Friday, August 28, 2009

How Lucrative Eagle Ford Shale Gas Play for Swift Energy?

Terry Swift, chief executive of Swift Energy (SFY-$20.00), announced on the second-quarter earnings call that the E&P company is planning to commence drilling in South Texas’ emerging Eagle Ford shale-gas play and expand horizontal drilling operations in the Olmos tight-sand formations of its AWP Field. With North America awash in natural gas and the commodity price environment showing no signs of improvement, does it make economic sense to increase drilling activities—especially where some gas pockets are estimated in some spots to be as deep as 12,000 feet?

Management believes that its balanced approach to growing reserves and production—total proved reserves at December 31 were comprised of approximately 43 percent crude oil, 42 percent natural gas, and 15 percent natural gas liquids - located onshore and the shallow waters of Louisiana and Texas, permits the company to adjust production output to prevailing market sensitivities. For example, a 35 percent sequential increase in second-quarter oil prices offset a 26 percent decline in natural gas prices, resulting in a 14 percent increase in average prices per BOE in the second quarter of 2009 to $36.71. Production revenue increased nine percent to $82.9 million over comparable first quarter 2009 levels.

With the pricing decline, chief operating officer Robert Banks insisted to analysts on the call that the company could make money at $4.00 gas—if it could continue to push down drilling costs. For the second-quarter, G&A decreased year-on-year 26 percent to a composite $3.36 a barrel, resulting from workforce reductions; Production costs fell year-on-year 34 percent to $8.34 per barrel, due to lower natural gas and NGL processing costs, and lower plant operating costs.

Energy Information Administration reporting that inventories of U.S. natural gas in storage were at a multi-year high sent the Henry Hub price of natural gas falling below $3.00 (per MMBtu) for the first time since August 2002. At June 30, Swift Energy had in place price floors in effect through the September 2009 contract month for crude oil. The oil price floors cover notional volumes of 645,000 barrels –expected to cover between 69 percent and 73 percent of third-quarter production — at a weighted average floor price of $62.00 per barrel. The company, however, has not hedged any natural gas scheduled for delivery in the third-quarter.

With the pricing of natural gas unlikely to rebound in the second-half of 2009, the 10Q Detective believes Swift management is being too optimistic on its ability to profitability develop its newer properties in South Texas. It is doubtful that the successful focus on controllable per unit cost in anchor fields in Louisiana and Texas can be applied with similar success on unconventional reserves, such as the Eagle Ford shale play or the Olmos tight-sand property. The rock layers that hold the reserves in both geological formations are very dense, so the gas doesn't flow easily. Completing such wells are enormously expensive—requiring more advanced—and expensive-fracturing and horizontal drilling technologies. If the company can economically recover gas from such unconventional properties at $4 a thousand cubic feet, investors have a lucrative investment opportunity—as opposed to a merely ‘promised’ one.

Editor David J Phillips holds a short interest position in Swift Energy. The 10Q Detective has a Full Disclosure Policy.

Monday, August 24, 2009

Healthcare Reform's Impact on DaVita's Dialysis Profits

Although DaVita (DVA-$52.38), posted solid second-quarter financial results, chief financial officer Rich Whitney admitted to analysts on the earnings call that Medicare composite rate adjustment provided for in 2009 and 2010 would not be sufficient to compensate for anticipated increases in forward operating costs subject to inflation, such as labor and pharmaceutical supplies. Whitney opined that the dialysis provider would likely continue the trend of steady growth and consistent cash flow going forward, but the 10Q Detective believes that operating profitability could tumble if the defined scope of new MediCare bundling rules, scheduled to be implemented in 2011, limit coverage for higher-cost cases and cap the utilization of prescribed erythropoiesis-stimulating agents (ESAs), such as Amgen’s Epogen (for end-stage renal disease (ESRD) patients with anemia).

Highlights of Business Operations

For the three-months ended June 30, DaVita said second-quarter revenue rose 8 percent year-on-year to $1.5 billion, driven principally by additional treatment days and average revenue per treatment (helped along by a one-percent increase in the Medicare composite rate), and gains in prescribed pharmaceuticals and average selling prices of drug reimbursement rates. The gains were partially offset by higher procurement costs for heparin and a seasonal decline in lab testing.

