Wednesday, September 26, 2007

"Gimme Head with Hair, " Says Regis Corp.

As the industry's global leader in salons and hair restoration centers, beauty means business at Regis Corporation (RGS-$30.73). The owner of such recognized salon franchise concepts as Vidal Sassoon, Supercuts, and SmartStyle (U.S.) and First Choice Haircutters (in Canada) and Hair Club for Men and Women (North America) projects sales to hit $2.7 billion in fiscal year ended June 30, 2008, from $1.9 billion in FY 04.

Financial Guidance

Management has grown revenue at a 5-year historic growth of 12.55% by building a portfolio of 11,881 salons through acquisition, new construction and franchising.

Increases in average ticket prices offset by continued declines in visitation patterns due to fashion trends (i.e., longer hairstyles) resulted in consolidated same-store sales growth of only 0.2 percent, 0.4 percent, and 0.9 percent in fiscal 2007, FY 06, and FY 05, respectively. Management expects fiscal year 2008 same-store sales growth to be consistent with this trend toward flat to 1.0% same-store sales growth.

The Company reported that earnings fell 24 percent to $83.2 million, or $1.82 per share, in 2007, compared to $109.6 million, or $2.36 per share, during 2006, due to higher operating expenses (as a percentage of sales) and impairment charges. Management blamed higher general & administrative costs on lower than normal salon advertising expenses in fiscal 2006 and negative leverage associated with minimum rents, area maintenance charges, and real estate taxes (growing at a rate slightly higher than same store sales).

Citing the aforementioned trends, the company, which also owns Jean Louis David and the Regis brand salons, recently reduced net income guidance for 2008 to the range of $2.01 to $2.27 per share. Analysts expected share-net of $2.25 in 2008, according to a Thomson Financial survey.

Opportunistic acquisition activity boosted sales 4.4% (year-year), respectively, but so, too, financial leverage. Interest expenses increased 30 basis points (as a percentage of sales) in the last 12-months.

Debt-to-capitalization level increased 200 basis points to 43.7%, primarily due to increased debt levels stemming from share repurchases, acquisitions and timing of customary income tax payments made during fiscal year 2007.

One balance sheet warning—the Company owes $875 million in off-balance sheet obligations (principally operating leases)—due within three years—that if added, would more than double the debt-capitalization ratio to 1.06 times.

The interest coverage ratio, however, is a comfortable 3.3 times earnings (before interest and taxes) and cash flow from operating activities was $241.8 million for FY 07.

Business Outlook

It is foolish to tear one's hair in grief, as though sorrow would be made less by baldness. ~ Roman Statesman and Philosopher Marcus Cicero [106 BC – 43 BC]

Tell that to Regis shareholders. Low organic growth and reduced earnings visibility has shaken investor confidence, with the share price down 14.85% (53-week change) compared to a 13.63% gain in the S&P 500 Index.

Life is an endless struggle full of frustrations and challenges, but eventually you find a hair stylist you like. ~Author Unknown

Management reminded investors on its fourth quarter conference call that demographics favor the Company’s business strategy. “As the population ages, said CEO Paul Finkelstein, “Individuals have to get their hair cut and colored more often. We are primarily a service-driven business… Once we get people going into our salons…we have a better opportunity to convert these customers to become retail product purchasers as well.”

The 10Q Detective points out several weaknesses in Finkelsteins’ argument: (i) Management has—to date—poorly executed on converting existing traffic into an add-on revenue stream. To wit: product sales fell 100 basis points, to 28.6% of consolidated sales, from 29.6% in fiscal 2005 (management blames increasing sales of diverted product lines and greater retail competition—e.g. Victoria’s Secret morphing into a beauty store); and (ii) although centralized control over salon operations have yielded some economies of scale (with gross margin as a percentage of service and product revenues improving 60 basis points in the last two years), traffic patterns remain soft (falling 3.5% in 2007).

The 10Q Detective does not expect a turnaround in product sales until at least the 1H:09. Regis management is looking to convert its 62,000 hair stylists into retailers. (We are not as optimistic as management about this opportunity, for more sales training means higher labor costs—unspecified, too, was employee turnover numbers and compensation incentives for cross-selling.)

Investment Thesis

By fiscal 2009, the Company expects successes in reducing diversion programs from Proctor & Gamble and L’Oreal and will be readying new product launches.

Regis is designing a customer loyalty program to work in some of its strip centers and its Master Cuts division (we are not as bullish as management on loyalty programs, for SuperCuts has one program already in place—nine haircuts, tenth free).

In our view, the Hair Club represents a forward growth driver. Fourth quarter revenue for fiscal 2007 increased about 11%, to $31.9 million, which was $2.5 million above plan. Hair Club revenues represented nearly 5 percent of consolidated 4Q:07 revenues. Strangely, aside from some talk about buying back franchises (increased margins) and “buying customer lists,” management was vague on how it planned to grow this segment (which sprouted a fourth quarter operating margin rate of 21.3%--or 130 basis point improvement year-year).

In the face of sliding performance metrics—trailing twelve month ROA and ROE of 4.0% and 9.3%, respectively, compared with five-year ROA and ROE averages of 6.28% and 13.2%, respectively—we are ‘less-than-comfortable’ with management’s ability to execute on its stated initiatives, too.

