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Somanetics (SMTS)
Discovery Group reported that it now has 631,737 shares (5.2%). The company paid a little more than $11.1 million, or $17.59 per share, to acquire its holding.

BUSINESS OVERVIEW

Overview
We develop, manufacture and market the INVOS System, a non-invasive patient monitoring system that continuously measures changes in the blood oxygen levels in the brain and elsewhere in the body in tissues beneath the sensor in patients with or at risk for restricted blood flow. The brain is the organ least tolerant of oxygen deprivation. Without sufficient oxygen, brain damage may occur within minutes, which can result in paralysis, other disabilities or death. Brain oxygen information, therefore, is important, especially in surgical procedures requiring general anesthesia and in other critical care situations with a high risk of the brain getting less oxygen than it needs. The INVOS System consists of a portable monitoring system, including proprietary technology, which is used with multiple single-use disposable sensors, called SomaSensors or OxyAlert sensors. During our fiscal year ended November 30, 2008, net revenues from disposable sensors comprised approximately 72 percent of our net revenues. As of November 30, 2008, we had an installed base of 2,523 INVOS System monitors in the United States in 714 hospitals, and during fiscal 2008 we sold 424,647 sensors worldwide.
Clinical studies have shown that using the INVOS System to monitor and provide information to help manage the regional brain blood oxygen saturation of patients is associated with significantly fewer incidences of major organ dysfunction, which can significantly improve patient outcomes and reduce hospital costs. During fiscal 2004, the results of the first prospective, randomized, blinded intervention trial were presented, and the results were published in the January 2007 issue of a peer-reviewed anesthesia journal. The study showed that when the INVOS System was used to monitor and provide information to help manage the regional brain blood oxygen saturation of coronary artery bypass surgery patients, the occurrence of major organ morbidity or mortality was reduced from 11 percent to three percent and patients with major organ morbidity or mortality have significantly longer length of stay in the intensive care unit, or ICU, than those without. Additionally, in 2004, the results of a large retrospective review showed a statistically significant greater than 50 percent reduction (2.01 percent versus 0.97 percent) in the incidence of permanent stroke when information from the INVOS System was used to help manage brain blood oxygen saturation of cardiac surgery patients. The results also showed a reduced length of hospital stay and reduced incidence of prolonged ventilation when the INVOS System was used.
Our INVOS System has U.S. Food and Drug Administration, or FDA, clearance in the United States for use on adults, children and infants. We target the sale of the INVOS System for use in surgical procedures and other critical care situations with a high risk of oxygen imbalances. We initially focused our marketing efforts primarily on adult and pediatric cardiac surgeries and carotid artery surgeries. In the first quarter of fiscal 2005, we initiated selling and marketing efforts for the INVOS System in the pediatric ICU. We are currently expanding the use of our INVOS System in the pediatric and neonatal ICU’s with the launch of our smaller sensor in the first half of fiscal 2008. Some of our potential future markets may include other major surgeries involving high risk patients. While our initial focus has been commercializing the INVOS System to measure blood oxygen saturation changes in the brain, many clinicians in the pediatric and neonatal ICU use the INVOS System to assess changes in oxygen saturation in regions of the body other than the brain in addition to cerebral oxygen saturation. In November 2005, we received 510(k) clearance from the FDA to market our INVOS System to monitor changes in somatic tissue blood oxygen saturation in regions of the body other than the brain in patients with or at risk for restricted blood flow. In May 2008, we received 510(k) clearance from the FDA to market our INVOS System to monitor changes in blood oxygen saturation in any tissues beneath the sensor, not limited to brain and somatic tissue, in any individual. Our four-channel cerebral and somatic INVOS System monitor, which we launched in the second quarter of 2006, can display information from four disposable sensors. This feature allows for the simultaneous monitoring of changes in blood oxygen saturation in tissues beneath the sensor in four different places in the body in patients with or at risk for restricted blood flow.
We are sponsoring and evaluating sponsorship of clinical trials which may allow us to more actively target the sale of the INVOS System for use in high risk patient populations. There are also numerous other independent clinical studies evaluating the use of the INVOS System.

In November 2008, we acquired substantially all of the assets of ICU Data Systems, Inc., a technology development company, for approximately $2,000,000 in cash plus the assumption of specified liabilities. ICU Data Systems has developed a patented technology that integrates data from a broad array of hospital bedside devices, such as physiological monitors, ventilators and infusion devices, into a single bedside display for comparison, data management and storage. We plan to further develop and launch our newly-acquired data integration technology as a stand-alone device in mid-2009. The INVOS System is one of many devices whose data can be integrated into the stand-alone device. To support the addition of the derived parameter features to the system, we will pursue a new FDA 510(k) clearance in 2009. In addition, we expect to invest to combine the ICU Data Systems and INVOS System technologies in a single product for launch expected in the second half of 2010. We also plan to pursue a new FDA 510(k) clearance for this integrated device in 2010.
We sell the INVOS System through a direct sales team in the United States, consisting of salespersons and clinical specialists, the size of which has increased from 44 persons at the end of fiscal 2006 to 55 persons at the end of fiscal 2008, and two independent sales representative firms. The direct sales team will also be expected to sell our integrated data device. Outside the United States, we market the INVOS System through independent distributors, including Covidien, formerly Tyco Healthcare, in Europe, Canada, the Middle East and South Africa, and Edwards Lifesciences Ltd. in Japan. We expect to increase the size of our U.S. direct sales team in fiscal 2009 and are planning to hire direct salespersons and clinical specialists in Europe to support Covidien and sell our integrated data device. Our net revenues have increased from $28.7 million in the fiscal year ended November 2006 to $47.5 million in fiscal 2008, representing a compounded annual growth rate of 28.6 percent. As a percentage of net revenues, our gross margin decreased from 88 percent in fiscal 2006 to 87 percent in fiscal 2008.
Our Corporate Information
We were incorporated under the laws of the State of Michigan in 1982. Our principal executive offices are located at 1653 East Maple Road, Troy, Michigan 48083-4208, and our telephone number is (248) 689-3050. Our website address is www.somanetics.com . The information on, or that can be accessed through, our website is not a part of this report. Unless the context indicates otherwise, as used in this report, the terms “Somanetics,” “Somanetics Corporation,” the “Company,” “we,” “us” and “our” refer to Somanetics Corporation, a Michigan corporation.
Somanetics ® , INVOS ® , SomaSensor ® , Window to the Brain ® , Reflecting the Color of Life ® , Enlightening Medicine ® , CorRestore ® , OxyAlert ® , OxyAlert NIRSensor ® , and iCuro ® are our United States registered trademarks. Each of the other trademarks, trade names or service marks appearing in this report is either pending registration or belongs to its respective holder.
Industry
Market Opportunity
We believe that in the United States in 2008 there were approximately five million surgeries involving elderly patients who, due to the type of surgery, age of the patient or other factors, have a higher risk of developing post-operative complications. Such surgeries include cardiac surgeries, carotid surgeries and other major general surgeries involving elderly patients. In addition, we believe that there are other patient populations, such as non-elderly adult, pediatric and neonatal patients, undergoing major surgeries and patients undergoing ICU treatment or in other critical care situations that face a high risk of tissue oxygen imbalances.
Hospitals in the United States have economic incentives to control health care costs. They often receive a fixed fee from Medicare, managed care organizations and private insurers based on the disease diagnosed, rather than on the services actually performed. Therefore, hospitals are increasingly focused on avoiding unexpected costs, such as those associated with increased hospital stays of patients with brain or other organ damage or other adverse outcomes following surgery or ICU treatment. The costs to the health care system associated with adverse surgical and ICU outcomes and lengthened hospital stays can be significant. In addition, lack of immediate knowledge about blood oxygen levels in areas such as the brain or other tissues can result in unnecessary medical treatments and associated costs. With the increasing focus by hospitals on avoiding unexpected costs, especially in the operating room, ICU and other critical care areas, we believe that there are significant incentives to evaluate and adopt new monitoring technologies which could provide information to improve patient care and reduce costs.

Brain Oxygen Imbalances and Its Effects
Oxygen is carried to the brain by hemoglobin in the blood. Hemoglobin passes through the lungs, bonds with oxygen and is pumped by the heart through arteries and capillaries to the brain. Brain cells extract oxygen and the blood carries away carbon dioxide through the capillaries and veins back to the lungs.
The brain is the human organ least tolerant of oxygen deprivation. Without sufficient oxygen, brain damage may occur within minutes, which can result in paralysis, severe and complex disabilities, or death. Undetected brain hypoxia, which is a condition in which there is a decrease of oxygen supply to the brain even though there is adequate blood flow, and ischemia, a condition in which blood flow, and thus oxygen, is restricted to a part of the body, are common causes of brain damage and death during and after many surgical procedures and in other critical care situations.
Brain oxygen imbalances can be caused by several factors, including changes in arterial blood oxygen saturation, which is the percentage of oxygenated hemoglobin contained in a given amount of blood which carries oxygen in the arteries to the tissues of the body, blood flow to the brain, hemoglobin concentration and oxygen consumption by the brain.
Brain oxygen information is important in surgical procedures requiring general anesthesia, in other critical care situations with a high risk of brain oxygen imbalances, as well as in the treatment of patients with head injuries or strokes. Once alerted to these imbalances, medical professionals can use this and other information to take corrective action through the introduction of medications, anesthetic agents or mechanical intervention, potentially improving patient outcomes and reducing the costs of care. Immediate and continuous information about changes in brain oxygen levels also provides immediate feedback regarding the adequacy of the selected therapy. Equally important, without information about brain oxygen levels, therapy that may not be necessary might be initiated in an attempt to ensure adequate brain oxygen levels and may have an adverse impact on patient safety and increase hospital costs.
Limitations of Traditional Monitoring Technologies
We believe that it is uncommon for patients undergoing surgery to receive any sort of direct neuromonitoring of brain blood oxygen saturation, in part due to some of the shortcomings of the traditional technologies. When patients are monitored directly, several different methods are used to detect one or more of the factors affecting brain oxygen levels or the effects of brain oxygen imbalances. These methods include invasive jugular bulb catheter monitoring, transcranial Doppler, electroencephalograms, or EEGs, intracranial pressure monitoring, and neurological examination. These methods have not been widely adopted to monitor brain oxygen levels in critical care situations for a variety of reasons. The use of these methods is limited because they are either expensive, difficult or impractical to use, invasive, not reliable under some circumstances, not organ specific, not able to measure more than one factor affecting oxygen imbalances in the brain, or not able to provide continuous information.
Our Solution
Our INVOS System is a non-invasive patient monitoring system that provides continuous information about changes in blood oxygen saturation levels. We believe that our INVOS System addresses the market’s need for a solution that is non-invasive, continuous, immediate, effective and easy to use. The INVOS System, which is predominantly used in hospital critical care areas such as operating rooms and ICUs, consists of a portable monitoring system, including proprietary technology, which is used with multiple single-use disposable sensors. For multi-channel cerebral monitoring, disposable sensors are placed on both sides of a patient’s forehead and are connected to the monitor. The INVOS System uses our proprietary technology to analyze information received from the disposable sensors and provides a continuous digital and trend display of an index of the blood oxygen saturation in the area of the body under the sensors. Our four-channel cerebral and somatic INVOS System monitor, which we launched in the second quarter of 2006, can display information from four disposable sensors. This feature allows for the simultaneous monitoring of changes in blood oxygen saturation in tissues beneath the sensor in four different places in the body in patients with or at risk for restricted blood flow.

Surgeons, anesthesiologists, pediatric and neonatal ICU physicians, and other medical professionals can use the information provided by the INVOS System, in conjunction with other available information, to identify brain and other tissue oxygen imbalances and take necessary corrective action, potentially improving patient outcomes and reducing the costs of care. Once the cause of a cerebral or other tissue oxygen imbalance is identified and therapy is initiated, the INVOS System provides immediate feedback regarding the adequacy of the selected therapy. It can also provide medical professionals with an additional level of assurance when they make decisions regarding the need for therapy.
Unlike some existing monitoring methods, the INVOS System functions even when the patient is unconscious, lacks a strong peripheral pulse or has suppressed neural activity. The measurement made by the INVOS System is dominated by information from the blood in the veins, where the balance of oxygen supply and demand can be more effectively assessed. Therefore, it responds to the changes in factors that affect the balance between oxygen supply and demand, including changes in arterial oxygen saturation, blood flow, hemoglobin concentration and oxygen consumption. The INVOS System responds to global changes in brain or other tissue oxygen levels and to events that affect oxygen levels in the region beneath the sensor.

ICU Data Systems, Inc.
In November 2008, we acquired substantially all of the assets of ICU Data Systems, Inc. ICU Data Systems has developed a patented technology that integrates data from a broad array of hospital bedside devices, such as physiological monitors, ventilators and infusion devices, into a single bedside display for comparison, data management and storage. The data integration technology allows customized presentation of data from various bedside devices for comparison on the same display and on the same timeline. The device can also calculate and display derived parameters, or calculated parameters based on the combination of two or more discrete parameters. In addition, the device can produce user-defined, automated event marks and alerts. All resulting information can be stored for inclusion in the patient record and clinical research.

We plan to further develop and launch our newly-acquired data integration technology as a stand-alone device in mid-2009. The INVOS System is one of many devices whose data can be integrated into the stand-alone device. To support the addition of the derived parameter features to the system, we will pursue a new FDA 510(k) clearance in 2009. In addition, we expect to invest to combine the ICU Data Systems and INVOS System technologies in a single product for launch expected in the second half of 2010. We also plan to pursue a new FDA 510(k) clearance for this integrated device in 2010.
Business Strategy
Our objective is to establish the INVOS System as a standard of care in surgical procedures requiring general anesthesia and in other critical care situations. Key elements of our strategy include to:
• Target Surgical Procedures and Other Critical Care Situations with a High Risk of Oxygen Imbalances. We target surgical procedures and other critical care situations with a high risk of oxygen imbalances. Some of our current and potential future markets include cardiac surgeries, carotid artery surgeries, pediatric and neonatal ICU applications and other major surgeries involving high risk patients. We believe that the medical professionals involved in these surgeries and ICU treatments are most aware of the risks of brain and other damage resulting from oxygen imbalances. Therefore, we believe that it will be easier to demonstrate the clinical importance of the information provided by the INVOS System to these professionals and potentially gain market acceptance for our products in connection with these surgeries and ICU treatments.

• Sponsor Clinical Studies to Promote Expanded Acceptance of the INVOS System. We believe that our INVOS System has been evaluated in over 600 presentations, study abstracts and published papers. During the second quarter of fiscal 2004, results of both the first prospective, randomized clinical trial and a larger retrospective review evaluating the INVOS System were presented, which we believe have contributed to the INVOS System gaining further market penetration. In addition, in January 2007 the results of the first prospective, randomized clinical trial mentioned above were published in a peer-reviewed anesthesia journal. We plan to sponsor clinical studies using the INVOS System to demonstrate its benefits. We are also sponsoring and evaluating sponsorship of other clinical trials which may allow us to more actively target the sale of the INVOS System for use in other high risk patient populations. We use the results of clinical studies to help convince the medical community of the clinical importance of the information provided by the INVOS System. We also sponsor peer-to-peer educational opportunities and promote use of the INVOS System in regional centers of influence that we believe will influence its adoption by others. In early 2008, The Society of Thoracic Surgeons began collecting cerebral oximetry information as part of its STS Adult Cardiac Surgery Database, which is used to develop practice standards intended to improve qualify and safety.

• Invest in Sales and Marketing Activities. We continue to increase our investment in our distribution network consisting of our direct sales employees, independent sales representative firms and distributors. We sell the INVOS System through a direct sales team in the United States, the size of which has increased from 44 persons at the end of fiscal 2006 to 55 persons at the end of fiscal 2008, and two independent sales representative firms. The direct sales team will also be expected to sell our integrated data device. We expect to increase the size of our U.S. direct sales team in fiscal 2009 and are planning to hire direct salespersons and clinical specialists in Europe to support Covidien. We participate in trade shows and medical conferences, ongoing peer-to-peer educational programs and targeted public relations opportunities.

• Interface and Integrate Our Technology into Other Manufacturers’ Multi-Modality Systems . There are many existing monitoring systems in the operating room and the ICU. We would like to interface with these monitors. We have interfaced the INVOS System with the Philips Medical Systems’ VueLink System to provide data, alarm events and status messages from the INVOS System on any monitor that accepts the VueLink module, a multi-parameter monitor. This enables oximetry data from our INVOS System to be displayed on the VueLink screen and integrated with other vital patient information. We plan to support the interface and integration of our INVOS System technology with other medical device

manufacturers to expand the installed base of INVOS System monitors and increase the demand for our sensors. We expect that such arrangements will provide another distribution channel for our INVOS System. We plan to further develop and launch our newly-acquired data integration technology as a stand-alone device in mid-2009. The INVOS System is one of many devices whose data can be integrated into the stand-alone device. In addition, we expect to invest to combine the ICU Data Systems and INVOS System technologies in a single product for launch expected in the second half of 2010. We also plan to pursue a new FDA 510(k) clearance for this integrated device in 2010.

• Develop Additional Applications and Markets for the INVOS System . We have developed a smaller sensor for use with infants, and are making other advances to the design and performance features of the INVOS System, including the disposable sensor. We are also evaluating additional potential market segments for our INVOS System, such as use in other major surgeries, in the adult ICU, and for applications of the technology to monitor other tissues. We are also exploring several novel near-infrared spectroscopy and imaging technologies and products under a Contract Development Agreement with Shirley Research Corporation. See “NeuroPhysics Corporation and Shirley Research Corporation” below. Pursuit of some of these potential market segments may require additional FDA clearance. We believe that these natural extensions of our technology will increase our market potential without the more significant risks and costs associated with developing entirely new products.
The INVOS System
Components of the INVOS System
The INVOS System consists of a portable monitoring system, including proprietary technology, which is used with multiple single-use disposable sensors.
• Monitor . Our oximeter is a portable monitor that uses our proprietary technology to analyze information received from the disposable sensors. It provides a continuous digital and trend display of an index of the oxygen saturation in the region of the body under the sensors. The monitor includes menus for users to set high and low audible alarms, customize the display and retrieve data. Single-function keys allow users to silence alarms, mark important events, store data for up to 28 surgical procedures, and retrieve data by USB storage device or through a direct link to a computer. Our four-channel cerebral and somatic INVOS System monitor, which we launched in the second quarter of 2006, measures approximately 11 inches wide, 9 inches high, and 7 inches deep and weighs approximately 11 pounds. We provide a one-year warranty on the monitor. As of November 30, 2008, we had an installed base of 2,523 INVOS System monitors in the United States in 714 hospitals.

• Disposable sensors . Each single-use disposable sensor contains a light source and two light detectors. For multi-channel cerebral monitoring, disposable sensors are placed on both sides of a patient’s forehead and are connected to the monitor, which allows for monitoring both sides of the brain. Our four-channel cerebral and somatic INVOS System monitor, which we launched in the second quarter of 2006, can display information from four sensors. This feature allows for the simultaneous monitoring of changes in blood oxygen saturation in tissues beneath the sensors in four different places in the body in patients with or at risk for restricted blood flow. The number of sensors used depends on the application. The INVOS System is being used to monitor simultaneously the brain and other tissue initially for patients in the pediatric and neonatal ICU and for monitoring other, non-brain tissue alone, and we expect that it will later also be used on adults for other, non-brain tissue. The disposable sensors contain information that is processed by the INVOS System allowing it to automatically calibrate each sensor. During our fiscal year ended November 30, 2008, net revenues from our disposable sensors comprised approximately 72 percent of our net revenues. During fiscal 2008 we sold 424,647 sensors worldwide.
Overview of INVOS Technology
Our proprietary In Vivo Optical Spectroscopy, or INVOS, technology is based primarily on the physics of optical spectroscopy. Optical spectroscopy is the interpretation of the interaction between matter and light.

Spectrometers and spectrophotometers function primarily by shining light through matter and measuring the extent to which the light is transmitted through, scattered by or absorbed by the matter. Physicians and scientists can use spectrophotometers to examine human blood and tissue. Although most human tissue is opaque to ordinary light, some wavelengths penetrate tissue more easily than others. Therefore, by shining appropriate wavelengths of light into the body and measuring its transmission, scattering and absorption, or a combination of each, physicians can obtain information about the matter under analysis. Optical spectroscopy generates no ionizing radiation and produces no known hazardous effects.
By identifying the hemoglobin and the oxygenated hemoglobin and measuring the relative amounts of each, oxygen saturation of hemoglobin can be measured. However, traditional optical spectroscopy was generally not useful when the substances to be measured were surrounded by, were behind or were near bone, muscle or other tissue, because they produce extraneous data that interferes with analysis of the data from the area being examined.
We have developed a method of reducing extraneous spectroscopic data caused by surrounding bone, muscle and other tissue. This method, which is embedded in our INVOS System, allows us to gather information about portions of the body that previously could not be analyzed using traditional optical spectroscopy. The INVOS System measurement is made by our disposable sensors transmitting low-intensity visible and near-infrared light through a portion of the body and detecting the manner in which the molecules of the exposed substance interact with light at specific wavelengths.
Each single-use disposable sensor contains a light source and two light detectors. The dual detector design of the sensor enables us to measure scattered light intensities from the intermediate tissues of skin, muscle and bone in a separate process. While both detectors receive similar information about the tissue between the sensor and the area under examination, the detector further from the light source detects light that has penetrated deeper into the body, and, therefore, receives more information specific to the brain or other tissue under examination than does the detector closer to the light source. By comparing the two measurements, our INVOS technology is able to suppress the influence of the tissues between the sensor and the brain or other tissue under examination to provide a measurement of changes in brain or other tissue blood oxygen saturation.
Applications and Market Segments
We target the sale of the INVOS System for use in surgical procedures and other critical care situations with a high risk of oxygen imbalances. We believe that our INVOS System has applications for cerebral and other tissue monitoring in the following key market segments:
• Cardiac and Carotid Artery Surgery. Until the first quarter of fiscal 2005, we focused our marketing efforts primarily on cardiac and carotid artery surgeries. We believed it would be easier to demonstrate clinical importance of the information provided by the INVOS System and potentially gain market acceptance for our products in connection with these surgeries. Moreover, much of the earliest clinical data regarding the use of the INVOS System involved these surgeries. In September 2000, we received 510(k) clearance from the FDA to market the model 5100 INVOS System in the United States. Unlike earlier models, the model 5100 INVOS System has the added capability of being able to monitor pediatric patients. After receiving this clearance, we expanded our marketing efforts to include pediatric cardiac surgeries.

MANAGEMENT DISCUSSION FROM LATEST 10K
Forward-Looking Statements
You should read the following discussion and analysis of our financial condition and results of operations together with our financial statements and the related notes and other financial data included elsewhere in this report. Some of the information contained in this discussion and analysis or set forth elsewhere in this report, including information with respect to our plans and strategy for our business, includes forward-looking statements that involve risks and uncertainties. You should review the “Risk Factors” section of this report for a discussion of important factors that could cause actual results to differ materially from the results described in or implied by the forward-looking statements contained in the following discussion and analysis. See also “Forward-Looking Statements” in Item 1A of this report.
Overview
We develop, manufacture and market the INVOS System, a non-invasive patient monitoring system that continuously measures changes in the blood oxygen levels in the brain and elsewhere in the body in tissues beneath the sensor in patients with or at risk for restricted blood flow.
We began commercializing our model 5100 INVOS System internationally in the third quarter of fiscal 1999 and in the United States in the fourth quarter of fiscal 2000. Unlike earlier models, the model 5100 has the added capability of being able to monitor pediatric patients. From product launch until the first quarter of fiscal 2005, we focused our marketing efforts primarily on adult and pediatric cardiac surgeries and carotid artery surgeries. During the second quarter of fiscal 2004, results of both the first prospective, randomized clinical trial and a larger retrospective review evaluating the INVOS System were presented, which we believe have contributed to the INVOS System gaining further market penetration.
In the first quarter of fiscal 2005, we initiated selling and marketing efforts for the INVOS System in the pediatric intensive care unit, or ICU. We are currently expanding the use of our INVOS System in the pediatric and neonatal ICU’s with the launch of our smaller sensor in the first half of fiscal 2008.
In November 2005, we received 510(k) clearance from the FDA to market our INVOS System to monitor changes in somatic tissue blood oxygen saturation in regions of the body other than the brain in patients with or at risk for restricted blood flow. In May 2008, we received 510(k) clearance from the FDA to market our INVOS System to monitor changes in blood oxygen saturation in any tissues beneath the sensor, not limited to brain and somatic tissue, in any individual. Our four-channel cerebral and somatic INVOS System monitor, which we launched in the second quarter of 2006, can display information from four disposable sensors. This feature allows for the simultaneous monitoring of changes in blood oxygen saturation in tissues beneath the sensor in four different places in the body in patients with or at risk for restricted blood flow, in somatic tissue.
In November 2008, we acquired substantially all of the assets of ICU Data Systems, Inc., a technology development company, for approximately $2,000,000 in cash plus the assumption of specified liabilities. ICU Data Systems has developed a patented technology that integrates data from a broad array of hospital bedside devices, such as physiological monitors, ventilators and infusion devices, into a single bedside display for comparison, data management and storage. We plan to further develop and launch our newly-acquired data integration technology as a stand-alone device in mid-2009. The INVOS System is one of many devices whose data can be integrated into the stand-alone device. To support the addition of the derived parameter features to the system, we will pursue a new FDA 510(k) clearance in 2009. In addition, we expect to invest to combine the ICU Data Systems and INVOS System technologies in a single product for launch expected in the second half of 2010. We also plan to pursue a new FDA 510(k) clearance for this integrated device in 2010.

Net Revenues and Cost of Sales
We derive our revenues primarily from sales of INVOS Systems to hospitals in the United States through our direct sales team and independent sales representative firms, although we expect to derive modest revenues in fiscal 2009 from our newly-acquired data integration technology, which we plan to launch as a stand-alone device in mid-2009 through our direct sales team. Outside the United States, we have distribution agreements with independent distributors for the INVOS System, including Covidien, formerly Tyco Healthcare, in Europe, Canada, the Middle East and South Africa, and Edwards Lifesciences Ltd. in Japan. Our cost of sales represent the cost of producing monitors and disposable sensors. Revenues from outside the United States contributed 20 percent to our fiscal 2008 net revenues. As a percentage of net revenues, the gross margins from our international sales are typically lower than gross margins from our U.S. sales, reflecting the difference between the prices we receive from distributors and from direct customers.
We recognize revenue when there is persuasive evidence of an arrangement with the customer, the product has been delivered, the sales price is fixed or determinable, and collectibility is reasonably assured. The product is considered delivered to the customer once we have shipped it, as this is when title and risk of loss have transferred. Payment terms are generally net 30 days for U.S. sales and net 60 days or longer for international sales.
Our INVOS System revenues are derived from the sale of monitors and our disposable sensors. We intend that disposable sensors will form the basis of a recurring revenue stream. In addition, we offer to our customers in the United States a no capital cost sales program whereby we ship the INVOS System monitor to the customer at no charge. Under this program, we do not recognize any revenue upon the shipment of the monitor. At the time of shipment of the monitor, we capitalize the monitor as an asset and depreciate this asset over five years, and this depreciation is included in cost of goods sold. We recognize sensor revenue when we receive purchase orders and ship the product to the customer.

Operating Expenses Selling, general and administrative expenses generally consist of:

• salaries, wages and related expenses of our employees and consultants;

• sales and marketing expenses, such as employee sales commissions, commissions to independent sales representatives, travel, entertainment, advertising, education and training expenses, depreciation of demonstration monitors and attendance at selected medical conferences;

• clinical research expenses, such as costs of supporting clinical trials; and

• general and administrative expenses, such as the cost of corporate operations, professional services, stock compensation, insurance, warranty and royalty expenses, investor relations, depreciation and amortization, facilities expenses and other general operating expenses.

We have increased the size of our direct sales team from 44 persons at the end of fiscal 2006 to 55 persons at the end of fiscal 2008. We expect to increase the size of our U.S. direct sales team in fiscal 2009 and are planning to hire direct salespersons and clinical specialists in Europe to support Covidien. We also expect increased sales and marketing expenses and increased stock compensation expenses in fiscal 2009. As a result, we expect selling, general and administrative expenses to increase in fiscal 2009.

Research, development and engineering expenses consist of:

• salaries, wages and related expenses of our research and development personnel and consultants;

• costs of various development projects; and

• costs of preparing and processing applications for FDA clearance of new products.
For the fiscal year ended November 30, 2006, we recorded a research and development expense of $1,000,000 in connection with our former contract development and exclusive licensing agreement with NeuroPhysics Corporation.

We expect our research and development expenses to increase in fiscal 2009 as a result of development costs associated with our newly-acquired data integration technology, development costs associated with our Contract Development Agreement with Shirley Research Corporation and the addition of research and development personnel.
Deferred Tax Assets and Impairment Charges
For the fiscal year ended November 30, 2006, we adjusted our deferred tax asset valuation allowance resulting in the recognition of additional deferred tax assets due to expected future tax benefits related to our net operating loss carryforwards. Recognition of this additional deferred tax asset resulted in a non-cash net tax benefit on our statement of operations for fiscal 2006 of $750,000.
For the fiscal year ended November 30, 2007, we recognized income tax expense at an estimated effective tax rate of 35 percent on our statement of operations. This income tax expense included a non-cash tax expense on our statement of operations for fiscal 2007 of $5,076,276. In November 2007, we wrote off obsolete inventory of $180,521.
For the fiscal year ended November 30, 2008, we recognized income tax expense at an estimated effective tax rate of 36 percent on our statement of operations. This income tax expense included a non-cash tax expense on our statement of operations for fiscal 2008 of $5,586,906. In addition, during fiscal 2008 we recognized deferred tax assets related to the exercise of stock options of approximately $1,012,000. These assets were recognized in additional paid in capital on our balance sheet because they were utilized and reduced current taxes payable.
Results of Operations
Fiscal Year Ended November 30, 2008 Compared to Fiscal Year Ended November 30, 2007
Net Revenues. Our net revenues increased $8,869,785, or 23 percent, from $38,585,832 in the fiscal year ended November 30, 2007 to $47,455,617 in the fiscal year ended November 30, 2008. The increase in net revenues is primarily attributable to:
• an increase in U.S. sales of $6,474,215, or 21 percent, from $31,560,930 in fiscal 2007 to $38,035,145 in fiscal 2008. The increase in U.S. sales was primarily due to an increase in sales of the disposable sensor of $5,619,820, or 23 percent, primarily as a result of a 16 percent increase in sensor unit sales. In addition, sales of the INVOS System monitor in the United States increased $932,969, or 14 percent, primarily as a result of increased purchases by pediatric hospitals; and

• an increase in international sales of $2,395,570, or 34 percent, from $7,024,902 in fiscal 2007 to $9,420,472 in fiscal 2008. The increase in international sales was primarily due to increased purchases of our INVOS System monitor and disposable sensors of $1,655,456 by Covidien in Europe, and $686,471 by Edwards Lifesciences in Japan. In fiscal 2008, international sales represented 20 percent of our net revenues, compared to 18 percent of our net revenues in fiscal 2007. Purchases by Covidien accounted for 14 percent of net revenues in fiscal 2008, compared to 13 percent in fiscal 2007.
In the United States, we sold 288,797 disposable sensors in fiscal 2008, and internationally, we sold 135,850. We placed 517 INVOS System monitors in the United States and 621 internationally in fiscal 2008, and our installed base of INVOS System monitors in the United States was 2,523, in 714 hospitals, as of November 30, 2008.

We believe that the current economic downturn in the United States and abroad could significantly lengthen the sales cycle for our products and reduce the growth in our net revenues in fiscal 2009.
Gross Margin. Gross margin as a percentage of net revenues was 87 percent for the fiscal year ended November 30, 2008 and 88 percent for the fiscal year ended November 30, 2007. The decrease in our gross margin percentage is primarily attributable to increased international sales, due to lower margins we receive on sales to our international distributors. This decrease was partially offset by a six percent increase in the average selling price of disposable sensors in the United States, which is attributable to increased sales of our pediatric sensors, which sell for a higher price than the adult sensor.
Research, Development and Engineering Expenses. Our research, development and engineering expenses increased $590,412, or 88 percent, from $668,815 in fiscal 2007 to $1,259,227 in fiscal 2008. The increase is primarily attributable to an increase in salaries of $279,487 due to the addition of research and development personnel in fiscal 2007 and 2008, and increased costs associated with advances to the design and performance features of our INVOS System monitor and disposable sensors of $214,803. We expect our research, development and engineering expenses to increase in fiscal 2009 primarily as a result of development costs associated with development of our newly-acquired data integration technology as a stand-alone device, development of a single product combining the data integration technology with our INVOS System technology, development costs associated with advances to the design and performance features of the INVOS System, including the disposable sensor, development costs associated with our Contract Development Agreement with Shirley Research Corporation and the hiring of additional research and development personnel.
Selling, General and Administrative Expenses. Selling, general and administrative expenses increased $3,896,936, or 17 percent, from $22,269,184 for the fiscal year ended November 30, 2007 to $26,166,120 for the fiscal year ended November 30, 2008, primarily due to:

We expect our selling, general and administrative expenses to increase in fiscal 2009, primarily as a result of our hiring additional direct sales personnel in fiscal 2008 and 2009, increased employee sales commissions payable as a result of increased sales, increased sales and marketing expenses and increased stock compensation expenses.
Other Income. During fiscal 2008, interest income decreased to $2,629,967, from $4,008,537 in fiscal 2007, primarily due to decreased interest rates, decreased investment balances, and the use of cash for the repurchase of common shares, partially offset by our increased cash and cash equivalents balances as a result of cash provided by operating activities and maturities and redemptions of investments.
Income Taxes. As of November 30, 2008, we recognized income tax expense at an estimated effective tax rate of 36 percent on our statement of operations. In addition, during fiscal 2008 we recognized deferred tax assets related to the exercise of stock options of approximately $1,012,000. These assets were recognized in additional paid in capital on our balance sheet because they were utilized and reduced current taxes payable. As of November 30, 2007, we recognized income tax expense at an estimated effective tax rate of 35 percent on our statement of operations.
Fiscal Year Ended November 30, 2007 Compared to Fiscal Year Ended November 30, 2006
Net Revenues. Our net revenues increased $9,885,232, or 34 percent, from $28,700,600 in the fiscal year ended November 30, 2006 to $38,585,832 in the fiscal year ended November 30, 2007. The increase in net revenues is primarily attributable to:
• an increase in U.S. sales of $8,284,866, or 36 percent, from $23,276,064 in fiscal 2006 to $31,560,930 in fiscal 2007. The increase in U.S. sales was primarily due to an increase in sales of the disposable sensor of $5,691,400, or 30 percent, primarily as a result of a 24 percent increase in sensor unit sales. In addition, sales of the INVOS System monitor in the United States increased $2,841,360, or 75 percent, primarily as a result of increased purchases by pediatric hospitals; and

• an increase in international sales of $1,600,366, or 30 percent, from $5,424,536 in fiscal 2006 to $7,024,902 in fiscal 2007. The increase in international sales was primarily due to increased purchases of the INVOS System monitor and disposable sensors by Covidien, formerly Tyco Healthcare, in Europe, and increased purchases by Edwards Lifesciences in connection with the launch of our four-channel cerebral and somatic INVOS System monitor in Japan, partially for evaluation and demonstration purposes. In fiscal 2007, international sales represented 18 percent of our net revenues, compared to 19 percent of our net revenues in fiscal 2006. Purchases by Covidien accounted for 13 percent of net revenues in fiscal 2007, compared to 15 percent in fiscal 2006.
In the United States, we sold 248,360 sensors in fiscal 2007, and internationally, we sold 122,690. We placed 509 INVOS System monitors in the United States and 434 internationally in fiscal 2007, and our installed base of INVOS System monitors in the United States was 2,006, in 664 hospitals, as of November 30, 2007.

Other Income. During fiscal 2007, interest income increased to $4,008,537, from $2,582,033 in fiscal 2006, primarily due to our increased cash, cash equivalents, marketable securities and long-term investment balances as a result of cash provided by operating activities and the proceeds from our public offering of common shares that closed in the second quarter of fiscal 2006, and increased interest rates.
Income Taxes. As of November 30, 2007, we recognized income tax expense at an estimated effective tax rate of 35 percent on our statement of operations, and we expect this to continue for future periods. As of November 30, 2006, we further adjusted our deferred tax asset valuation allowance resulting in the recognition of additional deferred tax assets as a result of expected future tax benefits related to our net operating loss carryforwards. Recognition of this additional deferred tax asset resulted in a non-cash tax benefit on our statement of operations for fiscal 2006 of $750,000, and increased our net income for fiscal 2006 to $10,399,957, or $0.75 per diluted common share. For fiscal 2006, the reversal of our valuation allowance was net of recorded taxes. The net income tax benefit of $750,000 consisted of income tax expense recorded at an estimated effective tax rate of 34 percent in the amount of $2,604,663 for the first three quarters of fiscal 2006, and a net deferred tax benefit of $3,354,663 recorded in the fourth quarter of fiscal 2006.

MANAGEMENT DISCUSSION FOR LATEST QUARTER

On August 7, 2009, Somanetics Corporation filed a patent infringement action against CAS Medical Systems, Inc. in the United States District Court for the Eastern District of Michigan. The complaint asserts that CAS Medical’s FORE-SIGHT ® Cerebral Oximeter willfully infringes upon one or more of Somanetics’ patents. The complaint also asserts that CAS Medical has engaged in unfair competition and false advertising, by making false or misleading statements in connection with its advertising and promotion of FORE-SIGHT, and false or misleading statements related to Somanetics’ products. The complaint seeks, among other things, compensation for damages and an injunction against CAS Medical from infringing upon Somanetics’ patents. CAS Medical Systems, Inc.’s CEO has stated that he does not believe CAS Medical has infringed on these patents or engaged in unfair competition and that it intends to vigorously defend all of the claims.

On April 3, 2008, we publicly announced that our Board of Directors authorized the repurchase of up to $15 million of our common shares. Purchases may be made from time to time in the open market or in privately negotiated transactions. The prices, timing and amount of, and purposes for, any purchases will be determined by management. On May 9, 2008, we publicly announced that our Board of Directors approved an increase in the limit on the share repurchase program and authorized the repurchase of up to an additional $15 million of our common shares, and on July 1, 2008, we publicly announced that our Board of Directors approved an increase in the limit on the share repurchase program and authorized the repurchase of up to an additional $15 million of our common shares, for a total of $45 million of our common shares under the repurchase program. During the fiscal year 2008, we repurchased 1,805,129 common shares at an average price of $17.42 per share and an aggregate cost of $31,449,420. All of the shares were purchased by us in open-market transactions pursuant to this publicly-announced share repurchase program. The program does not have an expiration date, except upon purchase of the maximum authorized dollar amount of our common shares.

CONF CALL

Mary Ann Victor
Thank you. Good morning everyone. Thank you for attending our third quarter 2009 investor conference call.
Statements concerning our future business, operating results, expected net revenues, anticipated investments and other guidance are forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. Such statements are based upon management’s expectations as of today, September 17, 2009. You are cautioned not to place undue reliance on these statements. Information contained in these statements is inherently uncertain and actual performance and results may differ materially.
Factors that could cause results to differ materially from any forward-looking statements include economic conditions in general and in the healthcare market, including the recent global economic crisis; market demand for our products; our dependence on the INVOS System and disposable sensors; and on distributors for a substantial portion of our sales; single source suppliers; competition; the management of our growth; our ability to attract and retain key personnel; the potential for product liability claims; government regulation; challenges associated with developing products and obtaining and maintaining regulatory approval; research and development; the lengthy sales cycle for our product; employee turnover; changes in actual or estimated future income; changes in accounting rules; enforceability and cost of enforcement of patents; potential infringements of others patents; the effect of acquisitions and other factors set forth from time to time in our SEC filings.
The company undertakes no obligation to revise or publicly release the results of any revisions in today’s forward-looking statements.
Now I will turn the call over to our President and CEO, Bruce Barrett.
Bruce J. Barrett
Thank you, Mary Ann. Good morning and welcome to our call.
We began our third quarter with the extension of our exclusive distribution agreement with Covidien in Europe, the Middle East and Africa. This extension enables us to move forward developing our INVOS Cerebral/Somatic Oximeter business in these important markets with an excellent partner.
In August we completed our initial hiring and training of personnel in Europe to support Covidien. We now have four people dedicated to the European market, with one person in each of Germany, Italy, France and Spain.
Also during the quarter we continued to make progress establishing the INVOS System in adult cardiovascular surgeries and laying the groundwork to capitalize on our entry into the neonatal ICU. We also experienced early success with adoption of the INVOS System for use during soldier surgeries performed with patients in a seated position, a new market opportunity that I will discuss later. And we initiated the launch of our Vital Sync System that integrates data from various bedside devices.
In August we filed a patent infringement and unfair competition complaint against CAS Medical Systems in the district court for the eastern district of Michigan. The complaint asserts that CAS Medicals’ FORE-SIGHT Cerebral Oximeter System infringes at least three of Somanetics U.S. patents and that CAS Medical has engaged in a pattern of false and misleading statements in advertising and promoting their device.
From a financial perspective, hospitals continue to limit capital spending and slow adoption of new technology to cope with the adverse economic conditions. U.S. invo system hardware revenue of nearly $1.3 million was almost double what we produced in the second quarter and similar to the same period a year ago. Yet we still found it difficult to finalize capital sales projects.
Purchases of hardware by our international distribution partners were down 58% against a very strong comparative quarter, but also reflecting the global nature of the economic crisis. In the U.S. market sensor revenue increased 13% over the same period a year ago. Sequential growth for sensors over the second quarter was similar to the level we’ve experienced in recent years. Disposable sensor purchases by our international distribution partners increased more than 20% over the same period a year ago.
We delivered strong earnings in the quarter, with diluted earnings per share of $0.17. Throughout the year we have slowed expansion of the U.S. sales and education team and generally managed our investments in response to the adverse economic environment.
We have completed beta testing for our new Vital Sync System and in August we completed initial training of our U.S. field sales and education team to initiate promotion of the system. While this is a capital sale that will take time to produce revenue, we are encouraged by early experience in the marketplace. In particular, early customer feedback reinforces our belief that the Vital Sync System will provide us a tool to accelerate research and understanding of the INVOS System, as well as further differentiate our product in the ICU environment.
In the neonatal ICU, customer response to the INVOS System has been very positive and we are encouraged by feedback from our early users as well as our clinical researchers. While the economic environment has greatly slowed early adoption in the neonatal ICU, we continue to work a growing number of new business opportunities as well as pursue further development for the value proposition for the INVOS System in this important market segment.
With regards to the value proposition, we are working to reduce the cost of use by extending the number of days a sensor can be used on a patient. Currently our sensors are labeled for 24 hour use and are difficult to re-adhere once removed. To extend the useful life of a sensor and reduce the cost of monitoring per day, we are validating and preparing a new FDA 510(k) filing to obtain clearance for an off-the-shelf adhesive solution that can be placed between the sensor and the patient that will permit removal and reapplication of the same sensor for several days. Our neonatal customers and advisors have indicated that extending the use of our sensors in this way would largely address the cost of use issue.
On the value side of the equation, many independent studies are ongoing that we expect to further establish the benefits of use of the INVOS System in the neonatal ICU. Certain of these studies are establishing normal and critical values for oxygen saturation of the brain, kidneys and bowels for patients of various gestational ages. This information allows clinicians to identify patients with abnormal vital organ profusion so they can take corrective action and assess the impact of the therapies. The results of one such study of 100 term and pre-term infants was recently published in the Journal of Neurovascular Research. These data give customers a basic understanding of the values they should expect in normal term and pre-term infants to use as a baseline for understanding when patients fall outside the norm.
Also, Dr. Istvan Seri from L.A. Children’s Hospital, who is a leading expert in hemodynamics and shock in neonates, directed and completed extensive neonatal piglet research in the period. This series of studies assessed the impact of various cardiac drugs routinely used in neonates on brain, bowel and kidney oxygenation and profusion. The results of these experiments seem to conclusively demonstrate the value of the INVOS System in managing cardiac drug use in neonates.
Other studies are evaluating the relationship between INVOS System values and clinical outcomes or pathologies. For example, we are very encouraged by early data evaluating the role of monitoring the regional oxygen saturation of the bowels in pre-term infants at risk of bowel ischemia or neck. Several studies relating to this topic are ongoing, and as these and other results are published we expect to build a stronger argument for use of the INVOS System in the neonatal ICU.
Overall, we are pleased with the progress we are making with our business in a challenging economic environment.
And now Bill is going to review our financial results in more detail for the periods. Bill?
William M. Iacona
Thanks, Bruce.
As we reported this morning, our net revenues for the third quarter were $12.5 million, a 1% increase over the same period of 2008. For the nine months ended August 31, net revenues were $35.5 million, a 5% increase over 2008. U.S. net revenues increased 10% in Q3 to $10.4 million and represented approximately 83% of our total sales for the quarter. For the nine months ended August 31, U.S. net revenues increased 5% to $28.4 million and represented 80% of our total company sales.
For the third quarter, U.S. disposable sensor revenues grew 13% to $9.1 million and our INVOS hardware decreased 2% to approximately $1.3 million. For the first nine months of 2009, U.S. disposable sensor revenues increased 15% to $25.6 million and our INVOS hardware revenues decreased 42% to approximately $2.8 million, reflecting slower hospital capital equipment spending in the U.S. as a result of the current economic climate.
Our international net revenues in Q3 were $2.1 million, a decrease of 28% from $3 million in Q3 ’08, primarily due to reduced purchases of our INVOS System monitor by Covidien in Europe, reflecting slower hospital capital equipment spending in Europe. Year-to-date our international net revenues increased 5% to $7.1 million.
For the quarter ended August 31, we placed 89 INVOS monitors in 53 hospital accounts in the United States. Internationally we sold 87 INVOS monitors. For the nine months ended, we placed 277 INVOS monitors in the U.S. and 360 OUS. As of August 31, 2009 our installed base of INVOS monitors in the U.S. grew to 2,800 monitors in more than 750 hospitals. In the third quarter, our U.S. sensor unit sales increased 10% to 83,540 and year-to-date U.S. sensor units grew 11% to 235,806.
Our combined pediatric and neonatal sensor sales accounted for approximately 35% of total U.S. sensor revenues and 27% of total U.S. sensor units for the quarter and year-to-date 2009. Total company sensor unit sales increased 12% to 132,130 in the third quarter of 2009 and increased 17% to 366,726 for the nine month period.
Gross margin was strong at 88% for the third quarter of 2009 compared to 86% in the same period a year ago, primarily due to an increased percentage of U.S. sales in Q3 of ’09. Year-to-date gross margin percentage was 87% for 2009 and 2008, consistent with our expected gross margin.
During 2009, our operating expenses have increased, primarily as a result of continued investments in sales and marketing and research and development, the establishment of our international BV and related branches in Europe and the hiring of international sales employees. For the three and nine months ended August 31, our operating expenses have increased 20% and 14% respectively compared to 2008, primarily due to items such as trade shows, sales training, recruiting, international sales hires and administrative expenses, as well as investments in R&D headcount and project expenses.
Q3 operating income was $3.2 million compared to $4.2 million a year ago, and year-to-date operating income was $7.6 million compared to $9.1 million in the first nine months of 2008.
Income before income taxes for the quarter was $3.5 million and net income for Q3 was $2.2 million or $0.17 per diluted share. Year-to-date income before income taxes was $8.5 million compared to $11.3 million a year ago and net income for the first nine months of 2009 was $5.3 million compared with $7.1 million in the same period of 2008.
Our balance sheet and operating cash flow continue to remain strong with cash, marketable securities and long-term investments totaling approximately $77.7 million as of August 31. And cash flow from operations for the first nine months of the year were approximately $7.9 million. The company has no borrowings.
I will now turn the call back over to Bruce, who will talk about the business for the remainder of 2009.
Bruce J. Barrett
Thank you, Bill.
At the end of the second quarter we offered guidance for net revenues in the range of $50 to $52 million and operating margin of approximately 20%. To achieve $50 million in revenue we need to deliver the same percentage of our total year sales in the fourth quarter that we’ve achieved in each of the past few years. While economic headwinds may pose a threat, given this history and our new business pipeline we are maintaining our revenue guidance.
With regards to operating margin, we previously offered guidance that operating margin as a percent of sales would come in at about 20% on continuing operations. Through nine months, operating margin is at 21.4% and w]]>Fri, 15 Jan 2010 05:22:50 GMThttp://www.dailystocks.com/forum/showtopic.php?tid/3743/http://www.dailystocks.com/forum/showtopic.php?tid/3743/
BPW Acquisition (BPW)
Loeb Arbitrage Management holds 2,183,363 shares (5.3%), after buying 199,363 from Dec. 18 through Dec. 28 at $10.36 a share.

