"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.

Raser Tech Performs Its Best -- At Raising More Money!

Raser Technologies (RZ-$2.30), focused on the construction of geothermal power plants, demonstrated once again that it is better at raising money than actually delivering megawatts of geothermal power. CEO Brent Cook said the company received net proceeds of $23.8 million from its most recent offering of common stock and warrants. As constructions costs per megawatt of capacity can run upwards of $6.0 million, it is unlikely that this latest capital raising will be the company’s last.

The 10Q Detective has followed the alleged progress of the Company for more than three years. As we said back in December 2005, Raser is a stock-promoter's dream--hyped PR with no content.

Since re-inventing itself as a builder of geothermal power plants almost five years ago, Raser has accumulated deficits of about $96.2 million—on cumulative revenues of approximately $1.0 million! In addition, at March 31, 2009, negative working capital totaling $58.7 million.

“There are some people so addicted to exaggeration that they can’t tell the truth without lying.” ~ American humorist Josh Billings (1818 – 1885)

Listening to the promulgations of chief executive Cook, one might think that Raser would single-handedly reduce the country’s dependence on OPEC crude. To date, the company has opened one facility, the Hatch Geothermal Power Plant, located in Beaver County, Utah, commonly referred to as the Thermo No. 1 project. In April 2009, Raser began selling electricity generated by the Thermo No. 1 geothermal power plant to the City of Anaheim, pursuant to a power purchase agreement previously entered into with Anaheim. Management expects the Thermo No. 1 Plant to be fully operational in the third quarter of this year [doubtful]. At full capacity, the plant is expected to produce up to 12 megawatts of geothermal power (enough to light up about 9,000 homes in Anaheim).

Despite the new financing, existing shareholders have about as much chance of seeing a return on their common shares as a Paleolithic Era caveman had of stumbling onto a copper cooking pot! The balance sheet is a mindless mess. In addition to owing $9.3 million in long-term debt obligations due in November 2009, the balance sheet is riddled with millions in warrants (most with reset pricing features). The company has also guaranteed cost overruns in construction-in- progress agreements with a plethora of sub-contractors—from drillers to vendors of transmission and cooling tower equipment. No sense even asking what the contingent exposure is, as the company has historically settled outstanding invoices and overdue promissory note obligations through the issuance of additional stock and warrants.

In additions, rumors are surfacing that service providers, tiring of late payments—if received at all—are walking away from some of the eight geothermal projects currently under development.

Raser’s business outlook is ambitious, including expectations to finish construction on additional geothermal power plants that will add an additional 50 megawatts, 40 megawatts, and 125 megawatts of electricity sold to utilities during 2010, 2011, and 2012. By 2013, Raser expects to have geothermal capacity totaling 377 megawatts of electricity for sale.

“An exaggeration is a truth that has lost its temper.” ~ Lebanese American poet Khalil Gibran (1883 – 1931)

Given its relentless struggle to improve its liquidity situation, a more likely scenario is that Raser curtails operations or liquidates assets. In any case, existing shareholders have a right to lose their tempers, for exaggeration is a bitter pill to swallow.

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.

Hidden Labor Costs at Kimberly-Clark?

Kimberly-Clark's (KMB-$53.79) plans to layoff three percent of its salaried employees, or 1,600 positions, will lead to an estimated savings of about $150 million annually. Chairman and chief executive Tom Falk said the move was necessary—and in step with other cost-reduction plans—if the personal care products company was to stay competitive against an increasing threat from private-label brands. If the company's latest recovery plan falters, however, union workers could be next up to fall by the roadside.

Huggies diapers, Kotex feminine products, Kleenex tissues, and Scott paper towels—sales volumes of these key products declined in the first-quarter, losing customers to the lower-cost store brands sold by retailers, such as Wal-Mart, and other consumer products companies, like Procter & Gamble (Bounty paper towels, Charmin toilet paper, and Luvs diapers). Nonetheless, the company still achieved three percent sales growth in the quarter, driven by selective price hikes.

Given the weak economy and growing threat from competitors, there is little wiggle room for the company to raise prices in coming months. Ergo, sequential margin improvements must spring from improvements in manufacturing efficiencies (such as transportation cost-savings resulting from moving diaper-making facilities to high-growth regions) and inventory control (March-ending quarter saw a seven-day sequential decline in inventory levels compared to year-end 2008).

Improved working capital performance, however, is being partially offset by poor returns on its defined contribution pension plan assets. …Continue Reading….

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.

Severity of Recession Trips Up Flow International

Chief executive Charley Brown of Flow International (FLOW-$2.39), a manufacturer of water-jet and routing machine tool systems for a variety of industrial applications, optimistically opined in a press release issued last week that although “the global economic slowdown continues to impact business, roughly two-thirds of its revenue stream has stabilized,” and the company is positioning itself for sustainable, long-term growth. Permit the 10Q Detective to proffer some skepticism, as red flags uncovered in Flow’s annual report for the year-ended April 30—combined with prior faulty predictions by Brown—suggest a successful turnaround is far from a certainty.

Fresh on the heels of a multi-million Airbus contract, Brown braved the recessionary headwinds blowing last summer and optimistically told analysts on the 2008 earnings call that Flow would deliver 20 percent compounded EBID growth on a 10 percent annual increase in annual sales for fiscal 2009. To the contrary, the company posted a loss of $23.8 million, down from a profit of $22.4 million a year earlier, primarily driven by a $29 million charge to settle patent litigation and an aborted merger with smaller rival Omax and $6.9 million in restructuring charges recorded to reduce global staffing levels.

