Wednesday, October 31, 2007

CEO of Bowl America -- 'Til Death do Part' Employment Contract

Leslie H. Goldberg, Chairman & CEO of Bowl America Inc. (BWL-$15.90), has one of the best severance contracts ever witnessed by the 10Q Detective— a consultancy agreement ‘til death do them part.’

In the event that Mr. Goldberg, 77, chooses to leave the employ of the Company at the termination of his employment contract, which expires June 29, 2008, he will receive a salary of about $100,000 per annum to act as a consultant to the bowling center operator for "a term equal to the number of years that he has been President of the Corporation." Serving as President for the past 31 years, Mr. Goldberg—in theory—could consult for the Company until he dies or celebrates his 110th birthday—whichever comes first!

At a company where the youngest director/named executive officer is 67—and the mean age is 73.5 years—Goldberg is probably still too young to retire.
Editor David J. Phillips does not hold a financial interest in Bowl America. The 10Q Detective has a Full Disclosure Policy.

Tuesday, October 30, 2007

Will So. California Firestorms Blur Earnings Visibility?

Those hot dry winds that come down through the mountain passes and curl your hair and make your nerves jump and your skin itch. On nights like that every booze party ends in a fight. Meek little wives feel the edge of the carving knife and study their husbands' necks. Anything can happen. ~ Raymond Chandler, "Red Wind”

Since last Sunday, wildfires fueled by
Santa Ana winds have burned more than 465,000 acres of land across Southern California, destroying more than 1,600 structures, and driving more than half-a-million people from their homes.

Losses from the wildfires could top $1.6 billion, according to
Risk Management Solutions, a leading provider of services for catastrophe risk management.

Moody's said that San Diego is bearing the brunt of the damage and will see the largest disruptions to its economy. Their analysts estimate San Diego County is losing $45 million daily from disruptions caused by the fires.

The report added, too: "In a worst-case scenario, if all 69,000 endangered homes were destroyed, the total damage to residential property would balloon to $42 billion."
Business Disruptions

Big businesses’ based in the San Diego area whose operations and productivity were disrupted include the hamburger chain Jack in the Box (JBX-$31.19), which either franchises or operates 43% of its quick-service restaurants in California, and Petco Animal Supplies Stores.

Customer traffic was adversely affected, too, at coffee chain Starbucks (SBUX-$26.23), which closed about 120 of its stores in San Diego and Ventura counties, and SeaWorld, the popular tourist destination owned by Anheuser-Busch (BUD-$51.74), which closed for three days (re-opening on Friday, October 26).

Indirectly affected by the firestorms was Sempra Energy (SRE-$60.60), which operates the San Diego Gas & Electric Co. (SDG&E) and Southern California Gas Company utilities. At its worst, about 33,000 homes and businesses were without power last Tuesday, according to a spokesman. SDG&E gets about half its electricity from outside its service area for the 1.3 million homes and businesses it serves.
Property & Casualty Insurers

Insurance experts say that wildland-urban fire losses tend to be concentrated in the personal lines sector of the market—homeowners and automobiles. The demographics of the burnt areas are quite varied, ranging from newer subdivisions to elite homes.

History as a guide, commercial lines will also be impacted, with claims expected in commercial property and business interruption that could be significant, according to a prior Fitch Ratings report (issued in 2003 for wildfires affecting Southern California in October of that year).

property and casualty insurers facing significant claims in the weeks and months ahead include State Farm Mutual, Farmers Insurance Group, and Allstate (ALL-$52.08). Allstate Corp., the largest publicly traded U.S. home insurer, may post fourth-quarter profit 8.6 percent below analysts' estimates because of the California wildfires, according to Lehman Brothers Holdings Inc. analyst Jay Gelb. “The wildfires will cut income for the insurer about 15 cents a share if industry losses reach $1 billion,” Gelb said in a note to investors.

Construction Boom

Ironically, a post-fire construction boom could bring back thousands of the more than 28,600 construction jobs that the region lost in the last 12-months amid the housing slump.

Contractors and carpenters will gain the bulk of the work because most people will try to rebuild on their own lots, says Fitch analyst Robert Curran. New homebuilders may get some "marginal, incremental business," he added. Those with a major presence in California include Standard Pacific (SPF-$4.82), DR Horton (DHI-$13.13), and KB Homes KBH-$27.83).
Editor David J. Phillips does not hold a financial interest in any of the companies mentioned in this column. The 10Q Detective has a Full Disclosure Policy.

Friday, October 26, 2007

Merrill Lynch's CEO Stan O'Neil Ready to Abandon Ship

Shares of Merrill Lynch & Co (MER-$65.00) are up about 7 percent to $65 in mid-day trading after CNBC television said Chief Executive Officer Stanley O'Neal allegedly told friends he expected to be ousted by the end of the weekend.

A mountain of ice and the debris of a ship that has been crushed by it. It is a great tragedy, not a single survivor. ~ German painter Caspar David Friedrich (1774 – 1840)

This breaking news follows on the heels of a New York Times report that O'Neal had angered the Board of Directors by broaching the idea of Merrill merging with Wachovia Corp (WB.N) without first getting his board's approval.

Unlike the British luxury passenger liner RMS Titanic, which sank on April 15, 1912, Stanley O’Neil is no Captain Edward John Smith, who went down with his ship.

The 10Q Detective speculates that O’Neil’s secret talks were motivated more by personal interest than by what was best for all stakeholders.

The Compensation Committee provides a compensation framework that is structured to reward its Named Executive Officers for their contribution to the Company’s financial success. Specifically, bonus compensation is weighted on year-over-year net revenue growth, pre-tax earnings growth, and ROE.

Global financial markets performed well for most of 2006, which translated into the global financial services titan reporting record net earnings of $7.59 per share in fiscal 2006 ending December 31, up 47% from $5.16 in 2005.

Merrill paid to O'Neal, 56, about $48 million last year, when the firm's net revenues increased by 26% to $32.7 billion, pre-tax earnings growth climbed 44% (on an operating basis), and operating ROE grew to 21.6% (nearly twice the Peer Group median increase) from 16.0% in 2005.

However, the 10Q Detective does note that his total compensation included $26.8 million in restricted stock grants, awarded at a fair market value of $95.825 per share.