BUSINESS OVERVIEW

Company Overview

We are a blank check company formed in Delaware on October 12, 2007. We were formed to effect a merger, capital stock exchange, asset acquisition, stock purchase, reorganization or other similar business combination with one or more operating businesses, which we refer to throughout this Annual Report as our initial business combination. We will focus on a business combination or combinations in the financial services or business services industries, but we may effect a business combination with a business outside those industries. We intend to effect our initial business combination using cash from the proceeds of our initial public offering, our capital stock, debt or a combination of cash, stock and debt.

On March 3, 2008, we completed our initial public offering of 35,000,000 units with each unit consisting of one share of our common stock and one warrant, each to purchase one share of our common stock at an exercise price of $7.50 per share. The units from the initial public offering were sold at an offering price of $10.00 per unit, generating total gross proceeds of $350 million. Simultaneously with the consummation of our initial public offering, we consummated the private sale of a total of 8,600,000 warrants to our sponsors at a price of $1.00 per warrant, generating gross proceeds of $8,600,000. After deducting the underwriting discounts and commissions and the initial public offering expenses, approximately $348,650,000 of the proceeds from the initial public offering and the private placement was deposited into a trust account maintained by Mellon Bank, N.A., as account agent. Such funds will not be released from the trust account to us until the earlier of completion of our initial business combination or our liquidation, although we may withdraw up to an aggregate of approximately $4.0 million of the interest income accumulated on the funds. After the payment of approximately $750,000 in expenses relating to the initial public offering plus the $9.1 million of underwriting discounts and commissions, $100,000 of the net proceeds of the public offering and private placement was not deposited into a trust account and retained by us for working capital purposes. Through December 31, 2008, we have generated approximately $3.4 million of interest earned on the net proceeds of our initial public offering held in the trust account, of which $860,000 was distributed to pay income taxes and $650,000 for working capital. Of the $650,000 distributed for working capital purposes, together with the $100,000 from the initial public offering not deposited in the trust account and $25,000 in initial founders’ equity, approximately $400,000 was used to pay offering costs and approximately $343,000 for operating and formation costs. The net proceeds deposited into the trust account remain on deposit in the trust account earning interest. As of December 31, 2008, there was $350,530,373 including interest earned and not distributed of $1,880,373 held in the trust account.

We are not presently engaged in, and we will not engage in, any substantive commercial business until we consummate an initial business combination. We intend to utilize our cash, including the funds held in the trust account, capital stock, debt or a combination of the foregoing in effecting an initial business combination. An initial business combination may involve the acquisition of, or merger with, a company which does not need substantial additional capital but which desires to establish a public trading market for its shares, while avoiding what it may deem to be adverse consequences of undertaking a public offering itself. These include time delays, significant expense, loss of voting control and compliance with various Federal and state securities laws. In the alternative, we may seek to consummate an initial business combination with a company that may be financially unstable or in its early stages of development or growth.

Recent Developments

On March 6, 2009, Michael E. Martin resigned as our Chief Executive Officer and Gary S. Barancik was appointed as our new Chief Executive Officer. Mr. Martin will continue to serve as our Chairman of the Board. For more information on Mr. Barancik, please see “Directors and Executive Officers”.

Selection of a target business and structuring of our initial business combination

Subject to the requirements that a target business or businesses have a collective fair market value of at least 80% of the balance in the trust account (excluding deferred underwriting discounts and commissions of $15.4 million) at the time of the signing of a definitive agreement in connection with our initial business combination and that we acquire control of the target business or businesses, our management has virtually unrestricted flexibility in identifying and selecting one or more prospective target businesses. In the event we structure our initial business combination to acquire less than 100% of the equity interests of the target business, we will only consummate such initial business combination if we become the controlling stockholder of the target. The key factor that we will rely on in determining controlling stockholder status will be our acquisition of at least 50.1% of the voting equity interests of the target company. We will not consider any such equity transaction that does not meet such criteria.

If we issue securities in order to consummate an initial business combination, our stockholders could end up owning a minority of the combined company’s voting securities as there is no requirement that our stockholders own a certain percentage of our company (or, depending on the structure of the initial business combination, an ultimate parent company that may be formed) after our business combination.

factors and criteria our management deems relevant to our business objective. In evaluating a prospective target business, we expect to conduct an extensive due diligence review which will encompass, among other things, meetings with management and employees, legal and accounting due diligence, inspection of facilities, calls with vendors and customers, as well as a review of financial and other information which will be made available to us.

The time required to select and evaluate a target business and to structure and complete our initial business combination, and the costs associated with this process, are not currently ascertainable with any degree of certainty. Any costs incurred with respect to the identification and evaluation of a prospective target business with which our initial business combination is not ultimately completed will result in our incurring losses and will reduce the funds we can use to complete another business combination. We will not, nor will a target business, pay or award any finders’ or consulting fees to, nor will any be earned by, members of our management team, or any of their respective affiliates, for services rendered to or in connection with our initial business combination.

Fair market value of target business or businesses

Our initial business combination must occur with one or more target businesses that collectively have a fair market value of at least 80% of the balance in the trust account (excluding deferred underwriting discounts and commissions of $15.4 million) at the time of the signing of a definitive agreement in connection with our initial business combination. If we acquire less than 100% of a target business in our initial business combination, the aggregate fair market value of the portion we acquire must equal at least 80% of the balance in the trust account (excluding deferred underwriting discounts and commissions) at the time of the signing of a definitive agreement in connection with our initial business combination. We may seek to consummate our initial business combination with an initial target business or businesses with a collective fair market value in excess of 80% of the balance in the trust account (excluding deferred underwriting discounts and commissions) at the time of the signing of a definitive agreement in connection with our initial business combination. This may be accomplished by identifying and effecting a business combination with a single business or by identifying and contemporaneously effecting a business combination with multiple operating businesses, which may or may not be related. In order to consummate our initial business combination, we may issue a significant amount of our debt or equity securities to the sellers of such business and/or seek to raise additional funds through a private offering of debt or equity securities. There are no limitations on our ability to incur debt or issue securities in order to consummate our initial business combination regardless of whether or not we acquire a target business or businesses having a collective fair market value substantially in excess of 80% of the balance in the trust account (excluding deferred underwriting discounts and commissions). If we issue securities in order to consummate such an initial business combination, our stockholders could end up owning a minority of the combined company’s voting securities as there is no requirement that our stockholders own a certain percentage of our company (or, depending on the structure of the initial business combination, an ultimate parent company that may be formed) after our business combination. Since we have no specific business combination under consideration, we have not entered into any such arrangement to issue our debt or equity securities and have no current intention of doing so.

In contrast to many other companies with business plans similar to ours that must combine with one or more target businesses that have a fair market value equal to 80% or more of the acquirer’s net assets, we will not combine with a target business or businesses unless the fair market value of such entity or entities meets a minimum valuation threshold of 80% of the amount in the trust account (excluding deferred underwriting discounts and commissions of $15,400,000) at the time of the signing of a definitive agreement in connection with our initial business combination. We have used this criterion to provide investors and our management team with greater certainty as to the fair market value that a target business or businesses must have in order to qualify for our initial business combination with us. The determination of net assets requires an acquirer to have deducted all liabilities from total assets to arrive at the balance of net assets. Given the on-going nature of legal, accounting, stockholder meeting and other expenses that will be incurred immediately before and at the time of our initial business combination, the balance of an acquirer’s total liabilities may be difficult to ascertain at a were deposited in the trust account, we expect that the initial per-share liquidation price (without taking into account any interest earned on the trust account) will be approximately $9.96, or $0.04 less than the per-unit offering price of $10.00. The proceeds deposited in the trust account could, however, become subject to claims of our creditors that are in preference to the claims of our stockholders. In addition, if we are forced to file a bankruptcy case or an involuntary bankruptcy case is filed against us that is not dismissed, the proceeds held in the trust account could be subject to applicable bankruptcy law, and may be included in our bankruptcy estate and subject to the claims of third parties with priority over the claims of our stockholders. Therefore, we cannot assure you that the actual per-share liquidation price will not be less than approximately $9.96.

Under the Delaware General Corporation Law, stockholders may be held liable for claims by third parties against a corporation to the extent of distributions received by them in a dissolution. If the corporation complies with certain procedures set forth in Section 280 of the Delaware General Corporation Law intended to ensure that it makes reasonable provision for all claims against it, including a 60-day notice period during which any third-party claims can be brought against the corporation, a 90-day period during which the corporation may reject any claims brought, and an additional 150-day waiting period before any liquidating distributions are made to stockholders, any liability of stockholders with respect to a liquidating distribution is limited to the lesser of such stockholder’s pro rata share of the claim or the amount distributed to the stockholder, and any liability of the stockholder would be barred after the third anniversary of the dissolution. However, we do not intend to comply with those procedures since, as stated above, it is our intention to make liquidating distributions to our stockholders as soon as reasonably possible after February 26, 2010 (or up to August 26, 2010 if extended pursuant to a stockholder vote) in the event our initial business combination has not been consummated. As such, our stockholders could potentially be liable for any claims to the extent of distributions received by them (but no more) and any liability of our stockholders may extend beyond the third anniversary of such date. Because we will not be complying with Section 280, Section 281(b) of the Delaware General Corporation Law requires us to adopt a plan that will provide for our payment, based on facts known to us at such time, of (i) all existing claims, including all contingent, conditional, or unmatured contractual claims known to us, (ii) all pending claims and (iii) all claims that may be potentially brought against us within the subsequent ten years. Accordingly, we would be required to provide for any claims of creditors known to us at that time or those that we believe could be potentially brought against us within the subsequent ten years prior to our distributing the funds in the trust account to our public stockholders. As a result, if we liquidate, the per-share distribution from the trust account could be less than $9.96 due to claims or potential claims of creditors. However, because we are a blank check company, rather than an operating company, and our operations are limited to searching for prospective target businesses to acquire, the only likely claims to arise would be from third parties, including lenders, with whom we entered into contractual relationships following the consummation of our initial public offering, vendors and service providers that we engage after the consummation of our initial public offering (such as accountants, lawyers, investment bankers, etc.) and potential target businesses and, as discussed above, we will seek to have all such third parties, vendors and service providers and prospective target businesses execute agreements with us waiving any right, title, interest or claim of any kind they may have in or to any monies held in the trust account.

Our public stockholders will be entitled to receive funds from the trust account only in the event of the expiration of our corporate existence and our liquidation or if they seek to convert their respective shares into cash upon our initial business combination or an extension of the time period within which we must complete an initial business combination as described in this Annual Report, which the stockholder voted against and which is approved and, in the case of the initial business combination, consummated. In no other circumstances will a stockholder have any right or interest of any kind to or in the trust account.

Competition

In identifying, evaluating and selecting a target business for an initial business combination, we may encounter intense competition from other entities having a business objective similar to ours, including other blank check companies, private equity groups and leveraged buyout funds, and operating businesses seeking strategic acquisitions. Many of these entities are well established and have extensive experience identifying and effecting business combinations directly or through affiliates. Moreover, many of these competitors possess greater financial, technical, human and other resources than us. Our ability to acquire larger target businesses will be limited by our available financial resources. This inherent limitation gives others an advantage in pursuing the acquisition of a target business. Furthermore:

MANAGEMENT DISCUSSION FROM LATEST 10K

Overview

We are a blank check company, formed on October 12, 2007, to effect a merger, capital stock exchange, asset acquisition, stock purchase, reorganization or other similar business combination with one or more operating businesses in the financial services or business services industries. We intend to effect such initial business combination using cash from the proceeds of our recently completed initial public offering and the private placements of the sponsors’ warrants, our capital stock, debt or a combination of cash, stock and debt.

The registration statement for our initial public offering was declared effective on February 26, 2008 (the “Effective Date”). We consummated our initial public offering on March 3, 2008 and received gross proceeds of $350,000,000 from the initial public offering and $8,600,000 from the sale of the sponsors’ warrants. We sold 35,000,000 units at the offering price of $10.00 per unit. Each unit consists of one share of our common stock and one warrant. Each warrant entitles the holder to purchase from us one share of common stock at an exercise price of $7.50 commencing the later of the completion of a our initial business combination or one year from the Effective Date and expiring six years from the Effective Date. We may redeem the warrants, at a price of $0.01 per warrant upon 30 days’ notice after the warrants become exercisable, only in the event that the last sale price of the common stock is at least $13.25 per share for any 20 trading days within a 30-trading day period ending on the third day prior to the date on which the notice of redemption is given. In accordance with the warrant agreement relating to the warrants, we are only required to use our best efforts to maintain the effectiveness of the registration statement covering the warrants. We will not be obligated to deliver securities, and there are no contractual penalties for failure to deliver securities, if a registration statement is not effective at the time of exercise. Additionally, in the event that a registration is not effective at the time of exercise, the holder of such warrant shall not be entitled to exercise such warrant and in no event (whether in the case of a registration statement not being effective or otherwise) will we be required to net cash settle the warrant exercise. Consequently, the warrants may expire unexercised and unredeemed.

Pursuant to an amended and restated sponsors’ warrants subscription agreement dated February 19, 2008, our sponsors have purchased from us, in the aggregate, 8,600,000 sponsors’ warrants for $8,600,000. The purchase and issuance of the sponsors’ warrants occurred simultaneously with the consummation of our initial public offering on a private placement basis. All of the proceeds we received from these purchases were placed in the trust account. The sponsors’ warrants are identical to the warrants included in the units sold in our initial public offering, except that (i) the sponsors’ warrants will not be transferable or salable (except to permitted transferees) until we complete our initial business combination, (ii) they are exercisable at the discretion of the holder for cash or on a cashless basis and (iii) are non-redeemable by us so long as they are held by the sponsors or their permitted transferees. If we do not complete an initial business combination, then the $8,600,000 paid in consideration for the sponsors’ warrants will be part of the liquidating distribution to our public stockholders, and the sponsors’ warrants will expire worthless.

We entered into an underwriting agreement with the underwriters of our initial public offering. The underwriting agreement required us to pay 2.6% of the gross proceeds of the initial public offering as an underwriting discount plus an additional 4.4% of the gross proceeds only upon consummation of our initial business combination. We paid an underwriting discount of 2.6% of the gross proceeds ($9,100,000) in connection with the consummation of our initial public offering and have placed 4.4% of the gross proceeds ($15,400,000) in the trust account. We did not pay any discount related to the sponsors’ warrants sold in the private placements. The underwriters have waived their right to receive payment of the 4.4% of the gross proceeds upon the our liquidation if we are unable to complete our initial business combination.

Results of Operations and Known Trends or Future Events

Through December 31, 2008, our efforts have been limited to organizational activities, activities relating to our initial public offering, activities relating to identifying and evaluating prospective acquisition candidates, and activities relating to general corporate matters; we have not generated any revenues, other than interest income earned on the proceeds of our initial public offering. As of December 31, 2008, approximately $350.5 million was held in the trust account (including $15.4 million of deferred underwriting commissions, $8.6 million from the sale of warrants to the initial stockholders and approximately $1.9 million in income earned) and we had cash outside of trust of approximately $32,000.

For the twelve months ended December 31, 2008, we earned approximately $3.4 million in interest income. All of our funds in the trust account are invested in U.S. “government securities,” defined as any Treasury Bill issued by the United States having a maturity of 180 days or less, or in money market funds meeting certain conditions under Rule 2a-7 promulgated under the Investment Company Act of 1940 that only invest in such “government securities” having a maturity of 180 days or less. As of December 31, 2008, the funds in the trust account were invested in the “Dreyfus Treasury Prime Cash Management” money market fund, a fund which invests exclusively in U.S. Treasury securities.

We have agreed to pay Perella Weinberg Partners Group LP, an affiliate of one of our sponsors, a total of $10,000 per month for office space and administrative services, including secretarial support. During the year ended December 31, 2008, we paid $100,000 under this agreement.

Off Balance Sheet Requirements

We have no obligations, assets or liabilities which would be considered off-balance sheet arrangements. We do not participate in transactions that create relationships with unconsolidated entities or financial partnerships, often referred to as variable interest entities, which would have been established for purposes of off-balance sheet arrangements.

We have not entered into any off-balance sheet financing arrangements, established any special purpose entities, guaranteed any debt or commitments of other entities or entered into any options on non-financial assets.

Contractual Obligations

We do not have any long term debt, capital lease obligations, operating lease obligations or long term liabilities other than a monthly fee of $10,000 for office space and certain office and secretarial services payable to Perella Weinberg Partners Group LP, an affiliate of one of our sponsors. We began incurring this fee on February 26, 2008 and will continue to incur this fee monthly until the completion of our initial business combination or our liquidation.

Critical Accounting Policies

Accounting and Reporting by Development Stage Enterprises

We comply with the accounting and reporting requirements of Statement of Financial Accounting Standards (“SFAS”) No. 7, “Accounting and Reporting by Development Stage Enterprises.”

Redeemable Common Stock

We account for redeemable common stock in accordance with the Financial Accounting Standards Board’s (“FASB”) Emerging Issue Task Force D-98 “Classification and Measurement of Redeemable Securities” (“EITF D-98”) which provides that securities that are redeemable for cash or other assets are classified outside of permanent equity if they are redeemable at the option of the holder. In addition, if the redemption causes a liquidation event, the redeemable securities should not be classified outside of permanent equity.

Income (Loss) per Common Share

We comply with the accounting and disclosure requirements of SFAS No. 128, “Earnings Per Share.” Basic income (loss) per common share for all periods is computed by dividing income (loss) applicable to common stockholders by the weighted average number of common shares outstanding for the period. Diluted income (loss) per share reflects the potential dilution that could occur assuming common shares were issued upon the exercise of outstanding in the money warrants and the proceeds thereof were used to purchase common shares at the average market price during the period. We use the treasury stock method to calculate potentially dilutive shares, as if they were converted into common stock at the beginning of the period.

Our statement of operations includes a presentation of income (loss) per share for common stock subject to possible redemption in a manner similar to the two-class method of income (loss) per common share. Basic and diluted income (loss) per common share for the maximum number of shares subject to possible redemption is calculated by dividing the net interest income attributable to common shares subject to redemption ($0 for the year ended December 31, 2008) by the weighted average number of shares subject to possible redemption. Basic and diluted income (loss) per common share for the shares outstanding not subject to possible redemption is calculated by dividing the net income (loss) exclusive of the net interest income attributable to common shares subject to redemption by the weighted average number of shares not subject to possible redemption.

Income Taxes

We comply with SFAS 109, “Accounting for Income Taxes,” which requires an asset and liability approach to financial accounting and reporting for income taxes. Deferred income tax assets and liabilities are computed for differences between the financial statement and tax bases of assets and liabilities that will result in future taxable or deductible amounts, based on enacted tax laws and rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established, when necessary, to reduce deferred tax assets to the amount expected to be realized.

We also comply with the provisions of the Financial Accounting Standards Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”). FIN 48 prescribes a recognition threshold and measurement process for recording in the financial statements uncertain tax positions taken or expected to be taken in a tax return. FIN 48 also provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosures and transitions. We adopted FIN 48 on the inception date, October 12, 2007. We did not recognize any adjustments for uncertain tax positions during the year ended December 31, 2008.

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Recent Accounting Pronouncements

In December 2007, the FASB issued SFAS No. 141(R), “Business Combinations”. SFAS No. 141(R) replaces SFAS No. 141 and establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, any noncontrolling interest in the acquiree and the goodwill acquired. SFAS No. 141(R) also establishes disclosure requirements which will enable users to evaluate the nature and financial effects of the business combination. Acquisition costs associated with the business combination will generally be expensed as incurred. SFAS No. 141(R) is effective for business combinations occurring in fiscal years beginning after December 15, 2008, which will require us to adopt these provisions for business combinations occurring in fiscal 2009 and thereafter. The adoption of SFAS No. 141(R) will not have a material impact on our financial statements; however, it could impact future transactions entered into by us.

In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements—An Amendment of ARB No. 51”. SFAS No. 160 requires reporting entities to present noncontrolling (minority) interests as equity as opposed to as a liability or mezzanine equity and provides guidance on the accounting for transactions between an entity and noncontrolling interests. SFAS No. 160 is effective the first fiscal year beginning after December 15, 2008, and interim periods within that fiscal year. SFAS No. 160 applies prospectively as of the beginning of the fiscal year SFAS No. 160 is initially applied, except for the presentation and disclosure requirements which are applied retrospectively for all periods presented subsequent to adoption. The adoption of SFAS No. 160 will not have a material impact on our financial statements; however, it could impact future transactions entered into by us.

In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities—An Amendment to FASB Statement No. 133”. SFAS No. 161 is intended to improve financial standards for derivative instruments and hedging activities by requiring enhanced disclosures to enable investors to better understand their effects on an entity’s financial position, financial performance, and cash flows. Entities are required to provide enhanced disclosures about: (a) how and why an entity uses derivative instruments; (b) how derivative instruments and related hedged items are accounted for under Statement 133 and its related interpretations; and (c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. It is effective for financial statements issued for fiscal years beginning after November 15, 2008, with early adoption encouraged. The adoption of this statement is not expected to have a material effect on our results of operations or financial position; however, it could impact future transactions entered into by us.


MANAGEMENT DISCUSSION FOR LATEST QUARTER

The following discussion should be read in conjunction with our condensed Financial Statements and notes thereto contained in this report.

Forward Looking Statements

All statements other than statements of historical fact included in this Form 10-Q including, without limitation, statements under “Management’s Discussion and Analysis of Financial Condition and Results of Operations” regarding our financial position, business strategy and the plans and objectives of management for future operations, are “forward looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act and Section 21E of the Exchange Act. When used in this Form 10-Q, words such as “anticipate,” “believe,” “estimate,” “expect,” “intend” and similar expressions, as they relate to us or our management, identify forward looking statements. Such forward looking statements are based on the beliefs of management, as well as assumptions made by, and information currently available to, our management. Actual results could differ materially from those contemplated by the forward looking statements as a result of certain factors detailed in our filings with the SEC. All subsequent written or oral forward looking statements attributable to us or persons acting on our behalf are qualified in their entirety by this paragraph.

Overview and Initial Public Offering

We are a blank check company, formed on October 12, 2007, to effect a merger, capital stock exchange, asset acquisition, stock purchase, reorganization or other similar business combination with one or more operating businesses in the financial services or business services industries. We intend to effect this Business Combination using cash from the proceeds of our recently completed Offering and the Private Placements of the Sponsors’ Warrants, our capital stock, debt or a combination of cash, stock and debt.

The registration statement for the Offering was declared effective on February 26, 2008 (the “Effective Date”). We consummated the Offering on March 3, 2008 and received gross proceeds of $350,000,000 from the Offering and $8,600,000 from the sale of the Sponsors’ Warrants. We sold 35,000,000 Units at the offering price of $10.00 per Unit. Each Unit consists of one share of our common stock and one Warrant. Each Warrant entitles the holder to purchase from us one share of common stock at an exercise price of $7.50 commencing the later of the completion of a Business Combination or one year from the Effective Date and expiring six years from the Effective Date. We may redeem the Warrants, at a price of $0.01 per Warrant upon 30 days’ notice after the Warrants become exercisable, only in the event that the last sale price of the common stock is at least $13.25 per share for any 20 trading days within a 30-trading day period ending on the third day prior to the date on which the notice of redemption is given. In accordance with the warrant agreement relating to the Warrants, we are only required to use our best efforts to maintain the effectiveness of the registration statement covering the Warrants. We will not be obligated to deliver securities, and there are no contractual penalties for failure to deliver securities, if a registration statement is not effective at the time of exercise. Additionally, in the event that a registration is not effective at the time of exercise, the holder of such Warrant shall not be entitled to exercise such Warrant and in no event (whether in the case of a registration statement not being effective or otherwise) will we be required to net cash settle the warrant exercise. Consequently, the Warrants may expire unexercised and unredeemed.

Pursuant to an Amended and Restated Sponsors’ Warrants Subscription Agreement dated February 19, 2008, our Sponsors have purchased from us, in the aggregate, 8,600,000 Sponsors’ Warrants for $8,600,000. The purchase and issuance of the Sponsors’ Warrants occurred simultaneously with the consummation of the Offering on a private placement basis. All of the proceeds we received from these purchases were placed in the Trust Account. The Sponsors’ Warrants are identical to the Warrants included in the Units sold in the Offering, except that (i) the Sponsors’ Warrants will not be transferable or salable (except to permitted transferees) until we complete our initial Business Combination, (ii) they are exercisable at the discretion of the holder for cash or on a cashless basis and (iii) are non-redeemable by us so long as they are held by the Sponsors or their permitted transferees. If we do not complete a Business Combination then the $8,600,000 paid in consideration for the Sponsors’ Warrants will be part of the liquidating distribution to our public stockholders, and the Sponsors’ Warrants will expire worthless.

We entered into an Underwriting Agreement with the underwriters of the Offering. The Underwriting Agreement required us to pay 2.6% of the gross proceeds of the Offering as an underwriting discount plus an additional 4.4% of the gross proceeds only upon consummation of a Business Combination. We paid an underwriting discount of 2.6% of the gross proceeds ($9,100,000) in connection with the consummation of the Offering and have placed 4.4% of the gross proceeds ($15,400,000) in the Trust Account. We did not pay any discount related to the Sponsors’ Warrants sold in the Private Placements. The underwriters have waived their right to receive payment of the 4.4% of the gross proceeds upon our liquidation if we are unable to complete a Business Combination.

We intend to utilize cash derived from the Offering, our capital stock, debt or combination of cash, capital stock and debt, to effect a Business Combination.

Results of Operations and Known Trends or Future Events

For the three months ended September 30, 2009, for the nine months ended September 30, 2009 and for the period from October 12, 2007 (inception) to September 30, 2009, we had net income (loss) of $(54,866), $(179,070) and $1,750,744, respectively. Our income was all derived from interest and dividends on the net proceeds of the Offering. We incurred $228,809, $602,541 and $1,073,121 in formation and operating costs during the three months ended September 30, 2009, for the nine months ended September 30, 2009 and for the period from October 12, 2007 (inception) to September 30, 2009, respectively.

All activity from October 12, 2007 (inception) through March 3, 2008 relates to our formation and the Offering described above. Since March 4, 2008, we have been searching for a target company to acquire. We believe that we have sufficient funds available to complete our efforts to effect a Business Combination with an operating business within the required 24 months (or up to 30 months if our stockholders approve an extension period) the from the date of the Offering.

Liquidity and Capital Resources

As of September 30, 2009, we had cash of and cash equivalents held in the Trust Account of $349,898,760. Until the Offering, as described above, our only source of liquidity was the proceeds from the initial private sale of our Founders’ Units and the promissory notes made by our Sponsors. As of September 30, 2009, we had repaid these promissory notes. Since the Offering, our only source of funding has been from the interest and dividends earned on our cash accounts. As of September 30, 2009, we have withdrawn $2,470,000 of the interest and dividends earned on the funds held in our Trust Account of which $1,159,000 was for the payment of income taxes and $1,311,000 was released for working capital requirements. Pursuant to the terms of our trust agreement governing our Trust Account, we are entitled to use up to $4,000,000 of the earnings (subject to restrictions for monies needed to pay income tax liabilities) for working capital, provided, however, that the aggregate amount of all such distributions for working capital and income tax payments shall not exceed the total earnings. Therefore, up to $2,689,000 is still to be remitted, for working capital purposes, to our operating account which had a balance of $78,826 as of September 30, 2009. Our liabilities are all related to accrued expenses and costs associated with operating as a public company and searching for an acquisition target. We believe our working capital will continue to be sufficient to fund our operations until a target is acquired.

Off-Balance Sheet Financing Arrangements

We have no obligations, assets or liabilities which would be considered off-balance sheet arrangements. We do not participate in transactions that create relationships with unconsolidated entities or financial partnerships, often referred to as variable interest entities, which would have been established for the purpose of facilitating off-balance sheet arrangements.

We have not entered into any off-balance sheet financing arrangements, established any special purpose entities, guaranteed any debt or commitments of other entities, or entered into any non-financial assets.

Contractual Obligations

We do not have any long-term debt, capital lease obligations, operating lease obligations or long-term liabilities other than a monthly fee of $10,000 for office space and certain office and secretarial services payable to Perella Weinberg Partners Group LP, an affiliate of one of our Sponsors. We began incurring this fee on February 26, 2008 and will continue to incur this fee monthly until the completion of our initial Business Combination or our liquidation.


]]>Thu, 14 Jan 2010 07:01:56 GMThttp://www.dailystocks.com/forum/showtopic.php?tid/3738/http://www.dailystocks.com/forum/showtopic.php?tid/3738/
GenCorp (GY)
Gamco Investors (GBL) increased its holdings to 6,732,426 shares (11.37%), by purchasing 125,250 from Oct. 29 to Dec. 24 at ranging from $6.83 to $8.34 per share.

BUSINESS OVERVIEW

Unless otherwise indicated or required by the context, as used in this Annual Report on Form 10-K, the terms “we,” “our,” and “us” refer to GenCorp Inc. and all of its subsidiaries that are consolidated in conformity with accounting principles generally accepted in the United States of America.

Certain information contained in this Annual Report on Form 10-K should be considered “forward-looking statements” as defined by Section 21E of the Private Securities Litigation Reform Act of 1995. All statements in this report other than historical information may be deemed forward-looking statements. These statements present (without limitation) the expectations, beliefs, plans, and objectives of management and future financial performance and assumptions underlying, or judgments concerning, the matters discussed in the statements. The words “believe,” “estimate,” “anticipate,” “project” and “expect,” and similar expressions, are intended to identify forward-looking statements. Forward-looking statements involve certain risks, estimates, assumptions, and uncertainties, including with respect to future sales and activity levels, cash flows, contract performance, the outcome of litigation and contingencies, environmental remediation, availability of capital, and anticipated costs of capital. A variety of factors could cause actual results or outcomes to differ materially from those expected and expressed in our forward-looking statements. Some important risk factors that could cause actual results or outcomes to differ from those expressed in the forward-looking statements are described in the section “Risk Factors” in Item 1A of this Report.

The list of factors that may affect future performance and the accuracy of forward-looking statements described in the section “Risk Factors” in Item 1A of this Report is illustrative, but by no means exhaustive. Additional risk factors may be described from time to time in our future filings with the Securities and Exchange Commission (SEC). Accordingly, all forward-looking statements should be evaluated with the understanding of their inherent uncertainty. All such risk factors are difficult to predict, contain material uncertainties that may affect actual results and may be beyond our control.

We are a manufacturer of aerospace and defense systems with a real estate segment that includes activities related to the entitlement, sale, and leasing of our excess real estate assets. Our continuing operations are organized into two segments:

Aerospace and Defense — includes the operations of Aerojet-General Corporation (Aerojet) which develops and manufactures propulsion systems for defense and space applications, armament systems for precision tactical weapon systems and munitions applications. We are one of the largest providers of such propulsion systems in the United States (U.S.) and the only U.S. company that provides both solid and liquid propellant based systems. Primary customers served include major prime contractors to the U.S. government, the Department of Defense (DoD), and the National Aeronautics and Space Administration (NASA).

Real Estate — includes activities related to the entitlement, sale, and leasing of our excess real estate assets. We own approximately 12,200 acres of land adjacent to U.S. Highway 50 between Rancho Cordova and Folsom, California, east of Sacramento (Sacramento Land). We are currently in the process of seeking zoning changes, removal of environmental restrictions and other governmental approvals on a portion of the Sacramento Land to optimize its value. We have filed applications with and submitted information to governmental and regulatory authorities for approvals necessary to re-zone approximately 6,000 acres of the Sacramento Land. We also own approximately 580 acres in Chino Hills, California. We are currently seeking removal of environmental restrictions on the Chino Hills property to optimize the value of such land.

Our fiscal year ends on November 30 of each year. When we refer to a fiscal year, such as fiscal 2008, we are referring to the fiscal year ended on November 30 of that year.

Sales, segment performance, total assets, and other financial data for each segment for fiscal 2008, 2007, and 2006 are set forth in Note 10 to the Consolidated Financial Statements, included in Item 8 of this Report.

We were incorporated in Ohio in 1915 and our principal executive offices are located at Highway 50 and Aerojet Road, Rancho Cordova, CA 95742. Our mailing address is P.O. Box 537012, Sacramento, CA 95853-7012 and our telephone number is 916-355-4000.

Our Internet website address is www.GenCorp.com. We have made available through our Internet website, free of charge, our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and

amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 (Exchange Act) as soon as reasonably practicable after such materials are electronically filed with, or furnished to, the SEC. We also make available on our Internet web site our corporate governance guidelines and the charters for each of the following committees of the Company’s Board of Directors: Audit; Corporate Governance & Nominating; and Organization & Compensation. Our corporate governance guidelines and such charters are also available in print to anyone who requests them.

Aerospace and Defense

For over 60 years, Aerojet has been an industry leader and pioneer in the development of critical products and technologies that have strengthened the U.S. military and enabled the exploration of space. Aerojet focuses on developing military, civil, and commercial systems and components that address the needs of the aerospace and defense industry markets. Due to the diversity of its propulsion technologies and the synergy of its product lines, Aerojet believes it is in a unique competitive position to offer its customers the most innovative and advanced solutions available in the domestic propulsion market. Aerojet has been able to capitalize on its strong technical capabilities to become a critical provider of components and systems for major propulsion programs. Aerojet propulsion systems have flown on human and robotic missions for NASA since the inception of the U.S. Space Program, and Aerojet has been a major supplier of propulsion products to the DoD since the founding of Aerojet. Principal customers include the DoD, NASA, United Launch Alliance (ULA), The Boeing Company (Boeing), Lockheed Martin Corporation (Lockheed Martin), and Raytheon Company (Raytheon).


• Defense systems — Our defense system products include liquid, solid, and air-breathing propulsion systems and components. In addition, Aerojet is a supplier of both composite and metallic aerospace structural components, fire suppression systems and armament systems to the DoD and its prime customers. Product applications for our defense systems include strategic, tactical and precision strike missiles, missile defense systems, maneuvering propulsion systems, precision war-fighting systems, and specialty metal products.

• Space systems — Our space systems products include liquid, solid, and electric propulsion systems and components. Product applications for space systems include expendable and reusable launch vehicles, transatmospheric vehicles and spacecraft, separation and maneuvering systems, upper stage engines, satellites, large solid boosters, and integrated propulsion subsystems.

Industry Overview

Broad support continues for DoD and NASA funding in the Government Fiscal Year ending September 30 (GFY), 2009 and beyond. However, these Federal department/agency budgets are under severe pressure due to the cost impacts of the global war on terrorism, the cost of military operations in Iraq and Afghanistan, the ongoing world-wide financial crisis, and a rising U.S. federal deficit. As a result, both the DoD and NASA budgets are expected to grow at modest levels through 2012.

Department of Defense

The Obama Administration has indicated that it is committed to maintaining adequate funding for the Department of Defense and building Defense capabilities for the 21 st century. President Obama’s stated focus areas that directly relate to Aerojet products are: fully equipping U.S forces for the missions they face; preserving global reach in the Air; maintaining power projection at Sea; protecting the U.S in cyberspace; ensuring freedom of Space; and a pragmatic and cost-effective development of Missile Defense. Congress has indicated they plan to work closely with the new Administration on these focus areas.

Following a period of budget decreases in the post-Cold War era, the U.S. defense appropriations have increased in recent years. Defense appropriations have risen to over $487 billion in GFY 2009 from $439 billion in GFY 2008. We expect the U.S. defense budgets for research, development, test and evaluation (RDT&E) and procurement, the primary funding sources for Aerojet’s programs, to remain level, with annual forecasts for RDT&E declining slightly, while procurement continues to show a slight increase through GFY 2012. While the top line DoD budget continues to increase, the Pentagon has announced it plans to reduce the overall rate of growth. Although the ultimate distribution of the Defense budget remains uncertain, Aerojet is well positioned to benefit from DoD investment in: high-priority, transformational systems that address current war fighting requirements; the re-capitalization of weapon systems and equipment being expended during combat deployments; and, systems that meet new threats world-wide.

NASA

Congress and the Obama Administration have indicated they believe NASA funding needs to be increased and more balanced across exploration, science, and aeronautics. NASA is operating under a Continuing Resolution through March 2009, at an annual funding level of $17.3 billion. The Obama Administration and Congress are expected to increase NASA GFY 2009 appropriations above the current Continuing Resolution annual funding level. In addition, there is broad support to fund the Constellation Program which will provide a new crew exploration spacecraft and launch system to replace the Space Shuttle. Earth Science, Space Science, and Aeronautics should receive funding increases.

In 2009, NASA’s primary space exploration objectives will be to: (i) complete construction of the International Space Station; (ii) phase out the Space Shuttle by 2010 at the earliest; (iii) develop Orion, a new crew exploration spacecraft and its launch vehicle Ares I; and (iv) move forward with the Commercial Orbital Transport System, which is designed to resupply the International Space Station.

The Orion prime contractor, Lockheed Martin, selected Aerojet to develop and produce all in-space propulsion for the Orion service and crew modules. In addition, Orbital Sciences, under contract to Lockheed Martin for the Orion launch abort system (LAS) selected Aerojet for significant propulsion work on the LAS program. The Orion program as currently envisioned represents potentially a decade’s long production program for Aerojet that will be the focal point for future U.S. human space exploration.

In addition, we believe Aerojet is well-positioned to provide propulsion solutions for some of NASA’s special interest areas: advanced propellant technology, attitude/reaction control systems, and robotic exploration propulsion. Furthermore, as a result of NASA’s intention to retire the Space Shuttle from service as early as 2010, we believe that NASA will focus on maneuvering and long-duration propulsion systems that are currently available and flight-proven, which may present additional opportunities for existing Aerojet product lines.

Competition

As the only domestic supplier of all four propulsion types — solid, liquid, air-breathing, and electric — we believe that Aerojet is in a unique competitive position. The diversity of its technologies and synergy of its product lines offer Aerojet customers the most innovative and advanced solutions available in the domestic propulsion market. The basis on which Aerojet competes in the Aerospace and Defense industry varies by program, but generally is based upon technology, quality, service, and price. Although market competition is intense, we believe Aerojet possesses innovative and advanced propulsion solutions, combined with adequate resources to continue to compete successfully.

Participation in the defense and space propulsion market can be capital intensive requiring long research and development periods that represent significant barriers to entry. Aerojet may partner on various programs with its major customers or suppliers, some of whom are, from time to time, competitors on other programs.
The domestic solid and liquid propulsion markets remained unchanged in fiscal 2008 with Aerojet in the number two position in both markets, second to Alliant Techsystems in solid propulsion (solids) and Pratt & Whitney Rocketdyne in liquid propulsion (liquids).

Major Customers

As a merchant supplier to the Aerospace and Defense industry, we do not align ourselves with any single prime contractor except on a project-by-project basis. We believe that our position as a merchant supplier has helped us become a trusted partner to our customers, enabling us to maintain strong long-term relationships with a variety of prime contractors. Under each of our contracts, we act either as a subcontractor, where we sell our products to other prime contractors, or as a prime contractor, where we sell directly to the end user.

The principal end user customers of our products and technology are agencies of the U.S. government, U.S. prime contractors, and government agencies. Since a majority of Aerojet’s sales are, directly or indirectly, to the U.S. government, funding for the purchase of Aerojet’s products and services generally follows trends in U.S. defense spending. However, individual government agencies, which include the military services, the Defense Advanced Research Projects Agency, NASA, the Missile Defense Agency, and the prime contractors that serve these agencies, exercise independent purchasing power within “budget top-line” limits. Therefore, sales to the U.S. government are not regarded as sales to one customer, but rather each contracting agency is viewed as a separate customer.

Major Programs

Defense Systems — Aerojet maintained a strong position in the defense market segment in fiscal 2008 with key new and follow-on awards. Significant new wins included the propulsion system for the Joint Air to Ground Missile (JAGM), the Multiple Kill Vehicle System, and other controllable solids programs. Important follow-on awards were received on the propulsion system for the Ground Based Midcourse Defense Exoatmospheric Kill Vehicle Divert and Attitude Controls System (GMD EKV DACS), Standard Missile 3, Standard Missile 3 Throttling Divert Attitude Control System, and F-22 programs. These successes continue to strengthen our position as a propulsion leader in missile defense and tactical systems. In addition, in April 2008, the Company again earned the Boeing Company’s “Supplier of the Year Award” for its commitment to superior performance and customer satisfaction.

