Friday, June 29, 2007

Brooke Corp: Questionable Lending Practices, Inflated Balance Sheet

Brooke Corporation (BXXX-$14.75) is engaged in franchise business with a network of 827 franchised locations (as of March 31, 2007), principally operating in the states of Texas, California, Kansas and Florida. The Company’s franchisees sell property and casualty insurance, and other services to individuals and small businesses.

philosophy of Brooke Corporation is outlined in the book titled "Death of an Insurance Salesman?" written by the company's founder, Robert D. Orr, who promulgates that the fundamental principle in selling insurance –and other related services—is more efficiently distributed by local businesses rather than by employees of large corporations.

In marketing campaigns, Brooke Corporation sells the idea to ‘mom and pop’ insurance agencies that signing onboard as franchisees combines the advantages of independent business ownership with the stability and resources of a larger organization.

Brooke Corporation can help its clients with the “wealth creation opportunities associated with independent business ownership,” while offering operational assistance of an insurance distribution company, including commissions accounting, financing, document management, and supplier access.

In exchange for initial franchise fees and a share of ongoing revenues, Brooke Franchise Corporation provides Brooke franchise agencies with access to the products of insurance companies, marketing assistance and administrative support.

To support its franchise business, the Company chartered Brooke Credit Corporation to lend monies to its franchisees to fund the acquisition of franchises or the start up of new franchises. In addition, Brooke Credit specializes in loaning money to professionals within the insurance and death care industries.

Other revenue generating businesses include (i) Brooke Brokerage Corporation, which serves as a wholesale insurance broker for its franchisees with respect to hard-to-place and niche insurance; (ii) Brooke Savings Bank, a federal savings bank; and (iii) Brooke Capital Corporation, a life insurance holding company, to enable franchisees to complement the property and casualty insurance products that they sell with the ability to offer bank, life insurance and annuity products and services to their customers.

Consolidated results of operations demonstrate that profitability and growth in recent years consists principally of adding new franchise locations, originating loans to franchisees, and commission-sharing arrangements (typically representing a percentage of insurance premiums paid by policyholders)

Net earnings for the three months ended March 31, 2007, totaled $6.81 million, or 48 cents per share, on revenues of $64.02 million, compared to net earnings of $3.53 million, or 27 cents per share, on revenues of $41.18 million for the same period in the prior year. Total earnings increased primarily as the result of increased initial franchise fee revenue from opening more franchise locations, increased loan interest revenues from a larger loan portfolio, and increased revenues from the sale of loans.

A total of 90 and 49 new franchise locations were added during the three month periods ended March 31, 2007 and 2006, respectively The amount of the initial franchise fees typically paid for basic services is currently $165,000.

Revenues from initial franchise fees for basic services are recognized as soon as Brooke Franchise delivers the basic services to the new franchisee, which includes access to a business model and the Company’s Internet-based management system, and use of the Company’s brand name.

As mentioned, a significant part of the Company’s growth strategy business strategy involves the success of its affiliate, Brooke Credit Corp., in financing franchisee origination activities and the continued sourcing of these loans. In the three months ended March 31, about 33% of operating revenue derived from interest income (from the foregoing loans) and initial franchise fees. It goes without saying that a reduction in lending opportunities would reduce the number of loans the Company originates, which would reduce profitability and the Company’s ability to grow its business.

Brooke’s dependency on these initial fees creates an incentive for management to extend credit to borrowers that may not meet stringent underwriting criteria. In fact, loans to franchisees are collateralized principally by intangible assets, such as customer lists (which may lose value if the local franchisees—borrowers—do not adequately serve their customers or if the products and services they offer are not competitively priced).

Expenses for write off of franchise balances increased to $3.05 million, for the three months ended March 31, 2007, from $0 for the prior year. Total write off expense increased as the result of the adverse affect on some franchisees of increased loan interest rates coupled with a reduction of commission revenues resulting from reduction of premium rates by insurance companies.

Of concern, too, Brooke Credit Corp. assists its franchisees by financing long-term producer development, cyclical fluctuations of commission income, receivables and payables. The Company also grants temporary extensions of due dates for franchisee statement balances owed by franchisees to the Company!

In essence, Brooke is lending money to Brooke—and booking it as interest revenue!

This extended credit, is referred to as “non-statement balances.” As of March 31, 2007, franchise statement balances totaled approximately $6.7 million, of which approximately $5.6 million was identified as “watch” balances, because the balances were not repaid in full at least once in the previous four months. Non-statement balances as of March 31, 2007 totaled $8.5 million owed to Brooke by its franchisees.

Brooke is highly leveraged, with long-term debt-to-shareholder equity of 109.1%, and this does not even include current off-balance sheet transactions (in the Lending Services segment) totaling $279.9 million!

For the three months ended March 31, insurance revenue grew 19% year-over-year to $32.7 million. A significant part of Brooke Franchise’s commission growth came from acquisitions of existing businesses that were subsequently converted into Brooke franchises.

Combined same store sales of seasoned converted franchises (twenty-four months after initial conversion) and start up franchises for twelve months ended March 31, 2007 and 2006, however, decreased .5% and 3.0%, respectively.

Management said that same store sales performance had been adversely affected by the “soft” property and casualty insurance market, which is characterized by a flattening or decreasing of premiums by insurance companies. In addition, Brooke franchisees predominately sell personal lines insurance with more than 50% of total commissions resulting from the sale of auto insurance policies and Brooke believes that the insurance market has been particularly soft with regards to premiums on personal lines insurance policies.