“It always looks darkest just before it gets totally black.” ~ Charlie Brown, Peanuts comic strip

Sales fell 14 percent to $210.1 million, resulting from a significant decline in system orders as customers delayed capital spending and expansion plans. In addition, although backlog increased 30 percent to $45.7 million, customers in North America and Europe negotiated for longer lead-times (from quote to purchase).

In our opinion, Brown erred in his 2009 guidance by mistakenly believing that Flow’s diversified revenue profile—spread across geographies and end-users—would shield the company from isolated industry-specific slowdowns. Although no single customer makes up more than five-percent of total sales and roughly 58 percent of revenue comes from customers outside the U.S., management under-estimated the breadth and scale of the global economic slowdown. In addition, the usually strong recurring revenue stream from spare parts dried up in 2009, falling five-percent year-on-year due to lower capacity utilization in customers’ operations.

At April 30, Flow held $10.1 million in cash, of which approximately $6.1 million was held by non-U.S. subsidiaries; working capital of $27.9 million plummeted to a skeletal $2.1 million (after backing out the $8.7 million in deferred tax assets and $17.1 million in deferred acquisitions costs payable to Omax); and, cash used in operations was $6.5 million. Should operations continue to deteriorate in coming quarters, this anemic balance sheet could weigh-down Flow’s growth/expansion plans, forcing the company to raise additional capital through financing vehicles potentially dilutive to existing Flow shareholders, such as a recently proposed $35 million stock offering.

Irrespective of its operating performance, the company is responsible for covering more than $38 million in contractual obligations and commercial commitments coming due in 2010 – 2011, including operating leases - $5.5 million; current portion, long term debt, notes payable and capital leases - $5.0 million; and, purchase commitments - $23.3 million.

Just as worrisome, weak operating results in coming quarters would likely trip loan covenants under existing credit facilities, too, further limiting the company’s ability to obtain financing on reasonable terms.

“In the book of life, the answers aren't in the back.” ~ Charlie Brown

Decreasing liquidity, questionable credit worthiness, and confutative ramblings of a chief executive—Flow International’s ability to deliver 20 percent compounded EBID growth rests entirely on a global economic recovery. If all else fails, management could always think positively, and manage its future earnings by decreasing the $20 million valuation allowance on its deferred tax assets—like it did in 2008!

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.

Rewarding Stupidity at Computer Portfolio Services

The share price of Computer Portfolio Services (CPSS-$0.69) has plummeted 89 percent in the last two years as its financial results continue to be hammered by credit losses in its managed portfolio of sub-prime auto loans. The specialty finance company is now alleging that the only way to motivate and retain key employees is to exchange and re-price outstanding stock options, according to its proxy statement. One might wonder how this exchange will create any long-term benefit—except dilution to the holdings of non-management shareholders.

Management insists that the best course of action for the company is to replace deeply ‘underwater’ stock option awards—with an exercise price greater than $2.50 a share—with new stock option grants. Options to purchase approximately 7.5 million shares are outstanding, of which options to purchase approximately 4.2 million shares would be eligible for surrender and exchange. Under the proposal, chief executive Charles Bradley has much to gain, owning 887,000 eligible options at an average weighted exercise price of $4.72 a share. Together, the top nine executives own almost 44 percent of eligible options (at an average, weighted price of about $5.00).

For fiscal 2008, the company posted total revenues of $368.4 million, a decrease of 6.6%, to $368.4 million. Net loss for the full year 2008 was $(26.1) million, compared to net income of $13.9 million in 2007, due to rising default rates and losses resulting from the sales of some packaged auto loans.

Management opines that the steep decline in Computer Portfolio Services’ stock price was mostly driven by factors external to how it operates the business:

Our management has taken actions to address the unprecedented economic environment. We undertook significant cost-reduction actions in late 2008 and early 2009. As of May 31, 2009, we have taken actions to eliminate a total of approximately $35 million of annual operating expenses for 2009. Among these actions are (i) a reduction in the number of employees from 873 at May 31, 2008 to 542 at May 31, 2009, (ii) a general freeze on salaries, suspending our long-established practice of annual adjustments, and (iii) as to officer-level employees, a 20% reduction in bonuses earned for achieving their personal performance goals in 2008. However, despite the actions we have taken to reinvigorate our business and improve our performance, our efforts have not had a significant effect on our stock price, which remains at a level significantly below that which prevailed in the years 2006 and 2007.

Following this logic, the 10-Q Detective argues that Bradley should return his cash bonuses of $1.06 million and $1.5 million that the Board rewarded to him for alleged performance in 2008 and 2007. As any farmer knows, when you plant the lettuce and it fails to grow well, you don’t blame the lettuce. Bradley and his team had no problem taking the accolades and the lettuce during the boom years!

Look, ain't no use in cryin'
Your story I ain't buyin'
Forget about it, ain't no use in tryin' ~ R&B singer-songwrite Montell Jordanl

A swap price of $1.00 per share—44 percent above the current price—would result in an incremental 12 percent hit to compensation expenses, or $457,000 (excluding tax-gross up considerations). If options are to remain a key incentive tool, tell us again how non-management shareholders benefit if top executives know that they will also be rewarded with stock option swaps if they screw up?

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.