Aerojet, who also won a Boeing supplier of the year award in 2005, was one of eleven (11) companies honored for its 2007 performance. We believe Aerojet is in a unique competitive position due to the diversity of propulsion technologies (solid, liquid, and air-breathing), complete warhead capabilities, composites and metallic structures expertise, and the synergy of its product lines to offer defense customers the most innovative and advanced solutions available in the domestic market.

Contract Types

Under each of its contracts, Aerojet acts either as a prime contractor, where it sells directly to the end user, or as a subcontractor, selling its products to other prime contractors. Research and development contracts are awarded during the inception stage of a program’s development. Production contracts provide for the production and delivery of mature products for operational use. Aerojet’s contracts are primarily categorized as either “fixed-price” or “cost-reimbursable.” During fiscal 2008, approximately 46% of our net sales was from fixed-price contracts and 41% from cost-reimbursable contracts.

Fixed-price contracts are typically (i) fixed-price, (ii) fixed-price-incentive fee, or (iii) fixed-price level of effort contracts. For fixed-price contracts, Aerojet performs work for a fixed price and realizes all of the profit or loss resulting from variations in costs of performance. For fixed-price-incentive contracts, Aerojet receives increased or decreased fees or profits based upon actual performance against established targets or other criteria. For fixed-price level of effort contracts, Aerojet generally receives a structured fixed price per labor hour, dependent upon the customer’s labor hour needs. All fixed-price contracts present the risk of unreimbursed cost overruns potentially resulting in losses.

Cost-reimbursable contracts are typically (i) cost plus fixed fee, (ii) cost plus incentive fee, or (iii) cost plus award fee contracts. For cost plus fixed fee contracts, Aerojet typically receives reimbursement of its costs, to the extent the costs are allowable under contractual provisions, in addition to receiving a fixed fee. For cost plus incentive fee contracts and cost plus award fee contracts, Aerojet receives adjustments to the contract fee, within designated limits, based on actual results as compared to contractual targets for factors such as cost, performance, quality, and schedule.

Many programs under contract have product life cycles exceeding 10 years, such as the Standard Missile, TOW, and Tomahawk programs. It is typical for U.S. government propulsion contracts to be relatively small during development phases that can last from two to five years, followed by low-rate and then full-rate production, where annual funding can grow as high as approximately $30 million to $60 million per year over many years.

Government Contracts and Regulations

Our sales are driven by pricing based on costs incurred to produce products or perform services under contracts with the U.S. government. U.S. government contracts generally are subject to Federal Acquisition Regulations (FAR), agency-specific regulations that implement or supplement FAR, such as the DoD’s Defense Federal Acquisition Regulations and other applicable laws and regulations. These regulations impose a broad range of requirements, many of which are unique to government contracting, including various procurement, import and export, security, contract pricing and cost, contract termination and adjustment, and audit requirements. A contractor’s failure to comply with these regulations and requirements could result in reductions of the value of contracts, contract modifications or termination, and the assessment of penalties and fines and could lead to suspension or debarment from government contracting or subcontracting for a period of time. In addition, government contractors are also subject to routine audits and investigations by U.S. government agencies such as the Defense Contract Audit Agency (DCAA). These agencies review a contractor’s performance, cost structure, and compliance with applicable laws, regulations, and standards. The DCAA also reviews the adequacy of, and a contractor’s compliance with, its internal control systems and policies, including the contractor’s purchasing, property, estimating, compensation, and information systems.

Backlog

As of November 30, 2008, our total contract backlog was $1,035 million compared with $912 million as of November 30, 2007. Of our November 30, 2008 contract backlog, approximately $535 million, or 52%, is not expected to be filled within one year. Funded backlog was $675 million and $566 million at November 30, 2008 and 2007, respectively.

Total backlog includes both funded backlog (the amount for which money has been directly authorized by the U.S. Congress, or for which a purchase order has been received from a commercial customer) and unfunded backlog (firm orders for which funding has not been appropriated). Indefinite delivery and quantity contracts and unexercised options are not reported in total backlog. Backlog is subject to delivery delays or program cancellations which are beyond our control.

Research and Development

We view Aerojet research and development efforts as critical to maintain its leadership position in markets in which it competes. We maintain an active research and development effort supported primarily by customer funding. Customer-funded research and development expenditures are funded under contract specifications, typically research and development contracts, several of which we believe may become key programs in the future. We believe customer-funded research and development activities are vital to our ability to compete for contracts and to enhance our technology base.

Aerojet’s company-funded research and development efforts include expenditures for technical activities that are vital to the development of new products, services, processes or techniques, as well as those expenses for significant improvements to existing products or processes.

Suppliers, Raw Materials and Seasonality

The national aerospace supply base continues to consolidate due to economic, environmental, and marketplace circumstances beyond Aerojet’s control. The loss of key qualified suppliers of technologies, components, and materials can cause significant disruption to Aerojet program performance and cost.

Availability of raw materials and supplies to Aerojet is generally sufficient. Aerojet is sometimes dependent, for a variety of reasons, upon sole-source or flight qualified suppliers and has in some instances in the past experienced difficulties meeting production and delivery obligations because of delays in delivery or reliance on such suppliers. We closely monitor sources of supply to assure adequate raw materials and other supplies needed in our manufacturing processes are available. As a U.S. government contractor, we are frequently limited to procuring materials and components from sources of supply that meet rigorous customer and/or government specifications. In addition, as business conditions, DoD budgets, and Congressional allocations change, suppliers of specialty chemicals and materials sometimes consider dropping low-volume items from their product lines. This may require us to qualify new suppliers for raw materials on key programs.

We are also impacted, as is the rest of the industry, by increases in the prices and lead-times of raw materials used in production on various fixed-price contracts. We have seen an increase in the price and lead-times for commodity metals, primarily steel, titanium and aluminum. Aerojet monitors the price and supply of these materials and wherever possible works closely with suppliers to schedule purchases far enough in advance and in the most economical means possible to minimize program impact.

Aerojet’s business is not subject to predictable seasonality. Primary factors affecting the timing of Aerojet’s sales include the timing of government awards, the availability of U.S. government funding, contractual product delivery requirements, and customer acceptances.

Intellectual Property

Where appropriate, Aerojet obtains patents in the U.S. and other countries covering various aspects of the design and manufacture of its products. We consider these patents to be important to Aerojet as they illustrate Aerojet’s innovative design ability and product development capabilities. We do not believe the loss or expiration of any single patent would have a material adverse effect on the business or financial results of Aerojet or on our business as a whole.

Real Estate

Through our Aerojet subsidiary, we own approximately 12,200 acres of land in the Sacramento metropolitan area (Sacramento Land). The Sacramento Land is located 15 miles east of downtown Sacramento, California along U.S. Highway 50, a key growth corridor in the region. We believe the Sacramento Land has competitive advantages over other land in the area, including being one of the largest single-owner land tracts suitable for development in the Sacramento region and being a desirable “in-fill” location surrounded by residential and business properties.

The Sacramento Land was acquired in the early 1950s for our aerospace and defense operations. Most of the Sacramento Land was used to provide safe buffer zones for testing and manufacturing operations. Changes in propulsion technology coupled with the relocation of certain of our propulsion operations led us to determine that some portions of the Sacramento Land were no longer needed for our operations in Sacramento. Consequently, our plan has been to reposition the excess Sacramento Land to optimize its value. We currently have entitlement requests pending for the re-zoning of approximately 6,000 acres of excess Sacramento Land. Our entitlement efforts are expected to increase the excess land value over its current value. The term “entitlements” is generally used to denote the set of regulatory approvals required to allow land to be zoned for requested uses. Required regulatory approvals vary with each land zoning proposal and may include permits, land use master plans, zoning designations, state and federal environmental documentation, and other regulatory approvals unique to the land.

CEO BACKGROUND

Name Date of First Election

Thomas A. Corcoran September 24, 2008
James R. Henderson March 5, 2008
Warren G. Lichtenstein March 5, 2008
David A. Lorber March 31, 2006
James H. Perry May 16, 2008
Martin Turchin March 5, 2008
Robert C. Woods March 31, 2006


MANAGEMENT DISCUSSION FROM LATEST 10K

We begin Management’s Discussion and Analysis of Financial Condition and Results of Operations with an overview of our business and operations, followed by a discussion of our business outlook and results of operations, including results of our operating segments, for the past two fiscal years. We then provide an analysis of our liquidity and capital resources, including discussions of our cash flows, debt arrangements, sources of capital, and financial commitments. In the next section, we discuss the critical accounting policies that we believe are important to understanding the assumptions and judgments incorporated in our reported financial results.

The following discussion should be read in conjunction with the other sections of this Report, including the Consolidated Financial Statements and Notes thereto appearing in Item 8. Consolidated Financial Statements and Supplementary Data of this Report, the risk factors appearing in Item 1A. Risk Factors of this Report and the disclaimer regarding forward-looking statements appearing at the beginning of Item 1. Business of this Report. Historical results set forth in Item 6. Selected Financial Data and Item 8. Consolidated Financial Statements and Supplementary Data of this Report should not be taken as indicative of our future operations.

Overview

We are a manufacturer of aerospace and defense systems with a real estate segment that includes activities related to the entitlement, sale, and leasing of our excess real estate assets. Our continuing operations are organized into two segments:

Aerospace and Defense — includes the operations of Aerojet-General Corporation, or Aerojet, which develops and manufactures propulsion systems for defense and space applications, armament systems for precision tactical weapon systems and munitions applications. We are one of the largest providers of such propulsion systems in the United States (U.S.) and the only U.S. company that provides both solid and liquid propellant based systems. Primary customers served include major prime contractors to the U.S. government, the Department of Defense (DoD), and the National Aeronautics and Space Administration (NASA).

Real Estate — includes activities related to the entitlement, sale, and leasing of our excess real estate assets. We own approximately 12,200 acres of land adjacent to U.S. Highway 50 between Rancho Cordova and Folsom, California, east of Sacramento (Sacramento Land). We are currently in the process of seeking zoning changes, removal of environmental restrictions and other governmental approvals on a portion of the Sacramento Land to optimize its value. We have filed applications with and submitted information to governmental and regulatory authorities for approvals necessary to re-zone approximately 6,000 acres of the Sacramento Land. We also own approximately 580 acres in Chino Hills, California. We are currently seeking removal of environmental restrictions on the Chino Hills property to optimize the value of such land.

On August 31, 2004, we completed the sale of our GDX business. On November 30, 2005, we completed the sale of our Fine Chemicals business. On November 17, 2006, we completed the sale of our Turbo product line. The GDX and Fine Chemicals businesses and the Turbo product line are classified as discontinued operations in the Consolidated Financial Statements and Notes to Consolidated Financial Statements (see Note 12 in Notes to Consolidated Financial Statements).

Net Sales

Consolidated net sales decreased to $742.3 million in fiscal 2008 compared to $745.4 million in fiscal 2007. The decrease was primarily the result of the close-out activities of the Titan program in fiscal 2007 partially offset by the $10.0 million sale of 400 acres of our Sacramento Land in the second quarter of fiscal 2008. In addition, fiscal 2008 includes one additional week of net sales of $19.1 million from Aerojet compared to the comparable periods in fiscal 2007 (see Note 1 in Notes to Consolidated Financial Statements).

Consolidated net sales increased to $745.4 million in fiscal 2007 compared to $621.1 million in fiscal 2006. The increase was the result of higher sales on numerous space and defense programs, including the Standard Missile, Orion, and Titan programs. The increase in the Standard Missile program was primarily due to deliveries associated with awards received in fiscal 2006 and the award of a new contract in fiscal 2007 to develop and qualify the Throttling Divert Attitude Control Systems for the Standard Missile 3 program. Capturing the Orion award in fiscal 2006 is another factor driving the fiscal 2007 increase in net sales. The increase in Titan sales during fiscal 2007 was the result of the final close-out activities of the program.

Effective December 1, 2006, Lockheed Martin and Boeing formed the joint venture United Launch Alliance (ULA). ULA operates the space launch systems using the Atlas V, Delta II, and Delta IV. The formation of ULA impacts the comparability of the net sales in fiscal 2008 and fiscal 2007 to fiscal 2006 for Lockheed Martin and Boeing.

Sales in fiscal 2008, 2007, and 2006 directly and indirectly to the U.S. government and its agencies, including sales to the Company’s significant customers discussed above, totaled $641.7 million, $665.9 million, and $523.5 million, respectively. The demand for certain of the Company’s services and products is directly related to the level of funding of government programs.

During fiscal 2008, approximately 46% of our net sales were from fixed-price contracts and 41% from cost reimbursable contracts.

Income (Loss) from Continuing Operations Before Income Taxes and Cumulative Effect of Changes in Accounting Principles

For fiscal 2008, we reported income from continuing operations before income taxes and cumulative effect of changes in accounting principles of $2.5 million compared to $23.0 million for fiscal 2007. The lower operating results were primarily due to the following:


• Increase of $32.4 million in unusual charges. See discussion of “Unusual Items” below.

• Decline of $12.2 million in segment performance, including environmental provision adjustments, of our Aerospace and Defense segment. See discussion of “Segment Performance” below.

• Decrease of $0.7 million in interest income. The decrease was primarily due to lower average cash levels and rates in fiscal 2008 compared to fiscal 2007.

The factors discussed above were partially offset by the following:


• Decrease of $13.6 million related to employee retirement benefit expense. See discussion of “Retirement Benefit Plans” below.

• Improvement of $6.8 million in segment performance of our Real Estate segment. See discussion of “Segment Performance” below.

• Decrease of $3.5 million related to corporate and other expenses. See discussion of “Corporate and Other Expenses” below.

• Decrease of $0.9 million in interest expense. The decline was primarily due to lower average interest rates on variable rate debt in fiscal 2008.

For fiscal 2007, we reported income from continuing operations before income taxes and cumulative effect of changes in accounting principles of $23.0 million compared to a loss of $43.7 million for fiscal 2006. The improved operating results were primarily due to the following:


• Improvement of $50.8 million in segment performance of our Aerospace and Defense segment. See discussion of “Segment Performance” below.

• Decrease of $21.9 million related to employee retirement benefit expense. See discussion of “Retirement Benefit Plans” below.



• Decrease of $7.8 million in unusual charges. See discussion of “Unusual Items” below.

• Decrease of $4.5 million related to corporate and other expenses. See discussion of “Corporate and Other Expenses” below.

• Increase of $1.3 million in interest income. The increase was primarily due to higher average cash levels and rates during fiscal 2007 compared to fiscal 2006.

The factors discussed above were partially offset by the following:


• Increased interest expense of $1.4 million. The increase was primarily due to higher rates and letter of credit levels during fiscal 2007 compared to fiscal 2006.

Segment Results

We evaluate our operating segments based on several factors, of which the primary financial measure is segment performance. Segment performance, which is a non-GAAP financial measure, represents net sales from continuing operations less applicable costs, expenses and provisions for unusual items relating to the segment. Excluded from segment performance are: corporate income and expenses, interest expense, interest income, income taxes, income or expenses related to divested businesses, and provisions for unusual items not related to the segment. We believe that segment performance provides information useful to investors in understanding our underlying operational performance. Specifically, we believe the exclusion of the items listed above permits an evaluation and a comparison of results for ongoing business operations, and it is on this basis that management internally assesses operational performance.



Aerospace and Defense

Fiscal 2008

Aerojet reports its fiscal year sales and income under a 52/53 week accounting convention. Fiscal 2008 is a 53 week year with the extra week accounted for in the first quarter of fiscal 2008, or one more week than as reported in fiscal 2007. Sales of $725.5 million for fiscal 2008 decreased from $739.1 million in fiscal 2007, reflecting decreases in various programs, including the Titan program, partially offset by the additional week of net sales of $19.1 million in fiscal 2008.

Segment performance was income of $40.8 million in fiscal 2008 compared to income of $61.3 million in fiscal 2007. The decrease in segment performance is primarily the result of: (i) the favorable performance on the close-out of the Titan program in fiscal 2007; (ii) an unusual charge in fiscal 2008 related to the freeze of the defined benefit pension plan; and (iii) higher estimated environmental remediation costs in fiscal 2008; partially offset by decreased retirement benefit plan expense in fiscal 2008.

Fiscal 2007

Sales for fiscal 2007 were $739.1 million compared to $614.6 million for fiscal 2006, representing a 20% increase. Higher sales volume on numerous space and defense system programs generated the improvement in fiscal 2007. Individual programs with sales increases of greater than $20.0 million during fiscal 2007 compared to fiscal 2006 were Standard Missile, Orion, and Titan.

The $50.8 million improvement in segment performance during fiscal 2007 compared to fiscal 2006 is the result of the following: (i) significantly improved margin on the Titan program as the result of favorable performance on close-out activities; (ii) higher sales volume; (iii) lower retirement benefit plan expense; (iv) lower estimated environmental remediation costs in fiscal 2007; and (v) higher expenses in fiscal 2006 related to legal matters.

Real Estate

Fiscal 2008

Sales for fiscal 2008 were $16.8 million compared to $6.3 million for fiscal 2007. Segment performance was $10.3 million and $3.5 million for fiscal 2008 and 2007, respectively. The increases in sales and segment performance are primarily due to the sale of 400 acres of the Sacramento Land to Elliott Homes Inc. (Elliott) for $10.0 million in cash during the second quarter of fiscal 2008.

Fiscal 2007

Real Estate sales and segment performance for fiscal 2007 were $6.3 million and $3.5 million, respectively, compared to $6.5 million and $2.3 million, respectively, for fiscal 2006. Results for fiscal 2007 and 2006 consist of rental property operations and there were no significant sales of real estate assets. During the third quarter of fiscal 2007, we began recognizing nominal royalty income on a mining agreement with Granite Construction Company.

Corporate and Other Expenses

Corporate and other expenses decreased to $16.2 million for fiscal 2008 compared to $19.7 million for fiscal 2007. The decrease primarily related to the reversal of previously recognized stock-based compensation due to the lower fair value of the stock appreciation rights, partially offset by higher charges for estimated future environmental remediation obligations in fiscal 2008.

Corporate and other expenses decreased to $19.7 million in fiscal 2007 compared to $24.2 million in fiscal 2006. The decrease was primarily due to higher expenses related to the election of the Company’s directors in fiscal 2006 and lower costs in fiscal 2007 associated with workers’ compensation matters, partially offset by higher charges for estimated future environmental remediation obligations in fiscal 2007.

On November 25, 2008, we decided to amend our defined benefit pension and benefits restoration plans to freeze future accruals under such plans. Effective February 1, 2009, we discontinued future benefit accruals for current salaried employees. No employees lost their previously earned pension benefit. As a result of the amendment and freeze, we incurred a curtailment charge of $14.6 million in the fourth quarter of fiscal 2008 primarily due to the immediate recognition of unrecognized prior service costs.

On March 5, 2008, we entered into a second amended and restated shareholder agreement (Shareholder Agreement) with Steel Partners II L.P. with respect to the election of Directors for the 2008 Annual Meeting and certain other related matters which resulted in a charge of $13.8 million in the first half of fiscal 2008. Additionally,

MANAGEMENT DISCUSSION FOR LATEST QUARTER

Unless otherwise indicated or required by the context, as used in this Quarterly Report on Form 10-Q, the terms " we, ” “ our” and " us” refer to GenCorp Inc. and all of its subsidiaries that are consolidated in conformity with accounting principles generally accepted in the United States of America.
The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires us to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates. In addition, our operating results for interim periods may not be indicative of the results of operations for a full year. This section contains a number of forward-looking statements, all of which are based on current expectations and are subject to risks and uncertainties including those described in this Quarterly Report under the heading “Forward-Looking Statements.” Actual results may differ materially. This section should be read in conjunction with our Annual Report on Form 10-K for the fiscal year ended November 30, 2008, and periodic reports subsequently filed with the Securities and Exchange Commission (“SEC”).
Overview
We are a manufacturer of aerospace and defense systems with a real estate segment that includes activities related to the entitlement, sale, and leasing of our excess real estate assets. Our continuing operations are organized into two segments:
Aerospace and Defense — includes the operations of Aerojet-General Corporation (“Aerojet”) which develops and manufactures propulsion systems for defense and space applications, armament systems for precision tactical weapon systems and munitions applications. We are one of the largest providers of such propulsion systems in the United States (“U.S.”) and the only U.S. company that provides both solid and liquid propellant based systems. Primary customers served include major prime contractors to the U.S. government, the Department of Defense (“DoD”), and the National Aeronautics and Space Administration (“NASA”).
Real Estate — includes activities related to the entitlement, sale, and leasing of our excess real estate assets. We own approximately 12,200 acres of land adjacent to U.S. Highway 50 between Rancho Cordova and Folsom, California, east of Sacramento (“Sacramento Land”). We are currently in the process of seeking zoning changes, removal of environmental restrictions and other governmental approvals on a portion of the Sacramento Land to optimize its value. We have filed applications with and submitted information to governmental and regulatory authorities for approvals necessary to re-zone approximately 6,000 acres of the Sacramento Land. We also own approximately 580 acres in Chino Hills, California. We are currently seeking removal of environmental restrictions on the Chino Hills property to optimize the value of such land.
On August 31, 2004, we completed the sale of our GDX Automotive (“GDX”) business. The remaining subsidiaries after the sale of GDX, including Snappon SA, are classified as discontinued operations in these Unaudited Condensed Consolidated Financial Statements (see Note 12 of the Unaudited Condensed Consolidated Financial Statements).

Primary reason for change. The increase in net sales for the third quarter of fiscal 2009 compared to the third quarter of fiscal 2008 was primarily the result of growth in the various Standard Missile programs and increased deliveries on the Patriot Advanced Capability — 3 and Atlas V programs, partially offset by lower sales volume on the Orion program as a result of NASA funding constraints.

Primary reason for change. The increase in net sales volume for the first nine months of fiscal 2009 compared to the first nine months of fiscal 2008 was primarily the result of growth in the various Standard Missile programs, partially offset by lower sales volume on the Orion program as a result of NASA funding constraints, sale of our Sacramento Land for $10.0 million in the second quarter of fiscal 2008, and an additional week of operations in the first quarter of fiscal 2008 resulting in $19.1 million in sales.


Discontinued Operations:
In November 2003, we announced the closing of a GDX manufacturing facility in Chartres, France owned by Snappon SA, a subsidiary of the Company. The decision resulted primarily from declining sales volumes with French automobile manufacturers. In June 2004, we completed the legal process for closing the facility and establishing a social plan. In fiscal 2004, an expense of approximately $14.0 million related to employee social costs was recorded in accordance with SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities. An expense of $1.0 million was recorded during fiscal 2005 primarily related to employee social costs that became estimable in fiscal 2005. During the first nine months of fiscal 2009, Snappon SA had legal judgments rendered against it under French law, aggregating $4.0 million related to wrongful discharge claims by certain former employees of Snappon SA. During the second quarter of fiscal 2009, Snappon SA filed for declaration of suspensions of payments with the clerk’s office of the Paris Commercial Court (see Note 8(a) of the Unaudited Condensed Consolidated Financial Statements).

Recently Adopted Accounting Pronouncements
As of November 30, 2007, we adopted Statement of Financial Accounting Standards (“SFAS”) No. 158 (“SFAS 158”), Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans , which requires that the consolidated balance sheets reflect the funded status of the pension and postretirement plans. Effective November 30, 2009, we will adopt the measurement provision of SFAS 158 which requires measurement of the pension and postretirement plans assets and benefit obligations at our fiscal year end. We currently perform this measurement as of August 31 of each fiscal year.
On December 1, 2007, we adopted the provisions of Financial Accounting Standards Board (“FASB”) Interpretation No. 48, Accounting for Uncertainty in Income Taxes (“FIN 48”). As of December 1, 2007, we had $3.2 million of unrecognized tax benefits, $3.0 million of which would impact our effective tax rate if recognized. The adoption resulted in a reclassification of certain tax liabilities from current to non-current, a reclassification of certain tax indemnification liabilities from income taxes payable to other current liabilities, and a cumulative effect adjustment benefit of $9.1 million that was recorded directly to our accumulated deficit. We recognize interest and penalties related to uncertain tax positions in income tax expense. Interest and penalties are immaterial at the date of adoption and are included in unrecognized tax benefits. As of August 31, 2009, our accrued interest and penalties related to uncertain tax positions is immaterial. The tax years ended November 30, 2005 through November 30, 2008 remain open to examination for U.S. federal income tax purposes. For our other major taxing jurisdictions, the tax years ended November 30, 2004 through November 30, 2008 remain open to examination.
On December 1, 2007, we adopted the provisions of SFAS No. 157 (“SFAS 157”), Fair Value Measurements , for financial instruments. Although the adoption of SFAS 157 did not materially impact our financial position or results of operations, we are now required to provide additional disclosures in the notes to our financial statements.
On December 1, 2007, we adopted SFAS No. 159 (“SFAS 159”), The Fair Value Option for Financial Assets and Financial Liabilities, including an amendment of FASB Statement No. 115 . At the date of adoption, we did not elect to use the fair value option for any of our outstanding financial assets or liabilities. Accordingly, the adoption of SFAS 159 did not have an impact on our financial position, results of operations, or cash flows.
As of December 1, 2008, we adopted Emerging Issues Task Force (“EITF”) No. 07-03 (“EITF 07-03”), Accounting for Non-Refundable Advance Payments for Goods or Services to Be Used in Future Research and Development Activities . EITF 07-03 provides guidance on whether non-refundable advance payments for goods that will be used or services that will be performed in future research and development activities should be accounted for as research and development costs or deferred and capitalized until the goods have been delivered or the related services have been rendered. The adoption of EITF 07-03 did not have a material impact on our financial position, results of operations, or cash flows.
As of December 1, 2008, we adopted Staff Position SFAS 157-2, Effective Date of FASB Statement No. 157, which approved a one-year deferral of SFAS 157 as it relates to non-financial assets and liabilities.
As of August 31, 2009, we adopted SFAS No. 165 (“SFAS 165”), Subsequent Events , which provides authoritative accounting literature for a topic that was previously addressed only in the auditing literature. The guidance in SFAS 165 largely is similar to the current guidance in the auditing literature with some exceptions that are not intended to result in significant changes in practice. The adoption of SFAS 165 in the third quarter of fiscal 2009 did not have a material impact on our financial position, results of operations, or cash flows.

New Accounting Pronouncements
In December 2007, the FASB issued SFAS No. 141 (revised 2007), Business Combinations (“SFAS 141(R)”). Under SFAS 141(R), an entity is required to recognize the assets acquired, liabilities assumed, contractual contingencies, and contingent consideration at their fair value on the acquisition date. It further requires that acquisition-related costs be recognized separately from the acquisition and expensed as incurred; that restructuring costs generally be expensed in periods subsequent to the acquisition date; and that changes in accounting for deferred tax asset valuation allowances and acquired income tax uncertainties after the measurement period be recognized as a component of the provision for taxes. In addition, acquired in-process research and development is capitalized as an intangible asset and amortized over its estimated useful life. The adoption of SFAS 141(R) will change our accounting treatment for business combinations on a prospective basis beginning December 1, 2009.
In December 2007, the FASB issued SFAS No. 160 (“SFAS 160”), Noncontrolling Interests in Consolidated Financial Statements—an amendment of ARB No. 51. SFAS 160 changes the accounting and reporting for minority interests, which will be recharacterized as non-controlling interests and classified as a component of equity. The adoption of SFAS 160 will change the accounting treatment for minority interests on a prospective basis beginning December 1, 2009. As of August 31, 2009, we did not have any minority interests. Accordingly, the adoption of SFAS 160 is not expected to impact our consolidated financial statements.
In May 2008, the FASB issued Staff Position No. Accounting Principles Board 14-1, Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement (“FSP APB 14-1”), which is effective for fiscal years beginning after December 15, 2008. FSP APB 14-1 clarifies that convertible debt instruments that may be settled in cash upon conversion are not addressed by paragraph 12 of Accounting Principles Board Opinion No. 14, Accounting for Convertible Debt and Debt Issued with Stock Purchase Warrants . FSP APB 14-1 also specifies that issuers of such instruments should separately account for the liability and equity components in a manner that will reflect the entity’s nonconvertible debt borrowing rate when interest cost is recognized in subsequent periods. We are currently evaluating the effect of FSP APB 14-1, and we have not yet determined the impact of the standard on our financial position or results of operations. However, we believe the adoption of FSP APB 14-1 will significantly increase non-cash interest expense.
In December 2008, the FASB issued Staff Position SFAS No. 132(R)-1 (“SFAS 132(R)-1”), Employers’ Disclosures about Postretirement Benefit Plan Assets, which provides guidance on disclosures about plan assets of a defined benefit pension or other postretirement plans. SFAS 132(R)-1 is effective for fiscal years beginning after December 15, 2009. The adoption of SFAS 132(R)-1 will not impact our financial position or results of operations, however, it will require us to provide additional disclosures as part of our financial statements.
In June 2009, the FASB issued Statement No. 168, The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles, a replacement of FASB Statement No. 162 (the “Codification”). The Codification, which was launched on July 1, 2009, became the single source of authoritative non-governmental GAAP, superseding various existing authoritative accounting pronouncements. The Codification establishes one level of authoritative GAAP. All other literature is considered non-authoritative. This Codification is effective for financial statements issued for interim and annual periods ending after September 15, 2009. We will adopt the Codification in the fourth quarter of fiscal 2009. There will be no change to our consolidated financial statements due to the implementation of the Codification other than changes in reference to various authoritative accounting pronouncements in the consolidated financial statements.
Operating Segment Information:



We evaluate our operating segments based on several factors, of which the primary financial measure is segment performance. Segment performance, which is a non-GAAP financial measure, represents net sales from continuing operations less applicable costs, expenses and provisions for unusual items relating to the segment. Excluded from segment performance are: corporate income and expenses, interest expense, interest income, income taxes, legacy income or expenses, and provisions for unusual items not related to the segment. We believe that segment performance provides information useful to investors in understanding our underlying operational performance. Specifically, we believe the exclusion of the items listed above permits an evaluation and a comparison of results for ongoing business operations, and it is on this basis that management internally assesses operational performance.

Primary reason for change. The increase in net sales for the third quarter of fiscal 2009 compared to the third quarter of fiscal 2008 was primarily the result of growth in the various Standard Missile programs and increased deliveries on the Patriot Advanced Capability — 3 and Atlas V programs, partially offset by lower sales volume on the Orion program as a result of NASA funding constraints.

Significant factors impacting the increase in segment performance were as follows: (i) a decrease of $5.6 million in non-cash retirement benefit plan expense primarily due to the freeze of the defined benefit pension and benefit restoration plans as well as the increase in the discount rate used to determine benefit obligations partially offset by lower expected investment returns; (ii) a decrease of $2.1 million for estimated future environmental remediation obligations; and (iii) favorable contract performance on higher net sales as a result of a decrease in overhead spending in the third quarter of fiscal 2009 compared to the third quarter of fiscal 2008 and other resulting in a $4.1 million increase in segment performance.

Primary reason for change . The increase in net sales volume for the first nine months of fiscal 2009 compared to the first nine months of fiscal 2008 was primarily the result of growth in the various Standard Missile programs, including deliveries to qualify the Throttling Divert Attitude Control Systems, and increased deliveries on the Patriot Advanced Capability — 3 program, partially offset by lower sales volume on the Orion program as a result of NASA funding constraints and an additional week of operations in the first quarter of fiscal 2008 resulting in $19.1 million in sales.

The increase in segment performance during the first nine months of fiscal 2009 as compared to the first nine months of fiscal 2008 period is primarily the result of: (i) a decrease of $16.9 million in non-cash retirement benefit plan expense primarily due to the freeze of the defined benefit pension and benefit restoration plans as well as the increase in the discount rate used to determine benefit obligations partially offset by lower expected investment returns and (ii) a decrease of $3.7 million for estimated future environmental remediation obligations.

Total backlog includes both funded backlog (the amount for which money has been directly appropriated by the U.S. Congress, or for which a purchase order has been received from a commercial customer) and unfunded backlog (firm orders for which funding has not been appropriated). Indefinite delivery and quantity contracts and unexercised options are not reported in total backlog. Backlog is subject to delivery delays or program cancellations which are beyond our control.
Real Estate Segment
We believe that the long-term prospects for the Sacramento real estate market remain attractive despite current economic conditions. We are continuing our efforts to enhance the value of our excess real estate assets by entitling approximately 6,000 acres of our Sacramento land as a master-planned community under the brand name “Easton.” Comprised of four “boroughs” located along a major state highway and transit corridor, the Easton plan is subject to the authority of three jurisdictions: the County of Sacramento, the City of Folsom, and the City of Rancho Cordova, as well as numerous state and federal regulatory agencies. As envisioned, Easton will provide a diversified range of residential, commercial and recreational uses in a desirable in-fill location.

CONF CALL

Linda Cutler

Before we start I’d like to remind you that during this conference call GenCorp’s management team may make forward-looking statements as defined by the Private Litigation Reform Act of 1995.

All statements in this conference call and in subsequent discussions other than historical information are forward-looking statements. These statements represent management’s current judgment on expectations for future operations. We encourage you to review the cautionary language regarding the forward-looking statements and the factors contained in the earnings release issued today, as well as management’s discussion and analysis and elsewhere in our most recent Form 10-K and other filings with the SEC.

These statements and factors could cause business conditions and actual results to differ materially from those expected by the company or as expressed in our forward-looking statements.

With that, now I’d like to turn the call over to Scott Neish.

J. Scott Neish

Also joining me this morning to discuss our third quarter results is our Chief Financial Officer, Yasmin Seyal.

As most of you probably know, this is a very sad time for us. Last week an employee at our Camden facility was fatally injured in a fire that resulted from the unplanned ignition of a rocket motor. We have formed a team to investigate the accident. We are also forming an independent review team of highly respected senior government and industry officials to evaluate the work of the internal investigation team. We’re very early in this process and have no conclusions to provide at this time.

I started out in our last call by indicating that the new board and management were working closely together how best to enhance shareholder value and that we had begun the process of looking at various options and scenarios. The current status is that this evaluation has not yet been completed and is still in process, and given the current market disruptions may take some time longer. Therefore the company is not yet in a position to share with you any further information.

Now I’m going to turn the call over to Yasmin to review our financial results for the quarter. Following her remarks I will then briefly address how Aerojet’s doing operationally and some key successes since we last talked with you. I’ll also give you an update with where we are with regards to our Real Estate projects.

But first Yasmin.

Yasmin Seyal

My comments this morning will focus on the financial results of our continuing operations, Aerojet and Real Estate. The company today reported a net loss of $2.7 million or $0.05 diluted loss per share for the third quarter 2008, compared to net income of $15.6 million or $0.26 diluted earnings per share in the third quarter of 2007.

The third quarter 2008 number includes approximately $7 million of charges associated with adjustments to our environmental reserves and $1 million of unusual items associated with unrecoverable portion of legal settlements. The third quarter 2007 number includes a net benefit of $1 million associated with adjustments to environmental reserves but $5 million of unusual items and it also included a $12 million income tax benefit related to certain tax settlements and statute expirations.

Commenting next on sales for the Corporation, which for the third quarter of 2008 were

$173 million compared to $199 million in 2007. Sales for the first nine months of 2008 were

$544 million compared to $542 million in 2007. With regard to Aerojet compared to 2007, sales were down for the third quarter and $8 million on a year-to-date basis as compared to 2007.

I think as many of you – we’ve talked to you in prior calls and as many of you will understand, the major driver here is really the completion of our Titan program in 2007, which had about

$31 million in sales in ’07. We have been working hard in 2008 and we continue our efforts to replace this Titan business with NASA and defense [programs] the results of which we hope you will see as we go forward.

With respect to Real Estate, the year-to-date t]]>Wed, 13 Jan 2010 05:12:44 GMThttp://www.dailystocks.com/forum/showtopic.php?tid/3736/http://www.dailystocks.com/forum/showtopic.php?tid/3736/
Array BioPharma (ARRY)
Kopp Investment Advisors increased its holdings to 3,693,956 shares (7.5%), after buying 883,935 from Oct. 19 to Dec. 18 at prices that ranged from $1.74 to $2.95.

BUSINESS OVERVIEW

Our Business

We are a biopharmaceutical company focused on the discovery, development and commercialization of targeted small molecule drugs to treat patients afflicted with cancer, inflammatory and metabolic diseases. Our proprietary drug development pipeline includes clinical candidates that are designed to regulate therapeutically important target proteins and are aimed at significant unmet medical needs. In addition, leading pharmaceutical and biotechnology companies collaborate with Array to discover and develop drug candidates across a broad range of therapeutic areas. We currently have seven wholly-owned programs in our development pipeline:

1.
ARRY-403, a glucokinase activator for Type 2 diabetes
2.
ARRY-162, a MEK inhibitor for rheumatoid arthritis and cancer
3.
ARRY-380, an ErbB-2 inhibitor for breast cancer
4.
ARRY-520, a KSP inhibitor for acute myeloid leukemia and multiple myeloma
5.
ARRY-614, a p38/Tie 2 dual inhibitor for myelodysplastic syndrome
6.
ARRY-543, an ErbB family (ErbB-2 / EGFR) inhibitor for solid tumors
7.
ARRY-797, a p38 inhibitor for subacute pain and cancer supportive care indications

We also have a portfolio of proprietary and partnered drug discovery programs that we believe will generate one to two Investigational New Drug, or IND, applications during fiscal 2010. Our drug discovery efforts have also generated additional early-stage drug candidates that we may choose to out-license through research partnerships prior to filing an IND application. Our drug discovery programs include an inhibitor that targets the kinase Chk-1 for the treatment of cancer and an inhibitor that targets a family of tyrosine kinase, or Trk, receptors for the treatment of pain. Our Chk-1 inhibitor is a first-in-class, selective, oral drug candidate and in preclinical studies has shown prolonged inhibition of the Chk-1 target. Our Trk family inhibitor is a first-in-class, selective, oral drug candidate targeting Trk A, B, and C.

Our Strategy

We are building a fully integrated, commercial-stage biopharmaceutical company that invents, develops and markets safe and effective small molecule drugs to treat patients afflicted with cancer, inflammatory and metabolic diseases. We intend to accomplish this through the following strategies:

•
Inventing targeted small molecule drugs that are either first-in-class or second generation drugs that demonstrate a competitive advantage over drugs currently on the market or in clinical development;
•
Partnering select drugs after establishing proof-of-concept data for co-development and commercialization, while retaining the right to commercialize and/or co-promote any resulting drugs in the U.S.;
•
Partnering select early-stage programs for continued research and development in exchange for research funding, plus significant milestone payments and royalties;
•
Leveraging our clinical development organization to provide timely, robust proof-of-concept data; and
•
In the longer term, conducting later-stage development and seeking marketing approval for important new drugs across multiple therapeutic areas and building commercial capabilities to position our drugs to maximize their overall value. As our first drug nears approval, we plan to build a U.S.-based, therapeutically-focused sales force to commercialize and/or co-promote our drugs.

We have a large number of research and development programs, and therefore partnering these programs with collaborators that will provide funding, development, manufacturing and commercial resources is central to our strategy over the next several years. These partnerships may include co-development or co-commercialization and either may be worldwide or limited to certain geographic areas. We plan to advance our most promising development assets internally through clinical proof-of-concept before partnering them, which we believe will maximize their value. However, we are also identifying certain programs to partner earlier during discovery or preclinical development with the goal of optimizing the potential return for Array on these programs.

Business History

We have built our proprietary pipeline of drug development and discovery programs on an investment of approximately $347.2 million from our inception through June 30, 2009. During fiscal 2009, research and development expenses for proprietary drug discovery were $89.6 million, as compared to $90.3 million for fiscal 2008 and $57.5 million for fiscal 2007.

Additionally, we have received a total of $349.5 million in research funding and in up-front and milestone payments from our collaboration partners through June 30, 2009. Under our existing collaboration agreements, we have the potential to earn nearly $1.4 billion in additional milestone payments if all the discovery and revenue objectives detailed in these agreements are achieved, as well as to earn royalties on any resulting product sales from 16 drug discovery and development programs.

Our most significant collaborations are with:

•
Celgene Corporation, which entered into a worldwide strategic collaboration agreement with us focused on the discovery, development and commercialization of novel therapeutics in cancer and inflammation;
•
Genentech, Inc., which entered into a worldwide strategic collaboration agreement with us to develop two of our cancer programs – which has been expanded to include three additional programs— all five of which are in discovery or preclinical development; and
•
AstraZeneca, PLC, which licensed three of our MEK inhibitors for cancer, including AZD6244 (ARRY-886), which is currently in multiple Phase 2 clinical trials.

Through drug discovery collaborations, we have also invented drugs that are currently in clinical development, including InterMune, Inc.'s hepatitis C virus NS3/4 protease inhibitor, ITMN-191, which is expected to enter a Phase 2 clinical trial in August 2009, Eli Lilly and Company's (formerly ICOS Corporation) Chk-1 inhibitor, IC83, which is currently in a Phase 1 clinical trial, and VentiRx Pharmaceutical's Toll-Like Receptors, VTX-2337 and VTX-1463, which are currently in Phase 1 clinical trials. Our out-license and collaboration agreements with these and our other partners typically provide for up-front payments, research funding, success-based milestone payments and/or royalties on product sales.

ARRY-403 – Glucokinase Activator for Type 2 Diabetes Program

According to the Centers for Disease Control, approximately 24.0 million or 8.0% of Americans have Type 2 diabetes. Current therapies for this progressive disease are insufficient or with unwanted side-effects, creating a need for the development of novel therapeutic approaches. Glucokinase activators, or GKAs, such as ARRY-403, represent a promising new class of drugs for the treatment of Type 2 diabetes. GKAs regulate glucose levels via a dual mechanism of action – working in both the pancreas and the liver. Glucokinase, or GK, is the enzyme that senses glucose in the pancreas. GK also increases glucose utilization and decreases glucose production in the liver. In diabetic patients, there is a reduction of GK activity in the pancreas and the liver. The activation of GK lowers glucose levels by enhancing the ability of the pancreas to sense glucose which leads to increased insulin production. Simultaneously, GKAs increase the net uptake of blood glucose by the liver. In multiple well-established in vivo models of Type 2 diabetes, ARRY-403 was highly efficacious in controlling both fasting and non-fasting blood glucose, with rapid onset of effect and maximal efficacy within five to eight once daily doses. When combined with existing standard-of-care drugs (metformin, sitagliptin and pioglitazone), ARRY-403 provided additional glucose control, which reached maximal efficacy after five to seven days

of once-daily dosing. ARRY-403 did not increase body weight, plasma triglycerides or total cholesterol, whether used as monotherapy or in combination with other diabetes drugs.

During fiscal 2009, we initiated a Phase 1 trial to evaluate ARRY-403 in a SAD study in Type 2 diabetic patients. The study evaluated safety, tolerability, exposure and blood glucose control. The study included seven dose cohorts with a total of 41 patients. ARRY-403 was shown to be well tolerated at all doses. ARRY-403 was rapidly absorbed, and exposure was does-dependent. The pharmacokinetic profile is consistent with once daily therapeutic dosing. ARRY-403 provided dose-dependent reduction in glucose excursions in response to a standardized meal as well as reduction in 24-hour fasting blood glucose.

During the second half of calendar 2009, we plan to initiate a Phase 1 MAD trial in patients with Type 2 diabetes to evaluate safety, exposure and glucose control over a 10-day period.

ARRY-162 - MEK for Inflammation and Cancer Program

MEK has been demonstrated to modulate the biosynthesis of certain pro-inflammatory cytokines, in particular, TNF, IL-1 and IL-6. We believe that the inhibition of MEK will have applications in inflammatory diseases characterized by high levels of these cytokines, such as arthritis, psoriasis and inflammatory bowel disease. ARRY-162 is a first in class, orally-active, selective MEK inhibitor and is the first MEK inhibitor in development for rheumatoid arthritis, or RA. In in vivo RA models, ARRY-162 was shown to be active, either alone, or in combination with other agents. In Phase 1 clinical trials, ARRY-162 exhibited significant cytokine inhibition and has been well tolerated. During fiscal 2009, we completed enrollment for a worldwide Phase 2 trial with ARRY-162 added to methotrexate in 200 patients with RA.