We believe that investors should be concerned about Brooke Corp.’s business strategy, which remains dependent on growth via its acquisition strategy. However, this roll-up strategy is founded on some questionable lending practices and a balance sheet that appears inflated (given probable reserve deficiencies).

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

Monday, June 25, 2007

Beware the Motivation of iMergent

Sales and marketing practices the subject of numerous State Attorney General investigations, a formal SEC investigation related to potential violation of securities laws (including the alleged disclosure of earnings forecasts to select investors, a Reg. FD ‘no-no’), and alleged accounting irregularities—all these price-busting concerns aside, the share price of iMergent, Inc. (IIG-$25.18) has soared 95 percent in value during the last year.

Business Overview

Headquartered in Orem, Utah, the company sells its proprietary
StoresOnline Pro software and training services, developed to help users build a successful Internet strategy to market products, accept online orders, analyze marketing performance, and manage pricing and customers. In connection with Internet software, iMergent also offers website development, website hosting, marketing and mentoring products and services.

iMergent typically reaches its target audience through concentrated direct marketing efforts to fill Preview Sessions, in which a StoresOnline expert reviews the product opportunities and costs. The sessions lead to a follow-up Workshop Conference, where experts train potential users on the software and services and encourage them to make purchases.

Legal Considerations

online testimonials, management buttresses its claims that its “eServices offerings leverage industry and customer practices and are also designed to help decrease the risks associated with eCommerce implementation by providing low-cost, scalable solutions with ongoing industry updates and support.”

Critics allege, however, that (i)
the seminars are really just high-pressure sales pitches and (ii) the web packages are 'overpriced' and consumers can find most of the items listed either for free, or at a much lower price than the $5,000 charged by iMergent for its suite of StoresOnline offerings.

Of concern, Attorney Generals in states across the Union—from Florida to California—have filed numerous actions against the Company in the past three years, alleging that the Company may have engaged in unfair business practices and/or consumer fraud (e.g. misrepresented the website’s income potential).

And, it gets worse. On May 29, 2007, The State of Utah—where the Company has its headquarters—the
Division of Consumer Protection issued (another) order demanding that iMergent and subsidiary StoresOnline cease and desist operations in the state until the company registers as a "business opportunity seller." [Adjudication is stayed pending exhaustion of “administrative remedies and judicial review.”]

IMergent’s activities have not been limited to these shores. The Company has been hosting free dinner events across Asia and the South Pacific—from Singapore to Australia—leaving a
history of alleged online scams in its wake.

Summary of Material Accounting Policies

  • Red Flag: The Company is subject to numerous legal petitions seeking refunds of good/services purchased together with unspecified statutory damages. Yet, iMergent has recorded a liability of $0 as of March 31, 2007, for estimated losses resulting from the foregoing legal proceedings against the Company!

Of equal—or greater concern—to the 10Q Detective, is the questionable accounting practices we have unearthed in our review of the Company’s quarterly filings.

On May 7,
iMergent announced its fiscal results for the three and nine-months ending March 31, 2007. Chairman and CEO Don Danks was “excited to report a 68 percent increase in net income to $4.7 million during the quarter, on total revenue of $42.6 million. Net income per share was $0.36 this quarter, compared to $0.22 in the prior year.”

Danks continued, "The key driver for our strong revenue growth during the quarter was an increase in the number of workshops in combination with the improvement in the percentage of attendees purchasing our software at our workshops. This improvement was attributable to refinements made in our workshop and preview presentations, which resulted in increased revenue and Net Dollar Volume of Contracts Written (NDVCW) per workshop and strengthened our margins.”

According to the company, it defines NDVCW as the gross dollar amount of contracts executed during the period less estimates for bad debts, discounts incurred on sales of trade receivables, and estimates for customer returns. Although NDVCW is not a U.S. generally accepted accounting principle (GAAP) metric, the company believes NDVCW is a consistent and relevant metric to understand the operations of the company.

Management now expects NDVCW to grow approximately 45 percent to 50 percent over fiscal 2006 NDVCW of $99.8 million. Management previously expected NDVCW growth to be 40 percent over the prior year?

IMergent recognizes revenue in one of two ways: (1) Cash Product Sales are recognized after the expiration of a three-day right of rescission; and (2) For products purchased by customers under extended payment term arrangements (EPTAs), the Company continues to defer and recognize revenue as cash payments are received from customers, typically over two years.
The Company records an appropriate allowance for doubtful accounts at the time the EPTA contract is perfected

Purchases under EPTAs as a percentage of total workshop purchases averaged 40% in recent quarters with a simple annual finance charge of 18% per annum.

  • Red Flag: Trade Receivables as a percentage of Current Assets have jumped 570 basis points in the first nine-months of fiscal 2007 to 34.3 percent. IMergent is becoming more dependent on EPTAs as a recurring source of income. In the third quarter ended March 31, 2007, interest income of $1.84 million contributed about 9 cents to earnings.

Management has experienced past difficulties in selling these installment contracts at levels that provide adequate cash flow for its business, and a recurrence of this inability to monetize these trade receivables generated from its workshop business would likely require the Company to raise additional working capital to allow it to service these assets on its own. Since May 2004, iMergent has not sold installment contracts with any recourse provision.

  • Red Flag: As of March 31, 2007, Allowance for Doubtful Accounts rose to 54.2% of trade receivables, an increase of 290 basis points from June 30, 2006.

For our readers not familiar with accounting nuances, the allowance for doubtful accounts—an area that involves ‘management discretion’—is a contra-asset account. It is a reduction to accounts receivable on the balance sheet. Instead of charging off customer accounts receivable losses directly to the income statement when they occur, using the allowance for doubtful accounts "smooths out" the income statement impact of bad debt by charging an equal amount of bad debt expense to the income statement each period and offsetting this entry to the contra-asset account called allowance for doubtful accounts.

