"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.

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.

Aha-ahaaa
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.

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?

[chorus]
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).

[chorus]
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.

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.

In 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.

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.

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.

Financials

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.

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.

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.

CEO 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, whatsonline.com (purchase cost of domain name was $50,000). On May 20,1999, Far West changed its name to WhatsOnline.com, Inc.

The Company also operated a website focused on the home improvement market (www.callapro.com).

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 WhatsOnline.com, 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) e.Deal.net, (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 eDeal.net, in lieu of a cash payment of $48,050 due from eDeal.net for web development and web hosting services rendered by Entheos. The number of eDeal.net shares issued to satisfy its debt to Entheos was calculated based on the then most recent quoted market closing price of eDeal.net’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, EquityAlert.com, 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.

Postmortem.

In June 2002, InnoTech filed papers with the SEC of its intent to terminate the continued registration of its common stock.

eDeal.net 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.

HepaLife Technologies: Death by Liver Failure?

HepaLife Technologies (HPLF-$1.00), which is focused on the identification and development of cell-based technologies and products, demonstrates the endemic weakness of one shareholder—in this case, one with no scientific credentials—substantially influencing virtually all business strategies requisite to shepherding a medical device through the FDA marketing maze.

Mr. Harmel S. Rayat, 46, is the largest shareholder, beneficially owning 44.21 million shares, constituting about 60 percent of the common stock outstanding, worth an estimated $44.21 million.

[Ed. note. During the past five years, Mr. Rayat has been a busy bio-entrepreneur, serving at various times, as a director, executive officer, and majority stockholder of a number of publicly traded companies. Future postings will unclothe his holdings/influence in these other companies, too.]

In October 2006, Mr. Rayat resigned his positions as president and chief executive officer, but retained the Company’s chief financial officer and principal accounting officer.

Artificial Liver Device

HepaLife’s lead product in development is a cell-supported artificial liver device. The Company is working towards optimizing the hepatic (liver) functionality of a porcine cell line, and subclones thereof, referred to as the “PICM-19 Cell Line.”

The HepaLife Bioartificial Liver device consists of three basic components: (1) a plasma filter, separating the patients blood into blood plasma and blood cells; (2) the bioreactor, a unit filled with PICM-19 cells which biologically mimic the liver’s function; and (3), the HepaDrive, a perfusion system for pumping the patient's plasma through the bioreactor while controlling gas supply and temperature for best possible performance of the cells.

According to US-based, Global Industry Analysts, Inc., one of the world’s largest market research companies, global demand for artificial liver systems is expected to rise to $2.795 billion in 2010, second only to artificial kidney support and more than double the expected $1.31 billion artificial heart market. (July 2007; Artificial Organs - A Global Strategic Business Report)

In early tests, HepaLife’s patented PICM-19 cell line, bioreactor, and HepaDrive perfusion system have demonstrated early success as an integrated system, successfully replicating the liver’s key function – removal of toxic ammonia and synthesis of urea.

Recent Financial Activity

Despite a promising commercial outlook, the ability of HepaLife to obtain additional funding will determine its ability to continue as a going concern, according to the Company’s independent auditors.

The Company has yet to establish any history of profitable operations. HepaLife has had no revenues during the last five fiscal years and does not expect to generate revenues from operations for the foreseeable future. At March 31, 2007, HepaLife had an accumulated deficit of $(11.95) million and a working capital deficit of $(1.19) million.

On May 11, 2007, HepaLife entered into a Securities Purchase Agreement pursuant to which, among other things, the Company issued a Convertible Note to GCA Strategic; the aggregate proceeds of $2,125,000 (85% of the principal amount of the Convertible Note) will be used for working capital and the further development of the Company’s proprietary bioreactor system, the main mechanical component of HepaLife’s patented bioartificial liver device.

This funding will satisfy existing contractual commitments through December 31, 2007; albeit management does not currently have sufficient cash on hand to sustain planned operating activities through the end of 2008.

The dark side to this offering, however, was a death-spiral convert. The conversion price for the common stock to be issued to GCA Strategic pursuant to the conversion provisions of the Convertible Note will fluctuate based on the price of HepaLife’s common stock. Because the price at which the Convertible Note may be converted is variable, the lower HepaLife’s stock price is, the more shares of common stock will have to be issued upon conversion of the Convertible Note.

