Wednesday, May 31, 2006

John Snow or Henry Paulson--What's the Difference?

George W. Bush, US president, who has been seeking a replacement for U.S. Treasury secretary, John Snow, for months, nominated Hank Paulson, chairman and chief executive of Goldman Sachs (GS-$149.83). President Bush hailed Mr. Paulson's Wall Street credentials and cited his record as "a strong and consistent voice for corporate accountability".

Mark Twain once said: “Truth is stranger than fiction, but it is because Fiction is obliged to stick to possibilities; Truth isn't.”

What follows are actual minutes from the first hearing, convened on January 28, 2003, before the Senate Finance Committee (108th Congress), to discuss the nomination of Dr. John W. Snow to be the Secretary, U.S. Department of the Treasury.

The 10Q Detective has taken liberties with the opening statement of the Honorable Senator from Iowa, Charles Grassley, Chairman of the Committee. The intent is to show our readers that even substituting fiction for fact, when it comes to politics and business, ethics never seem to change--especially when it comes to being the voice of accountability.

[FICTIONAL] Opening Statement of Sen. Chuck Grassley—Finance Committee Hearing, Nomination of Henry M. Paulson, Jr. for Secretary of the Treasury:

“Good morning, and welcome to a special hearing of the Senate Finance Committee for the 109th Congress. All of you are distinguished members and will contribute to the work of the Finance Committee. And of course, I welcome back all returning members to the Committee and particularly you, Senator Baucus (D-Montana). While the gavel may change hands, I don't expect anything to change regarding our good working relationship here on the Committee.

I want to emphasize right off the bat that the office we are considering today is a very important part of our constitutional responsibility. We need a person who can quickly tackle the challenges a Treasury secretary faces. We need a "can do" type of person.

The matter at hand today is the nomination of Henry M. Paulson, Jr. to be Treasury secretary. The Treasury secretary is, after the vice president, perhaps the most important position in the President's cabinet. Given the importance of the office of Treasury secretary, this committee has a bipartisan tradition of acting expeditiously on the nomination. We should not needlessly delay in carrying out our constitutional role with respect to this important position. I ask my colleagues on both sides of the aisle to help us move this nomination quickly. I expect the nominee and the administration to quickly answer questions that may arise.

I want to thank the nominee for his cooperation and his willingness to withstand the heightened scrutiny that has developed over recent years. In the course of our work on this nomination, we have found that Mr. Paulson participated in boardroom coups (the 2003 ouster of the NYSE's autocratic leader Dick Grasso) and executive compensation arrangements that were typical of senior executives in Fortune 500 companies. These kinds of arrangements were the subject of reforms in the Sarbanes-Oxley legislation.

The Finance Committee's retirement plan legislation also tackled many of the excesses in executive compensation. Unfortunately, that legislation was held up in the gridlock of last year. I intend to pursue the retirement plan legislation again. It's clear to me that we need to change the tax code and ensure that abusive executive compensation arrangements don't return.

Many have had questions about Mr. Paulson’s compensation package. Suffice to say, Mr. Paulson earned $38.8 million in total compensation for FY 2005.

Reviewing Goldman Sach’s recent Proxy Statement, filed with the SEC in February 2006, Senator Baucus and I believe that we have now a fairly good understanding of Mr. Paulson’s pay and benefits at Goldman Sachs: Base Salary of $600,000; Restricted Stock Units & Options worth $37.4 million; “Total Annual” Benefits and Perquisites totaling $255,000—of which $153,931 was for a car and driver; Dividend Equivalents on All Prior Years’ Restricted Stock Units totaling $527,000; and, [silent applause] the Committee would like to recognize Mr. Paulson for his investment acumen—Hank, you did not have to be so modest and bury deep in the report that you also earned $1.7 million in proprietary trading profits.

We've shared with members and the media the answers to those questions. Reasonable people can disagree, but it appears that Mr. Paulson’s pay and benefits are typical of a CEO after the Sarbanes-Oxley legislation. While people want to dwell on what Mr. Paulson made, I think it important to also bear in mind what Mr. Paulson is giving up to take the position of secretary of Treasury. Even though all his restricted stock units and options will fully vest upon his leave from the Company, Mr. Paulson will only own 6.05 million shares, worth approximately $907.5 million. Mr. Paulson is forfeiting millions more in salary, benefits, and bonuses by taking this position, which pays only $183,500 per annum.

Mr. Paulson will bring to the Treasury Department a distinguished background of business experience and prior public service. Most importantly, Mr. Paulson is a proven leader with a steady focus on long-range projects and short-term challenges. This focus on short-term problem solving and long-term planning is what the nation needs for a Treasury secretary. As one of our nation's principle economic policy makers, the Treasury secretary must face our nation's sluggish economic performance straight on.

In sum, Mr. Paulson has a reputation of "getting things done." That's good news, because that's what the message was from the election and what Senator Baucus and I want to do on the Finance Committee – get things done for the American people.

We welcome Mr. Paulson in helping us achieve that goal.

Before I conclude, I'd like to discuss international trade. Tax policy is not the only issue that matters to this committee or to the Treasury Department. Expanding international trade is critical to America's economic growth and security. And as Mr. Paulson grew up on a farm, he knows the importance of international trade to America’s heartland.

Treasury, as a steward of the U.S. economy, has always played an important role in the formulation and implementation of U.S. trade policy. As I stated many times last year, I don't want to see this role diminished, even as parts of the Customs Service are moved to Department of Homeland Security. I hope the nominee shares this view. I look forward to hearing from Mr. Paulson….”

Tuesday, May 30, 2006

Bed Bath & Beyond: Bargain Bedding... Bargain Stock Price?

Bed Bath & Beyond (BBBY-$35.22) has filed its Definitive Proxy Statement, announcing to shareholders that its annual meeting will be held on June 29, 2006. Among the items of business are three proposals submitted by shareholders that will require a vote of consideration:

  • ·Whereas, Bed, Bath & Beyond Inc. currently has a Board of 10 people, all of whom are white, and two of whom are female, the Board should publicly commit itself to a policy of inclusiveness and take every reasonable step to ensure that women and persons from minority racial groups are in the pool from which Board nominees are chosen.
  • ·Whereas, Bed Bath & Beyond Inc. currently has overseas operations, be it resolved that the shareholders request that the Company commit itself to the implementation of a code of conduct based on the International Labor Organization’s human rights standards and the United Nations’ Norms on the Responsibilities of Transnational Corporations with Regard to Human Rights, by its international suppliers and in its own international production facilities, and commit to a program of outside, independent monitoring of compliance with these standards.
  • ·Whereas, rising energy costs and concerns about energy security, climate change and the burning of fossil fuels are focusing increasing amounts of attention on energy efficiency, be it resolved that shareholders request that the Company assess its response to rising regulatory, competitive, and public pressure to increase energy efficiency and report to shareholders (at reasonable cost and omitting proprietary information) by December 31, 2006.

A “FOR” vote by a majority of the votes cast is required to approve these three proposals.

Lester R. Bittel, an internationally recognized authority on management and supervision, said: “Good plans shape good decisions. That's why good planning helps to make elusive dreams come true.”

For these shareholders, despite their fervent hopes, successful passage of the three aforementioned proposals will remain elusive, for there are more timely matters of corporate concern to be debated at the annual meeting. [re: Call for greater Board diversity—Similar proposals were placed before the Annual Meetings in 1999, 2000 and 2001. Support ranged from approximately 10% to less than 25% during that period; re: vendors’ human rights practices—This proposal was presented to shareholders last year. Approximately two-thirds of the shares voted opposed the measure, and it received the support of approximately 18% of the votes.]

In our opinion, these shareholder proposals waste valuable meeting time and distract shareholder attention from questionable corporate activity requiring of answers:

  • ·Warren Eisenberg, 75, is a Co-Founder of the Company and has served as Co-Chairman since 1999. Leonard Feinstein, 69, is the other Co-Founder of the Company and has served as Co-Chairman since 1999, too. Each Co-Chairman earned a salary –sorry, “earned” is a poor choice of words—the Company doled out to EACH Co-Chairman $1.10 million in annual salary and $2.40 million in Restricted Stock Units in FY 2005. Additionally, the Company provided $70,703 and $58,051 in FY 2004 to Messrs. Eisenberg and Feinstein, respectively, for personal benefits (such as the use of Company cars for non-business purposes, tax preparation services and other advisory services). As the Board of Directors only met seven times in FY ’05, why does Bed Bath & Beyond need two Chairmen? Granted, for vain posturing, each Co-founder still wants to still think that they are irreplaceable in the hierarchy of the decision-tree at the Company. But must the Company pay them each more than $3.0 million per annum to placate their egos?

    · The employment agreements with Messrs. Eisenberg and Feinstein for “executive employment” expire on June 30, 2007, but can be extended by mutual agreement. Under these agreements Messrs. Eisenberg and Feinstein may at any time elect “senior status” (i.e. to be continued to be employed to provide non-line executive consultative services) at a generous 50% of their salary prior to such election…. Blah! Blah! Blah! While on senior status, both men do not have to devote more than 50 hours in any three-month period to his consultative duties. [Postscript. This is a ten-year deal!] Additionally, following the Senior Status Period, Messrs. Eisenberg and Feinstein are each entitled to supplemental pension payments of $200,000 per year (plus a cost of living adjustment) until the death of the survivor of him AND his current spouse.
  • ·Under the agreements, if Messrs. Eisenberg and Feinstein decide to retire prior to election of their Senior Status Period, the Company must pay them them $700,000 (+) per annum for ten years (or, if the Company chooses, in a lump sum on a present value discounted basis of $7.0 M plus).
Since hitting $46.84 a share in the second quarter of 2005, the share price of this domestics and home furnishings retailer has eroded 24.81% on a general bearish market tone for hard-line retailers as well as company-specific concerns of a deceleration in the projected EPS growth rate for Bed Bath & Beyond. [ed. note. some analysts’ are projecting long-term, normalized EPS growth of 13 percent, lower than consensus Street estimates of 15% to 16 percent.]

Nonetheless [aside from questionable compensation packages to the Co-founders], going into the annual meeting—aside from a depressed share price—Common Stock holders should laud the efforts of management in guiding the Company to a strong 4Q:05 performance (notwithstanding a softening retail spending environment).

For the three months ended February 25, 2006, the Company's consolidated net sales increased by 14.8% to $1.69 billion, as compared to the corresponding quarter last year. Operating margins were in line with consensus estimates of 18.1%, and net earnings increased by $16.9 million, or 9.4%, with an EPS increase of 13.5% to $0.67 per share. (Had management not gone with early adoption of the new stock option expense accounting rules—and not made related compensation plan changes, EPS for the 4Q would have been approximately $0.70 per share, up about 18.6 percent.)

