Tuesday, October 31, 2006

Particle Drilling's CFO Responds


"Very articulate research on my company[
Particle Drilling Technology]; however, I need to point out that some of your valuation metrics are in conflict with our public disclosures. Following the recent private placement, we have just over 30 million shares outstanding. If you add in all of the options and warrants (many of which are currently under water), there are approximately 37.5 million shares fully diluted.

In terms of market size and earnings potential, I would direct investors to our investor presentation on our website. We have identified in excess of $1 billion in revenue potential in just three basins in the domestic market (see slide entitled "Initial Target Markets" on page 8 of the investor presentation). Further, we have stated on page 15 of that investor presentation that each PID unit should be capable of generating annual EBITDA $2.4 million. With a market of over $1 billion, it would not make much sense for us to simply operate two or three units as you speculate in your research.

We will in due time publish our own earnings forecast but not until we have more operating history. Due to regulation FD concerns therefore, I will need to leave it up to the analysts and others to speculate as to how many PID units we are able to deploy over the next 3-4 years.

Just to illustrate the point however, based on our publicly disclosed assumptions, 10 PID units should yield annual EBITDA of approximately $24 million, while 40 units should yield closer to $96 million. While the royalties we are obligated to pay on the technology are not insignificant, they represent the cost of protecting the $1 billion plus market and therefore they have been considered in our business model. I am limited as to what I can post in this forum but felt that I should highlight those few data points. Again, your article does a good job of pulling together the history of the Company and most of the public information so I look forward to your future comments as the Company moves toward full commercialization."

Chris Boswell, SVP & CFO
Particle Drilling Technologies, Inc

10Q Detective Response:


1. I did not add in the options and warrants too far “out of the money” to arrive at 40.0 million shares. In order to enter the oilfield services market on a full-scale basis, Particle Drilling must successfully complete additional research and development, the cost of which is estimated to exceed the amounts that your management team currently has budgeted in its operation’s plan. Ergo, I built in to my valuation metrics the assumption that you would have to tap the capital markets—preferably the issuance of additional shares.
2. My calculation of EBITDA of $3.0 million for FY ending September 30, 2008 assumes (i) resumption of commercial testing in 1H:07; (ii) first sales in 2008; and (iii) first royalty payments in 2008.
3. I do admit that my earn-out numbers are conservative, but I’d rather be proven wrong!
4. I am not passing a business judgment on the royalty payments as so structured, for as you say, “they [royalties] represent the cost of protecting the $1 billion plus market and therefore they have been considered in our business model.”

I look forward to eying your Company’s progress as it moves toward full commercialization.

David J Phillips, Publisher
10Q Detective

Monday, October 30, 2006

Is Particle Drilling's Technology Worth a Drill Bit?

Particle Drilling Technologies Inc (PDRT-$2.80), based in Houston, Texas, is a development-stage oilfield service company in the process of commercializing its patented advanced drilling technology known as Particle Impact Drilling (PID).

Unlike earlier particle recovery systems, PID technology does not require high surface pressures—up to 11,000 psi—in order to give the small particle the velocity to abrade the formation ahead of the drill bit. The PID System, which incorporates hydraulic energy, utilizes larger particles at normal rig pressures to fracture the formation ahead of the drill bit.

PID system proprietary technology employs a specially designed “fit for purpose” drill bit fitted with jetting nozzles and polycrystalline diamond compact cutting structures that readily adapts to typical conventional drilling rigs.

The system will be provided and operated by Particle Drilling as a service to the oil and gas company for drilling certain rock intervals (specifically in wells where hard and/or abrasive formations result in penetration rates averaging ten feet per hour or less).

The PID system is designed to connect to and service an operational well in progress with minimal interference to normal drilling operations. All PID System equipment is either mounted on trucks or trailers, and the Company expects that the system can be installed on a rig during a scheduled bit trip. A good portion of the PID System may be mobilized and rigged up offline so as not to interfere with the drilling operation in progress. Once the operator is finished with the PID System, it is expected that it can be taken offline in one to two hours and demobilized with no further interference with the drilling operation. Management believes this operational transparency is extremely important for industry acceptance of the PID System.

Test applications—to date—have demonstrated that the PID system is capable of drilling through rock formations at rates from two to four times faster than current conventional techniques. Depending on the volume of shot introduced into the drilling mud, the number of shot strikes on the formation is in excess of four million per minute, thereby yielding a higher rate of penetration than conventional roller cone rock bits (reducing the amount of time the operator spends on location to drill the well). The result is a much more efficient and cost-effective drilling process—generating savings in labor, fuel, rentals, rig time and other variable well costs.

The reduction in drilling time and reduction of other drilling problems resulting from the utilization of the PID system represents estimated savings between 35% and 50% of conventional drilling costs.

Financial Analysis

To date, the business has not generated any revenue from its operations.

As of June 30, 2006, Particle Drilling had approximately $5.1 million in cash, current liabilities of $1.6 million, and neglible long-term debt.

The accumulated deficit was $17.3 million.

Current monthly operating overhead is approximately $660,000 (excluding non-cash expenses such as depreciation and stock-based compensation) as compared to $240,000 in FY 2005.

In order to enter the oilfield services market on a full-scale basis, the Company must successfully complete additional research and development, the cost of which will exceed the amounts management has budgeted in its operation’s plan.

The financial condition of the Company has improved, however, for on October 19, 2006, the Company completed a
private placement of 5.0 million shares, at a per share price of $2.35, which raised net proceeds of about $10.7 million. These monies will be utilized by the Company to manufacture additional PID Systems, to fund the development of a new particle injection system, to fund additional research and development, and for general corporate purposes.

[Ed. note. As the Company has yet to generate cash flow from operations, and until revenues commence, the Company is highly dependent upon debt and equity funding. Ergo, stockholders should expect further dilution, for additional funds will have to be raised in the future, too.]

Valuation Analysis

How does one value a development company with no current revenue? On a relative basis, with no operating cash flow, earnings, or terminal growth projections, the intrinsic value of Particle Drilling is limited to its liquidation value—about 50 cents per share.

After the recent announcement by management that it has
suspended a commercial trial of its drilling technology due to the failure of a frac pump transmission, expected revenues of $16.3 million in FY 2007 are probably premature.

The price of the Common Stock of Particle Drilling has plunged 58.9% since late January 2006, as investors showed their disappointment in commercialization delays by selling en masse.

It is difficult to value Particle Drilling utilizing a going concern approach given: (1) no history of positive earnings and (2) the Company’s assets are not earning much in the way of return(s).

Nonetheless, the 10Q Detective is willing to go with The Rules-of-Thumb Approach, which can indicate certain measurable criteria that can be assessed and applied to “potential value.”

Recent acquisitions in the drilling equipment universe provide a comparable valuation analysis for Particle Drilling’s future valuation prospects:
  1. Tenaris S.A. (TS), a leading global manufacturer and supplier of tubular products used in the drilling, completion and production of oil and gas wells recently acquired tubular steel maker Maverick Tube Corporation for (US) $65.00 per share in cash, or 10.8 times trailing EBITDA of $288.0 million.
  2. Downhole instrumentation maker Sondex plc. has entered into an acquisition agreement with a leading Canadian manufacturer of downhole tools and equipment used in the oil & gas sector, Innicor Subsurface Technologies. Under the agreement, Sondex will acquire Innicor for approximately (C)$72.8 million, or about 10 times trailing EBITDA.
  3. Shares of NQL Energy Services, a leading independent supplier of directional & performance/straight hole drilling tools for oil and gas fields, was recently acquired by Houston-based energy drilling services company National Oilwell Varco Inc. (NOV) for (C)$345 million, or about 9 times trailing EBITDA.

The 10Q Detective went into our Due Diligence of Particle Drilling thinking that it had some “sizzle” to smell. Sadly, there just is no meat to be found. Even assuming the Company were to successful bring to market the PID System in 2008, based on the aforementioned comparables, the stock price—optimistically—is probably worth no more than $1.00 per share. [This target is based on shares outstanding of 40.0 million, little cash/debt on the balance sheet, and 2008 EBITDA of $3.0 million. As such, (even without using an appropriate risk discount, for Particle is a fraction the size of its comparables) the $1.00 price target would still value Particle Drilling at a slight premium over recently acquired drilling equipment companies.]

