Pork Producer Smithfield Foods Needs a Cash Cow

Smithfield Foods (SFD-$13.46) will continue to raise hogs and produce fresh pork, but management is intent on changing the cyclical nature of profits. Going forward, packaged-meats sold under the Armour, Butterball, and LunchMakers (among other) brands, will playing a larger role. Uncertainty exists at to whether CEO Larry Pope & his current management can “get the job done. ” In the first-quarter of 2010, packaged-meat sales of pork products actually declined two percent, as increases in average selling prices could not offset a 9 percent decline in volumes. Read More at BNET Food Industries….

Rig Count to Rise at Chesapeake Energy

To further develop its Big 4 shale leaseholds, Chesapeake Energy (CHK-$28.14) plans to operate an average of approximately 101 rigs in 2010 to drill up to 795 wells. The current operating rig count is 83. The company has had some success in raising cash - and lowering its own drill bit costs - by selling investment interests on some of this acreage. For example, the company expects that its joint venture partner, StatoilHydro, will pay 75 percent of drilling costs in the Marcellus for 2010. If weak natural gas prices persist during the next two years, can the company live within its cash resources? Read More at BNET Energy….

Shipping Rate Increases at FedEx Corp

Lower yields resulting from declining fuel surcharges are expected to hurt 2010 sales at FedEx Corp (FDX-$73.38). The package-delivery giant plans to increase shipping rates in January 2010. Continue Reading at BNET Travel….

Chesapeake Energy Drilling for Investment Grade Rating

With only about 21 percent of anticipated 2010 gas production hedged, Chesapeake Energy (CHK-$28.11) is gambling that an economic recovery will push demand for natural gas – and prices – higher in coming quarters. The largest domestic producer of natural gas currently carries a Ba2 bond rating by Moody’s. Higher energy prices, however, could change the company’s credit rating picture…. Continue Reading at BNET Energy….

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

More Worries For Jet-Lagged Cephalon Shareholders

The health of Cephalon (CEPH-$58.49) going forward could be influenced by more than just the drugmaker’s initial success in switching sleep-disorder patients from its blockbuster Provigil (modafinil) to long-term Nuvigil (armodafinil) users prior to the patent clock running down on its flagship drug. Adding to an already restless sleep for stockholders, the 10-Q Detective has identified potential intangible assets sitting on the balance sheet whose value is questionable.

At June 30, goodwill and intangible assets, totaling $1.14 billion, accounted for 25.4 percent of total assets. In my opinion, Cephalon has been ‘less-than’ transparent in adjusting the carrying amounts of certain assets, including the anticipated useful lives of certain products:

1. Cephalon is carrying $26.0 million in Actiq marketing rights, which is a fentanyl lollipop used to treat “breakthrough” pain in opioid-tolerant cancer patients. The company has estimated the drug has a useful life in the range of 10 – 12 years—even though generic alternatives have been available since June 2006. A price increase of 15 percent did little to offset a year-on-year 32 percent decline in sales.
2. Net carrying amount of the anticonvulsant Gabitril is $41.6 million in product rights. In the second-quarter ended June 30, sales of Gabitril in the U.S. decreased 25 percent from the prior year period, as prescriptions declined 19 percent. A late-stage clinical trial failure in patients with generalized anxiety disorder lessens the likelihood that the drug will find greater acceptance among primary care physicians who treat anxiety. Throw in the fact that two key patents expire in 2011 and 2012, and estimated useful life of between 9 – 15 years is obsolete.
3. $374.4 million in Ception Therapeutics product rights—but should its most promising drug candidate, a humanized monoclonal antibody (mAb) against interleukin-5 (IL-5), reslizumab, disappoint in clinical trials as an effective treatment for eosinophilic esophagitis in pediatric patients, expect asset impairment charges to follow.
4. The company is amortizing the $46.2 million intangible assets of its Durasolv orally disintegrating tablet (ODT) technology, a delivery system that permits the medicine to dissolve quickly in the mouth without chewing or the need for water, over an estimated economic life of 14 years. SPI Pharma’s Pharmafreeze ODT, Catalent Pharma Solutions’ Zydis ODT, and FlashDose (Fuisz Technologies) —a multitude of competing mouth dissolving options are flooding the market. That fact, combined with ongoing litigation against KV Pharma’s OraQuick tablet formulation [not going in Cephalon’s favor], suggest Cephalon might not be successful in protecting its intellectual drug delivery property—raising the risk a test of the useful life of this asset is coming (read charge-off).
   

Although impairment charges of such intangibles are non-cash in nature, such write-downs do affect stockholder equity and possible debt covenants—and could signal deteriorating fundamentals lay ahead. As if jet-lagged Cephalon stockholders donot have enough worries to keep them up at night.

Web Buzz: A working capital surplus of $1.07 billion and cash flow from operations of $313.5 million for the first six-months will not throw off enough cash sufficient to repay $750 million of convertible notes (if presented) and other cash obligations coming due in the next 12-18 months. Read More at BNET Pharma….

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

Pyramid Schemes -- "Main Street Bubble?"