The balance sheet remains healthy. BBBY has been debt-free for a decade, and even after deducting cash used for store openings and improvement programs, ongoing infrastructure enhancements and a $600 million share repurchase program (representing 16.4MM shares and an average price of approximately $36.58), cash equivalents and investment securities totaled about $1 billion at FY ending February 25, 2006. Additionally, net cash provided by operating activities in fiscal 2005 was $660.4 million and free cash flow was $440.1 million.

As of February 25, 2006, the Company operated 809 Bed Bath & Beyond stores; 29 Christmas Tree Shops, and 38 Harmon stores. Square footage totaled approximately 25.5 million square feet at the end of fiscal 2005. During fiscal 2005, the Company opened 83 BBB stores, three CTS stores and four Harmon stores, and closed one BBB store and one Harmon store, which resulted in the aggregate addition of approximately 2.6 million square feet of store space.

On its 4Q:05 Earnings Conference Call, management was comfortable—based on its most recent real-estate analysis—in updating the store openings [square footage] that will fuel this growth: “We now anticipate that we can grow to approximately 1,300 Bed Bath & Beyond stores in the United States [ed. note. before saturation becomes a concern], in addition to continuing the expansion and integration of our Christmas Tree and Harmon store concepts…. expanded information technology capabilities, new merchandising initiatives and developing concepts significantly adds to our potential to create a much larger, more successful retailing business.”

Corporate has issued guidance calling for FY 2006 EPS to grow by approximately 13% to about $2.17 per share, based on the following planning assumptions:

1. The Company’s fiscal 2006 store opening program is expected to include approximately 80 BBB stores, six CTS stores and the continuing development of its Harmon concept. The Company’s new store openings are expected to add approximately 2.5 million square feet of store space.
2. Bed Bath & Beyond new stores are expected to generate net sales of between $160-185 per square foot in the first 12 months of operation. Consolidated comp sales are expected to increase from 3-5% and net sales, including the 53rd week, are expected to increase between 13% and 14%.
3. Based on the current interest rate environment, interest income is expected to be somewhat higher than in FY ’05.
4. The effective income tax rate for FY 2006 is presently being estimated at about 36.6 percent.
5. Average diluted shares outstanding for full FY ’06 is estimated to be 288 million.
6. FY ’06 will be a 53-week year.

The Company has deployed a total of $950 million for share repurchases since December 2004. In our opinion, this demonstrates the impressive cash generating ability of the Company. Aside from initiating a cash dividend payout, the trailing twelve-month ROE of 25.65% suggests that management believes that share buybacks are a prudent investment—and will probably continue as a practical course of action in coming months.

In our opinion, now may be a good time to start accumulating shares in Bed Bath & Beyond. The stock price has already discounted any potential retail slowdown, with the forward P/E of 14 times 2007 consensus estimates of $2.49 is near the stock’s historic trough. Any sales or EPS guidance nudged upward by management will serve as the necessary catalyst to expand the P/E multiple and push the stock to a target value of $45.00 per share.

Friday, May 26, 2006

Sarbanes-Oxley Act--New Approach to Fraud Deterrence?

One of the highest profile white-collar fraud cases stumbled towards its conclusion yesterday when Enron founder, Kenneth Lay, and former Chief Executive, Jeffrey Skilling, were convicted of conspiracy, securities, and wire fraud. The verdict came in the sixth day of deliberations following a criminal trial that lasted nearly four months.

These guilty findings continue a string of government convictions in high-profile corporate scandals of recent years, including Rite-Aid (Martin Grass, CEO), WorldCom (Bernard Ebbers, Founder & CEO), ImClone (Sam Waksal, Founder & CEO)), Adelphia (founding Rigas family), and Tyco (Chief Executive, Dennis Kozlowski, & CFO, Mark Swartz).

In light of the Enron news, we thought it might be timely to revisit a question recently directed to the 10Q Detective by a loyal reader: "Has the SEC ever enforced Section 304 of the Sarbanes-Oxley Act of 2002?"

Beginning with Enron in the fall of 2001, a wave of management scandals scandals crashed on the U.S. economic shores. Responding to public outcry at this seemingly unending stream of corporate malfeasance, President Bush signed the Sarbanes-Oxley legislation into law on July 30, 2002.

At its core, the historic Sarbanes-Oxley legislation is about restoring investor confidence in the U.S. capital markets by promoting corporate transparency (by ensuring full, timely, and accurate disclosures of financial statements).

Section 304 - This section requires management to return bonuses or profits from stock sales received within 12 months of a restatement resulting from material non-compliance with financial reporting requirements as a result of misconduct. Albeit the 10Q Detective does not have a jurisprudential background, we believe that this provision should best be examined in parallel with an empowerment proviso, Section 305, which sets standards for imposing officer and director bars and penalties.

Looking at the SEC’s Division of Enforcement record for 2002 – present, the 10Q Detective could find only one case where Section 304 (Forfeiture of Certain Bonuses and Profit) has been used/enforced:

"This section has been used in the case of Wesley Colwell, an Enron employee who has agreed to be barred from acting as an officer or director of a public company, and who will pay $300,000 in disgorgement (a well-established, equitable remedy designed to deprive defendants of ill-gotten gains) and prejudgment interest and a civil penalty of $200,000." [ed. note. Why only him? How about Andrew Fastow?]

Since 1984, the SEC has used its leverage to slap civil and criminal fines on fraudsters—and recent success’ with these enforcement tools has weakened the necessity to turn to its new enforcement tools waiting in Sarbane-Oxley.

A look at some high-profile corporate scandals of recent years and the status of legal action in each case:

  1. QWEST COMMUNICATIONS INTERNATIONAL INC. (Q-$6.82): While former Qwest CEO Joseph Nacchio awaits trial on 42 federal charges of insider trading accusing him of illegally selling $101 million in stock…. erstwhile Qwest executive Marc B. Weisberg was fined $250,000 and sentenced to 60 days of home detention after pleading guilty to wire fraud. The Company agreed last year to pay $250 million to settle SEC charges of fraud in a deal that did not include individuals.
  2. ADELPHIA COMMUNICATIONS CORP. The founding Rigas family settled with the SEC and the Justice Department and agreed to forfeit over 95% of its collective value, estimated at $1.5 billion. Adelphia Common Stock investors lost approximately $3.9 billion (from the stock’s high in 1999).
  3. WORLDCOM INC. In June 2005, founder & former chief, Bernard Ebbers, agreed to pay $5 million and transfer nearly all his assets [worth approximately $40 million] into a liquidation trust to settle civil charges related to the company's accounting fraud. Ebbers was convicted of fraud and conspiracy in the $11 billion accounting-fraud collapse of WorldCom in 2002. He was given a twenty-five year sentence, but walks free, pending his appeal. [ed. note. Should he lose his appeal, Ebbers is facing a "life-sentence," for given his age (63), he would probably die in prison]
  4. GEMSTAR-TV GUIDE (GMST-$3.58). On May 8, 2006, a federal judge on Monday ordered the former CEO, Henry Yuen, to pay $22.3 million in fines and penalties in an investment fraud case. In March, Yuen was found liable for securities fraud in an SEC lawsuit that claimed he inflated the company's revenue by $248 million to boost its stock and for misrepresenting facts to Gemstar's auditors and falsifying its books. Nonetheless, the judgment against Henry Yuen was less than the $31.4 million sought by the Securities and Exchange Commission.
  5. TYCO INTERNATIONAL LTD. (TYC-$27.22). Although he has yet to reach a settlement with the Justice Department & the SEC, last week, the erstwhile Chief, Dennis Kozlowski, agreed to pay about $21.2 million to settle New York state tax liabilities. Dennis Kozlowski and former CFO, Mark Swartz, each received 8 1/3 to 25 years for their "expensive tastes."
  6. CENDANT CORP. (CD-$16.41). Former Cendant Corp. Vice Chairman E. Kirk Shelton was convicted in federal court in January 2005 of conspiracy and securities, wire and mail fraud. He was sentenced last August to 10 years in prison and ordered to pay full restitution for his role in an accounting scandal that cost investors and the company more than $3 billion. Shelton was ordered to pay $3.27 billion to Cendant.

In theory, Sections 304/305 ought to strengthen the SEC’s ability to obtain meaningful remedies and expand its authority to return funds to harmed investors. For example, the court judgment against the aforementioned Yuen of Gemstar was significantly less than the monies sought by the SEC. If ‘double-jeopardy’ does not apply, could the SEC seek recompense via Sarbanes-Oxley?

Citing research from Glass Lewis & Co., a leading investment research and proxy advisory firm, The Wall Street Journal recently reported that the number of financial restatements by U.S. companies soared to 1,195 last year from 613 in 2004. This is evidence, according to some, that Sarbanes-Oxley has had its intended effect on improved financial disclosure and governance.

Transparency may be improving, but—at present—Section(s) 304/305 still lacks bite. And we are still looking to the SEC to find a "test case" on which to cut its teeth.

"Laws are often made by fools, and even more often by men who fail in equity because they hate equality: but always by men, vain authorities who can resolve nothing.”

--Michel de Montaigne (1533 1592), French Philosopher

Wednesday, May 24, 2006

Charming Shoppes: Salad Days Ahead for This Plus-Size Apparel Retailer?

Despite earning $32.1 million, or 24 cents a share, on sales of $734.9 million in the fiscal first quarter ended April 29, shares of Charming Shoppes, Inc. (CHRS-$11.50) sold off 20 percent in the last four trading sessions, after the plus-size women’s apparel retailer warned of slowing traffic.

In the same period a year earlier, the Company earned $30 million, or 23 cents a share, on revenue of $603.3 million.

On its 1Q:06 conference call, Charming Shoppes guided 2Q:06 earnings lower, warning of slowing traffic at its FASHION BUG stores. In addition to plus-sizes, the 1,025 FASHION BUG stores also sell a wide variety of misses and junior apparel, accessories, intimate apparel, and footwear.

Management is looking for share-net of 24 cents –to-25 cents, while consensus estimates had called for 29 cents per share.

For the fiscal year ending February 3, 2007, the Company did reaffirm its projection for earnings per share in the range of $0.81 - $0.83, in line with analysts’ estimates.

Of concern, management’s guidance for 2H:06 estimates of 33 cents or 34 cents per share, assumes (i) comparable store sales increases of low single digits for the Company's retail stores segment and (ii) 75 – to – 80 new Lane Bryant outlet stores will open on schedule in July and August (and be profitable, too).

In contrast to the pain recently suffered by Common Stock shareholders, Ms. Dorrit J. Bern, Chairman of the Board, President & CEO, continues to lead a ‘charmed life.’