Catalysts for a turnaround in Particle Drilling’s stock include (i) the Company’s ability to produce a successful commercial field test and (ii) negotiations of commercial contracts with potential customers.

The Company has experienced leaders at the helm to deliver the goods. Chairman Ken R. LeSuer came onboard after retiring as Vice Chairman of Haliburton Company (HAL-$32.15) in 1999; Jim B Terry, CEO since January 2006, was formerly the Vice-President, Oilfield Drilling Services for Weatherford International (WFT).

The Company’s initial target customers will be oil and gas operators drilling onshore wells in geologic basins of the U.S. known to have hard rock and/or highly abrasive formations.

Management intends to initially focus its marketing and sales efforts on operators with multi-well drilling programs centered in a single U.S. basin.

Investment Risks & Considerations

Particle Drilling has a limited operating history and no revenues and is subject to risks inherent in a new business enterprise. Buying its Common Stock is a highly speculative investment and there are no assurances that the Company will be successful in achieving profitable operations, additional financing, or continue as a going concern.

The Company’s cash flows used for operations are primarily affected by its research and development progress and business development. Net cash flows used for operations during the nine months ended June 30, 2006 were $(5.2) million. Working capital since inception (June 9, 2003) has been fully funded from cash flows from financing activities.

Our biggest concern is that the Company—like down on his luck farmer, Jabez Stone, in Steven Vincent Benét’s
“The Devil and Daniel Webster”—might have sold away its soul to the Devil.
The Company—in Off-Balance Sheet Arrangements—is obligated to make certain royalty payments that will limit its profitability:

  • Particle Drilling has agreed to make certain royalty payments to ProDril Services (PSI). Particle Drilling is obligated to pay a royalty on a quarterly basis equal to 18.0% of its earnings before EBITDA derived from the use of the PID technology for such quarter until an aggregate of $67.5 million has been paid to PSI.
  • Under a separate agreement with ProDril Services International, Ltd. (PSIL), the Company is obligated to pay PSIL a royalty on a quarterly basis equal to 2.0% of EBITDA derived from the use of the PID technology for such quarter until an aggregate of $7.5 million has been paid.
  • There is an additional royalty agreement that requires Particle Drilling to pay a total of 4.0% of its quarterly gross revenue derived from the use of the PID technology to certain entities from which the Company acquired the PID technology [Curlett Family Limited Partnership, Ltd. & CCORE Technology and Licensing, Ltd.].

Harry Curlett founded ProDril as a Texas corporation in May 1992 for the purpose of developing oil and gas drill bit and served as CEO, president and board chairman.

Potential Parker Drilling investors ought to note that in late 2002, ProDril ran out of financial resources—still having not brought to market the hard-rock drilling technology

In October 2005, Curlett and three other individuals (William D. "Dan" Elsom, David A. Nall and Justin C. Nall)
were indicted for conspiracy to sell unregistered securities. According to court documents filed in February 2006, Curlett and the others "induced at least 400 individuals in Wyoming and Texas to invest about $6.4 million in shares of ProDril Services stock." The shares or securities were neither registered with the U.S. Securities and Exchange Commission nor deemed exempt from such registration, the indictments stated.

Through the plea bargain process, Curlett is currently serving a four-month federal prison sentence (conspiracy to sell unregistered securities). The two other ProDril executives, Elsom, and David Nall, each pleaded guilty to one felony charge in the case and are currently
under house arrest.

The price of the Common Stock of Particle Drilling might get a (short-term) boost when the Company announces a new commercial test for the PID system. Still, in our view, investing monies in Particle Drilling is no better than throwing your dollars down a sinkhole.

Editor David J Phillips does not have any financial interest in the stock of Particle Drilling Technology.

Thursday, October 26, 2006

Force Protection Redux & Other News

Crude oil futures closed at $61.37/bbl., fueled by news of more unrest in Nigeria and a U.S. government report that inventories had their biggest one-week decline since July 2006.

Below-normal temperatures in the U.S. Northeast and continued strong demand for U.S. distillates, including heating oil and gasoline, are bullish indicators for the 10-Q Detective’s stock portfolio—which is heavily weighted towards energy-related stocks.

“The really unhappy person is the one who leaves undone what they can do, and starts doing what they don't understand; no wonder they come to grief.”
Johanne W. Goethe

The price of the Common Stock of blast-protected military vehicle maker
Force Protection (FRPT-$7.20) has dropped an armored plate, losing about 10.5% in value since our last report on the Company (less than two weeks ago). Might this have something to do with the fact that defense contractor BAE Systems recently moved to introduce the RG-33L as a Cougar/Buffalo competitor?

Force Protection has been working as a sub on a
BAE contract to supply 4x4 Iraqi Light Armored Vehicles—which are similar in design to the Cougar 4x4 . If BAE is successful in rolling out the RG-33L, might this squash persistent rumors of a BAE buyout of Force Protection?

10Q DETECTIVE Portfolio Transaction(s) Update


The 10Q Detective has a FULL DISCLOSURE Policy.

New Executive Agreements at The Yankee Candle Co.--The Sweet Smell of Timing!

On September 14, 2006, the Board of Directors of The Yankee Candle Company, Inc. (YCC-$33.73) authorized the Company to enter into an Executive Severance Agreements with the Chairman of the Board and CEO Craig W. Ryden, President and COO Harlan M. Kent, CFO Bruce H. Besanko, as well as each of the other six top executives of the Company:

If any of the executives terminate their employment for “Good Reason” [is there any other kind?], or if the employment is terminated within two years following a “Change in Control” of the Company (without Cause) the executives will be entitled to receive severance benefits consisting of the following primary components:

  • a continuation of medical and dental benefits (subject to the severance period acknowledged for each so-named executive);
  • a one-time payment of their incentive award target under the executive compensation plan, pro rated based on the number of days of that fiscal year for the so-named executive was employed; Messrs. Ryden, Kent, Besanko could each receive (up to) an estimated $726,243, $200,000, and $187,000, respectively; and,
  • a one-time payment of the following amount: (1) in the case of CEO Ryden, an estimated $2.40 million; (2) in the case of the COO Kent, an estimated $912,000; (3) for the CFO Besanko, an estimated $653,190; and, (4) in the case of the Senior Vice Presidents, 100% of the sum of their base salary plus incentive award targets;

Immediately prior to a Change in Control Event,

  • all stock options held by the executives shall become fully vested (Ryden-540, 300 shares; Kent-155, 000 shares; and, Besanko- 60,000 shares);
  • each executive will be entitled to receive 66-2/3% of the target number of performance shares specified in the Award of Performance Shares Agreement covering the three fiscal years ending December 31, 2005, December 30, 2006 and December 29, 2007 (Ryden-29, 700 shares, Kent-6, 666 shares, and Besanko-6, 666 shares); and,
  • each so-named participating executive who remains employed by the Company for at least three months following a Change in Control Event will be entitled to a Special Retention Bonus, ranging from 20% -- to – 50% of their respective annual base salaries. Messrs. Rydin, Kent, and Besanko will receive an estimated $145,248, $81,605, and $124,230, respectively.

These Executive Severance Agreements smell as sweet as a Yankee candle—as long as a Change in Control event was to happen by April 1, 2007….

“We always have time enough if we will but use it aright.”Johanne W. Goethe

The scented-candle maker announced on Wednesday that is being sold to a Chicago-based private equity investment firm, Madison Dearborn Partners, LLC.

Under the agreement, Madison Dearborn will pay approximately $1.4 billion in cash -- or $34.75 a share -- and assume about $300 million in debt. The Company expects the transaction to close in the first quarter of 2007—one does not need to be a member of Mensa International to suppose that the deal will close by April 1, 2007.

Chairman and CEO Ryden said, " This transaction was in the best interest of our shareholders.”