However, the exact amount of future bad debt write-offs is always an unknown. And managements tend to hide behind the skirt of “historical precedent” when determining the bad debt expense for each quarter. Ergo, as there is plenty of room for judgment in this exercise, it can be an area used to boost earnings.

Reserving 50 cents of each dollar owed in trade receivables either means iMergent’s products are not as profitable to customers as alluded to in their testimonials and/or management is overstating bad debt expense in the current period to squeeze more profits out of future quarterly earnings.

In 2005,
in a letter generated by the SEC to iMergent, management was asked to qualify prior statements made by CEO Danks in a First Albany Sales Force Call held on February 25, 2005, regarding the policies and procedures used to determine the Company’s allowances for doubtful accounts.

To wit: “These statements appear to indicate that reserves are consistently recorded at rates in excess of your actual bad debt experience…. This practice was characterized by your CEO as “conservative” and he indicated that you “over reserve” and will be able to “add income as we collect more than we’ve reserved for.” These statements appear to indicate that reserves are consistently recorded at rates in excess of your actual bad debt experience.”

  • Red Flag: In our view, management is understating SG& A expenses.

The Company expenses costs of advertising and promotions as incurred, with the exception of direct-response advertising costs. SOP 93-7, “Reporting on Advertising Costs,” provides that direct-response advertising costs that meet specified criteria should be reported as assets and amortized over the estimated benefit period. The conditions for reporting the direct-response advertising costs as assets include evidence that customers have responded specifically to the advertising, and that the advertising results in probable future benefits.

The Company says it uses direct-response advertising to register customers for its workshops.

Further, management is purportedly able to document the responses of each customer to the advertising that elicited the response. Advertising expenses included in selling and marketing expenses for the three months ended March 31, 2007 and 2006 were approximately $8,161,000, and $4,557,000, respectively, and for the nine months ended March 31, 2007 and 2006 were approximately $21,784,000 and $14,500,000, respectively.

Internet training workshops conducted during the current quarter increased to 320 (including 91 that were held outside the United States) compared to 189 (including 7 that were held outside the United States) during the prior year quarter.

As of March 31, 2007 and June 30, 2006, the Company recorded approximately $5,273,000 and $1,855,000, respectively, of direct-response advertising related to future workshops as prepaid expenses. The Company justifies this deferral of expenses because even though the average number of “buying units” in attendance at workshops during the current quarter was 95—comparable to the prior year quarter—about 31% of the buying units made a purchase at the workshops during the current quarter compared to 26% during the prior year quarter.

Nonetheless, this ease of converting expenses to assets gives a boost to earnings [another way to massage quarterly numbers].

  • Red Flag. In an industry with low barriers to entry, iMergent spent less than one-million on all its R&D efforts in 2006! Small business owners—were it not for iMergent’s aggressive sales teams [nine in total]—might more readily look to a software product, such as Office Live by Microsoft (launched in November 2006), which offers professional website development and CRM tools for only $39.95 per month. One year of use with Office Live still pales in comparison to the average $5,000 start-up costs spent by the sucker—oops—sorry—customers at iMergent workshops.

Beware of computer programmers that carry screwdrivers. ~ Leonard Brandwein

iMergent is a one-product software company with questionable accounting practices and SEC and AG oversight.

In addition, management seems to be in the habit of heralding the promises of new online relationships, yet few of these announced deals result in material (new) revenue streams for iMergent.

These troubling concerns should give prospective investors reason to do additional due diligence.

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

Tuesday, June 19, 2007

Shareholders of Cleveland-Cliffs Still Standing in the Shadows

Last Friday, shares in Cleveland-Cliffs (CLF-$77.81) climbed $4.29, or 5.6% in price, following a report in the trade magazine, American Metal Market, that the world’s largest steelmaker, Arcelor Mittal (MT-$66.01), would make an offer of over $100 a share.

Another weekend came and went, however, and no steelmaker stepped forward with an offer for this U.S. producer of iron ore pellets.

Cleveland-Cliffs was a $53 stock before the first round of buyout rumors hit the stock back in March. Speculation about the Company’s future peaked on Monday, June 1, at an intra-day high of $92.06 per share, when traders looking for another round of consolidation in the steel industry, believed that either Brazilian iron ore miner Companhia Vale do Rio Doce (RIO-$46.50) or Australian miner Rio Tinto Plc. (RTP-$311.76) were negotiating a takeout of Cleveland-Cliffs.

Two weeks later, shareholders find themselves in the valley of the shadow of its peak price.

After reading the Company’s annual proxy, the 10Q Detective believes that shareholders “should feel no evil,” for management would quickly acquiesce if a buyout offer materialized.

“Over every mountain there is a path, although it may not be seen from the valley.” Theodore Roethke (American poet, 1908 –1963)

Looking at nonqualified deferred compensation and equity (restricted share grants, performance shares and beneficially-owned common stock) Chairman and CEO Joseph Carrabba, Former Vice-Chairman of the Board David Gunning, Executive VP William Calfee, and Pesident-US Ore Operations Don Gallagher stand to receive $10.79 million, $8.58 million, $10.32 million, and $12.12 million, respectively, with a ‘change in control without termination.’

If the foregoing executive officers were ‘terminated without cause following a change in control,’ each would receive $21.14 million, $14.31 million, $16.33 million, and $18.65 million, respectively. It would behoove each of the named officers to ‘leave for health reasons,’ for if they were to leave the Company following its acquisition, the higher payments would include tax gross-ups, too.