In August 1995, Ms Bern was hired as CEO. It took her ten years to accumulate 1.22 million shares, or approximately one percent, of the Common Stock outstanding, worth $14.03 million.

In January 2005, Ms. Bern signed a new Employment Agreement. Irrespective of future Company performance the agreement provides for an increase in her annual base salary from $1,000,000 to $1,250,000 per year in FY 2006. In the last 12-months, she has also received an aggregate 873,231 shares/units still to be vested (valued at $11.01 million).

Ms. Bern earned cash bonuses of $2.5 million in each of the last two Fiscal years. The 10Q Detective does not contest these payouts. Ms. Bern was at the helm, and thus can take credit for a corporate turnaround. Looking at performance metrics for the prior four year period (from the year-ended February 1, 2003 to January 28, 2006): stockholder equity increased $268 million to $814.3 million; ROE increased from (1.1)% to 13.2%; ROA increased 740 basis points to 6.9 percent; net income increased from $(0.05) per share to share-net of $0.83; and, the stock price increased 281.2 percent in value.

Looking ahead, if the Company does not deliver on its promised growth, the share price of Charming Shoppes will retest its 52-week low of $8.75 per share (set on May 24, 2005). The business plan of the Company is largely dependent upon continued growth in the plus-size women’s apparel market (75% of sales). As corporate, in our opinion, is too dependent on stores not yet open to drive top-line growth, we doubt that this growth will occur. Look for an announcement of comp-store sales decreases to be the catalyst for the next break in the stock price.

June 22, 2006, is the day of the annual shareholder meeting. Deteriorating fundamentals and a slipping stock price does not make it a good day to be the CEO.

The 10Q Detective noted that Ms. Bern’s annual compensation package also includes payment for the rent-free use of an apartment in Philadelphia. The amount for FY 2006 with respect to Bern included $68,671 attributable for use of this apartment. Also included for FY 2006 is the payment of $44,191, representing “gross-up” payments covering taxes payable on the apartment, air travel commuting expenses and medical and financial plan expense reimbursements. The amounts for fiscal 2005 and fiscal 2004 for Ms. Bern’s apartment use were $62,400 and $62,400, respectively.

…. And Caesar, lying in his own pool of blood after being stabbed on the Capitol steps, sees his friend Brutus among the conspirators, and utters his famous words, "Et tu, Brute?"

Knowing history in the corporate boardroom, we doubt, however, that Ms. Bern will ever need to utter those same words: “And you, Brutus?”

Tuesday, May 23, 2006

Arden Group--The Cheap Gourmet?

Arden Group Inc., (ARDNA-$92.36) is a real estate holding company that conducts operations through Arden-Mayfair, its wholly owned subsidiary. Arden-Mayfair's other subsidiary, Gelson's Markets, operates eighteen upscale supermarkets in Southern California. According to management, each location is singularly known as the “area's best market for superior produce, highest quality meat, seafood and deli, an unmatched selection of wine and liquor, and exceptional service.”

Arden Group is also the fiefdom of one Bernard Briskin. Controlling beneficial ownership of 59.1% of the Company Stock, he certainly lords it over his subordinates. Herr Briskin is Chairman of the Board of Directors, President and Chief Executive Officer of the Company and its two subsidiaries. The only executive hat not worn by Briskin is that of Chief Financial Officer. Fealty being suspect—two persons have rotated through the office in the last 2 ½ years—and the post has been vacant since July 1, 2005.

For the fiscal year ended December 31, 2005, Bernard Briskin’s total compensation was approximately $1.80 million, consisting of salary of $611,000 and bonus of $1.19 million. Looking at the terms of his employment agreement, the only compensation that seemed extraordinary was that terms of his contract provide for an annual medical expense reimbursement up to $200,000 for Mr. Briskin and his immediate family during each calendar year. Briskin is 81 years of age.

When the only press heralded by the Company (aside from earnings) is “Quarterly Dividend Declared,” it is hard to get excited about the investment potential of the Common Stock. In fact, unless you live in Southern California, you probably have never even heard of Gelsens. Arden Group, with a total market cap of only $298.2 million, is a food-retailing success with no research following on Wall Street. [ed. note. Might it also be due to a paucity of investment banking opportunities?]

Gelson's upscale stores average between 18,000 and 40,000 sq. ft. and carry traditional grocery items, as well as imported foods and unusual deli selections. Most of the stores also feature coffee bars, fresh pizza, and bakeries. Additionally, selected stores offer banking and pharmacy services through third parties.

Store format and corporate strategy is to remain competitive within its market niches, ranging from the more traditional to the more exotic, specialty or high-end retailers. The Company, however, is not seeking to win customer loyalty on price alone. Gelson’s direct advertising is very limited (primarily newsletters and direct mail) and is typically event rather than price oriented, emphasizing, for example, special holiday selections, specialty items and services, recipes and new products. In our opinion, this ad strategy sends a clear, branded message to customers that the Company offers a comfortable upscale shopping experience which is superior to its competitors in terms of customer service and merchandise selection and presentation.

In our opinion, establishing a positive relationship with its customer base augurs well for future sales momentum—customer loyalty can help fend off competitive threats from the likes of Wal-Mart and other super store discounters (which are eying the higher-margin organic food business’ and store locations nearer to Gelson stores).

Sustaining sales momentum is critical in a slow-growing industry like the supermarket business. For example, the distressed food retailer, Albertson’s (ABS-$25.60), put itself up for sale last September, after failing to cope with competition from discount retailers such as Wal-Mart and the increasing fragmentation of the US grocery market.

The biggest swing factor for investors in Arden Group is when will the Company step up and start aggressively expanding storefronts? Same store sales increased 1.8% during the first quarter ended April 1, 2006, compared to the prior year. This means that future growth depends to a significant degree on the Company’s ability to open or acquire new stores in existing and new markets.

Perhaps the Company should rename itself, “The Cheap Gourmet.” In 2005, despite generating operating cash flow of more than $33.0 million, capital expenditures totaled $6,390,000, which included costs of approximately $2,400,000 related to the remodeling and expansion of the Century City store. The balance sheet is in great shape, with Total Debt-to-Equity of approximately 2.0 percent.

In the 3Q:06, the Company should receive an incremental sales boost from the Century City store when a major road improvement project (which has been under construction along Santa Monica Boulevard since March 2003) is completed.

No other significant contributor to top-line growth is visible. In our opinion, corporate could do a better job of leveraging its real-estate acumen to identify new markets capable of supporting store openings. We contend, too, that increasing the number of store locations will also help to spread consumer awareness of the overall chain.

Nonetheless, Wall Street cannot complain about the Company’s use of assets, for The Arden Group boasted a trailing twelve-month ROA of 14.78%, compared to 6.21% and 5.54% for competitors, Kroger Co (KR-$20.13) and Safeway, Inc (SWY-$23.51), respectively.

Arden currently trades at an enterprise value (EV)/ trailing EBITDA value of 6.19 times and a trailing P/E multiple of 15.73 times. Kroger and Safeway sport trailing multiples of 6.53 times, 15.35 times and 7.32 times, 18.48 times, respectively.

Lord Briskin, age 81, is in no rush to change his conservative management style. There is little evidence to support sustainable sales or earnings growth over the next several years. As a result, in the opinion of the 10Q Detective—until Briskin passes the scepter or dies in office—investors should not expect Arden Group’s valuation to support expanding levels. The trailing dividend yield of 1.10% is not high enough to grab the attention of income-conscious investors, too.

Wednesday, May 17, 2006

Special Purpose Acquisition Companies (SPACs)--How Sound of an Investment?

“Blind pools" are investment vehicles that raise capital by selling securities in a public offering without telling investors how their monies will be used. A common form of blind pool is the "blank check" offering. While the blind pool will usually provide at least some indication of what general industry the funds will be invested in, blank check offerings do not identify any proposed investment intent whatsoever. They are literally "blank checks" that the promoter can use at his whim.

Fraudulent abuses in blind pools—the most common being the” pump and dump" scams of penny stock promoters—resulted in stepped up enforcement by the SEC. The Penny Stock Reform Act of 1990 and 1933 Act Rule 419 now restrict their activities, and an amendment to 1933 Act Section 7 lets the SEC impose special standards on their registration statements.

One of the most notorious blind-pool scams of the 1980s was a Fort Lauderdale, Fla., shell company called Hughes Capital Corp., which raised more than $650,000 from investors, promising to plow the money into profitable private companies. Instead, the Hughes blind pool turned out to be a plain old "pump and dump" stock swindle allegedly dreamed up to help pay off a former stockbroker's mob debts.

Blind pool offerings, which first surfaced in America during the stock market boom of the 1920s, and then again in the Reagan ‘go-go’ years of the 1980’s, are back again. This time, however, they have morphed into new investment vehicles, called Special Purpose Acquisition Companies (SPACs).

Like blind pools, SPACs are investment vehicles that allow retail investors to invest in areas sought by private equity firms. SPACs are shell or blank-check companies that have no operations but that go public with the intention of merging with or acquiring a company with the proceeds of an initial public offering (IPO).

SPACs are forming in many different industries and are also being used for companies that wish to go public but otherwise cannot. They are also used in areas where financing is scarce. Some SPACs go public with a target industry in mind while others do not have preset criteria. With SPACs, investors are betting on management’s ability to succeed. A potential risk for investors, however, is if management of a SPAC buys into an industry where those at the helm have scant experience.

Advocates promulgate that unlike blind pools, all SPACs operate within a carefully structured investor protection framework. At least 80 percent of the funds collected are set aside in escrow for the acquisition and if no acquisition takes place within a specified time, typically 18 months, at least 80 percent of the funds invested in the shell company are to be returned to investors. [ed. note. If the SPAC is unable to complete a business combination and is forced to liquidate its assets, the per-share liquidation amount will be less than IPO price because of the expenses related to initial offering, ongoing general and administrative expenses, and the anticipated cost of seeking a business combination. Furthermore, any warrants issued in conjunction with the public offering will probably expire with no value.]

Placing the funds in a trust account may not protect those funds from third-party claims—something SPAC enthusiasts usually fail to mention. Accordingly, the proceeds held in trust could be subject to claims that could take priority over the claims of the public stockholders and the per share liquidation price could be less the purported 80% liquidation value.

For practical purposes 80% of investors must approve a target acquisition. (The 10Q Detective does not view this particular item as a safeguard, for it is very unlikely that the SPAC investors will vote against the acquisition if the SPAC Sponsor is recommending it.)