In the opinion of the 10Q Detective, there is no better source to directly educate consumers on identifying and avoiding the deceptive and predatory income traps of multi-level marketing (MLM), pyramid, and Ponzi schemes than Robert L. Fitzpatrick, President of Pyramid Scheme Alert. Responding to our recent analysis on Medifast, “Ultimate Weight-Loss System or Pyramid Scheme,” we offer Mr. Fitzpatrick’s perspective on the financial consequences to self and our economy when the FTC and SEC fail to regulate or enforce existing laws against pyramid scams and Ponzi operators:

“Writing about pyramid schemes and stocks presents a strange dilemma. I have been asked to offer my views to various financial analysts regarding publicly traded pyramid selling schemes. Investors tend to view the pyramid scheme question with ambiguity. On the one hand, they don't want to be investing in a scheme that will collapse. However, given the pyramid's great capacity for rapid "growth", they do want to cash in on the revenue it generates. The issue of inherent fraudulence and harm caused is usually not on the table, only the question of timing for investment.

Pyramid selling schemes transfer money, causing losses to many and profits to a very few, without value being exchanged. In this sense, they cannot be called "businesses."

In the guise of selling products, they leave the victims with products they would not have normally bought, at prices they would never have paid in the open market, and with months or years of wasted time trying to make money from recruiting other
"salespeople." The schemes use the fraudulent "endless chain" proposition, a per se fraud, as their main "selling" tool to induce the purchases and the futile, misdirected and uncompensated marketing work of the "last ones in" (who are 80-95% of the total at all times).

It is sad to me to see that these fraudulent practices, which, by design, concentrate wealth and derail real entrepreneurship, have become imbedded in the economy. When they come to Wall Street, they gain new stakeholders who are betting on cashing in as they rise. They constitute a "Main Street Bubble" of perhaps $15 billion each year, causing losses to about 10 million Americans each year. Today, this bubble, much like our mortgage bubble a few years ago, has a large lobby in DC, in the Direct Selling Association. This Main Street Bubble can sustain itself longer than a Wall Street bubble, as long as it upholds a facade of a "legitimate business" and enough people believe they offer an "opportunity", which currently millions still do. Losses tend to be hidden and so while it causes enormous harm, the structure itself remains intact to continue preying on people (and so, as you noted, continue to reward shareholders.)

China is the only country that has banned them outright and is using the force of the state to keep them out of the economy. In the end, I see them as a self-destructive force in our country, hitting us at the grass roots where maximum damage is inflicted to the heart of the economy. They are sapping wealth, a form of economic cancer. Predators are feeding off the savings or debts of many others. Nothing is being invented, produced. No true growth is occurring and certainly true value is not being exchanged.”

Respectfully,
Robert L. FitzPatrick, Pres.

H&R Block Copies Jackson Hewitt Playbook

H&R Block (HRB-$17.52) performed miserably in the 2009 tax season, handling 5.8 percent fewer in-store, retail tax returns, as clients sought lower-cost IRS filing alternatives due to difficult economic conditions. Can the largest provider of tax preparation services in the U.S, with almost 13,000 retail outlets, draw more customers to its stores for the 2010 tax season by re-focusing marketing and operational initiatives back towards its core, store-front business? … Continue Reading at BNET Finance Industries….

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

Medifast: Ultimate Weight-Loss System or Pyramid Scheme

Liquid protein drinks, raw foods, Scarsdale and Atkins — is the Medifast (MED-$19.44) Meal Plan an amazing weight-loss product, or just another in a long list of fad diets? Medifast meals are formulated with low-fat protein and fiber, and are supposedly “clinically proven” to help users lose weight quickly — up to an alleged 20 pounds a month — through a process called ketosis, a metabolic state where the body is tricked into burning its own fat reserves. A review of the clinical studies provided by the company online and in regulatory filings, however, finds a troubling theme underlying most of the treatment protocols… Continue Reading at BNET Health Care Industries.

The Take Shape For Life (TFSL) website boasts that becoming a health coach is a business opportunity that has a low cost of start-up, requiring no holding of inventory as all orders are shipped to the end consumer. Detractors allege, however, the company’s growth is attributable to nothing more than a twist of the notorious Ponzi postage stamp con of 1921 — a modern day, multilevel pyramid scheme…. Continue Reading at BNET Health Care Industries.

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

Fossil Fuel Prices Depress Demand for Trinal Solar's Panels

With many positives developing for solar companies and the industry, such as subsidies offered by governments and plummeting prices of the key raw material poly-silicon, why are the solar stocks giving up their huge gains of the last three months? Could it be that “grid parity” is more dependent on the price of fossil fuels than previously hypothesized? Just check out the fortunes at solar panel maker Trina Solar (TSL-$26.00) for answers … Read More at BNET Energy….

How Lucrative Eagle Ford Shale Gas Play for Swift Energy?

Terry Swift, chief executive of Swift Energy (SFY-$20.00), announced on the second-quarter earnings call that the E&P company is planning to commence drilling in South Texas’ emerging Eagle Ford shale-gas play and expand horizontal drilling operations in the Olmos tight-sand formations of its AWP Field. With North America awash in natural gas and the commodity price environment showing no signs of improvement, does it make economic sense to increase drilling activities—especially where some gas pockets are estimated in some spots to be as deep as 12,000 feet?

Management believes that its balanced approach to growing reserves and production—total proved reserves at December 31 were comprised of approximately 43 percent crude oil, 42 percent natural gas, and 15 percent natural gas liquids - located onshore and the shallow waters of Louisiana and Texas, permits the company to adjust production output to prevailing market sensitivities. For example, a 35 percent sequential increase in second-quarter oil prices offset a 26 percent decline in natural gas prices, resulting in a 14 percent increase in average prices per BOE in the second quarter of 2009 to $36.71. Production revenue increased nine percent to $82.9 million over comparable first quarter 2009 levels.