Beware of the little expenses; a small leak will sink a great ship. ~ Benjamin Franklin (1706 – 1790)

On Wednesday, Merrill Lynch & Co. announced $8.4 billion in write-downs for the third quarter—much larger than those posted by any of the bank's Wall Street competitors—and equaling 14% of its market capitalization (and exceeded its earnings in all of 2006).

Merrill also reported a $2.3 billion loss, the biggest quarterly loss in its history.

Goldman Sachs analyst William Tanona also estimated Merrill Lynch could have a $4.5 billion write-down in the current quarter on its remaining $20.9 billion exposure to collateralized debt obligations and subprime mortgages. He said the market for those securities continues to deteriorate.

Given the third-quarter loss, Merrill's annualized ROE for the first nine months of the year is 6.5%, putting O’Neil’s 2007 bonus in jeopardy. As stated in the company’s 2006 Proxy: “Failure to achieve at least 2005 baseline ROE for any performance year results in the complete forfeiture of the Company match for that year.”

Of interest, too, the Company “does not have agreements with executive officers that provide for severance unless there has been a “Change in Control” of Merrill Lynch.” Accordingly, if O’Neil terminated his employment for any reason and there has not been a “Change in Control,” any severance benefits are at the discretion of the Compensation Committee.

If Wachovia—or any other interested suitor—were to acquire the Company, Mr. O’Neil could receive “Change-in-Control” Severance Payments, Retirement/Insurance Benefit Payments, and (Accelerate) Stock-Based Compensation of $29.5 million, $116,609, and $221.8 million (value assumption was based on $93.10 per share), respectively!

Short of a takeover, Mr. O’Neil—with more than 20-years of service—will still leave a rich man: 1.75 million in unexercised (vested) options, exercise prices between $39.80 - $59.85 per share, $24.8 million in accumulated benefits in his pension plan, and $50.79 million in aggregate balance (at last fiscal year) in a non-qualified deferred compensation plan.

Here's your hat, what's your hurry? ~ Jimmy Stewart (It’s a Wonderful Life, 1946)

Shares in Merrill have fallen by more than 30 percent this year. Those investors who purchased stock near its 52-weak high of $98.68 per share are eagerly lining up to show O’Neil the door.

Editor David J. Phillips does not own shares in any companies mentioned in this column. The 10Q Detective has a Full Disclosure Policy.

Wednesday, October 24, 2007

Millennium Cell -- Running on Empty Fuel Cells

Millennium Cell Inc. (MCEL-$0.62), which is developing hydrogen battery technology for portable applications (such as off-grid power supplies, portable charging docks for small electronics, and laptop personal computers) said it exchanged equity with Singapore's Horizon Fuel Cell Technologies Ltd. as part of an agreement to jointly develop and sell hydrogen fuel cell products on a global basis.

"This agreement with Horizon adds a new dimension to our business model," commented Adam P. Briggs, Millennium Cell President. "The objective is to generate product revenues for both Millennium Cell and Horizon in 2008."

The two plan to start selling a
50-watt emergency power unit in 2008, with additional hydrogen battery products for consumer and military use to be launched in 2008 [soldier power applications] and 2009 [unmanned aerial surveillance].

Strategic Initiatives

Millenium’s primary business model is to partner with various fuel cell companies and to integrate its proprietary Hydrogen on Demand technology to form a complete power source solution (to safely store and deliver hydrogen energy in a “battery” sized package, which will provide longer runtime and lighter weight in a compact space) for device manufacturers and consumers.

In pursuit of its strategic goal, Millennium—to date—has allied with several other fuel cell companies, including strategic relationships with Jadoo Power Systems (entered into February 2005), The Dow Chemical Company (April 2005), and Protonex Technology Corporation (in 2003).

Brigg’s good faith comment was but the latest in a series of promises suggesting that Millennium was accelerating its path towards product commercialization(s).

Promises are like the full moon, if they are not kept at once they diminish day by day. ~ German proverb

For example, in Millennium’s 2006 Annual Report, Briggs and CEO H. David Ramm told shareholders to expect “[initial] shipping of Protonex Corporations ProFuel C720 fuel cartridges [targeted to replace military battery applications] and fuel cartridges for Jadoo Power Systems products like the XRT [designed to provide emergency power in the field for first responders to charge radios and power other critical devices] and the IFS24 power module [a military radio power source] in the first-quarter 2007.”

Field trials of Jadoo’s XRTFuel Cell Power Units utilizing Millennium’s hydrogen fuel cell cartridges are now expected in 4Q:07.

A half-truth is usually less than half of that.

Investors ought be mindful that initial shipments are only for prototype testing purposes.

The Company has yet to attain any industrial OEM product commitments of any substance, due to delays in development of its ‘solid state’ hydrogen battery technology.

Research & Development Issues

Management believes that the promise of hydrogen fuel cell technology has not yet been fully realized because of numerous engineering design challenges that have resulted in system complexity and increased cost. A fuel cell requires air to operate and the temperature, humidification, and flow rate of the air are critical factors in the fuel cell’s performance. For these reasons, designers of fuel cells have had to add additional components to control these three variables. As a result, most of the space required by small portable fuel cell power systems is comprised of what is commonly referred to in the fuel cell industry as “Balance of Plant” or “BOP”.

BOP consists of pumps, fans, valves and other devices that are used to control the movement of liquid fuel, airflow, temperature, and humidity. To greatly reduce the cost and challenge associated with commercializing fuel cell systems, the Company’s fuel cell design eliminated the mechanical BOP and replaces it with a proprietary electronic control system, thus reducing cost and system complexity by eliminating pumps, fans, and compressors.

Nonetheless, the end goal is to reduce the total manufacturing cost in order to compete with current market technologies, including the separate families of chemical-based battery technologies (including, alkaline, nickel-cadmium, and lithium-ion).

Financial Outlook

The monthly cash-burn rate was $600,000 and $1.1 million, respectively, in fiscal 2006 and for the 1H:07. Management previously called for a reduction in its cash-burn to about $542,000 per month in fiscal 2007.