The aforementioned severance amounts belie the actual amounts each named executive officer would receive, for the stated amounts are based on the closing price of Cleveland-Cliffs on June 7, 2007, which was $82.60 per share.

Former Chairman and CEO John S. Brinzo would benefit handsomely, too, should the Company yield to one of the named predators. Messer. Brinzo, who retired on September 1, 2006, would receive about $10.87 million (at a price of $100 per share).

CEO Joseph Carrabba, who is only 54 years old, could easily find work at another Company. The one potential hit he would have to absorb is country club membership fees. In 2006, the Company paid $67,539 in club dues for him.

Traders should note, however, that the options market is not expecting much in terms of a premium bid for Cleveland-Cliffs in the coming weeks. For example, the bid-ask spread for the July 80 call options (which expire July 21, 2007) is $3.00 per contract - $3.20 per contract [all time premium], with open interest of 4,312 contracts.

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

Friday, June 15, 2007

World Wrestling Entertainment: Goodbye, Vince -- The Show Must Go On.

On June 12, 2007, World Wresting Entertainment (WWE-$17.04) announced that its Chairman Vincent K. McMahon entered his limousine when it suddenly exploded. Although full details were not disclosed, initial reports indicated that Mr. McMahon was presumed dead.

Upon hearing the news, investors sold stock, sending the price down a modest 30 cents per share, or 1.8% in value.

Yawn! Serious investors—and the Company—know that Mr. McMahon “will survive the fiery explosion.” And the only ones guilty of committing such a heinous act are the writers who came up with this melodramatic and predictable storyline.

However, for funs sake, let’s play along:

"The investigation into Mr. McMahon's limo explosion is currently underway, with no one being ruled out as a suspect."

Will we learn new information regarding the startling demise of the Chairman?

Will we ever learn exactly what happened after Raw that caused the fiery explosion? [Sounds like an old Batman cliff-hanger ending: "Same bat-time, same bat-channel!"]

Stay tuned!

To be continued on SmackDown Friday night.

If WWE lets this story roll on into next week, however, management will be in violation of SEC regulatory disclosures, for public companies must file with the SEC to announce any material events that affect shareholders—within four business days of the occurrence of the event.

The death of Mr. McMahon, who beneficially owns approximately 66 percent of the Company’s outstanding equity, and controls about 94 percent of the voting stock, would trigger a Form 8-K filing.

Maybe we watch too many cop shows, but if someone did blowup Mr. McMahon, our primary suspect(s) would be his wife and WWE co-founder and CEO, Linda E. McMahon, or children.

Shane McMahon is the son, and Stephanie Levesque and Paul Levesque are the daughter and son-in-law, of Vincent and Linda McMahon. Shane and Stephanie both work for the Company, and in 2006, earned only $471,000 and $353,000, respectively.

According to the Company’s annual proxy, son-in-law, Paul Levesque, is a key performer for, and independent contractor of, the Company. Paul receives talent pay and royalties, subject to a guaranteed minimum. The regulatory filing, however, did not disclose details of his 2006 compensation.

Upon his death, McMahon’s heirs would receive an estate valued at about $800 million (most of it in WWE stock). In addition, WWE is obligated to pay, upon his death, a lump sum in cash—within 90 days—of $4.34 million to his trust.

What serious investors really want to know, however, is (i) was the limousine insured for an explosion? (ii) Who is responsible for paying for the cleanup of the destruction and mess caused by the explosion?

McMahon’s contract states that he is “eligible to receive reimbursement in an amount up to $50,000 in any calendar year for his expenses for cleaning services.”

The explosion will likely be properly accounted for as a “reasonable business expense incurred by him [McMahon] in the course of the performance of his duties.” Ergo, WWE will pick up the blown-up limo expenses (and Mr. McMahon can save the $50,000 for dry-cleaning bills and landscaping and house-cleaning services from "undocumented Americans.")

On the surface, there is no apparent reason for WWE to “kill-off” Vince McMahon. Back on May 3, the Company reported first-quarter earnings of $15.1 million, or 21 cents per share, a 59 percent increase over the prior year. The Company attributed the gain to positive operating metrics, such as increased event attendance, and a dip in state and local taxes.

Profit contributions increased 13 percent to $49.3 million, led by net income gains of $7.1 million, $10.3 million, $6.4 million, and $15.1 million from Live-events/venue merchandise, pay-per view, television, and licensing.

Average Event Attendance in North America rose 15% to 6,900 per event. However, Average Event Attendance in international markets fell 23% to 9,300 per event. There were 63 live events [up from 61] in North America and 8 live events (down from 11) in the international market. A key driver of profit was an 8 percent ticket price hike and fixed, guaranteed sales contracts in emerging markets, such as Guatemala and Mexico.

Of concern, pay-per view income fell 4 percent year-over-year, due to a 24 percent decline in pay-per view buys for the comparable three-month period ended March 31, 2007. Offsetting the $1.3 million, or 8 percent, sales decline was a $5 domestic price hike to $39.95 per event.

Television net-income fell 16 percent year-over year. Of its two key drivers, viewer attendance remains flat: RAW drew an average of 4.1 million viewers (down 2%) and the audience for SmackDown was flat at 2.9 weekly viewers.

Without promotion something terrible happens... Nothing! American circus entertainer P.T. Barnum (1810 – 1891)

Perhaps the decline in viewers inspired Stephanie McMahon Levesque—who is responsible for overseeing the creative writing process for all television and pay-per-view programming—to instruct the writing staff to script the McMahon “who done it’ event?