In the case of Ryden and the other senior executives, his comment rings loud and true.

Editor David J Phillips does not have any financial interest in the stock of The Yankee Candle Company.

Monday, October 23, 2006

Costco's CEO Refuses 2006 Bonus--Not Exactly Financial 'Hari-Kari.'

On October 17, the Compensation Committee of Costco Wholesale Corp. (COST-$51.69), the nation's largest wholesale club operator, approved final bonus awards for executive officers for fiscal year 2006. The Committee did not release (previously approved) performance bonus awards to President and Chief Executive Officer James Sinegal or Chief Financial Officer Richard Galanti of $200,000 and $82,000, respectively.

According to last Thursday's regulatory
8-K filing with the SEC, Sinegal and Galanti suggested that they not receive their bonuses this year due to to prior irregularities in the Company’s stock options granting process that occurred on their watch.

Following the recent publicity regarding the granting of stock options, Costco initiated an internal review of its historical stock option grant practices to determine whether the stated grant date of options (made during the years 1996 through 2005) were supported by the Company’s books.

As the 10Q Detective has repeatedly disclosed in prior postings, it is rare that corporate leaders unclothe themselves to be held accountable. They would either deny wrongdoing—seeing himself or herself above the law—rex non potest peccare (“the King can do no wrong”); or hide behind the veil of immunity just because they were the leaders—immunity rationae materiae.

We laud the gestures of accountability displayed by both Sinegal and Galanti to refuse their cash bonuses. Sadly, however, the 10Q Detective suspects that both executives might have been motivated more by their regard to self-interest than by unselfish minding for corporate governance.

Although the inside review identified no evidence of fraud, falsification of records, or intentional deviation from generally accepted accounting principles, the audit did find, however, that in several instances, it was impossible to determine “with precision” the appropriate measurement date for specific grants. For these grants it was feasible only to identify a range of dates that included the appropriate measurement dates, where some dates in the range were after the recorded grant date.

In April 1997, both Sinegal and Galanti received “one grant subject to imprecision that may have benefited (Sinegal) by up to $200,000” (and Galanti. by an undisclosed amount).

Louise Augusta, Queen of Prussia, met the conquering Napoleon (July 1807) in person at Tilsit in Russia to sign a peace treaty, she toasted to him: "To the health and kindness of Napoleon the Great. He has taken our states, and soon will return them to us." Napoleon bowed and replied, "Do not drink it all, Madame."

Although the Company has not disclosed the total compensation for fiscal year 2006 earned by each of the above-named executive officers, it is safe to suggest that their absence of performance bonuses (for the option “imprecisions”) will not be a cause of financial hardship:

· In FY ’03 – ’05, the Company granted Sinegal and Galanti 450,000 and 225,000 stock appreciation rights (SARs), respectively;
· During FY ’05, Sinegal and Galanti exercised stock options worth a realized value of $3.74 million and $2.72 million, respectively;
· At Fiscal Year-End 2005, the value of in-the-money (exercisable) Options/SARs held by Sinegal and Galanti were $20.77 million and $5.98 million, respectively.

Certain Relationships and Transactions

· James D. Sinegal’s son and brother-in-law were employed by the Company during fiscal year 2005 at annual salaries (including cash bonuses) of $266,209 and $216,541, and received grants of 37,500 and 18,750 options, respectively.
· In addition, a company controlled by one of Mr. Sinegal’s other sons (who is not employed by the Company) sold merchandise to the Company for resale in FY ‘05, for which the Company paid $1,351,826.

Suffice to say, in light of all these facts, Sinegal and Galanti were no corporate martyrs committing

One might readily argue, however, that compared to their respective peers at BJ’s Wholesale Club (BJ-$28.60), the nation’s third-largest warehouse membership club, that CEO Sinegal and CFO Galanti are either under-paid in terms of performance (or BJ’s top executives are overpaid)?

Costco’s and BJ’s operating margins and ROEs (trailing twelve-month basis) were 2.71%, 2.36% and 12.18%, 12.40%, respectively.

In FY ’05, the Chief Executive Officer of BJ’s, Michael T. Wedge, and the CFO, Frank D. Forward, earned cash compensation of $1.63 million and $742,000, respectively. In comparison, Costco CEO Sinegal and CFO Galanti earned cash compensation of $450,000 and $536,800, respectively, in the last fiscal year.

Valuation Analysis

This no-frills, self-service BOX-Retailing business model enables the Company to operate profitably on smaller margins than discount retailers like Target Corp. (TGT) and Wal-Mart Stores.

On October 12, 2006, Costco reported that
4Q:06 Earnings Edged Up two cents (share-net of 75 cents) on an 8 percent rise in same-store sales comparables and net-income growth of 0.25 percent to $355.6 million.

In our opinion, the 9.4% gain in the price of the Common Stock already discounts an improving earnings growth picture (given the nearly 43 percent drop in the price of retail gasoline—in the same time period—to about $2.00 per gallon).

For fiscal year 2007, consensus estimates call for Costco to earn $2.58 on estimated sales of $65.4 billion. The Common Stock is fetching 17.6 times forward September ’08 share-net estimates of $2.94.

The Common Stock is selling at about an 8 percent discount to its intrinsic value of $56.00 per share (derived from a blend of average P/E multiples and discounted cash flow analysis—which includes a weighted average cost of capital of about 7.6 percent and a forward earnings growth rate of 11.3 percent).

Risks to this value proposition include rising energy prices, delays in store expansions, and decreasing pricing power (due to increased competition).

Editor David J Phillips does not own any of the stocks mentioned in this article. You can see his portfolio holdings in the sidebar. The 10Q Detective has a full disclosure policy.

Wednesday, October 18, 2006

Precision Drilling Trust--Offering Income & Growth

Precision Drilling Trust (PDS-$28.30) is the leading provider of energy services to the Canadian oil and gas industry.

Income-oriented investors might want to take a look at Precision Drilling, for it is an open-ended investment trust that makes monthly cash distributions. The estimated dividend yield for FY 2006 is about 12 percent. The Trust holds a 99.12% interest in Precision Drilling Limited Partnerships (which owns Precision Drilling Corp.).

Company Overview

Precision’s operations are reported in two segments. The Contract Drilling Services segment—which comprises the foundation of the Company’s oilfield services enterprise (about 77 percent of operating profits)—includes contract drilling rigs, camp and catering (LRG Catering), oilfield supply, and manufacturing divisions. The Completion and Production Services segment includes well servicing (for completions, workover, maintenance and abandonment work on any well), wastewater treatment units, rig-assist snubbing (for under-balanced drilling), and rental divisions.

Precision is Canada’s largest drilling contractor with a 30 percent market share and a modern fleet that consists of 234 rigs covering depth ranges from a few hundred meters to almost 6,700 meters.

Precision dominates in the Western Canada Sedimentary Basin (WCSB). The WCSB has a complex mix of energy reserves—oil sands, heavy oil, conventional oil, coal bed methane, deep gas and shallow gas—as well as challenging geography and ever-changing weather conditions. As the basin matures, Precision is able to offer its customers greater efficiencies and “best-of” technology through the provision of a diversified inventory of oil-service equipment and a highly qualified and experienced technical staff.

Precision has a balanced drilling rig portfolio, with a particular strength in deep drilling. As customers turn to deeper wells to discover new reserves, Precision’s 40 percent market share in rigs with a depth capacity greater than 3,600 meters is noteworthy. Drilling opportunities for natural gas reserves is a market where the Company has an advantage, a market many expect to emerge in Canada.

Financial Overview

For the six months ended June 30, 2006, earnings from continuing operations were $312.5 million on revenue of $759.9 million, as compared to $97.6 million on revenue of $541.3 million in 2005. The 1H:06 benefited from a combination of higher equipment utilization (in part due to dry weather conditions) and continued strong pricing in both the Contract Drilling and the Completion and Production business segments.

Net earnings per unit share were $2.49 in the 1H:06 compared to $1.32 in 2005. A lower effective tax rate (as Precision converted to a Trust in November 2005) and substantively enacted tax rate reductions contributed to an increase of $0.81 per unit in the 1:06 over the same period last year. The effective income tax rate in the 1H:06 was about 8 percent compared to 37 percent last year.