With Regis expected to generate only modest growth in the coming quarters, coupled with concerns about consumer discretionary spending (rising food and energy costs), we do not believe that any catalysts exist for a sustainable upward move in the stock price at this time.

Long-term investors with an eye toward value, however, may want to establish a forward position in the stock, with the stock selling at a modest 12.8 times June ’09 estimates of $2.43 per share. Intrinsic stock value is estimated at $46.50 per share.

Gimme head with hair
Long beautiful hair
Shining, gleaming,
Streaming, flaxen, waxen

In our view, however, such optimism is premature, for forward valuation assumes weighted average cost of capital of 6.8% and sustainable top-line growth of 8 percent (per annum). Sales move inversely to hair cut lengths—contrary to management’s stated opinion—there is little evidence to support shorter hairstyles are coming back in vogue.

Give me down to there hair
Shoulder length or longer hair
Here baby, there mama
Everywhere daddy daddy

Hair, hair, hair, hair
Grow it, show it
Long as I can grow it
My hair

The faces of management at Regis must blanche in terror upon hearing such lyrics [from the bubblegum, psycho-pop group The Cowsills].

Beauty may mean business at Regis, but a look at related party transactions reveals that only insiders consistently profit from the haircuts, styling, coloring and waxing services provided to
“more than 160 million satisfied clients each year.”

Certain Relationships and Related Transactions

Mr. Myron Kunin, 78, is a founder of Regis and has served as a director since its incorporation in 1954. He is Vice Chairman of the Board (earning a salary of $789,371 in FY 07) and holds the majority of voting shares of Curtis Squire, Inc. (CSI), a significant shareholder of Regis, the beneficial owner of 1.02 million shares, or 2.31% of the outstanding common stock).

Curtis Squire, Inc rents artworks to the Company in return for which Regis compensates certain of its employees who devote time to CSI business. Regis also furnishes office space and equipment for use by CSI. The reasonable value of this arrangement was estimated at $200,000 last year.

Messer. Kunin received $134,851 in annual pension benefits in 2007. The present value of accumulated benefits is $7.08 million, for 53 years of credited service [god bless him!]. Kunin did not take any non-qualified deferred compensation in 2007, leaving his plan with an aggregate value of $2.22 million.

The Company paid $1,268,396 to Beautopia, LLC, which is owned by David B Kunin and CSI, for hair care products purchased in the ordinary course of business in 2007. In addition, Mr. Kunin serves as a director at Regis, receiving total compensation of $74,506 in 2007. David Kunin, 48, is the son of Myron Kunin.

Regis paid Timothy Kunin, a son of Myron Kunin and a brother of David Kunin, $309,938 for subscriptions to magazines for the salons in 2007.

The Company purchases from the Northwestern Mutual Life Insurance Company insurance policies on the lives of certain of its employees and officers. Regis paid aggregate premiums of $3,432,286 for these insurance policies in 2007.

Michael Finkelstein, a son of Paul Finkelstein, is a registered insurance agent and received commissions of $404,479 related to these insurance policies in 2007!

The Company reimburses Chairman and CEO Paul Finkelstein $100,000 annually for premiums payable by the Executive with respect to life insurance coverage under a policy with a face amount of $10 million. Regis also provides Mr. Finkelstein with a gross-up for the federal and state income taxes on the resulting income.

By comparison, Microsoft just announced that it gave CEO Steve Ballmer approximately $3,000 worth of life insurance premiums in the last year!

Editor David J. Phillips does not hold a financial interest in Regis Corp. The 10Q Detective has a Full Disclosure Policy.

Monday, September 24, 2007

It's a Rich Man's World at Luminent Mortgage Capital

On September 11, Luminent Mortgage Capital Inc (LUM-$1.59), a real estate investment trust that has struggled with liquidity issues facing many of the participant’s in the U.S. residential mortgage markets, said it repaid all its warehouse credit lines that were financing the purchase of outstanding commitments.

In addition to reducing debt, the mortgage lender said it was eliminating staff positions to stabilize its business. These initiatives could not have come at a better time for shareholders, for last month the asset manager suspended its quarterly dividend and had received default notices for about $2.3 billion of its debt.

Ironically, the CEO and CFO of Luminent do not share equally in the suffering of these same shareholders, who have watched their holdings lose some 85 percent in value since July 2007.

In a regulatory filing on August 31, Luminent disclosed that it agreed to pay retention bonuses of $1 million to President and CEO S. Trezevant Moore Jr., and $750,000 to Senior Vice President and Chief Financial Officer Christopher J. Zyda.

“The purpose of these bonuses was to incentivize [sic] Mr. Moore and Mr. Zyda to remain in [its] employ through December 31, 2007 in light of the unprecedented conditions affecting the mortgage industry ... and for their efforts in managing the company during this period," the Company said in the regulatory 8-K filing.

Each executive will receive the retention bonus for services extending through just the fourth quarter of fiscal 2007: “in equal payments over the remaining eight (8) paychecks of the fiscal year beginning September 15, 2007.”

The 10Q Detective begs to differ with the Board’s decision to pay both Moore and Zyda their respective retention bonuses. In our view, the two executives are being rewarded for past behavior that lead to the dislocation of risk in the monitoring of residential mortgage originations and the dissolution of shareholder equity.

Irrespective of performance, as part of their [prior} Employment Agreement for fiscal year 2007, Moore and Zyda were already guaranteed minimum cash performance bonuses of $500,000 and $125,000, respectively.