With the pricing decline, chief operating officer Robert Banks insisted to analysts on the call that the company could make money at $4.00 gas—if it could continue to push down drilling costs. For the second-quarter, G&A decreased year-on-year 26 percent to a composite $3.36 a barrel, resulting from workforce reductions; Production costs fell year-on-year 34 percent to $8.34 per barrel, due to lower natural gas and NGL processing costs, and lower plant operating costs.

The Energy Information Administration reporting that inventories of U.S. natural gas in storage were at a multi-year high sent the Henry Hub price of natural gas falling below $3.00 (per MMBtu) for the first time since August 2002. At June 30, Swift Energy had in place price floors in effect through the September 2009 contract month for crude oil. The oil price floors cover notional volumes of 645,000 barrels –expected to cover between 69 percent and 73 percent of third-quarter production — at a weighted average floor price of $62.00 per barrel. The company, however, has not hedged any natural gas scheduled for delivery in the third-quarter.

With the pricing of natural gas unlikely to rebound in the second-half of 2009, the 10Q Detective believes Swift management is being too optimistic on its ability to profitability develop its newer properties in South Texas. It is doubtful that the successful focus on controllable per unit cost in anchor fields in Louisiana and Texas can be applied with similar success on unconventional reserves, such as the Eagle Ford shale play or the Olmos tight-sand property. The rock layers that hold the reserves in both geological formations are very dense, so the gas doesn't flow easily. Completing such wells are enormously expensive—requiring more advanced—and expensive-fracturing and horizontal drilling technologies. If the company can economically recover gas from such unconventional properties at $4 a thousand cubic feet, investors have a lucrative investment opportunity—as opposed to a merely ‘promised’ one.

Editor David J Phillips holds a short interest position in Swift Energy. The 10Q Detective has a Full Disclosure Policy.

Healthcare Reform's Impact on DaVita's Dialysis Profits

Although DaVita (DVA-$52.38), posted solid second-quarter financial results, chief financial officer Rich Whitney admitted to analysts on the earnings call that Medicare composite rate adjustment provided for in 2009 and 2010 would not be sufficient to compensate for anticipated increases in forward operating costs subject to inflation, such as labor and pharmaceutical supplies. Whitney opined that the dialysis provider would likely continue the trend of steady growth and consistent cash flow going forward, but the 10Q Detective believes that operating profitability could tumble if the defined scope of new MediCare bundling rules, scheduled to be implemented in 2011, limit coverage for higher-cost cases and cap the utilization of prescribed erythropoiesis-stimulating agents (ESAs), such as Amgen’s Epogen (for end-stage renal disease (ESRD) patients with anemia).

Highlights of Business Operations

For the three-months ended June 30, DaVita said second-quarter revenue rose 8 percent year-on-year to $1.5 billion, driven principally by additional treatment days and average revenue per treatment (helped along by a one-percent increase in the Medicare composite rate), and gains in prescribed pharmaceuticals and average selling prices of drug reimbursement rates. The gains were partially offset by higher procurement costs for heparin and a seasonal decline in lab testing.

Operating income increased year-on-year by 8 percent to $236 million, due to an increase in average dialysis revenue per treatment, improved labor productivity, and lower operating costs of dialysis centers (due to the timing of certain expenses previously recorded in the first quarter of 2009).

Cash flow from operations during the quarter was $212 million, up from $147 million last year. The main contributors to this increase were the gain in net income and positive working capital changes (such as comparable declines in accounts receivables and inventories).

Implications of Medicare Bundling Rate Changes

DaVita generates approximately 65 percent of its sales from Medicare patients, but nearly all of its profits are derived from the 35 percent of its patients who have commercial health insurance, as rates from private insurers have historically paid on terms that are significantly higher than government programs (the average Medicare composite rate was $157 per treatment in 2008). Even lucrative payments from these private insurers, however, are unlikely to offset cuts expected in payment rates under the Medicare ESRD program, according to the second-quarter 2009 regulatory 10-Q filing:

In July 2008, the Medicare Improvements for Patients and Providers Act for 2008 was passed by Congress. This legislation provides for an increase in the composite rate of 1% in 2009 and in 2010. In addition this legislation introduces a new payment system for dialysis services beginning in January 2011 whereby ESRD payments will be made under a “bundled” payment rate which will provide for a fixed rate for all goods and services provided during the dialysis treatment, including laboratory services and the administration of pharmaceuticals. The initial 2011 bundled rate will be set 2% below the payment rate that providers would have received under the historical fee for service payment methodology. Beginning in 2012, a new single bundled payment base rate will be adjusted annually for inflation based upon a market basket index, less 1% of such index.

The two-percent reimbursement cut will reduce Medicare revenues by an estimated $60 million, according to Whitney. As DaVita operates principally as a dialysis and related lab services business, the company does not have the ability to quickly offset the hit to revenues. What the company can do, however, is continue to focus on cost-control initiatives, such as increased use of cheaper drugs where possible. For example, a generic alternative to Watson Pharmaceuticals’ Ferrlecit, an intravenous iron-supplement for the treatment of iron deficiency anemia in hemodialysis patients receiving supplemental epoetin therapy, is expected to enter the market later this year. Ferrlecit currently has about 30 percent of the $660 million U.S. IV iron-replacement therapy market, according to IMS Health, a pharmaceutical market researcher.