There is no limit to the number of shares that HepaLife may be required to issue upon conversion of the Convertible Note—as it is dependent upon the share price, which varies from day to day. This could cause significant downward pressure on the price of HepaLife’s common stock. For example, if the share price were to fall to 84 cents, 56 cents, or 28 cents, respectively, the Company would have to issue 2.96 million, 4.44 million, or 8.89 million additional shares, respectively.

To date, most of its operating losses were due to expenses related to HepaLife’s advertising and investor relations program rather than to sponsored research and development programs!

From inception through March 31, 2007, expenditures for advertising and investor relations aggregated $3.25 million or approximately 27% of total expenditures as compared to total R&D expenses during the same period of $878,376 or approximately 7% of total expenditures.

What majority shareholder benefited handsomely from this disproportionate—and irresponsible—use of capital spending? Harmel S. Rayat.

Prior thereto his Named Executive positions, Mr. Rayat served as the president of several companies that provided financial consulting services to a wide range of emerging growth corporations, including HepaLife. In this lifetime, however, Rayat ran afoul of federal securities laws (regarding unrestricted stock).

SEC Cease-and-Desist Decree

In recent years, many small publicly held companies have hired stock promoters to promote them on stock-picking websites and through mass-mailed e-mail messages. The promoter is often compensated in the form of purportedly unrestricted shares of the company's common stock, which the promoter sells after its promotional activities have attracted investor interest in the company.

Under federal securities laws, a public company cannot distribute unrestricted stock to public investors without first registering the offering with the Commission or having a valid exemption from registration for the transaction. Registration requires a company to provide important information about its finances and business to potential investors, and allows the Commission to review the company's disclosures.

In an attempt to circumvent those registration requirements, certain issuers have sought alternate sources of purportedly "free trading" company stock in order to compensate the stock promoters. In such arrangements, the issuers and promoters are nonetheless participating in an unregistered offering of securities to the public in violation of the federal securities laws, as described below.

In 2003, Rayat, EquityAlert.com, Inc. and Innotech Corporation (public relation firms collectively owned by Rayat)—the respondents—were found to have violated the aforementioned federal securities laws.

Without admitting or denying any of the findings and/or allegations of the U.S. Securities & Exchange Commission the respondents agreed, on October 23, 2003 to cease and desist, among other things, from committing or causing any violations and any future violations.

In addition, Respondents Innotech Corporation and EquityAlert.com, Inc. were ordered to pay disgorgement of $171,370 plus prejudgment interest; but that payment in excess of $31,555.14 was waived because “the Respondents submitted a sworn Statement of Financial Condition dated March 31, 2003, and other evidence, asserting their inability to pay full disgorgement plus prejudgment interest.” [HA! HA!]

If you can do a half-assed job of anything, you're a one-eyed man in a kingdom of the blind. ~ American writer Kurt Vonnegut, Jr. (1922 – 2007)

On April 26, 2002, the 10Q Detective unearthed that HepaLife issued 2.16 million of common shares at a price of $0.05 per share in exchange for the satisfaction of debt owed to Harmel S. Rayat. The debt was for a total of $108,000 due for the forequoted management and consulting (PR) fees.

In March 2007, Rayat disposed of 2.25 million shares at 64 cents per share.

Related Party Transaction(s)

The Company’s administrative office is located in Vancouver, British Columbia, Canada—in a building owned by a private corporation controlled by Mr. Rayat. Ergo, as long as the Company sustains operations, Rayat will receive a monthly rent check of C$3,200 from HepaLife (among other concerns that Rayat has a controlling interest, too).

Working hard to get my fill
Everybody wants a thrill
Paying anything to roll the dice
Just one more time

As of June 8, 2007, HepaLife owed an aggregate of $877,800 to Rayat, pursuant to a prior $1.60 million loan commitment. The loans bear interest at the rate of 8.50% per annum (and are due upon the receipt of the written demand from Mr. Rayat). HepaLife does not currently have sufficient capital on hand to repay these loans. (The Company may not use any of the proceeds from the issuance of the Convertible Note to GCA Strategic to repay these loans.)