Sorry, Stephanie-- cliffhangers have been done too death. Sometimes they work--think the season two ending episode "Who shot J.R.?" on Dallas or to be continued endings on Heroes; but sometimes they don't: the "Who Won?" episode on Benson, or the "Conclave" epsisode on Blade: The Series; and, sometimes, a show is gone even before it completes its first-season story arc--think the day-repeating themed show, Day Break, cancelled by ABC in December 2006, after airing only six six episodes of a 13-episode plot.


The effective tax rate also plunged for the quarter to 35 percent from 45 percent in the first quarter of 2006. We estimate that the Company saved about 3 cents in reported income due to greater tax-exemptions.

The Company also needs to divert investor attention because its feature film strategy has been a bust. Two feature films which were released in fiscal 2006, See No Evil and The Marine, achieved about $15 million and $18.8 million in gross domestic box office receipts, respectively. Both films have already been released on video, yet the Company still hasn't recovered any revenues sufficient to recover unamortized assets. Why then the delay in writing down these two impaired assets? [Ed. note. It is because such a write-down will adversely impact earnings.]

The show must go on
The show must go on
I'll face it with a grin
I'm never giving in
On - with the show -

WWE says McMahon’s supposed demise “has the sports-entertainment world reeling.” The foregoing stats, however, have us somewhat more lightheaded about WWE’s future earnings.

I'll top the bill,
I'll overkill
I have to find the will to carry on
On with the -
On with the show
– Queen (Album Innuendo, Track #12. The Show Must Go On) [video]

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

Wednesday, June 13, 2007

Bed Bath & Beyond: Don't Confuse Social and Shareholder Activism

Shareholder activism is a way that shareholders can claim their power as company owners to influence a corporation's behavior. Stockholders looking to effect change usually employ similar tools, such as direct dialogue, publicity campaigns, and formal shareholder resolutions (through proxy access).

Today, a common problem confronting activists looking to hold their companies accountable is that the concerns of stakeholders may cover a dissimilar range of issues, from shareholder value creation to corporate governance and transparency to social responsibility (on the environment, international events, workplace equality, etc.).

Shareholder annual meetings are the preferred venues for airing grievances, for advocacy groups have a chance to speak directly with the company boards in a public forum.

Of interest to us, most environmental or socio-oriented campaigns fall down at proxy events—characteristically because the authors of the resolutions fail to frame—or communicate—how their gospel can increase profitability (shareholder wealth).

To be heard above the din, it is not just sufficient to introduce a proposal.
A successful campaign enlists the support and active involvement from large institutional investors and presents a compelling financial argument.

Leaving aside the usual executive compensation issue, two shareholder resolutions of interest on the docket at the July 10 proxy meeting of Bed Bath & Beyond (BBBY-$37.43) are (1) climate change and (2) product impact on consumer safety and the environment.

Shareholder Proposal – Climate Change

Shareholders request that the Board assess how the company is responding to rising regulatory, competitive, and public pressure to address climate change and report to shareholders (at a reasonable cost and omitting proprietary information) by December 1, 2007.

Shareholder’s Supporting Statement

We believe management has a fiduciary duty to carefully assess and disclose to shareholders all pertinent information on its response to climate change. We believe taking early action to reduce emissions and prepare for standards could provide competitive advantages, while inaction and opposition to climate change mitigation efforts could expose companies to regulatory and litigation risk and reputation damage.

How does the Company address the climate change issues raised in this proposal?
The Company is very aware of and responsive to issues related to consumption of natural resources and climate change…. and has continued to extend its commitment to reducing its own emissions.

The proposal on energy efficiency efforts in last year’s proxy statement garnered approximately 25.8% of the votes cast last year, representing about 19.8% of outstanding shares. There does appear to be some appetite among the Company’s shareholders for information regarding the efforts undertaken in the areas of energy efficiency, emissions reduction and broad response to climate change issues.

During the last year, senior management of the Company pulled a team together to coordinate information regarding the Company’s various efforts in the area of energy efficiency and emissions reduction as well as other related issues, to consider ways of possibly publicizing those efforts, and to develop and implement additional measures.

10Q Detective: Climate-change activists failed to clearly craft their message. For example, they neglected to define the vague term ‘competitive advantages.’ In addition, they did not communicate to the majority of shareholders—who are purely financially oriented—any evidence of cost-savings to the company if their proposal were to pass.

This issue campaign will fail, too, because the proponents yielded to management the high ground (letting management shape the content of the argument). To wit:

The Company [has] spent tens of millions of dollars over the last several years on equipment and systems dedicated to controlling and reducing energy consumption in its stores, including retrofitting nearly all Bed Bath & Beyond stores opened prior to 2001 with state-of-the-art conservation systems. As noted in last year’s shareholder letter, by way of example, efforts also involved the use of new, “cooler” roofing materials and more efficient outdoor and store sign illumination.

When completed [solar arrays], these [four] facilities will make Bed Bath & Beyond one of the largest solar energy producers in the State of New Jersey. The combined solar arrays, over a 30-year period, should conserve 109,500 barrels of oil and reduce CO2 by 38 million pounds, the equivalent of removing 3,800 cars from the road or powering 1700 homes for 30 years.


Shareholder Proposal – Product Safety

Shareholders request that the Board publish a report to shareholders on Bed Bath & Beyond policies on product safety, at reasonable expense and omitting proprietary information, by December 2007. This report should summarize which, if any, product lines or categories sold in Bed Bath & Beyond stores may be affected by product safety concerns, and options for new initiatives that management can or will take to respond to this public policy challenge (beyond those initiatives or actions already required by law).