Wyeth Heartburn for Pfizer

The state of Massachusetts announced Monday that it has joined fourteen other states in a pricing suit against Wyeth (WYE-$44.62), alleging that the drug manufacturer “knowingly failed to give the government the same discounts it provided to private purchasers” for its blockbuster GI drug Protonix. This litigation is just one in a litany of “at risk” problems Pfizer (PFE-$14.63), the world’s largest drugmaker, will inherit with its $68 billion acquisition of Wyeth, pending approval by the stockholders of both companies.

The states’ action follows on the heels of two whistleblower lawsuits filed last month which allege that Wyeth avoided paying hundreds of millions in rebates due to state Medicaid programs for two versions—oral and intravenous—of Protonix.

Wyeth's sales performance to 2013 will be hampered by the patent expiry of four key products, including the $2.6 billion selling Enbrel (rheumatoid arthritis and psoriatic drug loses patent in 2012) and its hemophilia drug Refacto (with patent expiry in 2010).

Wyeth has patent protection on its $3.9 billion anti-depressant drug, Effexor, through 2010. The timing of generic launches, however, will likely impact the ability of the company’s sales representatives to “convince” prescribing physician that its follow-up compound Pristiq, a new antidepressant launched last year, is the “better” therapeutic agent.

Even drugs in the company’s portfolio with existing patent protection are no longer insulated from intrusion, as generic competitors are becoming more aggressive in their attempts to disrupt existing market exclusivity. For example, despite the existence of patent protection until 2010, Teva attempted in late 2007 to launch a generic version of Protonix tablets, with an intended goal of bullying Wyeth to essentially pay the Israeli-based generic firm as part of a standstill agreement. A similar legacy awaits Pfizer with Wyeth’s $1.3 billion antibiotic drug Zosyn/Tazocin. Although the Food and Drug Administration granted patent extension on this key hospital product until 2023, Wyeth management admitted back in April that generics would likely be launched in the third-quarter.

One of the most promising drugs that Pfizer will inherit in Wyeth’s pipeline is the experimental vaccine bapineuzumab, which the company is developing with Elan for the treatment of Alzheimer’s disease. To date, released data is showing mixed results—both with efficacy and side effects. Of concern, in July 2008, Phase 2 published results revealed that the drug worked no better in the patients with the gene that was a risk factor for Alzheimer’s disease as in those without the gene.

Pfizer will also inherit $5.6 billion and $1.9 billion in pension benefit and other post-retirement obligations (such as healthcare) owed to current and retired Wyeth employees. In addition, if the markets suffer more losses this year, the company could be forced to pony up more than the approximately $440 million Wyeth had planned to contribute to its qualified defined benefit pension plans (expected return on assets this year is 8.75 percent, according to the 2008 10-K). Of note, last year Wyeth contributed $664.6 million to its current pension plan to offset experienced investment losses (60 percent asset exposure to stocks).]

"Mama Mia! That's a spicy meat-a-ball!"



Lost profits to generics, pipeline setbacks, and rising pension obligations – management at Pfizer may need some Protonix for the heartburn sure to follow upon completion of the merger with Wyeth.

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.

No Smell of Profits at Matrixx Initiatives

Matrixx Initiatives (MTXX-$5.55) confirmed that it received a warning letter from the Food and Drug Administration about several of its 19 existing homeopathic Zicam products, specifically Zicam Cold Remedy Nasal Gel and Zicam Cold Remedy Swabs. The letter cited consumer reports that the use of these products could cause a temporary or permanent loss of smell, known as anosmia. The company is complying with the FDA request, but management is seeking a meeting with the FDA to defend the scientific data demonstrating the products’ safety. Nonetheless, the resulting adverse publicity could damage public confidence and kill sales across all product lines.

"Matrixx Initiatives stands behind the science of its products and its belief that there is no causal link between its Zicam Cold Remedy intranasal gel products and anosmia," said William Hemelt, Matrixx Initiatives' acting president in a press release. "It is well understood in the medical and scientific communities that the most common cause of anosmia is the common cold, which Zicam Cold Remedy intranasal gel products are taken to treat. Given the enormous number of doses sold and colds treated, there is no reason to believe the number of complaints of anosmia received is more than the number that would be expected in the general population.”

Management says, “no reliable scientific evidence exists that supports the claim that Zicam causes anosmia and that no plaintiff has ever won a product liability case against the company.” Still, that has not stopped folks from trying, with hundreds of lawsuits having been filed against the company since 2003. As part of the overall attempt to wind-down product liability litigation connected with Zicam, the company did settle approximately 500 of these lawsuits in recent years—at a cost of about $12 million. In addition, the company has spent almost $17.9 million on litigation expenses in just the last four years.

Hemelt had previously noted on the 2009 earnings call (ended March 31) that net sales would grow five-percent in fiscal 2010, representing a targeted amount of approximately $117 million. Based on forecast, share-net was expected to come in between 10 percent –to- 15 percent higher, at about $1.61 to $1.68 per share.

The company had factored into 2010 guidance that perhaps 20 percent of the oral Zicam cold remedy line was at risk from increased generic competition—but now all bets are off until management meets with the FDA to review safety issues. In our opinion, an FDA mandate requiring new safety studies would likely sink Matrixx.

Investors seduced by Matrixx Initiatives’ clean balance sheet—approximately $4.25 a share in cash and zero long-term debt—might pause and reflect on the fact that product recalls and a predicted slew of new lawsuits challenging the safety of Zicam will quickly drain the $51 million in working capital. In addition, the company acknowledged in its 2009 annual report that it is did not anticipate receiving any significant reimbursements from its insurance carriers in 2010. As of March 31, Matrixx had set aside only $785,000 and approximately $2 million in reserves for product liability litigation and product recalls, respectively. Oops!