Operating income increased year-on-year by 8 percent to $236 million, due to an increase in average dialysis revenue per treatment, improved labor productivity, and lower operating costs of dialysis centers (due to the timing of certain expenses previously recorded in the first quarter of 2009).

Cash flow from operations during the quarter was $212 million, up from $147 million last year. The main contributors to this increase were the gain in net income and positive working capital changes (such as comparable declines in accounts receivables and inventories).

Implications of Medicare Bundling Rate Changes

DaVita generates approximately 65 percent of its sales from Medicare patients, but nearly all of its profits are derived from the 35 percent of its patients who have commercial health insurance, as rates from private insurers have historically paid on terms that are significantly higher than government programs (the average Medicare composite rate was $157 per treatment in 2008). Even lucrative payments from these private insurers, however, are unlikely to offset cuts expected in payment rates under the Medicare ESRD program, according to the
second-quarter 2009 regulatory 10-Q filing:

In July 2008, the Medicare Improvements for Patients and Providers Act for 2008 was passed by Congress. This legislation provides for an increase in the composite rate of 1% in 2009 and in 2010. In addition this legislation introduces a new payment system for dialysis services beginning in January 2011 whereby ESRD payments will be made under a “bundled” payment rate which will provide for a fixed rate for all goods and services provided during the dialysis treatment, including laboratory services and the administration of pharmaceuticals. The initial 2011 bundled rate will be set 2% below the payment rate that providers would have received under the historical fee for service payment methodology. Beginning in 2012, a new single bundled payment base rate will be adjusted annually for inflation based upon a market basket index, less 1% of such index.

The two-percent reimbursement cut will reduce Medicare revenues by an estimated $60 million, according to Whitney. As DaVita operates principally as a dialysis and related lab services business, the company does not have the ability to quickly offset the hit to revenues. What the company can do, however, is continue to focus on cost-control initiatives, such as increased use of cheaper drugs where possible. For example, a generic alternative to Watson PharmaceuticalsFerrlecit, an intravenous iron-supplement for the treatment of iron deficiency anemia in hemodialysis patients receiving supplemental epoetin therapy, is expected to enter the market later this year. Ferrlecit currently has about 30 percent of the $660 million U.S. IV iron-replacement therapy market, according to IMS Health, a pharmaceutical market researcher.

Prior to bundling, use of branded iron was a benefit, for the company was reimbursed at average selling price plus six-percent. Come 2011, a bundling system that includes one payment for treatment plus drug use likely motivates DaVita to extract margin gains through clinical outcome efficiencies. For example, several studies suggest regular IV iron-supplementation can reduce the total amount of the more expensive EPO needed by patients. Avoiding the high cost of EPO therapy is not without its own set of risks for DaVita, however, as Epogen currently accounts for approximately 20 percent of dialysis and related lab services revenues.

Analysts estimate that 60 percent of the 345,000 U.S. dialysis patients with ESRD now dialyze at either DaVita or its larger rival, Fresenius. This stronghold on the dialysis market, however, means little when it is the U.S. government that ultimately controls pricing power.

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

Tuesday, August 18, 2009

Wall Street Sycophants Praise Trina Solar's Performance

Chairman and CEO Jifan Gao of Trina Solar (TSL-$27.10) optimistically told analysts on its second-quarter earnings call that he believed market confidence was returning to the photovoltaic sector and expected gross margin to stabilize going forward. Overlooked by the Wall Street sycophants in their effusive praise, however, was the admission by chief financial officer Terry Wang that profitability going forward remained dependent on the solar company cutting manufacturing costs greater than sequential declines being experienced in average selling prices (ASPs).

For the third quarter of 2009, the Company expects to ship between 90 MW to 110 MW of PV modules. The Company believes gross margin for the third quarter of 2009 will likely be between 23.5 percent and 26.5 percent, up from 22 percent in the prior year period.

The company expects a reduction of its non-silicon manufacturing costs to $0.73 per watt in the third-quarter, down from $0.85 per watt last year. Management believes it is on track to achieve additional cost-savings of 15 percent to 20 percent cost reduction by the end of 2009, helped by process improvements in manufacturing (reductions in cycle time and consumable materials), scale benefits (from consolidation of its supplier chain), and technology (increases in cell and module conversions).

