Goode Trades

Not bad considering that music sales were down big. Rick Munarriz has a decent take on the earnings announcement over at The Motley Fool.

Hastings [[hast]], currently selling around $7 per share, is a scrappy little retailer that sells books, music, movies, video games, and rents movies and video games. The company is cheap when compared to its book value or earnings. I generally think management is competent, although the company should institute a dividend to better allocate capital.

Disclosure: I own Hastings stock. My disclosure policy always beats analyst estimates.

No, I’m not writing about the old school rap group. I’m writing about Document Security Systems, Inc. [[DMC]], which is currently trading at $10.90. Any investor in DMC should do one thing: run!

DMC is a company without a decent product, without any significant assets (tangible or intangible), without any hope of ever making any sales significant enough to justify its current market cap. While the company has doubled its revenues over the last year ($1.75 million in Q1 2007, vs. $0.86 million in Q1 2006), about half of that increase has come from acquisitions ($215k from 2006 acquisition of P3) and from growth in the acquired companies (approximately $200k in sales growth in P3, see p.17 of the 10Q for details). Also, for an intellectual property company, Document Security Systems spends very little on R&D: $109k in the most recent quarter (see the August 9, 2007 press release). Net loss was $2.9 million in the most recent quarter (Q2, ended June 30). As for sales, they were up 10% in Q2 2007 versus Q2 2006. Not bad. But again, the company did make some acquisitions in that time. Oh, and share count was up 6% in the same period of time.

DMC’s one supposed asset is a patent on a document security system that prevents documents from being digitally scanned or copied. The one problem is that the patent was ruled invalid in the United States in 2000 and was ruled invalid in Britain and WIPO just this spring (the company has filed appeals). The company is of course appealing the recent rulings in Europe, but the case against them seems to me to be pretty strong. Also, if the company loses its appeals in Europe, it will not only have its patents invalidated but it will be liable for the court costs of the European Central Bank (which is trying to have the patents ruled invalid). The company did win an identical case in Germany, but it is unclear what would happen if the company won cases in some countries but not others. For a brief synopsis, I suggest reading Asensio.com’s report (Asensio.com is an independent short-selling research outfit). I also suggest reading Asensio’s prior reports on DMC. You can see DMC’s European patent online. I have uploaded a pdf copy of the patent to my website here.

I came across an analyst that upgraded DMC to buy recently (see report). It turns out that the company that hired the analyst is being paid $30,000 per year to ‘to assist with strategies related to the increase of share liquidity and general market presence’. That sounds a lot like ‘pump up the stock’ to me. And while the analyst himself is independent, he would be a fool to bite the hand that feeds him, and he is no fool. CCM Opportunities, the research company that hired the analyst, has only 1 company with a rating of sell or avoid, and of the companies that it rates hold, only one is a microcap (others, like WMT and ADM are megacaps). So in other words, if you pay CCM to get coverage for your microcap company, you can be pretty darn sure that you will get at least a ‘speculative buy’ rating. Not bad for $30k.

DMC has a market cap of $148 million. It has net tangible assets of about $3 million. Because of its huge SG&A costs and resulting losses, the company’s fair value is $0. I suggest avoiding investing in DMC.

I am currently trying to get a copy of the German patent court decision and I am trying to get an opinion from an expert on European patent law. I will post an update when I know more information.

Disclosure: I am short DMC. Short selling is very risky and I do not recommend it. My disclosure policy has patents pending.

Successful executives can turn around even bad companies. Consider Jack Byrne, who has turned around numerous insurance companies such as Fireman’s Fund, Travelers, and GEICO; he recently served as chairman of White Mountains Insurance [[WTM]]. On the other hand, bad executives tend to be consistently bad. So it should not surprise us that our friends at Remote MDx Inc. (RMDX.ob), James Dalton and David Derrick, both had high level positions at former biotech flame-out Biomune. Biomune delisted from the Nasdaq in 2000. Biomune was sued by shareholders back in 1998, and while the lawsuit was dismissed because the statute of limitations had passed, the allegations of the plaintiffs make for interesting reading. As for myself, I won’t accuse our friends James and David of being anything more than inept. I anticipate Remote MDX will end up like Biomune: a forgotten, worthless shell of a company.

Relating to Remote MDX’s future, I found some more fun information in the company’s financial statements. See pages 5 & 26 in the company’s 2006 10k. The company’s main subsidiary, SecureAlert, has a bunch of convertible preferred stock outstanding. Some of that stock is controlled by insiders. The conversion privilege of those preferred stockholders means that Remote MDX beneficially owns only 80% of SecureAlert:

"As a group, all Series A Preferred Stock may be converted at the
holder's option at any time into an aggregate of 20% ownership of the common
shares of the SecureAlert, Inc. During the quarter ended December 31, 2005, the
Company sold 600,000 of these shares for $600,000. As of December 31, 2005,
there were 3,590,000 shares of SecureAlert Series A Preferred Stock."

