RJH considers the iSoft revolving credit facility in context...

"Manna from heaven!" must have cried iSoft's board when lenders agreed to raise the group's off-balance sheet revolving credit facility from £30m to £85m in 2003/2004. Yet now, hand-in-hand with aggressive revenue recognition (whatever the footnotes to the accounts may claim) the grab for the increase looks a serious mistake.

If the credit facility, probably near its upper limit, is secured against receivables and Deloitte (iSoft's new auditors) require a restatement backing some of these out from the already recognised NHS contract revenues, it may be the case that the facility's outstanding borrowings have/will become under-collateralised.

It is known that over £50m is uncollected under the NHS contract, a piece of business showing over 800 debtor days and with no end yet in sight. A restatement approaching that size will certainly mean the facility is under-collateralised and is the most likely danger to iSoft's financial stability: insufficient collateral assets with which to repay the revolving credit facility.

If iSoft are in default of their revolving credit facility agreement - and it must be touch and go - they are surely arguing the timing of those NHS revenues (20% of turnover) with lenders. Assuming they secure the best outcome of a waiver (for a fee) against whatever financial covenant the lenders have surely protected themselves with, the firm will still face the possibility of increased cost for the facility going forward. But at least that would be better than ceding control over any company assets in order to honour the covenants of the revolving credit facility agreement.

One wonders why iSoft failed to publish the complete detail of the revolving facility in the accounts long ago. Transparency, in a similar vein to confession, improves accountability, business performance, investor confidence and, in due course, share prices.

And it is good for the soul: perhaps iSoft's PR outfit Financial Dynamics might advise their client to frankness in the April pre-close statement, not the misplaced borderline cocky spin which has characterised recent pronouncements. iSoft need to start rebuilding trust with owners.

The writer owns iSoft plc equity

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RJH writes...

The Financial Services Authority (FSA) announcement that they will investigate the iSoft share price gyrations of 6 April is welcome.

At least Morgan Stanley ought to have little to worry about. Their holdings of iSoft equity changed little between end-March and 7 April, the period in question. The firm, which enjoys an extensive investment banking relationship with Accenture (the company whose 29 March profit warning in part prominently blamed iSoft), has consistently held between 4% and 8% of iSoft's equity since February. The following timeline illustrates:

6 Feb: 4.38% of the outstanding shares held
7 Feb: 6.4% of the outstanding shares held
10 Feb: 6.17% of the outstanding shares held
28 Feb: 5.94% of the outstanding shares held
8 March: 4.8% of the outstanding shares held
13 March: 3.99% of the outstanding shares held
13 March: 5.47% of the outstanding shares held

24 March: 0% of the outstanding shares held
29 March: Accenture blame iSoft for profit warning, iSoft shares fall 12%
31 March: 5.9% of the outstanding shares held

31 March: 7.93% of the outstanding shares held
6 April: iSoft shares fall 40% on an intraday basis, closing down 16%
7 April: 6.87% of the outstanding shares held

The Morgan Stanley sell-out of 24 March looks a bit odd but readers may be certain there is a perfectly innocent explanation - brilliant foresight, for example. The scribe is at an utter loss to provide an alternative to this, but he is a simple chap.

Anyway, at least there is little question Morgan Stanley should be very low on the FSA scrutiny list for 6 April. After all, with circa 7% of the equity and nursing hefty paper losses, they must be as keen as anyone to get to the bottom of these curious dealings.

Then again, maybe not. Good luck FSA.

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RJH writes...

Since the iSoft post in February, there have been several notable developments:

* one of its "partners" on the poisoned-chalice National Health Service
(NHS) contract, Accenture, itself warned on profits and blamed, partially, iSoft

* the iSoft share price suffered a day of what looks like manipulation on 6 April

* the iSoft house broker has warned that accounts may be restated

* at least one press article complains of opacity on the part of management citing as evidence the unknown position of the firm's off balance sheet multi-currency revolving £85m credit facility

iSoft have collected £47m of £109m of recognised revenue from the NHS contract thus far. The difference is about equal to what net current assets were at the half. Presumably the restatement - for surely it is coming if the house broker Bridgewell feels obliged to mention it in client notes - will back out some proportion from both receivables and revenue.

Unless the finance team is putting in an Olympian performance in non-NHS credit collection, positive operating cash flow looks wishful thinking in this scenario. The balance sheet will also appear greatly weakened from the last photo and - add in the factor of the likely 100%+ used position of the revolving credit facility - the issue of banking covenant renegotiation presses.

Take one step back from this din and the question becomes this: is iSoft suffering a crisis of solvency or liquidity?

Long-term debt falling due in 2007 is approximately £13m, and that looks a painless repayment. It is guesswork to assess the impact of a (perhaps) fully used revolving credit facility without data. However, barring fraud it is difficult for this scribe to envisage that the nature of such a facility (principally to provide short term liquidity) would contribute fatally to iSoft. The catastrophe that is the NHS deal means iSoft have anaconda-like swallowed a goat; but, assuming flexible bankers, the firm's existing operations can generate sufficient cash to work off the debauch.

Isoft's is therefore a liquidity crisis and, as bad as matters have become, iSoft management should turn the situation into an opportunity by clearing the financial decks with a conservative set of accounts for end-April 2006. More prudent and thoughtful communication starting with the April pre-close statement would not go amiss either. Few have lost jobs by under-promising and over-delivering.

The scribe owns shares in iSoft plc

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