Although Trina is to be complimented for manufacturing cost controls, bullish optimism on gross margin assumes stabilization of average selling prices, which fell year-on-year 81.6% to $2.32 per watt. Wang admitted on the call that third and fourth-quarter ASP will sequentially decline an additional 10 percent to 15 percent and 10 percent to 12 percent, respectively.

Like most solar companies, Trina remains dependent on Italy, Germany, and Spain for its top-line growth. Given uncertainty on the sustainability of feed-in-tariff quotas in Europe and limited visibility on growth prospects in China and the U.S., the 10Q Detective opines that competitive production ramp-ups will likely intensify ASP declines. Consequently, overall profitability level improvements at Trina are unlikely in 2010, and investors—and analysts—might want to hold off on that round of applause for Trina.

Editor David J Phillips holds a short interest position in Trina Solar. The 10Q Detective has a Full Disclosure Policy.

Monday, August 17, 2009

New Revenue-Sharing Deals With Studios No Win for Blockbuster

Speaking to analysts during a second-quarter financial call on August 13, Blockbuster (BBI-$0.72) chief executive Jim Keyes said the video rental chain had drafted new revenue-sharing agreements with studios— “win-win” initiatives designed to increase the number of rentals at Blockbuster and improve profits for the studios on the backend. To the contrary, given the company’s existing debt-service obligations on its levered capital structure, the 10Q Detective believes that the motivation behind the new purchase arrangements was not for growth but an attempt by Blockbuster to continue managing the business for cash conservation, as additional credit restrictions were forced on the company by its suppliers, according to its 10-Q regulatory filing:

Given our liquidity limitations and uncertainty surrounding our ability to finance our obligations, we are currently in discussions with several of the large studios regarding the credit terms for our inventory purchases. Several of the studios have tightened their credit terms and one studio has eliminated its provision of credit to us, meaning that we must purchase product from this particular studio with cash in advance.

Purchases under revenue sharing arrangements already make up 85 percent of total domestic movie rental fees. Although details are confidential, it is likely that the newly negotiated deals provide for lower initial payments by Blockbuster to acquire the inventories. A read of past regulatory filings suggest that in exchange for lower up-front cash payments, these purchase contracts likely include minimum purchase requirements (that are based upon box office results of the titles). In addition, Blockbuster has historically paid an agreed upon percentage of rental income earned from supplied product(s) to the studio/game vendor for a limited period of time (usually 30 – 45 days).

Kick it!

In addition, a majority of its revenue-sharing agreements have historically required video product to be destroyed at the conclusion of the initial rental cycle. As studios move more aggressively to
preserve their pricing control over new DVD releases, this shortening of the rental life cycle will likely adversely affect ‘previously rented product’ (PRP) going forward. In the second-quarter ended July 5, PRP sales declined 15.8% year-on-year.

You wake up late for school man you don't wanna go
You ask your mom, "Please?" but she still says, "No!
"You missed two classes and no homework
But your teacher preaches class like you're some kind of jerk

Same-store rental revenue tumbled 13.3 percent, driven by lower store traffic and lower copy depth (as management tried to conserve cash and get a handle on upcoming debt maturities). Keyes said Blockbuster was making a “concerted effort to improve unit availability,” inferring on the earnings call that increased unit availability would at least partially offset anticipated lower same-store comparables in the second half of the year. The rift in his logic, in our opinion, is that even an increase in favorable title releases (games and movies) will do little to reverse changing consumer preferences as to how they access entertainment, demonstrated by customer defections to rivals like rental-by-mail provider Netflix and DVD-rental kiosk operator Redbox.

You gotta fight for your right to paaaaaaaaaarty! [youtube video]

The combination of tight expense controls and working capital management resulted in a significant turnaround in net cash from operations in the second-quarter: $114 million as compared to a $63 million use of cash in the same period last year. In the context of uncertain market dynamics (including consumer spending behavior), $729 million in interest payments and debt maturing over the next three years, and the company’s desire to replace existing credit facilities (interest rate of 13.5 percent) with less-costly options, cash management remains a priority in the months ahead at Blockbuster.