Since 2003, sponsors have launched IPOS for about 50 SPACs, raising about $3.33 billion, according to The Reverse Merger Report. Ten of those have announced mergers and six have completed them. The 10Q Detective mentions these stats because all of this increased competition from numerous “blank check” companies (with similar aspirations) seeking to effectuate a business combination, might make it more difficult and/or expensive to complete desired business combinations (at fair value).

EXAMPLES of SPAC Initial Public Offerings (IPOs):

NAME: e-Trials Worldwide / (ETWC - $4.75) / AVG. Daily Volume: 21,682
IPO Info: Formerly known as CEA Acquisition Corporation, a special purpose acquisition corporation, which traded under the symbol CEAC, commenced with an IPO on Feb. 19, 2004. According to the prospectus, CEA issued 4.5 million shares of common stock, including 500,000 shares for underwriter over-allotments at $6 per share. Each share also included two warrants to purchase additional common shares priced at $5 each, exercisable by Feb. 12, 2005, or by the time CEA Acquisition makes a purchase, whichever comes later.
INTENT: CEA’s status as a shell company changed on February 9, 2006, when CEA consummated its merger with eTrials, which offers clinical trial management software for the pharmaceutical industry.
e-Trials Worldwide Unit Value (ETWCU): $7.37/ %-Gain: 22.8

NAME: Fortress America Acq. (FAAC.OB-$5.50) / AVG Daily Vol: N/A
IPO INFO: On July 20, 2005, the initial public offering) of 7,000,000 units of Fortress America Acquisition Corporation (the Company) was consummated. Each unit, purchased at $6.00, consists of one share of common stock and two warrants (each Warrant to purchase one share of Common Stock at $5.00 per share). The Units were sold at an offering price of $6.00 per Unit, generating gross proceeds of $42,000,000. On August 24, 2005, an additional 800,000 units pursuant to the underwriters’ over-allotment option were sold, raising additional gross proceeds of $4,800,000. After deducting for fees, the total net proceeds to the Company from the offering were approximately $43,183,521, of which $41,964,000.
INTENT: FAAC, a blank check company, was formed to acquire an operating business in the homeland security industry.
Fortress America Acq. Unit Value (FAACU.OB): $6.70 / %-Gain: 11.7

NAME: Ithaka Acquisition Corp./ (ITHK.OB - $5.46) / AVG. Daily Vol: N/A
IPO INFO: In August 2005, 8,849,100 Units sold in the IPO, including the 349,100 Units subject to the over-allotment option, were sold at an offering price of $6.00 per Unit, generating total gross proceeds of $53,094,600. Each Unit sold in the IPO consisted of one share of common stock and two warrants, each to purchase one share of the Company's common stock
INTENT: To acquire a business in a health-care related field.
Ithaka Acquisition Unit Value (ITHKU.OB): $6.75 / %-Gain: 12.5%

NAME: Chardan No. Corp. (CNCA.OB-$11.40) / AVG. Daily Vol: 8,430
IPO INFO: In August 2005, CNCA closed on its initial public offering of 5,750,000 units, including 750,000 units issued upon exercise of the underwriters' over-allotment option, with each unit consisting of one share of common stock and two warrants, each to purchase one share of common stock at an exercise price of $5.00 per share. The units were sold at an offering price of $6.00 per unit, generating gross proceeds of $34,500,000. The total net proceeds to the Company from the offering were approximately $30,946,000, of which $29,835,000 was deposited into a trust fund. INTENT: Management’s objective is to acquire an operating business that has its primary operating facilities located in the People's Republic of China in any city or province north of the Yangtze River. On February 2, 2006, the Company entered into a Stock Purchase Agreement with the stockholders of Gifted Time Holdings Ltd. for the acquisition of that company, which is a holding company owning two Chinese companies (Beijing HollySys and Hangzhou HollySys) engaged in the production and sale of industrial automation and control systems.
Chardan North Unit Value (CNCAU.OB): $24.00 / %-Gain: 300.0%

NAME: Cold Springs Capital / (CDS - $5.29) / AVG. Daily Vol: 69,100
IPO INFO: On November 16, 2005, Cold Springs sold 20,000,000 units in its initial public offering. Each unit consists of one share of common stock and two redeemable common stock purchase warrants. Each warrant sold in the initial public offering entitles the holder to purchase from CDS one share of common stock at an exercise price of $5.00. The Company received net proceeds of $109,966,924 from its initial public offering. Of those net proceeds, approximately $107,426,000 (plus an additional $2,400,000 attributable to a deferred underwriters’ discount) was placed in a trust account and will not be released until the earlier of (i) the completion of an initial transaction or (ii) our liquidation.
INTENT: CDS will focus on specialty finance companies.
Cold Springs Capital Unit Value (CDS-U): $6.31 / %-Gain: 5.2%

NAME: Grubb & Ellis Realty Advisors'/ (GAV - $5.60) / Avg. Daily Vol: 1,000 units
IPO INFO: The Company closed the Offering on March 3, 2006 and received net proceeds of approximately $133,400,000 after payment of related offering costs.
INTENT: The IPO will serve as a vehicle for the acquisition of one or more commercial real estate properties or assets. $6.00/Unit [1-share – 2 warrants]
Grubb & Ellis Realty Advisors' Unit Value (GAV-U): $6.80 %-Gain: 13.3

NAME: Star Maritime Acq. (SEA-$9.66) / AVG. Daily Vol: N/A
IPO INFO: $10.00 per Unit. On Friday, March 31, 2006, Mr. Akis Tsirigakis, President and Chief Executive Officer on behalf of the management rang the opening bell at the American Stock Exchange. The Company had previously consummated the Public Offering of 18,867,500 units on December 21, 2005, and received net proceeds of $174,581,364. Of the proceeds of the Offerings, $188,675,000 is being held in a trust account. Each unit consists of one share of our common stock and one warrant. Each warrant entitles the holder to purchase one share of our common stock at an exercise price of $8.00 per share.
INTENT: A blank check company recently formed for the purpose of effecting a merger, capital stock exchange, asset acquisition or other business combination in the shipping industry.
Sea Unit Value: (SEA-$9.66) + (SEA-WT - $1.02): $10.68 / %-Gain: 6.8

NAME: Acquicor Technology/ (AQR-$5.62) / Avg. Daily Vol: 92,100
IPO INFO: March 17, 2006/ $6.00/Unit [1 share- 2warrants]
INTENT: Companies that leverage the adoption of Internet Protocol-based technologies.
AQR Tech Unit Value (AQR-U): $6.95 / %-Gain: 15.8

VALUATION METRICS: Typically, valuation analyses have focused on forward EBITDA. For example, shipping SPACS have been trading at 4-to-5 times forward 12-month EBITDA.

PERFORMANCE REVIEW: The average unit (stock plus warrants) price for SPACs that have not announced or completed a deal, is currently trading at a slight premium to the IPO price. [ed note. these gains disguise the inherent price volatility in trying to sell shares in thinly traded SPACs; the Listed %-gains do not discriminate between bid-offer pricing].

Performance results are mixed for those SPACs that either have announced [CNCA.OB] or have completed deals: Soon after NationsHealth, Inc. (NHRX-$2.40) announced a merger deal with MillStream Acquisition Company, the units peaked at $13.00, providing stakeholders in the IPO with 116.6% upside. Deteriorating fundamentals have since anchored the units back to earth—reporting sequential operating losses and the units were recently quoted at $3.05. Prior to is August 2005 acquisition of Navios Maritime Holdings, a Greek shipping company specializing in the dry-bulk shipping industry, units of International Shipping Enterprises (BULK-$4.75), peaked at $10.50 (+). Fundamentals—once again—have righted this ship, too, and today the unit price (BULKU-$5.69) is down 5.3% from its IPO.

Contrary to what the 10Q Detective has read on the Internet, the SEC is not actively seeking to ban future SPAC public offerings. Nonetheless, investors should pause before leaping in—on faith in management alone—to purchase shares of any SPAC. Like going to the beach, investors ought to read the signs, for SPACs contain the following statement in their Form S-1 Registration filing with the SEC: “The Company has neither engaged in any operations nor generated any revenues to date.” If you are thinking of swimming in the SPAC market—BEWARE UNDERTOW.

Monday, May 15, 2006

CarMax--"Best Company to Work For"

CarMax, Inc. (KMX-$32.66), is the nation's largest retailer of used cars and one of the Fortune 2006 "100 Best Companies to Work For.” Of the 11,500 (+) U.S. employees, 42% are classified as minorities and the voluntary turnover rate is 17% per annum. Employees can also buy any car left on the lot longer than 14 days for $200 over cost.

The 10Q Detective nominates CarMax as one of the “100 Best Companies to be on the Board of Directors For,” too.

The annual cash retainer was increased from $35,000 to $50,000 in the second quarter of fiscal 2006 for non-employee directors. Non-employee director compensation, including both cash and equity components, will average approximately $136,300 in FY 2006—all for no more than (on average) three weeks worth of “work.” Contrast that with CarMax employed buyers, who are responsible for obtaining CarMax’s used-car inventory through appraisals and by attending off-site auctions. Buyers earned (on average) $55,000 for their full-year employment (in 2004).

CarMax reimburses all directors for travel and other necessary business expenses incurred in the performance of their services to the company and extend coverage to them under the company’s health insurance policies. The Company also permits all directors to use the company’s corporate jet for personal travel; and the directors may also participate in the company’s vehicle discount purchase program that is available to all company associates.

The CarMax ‘Commitment to Diversity’ states: CarMax is committed to respecting the unique attributes of its Associates, customers and vendors. These attributes may include age, race, color, gender, disability, sexual orientation, religious affiliation, national origin, marital and citizenship status.

Consistent with this commitment, CarMax does not tolerate discrimination of any kind—except when it comes to compensation for corporate insiders.

Friday, May 12, 2006

"There's No Such Thing as a Free Lunch."--Milton Friedman

The 10Q Detective is pleased to announce that come June 2006, readers will be afforded the opportunity to join our soon-to-be launched bi-weekly online newsletter as charter members (yes! That means being able to subscribe at a discounted rate.)

The 10Q Detective will still be offering investment ideas and exposing managerial malfeasance on our blogspot, but detailed analysis, including interim reports and follow-up(s) until price-closeout will only be accessible to subscribers of the newsletter.

Quid pro Quo. To those loyal readers who have helped to make our web log one of the more popular online stock destinations, we thus—one last time—offer (for free) follow-up opinions on some of our more popular stock ideas:

12-22-05. Taser Int’l (TASR-$7.20) $10.16 41.11%
SELL. Recent court cases continue to validate the use of the TASER device. On May 10, 2006, the sixteenth product-liability lawsuit against the Company was dismissed. Nonetheless, profitability still remains elusive. CLOSEOUT.