Some will win,
some will lose
Some were born to sing the blues
Oh the movie never ends
It goes on and on and on and on ~ Artist: Journey (Don’t Stop Believin’, 1981)

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

CEO of Hi-Shear Technology Whistles: "Back at Home There's Nothin' to Do."

George W. Trahan, 59, Chief Executive Officer and Chairman of the Board (since April 2000) of Hi-Shear Technology Corp. (HSR-$9.59), manufacturer of electronic firing devices and fail-safe pyrotechnic initiation and separation products for the aerospace industry, has a two-year employment agreement, which provides for 12-weeks paid vacation each year—three months of each year!

Can't seem to get my mind off of you
Back here at home there's nothin' to do
Now that I'm away
I wish I'd stayed
Tomorrow's a day of mine
That you won't be in

Who is there to tell Trahan to get his mind off of Hi-Shear and stay away for a few days? Trahan, who beneficially owns 38.3% of the common stock outstanding, can pretty much dictate the terms of his employment.

When you looked at me
I should've run
But I thought it was just for fun
I see I was wrong
And I'm not so strong
I should've known all along
That time would tell

As of May 31, 2007, the total cumulative vacation hours earned by, but unpaid to, Mr. Trahan was $594,000.

A week without you
Thought I'd forget
Two weeks without you and I
Still haven't gotten over you yet

The Agreement also provides that Trahan’s base salary shall be increased from $484,000 in fiscal 2007 to $532,000 as of February 28, 2008. Ergo, if he elects not to ‘take holiday,’ he could cumulate an additional $123,000 in fiscal 2008.

Vacation
All I ever wanted
Vacation
Had to get away
Vacation
Meant to be spent alone

Ironically—given the industry that Hi-Shear services—the Company does not provide to Trahan a corporate jet; but, his employment contract stipulates that he is to fly in ‘first class.’

Vacation
All I ever wanted
Vacation
Had to get away
Vacation
Meant to be spent alone ~ The Go-Go’s (Vacation –audio clip, 1982)

In recognition of the requirements for business travel, the Company provides Mr. Trahan with the use of a Cadillac Seville (or other automobile of equivalent cost of Executive's choice). The automobile may be purchased by Mr. Trahan at the end of the lease or renewal of a new lease for just $1.00.

Beyond raised eyebrows, the 10Q Detective noted, too, that—irrespective of his past performance—if Mr. Trahan's employment with the Company is terminated for any reason other than death, permanent disability, or ‘for cause,’ Trahan shall continue to receive compensation for 48 months—or four times his annual salary! [Typically, exit packages involve a cash severance of two or three times salary plus bonus.]

Thomas R. Mooney, 70, the Co-chairman of the Board, performs consulting services for the Company, for which he received $230,000 during fiscal year 2007, which included a discretionary bonus of $36,000 earned in fiscal year 2006, pursuant to his consulting agreement with the Company (under its Executive Bonus Plan).

The Consulting Agreement provides that Mr. Mooney “will work on projects as assigned by the Company.” Curiously, his agreement does not include a requisite minimum of hours that Messer. Mooney has to work each month.

Mr. Mooney retired from active employment and as Chief Executive Officer in February 2000. Mr. Mooney served as Chief Executive Officer and Chairman of the Board from June 1994 until February 2000.

Oh—Mooney is also the other major stockholder, beneficially owning 30.6% of the common stock outstanding.

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

J.L. Halsey -- The Biggest Story Never Told!

In July 2001, J.L. Halsey (JLHY-$1.05) was just a shell of a public company, with nothing much to offer potential investors, save for about $135 million in net operating loss carryforwards. However, anyone drunk enough—oh! prescient enough—to have bought just $100 worth of this penny stock would have witnessed their investment grow to more than $35,000 by June 2006!

Halsey is the successor to NovaCare, which was a national leader in physical rehabilitation services, orthotics and prosthetics and employee services. The changes to Medicare reimbursement in the late 1990’s (due to the Balanced Budget Act of 1997) had deleterious effects on NovaCare and its competitors and customers. The prior operating business most affected by the Medicare changes was the long-term care services segment in which NovaCare provided therapists to skilled nursing facilities.

This business was disposed of in fiscal 1999 with the shutdown of certain of NovaCare’s operations in the Western United States during the third fiscal quarter and the sale of the remaining operations on June 1, 1999.

