Friday, June 30, 2006

Connetics: A Dermatology Company with a Rash

Itchy investors have pushed the sell button on the dermatology company, Connetics Corp. (CNCT-$11.65) driving the stock price 31% lower since March 2006, due to a rash of potentially injurious news releases:

  • On March 28th, the SEC filed a civil lawsuit against a Connetics employee, Alexander Yaroshinsky, Vice President of Biostatistics and Clinical Operations, for alleged insider trading. According to a complaint filed in federal court, Mr. Yaroshinsky made at least $680,000 by trading Connetics stock soon after learning the Food and Drug Administration's (negative) preliminary views on the company's proposed acne drug, Velac Gel, which (because of tumorigenic concerns) was later deemed unsafe by the agency. [CNCT-$16.60]
  • On Friday, April 8, 2006, Connetics announced that the SEC was widening its formal investigation into whether the company or any of its employees, officers or directors may have violated federal securities laws. [CNCT-$15.27]
  • After the close of trading on May 3, the Company announced that after an investigation, it found that its reserve provisions for rebates—contractual discounts offered to government programs and private health plans when prescriptions are dispensed—were understated by about $8 million to $9 million as of Dec. 31, 2005. The estimated increased rebate reserve amount represents approximately 1.7% of cumulative total reported net sales for Connetics' four products.

By recording the additional rebate reserve to the balance sheet, aggregate historic net sales would be reduced by the amount of the reserve provision and net income and earnings per share would be reduced as well.

On a conference call, management also lowered revenue guidance due to increased competition. Total revenues are now expected to be $211 million to $217 million, compared with prior guidance of $221 million to $225 million, reflecting increased competition in the psoriasis market. Diluted EPS for 2006 is projected to be in the range of $0.44 to $0.50, including an estimated $6.8 million or $0.17 per diluted share in stock-based compensation expense. [CNCT- $13.76]

  • On May 19, 2006, the Company announced that due to the delay in filing its Form 10-Q for the period ended March 31, 2006, the Company had received a letter from the The Nasdaq Stock Market indicating that the Company's Common Stock was subject to potential delisting pursuant to Nasdaq Marketplace Rules.

The Company, however, has requested a hearing before the Nasdaq Listing Qualifications Panel, thereby automatically deferring the de-listing of its common stock pending the Panel's review and determination. Until the Panel issues a determination and the expiration of any exception granted by the Panel, Connetics' Common Stock will continue to be traded on The Nasdaq National Market. [CNCT - $13.26]

  • After the close of trading on Tuesday, May 30, 2006, Connetics received a Failure to Comply notice from Convertible Note holders. Specifically, management said that its debt holders communicated to the Company that its failure to file its first-quarter report for the period ending March 31, 2006, on time represented a breach of indentures governing the notes.

According to the Company, the notices were from debt holders who claim to hold more than 25 percent of each of the company's outstanding 2 percent and 2.25 percent convertible senior notes. In March 2005, the Company issued $200 million of 2.00% convertible senior notes in a private placement; and on May 28, 2003, Connetics issued $90 million of 2.25% convertible senior notes due May 30, 2008, in a private placement. Breaches could be interpreted as a potential defaults on its convertible debt obligations.

The Company has sixty days to remedy this breach (by filing its 1Q:06 10Q with the SEC). [CNCT -$12.60]

  • In motion filed on June 23, 2006, the SEC moved to add Victor E. Zak, 51, of Newton, Mass., as a defendant to an insider-trading lawsuit it filed earlier this year against Alexander J. Yaroshinsky, the erstwhile vice-president previously accused of profiting from insider information.

Yaroshinsky, 52, of Mountain View, Calif., and Zak were neighbors in Massachusetts in 1992, according to the lawsuit.

As a result of their improper trading, Yaroshinsky allegedly made more than $680,000, while Zak allegedly benefited by more than $900,000, the SEC said in its proposed amended lawsuit. [CNCT-$11.96]

Now that we have profiled the operating climate facing the Company, the question remains—Is now a good time to purchase shares of the Common Stock of Connetics?

First, the 10Q Detective believes that management (and the Board of Directors) are “worth their salt,” are motivated, and possess the experience and leadership necessary to remedy existing problems and to continue to build Connetics into a leading dermatology company.

Top executives are tenured, with years of pharmaceutical, wholesaler, and/or experience in working with clinical trials and the submission process to the FDA.

Additionally, the Board of Directors reads like a “Who’s Who” of Biotechnology & Government. For example, a Director since 1995, G. Kirk Raab, former CEO of biotech behemoth Genentech (DNA- $80.13) and the first chairman of the Biotechnology Industry Organization (BIO); Leon E. Panetta, a Director since 2000, served as President Clinton’s White House Chief of Staff; John C. Kane, Director since 1997, was the President and COO of drug wholesaler, Cardinal Health, Inc., from March 1993 until his retirement in December 2000; Denise M. Gilbert, Ph.D., a Director since 2003, has ties to Wall Street. From 1986 through 1993 Dr. Gilbert was a Managing Director and senior biotechnology analyst at Smith Barney Harris & Upham and Vice President and biotechnology analyst at Montgomery Securities; Carl B. Feldbaum, Director since 2005, served as President of BIO from its founding in 1993 until January 2005, and was former Chief of Staff to Senator Arlen Specter of Pennsylvania;

Management is motivated to see the Company through its sea of troubles. What better motivation than to know that all of the stock option grants awarded to executive management in FY 2005 are drowning—as they are all more than 50% out-of-the-money. Thomas G. Wiggins, CEO, was issued 135,000 option grants in 2005 at an exercise price of $23.35 per share; C. Gregory Vontz, President and Chief Operating Officer, was issued 90,000 option grants at an exercise price of $23.35; and, John L. Higgins, Executive Vice President-Corporate Development and Chief Financial Officer, was granted 81,000 shares.

We like Connetics because it is a company that knows its strength—the therapeutic dermatology category—and it has not tried to stray beyond its core competence. In our opinion, over time, Connetics will be able to drive more value to shareholders this way.

Connetics is a specialty pharmaceutical company that currently markets four products for the medical dermatology marketplace, Luxíq (betamethasone valerate) Foam, 0.12%, OLUX (clobetasol propionate) Foam, 0.05%, Soriatane (acitretin), and Evoclin (clindamycin) Foam, 1%.

Connetics’ proprietary foam delivery system used in Luxiq Foam, OLUX Foam and Evoclin Foam, has significant advantages over conventional therapies for dermatological diseases. The foam formulation liquefies when applied to the skin, and enables the active therapeutic agent to penetrate rapidly. When the foam is applied, it dries quickly and leaves minimal residue, and no stains or odor. The Company believes the cosmetic elegance of the foam improves patient compliance and satisfaction. In market research sponsored by Connetics, more than 80% of patients said they preferred the foam to other topical delivery vehicles.

.Luxíq Foam competes in the mid-potency topical steroid market while OLUX Foam competes in the high- and super-high potency topical steroid market. According to NDC Healthcare, or NDC, for the 12 months ended December 2005, the value of the total retail topical steroid market was $1 billion.

.OLUX Foam is a foam formulation of clobetasol propionate, one of the most widely prescribed super high-potency topical steroids. OLUX Foam has been proven to deliver rapid and effective results for scalp dermatoses, and for scalp and non-scalp psoriasis. Luxíq Foam is a foam formulation of betamethasone valerate, a mid-potency topical steroid prescribed for the treatment of mild-to -moderate steroid-responsive scalp dermatoses such as psoriasis, eczema and seborrheic dermatitis.

.Topical steroids are used to treat a range of dermatoses, for which approximately 30 million steroid prescriptions are written annually.