01-17-06. Convergys (CVG-$15.82) $19.54 23.5%
SELL. Investors have ‘converged’ on our initial investment thesis: “IF Convergys can demonstrate sustainable quarterly-Earnings-Growth….investors would be willing to expand the Company's forward earnings multiple….” Recently, this provider of outsourced business services, said its earnings grew 18 percent in the first quarter (from growth in its customer and employee care groups). The company also boosted its full-year outlook. The stock still has room to run, but the 10Q Detective is pleased to trade-out with a 23.5% gain in only four months.

02-09-06. Genesis Microchip (GNSS-$19.25) $12.33 35.94%
BUY. Jim Cramer screamed BUY on his ‘Mad Money’ show—good enough reason for us to consider the contraire position. Kidding aside—we did warn readers that business was cyclical and that GNSS was too dependent on too few companies for business. On May 3rd, Genesis said in a conference call that it lost business from two major customers, LG and Toshiba. Ergo, this designer of integrated circuits used in flat-panel displays tripped up investors and Wall Street analysts alike when reported earnings fell short of expectations. CLOSEOUT OPEN SHORT.

03-27-06. Gigabeam (GGBM-$10.80) $13.15 21.75%
SELL. Competition for WIFI is fierce—lock in predicted profits.

03-14-06. Martek Bio (MATK-34.24) $27.11 20.82%
BUY. Like shark cartilage tablets, over-priced and a questionable cure-all for what ails the patient. One can get their required daily dietary requirement of essential fatty acids by eating right. CLOSEOUT OPEN SHORT

03-29-06. Spectrum Brands (SPC-21.25) $16.92 20.38%
BUY. Shares of this consumer product supplier fell a fortnight ago after the company reported fiscal second quarter profit below its own estimates due to weak battery sales in North America and Europe. Housecleaning—CLOSEOUT OPEN SHORT

01-10-06. BioCryst Pharma (BCRX-.$20.08) $13.54 32.57%
BUY. A highly touted bird-flu vaccine play that is rolling in red ink. Could probably fall to single-digits, but why turn down bragging rights? CLOSEOUT OPEN SHORT.

12-21-05. Brookdale (BKD-$31.00) $37.32 (21.77)%
SHORT. Brookdale Senior Living Common Stock shares continue to trade on helium, as investors anticipate a fundamental turnaround in earnings. Back in March, the Company reported a 3Q loss of $(24.5) million, yet boosted its quarterly dividend 40% to $0.35 per share. The balance sheet cannot support this dividend payment, with a total debt-equity ratio of 119.7%, and a quarterly debt service expense of $12.8 million. Fortress Investment Holdings, which owns 66.5% of Common Stock outstanding (and controls the Board of Directors), basically rewarded itself with this dividend ploy. OPEN POSITION

Want to continue to follow Brookdale in future months? You will soon find out how easy it will be to do so!

If readers have any questions or concerns on the announced changes, do not hesitate to send an e-mail.

Thursday, May 11, 2006

VIVUS, Inc--Better than Sex!

Last week, when VIVUS, Inc. was selling for $3.06 per share, we recommended the purchase of the Common Stock of this biopharma concern, which is developing treatments for male and female sexual disorders. Succinctly, our investment thesis read: “Vivus has an enterprise value of only $114.7 million. This stock is cheap and does not reflect the future value potential of its proprietary drug portfolio— the four leadership products in development are each targeting markets with more than $1 billion in annual sales.”

Shares of VIVUS have jumped almost 41% in the last three trading days after the Company announced positive clinical results from two drugs in development. First, the Company said on Friday that its spray-on menopause treatment, Evamist, significantly reduced hot flashes in a late-stage clinical study.

Second, corporate reported earlier today that a weight-loss trial showed that participants given the Company’s proprietary weight-loss drug, Qnexa, reportedly lost an average of 25.1 pounds after 24 weeks, compared with the average 4.8 pounds in the placebo group.

We suggest that our readers heed the advice of our favorite Wall Street aphorism: a bull makes money, a bear makes, money, but a hog never makes anything. A 41% gain in nine days? SELL and walk away—for now….

Wednesday, May 10, 2006

Dollar Tree Company--"Just an Old Stump?"

Since its founding in 1986, Dollar Tree Stores, Inc. (DLTR-$27.43) has become the leading operator of discount variety stores offering merchandise at the fixed price of $1.00. At January 28, 2006, the Company operated 2,914 single-price point stores under the names of Dollar Tree, Dollar Bills and Dollar Express.

Management prides itself on maintaining a disciplined, cost-sensitive approach to store site selection in order to “minimize the initial capital investment required and maximize the potential to generate high operating margins and strong cash flows.” In other words, corporate primarily looks for ‘lower-rent’ districts—like strip shopping malls—and prefers to lease (as opposed to owning) the store properties.

Dollar Tree’s business model translates into a Value Merchandising Offering strategy. The Company strives to exceed its customers’ expectations over the scope and quality of products that they can purchase for a buck by offering items that management believes would typically sell for higher prices elsewhere.

Dollar Tree offers a wide selection of everyday basic products, supplemented with seasonal and closeout merchandise. The Company attempts to keep certain basic consumable merchandise in its stores continuously to establish its stores as a destination. Closeout merchandise is purchased opportunistically and represents less than 10% of corporate purchases.

The merchandise mix consists of:

  • consumable merchandise, which includes candy and food, health and beauty care, and household consumables such as paper, plastics and household chemicals and in select stores, frozen and refrigerated food;
  • variety merchandise, which includes toys, durable housewares, gifts, party goods, greeting cards, hardware, and other items; and,
  • seasonal goods include Easter, Halloween and Christmas merchandise, along with summer toys and lawn and garden merchandise.

The Company has added freezers and coolers to approximately 200 stores in 2005 and plans to add them to approximately 250 more Dollar Tree stores in 2006. As a percentage of purchases and sales, consumable merchandise grew 350 basis points year-over-year to 44.9% by February 1, 2006.

In 2005, corporate expanded the tender types accepted at Company stores. Prior to May 2005, approximately 900 stores accepted debit cards. By the end of 2005, approximately 2,300 stores accepted debit cards as a result of the debit rollout. Dollar Tree also began accepting food stamps at certain of its stores in 2005.

The 10Q Detective believes that the aforementioned moves made by corporate will grow Dollar Tree’s image among consumers as a ‘destination’ store. This enhanced visibility will help to grow the topline, for both the average dollar size of transactions [more ‘impulse’ buys] and repeat business will expand.

Implicit in advertising product(s) at the $1.00 price-point is cost-control. Dollar Tree minimizes potential markdowns by buying products on an order-by-order basis and making sure that no vendor accounts for more than 10% of total merchandise. Using point-of-sale data (POS) software installed in 2004, the Company has been successful in reducing its inventory per store (approximately 12% and increase inventory turns in the current year—3.7 times in 2005).

The Company’s operating margins (looking at comparables) are swamping the competition. Direct competitor comparisons of operating margins for Dollar Tree, 99 Cents Only Stores (NDN-$12.02), Dollar General Corp. (DG-$17.08), and Family Dollar Stores (FDO-$26.73) are 8.35%, 2.35%, 6.55%, and 5.70%, respectively. [ed. note. Operating margins for Dollar Tree actually fell year-over-year for FY ended January 28, 2006—more on that later.]

Additionally, existing stores are throwing off enough cash flow to permit the Company to self-fund infrastructure investment and new store openings.

Contrary to this tight-fisted public image, our readers might be surprised to read about the spendthrift ways of the Company “in private.” The 10Q Detective has unearthed some great water cooler gossip in the DEF 14A filed last week with the SEC:

  • Non-employee Directors receive an annual retainer of $80,000. During 2005, the Board held five formal meetings, which equates to a $16,000 payment per meeting! [The 10Q Detective did not include committee meetings in this total—suffice to say that Directors are compensated with additional $$$ for other duties, too.]

Same-store sales comparables fell (0.8%) in the FY ended January 28, 2006 compared to the prior year and operating income as a percentage of sales dropped 110 basis points to 8.3 percent. ROA fell 120 basis points to 9.7% and ROE slipped 160 basis points to 14.9%. Nonetheless, in late 2005, in order to improve performance incentives, the Compensation Committee approved the acceleration of vesting for all outstanding stock options for both officers and non-officers. Huh?

  • Dollar Tree’s Chief Executive Officer. Bob Sasser, was paid a base salary was $700,000 in 2005. At the beginning of the fiscal year, the committee established certain operational and managerial goals for Mr. Sasser for the fiscal year ending January 28, 2006. In recognition of his achievement of certain operational and managerial goals and the company’s performance in 2005, Mr. Sasser earned a bonus of $171,920. Huh? [One can only drool with envy at the thought of what his bonus might have been—had the Company’s financial showing been even better in FY 2005.]
  • Macon F. Brock, one of the Company’s founders, currently serves as Chairman of the Board. For fiscal 2005, Mr. Brock’s base salary was $400,000. This payment was justified on the merit—cough! Cough! —Mr. Brock is STILL CONSIDERED to be a KEY employee: “whose responsibilities included long-term and strategic planning.” Readers ought to note that Mr. Brock resigned as CEO back on January 1, 2004. [In 2003, he received $50,350 towards his ‘purported’ retirement. This amount included $15,432 of tax preparation services that the Company paid on his behalf and a retirement gift of $34,918.]
  • At the beginning of the FY 2005, the Compensation Committee established certain operational and managerial goals for Mr. Brock. In recognition of his achievement of these goals and the company’s performance in 2005, Mr. Brock earned a bonus of $102,760. Huh? The 10Q Detective could have sworn we just read that he retired in 2003/04?
  • In fiscal 2005, the Committee also granted him the option to purchase 20,000 shares of common stock and awarded 5,000 restricted stock units. [ed. note. Not that Mr. Brock needs to accumulate additional shares, for he already owned approximately 2.2 million shares, or 2.1% of the Company.]
  • J. Douglas Perry, one of the three founders of Dollar Tree back in 1986, became Chairman Emeritus of the Board in 2001. [ed. note. How many Chairman of the Board does one company need?] On January 29, 2005, the company entered into a consulting agreement with Mr. Perry that provides for an annual consulting fee of $30,000. Payment of such will ensure his continued eligibility in the company’s group health plans. [ed. note. The man owns 1.1% of the Company, or approximately 1.2 million shares, worth about which translates into about $32.92 million—and he’s worried about health insurance? Try Medicare, Part D!]
  • Not to be left out, the third founder, H. Ray Compton, who retired from the Company in 2004, also negotiated the same consulting agreement as J. Douglas Perry.
  • Remember the aforementioned comment that Dollar Tree prefers to lease their stores? Filed under Certain Relationships & Transactions: “We currently lease three stores from lessors who are affiliated with officers or directors of our company. We lease a store from Hampton Roads Enterprises, Inc., controlled by Mr. Perry [founder]. In addition, we rent two stores from DMK Associates, a partnership controlled by Mr. Perry and Mr. Brock [founder]. Rental payments on the three stores totaled approximately $220,000 in 2005…. terms were not negotiated on an arms-length basis and accordingly the terms of the leases may not be as favorable to us as those that we could have obtained from an independent third party.”
  • The son of Bob Sasser, CEO, is an account executive with an office supply company, which provides Dollar Tree with certain items for all of its locations, including the Store Support Center, Distribution Centers and stores. During fiscal year 2005, the supply company received approximately $657,000 in payment for goods provided.