The actual fallout from product recalls and the resulting publicity nightmare (adverse effect on allergy relief swabs business) could prove to be the killer cold virus for Matrixx, as cold remedy products (intranasal and oral) constituted almost 73 percent of its $111.6 million in sales last year.

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.

Insomnia for Somaxon Pharma Shareholders

Richard Pascoe, chief executive of Somaxon Pharmaceuticals (SOMX-$1.10), expressed confidence that the resubmitted New Drug Application of Silenor (doxepin) for insomnia in adults will address the FDA’s concerns about the drug's sleep maintenance efficacy and cardiac safety profile (risk of ventricular arrhythmias). Irrespective of a favorable approval, the commercial success of Silenor is far from a certainty.

It will take at least six-months for the FDA to complete its review—and the marketing window for Silenor is closing quickly, with the in-licensed patent for the treatment of chronic insomnia (when the inability to fall asleep last for more than three weeks) scheduled to expire in March 2013. In addition, although the company claims that Silenor’s selective histamine H-1 blockade – and lack of specificity for re-uptake at other central nervous system target sites – makes the drug a good candidate for insomnia, it is unlikely that mechanism of action alone will be enough to convince physicians to switch from better established sleep hypnotics, which include Lunesta (eszopiclone), Ambien CR (and its generic zolpidem), and Restoril (and its generic temazepam).

Somaxon is running out of cash, and is expected to announce a highly dilutive capital offering by the end of July (likely stock-warrant units). Management has yet to formalize a strategic partnership with a pharmaceutical company that already has established access to the highest prescribing physicians of insomnia treatments, too. The longer it takes the company to announce a strategic deal, the less income it is likely to keep in a royalty-sharing arrangement.

It’s a common myth that your sleep quality decreases as you age. Existing Somaxon shareholders, however, have plenty of worries to keep them up at night.

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.

GT Solar, Yingli & Others in Solar Space Unlikely to Profit From Higher Crude Prices

As crude oil futures cross the $72 a barrel mark—more than doubling off their December low of $35 a barrel, advocates of solar energy—likely giddy from breathing in too much carbon monoxide from auto exhausts—herald a probable industry turnaround, both in industry utilization (across the photovoltaic supply chain) and company-specific profitability. The solar advocates may want to reign in their enthusiasm, for judging from comments [ranging from] chief executive Tom Zarrella of GT Solar (SOLR-$6.96), a provider of specialized equipment for the solar power industry, to Liansheng Miao, chairman and CEO of solar module maker Yingli Green Energy (YGE-$15.02), a rebound in customer demand is still unlikely to occur prior to 2011.

Chairman Miao told investors on Yingli’s first-quarter 2009 earnings report that although the company remained confident in the future of the global solar market, current market and operating conditions had forced the company to reduce its 2009 production outlook to a range of 450 megawatts to 500 megawatts, down from a previous estimate of 550 to 600 megawatts.

Tom Zarrella announced last month that a slowdown in spending by customers for its photovoltaic (PV) equipment business would likely continue through fiscal 2010 ended March. Albeit the chief executive of GT Solar expressed confidence on the earnings call that polysilicon customers would honor their existing photovoltaic purchase contracts, due to “anticipation of the promising long-term future growth of solar,” evidence presented in the recently filed 2009 annual report suggests that cancellation risks on existing multi-million dollar photovoltaic (PV) and polysilicon contracts remain high.

GT Solar’s two principal business categories, photovoltaic (directional solidification systems, or DSS units) and polysilicon (chemical vapor deposition, or CVD, reactors) contribute 82 percent and 18 percent of total revenue: DSS units are specialized furnaces that melt polysilicon feedstock and cast multicrystalline ingots from which solar wafers are made; CVD reactors are used to react gases at high temperatures and pressures to produce polysilicon, the key raw material used in solar cells. During fiscal 2009 ended March 28, the four largest customers by sales were: (i) LDK Solar Co., (ii) South Korea's OCI Company ,(iii) Yingli Green Energy, and (iv) Glory Silicon Energy Co., of JiangSu, China—accounting for approximately 20 percent, 17 percent, 14 percent, and 11 percent of revenue, respectively.

GT Solar expects to convert approximately 40 percent of its $341 million in DSS furnace order backlog to revenue by April 3, 2010 (consisting of 34 PV equipment contracts). The company admits, however, that capex budget cuts by customers has reduced visibility of forward order rates and that the company has been approached by existing customers about contract revisions, specifically the pushing out of delivery schedules of contracts in its order backlog.

Industry analysts contend that the risk of customers actually canceling contracts is limited, as GT Solar usually requires deposits of 20 percent to 40 percent of the value of the contract. Nonetheless, this has not proved a determent in preventing some customers from breaching the terms of their contracts. In fact, during fiscal 2009, some customers just walked away from their contracts, forcing the company to take an $11.5 million charge against earnings and to reduce its order backlog value by about $39 million.

All along the PV value chain—from raw material suppliers of polysilicon feedstock to the megawatts shipped and installed by solar module manufacturers—prices are still in freefall. Since hitting about $500 per kg last year, spot polysilicon prices have plummeted to around $70 per kilogram. Some forecasts are calling for solar-grade crystalline ingots to drop as low as $25 per kilogram. If true, this could prove to be bad news for fabrication wafer customers of GT Solar and good news to consumers.