Prior to bundling, use of branded iron was a benefit, for the company was reimbursed at average selling price plus six-percent. Come 2011, a bundling system that includes one payment for treatment plus drug use likely motivates DaVita to extract margin gains through clinical outcome efficiencies. For example, several studies suggest regular IV iron-supplementation can reduce the total amount of the more expensive EPO needed by patients. Avoiding the high cost of EPO therapy is not without its own set of risks for DaVita, however, as Epogen currently accounts for approximately 20 percent of dialysis and related lab services revenues.

Analysts estimate that 60 percent of the 345,000 U.S. dialysis patients with ESRD now dialyze at either DaVita or its larger rival, Fresenius. This stronghold on the dialysis market, however, means little when it is the U.S. government that ultimately controls pricing power.

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

Wall Street Sycophants Praise Trina Solar's Performance

Chairman and CEO Jifan Gao of Trina Solar (TSL-$27.10) optimistically told analysts on its second-quarter earnings call that he believed market confidence was returning to the photovoltaic sector and expected gross margin to stabilize going forward. Overlooked by the Wall Street sycophants in their effusive praise, however, was the admission by chief financial officer Terry Wang that profitability going forward remained dependent on the solar company cutting manufacturing costs greater than sequential declines being experienced in average selling prices (ASPs).

For the third quarter of 2009, the Company expects to ship between 90 MW to 110 MW of PV modules. The Company believes gross margin for the third quarter of 2009 will likely be between 23.5 percent and 26.5 percent, up from 22 percent in the prior year period.

The company expects a reduction of its non-silicon manufacturing costs to $0.73 per watt in the third-quarter, down from $0.85 per watt last year. Management believes it is on track to achieve additional cost-savings of 15 percent to 20 percent cost reduction by the end of 2009, helped by process improvements in manufacturing (reductions in cycle time and consumable materials), scale benefits (from consolidation of its supplier chain), and technology (increases in cell and module conversions).

Although Trina is to be complimented for manufacturing cost controls, bullish optimism on gross margin assumes stabilization of average selling prices, which fell year-on-year 81.6% to $2.32 per watt. Wang admitted on the call that third and fourth-quarter ASP will sequentially decline an additional 10 percent to 15 percent and 10 percent to 12 percent, respectively.

Like most solar companies, Trina remains dependent on Italy, Germany, and Spain for its top-line growth. Given uncertainty on the sustainability of feed-in-tariff quotas in Europe and limited visibility on growth prospects in China and the U.S., the 10Q Detective opines that competitive production ramp-ups will likely intensify ASP declines. Consequently, overall profitability level improvements at Trina are unlikely in 2010, and investors—and analysts—might want to hold off on that round of applause for Trina.

Editor David J Phillips holds a short interest position in Trina Solar. The 10Q Detective has a Full Disclosure Policy.

New Revenue-Sharing Deals With Studios No Win for Blockbuster

Speaking to analysts during a second-quarter financial call on August 13, Blockbuster (BBI-$0.72) chief executive Jim Keyes said the video rental chain had drafted new revenue-sharing agreements with studios— “win-win” initiatives designed to increase the number of rentals at Blockbuster and improve profits for the studios on the backend. To the contrary, given the company’s existing debt-service obligations on its levered capital structure, the 10Q Detective believes that the motivation behind the new purchase arrangements was not for growth but an attempt by Blockbuster to continue managing the business for cash conservation, as additional credit restrictions were forced on the company by its suppliers, according to its 10-Q regulatory filing:

Given our liquidity limitations and uncertainty surrounding our ability to finance our obligations, we are currently in discussions with several of the large studios regarding the credit terms for our inventory purchases. Several of the studios have tightened their credit terms and one studio has eliminated its provision of credit to us, meaning that we must purchase product from this particular studio with cash in advance.

Purchases under revenue sharing arrangements already make up 85 percent of total domestic movie rental fees. Although details are confidential, it is likely that the newly negotiated deals provide for lower initial payments by Blockbuster to acquire the inventories. A read of past regulatory filings suggest that in exchange for lower up-front cash payments, these purchase contracts likely include minimum purchase requirements (that are based upon box office results of the titles). In addition, Blockbuster has historically paid an agreed upon percentage of rental income earned from supplied product(s) to the studio/game vendor for a limited period of time (usually 30 – 45 days).

Kick it!

In addition, a majority of its revenue-sharing agreements have historically required video product to be destroyed at the conclusion of the initial rental cycle. As studios move more aggressively to preserve their pricing control over new DVD releases, this shortening of the rental life cycle will likely adversely affect ‘previously rented product’ (PRP) going forward. In the second-quarter ended July 5, PRP sales declined 15.8% year-on-year.

You wake up late for school man you don't wanna go
You ask your mom, "Please?" but she still says, "No!
"You missed two classes and no homework
But your teacher preaches class like you're some kind of jerk

Same-store rental revenue tumbled 13.3 percent, driven by lower store traffic and lower copy depth (as management tried to conserve cash and get a handle on upcoming debt maturities). Keyes said Blockbuster was making a “concerted effort to improve unit availability,” inferring on the earnings call that increased unit availability would at least partially offset anticipated lower same-store comparables in the second half of the year. The rift in his logic, in our opinion, is that even an increase in favorable title releases (games and movies) will do little to reverse changing consumer preferences as to how they access entertainment, demonstrated by customer defections to rivals like rental-by-mail provider Netflix and DVD-rental kiosk operator Redbox.