In fiscal 2006, Moore and Zyda were awarded 50,000 shares and 35,000 shares, respectively, of restricted stock with award date values of $497,000 and $347,900, respectively [or $9.94 per share].

Money, money, money
Must be funny
In the rich man's world
Money, money, money
Always sunny
In the rich man's world

Perhaps Moore and Zyda are staying put just long enough to recoup the aggregate losses of their now worthless stock awards.

All the things I could do
If I had a little money
It's a rich man's world

As common stock shareholders are not afforded similar risk-reduction benefits, the only recourse is as plaintiffs in securities class action litigation against Luminent –two lawsuits of which have already been filed.

It's a rich man's world. ~~ ABBA (Money, Money, Money)

Editor David J. Phillips does not hold a financial position in any REITs. The 10Q Detective has a Full Disclosure policy.

Tuesday, September 18, 2007

Apollo Group Gives Free Ride to Top Executives at Aptimus

On August 8, Aptimus Inc. (APTM-$6.25), which derives its sales principally from response-based advertising contracts, announced a definitive agreement to be acquired by for-profit education provider Apollo Group (APOL-$53.82) for about $41.3 million, or $6.25 per share, in cash.

This offer price, however, is a far cry from its five-year high of $27.00 per share, the closing price on February 7, 2005.

Blessed is the man who expects nothing, for he shall never be disappointed. — English poet Alexander Pope [1688 – 1744]

Investors fled the stock long-ago, for the online advertising network has suffered recurring operating losses from continuing operations for six consecutive quarters, due in part to a decline in revenue per thousand page impressions (RPM—the revenue earned on those consumers who respond to advertiser offers presented on the publisher websites divided by impressions and multiplied times one thousand).

Average RPM, was $35.12 during the three months ended June 30, 2007, decreasing 41% from the $59.24 average in the comparable period of 2006. The lower RPM levels year-over-year were primarily due to a shift toward a broader set of placement types that were less responsive than historic registration placement locations. Management said, too, the slide in RPM was due in part to the Company’s continuous quality improvement efforts which could lead to lower offer response rates balanced by higher quality (which allegedly leads to higher lead prices over time).

Management’s objective in expanding placement formats and Ad products for advertisers did lead to higher combined placement page impressions: 113.9 million for the three months ended June 30, 2007, compared to 53.78 million for the prior year period. But, as previously mentioned, this marketing strategy failed to translate into greater RPM.

The mountain is high
The valley is low
and you confused on which way to go
so i'm from here
to give you a hand
and lead you into the promise lands

The timing of the deal could not have come at a better time—for management. Recent regulatory filings disclose that the acquisition serves to advance the pecuniary needs of directors and Named Executive Officers of the money-losing Ad network, offsetting now worthless past option grants (out-of-the money) with significant new cash awards.

come on and take a free ride(free ride)
come on and sit here by my side
come on and take a fr-ee ri-de

This deal exemplifies the most egregious traits associated with rewarding prior poor performance. For example, certain of Aptimus executive officers have entered into employment agreements with Apollo which provide for significant increases in base salary, performance bonus, integration bonus, retention bonus, closing bonus, Apollo option grants, and other specified payments and benefits.

all over the country
i've seen it the sa-me
nobody's winning
at this kind of game
we gotta do better
it's time to begin
you know all the answers
are stored from within so,

How many different ways can one earn a bonus?

come on and take a free ride (free ride)
come on and sit here by my side
come on and take a fr-ee ri-de

Robert W. Wrubel, who joined Aptimus in June 2005 and became CEO of the Company in August 2006, failed in his efforts to right the ship. Nonetheless, he has entered into an employment offer letter with Apollo that rewards him with him with the job as the online educator’s new CEO, with a 35 percent base salary increase to $275,000 (per annum)!
  • Messer. Wrubel is also entitled to receive integration, retention, and stay cash bonuses of $103,125, $103,125, and $100,00, respectively. Can anyone tell us what is the material difference between a ‘retention’ and a ‘stay’ bonus?
  • If the merger is completed by October 1, 2007, Wrubel is entitled to receive a one-time ‘cash closing’ bonus of $42,188, too.
  • Mr. Wrubel will be granted options to purchase 75,000 shares of Apollo Class A common stock, subject to one-fourth of the shares vesting on each of the first through fourth anniversaries of the completion of the merger.

Feeding at the trough, too, is Aptimus founder and Chairman Timothy C. Choate. On August 7, 2007, Mr. Choate entered into a two-year consulting agreement with Apollo, which will pay him a fixed retainer in the amount of $25,000 per quarter.

  • In addition, Mr. Choate will receive a severance payment equal to $200,000 (equal to his fiscal 2006 base salary), payment of health insurance continuation coverage premiums equal to an amount of $13,924, and an incentive payment of $37,500.
  • Upon the completion of the merger, Mr. Choate, who beneficially owns 1.65 million shares, or 25.3% of the outstanding common stock of Aptimus, will also be able to accelerate the vesting of approximately 291,150 additional shares (option strike prices ranging from $0.00 - $1.02 per share).