Your pops caught you smoking and he said, "No way!"
That hypocrite smokes two packs a day
Man, living at home is such a drag
Now your mom threw away your best porno mag (Busted!)
~ Beastie Boys

In the mid-1980’s, fraternities embraced the Beastie Boys “Fight for your right” as their party anthem. Little did the souses know that the Beastie Boys’ song parodied their hollow ‘bad boy’ antics. Similarly, in the months ahead, there is no real “win” for Blockbuster stockholders resulting from the new video distribution deals. If anything, the goal remains the same as six-months ago—avoiding bankruptcy.

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

Wednesday, August 12, 2009

Generic Vancocin Threatens Optimer Pharmaceuticals' Fidaxomicin Success

The relative efficacy of Optimer Pharma's (OPTR-$13.49) investigational antibiotic, fidaxomicin, compared to standard-of-care vancomycin (marketed as Vancocin by drugmaker ViroPharma), for the treatment of the hospital-acquired gastrointestinal infection Clostridium difficile remains unclear, as published results show similar recurrence rates in a subset of patients infected with a life-threatening strain of the C. difficile spores. In the opinion of the 10Q Detective, even if Optimer obtains regulatory approval to market fidaxomicin, its commercial success will be limited, as the Food & Drug Administration is likely to move forward on an advisory committee’s recommendation for the sale of cheaper, generic copies of Vancocin.

Risk factors for C. difficile include advanced age, antibiotic therapy, and severe underlying diseases—with the precipitating event a disruption of the normal microflora in the colon. Acquisition of C. difficile occurs primarily in the hospital setting, where the organism has been cultured from bed rails, floors, windowsills, and toilets, as well as the hands of hospital workers who provide care for patients with C. difficile infection. The organism can persist in hospital rooms for up to 40 days after infected patients have been discharged, according to an article authored by Michael Schroeder, MD, in the peer-review journal
American Family Physician.

Optimer reported top line data from a
late-stage study in November 2008, showing that fidaxomicin met both its primary endpoint of clinical cure (defined as patients requiring no further therapy two days after completion of study medication) and secondary endpoint (which evaluated recurrence up to four weeks post therapy, with recurrence defined as the return of diarrhea associated with C. difficile confirmed by a positive toxin test.

A more
detailed analysis of the Phase 3 study presented at the 19th annual European Congress of Clinical Microbiology and Infectious Diseases in May, however, showed that fidaxomicin was no more effective compared to Vancocin in a subset of patients with the most virulent strain (known as BI/NAP1/ribotype 027). The recurrence rates for fidaxomicin and Vancocin in the BI/NAP1/027 subgroup were 25.0% and 24.1 percent.

Relapse with the same or different strains occurs in about 10 percent to 35 percent of patients treated with either oral vancomycin or the oral anti-infective metronidazole (off-label usage). Although fidaxomicin affords no special protection from recurrence with the hyper-virulent strain, chief financial officer John Prunty remains optimistic, telling
Xconomy editor Luke Timmerman that looking at the results and simply inferring the market just shrunk by one-third would be a mistake:

“Doctors faced with a diagnosis of “C.Diff” are dealing with an emergency that requires immediate treatment. The current lab tests that are sensitive enough to tell the difference between normal C.Diff and the hypervirulent form take three weeks to produce a result. [Ed. Note. The most common confirmatory study is an enzyme immunoassay for C. difficile toxins A and B, with results available in two to four hours.] So in the real world, no doctor is going to wait around for that result before deciding whether to prescribe the Optimer drug, or the usual vancomycin…. They’re likely to prescribe fidaxomycin anyway, in the hopes that the patient is among the two-thirds of the population who will get a greater protection against relapse.”

Whatever you say, say it with conviction. ~ American author and humorist Mark Twain (1835 – 1910)

Although C. difficile results in longer hospital stays (from three –to- thirteen days), Prunty is gravely mistaken in assumming that doctors would be more inclined “to prescribe fidaxomicin anyway.” In the real world community hospitals are under tremendous pressure to rein in all costs. And, as drug procurement costs are visible and easy to quantify, one could just as easily conclude that hospital administrators would “encourage” treatment algorithms favoring generic vancomycin or metronidazole (off-label usage) - especially with potential Medicare reimbursement cuts on the horizon.