So have the insiders justifiably earned the aforementioned compensation dollars heaped upon them? Using gains on dollars invested as the benchmark definition of performance—the answer is NO! Comparing the cumulative total shareholder returns on Dollar Tree Common Stock against a cumulative total return of the S&P 500 Retailing Index, Dollar Tree under performed in four out of the last five years.

Perhaps the name of the Company should be changed to The Giving Tree. For those who do not remember—The Giving Tree is a children’s book written by Shel Silverstein, who tells the story of a tree that loved a little boy…and gave and gave of itself to satisfy every want of the little boy…until the tree had nothing left:

And after a long time
the boy came back again.
“I am sorry, Boy,” said the tree, “but I have nothing
left to give you—I wish I could
give you something…
but I have nothing left. I am just an old stump. I am sorry….”

In go the spears full sadly in arest [sic]--- Geoffrey Chaucer (ca.1343-1400)

Despite declining operating margins in FY 2005, how do the prospects look for the Company going forward? And, is the stock a BUY based on its current trading price?

The primary growth drivers to Dollar Tree’s net sales growth have been new store openings, an active store expansion and remodel program, and selective mergers and acquisitions. From 2001 to 2005, net sales increased at a compound annual growth rate of 14.3%. Corporate expects that the majority of its future sales growth will come primarily from new store openings and secondarily from store expansion and relocation program.

Ergo, management believes the use of selling square footage yields a more accurate measure of store productivity (than same store comparables). In the last five years, the average selling square footage per store and per new store opened (less than a year) has grown 2,770 square feet and 2,686 square feet to 7,900 square footage and 9,756 square footage, respectively. [Net sales per selling square foot fell $17 year-over-year to $152 for the FY ended January 28, 2006.]

Corporate expects to increase its selling square footage in the future by opening new stores in underserved markets and strategically increasing its presence in existing markets via new store openings and store expansions (expansions include store relocations). [ed. note. Increasing the size of the store is meaningless unless accompanied by a parallel increase in average sale per transaction & aggregate volume of transactions—i.e. store traffic. For example, despite an overall increase in year-year sales, the aforementioned decrease in comparable store net sales was the result of a decline of 2.6% in the number of transactions, partially offset by an increase of 1.9% in transaction size.]

In fiscal 2006 and beyond, Dollar Tree plans to predominantly open stores that are approximately 10,000 selling square feet. At January 28, 2006, 673 of its stores, totaling 39.1% of selling square footage, were 10,000 selling square feet or larger.

Risk Factors.

  • Corporate profitability is especially vulnerable to material cost increases. Future increase in costs such as the cost of merchandise, shipping rates, freight costs, fuel costs, wage levels and store occupancy costs may reduce profitability. As a fixed price retailer, Dollar Tree cannot raise the sales price of its merchandise to offset cost increases. Unlike multi-price retailers, the Company is primarily dependent on its ability to operate more efficiently or increase its comparable store net sales in order to offset inflation. Albeit corporate expects comparable store net sales will be about flat to slightly positive in 2006, management has demonstrated its ability to contain SG&A costs. [As a percentage of net sales, SG&A remained stable at 25.2% year-over-year ending January 2006.]
  • The mix of products sold affects Dollar Tree’s profitability. Refrigerated consumable goods are growing as a percentage of total sales but carry higher material costs. Gross profit will decrease unless corporate can increase the amount of its net sales sufficiently to offset any decrease in product margin percentages. [Witness the 110 basis point drop in gross margins to 34.5% for the year-ended January 28, 2006.]
  • Ability to expand store square footage as profitably as planned. The Company’s failure to achieve its expansion plans could materially and adversely affect its business, leading corporate to lower guidance in the coming months.

Management recently issued guidance for FY 2006. The Company estimates sales will range from $3.845-$3.940 billion. This estimate is predicated on a square footage growth of 12-14%, which includes the 138 Deal$-Nothing Over a Dollar discount-chain (purchased in March 2006), or about 5% of the annual increase. Comparable store sales performance is projected to be nearly flat to positive low single digits.

Fiscal year 2006 diluted earnings per share are forecast to be in the range of $1.68 to $1.80. These estimates exclude any impact of share repurchase in 2006. The Company has $173 million available to repurchase shares under an original $300 million authorization.

Rising energy costs do not just impact business, but the discretionary income of households, too. The 10Q Detective suspects that Dollar Tree faces a real threat to top-line growth because if faced with the choice of gas for their cars or a snack & soda, low-income consumers are going to choose the gasoline.

We also believe that despite the benefits of the POS system, margins will be pressured with trying to integrate the Deal$ acquisition (as well as previously mentioned increasing product costs).

At a current price of $27.43, the 10Q Detective believes the risk/reward ratio is listing unfavorably for new investors of Dollar Tree Common Stock. Dollar Tree is selling for 16.3 times the low-end FY 2006 EPS of $1.68. Given its PEG ratio of 1.12, we believe that the current stock price has already discounted management’s guidance. Any misstep will lead to a P/E multiple contraction, with a corresponding drop in Dollar Tree’s Common Stock Price below critical support of $25.30 per share (200-day moving average). AVOID

Monday, May 08, 2006

Lifetime Brands: Tracking the Family (Money) Tree.

Lifetime Brands (LCUT-$29.10) designs, markets & distributes a wide array of consumer products for the home, including kitchenware, cutlery & cutting boards, bakeware & cookware, pantryware & spices, tabletop and bath accessories, which it markets under some of the better-known brands in the housewares industry. Among the brands it owns or licenses are KitchenAid and Farberware, the #1 and #2 brands in kitchen gadgets, according to the Home Furnishing Network 2005 Brand Survey. Other outstanding brands are Pfaltzgraff, Cuisinart, Sabatier, Calvin Klein, and Hoffritz.

It seems, however, that Lifetime Brands should also be known for its “lifetime employment opportunities" for family members of Jeffrey Siegel and Milton L. Cohen. Mr. Siegel, the CEO & Chairman of the Board, is the beneficial owner of 9.14% of the outstanding shares of the Company’s Common Stock, worth an estimated $34.6 million.

Milton L. Cohen was a Director of Lifetime until June 2005. As of December 31, 2005, Milton L. Cohen and his wife, Norma, beneficially owned 1,126,234 shares, or 8.66%, of the Common Stock of Lifetime Brands, Inc., worth an estimated $32.6 million (based on Friday’s closing price).

An interesting fact to pass along to our readers [jealousy!]: On December 15, 1985, Mr. Cohen exercised options for the bulk of shares currently owned at an average price of $0.27 per share. The aggregate purchase price was $469,120—and at the time Mr. Cohen only put up $46,912 of his own monies (with the Company lending him the balance due).

Jeffrey Siegel exercised 1.39 million shares at $0.27 per share, too, with similar lending terms.

Of greater interest, however, might be the geneology of the executives working at Lifetime Brands. As recently disclosed in the Company’s Schedule 14A filed with the SEC:

  • Evan Miller, a son-in-law of Milton Cohen, is employed by the Company as President of Sales and Executive Vice President. His total compensation in 2005 (including salary plus bonus) was $679,727. “All other compensation,” which consisted of the value of premiums paid for split-dollar life insurance by the Company and automobile related expenses paid by the Company, totaled $12,375. Mr. Miller is also the beneficial owner of 89,783 shares of the outstanding Common Stock of Lifetime Brands, worth approximately $2.6 million.
  • Craig Philips, a cousin of Jeffrey Siegel, is employed by the Company as Senior Vice-President—Distribution and Secretary and is a Director. His total compensation in 2005 was $365,623. Mr. Philips is also the beneficial owner of 814,392 shares, or 6.26%, of the outstanding Common Stock of Lifetime Brands, worth approximately $23.7 million.
  • Daniel Siegel, a son of Jeffrey Siegel, is employed by the Company as a Senior Vice-President—Sales. His total compensation in 2005 was $461,553.
  • James Wells, a son-in-law of Jeffrey Siegel and the husband of Tracy Wells, is employed by the Company as a Senior Vice-President—Sales. His total compensation in 2005 was $446,509. His wife, Tracy, is the beneficial owner of 706,465 shares (which includes shares held in trusts for Dan and Clifford Siegel), or 5.43%, of the outstanding Common Stock of Lifetime Brands, worth approximately $20.6 million.
  • Stuart Glickman, a son-in-law of Milton Cohen, is employed by the Company as Vice President—National Sales Manager. His total compensation in 2005 was $272,693.
  • Clifford Siegel, a son of Jeffrey Siegel, is employed by the Company as Vice-President—Inventory Forecasting & Replenishment. His total compensation in 2005 was $230,000.
  • Scott Wit, a son-in-law of Jodie Glickman, is employed by the Company as a Regional Sales Manager. His total compensation in 2005 was $90,000.

To put a face on persons—no matter how confusing, the 10Q Detective was also able to ascertain through various Schedule 13G filings, that Bruce Cohen, Jodie Glickman, and Laurie Miller are siblings. We bring this point to our reader’s attention, for millions of additional Lifetime shares are intermingled in a web of additional trusts [not mentioned in this report] by various relations of Jeffrey Siegel and Milton Cohen. One needs a family tree just to keep track of the flow of money.

Bruce Cohen, the son of Milton and Norma Cohen, and the beneficial owner of 5.83% of the Common Stock of Lifetime, was the erstwhile President—Outlet Retail Stores, until his resignation last year. Mr. Cohen gave up an annual base salary of $313,603 (excluding ancillary perquisites, which totaled $12, 354 in FY 2004). Sob no tears for Bruce: On July 6, 2005, the date of his resignation, Mr. Cohen became entitled to receive a severance benefit that provided for a severance benefit of $313,603 payable in 26 installments through July 6, 2006.

Someone once said: “The best inheritance a parent can give his children is a few minutes of his time each day.” [Orlando A. Battista]

In the case of Lifetime Brands, this inheritance also seems to include a high-paying job, too.