.While the topical steroid market is highly fragmented, Connetics believes OLUX Foam is the number one branded super-high potency topical steroid prescribed by U.S. physicians, and Luxíq Foam is the number one branded mid-potency topical steroid by retail sales and the third most commonly prescribed mid-potency topical steroid by U.S. dermatologists in 2005. Net product revenues for OLUX Foam and Luxiq Foam were $61.8 million (33.5% of total net revenue) and 24.1 million (13.1% of total revenue) in 2005, respectively.

Connetics acquired the exclusive U.S. rights to Soriatane from Hoffmann-La Roche, Inc., or Roche, in March 2004. Soriatane is an approved oral therapy for the treatment of severe psoriasis in adults. According to NDC, the value of the entire retail market for psoriasis was $875 million in 2005. Soriatane is currently the only oral retinoid indicated for psoriasis in the U.S. Net product revenues for Soriatane were $72.6 million (39.4% of total net revenue) in 2005.

Evoclin is approved for the treatment of acne vulgaris (the common form of acne seen in young adults, characterized by overactive oil glands that become plugged, red, and inflamed), and competes in the topical antibiotics market for the treatment of acne. Evoclin Foam is Connetics’ first commercial product that addresses the acne market.

According to the National Institute of Arthritis, Musculoskeletal and Skin Disorders, in the U.S. an estimated 17 million people are affected by acne annually, and an estimated 5.8 million people visited a physician for treatment during the 12 months ended September 2005. Industry sources indicate that the topical acne market is the largest segment of the U.S. dermatology market, generating approximately $1.3 billion in prescriptions in 2005, and that the active ingredient clindamycin is one of the most widely prescribed for acne in the U.S., with total revenues over $500 million in 2005.

Acne can be treated topically or systemically. Evoclin Foam competes primarily in the topical antibiotic acne market, representing approximately $599 million in U.S. prescriptions during the 12-month period ended December 2005. Connetics received FDA approval to market Evoclin Foam in October 2004 and began selling the product in December 2004. Net product revenues for Evoclin Foam were $24.7 million (13.4% of total net revenue) in 2005.

The Company has one New Drug Application (NDA) currently under review by the FDA, and two other product candidates for which management expects to file NDAs during 2006.

In November 2005, Connetics submitted an NDA for Desilux Foam, a low-potency topical steroid for the treatment of atopic dermatitis, formulated with 0.05% desonide in a proprietary emollient foam delivery vehicle, VersaFoam-EF. In January 2006, the FDA accepted the NDA for filing with a user fee date of September 21, 2006.

In September and November 2005, the Company completed two Phase III clinical trials designed to evaluate Primolux Foam, a super high-potency topical steroid (0.05% clobestasol propionate in a proprietary emollient foam delivery vehicle). Management plans to submit an NDA for Primolux Foam in the first quarter of 2006.

In July 2003, the Company submitted an NDA for Extina Foam, an investigational new drug formulation of 2% ketoconazole formulated using Connetics’ proprietary platform foam delivery vehicle for the treatment of seborrheic dermatitis. In November 2004, Connetics received a non-approvable letter from the FDA for Extina Foam based on its conclusion that Extina Foam did not demonstrate statistically significant superiority to placebo foam. Following continued discussions with the FDA, the Company initiated a Phase III trial of Extina Foam in September 2005, intended to demonstrate that Extina Foam is superior to placebo foam. Pending positive results from this Phase III trail, management anticipates submitting a Class 2 Resubmission for Extina Foam to the FDA by the end of 2006.

Connetics also owns worldwide rights to a number of unique topical delivery systems, including several distinctive aerosol foams. The Company has leveraged its broad range of drug delivery technologies by entering into royalty-bearing license agreements with several well-known pharmaceutical companies around the world.

· Liquipatch is a multi-polymer gel-matrix delivery system that applies to the skin like a normal gel and dries to form a very thin, invisible, water-resistant film. This film enables a controlled release of the active agent, which Connetics believes will provide a longer treatment period. Management anticipates developing one or more new products in the aerosol foam or gel matrix formulations, by incorporating leading dermatological agents in formulations that are tailored to treat specific diseases or different areas of the body.

In 2001, Connetics entered into a global licensing agreement with Novartis Consumer Health SA for the use of its Liquipatch drug-delivery system in topical anti-fungal applications. Novartis anticipates initial European launch of a product using the Liquipatch technology in 2006.

· Rogaine Foam. In 2002, the Company entered into a license agreement with Pfizer, Inc.) pursuant to which Connetics granted Pfizer exclusive global rights, excluding Japan, to its proprietary foam drug delivery technology for use with Pfizer’s Rogaine hair loss treatment. The FDA approved Rogaine Foam in January 2006. Pfizer has not yet announced its launch plans.

· OLUX Foam. In September 2004, Connetics entered into a license agreement granting Pierre Fabre Dermatologie exclusive commercial rights to OLUX for Europe, excluding Italy, where the product is licensed to Mipharm S.p.A. The license agreement with Pierre Fabre also grants marketing rights for certain countries in South America and Africa. Pierre Fabre will market the product under different trade names. Under the terms of the license agreement with Pierre Fabre, Connetics received an upfront license payment, and will receive milestone payments and royalties on product sales. Pierre Fabre anticipates an initial launch of OLUX in select European markets in 2006.

Dermatological disorders represent significant growth markets, since treatments are often under-treated or are less than efficacious. Granted, Connetics has its fair share of problems, but we believe for risk-tolerant investors, the Company is trading at an attractive valuation—16.2 multiple to forward December ’07 FY earnings estimates of $0.72 per share. This is only an 11% discount to the specialty pharmaceutical P/E multiple of 18 times, but forward earnings do not include a premium for the next generation foam products sitting in the Company’s pipeline.

Investment Risks. Delisting of Connetics from Nasdaq for failure to comply with timely filing of financial reports, convertible debt covenant issues (which could limit future financial flexibility), and/ or clinical and regulatory delays of products in pipeline could adversely affect the share-price of the Company’s Common Stock price.

Monday, June 26, 2006

YAHOO! Executive Retention Bonuses--The American Way?

In an early June 2006 Form 8K filing with the SEC, the Compensation Committee of the Board of Directors of Yahoo! Inc. (YHOO-$31.56)—among other pay issues—approved long-term retention bonuses with certain executive officers.

For example, as a retention incentive for the next three years, the Committee granted Terry S. Semel, the Company's Chairman and Chief Executive Officer, a stock option to purchase 6 million shares of the Company's common stock at a per share exercise price of $31.59 (the closing trading price of the Company's common stock on the date of the grant). The stock options vest over a three-year period, with 25%, 35% and 40%, respectively, vesting on each anniversary of the grant date as long as Mr. Semel remains CEO of the Company. The stock options have a term of seven years.

Retention packages are designed as “incentives” to retain key executive talent and to ensure the stability of the senior management team for the predictable future. The 10Q Detective is of the opinion that Yahoo!’s good-faith gesture of granting millions of Common Stock options is a needless incentive—akin to the pay or play contracts that Hollywood studios commonly dole out to A-list actors to secure their availaibility for proposed movies in the offing.

The theatrical release of Superman Returns reminds us of an earlier Superman pay or play incentive. Warner Bros.—with no more than a storyboard—spent an estimated $25 million [1997-1998] for the services of Director Tim Burton and to Nicolas Cage (to star) in the tentatively titled Superman sequel, Superman Lives—and not a single frame of film was ever shot [we are not kidding]!
In 2005, Yahoo! paid Terry Semel, 63, total compensation of approximately $12.5 million. This does not even include the two million options granted to him (at an exercise of $34.75 per share). According to the Company’s Annual Proxy Statement, assuming a conservative 5.0% annual rate of appreciation, this one-year grant could show a realizable value of $43.7 million in 2015. Additionally, Mr. Semel exercised options underlying approximately 7.0 million shares, worth a realized value of $173.6 million! [Ed. note. The value realized represents the difference between the fair market value of the Company's common stock on the day of exercise and the exercise price of the options, and does not necessarily indicate that Semel sold such stock.]