Recent research confirms that the MEK pathway also acts as a central axis in the proliferation of different tumors including melanoma, non-small cell lung, head, neck and pancreatic cancers. Increasing evidence confirms that MEK inhibition, either alone or in combination with other agents, is an important therapeutic strategy in treating cancer. In July 2009, we filed an IND application with the U.S Food and Drug Administration to initiate a Phase 1 clinical trial in cancer patients with ARRY-162, and we plan to simultaneously develop ARRY-162 for the treatment of both cancer and inflammatory disease. We believe ARRY-162 will be most effective in selected populations of cancer patients, such as those with tumors having BRAF or KRAS mutations and in targeted combinations. We also believe ARRY-162 has advantages over other MEK inhibitors currently in development, including greater potency, and improved safety and pharmacokinetics. As stated above, ARRY-162 has been administered to more than 200 patients/volunteers in clinical trials for either safety assessment or the treatment of inflammatory disease. The drug has been well-tolerated and demonstrated significant pharmacodynamic responses in the completed trials. In addition, we have completed long-term preclinical regulated safety studies and identified a commercially viable synthetic process and oral formulation for ARRY-162.

During fiscal 2010, we plan to do the following:

•
Receive top-line results on the Phase 2 RA trial during the second half of calendar 2009; and
•
Initiate a Phase 1 dose escalation trial in cancer patients during the second half of calendar 2009.

ARRY-797 - p38 Program

p38 is a critical mediator of pain and inflammation, which acts by modulating the production of the pro-inflammatory cytokines TNF, IL-6 and IL-1 as well as the pain mediator PGE2. ARRY-797 is a novel, selective, potent inhibitor of p38 with unique physical properties. It is highly selective with nanomolar potency, high water solubility and low potential to cross the blood brain barrier. In a Phase 1 clinical trial in
healthy volunteers, ARRY-797 demonstrated dose-dependent marked suppression of all three of these cytokines, as measured in ex vivo LPS-stimulated whole blood samples.

In a Phase 2 trial in acute inflammatory pain using a dental pain model, ARRY-797 achieved its primary and secondary endpoints for analgesic effect, was well tolerated, and prevented the rise in C-reactive protein that follows oral surgery. And in a second Phase 2 acute inflammatory pain trial in 253 patients, in which we compared three doses of ARRY-797 (200, 400 and 600 mg) with both placebo and with an active comparator, Celebrex® (celecoxib) (400 mg), we found that ARRY-797 demonstrated significant analgesic benefit when administered either prior to or following surgery.

During fiscal 2009, we conducted a 28-day Phase 1 trial in 30 RA patients on stable doses of methotrexate and initiated a 12-week Phase 2 trial in AS patients. The 28-day Phase 1 RA trial results indicated only transitory reduction in inflammation and, as a result, we have stopped enrollment for the Phase 2 trial in AS patients.

During fiscal 2010, we plan to evaluate options for further development of ARRY-797 for subacute pain and cancer supportive care indications.

ARRY-380 - ErbB-2 Program

ErbB-2, also known as HER2, is a clinically proven receptor tyrosine kinase target that is over-expressed in breast cancer and other cancers such as gastric and ovarian cancer. Herceptin® (trastuzumab), the intravenously-dosed protein inhibitor that modulates ErbB-2, has been approved for ErbB-2+ metastatic breast cancer patients as well as an adjuvant to surgery in early stage breast cancer patients. The second indication has significantly expanded the number of breast cancer patients eligible for an ErbB-2 inhibitor. ARRY-380 is an orally active, reversible and selective ErbB-2 inhibitor. In multiple preclinical tumor models, ARRY-380 was well tolerated and demonstrated significant dose-related tumor growth inhibition that was superior to Herceptin and Tykerb® (lapatinib). Additionally, in these models, ARRY-380 was well tolerated and additive for tumor growth inhibition when dosed in combination with the standard of care therapeutics Herceptin or Taxotere® (docetaxel).

During fiscal 2009, we remained on track for patient recruitment in a Phase 1 dose escalation clinical trial in advanced cancer patients and plan to complete the trial during the second half of calendar 2009.

ARRY-520 - KSP Program

ARRY-520 inhibits kinesin spindle protein, or KSP, which plays an essential role in mitotic spindle formation. Like taxanes and vinca alkaloids, KSP inhibitors inhibit tumor growth by preventing mitotic spindle formation and cell division. However, unlike taxanes and vinca alkaloids, KSP inhibitors do not demonstrate certain side effects such as peripheral neuropathy and alopecia.

ARRY-520 has demonstrated efficacy in preclinical hematological tumor models, with a 100.0% complete response rate observed in models of acute myeloid leukemia, or AML, and multiple myeloma, or MM. Treatment of MM models with ARRY-520 resulted in significant regression of tumors that had previously progressed after treatment with Velcade® (bortezomib) or Revlimid® (lenalidomide). In addition, ARRY-520 retained activity in a wide range of tumors resistant to other molecules with different mechanisms of action, such as the taxanes. Examination of pharmacodynamic activity in preclinical models reinforced that hematological cancers were among the most sensitive to ARRY-520.

Our clinical development activities for ARRY-520 consisted of the following during fiscal 2009:

•
Continued a Phase 1 trial of ARRY-520 in patients with solid tumors;
•
Continued a Phase 1 trial in patients with AML; and
•
Initiated a Phase 1/2 trial in patients with MM.



During fiscal 2010, we plan to complete the Phase 1solid tumor and AML trials and the phase 1b portion of the MM trial.

ARRY 614 - p38/Tie2 for Cancer Program

As discussed above, p38 regulates the production of numerous cytokines, such as TNF, IL-1 and IL-6, the increased production of which can cause inflammation and aberrant tissue proliferation. Tie2 plays an important role in angiogenesis, the growth, differentiation and maintenance of new blood vessels. ARRY-614, an orally active compound that inhibits both p38 and Tie2, has been shown to block angiogenesis, to inhibit inflammation and to antagonize tumor growth, while showing a low side effect profile after prolonged dosing in preclinical models.

In preclinical hematological tumor models, ARRY-614 demonstrated activity both as a single agent and in combination with Revlimid® (lenalidomide). Results show that ARRY-614 was well-tolerated and effective in inhibiting cytokines, including IL-6 and TNF, which play a role in the regulation of growth and survival in a number of cancers, particularly hematological cancers. Additionally, data show that administering p38 inhibitors in combination with lenalidomide yielded superior inhibition of proinflammatory cytokines. As a single agent, ARRY-614 effectively inhibited angiogenesis in vivo and inhibited tumor growth in preclinical models of MM, and combining ARRY-614 with standard-of-care agents, lenalidomide and Decadron® (dexamethasone), in MM models was shown to provide additional anti-tumor effects.

Our clinical development activities for ARRY-614 consisted of the following during fiscal 2009:

•
Completed a single and multiple dose escalation study with ARRY-614 in healthy volunteers for safety, tolerability, exposure and inhibition of mechanism-related biomarkers; and
•
Initiated a Phase 1b/2 trial in myelodysplastic syndrome, or MDS patients.

During fiscal 2010, we plan to continue the Phase 1b/2 trial in MDS, patients.

ARRY-543 - ErbB family (ErbB-2 / EGFR) Program

ErbB-2 and EGFR are receptor kinase targets that are over-expressed in a number of malignancies, including breast, lung, pancreas, colon and head and neck cancers. ARRY-543 is a novel, oral ErbB family inhibitor that, unlike approved ErbB inhibitors, targets all members of the ErbB family, including ErbB3, either directly or indirectly, and has potential advantages in treating tumors that signal through multiple ErbB family members. ARRY-543 showed benefit in preclinical tumor models that signal through multiple ErbB family members, as well as its efficacy in preclinical models when compared to, and combined with, Herceptin® (trastuzumab), Xeloda® (capecitabine) and Taxotere® (docetaxel) – widely used treatments for solid tumors.

In a Phase 1 trial, ARRY-543 produced prolonged stable disease in patients who have previously failed prior treatments with solid tumors. ARRY-543 was well-tolerated up to 400 mg twice daily, or BID, dosing. Systemic concentrations of ARRY-543 increased with escalating doses at all dose levels tested, providing continuous exposure over a 24-hour period. Sixty percent of patients receiving doses of 200 mg BID and higher had prolonged stable disease.

Our clinical development activities for ARRY-543 consisted of the following during fiscal 2009:

•
Reported results of a Phase 1b trial in ErbB-2-positive metastatic breast cancer, or MBC, and ErbB-family cancer patients showing that ARRY-543 was generally well tolerated and demonstrated evidence of tumor regression and prolonged stable disease in EGFR- and ErbB-2-expressing cancers. Twenty one patients were evaluated: 12 had available biopsies and eight were confirmed ErbB-2-positive. Of the confirmed patients with ErbB-2-positive MBC treated with ARRY-543, 63 percent achieved stable disease for 16 weeks or longer. Clinical benefit was demonstrated in five of the eight confirmed ErbB-2 patients, and patients with confirmed co-expression of ErbB-2 and EGFR tended to have the best clinical benefit. In patients with other cancers shown to express ErbB family members, three patients, with ovarian cancer, cervical cancer and cholangiocarcinoma, respectively, treated with ARRY-543 also achieved stable disease for 16 weeks or more; the patient with cholangiocarcinoma experienced a tumor marker response that was accompanied by a 25 percent regression of target lesions; and

•
Initiated Phase 1b studies of ARRY-543 in combination with Xeloda® (capecitabine), Taxotere® (docetaxel) and Gemzar® (gemcitabine), which are currently enrolling patients with solid tumors.

During fiscal 2010, we plan to complete the Phase 1b combination studies of ARRY-543 and to initiate a Phase 2 trial in combination with another anti-cancer drug in patients with certain gastrointestinal cancers that have dual-expressing tumors.

Partnered Discovery and Development Programs

We have collaborations with leading pharmaceutical and biotechnology companies under which we have out-licensed certain of our proprietary drug programs for further research, development and commercialization. We also have research partnerships with leading pharmaceutical and biotechnology companies, for which we design, create and optimize drug candidates, and conduct preclinical testing across a broad range of therapeutic areas, on targets selected by our partners. In certain of these partnerships, we also perform process research and development, clinical development and manufacture clinical supplies.

Our discovery and development collaborations provide funding for research and development activities we conduct and, in a number of our current agreements, up-front fees, milestone payments and/or royalties based upon the success of the program. Our largest or most advanced collaborations include our agreements with AstraZeneca, Celgene, Eli Lilly, Genentech, InterMune and VentiRx.

Information about collaborators that comprise 10.0% or more of our total revenue and about revenue we receive within and outside the U.S. can be found in Note 2 to the accompanying audited Financial Statements included elsewhere in this Annual Report.

Below are summaries of our most advanced ongoing partnered discovery and development programs. Any information we report about the development plans or the progress or results of clinical trials or other development activities conducted by our partners is based on information that has been reported to us or is otherwise publicly disclosed by our collaboration partners.

AstraZeneca - AZD6244 / MEK Program

We initiated an anti-cancer research program targeting MEK in July 2001, and quickly identified AZD6244, an orally active clinical candidate. AZD6244 and other compounds have shown tumor suppressive or regressive activity in multiple preclinical models of human cancer, including melanoma, pancreatic, colon, lung, and breast cancers. Potential advantages of MEK inhibitors over current therapies include potential improved efficacy and reduced side effects.

In December 2003, we entered into an out-licensing and collaboration agreement with AstraZeneca to develop our MEK program solely in the field of oncology. Under the agreement, AstraZeneca acquired

exclusive worldwide rights to our clinical development candidate, AZD6244, together with two other compounds we developed during the collaboration for oncology indications. We retain the rights to all non-oncology therapeutic indications for MEK compounds not selected by AstraZeneca for development. In April 2009, the exclusivity of the parties' relationship ended, and both companies are now free to independently research, develop and commercialize small molecule MEK inhibitors in the field of oncology. To date, we have earned $21.5 million in up-front and milestone payments. The agreement also provides for research funding, which is now complete, and potential additional development milestone payments of approximately $75.0 million and royalties on product sales. AstraZeneca is responsible for further clinical development and commercialization for AZD6244, and for clinical development and commercialization for the other two compounds it licensed.

Under our collaboration with AstraZeneca, we conducted Phase 1 clinical testing in 2004. The trial evaluated tolerability and pharmacokinetics of AZD6244 following oral administration to patients with advanced cancer. In addition, the trial examined patients for indications of biological activity as well as pharmacodynamic and tumor biomarkers. Phase 1 testing showed that AZD6244 inhibited the MEK pathway in tumor tissue at the dose that was later selected for the Phase 2 studies and provided prolonged disease stabilization in a number of cancer patients that had previously received numerous other cancer therapies.

In June 2006, AstraZeneca initiated a Phase 2 study for AZD6244 in malignant melanoma, resulting in a $3.0 million milestone payment to us. The trial was a randomized Phase 2 study that compared AZD6244 to Temodar® (temozolomide) in the treatment of stage III / IV melanoma patients. AstraZeneca enrolled approximately 180 patients at 40 centers worldwide. AstraZeneca also initiated additional Phase 2 studies for AZD6244 in colorectal, pancreatic and non-small cell lung cancer during 2006. In March 2007, AstraZeneca reported that it dosed its first cancer patient in a Phase 1 clinical trial with AZD8330, triggering a $2.0 million milestone payment to us. The trial is ongoing.

In 2008, AstraZeneca presented Phase 1 clinical trial results at the American Society of Clinical Oncology, or ASCO, annual meeting of a new AZD6244 capsule formulation that replaces the mix/drink formulation used in all prior trials to that time. AstraZeneca reported that the new capsule's maximum tolerated dose was 25.0% lower yet provided, on average, higher exposure than historical values for the mix/drink formulation. The study also reported a complete response in one of the patients. AstraZeneca also presented the following Phase 2 clinical trial results of AZD6244 at ASCO:

•
AZD6244 compared to Alimta® (pemetrexed) in 84 non-small cell lung cancer, or NSCLC, patients, neither of these drugs demonstrated superior efficacy.
•
AZD6244 compared to Temodar® (temozolomide) in patients with advanced melanoma; results showed no difference between the two treatment arms in the overall population comparing the safety and tolerability profile for AZD6244 and were consistent with the results reported from the Phase 1 trial.
•
AZD6244 compared to Xeloda® (capecitabine) in patients with metastatic colorectal cancer; results showed that AZD6244 was generally well tolerated, with neither of these drugs demonstrating superior efficacy.
•
In patients suffering from melanomas with RAF mutations in clinical trials, AZD6244 provided partial responses in two out of 14 patients using the Phase 2 mix and drink formulation, and a complete response in one out of eight patients using the Phase 1 new capsule formulation.

Further, AstraZeneca presented at the 2009 American Association for Cancer Research annual meeting results on a Phase 2 trial of AZD6244 that showed a 12 percent overall response rate among patients with biliary cancer.

AstraZeneca has reported that it is currently recruiting patients for the following Phase 2 trials:

•
AZD6244 in combination with Taxotere® (Docetaxel) and versus Taxotere alone in KRas mutation positive NSCLC.
•
AZD6244 in combination with DTIC® (dacarbazine) versus DTIC alone in BRAF mutation positive melanoma patients.

In addition, AZD6244 is being investigated in a number of studies conducted by the National Cancer Institute in collaboration with AstraZeneca.

In June 2009, AstraZeneca and Merck & Co., Inc. announced a collaboration to research AZD6244 in combination with MK-2206 from Merck in a Phase 1 trial in patients with solid tumors. Preclinical evidence indicates that combined administration of these compounds could enhance their anticancer properties. The collaboration is expected to more quickly advance a potentially promising anticancer treatment. Historically, similar combinations would only be studied when one or both of the drugs has entered late-stage development or received marketing approval, and this is the first time that two large pharmaceutical companies have established a collaboration to evaluate the potential for combining drug candidates at such an early stage of development.

Celgene – Oncology and Inflammation Programs

In September 2007, we entered into a worldwide strategic collaboration with Celgene focused on the discovery, development and commercialization of novel therapeutics in cancer and inflammation. Under the agreement, Celgene made an up-front payment of $40.0 million to us to provide research funding for activities conducted by Array under the agreement. We are responsible for all discovery and clinical development through Phase 1 or Phase 2a. Celgene has an option to select a limited number of drugs developed under the collaboration that are directed to up to two of four mutually selected discovery targets and will receive exclusive worldwide rights to the drugs, except for limited co-promotional rights in the U.S. Celgene's option may be exercised with respect to drugs directed at any of the four targets at any time until the earlier of completion of Phase 1 or Phase 2a trials for the drug or September 2014. Additionally, we are entitled to receive, for each drug, potential milestone payments of approximately $200.0 million, if certain discovery, development and regulatory milestones are achieved and an additional $300.0 million if certain commercial milestones are achieved, as well as royalties on net sales. We retain all rights to the other programs. In June 2009, the parties amended the agreement to substitute a new discovery target in place of an existing target, and Celgene paid Array an up-front fee of $4.5 million in consideration for the amendment. No other terms of the agreement with Celgene were modified by the amendment.

Celgene may terminate the agreement in whole, or in part with respect to individual drug development programs for which Celgene has exercised its option, upon six months' written notice to us. In addition, either party may terminate the agreement, following certain cure periods, in the event of a breach by the other party of its obligations under the agreement. Celgene can also choose to terminate any drug development program for which they have not exercised an option at any time, provided that they must give us prior notice, generally less than 30 days. In this event, all rights to the program remain with Array and we would no longer be entitled to receive milestone payments for further development or regulatory milestones we achieve if we choose to continue development of the program.

Eli Lilly – IC83 / CHK-1 Program

We entered into a collaboration agreement with ICOS Corporation in 1999 to create small molecule CHK-1 inhibitors. Our scientists and ICOS scientists invented IC83, and we received a $250 thousand

milestone payment after the first patient was dosed with this molecule in a Phase 1 clinical trial in early 2007. The agreement provided research funding, which has now ended, and we are entitled to receive additional milestone payments totaling $3.5 million based on Eli Lilly's achievement of clinical milestones. Eli Lilly acquired ICOS in 2007.

CEO BACKGROUND

EXECUTIVE OFFICERS

The table below shows the names, ages and positions of our executive officers as of September 1, 2009.

Name Age Position

Robert E. Conway 55

Chief Executive Officer
Kevin Koch, Ph.D. 49

President and Chief Scientific Officer
David L. Snitman, Ph.D. 57

Chief Operating Officer and Vice President, Business Development

R. Michael Carruthers 51

Chief Financial Officer

John R. Moore 45

Vice President, General Counsel and Secretary

MANAGEMENT DISCUSSION FROM LATEST 10K

The Management's Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, including statements about our expectations related to the progress and success of drug discovery activities conducted by Array and by our collaborators, our ability to obtain additional capital to fund our operations and/or reduce our research and development spending, realizing new revenue streams and obtaining future out-licensing collaboration agreements that include up-front milestone and/or royalty payments, our ability to realize up-front milestone and royalty payments under our existing or any future agreements, future research and development spending and projections relating to the level of cash we expect to use in operations, our working capital requirements and our future headcount requirements. In some cases, forward-looking statements can be identified by the use of terminology such as "may," "will," "expects," "intends," "plans," "anticipates," "estimates," "potential," or "continue," or the negative thereof or other comparable terminology. These statements are based on current expectations, projections and assumptions made by management and are not guarantees of future performance. Although we believe that the expectations reflected in the forward-looking statements contained herein are reasonable, these expectations or any of the forward-looking statements could prove to be incorrect, and actual results could differ materially from those projected or assumed in the forward-looking statements. Our future financial condition, as well as any forward-looking statements are subject to significant risks and uncertainties, including but not limited to the factors set forth under the heading "Item IA – Risk Factors" of this Annual Report on Form 10-K. All forward looking statements are made as of the date hereof, and, unless required by law, we undertake no obligation to update any forward-looking statements.

The following discussion of our financial condition and results of operations should be read in conjunction with the financial statements and notes to those statements included elsewhere in this annual report, which have been prepared assuming we will continue as a going concern. The terms "we," "us," "our" and similar terms refer to Array BioPharma Inc.

Overview

We are a biopharmaceutical company focused on the discovery, development and commercialization of targeted small molecule drugs to treat patients afflicted with cancer, inflammatory and metabolic diseases. Our proprietary drug development pipeline includes clinical candidates that are designed to regulate therapeutically important target proteins. In addition, leading pharmaceutical and biotechnology companies partner with us to discover and develop drug candidates across a broad range of therapeutic areas.

The seven most advanced wholly-owned programs in our development pipeline are as follows:

1.
ARRY-403, a glucokinase activator for Type 2 diabetes
2.
ARRY-162, a MEK inhibitor for rheumatoid arthritis, or RA, and cancer
3.
ARRY-380, an ErbB-2 inhibitor for breast cancer
4.
ARRY-520, a KSP inhibitor for acute myeloid leukemia, or AML, and multiple myeloma, or MM
5.
ARRY-614, a p38/Tie 2 dual inhibitor for myelodysplastic syndrome, or MDS
6.
ARRY-543, an ErbB family (ErbB-2 / EGFR) inhibitor for solid tumors
7.
ARRY-797, a p38 inhibitor for subacute pain and cancer supportive care indications

We also have a portfolio of drug discovery programs that we believe will generate one to two Investigational New Drug, or IND, applications in fiscal 2010. Our discovery efforts have also generated

additional early-stage drug candidates and we may choose to out-license select promising candidates through research partnerships prior to filing an IND application.

We have built our proprietary pipeline of research and development programs on an investment of $347.2 million from our inception through June 30, 2009. We continue to commit significant resources to create our own proprietary drug candidates and to build a commercial-stage biopharmaceutical company. In fiscal 2009, we continued our investment in proprietary research and spent $89.6 million in research and development for proprietary drug discovery expenses, compared to $90.3 million and $57.5 million for fiscal years 2008 and 2007, respectively.

In light of ongoing uncertainty in the capital markets as well as general economic conditions that have negatively affected the biopharmaceutical market, we determined in the second half of fiscal 2009 to reduce the pace of our spending on our proprietary discovery and development programs to focus on advancing our most promising clinical programs through proof-of-concept, which we believe will maximize their value, and, on our most promising discovery candidates. We are also accelerating our efforts to partner select discovery and development programs with collaborators that will provide funding, development and commercial resources, with the goal of optimizing the value of our drug portfolio. As part of these efforts, we reduced our workforce in January 2009 by approximately 40 employees who were primarily in discovery research and support positions, resulting in a restructuring charge of approximately $1.5 million in the third quarter of fiscal 2009. As a result of this strategy, we expect the level of our spending on research and development for proprietary drug discovery to remain relatively constant for fiscal 2010 as compared to the last half of fiscal 2009. We currently expect that cash used in operations will be approximately $21 million per quarter during fiscal 2010. If we do not receive any milestone payments when anticipated under existing collaborations or any up-front license payments under new collaborations, however, we will be required to further reduce our costs by approximately $17.5 million during fiscal 2010 to avoid accelerating our repayment obligations under our credit facility with Deerfield and our loan agreement with Comerica Bank.

We have received a total of $349.5 million in research funding and in up-front and milestone payments from our collaboration partners through June 30, 2009. Under our existing collaboration agreements, we have the potential to earn over $1.4 billion in additional milestone payments if we or our collaborators achieve all the drug discovery objectives detailed in those agreements, as well as the potential to earn royalties on any resulting product sales from 16 drug development programs.

Our significant existing collaborators include:

•
Genentech, Inc., which entered into a worldwide strategic collaboration agreement with us to develop two of our cancer programs – which has been expanded to include three additional programs – all five of which are in preclinical development;
•
Celgene Corporation, which entered into a worldwide strategic collaboration agreement with us focused on the discovery, development and commercialization of novel therapeutics in cancer and inflammation;
•
AstraZeneca, PLC, which licensed three of our MEK inhibitors for cancer, including AZD6244 (ARRY-886), which is currently in multiple Phase 2 clinical trials.

Our fiscal year ends on June 30. When we refer to a fiscal year or quarter, we are referring to the year in which the fiscal year ends and the quarters during that fiscal year. Therefore, fiscal 2009 refers to the fiscal year ended June 30, 2009.

Business Development and Collaborator Concentrations

We currently license or partner certain of our compounds and/or programs and enter into collaborations directly with pharmaceutical and biotechnology companies through opportunities identified by our business development group, senior management, scientists and customer referrals. In addition, we may license our compounds and enter into collaborations in Japan through an agent.

In general, certain of our collaborators may terminate their collaboration agreements with 90 to 180 days' prior notice. Our agreement with Genentech can be terminated with 120 days' notice. Celgene may terminate its agreement with us with six months' notice.

Critical Accounting Policies and Estimates

Management's discussion and analysis of financial condition and results of operations are based upon our accompanying Financial Statements, which have been prepared in accordance with accounting principles generally accepted in the U.S. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses as well as the disclosure of contingent assets and liabilities. We regularly review our estimates and assumptions. These estimates and assumptions, which are based upon historical experience and on various other factors believed to be reasonable under the circumstances, form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Reported amounts and disclosures may have been different had management used different estimates and assumptions or if different conditions had occurred in the periods presented.

Below is a discussion of the policies and estimates that we believe involve a high degree of judgment and complexity.

Revenue Recognition

Most of our revenue is in the form of research funding, up-front or license fees and milestone payments derived from designing, creating, optimizing, evaluating and developing drug candidates for our collaborators. Our agreements with our collaboration partners include fees based on contracted annual rates for full-time-equivalent employees working on a project, and may also include non-refundable license and up-front fees, non-refundable milestone payments that are triggered upon achievement of specific research or development goals, and future royalties on sales of products that result from the collaboration. A small portion of our revenue comes from sales of compounds on a per-compound basis. We report revenue for lead generation and lead optimization research, process research, the development and sale of chemical compounds and the co-development of proprietary drug candidates we out-license, as Collaboration Revenue. License and Milestone Revenue is combined and reported separately from Collaboration Revenue.

We recognize revenue in accordance with Staff Accounting Bulletin No. 104, Revenue Recognition "SAB 104"). SAB 104 established four criteria, each of which must be met, in order to recognize revenue related to the performance of services or the shipment of products. Revenue is recognized when (a) persuasive evidence of an arrangement exists, (b) products are delivered or services are rendered, (c) the sales price is fixed or determinable and (d) collectability is reasonably assured.

Collaboration agreements that include a combination of research funding, up-front or license fees, milestone payments and/or royalties are evaluated to determine whether each deliverable under the agreement has value to the customer on a stand-alone basis and whether reliable evidence of fair value for the deliverable exists. Deliverables in an arrangement that do not meet the separation criteria are treated as a single unit of accounting, generally applying applicable revenue recognition guidance for the final deliverable to the combined unit of accounting in accordance with SAB 104.

We recognize revenue from non-refundable up-front payments and license fees on a straight-line basis over the term of performance under the agreement, which is generally the research term specified in the agreement. These advance payments are deferred and recorded as Deferred Revenue upon receipt, pending recognition, and are classified as a short-term or long-term liability on our accompanying Balance Sheets. When the performance period is not specifically identifiable from the agreement, we estimate the performance period based upon provisions contained within the agreement, such as the duration of the research term, the specific number of full-time-equivalent scientists working a defined number of hours per year at a stated price under the agreement, the existence, or likelihood of achievement, of development commitments, and other significant commitments of ours.

We determined that the performance period applicable to our agreement with Celgene Corporation is seven years ending September 2014. We determined the performance period for our collaboration and licensing agreement with VentiRx to be one year, which ended in March 2008. Each of these periods coincides with the research terms specified in each licensing agreement.

Under our agreement with VentiRx, we received a non-refundable cash technology access fee and shares of preferred stock valued at $1.5 million based on the price at which such preferred stock was sold to investors in a private offering. Both the technology access fee and the value of the preferred stock were recorded as advance payments from collaborators in Deferred Revenue, and were recognized as revenue on a straight-line basis over the estimated one-year research term. The preferred stock is recorded in Other Long-term Assets in the accompanying Balance Sheets.

MANAGEMENT DISCUSSION FOR LATEST QUARTER

Management's Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, including statements about our expectations related to the progress and success of drug discovery activities conducted by Array and by our collaborators, our ability to obtain additional capital to fund our operations and/or reduce our research and development spending, realizing new revenue streams and obtaining future out-licensing collaboration agreements that include up-front milestone and/or royalty payments, our ability to realize up-front milestone and royalty payments under our existing or any future agreements, future research and development spending and projections relating to the level of cash we expect to use in operations, our working capital requirements and our future headcount requirements. In some cases, forward-looking statements can be identified by the use of terminology such as "may," "will," "expects," "intends," "plans," "anticipates," "estimates," "potential," or "continue," or the negative thereof or other comparable terminology. These statements are based on current expectations, projections and assumptions made by management and are not guarantees of future performance. Although we believe that the expectations reflected in the forward-looking statements contained herein are reasonable, these expectations or any of the forward-looking statements could prove to be incorrect, and actual results could differ materially from those projected or assumed in the forward-looking statements. Our future financial condition, as well as any forward-looking statements are subject to significant risks and uncertainties, including but not limited to the factors set forth under the heading “Risk Factors” in Part II, Item 1A of this Quarterly Report on Form 10-Q and Item 1A of our Annual Report on Form 10-K for the fiscal year ended June 30, 2009. All forward looking statements are made as of the date hereof, and, unless required by law, we undertake no obligation to update any forward-looking statements.



The following discussion of our financial condition and results of operations should be read in conjunction with the financial statements and notes to those statements included elsewhere in this quarterly report, which have been prepared assuming we will continue as a going concern. The terms "we," "us," "our" and similar terms refer to Array BioPharma Inc.



Overview



We are a biopharmaceutical company focused on the discovery, development and commercialization of targeted small molecule drugs to treat patients afflicted with cancer, inflammatory diseases, pain and metabolic diseases. Our proprietary drug development pipeline includes clinical candidates that are designed to regulate therapeutically important target proteins. In addition, leading pharmaceutical and biotechnology companies partner with us to discover and develop drug candidates across a broad range of therapeutic areas.



The seven most advanced wholly-owned programs in our development pipeline are as follows:



1. ARRY-403, a glucokinase activator for Type 2 diabetes

2. ARRY-162, a MEK inhibitor for cancer

3. ARRY-380, an ErbB-2 inhibitor for breast cancer

4. ARRY-520, a KSP inhibitor for acute myeloid leukemia, or AML, and multiple myeloma, or MM

5. ARRY-614, a p38/Tie 2 dual inhibitor for myelodysplastic syndrome, or MDS

6. ARRY-543, an ErbB family (ErbB-2 / EGFR) inhibitor for solid tumors

7. ARRY-797, a p38 inhibitor for subacute pain and cancer supportive care indications



In addition to these proprietary development programs, we have six partnered drugs in clinical development:



1. AZD6244, a MEK inhibitor for cancer, partnered with AstraZeneca, PLC

2. AZD8330, a MEK inhibitor for cancer, partnered with AstraZeneca, PLC

3. ITMN-191, an NS3/4 protease inhibitor for Hepatitis C Virus, partnered with InterMune, Inc./Roche Holding AG

4. IC83, a Chk inhibitor for cancer, partnered with Eli Lilly and Company

5. VTX-2337, a Toll-like receptor for cancer, partnered with VentiRx Pharmaceuticals, Inc.

6. VTX-1463, a Toll-like receptor for allergy, partnered with VentiRx Pharmaceuticals, Inc.



We also have a portfolio of proprietary and partnered drug discovery programs that we believe will generate one to two Investigational New Drug, or IND, applications in fiscal 2010. Our discovery efforts have also generated additional early-stage drug candidates and we may choose to out-license select promising candidates through research partnerships prior to filing an IND application.



We have built our proprietary pipeline of research and development programs on spending of $366.4 million from our inception through September 30, 2009. We continue to commit significant resources to create our own proprietary drug candidates and to build a commercial-stage biopharmaceutical company. In the first quarter of fiscal 2010 and 2009, our spending on research and development for proprietary drug discovery was $19.2 million and $24.5 million, respectively. In fiscal 2009, we spent $89.6 million in research and development for proprietary drug discovery expenses, as compared to $90.3 million and $57.5 million for fiscal years 2008 and 2007, respectively.



Due to ongoing uncertainty in the capital markets as well as general economic conditions that have negatively affected the biopharmaceutical market, we reduced our spending on our proprietary discovery and development programs to focus on advancing our most promising clinical programs through proof-of-concept, which we believe will maximize their value, and, on our most promising discovery candidates. We are also accelerating our efforts to partner select discovery and development programs that will provide funding, development and commercial resources, with the goal of optimizing the value of our drug portfolio. As part of these efforts, we reduced our workforce in January 2009 by approximately 40 employees, or 10%, who were primarily in discovery research and support positions, resulting in a restructuring charge of approximately $1.5 million in the third quarter of fiscal 2009. Our current quarterly cash used in operations is approximately $21 million per quarter. If we do not receive any up-front license payments under new collaborations, we will be required to significantly reduce our costs to conserve our cash resources to fund our operations and to remain in compliance with covenants under our credit facilities with Deerfield Private Design Fund, L.P. and Deerfield Private Design International Fund, L.P., who we collectively refer to as Deerfield, and our loan agreement with Comerica Bank relating to the level of our cash, cash equivalents and marketable securities.



We have received a total of $353.6 million in research funding and in up-front and milestone payments from our collaboration partners through September 30, 2009. Under our existing collaboration agreements, we have the potential to earn over $1.3 billion in additional milestone payments if we or our collaborators achieve all the drug discovery objectives detailed in those agreements, as well as the potential to earn royalties on any resulting product sales from 16 drug development programs.



Our significant existing collaborators include:



• Genentech, Inc., which entered into a worldwide strategic collaboration agreement with us to develop two of our cancer programs – which has been expanded to include three additional programs – all five of which are in preclinical development.

•Celgene Corporation, which entered into a worldwide strategic collaboration agreement with us focused on the discovery, development and commercialization of novel therapeutics in cancer and inflammation.

•AstraZeneca, which licensed three of our MEK inhibitors for cancer, including AZD6244 (ARRY-886), which is currently in multiple Phase 2 clinical trials.

•InterMune, Inc., which collaborated with us on the discovery of RG7227 / ITMN-191, a novel small molecule inhibitor of the Hepatitis C Virus NS3/4 protease. InterMune and its development partner, Roche, have reported that they are currently advancing the drug in a Phase 2b trial evaluating ITMN-191 in combination with standard of care therapies.



Our fiscal year ends on June 30. When we refer to a fiscal year or quarter, we are referring to the year in which the fiscal year ends and the quarters during that fiscal year. Therefore, fiscal 2010 refers to the fiscal year ended June 30, 2010 and the first quarter of fiscal 2010 refers to the three months ended September 30, 2009.



Business Development and Collaborator Concentrations



We currently license or partner certain of our compounds and/or programs and enter into collaborations directly with pharmaceutical and biotechnology companies through opportunities identified by our business development group, senior management, scientists and customer referrals. In addition, we may license our compounds and enter into collaborations in Japan through an agent.

Critical Accounting Policies and Estimates



Management's discussion and analysis of financial condition and results of operations are based upon our accompanying Condensed Financial Statements, which have been prepared in accordance with accounting principles generally accepted in the U.S. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses as well as the disclosure of contingent assets and liabilities. We regularly review our estimates and assumptions. These estimates and assumptions, which are based upon historical experience and on various other factors believed to be reasonable under the circumstances, form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Reported amounts and disclosures may have been different had management used different estimates and assumptions or if different conditions had occurred in the periods presented.



Below is a discussion of the policies and estimates that we believe involve a high degree of judgment and complexity.



Fair Value Measurements



Our financial instruments are recognized and measured at fair value in our financial statements and mainly consist of cash and cash equivalents, marketable securities, long-term investments, trade receivables and payables, accrued outsourcing costs, accrued expenses, long-term debt, embedded derivatives associated with the long-term debt, and warrants. We use different valuation techniques to measure the fair value of assets and liabilities, as discussed in more detail below. Fair value is defined as the price that would be received to sell the financial instruments in an orderly transaction between market participants at the measurement date. We use a framework for measuring fair value based on a hierarchy that distinguishes sources of available information used in fair value measurements and categorizes them into three levels:



• Level I: Quoted prices in active markets for identical assets and liabilities.

• Level II: Observable inputs other than quoted prices in active markets for identical assets and liabilities.

• Level III: Unobservable inputs.



We disclose assets and liabilities measured at fair value based on their level in the hierarchy. In determining fair value for assets or liabilities for which there are no quoted prices in active markets, including ARS, warrants issued by us or embedded derivatives associated with the long-term debt, considerable judgment is required in interpreting market data to develop estimates of fair value. Accordingly, the fair value estimates disclosed by us may not be indicative of the amount that we or holders of the instruments could realize in a current market exchange. The use of different assumptions and/or estimation methodologies may have a material effect on their estimated fair value.



We periodically review the realizability of each investment when impairment indicators exist with respect to the investment. If an other-than-temporary impairment of the value of an investment is deemed to exist, the carrying value of the investment is written down to its estimated fair value.



Long-term Debt and Embedded Derivatives



The terms of our long-term debt are discussed in detail in Note 5 "Long-term Debt." The accounting for these arrangements is complex and is based upon significant estimates by management. We review all debt agreements to determine the appropriate accounting treatment when the agreement is entered into, and review all amendments to determine if the changes require accounting for the amendment as a modification, or extinguishment and new debt. We also review each long-term debt arrangement to determine if any feature of the debt requires bifurcation and/or separate valuation. These features include
hybrid instruments, which are comprised of at least two components ((1) a debt host instrument and (2) one or more conversion features), other embedded derivatives, such as warrants, and other rights of the debt holder.



We currently have two embedded derivatives related to our long-term debt with Deerfield. The first is a variable interest rate structure that constitutes a liquidity-linked variable spread feature. The second derivative is a significant transaction contingent put option relating to the ability of Deerfield to accelerate repayment of the debt in the event of certain changes in control of our company. Collectively, they are referred to as the “Embedded Derivatives.” Under the fair value hierarchy, our Embedded Derivatives are measured using Level 3, or unobservable, inputs as there is no active market for them. The fair value of the variable interest rate structure is based on our estimate of the probable effective interest rate over the term of the credit facilities. The fair value of the put option is based on our estimate of the probability that a change in control that triggers Deerfield’s right to accelerate the debt will occur. With those inputs, the fair value of each Embedded Derivative is calculated as the difference between the fair value of the Deerfield credit facilities if the Embedded Derivatives are included, and the fair value of the Deerfield credit facilities if the Embedded Derivatives are excluded. Due to the inherent complexity in valuing the Deerfield Credit Facility and the Embedded Derivatives, we engaged a third-party valuation firm to perform the valuation as of July 31, 2009 and September 30, 2009. The estimated fair value of the Embedded Derivatives was determined based on Management’s judgment and assumptions. It is reasonably possible that the use of different assumptions could result in significantly different estimated fair values.



The fair value of the Embedded Derivatives is initially recorded as Derivative Liabilities and as Debt Discount in our Condensed Balance Sheets. Any change in the value of the Embedded Derivatives will be adjusted quarterly as appropriate and recorded to Derivative Liabilities in the Condensed Balance Sheets and Interest Expense in the accompanying Condensed Statements of Operations and Comprehensive Loss. The Debt Discount is being amortized from the draw date of July 31, 2009 to the end of the term of the Deerfield credit facilities and recorded as Interest Expense in the accompanying Condensed Statements of Operations and Comprehensive Loss.



Warrants we issue in connection with our long-term debt arrangements are reviewed to determine if they should be classified as liabilities or as equity. All outstanding warrants issued by us have been classified as equity. We value the warrants at issuance based on a Black-Scholes option pricing model and then allocate a portion of the proceeds under the debt to the warrants based upon their relative fair valu]]>Tue, 12 Jan 2010 05:54:46 GMThttp://www.dailystocks.com/forum/showtopic.php?tid/3733/http://www.dailystocks.com/forum/showtopic.php?tid/3733/
Alliance Data Systems (ADS)
ValueAct Capital reduced its holdings to 2,583,900 shares (4.9%), by selling 661,418 from Dec. 11 through Dec. 28 at prices that ranged from $63.51 to $65.33 per share.

BUSINESS OVERVIEW

Our Company

We are a leading provider of data-driven and transaction-based marketing and customer loyalty solutions. We offer a comprehensive portfolio of integrated outsourced marketing solutions, including customer loyalty programs, database marketing services, marketing strategy consulting, analytics and creative services, permission-based email marketing and private label and co-brand retail credit programs. We focus on facilitating and managing interactions between our clients and their customers through a variety of consumer marketing channels, including in-store, on-line, catalog, mail and telephone. We capture and analyze data created during each customer interaction, leveraging the insight derived from that data to enable clients to identify and acquire new customers and to enhance customer loyalty. We believe that our services are becoming increasingly valuable as businesses shift marketing resources away from traditional mass marketing toward more targeted marketing programs that provide measurable returns on marketing investments.

Our client base of more than 800 companies consists primarily of large consumer-based businesses, including well-known brands such as Bank of Montreal, Citibank, Hilton, Bank of America, Victoria’s Secret, Canada Safeway, Shell Canada, Pottery Barn, Ann Taylor and J. Crew. Our client base is diversified across a broad range of end-markets, including, among others, financial services, specialty retail, grocery and drugstore chains, petroleum retail, technology, hospitality and travel, media and pharmaceuticals. We believe our comprehensive suite of marketing solutions offers us a significant competitive advantage, as many of our competitors offer a more limited range of services. We believe the breadth and quality of our service offerings have enabled us to establish and maintain long-standing client relationships.

We continue to execute on our growth strategy through internal growth and acquisition of new clients. In 2008, we entered into new agreements for private label retail card services with Hot Topic, Inc., PD Financial Corporation, Beall’s Department Stores, Southern Pipe & Supply Company, and with Orchard Brands for their family of specialty brands. We also acquired the existing private label credit card portfolio of HSN, an interactive lifestyle network and retail destination, and entered into a multi-year agreement to provide both private label and co-brand credit card services to HSN. We signed Hilton HHonors ® as a new sponsor in the AIR MILES ® Reward Program. We also signed new contracts with Commerce Bank, N.A., Beech-Nut Nutrition Corporation and Marriott International, Inc. to provide integrated email and marketing solutions.

We further expanded our relationships with several key clients, including AnnTaylor Stores, to launch a new co-brand credit program, Gander Mountain to provide fully integrated private label credit services and MedChoice Financial to provide consumer private label credit card services for veterinary

•

Optimize our Business Portfolio. We will continue to evaluate our products and services given our strategic direction and demand trends. While we are focused on realizing organic revenue growth and margin expansion, we will consider select acquisitions of complementary businesses that would enhance our product portfolio, market positioning or geographic presence. We have a strong track record of identifying and integrating such targeted acquisitions.

Our Loyalty Services clients are focused on targeting, acquiring and retaining loyal and profitable customers. We use the information gathered through our loyalty programs to help our clients design and implement effective marketing programs. Our clients within this segment include, among others, financial services providers, supermarkets, petroleum retailers, specialty retailers and pharmaceutical companies.

Our AIR MILES Reward Program is the largest coalition loyalty program in Canada, with over 120 sponsors participating in the program. The AIR MILES Reward Program enables consumers to earn AIR MILES reward miles as they shop within a range of retailers and other sponsors participating in the AIR MILES Reward Program. These AIR MILES reward miles operate as points that consumers, who we refer to as collectors, can redeem for travel or other awards. We believe that one of the reasons our AIR MILES Reward Program is so popular, as evidenced by the approximately 70% participation rate for Canadian households, is that it allows consumers to rapidly accumulate AIR MILES reward miles across a significant portion of their day to day spending. The three primary parties involved in our AIR MILES Reward Program are: sponsors, collectors and suppliers, each of which is described below.

Sponsors . More than 120 brand name sponsors participate in our AIR MILES Reward Program, including Canada Safeway, Shell Canada, Jean Coutu, Amex Bank of Canada and Bank of Montreal. The AIR MILES Reward Program is a full service outsourced loyalty program for our sponsors, who pay us a fee per AIR MILES reward mile issued, in return for which we provide all marketing, customer service and rewards and redemption management. We typically grant participating sponsors exclusivity in their market category, enabling them to realize incremental sales and increase market share as a result of their participation in the AIR MILES Reward Program coalition.

Collectors . Collectors earn AIR MILES reward miles at thousands of retail and service locations in addition to the many locations where collectors can use certain cards issued by Bank of Montreal and Amex Bank of Canada to earn AIR MILES reward miles. The AIR MILES Reward Program offers a reward structure that provides a quick, easy and free way for collectors to earn a broad selection of travel, entertainment and other lifestyle rewards through their day to day shopping at participating sponsors.

Suppliers . We enter into agreements with airlines, movie theaters and manufacturers of consumer electronics and other providers to supply rewards for the AIR MILES Reward Program, with over 300 suppliers using the AIR MILES Reward Program as an additional distribution channel for their products. Suppliers include such well-recognized companies as Apple, Starbucks and Sony.