Given current cash and cash equivalents of approximately $7.5 million, we believe Millennium should have sufficient liquidity to satisfy anticipated cash needs through the 1Q:08.

As of June 30, 2007, Millennium had an accumulated deficit of $(113.6) million.

Investment & Risk Considerations

Most investors in fuel cell stocks could care less—nor even understand—that fuel cells are different from batteries in that they consume reactant, which must be replenished, while batteries store electrical energy chemically in a closed system. Hydrogen fuel cells take in hydrogen-rich fuel (H) and oxygen (O) and turn them into electricity and heat: or, “H-2(g)+ 1/2 0-2(g)-> H-2O”. The waste product is water.

The ultimate metric investors ought to consider when making the decision to buy Millennium Cell common stock is acceptance of product in the energy storage space—military applications being the first to reach prototyping timelines.

They're running on their worst defense,
They're running on their worst defense,

As discussed, however, until the Company can work through technological feasibility issues and economic/manufacturing costs, management will continue stumbling to find a footing in a competitive market, which includes traditional batteries (which convert chemical energy to electrical energy) and other fuel-cell initiatives (such as,
Zinc-air, Proton exchange membrane, and Direct formic acid).

No light,
Guides you.
Leads you on.
Blinds you.

The fact that the market valuation of Millennium Cell was composed of promises rather than actual product performance—or the attainment of previously specified timelines—illustrates why the share price has lost about 49 percent in value over the last 52-weeks.

The voice that cracks the latest pressure.
Chips, their finest phrase that pays you
Off, with hands you cant depend on
For the best defense.
~ Archers of Loaf (All The Nations Airports, #4. Worst Defense)

The 10Q Detective does not see any BUY catalysts on the event horizon.

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

Monday, October 22, 2007

Mortgage Woes Hit Thornburg's 21 Percent Dividend Yield

The mortgage fallout first hit Thornburg Mortgage (TMA-$9.46) back on August 9 when analysts voiced concerns that the lender could face margin calls—even though its mortgage backed securities were AAA-rated.

Would the mortgage woes also hit Thornburg's quarterly dividend payout of 68 cents per share? “I'm pretty confident we're going to be able to make that payment,” said Thornburg President Larry Goldstone, in an interview with CNBC.

On October 17, the mortgage company
canceled its dividend.

"We are concerned about the potential for another mini-liquidity crisis in the market going forward," Goldstone said as the company announced a third quarter loss of $8.83 per share, vs. earnings of 64 cents a year ago.

Goldstone said the board of directors were divided on whether to pay out a dividend. The company had the money, he said, but wanted to save cash because of heightened worries about structured investment vehicles, or SIVs, that hold hundreds of billions of dollars of mortgage debt. Rising mortgage default rates have hurt the value of this debt, putting at least some SIVs in trouble.

The decision to not pay out a dividend was “unexpected and unusual,” according to many mortgage analysts.

Who pays the salaries of these highly-paid Wall Street clowns?

Like other big players in the mortgage-backed securities market, Thornburg sold billions of dollars of its mortgages in the last two weeks of August—at a huge discount—in a move to increase its liquidity during the ongoing credit crunch.

Declining mortgage values sank Thornburg's book value to $12.40 per share on August 20 from $19.38 per share at the end of June.

Apparently the old adage still applies: If it sounds too good to be true, it probably is. In our view, Goldstone's equivocating notwithstanding, a dividend yield on its common stock of about 21 percent (stock price - $13.00) was more than convincing evidence that Thornburg would not be able to continue paying its common stock dividend.
Editor David J. Phillips does not hold a financial interest in any mortgage originator. The 10Q Detective has a Full Disclosure Policy.

Friday, October 19, 2007

Can Exact Sciences turn Fecal DNA into Gold?

The Food and Drug Administration’s (FDA) Office of In Vitro Diagnostic Device Evaluation and Safety issued a Warning Letter to cancer test developer Exact Sciences (EXAS-$4.70) on Wednesday regarding regulatory matters related to its stool-based DNA test for colorectal cancer screening. According to the letter, the FDA believes that the commercial PreGen-Plus assay is a medical device requiring premarket approval or clearance.

In a conference call with investors, Chief Financial Officer Charles R. Carelli Jr. said the company had been planning to apply for FDA approval, but was waiting for guidelines from the American Cancer Society as part of the process. He said the letter was a "surprise" in light of the numerous discussions the company previously had with the FDA over the device.

Why did the FDA step in now?

Although the FDA regulates diagnostic tests sold to laboratories, hospitals and physicians, it uses discretion when regulating tests developed and performed by single laboratories, a group of tests known as “home brew” assays.

Careilli said the Company believed that the Centers for Medicare & Medicaid Services —once it accepted Exact Science’s
application requesting a national coverage determination for the Company's DNA-based colorectal cancer (CRC) screening technologies—reached out to the FDA (back in August) for help in reviewing the clinical evidence supporting reimbursement for stool-based DNA screening technology.

After reviewing previously filed company documents with the SEC and
recent regulatory developments at the FDA, the 10Q Detective believes that management at the cancer test developer mislead investorsor was grossly negligent in preparing the Company—to the likelihood that previously unregulated diagnostics could soon require FDA approval or clearance prior to marketing as well as being subject to other medical device requirements.


Although the scientific studies that are the basis of the
PreGen-Plus test were conducted or funded by Exact Sciences, the Company sells the product in collaboration with Laboratory Corp. of America Holdings (LabCorp), collecting up-front technology license fees (and, to a lesser extent, royalties on LabCorp’s sales of PreGen-Plus).

LapCorp is regulated under the Clinical laboratory Improvement Amendment of 1988 (CLIA) and is certified as qualified to perform high-complexity testing. As a result, LabCorp may develop tests in-house and offer them as laboratory services (so-called “home-brew” tests). As mentioned, the FDA has not historically regulated home-brew tests.

On January 13, 2006, the FDA sent correspondence to LabCorp indicating that PreGen-Plus may be subject to FDA regulation as a medical device. The FDA expressed particular concern that Effipure, supplied by Exact Sciences to LabCorp and used to enhance purification of DNA from stool samples, may be viewed as a device in of itself, potentially requiring FDA approval.