Mr. Semel became CEO in April 2001. [Rhetorical] Did the Compensation Committee have to throw 6.0 million more shares at him as a retention incentive to get him to stay?

As stated in the Proxy Statement by the Compensation Committee: “Mr. Semel's unique skills, experience spanning the Internet and media industries, and repeated past success make him an attractive candidate to competing organizations. In view of his attractiveness to competing organizations, the Compensation Committee believes it has been and remains important to provide Mr. Semel with retention as well as performance equity awards to provide him with substantial incentives to remain with the Company.”

The man already owns 18.4 million shares of Common Stock—1.3% of the Company. Additionally, he owns 17.6 options that he has yet to exercise. And really—where is he going? Maybe down to Brazil to lead the online provider, Universo Online?

The Compensation Committee’s retention bonus philosophy is not exclusive to Yahoo! Inc. Companies as small as ($5.4 million market cap.) defense and private security contractor, DynCorp International (DCP-$10.50) and as big as ($7.08 billion) tobacco company, UST Inc. (UST-$43.89), have issued retention bonuses for key executives in the last year.

A key provision of the Sarbanes-Oxley Act of 2002 specifically prohibits company loans to executives. Our friend, Michelle Leder, writer of the daily blog,, wrote in an article in Slate (“Outfoxing SOX,” January 24, 2005), how companies (and their executives) are devising clever new methods to circumvent this provision [Section 402] and legally allow the firms to direct money to its top executives. Three of the more-popular strategies that Michelle identified:
  • Special signing bonus: upfront money for joining a company.
  • Retention bonus: money upon renewal of employment contracts.
  • Death retention bonus: money payable to executive’s beneficiaries upon proof of death of the executive.

Just think of the competitive edge many companies could attain if they invested more incubation time on R&D—and less on constantly trying to outfox the SEC?

“Truth, Justice, and the American Way!” The three cardinal words wrapped up in Superman’s red cape. Sadly, when it comes to executive compensation—often times truth and justice are laid siege by greed: Is it not the American Way?”

Saturday, June 24, 2006

Novell: Messman Toppled--New Day for Investors?

The news that the Board of Directors of struggling, open-source software developer Novell, Inc. (NOVL-$6.66) ousted CEO Jack Messman and CFO Joseph Tibbets was met with applause by investors, as the stock was bid up 11.0% in the last two trading days.

Erstwhile owner of WordPerfect and the Quattro Pro spreadsheet, Novell in recent years has struggled in finding a sustainable—and profitable—growth strategy.

In July 2001, Jack L. Messman became Chief Executive Officer of Novell in connection with Novell’s acquisition of Cambridge Technology Partners, Inc. Embracing the open-source movement, Messman built—through acquisitions—a Company that supported a full range of enterprise solutions on the Linux platform, from the desktop, to the server, to the mainframe. Open source is a term used to describe software source code that generally allows free use, modification, and distribution of source code.

Despite a market for Linux (open source) products and services growing at an overall rate of approximately 26 percent per year through 2008, Novell (under the tutelage of Messman) lagged behind. Hobbled by delays in the introduction of new products, declining revenue streams from legacy products (such as Netware), and an inability to execute on its market plans, year-over-year net revenue in 2005 and 2004 grew an anemic three percent and five percent, respectively.

Software competitor, Red Hat, Inc. (RHAT-$26.67), reported that 12-month sales for the year-ended February 28, 2006, jump 41.7% compared to the prior year. And, manufacturers and vendors who work with Red Hat expect business to grow by at least 31 percent in FY 2006.

According to an October 2005 BusinessWeek article, Red Hat had 63% of the Linux server market share in 2004, compared with just 20% for Novell.

After two years of Board indifference to shareholder grumbling that Messman was too slow to cut costs (including a bloated R&D department), divest non-core businesses, and was losing [unwarranted] market share to the likes of Red Hat, Novell has finally installed a new Commander-in-Chief. Promoted to be the new CEO is Novell's current president, Ronald Hovsepian.

In a morning call with analysts, Hovsepian pledged, “to accelerate growth.” Analysts speculate [that aside from slashing costs and other restructuring moves to give a bounce to short-term profits] the new CEO will look to acquire a fast-growing open-source software distributor or startup. As of April 30, 2006, the Company had approximately $1.3 billion, or $3.95 per share, in cash.

What of the Messman Legacy? When he started as CEO on July 10, 2001, the Common Stock of Novell traded at $4.87 per share. On July 21, 2006, the Common Stock traded at $6.00. An investor could have received a higher return on invested capital by buying a 10-year Treasury note in July 2001, which yielded approximately 5.5 percent.

Albeit shareholders have suffered, a look at Jack Messman’s employment and severance agreements reveal the quintessence of absurdity:

  • Upon his initial employment, Mr. Messman received options to purchase a total of 2,408,045 shares of Novell’s common stock at a purchase price of $5.02 per share (all fully vested now) and the right to purchase 715,780 shares of restricted common stock for a purchase price of $.10 per share.
  • As of February 28, 2006, Messman beneficially owned 1.56%, or 6.2 million shares of the Common Stock of Novell, worth an estimated $41.29 million. He currently owns 804,406 shares of Common Stock with the right to acquire an additional 5.3 million shares (this latter amount includes shares that can be acquired through stock options that are exercisable through April 1, 2006). According to his updated Severance Agreement (dated January 7, 2005), none of these shares revert back to the Company.
  • If Messman, 63, should choose not to retire, the Company is obligated to spend up to $190,000 on executive “outplacement services.” Mr. Messman is currently on the Board of Directors of RadioShack Corp. (RSH-$14.39), where he earned $40,000 last year [He also has a discount card that entitles him to receive a 30% discount on all RadioShack-branded merchandise and a 10% discount on branded merchandise purchased at RadioShack stores.] and Safeguard Scientifics, Inc. (SFE-$2.30), where he earns an annual retainer of $35,000. [ed. note. These annual retainer figures exclude additional compensation for Board meetings, committee attendance(s), and stock units awarded to him.] He is also a Director at Timminco Limited (TIM.TSX-$0.28), a Canadian manufacturer and supplier of engineered magnesium extrusions. In other words, he has plenty to do to keep him busy when he steps down from the Board of Novell come October 31, 2006.
  • As a result of his “involuntary termination,” Messman is entitled to receive 150% of his Base Pay, or approximately $1.43 million (in installments or in a lump sum).

Even on his way out the door, Messman is still making Novell bleed. For making a real “mess, man,” Jack Messman arranged a favorable severance for himself.

Just to rub some salt in the wound—Messman’s & existing shareholders’—the 10Q Detective thought it prudent just to make mention of the perquisites that the former CEO will have to leave behind:

  • In FY 2005 and FY 2004, personal use of Novell’s corporate aircraft that was valued at $137,711 (valued at the incremental cost to the corporation) and $54,615 (valued using Standard Industry Fare Level (“SIFL”) rates from the U.S. Department of Transportation), respectively. For FY 2005, there is another $34,000 listed in ‘Other Annual’ compensation that is not broken out in detail.
  • Despite dismal leadership and corporate performance in FY 2005, the Board had granted to Messman a cash bonus of $625,000 and the right to purchase 1,551,528 shares of stock (at an exercise price of $6.67 per share).