Directors of the Company did not receive cash compensation for their services as directors or members of committees of the Board, but were paid with stock appreciation rights and/or stock options (most of which granted at a range of exercise prices less than $6.95 per underlying share). No matter-- upon the completion of the merger, each of outside directors of Aptimus are entitled to cash payments of $75,000 (with the lead director, Mr. Eric Helgeland, receiving $175,000).

come on and take a free ride (free ride)
come on and sit here by my side
come on and take a fr-ee ri-de
~ Jefferson Airplane [Free Ride lyrics]

Editor David J. Phillips does not hold a financial interest in any of the stocks mentioned in this article. The 10Q Detective has a Full Disclosure Policy.

Wednesday, September 12, 2007

Is S1 Corp. Being Too Optimistic with EPS Guidance?

In August, financial services software company S1 Corp. (SONE-$8.45) posted a profit of $4.9 million on $52.6 million in revenue for the second quarter ended June 30, 2007 (helped in part by tax credit carryforwards and stock repurchases).

In a ‘feel-good’ mood, management increased its earnings outlook to the range of $0.26 - $0.29 per share from previous guidance range of $0.25 - $0.28 per share.

Revenue estimates were upped, too, now projected between $202 and $206 million, due in part to the launch of a new product, Enterprise 3.5. Earlier, the company estimated revenues to be in the range of $200.0 - $206.0 million.

a research note published last week, analyst John Kraft of DA Davidson maintained his "buy" rating on S1 Corporation, citing management’s success in executing on its restructuring initiatives – introduced back in January 2007, when S1 established individualized branding around products and addressable markets: (i) Postilion, which delivers integrated solutions for self-service banking and a global ATM/payments processing platform; and (ii) S1 Enterprise, a provider of multi-channel, front-office banking solutions.

The financial services software maker’s sales are unlikely to be significantly affected by macroeconomic trends, DA Davidson added.

The 10Q Detective begs to differ.

Last Wednesday, TIBCO Software (TIBX-$7.14) forecasted third-quarter earnings below analysts' estimate as it experienced an unexpected delay in closing some business deals in the last few days of the quarter. Although the late change in business was spread across client markets and was largely due to delays in specific deals, the business software maker admitted that business was especially weak in financial services (due to the ongoing turmoil in the credit and mortgage markets). TIBCO generates about 25 percent of its quarterly revenue from the financial services sector.

Contrary to DA Davidson’s optimism, S1 is not immune to a slowdown in financial services spending, too. Like TIBCO, S1 is dependent on increasing licensing activity and professional service fees with its corporate banking clients for organic growth.

In its second quarter 10Q regulatory filing, S1 said: “A significant portion of our customers are in a consolidating financial services industry, which is subject to economic changes that could reduce demand for our products and services.”

Of concern, too, as of the six months ended June 30, 2007, 42% of Enterprise segment sales, or about $22.94 million, came from one customer, State Farm (about 23% of total revenues).

“Like a good neighbor, State Farm is there.”

State Farm is everywhere. The Company is the leading US personal lines property/casualty company (by premiums), and is the largest private insurer to homeowners in catastrophe-prone states (hurricanes) like Louisiana and Florida. Homeowners represent about 21.2% of written policies.

State Farm Mutual Automobile Insurance Company is the #1 provider of auto insurance (auto policies represent 52.2% of the company’s total accounts). It also is the leading home insurer and offers non-medical health and life insurance through its subsidiary companies.

After an analysis of statutory filings for the property & casualty insurance industry (as of year-end 2006),
Fitch Ratings believes the industry's risk from various sub-prime mortgage exposures is minimal. However, property casualty insurance companies could be exposed to subprime mortgage problems through their investment in residential mortgage-backed securities, asset backed securities and collateralized debt obligations.

State Farm’s property & casualty division earned a pretax operating profit of $6 billion in 2006. Consequently, the Company probably has minimal immediate liquidity needs, and thus is well positioned to weather a 'capital markets storm'.

The 10Q Detective notes, however, that with the fall of barriers between the banking, securities, and insurance industries, State Farm's is now exposed to the housing and mortgage crises. State Farm owns a
federal savings bank charter (State Farm Bank) that offers consumer financial products, including mortgages.

State Farm VP Management Corp. and State Farm Investment Management Corp. (including retail mutual fund operations) reported a combined after-tax net loss of $14 million in 2006.

S1 expects to derive revenues from State Farm of between $45 and $48 million in 2007, representing about 23 percent of aggregate sales. State Farm is free—without recourse—to cancel or reschedule projects at any time.

Given the expected slowdown in financial sector spending—compounded by the Company’s historically long sales cycles—we look for S1 to revisit their earnings/revenue guidance.

Editor David J. Phillips does not hold a financial interest in any of the companies mentioned in this article. The 10Q Detective has a Full Disclosure Policy.

Monday, September 10, 2007

Alt-A Mortgages Trip Up Impac Mortgage Holdings

On August 14, Impac Mortgage Holdings, Inc. (IMH-$1.51), one of the largest "Alt-A" residential mortgages lenders (loans that are typically between prime and subprime in terms of quality), reported a second quarter 2007 net loss of $(152.5) million, or $2.05 per common share, as compared to net earnings of $26.4 million, or $0.30 per diluted common share for previous year. The net loss was primarily the result of a $163.0 million increase in the provision for loan losses as a result of deteriorating market conditions and higher delinquencies.

Pools of
Alt-A mortgage backed securities (MBS) are packaged and marketed as being more appealing to traditional MBS yield seekers because they are perceived to offer temporary protection from prepayment risk (in a falling interest rate environment). However, this prepayment risk can be counterbalanced by a higher credit risk—as is being borne out in the volatile credit markets of 2007.