Marketing Database Services . We provide design and management of outsourced loyalty programs, integrated marketing databases, customer and prospect data integration and data hygiene, campaign management and marketing application integration and web design and development.

Interactive Communications . We provide strategic, permission-based email communication solutions and marketing technologies. Our end-to-end suite of industry specific products and services includes scalable email campaign technology, delivery optimization, marketing automation tools, turnkey integration solutions, strategic consulting and creative expertise to produce email programs that generate measurable results throughout the customer lifecycle.



Private Label Services

Our Private Label Services segment assists some of the best known retailers in extending their brand with a private label and/or co-brand credit account that can be used by customers at the clients’ store locations, or through on-line or catalog purchases. Our co-brand credit accounts can also be used by customers outside of our clients’ store locations. Our clients include Victoria’s Secret, Ann Taylor, Eddie Bauer, Pottery Barn, Pac Sun and The Buckle. We provide service and maintenance to our clients’ private label credit and co-brand credit programs and assist our clients in acquiring, retaining and managing valuable repeat customers. Our Private Label Services segment performs processing services for our Private Label Credit segment in connection with that segment’s private label credit and co-brand programs. These inter-segment services accounted for approximately 97.1% of Private Label Services’ revenue for the year ended December 31, 2008. We have developed a proprietary credit system designed specifically for retailers that has the flexibility to be customized to accommodate our clients’ specific needs. We have also built into the system marketing tools to assist our clients in increasing sales. We use our Quick Credit and On-Line Prescreen products to originate new private label and co-brand credit accounts. We believe that these products provide an effective marketing advantage over competing services.

We use automated technology for bill preparation, printing and mailing, and also offer consumers the ability to view, print and pay their bills on-line. By doing so, we improve the funds availability for both our clients and for those private label and co-brand credit receivables that we own or securitize. Our customer care operations are influenced by our retail heritage. We focus our training programs in all areas to achieve the highest possible standards and monitor our performance by conducting surveys with our clients and their customers. Our call centers are equipped to handle phone, mail, fax and on-line inquiries. We also provide collection activities on delinquent accounts to support our private label and co-brand credit programs.

Private Label Credit

Our Private Label Credit segment provides risk management solutions, account origination and funding services for our more than 100 private label and co-brand retail credit programs. Through these programs, we managed approximately $4.1 billion in average receivables from approximately 22 million active accounts for the year ended December 31, 2008, with an average balance during that period of approximately $394 for accounts with outstanding balances. We process millions of credit applications each year using automated proprietary scoring technology and verification procedures to make risk-based origination decisions when approving new account-holders and establishing their credit limits. These procedures help us segment prospects into narrower ranges within each risk score provided by credit bureaus, allowing us to better evaluate individual credit risk and tailor our risk-based pricing accordingly. Our accountholder base consists primarily of middle- to upper-income individuals, in particular 35 to 49 year-old married females who use our accounts primarily as brand affinity tools rather than pure financing instruments, resulting in lower average balances compared to balances on general purpose credit cards. We focus our sales efforts on prime borrowers and do not target sub-prime borrowers.

Historically, we have used a securitization program as our primary funding vehicle for retail credit receivables. Securitizations involve the packaging and selling of both current and future receivable balances of credit accounts to a special purpose entity that then sells them to a master trust. Our securitizations are treated as sales for accounting purposes and, accordingly, the receivables are removed from our balance sheet. We retain an ownership interest in the receivables, which is commonly referred to as a seller’s interest, and a residual interest in the trust, which is commonly referred to as an interest-only strip. As of December 31, 2008, Limited Brands accounted for approximately 18.8% of the receivables in the trust portfolio.

Safeguards to Our Business; Disaster and Contingency Planning

We operate multiple data processing centers to process and store our customer transaction data. Given the significant amount of data that we manage, much of which is real-time data to support our clients’ commerce

initiatives, we have established redundant capabilities for our data centers. We have a number of safeguards in place that are designed to protect our company from data related risks and in the event of a disaster, to restore our data centers’ systems.

Protection of Intellectual Property and Other Proprietary Rights

We rely on a combination of copyright, trade secret and trademark laws, confidentiality procedures, contractual provisions and other similar measures to protect our proprietary information and technology used in each segment of our business. We currently have seven patent applications pending with the U.S. Patent and Trademark Office and one international application. We generally enter into confidentiality or license agreements with our employees, consultants and corporate partners, and generally control access to and distribution of our technology, documentation and other proprietary information. Despite the efforts to protect our proprietary rights, unauthorized parties may attempt to copy or otherwise obtain the use of our products or technology that we consider proprietary and third parties may attempt to develop similar technology independently. We pursue registration and protection of our trademarks primarily in the United States and Canada, although we also have either registered trademarks or applications pending in Argentina, New Zealand, the European Union and the Madrid Protocol, Peru, Mexico, Venezuela, Brazil, United Kingdom, Australia, China, Hong Kong, Japan and Singapore.

Effective protection of intellectual property rights may be unavailable or limited in some countries. The laws of some countries do not protect our proprietary rights to the same extent as in the United States and Canada. We are the exclusive Canadian licensee of the AIR MILES family of trademarks pursuant to a perpetual license agreement with Air Miles International Trading B.V., for which we pay a royalty fee. We believe that the AIR MILES family of trademarks and our other trademarks are important for our branding, corporate identification and marketing of our services in each business segment.

Competition

The markets for our products and services are highly competitive. We compete with marketing services companies, credit card issuers, and data processing companies, as well as with the in-house staffs of our current and potential clients.

Loyalty Services. As a provider of marketing services, our Loyalty Services segment generally competes with advertising and other promotional and loyalty programs, both traditional and on-line, for a portion of a client’s total marketing budget. In addition, we compete against internally developed products and services created by our existing and potential clients. We expect competition to intensify as more competitors enter our market. Competitors with our AIR MILES Reward Program may target our sponsors and collectors as well as draw rewards from our rewards suppliers. Our ability to generate significant revenue from clients and loyalty partners will depend on our ability to differentiate ourselves through the products and services we provide and the attractiveness of our loyalty and rewards programs to consumers. The continued attractiveness of our loyalty and rewards programs will also depend on our ability to remain affiliated with sponsors that are desirable to consumers and to offer rewards that are both attainable and attractive to consumers. Intensifying competition may make it more difficult for us to do this.

Epsilon Marketing Services. Our Epsilon Marketing Services segment generally competes with a variety of niche providers. These competitors’ focus has primarily been on one or two services within the marketing value chain, rather than the full spectrum of data-driven marketing services used for both traditional and on-line advertising and promotional programs. In addition, Epsilon Marketing Services also competes against internally developed products and services created by our existing clients and others. We expect competition to intensify as more competitors enter our market. For our targeted direct marketing services offerings, our ability to continue to capture detailed customer transaction data is critical in providing effective customer relationship management strategies for our clients. Our ability to differentiate the mix of products and services that we offer, together with the effective delivery of those products and services, are also important factors in meeting our clients’ objective to continually improve their return on marketing investment.

Private Label Services and Private Label Credit. Our Private Label Credit and Private Label Services segments generally compete primarily with financial institutions whose marketing focus has been on developing credit card programs with large revolving balances. These competitors further drive their businesses by cross selling their other financial products to their cardholders. Our focus has primarily been on targeting specialty retailers that understand the competitive advantage of developing loyal customers. Typically these retailers have customers that make more frequent and smaller transactions. As a result, we are able to analyze card-based transaction data we obtain through managing our card programs, including customer specific transaction data and overall consumer spending patterns, to develop and implement targeted marketing strategies and to develop successful customer relationship management strategies for our clients. As an issuer of private label retail cards, we compete with other payment methods, primarily general purpose credit cards like Visa and MasterCard, which we also issue primarily as co-branded private label retail cards, American Express and Discover Card, as well as cash, checks and debit cards.

Regulation

Federal and state laws and regulations extensively regulate the operations of our credit card services bank subsidiary, World Financial Network National Bank, and our industrial bank subsidiary, World Financial Capital Bank. Many of these laws and regulations are intended to maintain the safety and soundness of World Financial Network National Bank and World Financial Capital Bank, and they impose significant restraints on those companies to which other non-regulated companies are not subject. Because World Financial Network National Bank is deemed a credit card bank and World Financial Capital Bank is an industrial bank within the meaning of the Bank Holding Company Act, we are not subject to regulation as a bank holding company. If we were subject to regulation as a bank holding company, we would be constrained in our operations to a limited number of activities that are closely related to banking or financial services in nature. Nevertheless, as a national bank, World Financial Network National Bank is still subject to overlapping supervision by the Office of the Comptroller of the Currency, or OCC, and the Federal Deposit Insurance Corporation, or FDIC; and, as an industrial bank, World Financial Capital Bank is still subject to overlapping supervision by the FDIC and the State of Utah.

World Financial Network National Bank and World Financial Capital Bank must maintain minimum amounts of regulatory capital. If World Financial Network National Bank or World Financial Capital Bank does not meet these capital requirements, their respective regulators have broad discretion to institute a number of corrective actions that could have a direct material effect on our financial statements. World Financial Capital Bank, as an institution insured by the FDIC, must maintain certain capital ratios, paid-in capital minimums and adequate allowances for loan losses. World Financial Network National Bank must meet specific guidelines that involve measures and ratios of its assets, liabilities, regulatory capital, interest rate exposure and certain off-balance sheet items under regulatory accounting standards, among other factors. Under the National Bank Act, if the capital stock of World Financial Network National Bank is impaired by losses or otherwise, we, as the sole shareholder, may be assessed the deficiency. To the extent necessary, if a deficiency in capital still exists, the FDIC may be appointed as a receiver to wind up World Financial Network National Bank’s affairs.

Before World Financial Network National Bank can pay dividends to us, it must obtain prior regulatory approval if all dividends declared in any calendar year would exceed its net profits for that year plus its retained net profits for the preceding two calendar years, less any transfers to surplus. In addition, World Financial Network National Bank may only pay dividends to the extent that retained net profits, including the portion transferred to surplus, exceed bad debts. Moreover, to pay any dividend, World Financial Network National Bank must maintain adequate capital above regulatory guidelines. Further, if a regulatory authority believes that World Financial Network National Bank is engaged in or is about to engage in an unsafe or unsound banking practice, which, depending on its financial condition, could include the payment of dividends, that regulatory authority may require, after notice and hearing, that World Financial Network National Bank also cease and desist from the unsafe practice. To pay any dividend, World Financial Capital Bank must also maintain adequate capital above regulatory guidelines.

CEO BACKGROUND

DIRECTORS, EXECUTIVE OFFICERS AND OTHER KEY EMPLOYEES

The following table sets forth the name, age and positions of each of our directors, nominees for director, executive officers, business unit presidents and certain other key employees as of April 16, 2009:




Name Age

Positions

Bruce K. Anderson 69 Director


Robert P. Armiak 47 Senior Vice President and Treasurer


Roger H. Ballou 58 Director


Lawrence M. Benveniste, Ph. D. 58 Director


D. Keith Cobb 68 Director


E. Linn Draper, Jr., Ph.D. 67 Director


Edward J. Heffernan 46 Director Nominee, President and Chief Executive Officer


Kenneth R. Jensen 65 Director


Bryan J. Kennedy 41 Executive Vice President and President, Marketing Services


Michael D. Kubic 53 Senior Vice President, Interim Chief Financial Officer, Corporate Controller and Chief Accounting Officer


Robert A. Minicucci 56 Director


J. Michael Parks 58 Chairman of the Board


Bryan A. Pearson 45 Executive Vice President and President, Loyalty Services


Richard E. Schumacher, Jr. 42 Senior Vice President, Tax


Ivan M. Szeftel 55 Executive Vice President and President, Retail Credit Services


Dwayne H. Tucker 52 Executive Vice President, Human Resources


Alan M. Utay 44 Executive Vice President, General Counsel, Chief Administrative Officer and Secretary

MANAGEMENT DISCUSSION FROM LATEST 10K

Overview

We are a leading provider of data-driven and transaction-based marketing and customer loyalty solutions. We offer a comprehensive portfolio of integrated outsourced marketing solutions, including customer loyalty programs, database marketing services, marketing strategy consulting, analytics and creative services, permission-based email marketing and private label retail credit card programs. We focus on facilitating and managing interactions between our clients and their customers through a variety of consumer marketing channels, including in-store, catalog, mail, telephone and on-line. We capture data created during each customer interaction, analyze the data and leverage the insight derived from that data to enable clients to identify and acquire new customers, as well as to enhance customer loyalty. We believe that our services are becoming increasingly valuable as companies continue to shift their marketing resources away from traditional mass marketing campaigns toward more targeted marketing programs that provide measurable returns on marketing investments. We operate in the following business segments: Loyalty Services, Epsilon Marketing Services, Private Label Credit and Private Label Services.

Loyalty Services. The Loyalty Services segment generates revenue primarily from our coalition loyalty program in Canada.

In our AIR MILES Reward Program, we primarily collect fees from our clients based on the number of AIR MILES reward miles issued and, in limited circumstances, the number of AIR MILES reward miles redeemed. All of the fees collected for AIR MILES reward miles issued are deferred and recognized over time. AIR MILES reward miles issued and AIR MILES reward miles redeemed are the two primary drivers of Loyalty Services’ revenue and indicators of the success of the program. These two drivers are also important in the revenue recognition process.


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AIR MILES Reward Miles Issued: The number of AIR MILES reward miles issued reflects the buying activity of the collectors at our participating sponsors, who pay us a fee per AIR MILES reward mile issued. The fees collected from sponsors for the issuance of AIR MILES reward miles represent future revenue and earnings for us. The revenue related to the service element of the AIR MILES reward miles (which consists of marketing and administrative services provided to sponsors) is initially deferred and amortized over a period of 42 months, which is the estimated life of an AIR MILES reward mile, beginning with the issuance of the AIR MILES reward mile and ending upon its expected redemption.


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AIR MILES Reward Miles Redeemed: Redemptions show that collectors are redeeming AIR MILES reward miles to collect the rewards that are offered through our programs, which is an indicator of the success of the program. We also recognize revenue from the redemptions of AIR MILES reward miles by collectors. The revenue related to the redemption element is deferred until the collector redeems the AIR MILES reward miles or over the estimated life of an AIR MILES reward mile in the case of AIR MILES reward miles that we estimate will go unused by the collector base or “breakage.” We currently estimate breakage to be 28% of AIR MILES reward miles issued. There have been no changes to management’s estimate of the life of a mile in the periods presented. Our estimated breakage changed from one-third to 28% effective June 1, 2008. See Note 10 “Deferred Revenue” of our consolidated financial statements for additional information.

Our AIR MILES Reward Program tends to be more resilient to economic swings, because many of our sponsors are in non-discretionary retail categories such as grocery stores, gas stations and pharmacies. Additionally, we target the sponsors’ most loyal customers, who we believe are unlikely to significantly change their spending patterns. We are impacted by changes in the exchange rate between the U.S. dollar and the Canadian dollar.



Epsilon Marketing Services . Epsilon Marketing Services is a leader in providing integrated direct marketing solutions that combine database marketing technology and analytics with a broad range of direct marketing services. Epsilon Marketing Services has over 500 clients, primarily in the financial services, specialty retail, hospitality and pharmaceutical end-markets.

Private Label Services. The Private Label Services segment primarily generates revenue based on the number of statements generated, customer calls handled, remittance processing, customer care and various marketing services. Statements generated represent the number of statements generated for our credit cards. The number of statements generated in any given period is a fairly reliable indicator of the number of active account holders during that period.

Companies are increasingly outsourcing their non-core processes such as billing and customer care. The Private Label Services segment is primarily affected by those industry trends that affect our Private Label Credit segment as discussed below.

Private Label Credit. The Private Label Credit segment provides risk management solutions, account origination and funding services for our more than 100 private label retail and co-branded credit card programs. Private Label Credit primarily generates revenue from securitization income, servicing fees from our securitization trusts and merchant discount fees. Private label credit sales and average managed receivables are the two primary drivers of revenue for this segment.


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Private Label Credit Sales: This represents the dollar value of private label retail card sales that occur at our clients’ point of sale terminals or through catalogs or web sites. Generally, we are paid a percentage of these sales, referred to as merchant discount, from the retailers that utilize our program. Private label credit sales typically lead to higher portfolio balances as cardholders finance their purchases through our credit card banks.


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Average Managed Receivables: This represents the average balance of outstanding receivables from our cardholders at the beginning of each month during the period in question. Customers are assessed a finance charge based on their outstanding balance at the end of a billing cycle. There are many factors that drive the outstanding balances, such as payment rates, charge-offs, recoveries and delinquencies. Management actively monitors all of these factors.

The Private Label Credit segment is affected by increased outsourcing in targeted industries. The growing trend of outsourcing private label retail card programs leads to increased accounts and balances to finance. We focus our sales efforts on prime borrowers and do not target sub-prime borrowers. Additionally, economic trends can impact this segment. Interest expense is a significant component of operating costs for the securitization trusts.

Corporate/Other. This includes corporate overhead which is not allocated to our segments, as well as all other immaterial businesses.

When there are areas in our business units that no longer align with our strategy, we may explore the sale of those assets. On November 7, 2007 we sold ADS MB Corporation, which operated our mail services business. These mail services included personalized customer communications and intelligent inserting and commingling capabilities for clients in the financial services, healthcare, retail, government and utilities end markets.

In March 2008, we determined that our merchant services and utility services businesses were not aligned with our long-term strategy and committed to a disposition plan for these businesses. In May 2008, we sold our merchant services business; in July 2008, we sold the majority of our utility services business; and in February 2009, we completed the sale of the remainder of our utility services business.



2009 Outlook

Despite the difficult current macro-environment, we expect solid growth to continue during 2009. We expect that Loyalty Services will have growth, in local currency, in revenue and adjusted EBITDA in the mid-teens, more in line with its historical growth rates. We expect relationships with our sponsors to expand and grow, while adding new sponsors and expanding into new categories. However, we expect that our results will be negatively impacted by changes in the value of the Canadian dollar. We expect Epsilon Marketing Services will have growth rates in revenue and adjusted EBITDA in a similar range as achieved during 2008, as the demand for database, analytics and interactive services should continue. For Private Label Credit, we expect credit losses to average approximately 9.2%, in line with expected unemployment rate movement. However, we expect to mitigate the impact of higher credit losses with portfolio growth from 2008 signings coupled with the benefit of a lower cost of funds as spreads continue to narrow in 2009. In addition, we expect strong cash flow generation, with capital expenditures of approximately 3% of revenue. We also expect our earnings per share to benefit from the share repurchase programs. Overall, we expect to see moderate Adjusted EBITDA growth overall, despite the difficult macro-environment.

Discussion of Critical Accounting Policies

Our discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting policies that are described in the Notes to the Consolidated Financial Statements. The preparation of the consolidated financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We continually evaluate our judgments and estimates in determination of our financial condition and operating results. Estimates are based on information available as of the date of the financial statements and, accordingly, actual results could differ from these estimates, sometimes materially. Critical accounting policies and estimates are defined as those that are both most important to the portrayal of our financial condition and operating results and require management’s most subjective judgments. The most critical accounting policies and estimates are described below.

Securitization of credit card receivables. We utilize a securitization program to finance a majority of the credit card receivables that we underwrite. We use our off-balance sheet securitization program to lower our cost of funds and more efficiently use capital. In a securitization transaction, we sell credit card receivables originated by our Private Label Credit segment to a trust and retain servicing rights to those receivables, an equity interest in the trust, an interest in the receivables and retained interests in our subordinated notes. Our securitization trusts allow us to sell credit card receivables to the trusts on a daily basis. The securitization trusts are deemed to be qualifying special purpose entities under GAAP and are appropriately not included in our consolidated financial statements. Our interest in our securitization program is represented on our consolidated balance sheets as seller’s interest (our interest in the receivables) and due from securitizations (our retained interests and credit enhancement components).

The trusts issue bonds in the capital markets and notes in private transactions. The proceeds from the bonds and other debt are used to fund the receivables, while cash collected from cardholders is used to finance new receivables and repay borrowings and related borrowing costs. The excess spread is remitted to us as securitization income.

Our residual interest, often referred to as an interest-only strip, is recorded at fair value. The fair value of our interest-only strip represents the present value of the anticipated cash flows we will receive over the estimated life of the receivables, which ranges from 9.25 months to 11 months. This anticipated excess cash flow consists of the excess of finance charges and past-due fees net of the sum of the return paid to bond and note holders, estimated contractual servicing fees and credit losses. Because there is not a highly liquid market for these assets, we estimate the fair value of the interest-only strip primarily based upon discount, payment and default rates, which is the method we assume that another market participant would use to purchase the interest-only strip. The fair value of the interest-only strip, and the corresponding gain or loss, will be impacted by the estimated excess spread over the following two or three quarters. The excess spread is impacted primarily by finance and late fees collected, net charge-offs and interest rates.

Changes in the fair value of the interest-only strip are reflected in our financial statements as additional gains related to new receivables originated and securitized or other comprehensive income related to mark-to-market changes of our residual interest.

In recording and accounting for interest-only strips, we make assumptions about rates of payments and defaults that we believe reasonably reflect economic and other relevant conditions that affect fair value. Due to subsequent changes in economic and other relevant conditions, the actual rates of principal payments and defaults generally differ from our initial estimates, and these differences could sometimes be material. If actual payment and default rates are higher than previously assumed, the value of the interest-only strip could be impaired and the decline in the fair value would be recorded in earnings.

If management used different assumptions in estimating the value of the interest-only strip, the impact could have a significant effect on our consolidated financial statements. For example, a 10% change in the net charge-off rate assumption for our securitized credit card receivables could have resulted in a change of approximately $12.0 million in the value of the interest-only strip as of December 31, 2008.

We also retain certain subordinated beneficial interests in our securitized assets, primarily Class M, Class B and Class C notes issued by the securitization trusts as well as seller’s interest.

Seller’s interest ranks pari passu with investors’ interests in the securitization trusts and is carried on our consolidated financial statements at their estimated fair values. Changes in the fair values of our seller’s interest are recorded through securitization income and finance charges, net, on our consolidated statements of income. We determine the fair value of our seller’s interest through discounted cash flow models. The estimated cash flows used include assumptions related to rates of payments and defaults, which reflect economic and other relevant conditions. The discount rate used is based on an interest rate curve that is observable in the market place plus a credit spread. If management used different assumptions in estimating the value of seller’s interest, it could have an impact on our consolidated financial statements. For example a 10% change in the net charge-off rate assumption could have resulted in a decrease of approximately $0.6 million in the value of the seller’s interest as of December 31, 2008.

Our retained interests are classified as available-for-sale investment securities and are carried on our consolidated financial statements at their estimated fair values. Changes in the fair values of these notes are recorded in other comprehensive income within stockholders’ equity. The fair value of these securities are estimated utilizing discounted cash flow models, where the interest and principal payments are discounted at assumed current market rates for the same or comparable transactions. In doing these valuations, management makes certain assumptions about the credit spreads the market participants would demand on the same or similar investments given the currently inactive market for credit card asset-backed securities. Assumed discount rates are derived from indicative pricing observed in the most recent active market for such instruments, adjusted for changes occurring thereafter in relative credit spreads and liquidity risk premiums. If management used different assumptions in estimating the value of our retained interests, it could have an impact on our consolidated financial statements. For example, a 10% change in the discount rate could have resulted in a decrease of approximately $6.2 million in the value of the retained interest as of December 31, 2008.

See Note 7 “Securitization of Credit Card Receivables” of our consolidated financial statements for additional information.

We recognize the implicit forward contract to sell new receivables during a revolving period at its fair value at the time of sale. The implicit forward contract is entered into at the market rate and thus, its initial measure is zero at inception. In addition, we do not mark the forward contract to fair value in accounting periods following the securitization because management has concluded that the fair value of the implicit forward contract in subsequent periods is not material. We believe that servicing fees received represent adequate compensation based on the amount currently demanded by the marketplace. Additionally, these fees are the same as would fairly compensate a substitute servicer should one be required and, thus, we neither record a servicing asset nor servicing liability.

AIR MILES Reward Program. Because management has determined that the earnings process is not complete at the time an AIR MILES reward mile is issued, the recognition of revenue on all fees received based on issuance is deferred. We allocate the proceeds from issuances of AIR MILES reward miles into two components based on the relative fair value of the related element:


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Redemption element. The redemption element is the larger of the two components. For this component, we recognize revenue at the time an AIR MILES reward mile is redeemed, or, for those AIR MILES reward miles that we estimate will go unredeemed by the collector base, known as “breakage,” over the estimated life of an AIR MILES reward mile.


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Service element. For this component, which consists of marketing and administrative services provided to sponsors, we recognize revenue pro rata over the estimated life of an AIR MILES reward mile.

Under certain of our contracts, a portion of the proceeds is paid to us at the issuance of AIR MILES reward miles and a portion is paid at the time of redemption. Under such contracts the proceeds received at issuance are initially deferred as service revenue and the revenue and earnings are recognized pro rata over the estimated life of an AIR MILES reward mile.

The amount of revenue recognized in a period is subject to the estimated life of an AIR MILES reward mile. Based on our historical analysis, we make a determination as to average life of an AIR MILES reward mile. The estimated life of an AIR MILES reward mile of 42 months and a breakage rate of 28% subsequent to June 1, 2008 and one-third for previous periods presented.

In May 2008, we secured a comprehensive long-term renewal and expansion agreement with Bank of Montreal as a sponsor in the AIR MILES Reward Program, pursuant to which Bank of Montreal transferred to us the responsibility of reserving for costs associated with the redemption of AIR MILES reward miles issued by Bank of Montreal as a sponsor. We received $369.9 million for the assumption of this liability. Historically, AIR MILES reward miles issued by Bank of Montreal have been excluded from our estimate of breakage as Bank of Montreal had the responsibility of redemption, and therefore no breakage estimate was required. However, changing the nature of our agreement required us to include these miles in our analysis, which impacted both the redemption rate and our estimate of breakage. After evaluating the impact of this transaction, we adjusted our estimate of breakage from one-third to 28%. The decline in the breakage rate assumption was due to greater redemption activity by collectors who use Bank of Montreal credit cards. The change in estimate had no impact on the total redemption liability, but reduced the amount of deferred breakage within the redemption liability that is expected to be recognized over the expected life of the AIR MILES reward mile.

Breakage and the life of an AIR MILES reward mile is based on management’s estimate after viewing and analyzing various historical trends including vintage analysis, current run rates and other pertinent factors. The estimated life of an AIR MILES reward mile and breakage are actively monitored by management and subject to external influences that may cause actual performance to differ from estimates.

We believe that the issuance and redemption of AIR MILES reward miles is influenced by the nature and volume of sponsors, the type of rewards offered, the overall health of the Canadian economy, the nature and extent of AIR MILES Reward Program promotional activity in the marketplace and the extent of competing loyalty programs. These influences will primarily affect the average life of an AIR MILES reward mile. We do not believe that the estimated life will vary significantly over time, consistent with historical trends. The shortening of the life of an AIR MILES reward mile would accelerate the recognition of revenue and may affect the breakage rate. As of December 31, 2008, we had $995.6 million in deferred revenue related to the AIR MILES Reward Program that will be recognized in the future. Further information is provided in Note 10 “Deferred Revenue” of our consolidated financial statements.

Stock-based compensation. On January 1, 2006, we adopted the provisions of, and account for stock-based compensation in accordance with, Statement of Financial Accounting Standards No. 123 (revised 2004), “Share- Based Payment” (“SFAS No. 123R”). We elected the modified-prospective method, under which prior periods are not revised for comparative purposes. Under the fair value recognition provisions of SFAS No. 123R, stock based compensation cost is measured at the grant date based on the fair value of the award and is recognized ratably over the requisite service period.

We used a binomial lattice option pricing model to determine the fair value of stock options. The determination of the fair value of stock-based payment awards on the date of grant using an option pricing model is affected by our stock price as well as assumptions regarding a number of complex and subjective variables. These variables included our expected stock price volatility over the term of the awards, actual and projected employee stock option exercise behaviors, risk-free interest rate and expected dividends.

We estimated the expected term of options granted by calculating the average term from our historical stock option exercise experience. We estimated the volatility of our common stock by using an implied volatility. We based the risk-free interest rate that we used in the option pricing model on a forward curve of risk free interest rates based on constant maturity rates provided by the U.S. Treasury. We have not paid and do not anticipate paying any cash dividends in the foreseeable future and therefore used an expected dividend yield of zero in the option pricing model. We are required to estimate forfeitures at the time of grant and revise those estimates in subsequent periods if actual forfeitures differ from those estimates. We used historical data to estimate pre-vesting option forfeitures and record stock-based compensation expense only for those awards that are expected to vest. All share-based payment awards are amortized on a straight-line basis over the awards’ requisite service periods, which are generally the vesting periods. No options were issued during 2008.

If factors change and we employ different assumptions for estimating stock-based compensation expense, the future periods may differ from what we have recorded in the current period and could affect our operating income, net income and net income per share.

See Note 14 “Stock Compensation Plans” of our consolidated financial statements for further information regarding the SFAS No. 123R disclosures.

Income Taxes. We account for uncertain tax positions in accordance with Financial Accounting Standards Board Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” an interpretation of Statement of Financial Accounting Standards No. 109 (“FIN No. 48”). The application of income tax law is inherently complex. Laws and regulations in this area are voluminous and are often ambiguous. As such, we are required to make many subjective assumptions and judgments regarding our income tax exposures. Interpretations of, and guidance surrounding, income tax laws and regulations change over time. As such, changes in our subjective assumptions and judgments can materially affect amounts recognized in the consolidated balance sheets and statements of income. See Note 12 “Income Taxes” of our consolidated financial statements for additional detail on our uncertain tax positions and further information regarding FIN No. 48.

Inter-Segment Sales

Our Private Label Services segment performs card processing and servicing activities related to our Private Label Credit segment. For this, our Private Label Services segment receives a fee equal to its direct costs before corporate overhead plus a margin. The margin is based on current estimated market rates for similar services. This fee represents an operating cost to the Private Label Credit segment and corresponding revenue for our Private Label Services segment. Inter-segment sales are eliminated upon consolidation. Revenues earned by our Private Label Services segment from servicing our Private Label Credit segment, and consequently paid by our Private Label Credit segment to our Private Label Services segment, are set forth under “Eliminations” in the tables presented in the annual comparisons in our “Results of Operations.”

Use of Non-GAAP Financial Measures

Adjusted EBITDA is a non-GAAP financial measure equal to income from continuing operations, the most directly comparable GAAP financial measure, plus stock compensation expense, provision for income taxes, interest expense, net, fair value loss on interest rate derivative, loss on the sale of assets, merger and other costs, depreciation and other amortization and amortization of purchased intangibles.

We use adjusted EBITDA as an integral part of our internal reporting to measure the performance of our reportable segments and to evaluate the performance of our senior management. Adjusted EBITDA is considered an important indicator of the operational strength of our businesses. Adjusted EBITDA eliminates the uneven effect across all business segments of considerable amounts of non-cash depreciation of tangible assets and amortization of certain intangible assets that were recognized in business combinations. A limitation of this measure, however, is that it does not reflect the periodic costs of certain capitalized tangible and intangible assets used in generating revenues in our businesses. Management evaluates the costs of such tangible and intangible assets, the impact of related impairments, as well as asset sales through other financial measures, such as capital expenditures, investment spending and return on capital and therefore the effects are excluded from Adjusted EBITDA. Adjusted EBITDA also eliminates the non-cash effect of stock compensation expense. Stock compensation expense is not included in the measurement of segment adjusted EBITDA provided to the chief operating decision maker for purposes of assessing segment performance and decision making with respect to resource allocations. Therefore, we believe that adjusted EBITDA provides useful information to our investors regarding our performance and overall results of operations. Adjusted EBITDA is not intended to be a performance measure that should be regarded as an alternative to, or more meaningful than, either operating income or net income as an indicator of operating performance or to cash flows from operating activities as a measure of liquidity. In addition, adjusted EBITDA is not intended to represent funds available for dividends, reinvestment or other discretionary uses, and should not be considered in isolation or as a substitute for measures of performance prepared in accordance with GAAP. The adjusted EBITDA measure presented in this Annual Report on Form 10-K may not be comparable to similarly titled measures presented by other companies, and may not be identical to corresponding measures used in our various agreements.

MANAGEMENT DISCUSSION FOR LATEST QUARTER

The following discussion should be read in conjunction with the unaudited condensed consolidated financial statements and related notes thereto presented in this quarterly report and the audited consolidated financial statements and related notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2008, filed with the SEC on March 2, 2009, and our Current Report on Form 8-K, filed with the SEC on May 22, 2009, which re-issued certain items of our Annual Report on Form 10-K.

In October 2009, we announced an expansion agreement with tobacco company, R.J. Reynolds, for Epsilon to host its consumer database and support its consumer communication programs and that LoyaltyOne acquired a 29 percent interest in CBSM – Companhia Brasileira De Servicos De Marketing, operator of Brazil’s dotz loyalty program.

Critical Accounting Policies and Estimates

There have been no material changes to our critical accounting policies and estimates from the information provided in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” included in our Annual Report on Form 10-K for the year ended December 31, 2008.

Use of Non-GAAP Financial Measures

Adjusted EBITDA is a non-GAAP financial measure equal to income from continuing operations, the most directly comparable GAAP financial measure, plus stock compensation expense, provision for income taxes, interest expense, net, loss on the sale of assets, merger and other costs, depreciation and other amortization and amortization of purchased intangibles.

We use adjusted EBITDA as an integral part of our internal reporting to measure the performance of our reportable segments and to evaluate the performance of our senior management. Adjusted EBITDA is considered

an important indicator of the operational strength of our businesses. Adjusted EBITDA eliminates the uneven effect across all business segments of considerable amounts of non-cash depreciation of tangible assets and amortization of certain intangible assets that were recognized in business combinations. A limitation of this measure, however, is that it does not reflect the periodic costs of certain capitalized tangible and intangible assets used in generating revenues in our businesses. Management evaluates the costs of such tangible and intangible assets, the impact of related impairments, as well as asset sales through other financial measures, such as capital expenditures, investment spending and return on capital and therefore the effects are excluded from adjusted EBITDA. Adjusted EBITDA also eliminates the non-cash effect of stock compensation expense. Stock compensation expense is not included in the measurement of segment adjusted EBITDA provided to the chief operating decision maker for purposes of assessing segment performance and decision making with respect to resource allocations. Therefore, we believe that adjusted EBITDA provides useful information to our investors regarding our performance and overall results of operations. Adjusted EBITDA is not intended to be a performance measure that should be regarded as an alternative to, or more meaningful than, either operating income or net income as an indicator of operating performance or to cash flows from operating activities as a measure of liquidity. In addition, adjusted EBITDA is not intended to represent funds available for dividends, reinvestment or other discretionary uses, and should not be considered in isolation or as a substitute for measures of performance prepared in accordance with GAAP. The adjusted EBITDA measures presented in this Quarterly Report on Form 10-Q may not be comparable to similarly titled measures presented by other companies, and may not be identical to corresponding measures used in our various agreements.
Stock compensation expense. Stock compensation expense decreased $2.6 million, or 15.0%, to $14.6 million for the three months ended September 30, 2009. The decrease was the result of a reduction in expense of $6.9 million related to performance-based restricted stock unit awards that are no longer expected to vest and for which no expense was recognized during the three months ended September 30, 2009. This increase was partially offset by an increase in expense of $3.1 million related to equity awards issued to associates in 2009.

Depreciation and Amortization. Depreciation and amortization decreased $2.9 million, or 8.5%, to $31.2 million for the three months ended September 30, 2009 primarily due to a $2.0 million decrease in depreciation and other amortization and a $0.9 million decrease in amortization of purchased intangibles as certain assets became fully amortized.

Merger and other costs. Merger and other costs were $0.9 million for the three months ended September 30, 2009 compared to income of $1.1 million for the comparable period in 2008. Merger and other costs for the three months ended September 30, 2009 represent compensation charges related to the severance of a certain executive. For the comparable period in 2008, amounts include the receipt of $(3.0) million for reimbursement of costs incurred by us related to the Blackstone entities’ financing of the proposed merger offset by $0.9 million of expenditures directly associated with the proposed merger of us with an affiliate of The Blackstone Group and approximately $1.0 million of other non-routine costs associated with the disposition of non-core operations.

Operating Income. Operating income decreased $25.0 million, or 20.9%, to $94.8 million for the three months ended September 30, 2009 from $119.8 million for the comparable period in 2008. Operating income decreased due to the revenue and expense factors discussed above.

Interest Expense, net. Interest expense, net increased $15.7 million, or 67.4%, to $39.0 million for the three months ended September 30, 2009 from $23.3 million for the comparable period in 2008. This increase can be attributed in part to additional interest expense of $13.5 million associated with our convertible senior notes due 2013 and 2014, which were issued in July 2008 and June 2009, respectively. Interest expense on certificates of deposit also increased $4.7 million as a result of higher average balances during the three months ended September 30, 2009 than during the comparable period in 2008. Interest expense on our credit facilities and senior notes decreased $5.3 million as a result of lower interest rates and the repayment of $250.0 million aggregate principal amount of 6.00% Series A senior notes in May 2009. Interest income decreased $2.3 million due to lower average balances of our short term cash investments, as well as a decrease in the yield earned on those short term cash investments.

Taxes. Income tax expense decreased $27.7 million to $9.9 million for the three months ended September 30, 2009 from $37.6 million for the comparable period in 2008 due to a decrease in taxable income and a decrease in our effective tax rate to 17.8% for the three months ended September 30, 2009 from 38.9% for the comparable period in 2008. During the three months ended September 30, 2009, we recognized an $11.7 million tax benefit related to previously established tax reserves to cover various uncertain tax positions, including the potential impact related to the timing of certain taxable income recognition. Based on a recent United States Tax Court decision, statute of limitations expirations, and other factors, the uncertainty around this taxable income recognition has been removed and, as such, the related reserve, primarily associated with accrued interest, is no longer required.

Discontinued Operations

In February 2009, we completed the plan to dispose of our merchant services and utility services businesses. As a result, there was no activity associated with discontinued operations in our unaudited condensed consolidated statement of income for the three months ended September 30, 2009. In the comparable period in 2008, income from discontinued operations was $5.9 million, which was the result of a tax benefit resulting from our ability to utilize previously unrealized tax benefits due to the sale of the majority of our utility services business.

Adjusted EBITDA. For purposes of the discussion below, adjusted EBITDA is equal to income from continuing operations, plus stock compensation expense, provision for income taxes, interest expense, net, loss on the sale of assets, merger and other costs, depreciation and amortization. Adjusted EBITDA decreased $78.4 million, or 15.8%, to $418.0 million for the nine months ended September 30, 2009. Adjusted EBITDA margin, which for purposes of the discussion below is equal to adjusted EBITDA divided by revenue, decreased to 29.4% for the nine months ended September 30, 2009 from 32.7% for the comparable period in 2008. The changes in adjusted EBITDA and adjusted EBITDA margin are due to the following:
Stock compensation expense. Stock compensation expense increased $12.1 million, or 38.7%, to $43.3 million for the nine months ended September 30, 2009. The increase is the result of the issuance of restricted stock toward the end of the second quarter of 2008, which increased expense by $11.5 million for the nine months ended September 30, 2009.

Depreciation and Amortization. Depreciation and amortization decreased $11.7 million, or 11.4%, to $91.6 million for the nine months ended September 30, 2009 primarily due to a $6.9 million decrease in depreciation and other amortization and a $4.8 million decrease in amortization of purchased intangibles as certain assets became fully amortized.

Merger and other costs. Merger and other costs decreased $4.4 million to $3.9 million for the nine months ended September 30, 2009 from $8.3 million in the comparable period of 2008. During the nine months ended September 30, 2009, we incurred approximately $4.4 million in compensation charges related to the departure of certain executives and approximately $0.2 million of legal costs associated with the termination of our merger with an affiliate of The Blackstone Group. These costs were offset in part by a reimbursement from our insurer in the amount of $(0.7) million related to payments made to settle certain shareholder litigation associated with the proposed merger. During the nine months ended September 30, 2008, we incurred approximately $2.3 million of costs associated with the proposed merger including a $(3.0) million reimbursement of costs incurred by us related to the Blackstone entities’ financing of the proposed merger. In addition, during the nine months ended September 30, 2008, we incurred $6.0 million in compensation charges related to the severance of certain employees and other non-routine costs.

Loss on the sale of assets. In March 2008, we incurred a loss of $1.1 million related to the settlement of certain working capital accounts in connection with the disposition of our mail services business.

Operating Income. Operating income decreased $73.3 million, or 20.8%, to $279.2 million for the nine months ended Septe]]>Mon, 11 Jan 2010 04:59:07 GMThttp://www.dailystocks.com/forum/showtopic.php?tid/3731/http://www.dailystocks.com/forum/showtopic.php?tid/3731/ First Eagle Investment Management disclosed that it owns 2,123,646 shares (8.67%). The firm paid approximately $10.6 million, or $4.99 per share, to acquire its holding, which includes 1,050,000 shares purchased from Dec. 18 through Dec. 21 at $4.84 to $4.90 per share.
First Eagle said that it is evaluating Myriad's proposed stock-for-stock acquisition of Javelin

BUSINESS OVERVIEW

Overview

We are a specialty pharmaceutical company focused on discovering, developing, and commercializing novel small molecule drugs that address severe medical conditions with large potential markets, including cancer and HIV infection. Our pipeline includes clinical and preclinical drug candidates with distinct mechanisms of action and novel chemical structures. The discovery and development of each of our drug candidates has been guided by a unique understanding of the genetic causes of human diseases and the genetic factors that may cause drug side effects, drug interactions, and poor drug metabolism. Our extensive experience in human genetics, protein-protein interaction technology and chemical proteomic drug discovery has allowed identification of novel drug targets and accelerated progression from chemical lead compounds to investigational drug candidates.

We currently retain all rights to all of our drug candidates and programs across all geographic markets and therapeutic indications. Our strategy includes establishing our own commercial infrastructure in the United States and clinical development and commercial collaborations in other geographic regions.

Our Clinical-Stage Oncology Programs

We currently have two clinical-stage programs in oncology:


• Azixa . Azixa is our most advanced cancer drug candidate and is being developed for the treatment of advanced primary and metastatic tumors. Azixa is currently in two Phase 2 clinical trials to determine its efficacy in glioblastoma and metastatic melanoma, respectively. In the second quarter of 2009, we initiated a third Phase 2 trial of Azixa as monotherapy in patients with glioblastoma.


• MPC-3100 . MPC-3100 is an Hsp90 inhibitor we are developing for the treatment of cancer. In the second quarter of 2009, we initiated a Phase 1 open-label, dose-finding, multiple-dose clinical trial in patients with refractory or relapsed cancers, including solid tumors, lymphomas and leukemias.

Oncology Market Opportunity

The World Health Organization estimates that more than 11 million people are diagnosed with cancer every year worldwide, and seven million people die from the disease annually. The American Cancer Society estimated that approximately 1.4 million people in the United States would be diagnosed with cancer in 2008, and approximately 566,000 people would die from the disease in 2008. According to a 2007 IMS Health report, oncology products are the largest therapeutic class of pharmaceuticals in the world, with global sales of over $40.0 billion in 2007.

Azixa: Our Lead Drug Candidate for the Treatment of Cancer

Background

Cancers are diseases characterized by abnormal and uncontrolled cell growth and division, typically leading to tumor formation. As a tumor grows, it can directly disrupt organ function at its site of origin. In addition, cancer cells can also spread to other organs, such as the brain, bones and liver, by a process called metastasis. The growth of metastatic tumors at these new sites can disrupt the function of these other organs. There are many kinds of cancer, but all are characterized by uncontrolled growth of abnormal cells. Cancer tumors cannot grow more than a few millimeters in size, nor can they spread without developing their own network of blood vessels to supply oxygen and nutrients. Anticancer therapies typically consist of drugs which either directly inhibit uncontrolled cell growth and division or restrict oxygen supply to the tumor.

Glioblastoma multiforme, or GBM, is a type of brain tumor and is amongst the most highly vascularized tumors, characterized by abnormal vessel structure and unique vascular cells. This vascular hyperplasia is believed to be essential to the rapid growth of the tumor and may offer an opportunity for treatment by agents that are both able to penetrate the brain and selectively disrupt tumor vasculature. The American Cancer Society estimated the incidence of primary central nervous system, or CNS, tumors in the United States in 2007 as 21,810. GBM represents approximately 15-20% of primary brain tumors and prognosis remains poor with median survival estimated to be between 12 to 18 months from the time of diagnosis.