As an investment, once the stock price retraces some of its recent optimistic gains [the “Messman Ouster” effect), investors might want to take a look at this new day at Novell, Inc. More than one pundit has repeatedly said that market dynamics support—and need—a counterweight to Red Hat. Computer makers Hewlett-Packard, Dell, and IBM—these are three among many OEM that are looking for choice in [Linux] suppliers.

Additionally, the Company does have products lauded by many in the software industry as best in class. For home office computing, SUSE Linux 10.1 features an easy-to-install Linux operating system that lets users browse the Web, send e-mail, organize digital photos, play movies and songs, and create documents and spreadsheets. And, the Company’s security and management suite of products have won industry awards for “Best Enterprise Security Solution.”

Investors can buy in to a company that sells for only two times book [which does not reflect current valuation of real-estate assets] and a trailing twelve-month enterprise value–to- revenue of 1.31, compared to Red Hat’s P/B and P/S of 10.04x and 16.78x, respectively.

Wednesday, June 21, 2006

Time-Warner: Return to Soap Operas--"Date Night."

The giant media conglomerate, Time-Warner, Inc. (TWX-$17.25) and CBS Corp. (CBS-$26.04) recently told advertisers that a joint-venture, to be shown on CW, is planning to offer serialized commercials starting in the fall 2006 television season.

In a recent New York Times article, Dawn Ostroff, president for entertainment at CW, said [that] “the goal in embracing the genre is to increase the appeal of programs to advertisers by forging stronger, more emotional bonds with viewers — particularly the younger ones who are willing to follow a series from the TV set onto the Internet, iPods and cellphones.”

As for the serialized commercials on CW, plans include content wraps.

They are commercials [mini ‘infomercials’], produced to resemble programs, that will tell a story with a beginning, middle and end. The content wraps can be bought by advertisers to run as a series of two-minute spots during a night of CW programming.

Proposed for the CW Tuesday lineup of two female-focused series, "Gilmore Girls" and "Veronica Mars." is a serialized commercial, “Date Night.” In the first two-minute commercial, a couple gets made over for a date. In the second segment, the couple goes out on the date. In the third and final spot, the couple recaps the date in a post-mortem.

Advertisers that sponsor the segments would get their products embedded in the content wraps; they also could run regular 15-second spots before and after each segment. The advertisers suggested for "Date Night” included makers of cosmetics, fragrances and clothing.

Unfortunately for Time Warner, the Company and its CFO are currently involved in their own soap opera.

On June 17, 2006, the New York Daily News and The New York Post reported that an accused prostitution ringleader, Andreia Schwartz, said Wayne Pace, Chief Financial Officer of Time Warner, Inc., was her "sugar daddy" in a relationship where he had showered her with gifts.

Pace's lawyer Mark Pomerantz has responded by saying that his client "had no inappropriate relationship with her." Pace still has yet to persuasively explain (to his wife and to the media giant that he works for) what “relationship” he did have with Ms. Schwartz? To date, all that is known is that Pace identified Schwartz as a real-estate agent.

The 10Q Detective admits to a natural prurient curiosity in this story, but respects Pace’s right to privacy in this matter. Nonetheless, Time Warner is the world’s largest media conglomerate, and stakeholders in the Company have the right to know (a) if Pace misused any corporate assets and (b) whether or not Pace disclosed any insider information.

Yesterday, Time Warner did say that it was looking into whether company funds were used by its chief financial officer for gifts he allegedly gave an accused prostitution ringleader.

The 10Q Detective is willing to go on record and say that Wayne Pace will probably resign [before the year is out] for “personal reasons” or to “pursue other business opportunities.”

According to the Company's Schedule 14A (Proxy Statement) filed with the SEC on April 14, 2006, Wayne Pace’s 2005 annual compensation totaled $6.8 million, consisting of $3.7 million in salary and bonus, $373,276 in “Other Annual” compensation, $1.6 million in long term compensation (Restricted Stock Awards & Securities Underlying Options), and, $1.4 million in awarded Option Grants.

“Other Annual” is defined as personal benefits, which included: financial services of $10,000; commercial car services of $ 338,796 to Pace. [ed. note. Do limo drivers talk?]; and, $24,480 to cover the cost of Group Life Insurance.

The employment agreement with Pace includes a narrow definition of the “cause” for which the executive’s employment may be terminated. According to the Form 8-K, filed on April 29, 2005, termination by the Company for `cause' means termination because of (a) conviction of a felony (whether or not any right to appeal has been or may be exercised), (b) willful failure or refusal without proper cause to perform duties with the Company (other than any such failure resulting from incapacity due to physical or mental impairment), (c) fraud, misappropriation, embezzlement or reckless or willful destruction of Company property, (d) a material and willful breach of any statutory or common law duty of loyalty to the Company; or (e) intentional and improper conduct materially prejudicial and detrimental to the business of the Company or any of its affiliates.

A look at Mr. Pace’s 2005 employment agreement shed’s some light on what he stands to gain by resigning –as opposed to being fired for ‘cause.’ The 10Q Detective believes that Time Warner will backdate [re-adjust] Mr. Pace’s current December 31, 2007, retirement date. Doing so allows the Company and Mr. Pace to both “save face.”

Such an accord preserves additional benefits guaranteed to Mr. Pace, too, including: Mr. Pace and his spouse will continue to have access to medical insurance coverage through the Company that is substantially similar to the coverage afforded to active employees of the Company at that time; 201,637 shares and unvested stock units valued at $3,515,283 will not have to be returned to the Company; and, a portion or all of the unvested stock options previously granted to Mr. Pace will vest and some or all of the vested stock options will remain exercisable for a period of time longer than would generally apply to stock options awarded by the Company.

Additionally, if Mr. Pace and Time Warner were to renegotiate the timing of his retirement, Pace would become a part-time employee of the Company, providing advisory services through December 31, 2009 at an annual salary equal to $1 million.

Pace owns 173,045 shares and 1,416,213 options (to buy shares) of Time-Warner worth an estimated $27.4 million. When he retires, he is also entitled to the maximum annual Pension Plan payout of $350,000—which does not include payouts from any other Executive Savings Plan.

In addition to lavishing her with gifts, Schwartz alleges that during the course of their ‘relationship’ that Pace sent her e-mails and wrote checks to her. If true, retirement smells like a sweet rose to Pace.

In his play, The Mourning Bride (1697), playwright, William Congreve (1670-1729, said, “Heaven has no rage like love to hatred turned, Nor hell a fury like a woman scorned.” Wayne Pace has more to fear than Time Warner, Inc.

Monday, June 19, 2006

Vonage: Investors Dial a Wrong Number.

As of June 16, 2006, Vonage Holdings Corp. (VG-$9.60) is the target of 10 class action lawsuits (and still climbing) that claims the Internet phone company beguilingly steered consumers (through its Directed Share Program) toward investing in its $531 million initial public offering. The company had set aside 4.2 million IPO shares for its customers [A daily Class Action Tracker is provided courtesy of Eric Savitz’s Tech Trader Daily.]

Shares of Vonage have plunged 45.6% from the May 24, 2006, IPO of $17.00 per share.

Among assorted violations of federal securities laws, a theme of alleged insider fraud runs through all the complaints. More specifically, the Company (management) failed to disclose and misrepresented the following material adverse facts: (1) Vonage failed to disclose to potential investors in its prospectus that its technology platform experienced problems carrying telephone data over the networks of certain Internet service providers, including Time Warner Inc.'s AOL; (2) that Vonage's broadband Voice over Internet Protocol (VoIP) technology did not properly allow facsimile transmissions; (3) that the Company did not adequately inform investors about the history of Vonage's management team. Specifically, that Vonage failed to disclose that Tyco's ADT Security division took $600 million in charges for accounting improprieties while defendant Michael Snyder was President of the division; (4) that the Company did not adequately inform its retail customers that Vonage customers that participated in the Directed Share Program were obligated to purchase allocated shares before they received notice that their conditional offers had been accepted, and were led to believe that the IPO would take place later than May 23, 2006; and (5) the Company, realizing that institutional investors who normally buy in IPOs would be reluctant at best to purchase Vonage shares as-priced, recommended the purchase of its securities to customers irrespective of their investment suitability.