The question still needs to be asked—and answered—however, if commercial solar cell makers can improve utilization yields and lower variable costs enough to generate margin gains on end-product (gigawatts of solar modules) delivered to customers?

In a research note to clients, Hapoalim Securities analyst Gordon Johnson warned that solar industry fundamentals are in bigger trouble than expected by most observers. Many Chinese solar vendors are offering modules for prices far below what most American and European solar cell makers could conceivably operate at even marginal profitability. As recounted in Eric Savitz’s Tech Trader Daily, Johnson asserts that some of his “most trusted industry contacts” say that companies like Yingli , Suntech, and Trina Solar are able to offer modules for sale at $1.70-$1.80/watt, or 1.21-1.28 Euros/watt, by slashing wages of their Chinese workers. He notes that at the recent Intersolar conference, the talk was that solar modules were priced in the 1.60-1.70 Euros/watt range.

At the risk of sounding obvious, the strategy of Yingli and other Chinese vendors is to leverage the cost-competitive advantage of its commodity-like business model to expand market share at the expense of its American and European competitors. Ergo, even though government policies towards alternative energy in the United States and European countries gives one reason to be confident in the future of the global solar market, it is unclear which players in their respective space along the PV value chain—stretching from Chinese silicon wafer makers LDK and Yingli, to fabrication equipment provider GT Solar, up the chain to fully-integrated manufacturers of everything from ingots to solar panels (like Canadian Solar)—will be left standing after the coming tectonic-plate shifting shakeout of seismic proportions. Whether or not any solar company can generate sustainable profitability in the growing commoditization of the industry is another question best asked when the actual recovery occurs.

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.

Influence Peddling in Dell's Boardroom?

Dell (DELL-$12.08) struggles with another year of disappointing computer sales and a 63 percent drop in profits, and there is little scrutiny in the business press on the outlandish perquisites ($2,100 notebook computers and hundreds spent on technical support on how to use the PCs!) and egregious compensation (cash retainers and stock options worth up to $500,000 per annum) rewarded by the board to its members [save for the usual, first-rate disclosures by Michelle Leder’s footnoted.org site].

The pundits tell us less-informed folks that the board pay packages are justified because during these dire times directors are faced with even greater workloads and responsibilities. Might the settlement of compensation have more to do with board members’ interests being aligned closer to those of top executives, however, than the amount and type of remuneration necessary to attract and retain talented directors?

The governing ethical principle at Dell is that “the interests of the stockholders are best served by having a substantial number of objective, independent representatives on the board,” according to the 2009 proxy filing. For this purpose, a director is considered to be “independent” if the collective members affirmatively determine that the director does not have any direct or indirect material relationship with Dell that may impair, or appear to impair, the director’s ability to make independent judgments. In a related decision, the NYSE and NASDAQ Exchanges expanded the definition of director independence in 2008 to include immediate family members, too, none of who could have received more than $120,000 in direct compensation (or related-transactions) during any twelve-months during the prior three years.

On the basis of the standards set forth above, Dell stated in its regulatory filing that only two of the 12 board members were not independent: Michael Dell and Donald Carty, best-known as the erstwhile chairman of American Airlines (until his retirement in 2003) and also a former Vice Chairman and chief financial officer of the PC Maker (from January 2007 – June 2008).

Independent Directors Unable—or Unwilling—to Make Independent Decisions:

1. James W. Breyer, 47, joined the board in April 2009, and is currently a partner with the venture capital firm Accel Partners (located in Palo Alto, California). Dell and Michael Dell have a history of making investments as limited partners in several Internet-related ventures with Accel Partners.
2. Director Sallie L. Krawcheck, 44, served as the chairman of Citi Global Wealth Management until January 2009. During Fiscal 2009, Dell was both a customer of and a supplier to Citi Global. Among other institutions of national prominence, Krawcheck serves on the board of Carnegie Hall and the University of North Carolina. [Like all Dell board members, observe a web of outside common interests.]
3. Thomas W. Luce, III, a director from November 1991 – present, currently serves as chief executive of the National Math and Science Initiative Inc. (NMSI), a not-for-profit organization dedicated to expanding programs that have a proven positive impact on math and science education. The Michael and Susan Dell Foundation donated $1.5 million to NMSI in Fiscal 2009.

To list the activities of the other seven (alleged) independent directors would just serve as an exercise in overkill—not one member is involved in a charity or business where interests do not collide. Irrespective of what the company says, the ancient Greek lyric poet Pindar best captured the essence of “influence” on decision-making at Dell when he wrote: “even wisdom yields to self-interest.”

Dell was displaced as the top U.S. PC maker for the first time since 1999, according to research firm IDC, falling behind Hewlett-Packard in its first-quarter 2009. Given the board is failing shareholders—including Michael Dell (who still owns 11.83% of the company)—here’s a suggestion: the decisions of the existing board are obviously self-serving and of little value to stockholders and your own family’s financial well-being [Mr. Dell]. Throw the bums out and bring into the boardroom some college [geek] dropouts—like yourself—who actually know how to use a computer. It would certainly be less expensive and might actually yield some positive gains to the company’s bottom-line!

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.