Subsequently, NovaCare sold off its other segments, and on June 18, 2002, the shell merged with and into Halsey, its remaining wholly owned subsidiary.

Shares rocketed in price after Halsey acquired four Emarketing software companies during the past two years: Lyris Technologies (March 2005, Email marketing software & Hosting services), EmailLabs (October 2005, Email marketing software), ClickTracks (August 2006, Web Site Analysis Tools), and Hot Banana (August 2006, Web Content Management Software Suite).

In July 2007, Ziff Davis Media's IT publication, Baseline Magazine, ranked the company No. 1 on its list of the fastest-growing, publicly-traded software companies with sales of less than $150 million. J.L. Halsey landed at the top with 1003 percent 2006 sales growth to $24.4 million in sales, from $2.2 million in 2005.

More than 80% of Halsey’s revenue comes from the email marketing market — from the licensing of software, the sale of support and maintenance contracts related to its software, and from the sale of hosted services. The remainder of its revenue, with the acquisitions of ClickTracks and Hot Banana, comes from Web analytics (the ability to monitor and understand visitor behavior, funnel paths, track conversions and optimize pay-per-click (PPC) programs) and content management.

In our view, despite its torrid sales growth, the current valuation of Halsey discounts the price performance potential over the next 12-months. Granted, the Company is focused on high-growth technologies—and management’s ability to execute on successfully completing the integration of its acquisitions could drive sales and earnings higher. However, our confidence in Halsey forward earnings’ visibility dissipated after a quantitative look at growth, profitability, and capital strength metrics.

Financials

Total revenue was $28.2 million for the nine months ended March 31, 2007, compared to $16.7 million for the prior year. Lyris’ hosted revenue increased to approximately $6.8 million for the nine months ended March 31, 2007, from approximately $4.7 million for the nine months ended March 31, 2006. In addition, the acquisitions of EmailLabs and ClickTracks kicked in incremental sales of $5.5 million and $2.5 million, respectively.

Halsey reported a net loss of $(430,000), or $0.00 per share, for the nine months ended March 31, 2007, compared to net income of $2.2 million, or share-net of $0.03, last year. The primary reasons for the decrease of approximately $2.6 million were increases in research and development of $1.2 million and interest expense of $576,000.

“Some people find fault as if it were buried treasure.”

Doing what we do best, the 10Q dug into Halsey’s Income statement and found some interred accounting gems. To wit:

• Discontinued Operations – Management is boosting its bottom line by annual changes to discontinued adjustments ($374.1 million loss on disposal of operations, which were originally recorded in fiscal year 2000).

The Company maintains allowances for the collection of its receivables remaining from its erstwhile healthcare operations. These allowances resulted from the purported inability or unwillingness of many of the Company’s former healthcare customers to make payments and Medicare related indemnification receivables. At March 31, 2007, the Company believed that “the probability of collecting the $563,000 in receivables was low” and accordingly, has fully reserved these receivables to reduce their net realizable value to zero. However, if any of these receivables are collected, the Company will record a gain in the period of collection.

Halsey also maintains $1.54 million (down from $2.31 million in 2006) in accrued expenses (still remaining from the 2000 discontinued operations, primarily consisting of liabilities that arose prior to or as a result of the disposed transactions). These liabilities include costs for litigation (necessary to defend itself against legal claims related to its discontinued operations), workers’ compensation claims, professional liability claims and other liabilities.

Management claims that the actual collections of assets or actual costs of liabilities are difficult to estimate because of the high variability of possible outcomes: “As a result, the actual costs could differ significantly from [prior] estimates.”

Of interest, management has consistently erred on its estimates (to the Company’s benefit) of its legacy assets and liabilities. For the nine-months ended March 31, 2007, management reversed a previously booked loss of $560,000. As such, the nine-month loss shrank by $0.01 per share. And, in the same period for fiscal 2006, there was a reversal of $448,000, boosting share-net by one-cent.

• Income Tax Provision – Halsey continues to utilize its net operating loss carryforwards to lower taxable income. For federal income tax purposes, 90% of the Company’s consolidated year to date income was offset by prior cumulative NOLs. For state income tax purposes, the company pays at the statutory rate of 8.84 percent (the statutory rate in California).