Readers know that the 10Q Detective is sympathetic to investors who have lost monies due to corporate malfeasance. It is our opinion, however, that in the case of Vonage, investors just dialed a wrong number in their search for quick profit.
Yes, the Registration Statement (Form S-1) reads like Tolstoy’s War and Peace; nonetheless, the potential loss of an investor’s monies are accented in plain English in the Risk Factors section on Page eight [even if an investor felt lost in reading the fine print—each risk is summarized and spelled out in bold, italic font]:

Vonage has incurred increasing quarterly losses since our inception, and expects to continue to incur losses in the future. For the period from its inception through March 31, 2006, Vonage's accumulated deficit was $467.4 million…. The Company intends to increase its marketing expenses in future quarters in order to replace customers who terminate service, or “churn.” Further, marketing expense is not the only factor that may contribute to net losses. For example, interest expense on convertible notes of at least $12.7 million annually will contribute to net losses. As a result, even if Vonage significantly reduces its marketing expense, the Company may continue to incur net losses.

If Vonage is unable to compete successfully, it could lose market share and revenue. The telecommunications industry is highly competitive. Vonage faces intense competition from traditional telephone companies, wireless companies, cable companies and alternative voice communication providers. Principal competitors are the traditional telephone service providers, namely AT&T, Inc. (formerly SBC Communications Inc.), BellSouth Corp., Citizens Communications Corp., Qwest Communications International Inc. and Verizon Communications, Inc., which provide telephone service based on the public switched telephone network. Some of these traditional providers also have added or are planning to add VoIP services to their existing telephone and broadband offerings.

The Company also faces, or expects to face, competition from cable companies, such as Cablevision Systems Corp., Charter Communications, Inc., Comcast Corporation, Cox Communications, Inc. and Time Warner Cable (a division of Time Warner Inc.), which have added or are planning to add VoIP services to their existing cable television, voice and broadband offerings.

Further, wireless providers, including Cingular Wireless LLC, Sprint Nextel Corporation, T-Mobile USA Inc. and Verizon Wireless, offer services that some customers may prefer over wireline service. In the future, as wireless companies offer more minutes at lower prices, their services may become more attractive to customers as a replacement for wireline service. Some of these providers may be developing a dual mode phone that will be able to use VoIP where broadband access is available and cellular phone service elsewhere, which will pose additional competition to Vonage’s offerings.

Most traditional wireline and wireless telephone service providers and cable companies are substantially larger and better capitalized than Vonage and have the advantage of a large existing customer base….. Any of these [competitive] factors could make it more difficult for Vonage to attract and retain customers, cause Vonage to lower its prices in order to compete and reduce its market share and revenues.

If VoIP technology fails to gain acceptance among mainstream consumers, the Company’s ability to grow its business will be limited. The market for VoIP services has only recently begun to develop and is rapidly evolving. The Company currently generates all of its revenue from the sale of VoIP services and related products to residential and small office or home office customers….If mainstream consumers choose not to adopt Vonage’s technology, its ability to grow business will be limited.

Vonage’s emergency and new E-911 calling services are different from those offered by traditional wireline telephone companies and may expose the Company to significant liability. Delays customers encounter when making emergency services calls and any inability of the answering point to automatically recognize the caller's location or telephone number can have devastating consequences. Customers have attempted, and may in the future attempt, to hold the Company responsible for any loss, damage, personal injury or death suffered as a result. Some traditional phone companies also may be unable to provide the precise location or the caller's telephone number when their customers place emergency calls. However, traditional phone companies are covered by legislation exempting them from liability for failures of emergency calling services and Vonage is not.This liability could be significant. In addition, the Company has lost, and may in the future lose, existing and prospective customers because of the limitations inherent in its emergency calling services. Any of these factors could cause the Company to lose revenues, incur greater expenses or cause Vonage’s reputation or financial results to suffer.

Flaws in the Company’s technology and systems could cause delays or interruptions of service, damage the Company’s reputation, cause the Company to lose customers and limit future growth. Service may be disrupted by problems with Vonage’s technology and systems, such as malfunctions in software or other facilities and overloading of the network. Customers have experienced interruptions in the past and may experience interruptions in the future as a result of these types of problems. Interruptions have in the past and may in the future cause Vonage to lose customers and offer substantial customer credits, which could adversely affect revenue and profitability.

Vonage may not be able to maintain adequate customer care during periods of growth or in connection with the addition of new and complex Vonage-enabled devices, which could adversely affect the ability to grow and cause financial results to be negatively impacted.

If Vonage is unable to improve its process for local number portability provisioning, its growth may be negatively impacted.

The past background of Vonage’s founder, Chairman and Chief Strategist, Jeffrey A. Citron, may adversely affect the Company’s ability to enter into business relationships and may have other adverse effects on business.

The list of additional risk factors related specifically to Vonage, and [in general] to the VoIP industry runs on in the prospectus for fifteen pages. In respect to the aforementioned putative class-action lawsuits, shame on investors, for even if the IPO prospectus allegedly contained misrepresentations or some omissions concerning various Vonage products, the 10Q Detective contends that there was more than enough material information made public for investors to have made their own educated decisions as to the financial appropriateness of buying shares in the Vonage IPO.

Sadly, greed can blind investors to fiduciary prudence. And class actions are promoted by trial lawyers as a ‘no upfront’ cost platform to recoup losses. Press releases tell you how Vonage wronged you and e-mail gives you a convenient way to contact the lawyers. And thereupon, let us not forget the website, where Greed, Greedier & Greediest lets you know that they have substantial experience representing investors who have suffered losses buying stocks like Vonage

Class actions can enable plaintiffs' attorneys to pursue claims on behalf of clients with little interest in the case and extract settlements from defendants whose cases look better on the merits. For example, in one recent case, defendant corporations settled a class action case for approximately $200 million, even though a litigation risk expert assessed the probability of the plaintiffs' case winning at trial at only 7 percent. For companies, it is often cost-prohibitive to litigate the claim, so they settle—which has the unintended effect of encouraging lawyers to file still more such suits.

In 2004, according to a Presidential commission, the costs of litigation per person in the United States was far higher than in any other major industrialized nation in the world. Lawsuit costs have risen substantially over the past several decades, and a significant part of the costs from lawsuits goes to paying lawyers' fees and transaction costs -- not to the injured parties. This explosion in litigation is creating a logjam in America's civil courts and threatening jobs across America. Small businesses spend, on average, about $150,000 per year on litigation expenses.

The 1995 Reform Act, Uniform Standards Act of 1998, and the Class Action Fairness Act of 2005 (hinders so-called judge shopping)—all attempts at ending rampant and frivoulous lawsuits by trial lawyers. Despite Bush’s people calling the latest bill as a victory for tort reform, recent security class-action activity begs the 10Q Detective to reach a contrary opinion: Vonage, The Este Lauder Companies, Inc. (EL-$38.35), Yahoo! (YHOO-$30.36), Jarden Corp. (JEH-$29.61), and Infosonics Corp. (IFO-$15.49)—among the better and lesser known publicly-traded companies that have been hit recently with one (or more) class-action lawsuits.
Better we leave it to the legal blogs to debate the finer points of shareholder litigation reform.
Suffice to say, when it comes to a “hot” IPO being offered to you—the individual investor—by either the Company [directly] or by your retail broker, stop and ask two questions? If this deal is so hot, why are the institutions passing on it? And, why me?