Shareholder’s Supporting Statement

Numerous products sold in our stores contain materials, which are controversial because of their potential health and environmental impacts, such as polyvinyl chloride (PVC) and perfluorooctanoic acid (PFOA). In addition, our company through its Harmon division, retails beauty products, many of which may contain chemicals known to cause cancer, developmental harm to children, and other health concerns.

How does the Company respond to these product safety issues?

The Company respects the point of view represented in the proposal with respect to product content and manufacture process, and the Company monitors developments with respect to these issues through its presence in the markets for these products.

10Q Detective: After the market close on June 4, the home furnishings retailer lowered its outlook for the fiscal first-quarter ended June 2, 2007, to between 36 cents and 38 cents per share, citing the adverse effect on consumer spending due to the sluggish housing market. Analysts polled by Thomson Financial had expected a 39-cent per share profit.

Given the current business climate at Bed Bath & Beyond, save for litigation concerns, it will be difficult for safety activists to argue that the timing is right for management to ignore their fiduciary responsibilities and make the “morally-right” decision.

It is likely, too, that the negative impact of housing turnover, coupled with rising energy costs and interest rates will lead to a pause in consumer spending. Home furnishings is a competitive space. Ergo, to stimulate in-store sales and retain share, BBBY will need to discount prices and increase spending on marketing—pressuring profit margins in coming quarters.

Why does the Company oppose this proposal?

The proposal requests a report on products that may be affected by the concerns raised. There are currently well in excess of 50,000 individual stock keeping units in the Bed Bath & Beyond stores alone, representing goods sold to the Company by over 2,000 separate vendors. There are tens of thousands of additional items in Harmon, Christmas Tree Shops and buybuy BABY stores. As noted previously, the Company is not a manufacturer and does not believe its shareholders would be well served by diverting resources from its core businesses and into chemical research.


Human nature is above all things—lazy. ~ Harriet Beecher Stowe (1811–1896), writer.

10Q Detective: The majority of investors are more concerned about management’s merchandising, store level pricing and execution than emission reductions and PVCs. The aforementioned resolutions will not receive a majority of votes.

Lessons Learned

Social activism differs from dissident activism. Whereas, the former deals with political, environmental, and social issues, the latter validates the creation of shareholder wealth (the public face of a Carl Icahn, institutional investors, and/or hedge funds) as its endgame.

Social activists—in the short-term—will fail because their dialogue with management is never aimed at bolstering shareholder value. To appease all investors, these activists can only become empowered by adding bench strength [institutional shareholders]; be prepared to define the actual cost(s) of change; and, be able to communicate how successfully effecting change will improve overall returns (economic and financial).
Editor David J. Phillips does not hold a financial position in any home furnishings stock. The 10Q Detective has a Full Disclosure Policy.

Monday, June 11, 2007

The 10Q Detective Adds Cryptologic and Provident Energy to Portfolio

CryptoLogic Inc. (CRYP-$24.57) is a leading software developer to the global Internet gaming market.

Prior to enactment of the Unlawful Internet Gaming Enforcement Act (UIGEA) passed in October 2006, licensees' revenue from Europe-based players was approximately 70% of total revenue; now all revenue is from non-U.S. based players.

In our view, the Company is in a win-win position. Should legislation introduced by Massachusetts representative Barney Frank to repeal the unpopular UIGEA become law, CRYP would benefit handsomely.

However, even without repeal, management is positioning the Company for sustainable growth outside the United States. Recent initiatives include (i) signing new customers, such as an exclusive three year contract for on-line poker with the World Poker Tour; (ii) making a strategic acquisition, which was the acquisition of the poker brand and related assets of, a popular Scandinavian online poker room; (iii) entering a joint venture in Asia to penetrate the high- growth Chinese market with CryptoLogic 's existing games, and (iv) entering a new market: Government-owned casino (a signed three-year agreement to provide both poker and casino software for Holland Casino, the Netherlands' government-owned casino operator).

Blue NileAug 50 puts2005/29/07$1.60$3,280.00
CryptoLogic, Inc.CRYP30006/08/07$24.27$7,293.81
Provident Energy TrustPVX50006/08/07$11.81$5,917.99

Provident Energy Trust (PVX-$11.88) is the only Canadian Energy Trust to combine upstream oil and gas production in both Canada and the United States with Canada’s second-largest midstream natural gas liquids businesses.

The Company’s upstream production reflects a geographically diverse footprint, from predictable producing regions in the western Canadian sedimentary basin to operating crude oil wells and natural gas facilities in Southern California, west Texas, and Wyoming. Production is approximately 95 percent oil and five percent natural gas. U.S. operations give Provident long-life reserves and an excellent platform for future growth.

Provident’s Canadian upstream business will be strengthened by the May 3, 2007, announcement of the Company’s intention to acquire Capitol Energy, which owns a conventional oil field in Canada's Alberta province. Provident estimates the field holds 30 million barrels of proved and probable oil reserves, which increases Provident's Canadian proved plus probable reserves base by 40 percent.

Consolidated per-barrel operating costs are estimated to be below $5.00 per b.o.e. at Capitol’s producing field.

In addition, Provident calculates the Capitol Energy purchase will increase the Company’s total reserves life index (RLI) by 10 percent to 13.6 years. RLI is a simplified representation of the number of years of oil & gas reserves remaining if production remained constant at current rate(s) of production.

Midstream is a business with long-life physical assets (plants, pipelines, storage facilities, etc.) that complement Provident's upstream production business units.

In our view, the integration of upstream and infrastructure assets offers investors a sustainable yield-play (of 11 percent) with long-term value potential.