In the 1H:06, the Company had a dividend payout ratio of 68.3 percent, declaring $1.70 in distributions per unit share.

Precision’s liquidity and financial health remains strong, as working capital exceeded long-term debt and other liabilities by $83.7 million at June 30, 2006. Long-term debt stood at $45.0 million, for a long-term debt to long-term debt (plus equity ratio) of 4.0 percent.

Growth Initiatives

Accretive growth is being delivered organically through the addition of new equipment lines across the organization and geographic expansion into other North American markets. Growth is anticipated, too, from value-added acquisitions.

Precision Drilling is moving forward on several growth initiatives:

1. The geographic expansion of Precision’s Contract Drilling services segment to the United States is proceeding as planned. A drilling rig commenced work in Texas in late June 2006. Plans to construct an additional 10 drilling rigs for the U.S. market is proceeding on schedule. Precision expects to have a fleet of 11 drilling rigs operating in the U.S. by the end of the second quarter of 2008.
2. By the 4Q:07, Precision expects to have a fleet of 252 drilling rigs operating in Canada, up from the 2Q:06 end count of 234.
3. The Completion and Production Services segment has initiated several growth measures for its domestic market. The Service Rig unit secured a long-term customer commitment to construct two slant service rigs for the heavy oil market.
4. By the 1Q:07, the Company’s Production Services segment expects to be operating a fleet of 239 service rigs compared to a current fleet size of 237.
5. In addition, the snubbing unit division has initiated plans to construct four new stand-alone units, of which two will be a rack and pinion design. By the end of the 3Q:07, Precision expects to be operating a snubbing fleet of 30 units.
6. In August 2006, Precision acquired Terra Water Group Ltd., an Alberta based company that operates 40 wastewater treatment units for the traditional drilling rig camp market in western Canada

Valuation Analysis

The oils-service industry has been in a freefall since May, as investors fled the stocks in the belief that declining energy prices meant that the current cycle in drilling activity was peaking. The Philadelphia Oil Service Sector Index (OSX) has slipped 20.2 percent in the last five-months.

Our forward view remains that energy prices will stabilize, and possibly turn higher, for a supply imbalance (where field depletion rates outstrip new reserve additions) will put a floor on commodity prices and precipitate the continuing need for exploration and drilling activity.

Albeit oil and gas prices have slipped, they still remain high relative to historical benchmarks. West-Texas Intermediate (WTI) oil prices averaged US ($) 56 per barrel during 2005, an increase of 37 percent over the 2004 average of US ($) 41 per barrel.

North American natural gas prices are also being supported by strong fundamentals (as older, shallow wells are being depleted). North American Henry Hub natural gas prices surged 45 percent in 2005, averaging US ($) 8.96 per mmbtu, an increase of US ($) 2.78 per mmbtu over 2004. Demand for natural gas is increasing with economic activity while the supply from relatively mature basins is continuing to decline.

Industry fundamentals remain strong in Canada. Although the Canadian Association of Oilwell Drilling Contractors has decreased its 2006 industry well count forecast from 26,070 to 23,827 wells, it has increased its estimate of average drilling rig operating days per well assumption from 6.4 to 7.2 days. This results in a net increase of 3 percent in the forecast industry operating days for 2006 from 166,849 to 171,489 days.

On a valuation basis, Precision Drilling is selling at for a forward 12-month P/E multiple and trailing EV/EBITDA of 8.73 times and 5.90 times, respectively. The Common Stock is selling at a discount to its peers: Schlumberger Ltd. (SLB), 16.68x and 14.03x; Baker Hughes Inc. (BHI), 13.55x and 10.54 times; and, Nabors Industries Ltd. (NBR), 6.42x and 7.19 times, respectively.

Precision offers attractive growth prospects (and income) for value-oriented investors and a “bounce” trading opportunity for speculators (the stock has slipped about 23 percent in price since early May).

For traders, the catalysts for a positive shift in investor sentiment could be a colder-than expected winter in North America and a firming in energy prices.

Investment Risks and Considerations

Financial performance in the oilfield service industry in Canada is subject to seasonal trends. The first quarter is usually the most active and prosperous as winter ground conditions typically allow complete access to well locations [frozen lakes and compacted snow make for good roads]. In the second quarter, spring weather (rain) softens ground conditions and can slow oilfield service activity dramatically. Subject to dry weather, activity resumes and will sequentially gain momentum in the third and fourth quarters.

Volatility in oil and natural gas prices can impact Precision’s customers’ activity levels and spending for its products and services. While current energy prices are important contributors to positive cash flow for its customers, expectations about future prices and price volatility are generally more important for determining future capital spending levels. For example, almost three-quarters of the drilling activity in western Canada is targeting natural gas reservoirs, making this activity the primary driver of demand for Canadian oilfield services. A continued decline in natural gas prices could lead to capital spending cuts by the customers—with a resultant slowdown in demand for Precision’s products and services

Precision operates in a highly competitive environment, which may adversely affect the Company’s ability pricing power (e.g. rig rates).

Editor David J Phillips is long shares of Precision Drilling Trust but has no financial interest in any other company mentioned in this posting. The 10Q Detective has a full disclosure policy.

Monday, October 16, 2006





The 10Q Detective has a FULL DISCLOSURE Policy.

Saturday, October 14, 2006

Force Protection Update -- Would Bernard Baruch Be a Buyer?

Famous Wall Street financier, Bernard Baruch (1870 – 1965), was reputed to have said: "Don't try to buy at the bottom and sell at the top. It can't be done except by liars."

Back in August, when the stock price of blast-protected military vehicle maker Force Protection (FRPT-$8.04) was already up about 306 percent, we expressed our concerns that—although the Company had an attractive product(s) and backlog—that (1) with relatively short production runs and high fixed factory costs, sustainability of future profitability would be difficult to predict; and (2) the price run-up in the stock already reflected the profits being reaped by the Company because of the U.S. military’s need to ramp-up of combat-ready protective vehicles for service in Iraq and Afghanistan.

Contrary to what the ardent bulls believe, the stock price of Force Protection continues to defy gravity. On September 23, 2006, the Common Stock price hit an intra-day (52-week) high of $9.43—probably fueled by investor euphoria after leaving—the revival tent—oops!—the annual shareholder meeting.

First described by Sir Isaac Newton in his universal law of gravitation, what goes up—must come down.

“Millions saw the apple fall, but Newton was the one who asked why” – Bernard Baruch.

As the following table highlights, selling of shares by insiders - which includes executives, directors and top shareholders at the Company - has been rampant in recent months. In our view, the Common Stock of Force Protection is Newton’s apple, almost ready to fall from the tree:

Gordon R.
CEO10-09-06Disposed of100,0008.38
10-10-06Disposed of77,4008.17
10-11-06Disposed of122,6008.11
Director10-03-06Disposed of178,6008.55
10-04-06Disposed of114,1238.48
10-05-06Disposed of287,2778.11
Gordon R.
CEO9-26-06Disposed of83,3338.77
Ervin R.
Director9-25-06Disposed of190,7368.90 – 9.10
9-21-06Disposed of134,0008.99 – 9.18
9-22-06Disposed of129,5008.90 – 9.05
Director9-15-06Disposed of599,6407.48
9-18-06Disposed of84,8657.98

9-08-06Disposed of309,0007.02
9-11-06Disposed of119,7507.01
9-12-06Disposed of119,7507.36
Ashford Capital, LLC
Frank Kavanaugh,

Disposed of1.0 MOngoing
On August 10, 2006, a prospectus related to the sale of up to 8,250,000 shares of Common Stock was filed by existing stockholders with the SEC. Force Protection will not receive proceeds from the sale of shares of Common Stock in this offering.

Is the stock price of Force Protection starting to tire?