Wednesday, June 14, 2006

Southwest Casino--"Double Carpet" Odds that Management Wins.

In addition to managing Native American gaming facilities in Oklahoma and owning and operating three casinos in Cripple Creek, Colorado, Southwest Casino Corp. (SWCC.OB-$0.70) also provides consulting services for gaming operations.

Before commencing operations in the casino entertainment industry in 2004, Southwest Casino began as the shell of a publicly traded company called Lone Moose Adventures, Inc. Formed on January 2, 2002, Lone Moose was originally organized to take clients on adventure tours in the Wasatch mountain range of Utah. Since inception, Lone Moose conducted minimal operations and received only nominal revenue, for the company ran fewer than two-dozen adventure tours. Subsequently, Lone Moose ceased operations as a going concern. Upon closing, new management planned a reorganization and back door listing, and sold substantially all of the assets and liabilities of Lone Moose’s adventure tour business to Lone Moose’s founding shareholders.

Depending on the game and how wagers are placed, casinos earn anywhere from a 1 percent to 35 percent commission from your winnings. The 10Q Detective took an interest in Southwest Casino because this is one casino operator where the odds do favor the house—especially when it comes to the pay packages of its management.

On June 29, 2004—one month before the July 22nd reorganization of Lone Moose— Messrs. Druck (Southwest CEO), Halpern (Southwest – Chairman of the Board of Directors), and Fox (- President, Chief Operating Officer and Chief Financial Officer) struck separate Stock Purchase Agreements with Lone Moose Adventures that entitled each of Messrs. Druck, Halpern and Fox to purchase 66,960 shares of Lone Moose Adventures, Inc. Common Stock at a purchase price of $0.37335 per share for a total purchase price, for each of such block of 66,960 shares purchased, of $25,000.

Lone Moose announced on July 2, 2004 that the parties agreed in principle to pursue the contemplated reverse merger transaction

Then, On July 14, 2004, the Company issued 1,500,000 shares of its common stock under the terms of stock purchase agreements entered into on June 29, 2004, therewith each of Messrs. Druck, Halpern, and Fox received 500,000 shares. Today, each of these aggregate $25,000 investments is worth $350,000—a cool two-year ROI of 1,300 percent!

The Southwest Casino provides management services in connection with two Lucky Star casino facilities, one located in Concho, Oklahoma and the other located in Clinton, Oklahoma, under the terms of a management agreement with the Cheyenne and Arapaho Tribes of Oklahoma. In early 2005, the Tribes entered into a gaming compact with the State of Oklahoma that permitted the Tribes to offer an expanded scope of gaming, including permitted card games, at the casinos managed by Southwest. This coincided with a peak high for the stock trading price of Southwest Casino Common Stock (~$.3.75 per share) as investors probably anticipated a material increase in top-line growth from the addition of new management fees (the direct result of the Tribes signing the gaming compact that allowed new gaming opportunities such as card games and poker, as well as certain Class III electronic games).

In a filing with the SEC in early July 2004 (prior to the reorganization of Lone Moose into a Casino operator), the Company did state: “The purpose of the acquisition of securities of Lone Moose by each of Messrs. Druck, Halpern and Fox was to provide appropriate equity-based incentives to these individuals as the new executive managers of Lone Moose to pursue the long-term future growth of the company following consummation of the proposed reverse merger of Southwest Casino and Hotel Corp with and into a wholly-owned subsidiary of Lone Moose (Reverse Merger).” Like we said, the odds favor the House.

If any of our readers are thinking of Southwest Casino Corp. as a potential speculative gaming entertainment BUY for their stock portfolios—move it along. This a small-time casino operator in Colorado with Las-Vegas dreams. Current gaming activities are concentrated in Oklahoma and Colorado operations.

In FY 2005, Southwest did manage to scratch out net income of $566,350, share-net of $0.03, on total revenue of $20.7 million. Remember we said Southwest Casino was a ‘small-time’ operator. Looking at peer comparables, the Industry average for net income was $16.4 MILLION in 2005. And, looking at a true sign of management efficiency—operating margins: Southwest Casino had an operating margin of 2.3% in FY ’05 compared to the industry average of 6.98%--never mind that the better run casinos like MGM, Harrah’s or Aztar Corp. showed margins of 19.47%, 18.38%, and 16.81%, respectively.

In FY ’05 ending December 31, 2005, the Gold-Rush/Gold-Digger Casino’s posted a (1.3)% decline in casino revenues to $14.03 million. The revenues remained relatively flat as a result of competition in the market and an inability to add more games to the facility.

The Company’s third casino, Uncle Sam’s Casino, is a facility with only 67 slot machines that primarily serves the local residents market in Cripple Creek, Colorado. Casino revenues declined (25.3)% in 2005 to $952,067. In 2004, a new casino that also caters to the local residents entered the market, bringing with it hundreds of new-coin hungry-slot machines. As a result, Uncle Sam’s lost market share.

In FY ’05, Southwest Casino generated approximately 24%, or $4.9 million, of its revenue through its management agreement with the Cheyenne and Arapaho Tribes of Oklahoma for the Lucky Star casinos in Concho, Oklahoma and Clinton, Oklahoma. The current management agreement runs through May 20, 2007. Any extension of the management agreement beyond May 19, 2007 can only occur with the consent of the Cheyenne and Arapaho Tribes of Oklahoma and the approval of the National Indian Gaming Commission

There is a possibility that the Company could lose this contract. The National Indian Gaming Commission (NIGC) has expressed concern about the distribution of gaming proceeds by the Cheyenne and Arapaho Tribes of Oklahoma, for whom the Company manages casinos. In December 2004, the NIGC notified the Tribes that the NIGC was concerned the Tribes were not distributing properly the net revenue they receive from gaming operations. Albeit the NIGC’s concerns relate to the use of gaming revenue after Southwest has distributed it to the Tribes and are not related to management of the Tribes’ casinos. However, if the NIGC determines that the Tribes have committed a substantial violation of the Indian Gaming Regulatory Act, NIGC rules, or the Tribes’ gaming ordinance, it could bring an enforcement action against the Tribes. If an enforcement action were successful, potential penalties range from fines to, in extreme cases, an order closing the Tribes’ gaming operations. Closure of these facilities would eliminate a primary source of operating revenue and have a material adverse impact on the Company’s financial condition.

Financially, the Company is in tough shape. Southwest has incurred substantial operating losses since inception and had an accumulated deficit of $9,736,506 as of December 31, 2005. These losses are “primarily the result of expenses related to ongoing pursuit of new gaming opportunities.”

In our opinion, however, the balance sheet leaves little room for “new gaming opportunities.” The Company has ($2.71) million in working capital and long-term debt ($9.1 million) plus future long-term operating lease liabilities ($1.0 million) swamp stockholder equity ($6.2 million)—ratio of 162.9 percent! And the times-interest-earned ratio (how many times a company can cover it's interest payments) at FY ended December 2005 was 0.61—which means that the Company cannot AFFORD attainable growth—never mind sustainable growth.

Additionally, On October 20, 2005, the Company Entered into a new $2.5 million term loan agreement, secured by substantially all of the Company assets, including 12 shareholder guarantors, too. [ed. note. Messrs. Druck, Fox and Halpern in consideration of each of their agreements to guarantee personally up to $100,000 each of the loan were each granted warrants to purchase 50,000 shares of Common Stock at an exercise price of $0.58 per share.]

Monday, June 12, 2006

Syscan Imaging--Who's Watching Management?