Unfortunately, management’s concept of embracing innovative mortgage lending by “questioning the basic assumptions of making mortgage loans,” turned out to be no more than another credit scheme designed to promote revenue growth by minimizing borrowers’ varying credit-risk profiles and loosening loan-to-value requirements.

On August 22, the loan originator took steps to substantially reduce its operating expenses, including staff reductions and closure of selected mortgage origination facilities. Given pink slips were approximately 350 employees of its nationwide workforce.

Commenting on the restructuring, Chairman, CEO, and co-founder Joseph R. Tomkinson said, “We are deeply saddened by the displacement of these employees, many of whom have been loyal to the Company for more than a decade. During this very difficult time, the Company is hosting a variety of seminars, career days, daily lab environments and a job fair to assist our employees in their job searches.”

As few CEOs are ever fired “for cause,” we thought it might be of interest to review the termination provisions of Messer. Tomkinson’s own employment agreement. As of December 31, 2006, if Tomkinson were to be ‘let go without cause,’ he is entitled to a severance package of about $1.92 million, which includes $1.5 million in a lump-sum cash severance, $106,560 in owed cash bonus, and the continuation of health benefits, stock options and non-vested stock vesting for an additional thirty months after separation from the Company.

Somehow, we find it difficult to believe that the 350 ‘loyal employees’ shown the door were given similar severance benefits.

Oh—a check of Impac’s online job center showed this originator of non-conforming residential mortgages was running an ad seeking a defaulted loan operations specialist.

Editor David J. Phillips does not hold a financial interest in Impac Mortgage Holdings. The 10Q Detective has a Full Disclosure Policy.

Friday, September 07, 2007

Overpricing at Landry's -- Not the Menu!

According to his online bio, Tilman J. Fertitta, the Chairman and CEO of Landry’s Restaurants, Inc. (LNY-$28.12), is a prominent Houston entrepreneur who grew up peeling shrimp and waiting tables at his father’s surfside eatery in Galveston, Texas.

A partner in the first Landry’s Seafood House Restaurant, which opened in 1980 in Katy, Texas, Feritta has been instrumental in helping to grow the Company into an operator of 179 full-service, casual dining restaurants, which include the brand names of Rainforest Café, Saltgrass Steakhouse, The Crab House, Charley’s Crab, and The Chart House.

Feritta has helped to launch Landry’s as a major player in the Texas hospitality industry, too, with the Company’s master-planned redevelopment of Galveston’s Seawall Boulevard – which includes the 2004 opening of the Galveston Island Convention Center. Albeit, his personal fortune(s) rose with this development, too [more on that later!].

And, in 2005, Landry’s moved into the gaming business, acquiring the Golden Nugget Hotel & Casinos in Las Vegas and Laughlin.


Restaurant and hospitality revenues increased $71.1 million, or 8.5%, to $902.9 million for the year ended December 31, 2006. Including gaming revenue, Landry earned $29.5 million, or $1.39 per share, in income from continuing operations, on net sales of $1.1 billion.

Nonetheless, this growth came with a price. In fiscal 2006, the interest coverage ratio of 1.76 times operating income (before taxes) fell precipitously, down from 5.08 times in December 2004 (prior to Golden Nugget acquisition).

The 10Q Detective looked behind Landry’s ‘Sales & Share-net” headlines. For example, compared to fiscal 2005, income from continuing operations actually fell 2.6 percent, due to higher labor expenses (gaming employees) and higher net interest expenses (increase in borrowings).

Contrary to management’s expectations, the Golden Nugget casinos are not making up for slower organic growth from the restaurant business.

In 2007, Landry had to delay its fiscal 2006 10-K filing with the SEC because the regulatory agency was investigating prior stock-option granting practices.

In addition, when Landry's failed to file its 2006 annual report on time, bondholders claimed that Landry's violated its debt covenants by failing to file the required SEC reports in a timely manner—and they demanded immediate repayment.

An internal audit did not uncover any intentional wrongdoing by management, and the SEC declined against conducting a formal investigation.

Last month, Landry’s
reached an agreement with the creditors, reinstating the $400 million in 7.5% senior notes with a new, higher interest rate of 9.5 percent. The settlement also required the Company to pay at least $1.6 million in legal fees incurred by or on behalf of the bondholders and a one-time $3 million "consent" fee to reinstate the bonds.

This new debt agreement burdens an already highly leveraged capital structure with an additional debt servicing of $8.0 million per annum (not including the $4.6 million in one-time fees).

As of June 30, 2007, long-term debt stood at 192.0% of shareholder-equity—not including contractual obligations of $105.5 million , $42.3 million, and $61.1 million from operating leases, purchases obligations, and other long term obligations, respectively, coming due in 2007 – 2009.

Landry’s has a junk bond credit rating, with its senior secured credit facility rated 'BB-' by S&P and that of the aforementioned $400 million (unsecured) senior notes due 2014 rated ‘CCC+.’

Corporate Governance

Too often, an executive compensation package that initially was designed to reward innovative decision-making and bold leadership, mutates with age—due to Board complacency—and no longer serves the long-term interests of the company, its shareholders and employees.

Sadly, the existing pay package of Fertitta is a glaring example of Board indifference.