On October 6, 2006, Congress approved a $448 billion defense-spending bill (including $70 billion in emergency spending for the Iraq and Afghanistan wars). The news boosted the prices of most defense contractors, with the Spade Defense Index (^DXS), which tracks the industry and trades on the American Stock Exchange, rising 4.3 percent in the last two weeks. The price of Force Protection dropped 0.7 percent in the same period.

In the appropriations bill are line items provisions that could prove attractive to the top-line of Force Protection, including contract opportunities for a chunk of the (1) almost $300 million allocated for Mine Resistant Utility Vehicles (MURVs); and (2) $1.7 billion targeted for the indigenous Iraqi Defenses Force as it continues to build-out its own security capabilities (which we assume would include armored vehicles).

If insiders thought that the Company was going to benefit from the latest appropriations bill, would it not be in their best interest to hold on to their shares?

“There is something about inside information which seems to paralyze a man's reasoning powers.” – Bernard Baruch

At the recent shareholder meeting, CEO Gordon McGilton remarked: “The future of the company looks better than it ever has, to those that are working in, and on, it daily. Vehicle deliveries to the customer are increasing steadily. We have now secured contracts with an international customer, and we have future products well into the development process that will create an even broader product offering as we go forward.”

“Never pay the slightest attention to what a company president ever says about his stock.” – Bernard Baruch

Apparently, the company's insiders seemed to have ignored McGilton's remarks (including himself). Granted, insiders sell for many reasons, but when Force Protection insiders register to dump (sell) on the market —or have already sold hand over fist—a combined 23.5 percent of the Common Stock float in the last ten weeks, this raises an ominous red flag.

There has been no reported insider buying during this time period, too.

“Do not blame anybody for your mistakes and failures.” – Bernard Baruch

There will be investors who will fail to heed this warning—instead, accusing the 10Q Detective of being a shill for short-sellers. As editor, I will repeat one more time: The 10Q Detective has NO financial interest in Force Protection and has a FULL DISCLOSURE policy.

In our view, fiscal 2007 may represent the cyclical peak in a multi-year rise in military spending. We caution that unseen rust may be corroding the underbelly of Force Protection’s armored growth engine. The catalysts for a precipitous collapse in the price of the Common Stock price include (a) the missing of unit volume targets because of delays in certain military contracts; (b) a November mid-term elections (majority) win by the Democrats in either the House or the Senate (which could lead to a future draw-down of U.S. troops in Iraq); and (c) less-than-anticipated contract wins.

“I made my money by selling too soon.” – Bernard Baruch

Editor David J Phillips does not have any financial interest in the stock of Force Protection (long or short). You can see his portfolio holdings in the sidebar. The 10Q Detective has a full disclosure policy.

Thursday, October 12, 2006

Sovereign Bancorp CEO Doesn’t Deliver the Goods (but Walks Away with Them)

Last evening, financial services company Sovereign Bancorp Inc (SOV-$24.31) said that longtime President and Chief Executive Officer Jay Sidhu resigned (and retired) over “family and health-related issues.”

And Jesus said "...you shall know the truth, and the truth shall make you free." [John 8:32]

The truth is that family played no role with Sidhu’s decision. The Board and major shareholders pressured Sidhu to resign amid concerns over the Company’s deteriorating fundamentals, coupled with the fact that Sidhu had failed to follow through on prior promises to boost the valuation of the banking company. According to a California Public Employees’ Retirement System PX14A6G filing with the SEC (on September 8, 2006), Sovereign’s three-year stock performance had under-performed both the S&P 500 and S&P 500 Bank Index by more than 20 percent.

Nevertheless, the Board and the Company thanked “Jay for his outstanding service to Sovereign over a long and distinguished career.”

In a research note filed Wednesday morning, Richard Weiss of Janney Montgomery Scott upped his rating to a “buy,” citing the resignation of Sidhu as a positive for shareholders, “as it greatly increased the probability of a sale to another institution and lowered the odds of Sovereign acquiring yet another company."

Paul A Samuelson, a Nobel laureate in Economics (1970), said: “Wall Street indices (have) predicted nine out of the last five recessions!” Ask two equity analysts for their thinking on a stock and you’ll get three opinions—buy, sell, and hold.

Alternatively, Salvatore DiMartino, a banking analyst at Bear Stearns & Co: Company, thought it “unlikely that (Sovereign) would be sold in the near term given weakening fundamentals, increased competition from larger banks, and the lack of buyers. Maintaining peer performance" [which means if banking valuations increase, up goes the stock price of Sovereign—and if the valuations of bank stocks decline, so, too, will the price of Sovereign’s Common Stock].

Citigroup cut Sovereign to "sell" from "hold," and lowered its price target by a dollar to $23. The brokerage in a research note said it lowered its rating because “Sovereign shares are overvalued in the absence of a takeover.”

Amidst all this dubiety, the only certainty is Mr. Sidhu's severance package, which entitles him to benefits of approximately $13 million (which excludes an additional $37.4 million in exercisable stock options).

“Markets can remain irrational longer than you can remain solvent."John Maynard Keynes

Editor David J Phillips does not own any of the stocks mentioned in this article. You can see his portfolio holdings in the sidebar. The 10Q Detective has a full disclosure policy.

Wednesday, October 11, 2006

Microsoft Corp.--Praise for Its Executive Pay Practices

Unlawful monopolistic practices, an adapt and overwhelm (predatory) R&D strategy, and vendor lock-in tactics— criticism of software maker Microsoft (MSFT-$27.69) has followed the company's existence because of various aspects of its products and business practices. Yet, after reviewing Microsoft’s Proxy Statement filed with the SEC last week, the 10Q Detective found few irregularities that suggest—at least when it comes to the Company’s executive compensation policy—the software maker is less a golden cow being milked by insiders and more of a “velvet sweatshop.”

[Ed. note. The first instance of "velvet sweatshop" used in reference to Microsoft originated from a Seattle Times article in 1989,which disclosed allegations of the company working its employees to the point where it might be bad for their health.]

As disclosed in its fiscal year 2006 Proxy, the average salary for its top five executives was about $600,000 (and between $350,000 and $500,000 in cash bonus). The compensation (salary plus cash bonuses) for Chairman Bill Gates and CEO Steve Ballmer were $966,667 and $966,667, respectively. Additionally, both men did not receive any long-term compensation (Restricted Stock Units and/or Stock Options).

Their salaries and total compensation are significantly below competitive levels for the information technology industry and large market capitalization U.S. companies. Additionally, Microsoft does not grant regular stock awards to its most senior executives (approximately 15 individuals) and (aside from the Company’s 401(k) Plan and welfare benefit programs) there is no other Company-sponsored retirement program (like a Supplemental Executive Retirement Plan).






Advanced Micro


Hector de J. Ruiz

$4.95 Mil.

$3.13 Mil.

Cisco Systems


John T. Chanbers

$1.65 Mil.

$61.33 Mil.


CEO & Chairman

Joseph M. Tucci

$3.16 Mil.



CEO & Chairman

Samuel J. Palmisano

$6.86 Mil.

$9.45 Mil.



Paul S. Otellini

$3.29 Mil.

$5.36 Mil.


CEO & Chairman

Edward J. Zander

$4.50 Mil.




Lawrence J. Ellison

$7.48 Mil.

$66.89 Mil.



Scott G. McNealy

$1.23 Mil.

$11.84 Mil.

In comparison, the average CEO salary and bonus for the aforementioned high-profile group was $4.14 million in base salary (and bonus) and $19.75 million in exercised stock options.

The Compensation Committee took into account the status of Messrs. Ballmer and Gates as significant shareholders of the Company when calculating their annual incomes. Gates and Ballmer, beneficially own 957.5 million shares and 408.3 million shares, worth an estimated $26.5 billion and $11.3 billion, respectively. We laud the philosophy of the Committee: “As the leaders of the Company, they are focused on building long-term success, and as significant shareholders in the Company, their personal wealth is tied directly to sustained increases in the Company’s value.” This principle is exposited by many a Compensation Committee—but rarely displayed in practice.