LabCorp informed the FDA during 2006 that they were developing an alternative in-house DNA purification procedure that could eliminate the use of Effipure in PreGen-Plus.

Nonetheless, on September 7, 2006, additional alarm bells sounded when the FDA issued a Draft Guidance Document, which indicated the FDA was readying policies to include “homebrew” tests as medical devices, subject to FDA regulation—and that the FDA would require pre-market clearance for certain types of homebrew tests involving the use of algorithms and scoring of results (in high-risk applications and strong clinical claims).

Scientific Background

Colorectal cancer is the third most frequently diagnosed cancer in the United States in both men and women. It is also the second leading cause of cancer death after lung cancer. CRC is thought to develop as a result of genes inactivated by mutation or other chemical modifications. Chromosomal instability is the most common CRC pathway and involves point mutations that occur in CRC-related tumor suppressor genes.

Clinical data on Exact Sciences fecal DNA assay reports a sensitivity of approximately 65% for CRC, 30% to 40% for advanced adenomas, and a specificity (calculated in patients with no presence of neoplastic lesions in the colon) of approximately 95 percent.

Principal investigator Thomas F. Imperiale, MD, from Indiana University, reported in this comparative trial that Exact Science’s DNA capture technology was four times more sensitive than fecal occult blood testing (FOBT).

As false positives are reported with DNA capture technology and FOBT, procedure-based detection technologies such as flexible sigmoidoscopy or colonoscopy are still recommended first-line.

Management at Exact Sciences previously insisted that the PreGen-Plus test did not represent the type of “algorithm-based” or “scoring” test to which the FDA Draft Guidance Document referred.

Screening for CRC lowers both the mortality and the incidence of CRC disease. Ergo,
contrary to the claims of Exact Sciences, the “high-risk” application” criteria does apply to the PreGen-Plus test.

Managed-Care Policies

  1. In 2006, the American Society for Gastrointestinal Endoscopy (ASGE), in their guidelines for CRC screening and surveillance, stated “there are currently no studies demonstrating a reduction in CRC-related mortality from fecal DNA testing, and the technique for the test has not been standardized.” As such, the ASGE did not recommend the PreGen assay for CRC screening.
  2. In 2007, the American Cancer Society (ACS), while recognizing the potential promise in DNA testing, said, nonetheless, “more research is needed to confirm the accuracy of [these] tests before widespread use [can be] recommended.”
  3. And, the National Cancer Institute said that although “the approach (e.g. detection of DNA mutations in the stool) looks promising, but…would be improved, if possible, by increasing sensitivity (perhaps by increasing the number of DNA markers.” (2007)
  4. Cigna Healthcare’s current coverage position states that the “stool-based test is not intended to replace the colonoscopy in those patients who are willing to undergo the procedure” and “is not intended as a primary tool for individuals at increased risk.”5 Studies conclude that there may be a role for SB-DNA testing for individuals who may not be willing to undergo colonoscopy, which remains the “gold-standard” screening test. One-time testing is not reliable, and further studies are needed.

In our view, this reluctance or refusal on the part of guidelines writers to include stool-based DNA testing within screening guidelines as well as a reluctance or refusal on the part of physicians to order, and third-party payors to pay for tests based on PreGen-Plus, is material to the viability of the company as a going-concern. As such, contrary to the company’s position, strong clinical claims are necessary to convince third parties, physicians, thought leaders, and colorectal cancer screening guideline writers of the clinical value of PreGen-Plus or other stool-based DNA testing services utilizing Exact Science’s technologies. [Ed. note. Sufficient to ensuring FDA regulation!]

When a 510(k) is Not Required

In our view, more damning evidence of Exact Science’s culpability—or negligence—is found on the FDA’s home page, which lists
exemptions/examples of when a 510(k) is not required.

As PreGen-plus “has a new intended use or operates using a different fundamental scientific technology (DNA capture technology/stool samples) than a legally marketed device then a 510(k) must be submitted to market the new device.”

Premarket 510 (k) Notification

510 (k) is a premarketing submission made to the FDA to demonstrate that the device to be marketed is safe and effective by proving substantial equivalence (SE) to a legally marketed device (predicate device). Substantial equivalence means that the new device is at least as safe and effective as the predicate.

Once Exact Sciences submits the 510(k), the FDA legally has 90 days to review it. During that process, the FDA may ask Exact Sciences for additional information at which time the "clock" is stopped and then resumed upon the FDA's receipt of the answer to their questions. If approved, the FDA will mail you a letter, with an assigned 510(k) number, that says they “have determined that [the] device is substantially equivalent to legally marketed predicate devices...and [company] may therefore market the device subject to general controls provisions of the (Food, Drug and Cosmetics) Act”

[Ed. note. The letter does not necessarily mean that the FDA is “approving” the device, only that the device is sufficient to—much the same as other devices (predicates) already approved by the FDA.]

Investment Risks & Considerations

Exact Sciences said it does not yet know the costs or timing of the approval process, or how the Warning Letter will effect Medicare's decision, leading to a $1.30, or 21.6%, drop in the price of its common stock.

Only an alchemist can turn sh-t into gold! ~ Unknown

In our view, visibility is lacking as to whether the Company has the
expertise (e.g. regulatory/clinical affairs) necessary to shepherd its in vitro diagnostic kit through FDA regulatory approval.

In addition, while the stool-based DNA testing appears to offer promise as a noninvasive diagnostic tool in identifying the presence of genetic mutations known to be associated with CRC, the accuracy of the test in asymptomatic persons is unclear.

We believe that important concerns remain to be addressed before the FDA will recommend Exact Sciences stool-based DNA assay [for anyone but the most fragile patients—who have difficulty tolerating the currently available invasive CRC tests]:

  • The Imperiale study was not an intent-to-treat analysis. Approximately 20% of subjects were not evaluated (12% did not provide an adequate stool sample for DNA testing; 8% did not complete FOBT cards; 14% did not complete colonoscopy). Missing data were not imputed.
  • Does fecal DNA assay offer improved sensitivity against the “gold-standard” colonoscopy in a cross-over trial?
  • Can false positive rates be maintained appropriately low for a screening program?
  • What is the optimal screening interval?
  • Which patients should not be screened with fecal DNA testing?
  • Does the test improve compliance with colorectal cancer screening?