You gotta fight for your right to paaaaaaaaaarty! [youtube video]

The combination of tight expense controls and working capital management resulted in a significant turnaround in net cash from operations in the second-quarter: $114 million as compared to a $63 million use of cash in the same period last year. In the context of uncertain market dynamics (including consumer spending behavior), $729 million in interest payments and debt maturing over the next three years, and the company’s desire to replace existing credit facilities (interest rate of 13.5 percent) with less-costly options, cash management remains a priority in the months ahead at Blockbuster.

Your pops caught you smoking and he said, "No way!"
That hypocrite smokes two packs a day
Man, living at home is such a drag
Now your mom threw away your best porno mag (Busted!) ~ Beastie Boys

In the mid-1980’s, fraternities embraced the Beastie Boys “Fight for your right” as their party anthem. Little did the souses know that the Beastie Boys’ song parodied their hollow ‘bad boy’ antics. Similarly, in the months ahead, there is no real “win” for Blockbuster stockholders resulting from the new video distribution deals. If anything, the goal remains the same as six-months ago—avoiding bankruptcy.

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

Generic Vancocin Threatens Optimer Pharmaceuticals' Fidaxomicin Success

The relative efficacy of Optimer Pharma's (OPTR-$13.49) investigational antibiotic, fidaxomicin, compared to standard-of-care vancomycin (marketed as Vancocin by drugmaker ViroPharma), for the treatment of the hospital-acquired gastrointestinal infection Clostridium difficile remains unclear, as published results show similar recurrence rates in a subset of patients infected with a life-threatening strain of the C. difficile spores. In the opinion of the 10Q Detective, even if Optimer obtains regulatory approval to market fidaxomicin, its commercial success will be limited, as the Food & Drug Administration is likely to move forward on an advisory committee’s recommendation for the sale of cheaper, generic copies of Vancocin.

Risk factors for C. difficile include advanced age, antibiotic therapy, and severe underlying diseases—with the precipitating event a disruption of the normal microflora in the colon. Acquisition of C. difficile occurs primarily in the hospital setting, where the organism has been cultured from bed rails, floors, windowsills, and toilets, as well as the hands of hospital workers who provide care for patients with C. difficile infection. The organism can persist in hospital rooms for up to 40 days after infected patients have been discharged, according to an article authored by Michael Schroeder, MD, in the peer-review journal American Family Physician.

Optimer reported top line data from a late-stage study in November 2008, showing that fidaxomicin met both its primary endpoint of clinical cure (defined as patients requiring no further therapy two days after completion of study medication) and secondary endpoint (which evaluated recurrence up to four weeks post therapy, with recurrence defined as the return of diarrhea associated with C. difficile confirmed by a positive toxin test.

A more detailed analysis of the Phase 3 study presented at the 19th annual European Congress of Clinical Microbiology and Infectious Diseases in May, however, showed that fidaxomicin was no more effective compared to Vancocin in a subset of patients with the most virulent strain (known as BI/NAP1/ribotype 027). The recurrence rates for fidaxomicin and Vancocin in the BI/NAP1/027 subgroup were 25.0% and 24.1 percent.

Relapse with the same or different strains occurs in about 10 percent to 35 percent of patients treated with either oral vancomycin or the oral anti-infective metronidazole (off-label usage). Although fidaxomicin affords no special protection from recurrence with the hyper-virulent strain, chief financial officer John Prunty remains optimistic, telling Xconomy editor Luke Timmerman that looking at the results and simply inferring the market just shrunk by one-third would be a mistake:

“Doctors faced with a diagnosis of “C.Diff” are dealing with an emergency that requires immediate treatment. The current lab tests that are sensitive enough to tell the difference between normal C.Diff and the hypervirulent form take three weeks to produce a result. [Ed. Note. The most common confirmatory study is an enzyme immunoassay for C. difficile toxins A and B, with results available in two to four hours.] So in the real world, no doctor is going to wait around for that result before deciding whether to prescribe the Optimer drug, or the usual vancomycin…. They’re likely to prescribe fidaxomycin anyway, in the hopes that the patient is among the two-thirds of the population who will get a greater protection against relapse.”

Whatever you say, say it with conviction. ~ American author and humorist Mark Twain (1835 – 1910)

Although C. difficile results in longer hospital stays (from three –to- thirteen days), Prunty is gravely mistaken in assumming that doctors would be more inclined “to prescribe fidaxomicin anyway.” In the real world community hospitals are under tremendous pressure to rein in all costs. And, as drug procurement costs are visible and easy to quantify, one could just as easily conclude that hospital administrators would “encourage” treatment algorithms favoring generic vancomycin or metronidazole (off-label usage) - especially with potential Medicare reimbursement cuts on the horizon.

A second fidaxomicin Phase 3 clinical trial is ongoing, and Optimar anticipates reporting data from this trial later this year. Assuming this study demonstrates similar top-line results, fidaxomicin could be on hospital pharmacy shelves by mid-2010. However, until the company has data on fidaxomicin’s cost-effectiveness (calculated as total costs divided by proportion of successes) the drug will likely be reserved for use in vancomycin-resistant enterococci (VRE) infections.