The 10Q Detective could detect few corporate governance offenses in Microsoft’s Proxy Statement. The only conflict worth noting is that Messer. Gates is the sole shareholder of Corbis Corporation, a company that provides digitized images and production services. Microsoft paid Corbis approximately $860,000 in fiscal year 2006 as licensing fees for digital images to be used in Microsoft’s products, services, and marketing materials. We doubt, however, that this business is material to Gates, for he is worth an estimated $53 billion outright.

Labor practices, high-profile Internet-related product security lapses, and usability issues—just another three in a litany of business abuse practices spewed at Microsoft. An "evil empire" to its critics, but less than so when it comes to executive pay practices.

Editor David J Phillips has no financial interest in any companies mentioned in this posting. The 10Q Detective has a full disclosure policy.

Monday, October 09, 2006

"See the Unexpected"--A New CEO at Clorox

On August 30, 2006, The Clorox Company (CLX-$64.44), marketer of recognized brand names, including its namesake bleach and cleaning products, Fresh Step and Scoop Away cat litters, Kingsford charcoal briquettes, Hidden Valley and K C Masterpiece dressings and sauces, and Glad trash bags, wraps and containers, entered into an employment agreement with Mr. Donald Knauss, which became effective on October 2, 2006, when Mr. Knauss began his employment as Chairman and CEO of the Company.

Under the terms of the agreement, Mr. Knauss, 55, will receive, among other things, an annual base salary of $950,000 and a sign-on cash bonus of $500,000. On his first day of employment, he received a ten-year option to purchase 275,000 shares of Common Stock and 83,500 restricted stock units (RSUs) that will vest over four years. The closing price of the Common Stock of Clorox on October 2nd was $63.21 per share, giving him an unrealized gain of about 1.9% on his potential new holdings.

Like Katie Couric at CBS Evening news, performance has nothing to do with the monies being guaranteed to Knauss—at least for his first year behind the anchor desk. Irrespective of Clorox’s financial performance for the fiscal year ending June 30, 2007, Knauss’ annual incentive bonus is guaranteed to equal at least $1.09 million (with a maximum payout for performance of $1.90 million).

Mr. Knauss is entitled to relocation benefits, including up to $50,000 in loss protection on the sale of his residence in Atlanta, Georgia, and up to $10,000 per month for temporary housing, plus certain commuting and house hunting travel costs, for a period of up to one year.

How desperate was Clorox to fill a leadership void at the Company? In addition to the aforementioned benefits, the new CEO talked Clorox into reimbursing him up to $40,000 for any legal fees and other expenses incurred in connection with the negotiation and drafting of the employment agreement, too!

"Money is plentiful for those who understand the simple laws which govern its acquisition."
–Personal Finance Author George S. Clason

Timing is everything. If so, Knauss is off to a good start at The Clorox Company. Slowing price growth in raw material costs should relieve some of the cost pressures that saddled key inputs to manufacturing and distribution in Fiscal Year 2006. These increases, which impacted commodities such as resin and diesel, contributed to a gross margin decline of 100 basis points (to 42.2% from 43.2% in fiscal year 2005).

For the year, income dropped 60 percent to $444 million, or $2.90 per share, from $1.1 billion, or $6.11 per share last year. Revenue grew 6 percent to $4.64 billion, from $4.39 billion last year.

The Clorox Company expects FY 2007 and FY 2008 earnings of $3.20 - $3.30 per share and $3.50 - $4.00 per share, respectively (on expected long-term sales growth of 3.0% - 5.0%). According to Reuters consensus estimates, analysts had been expecting the Company to report revenue of $4.8 billion in FY 2007 and share-net of $3.59 in FY 2008.

Citing an improving outlook for commodity costs, some analysts are revising upward their 2008 share-net estimates. Merrill Lynch, in a recent RESEARCH UPDATE raised the Common Stock of Clorox to a “buy” from “neutral,” and said it also raised its 2008 earnings per share estimate for Clorox to $3.73 from $3.55, up 15 percent year-on-year.

Viewing the current stock price in the context of its average four-year trailing multiple of 21.0 times earnings, at $64.44 per share, Clorox is fairly valued. In our view, the almost 20 percent gain in the price of Clorox’s stock already discounts the expected turnaround in operating margins and share-net growth.

Risks and positive adjustments to our opinion include quicker consumer acceptance of new product introductions (with lower than expected promotional activity) and continued manufacturing efficiencies (from lower raw material costs) leading to greater operating profitability.

Editor David J Phillips has no financial interest in any companies mentioned in this posting. The 10Q Detective has a full disclosure policy.

Friday, October 06, 2006

Northern Orion Resources--A Polished Copper Play?

On August 30, 2006, the International Copper Study Group (ICSG) said that its preliminary data showed that world copper production exceeded consumption by 13,000 tons in the first five months of 2006.

Strikes at mines in South America, short covering, and competitive purchases by commodity investment funds—this was the witches brew that resulted in the price of copper hitting a cyclical high in May 2006, when it reached $4.00 a pound.

Longer-term, as articulated by Standard & Poor: “ we are positive on the secular demand for copper…. industrialization of China and India will lead to greater demand. At the same time, the production of copper will increase less rapidly than demand, as output at (some) existing mines is exhausted and fewer mines come into production…. the next market peak should result in copper prices reaching a higher average (price) than the average price seen in 2006 (average price of $2.86 per pound).”

Company Overview
10Q Detective is stepping up to the plate and making a purchase of Northern Orion Resources (NTO-$3.65), a Canadian-based copper and base metals miner with principal operations (a 12.5% indirect ownership interest) in Bajo de la Alumbrera. This geographical area of activity is located in the Catamarca Province (a six-hour drive by car in northwest Argentina from Buenos Aires). Northern Orion, with proven and probable reserves of about 4.0 billion pounds of copper and 6.4 million ounces of gold, is one of the world's largest copper and gold mining operations, and is among the world's lowest cash cost copper producers (current cost per pound is about 10 cents).

The Alumbrera Mine has an estimated mine life of ten years (to 2016).

Second Quarter 2006 Financial Highlights

For the quarter ending June 30, 2006, Northern Orion recorded record net earnings of $32.8 million, or share-net of $0.18, as compared with net earnings of $3.6 million, or $0.02 per share, for the prior year. Last 12-months earnings were $0.49 per share compared with a share-net loss of one cent a year ago.

The average realized copper and gold prices were $4.44 per pound, or 179% higher, and $608 per ounce, or 44% higher, respectively, than for the same period in 2005.

Northern Orion carries no long-term debt, and at June 30, 2006, the Company had a cash position of $172.4 million (including temporary investments).

Valuation Analysis

Northern Orion has a major catalyst that could unlock potential wealth for the Company and shareholders alike. In late 2004, the Company commissioned an initial feasibility study to support financing of an independent mine and processing facility at its 100% owned
Agua Rica Project, a copper/gold development property (also located in the Catmarca Province, Argentina). The property is comprised of mining claims and exploration licenses.

The feasibility study, which is nearing completion, has focused on the cost-economics of commencing planned production approximately three years after the Company obtains all necessary permits.

[Ed. note. According to information supplied by the Company, none of the experts preparing the report had or received any registered or beneficial interests, direct or indirect, in Northern Orion or other property of the Company.]

Guidance does suggest that Agua Rica will be a very low cost producer, based on work completed to date. Subject to confirmation on completion of the updated study, Agua Rica has:

· 23-year life of mine
· Capital costs of $1.9 billion
· Cash costs of $0.09 per pound of copper of net by-products (based on $435/0z gold).
· Drillings indicate that the site may contain 21.8 billion pounds of copper and 13.3 million ounces of gold.

Based on current commodity prices, market conditions, and planned production levels at Alumbrera, the Company expects to receive significant cash flows from Alumbrera for at least the next eight to ten years (trailing-twelve month cash flow was $42.8 million). . Management believes that expected cash flows, along with the Company’s current cash balances, will provide a significant part of the equity contribution necessary to bring Agua Rica into production. Outside financing will be needed, too.

After hitting a 52-week high of $6.32 per share in May 2006, the Common Stock price of Northern Orion has dropped 43 percent, tracing the decline in copper prices.