The Company compensated Fertitta handsomely for a mediocre fiscal 2006. According to its recently filed Annual Proxy Statement, Fertitta earned $15.3 million in fiscal 2006. This amount included salary, cash bonus, and stock awards of $1.45 million, $1.58 million, and $11.4 million, respectively.

Two of the four independent directors have served on the Board for more than five years, signaling that with longevity comes acquiescence.

  1. In fiscal 2006, Landry spent $130,500, $246,912, respectively, for the use of Company personnel and security services provided to Mr. Fertitta.
  2. The Company also spent $70,897 of shareholder funds on (i) boat fees, (ii) membership fees and dues for country clubs, and (iii) tax preparation fees, estate planning and legal or financial advice for Fertitta.
  3. Fertitta serves on numerous boards and charitable organizations. Fertitta’s Employment Agreement dictates that the Company issue contributions to charities of Mr. Fertitta’s choice of at least $500,000, as well as match Mr. Fertitta’s charitable contributions in an amount not to exceed $250,000 per year. [Fertitta gets the accolades—and shareholders foot the bill!]

Experience being our teacher, the 10Q Detective has uncovered many a majority shareholder treating their public company like a fiefdom.

Now, if the greenbacks don't stack large on my side of the yard
I ain't f-ckin with it
This cake has got to be all icing baby
Now I know I'm taking the biggest piece
but god damn I'm the biggest fish with the biggest mouth bitch
You wanna be rich right? (Hell yeah)
Well stick with me, do as I does, and be as I be

Fertitta, the beneficial owner of 34.6% of the outstanding common stock, worth an estimated $187.8 million (not including 675,000 stock options, with a current market value of $20.3 million, vesting in January 2013 – 2016.), has steered profitable deals to Fertitta Hospitality, a private business he owns with his wife:

  • $7,500 a month in management fees;
  • $567,000 in leasing fees to operate a waterfront site the for its Rainforest Cafe restaurant in Galveston; and,
  • $50,000 in promotional events, training seminars and conferences held at Fertitta-owned resort hotel properties.

Greed, give me everything that I need

In addition, none of the aforementioned agreements were the result of arm’s-length negotiations!

I own a mansion and a yacht, haha
We do it like it should be does
~ Ice Cube (War & Peace Vol. 1: The War Disc Album, Greed)

Irrespective of future performance, Fertitta has a severance package worth approximately $56.5 million, which includes a tax gross-up of $20.7 million.

Of course, such a generous exit package awaits none of Landry’s non-executive workers.

Editor David J. Phillips does not hold a financial interest in Landry's Restaurants. The 10Q Detective has a Full Disclosure Policy.

Wednesday, September 05, 2007

Reel-to-Reel Problems at Imax Corp.

On September 10, Imax Corp. (IMAX-$4.56) will hold its annual meeting of shareholders. As both the share price and revenue of the maker of movie projection systems have not budged in five years, the 10Q Detective finds it disingenuous for Co-Chairmen and Co-Chief Executive Officers, Richard Gelfond and Bradley Wechsler, in their welcome letter to shareholders, to say:

“We are pleased to report to you that IMAX’s underlying business momentum is continuing to improve, particularly with regard to our two key corporate initiatives implemented in 2006: supplementing IMAX’s existing theatre system sales/lease model through attractive joint ventures, and transitioning the IMAX system to digital for a large portion of our client base by late 2008 to mid-2009.”

Management’s newly founded belief that the Company is positioned to achieve attractive growth and enhanced value over the long term contradicts their earlier business outlook—issued less than one month prior: “Theater system installations slip from period to period in the course of the Company’s business, and the Company has seen a significant number of theater system installations originally anticipated for the third and fourth quarters of 2006 move to anticipated installations for 2007 and beyond. The Company currently has 17 complete theater systems in its backlog that it anticipates will be installed in the second half of 2007, however it cautions that slippages remain a recurring and unpredictable part of its business.”

Despite a five-year history of non-performance, the Board—on February 15, 2007—extended the employment contracts of both Mr. Gelfond and Mr. Wechsler to December 31, 2007. Each Co-Chairman also received an incentive retention bonus of 300,000 stock appreciation rights (with an exercise price of $4.34).

If Gelfond and Wechsler elected voluntary retirement, they are entitled to receive estimated lump sum payments of approximately $11.2 million and $16.5 million, respectively, under terms of their Supplemental Executive Retirement Plans (value as of June 07, 2007). Shareholders might note, too, that these projected benefit obligations are unfunded, which means that IMAX’s reports these monies owed as accrued liabilities of about $27.7 million on its balance sheet!

Oh—throw in lump sum payments for salary and bonus, a defined contribution plan, and provision of health benefits, the amounts owed grow to $18.2 million and $17.2 million, respectively.

Never you mind that current shareholder value is $(63.8) million, or a book value of $(1.49) per share.

Should I stay or should I go now?
Should I stay or should I go now?
If I go there will be trouble
An if I stay it will be double
So come on and let me know
~ The Clash

In the recent quarter ended June 30, IMAX said it lost $4.57 million from continuing operations, or 11 cents per share, compared to a profit of $1.63 million, or 4 cents per share, during the same period last year.

The loss was wider than the consensus estimate of 6 cents per share.

Revenue during the quarter fell by 27.9% to $27.5 million, down from $38.1 million previously. Management attributed much of the decline to slipping equipment, product, and film distribution sales.