Electronic Arts Defaults on Lease Covenants

Electronic Arts (ERTS-$23.13), home to some of the most popular PC games of all time, including the blockbuster Sims, Madden football, and Rock Band franchises, reported a loss of $1.08 billion for fiscal 2009 ended March, hurt by weaker-than-expected holiday sales and an admitted failure to score enough big sellers on the most popular game console system, Nintendo’s Wii. The video game publisher can weather the current downturn in consumer spending, as it sits on more than $2.1 billion in cash, according to its annual regulatory filing with the SEC. Curiously, as Wall Street analysts argue amongst themselves about the merits of EA driving growth by staying on roads well-traveled—reliance on churning out sequels to pre-existing hits and producing big, expensive Hollywood-style games (think the oft delayed Harry Potter and the Half-Blood Prince)—not one analyst bothered to voice any concerns on information buried deep in the body of the regulatory filing—the fact that the video game maker almost defaulted on real-estate loan covenants!

Electronic Arts leases certain of its current facilities, furniture, and equipment under non-cancelable operating lease agreements (recorded as off-balance sheet commitments). In February 1995, the company entered into a build-to-suit lease for its headquarters in Redwood City, California. This facility comprises a total of approximately 350,000 square feet and provides space for sales, marketing, administration and research and development functions. The lease expires in January 2039.

On February 2, 2009, the lease was amended to modify the Fixed Charge Coverage Ratio, the Quick Ratio and the Consolidated EBIDTA definitions used in the covenants. In the event that the company had not entered into this amendment, which covered the quarter ended December 31, 2008, as well as future quarters, Electronic Arts would have been unable to meet the Fixed Charge Coverage Ratio for the December quarter—default!

In December 2000, the company also entered into a second build-to-suit lease to expand the Redwood City headquarters facilities by an additional 310,000 square feet. Development of the adjacent property was completed in June 2002. Similar to the 1995 lease, had the company not modified the Fixed Charge Coverage Ratio, it would have been in non-compliance of that lease, too.

The two lease agreements are with KeyBank National Association. The following table sets forth the amended financial covenants as of February 2, 2009 (all of which EA is currently in compliance with as of March 31, 2009):

Are the financial covenant issues more an annoyance than an omen of future balance sheet concerns? Afterall, EA could purchase both properties for $247 million, according to related arrangements disclosed in the 10-K filing.

Fixed charge coverage rato indicates a firm’s ability to satisfy fixed charge obligations (such as bond interest and lease payments). As previously mentioned, EA is sitting on more than $2.0 billion in cash—more than enough to meet its fixed charge obligations. In singularity, the lease issues are irrelevant. However, if EA keeps churning out recyled versions of “in-the-box” units for PC-platform games while ignoring the explosion of software apps being written for iPhone, Facebook, and 3-D Second Life virtual gaming communities—EA could find its cash hoard being eaten faster than the tape of an eight-track cartridge.

Even scarier is the rise of free games. As presciently opined by Dean Takahashi last month in VentureBeat: What happens when the user decides that free is best? This is the same problem that newspapers, movies, music, and other producers of content are facing as the Internet undercuts the traditional barriers that have kept prices high.

As EA grapples with a weak consumer spending environment and the changing dynamics of interactive entertainment, fissures are opening up on the balance sheet: cash generated from operations plummeted 96 percent to $12 million and shareholder equity fell 28 percent to $3.1 billion. Nonetheless, chief executive John Riccitiello remains cautiously optimistic on the sales outlook for 2010, telling analysts on the earnings call that a strong lineup of titles on EA’s core platforms (PS3, Xbox 360, and Nintendo Wii), including The Sims 3, Tiger Woods PGA Tour 10, and Harry Potter should drive sales and profitability.

In my opinion, EA’s wireless, digital service initiatives will define the financial health of the company in the years ahead. The digital business is currently scaled at over $400 million and is growing north of 20 percent per annum. Although wireless sales will contribute only about 10 percent of anticipated revenue of $3.7 billion to $3.85 billion in fiscal 2010, EA remains committed to being the number one publisher in wireless in North America and Europe combined, said Riccitiello.

EA’s global publishing footprint has long been a strategic advantage for the company. Setting the investment stage in wireless and making their games more accessible to a broader audience, including social networking (such as Pogo on Twitter!) will, in my opinion, strengthen further its balance sheet in coming years, too. Or, as Oliver Wendell Holmes said: “it is not so much where we stand, as in what direction we are going.”

However, with management providing 2010 guidance of additional losses in the range of $0.85 to $1.45 per share, EA could find itself amending lease - loan covenants once again.

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.

Nothing for GM Common Stockholders

To no one’s surprise, General Motors Corp. filed for Chapter 11 bankruptcy on Monday. According to published reports, the largest U.S. automaker will issue new stock to the company’s retiree health care trust, the Voluntary Employees' Beneficiary Association (VEBA), totaling 17.5 percent of the equity in the new GM (and warrants to purchase another 2.5 percent). GM also has agreed to give the governments of Canada and Ontario a stake of about 12 percent. The U.S. Treasury and current bondholders will own around 60 percent and 10 percent, respectively. Add the equity shares up and it equals zero for existing common shareholders. Why is the stock selling for 75 cents a share? “Hope springs eternal in the human breast,” said the English poet Alexander Pope.

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.

LOFTy Fashion Changes at Ann Taylor Stores

Same-store sales in the first-quarter fell 30.7 percent at Ann Taylor Stores (ANN-$7.79), reflecting the disproportionate impact the current recession is having on the women’s apparel sector—particularly the spending pullback by professional, working women. Chief executive Kay Krill told analysts on the first-quarter earnings call, that the retailer believes it can rejuvenate flagging sales by offering shoppers more exciting fashions—starting with its fall lines. Given a history of inconsistent execution, however, will the introduction of new designs at its flagship stores and the more causal LOFT stores chain be sufficient to revive sales?