For the nine-months ended March 31, 2007, Halsey’s effective income tax rate was 23.5 percent, compared to 24.3% in the prior year. In 2006, the U.S. average statutory rate was 39.3 percent.

• Contingent acquisition payments – The Company spent about $54 million in payments for the four most recent acquisitions. In addition, each of the four foregoing acquisitions requires Halsey to make additional earn-out payments to the sellers of the businesses if certain conditions are met (specified revenue targets) totaling $13.7 million. A principle use of cash in the future will be the payment of these earn-outs (and the pay down of debt). C

Cash on hand, cash flow, and borrowing capacity under its credit facility currently are insufficient to pay these earn outs. As of March 31, 2007, the Company had only $346,000 in cash.

In addition, the Company has a current account deficit of about $(208.4) million.

1. Lyris achieved its specified revenue targets, and was owed $6.6 million in May 2007. Halsey extended the maturity date, with interest accruing at 10% per annum, to November 12, 2008. [est. total due—with interest--$7.2 million]
2. EmailLabs achieved its specific revenue targets, too, and is owed $1.72 million (due on October 11, 2007).
3. Additional payments totaling approximately $4.0 million may be made in the event ClickTracks achieves future revenue targets. Halsey does not believe it is probable that ClickTracks will achieve the specified targets and accordingly has not recorded a liability as of (March 31, 2007).
4. Halsey believes it is probable that Hot Banana’s performance will result in contingent payments for revenue targets and the second installment of a technology integration target to the sellers of Hot Banana and, as a result, the Company has accrued $882,488 in liabilities (as of March 31, 2007).

Halsey carries a market capitalization of only $103.3 million, which belies an air of ‘undervaluation.’ In our view, the trailing twelve-month ROA and ROE of 2.24% and (1.61)%, respectively, speak more to the problematic growth prospects ahead.

Investors ought note, too, that the existing capital structure can no longer support new acquisitions: intangible assets (e.g. customer relations, developed technology) and goodwill of $23.3 million and $35.8 million, collectively represented approximately 84% of total assets; and, the Company has revolving line of with Comerca Bank with some restrictive financial covenants, including fixed charge coverage ratio and senior debt to EBITDA.

J.L. Halsey said that it will seek stockholder approval to change its name to Lyris Solutions, Inc., at the company's annual stockholder meeting, which is expected to take place on September 12, 2007.

Editor David J. Phillips does not hold a financial position in J.L. Halsey. The 10Q Detective has a Full Disclosure Policy.

Advanced Environmental Recycling Tech: Quality Decking -- Lousy Stock

You should not buy a stock because it's cheap but because you know a lot about it. ~ Peter Lynch (Former Fidelity Magellan Fund Manager and Author)

If that were true—would we not all be millionaires? The 10Q Detective believes that this advice—taken out of context—has probably lost more monies for investors than it has made for them.

Advanced Environmental Recycling Technologies (AERT-$1.43) manufactures a line of low-maintenance composite building products, which are used as a non-wood alternative building material for the homebuilding market, including decking, door and window components, and exterior trim.

A read of online message boards is swimming with glowing testimonials from owners of AERT’s product(s). How many—we wonder—are from the approximately 1,600 holders of record of the Class A common stock?

The Company’s proprietary MoistureShield decking is formulated from a mixture of recycled wood fiber and plastic for long lasting beauty and low lifecycle cost. Unlike traditional wooden decking, composite decking material does not need staining, painting or sealing to maintain its natural look. The deep wood grain texture has the appearance and texture of real wood, and its water/termite resistant composition shields the wood fiber from moisture and rot damage.

The Company’s revenues are derived principally from a number of regional and national door and window manufacturers, regional building materials dealers and Weyerhaeuser, the Company’s primary decking customer.

AERT’s recycling and manufacturing facilities make Decking board, handrails, and stair applications for Weyerhaeuser under the ChoiceDek brand (carried exclusively at 1,300 (+) Lowes Home Improvement stores).

You shouldn't just pick a stock - you should do your homework. In our view, this is sager counsel from the Fidelity stock-picking legend.