Even better, the owners of that preferred stock get paid dividends at a rate of 10% and an extra $1.50 per day for each parolee that is using the company’s product (see page Q-11 of this filing with the SEC). That total dividend is divided among all preferred stock holders (it is not per share), but it is still outrageously high.

Disclosure: I am short RMDX.ob. I do not recommend short selling due to its high risk. See my disclosure policy.

Remote MDx Inc. (RMDX.ob), currently trading at $1.86, sells tracking systems to be used either on parolees or on the elderly. The systems allow for the location of the person wearing the device and instant communication with an operator in a call center run by the company; the call center operator can quickly call a parole officer or anyone else should a reason to do so arise. The system can also set off an alert based on many different situations (such as an elderly person falling down or a parolee leaving the state). The company also has another segment, but I will not discuss that because it has annual sales under $1 million, has little prospect of growth, and operates at a loss. The company has a market cap of $230 million, yet it has a book value available to common stockholders of negative $2 million and an accumulated deficit (total loss since the company’s founding) of $127 million. I do not foresee the company ever making significant profits. Therefore, I believe that Remote MDX is essentially worthless. Current (and potential future) shareholders beware.

Despite horrendous losses, the company continues to dole out huge stock option awards to its two main executives: chairman and CEO David G. Derrick and President James J. Dalton. In FY2005 the pair each received 2.5 million stock options (with an exercise price of $0.54), in addition to $540k cash each. Over the past year the pair have been dumping a lot of stock: they owned 9.1 and 8.9 million shares respectively as of June 6, 2006 (all data from the company’s 2006 proxy; see all their SEC filings). As of July 25, 2007, each owned 5.2 million shares. And this doesn’t even account for all the options they have exercised–just in their most recent forms 4 linked above, the pair acquired over 14 million shares. So the two top executives have sold well in excess of 22 million shares over the last year. That is not exactly a sign of confidence in the future.

Unlike some of the OTC stocks I come across, Remote MDX is a real company with a real product and real employees (112 full time at last count). The only problem is that the company is not likely to ever make a profit, because it competes against a number of much larger and more profitable companies (such as Philips [[PHG]], ProTech, and Sentinel Security. It should be instructive from a valuation standpoint that two of the companies that Remote MDX’s itself calls significant competitors (see p.26 in the recent form SB-2) also trade over the counter and have market caps of under $15 million each. These companies are Wherify (wfyw.ob) and iSecureTrac (isec.ob). iSecureTrac has greater revenue than Remote MDX, a decent gross profit margin, smaller losses than Remote MDX, and yet somehow investors think that Remote MDX is 15 times more valuable ($230 million market cap v. $15 million market cap). Something doesn’t seem right with that comparison, and that something is that Remote MDX is way overvalued.

A bull in the stock would argue that the company has just recently increased its revenues drastically, that these increasing revenues will soon lead it to profitability, and that the company is in a great growth niche. I won’t disagree with the first and third points. But I have some trouble believing the company will be profitable anytime soon. For example, in the most recent quarter the company reported sales of $3.1 million and selling, general, and administrative (SG&A) expenses of $5 million. In the past 9 months the company has had $5.8 million in revenue and $15.7 million in SG&A expenses. Most of the SG&A is from executive compensation. As long as the executives of Remote MDX overpay themselves, the company will not be profitable. Notice that this comparison doesn’t even include cost of goods sold or R&D expenses. Even though the company’s sales have increased drastically, it has not been able to narrow its losses significantly. It had a $5.3 million loss in the most recent quarter, essentially the same as the loss from the year ago quarter (after accounting for the greater stock option awards in 2006).

Perhaps the worst part of Remote MDX from an investment standpoint is the share situation. There are currently 123,008,784 shares outstanding. Exactly 13 months ago there were 71,878,237 outstanding. The number of shares has increased by a whopping 70% in just over one year! And the company has gotten essentially nothing from those shares because it has lost as much money over the last year as it received for selling its shares. Even worse, many of the company’s largest shareholders are about to sell 23 million of their shares (see the registration statement filed with the SEC). It is obvious what such massive selling will do to the stock’s price in the near term.

Remote MDX is a good example of why most people should avoid OTC stocks. It has a nice story, and even a product, but it will not generate profits anytime soon. If management were more interested in the company’s success than in their own paychecks, perhaps the future would be brighter for the company. Alas, that is not the case.

Disclosure: I am short RMDX.ob. I do not encourage short selling as it is very risky. My disclosure policy cannot be sold short.