Net revenue decreased 27.9% during the quarter-ended May 2, 2009, driven by lower traffic and a 14 percent drop in average dollars per transaction. Management attributed the 42.7 percent plunge in comparable store sales at the Ann Taylor chain to a combination of the recession and a dearth of unexciting merchandise on the racks, according to the 10-Q regulatory filing:

In terms of overall performance, as expected, Ann Taylor experienced a very difficult quarter. We continued to work through assortments that were too serious and not as compelling, modern or versatile as needed to meet the more fashionable and stylish apparel needs our clients now demand.

The company had better success in reducing its cost structure, with gross margin improving 230 basis points to 55.5 percent, driven by smaller inventories (down 16 percent per square foot) and a 50 percent decline in mark-down activity. In addition, only nine new stores opened in the quarter, down from 25 in the year-ago period.

A recently hosted fall fashion preview for the fashion community—for both Ann Taylor and LOFT—was well received, said Krill. I am not convinced, however, that Ann Taylor’s reliance on “taste” will be enough to stop shoppers from looking elsewhere, especially if consumer spending trends do not improve and competitors—such as New York & Co., Nordstrom, and Saks—actively promote discounting to offset sluggish sales.

Krill also remarked on the conference call that in a continuing effort to watch its margins, the company will continue its conservative inventory control practices for fall merchandise as it “tests and learns [the] way to a more robust performance.” This strategy of investing behind success rather than ahead of it could backfire on the company, however, if customers perceive the store shelves to be empty of fashionable items. Either way, the company is betting that most women are weary of their old clothes, and unlike the late comedian Gilda Radner, do not base their fashion sense “on what doesn’t itch!”

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.

Do You Like the Way Men’s Wearhouse Looks?

Neill Davis, chief financial officer of The Men’s Wearhouse (MW-$16.16), told analysts on the fourth-quarter 2008 earnings call that “promotional posture is resonating with customers—both new and existing—and is positively impacting gross profit dollars, due in large part to effective marketing and merchandising initiatives.” Despite management’s attempt to put a positive spin on ‘buy one – get one free’ promotions and other markdown sales, Davis’ corporate-speak cannot sweeten the hit to profitability caused by the apparel retailer’s discounting practices.

Total store sales for the year-ended January 31 slumped 6.6 percent to $1.97 billion, due to declining store traffic and deteriorating average net sales per square foot (8.2% at Men’s Wearhouse locations and 16.4% at K&G locations) caused by the recession.

Gross margin declined 280 basis points to 43.1 percent, resulting from increased occupancy costs [from higher rental rates for new and renewed leases] and the failure—Neill’s remarks not withstanding—of merchandising discounts to influence buying patterns of apparel shoppers.

Expectations are that difficult economic conditions will continue into 2010. As the company cannot predict when the economy will recover, senior management plans to stimulate sales with even deeper clothing discounts and to implement additional operation cost controls, such as reductions in inventory purchases and fewer store openings.

Due primarily to the lack of forward visibility as to macro economic conditions, management will only provide financial guidance for the first half: earnings per share in a range of $0.45 to $0.65; comparable store sales of its retail apparel business are anticipated to decline in a range of six percent to 10 percent and comparable store sales of its tuxedo rental revenues are expected to increase between seven percent and nine percent.

Several retail analysts have upgraded their ratings, too, opining that Men’s Wearhouse could deliver better-than expected 2009 operating results, driven by significant cost-savings and higher tuxedo rental bookings and clothing sales (from additional discounting). The 10Q Detective disagrees, predicting that a growing dependence on deep discounts will serve only to further pressure merchandising margins. In addition, although tuxedo rentals remain an area of growth, even a nine percent sales gain will do little to offset falling sales (as tuxedo rental sales represented only 7.5% of total apparel sales in the fourth quarter of 2008).

Because an appeal makes logical sense is no guarantee that it will work. ~ NYC ad genius William Bernbach (1911 – 1982)

Chief executive and founder, George Zimmer also serves as the face of the company in television commercials, simply extolling: “you’re gonna’ like the way you look! I guarantee it.” Unfortunately, the apparel retailer’s discounting practices might not be a comfortable fit with actual earnings results in coming quarters.

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.

Is Build-A-Bear Fad finally Over?

Faced with a slowing economy, Build-A-Bear Workshop (BBW-$4.51) has moved away from featuring its $18 and $20 stuffed toys in ad campaigns, going instead with $10 and $12 price points to attract walk-in traffic. Although management said it saw success in attracting new customers, the mall-based specialty retailer posted an $(826,000) loss in the first-quarter (compared to earnings of $6.4 million a year earlier) on a 25.5 percent decline in retail sales to $96.3 million. Can management find the right balance of merchandise across the range of price points to deliver operating profits—or has the “build-your-own” furry friends fad finally peaked? Read More….

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.

Auto Dealer Closures a Negative for DealerTrack

Mark O’Neil, chairman and chief executive of DealerTrack Holdings (TRAK-$13.54), said on the first-quarter earnings call he expected the provider of sales and finance on-demand software for the automotive retail industry to post a net loss of between $(7.0) million and $(5.5) million in 2009 on revenue of between $232 million and $238 million. The reality of accelerated dealership closures in the U.S. announced by Chrysler and Generals Motors, in our opinion, will lead to a revised downward guidance in sales and corresponding income, as cost containment initiatives are unlikely to offset subscription cancellations.