For GBM, first line treatment is surgical resection followed by radiation and administration of temozolomide. At recurrence, there is less guidance, usually resection if possible, re-irradiation and treatment with another systemic chemotherapy or immunotherapy. The treatment of patients with recurrent primary brain tumors is problematic, as the majority of patients with GBM are not candidates for re-operation due to tumor size and location, or poor performance status and only modestly effective therapeutic modalities are available. These therapies include drugs that kill cancer cells, or cytotoxic agents, radioactive seed implants, stereotactic radiotherapies or immunotherapy. Responses to chemotherapy regimes are generally palliative, reducing symptoms but not effecting a cure, and of limited duration. Accordingly, there are currently no approved chemotherapy regimes for recurrent malignant primary brain tumors. Stereotactic radiotherapies, such as radiosurgery or implants, benefit a minority of patients due to the large size and infiltrative nature of recurrent malignant gliomas. Additional fractionated external beam irradiation has only a modest effect on the growth of recurrent tumors and often exacerbates neurologic toxicity.

Few clinical trials address the issue of recurrent GBM and the majority of trials have suffered from comparatively small numbers of highly selected patients treated with a particular therapy. New treatments for GBM are clearly needed.

Melanomas, like GBM, are highly vascularized tumors. There are expected to be approximately 62,000 Americans diagnosed with melanoma this year. Advanced metastatic melanoma is associated with a poor prognosis, and effective treatment options are limited. Patients with stage IV melanoma generally have a median survival of only six to nine months, and a low probability of 10% to 20% for five-year survival. Up to 75% of patients with metastatic melanoma develop brain metastases during the course of their disease. In fact, patients with metastatic melanoma who respond to aggressive systemic therapy often relapse with metastases in the CNS.

Once patients develop brain metastases, treatment is palliative. Surgery and radiosurgery can produce effective palliation in selected cases but are usually restricted to patients with solitary CNS lesions. Radiation therapy is the current standard of care for multiple brain metastases and it can improve neurologic symptoms but does not alter disease outcome. Metastatic melanoma is poorly responsive to chemotherapy, with dacarbazine being the most widely used agent for treatment. Temozolomide is not an FDA-approved therapy for melanoma but is sometimes used, as recent studies indicate patients treated with temozolomide experienced an improvement in quality of life without increasing overall survival. However, only 20% of the temozolomide plasma concentration penetrates the blood brain barrier. Novel agents with better brain penetration are needed.

Azixa Overview

Azixa is a novel, small molecule drug candidate that acts as a microtubule destabilizing agent, causing arrest of cell division and programmed cell death, or apoptosis, in cancer cells. Azixa has also been shown to be a vascular disrupting agent, or VDA, in a mouse model of human ovarian cancer. Thus, Azixa has a dual mode of action; it induces apoptosis and acts as a VDA, resulting in tumor cell death. Importantly, in non-clinical studies, Azixa has demonstrated the unique ability to effectively cross the blood-brain barrier and accumulate in the brain. Azixa does not appear to be subject to multiple drug resistance. In 2007, we completed two open-label, dose-escalating, multiple dose Phase 1 clinical trials to investigate the safety, tolerability and pharmacokinetics of Azixa and to observe any evidence of anti-tumor activity in treatment of a variety of refractory solid tumors with and without brain metastases.

Azixa: Preclinical Development

In vitro mechanism of action studies have shown that Azixa binds to tubulin and destabilizes microtubules, which are cellular structures that play an important role in cell division and proliferation. This leads to inhibition of cell division and apoptosis. However, unlike other tubulin binding drugs, such as vincristine, vinblastine and vinorelbine, and the chemotherapeutic class of drugs known as taxanes, such as paclitaxel and docetaxel, Azixa does not appear to be a substrate for multidrug resistance pumps. The activity of Azixa in multidrug resistant cell lines was similar to its activity in nonresistant cell lines. Azixa has demonstrated potent activity in multiple cancer cell types, including glioma, melanoma, colon cancer, pancreatic cancer, breast cancer and ovarian cancer. In mice, Azixa significantly inhibited the growth of a variety of subcutaneously implanted tumor lines.

Azixa has also been shown to act as a VDA in a mouse model of human ovarian cancer. Thus, Azixa has a dual mode of action; it induces apoptosis and acts as a VDA, resulting in tumor cell death. VDAs have been established to reduce interstitial pressure in the tumor microenvironment which may increase local exposure to cytotoxic chemotherapy. Consistent with this hypothesis, Azixa has been demonstrated to act synergistically with the chemotherapeutic agent carboplatin in this mouse model of ovarian cancer. Accordingly, we believe Azixa has the potential to be used either in combination with cytotoxic chemotherapies or as a single agent.

The distribution of Azixa into the CNS was evaluated in mice and the time to maximum drug concentration was the same in both plasma and brain tissue, indicating that Azixa distributed rapidly into the CNS. Remarkably, Azixa concentration in the brain was 14 fold that in the plasma. Similar studies were performed in dogs and demonstrated a 30 fold higher concentration in the brain. These data suggest that it is possible to reach therapeutic drug concentrations of Azixa in the CNS with minimal systemic exposure. Based on these results, we tested the anti-tumor activity (tumor growth and survival) of Azixa in a mouse model in which human glioma cells had been implated in the brain. This study showed a statistically significant reduction in tumor burden and a statistically significant increase in survival when compared to vehicle treated mice.

Azixa: Completed Clinical Development

In 2007, we completed two open-label, dose-escalating, multiple dose Phase 1 clinical trials to investigate the safety, tolerability and pharmacokinetics of Azixa and to observe for any evidence of anti-tumor activity in treatment of a variety of refractory solid tumors with and without brain metastases. In these Phase 1 trials, 6 out of 66 subjects had stable disease ranging from 5 to 16 months and there was no evidence of CNS toxicities or development of peripheral neuropathies.

Azixa: Ongoing and Planned Clinical Development

In 2008, we initiated recruitment of patients for an open-label, dose finding, multiple-dose Phase 2 clinical trial in subjects with recurring/relapsing GBM. We expect to enroll up to 36 subjects in this trial. Patients with recurrent GBM will receive escalating dose levels of Azixa administered in combination with a fixed dose of carboplatin. Study endpoints include determination of the maximum tolerated dose, dose limiting toxicities, and evaluation of evidence of anti-tumor activity of Azixa when given with carboplatin as judged by response rate and progression-free survival. We expect to release the results of this trial in the first half of 2010.

In 2008, we initiated an open-label, dose finding, multiple-dose Phase 2 clinical trial to confirm the safety profile of Azixa in combination with the chemotherapeutic agent temozolomide, the current standard of care for recurrent metastatic melanoma, and to look for evidence of reduced tumor burden and improved survival. We expect to enroll up to 36 subjects in this trial which will explore Azixa’s efficacy in patients with metastatic melanoma with and without CNS metastasis. Patients with metastatic melanoma will receive escalating dose levels of Azixa administered in combination with a fixed dose of temozolomide. Study endpoints include determination of the maximum tolerated dose, dose limiting toxicities, and evaluation of evidence of anti-tumor activity of Azixa when given with temozolomide as judged by response rate and progression-free survival. We expect to release the results of this trial by the end of 2009.

In both the ongoing GBM (combination with carboplatin) and melanoma trials, we have observed both stable disease and partial responses in evaluable patients.

In the second quarter of 2009, we initiated an open-label Phase 2 clinical trial to evaluate Azixa as monotherapy in patients with GBM. In this planned trial, we currently expect to enroll approximately 68 subjects with first recurrence of GBM .We intend to investigate progression-free survival at six months as a primary endpoint with safety, pharmacokinetic parameters and overall survival as secondary endpoints. We expect this trial to take 12 to 18 months to be completed.

Azixa Safety Summary

In completed and ongoing clinical trials in which 102 subjects have been treated with Azixa, eight serious adverse events in seven subjects have been reported as possibly, probably or definitely related to Azixa: nonfatal myocardial infarction (single events in two subjects), cerebral hemorrhage (single events in two subjects), cerebral ischemia (one event in one subject), troponin I increased (one event in one subject) and hypersensitivity (two events in one subject). To date, the overall incidence of myocardial infarction is 2.0%, the incidence of cerebral hemorrhage is 2.0%, the incidence of cerebral ischemia is 1.0% and the incidence of troponin I increase is 1.0%.

MPC-3100 for the Treatment of Cancer

Background

Heat shock protein 90, or Hsp90, is a chaperone protein that plays an important role in regulating the activity and function of numerous signaling proteins, or client proteins, that trigger proliferation of cancer cells. Important client proteins in cancer include steroid hormone receptors, protein kinases, mutant p53, and telomerase h-TERT. Hsp90 binds and stabilizes these client proteins and inhibition of Hsp90 leads to degradation of the client proteins important for growth of the cancer.

Early Hsp90 inhibitors have been analogs of the natural product molecule geldanamycin that have demonstrated promising preclinical and clinical proof of concept activity, but have been challenging to develop because of drug related toxicities, including hepatotoxicity, nephrotoxicity and pancreatitis that do not appear to be related to inhibition of Hsp90. Additional limitations to geldanamycin derivatives include poor solubility, metabolic stability and difficulty in administration.

MPC-3100: Development

MPC-3100 is a fully synthetic, orally bioavailable, non-geldanamycin compound that has shown significant and broad preclinical anti-tumor activity in mouse models of human cancers. MPC-3100 has not demonstrated the same hepatic or renal toxicity in vivo as the geldanamycin analogs. MPC-3100 inhibits Hsp90 by binding to the same site as geldanamycin and has displayed potent anticancer activity in several in vitro and in vivo models. MPC-3100 significantly and dose-dependently reduced tumor growth in multiple studies conducted in mice implanted with a variety of human cancer cell lines, including colon, prostate, myeloid leukemia, small cell lung, gastric, breast, and ovarian cancers.

We submitted an investigational new drug application, or IND, for MPC-3100 in the first quarter of 2009 and initiated patient enrollment of a Phase 1 clinical trial in the second quarter of 2009 to investigate the safety and tolerability of MPC-3100, pharmacokinetics, and the potential for anti-tumor activity. This trial is an open-label, multiple-dose, dose escalation design in up to 40 subjects with refractory or relapsed cancer. Physical examination findings, electrocardiograms, pharmacokinetics, clinical laboratory parameters, and adverse events will be evaluated in subjects at each dose level to assess safety. Disease progression will be evaluated using standard clinical practice guidelines for each patient’s cancer type. In this ongoing study, MPC-3100 has been observed to be orally bioavailable in cancer patients. The pharmacokinetic properties and drug concentration achieved in patients to date are similar to those observed in efficacious animal studies and no dose limiting toxicities have been reported to date.

Our Clinical-Stage HIV Programs

We currently have two clinical-stage programs for the treatment of HIV:


•

MPC-4326 . MPC-4326 is a first-in-class small molecule inhibitor of HIV-1 maturation that we are developing for the oral treatment of HIV infection. To date, over 740 subjects, including over 180 HIV-infected patients, have been studied in clinical trials of MPC-4326. Results from these trials have shown MPC-4326 to be well tolerated and have demonstrated significant and clinically relevant reductions in viral load. We expect to initiate a Phase 2b clinical trial of MPC-4326 in treatment-experienced HIV patients by the end of 2009.


•

MPC-9055 . MPC-9055 is also a small molecule inhibitor of HIV-1 maturation that we are developing for the oral treatment of HIV infection. MPC-9055 is a backup program to MPC-4326 and is ready to begin Phase 2 clinical development.

HIV Background and Market Opportunity

Infection by HIV causes a slowly progressive deterioration of the immune system resulting in Acquired Immune Deficiency Syndrome, or AIDS. Approximately 33 million people worldwide are living with HIV. In North America, Central Europe and Western Europe, HIV infects approximately 2.1 million people. Approximately 475,000 patients are currently being treated for HIV with antiretroviral, or ARV, drug therapy in the United States. With new HIV testing mandates from both governmental and academic groups, more people with HIV are expected to seek treatment.

Several major classes of ARV drugs are available for use by patients, including reverse transcriptase inhibitors (NRTIs, NTRTIs, NNRTIs), protease inhibitors, a fusion inhibitor (enfuvirtide), an integrase inhibitor (raltegravir) and a CCR5 antagonist (maraviroc). Up to 85% of treated patients harbor at least some drug-resistant HIV strains, as do up to approximately 25% of newly diagnosed patients, making drug resistance a major problem in the treatment of HIV. As a result, patient treatment regimens must include the use of at least three drugs in combination and may require frequent readjustment. HIV drug treatment regimens can include multiple drugs from the same class, and increasingly include drugs available as co-formulations or fixed dosage combinations. Some recent data suggests that as many as one third of patients change their HIV treatment regimen each year, a manifestation of this treatment resistance in patients. These treatment changes, coupled with approximately 25,000 patients who start treatment each year, result in opportunities for new products to be incorporated into the new treatment regimens.

In 2005, worldwide sales for NRTIs and NRTI co-formulations totaled approximately $4.3 billion. In 2005, worldwide sales for NNRTIs and protease inhibitors totaled approximately $1.0 billion and $2.2 billion, respectively. A recent Datamonitor report estimates that the HIV drug market will be over $10 billion globally by the year 2015, largely due to the launch of new classes of drugs.

Because the most important problem in treating HIV is the emergence of viral strains that are resistant to currently approved drugs, our proprietary discovery technologies focus on novel targets in the virus life cycle, including virus maturation and virus fusion. Our primary aim is to develop small molecule oral drugs that treat HIV by addressing these novel targets. By focusing on novel classes of ARVs, we aim to meet the growing unmet need caused by resistance development to current classes of ARVs.

MPC-4326 for the Treatment of HIV

MPC-4326 is a first-in-class, small molecule inhibitor of HIV-1 maturation we are developing for the oral treatment of HIV infection that we acquired from Panacos Pharmaceuticals, Inc. in January 2009. MPC-4326 has demonstrated potent activity against a broad range of HIV strains, and laboratory studies have shown MPC-4326 to be an inhibitor of HIV isolates that are resistant to a large range of currently approved HIV drugs. Over 740 subjects, including over 180 HIV-infected subjects, have been studied in clinical trials of MPC-4326. Results from these trials have shown MPC-4326 to be well tolerated and have demonstrated significant and clinically relevant reductions in viral load in a subset of HIV-infected patients representing approximately 60% of HIV-infected patients, who can be identified by a simple, rapid and inexpensive assay of the HIV virus. In a Phase 2 clinical trial completed in 2008, MPC-4326 met its primary objective by demonstrating drug plasma levels in HIV-positive subjects to be in a target range for virologic reduction. In addition, MPC-4326’s safety profile was comparable to earlier studies where it had been indistinguishable from placebo. We expect to initiate a Phase 2b trial of MPC-4326 by the end of 2009.

MPC-4326: Preclinical Development

MPC-4326 is the first of a class of ARV drugs which inhibit HIV-1 replication by interfering with the maturation of the HIV-1 virus. Specifically, MPC-4326 interferes with a late step in the processing of the HIV-1 Gag protein. This inhibition leads to formation of noninfectious, immature virus particles, thus preventing subsequent rounds of HIV infection. As expected for a novel mechanism of action, MPC-4326 retains inhibitory activity against HIV-1 isolates resistant to the four classes of currently approved drugs commonly used by HIV-infected patients: NRTIs, NNRTIs, protease inhibitors and fusion inhibitors. As a corollary to this, isolates resistant to MPC-4326 have been shown to be fully sensitive to all classes of approved anti-HIV drugs. No cross-resistance has been observed. In addition, in vitro combination activity studies have demonstrated that MPC-4326 was synergistic when combined with most approved anti-HIV drugs that have been tested.

MPC-4326: Completed Phase 2 Clinical Trials

A Phase 2 clinical trial of MPC-4326 in HIV patients met its primary endpoint by demonstrating a statistically significant reduction in the viral load compared to placebo. This trial was a randomized, double-blind, placebo-controlled Phase 2 trial conducted in the United States. MPC-4326 at one of four doses (25 mg,

50 mg, 100 mg or 200 mg) or placebo (six to eight subjects per group) was administered orally in a liquid formulation once daily for 10 days to HIV-positive subjects who were not on other ARV therapy during the trial and for at least the previous 12 weeks. The primary endpoint was viral load reduction on day 11. Secondary endpoints included safety, tolerability and pharmacokinetics.

At the 50 mg, 100 mg and 200 mg doses, MPC-4326 treatment for ten days resulted in statistically significant reductions in viral load compared to placebo, with decreases of up to 98%, in individual subjects. The magnitude of viral load reduction increased with increasing MPC-4326 dose, and reduction in viral load compared to placebo was seen in both treatment-naive and in treatment-experienced subjects, confirming the potent antiviral activity of MPC-4326. In this trial, all doses were well tolerated with no Grade 3 or 4 treatment-related laboratory abnormalities. All adverse events were of mild to moderate intensity and no dose-limiting toxicity was identified. One serious adverse event was considered to be possibly drug related. It involved a subject with a 5-year history of hypertension and recent poor medication compliance who exhibited transient findings of a type of stroke which is a known complication of hypertension. This event resolved without consequence.

A second Phase 2 clinical trial of MPC-4326 was conducted at multiple clinical sites in the United States. In this trial, initially using a 50 mg tablet formulation, MPC-4326 was administered to 46 HIV-positive subjects in combination with approved HIV drugs. Subjects failing standard of care therapies were enrolled in this trial and received either placebo or MPC-4326 at one of several doses. The primary efficacy endpoint of the trial was viral load reduction after two weeks of MPC-4326 dosing on top of subjects’ background drug regimens. Additional endpoints of this trial were safety after two weeks and, for the first (tablet) cohort only, safety and viral load reduction after an additional ten weeks of dosing on top of optimized background therapy.

Due to stability problems with the 50 mg tablet, the protocol was revised to allow dosing with the liquid formulation. Consistent with earlier data from trials in healthy volunteers, there were generally proportional increases in plasma concentration associated with increased MPC-4326 doses. The MPC-4326 trough concentration, also referred to as C min (the blood level 24 hours after dosing), that appears to be associated with a virologic response is 20 µg/mL, a mean threshold that was achieved in a substantial majority of subjects in this clinical trial.

The efficacy data from this trial suggest that there are two populations of subjects, responders and non-responders. Statistically significant differences between responders and non-responders exist for certain changes, or polymorphisms, in the viral DNA sequences encoding the Gag protein, or viral genotype, which is the molecular target of MPC-4326. Responders generally have none of these polymorphisms in Gag, while non-responders generally have at least one polymorphism. Of the subjects who received active MPC-4326 treatment, 34% had more than a 90% viral load reduction at day 15. Of those subjects who had a C min of at least 20 µg/mL and had no Gag polymorphisms, 77% had at least a 90% viral load reduction at day 15. We anticipate that future clinical trials of MPC-4326 will enroll patients having a Gag genotype correlated with a positive drug response. The most commonly reported adverse events for subjects receiving MPC-4326 were diarrhea, nausea, headache, abnormal dreams, and dizziness.

A recently completed Phase 2 clinical trial conducted in Australia was designed to evaluate the safety, pharmacokinetics and ARV activity of 200 mg twice daily or 300 mg twice daily doses of MPC-4326 administered as monotherapy to 32 HIV-positive patients for 14 days. Patients were stratified on the basis of prior ARV therapy use; 26 patients were treatment-naïve and six were treatment-experienced. All patients were treated exclusively with MPC-4326 for 14 days; no placebo was used. Treatment-experienced patients discontinued their ARV therapy regimen at least three days prior to the start of MPC-4326 treatment. At the end of the 14 day treatment period, six patients continued treatment in an open-label extension study.

Consistent with other trials in both healthy volunteer subjects and in HIV-positive patients, the rate and type of treatment emergent adverse events was primarily gastrointestinal or CNS related and judged to be of mild intensity. There were no serious adverse events, no treatment related discontinuations and no deaths reported. All patients, regardless of dose, had MPC-4326 plasma concentrations in excess of the previously identified target levels required for treatment response. Confirming observations made in previous trials, there were two populations of subjects with respect to viral load reduction, responders and non-responders. The statistically significant differences in viral load reductions between these two populations appear to be explained by certain polymorphisms in the viral genome encoding the Gag protein. Four subjects continued to be treated in an open-label extension study through 48 weeks and have maintained undetectable viral load.

MANAGEMENT DISCUSSION FROM LATEST 10K

Overview

We were incorporated in Delaware in January 2009 as a new, wholly owned subsidiary of Myriad Genetics, Inc. in order to effect the separation and spin-off of Myriad Genetics’ research and drug development businesses as a stand-alone, independent, publicly traded company. In connection with the formation of this new subsidiary, Myriad Genetics’ existing subsidiary, Myriad Pharmaceuticals, Inc., changed its corporate name to Myriad Therapeutics, Inc., and we adopted the name of Myriad Pharmaceuticals, Inc. On June 30, 2009, Myriad Genetics contributed substantially all of the assets and certain liabilities of its research and drug development businesses as well as $188 million in cash and marketable securities to us and effected the spin-off of our company through a pro rata dividend distribution to its stockholders of all outstanding shares of our common stock.

Myriad Pharmaceuticals, Inc. is a specialty pharmaceutical company focused on discovering, developing, and commercializing novel small molecule drugs that address severe medical conditions with large potential markets, including cancer and HIV infection. Our pipeline includes clinical and preclinical drug candidates with distinct mechanisms of action and novel chemical structures. The discovery and development of each of our drug candidates has been guided by a unique understanding of the genetic causes of human diseases and the genetic factors that may cause drug side effects, drug interactions, and poor drug metabolism. Our extensive experience in human genetics, protein-protein interaction technology and chemical proteomic drug discovery has allowed identification of novel drug targets and accelerated progression from chemical lead compounds to investigational drug candidates.

We operate in one reportable operating segment that includes research and drug development. Until the fiscal year ended June 30, 2008, our revenues have consisted primarily of research payments related to research collaboration agreements. In fiscal 2008, our revenue included a $100.0 million non-refundable fee received from H. Lundbeck A/S, or Lundbeck, in connection with an agreement granting Lundbeck European commercialization rights to Flurizan, our former drug candidate for the treatment of Alzheimer’s disease. During the year ended June 30, 2009, we reported a net loss of $58.1 million.

We expect to incur significant net losses for the foreseeable future and that such losses will fluctuate from quarter to quarter and that such fluctuations may be substantial. Additionally, we expect to incur substantial sales, marketing and other expenses in preparation for the commercialization of our drug candidates and some of these expenses will be incurred prior to FDA approval, which approval is not assured.

Our drug development research and development expenses include costs incurred for our current clinical-stage drug candidates as well as our discontinued drug candidates Flurizan and MPC-9055. Currently, the only costs we track by each drug candidate are external costs such as services provided to us by clinical research organizations, manufacturing of drug supply, and other outsourced research. We do not assign or allocate internal costs such as salaries and benefits, facilities costs, lab supplies and the costs of preclinical research and studies to individual development programs. We also incurred costs related to external research collaborations from our research services business. We track all underlying principal costs associated with our research collaborations.

We do not know if we will be successful in developing any of our drug candidates. While expenses associated with the completion of our current clinical programs are expected to be substantial and increase, we believe that accurately projecting total program-specific expenses through commercialization is not possible at this time. The timing and amount of these expenses will depend upon the costs associated with potential future clinical trials of our drug candidates, and the related expansion of our research and development organization, regulatory requirements, advancement of our preclinical programs and product manufacturing costs, many of which cannot be determined with accuracy at this time. We are also unable to predict when, if ever, material net cash inflows will commence from our drug candidates. This is due to the numerous risks and uncertainties associated with the duration and cost of clinical trials, which vary significantly over the life of a project as a result of unanticipated events arising during clinical development, including:


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the scope, rate of progress, and expense of our clinical trials and other research and development activities;


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the length of time required to enroll suitable subjects;


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the number of subjects that ultimately participate in the trials;


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the efficacy and safety results of our clinical trials and the number of additional required clinical trials;


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the terms and timing of regulatory approvals;


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our ability to market, commercialize, manufacture and supply, and achieve market acceptance for our drug candidates that we are developing or may develop in the future; and


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the filing, prosecuting, defending or enforcing any patent claims or other intellectual property rights.

A change in the outcome of any of the foregoing variables in the development of a drug candidate could mean a significant change in the costs and timing associated with the development of that drug candidate. For example, if the FDA or another regulatory authority were to require us to conduct clinical trials beyond those which we currently anticipate to complete clinical development of a drug candidate, or if we experience significant delays in the enrollment of patients in any of our clinical trials, we would be required to expend significant additional financial resources and time on the completion of clinical development.
Critical Accounting Policies and Use of Estimates

Critical accounting policies are those policies which are both important to the portrayal of a company’s financial condition and results and require management’s most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. Our critical accounting policies are as follows:


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revenue recognition;


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clinical trial expenses; and


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share-based payment expense.

Revenue Recognition

Revenue from non-refundable upfront license fees where we have continuing involvement is recognized ratably over the development or agreement period or upon termination of a development or license agreement when we have no ongoing obligation.

Research revenue includes revenue from research services agreements, milestone payments, and technology licensing agreements. In applying the principles of SEC Staff Accounting Bulletin No. 104, Revenue Recognition , as well as Emerging Issues Task Force, or EITF, 00-21, Revenue Arrangements with Multiple Deliverables , or EITF 00-21, to research and technology license agreements we consider the terms and conditions of each agreement separately to arrive at a proportional performance methodology of recognizing revenue. Such methodologies involve recognizing revenue on a straight-line basis over the term of the agreement, as underlying research costs are incurred, or on the basis of contractually defined output measures such as units delivered. We make adjustments, if necessary, to the estimates used in our calculations as work progresses and we gain experience. The principal costs under these agreements are for personnel expenses to conduct research and development but also include costs for materials and other direct and indirect items necessary to complete the research under these agreements. Actual results may vary from our estimates. Payments received on uncompleted long-term contracts may be greater than or less than incurred costs and estimated earnings and have been recorded as other receivables or deferred revenues in the accompanying balance sheets. Revenue from milestone payments for which we have no continuing performance obligations is recognized upon achievement of the related milestone. When we have continuing performance obligations, the milestone payments are deferred and recognized as revenue over the term of the arrangement as we complete our performance obligations. We recognize revenue from upfront nonrefundable license fees on a straight-line basis over the period of our continued involvement in the research and development project.

Clinical Trial Expenses

The cost of our clinical trials is based, in part, on estimates of the services received and efforts expended pursuant to contracts with numerous clinical trial centers and clinical research organizations (the CROs). In the normal course of business, we contract with third parties to perform various clinical trial activities in the ongoing development of our drug candidates. The financial terms of these agreements vary from contract to contract, are subject to negotiation and may result in uneven payment flows. Payments under the contracts depend on factors such as the achievement of certain events, the successful enrollment of patients or the completion of portions of the clinical trial or similar conditions. The objective of our accrual policy is to match the recording of expenses in our financial statements to the actual services received and efforts expended. As such, we recognize direct expenses related to each patient enrolled in a clinical trial on an estimated cost-per-patient basis as services are performed. In addition to considering information from our clinical operations group regarding the status of our clinical trials, we rely on information from CROs, such as estimated costs per patient, to calculate our accrual for direct clinical expenses at the end of each reporting period. For indirect expenses, which relate to site and other administrative costs to manage our clinical trials, we rely on information provided by the CRO, including costs incurred by the CRO as of a particular reporting date, to calculate our indirect clinical expenses. In the event of early termination of a clinical trial, we would recognize expenses in an amount based on our estimate of the remaining non-cancelable obligations associated with the winding down of the clinical trial, which we would confirm directly with the CRO.

If our CROs were to either under or over report the costs that they have incurred or if there is a change in the estimated per patient costs, it could have an impact on our clinical trial expenses during the period in which they report a change in estimated costs to us. Adjustments to our clinical trial accruals primarily relate to indirect costs, for which we place significant reliance on our CROs for accurate information at the end of each reporting period.

Share-Based Payment Expense

Financial Accounting Standards Board, or FASB, Statement No. 123R, Share-Based Payment , or SFAS 123R, sets accounting requirements for “share-based” compensation to employees, including employee stock purchase plans, and requires us to recognize, as expense, in our statements of operations, the grant-date fair value of our stock options and other equity-based compensation. The determination of grant-date fair value is estimated using an option-pricing model, which includes variables such as the terms of each grant, the expected volatility of our share price, the exercise behavior of our employees, interest rates, and dividend yields. These variables are projected based on our historical data, experience, and other factors. Changes in any of these variables could result in material adjustments to the expense recognized for share-based payments.

In connection with the separation and related transactions, each outstanding Myriad Genetics stock option was converted into an adjusted Myriad Genetics common stock option, exercisable for the same number of shares of common stock as the original Myriad Genetics option, and a new MPI common stock option, exercisable for one-fourth of the number of shares of common stock as the original Myriad Genetics option. An adjusted exercise price of each converted option was determined in accordance with Section 409A and Section 422 of the Internal Revenue Code of 1986. All other terms of the converted options remain the same however; the vesting and expiration of the converted options will be based on the optionholder’s continuing employment with Myriad Genetics or MPI, as applicable, following the separation.

As a result of the option modifications that occurred in connection with the separation from Myriad Genetics, Myriad Genetics measured the potential accounting impact of these option modifications as set forth in SFAS 123R paragraphs 53 and 54. Based upon the analysis, which included a comparison of the fair value of the modified options granted to our employees and directors immediately after the modification with the fair value of the original option immediately prior to the modification, it was determined that there was no incremental compensation expense. All unrecognized SFAS 123R compensation expense at June 30, 2009, that is related to Myriad Genetics options and MPI options that are held by current MPI employees and directors will be recognized by us over the remaining vesting term of the option. All such expense relating to MPI options held by current and former Myriad Genetics employees, directors or consultants will not be recognized by us.

Recent Accounting Pronouncements

In February 2008, the FASB issued FSP No. 157-2, which delays the effective date of FAS 157 for non-financial assets and non-financial liabilities, except for items that are recognized or disclosed at fair value on a recurring basis (items that are re-measured at least annually). The FSP deferred the effective date of FAS 157 for non-financial assets and non-financial liabilities until our fiscal year beginning on July 1, 2009. The adoption of this standard by us is not expected to have a material effect on our financial statements.

Results of Operations

The balance sheet as of June 30, 2009 and notes related thereto reflect the opening balances of MPI as an independent company. All other amounts reflected in the financial statements include the assets, liabilities and results of operations of the components of Myriad Genetics that constituted the research and drug development

businesses that were separated. The financial statements have been prepared using Myriad Genetics’ historical costs basis of the assets and liabilities of the various activities that reflect the combined results of operations, financial condition and cash flows of us as a component of Myriad Genetics. Specific costs attributable to our operations have been included in the financial statements. The financial statements also include some proportional cost allocations of certain common costs of Myriad Genetics because these expenses were not specifically identified at the subsidiary level. The basis of these allocations includes full-time equivalent employees for the respective periods presented, square footage, and other appropriate allocation drivers.

The financial information in the financial statements does not include all of the expenses that would have been incurred had we been a separate, stand-alone publicly traded entity, including, but not limited to, costs to implement accounting, human resource, payroll, purchasing, information technology, legal and other business functions and systems. As such, the financial information herein does not reflect the financial position, results of operations or cash flows of us in the future or what they would have been, had we been a separate, stand-alone entity during the periods presented.

Years ended June 30, 2009 and 2008

Research and other revenue is comprised of research payments received pursuant to external collaborative agreements. Research revenue for the fiscal year ended June 30, 2009 was $5.5 million compared to $6.8 million in the prior year. The 19% decrease in research revenue was primarily attributable to the completion of genomic sequencing research collaboration in September 2008. Research revenue from our research collaboration agreements is recognized using a proportional performance methodology. Consequently, as these programs progress and outputs increase or decrease, revenue may increase or decrease proportionately.

Pharmaceutical revenue is comprised of co-marketing agreement payments received relating to our former drug candidate for the treatment of Alzheimer’s disease, Flurizan. On May 21, 2008, we entered into an agreement with Lundbeck for European commercialization of Flurizan. As consideration for entering into the agreement we received a $100.0 million non-refundable upfront fee which we expected to recognize over 15 years. On June 30, 2008, we announced the results of our U.S. 18-month Phase 3 clinical trial of Flurizan in patients with mild Alzheimer’s disease. The trial did not achieve statistical significance on either of its primary endpoints, cognition and activities of daily living. As a result we discontinued all ongoing Flurizan clinical studies in 2008, including the decision to discontinue our global Phase 3 trial, and have no further performance obligations under the agreement. The discontinuance of the Flurizan development program and any ongoing development activity related to Flurizan resulted in the recognition of the full $100.0 million upfront fee as pharmaceutical revenue in fiscal 2008. In the fiscal year ended June 30, 2008, we recognized $104 million in pharmaceutical and other revenues relating to payments received under the agreement with Lundbeck. We had no pharmaceutical or other revenue in fiscal 2009.

Research and development expenses are comprised primarily of salaries and related personnel costs, laboratory supplies, equipments costs, facilities expense, and costs associated with our clinical trials. Research and development expenses for the fiscal year ended June 30, 2009 were $54.6 million compared to $121.5 million in 2008. This 55% decrease was primarily due to:


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decreased external drug development costs of approximately $76.0 million resulting from the discontinuance of our former drug candidate Flurizan that includes a $9.0 million credit, recorded in fiscal 2009, resulting from the difference in an estimated sublicense fee accrual recorded in fiscal 2008 and amounts actually paid in 2009;

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increased external drug development costs of approximately $2.5 million and $1.3 million for MPC-3100 and Azixa, respectively, our oncology drug candidates currently in clinical development; and

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a decrease of approximately $2.9 million due to the completion of external research collaborations.

We expect our research and development expenses will fluctuate over the next several years as we conduct additional clinical trials to support the potential commercialization of our drug candidates currently in clinical development, including Azixa, MPC-3100 and MPC-4326, and advance other drug candidates into clinical development.

Selling, general and administrative expenses consist primarily of salaries and related personnel costs for marketing, executive, legal, finance and accounting, information technology, human resources, and allocated facilities expenses. Selling, general and administrative expenses for the fiscal year ended June 30, 2009 were $9.0 million, compared to $20.6 million in 2008. The decrease in selling, general and administrative expenses of 56% was due primarily to a decrease in commercialization efforts and internal expense allocations resulting from the discontinuance of our drug candidate Flurizan. We expect our selling, general and administrative expenses will continue to fluctuate depending on our drug discovery and drug development efforts.

We had no other income (expense) for the fiscal year ended June 30, 2009 compared to a $3.0 million net expense for the fiscal year ended June 30, 2008. This change was primarily attributable to the write-off of $3 million of our preferred stock investment in Encore Pharmaceuticals, Inc. (from whom we had previously licensed Flurizan) in 2008 as a result of our discontinuation of our drug candidate Flurizan.

Years ended June 30, 2008 and 2007

Research and other revenue for the fiscal year ended June 30, 2008 was $10.8 million compared to $11.8 million for the prior fiscal year. This 9% decrease in research and other revenue was primarily attributable to the successful completion of research collaborations during 2008.

In the fiscal year ended June 30, 2008, we recognized $104 million in pharmaceutical and other revenues relating to payments made under the agreement with Lundbeck. We had no pharmaceutical revenue in the fiscal year ended June 30, 2007. •

increased external drug development costs associated with our HIV drug candidates of $9.2 million due to the purchase of in process research and development related to MPC-4326 and further development of this drug candidate, which was offset by a $2.0 million decrease in expenditures relating to MPC-9055;

Other income (expense), net for the fiscal year ended June 30, 2008 decreased $3.6 million from net income of $0.6 million for the fiscal year ended June 30, 2007 to a $3.0 million net expense for the fiscal year ended June 30, 2008. The decrease was primarily attributable to the write-off of $3.0 million of our preferred stock investment in Encore Pharmaceuticals, Inc. (from whom we had previously licensed Flurizan) in 2008 as a result of our discontinuation of our drug candidate Flurizan. We had no tax expense during the period due to our net loss position.

Liquidity and Capital Resources

Net cash used in operating activities was $60.7 million during the fiscal year ended June 30, 2009 compared to $12.2 million provided by operating activities during the prior fiscal year. The change in cash flow from operating activity can be attributed primarily to the higher net loss in fiscal 2009 and the payment of accrued expenses associated with the our former drug candidate Flurizan. These were offset, in part, by higher non-cash charges associated with share-based compensation and the write-off of purchased in-process research and development recorded in fiscal 2009.

Our investing activities used $7.4 million in cash during the fiscal year ended June 30, 2009 compared to $2.6 million during the prior fiscal year. The change is primarily due to the acquisition of in-process research and development in fiscal 2009, offset by a reduction in capital expenditures for research equipment.

Approximately $196.4 million in cash was provided by financing activities during fiscal 2009, which amount reflects cash and the changes in Myriad Genetics net investment in MPI both of which were contributed to capital in connection with the spin-off. During the fiscal year ended June 30, 2008, financing activities used cash of $9.6 million, which represents the net change in Myriad Genetics’ net investment in MPI.

Prior to June 30, 2009, all cash and investments were held and managed by Myriad Genetics. Accordingly, cash used to pay our expenses or cash collected from collaboration agreements was provided or received by Myriad Genetics on our behalf and were recorded as an increase or decrease in the Myriad Genetics net investment (capital deficiency).

On June 30, 2009 Myriad Genetics contributed substantially all of the assets and certain liabilities of its research and drug development businesses as well as $188.0 million in cash and marketable securities to us. We believe that with our existing capital resources, we will have adequate funds to maintain our current and planned operations through at least June 30, 2012, although no assurance can be given that changes will not occur that would consume available capital resources before such time and we may need or want to raise additional financing within this period of time.


]]>Fri, 08 Jan 2010 05:10:48 GMThttp://www.dailystocks.com/forum/showtopic.php?tid/3724/http://www.dailystocks.com/forum/showtopic.php?tid/3724/
Microtune (TUNE)
Hedge fund Ramius Capital has nominated four individuals for election to Microtune's board. Ramius further disclosed that it has engaged in discussions with representatives of Microtune, which designs and markets radio-frequency integrated circuits and subsystem modules. Ramius said that it expected to continue the discussions in connection with its nominations.
Its nominees are John Buckett; a former executive at Scientific-Atlanta; John Hamm, a general partner at venture-capital firm VSP Capital; Mark Mitchell, the managing director of Ramius; and Raghu Rau, a former Motorola executive.
Ramius owns 3,950,000 Microtune shares (7.5% of the total outstanding).
BUSINESS OVERVIEW

Website Access to Reports and Other Information

We make our Proxy Statements, Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to those reports, filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, available free of charge upon request by phone (telephone number: (972) 673-1610), by email to ir@microtune.com, in writing to our Investor Relations department at 2201 10 th Street, Plano, Texas 75074 or through our internet website, www.microtune.com , as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. You may also access these materials at the SEC’s website located at www.sec.gov.

Overview

Microtune, Inc. was incorporated in 1996. We design and market radio frequency (RF) integrated circuits (ICs) and subsystem module solutions for the cable, automotive entertainment electronics and digital television (DTV) markets. Our tuner, amplifier and upconverter products permit the delivery, reception and exchange of broadband video, audio and data using terrestrial (off-air) and/or cable communications systems. Our tuner products shipped into the cable and DTV markets are in the form of ICs while our tuner products shipped into the automotive entertainment electronics market are principally in the form of subsystem modules, but are expected to be increasingly in the form of ICs in the near future. Our amplifier products are principally in the form of both ICs and subsystem modules and our upconverter products are principally in the form of subsystem modules, but also contain our ICs.

Our products enable or target various consumer electronics, broadband communications and automotive entertainment electronics applications or devices, including cable television set-top boxes; DOCSIS ® -based, high-speed voice and data cable modems; car audio, television and antenna amplifier systems; digital/analog television systems, including high-definition televisions (HDTV); personal computer television (PC/TV) multimedia products; and mobile television receivers. We sell our products to original equipment manufacturers (OEMs) and original design manufacturers (ODMs) who sell devices, subsystems and applications to consumers or service providers within the cable, automotive entertainment electronics and DTV markets. We operate Microtune as a single business unit or reportable operating segment serving our target markets. We record our operating expenses by functional area and account type, but we do not record or analyze our operating expenses by market, product type or product. We attempt to analyze our net revenue by market, but in some cases we sell our products to resellers or distributors serving multiple end markets, giving us limited ability to determine market composition of our net revenue from these customers. In addition, certain of our OEM customers purchase products from us for applications in multiple end-markets, also limiting our ability to determine our net revenue contribution from each market.

The cable, automotive entertainment electronics and DTV markets are intensely competitive and historically have seen rapid changes in demand. Certain applications, such as PC/TV, within our target markets can be characterized as having short product life cycles due to rapid technological changes, relatively simple application designs and aggressive competitive pricing. These factors can result in rapidly decreasing average selling prices, which we attempt to mitigate with our product cost reduction efforts and higher levels of integration and functionality. The volatility of demand within our target markets makes it difficult for us to identify and discuss business trends or to predict future results.

Today, our products are marketed principally to OEMs and ODMs in the following markets:


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Cable

Products targeting this market send and/or receive cable broadband signals. These products include tuners used in consumer premise equipment (CPE), including high-speed voice and data cable modems, digital cable set-top boxes and hybrid analog/digital cable set-top boxes; upconverter modules and

chipsets used in headend modulators; and RF amplifiers used to send and receive signals between the cable headend and CPE. In some cases, the same tuners may be used to receive digital terrestrial signals. In this market, performance, the ability to support industry standards and overall solution cost are key factors in competing for design wins. Design cycles in the cable market can range from a few months to more than one year.


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Automotive Entertainment Electronics

This market includes products targeting mobile automotive and, to a lesser extent, commercial aircraft environments. Our automotive entertainment electronics products range from components for traditional AM/FM radios (including tuners and antenna amplifiers) to components for emerging entertainment applications, including in-car television; in-flight video; digital radio, such as digital audio broadcast (DAB); and HD radio™. Both performance and overall solution cost are key competitive factors in this market. Design cycles in the automotive entertainment electronics market are generally very long, in some cases, two to three years.


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Digital Television

Products targeting this market receive digital terrestrial signals or digital and analog terrestrial signals. These products are designed for use in consumer electronics devices such as mobile televisions; integrated digital television (iDTV) sets; digital terrestrial set-top converter boxes; satellite and IP set-top boxes that include one or more terrestrial tuners used to receive local high-definition television broadcasts; portable DVD players; digital video recorders (DVRs); DVD recorders; and PC/TV multimedia products, including both USB and PCI or PCI Express OEM and add-on devices. One specific DTV opportunity is the coupon eligible converter box (CECB) opportunity. This market segment relates to the shut-off of full power analog terrestrial broadcast signals in the United States, and the need for a digital to analog converter box to allow analog televisions to receive digital signals. This market segment is non-recurring and is expected to be active through the first half of 2009. Products targeting these applications require both high performance and competitive overall solution cost. The design cycles for PC/TV are relatively shorter and require very low overall solution cost and low power consumption. Design cycles in the DTV market can range from a few months to more than one year for peripheral devices and from a few months to several months for PC/TV applications.

Business Strategy

Our goal is to be the leading supplier of RF tuner technology in our target markets. Key elements of our strategy include:


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Focusing on RF tuner technology and products where we believe our experience, expertise and patent portfolio provide strategic and competitive advantages;


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Leveraging our RF systems and support expertise to help our customers design superior performing and cost effective applications and devices;


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Leveraging our core technologies and experience in real-world terrestrial environments to provide silicon solutions for evolving markets, including the automotive entertainment electronics and DTV markets;


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Protecting or increasing our opportunities through expanded relationships with existing or new key partners;


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Continuing to grow revenues and profits in the cable market through innovative product introductions and market share increases;


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Combining our RF IC and automotive systems expertise and established products to expand our presence in the automotive entertainment electronics market as this market transitions from modules to more highly-integrated RF IC solutions;


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Investing in new products to target the significant long-term opportunities in the DTV market;



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Investing in new products to achieve a higher level of integration of the digital functions necessary for applications in our target markets; and


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Investing in new technologies to remain competitive in all our target markets to produce more cost-efficient, low power consumption and more highly-integrated products that leverage next-generation technology.

Organization

To implement our strategy effectively, our systems engineering and marketing teams are organized into two specialties: automotive entertainment electronics and broadband communications electronics, which includes the cable and DTV markets. Our IC design, product and test engineering, mechanical design, quality, marketing communications, investor relations, sales, finance and accounting, information technology, legal, operations and human resources teams are generally centralized to achieve operational efficiencies.