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

10Q Detective in Distribution Deal with BusinessWeek

10Q Detective is pleased to announce a definitive distribution arrangement with BusinessWeek, where original 10Q Detective content can now be found on a bi-weekly column at BusinessWeek’s Investor Channel.

This deal affords us a unique platform from which to nationally distribute 10Q Detective analysis to a wider audience. Loyal readers still counting on the 10Q Detective "to dig through businesses’ 8-K, 10-Q, and proxy statements filed with the SEC, looking for financial statement 'soft spots' and other juicy insider transactions,” however, can still find additional stock analysis and comments here at our original home.

In the meantime, meander over to BusinessWeek.com for our first article, which looks at Vornado Realty Trust (VNO), one of the biggest landlords in the Manhattan and Washington DC office property markets:

Can the highly levered real estate investment trust (REIT), which has a ratio of
total debt to enterprise value of approximately 60 percent, juggle dividend
payouts owed to stockholders, honor interest-coverage and maturing debt
obligations, and stabilize decreasing spreads between new tenant and expiring
rentals?

Contract Termination Fees Inflate Nabors Industries' Earnings

The operating performance of the land drilling contractor Nabors Industries (NBR-$17.03) continues to be hurt by low natural gas prices in the U.S. Lower 48 states and the resultant decrease in drilling activities as producers shut in unprofitable wells. Although weak demand for rigging and well-servicing will likely continue to weigh on dayrate revenues and margins into 2010, the company is seeing an earnings boost from “prepaid cancelled domestic rigs,” which are cash payments from exploration clients allowing for early contract terminations, according to quarterly regulatory filings:

… customers released rigs and delayed drilling projects in response to the significant drop in natural gas prices and the tightening of the credit markets. Operating revenues earned during the three months [a decrease of 43 percent to $249.8 million] and six months [a decrease of 24 percent to $639.7 million] ended June 30, 2009, includes $17.5 million and $48.8 million, respectively, related to early contract termination revenue including approximately $7.7 million and $13.1 million, respectively, which would have been earned during the current period regardless of early termination.

The decline in rig count is hurting margins, but contract terminations are disingenuously inflating reported operating metrics. In the second quarter, average margins were $10,250 per rig day, but would have been $8,900 per day, if not for that portion of the lump-sum payments that would have been earned in future quarters.

Chief Executive Eugene Isenberg said on the second-quarter earnings call that he believed “that the third quarter will likely represent a bottom in all operations, although it remains difficult to predict the timing and pace of the eventual upturn in natural gas driven activity.”

At July 29, rig count activity in U.S. Lower 48 Land Drilling operations decreased from the October 2008 peak of 273 rigs to 93 rigs. Well-servicing activity is down, too, off approximately 51 percent from its October peak to current estimated rig hours of 51,796.

Natural gas has been holding in the $3.30-$3.60-per-thousand-cubic-feet [mcf] range and storage at natural gas hubs is higher year-over-year. In addition, with no sign of increased rig additions at this time, the 10-Q Detective believes that operating income for Nabors' third quarter could be down sequentially more than the guidance of 50 percent (from the second quarter) provided by the company for its domestic operations.

Nabors still has a substantial number of rigs that are on contract not only through the end of this year, but for 2010, too, when the company is going to have an average of 70 rigs on contract, which will mitigate the downside, according to Isenberg.

In the opinion of the 10-Q Detective, the supply-demand imbalance of gas reserves remains dependent on an uncertain economic turnaround. A visible increase in U.S. onshore rig activity will unlikely occur until gas prices reach $6.00 to $7.00 per mcf, for promising shale plays, such as Fayetteville and Woodford, require such market prices to make production worthwhile. Until market conditions improve, Nabors will need to depend on early termination revenue to lift income and cash flow during the downturn.

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

"It'll Be Great, Just Wait!" Says CEO Rick Lepley of A.C. Moore

As a result of A.C. Moore’s (ACMR-$3.41) weak overall performance in fiscal 2008, competitive pressures, and the current economic recession, the specialty retailer of arts, crafts, and home floral merchandise has determined for fiscal 2009 to not increase base salaries or offer incentive bonuses for its executive officers, according to its 2009 proxy statement. As the specialty retailer has failed to meaningfully improve store profitability for four successive years running, this suspension in reward compensation is little more than a decorative attempt to mollify disenfranchised stockholders, and reflects the board of director’s feigned commitment to good corporate governance.

And I could be good, and I would - if I knew I was understood
And itll be great, just wait - or is it too little too late?

To his credit, Rick Lepley, anointed chief executive officer in June 2006, has taken steps to make the business more profitable, such as the shuttering of 11 stores in two years, installing up-to-date inventory software programs, and expanding merchandise (beyond traditional craft and art and scrapbooking categories) to attract kids – parents with child hobby activities, such as wood-model kits (boats, planes, drag racing cars) and the newest trends in paint crafts and pen sets.

How many times can a person water a houseful of plastic plants purchased at A.C. Moore’s before the owner realizes that she has no need for a gardener? Despite the endless rewind of initiatives, Lepley’s track record as executive steward has been abysmal: income from operations plummeted from $913,000 in 2006 to a loss of $(23.7) million in 2008 ended January 4, 2009; net sales declined 24.4% to $177 per square-foot by 2008 and average net sales per store fell 25.1% to $4,407 in the same period; and, the stock price during Lepley’s tenure has declined almost 81 percent!

One day, this embarrassment will fade behind me
And that day I could think of things that wont remind me
But these days its unbearable for both of us
We cant discuss it this way.