Copper producer Phelps Dodge (PD-$82.76), with a market capitalization of $17.01 billion, dwarfs the value of Northern Orion (with a market capitalization of $549.1 million)! Of interest to us, however, is that the ROA and ROE of both companies are similar: 15.6% and 24.6% (PD) and 15.9% and 23.1% (NTO), respectively.

Looking at a worst case scenario for 2007—a moderation in residential construction, little labor unrest at mines, and less-than expected consumption in China—doom & gloom consensus estimates are projecting copper prices at $2.40 –to- $2.50 per pound. Readers should remember that even at that price, Northern Orion’s mining costs are significantly lower than this forecast.

In our view, Northern Orion, selling for eight times forward 2007 earnings estimates of $0.45 per share, already discounts an expected further drop in the commodity price of copper to the $2.50 level. A reversal in the price(s) of copper/gold could quickly lead to a turnaround in the share price of Northern Orion, too.

A reasonable P/E multiple for the larger capitalized copper/gold producers is 10 times forward 12-months earnings. Applying this P/E multiple, would imply a $4.50 price per share for Northern Orion. We remind our readers, however, that this price target assumes a lower price for copper and no news on the Agua Rica project. In our view, this company—albeit speculative—offers a compelling growth story. Those patient investors with an eye to long-term fundamentals could be handsomely rewarded.

Investment Risks and Considerations

Weakness in Copper Demand greater than consensus forecasts. A bigger than anticipated drop in the price of copper could adversely impact the financial results of the Company.

Mining operations generally involve a high degree of risks and hazards, including—but not limited to—unexpected seismic activity, cave-ins, flooding, and other conditions involved in the drilling and removal of metals. Although adequate precautions are taken to minimize risk, damage to life, property, and the environment are still a possibility.

Additionally, as Northern Orion is highly dependent on the Alumbrera Mine for current and future revenues, any unforeseen interruption to existing mining activities could have an adverse material impact on the financial performance of the Company.

The development and exploration of the Agua Rica project will require substantial additional financing. Failure to obtain additional capital or other types of financing may result in delaying or a postponement of the development or production of the property. Low gold prices during the five years prior to 2002 adversely affected the Company’s ability to obtain financing, and low gold and copper prices could have similar effects in the future.

Editor David J Phillips is long shares of Northern Orion Resources but has no financial interest in any other company mentioned in this posting. The 10Q Detective has a full disclosure policy.

Wednesday, October 04, 2006

Estée Lauder: Distinctive Odor of Nepotism?

For the latest fiscal year ended June 30, 2006, the cosmetic company Estée Lauder (EL-$39.91), whose brands include Aveda, Clinique, and Tommy Hilfiger, reported a nearly 40 percent drop in net income to $44.5 million, on a 3 percent rise in sales to approximately $6.5 billion.

In the Company’s recently file Annual Proxy it was revealed that Chairman Leonard A. Lauder cut his own salary by approximately 20 percent to $1.44 million for Fiscal 2006. He also was paid a cash bonus of about $1.37 million (a 15.5 percent decrease from the prior year). According to his employment agreement, the Compensation Committee has granted to Mr. Lauder aggregate bonus opportunities for fiscal 2007 with a target payout of $1.8 million. Why is he making any bonus at all?

The Board of Directors met only five times in fiscal year 2006. Mr. Lauder is also a member of the Nominating and Board Affairs Committee, which met four times. The Nominating Committee, among other things, reviews the compensation for service as a Board member.

If –and when—Mr. Lauder retires, the Company will continue to provide him with the office he currently occupies and a full-time executive secretary for as long as he would like.

Leonard Lauder, 73, worth an estimated $2.9 billion, will be comfortable in his golden years. If he were to retire currently, he is sitting on 3.0 million unexercised ‘in-the-money’ options valued at $17.7 million. His annual retirement benefits would be approximately $1.4 million. In addition, he is being paid approximately $2.0 million per year, pursuant to a deferred compensation arrangement in his current and former employment agreements. Payments under such arrangement commenced upon his 70th birthday in March 2003 and will continue until March 2013.

The Company may terminate Mr. Lauder's employment at any time if he becomes "permanently disabled," in which event Mr. Lauder will be entitled to (i) receive his current base salary of $1.44 million for a period of two years after termination and (ii) receive bonus compensation at an annual rate equal to the average of the actual bonuses paid to him prior to such termination. [Ed. note. Long-term disability is usually paid at a rate equal to 60 percent of current base salary]

Lauder Family Relationships

“Families aren’t dying. They’re merging into large conglomerates.” –Erma Bombeck

The Estée Lauder Companies is more than just a portfolio of skin care, makeup, fragrance and hair care products. Not surprisingly, it is also a company seeded with the family relations of the founders, Mrs. Estée Lauder and her husband, Joseph Lauder.

Leonard A. Lauder's wife, Evelyn H. Lauder, is Senior Corporate Vice President of the Company.

Leonard and Evelyn Lauder son, (billionaire) William P. Lauder, is President/ CEO and a Director of the Company.

Leonard’s brother, Ronald S. Lauder, is a Senior Vice President and a director of the Company and Chairman of Clinique Laboratories, LLC.

Ronald S. Lauder and his wife, Jo Carole Lauder, have two daughters, Aerin Lauder and Jane Lauder. Aerin Lauder is Senior Vice President—Global Creative Directions for the Estée Lauder brand and is a Director of the Company. Jane Lauder is Senior Vice President, Global Product Marketing for Clinique.

In Fiscal 2006, the Lauder Family Members received the following amounts from the Company as compensation: President and Chief Executive, William Lauder, earned a base salary of $1.5 million and cash bonus of $1.52 million; Ronald S. Lauder received $400,000 in salary; Evelyn H. Lauder received $575,980 in salary and a bonus of $221,400; Aerin Lauder received $260,000 in salary and a bonus of $72,450; and Jane Lauder received $180,100 in salary and a bonus of $59,500.

For Fiscal 2007, Evelyn H. Lauder received a raise in her base salary to $600,000 and bonus opportunities with a target payout of $287,000; Aerin Lauder will receive a base salary of $271,700 and bonus opportunities with a target payout of $107,150; and Jane Lauder received a promotion and a big jump in her base salary to $250,000 and bonus opportunities with a target payout of $100,000.

Stock Performance

The Common Stock sported a 13.45% gain in the past year, compared to a 9.85% change in the S&P 500 Index. Ergot, shareholders cannot complain about the scent of Lauders at the Company.

In our view, valuation metrics do suggest, however, that the stock is fairly valued, with an Enterprise Value at 1.33 times its trailing 12-months revenue. The Common Stock prices of competitors Avon Products (AVP-$30.23), Revlon (REV-$1.26) and Inter Parfums (IPAR-$18.51) fetch EV of 1.69, 1.41 and 1.20 times revenue, respectively.

Estée Lauder—like its peers—is struggling with department-store mergers, which has cut the number of selling locations. In particular, the Company said 1H:07 results will be hurt by the closing of stores last year due to the merger of Federated Department Stores (FD-$43.49) and May.

Management expects Fiscal 2007 share-net earnings of $2 to $2.10 a share and sales growth of between 5 percent and 7 percent. Analysts had been expecting earnings of $2.10 a share.

In his fable, “The Fox and the Lion,” Aesop wrote, “Familiarity brings contempt.”

As this proverb relates to family run (publicly-traded) companies, it is only when the stock price declines that this adage is true. Ask William Clay Ford, Jr.

Editor David J Phillips does not own any of the stocks mentioned in this article. You can see his portfolio holdings in the sidebar. The 10Q Detective has a full disclosure policy.

Monday, October 02, 2006

Bodisen Biotech--A Bountiful Harvest in its Future?

Investors in Bodisen Biotech, Inc. (BBC-$8.94), a manufacturer of organic fertilizers and pesticides targeting The People’s Republic of China’s (PRC) agricultural markets, saw the value of their holdings’ lose about 17% last week, as the Company’s past relationship with a ‘colorful’ adviser to emerging Chinese companies came to light.