Institutional holders own about 30 percent of the outstanding common stock of IMAX. The reticence of these stakeholders, including MFC Global Investment Management (U.S.), LLC., First Wilshire Securities Management, Inc., and Goldman Sachs Group, which beneficially own 6.41 percent, 5.95 percent, and 2.62 percent, respectively, in voicing any concerns on the management record and/or performance payouts of/to Gelfond and Wechsler is puzzling to us.

Given the (unfunded) monies owed to the Co-Chairmen, institutional holders are damned if they do, and damned if they don't—in petioning Gelfond and Wechsler to retire come December 2007.

Editor David J. Phillips does not hold a financial interest in Imax. The 10Q Detective has a Full Disclosure policy.

Sunday, September 02, 2007

Entheos Tech, Internat'l Energy, PhytoMedical, and Octillion Corp.-- No Bargains in This Penny Stock Bin

According the Bureau of Labor Statistics, there were nearly 24 million small businesses in America in 2003, responsible for creating up to 80% of net new jobs annually over the past decade and generating more than half of the nation's non-farm gross domestic product (GDP).

These businesses cited "sending and receiving email" among their three most important uses of the Internet.

Entheos Technologies, Inc. (ETHT-$0.66), through its wholly owned subsidiary, Email Solutions, Inc., had hoped to capture some of this business by offering a proprietary application capable of delivering over 1,000,000 customized email messages per hour, with the ability to handle upwards of 20,000,000 emails per day.

Business Model

The Company’s business strategy was to market its email ASP services, which included the deployment, management and hosting of pre-packaged software applications through centrally located servers to this market of small to mid-sized enterprises (with fewer than 500 employees).

To date the Company—according to management—has realized limited success at attracting clients due to (1) strong competition and (2) a dearth of high volume email clients, many of whom are either entrenched with existing vendors or have developed in house applications and infrastructures.

The 10Q Detective believes the explication of Entheos’ financial failing has more to do with the conflicting interests of its CEO than any rivalry in the marketplace for ASP services.

Harmel S. Rayat, 46, who beneficially owns 95.9% of the outstanding common stock, has had a parasitic relationship with the Company for almost a decade, to the detriment of Entheos itself.

Operating History

Entheos presently operates on a limited basis and plans to sell its ASP business and use the sale proceeds, as well as other available cash, to invest in or develop other technology-based ventures.

However, its ASP business may not be saleable, for the Company failed to upgrade its technology and network infrastructure (due to limited financial resources). In addition, a sale may not generate enough to recoup development costs.

Similar to all of the companies where Rayat is a Named Executive Officer, Entheos has a colorful lineage, knee-deep in high hopes but drenched with failure—in perpetual “start-up” mode.

That o'er my sky fresh clouds arise
And drench my path with rain.
~ Grace Troy

The Company was incorporated in the State of Utah on July 14, 1983, under the name of Far West Gold, Inc. In 1998, the Company switched its business model to that of an online brokerage service, Rowland, Carmichael and Associates, Inc.

In January 1999, the Company shifted its planned principal operations—again—entering the field of Internet streaming with the launch of a media-streaming portal, (purchase cost of domain name was $50,000). On May 20,1999, Far West changed its name to, Inc.

The Company also operated a website focused on the home improvement market (

On March 21, 2001, Entheos announced its plans to sell both of its online properties due to low traffic and lack of meaningful revenues from the sites. Unable to find a buyer, during the fourth quarter of 2001, the Company wrote off the remaining value of the whatsonline site and charged to operations $31,250.

In June 2000, the Board approved a proposal to change the Company's name from, Inc. to Entheos Technologies, Inc.

On September 15, 2000, the Company purchased 100% of the voting common stock of Email Solutions, Inc., a Nevada corporation, for $283,000—from Harmel Rayat. Assets acquired consisted primarily of software and computer hardware equipment used in the emailing of news alerts.

Entheos has had limited revenues since inception, and revenues of $0 for the years ended December 31, 2003 - 2006. Historically, the Company has not been profitable, experiencing an accumulated deficit of $(3.79) million through December 31, 2006.

For the year ended December 31, 2002, the Company recorded a net loss of $262,401, or $(0.10) per share, on sales of $919,418, versus a net loss of $317,965, or $(0.16) per share, on sales of $463,288, for the same twelve-month period ending December 31, 2001.

Related Party Conflicts of Interest

Approximately 98% of the Company’s revenues for 2002 were derived from related entities, all controlled by Harmel S. Rayat: (i) Innotech Corporation for emailing services and (ii), (an on-line auto auction site) for web development and hosting services. Until the first quarter of 2002, all of Entheos’ revenues were derived from Innotech for emailing services.

In this world it is not what we take up, but what we give up, that makes us rich. ~ Henry Ward Beecher (1813 – 1887).

In our view, clergyman Beecher got it wrong, for you can get rich by take, take, and taking some more—ask Rayat.