Syscan Imaging (SYII.OB-$1.25), a leader in USB powered portable image scanners, is a prime example of the lack of corporate accountability that the 10Q Detective has been working to expose since our founding last year.
On April 26, 2005, the Company entered into employment agreements with each of Darwin Hu, the Chief Executive Officer, William Hawkins, the Chief Operating Officer and Acting Chief Financial Officer, and David Clark, Senior Vice President of Business Development. In connection therewith the Board of Directors granted options to each of Messrs. Hu, Hawkins, and Clark to purchase 1,500,000, 1,000,000 and 800,000 shares of our common stock, respectively, at an exercise price of $0.01 per share. The options vest one-third on the execution date of the employment agreement, one-third on April 3, 2006 and one-third on April 2, 2007.

In addition to the aforementioned stock options, the terms and conditions of each employment agreement—including base salary and annual bonus—were approved by the "independent members"--all two of them-- of the Company's Board of Directors.

During the fiscal year ended December 31, 2005, the Board of Directors held one meeting [ed. note. Why bother to even have a Board?] The Board of Directors totals five: Messrs. Hu, Hawkins, Clark, and the two “independent” directors, Peter Mor and Lawrence Liang.

Syscan is materially dependent upon the performance of its executive officers and we agree that these key employees should be compensated accordingly, but the Board issued these option awards well below fair market value—approximately 99.5% below fair value. In February 2005, when the option contracts were first drawn up as part of the comprehensive employee agreements, the Common Stock traded between $2.00 to $3.00 per share.

By the way, on December 8, 2005, OTHER employees were granted options under the Plan to purchase 230,000 shares of the Company's common stock at $0.65 per share—the fair market value of the stock on the grant date.

Talk about the fox watching the henhouse, although Peter Mor and Lawrence Liang approved the employment agreements for Hu, Hawkins, and Clark, the entire Board of Directors was active in the aforementioned compensation process.

The lack of corporate governance extends to other activities beyond executive compensation, too. For example, the Company purchases significantly its entire finished scanner imaging products from the parent company of its majority stockholder, Syscan Technology Holdings Limited (STH). Chairman and CEO, Darwin Hu, was formerly the CEO of STH, and beneficially still owns approximately 5.33% of the issued and outstanding capital stock of STH (shares are listed on The Growth Enterprise Market of The Stock Exchange of Hong Kong Limited). The Company purchased $4.91 million and $4.34 million in equipment during the years ended December 31, 2005 and 2004, respectively.

Despite the lack of corporate accountability, the 10Q Detective believes that the Company’s technology holds promise: While Syscan continues to grow its presence in image capture technology, it has begun creating, through acquisition and research and development, new technology solutions for the substantially larger, image display market. More specifically Syscan is creating products and technologies to accent and enhance the HDTV television market. Its image display product is expected to be available for delivery during the first quarter of 2007.

To reflect its new business’, the Company will be changing its name at the end of June 2006 to Sysview, Inc.

Unfortunately, in addition to weak corporate oversight, there are other red flags for potential investors to consider:

  • During the year ended December 31, 2005 three of Syscan’s customers accounted for approximately 66% of total revenues. The loss of any of these clients would have a material adverse effect on business.
  • The law firm of Richardson & Patel LLP, of New York, New York, refused to pass validity on Syscan’s Common Stock. A partner of the firm beneficially owns 16,667 shares of Common Stock, which shares were issued to the partner in exchange for legal services rendered when the partner was employed by a prior law firm.
  • In connection with investor relations services rendered for Common Stock issued, the Company overpaid the consultant $30,000. The Company also has ended its relationship with the consultant due to non-performance. The consultant has agreed to repay the $30,000 overpayment by December 1, 2006 and return 75,000 shares. As of July 11, 2006, both remain outstanding. [ed note. How come in financial statements the going concern always refers to the object of the declaration in the third person?] Doing some digging, the 10Q Detective unearthed that Syscan had signed The Investor Relations Group, Inc. (IRG), based in New York City, to serve as its money relations and corporate public-relations agency of record.

On March 15, 2005, the Company sold $1.865 million of a Convertible Preferred Stock (par value--$100). The Series A Preferred Stock is convertible into shares of Common Stock at a conversion price of $1.00 per share and is entitled to receive interest at a rate of 5.0% per annum. (The Company also issued to the selling stockholders warrants to purchase up to 932,500 shares of Common Stock at a price equal to $2.00 per share.) The problem for existing shareholders, however, is that the Preferred Stock Conversion Price is subject to anti-dilution protection adjustments, on a full ratchet basis. What this means is if Syscan issues even one share of stock in a future financing deal at a price below the conversion price of $1.00 (Series A Preferred Stock Conversion Price), then the new conversion price drops downward fully to that new price—dilution that ultimately proves to be punitive to existing shareholders.

As the Company has no Audit Committee, it should surprise none that on June 1, 2006, as the result of review by the SEC of Syscan’s accounting for its non-cash, stock-based, employee compensation, that its consolidated financial statements for the year ended December 31, 2005 and for the quarter ended March 31, 2006 may have to be amended. In the event that the Company may need to make any accounting adjustments, reclassifications and/or write-downs of a material amount of its assets, investors ought note that there might be a risk that Syscan could be in violation of certain financial covenants under its credit facility, which would adversely affected the financial health of the Company.

“Sunlight is said to be the best of disinfectants; electric light the most efficient policeman." – Supreme Court Justice, Louis Dembitz Brandeis (1856-1941)

Friday, June 09, 2006

Raser Tech.--Be Good to Family!

Raser Tech. (RZ-$14.45), a company that purports to be developing and licensing electric motor, controller and related technologies, should be a familiar name to regular readers of the 10Q Detective web log. Management continues to tout its “breakthrough” electromagnetic technology, yet for the year ending December 31, 2005, the Company only managed to book $331,375 in sales—the result of an existing Cooperative Research and Development Agreement (CRADA) between Raser and the US Army.

Since inception three years ago, Raser has accumulated a deficit of approximately $(16.98) million.

As of December 31, 2005, Raser had 26 full-time employees, including 15 in engineering and 4 in sales and marketing and 7 in its executive and administrative department. Management considers its employee relationships to be positive. One might say that Raser provides an “enriching” work environment:

Del Higginson, the brother of the Company’s Chairman of the Board of Directors, Kraig Higginson, was an employee of the Company. Del Higginson served as a Mechanical Technician and had an annual salary of $43,200. In connection with his employment, the Company granted Del Higginson an option to purchase 10,000 shares of the Company’s common stock at an exercise price of $3.65 per share (which reflected the fair market value per share of our common stock at the time of the grant). Del Higginson resigned from the Company in 2005, but prior to leaving, he exercised 3,333 options. The remaining 6,667 options were unvested at the time of his resignation and returned to the Company.

Kort Sandberg, the brother-in-law of Ned Warner, a beneficial holder of 12.4% of the outstanding shares of Common Stock of the Company, was an employee of the Company. Kort Sandberg served as an Electrical Engineer and had an annual salary of $60,000. In connection with his employment, the Company granted Kort Sandberg an option to purchase 100,000 shares of the Company’s common stock at an exercise price of $3.65 per share. Kort Sandberg had vested in 55,556 options at the time of his resignation in 2005. The vesting schedule for an additional 25,000 shares was accelerated in settlement of an ownership and employment dispute. All 80,556 vested options were exercised in 2005, and the remaining 19,444 options that were unvested at the time of his resignation were returned to the Company.

Kevin Kerlin, the son of Jack Kerlin, a beneficial holder of 10.85% of the outstanding shares of Common Stock of the Company, is currently an employee of the Company. Kevin Kerlin serves as a Mechanical Engineer and has an annual salary of $48,000. In addition, in connection with his employment, the Company granted Kevin Kerlin an option to purchase 50,000 shares of the Company’s common stock at an exercise price of $3.65 per share.
Like we said, Raser provides an enriching work environment—especially for those with connections.