A second fidaxomicin Phase 3 clinical trial is ongoing, and Optimar anticipates reporting data from this trial later this year. Assuming this study demonstrates similar top-line results, fidaxomicin could be on hospital pharmacy shelves by mid-2010. However, until the company has data on fidaxomicin’s cost-effectiveness (calculated as total costs divided by proportion of successes) the drug will likely be reserved for use in vancomycin-resistant enterococci (VRE) infections.

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

Friday, August 07, 2009

10Q Detective in Distribution Deal with BusinessWeek

10Q Detective is pleased to announce a definitive distribution arrangement with BusinessWeek, where original 10Q Detective content can now be found on a bi-weekly column at BusinessWeek’s Investor Channel.

This deal affords us a unique platform from which to nationally distribute 10Q Detective analysis to a wider audience. Loyal readers still counting on the 10Q Detective "to dig through businesses’ 8-K, 10-Q, and proxy statements filed with the SEC, looking for financial statement 'soft spots' and other juicy insider transactions,” however, can still find additional stock analysis and comments here at our original home.

In the meantime, meander over to for our first article, which looks at
Vornado Realty Trust (VNO), one of the biggest landlords in the Manhattan and Washington DC office property markets:

Can the highly levered real estate investment trust (REIT), which has a ratio of
total debt to enterprise value of approximately 60 percent, juggle dividend
payouts owed to stockholders, honor interest-coverage and maturing debt
obligations, and stabilize decreasing spreads between new tenant and expiring

Sunday, August 02, 2009

Contract Termination Fees Inflate Nabors Industries' Earnings

The operating performance of the land drilling contractor Nabors Industries (NBR-$17.03) continues to be hurt by low natural gas prices in the U.S. Lower 48 states and the resultant decrease in drilling activities as producers shut in unprofitable wells. Although weak demand for rigging and well-servicing will likely continue to weigh on dayrate revenues and margins into 2010, the company is seeing an earnings boost from “prepaid cancelled domestic rigs,” which are cash payments from exploration clients allowing for early contract terminations, according to quarterly regulatory filings:

… customers released rigs and delayed drilling projects in response to the significant drop in natural gas prices and the tightening of the credit markets. Operating revenues earned during the three months [a decrease of 43 percent to $249.8 million] and six months [a decrease of 24 percent to $639.7 million] ended June 30, 2009, includes $17.5 million and $48.8 million, respectively, related to early contract termination revenue including approximately $7.7 million and $13.1 million, respectively, which would have been earned during the current period regardless of early termination.

The decline in rig count is hurting margins, but contract terminations are disingenuously inflating reported operating metrics. In the second quarter, average margins were $10,250 per rig day, but would have been $8,900 per day, if not for that portion of the lump-sum payments that would have been earned in future quarters.

Chief Executive Eugene Isenberg said on the second-quarter
earnings call that he believed “that the third quarter will likely represent a bottom in all operations, although it remains difficult to predict the timing and pace of the eventual upturn in natural gas driven activity.”

At July 29, rig count activity in U.S. Lower 48 Land Drilling operations decreased from the October 2008 peak of 273 rigs to 93 rigs. Well-servicing activity is down, too, off approximately 51 percent from its October peak to current estimated rig hours of 51,796.

Natural gas has been holding in the $3.30-$3.60-per-thousand-cubic-feet [mcf] range and storage at natural gas hubs is higher year-over-year. In addition, with no sign of increased rig additions at this time, the 10-Q Detective believes that operating income for Nabors' third quarter could be down sequentially more than the guidance of 50 percent (from the second quarter) provided by the company for its domestic operations.

Nabors still has a substantial number of rigs that are on contract not only through the end of this year, but for 2010, too, when the company is going to have an average of 70 rigs on contract, which will mitigate the downside, according to Isenberg.

In the opinion of the 10-Q Detective, the supply-demand imbalance of gas reserves remains dependent on an uncertain economic turnaround. A visible increase in U.S. onshore rig activity will unlikely occur until gas prices reach $6.00 to $7.00 per mcf, for promising shale plays, such as Fayetteville and Woodford, require such market prices to make production worthwhile. Until market conditions improve, Nabors will need to depend on early termination revenue to lift income and cash flow during the downturn.

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