Markets

The worldwide reliance on the internet; the transition from analog to digital transmission standards for both cable and terrestrial television; the greater use of broadband, mobile and wireless communications; and the growing interrelation of televisions, personal computers, cable communications and the internet, coupled with an end-user desire for mobility, have fostered dramatic changes in business and consumer electronics, broadband communications and automotive entertainment electronics. These drivers have propelled the development of new classes of products and new forms of entertainment and information, based on innovative technologies that deliver better, faster and improved communications.


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Cable

According to an In-Stat study, total worldwide cable subscribers are projected to exceed 550 million within the next three years. During the last several years, the worldwide cable industry has evolved from a supplier of analog video programming to a competitive provider of digital voice, data and video services, including ultra high speed telecommunications services, supporting high definition (HD) formats and DVR functionality. In-Stat predicts that over 250 million households will be subscribing to digital video services by 2012.

In order to support these new services, cable service providers continue to invest in new technology and infrastructure, to upgrade their networks to 1 GHz to deliver more channels to consumers; digital and HDTV programming; high-speed data communications; home networking; and two-way interactive services, including digital telecommunications and on-demand services. As a part of this upgrade, cable service providers continue to deploy new classes of digital consumer equipment that allow users to access a range of enhanced services such as:




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DOCSIS ® 2.0 Modems: Cable modems and Embedded Multimedia Terminal Adapters (EMTAs) which can be stand-alone devices or integrated into set-top boxes. DOCSIS ® 2.0 cable modems enable high-speed internet service via two-way cable, while EMTAs enable Voice over Internet Protocol (VoIP) for digital phone service;




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DOCSIS ® 3.0 Modems and IPTV Set-top Boxes: Cable operators in Japan, Korea, the United Kingdom, the Netherlands, Brazil, the U.S. and Canada have launched new channel-bonded DOCSIS ® 3.0 services. As part of the new modems and IPTV set-top box solutions required for these new services, we provide the industry’s only wideband RF tuner, which was in every CableLabs ® DOCSIS ® 3.0 certified product in 2008.


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CATV Set-top Boxes: Digital interactive set-top boxes, which serve as the home access point for a number of video services, including HD and standard-definition (SD) digital channels, analog channels and new applications such as digital video recording and video-on-demand services. In some deployments, the digital interactive set-top box is evolving into a “home gateway,” a multifunctional box designed to serve as the distribution “hub” for home networked video, voice and/or data services.



The cable industry’s adoption of industry standards, such as CableLabs ® standards for DOCSIS ® (cable modems) and PacketCable™ EMTAs, as well as support for complementary standards, such as tru2way™ to enable digital set-top box functionality in television sets, has served as an additional catalyst to fuel the deployment of enhanced broadband services. These standards are designed to ensure interoperability between different manufacturers’ customer premise equipment and cable infrastructure (headend) equipment products. They have stimulated a number of vendors to develop cost-effective, non-proprietary products that can operate efficiently and harmoniously in cable environments. New versions of the DOCSIS standard, DOCSIS ® 3.0 and Euro DOCSIS ® 3.0, are designed to achieve data communications speeds of 160 Mbps downstream and 120 Mbps upstream, or higher, via the cable network. Earlier versions of the standards only supported 30 to 40 Mbps in each direction. DOCSIS 3.0 cable modems require multiple and/or specialized cable tuners as well as a new generation of high performance upstream amplifiers. This new standard enables cable operators to offer a more competitive, new class of ultra high speed telecommunications and business services.

We provide tuners and amplifiers for cable modems, EMTAs and set-top boxes, which support the two-way transmission of data to and from the consumer and the cable operator’s headend. Multiple tuners are increasingly implemented in cable set-top boxes to support simultaneous viewing of one channel while recording a second channel using a DVR, on-demand services and internet access.

Historically, we have seen the demand for our products in the cable market follow a seasonal pattern, with the highest demand occurring during our fiscal second quarter and the lowest demand occurring during our fiscal fourth quarter resulting in a sequential decrease in net revenue from our fiscal third quarter. This seasonal pattern has also influenced our total net revenue since our net revenue from the cable market has historically represented the majority of our total net revenue.


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Automotive Entertainment Electronics

Technology convergence and integration is beginning to impact the automotive and airline industries. In the automotive entertainment electronics market, for example, low-cost communications, navigation, information and entertainment technologies are combining with traditional in-car display and audio systems to create new applications and potential new markets for in-car systems. Driven by consumer demand, new applications are rapidly evolving beyond the conventional car audio system to include digital sound systems, digital radio, such as DAB and HD radio TM , and a suite of applications that allow passengers to watch digital television and video and play interactive games. These newer applications are expected to gain greater consumer acceptance during the next decade, driving continued market opportunity for providers of these products and services and for suppliers of the underlying technology.

Currently, the majority of our products sold into the automotive entertainment electronics market are utilized in car televisions and AM/FM radios, primarily for European end markets. Demand for car television and newer digital radio is expected to grow rapidly as automakers offer a range of systems in more vehicles, moving from luxury cars into mid-priced models.

Data delivered via RF communications is integral to these emerging automotive entertainment electronics applications, and we provide enabling technology, including AM/FM tuners, digital radio front-ends, antenna amplifiers and in-car television tuners, which are incorporated into automotive entertainment electronics subsystems to support these applications. Currently, we are supplying module-based tuner products for radio applications, both silicon and module-based tuner products for in-car television applications, and both silicon and module amplifiers for antenna amplifier applications. We are also currently developing silicon products for radio applications, although we expect the transition to silicon products within this market to take several years, primarily due to very long design cycles.

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Digital Television

The worldwide transition to digital technologies represents a massive technology transformation. According to In-Stat, annual global DTV unit shipments are expected to grow from 119 million units in 2008 to over 166 million units by 2012. As originally conceived, the idea of digital television was to deploy improved bandwidth efficiency techniques to provide either a picture with much greater detail (e.g. HDTV) than that provided by an analog channel, or to provide multiple digital video streams within the bandwidth of an existing analog channel. Any digital data, from digital video and audio to packetized internet data, can be broadcast using digital transmission.

The definition of terrestrial ‘digital television’ is determined by standards adopted by various countries. For fixed terrestrial reception, the Advanced Television Systems Committee (ATSC) standard is deployed primarily in North America and the Digital Video Broadcast—Terrestrial (DVB-T) standard is implemented in Europe and other parts of the world. Japan and Brazil have adopted the Integrated Services Digital Broadcast—Terrestrial (ISDB-T) standard for digital terrestrial broadcast. China has recently taken steps to unify its domestic digital television schemes under the GB20600-2006 standard, also known as Digital Terrestrial Multimedia Broadcast (DTMB). In some cases, these same standards may also be suitable for and/or provide modes for mobile terrestrial reception, although there may also be separate standards for mobile reception (e.g. DVB-H in Europe, CMMB in China).

We provide tuners and amplifiers used for the RF tuning and reception of signals for DTV products. Historically, DTV customers have relied on subsystem module tuners for the RF front-end, either produced internally by the customer or purchased from a third-party for the RF front-end. We expect DTV manufacturers will transition to next-generation silicon tuner technology in the future and expect the transition from subsystem module tuners to silicon tuners will take several years.

Products

The applications or devices associated with the cable, automotive entertainment electronics and DTV markets require high levels of RF performance, power efficiency, functionality and integration, which must all be delivered with a low overall solution cost. Our products are engineered to address the complex, high-performance RF requirements of broadband transmission and reception.

We classify our products into two types: integrated circuit products or ICs (also referred to as “silicon”) and subsystem-level RF solutions (called “modules”).


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Integrated Circuit Products

We offer a product portfolio that includes:

MicroTuner Single-Chip Broadband Tuners

Our premier products are our single-chip MicroTuner IC tuners. In 1999, we introduced the world’s first broadband television tuners with all active components implemented in a single microcircuit. We believe our MicroTuner chips are among the few single chip IC television tuners in high volume production today that incorporate all of the active elements of a RF broadband tuner, including low-noise and intermediate frequency amplifiers. Our MicroTuner chips are based on both a patented architecture and multiple patented integrated circuit implementations.

Silicon Amplifiers

We offer a family of amplifiers, including upstream amplifiers, Intermediate Frequency (IF) amplifiers and broadband antenna amplifiers, which can be used as companion products to our single-chip tuners, or used separately. These products enable or support a variety of specialized functions, including high-speed upstream cable communications and the distribution of a broadband signal across multiple tuners. Our silicon amplifiers support these functions by conditioning signals within the RF front-end and boosting them for distribution through a system. The amplifiers also enable two-way communications capability in cable access applications and provide downstream amplification in automotive radio and in-car television applications.


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Subsystem-Level RF Solutions

Our subsystem-level products, called modules, are RF solutions consisting of tuner and/or transmit/receive functions that are pre-assembled into tested, production-ready RF front-ends. Our subsystem solutions are available for multiple applications, including analog and digital car radio, analog and digital in-car television, in-flight entertainment, automotive antenna amplifiers and cable system headend upconverters.

Some of our subsystem-level products contain our own IC components, which we believe provides a competitive advantage through high levels of functional integration. Our modules are pre-configured and pre-tested for ready placement on motherboards, printed circuit boards or chassis.

See Item 7., “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for discussion of net revenue by product type.

Technology, Intellectual Property and Research and Development

We were founded in 1996 on a commitment to RF IC innovation. We have an established track record of introducing advanced products, based on our pioneering RF IC technology, that address emerging markets and serve customers in existing markets.

As of December 31, 2008, we had 129 technical personnel. Our technical team represents one of our most important strategic and competitive assets. Our team, comprised of RF, analog and digital IC, systems, and product and test engineers and technicians, enables us to produce differentiated RF IC and subsystem module solutions for applications in our targeted markets. Team members are located in our design centers in Plano, Texas; Plantation, Florida; Boulder, Colorado and Ingolstadt, Germany.

We believe we have a strong intellectual property portfolio, which is of vital importance to our business as many of our competitors are larger, more diversified companies with substantially greater financial resources. Our ability to protect our proprietary innovations from exploitation by our competitors is crucial to our future success. We have in the past and will continue to vigorously pursue and maintain protection for the proprietary technology used in our products. Currently, we hold 83 issued United States utility patents and have more than 25 additional United States patent applications pending. Our issued United States patents begin to expire in 2015. Our patents generally cover various aspects of our RF and analog technologies at the broad architectural, circuit and building-block levels.

See Part IV, Item 15., “Exhibits, Financial Statement Schedules” for our patent license agreement with Broadcom Corporation.

Our research and development expenses were $25.9 million, $23.7 million and $21.4 million for 2008, 2007 and 2006, respectively. Of these amounts, stock-based compensation expense comprised $1.9 million, $2.4 million and $2.6 million, respectively. We internally sponsor all of our research and development activities. See Item 7., “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for a discussion of research and development expenses.

Sales and Marketing

As of December 31, 2008, our worldwide sales organization consisted of over 30 employees with offices located throughout the United States: Plano, Texas; Huntsville, Alabama; Duluth, Georgia; Naperville, Illinois; Campbell, California; Irvine, California and Raleigh, North Carolina, and in regional centers around the world:


Ingolstadt, Germany; Taipei, Taiwan; Tokyo, Japan; Seoul, South Korea, Shenzhen, China and Basingstoke, United Kingdom. Our sales organization consists of technical sales, service and customer support professionals and includes a field application engineering staff that is involved with customers during various phases of design and production. The field applications engineering function, located throughout our worldwide sales offices, is a critical element in achieving customer design wins. We also provide customers with application engineering support from our systems engineering personnel based in Plano and Ingolstadt.

We centralize and manage sales for all of our products across each of our target markets under one worldwide sales organization. We primarily sell our products directly to our customers and to a lesser extent via a network of distributors and independent sales representatives located around the world.

Historically, revenues from international markets have represented the majority of our total revenues. See Item 1A., “Risk Factors” for a description of this risk and other risks. See Note 11, “Geographic Information and Significant Customers” to the Notes to Consolidated Financial Statements for a discussion of financial information by geographic area.

Backlog

Our sales are made primarily pursuant to standard purchase orders for delivery of products. Industry fluctuations in the supply and demand balance for component parts result in frequent and potentially significant changes in the lead times provided by our customers when placing purchase orders. Although our backlog at the beginning of a quarter represents a significant portion of the net revenue we anticipate for that quarter, we do not believe that backlog is a reliable indicator of future revenue levels.

Customers

We market and sell our ICs and subsystem module solutions directly to OEMs, ODMs and their suppliers who sell devices or applications to consumers, other OEMs or service providers (cable) within the cable, DTV and automotive entertainment electronics markets. The devices or applications that our customers produce include cable television set-top boxes; DOCSIS ® -based, high-speed voice and data cable modems; car audio, television and antenna amplifier systems; digital/analog television systems, including HDTV; PC/TV multimedia products; and mobile television receivers. We also market and sell to third-party manufacturers and to distributors who sell directly to OEMs and ODMs. We engage with customers at multiple levels within their organizations, provide design and systems services and applications engineering support, and align our product roadmaps to meet their product requirements.

We supplied our ICs and module products to more than 50 customers or their contract manufacturers worldwide during 2008, including the following:

Cable: Advanced Digital Broadcast, ARRIS, Cisco, Hitron, Humax, Motorola, Pace, Panasonic and Samsung.

Automotive Entertainment Electronics: Delphi Delco Electronics (formerly Fuba), Harman Becker Automotive Systems, Hirschmann Car Communications, Lear, Magnetti Marelli, Panasonic, Pilkington, Rockwell Collins and Thales.

Digital Television: AccessHD, AMD, Apex Digital, Echostar, Hauppauge, Lasonic, Pace, Sansonic, TiVo, Toshiba and Zinwell.

See Item 7., “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for a discussion of net revenue from significant customers and Item 1A., “Risk Factors” for a description of risks associated with our significant customers.

CEO BACKGROUND

Restricted Stock
Unit Awards (1)(2)
James A. Fontaine Chief Executive Officer and President $ 350,000 80,000
Jeffrey A. Kupp Chief Financial Officer $ 256,025 30,000
Albert H. Taddiken Chief Operating Officer $ 256,025 48,000
Robert S. Kirk Vice President of Worldwide Sales $ 166,002 28,000
Barry F. Koch Vice President and Managing Director,
Microtune GmbH & Co. KG € 147,624 (3) 24,000
Phillip D. Peterson General Counsel $ 210,000 16,000

MANAGEMENT DISCUSSION FROM LATEST 10K
NOTE: For a more complete understanding of our financial condition and results of operations, and the risks that could affect our future results, see “Risk Factors” in Part I, Item 1A., which describes some of the important risk factors that may affect our business, results of operations and financial condition. You should carefully consider those risks, in addition to the other information in this report and in our other filings with the SEC, before deciding to make an investment in our stock. You should also read “Quantitative and Qualitative Disclosures About Market Risk” in Part II, Item 7A.

You should also read the following discussion and analysis in conjunction with “Financial Statements and Supplementary Data” in Item 8.

OVERVIEW

We design and market radio frequency (RF) integrated circuits (ICs) and subsystem module solutions for the cable, automotive entertainment electronics and DTV markets. We operate Microtune as a single business unit or reportable operating segment serving our target markets. We record our operating expenses by functional area and account type, but we do not record or analyze our operating expenses by market, product type or product. We attempt to analyze our net revenue by market, but in some cases we sell our products to resellers or distributors serving multiple end markets, giving us limited ability to determine market composition of our net revenue from these customers. In addition, certain of our OEM customers purchase products from us for applications in multiple end-markets, also limiting our ability to determine our net revenue contribution from each market.

We monitor and analyze a number of key financial performance indicators in order to manage our business and evaluate our financial and operating performance. Those indicators include:




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Net Revenue : Our net revenue is generated principally by sales of our integrated circuits and subsystem module products directly to OEMs and ODMs who sell devices or applications to consumers or service providers within the cable, automotive entertainment electronics and DTV markets. The devices or applications that our customers produce include cable television set-top boxes; DOCSIS ® -based, high-speed voice and data cable modems; car audio, television and antenna amplifier systems; digital/analog television systems, including HDTVs; PC/TV multimedia products; and mobile television receivers. We also market and sell to third-party manufacturers and to distributors who sell directly to the OEMs and ODMs. The majority of our net revenue is generated through the efforts of our sales organization. However, we generated approximately 14%, 10% and 18% of our net revenue from sales made to distributors in 2008, 2007 and 2006, respectively. The increase in net revenue from sales made to distributors in 2008 was due to increased shipments of silicon tuner products for the CECB market segment. See Part I, Item 1A., “Risk Factors” for a description of the risks associated with the CECB market. Our net revenue varies based upon economic and market conditions in the semiconductor industry and our target markets; the timing, rescheduling or cancellation of customer orders; our ability, as well as the ability of our customers, to manage inventory; seasonality in the demand for consumer products into which our products are incorporated; and large orders placed by our key customers. These factors may cause our quarterly and yearly net revenue to fluctuate significantly, which makes it difficult for us to discuss revenue trends or to predict future results. We expect these fluctuations will continue in the future. We analyze trends in total net revenue and we attempt to analyze total net revenue trends by market, which is limited due to our lack of visibility into customers and/or applications, as described above. We also analyze revenue from key customers, focusing on our ten-percent customers, and aggregate net revenue from our top ten customers.


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Cost of Revenue and Gross Margin : Cost of revenue includes the cost of subcontracted materials and wafer fabrication, IC assembly, final test, factory labor and overhead, shipping of materials, shipping costs to customers, customs expenses, warranty costs, production employee expenses and inventory charges or benefits relating to excess or obsolete inventory. We also report expenses for the depreciation of our test and handling equipment and logistics in cost of revenue. Significant items impacting cost of revenue include our product mix and volumes of product sales; the position of our products in their respective life cycles; the effects of competitive pricing programs; manufacturing costs; fluctuations in direct product costs such as wafer pricing and assembly, packaging and testing costs, and overhead costs; and provisions for excess or obsolete inventory. Stock-based compensation expense recorded in cost of revenue under SFAS No. 123(R) was insignificant, and is expected to continue to be insignificant as we use third-party contract manufacturers to produce the majority of our products enabling us to employ a limited number of production employees. Our cost of revenue may increase due to price fluctuations and cyclical demand and we may not be able to pass this increase on to our customers, which makes it difficult for us to determine if cost of revenue and gross margin trends will continue or to predict future results. We analyze absolute gross margin dollars and gross margin percentage. We also analyze the key drivers of gross margin, namely typical selling price trends and the components of cost of revenue. In 2009, we expect the average selling prices of our products to slightly decrease. More significant decreases, should they occur, could have a material adverse effect on our gross margins, results of operations and financial condition.


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Operating Expenses : Operating expenses are substantially driven by personnel-related expenses, including cash and stock-based compensation expense, lab supplies, training and prototype materials, professional fees and insurance expenses. We record stock-based compensation expense in operating expenses in accordance with SFAS No. 123(R), which has resulted in a material charge each period as the majority of our employees are classified in this category. We analyze trends in the absolute dollar value and percentage of net revenue for research and development and selling, general and administrative expenses. We also analyze the underlying expense inputs of significant operating expenses.


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Other Income and Expense : We analyze the individual components of other income and expense. We also analyze interest income and the rate of return earned on our cash and cash equivalents and short-term investments.


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Liquidity and Cash Flows : Our cash flows are primarily driven by our cash operating results and sales and purchases of investments. The primary source of our liquidity is our cash and cash equivalents and short-term investments. From period to period, we experience fluctuations in various items, including our working capital accounts, capital expenditures and proceeds from the exercise of employee stock options and shares purchased under our employee stock purchase program.


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Balance Sheet : We view cash and cash equivalents, short-term investments, accounts receivable, days sales outstanding, inventory, inventory turns, and working capital as important indicators of our financial health.

The increase in net revenue in 2008 as compared to 2007 was primarily the result of increased shipments of silicon tuner products for the cable market, particularly for set-top box applications, module products for the automotive entertainment electronics market, particularly for car radio applications, and silicon tuner products for the DTV market, primarily relating to the CECB market segment, partially offset by slightly lower average selling prices of silicon tuner products for the cable market. Net revenue from the CECB market segment was $7.6 million for 2008. Silicon tuner unit shipments increased approximately 22% in 2008 from 2007, primarily relating to the cable market and the CECB market segment. Module unit shipments for the automotive entertainment electronics market increased approximately 26% in 2008 from 2007, primarily relating to car radio applications.

The increase in net revenue in 2007 as compared to 2006 was primarily the result of increased shipments of silicon tuner products for the cable market, partially offset by decreased shipments of silicon tuner products for the DTV market, particularly for PC/TV and mobile television, and decreased shipments of silicon amplifier products for the cable market. An increase in shipments of module products for the automotive entertainment electronics market also contributed to the increase in net revenue in 2007. Silicon tuner unit shipments increased approximately 55% in 2007 from 2006, primarily in the cable market. Silicon amplifier unit shipments decreased approximately 57% in 2007 from 2006, primarily in the cable market, due to the integration of its functionality into one of our partner’s demodulator products and also certain of our next-generation silicon tuner products. Module unit shipments increased approximately 17% in 2007 from 2006, primarily in the automotive entertainment electronics market.

We expect net revenues to decline significantly in 2009 as compared to 2008, primarily due to the impact of the economic slowdown, and to a lesser extent, the expected decrease in revenue from the short-term CECB market segment opportunity.

Gross margin increased in 2008 as compared to 2007 primarily due to an approximate $16.9 million increase in net revenue, partially offset by a 1.6 point decrease in gross margin percentage. Gross margin percentage in 2008 as compared to 2007 was negatively impacted by slightly lower average selling prices of silicon tuner products for the cable market, an increase in net revenue for the automotive entertainment electronics market as a percentage of total net revenue, which had a lower gross margin percentage as compared to other markets, and lower than expected yields on initial product runs of a new cable silicon tuner during the first quarter of 2008.

Gross margin increased during 2007 as compared to 2006 primarily due to an approximate $21.9 million increase in net revenue and to a lesser extent a 1.1 point increase in gross margin percentage. Gross margin percentage in 2007 as compared to 2006 was positively impacted by an increase in net revenue from the cable market as a percentage of total net revenue, which generally had a higher gross margin percentage as compared to other markets, and to a lesser extent, a change in the product mix of our silicon tuner products for the cable market and our module products for the automotive entertainment electronics market. Gross margin percentage in 2007 as compared to 2006 was negatively impacted by a change in the product mix of our silicon amplifier products for the cable market and silicon tuner products for the DTV market.

We expect our gross margin percentage in 2009 to be similar to 2008 and fall within our target range of 49% to 50%.

Our cost of revenue for 2008, 2007 and 2006 benefited from the sale of inventory which had previously been identified as excess to expected demand and expensed in prior periods. The total value of these inventories for 2008, 2007 and 2006 was $0.4 million, $0.8 million and $1.1 million, respectively. The net impact of changes in the inventory valuation allowance was insignificant in 2008 and a charge to cost of revenue of $0.4 million for 2007 and 2006, respectively.

CONF CALL

Jeff Kupp
Thank you, good afternoon everyone and thank you for joining us today. I am joined on this call by Jim Fontaine, President and Chief Executive Officer and Barry Koch, Executive Vice President.
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Earlier this afternoon Microtune issued a press release announcing our financial results for the quarter and nine months ended September 30, 2009. This press release was also filed on Form 8-K with the SEC and has been posted to Microtune’s website at www.microtune.com.

During this call we will discuss certain non-GAAP measures. Please refer to our press release for a reconciliation of these non-GAAP financial measures to the most directly comparable GAAP financial measures in accordance with SEC Regulation G.
During this call we may make forward-looking statements. Please refer to the cautionary forward-looking statements language included in our press release and SEC filings. Also please read our Form 10-K, Forms 10-Q and other reports filed with the SEC for a discussion of the risks and uncertainties facing our business.
Now I will review our third quarter results after which Jim will provide a market and strategic update.
Third quarter 2009 revenue was $18 million which included about $400,000 of Auvitek product revenue. Our net revenue level compared favorably to our stand-alone revenue guidance range of $16 to $17 million primarily driven by stronger than expected demand for cable modem, cable set top box products and to a lesser extent slightly higher than expected demand for car radio products.
On a sequential basis revenue was up by about $400,000 or 2% if revenue from Auvitek products is included and revenue was essentially flat with Auvitek revenue removed from the comparison.
From a market end market segment perspective cable revenue was up about 1% with cable modem revenue up about 4% and set top box revenue down about 1%.
Within the cable modem segment we saw strong demand for our DOCSIS 3.0 products with our revenue up over 35% sequentially, although demand for DOCSIS 2.0 products was down about 8%.
Within the cable set top box segment we saw a 41% sequential increase in international set top box business and a 33% decrease in our North America set top box business. We expect the North America set top box business to recover to Q2 levels in the fourth quarter.
Automotive revenue is down about 4% with revenue from antenna amplifiers and specialized avionics products being up and revenue from car TV and car radio both being down slightly.
DTV revenue was up about $400,000 or 83%. Almost all of the increase coming from Auvitek demodulator products, but with some modest gains in tuner sales in the DVB-T and Brazilian IS DB-T markets.
Compared to the prior year third quarter and year-to-date revenue levels were down significantly due primarily to the economic environment and the significant non-recurring revenue in the second half of 2008 from coupon eligible converter boxes. Comparing the third quarter of 2009 to the prior year revenue declined by approximately 44% with decreases of 57% in automotive, 22% in cable and 86% in DTV. Excluding the $5.7 million in converter box revenue in the third quarter of 2008 third quarter 2009 revenue was down about 31%.
Consistent with the guidance we provided in July we expect fourth quarter 2009 revenue to increase from the third quarter; specifically we expect revenue to fall between $19 and $20 million.
Third quarter 2009 gross margin was 53%, up about 5 points from the second quarter and well above our target range of 49% to 50%. There were several factors driving the higher than expected gross margin percentage including that we had no new net excess inventory reserves, we actually had a small benefit from the release of existing reserves, and we also benefited from the value added tax refunds relating to certain prior periods. Year-to-date through September 30th our gross margin was 49.4%. For the full year of 2009 we expect gross margins to be around 50%.
In the third quarter of 2009 non-GAAP operating expenses, which are comprised of non-GAAP R&D and non-GAAP SG&A expenses were $12.6 million and included two full months of Auvitek operations. The $12.6 million represents a sequential increase of $1.5 million virtually all of which is explained by the acquired Auvitek operations and transaction expenses. For the full year of 2009 on a non-GAAP basis we expect R&D expenses to increase between 7% and 10% and SG&A expenses to increase between 4% and 6%.
For the full year of 2010 also on a non-GAAP basis R&D expenses are expected to increase between 3% and 8% and SG&A expenses are expected to decrease between 15% and 20%.
The guidance numbers we are providing already contemplate the cost impact of the restructuring activities that we announced last week. We expect that the majority of the cost reduction efforts will be implemented before the end of the year and will result in a restructuring charge of approximately $1.3 to $1.5 million. Once fully implemented we expect the cost reduction efforts will decrease our spending by about $7 million or more on an annual basis.
Compared to our GAAP numbers the non-GAAP numbers exclude 123-R stock based compensation, certain legal and professional fees associated with the litigation between the SEC and certain former officers, and now moving forward the amortization of intangible assets relating to the Auvitek acquisition.
In terms of the acquisition accounting total consideration paid was about $9.1 million. The $9.1 million will hit our books as follows: $0.7 million of net identified assets and liabilities which includes normal course of business items like fixed assets and inventory; $1.3 million for intangible assets for developed technology; $1.6 million for intangible assets for in process research and development; and $5.5 million for goodwill. We have begun to amortize the developed technology and tangible asset of which about $55,000 will hit our cost of goods sold on a quarterly basis. The in process R&D intangible is not yet being amortized and will not be amortized until the related technology achieves technological feasibility.
We continue to be pleased with the strength of our balance sheet. Of the $115 million in assets $80.7 million is represented by cash and short-term investments. Our cash and investments balance decreased by $9.2 million compared to last quarter driven by the $7 million in cash consideration paid in the Auvitek acquisition. In addition, our accounts receivable balance was up slightly although we still maintained a very attractive DSO metric of 41 days and our inventory balance decreased slightly resulting in a turns metric of a very healthy 6.1.
That concludes my prepared remarks, so I will turn the call over to Jim. As always thanks for your support.
Jim Fontaine
Thank you, Jeff. Today I will provide a progress update on our efforts to transform Microtune from a tuner only company to a more broad based receiver solutions company. First however, I will add a little more color to Jeff’s comments on the state of our business.
We are pleased to report that the revenue at $18 million exceeded the top line range of our guidance. Given the continued weakness in the economy we view this as a solid achievement. We also achieved a respectable gross margin at 53%, well above our guidance range. As Jeff mentioned, we recently initiated a plan to reduce our operating expenses with a target to achieve break even revenue of approximately $22.5 million per quarter, essentially reducing our total OpEx to a pre-Auvitek acquisition levels while making no R&D headcount reductions with our newly acquired Shanghai engineering team, which is focused on the development of digital demodulators and micro receivers.
Our expense reduction plan is being implemented with the goal of returning to profitability by mid-2010, at the same time refocusing our R&D development and product marketing resources to align more effectively with the new market opportunities, in particular the expanded opportunities in digital television. Based on our customers outlook we now believe that we have passed through the bottom of the revenue trough and are on an upward revenue trajectory. We are guiding between $19 and $20 million in revenue for Q4 and as our break even commentary implies we see revenue growth continuing as we enter 2010.
In our last call I discussed at length our well-defined strategy, strategic direction, and vision for the Company. I explained how our acquisition of Auvitek coupled with our new generation of products under development will prepare us for the future. Microtune’s mission simply stated is to be a dominant supplier of receivers in the cable, digital television, and car radio markets.
Let me give you an update on our acquisition of Auvitek which occurred in July. History tells us that the results of any acquisition are mixed at best no matter who the acquirer is. So, the No. 1 priority of any acquisition has to be an efficient and effective integration of the acquired party into the Company in order to make the ultimate outcome financially successful. We believe that we are making good progress in the integration of the Auvitek team ad products. We have executed well on our initial integration efforts and are on track to meet our integration milestones. We have completed the integration of our sales, accounting, and manufacturing teams, we are now operating with a combined infrastructure and have taken advantage of the synergies associated with our merged strengths.
We have developed and are actively promoting a tuner and demodulator combination, particularly in the China market where we were able to quote attractive and highly competitive pricing and this Fall we will have the first of our tuner demod reference designs that will make it easy for customers to adopt our technology for complete RF digital front ends. We have reorganized our engineering and cooperatives and are putting in place new communication initiatives to better promote a cooperative, multi-national engineering developments which we believe will result in faster delivery of products to the market. Our most important and I think our most exciting accomplishment in this phase of our Auvitek integration is that we have defined a unified product road map and have begun the engineering process to make the combined road map a reality. Our road map is now able to leverage the technologies, the intellectual property and talent of our tuner and demod teams and we are engaged in the design of the next generation highly integrated receiver solutions which we expect to expand our market opportunity in the digital television.
We are already beginning to see synergistic benefits from the acquisition, particularly in China, which for us represents a new high volume market opportunity. The greater reach of our combined sales force and Microtune’s credibility and established silicon fire is starting to generate new opportunities. The roll out of China’s home ground digital terrestrial TV broadcast system continues to be supported and driven by various government bodies across all provinces in China. We are making good progress in securing a number of nascent design wins in China in a variety of DTV applications.
The China standard previously referred to as DTMD and now more commonly referred to as CTTB or China Terrestrial TV broadcast represents a most complex and technically advanced digital terrestrial system in use today. With other new and equally complex standards such as the next generation European terrestrial DTV broadcast standard DVDT 2 the value captured by the receiver in the overall system naturally increases. Microtune has positioned itself to take maximum advantage of these changes in the market.
I am also proud to report that our demodulator product has been validated by state owned Chinese TV broadcasters in extensive field trials across multiple cities and provinces in China. In each case our demod was able to deliver not only superior lab test results, but also excellent real world demodulator performance. Validation is a significant achievement, particularly given the rigorous and complex Chinese digital TV standard.
The acquisition of Auvitek was one of the first steps in our transition to become a buyer of highly integrated receiver products and our expanded move into digital television. This transition process was reinforced this week with the announcement of our micro receiver platform. I referenced this platform briefly in our last conference call and described it as technology foundation for a suite of upcoming products. Let me give you an update on our new micro receiver technology in these products.
First of all, what is a micro receiver? A micro receiver is a new technology platform for a highly integrated front-end receiver. It is a complete analogue and digital demodulation system in a single chip. We base the micro receiver system on a proprietary new architecture that erases the boundaries between the tuner and the demodulator and fuses their functions together in a single device.
The first product based on the micro receiver platform was a new part for digital TV. We are currently engaged with customers, have sampled the part to them, and expect to formally introduce this part in December. The strong road map for our micro receiver products is receiving good responses from major TV manufacturers and consumer suppliers as we begin to emphasize Microtune’s commitment to the DTV market.
Based on feedback from our leading customers we are also beginning to see major transitions in our three target markets that will occur over the next three to five years. These changes will affect the architectural evolution of our products: for example, some of these market transitions include cable migration to connected interacted multi-media entertainment hubs; digital television manufacturers are migrating to single electronics panels for all TV models and price points; and car entertainment is driving to new world standard multi-media receivers with a common hardware platform that will reduce complexity and costs.
Speaking of car entertainment we are also tracking on a new silicone car radio device. This product is also based on a new architecture and is already being sampled to select customers. It has generated significant interest from worldwide auto manufacturers.
Our investment in new R&D is designed to leap frog the current state of the art in technology and lead the market transitions. We believe this will translate into very advanced, competitive products with future growth.
I think it is important to point out that our customers are not only looking for advanced technology, they are looking for competitive solutions with features that aligns to their own evolving needs. We feel that our proactive engagement with our customers about their product requirements, backed by our dedicated applications in engineering support is truly a significant differentiator. As an example of the effectiveness of this philosophy, we are pleased to be recently recognized by Cisco in an award to Microtune Cisco’s Technology Alignment Supplier of the Year award. As Jodi Kail, Senior Director of Global Supply Management Cisco stated, “Microtune’s development execution leads its competition with consistent and reliable focus on meeting all specifications. Microtune is very actively engaged with our engineering staff to create products that align to Cisco’s road map and our customers evolving requirements. We are pleased to honor Microtune with this award”. Needless to say we are proud to receive this award from Cisco and believe it validates our philosophy at Microtune that the customer is king.
In summary, we achieved solid quarterly results and are beginning to see a number of positive trends in our business. We are actively managing expenses to reduce our break even while maintaining our R&D investment in our micro receiver road map strategy. We are making good progress on the full integration of the Auvitek team. We have a solid balance sheet, and we remain focused on preparing for the future with a well-defined vision and focus on execution.
Thank you. We will now take questions from our listeners.

]]>Thu, 07 Jan 2010 09:15:28 GMThttp://www.dailystocks.com/forum/showtopic.php?tid/3721/http://www.dailystocks.com/forum/showtopic.php?tid/3721/ The estate of Wade F.B. Thompson cut its holdings to 9,473,470 shares (18.4%), by selling 5,980,000 on Dec. 17 at $29 a share. The recreational vehicle and bus manufacturer repurchased 3,980,000 of the shares from the estate of Thompson, its co-founder, who died in November.

BUSINESS OVERVIEW

General Development of Business
Our company was founded in 1980 and manufactures and sells a wide range of recreation vehicles and small and mid-size buses in the United States and Canada. We are incorporated in Delaware and are the successor to a corporation of the same name which was incorporated in Nevada on July 29, 1980. Our principal executive office is located at 419 West Pike Street, Jackson Center, Ohio 45334 and our telephone number is (937) 596-6849. Our Internet address is www.thorindustries.com. We maintain copies of our recent filings with the Securities and Exchange Commission (SEC), available free of charge, on our web site. Unless the context otherwise requires or indicates, all references to “Thor”, the “Company”, “we”, “our”, and “us” refer to Thor Industries, Inc. and its subsidiaries.
Our principal recreation vehicle operating subsidiaries are Airstream, Inc. ( Airstream ), CrossRoads RV (CrossRoads) , Dutchmen Manufacturing, Inc. ( Dutchmen ), Four Winds International, Inc. ( Four Winds ), Keystone RV Company ( Keystone ), Komfort Corp. ( Komfort ), Citair, Inc. ( Citair ), and Damon Corporation (Damon) . Our principal bus operating subsidiaries are Champion Bus, Inc. ( Champion ), General Coach America, Inc., (General Coach), ElDorado National California, Inc. ( ElDorado California ), ElDorado National Kansas, Inc. ( ElDorado Kansas ) and Goshen Coach, Inc. (Goshen Coach) .
Recreation Vehicles
We believe that we are the largest unit and revenue manufacturer of recreation vehicles in North America based on retail statistics published by Statistical Surveys, Inc. and publicly reported results.
Airstream
Our Airstream subsidiary manufactures and sells premium and medium-high priced travel trailers and motorhomes under the trade name Airstream . Airstream vehicles are distinguished by their rounded shape and bright aluminum finish and, in our opinion, constitute the most recognized product in the recreation vehicle industry. Airstream, responding to the demands of the market for a lighter, lower-cost product, also manufactures and sells the Airstream Safari , International, Flying Cloud and Bambi travel trailers. Airstream also sells the Interstate Class B motorhome.
Dutchmen
Our Dutchmen subsidiary manufactures and sells conventional travel trailers and fifth wheels primarily under the trade names Dutchmen , Four Winds, Aero, Grand Junction and Colorado .
Four Winds
Our Four Winds subsidiary manufactures and sells gasoline and diesel Class C, Class A and Class B motorhomes. Its products are sold under trade names such as Four Winds , Hurricane , Windsport, Mandalay, Dutchmen , Chateau, Serrano, Ventura and Fun Mover .
CrossRoads
Our CrossRoads subsidiary manufactures and sells conventional travel trailers and fifth wheels under the trade names Cruiser, Seville, Zinger and Sunset Trail and park models under the trade names Tranquility and Westchester. Park models are factory built second homes designed for recreational living. They are towed to a destination site such as a lake, woods or park and are considered a country cottage.
Citair
Our Citair subsidiary manufactures travel trailers, fifth wheels, truck campers and park models. It operates under the name General Coach and sells recreation vehicles and park models under various trade names.

Keystone
Our Keystone subsidiary manufactures and sells travel trailers and fifth wheels under trade names such as Montana , Springdale , Hornet , Sprinter , Outback , Laredo , Everest , Mountaineer , Challenger , and Cougar .
Komfort
Our Komfort subsidiary manufactures and sells travel trailers and fifth wheels under the trade names Komfort and Trailblazer primarily in the western United States and western Canada.
Damon
Our Damon subsidiary manufactures and sells gasoline and diesel Class A motor homes under the trade names Daybreak, Challenger, Astoria, Tuscany and Outlaw . Damon also introduced the Avanti , a new fuel efficient Class A diesel motorhome, in 2008.
Breckenridge
Breckenridge is the park model division of Damon Corporation. Park models are factory built second homes designed for recreational living. They are towed to a destination site such as a lake, woods or park and are considered a country cottage.
Buses
We believe that our bus segment is the largest manufacturer of small and mid-size transit and commercial buses in North America (those up to 35’) based on statistics published by the Mid-size Bus Manufacturers Association. We also build 40-foot buses for transit and airport shuttle use.
ElDorado National
ElDorado National, comprised of our ElDorado Kansas and ElDorado California subsidiaries, manufactures and sells buses for transit, airport car rental and hotel/motel shuttles, paramedical transit for hospitals and nursing homes, tour and charter operations and other uses.
ElDorado National manufactures and sells buses under trade names such as Aerolite , AeroElite , Aerotech , Escort , MST , Transmark , EZ Rider, and Axess, its 40 foot bus.
Champion Bus
Champion manufactures and sells small and mid-size buses under trade names such as Challenger , Defender , and Crusader .
General Coach
General Coach manufactures and sells small and mid-sized buses under trade names such as American Cruiser, Classic Coach, and EZ Trans.
Goshen Coach
Goshen Coach manufactures and sells small and mid-size buses under trade names such as GC II and Pacer .
Product Line Sales and Segment Information
The Company has three reportable segments: 1.) towable recreation vehicles, 2.) motorized recreation vehicles, and 3.) buses. The towable recreation vehicle segment consists of product lines from the following operating companies that have been aggregated: Airstream, Breckenridge, CrossRoads, Dutchmen, General Coach, Keystone, and Komfort. The motorized recreation vehicle segment consists of product lines from the following operating companies that have been aggregated: Airstream, Damon, and Four Winds. The bus segment consists of the following operating companies that have been aggregated: Champion Bus, ElDorado California, ElDorado Kansas, and Goshen Coach.

Overview
We manufacture and sell a wide variety of recreation vehicles throughout the United States and Canada, as well as related parts and accessories. Recreation vehicle classifications are based upon standards established by the Recreation Vehicle Industry Association (“RVIA”) and park model classifications are based upon standards established by the Recreation Park Trailer Industry Association (“RPTIA”). The principal types of recreation vehicles that we produce include conventional travel trailers, fifth wheels, Class A, Class C, and Class B motorhomes and park models.
Travel trailers are non-motorized vehicles which are designed to be towed by passenger automobiles, pickup trucks, SUVs or vans. Travel trailers provide comfortable, self-contained living facilities for short periods of time. We produce “conventional” and “fifth wheel” travel trailers. Conventional trailers are towed by means of a frame hitch attached to the towing vehicle. Fifth wheel trailers, designed to be towed by pickup trucks, are constructed with a raised forward section that is attached to the bed area of the pickup truck.
Park models are recreational dwellings towed to a permanent site such as a lake, woods or park. The maximum size of park models in the United States is 400 square feet. They provide comfortable self contained living and are second homes for their owners, according to RPTIA.
A motorhome is a self-powered vehicle built on a motor vehicle chassis. Motorhomes are self-contained with their own lighting, heating, cooking, refrigeration, sewage holding and water storage facilities, so that they can be lived in without being attached to utilities.
Class A motorhomes, constructed on medium-duty truck chassis, are supplied complete with engine and drive train components by motor vehicle manufacturers such as Workhorse Custom Chassis, Spartan, Ford and Freightliner. We design, manufacture and install the living area and driver’s compartment of Class A motorhomes. Class C and Class B motorhomes are built on a Ford, General Motors or Freightliner small truck or van chassis which includes an engine, drive train components, and a finished cab section. We construct a living area which has access to the driver’s compartment and attaches to the cab section. Although they are not designed for permanent or semi-permanent living, motorhomes can provide comfortable living facilities for short periods of time.
Production
In order to minimize finished inventory, our recreation vehicles generally are produced to dealer order. Our facilities are designed to provide efficient assembly line manufacturing of products. Capacity increases can be achieved at relatively low cost, largely by increasing the number of production employees or by acquiring or leasing additional facilities and equipment.
We purchase in finished form many of the components used in the production of our recreation vehicles. The principal raw materials used in the manufacturing processes for motorhomes and travel trailers are aluminum, lumber, plywood, plastic, fiberglass, and steel purchased from numerous suppliers. We believe that, except for chassis, substitute sources for raw materials and components are available with no material impact on our operations.
Our relationship with our chassis suppliers is similar to our other buyer/vendor relationships in that no special contractual commitments are engaged in by either party. Historically, Ford and General Motors resort to an industry-wide allocation system during periods when supply is restricted. These allocations would be based on the volume of chassis previously purchased. Sales of motorhomes and small buses rely on these chassis and are affected accordingly.