Financials

Net sales for the second quarter ended June 30, 2007, fell 9.8% to $25.3 million compared with the prior year. Despite a strategic plan to diversify its distribution channel, which includes leading national companies such as the Weyerhaeuser Company, Lowe’s Companies, Inc. and Therma-Tru Corporation, sales to Weyerhaeuser still comprise about 80% of total gross sales.
MoistureShield decking sales were up 75% year-over-year (and comprise about 10% of aggregate sales), but ChoiceDek decking sales were lower by 15.6 percent. Ergo, overall decking sales were down 7.5% versus second quarter 2006.

Sales of OEM parts like door rails (to Therma-Tru Corporation) and windowsills (to Stock Building Supply Co.) were down significantly (41%) from the prior year because of the slowdown in new home construction.

In 2Q:07, gross, operating, and net margins fell 14.5%, 13.2%, and 7.6%, respectively. Year-over-year, raw material costs increased 680 basis points, due to the increased use of colorants and additives and increased use of higher grades of polyethylene. In addition, the slowdown in the building products industry translated into lower unit volume sales by cabinet and hardwood flooring manufacturers—meaning less scrap wood fiber available for purchase by AERT (acting to raise the cost of wood raw materials).

In addition, slower sales left the Company with some under-used manufacturing and administrative capacity, which increased overhead costs relative to sales and reduced profit margins.

The net loss for the 2Q:07 was $(383,919), or $(0.01) per share, compared with net income for the 2Q:06 of approximately $1.72 million, or 4 cents per share.

Liquidity and Capital Resources

At June 30, 2007, AERT had a working capital surplus of $365,604 compared to a working capital deficit of $(3.5) million at December 31, 2006, due primarily to a $5 million financing from Allstate investments in June 2007. Loan proceeds were used to reduce accounts payable and pay down a working capital line of credit, among other uses.

Hold the applause—the balance sheet is weaker than management makes it out to be: back out $16.3 million and $1.8 million of inventories and prepaid expenses, respectively, and AERT is running a working capital deficit of about $(10.2) million.

Operating cash flow for the six-months ended June 30, 2007, was $(4.73) million.

AERT’s capital improvement budget for 2007 is currently estimated at $4 million (excluding a proposed new waste recycling facility in Oklahoma, which is designed for less desirable, but low cost, forms of waste polyethylene and additional sources of waste wood fiber), most of which will be funded from either cash flow or a long-term lease.

The 10Q Detective applauds AERT’s management for looking to lower its cost of goods structure, but moving forward with the initiative will require monies not in the Company’s strongbox—yet. For example, just the first phase of the Oklahoma project will require $15.0 million in financing.

AERT is looking to the Adair County Oklahoma Economic Development Authority to finance the construction of the proposed new waste recycling facility through the issuance of tax-exempt industrial development bonds. Although the Company recently received initial regulatory environmental approval, there is no assurance that the anticipated funding will materialize. Without funding, AERT would have to pay for a large portion of the project costs from cash flow, ensuring the project would be delayed.

Approximately $3.5 million was available to borrow on an existing $15.0 million line of credit at June 30, 2007.

Long-term debt currently gobbles up 77 cents of each dollar in shareholder equity.

AERT will find it difficult to tap the credit markets, for AERT is currently in violation of two covenants from a 2003 bond agreement with Allstate Insurance Company: (i) accounts payable (not more than 10% of a/c payable in excess of 75 days past invoice date / June 2007: 11.1%) and (ii) debt service covenants (long-term debt service coverage ratio for last four quarters of at least 2.00 – 1.00 / Jun 2007: -0.03).

Corporate Governance

Irrespective of the Company’s cyclical financial and stock performance, AERT has been kind to the Brooks family.

Matriarch Marjorie S. Brooks, who beneficially owns 30.1% of the total voting stock, is the secretary, Treasurer and a director. Her sons, Joe G. Brooks, Stephen W. Brooks, and J. Douglas Brooks are the Chairman and co-Chief Executive Officer, co-CEO and director, and senior VP-sales and marketing, respectively.

In the second quarter of 2007, the Company purchased approximately $894,000 of certain of its raw materials through Brooks Investment Company, which is controlled by Marjorie S. Brooks. Additionally, the Company was charged interest costs by Brooks Investment Company of approximately $6,000 related to those purchases!