Bodisen Biotech has since ended its relationship with the advisor, Benjamin Wey, and
New York Global Group.

Along with public relations work here in the U.S., according to a SB-2/A filed with the SEC in February 2006, the Company had an oral agreement with the Beijing office of New York Global Capital, Inc. for the payment of a corporate finance fee of $300,000 for help with getting Bodisen a dual listing on the London Stock Exchange.

Company and Market Description

The 10Q Detective first learned of Bodisen when we did our due diligence on
China Natural Gas (CHNG-$2.85), for the Company beneficially owns approximately 2.03 million, or about nine percent, of the Common Stock of CHNG (at $1.39 per share). Through the investment, Bodisen is looking to leverage CHNG’s relationships with urea suppliers to obtain price discounts. Urea is a natural gas byproduct used in fertilizer production.

Bodisen's organic products have many advantages over chemical fertilizers. Its fertilizer products improve crop yields by 10% to 35% and are sold at prices similar to chemical fertilizers. Additionally, Chinese farmers that use Bodisen’s organic fertilizer can have their fruits and vegetables government certified as "organic produce," which command as much as 200% higher in retail prices compared to non-organic produce, therefore substantially increasing farmers’ income levels.

Bodisen's compound fertilizer products offer ease of use, for they are applied one time while each type of chemical fertilizers may have to be applied separately.

The Company is growing its business in a favorable market environment. The agricultural industry is strongly supported by the Chinese government. China, with 1.3 billion people, is one of the largest importers of grains in the world. Much of China's urban population of 500 million depends on imported grains to support higher demand for meat. In order to reduce dependence on foreign grains, the Chinese government supports the agricultural industry by providing many incentives to agricultural product companies. Bodisen enjoys tax-free status and is exempt from sales tax, VAT, agricultural product tax and income tax (income tax holiday through the end of 2007 and renewable thereafter).

Emerging from the shell of a start-up stage Internet-based commercial mortgage originator called Stratabid.com, Inc., Bodisen is now a highly profitable, one stop solution provider of the entire planting needs for Chinese farmers. With over 60 different
products (sold in all seasons) in four categories: compound fertilizers, liquid fertilizers, pesticides, and agricultural raw materials, the Company has enjoyed—on average—a net margin of approximately 30% across its product lines.

Financial Analysis

The Company generated revenues of $26.9 million for the six months ended June 30, 2006, an increase of about $13.8 million, or 105.3%, compared to $13.1 million for the prior year period. Management believes that the strong first half of the year was made possible by repeat business from a loyal base of customers buying more items from Bodisen’s product line (as they keep achieving greater crop yields).

Gross margin, as a percentage of revenues, increased from 37.4% for the six months ended June 30, 2005, to 39.6% for the six months ended June 30, 2006. The increase in gross margin was primarily attributable to an across the board increase in the selling price of its products.

Comprehensive income increased by 117.1% to $7.6 million (share-net of $0.48) during the six months ended June 30, 2006, as compared to $3.5 million (share-net of $0.22) for last year. The increase was attributed to a successful marketing campaign focused on increasing cross selling of all Bodisen’s products to its customer base, and growing demand in new markets and regions throughout China. The Company also benefited from a prudent decision made in December 2005 to lock in raw material costs before cost increases were announced in the 1H:06.

[Ed. note. Talk about controversy! On December 8, 2005, Bodisen issued a $5.0 million
promissory note to Amaranth Partners L.L.C. The obligation was used to lock in hedges against the aforementioned raw material cost increases in the current fiscal year. Amaranth Partners L.L.C. is a Delaware-registered subsidiary of the Greenwich, Conn.-based Hedge Fund Amaranth Advisors that collapsed after a misplaced bet on natural gas! The loan has since been paid back.

However, in connection with the issuance of the Note, the Company agreed to issue to Amaranth a warrant to purchase 133,333 shares of the Company’s common stock at $7.50 per share (subject to adjustment). Given the liquidation going on over at Amaranth, one would suspect that these shares will hit the market--putting some short-term pressure on the price of Bodisen, too.]

Accounts receivables rose by $10.0 million in the 1H:06, resulting in negative cash flow from operations of about $(3.7) million.

The Company also advances credit to certain vendors for purchase of its material. The advances to suppliers are interest free and unsecured. The advances to suppliers amounted to $9.9 million at June 30, 2006.

Albeit red flags do exist, in our view, we can shrug them off (for now) because the Company does have a strong balance sheet without any long-term debts. As of June 30, 2006, working capital was $29.0 million (net unsecured advances to suppliers and monies kept in a bank account for investment in a new compound fertilizer plant in Xinjiang Province A La Er City).

Book value stood at $3.36 per share.

Valuation Analysis

In a short time the Company has gained a reputation for producing "green" products that address farmers' concerns in a market that is growing exponentially. Bodisen could easily earn $1.00 per share this fiscal year and is selling for a fraction of the (TTM) 36.5 and 22.5 P/E multiples commanded by agri-chemical giants Monsanto Co. (MON-$47.01) and Swiss Syngenta AG (SYT-$30.18), respectively.

The 10Q Detective prefers to look beyond Bodisen’s short-term worries, for we see a favorable profit picture in this Company’s future (forward five-year average growth of about 35 percent per annum).

Bodisen has one of the largest Chinese agricultural product distribution networks (Product Sale Agreements with more than 155 wholesalers), with current potential to reach more than 60% of China's agricultural markets. As previously mentioned, the Company is building new compound fertilizer plant in Xinjiang Province.

Our two-year target price is $26.00 per share, which implies (among other variables) the issuance of an additional seven million shares for future capex needs; the Company growing at 35% per annum; gross margins of at least 36.7%; equity risk premium of 5.0%; and an assumed WACC of 10 percent.

Investment Risks and Considerations

Risks to our opinion include gross margins squeezed by unanticipated raw material cost increases; unexpected competition from international agri-chemical giants; and, pricing power erosion related to declining economic benefits to farmers (defined in terms of crop yield and prices).

Management owns a significant amount of the Common Stock, giving them influence or control in corporate transactions and other matters, and their interests could differ from those of other stockholders. Two of Bodisen’s principal executive officers, CEO Wang Qiong and President Chen Bo, collectively own approximately 45.48% of the Existing Common Stock. As a result, they are in a position to significantly influence or control the outcome of matters requiring a stockholder vote, including the election of directors and the approval of significant corporate transactions.

Bodisen’s financial success depends upon the development of The People’s Republic of China’s agricultural industry. Roughly half of the PRC’s labor force is engaged in agriculture, even though only about 10% of the land is suitable for cultivation. Although the PRC hopes to further increase agricultural production, incomes for Chinese farmers are stagnating. Despite the Chinese government’s continued emphasis on agricultural self-sufficiency, an inadequate infrastructure, from port facilities to a lack of warehousing and cold storage facilities impedes the domestic agricultural trade.
Bodisen relies on local farmers to purchase its products, which are generally purchased under a “Cash on Delivery” or (as previously mentioned) on a 9-12 months credit, the farmers’ inability to sell their agricultural goods could therefore hinder their ability to timely pay their credit obligations to the Company.

Of concern, in the 2Q:06, days-of-sales outstanding jumped almost 21 days to 97 days (as compared to the 2Q:05). To our new readers, this means that it is taking longer for Bodisen to collect on what it is owed by its customers—indicative of an ‘easy money’ lending policy? Management does note, however, in its SEC filings that credit terms of the sales vary from COD through a credit term up to 9 to 12 months.

However, should central China be hit with an 'Act of God'--floods,drought, or locusts--the allowance for doubtful accounts of $697,209 might prove to be woefully inadequate.

The People’s Republic of China’s Economic Policies could affect the Company’s business. Substantially all of the Company’s assets are located in the PRC and substantially all of its revenue is derived from operations in the PRC. Accordingly, results of operations and prospects are subject, to a significant extent, to the economic, political and legal developments in the PRC.

Editor David J Phillips is long shares of Bodisen Biotech and China Natural Gas but has no financial interest in any other company mentioned in this posting. The 10Q Detective has a full disclosure policy.