Where's the Beef?

By Lawrence Carrel

SmartMoney.com

Published: October 29, 2004

Shares of Emerge Interactive (EMRG) have sizzled 79% higher over the past two trading sessions following Japan's weekend decision to end its 10-month ban and resume U.S. beef imports. On Monday, the stock jumped 40% to $1.22 on speculation that demand for the Sebastian, Fla., company's food-safety technology would surge on the news. The stampede continued Tuesday as Emerge shares tacked on an additional 28% to close at $1.56. The stock climbed as high as $2.02 intraday.

It was Emerge's press release on Tuesday that sparked continued interest in the shares. In the statement, Emerge reminded investors that its CattleLog Process Verified Program is the only system approved by the U.S. Department of Agriculture to collect and report data on individual animals to beef producers and processors. The approval wasn't new; the USDA initially cleared the CattleLog system for six months in January and renewed its approval for 12 months in July. And while the agreement with Japan does open the door for wider use of CattleLog, it neither mandates its use nor explicitly excludes the use of other means of tracking the cows.

"Our system is the most practical and expedited means of verifying that cattle meet the 20-month-or-younger criteria - that's what's new," says Bob Drury, Emerge's chief financial officer. "Frankly, it's not clear - and the people at the USDA have not stated - whether a non-PVP [Process Verified Program] process will be acceptable for the fulfillment of the requirement."

Saturday's decision by Japan to restart limited imports for the first time since December 2003, when a single case of mad-cow disease was discovered in the U.S., is a boon to the beef industry. Before finding the potentially fatal brain-wasting disease, formally known as bovine spongiform encephalopathy, in that lone cow, Japan had been annually importing $1.7 billion worth of beef. The USDA didn't specify when shipments will resume.

"We are undertaking a study to define the criteria to determine an animal's eligibility for export," says USDA spokeswoman Julie Quick. "It's too early to determine how that will work until we have results from the study, which should be completed within 45 days."

At issue is the age of the imported cows. Japan says it will import only cattle that are 20-months-old or younger, since the earliest case of mad-cow disease was found in a 21-month-old cow. Birth records will be used, but they're not always available. The USDA study is also trying to determine if there's a correlation between a cow's chronological age and its physiological characteristics. That's were CattleLog comes in. Data of a cow's birth and origin would be input into the system's database for later verification of the age and characteristics of individual cattle.

The USDA's Quick confirmed that Emerge's system is approved for this type of record-keeping, but she couldn't confirm by press time whether CattleLog was the only acceptable product for performing this function.

Much is riding on the adoption of CattleLog. Emerge posted a second-quarter loss of $2.8 million, 22% wider than its $2.3 million loss a year earlier. Revenue plunged 34% to $212,000. And while the company's cash balance rose to $4.9 million at the end of June from $1.6 million at the end of 2003, Emerge is burning through cash at a rate of $350,000 to $400,000 a month. According to StockDiagnostics.com, a research firm focused on the cash flow of public companies, Emerge had negative cash flow of $2.5 million in the second quarter.

"We are in the process of reviewing our alternatives for additional financing," says CFO Drury. "We believe we have adequate alternatives to ensure adequate available cash."

This isn't the first time that Emerge has shown up on the One-Day Wonder radar. We wrote about the company last year, when its stock soared 82% to $1.15 in a single session. The run-up was sparked by news that five of the nation's top beef processors were using Emerge's Verifeye Solo hand-held scanners for detecting tainted meat. After that, sales of the scanner stagnated, and the stock fell back below a buck.

Emerge's main sales driver is the large-scale Carcass Inspection System, a scanner on two 12-foot towers that can inspect the entire surface of 450 carcasses in an hour. Emerge charges a three-year leasing fee of up to $1.5 million for the system. But since last summer the company has sold only three CIS systems.

Emerge wouldn't speculate on future sales, but Drury expects demand for CattleLog to climb over the next three years. He says McDonald's (MCD) recently vowed to track the beef entering its supply chain. He also thinks the government will eventually mandate the use of animal tracking systems like CattleLog to prevent tainted beef from reaching store shelves and restaurant tables.

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"At that negative cash-flow rate, the company has two quarters to live," says Michael Markowski, director of research at StockDiagnostics.com. "There's no sales growth there. It really needs to raise capital by Dec. 31 or it'll be in big trouble. The problem is the stock price is still so low that [the company] might not be able to do a secondary offering. In that case, it would need to do a private placement or reverse split, and either case would put pressure on the stock." (Markowski doesn't own shares of Emerge Interactive; StockDiagnostics.com doesn't have a business relationship with the company.)