As previously mentioned, too, investors—or those looking to purchase shares—ought note that the American Cancer Society and the American Gastroenterological Association do not recommend analysis of human DNA in stool samples for colorectal screening.

In fact, no other medical specialty society or other related health organization has issued a policy statement, practice guideline, or position statement that endorses the use of the analysis of fecal DNA as a screening test for colorectal cancer including the American College of Physicians, the American College of Colorectal Surgeons, and the National Cancer Institute.

Editor David J. Phillips does not own a financial interest in Exact Sciences. The 10Q Detective has a Full Disclosure Policy.

Tuesday, October 16, 2007

Does Nortel's $35 Million Settlement With SEC Further Victimize Stockholders?

Nortel Networks (NT-$16.76), the Canadian manufacturer of telecommunications equipment, brought closure to an accounting scandal when it agreed to pay a civil penalty of US$35 million and consented to injunctions against it from violations of certain provisions of federal securities laws.

The payment settles a
civil suit filed by the Securities and in New York alleging that Nortel's previous management engaged in two fraudulent accounting schemes, one involving earnings and the other revenue, between 2000 and 2003.

Further, Nortel will provide to the SEC quarterly written reports detailing its progress in implementing its remediation plan and actions to address its outstanding material weakness in internal controls.

“The settlement reached today reflects the seriousness of the company's past activity,” said Christopher Conte, an Associate Director of the Commission's Division of Enforcement. “Nortel's fraud was long-running, intentional and pervasive.”

In 2006, Nortel agreed to pay nearly $2.5 billion in cash and stock to settle two shareholder class-action lawsuits over the company's accounting scandal.

SEC commissioner
Paul S. Atkins criticized the latest settlement, saying the penalty was no more than “a public relations gesture.”

“Congress anticipated that we would take previously paid restitution into account before imposing an issuer penalty,” Atkins said. “We should have refrained from further victimizing shareholders.”

In our view, the $35 million should be extracted—through penalties and disgorgement orders—from those
Nortel executives who knowingly engaged in and profited from the fraud-- former CEO Frank Dunn, former CFO Douglas Beatty, former Controller Michael Gollogly and former Assistant Controller MaryAnne Pahapill.

“As with all costs imposed upon a corporation,” said Commissioner Atkins, “the penalty will be paid by Nortel shareholders, many of who were victims of the financial fraud.”

Atkins' comments may
reopen a debate among the regulator's leaders over whether such actions help or harm investors.
Editor David J. Phillips does not hold a financial interest in Nortel Networks. The 10Q Detective has a Full Disclosure Policy.

Monday, October 15, 2007

Bush, Clinton, Obama -- Reasoning Power of Monkeys!

A few important observations, before the election campaign heats-up:

Democrats make a lot of plans, but don't do much with them.
Republicans are still following the plans their grandfathers made.

Democrats style themselves as highly intellectual, nuanced global thinkers. But both in Congress and on the campaign trail they've shown themselves to be a bunch of bumbling, foreign-policy-challenged amateurs.

Example # 1.The Democrat-led House Foreign Affairs Committee attempt to push through a resolution recognizing as genocide the murder of an estimated 1.5 million Armenians at the end of the first World War.

Example # 2. Senator Hillary Clinton admitted—Dartmouth debate, September 26—that there was evidence of a North Korea freighter coming in with supplies for a nuclear reactor to Syria.

When asked about Iran’s ability to develop and become a nuclear power—the Democratic candidates—specifically Senator Obama said: “I make an absolute commitment that we will do everything we need to do to prevent Iran from developing nuclear weapons…. One of the things we have to try, though, is to talk directly to Iran; something that we have not been doing…. the next president is going to have to engage in the sort of personal diplomacy that can bring about a new era in the region. And that means talking to everybody. We've got to talk to our enemies and not just our friends.”

Ed note: Analysis of environmental samples and U.S. satellite images determined that throughout the 1990’s—despite repeated multi-party negotiation by the U.S., China, South Korea and Japan—North Korea continued to develop its nuclear weapons program.

On the morning of October 9, 2006, North Korea informed the Chinese government that they should expect a four-kiloton nuclear test. The test was followed by a public declaration of success by the North Korean government.

Hey, Barack, if history is any guide, your idea of “personal diplomacy” will only usher in another member to the Nuclear_Club—the Islamic Republic of Iran!

The Sanctions Myth: A study by the Peterson Institute for International Economics, a Washington, D.C. think tank, says unilateral efforts to choke off investment, trade and the like succeed in maybe one in five cases. It's hard to recall a case where sanctions by themselves have brought down an evil regime. The chronic reluctance of China and Russia doesn't help.

Hey, George, if history is any guide, your idea of “personal diplomacy” will only usher in another member to the Nuclear_Club—the Islamic Republic of Iran!

I am quite sure now that often, very often, in matters concerning religion and politics a man's reasoning powers are not above the monkey's. - Mark Twain

Friday, October 12, 2007

Dropped Call Earns Ousted Sprint CEO $55.3 Million in Severance

Disappointed with weak financial results, including lowered sales guidance in coming quarters and larger than-expected subscriber losses, the Board of cell phone carrier Sprint-Nextel Corp. (S-$17.99) finally pushed out Chairman and Chief Executive Gary D. Forsee on Monday.

Gary Forsee orchestrated Sprint's troublesome $36.8 billion takeover of Nextel in 2005, promising efficiencies from expanded economies of scope/scale.

Footprint of Failure

Integration initiatives intended to merge networks, technology platforms, and customer care and billing services took longer than Forsee or the Company predicted—which proved to be a distraction, having an adverse effect on the Company’s results of operations.

The difference between genius and stupidity is that genius has its limits. ~ Physicist Albert Einstein (1879 – 1955)

Forsee miscalculated the costs of integration, too.

In February 2005, Forsee communicated to shareholders that “the integration costs [would] be significant, $800 million will be an estimate of the integration cost that will be provided to allow us to take care of branding, to take care of systems, to take care of any reduction in workforce as we look at the combination timeline and schedule.”

Each quarter, each further step to reduce a sprawling cost structure only resulted in more red ink—and more employees losing their jobs.