The opinions expressed herein are subject to change without notice. Neither the information nor any opinion expressed herein constitutes a solicitation by us of the purchase or sale of any securities. Blue Sky Enterprises, LLC., its affiliates, and/or their officers and employers may from time to time acquire, hold, or sell a position in the securities mentioned herein. Upon receipt of queries, specific information in this regard will be furnished.

Copyright © 2007 Blue Sky Enterprises, LLC. No part of the material may be reproduced or transmitted by any process in whole or in part without prior permission in writing.

Thursday, June 07, 2007

TiVo is Not Mister Rogers' Neighborhood

What do you do with the mad that you feel
When you feel so mad you could bite?
When the whole wide world seems oh, so wrong...
And nothing you do seems very right?

Shareholders in TiVo Inc. ($6.15), a provider of digital video recorder services, have watched the value of their shareholdings tread water for more than three years, amid ongoing patent litigation, increasing competition from generic digital video recorders (DVRs), disappointing profitability, increasing subscriber churn (cancellations of recurring subscriptions), and falling barriers to competition with the introduction of Webtv (such as AppleTV and and digital server Video-on-Demand offered by cable companies (such as Comcast).

What do you do?
Do you punch a bag?
Do you pound some clay or some dough?
Do you round up friends for a game of tag?
Or see how fast you go?

TiVo is trying to re-boot subscriber growth by (i) offering increasingly differentiated services, such as a new service feature called TiVo KidZone (introduced in fiscal 2007), which is a personalized TV area where children are able to find quality live or recorded programming that their parents deem appropriate; (ii) deploying a software version of the TiVo service that could be integrated on certain third-party DVR platforms (of satellite and cable operators) in order to promote the mass deployment of devices capable of running its proprietary service.

It's great to be able to stop
When you've planned a thing that's wrong,
And be able to do something else instead
And think this song:

Management’s existing strategies of leveraging the TiVo brand have yielded little in terms of subscriber gains or top-line growth. TiVo-owned subscription gross additions for the fiscal year ended January 31, 2007, were 429,000, which was down 13 percent from the fiscal year 2006.

TiVo-owned Average Revenue per Subscriber (ARPU) per month for the fiscal year ended January 31, 2007 decreased 5 cents year-over-year to $8.78. The decrease in TiVo-owned ARPU for fiscal 2007 was due to the increase in fully amortized and still active product lifetime subscriptions.

Subscription Acquisition Costs increased $71 per subscriber to $267 for fiscal 2007, primarily due to contractual revenue-sharing in place with some of its retail customers and consumer electronics manufacturing companies, a new multi-tiered pricing structure in exchange for a customer commitment to either a one, two, or three year service plan, and higher hardware rebates offers available to consumers.

During the fiscal years ended January 31, 2007, 2006, and 2005, TiVo’s net losses were $(47.8) million, $(37.0) million, and $(79.8) million, respectively. As of January 31, 2007, the Company had an accumulated deficit of $(741.8) million.

I can stop when I want to
Can stop when I wish.
I can stop, stop, stop any time.
And what a good feeling to feel like this
And know that the feeling is really mine.

Time to rewind--acquisition costs almost 30 times ARPU does not make for a sustainable business model.

Another legitimate concern--given churn--even if TiVo were to lower price of its hardware, there just might not be enough customers interested in this in-home entertainment format!

Know that there's something deep inside
That helps us become what we can.
For a girl can be someday a woman
And a boy can be someday a man.
Mister Rogers’ Neighborhood [Real Audio File – What Do You Do?]

As TiVo’s fortunes remain closely linked to its dependence on its current distribution channel-- major retail partners include Best Buy, Circuit City, and Radio Shack—is it no wonder that CEO Thomas S. Rogers has a contractual agreement that states that he can perform his executive duties at either TiVo’s offices in Alviso, California, or at an office to be maintained by TiVo for Messer. Rogers back in New York City?

Pursuant to his employment agreement, the Company provides Mr. Rogers with air travel from New York City to Alviso, California, a furnished apartment within 15 miles of its Alviso, California offices, an automobile for Mr. Rogers’s use while working out of the Alviso, California offices and reimbursement for other out-of-pocket expenses while “on company business.”

TiVo paid their CEO a salary, cash bonus, and stock grants/options of $750,000, $303,000, and $2.32 million, respectively, in fiscal 2007.

In addition, Mr. Rogers received $38,472 for housing and living expenses (in Alviso) and $21,631 in family travel-related expenses. Tivo reimbursed him $72,182 in tax gross up payments made in connection with these taxable perquisites, too.

TiVo shareholders are living in the wrong Mister Rogers’ neighborhood.

And, CEO Thomas Rogers cannot placate angry shareholders over continuing management missteps by whistling to them a toddler’s tune.

What do you do with the mad that you feel
When you feel so mad you could bite?
When the whole wide world seems oh, so wrong...
And nothing you do seems very right?

Can you blame Mr. Rogers for not wanting to leave New York?

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

Monday, June 04, 2007

The Best in Excuses & Lies -- by Cell Therapeutics

In July 2006, the 10Q Detective skeptically observed that senior management at Cell Therapeutics had “a history of spending as much time raising capital as it [seemed to] spend on actual clinical testing of its flagship drug, XYOTAX, for the treatment of non-small cell lung cancer and ovarian cancer.”

Cell Therapeutics (CTIC-$4.17) waited until after the close of trading on Friday to announce its filing for a $150 million mixed shelf registration statement. Ostensibly, the Company “plans to use the proceeds from the offering for clinical development of drug candidates, commercialization activities, and general corporate purposes.”

The price of CTIC dropped 10.1% on the news, as investors finally seem to be tiring of the hollow promulgations of founder and CEO James Bianco.