In our opinion, the goings on at Lifetime Brands makes a mockery of the Sarbanes-Oxley Act of 2002, which was passed to provide greater oversight and accountability of financial management. Aside from the fact that Wal-Mart is Lifetime Brands single largest customer, accounting for approximately 20% of net sales in 2005, 10Q Detective readers have been forewarned.

Sunday, May 07, 2006

Michael's Stores--More than Needlepoint (for insiders).

There comes a point when a man must refuse to answer to his leader if he is also to answer to his own conscience.
-- Lord Hartley William Shawcross

Michael’s Stores, Inc. (MIK-39.09), is the nation’s largest specialty retailer providing materials, ideas, and education for creative activities in home décor, art, and craft projects. The Company’s recently filed annual proxy reveals that when it comes to the most senior of executives, car giveaways are the preferred ‘other compensation,’ not needlepoint and doll-making supplies:

  • R. Michael Rouleau, the President and CEO, made $1.3 million in salary and bonus in 2005. Other annual compensation included (i) $15,078, $23,884 and $20,494 for the personal use of a company-owned automobile in fiscal 2005, 2004 and 2003, respectively, and the transfer of a company-owned automobile, valued at $55,380, to Mr. Rouleau in fiscal 2004. As if owning one luxury vehicle just given to him were not enough, the Company recently disclosed that in connection with Mr. Rouleau’s retirement on March 15, 2006, Mr. Rouleau’s [2005] company-paid automobile was transferred to him in connection with his impending retirement and Michaels would make a tax gross-up payment to Mr. Rouleau for the income tax effect of this transfer, too.

The 10Q Detective might have overlooked Mr. Rouleau’s apparent fondess for luxury automobiles, were it not for the fact that the Company had just fully vested and made available for exercise to Rouleau all options to purchase common stock issued prior to August 5, 2005. One would think that with the $10.6 million Mr. Rouleau received upon the exercise of these shares, might he not have afforded the price of a second family car with his own monies?

  • Mr. Charles J. Wyly, Jr. is the Chairman of the Board and a co-founder of Michael’s Stores, Inc. In his role of Chairman of the Board, Michael’s Stores remunerated to him a salary of $450,000. Under ‘other annual compensation,’ Wyly also received $22,322, $21,366 and $21,355 for the personal use of a company-owned automobile in fiscal 2005, 2004 and 2003, respectively. In fiscal year 2004, the Company also transferred to him a company-owned valued at $51,550. Charles J. Wyly, Jr., is the beneficial owner of 4.4% of common stock, currently valued at approximately $225.7 million.
  • In fiscal 2005, Michael’s Stores paid $263,654 in salary to Donald R. Miller, Jr., Vice President — Market Development. In connection with his employment with Michaels in fiscal 2005, Mr. Miller also (i) earned a cash bonus of $116,100, (ii) received $24,239 for the personal use of a company-owned automobile, (iii) was transferred the ownership of another company-owned automobile, valued at $53,405. In addition, Michaels (i) reimbursed Mr. Miller $16,867 for golf/health club membership dues and the related tax gross-up. (Mr. Miller is the son-in-law of Charles J. Wyly, Jr.)
  • During fiscal year 2005, Sam Wyly, the brother of Charles and co-founder of Michael’s Stores, was compensated for his service as Vice Chairman of the Board with (i) $18,750 per month, (ii) options to purchase 117,500 shares of common stock, and (iii) $17,764 for the personal use of a company-owned automobile. Sam Wyly is the beneficial owner of 3.4% of common stock, currently valued at approximately $176.5 million.

Michael’s Stores relies to a significant extent on foreign manufacturers located in Asia, Canada, and Mexico for various products that the Company sells. Many of its domestic suppliers purchase a portion of their products from foreign sources, too. The 10Q Detective can only hope that when it comes to automobiles, that Michael’s Stores buys American.

Thursday, May 04, 2006

Continental Minerals--An Unknown Copper Play.

Copper is one of the oldest metals ever used and dates back more than 10,000 years. A copper pendant discovered in what is now northern Iraq goes back to about 8700 B.C.

Because of its properties, such as high ductility, malleability, and thermal and electrical conductivity, and its resistance to corrosion, copper has become a major industrial metal, ranking third after iron and aluminum in terms of quantities consumed.

Power transmission and generation, building wiring, telecommunication, and electrical and electronic products—these applications account for about three quarters of total copper use. Building construction is the single largest market, followed by electronics and electronic products, transportation, industrial machinery, and consumer and general products.

Commodity prices of copper continue to trend upward, with the New York Mercantile Exchange’s COMEX spot price recently reaching a record-high monthly average $3.50 per pound for May delivery [on April 26]. Supply troubles, strong demand, and automated fund trading systems—all these factors are expected to keep the copper market surging higher.

Leading world miner BHP Billiton, Ltd./Plc. (BHP-46.96) said difficulties finding personnel and mine equipment as global demand for minerals soared was restraining supply across the industry

Mine capacity utilization has fallen to its lowest level in recent years, compounded by industrial unrest at mining operations in Congo, Chile, Mexico, and elsewhere, too.

Global inventories of refined copper held in metal exchange warehouses continued their downward trend in April 2006. Stocks of the key industrial metal in LME warehouses totaled 117,950 tons, equivalent to about 2-1/2 days of world consumption and down from almost 1 million tons in April 2002.

The International Copper Study Group said in its latest forecast that growth in use would result in a production surplus in 2007 of only about 55,000 tons.

Economic growth is accelerating in China, the world's biggest user. On April 20, 2006, China's President Hu Jintao said that the economy grew 10.2 per cent in the first quarter up from 9.9 per cent in the fourth quarter.

Additionally, Chinese copper demand might increase 8 per cent to 3.9 million tones this year exceeding production by 1.05 million tones, according to the government-affiliated China Non-ferrous Metals Industry Association.

And the third variable feeding copper’s pricing volatility is alleged to be hedge funds out of New York and London. In letter sent to to the LME and the Financial Services Authority on February 5, 2006, the International Wrought Copper Council said the buying was forcing copper prices to extreme levels, causing financial difficulties for copper users. The council also argued that the copper price did not reflect industrial supply and demand. It questioned whether the exchange should continue to be the recognized reference price for the industry.

Shares in copper miners tend to mirror the LME price rise.

The 10Q Detective is proffering Continental Miinerals (KMKCF.OB-$2.30), a junior exploration company as our speculative copper pay dirt play. KMKCF is the operator of the recently discovered Xietongmen copper-gold deposit located near the city of Lhasa in Tibet.

The Xietongmen Property hosts a porphyry copper-gold deposit with significant mineral resources that were outlined by drilling in 2005. Given that the deposit is amenable to open pit mining, there is excellent potential for expansion, too.

The comprehensive program in 2006 will encompass extensive drilling to fully assess the resource potential of the property, as well as engineering, environmental and socio-economic studies, and community and stakeholder engagement activities. The objective is to collect the data necessary for a feasibility study and environmental and social impact assessments. The studies are targeted for completion in 2007

The Xietongmen property is located in a rural area. The nearest village is two kilometers from the property and its economy is based on agricultural activities. The nearest commercial facilities (food, fuel, accommodation) and population center is the city of Rikaze, located 53 kilometers from the property. Other supplies and equipment are available 260 kilometers away in the city of Lhasa, which is the transportation and commercial center of Tibet.

Nonetheless, the project is well located for development. A paved highway and hydro-generated electric transmission lines pass near the southern end of the property. Logistical supplies, including fuel and food, are readily available in Rikaze. The paved highway makes it easier, too, for heavy equipment and other vehicles to access the site.

The infrastructure also touts a railway system to Lhasa, completed in 2005, which connects to multiple copper smelters and other industrial centers located throughout China. The Chinese government has initiated construction of a railway extension from Lhasa to Rikaze, with an expected completion date in 2010.

On April 13, 2006, KMKCF announced its intent to merge with Great China Mining, Inc. (GCHA.OB-$0.24), its partner in the Xietongmen Copper-Gold Property. A successful merger will unify 100% of the property and will give KMKCF interests in the three other properties, totaling 109 square kilometers, which surround the Xietongmen Property.

Based on drill core assay results from 62 vertical holes, initial resource estimates total more than 106 million tons containing 2.49 million ounces of gold and 1.15 billion pounds of copper. Still to be answered, how much is recoverable? And, what is the demonstrated economic viability of the entire property?

The two catalysts for an upward move in the share price of KMKCF are (1) event-driven, based on exploration results and (2) the commodity price of copper, for the share prices of copper mining companies tend to move in sync. with the contract price of the metal itself.

The 10Q Detective reminds our readers that (a) any investment in KMKCF shares is not suitable for conservative investors and (b) the COMEX/LME price(s) of copper have been highly volatile in the past year.

“ This is a perfect storm. If oil takes a dive, there are going to be a chain of margin calls going through the copper market, and then we'll find there are no buyers," says David Threlkeld, a veteran copper trader. "Copper will implode overnight. This is like flipping condos in Miami, the last one holds the bag."


Information has been obtained from sources believed to be reliable, but its accuracy or completeness is not guaranteed. We advise readers to recognize that they should not assume that present or future recommendations will be profitable or will equal the performance of securities listed or recommended here in the past. Readers should be aware, too, that the purchase of securities, particularly in the case of low-priced shares, involves substantial risk of capital. The 10Q Detective is published by Blue Sky Enterprises, LLC. Blue Sky Enterprises, LLC. is not a registered investment advisor and therefore cannot give individual investment advice. The opinions expressed herein are subject to change without notice. Neither the information nor any opinion expressed herein constitutes a solicitation by us of the purchase or sale of any securities. Blue Sky Enterprises, LLC., its affiliates, and/or their officers and employers may from time to time acquire, hold, or sell a position in the securities mentioned herein. Upon receipt of queries, specific information in this regard will be furnished.

Monday, May 01, 2006

VIVUS--The Latin Root for "life."

  • As mentioned in a recent web log on April 27th, VIVUS, Inc. (VVUS-3.06) is an emerging pharmaceutical company dedicated to the development and commercialization of novel therapeutics to restore sexual function in women and men. The Company’s current product pipeline includes four investigational products in late stage clinical development—each of which targets an estimated existing or potential market in excess of $1 billion annually:

    Menopausal Vasomotor Symptoms – Evamist

Vasomotor symptoms such as hot flashes and vaginal atrophy are reported to be among the most common medical complaints of women going through menopause. Each year an estimated 1.5 million women in the United States enter menopause. The cause of vasomotor symptoms is related to a decrease in estrogen production by the ovaries that accompanies menopause. As a result, temperature regulation is altered, resulting in increased vasodilatation of skin blood vessels and feelings of hot flashes and sweating.