As for that hackneyed aphorism that the goals of Named Executive Officers’ compensation packages are to “motivate executives and align the interests of senior management with those of the shareholders,” the 10-Q Detective says rubbish!

On June 1, 2006, Mr. Lepley received a cash sign-on lump sum retention bonus of $280,000 and guaranteed cash bonus of $320,000, payable by March 31, 2007—in addition to the usual stock options, grants, and stock appreciation rights showered upon new chief executives. Adding further insult to injury, Lepley’s original employment agreement articulated limits to his relocation benefits:

1. For up to six months, Company shall pay for temporary housing for Executive and spouse in the vicinity of the Company's headquarters and for storage of household goods;
2. Company shall reimburse Executive for standard out-of-pocket relocation and moving expenses, subject to the Company's requirements with respect to reporting and documentation of such expenses; and,
3. For house hunting and relocation investigation for up to six-months, Company shall pay for monthly round trip travel for each of Executive and his spouse.

In addition to being reimbursed $40,091 for relocation expenses in 2006 and 2007, a read of the 2009 proxy statement discloses the company paid its CEO $114,995 related to the sale of his house in Florida (per his “employment agreement”). Brushing aside the fact that Lepley continued to receive housing benefits beyond six-months, no where in the three filed regulatory amendments to Lepley’s employment agreement was any mention made of sale-related benefits owed to Lepley.

Oh—as for belt tightening—and “feeling the pain” of common stockholders, the compensation board rewarded Lepley with another $550,000 special retention bonus in April 2008, complementing a 4.5% base salary wage increase, too. [Ed. Note. Other senior exexcutives received pay hikes ranging from 8.6 percent to almost 10 percent and special retention awards equivalent to 100 percent of their base salaries!]

If I knew I was understood
And itll be great, just wait -Or is it too little too late? ~ Barenaked Ladies (“Too Little Too Late”)

Commenting on Moore’s dismal first quarter 2009 results, Lepley said the specialty retailer “did nor expect any meaningful improvement before the second half of this year.”

It will be great, just wait—especially if you are an A.C. Moore executive collecting on guaranteed bonuses!

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

‘Chic’ Accounting Tricks Boost Sales at Swank Inc.

As retailing continues to face the weakest consumer-spending environment in decades, Swank Inc (SNKI-$2.49), a men’s accessories supplier of leather goods and jewelry collections, reaches deeper into its fashion bag of accounting tricks to boost annual sales.

Distributing its namesake Swank, and well-known brands (like Claiborne, Kenneth Cole, Guess?, and Tommy Hilfiger) primarily to national retailers, such as Macy’s, Kohl’s, and TJX, the New-York marketer continues to demonstrate how to offset year-on-year declines in belt and jewelry sales and increases of in-store markdowns (associated with slow moving or discontinued merchandise) by manipulating period-end adjustments of customer returns.

Net sales in 2008, 2007, and 2006 were favorably affected by over-estimating the annual returns adjustment made during each prior year’s second quarter, according to regulatory filings:

"Each spring upon the completion of processing returns from the preceding fall season, we record adjustments to net sales in the second quarter to reflect the difference between customer returns of prior year shipments actually received in the current year and the estimate used to establish the allowance for customer returns at the end of the preceding fiscal year."

As the actual returns experienced during the spring of 2008, 2007, and 2006 were less than the reserves established at the end of the preceding fiscal year, the subsequent adjustments increased net sales by $872,000 in fiscal 2008, $637,000 in fiscal 2007, and $1.25 million in fiscal 2006!

In 1995, the late Swank chairman Marshall Tulin (who died in 2005) passed the leadership reigns of president and chief executive officer to his son, John, stating his belief in the 1995 chairman's message that "it was time to let younger minds handle daily operations."

I wish I had it back again
The urge to sip from every mountain stream
Where every season promises
A host of golden, open-ended dreams
And every morning's joyful
With the prospect of days and nights to come
I love it most of all
The wisdom of the young ~ Saw Doctors (“Wisdom of Youth” / youtube video)

Given John Tulin’s nimble use of the aforementioned accounting estimates – albeit within guidelines provided by generally accepted accounting principles – the 10Q Detective can only caution investors that youthful leadership might not profit Swank shareholders so much as what can be lost without the wisdom of age.

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

Has Noven Pharma's CEO Brandt Earned A $6.0 Million Payday?

Hisamitsu Pharmaceutical is acquiring U.S. drug delivery innovator Noven Pharmaceuticals (NOVN-$16.50), in an all-cash tender offer worth approximately $430 million, or $16.50 per share. Commenting on the merger agreement, Noven chief executive Peter Brandt said it was a great day for Noven, its shareholders, and employees—as the definitive deal “provides substantial value to Noven shareholders.” A read of Brandt’s employment agreement suggests that, in particular, it was an especially rewarding day for Brandt, too.

Hisamitsu, a Japanese manufacturer of transdermal patches for pain relief, is purchasing Noven to expand its business to the United States. Noven provides the company with the sufficient infrastructure—at a good price—necessary to build its presence and brand in the U.S. market.

Following the transaction, Noven’s Peter Brandt, will step down as chief executive—less than fifteen-months after being hired to clean up the unprofitable mess left behind by erstwhile chief executive Robert Strauss, whose contract (after a 10-year tenure) was not renewed due to a 60 percent vertical plunge in the share price of the drugmaker in 2007 [investor impatience with failed initiatives to grow shareholder value].

