cash flow will be important, and if my AR seasonality theory works, the extra cash flow can be leveraged to pay off debt and buy back stocks, both accretive to EPS. If the company can show good results in cash flow, it will bring more confidence to the longs.

I believe the stock deserves a price range of $10-$12 for now. I'll consider offloading a part of my positions if the price goes up to $9.50 or $10 for portfolio rebalancing (OCA is 40% of my portfolio after my recent profit taking of some other stocks). I didn't see even a weak case for the shorters: the fundamentals are improving and company is nowhere near bankruptcy.

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