In the 1H:07, total severance, exit costs and asset impairment costs aggregated $259 million compared to $78 million in the prior year period.

In fiscal 2006 and 2005, Sprint recorded net charges of $620 million $723 million, respectively, primarily related to merger and integration costs, asset impairments, severance and exit costs.

Updated Financial Guidance

The Company pre-announced a loss of about 337,000 dissatisfied net postpaid customers for the 3Q:07. Management blamed the defections on increasing churn, due to customer service problems with its
code division multiple access (CDMA) technology, and on customers fleeing Integrated_Digital_Enhanced_Network (iDEN), due to capacity constraint issues with Nextel’s iDEN network.

Straining capacity problems—an overloaded wireless system, due to the addition to the network in recent years of many high-call-volume subscribers; limited effectiveness of the 6:1 voice coder upgrade in the iDEN technology (designed to increase network capacity); and, the impact of the reconfiguration process under the Report and Order (which implemented a spectrum reconfiguration plan designed to eliminate interference with public safety operators in the 800 MHz band).

As part of the announcement, Sprint also said operating income would fall below the expected $11 billion to $11.5 billion range and revenue would not meet the expected $41 billion to $42 billion range either.

Operational Metrics

In addition to failing to wrest customers from Verizon Wireless and AT&T Inc., the beleaguered Forsee stumbled in trying to integrate Sprint’s wireless standard (known as CDMA) with Nextel’s iDEN wireless networks, systems which operated on different technology platforms and used different spectrum bands.

The merger, contrary to Forsee’s best efforts, splintered from the start, given the difficulties in developing an integrated customer service platform and wireless devices and other products and services that operated seamlessly off the multiple legacy platforms in existence.

Not surprisingly, Sprint was the only big carrier to show churn divergence during the period 2Q:06 – 2Q:07, increasing from 2.10% to 2.25 percent.

Selected subscriber data revealed that weighted average monthly service revenue per user continued to erode, falling from $62 in 2005 and 2004 to $57 for the second quarter-ended June 30, 2007, primarily due to decreases in pricing (due to competitive market pricing), incremental customer acquisitions at lower average revenues, and existing customer migrations to lower priced plans.

Pay for Non-Performance

In August 2005, CEO Forsee said: “In this challenging environment, leadership is about ensuring that the individuals in [our] organization know what our priorities are. We are working hard to make sure our employees know how important they are. If we do that, the legacy of Sprint's winning culture will be reinforced.”

Sadly, Forsee’s legacy is a myopic vision fraught with a telecom company struggling to veer back to a path on which it can compete profitably against larger rivals,
AT&T Mobility and Verizon Wireless.

According to available proxy documents, Forsee’s contract calls for a severance outlay of about $55.3 million, which includes base salary, option incentives, and retirement benefits of approximately $2.9 million, $48.5 million, and $2.7 million, respectively.

Ironically, the bulk of Forsee’s severance was effective and conditioned sufficiently on the completion of the merger—not on the success of the combined venture!

Messer. Forsee, however, did not receive any excise tax reimbursement.

No legacy is so rich as honesty. ~ William Shakespeare (1564 - 1616), "All's Well that Ends Well", Act 3 Scene 5.

Little consolation, however, to the approximately 5,000 workers who learned just ‘how important they were’ to Sprint after being
terminated in 2006—in one of Forsee’s poorly executed attempts to achieve “$1.0 billion in adjusted OIBDA benefit from anticipated synergy attainment” through headcount reductions.

Too bad honesty doesn’t pay as well as a sycophantic Board of Directors ~ David J. Phillips

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

Wednesday, October 10, 2007

Wintry Ocean Conditions at Fountain Powerboat Industries

At last the anchor was up, the sails were set, and off we glided. It was a sharp, cold Christmas; and as the short northern day merged into night, we found ourselves almost broad upon the wintry ocean, whose freezing spray cased us in ice, as in polished armor.

Fountain Powerboat Industries, Inc. (FPB-$1.90), a manufacturer of high performance sport boats, express cruisers and fish boats, reported net sales for fiscal 2007 ended June 30 of $68.83 million, a decrease of 13 percent when compared to net sales of $79,226,224 for fiscal 2006.

The 13% decrease in sales for the year was due to an overall softening of the marine industry, according to management.

The number of boats completed and shipped during the last two fiscal years was 329 and 400 (for fiscal 2007 and 2006), respectively.

Net loss for fiscal 2007 was $(5.05) million, or a net loss of $(1.05) per share, versus net income of $2.40 million, or net earnings of $0.49 per share in the prior year.

Year-over year, total stockholder equity fell from $1.88 per share to $0.75 per share.

Though amid all the smoking horror and diabolism of a sea-fight, sharks will be seen longingly gazing up to the ship's decks, like hungry dogs round a table where red meat is being carved, ready to bolt down every killed man that is tossed to them . . .

Ironically, during fiscal 2007, the base salary of Reginald M. Fountain, Chairman & CEO of Fountain Powerboat increased 40.5%, or $170,000, to $520,000 from 2006.

"Come, Ahab’s compliments to ye; come and see if ye can swerve me. Swerve me? ye cannot swerve me, else ye swerve yourselves! man has ye there. Swerve me? The path to my fixed purpose is laid with iron rails, whereon my soul is grooved to run.”

The 10Q Detective notes that the stated base salary benchmarks at Fountain Powerboat have more to do with reviewing ‘other executive’ salaries at similar companies than with assessing executive performance within the context of the Company’s overall operating results!

“Some ships sail from their ports, and ever afterwards are missing…”

Chairman & CEO Reginald M. Fountain, however, did not receive an incentive cash bonus in fiscal 2007, for his performance pay related to the Company's consolidated net profits—of which there were none.

''There she blows!- there she blows! A hump like a snow-hill! It is Moby-Dick!''

Curiously, Fountain Powerboat does not offer an equity-based component to long-term compensation for its Named Executive Officers. Albeit the Company is cognizant that the stock ownership of its executives better aligns its officers with shareholder interests, the Compensation Committee does not believe it is appropriate to include a stock ownership element into the compensation program for its Named Executive Officers.