  1. Clinical Development. In April and May 2007, respectively, management said the FDA granted fast-track designation for its (i) lung cancer candidate XYOTAX, a biologically- enhanced version of one of the most used cancer drugs, Taxol, for the treatment of PS2 (poor performance status) women with first-line advanced non-small cell lung cancer and normal estrogen levels, and (ii) pixantrone, a novel anthracenedione, being investigated for the potential treatment of relapsed or refractory indolent non-Hodgkin's lymphoma (NHL).

    Management predicts that it will have interim data for both drugs by mid-2008. Meanwhile, the FDA has not even signed off on a study design for either drug candidate.

  2. Commercialization Activities. The Company does not even have a drug to license or to sell.
  3. General Corporate Purposes. Another misleading quote, for aside from jetting around the country, management does not seem to be accomplishing much of anything.

In fiscal 2006, CTIC generated $80,000 in revenue, and had an accumulated deficit of approximately $961.1 million.

Nevertheless, CEO James A Bianco still took home $2.3 million, including a $260,000 cash bonus; $219,832 for personal use of chartered aircraft for his spouse and a family member; and, $146,320 for tax reimbursements (bonuses paid, tax preparation fees, health club dues and insurance premiums).

In February 2007, the board authorized a reverse 1:4 stock split (effective April 2007). CEO Bianco confidently said: “A reverse split coupled with the significant phase III product and regulatory milestones we anticipate achieving this year could have a significant benefit by making the stock more available to a wider cross section of institutional fund investors.”

A track record of blunders, coupled with a share price below $5.00 per share, will not make the stock more appealing to institutional fund investors.

CTIC has endured several Phase III disappointments, but still manages to land on its feet. Long-suffering shareholders, however, continue to watch the averages hit new highs, while CTIC sits at a 52-week low.

Trust me, Wilbur. People are very gullible. They'll believe anything they see in print.
– Charlotte, the spider, to Wilbur, the pig. (
Charlotte's Web – E. B. White)

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

More Than Just Chicken In Every Tyson Family Pot

The share price of Tyson Foods (TSN-$22.22) has responded to profitable chicken prices (more than offsetting higher production costs, including corn feed) this year, rising about 37 percent since January.

Then again, even in an unprofitable year, if your last name is Tyson, chicken is always a lucrative business:

Don Tyson, 76, served as Senior Chairman of the Board from 1995 to 2001 when he retired and became a consultant to the Company. He entered into a contract with the Company on July 30, 2004, which provides that Mr. Tyson will furnish up to 20 hours per month of advisory services to the Company (for a term expiring on October 19, 2011). In consideration for his ‘advisory services,’ Mr. Tyson receives $1,200,000 per annum.

Mr. Tyson is also entitled to receive non-cash compensation, including: (i) personal use of Company aircraft for himself and/or his designated passengers for up to 150 hours per year, (ii) reimbursement for costs incurred relating to tax and estate planning advice or services from an entity recommended by the Company, (iii) personal use of Company-owned skyboxes and vacation homes, and (iv) up to 1,500 hours per year of security services (which the Company estimates will cost $40 per hour).

And, lest we forget, Mr. Tyson will be reimbursed, too, for any and all tax liability imposed on him in connection with the provision of the aforementioned non-cash compensation.

In fiscal 2006, non-cash compensation for Mr. Tyson included $247,182 attributable to personal use of Company aircraft, $141,633 attributable to tax and estate planning advice or services, $105,000 attributable to a split dollar insurance policy, $45,000 attributable to Company matching contributions to the Company’s Employee Stock Purchase Plan, and $126,850 for taxes paid on his behalf by the Company.

John Tyson, 53, the son of Don, is Chairman of the Board and has served in this capacity since 1998. Mr. Tyson served as Chairman and Chief Executive Officer from 2001 until May 2006.

In fiscal 2006, John Tyson earned $1.17 million in salary, $500,000 in options, and $673,363 in Other Annual Compensation (including 323,659 attributable to personal use of Company aircraft, $203,536 for taxes paid on his behalf by the Company, and $57,359 of reimbursement for certain insurance premiums).

Given John Tyson’s recent retirement from active employment with the Company, he recently entered into an ‘advisory’ contract (for a period of ten years), which will pay him to him—in the aggregate—$33.36 million.

And, not to be left out, Barbara A. Tyson, a sister-in-law to Don Tyson and aunt of John Tyson, is a consultant to the Company, too. In consideration for her advisory services, Ms. Tyson receives annual compensation of $7,200.

Related Party Transactions

During fiscal 2006, the Company leased certain farms (swine farrowing and rearing facilities) from Don Tyson, John Tyson, and other family memebers with aggregate lease payments totaling more than $880,000.

The Company has an aircraft lease agreement with Tyson Family Aviation, LLC, of which Don Tyson, John Tyson and other Tyson’s are members, with aggregate lease payments to Tyson Family Aviation, LLC during fiscal 2006 of $2,043,552.

The Company has an agreement with entities of which Don Tyson is a principal, with respect to the operation of a wastewater treatment plants, located adjacent to and services the Company’s chicken processing facility in Nashville and Springdale, Arkansas, with aggregate payments by the Company of $2,472,675 and $2,153,070, respectively, for fiscal 2006.
As our readers can tell, chicken is no joke to the Tyson family.

In Italy, chicken is called pollo; chicken in Finnish is kukko; and, chicken in Swedish is kyckling—but no matter where a Tyson lives, chicken translates into “money.”
Editor David J. Phillips holds no financial interest in any poultry concerns. The 10Q Detective has a Full Disclosure Policy.