Mrs. Brooks is paid a ‘credit enhancement fee’ for providing a personal guarantee on the balance outstanding on the Company’s $15 million bank line of credit. This fee is intended to compensate Mrs. Brooks for her $4 million personal guarantee on the Company’s industrial revenue bonds. For the three and six months ended June 30, 2007, the Company recorded fees of $68,284 and $132,681, respectively, related to this arrangement.

On May 29, CEO Joe Brooks disposed of 247,000 shares (at $1.41) that he exercised at 46 cents to 56 cents per share.

The prior month, brother Stephen sold 500,000 shares (at $1.52) that he acquired via previously awarded stock options at strike prices between 38 cents – 56 cents per share.



Time has not been as equitable to long-suffering Class A stockholders—unless they were good market timers: The price spiked from $1.70 in January 2006 to an intra-day high of $3.71 on June 15, 2006. Save for that anomaly, the share price has quietly tiptoed around the $1.50 level for the last five years.

Investment Thesis

Despite weak conditions in the building materials industry, AERT believes that sales can rebound in the 2H:07. Management’s growth and profit strategy is focused on (1) increasing sales, (2) increasing gross margins, (3) lowering overhead costs, and (4) reducing debt-servicing payments.

Granted, AERT has a contract with Weyerhaeuser requiring the integrated forest products company to purchase a minimum number of truckloads of ChoiceDek Premium decking and accessories, which amount was set by Weyerhaeuser each year subject to a minimum annual quantity of 1,850 truckloads—irrespective of inventory levels. Nonetheless, in a summary of its 2Q business performance on August 3, Weyerhaeuser told investors: “weak demand in housing continues to affect” the wood products segment (which does not bode well for growth in 3Q decking sales at AERT).

AERT is looking capture customer sales by expanding its wood composite footprint in the $5.1 billion outdoor decking (deck boards and handrail systems) market. Wood/plastic composite products total only about 19% of this market, but an independent, industry group estimated that annual unit sales of wood/plastic composite decking products grew about 25% per year from 2000 to 2005 and are expected to continue double-digit annual growth for the foreseeable future. Most end-user sales are for remodeling jobs.

AERT is introducing three new ChoiceDek products (and a minimum of two colors stocked) in all stores and expanding its MoistureShield decking product line into nationwide distribution by the end of the first quarter of 2008.

Although the 10Q Detective agrees that AERT’s core competency is extracting value from turning recycled plastics into new products, management has yet to demonstrate that it can successfully launch a non-deck product. For example, the Company is behind schedule in launching its new outdoor fencing product (LifeCycle).

In addition, even though the new Springdale South factory is finally operational, we believe margins will continue to be adversely affected by continued management inefficiencies (less than expected demand for expanded product offerings) and rising raw material costs. The onus is on management to show that it can execute on streamlining logistics and increasing automation to improve yield and lower labor costs.

Given the uncertainties as to when and at what pace existing business segments will recover, the 10Q Detective is avoiding purchase of AERT shares.

You have to research the company before you put your money into it. ~ Peter Lynch.

After doing our due diligence on AERT, we do not beg to differ on this advice.

Investment Risks & Considerations

The loss of one or more key customers could cause a substantial reduction in revenues and profits. As previously mentioned, AERT’s principal customer for its decking material is Weyerhaeuser, which accounts for about 80% sales. In addition, Therma-Tru and Stock Building Supply each purchase a large portion of the Company’s industrial products.

AERT’s products are used primarily in home improvement and new home construction. The home improvement and housing construction industries are currently subject to a cyclical downturn caused by general economic conditions. In particular, the present credit crisis has lead to reduced homebuilding and/or home improvement activity. A sustained reduction in such activity would have an adverse effect on the demand for AERT’s products.

Future sales of shares could be dilutive and impair AERT’s ability to raise capital. The conversion of a significant number of existing outstanding derivative securities into Class A common stock could adversely affect the market price of the stock. At December 31, 2006, there were “in-the-money” warrants outstanding for 4,606,132 shares of Class A common stock at an average exercise price of $1.21, and options outstanding for 2,872,130 shares of Class A common stock at an average exercise price of $1.09. The exercise or conversion of a material amount of such securities would result in a 16% dilution in interest for other security holders.

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.