Hearing the tremendous rush of the sea-crashing boat, the whale wheeled round to present his blank forehead at bay; but in that evolution, catching sight of the nearing black hull of the ship; seemingly seeing in it the source of all his persecutions; bethinking it—it may be—a larger and nobler foe; of a sudden, he bore down upon its advancing prow, smiting his jaws amid fiery showers of foam.

Common stockholders, mindful that rough seas have swamped Fountain Powerboat, abandoned the sinking ship, sending the share price of Fountain Powerboat down more than 54 percent in value.

“The whale! The ship!” cried the cringing oarsmen.

Like some shareholders still clinging to flotsam, Mr. Fountain, too, is choking on some seawater; he holds 450,000 stock options (from an erstwhile plan that expired in 2005) at an exercise price of $4.67 that expire in 2008.

But as the oarsmen violently forced their boat through the sledge-hammering seas, the before whale-smitten bow-ends of two planks burst through, and in an instant almost, the temporarily disabled boat lay nearly level with the waves; its half-wading, splashing crew, trying hard to stop the gap and bale out the pouring water.

2008 Outlook

Boat purchasing decisions are influenced by consumer confidence, which is affected by economic conditions—such as interest rates (financing of boat purchases) and fuel prices. At this time, industry analysts are forecasting that boat sales will continue to be down through the first half of calendar 2008, and do predict a turn around for the 2008 season.

Fountain Powerboats expects sales for fiscal 2008 to be at approximately the same level as 2007, approximately $68 million.

Selling expenses as a percentage of sales rose 315 basis points year-over-year to 11.68% for fiscal year 2007, primarily due to an increase in advertising expenses, including an expanded international advertising program, increased salaries and commissions and increased expenses for the Company’s support of offshore racing and fishing tournament programs.

The Company spent an aggregate $2.3 million on fishing/racing promotional expenses last year and only $691,633 on boat show advertising expenses. Cost reduction programs are currently underway to boost the bottom-line in fiscal 2008. In our view, management should focus promotional cuts on R. Fountain's hobbies--offshore racing expenses-- than on boat show advertising dollars.

In our view, overall attendance of 2008 season boat shows will portend forward quarter sales successes. The Company has increased its participation with its dealers at regional and national boat shows, with some success. At the Miami International Boat Show in February 2007 the Company recorded approximately $20 million in orders for new boats and boats from dealers’ inventory, the highest in the history of the Company.

In September, management said that while dealer inventories were at a four-year low, the results of late summer boat shows have been encouraging, with the Company maintaining market share in the sport boat segment and experienced improvement in the express cruiser segment.

The Miami International Boat Show 2008 is scheduled for February 14 – 18.

“Towards thee I roll, thou all-destroying but unconquering whale; to the last I grapple with thee; from hell's heart I stab at thee; for hate's sake, I spit my last breath at thee. Sink all coffins and hearses to one common pool! and since neither can be mine, let me then tow to pieces, while still chasing thee, though tied to thee, thou damned whale! Thus, I give up the spear!” ~ Herman Melville, Moby-Dick (1819-1891)

Related Person Transactions During 2007

Before we award a Gold Star in Corporate Governance matters to Fountain & Company, the 10Q Detective wanted to point out that Reginald Fountain—by regal right of 51.5% beneficial ownership—will profitable ride out the heavy sea swells predicted in coming quarters:

  • Messer. Fountain owns a company that leases an airplane to Fountain for business purposes. During Fiscal 2007, Fountain paid that company $297,785 in rentals.
  • Fountain also rents apartments from a company owned by Mr. Fountain as temporary housing for consultants and new employees. During 2007, Fountain paid that company $3,576 in apartment rental fees.
  • In addition, during Fiscal 2007, Fountain expensed $20,000 related to a race boat owned by Mr. Fountain as compensation for Fountain's use of the boat over the course of five years for promotion and demonstration purposes.
  • Wyatt M. Fountain, who is Mr. Fountain's son, is employed as Regional Sales Manager for Fountain's Southeast Region. For Fiscal 2007 his aggregate compensation was $214,875 (consisting of sales commissions).

Do not expect Reggie Fountain to cede his spear--to any damned whale!

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

Monday, October 08, 2007

Pay Inequality Extends to Boardroom

US companies are facing fresh pressure from regulators and shareholders to rein in excessive executive pay as research shows chief executives have been paid up to 10 times more than their top lieutenants.

The average total compensation for a S&P 500 chief executive was about twice as much as the second most highly paid executive last year,
according to a study conducted for the Financial Times by the research group,

The gap has been rising, too, partly due to a recent explosion in options awards.

The Securities and Exchange Commission is also believed to have asked a number of companies to explain the reason for
large pay gaps between top executives, as part of a review of corporate pay.

Thursday, October 04, 2007

Pay for Performance --Tilting at Windmills at Quixote Corp.

In the ‘Compensation Discussion and Analysis’ of its Proxy Statement, Quixote Corp. (QUIX-$19.93), a manufacturer of highway and transportation safety products, said its “Compensation Committee does not utilize objective guidelines or formulae, performance targets or short-term changes in its stock price to determine the elements and levels of compensation for our executive officers.”

Frustrated shareholders have witnessed the bull market from the sidelines, for the stock price of has treaded water for four years, as the maker of energy-absorbing highway crash cushions continues to report pretax losses (last reported profit was for fiscal year ended June 30, 2003).

Instead, the Committee typically “relies upon its collective judgment as applied to the challenges confronting the Company, together with advice from independent consultants, information provided by the Company and independent agencies” in its pay practices.

Pay for performance is tilting at windmills at Quixote Corp.

On August 21, 2007, the Committee approved base salary increases (effective July 1, 2007) for the executive officers, ranging from 6% to 6.8 percent. The salary for CEO Leslie J. Jezuit was increased to $510,000 from $480,000; the salary for CFO Daniel P. Gorey was increased to $318,000 from $300,000.

Irrespective of the Company’s financial performance, Mr. Jerzuit and Mr. Gorey continue to receive annual cash bonuses, too. In fiscal 2007 and fiscal 2006, Quixote paid bonuses of $240,000 and $200,000, respectively, to Jerzuit, and $145,000 and $120,000, respectively, to Gorey.