  • Despite limited operational activity, in fiscal 2000 and 1999, the Company rewarded Rayat with $100,000 and $200,000, respectively, for management and consulting fees! On December 13th, 2002, in lieu of a cash payment, the Board of Directors authorized the issuance of 14.13 million restricted common shares (at a price of $0.02 per share) in exchange for the satisfaction of $282,666 still owed to Rayat. At the close of trading today, the value of these shares were worth about $9.33 million!
  • In another coup for Rayat, in August 2002, Entheos agreed to accept 600,625 shares of restricted common stock (in another company controlled by Rayat) in, in lieu of a cash payment of $48,050 due from for web development and web hosting services rendered by Entheos. The number of shares issued to satisfy its debt to Entheos was calculated based on the then most recent quoted market closing price of’s common stock ($0.08 per share) at the settlement date.
  • And, during the fourth quarter of 2002, the Company wrote off $459,798 in accounts receivable representing amounts due from Innotech, which no longer had the ability to repay! The Company’s principal client,, Inc. (an online community site for investors), a subsidiary of Innotech Corporation, ceased operations during October 2002.
  • Despite a company owned by Rayat stiffing Entheos out of $459,798, on February 11, 2003, the Board of Entheos awarded a Stock Option Agreement to Mr. Harmel S. Rayat covering 6,000,000 shares at an exercisable price of $0.01 per share.
  • The Company’s principal office is located at premises owned by Rayat (Vancouver, British Columbia, Canada). The Company pays a monthly rent of C$700 effective from April 1, 2006. The Company paid rent of $5,631 for the year ended December 31, 2006.


In June 2002, InnoTech filed papers with the SEC of its intent to terminate the continued registration of its common stock. was inactive for fiscal years 2005 and 2004. Effective June 20, 2005, the Company completed a reorganization, ceased its business of providing online automotive information through e.Deal Enterprises and changed its name to International Energy, Inc. (IENI-$1.01), an exploration stage company involved in the (alleged) acquisition and exploration of petroleum and natural gas reserves in various parts of the United States and Canada.

Management said in its recent 10Q filing that for the year ended March 31, 2007, and three months ended June 30, 2007, the Company was focused solely on petroleum and natural gas exploration: “At present, we continue to investigate potential petroleum and natural gas prospects and additionally, we are also seeking to augment our position in the petroleum and natural gas sector through the acquisition of and/or joint venture with, other energy related ventures or technologies.”

We dispute this statement. Like so many of Rayat’s other business ventures, International Energy is running cash flow from operations in the red—$(1.69) million, as of June 30, 2007. To date, the Company’s cash flow requirements have been primarily met by (an endless loop of) debt and equity financings.

As at June 30, 2007, the Company had a cash balance of $20,269.

IENI currently has no sales and marketing force to generate revenue—nor any customers. International Energy’s management needs to devote substantially all of its present efforts to secure additional funds.

And like the aforementioned Entheos Technologies, International Energy has not made prudent business decisions with the monies it did have to invest.

For example, on June 13, 2005, IENI entered into a Joint Venture Agreement with Reserve Oil and Gas, Inc. for the purpose of purchasing oil and gas leases, drilling, completing oil and gas wells and the resale of acquired leases. The Company paid cash $112,000 to purchase four leases totaling 312.7 acres in Sevier County, Utah. The Company abandoned the properties and wrote off the cost of $112,000 on March 31, 2007!

Irrespective of whether the underlying company is profitable, Rayat always seems to come out ahead. To wit:

On September 22, 2006 the Board of IENI approved a stock acquisition agreement pursuant to which Mr. Rayat acquired 2,402,500 shares of the common stock of at a price of $0.035 per share or $84,087 in the aggregate. The Board’s approved the stock acquisition agreement based on their assessment of various factors including, “the Company’s financial needs over the next 12 to 24 months and the limited trading volume of International Energy Inc. stock on the NASD OTCBB.”

IENI is also obligated to pay rent for its principal office (located in Vancouver, British Columbia, Canada) to a private corporation controlled by CFO Harmel S. Rayat (who beneficially owns 69% of IENI, worth about $26 million). The Company paid rent to the lessor of $1,896 for the three months ended June 30, 2007.

Since January 2002, Mr. Rayat has been president of Montgomery Asset Management Corporation, a privately held firm providing financial consulting services to emerging growth corporations. The 10Q Detective believes that the activities of Harmel S. Rayat might be more akin to that of a moneylender—the Companies he is affiliated with have all borrowed monies from Rayat—perhaps because no bank will lend to them (for they all have less-than viable business plans). In the end, Rayat ends up with the controlling interest in the foregoing companies.

Rayat is also the leading shareholder of PhytoMedical (PYTO-$0.40), an early stage research based biopharmaceutical company focused on the development and eventual commercialization of innovative plant derived drugs, beneficially owning about 69% of the outstanding common stock, worth about $51.8 million (on paper); and is the majority shareholder in Octillion Corp (OCTL-$4.40), a technology incubator focused on the acquisition and eventual commercialization of emerging technologies [Ha! Ha!], owning 72% of the stock, worth an estimated $161.5 million (on paper).

As with the other public companies owned by ‘venture-capitalist,’ Harmel S. Rayat, PYTO or OCTL have not generated any revenues since inception and are not expected to generate any revenues for the foreseeable future. In addition, the ability of PYTO and OCTL to continue as going concerns will be dependent on their ability to obtain additional funding.

In our view, existing shareholders need to fear, for even though Rayat will end up lending all the monies PYTO and OCTL (and IENI, ETHT) need to stay operational—it will come at a price: the probability that when the companies shift to other activities—and after reverse and forward stock splits—existing shareholder positions after dilution will be nil!

Unlike with homeopathy, stockholders benefit little from dilution.

Editor David J. Phillips does not hold a position in any of the stocks mentioned in this column. The 10Q Detective has a Full Disclosure Policy.