When lifestyle changes and nonprescription approaches do not provide the desired relief, prescription options are available. Hormonal approaches, primarily systemic estrogen therapy and estradiol products are generally considered to be highly effective treatments for menopausal vasomotor symptoms. The current U.S. market for estrogen products is estimated to be approximately $1.4 billion in annual sales and the European market is estimated to be equally substantial.

Premarin, an oral preparation of conjugated estrogens (made from pregnant mares’ urine), is the most widely prescribed estrogen therapy in the United States. In 2004, the National Institutes of Health terminated a long-term, large-scale study that evaluated the effects of Premarin. This study, called the Women’s Health Initiative (WHI), demonstrated an increase in the number of strokes and deep vein thromboses in women receiving Premarin as compared to placebo. This controversial finding may be explained by previously published studies, which showed that when given orally, conjugated equine estrogens are associated with potentially deleterious changes in triglycerides, inflammatory mediators, and certain clotting factors. Some researchers believe that these changes may be the result of the liver’s metabolism of oral conjugated equine estrogens. [ed note. The main problem with the WHI, skeptics say, was that the average age of hormone trial participants was about 63. By that time, critics argue, atherosclerosis has too big of a head start on estrogen.]

In contrast to orally administered conjugated estrogens, the use of transdermal estradiol, which avoids hepatic metabolism, has been shown in studies to result in little or no significant changes in triglycerides, inflammatory mediators or clotting factors. Therefore, VIVUS believes transdermal estradiol may offer a safer means of treating vasomotor symptoms associated with menopause.

Evamist is VIVUS' patented estradiol spray being developed for the treatment of vasomotor symptoms associated with menopause. Evamist uses a proprietary, metered-dose transdermal spray, or MDTS, applicator that delivers a precise amount of estradiol to the skin. VIVUS believes that the MDTS technology has significant advantages over patches, creams and gels (such as Estraderm, Vivelle, Alora, and Climara patches; Estrace and Premarin creams; Estrogel and Bio-E-Gel). The applied dose dries in approximately 60 seconds. It is not messy. It is easy to apply and becomes invisible.

In December 2004, VIVUS initiated its Phase 3 study of Evamist in the United States to evaluate its safety and efficacy in menopausal women suffering from vasomotor symptoms. The Company received a Special Protocol Assessment (SPA) from the FDA, which is an official agreement that documents the agreed upon terms and conditions under which VIVUS will conduct and analyze the data from its Phase 3 trial. The primary endpoint is to assess the decrease in the frequency and severity of hot flashes at 4 and 12 weeks of treatment. In September 2005, the Company completed enrollment for this trial. Results from this study are expected in the second quarter of 2006. Assuming favorable study results, corporate anticipates submitting the New Drug Application (NDA) for Evamist mid year 2006.

  • Female Sexual Arousal Disorder – ALISTA

FSAD is defined as the persistent or recurrent inability to attain or maintain sufficient sexual excitement resulting in personal distress. A survey conducted by the American Medical Association in 1999 indicated that sexual dysfunction affects approximately 43% of women in the United States. Age may not be a significant factor, as women under 20 and over 50 experience problems with arousal, orgasm, and satisfaction. However, there is evidence that the majority of female sexual dysfunction happens after menopause, when hormone production drops and vascular conditions are more common.

Sexual arousal in females involves vasodilatation, or increased genital blood flow, which results in increased clitoral sensation and vaginal lubrication. Reduced vasodilatation and lubrication resulting from atherosclerosis, diabetes and advancing age as well as surgeries such as hysterectomies can deleteriously affect a woman’s ability to become sexually aroused.

ALISTA is a patented formulation of alprostadil that is intended for topical application to the female genitalia prior to sexual activity as an on-demand treatment for FSAD. ALISTA has been designed to increase blood flow in the genital region, allowing for greater sensitivity and sexual arousal. These positive effects have been observed as early as 5 to 15 minutes after application of ALISTA and may last up to two hours.

The active ingredient in ALISTA, alprostadil, is a synthetic version of a naturally occurring molecule found in humans. Alprostadil has been approved by the FDA for other indications, including erectile dysfunction in men. VIVUS believes the combination of alprostadil’s ability to achieve vasodilatation in genital tissues, its long-standing safety record, and short half-life makes it an ideal agent for the treatment of FSAD.

The Company has completed three double blind, randomized, placebo-controlled Phase 2 studies of ALISTA, all of which demonstrated statistically significant increases in arousal and/or satisfying sexual encounters in pre- and post-menopausal women with FSAD. In December 2005, VIVUS announced that the Company had completed enrollment in a multi-center, randomized, double blind, placebo-controlled Phase 2B study [Phase 2B implies a longer duration of dosing to obtain adequate safety data to embark on a Phase 3 study program.] Patients are expected to complete the trial late in 2006.

Albeit there are no FDA-approved medical treatments for FSAD, there is visible competition in the FDA pipeline for ALISTA, including two transdermal testosterone gel products being developing by Cellegy Pharm. (CLGY.OB-$0.71). The Company had previously announced results of an interim analysis of a Phase 2 study using Tostrelle (testosterone gel) for the treatment of female sexual dysfunction showing a favorable response rate of 71% versus a placebo response of 13 percent; and, NexMed, Inc. (NEXM-$0.80) is developing Femprox, an alprostadil cream for the treatment of FSAD.

  • Hypoactive Sexual Desire Disorder – Testosterone MDTS

A diagnosis of Hypoactive Sexual Desire Disorder refers to the condition in which an individual has very low desire for sex although sexual performance may be adequate once the activity has been initiated. This disorder occurs in approximately 20% of the population and occurs in both sexes though more commonly in women.

The administration of testosterone has been associated with an increase in sexual desire in both pre- and post-menopausal women. In addition to the gradual decline in testosterone that accompanies aging and natural menopause, the surgical removal of a woman’s ovaries rapidly results in a decrease of approximately one half of the woman’s testosterone production capability. Hence, HSDD can occur much faster, and at a younger age, in women who have undergone this type of surgically induced menopause. Furthermore, HSDD has been observed in pre-menopausal women with naturally occurring low levels of testosterone.

Testosterone MDTS is Vivus’ patent protected, transdermal product for the treatment of HSDD in women. The active ingredient in Testosterone MDTS is the synthetic version of the testosterone that is present naturally in women and men.

Testosterone MDTS utilizes a proprietary, metered-dose transdermal spray, or MDTS, applicator that delivers a precise amount of testosterone to the skin. The metered spray enables patients to apply a precise dose of testosterone for transdermal delivery. The applied dose dries in approximately 60 seconds and becomes invisible. Studies have demonstrated that the Testosterone MDTS system delivers sustained levels of testosterone in women over a 24-hour period, achieves efficacy in increasing the number of satisfying sexual events, and results in substantially lower rates of application site skin irritation than reported in women using testosterone patches.

Management believes that its Testosterone MDTS product has significant advantages over patches and other transdermal gels that are being developed for this indication. The Testosterone MDTS spray allows for discreet application, unlike patches that are visible and topical gels that are messy. Corporate believes, too, that the patented MDTS delivery technology will prevent others from commercializing competitive therapies utilizing a spray delivery technology.

VIVUS' specified business goal for Testosterone MDTS in 2006 is to continue to work with the FDA to define the Phase 3 protocol design and to request a Special Protocol Assessment from the FDA for the Phase 3 trials.


  • Male Sexual Health – Avanafil

As mentioned in our previous web log, this second-generation Viagra is what ‘arouses’ us here at the 10Q Detective. Clinical data suggests that because avanafil is a more selective PDE-5 inhibitor than sildenafil (Viagra), vardenafil (Levitra) and tadalafil (Cialis), the drug may result in a more favorable side effect profile.

While PDE-5 inhibitors currently on the market are often effective in treating ED, newer drugs that possess better specificity for the PDE-5 enzyme may be safer. In addition to PDE-5, there are at least ten other types of PDE enzymes in the human body. Drugs that inhibit more than one of these enzymes can potentially cause significant adverse effects, depending on the enzymes that are affected. In an in vitro study comparing the activity of avanafil, sildenafil, tadalafil and vardenafil against all 11 of the known PDE enzymes, researchers found that avanafil demonstrated the best specificity for PDE-5, with little activity against the other enzymes.

Avanafil possesses a shorter plasma half-life than other PDE-5 inhibitors currently on the market. The plasma half-life of a drug is the amount of time required for 50% of the drug to be removed from the bloodstream. In general, the shorter the half-life, the less potential there is for the drug to interact with other drugs that may also be in the bloodstream. All approved PDE-5 inhibitors are required by the FDA to include warnings against taking nitrates after administration. For example, Cialis’ label warns patients not to take nitrates within 48 hours of administration. Approximately 5.5 million men take nitrates on a regular basis for angina pectoris and another half million annually will experience a heart attack and are potential candidates for emergency nitrate therapy. Sildenafil and vardenafil possess plasma half-lives of approximately four hours, and tadalafil has an extended half-life of 17 to 18 hours. The plasma half-life of avanafil, however, is approximately 90 minutes, which means that it is removed from the bloodstream faster than the other currently available PDE-5 inhibitors.

VIVUS believes that avanafil’s short half-life, high specificity and fast onset of action are ideal characteristics for an on-demand treatment for ED.

Management has set lofty goals for 2006: (1) Complete the remaining preclinical and metabolism studies prior to advancing the compound into Phase 3; (2) Request an SPA for the Phase 3 trial design; (3) Enter into a partnership to fund Phase 3 development.

VIVUS' balance sheet is sound. The Company has a total debt-to-equity ratio of 19.4% and more than $27 million in cash—enough to last the Company through FY 2006.

VIVUS is building a broad portfolio of medicines to restore sexual function in both men and women. The company also offers MUSE for the treatment of erectile dysfunction, which generated worldwide sales of $14.5 million in 2005.

Selling for $3.06 per share, Vivus has an enterprise value of only $114.7 million. This stock is cheap and does not reflect the future value potential of its proprietary drug portfolio— the four leadership products in development are each targeting markets with more than $1 billion in annual sales.

Given the competition the Company faces (in each of its key markets) by better-capitalized companies, we understand why it appears that VIVUS is an underappreciated stock. VIVUS is derived from its latin root, ‘vivo,’ which means “living.” And this stock—like its Latin name implies—is far from moribund.

At this stage, we are not comfortable attempting a valuation analysis. Suffice to say, with modest Street expectations for the Company, news of a partnership deal to fund the development of pivotal Phase 3 trials for avanafil will provide the validation needed to ‘arouse’ investor interest in the share price. We believe that for risk-tolerant, patient investors, VIVUS is an attractive SD-focused company.

Full Disclosure: The 10Q Detective is a buyer at these prices for our own accounts.