Brandt will receive $1.3 million in cash severance (equal to two times the sum of his “annual base salary" plus 2008 bonus) and equity options and stock appreciation rights with fair-valued gains of more than $5.0 million upon exercise. His employment agreement requires Novem to “gross-up” compensation for all federal, state, and local income and excise taxes due on the aggregate total, too!

Is Brandt worth the more than $6.3 million he will likely receive upon his planned departure? Contrary to what some critics contend (as articulated by Jim Edwards over at BNET/CBS), Brandt cannot be blamed for the failed phase 3 clinical trial results of the developmental once-daily lithium carbonate drug, called Lithium QD, for bipolar disorder; the handling of manufacturing problems involving Daytrana, the only transdermal patch indicated for the treatment of the symptoms of Attention Deficit Hyperactivity Disorder (ADHD); and, the (August 2007) $130 million acquisition of JDS Pharmaceuticals, now known as Noven Therapeutics—all these disappointments rest on Strauss’ shoulders.

The 10Q Detective is not known for handing out accolades to chief executives—but, looking back over the past decade, the stock chart of Noven resembles the Nitro coaster ride at Six Flags: blasting skyward when investors anticipated the company would find success for its patented Dot-Matrix technology in other blockbuster markets beyond its core product offering, the Vivelle-dot for hormonal therapy. However, failure to successfully diversify into other patch markets—such as stalled growth in ADHD due to quality-control issues (adhesion failures) of Daytrana—coupled with other investigational drug disappointments (Lithium QD) inevitably led to the share price hurtling back down to earth. From $9.10 a share—the day he signed on as chief executive—to $16.50 a share in cash being offering by Hisamitsu, the 10Q Detective says: “Dōmo arigatō.” Thank you, Mr. Brandt.

Let Hisamitsu deal with the soaring administrative costs hung on Noven from its JDS acquisition and the R&D capital needed to bring the developmental drugs in its pipeline to market.

“Dōmo arigatō.”

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

Gloomy Christmas 2009 for Peabody Energy Stockholders?

Peabody Energy Corp. (BTU-$28.92), the world's largest private-sector coal company, appears reasonably positioned to ride out the economic downturn, having locked in thermal coal contracts last year for 2009 delivery and beyond at close to 50 –to- 60 percent premiums to current Powder River Basin (PRB) spot prices of $9.00 per short ton. Reduced electric demand and rising inventory stockpiles, however, have utilities clamoring for deferral and relief from their coal-supply off-take agreements—shipments integral to this coal miner’s financial results.

Year to date, coal-based electricity generation demand has declined nearly six percent from the prior year, or 15 million tons, according to the Energy Information Administration (EIA)—and could fall an aggregate 60 million to 70 million tons compared to 2008. Reduced steam generation combined with cheaper costs of competing power sources, such as natural gas, have contributed to an increase in utility inventory levels of coal, too. At March 31, current stockpiles represented a 21.5 million short ton oversupply, or approximately two-percent on annual consumption of 1.12 billion tons, according to the EIA.

During 2008, more than 80 percent of Peabody’s total sales (by volume), or almost 210 million tons of coal, went to U.S. electric utilities. Looking to address the current oversupply situation, chief executive officer Greg Boyce told analysts on the first-quarter 2009 earnings call to expect total production cuts of about 15 million tons this year, with most of the announced production cuts anticipated to come from its biggest mining operation in the U.S., the low-sulfur producing PRB coal region in Wyoming. Boyce guided listeners on the call to expect full-year 2009 U.S. production of 185 million and 190 million tons.

Entering the second quarter, Peabody was fully contracted for 2009 shipments and roughly 90 percent committed for 2010. Should generation burn continue to fall through the second-half of the year, there is a growing concern that that more customers would pressure the coal miner to renegotiate volume and price breakpoints or defer shipment schedules. Peabody president Rick Navarre stressed on the quarterly conference call, however, that the company was “not in active renegotiations of contracts,” although he admitted the company would welcome talks to customers having “issues”—depressed end-user demand accompanied by growing coal stockpiles.

When asked to quantify how much of the revised 2009 production target was currently under renegotiation, CEO Boyce was evasive, only repeating that the five million tons taken out of Peabody’s forecast accurately represented the “number of customers” whose burn rates were down and needed shipments curtailed.

Huh? As forecasted power demand is unlikely to rebound before first-half of 2010, odds favor additional utility customers petitioning the company for deferral or cancellation of contracted shipments. Boyce commented on the call that the company was open to amending off-take agreements only where “the value of those contracts” could be retained. In my opinion, his comments smacked of a rhapsody of extended delivery schedules designed to smooth out the current glut of coal clogging the distribution pipeline. The success of this value-trap, however, is premised on contango market theory, where coal in succeeding delivery months is contracted at progressively higher prices, due, in part, to an expected rebound in economic activity. In other words, the entire scheme is nothing more than an attempt to protect production output by back loading coal shipments (at higher price points).

Strong contractual commitments do not guarantee financial success in the current environment. Financially strapped utilities are walking away from their contractual obligations. In fiscal 2008, Peabody lost $56.9 million on failed cash buyout offers from such coal supply agreements. Coal-based utility customers are still trying to find a floor for generation demand, which signals more production cuts and broken supply contracts in the second-half of 2009 for Peabody—and more coal in shareholder stockings come Christmas.

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