Transaction services revenue fell 37 percent to $24.0 million, primarily due to a decline in auto loan applications. Subscription services revenue increased 25 percent to $27.9 million, helped by a seven percent increase in member dealers (to 14,646) and a 16 percent climb in average monthly spend per subscriber (to $635).

At the end of first quarter, DealerTrack had 736 financing sources in its network, a net gain of three members from year-end. Despite the slow pace of enrollment, O’Neil said on the call that he still believes the company could add some 100 new lenders in 2009. Stability in the credit markets and an increase in the number of lender-members should boost transaction volumes. However, alternative financing sources, such as RouteOne and Open Dealer Exchange [a joint venture from ADP and Reynolds & Reynolds] could present competitive headwinds in the loan origination business.

The company has yet to quantify the effect Chrysler’s shut down of 25 percent of its 3,200 U.S. dealers and GM’s closure of about 2,600 of its 6,200 domestic dealerships will have on subscription sales [including the percent contribution from recurring fees]. At March 31, more than 55 percent of Chrysler dealers and 52 percent of GM dealers had subscriptions for one or more DealerTrack products.

Although the number of active dealers on the network impacts the number of lender –to- dealer relationships, O’Neil insists that transaction volume will not necessarily be impacted by a decline in the number of lenders, declaring: “Our data shows that while consumers may shop at more than one dealership for a car, they generally apply for credit at only one.”

Until a definitive picture emerges on the financial impact resulting from subscription cancellations, we prefer to avoid the purchase of DealerTrack shares.

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.

More 'Aaugh' Moments at Affymetrix

Affymetrix (AFFX-$4.44) reported a 12 percent drop in product gross margin to 47 percent of sales for the March quarter, due to costs associated with the closing of its West Sacramento plant and average selling price declines in RNA consumables. Nonetheless, chief executive Kevin King told analysts on the earnings call that the genotype instrument maker continued to make steady progress against corporate goals of expanding its GeneChip ® technology platform into new markets and improving operating leverage. The 10Q Detective is less sanguine about the company’s ability to deliver sustainable profitability and generate growth in markets that are downstream from genome-wide analysis, such as pharmacogenomics.

Expanding into new markets

Looking to expand the diversity of its customer base beyond the cytogenetics market, Affymetrix purchased Panomics in November 2008. The acquisition will complement the company’s recently acquired liquid array technology, enabling the company to address low to mid-plex genetic analysis requirements more effectively in the future, according to Rob Lipshutz, Affymetrix’s senior VP, corporate development. Although Affymetrix now offers a scalable, cost-effective platform with applications in fields from copy number research to drug metabolism solutions (identifying chromosome abnormalities that impair metabolism), investors should remember that business depends on the research and development spending of customers, specifically in the life sciences. As companies in the pharmaceutical industry continue to cut their own costs because of the economic downturn and lost sales to generics (as blockbuster drugs lose patent protection), further reduction in demand for Affymetrix’s products is likely in coming quarters.

Another restructuring

In recent years, Affymetrix has engaged in numerous initiatives to reduce costs across its operations and generate sustainable profitability. The latest restructuring plan to “optimize production capacity and cost structure,” started in February 2008 and involves moving probe array manufacturing from Sacramento to Singapore, consolidating reagent manufacturing to the Cleveland facility, and outsourcing the instrument manufacturing operations. At December 31, the accumulated deficit stood at $416.4 million.

Relocation Assistance

On the conference call, King projected a $20 to $25 million reduction in annual operating expenses as a result of the ongoing steps, with realization of these savings beginning in the second half of 2009. Of subtle interest, King has yet to buy a home in California—two years after being hired by the company. Does this suggest a dearth of confidence in his rhetoric? In 2008, Affymetrix reimbursed $138,996 to King for his “temporary” housing expenses, according to the 2009 proxy filed on Monday.

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

King joined the company as president in 2007 and took over the top job from Affymetrix founder Stephen Fodor on January 1, 2009. As part of the December 2006 offer letter to King, the board also agreed to absolve him of any potential loss in the sale of his primary residence in New Jersey. As a result of market conditions, the company recognized a loss of approximately $400,000 upon the resale of the house in April 2008.

In aggregate, stockholders are on the hook for more than $419,000 in relocation expenses (plus a $100,000 signing bonus). Given continued softness in customer demand and falling prices per data point for genotyping over the last two years, we remain unconvinced that Affymetrix will realize the expected benefits from recent restructurings and new hires, including that of King.

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.

Arbitron Downplays Nielsen Threat

Arbitron Inc. (ARB-$20.34) confirmed in its first-quarter earnings report that the defection of key radio broadcasters to Nielsen for diary-based ratings services in certain small to mid-sized markets will adversely impact revenue by about $10 million per year starting in 2010. Will the country’s leading supplier of radio ratings data be able to supplant any additional contract losses in the sticker-diary business and invigorate organic growth with the national rollout of its electronic portable people meter (PPM)?

…. Read More….

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.

Share Price of BJ Services Gushes Higher – Despite Limited Rig Visibility!

Are rising energy prices an upbeat sign that demand for oil and natural gas services, from construction of rigging to actual drilling, will show a pickup in activity in coming months? Investors think so, having driven the share price of BJ Services Company (BJS-$16.80) up more than 60 percent in less than a month. However, the earnings report filed for the quarter ended March 31 by this leading provider of pressure pumping (and other oilfield services to the petroleum industry worldwide) suggests the market valuation may be getting frothy, for more doom and gloom could lay ahead for the company and its peers in the oilfield services industry... Read More…

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.