Tuesday, June 06, 2006

MOVE: Renovating Itself For Success.

Move (MOVE-$5.50), the world's largest moving community, provides home buyers and renters with the real estate content, decision support tools and professional connections they need before, during and after a move., the Company’s flagship site and the official site of the National Association of REALTORS, is the No. 1 consumer destination for real estate related information with more than 6.5 million monthly unique users.

Welcome Wagon has been introducing homeowners to their new communities for more than 78 years. The home visits stopped in 1998 as an increase in two-income families meant fewer people were home to accept visits. Welcome Wagon began greeting new homebuyers through the mail with a gift of an attractive, customized gift book, and is now beta-testing a website. The welcome gift book contains a customized neighborhood address book with exclusive merchant advertiser listings as well as coupons and special offers from local advertisers.

Move is also a leading supplier of media and technology solutions for real estate professionals, local and national advertisers, and providers of home and real estate-related products and services. TOP PRODUCER’s flagship 7i product is the No. 1 contact management software for real estate agents, and The Enterprise offers brokerages custom Web and video production services as well as interactive voice response systems.

Corporate is working to brand “Move” as an essential consumer resource and the premier venue for property owners and brokers to advertise. In our opinion, through infrastructure initiatives, the Company is tracking well and is on its way to enhance shareholder value.

Corporate initiatives fall into three closely related categories:

1. Consumer content enhancements.
2. New, easily scalable business models
3. Integrated brand marketing to extend traffic advantage

Falling into the first category is, a comprehensive (vertical) real estate search engine that enables consumers to view more than 3 million property listings (with exclusive access) available to

Launched last month,, according to management, also offers a dramatically expanded listings experience for new homes and apartments with over 850,000 new home and rental listings; five times the number of listings previously available on the erstwhile proprietary RENTNET and sites.

On the Company’s 1Q:06 conference call, corporate said: “Our previous sites for newly built homes and apartments, and RENTNET, use the content strategy we refer to as paid inclusion. The listings database was composed entirely of listings that homebuilders or apartment managers paid to advertise. In contrast, the strategy aggregates as much free content as possible from all over the Internet to provide consumers with the most listings possible in one place. Furthermore, many of these listings are now at the unit level, meaning consumers can see individual home plans and apartments, not just subdivisions and apartment complexes.”

Rather than simply indexing properties, the Company will continue to roll out new content-rich functionality over the next couple of months, including personalization features and self-service postings. For example, Move will be introducing a featured CMA, or Comparative Market Analysis, which enables realtors to provide consumers with home valuation and other important advice. This solution will enable the Company to fully leverage its traffic in answering the consumer question, “What’s my home worth?”

The second group of initiatives, which focuses on scalability, is designed to offer customers opportunities for more targeted and flexible marketing. To enable different marketing solutions for different market conditions, Move will offer its customers both subscription-based and performance-based marketing solutions including cost-per-click, cost-per-lead and CPM-based opportunities. Incorporating performance-based business models into the revenue mix also provides the ability to scale revenue with traffic levels, so that the Company can better monetize increases in site traffic.

The company is also developing a real-time auction-based bidding system, (similar to those found on Yahoo!) where the featured listings will be ranked by relevance and bid price. Additionally, the engine will carry third-party sponsored links in the right rail alongside the slotted results.

The final group of initiatives relates to introducing Move as an integral resource for connecting consumers with the solutions they need before, during and after a move—ideally, however, at the earliest stages of property searches. The first step in this process involves expanding consumer awareness of the Company’s offerings. Move has already integrated with its existing traffic partners including AOL, MSN and Yahoo!.

Next, corporate is planning to target new traffic sources for integration of the Company’s listings experience (by introducing its new scalable revenue models).

According to the recently filed 10Q for the 1Q:06, seventy percent of revenue was generated by real-estate services, consisting of a variety of advertising and software services.

Barriers to entry are low, and Move competes with a variety of online companies and web sites providing real estate content that sell classified advertising opportunities to real estate professionals; and companies that also sell display advertising opportunities to other advertisers, including real estate professionals, seeking to reach consumers interested in products and services related to the home and real estate.

We believe, however, that the Company’s nationally recognized brands, such as and The Welcome Wagon, help to differentiate its online content from the competition (specifically online real-estate search engines), like,,, and

A softening real-estate market does not equate to a moribund one. In the US each year 100 million consumers go online to look at real estate—more than 1 in 3 Americans. Move is renovating itself to be a dominant player in this market.

As in most companies we follow, the 10Q Detective did unearth some insider avarice: Chief Executive Officer W. Michael Long’s employment agreement calls for the Company to provide residential accommodations to Mr. Long with a budget of $5,000 per month. Additionally, Move reimburses Mr. Long the fixed operating costs and ‘reasonable’ business related variable operating costs of an airplane indirectly owned by him; Mr. Long was reimbursed approximately $1.68 million for the use of this airplane in 2005.

Coming to his defense [a rarity for the 10Q Detective], when the stock was selling for pennies, Mr. Long did lead the Company out from under an accounting scandal that threatened to bury the Company.

Smart money has invested in this stock: Fidelity Management beneficially owns 22.2 million shares, or 14.7%; technology guru (and Board member), Roger B. McNamee and his venture capital firm, Elevation Partners, own a (combined) stake of 48.5 million shares, or 27.8%; legendary Internet VC, L. John Doerr, owns a 2.9% stake (and sits on the Board of Directors); and the National Association of REALTORS owns a 2.6% share.

Think about following the smart money crowd in on this stock.

Thursday, June 01, 2006

D & E Communications-- Itch to Scratch?

Is the telecommunications company, D&E Communications, Inc. (DECC-$11.92), in violation of NASDAQ listing standards?

Steven B. Silverman, age 73, a director of D&E Communications, Inc., is counsel in the law firm of Cohen, Seglias, Pallas, Greenhall & Furman, P.C., which serves as labor counsel to D&E. Mr. Silverman is Chairman of the compensation committee and is a member of the strategic planning review committee. Not withstanding the $280,300 paid to his law firm in 2005, Mr. Silverman was determined by the Board of Directors to be independent.

D. Mark Thomas, age 58, is a managing partner in the law firm of Thomas, Thomas, Armstrong & Niesen, Harrisburg, Pennsylvania, which serves as regulatory counsel to D&E. He has been a director of the Company since 1997. Mr. Thomas serves as lead director and Vice Chairman, and as such he chairs executive sessions of the Board. Mr. Thomas is a member of the compensation committee, nominating and governance committee and the executive committee. Not withstanding the $83,900 paid to his law firm in 2005, Mr. Thomas was determined by the Board of Directors to be independent.

By Nasdaq definition “an independent director is a non-employee, whose relationship, in the opinion of the Board of Directors, would not interfere with the exercise of independent judgment in carrying out the responsibilities of a director.”

Technically, under NASDAQ rules, neither man is in violation of Nasdaq rules, for [given that] D& E Communications did not make “payments for services in the current (or any of the past three fiscal years) that exceeded five percent of the recipient’s [respective law firm] consolidated gross revenues for that year, or $200,000, (whichever was more),” their respective independence was not compromised.

The 10Q Detective disagrees, for both men serve on the compensation committee of D&E, and the possibility for “interference in judgment” does exist. Hypothetically, let us suppose that Cohen, Seglias, Pallas , et. al. was replaced as labor counsel for D&E--What material effect would this future act have on Stephen Silverman’s judgement in agreeing to bonus compensation for D&E’s senior management? In addition to the three-year “look back” litmus test, perchance a three-year “look forward” would be a proper reagent for the Nasdaq to consider when defining independence?

How does that English proverb go? “You scratch my back and I'll scratch yours."