Management is optimistic that end-market conditions will improve in fiscal 2008, citing an expected increase in highway construction activity (federal transportation bill
SAFETEA-LU). A favorable sales mix, including international growth in the Asia-Pacific region, coupled with cost structure initiatives, should yield a profitable outcome in fiscal 2008, according to management.

In our view, operating profits will continue to be pressured by higher raw material (aluminum, steel and resin), fuel, and freight costs.

In a village in La Mancha (whose name I do not care to recall) there lived, not very long ago, one of those gentlemen who keep a lance in the lance-rack, an ancient shield, a skinny old horse, and a fast greyhound. ~ Spanish novelist Miguel de Cervantes Saavedra, Don Quixote (1605)

Senior management is not as chivalrous as Don Quixote de la Mancha, and it is doubtful that they would take up the order of knight-errantry: “ to defend maidens, to protect widows, and to rescue orphans and distressed persons."

Regardless of financial or stock performance, if history is a guide, senior management will still get paid their bonuses.

Perhaps someone should remind Quixote’s Compensation Committee—and management—that they are in the service of shareholders.

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

Wednesday, October 03, 2007

CEO Kisses The Hershey Company 'Bye-Bye.'

Investors—with no specific reasons for optimism—drove the share price of The Hershey Company (HSY-$45.78) down $1.63, or 3.44%, after the struggling chocolate maker announced a shakeup in senior management.

Looking for mr. Goodbar? Effective immediately, chief operating officer David West will assume the position as president and will take the CEO reigns on Dec. 1 from Richard H. Lenny. Mr. Lenny will stay on as chairman of the board through the end of the year.

Asked why Lenny decided to retire now, Hershey spokesman Kirk D. Saville declined to elaborate beyond a one-line statement: "After more than six years, Mr. Lenny feels that this is the right time for a new leader to take the company to the next level.”

The Wall Street Journal, reported Lenny had SOURZed on the Company and was frustrated with the Hershey Trust, which controls 78% of the voting rights for the candy manufacturer, though Lenny made no such claims in a company-issued statement.

Irrespective of alleged differences with the Hershey Trust, our review of the Company’s Proxy Statement suggests—from pecuniary realities—the here-and-now was a good time for Lenny to TAKE-5.

The shares have declined 12 percent in the past year and are below their closing high of $66.65 set in May 2005.

Hershey, the maker of its namesake chocolate bars and other iconic brands like Reeses and Kisses treats, has been hurt by rising ingredient costs and the loss of market share to Mars, home to M&M's candies and Snickers bars.

Summary Compensation

According to the Proxy filed on March 16, Lenny received compensation valued at about $11.4 million in fiscal 2006.

The Company paid to Lenny a base salary of $1.1 million for the fiscal year ended December 31, 2006. He also received about $7.9 million and $2.2 for option/stock awards and pension value benefits, respectively.

These figures are misleading. The $7.9 million in option/stock awards represented the dollar amount recognized as expense during fiscal 2006 for financial statement purposes—and not actual dollar compensation received by Lenny. As noted on the Option Exercises and Stock Vested table of the Proxy, Mr. Lenny did not receive cash or stock from the exercise of any option awards in 2006. In addition, the $2.2 million in pension value benefits reflects only the change in pension value and nonqualified deferred compensation earnings—and not actual cash awards.

Since Hershey’s actual corporate [financial] results fell below agreed-to financial performance metrics (3.0% - 4.0% growth in net sales, 7.0% to 9.0% share-net growth, and minimal improvement in EBIT margin), the base salary for Lenny did not change in 2007—nor did he receive a 2006 cash incentive bonus.

Fiscal 2007 incentives were similar to the aforementioned WHATCHAMACALLIT metrics established for last year.

A quick recap of 1H:07 pro forma results shows that 2007 was shaping up to be another ZERO for Lenny—with respect to both cash awards and performance stock units/options: net sales increased only about 0.6% in the first half (or 0.3% excluding Godrej Hershey in India). EBIT from operations declined 8% with EBIT margin down 150 basis points to 16.7% from 18.2 percent. And, EPS diluted from operations in the first half declined 6.5% to $0.86 per share.

A commitment by the Company to increase its spending behind its brands to reestablish ‘marketplace momentum’ (i.e. market share) lead management to lower full-year guidance, too.

Based on the plans in place in the second half, management expects sequential improvement in organic net sales that will result in full year 2007 growth in the low single-digit range. Against this backdrop of improving sales, however, remain higher dairy costs and stronger investment levels—both will pressure margins. As such, the Company expected earnings per share diluted from
operations for 2007 to decline mid single-digits.

Severance Benefits

According to his employment contract, Mr. Lenny is entitled to $2.2 million (two years salary) in wages.

Pension Benefits

Of interest, the employment agreement with Mr. Lenny contains special provisions relating to his vesting and the calculation of his benefit under the Supplemental Executive Retirement Plan (SERP). Under the employment agreement, Mr. Lenny would have forfeited his SERP benefit had had he terminated his employment without “good reason” before his 55th birthday. He became fully vested in his accrued SERP benefit on January 5, 2007. Additionally, he was effectively credited with two years of service for each year of service from his hire date through his 55th birthday.

As of December 31, 2006, the present value of his accumulated SERP was a NUTRAGEOUS $11.82 million.

Non-Qualified Deferred Compensation

As of December 31, 2006, the aggregate balance of Lenny’s non-qualified deferred compensation account was about $9.16 million.

Outstanding Equity/Option Awards

The Incentive Plan provides that all vested stock options remain exercisable for five years following termination due to retirement after age 55.

As of December 31, 2006, Lenny held 1.25 million in exercisable and 424,050 shares of unvested stock options (underlying strike prices between $32.25 – 61.70) worth an estimated $52.22 million and $19.4 million, respectively.

Do not cry for Lenny. Given the PoT of Gold he received for only 6 ½ years of employment, he will still be able to retire to expensive park-view real estate on 5th Avenue. Altogether, quite a ‘Good & PlentyPayDay for Rick Lenny.

Aside from an occasional KitKat wafer bar, editor David J. Phillips holds no financial interest in The Hershey Company. The 10Q Detective has a Full Disclosure Policy.