We do not expect the current condition of the U.S. auto industry, including the recent bankruptcy filings and reorganizations of General Motors and Chrysler, to have a significant impact on our supply of motorhome chassis. Supply of motorhome chassis is adequate for now and we believe that on-hand inventory would compensate for changes in supply schedules if they occur. To date, we have not noticed any unusual cost increases from our motorhome chassis suppliers. If the condition of the U.S. auto industry significantly worsens, this could result in supply interruptions and a decrease in our sales and earnings while we obtain replacement chassis from other sources.
Generally, all of our operating subsidiaries introduce new or improved lines or models of recreation vehicles each year. Changes typically include new sizes and floorplans, different decors or design features, and engineering improvements.
Seasonality
Since recreation vehicles are used primarily by vacationers and campers, our recreation vehicle sales are seasonal and, in most geographical areas, tend to be significantly lower during the winter months than in other periods. As a result, recreation vehicle sales are historically lowest during the second fiscal quarter, which ends on January 31 of each year.
Marketing and Distribution
We market our recreation vehicles through independent dealers located throughout the United States and Canada. Each of our recreation vehicle operating subsidiaries maintains its own dealer organization, with some dealers carrying more than one of our product lines. As of July 31, 2009, there were approximately 1,418 dealers carrying our products in the U.S. and Canada. We believe that close working relationships between our management and sales personnel and the many independent dealers we work with provide us with valuable information on customer preferences and the quality and marketability of our products. Additionally, by maintaining substantially separate dealer networks for each of our subsidiaries, our products are more likely to be competing against competitors’ products in similar price ranges rather than against our other products. Park models are typically sold by park model dealers as well as by some travel trailer dealers.
Each of our recreation vehicle operating subsidiaries has an independent sales force to call on their dealers. Our most important sales promotions occur at the major recreation vehicle shows which take place throughout the year at different locations across the country. We benefit from the recreation vehicle awareness advertising and major marketing programs sponsored by the RVIA in national print media and television. We engage in a limited amount of consumer-oriented advertising for our recreation vehicles, primarily through industry magazines, product brochures, direct mail advertising campaigns and the internet.
In our selection of individual dealers, we emphasize the dealer’s ability to maintain a sufficient inventory of our products, as well as their reputation, experience, and ability to provide service. Many of our dealers carry the recreation vehicle lines of one or more of our competitors. Generally, each of our operating subsidiaries has sales agreements with their dealers and these agreements are subject to annual review.
During fiscal 2009, one of our dealers, FreedomRoads, LLC, accounted for 15% of the Company’s consolidated recreation vehicle net sales and 11% of the Company’s consolidated net sales, among FreedomRoads, LLC’s 47 dealership locations in 26 US states. In January 2009 we entered into two credit agreements with Stephen Adams, in his individual capacity, and Stephen Adams and his successors, as trustee under the Stephen Adams Living Trust (the “Trust”) and together with each of the foregoing persons, the (“Borrowers”), pursuant to which we made two $10,000 loans to the Borrowers. The first loan is payable in full on January 15, 2014 and the second loan is payable in full on January 29, 2010. The Borrowers own approximately 90% of FreedomRoads Holding Company, LLC (“FreedomRoads Holding”) the parent company of FreedomRoads, LLC. The loans are guaranteed by FreedomRoads Holding and are secured by a first priority security interest in all of the direct and indirect legal, equitable and beneficial interests of the Borrowers in FreedomRoads Holding.
Substantially all of our sales to dealers are made on terms requiring cash on delivery or within 15 days of the invoice date. We generally do not finance dealer purchases. Most dealers are financed on a “floorplan” basis by an unrelated bank or financing company which lends the dealer all or substantially all of the wholesale purchase price and retains a security interest in the vehicles purchased. As is customary in the recreation vehicle industry, we will execute a repurchase agreement with a lending institution financing a dealer’s purchase of our products upon the lending institution’s request. Repurchase agreements provide that, for up to 18 months after a unit is financed and in the event of default by the dealer, we will repurchase the unit repossessed by the lending institution for the amount then due, which is often less than 100% of the dealer’s cost. The risk of loss under repurchase agreements is spread over numerous dealers and is further reduced by the resale value of the units which we would be required to repurchase. We believe that any future losses under these agreements would not have a material adverse effect on our Company.

The losses incurred due to repurchase were approximately $5,261, $1,857, and $1,017 in fiscal 2009, 2008 and 2007, respectively. The increase in losses results from the more difficult current market for the recreation vehicle business. We increased our reserve for repurchase and guarantees at July 31, 2009 to $6,349 from $5,040 at July 31, 2008 to account for future losses.
Joint Ventures
In March 1996, our Company and Cruise America, Inc. formed a 50/50 owned joint venture, CAT Joint Venture LLC (“CAT”), to make short-term rentals of motorized recreation vehicles to the public. As of July 31, 2009, we were contingently liable for repurchase obligations of CAT inventory in the amount of approximately $13,537.
In March 1994, the Company and a financial services company formed a joint venture, Thor Credit Corporation (“TCC”) to finance the sale of recreation vehicles to consumer buyers. This joint venture was dissolved in September 2008 after the joint venture partner informed us that it was no longer providing retail financing for recreation vehicles. We recovered our investment of $1,578 upon dissolution.
Backlog
As of July 31, 2009, the backlog for towable and motorized recreation vehicle orders was $262,072 and $36,256, respectively, compared to $106,792 and $38,774, respectively, at July 31, 2008. Backlog represents unfilled dealer orders on a particular day which can and do fluctuate on a seasonal basis. In the recreation vehicle business our manufacturing time is relatively short.
Historically, the amount of our current backlog compared to our backlog in previous periods reflects general economic and industry conditions and, together with other relevant factors such as continued acceptance of our products by the consumer, may be an indicator of our revenues in the near term.
Product Warranties
We currently provide purchasers of our recreation vehicles with primarily a one-year limited warranty against defects in materials and workmanship and a standard two year limited warranty on certain major components separately warranted by the suppliers of these components. The chassis and engines of our motorhomes are warranted for three years or 36,000 miles by their manufacturers.
Buses
Overview
Our buses are sold under the names ElDorado National, Champion Bus, General Coach and Goshen Coach. Our small and mid-size products consist of mass transit, airport shuttle and commercial and tourist use buses. Our larger Axess 40 foot bus is designed for transit and airport shuttle uses.
Production
Our bus production facilities in Salina, Kansas; Riverside, California; Imlay City, Michigan; and Elkhart, Indiana are designed to provide efficient assembly line manufacturing of our buses. The vehicles are produced according to specific orders which are normally obtained by dealers.
Some of the chassis, all of the engines and auxiliary units, and some of the seating and other components used in the production of our small and mid-size buses are purchased in finished form. Our Riverside, California facility assembles chassis for our rear engine buses from industry standard components and assembles these buses directly on the chassis.
The principal raw materials used in the manufacturing of our buses are fiberglass, steel, aluminum, plywood, and plastic. We purchase most of the raw materials and components from numerous suppliers. We purchase most of our bus chassis from Ford, Navistar, Chrysler and General Motors and engines from Cummins and Caterpillar. We believe that, except for chassis, raw materials and components could be purchased from other sources, if necessary, with no material impact on our operations.
We do not expect the current condition of the U.S. auto industry, including the recent bankruptcy filings and reorganizations of General Motors and Chrysler, to have a significant impact on our supply of bus chassis. Supply of bus chassis is adequate for now and we believe that on-hand inventory would compensate for changes in supply schedules if they occur. To date, we have not noticed any unusual cost increases from our chassis suppliers. If the condition of the U.S. auto industry significantly worsens, this could result in supply interruptions and a decrease in our sales and earnings while we obtain replacement chassis from other sources.
Marketing and Distribution
We market our small and mid-size buses through a network of 70 independent dealers in the United States and Canada. We select dealers using criteria similar to those used in selecting recreation vehicle dealers. During fiscal 2009, one of our dealers accounted for 19% of the Company’s consolidated bus net sales and another accounted for 10%. We also sell our small and mid-size buses directly to certain national accounts such as major rental car companies, hotel chains, and transit authorities. Most of our bus sales are derived from contracts with state and local transportation authorities, in some cases with partial funding from federal agencies.
Terms of sale are typically cash on delivery or through national floorplan financing institutions. Sales to some state transportation agencies and other government agencies may be on longer terms.
Backlog
As of July 31, 2009, the backlog for bus orders was $289,531, compared to $260,805 at July 31, 2008. The time for fulfillment of bus orders is substantially longer than in the recreation vehicle industry because generally buses are made to customer specification. The existing backlog of bus orders is expected to be filled in fiscal 2010.
Historically, the amount of our current backlog compared to our backlog in previous periods reflects general economic and industry conditions and, together with other relevant factors such as continued acceptance of our products by the consumer, may be an indicator of our revenues in the near term.
Product Warranties
We currently provide purchasers of our buses with a limited warranty for one year or 12,000 miles against defects in materials and workmanship, excluding only certain specified components which are separately warranted by suppliers. We provide body structure warranty on buses ranging from 2 years or 50,000 miles to 5 years or 75,000 miles. The chassis and engines of our small and mid-size buses are warranted for 3 years or 36,000 miles by their manufacturers.
Regulation
We are subject to the provisions of the National Traffic and Motor Vehicle Safety Act (“NTMVSA”) and the safety standards for recreation vehicles, buses and recreation vehicle and bus components which have been promulgated thereunder by the U.S. Department of Transportation. Because of our sales in Canada, we are also governed by similar laws and regulations issued by the Canadian government.
We are a member of the RVIA, a voluntary association of recreation vehicle manufacturers which promulgates recreation vehicle safety standards. We place an RVIA seal on each of our recreation vehicles to certify that the RVIA’s standards have been met.
Both federal and state authorities have various environmental control standards relating to air, water and noise pollution which affect our business and operations. For example, these standards, which are generally applicable to all companies, control our choice of paints, discharge of air compressor, waste water and noise emitted by factories. We rely upon certifications obtained by chassis manufacturers with respect to compliance by our vehicles with all applicable emission control standards.
We are also subject to the regulations promulgated by the Occupational Safety and Health Administration (“OSHA”). Our plants are periodically inspected by federal agencies concerned with health and safety in the work place, and by the RVIA, to ensure that our plants and products comply with applicable governmental and industry standards.
We believe that our products and facilities comply in all material respects with applicable vehicle safety, environmental, RVIA and OSHA regulations.
We do not believe that ongoing compliance with the regulations discussed above will have a material effect on our capital expenditures, earnings or competitive position.

Competition
Recreation Vehicles
The recreation vehicle industry is generally characterized by ease of entry, although the codes, standards, and safety requirements introduced in recent years are a deterrent to new competitors. The need to develop an effective dealer network also acts as a barrier to entry. The recreation vehicle market is intensely competitive with a number of other manufacturers selling products which compete directly with our products. Competition in the recreation vehicle industry is based upon price, design, value, quality and service. We believe that the quality, design and price of our products and the warranty coverage and service that we provide allow us to compete favorably for retail purchasers of recreation vehicles. We estimate that we are the largest recreation vehicle manufacturer in terms of units produced and revenue. According to Statistical Surveys, for the 7 months ending July 31, 2009, our market share for travel trailers and fifth wheels was 31% and our market share for motorhomes was 18%.
Small and Mid-Size Buses
We estimate that we have a 40% market share of the U.S. and Canadian small and mid-size bus market, according to the Mid-Size Bus Manufacturers Association. Our competitors offer lines of buses which compete with all of our products. Price, quality and delivery are the primary competitive factors. As with recreation vehicles, we believe that the quality, design and price of small and mid-size buses, the warranty coverage and service that we provide, and the loyalty of our customers allow us to compete favorably with similar products of our competitors.
Trademarks and Patents
We have registered United States and Canadian trademarks or licenses carrying the principal trade names and model lines under which our products are marketed. We are not dependent upon any patents or technology licenses for the conduct of our business.
Employee Relations
At July 31, 2009, we had approximately 5,203 full time employees in the United States and 175 full-time employees in Canada. Of these 5,378 employees, 793 are salaried. Citair’s approximately 146 Canadian hourly employees are currently represented by certified labor organizations. Our Citair Hensall division labor contract was ratified on August 18, 2006 and expired on August 18, 2009. Citair Oliver’s labor contract was ratified on October 17, 2003 and expired on October 16, 2008, and was subsequently extended to October 16, 2009. Both the Hensall and Oliver labor contracts are currently in the negotiation process. Employees of our other subsidiaries are not represented by certified labor organizations. We believe that we maintain a good working relationship with our employees.
Information About Foreign and Domestic Operations and Export Sales
Sales from our Canadian operations and export sales to Canada from our U.S. operations amounted to approximately 0.9% and 15.6% in fiscal 2009, 1.1% and 15.9% in fiscal 2008 and 1.2% and 12.7% in fiscal 2007, respectively, of our total net sales to unaffiliated customers. Export sales to Canada from our U.S. operations were $237,584, $421,008, and $360,198 in fiscal 2009, 2008, and 2007, respectively.
Forward Looking Statements
This Annual Report on Form 10-K includes certain statements that are “forward looking” statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934 as amended. These forward looking statements involve uncertainties and risks. There can be no assurance that actual results will not differ from our expectations. Factors which could cause materially different results include, among others, additional issues that may arise in connection with the findings of the completed investigation by the Audit Committee of the Board of Directors and the SEC’s requests for additional information, fuel prices, fuel availability, lower consumer confidence, interest rate increases, tight lending practices, increased material costs, the success of new product introductions, the pace of acquisitions, cost structure improvements, the impact of the recent auction market failures on our liquidity, competition and general economic conditions and the other risks and uncertainties discussed more fully in Item 1A. “Risk Factors” below. We disclaim any obligation or undertaking to disseminate any updates or revisions to any forward looking statements contained in this Annual Report on Form 10-K or to reflect any change in our expectations after the date of this Annual Report on Form 10-K or any change in events, conditions or circumstances on which any statement is based, except as required by law.

CEO BACKGROUND

First Year
Nominee Age Principal Occupation as Director

Neil D. Chrisman
72 Retired Managing Director of J.P. Morgan & Co. 1999
Alan Siegel
74 Retired partner of Akin Gump Strauss Hauer & Feld LLP 1983
Geoffrey A. Thompson
69 Partner, Palisades Advisors, LLC 2003

MANAGEMENT DISCUSSION FROM LATEST 10K

Executive Overview
We were founded in 1980 and have grown to be the largest manufacturer of Recreation Vehicles (“RVs”) and a major manufacturer of commercial buses in North America. Our market share in the travel trailer and fifth wheel segment of the industry (towables) is approximately 31%. In the motorized segment of the industry we have a market share of approximately 18%. Our market share in small and mid-size buses is approximately 40%. We also manufacture and sell 40-foot buses at our facility in Southern California.
Our growth has been internal and by acquisition. Our strategy has been to increase our profitability in North America in the RV industry and in the bus business through product innovation, service to our customers, manufacturing quality products, improving our facilities and acquisitions. We have not entered unrelated businesses and have no plans to do so in the future.
We rely on internally generated cash flows from operations to finance our growth although we may borrow to make an acquisition if we believe the incremental cash flows will provide for rapid payback. Capital expenditures of approximately $5,135 in fiscal 2009 were made primarily to upgrade IT systems and replace machinery and equipment used in the ordinary course of business.
Our business model includes decentralized operating units and we compensate operating management primarily with cash based upon profitability of the business unit which they manage. Our corporate staff provides financial management, purchasing services, insurance, legal and human resources, risk management and internal audit functions. Senior corporate management interacts regularly with operating management to assure that corporate objectives are understood clearly and are monitored appropriately.
Our RV products are sold to dealers who, in turn, retail those products. Our buses are sold through dealers to municipalities and private purchasers such as rental car companies and hotels. We generally do not directly finance dealers but do provide repurchase agreements in order to facilitate the dealers obtaining floor plan financing.
Trends and Business Outlook
Industry conditions in the RV market have been adversely affected by low consumer confidence, tighter lending practices and the general economic downturn. As a result of these continuing concerns, market conditions continue to be soft and we anticipate this weakness may continue in fiscal 2010.
The motorized market has been significantly impacted by current market conditions. The tightening of the retail credit markets, low consumer confidence and the volatility of fuel prices are continuing to place pressure on retail sales and our dealers continue to be cautious in the amount of inventory they are willing to carry. Based on the foregoing and with the assistance of an independent valuation firm, we recognized a non-cash goodwill impairment of $9,717 in the third quarter of fiscal 2009 for the goodwill associated with an operating subsidiary within our motorized segment. The Company also completed an impairment review in the second quarter which resulted in a non-cash trademark impairment charge of $564 for the trademark associated with an operating subsidiary in our motorized segment. The impairments result from the difficult market environment and outlook for the motorhome business. For fiscal 2009, net sales in our motorized segment decreased 65% compared to fiscal 2008. Our towables market has been significantly impacted as well, albeit less than our motorized market, as the price of a towable recreation vehicle is generally about one-fourth that of a motorhome and sales of more expensive recreation vehicles have suffered greater in the current economic downturn. Dealers continue to sell older model-year units before replacing them with new products. The decline in wholesale demand has directly impacted our gross margins as we have had to increase our discounts to meet competitive pricing.
The Company has reacted to the difficult business environment by scaling back its activities and reducing its workforce. If the current market environment persists, we may have to take additional cost-cutting measures including idling additional plants, if necessary.
When consumer confidence stabilizes and retail and wholesale credit availability improves, we expect to see a rebound in sales from dealers ordering units for stock and expect to benefit from our ability to ramp up production in an industry with fewer manufacturing facilities than before, due to competitor failures or plant consolidations. A short-term positive indicator for us is reflected in our order backlog, which has increased from $406,371 at July 31, 2008 to $587,859 at July 31, 2009, an increase of $181,488 or 45%. A longer-term positive outlook for the recreation vehicle industry is supported by favorable demographics as baby boomers reach the age brackets that historically have accounted for the bulk of retail RV sales, and an increase in interest has occurred in the RV lifestyle among both older and younger segments of the population than have traditionally participated.

We believe an important determinant of demand for recreation vehicles is demographics. The baby boomer population is now reaching retirement age and retirees are a large market for our products. The baby boomer retiree population in the United States is expected to grow five times as fast as the total United States population. We believe a primary indicator of the strength of the recreation vehicle industry is retail RV sales, which we closely monitor to determine industry trends. Recently, although the entire RV industry has been weak, the towable segment of the RV industry has been stronger than the motorized segment. For the towable segment, retail sales as reported by Statistical Surveys, Inc. were down approximately 31% for the seven months ended July 31, 2009 compared with the same period last year. The motorized segment was down approximately 42%. Tighter retail credit and lower consumer confidence appear to affect the motorized segment more severely.
Economic or industry-wide factors affecting our recreation vehicle business include raw material costs of commodities used in the manufacture of our product. Material cost is the primary factor determining our cost of products sold. Material costs have generally been flat in 2009. Future increases in raw material costs would impact our profit margins negatively if we were unable to raise prices for our products by corresponding amounts.
Government entities are the primary users of our buses. Demand in this segment is subject to fluctuations in government spending on transit. In addition, hotel and rental car companies are also major users of our small and mid-size buses and therefore travel is an important indicator for this market. The majority of our buses have a 5-year useful life and are being continuously replaced by operators. According to the Mid Size Bus Manufacturers Association, unit sales of small and mid-sized buses are down 12.1% for the six months ended June 30, 2009 compared with the same period last year. Bus sales may benefit from the U.S. government’s emphasis on mass transportation in the American Reinvestment and Recovery Act stimulus package.
We do not expect the current condition of the U.S. auto industry, including the recent bankruptcy filings and reorganizations of General Motors and Chrysler, to have a significant impact on our supply of chassis. Supply of chassis is adequate for now and we believe that on-hand inventory would compensate for changes in supply schedules if they occur. To date, we have not noticed any unusual cost increases from our chassis suppliers. If the condition of the U.S. auto industry significantly worsens, this could result in supply interruptions and a decrease in our sales and earnings while we obtain replacement chassis from other sources.

CONSOLIDATED
Net sales and gross profit for fiscal 2009 decreased 42.4% and 52.7% respectively, compared to fiscal 2008. Selling, general and administrative expenses for fiscal 2009 decreased 29.6% compared to fiscal 2008. Income before income taxes for fiscal 2009 decreased 84.6% compared to fiscal 2008. The specifics on changes in net sales, gross profit, selling, general and administrative expense and income before income taxes are addressed in the segment reporting below.
Corporate costs in selling, general and administrative were $17,660 for fiscal 2009 compared to $27,725 for fiscal 2008. This decrease of $10,065 is primarily due to a decrease of $3,142 in insurance related expense, $1,532 in audit and tax related fees, $1,414 in self-insured workers compensation costs, $1,569 in legal and professional fees, and $828 in incentive based compensation. These decreases resulted from the overall decline in our business and cost reduction efforts. In addition, the Company’s expense for probable losses related to vehicle repurchase commitments decreased by $1,176 due to a decrease in actual and anticipated repurchase activity resulting from lower dealer inventory. Corporate interest and other income was $6,014 for fiscal 2009 compared to $13,333 for fiscal 2008. The decrease of $7,319 is attributed to a $5,792 decrease in interest income due to lower interest rates and the contractual terms of our auction rate securities which restrict the maximum yearly interest earned and a $1,519 decrease in income from TCC, our former joint venture, which dissolved in September 2008.
The overall annual effective tax rate for fiscal 2009 was 26.7% on $23,395 of income before income taxes, compared to 39.2% on $152,407 of income before income taxes for fiscal 2008. The primary reasons for this decrease in rate were (1) the benefit derived from recording Qualified Alternative Fuel Motor Vehicle (”QAFMV”) credits for fiscal years ended 2007 and 2008 in the current year provision and the current year 2009 QAFMV credits received (2) recording the benefit derived from amending the Company’s federal and state income tax returns as a result of the Company’s IRS examination (3) the benefit of changes in legislation relative to the Company’s fiscal year 2008 research and development credit and (4) adjustments to the Company’s income taxes payable as a result of entries to correct the Company’s prior year deferred taxes and state tax expense. The income tax payable adjustments are for FASB Interpretation No. 48 (“FIN 48”) deferred tax assets, accrued dealer incentives, and an adjustment for the difference between state income tax expense accrued vs. paid.
The changes in costs and price within the Company’s business due to inflation were not significantly different from inflation in the United States economy as a whole. Levels of capital investment, pricing and inventory investment were not materially affected by changes caused by inflation.

The decrease in towable net sales of 45.9% resulted primarily from a 45.1% decrease in unit shipments and an 0.8% decrease in the impact of the change in the net price per unit. The overall industry decrease in wholesale unit shipments of towables for August 2008 through July 2009 was 51.2%, according to statistics published by the RVIA.
The impact of the change in net price per unit of towables was a decrease of 0.8%, which included decreases in travel trailers of 1.3% and increases in fifth wheels of 1.6%, in fiscal year 2009 as compared to fiscal year 2008. The primary reason for the decrease or nominal increase in the change in the net price per unit is due to heavier discounting and increased incentives in fiscal 2009 necessitated by prevailing depressed market conditions. This decrease created by discounting was offset, to varying degrees, by continued consumer demands for additional features or upgrades.
Cost of products sold decreased $674,790 to $841,804 or 88.3% of towable net sales for fiscal 2009 compared to $1,516,594 or 86.0% of towable net sales for fiscal 2008. The change in material, labor, freight-out and warranty comprised $626,299 of the $674,790 decrease in cost of products sold and was due to decreased sales volume. In addition, in fiscal 2008 cost of products sold included an impairment and other charges of $5,711, of which $5,411 related to the sale of our Thor California subsidiary and $300 related to the write-down of certain properties to fair value. Material, labor, freight-out and warranty as a percentage of net sales increased to 79.8% from 78.7% from fiscal 2008 to 2009. The 1.1% increase as a percentage of net sales is due primarily to the additional discounting in fiscal 2009. These costs in relation to gross sales remained consistent with fiscal 2008. Manufacturing overhead decreased $42,780 to $80,837 in fiscal 2009 compared to $123,617 in fiscal 2008. Variable costs in manufacturing overhead decreased $41,493 to $68,679 or 7.2% of towable net sales for fiscal 2009 compared to $110,172 or 6.2% of towable net sales for fiscal 2008 due to lower production. Fixed costs in manufacturing overhead, which consist primarily of facility costs and property taxes, decreased $1,287 to $12,158 in fiscal 2009 from $13,445 in fiscal 2008.
Towable gross profit decreased $135,030 to $111,475 or 11.7% of towable net sales for fiscal 2009 compared to $246,505 or 14.0% of towable net sales for fiscal 2008. The decrease in gross profit was due primarily to the 45.1% decrease in unit sales volume and the additional discounting during fiscal 2009.
Selling, general and administrative expenses were $64,441 or 6.8% of towable net sales for fiscal 2009 compared to $102,356 or 5.8% of towable net sales for fiscal 2008. The primary reason for the $37,915 decrease in selling, general and administrative expenses was decreased net sales, which caused related commissions, bonuses and other compensation to decrease by $32,385. In addition, advertising and selling related costs decreased $2,708 due to decreased sales activity and legal and settlement costs decreased $1,604 due to the resolution of various legal and product disputes.
Towable income before income taxes decreased to 5.0% of towable net sales for fiscal 2009 from 8.3% of towable net sales for fiscal 2008. The primary factor for this decrease was the reduction in unit sales coupled with additional discounting.

The decrease in motorized net sales of 65.0% resulted primarily from a 63.1% decrease in unit shipments and the impact of a 1.9% decrease in the impact of the change in net price per unit. The overall industry decrease in wholesale unit shipments of motorhomes for the period August 2008 through July 2009 was 70.2% according to statistics published by the RVIA.
The impact of the change in the net price per unit of motorized was a decrease of 1.9%, which included increases in Class A motorized units of 0.6%, and decreases in Class C motorized units of 1.7% in fiscal year 2009 as compared to fiscal year 2008. The nominal increase or decrease in the impact in net price per unit is attributable to much greater discounting and increased wholesale and retail incentives in fiscal 2009 in response to the significant contraction within the motorized market. The negative effects of the increase in discounting was offset in the Class A segment by the continued increase in the concentration of diesel units within the Class A line (30.9% in 2009 and 25.7% in 2008). Diesel units are generally larger and more expensive than gas units.
Cost of products sold decreased $264,473 to $161,455 or 99.8% of motorized net sales for fiscal 2009 compared to $425,928 or 92.2% of motorized net sales for fiscal 2008. The change in material, labor, freight-out and warranty comprised $252,347 of the $264,473 decrease in cost of products sold and was due to decreased sales volume. In addition, in fiscal 2008 cost of products sold includes charges of $1,526 related to the write-down of certain properties to fair value. Material, labor, freight-out and warranty as a percentage of net sales increased to 87.4% from 85.2% from fiscal 2008 to 2009. This 2.2% increase as a percentage of net sales was primarily driven by the deep discounting done in fiscal 2009 to remain competitive in the difficult motorized market segment. Labor, freight-out and warranty costs in relation to gross sales remained consistent with fiscal 2008. Material costs in relation to gross sales decreased by 1.0% in fiscal 2009 primarily due to the favorable impact of the LIFO inventory liquidations of $4,430. Manufacturing overhead decreased $10,600 to $20,083 in fiscal 2009 compared to $30,683 in fiscal 2008. Variable costs in manufacturing overhead decreased $10,889 to $15,920 or 9.8% of motorized net sales for fiscal 2009 compared to $26,809 or 5.8% of motorized net sales for fiscal 2008 due to lower production. Fixed costs in manufacturing overhead, which consist primarily of facility costs and property taxes, increased $289 to $4,163 from $3,874 in fiscal 2008.
Motorized gross profit decreased $35,656 to $272 or 0.2% of motorized net sales for fiscal 2009 compared to $35,928 or 7.8% of motorized net sales for fiscal 2008. The decrease in gross profit was due primarily to the 63.1% decrease in unit sales volume and additional discounting.
Selling, general and administrative expenses were $19,695 or 12.2% of motorized net sales for fiscal 2009 compared to $28,899 or 6.3% of motorized net sales for fiscal 2008. The primary reason for the $9,204 decrease in selling, general and administrative expenses was decreased net sales which caused related commissions, bonuses and other compensation to decrease by $7,681. In addition, self-insurance costs decreased $2,650 due to the settlement in fiscal 2008 of a single self insurance product liability claim, and advertising and selling costs decreased $1,013 due to decreased sales activity. These decreases were offset by increases of $955 for legal and settlement costs due to increases in various legal and product disputes and increased costs of $1,537 related to vehicle repurchase activity.
Motorized income before income taxes was a negative 18.4% of net sales for fiscal 2009 and a negative 0.1% of net sales for fiscal 2008. This reflects the impact of the decrease in unit sales, increased discounting, and the related impact on gross profit, and goodwill and trademark impairments of $9,717 and $564, respectively, at two of our motorized subsidiaries.

The decrease in buses net sales of 2.1% resulted from a 2.1% decrease in unit shipments.
There was no impact of the change in the price per unit of buses in fiscal year 2009 as compared to fiscal year 2008 as modest selling price increases were offset by similar nominal increases in discounting.
Cost of products sold decreased $9,632 to $366,100 or 90.0% of net sales for fiscal 2009 compared to $375,732 or 90.4% of buses net sales for fiscal 2008. The decrease in material, labor, freight-out and warranty represents $9,982 of the $9,632 decrease in cost of products sold offset by an increase of $350 in manufacturing overhead. Material, labor, freight-out and warranty as a percentage of buses net sales decreased slightly to 82.4% from 83.1% from fiscal 2008 to 2009. The individual relationships of labor, freight-out and warranty to buses net sales did not vary significantly in fiscal 2009 compared to fiscal 2008. Manufacturing overhead increased $350 to $30,795 in fiscal 2009 compared to $30,445 in fiscal 2008. Variable costs in manufacturing overhead increased $542 to $28,549 or 7.0% of buses net sales for fiscal 2009 compared to $28,007 or 6.7% of buses net sales for fiscal 2008. Fixed costs in manufacturing overhead, which consist primarily of facility costs and property taxes, decreased $192 to $2,246 in fiscal 2009 from $2,438 in fiscal 2008.
Buses gross profit increased $797 to $40,790 or 10.0% of buses net sales for fiscal 2009 compared to $39,993 or 9.6% of buses net sales for fiscal 2008. The increase in gross profit resulted primarily from the change in cost of products sold as discussed above.
Selling, general and administrative expenses were $22,782 or 5.6% of buses net sales for fiscal 2009 compared to $18,088 or 4.4% of net bus sales for fiscal 2008. The primary reason for the $4,694 increase in selling, general and administrative expenses was a $3,000 increase in self insurance reserves related to a single product liability case. Additionally, legal and settlement costs increased $1,270, a portion of which related to this same product liability case.
Buses income before income taxes decreased to 4.3% of buses net sales for 2009 from 5.1% of buses net sales for fiscal 2008. This reflects the impact of the increase in selling, general and administrative expenses, offset in part by the increase in gross profit, each as discussed above.

CONSOLIDATED
Net sales and gross profit for fiscal 2008 decreased 7.5% and 11.2%, respectively, compared to fiscal 2007. Selling, general and administrative expenses for fiscal 2008 decreased 0.4% compared to fiscal 2007. Income before income taxes for fiscal 2008 decreased 22.6% compared to fiscal 2007. The specifics on changes in net sales, gross profit, general and administrative expense and income before income taxes are addressed in the segment reporting below.
Corporate selling, general and administrative expenses were $27,725 for fiscal 2008 compared to $25,016 for fiscal 2007. This increase resulted from increases of $2,033 for self insurance costs related to products liability and medical claims, $1,984 for legal and accounting expenses due to increased professional services primarily for tax and growth initiatives, $3,393 for a charge related to higher vehicle repurchase activity resulting from a decline in the recreation vehicle industry and $478 for an unclaimed property tax settlement. These increases were offset by a decrease in legal costs of $5,480 related to the previously disclosed Dutchmen investigation.
Corporate interest income and other income was $13,333 for fiscal 2008 compared to $12,499 for fiscal 2007.
The overall annual effective tax rate for fiscal 2008 was 39.2% on $152,407 of income before income taxes, compared to 31.6% on $196,860 of income before income taxes for fiscal 2007. The primary reasons for this increase in rate were (1) an increase in our liability for unrecognized tax benefits pursuant to FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes – an interpretation of SFAS No. 109 (“FIN 48”), (2) the increased impact of specific permanent items when compared to lower income before income taxes, including impairment charges, and (3) the reversal in fiscal 2007 of income tax reserves due to settlements of an Internal Revenue Service examination and a tax dispute with the State of Indiana. The tax dispute with the State of Indiana involved a disagreement on the eligibility of the Company to file a unitary state tax return. The Company had established reserves for this dispute in fiscal 2003 through fiscal 2006, which it reversed in fiscal 2007. In the settlement agreement with Indiana, the Company obtained permission to file a unitary state tax return for fiscal 2006 and thereafter which is expected to be favorable to the overall annual effective tax rate.

The decrease in towable net sales of 6.7% resulted primarily from a 9.8% decrease in unit shipments offset by a 3.1% increase in the impact of the change in price per unit. The overall industry decrease in wholesale unit shipments of towables for August 2007 through July 2008 was 10.7% according to statistics published by the RVIA.
The impact of the change in price per unit of towables was an increase of 3.1%, which included increases in travel trailers and fifth wheels of 2.5% and 4.1%, respectively, in fiscal year 2008 as compared to fiscal year 2007. These increases were primarily due to increased freight costs associated with higher fuel prices, and demand by customers for additional features or upgrades, offset by decreases resulting from increased discounts and increased wholesale and retail incentives provided to customers. Additional discounts and incentives were provided as a result of an overall decline in the recreation vehicle industry.
Cost of products sold decreased $100,061 to $1,516,594 or 86.0% of towable net sales for fiscal 2008 compared to $1,616,655 or 85.5% of towable net sales for fiscal 2007. The change in material, labor, freight-out and warranty comprised $93,416 of the $100,061 decrease in

cost of products sold and was due to decreased sales volume. Material, labor, freight-out and warranty as a percentage of net sales increased to 78.7% from 78.3% from fiscal 2007 to 2008. The individual relationships of material, labor, freight-out and warranty to net sales did not vary significantly in fiscal 2008 compared to fiscal 2007. Manufacturing overhead decreased $12,356 to $123,617 in fiscal 2008 compared to $135,973 in fiscal 2007. Variable costs in manufacturing overhead decreased $11,725 to $110,172 or 6.2% of towable net sales for fiscal 2008 compared to $121,897 or 6.4% of towable net sales for fiscal 2007 due to lower production. Fixed costs in manufacturing overhead, which consist primarily of facility costs and property taxes, decreased $631 to $13,445 in fiscal 2008 from $14,076 in fiscal 2007. In addition, cost of products sold in fiscal 2008 included an impairment and other charges of $5,711, of which $5,411 related to the sale of our Thor California subsidiary and $300 related to the write-down of certain properties to fair value.
Towable gross profit decreased $26,940 to $246,505 or 14.0% of towable net sales for fiscal 2008 compared to $273,445 or 14.5% of towable net sales for fiscal 2007. The decrease in gross profit was due primarily to the 9.8% decrease in unit sales volume. In addition, decreases in gross profit resulted from the 3.6% increase in the impact of the change in the cost per unit, which occurred due to the addition of extra product options on units demanded by customers, the costs of which were not fully recoverable.
Selling, general and administrative expenses were $102,356 or 5.8% of towable net sales for fiscal 2008 compared to $107,804 or 5.7% of towable net sales for fiscal 2007. The primary reason for the $5,448 decrease in selling, general and administrative expenses was decreased net sales, which caused commissions, bonuses and other compensation to decrease by $5,647. In addition, legal and settlement costs decreased by $2,639 due to resolution of various legal and product disputes during 2007. These decreases were offset by increases of $619 for self insurance costs related to products liability and medical claims, $777 for vehicle repurchase activities resulting from a decline in the recreation vehicle industry and $560 for accounting and related expenses due to increased outsourcing of professional services.
Towable income before income taxes decreased to 8.3% of net sales for fiscal 2008 from 8.7% of net sales for fiscal 2007. The primary factor for this decrease was the reduction in unit sales and corresponding margins.

MANAGEMENT DISCUSSION FOR LATEST QUARTER

Executive Overview
We were founded in 1980 and have grown to be the largest manufacturer of Recreation Vehicles (“RVs”) and a major manufacturer of commercial buses in North America. Our market share in the travel trailer and fifth wheel segment of the industry (towables) is approximately 31%. In the motorized segment of the industry we have a market share of approximately 17%. Our market share in small and mid-size buses is approximately 40%. We also manufacture and sell 30-foot buses, 35-foot buses, and 40-foot buses.
On November 13, 2009, the Company reported that Wade F. B. Thompson, our co-founder, chairman, president and CEO passed away. He has been succeeded by Peter B. Orthwein, also a co-founder of the Company, to the offices of chairman, president and CEO. Management succession is in place and the Company is proceeding with its business uninterrupted.
Our growth has been internal and by acquisition. Our strategy has been to increase our profitability in North America in the recreation vehicle industry and in the bus business through product innovation, service to our customers, manufacturing quality products, improving our facilities and acquisitions.
We rely on internally generated cash flows from operations to finance our growth although we may borrow to make an acquisition if we believe the incremental cash flows will provide for rapid payback. In fiscal 2009, capital expenditures of approximately $5,135 were made primarily to upgrade IT systems and replace machinery and equipment used in the ordinary course of business.
Our business model includes decentralized operating units and we compensate operating management primarily with cash based upon the profitability of the unit which they manage. Our corporate staff provides financial management, purchasing services, insurance, legal and human resources, risk management, and internal audit functions. Senior corporate management interacts regularly with operating management to assure that corporate objectives are understood clearly and are monitored appropriately.
Our RV products are sold to dealers who, in turn, retail those products. Our buses are sold through dealers to municipalities and private purchasers such as rental car companies and hotels. We generally do not directly finance dealers but do provide repurchase agreements to make it easier for our dealers to obtain floor plan financing.
In October 2009 we decided to close our General Coach, Oliver, British Columbia production facility and move all General Coach RV and Park Model production to our other General Coach facility in Hensall, Ontario. We expect the wind-down of production in Oliver to be completed by the end of the calendar year. Related closure costs of approximately $1,900 were recorded in the first quarter ended October 31, 2009.

One of our recreation vehicle dealers accounted for 20% of RV net sales for the three months ended October 31, 2009.
Trends and Business Outlook
Industry conditions in the RV market have been adversely affected over the past year by low consumer confidence, tighter lending practices and the general economic downturn. Although the RV market is beginning to improve, market conditions continue to be relatively soft and we anticipate this weakness may continue in fiscal 2010.
The motorized market has been significantly impacted by current market conditions. The tightening of the retail credit markets, low consumer confidence, the volatility of fuel prices and the uncertainty of economic recovery are continuing to place pressure on retail sales and our dealers continue to be cautious in the amount of inventory they are willing to carry. Our towables market has been significantly impacted as well, albeit less than our motorized market, as the price of a towable recreation vehicle is generally about one-fourth that of a motorhome and sales of more expensive recreation vehicles have suffered greater in the current economic downturn. The decline in wholesale demand has directly impacted our gross margins as we have had to offer historically higher discounts to meet competitive pricing.
When consumer confidence stabilizes and retail and wholesale credit availability improves, we expect to see a rebound in sales from dealers ordering units for stock and expect to benefit from our ability to ramp up production in an industry with fewer manufacturing facilities than before, due to competitor failures or plant consolidations. A short-term positive indicator for us is reflected in our order backlog, which has increased from $381,187 at October 31, 2008 to $599,001 at October 31, 2009, an increase of $217,814 or 57%. A longer-term positive outlook for the recreation vehicle industry is supported by favorable demographics as baby boomers reach the age brackets that historically have accounted for the bulk of retail RV sales, and an increase in interest has occurred in the RV lifestyle among both older and younger segments of the population.
We believe an important determinant of demand for recreation vehicles is demographics. The baby boomer retiree population in the United States is expected to grow five times as fast as the total United States population. We believe a primary indicator of the strength of the recreation vehicle industry is retail RV sales, which we closely monitor to determine industry trends. Recently, although the entire RV industry has been weak, the towable segment of the RV industry has been stronger than the motorized segment. For the towable segment, retail sales as reported by Statistical Surveys, Inc. were down approximately 29% for the nine months ended September 30, 2009 compared with the same period last year. The motorized segment was down approximately 39%. Tighter retail credit and lower consumer confidence appear to affect the motorized segment more severely.
Economic or industry-wide factors affecting our recreation vehicle business include raw material costs of commodities used in the manufacture of our product. Material cost is the primary factor determining our cost of products sold. Material costs have generally been flat in 2009. Future increases in raw material costs would impact our profit margins negatively if we were unable to raise prices for our products by corresponding amounts.

Government entities are the primary users of our buses. Demand in this segment is subject to fluctuations in government spending on transit. In addition, hotel and rental car companies are also major users of our small and mid-size buses and therefore travel is an important indicator for this market. The majority of our buses have a 5-year useful life and are being continuously replaced by operators. According to the Mid Size Bus Manufacturers Association, unit sales of small and mid-sized buses are down 8.9% for the nine months ended September 30, 2009 compared with the same period last year. Bus sales may benefit from the U.S. government’s emphasis on mass transportation in the American Reinvestment and Recovery Act stimulus package.
We do not expect the current condition of the U.S. auto industry, including the recent bankruptcy filings and reorganizations of General Motors and Chrysler, to have a significant impact on our supply of chassis. Supply of chassis is adequate for now and we believe that on-hand inventory would compensate for changes in supply schedules if they occur. To date, we have not noticed any unusual cost increases from our chassis suppliers. If the condition of the U.S. auto industry significantly worsens, this could result in supply interruptions and a decrease in our sales and earnings while we obtain replacement chassis from other sources.
Wed, 06 Jan 2010 05:20:40 GMThttp://www.dailystocks.com/forum/showtopic.php?tid/3718/http://www.dailystocks.com/forum/showtopic.php?tid/3718/ Red Mountain Capital boosted its holdings to 783,888 shares (6.2%), by buying 77,343 from Nov. 4 to Dec. 21 at prices ranging from $7.02 to $7.99.

BUSINESS OVERVIEW

Overview

We are a nationwide provider of equipment financing and working capital solutions primarily to small businesses. We finance over 80 categories of commercial equipment important to our end user customers, including copiers, certain commercial and industrial equipment, security systems, computers and telecommunications equipment. Our average lease transaction was approximately $11,000 at December 31, 2008, and we typically do not exceed $250,000 for any single lease transaction. This segment of the equipment leasing market is commonly known in the industry as the small-ticket segment. We access our end user customers through origination sources comprised of our existing network of over 11,400 independent commercial equipment dealers and, to a lesser extent, through relationships with lease brokers and direct solicitation of our end user customers. We use a highly efficient telephonic direct sales model to market to our origination sources. Through these origination sources, we are able to deliver convenient and flexible equipment financing to our end user customers. Our typical financing transaction involves a non-cancelable, full-payout lease with payments sufficient to recover the purchase price of the underlying equipment plus an expected profit. As of December 31, 2008, we serviced approximately 113,000 active equipment leases having a total original equipment cost of $1.2 billion for approximately 92,000 end user customers.

In November 2006 we announced the introduction of business capital loans. Business capital loans provide small business customers access to working capital credit through term loans. At December 31, 2008, the business capital loan portfolio totaled $12.3 million.

On March 20, 2007, the Federal Deposit Insurance Corporation (“FDIC”) approved the application of our wholly-owned subsidiary, Marlin Business Bank (“MBB”) to become an industrial bank chartered by the State of Utah. MBB commenced operations effective March 12, 2008. MBB provides diversification of the Company’s funding sources and, over time, may add other product offerings to better serve our customer base.

On December 31, 2008, MBB received approval from the Federal Reserve Bank of San Francisco (“FRB”) to (i) convert from an industrial bank to a state-chartered commercial bank and (ii) become a member of the Federal Reserve System. In addition, on December 31, 2008, Marlin Business Services Corp. received approval to become a bank holding company upon conversion of MBB from an industrial bank to a commercial bank.

On January 13, 2009, MBB converted from an industrial bank to a commercial bank chartered and supervised by the State of Utah and the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”). In connection with the conversion of MBB to a commercial bank, Marlin Business Services Corp. became a bank holding company on January 13, 2009. In connection with this approval, the Federal Reserve Board required the Company to identify any of its activities or investments that were impermissible under the Bank Holding Company Act of 1956, as amended (the “Bank Holding Company Act”). Such activities or investments must be terminated or conform to the Bank Holding Company Act within two years of the approval (unless additional time is granted by the Federal Reserve Board). (See Regulation and Supervision in this Item 1). The Company’s reinsurance activities conducted through its wholly-owned subsidiary, AssuranceOne, Ltd., are impermissible under the Bank Holding Company Act. However, such activities would be permissible if the Company was a financial holding company, and the Company intends to seek certification from the Federal Reserve Board to become a financial holding company within two years from its approval to become a bank holding company.

The small-ticket equipment leasing market is highly fragmented. We estimate that there are up to 75,000 independent equipment dealers who sell the types of equipment we finance. We focus primarily on the segment of the market comprised of the small and mid-size independent equipment dealers. We believe this segment is underserved because: 1) the large commercial finance companies and large commercial banks typically concentrate their efforts on marketing their products and services directly to equipment manufacturers and larger distributors, rather than the independent equipment dealers; and 2) many smaller commercial finance companies and regional banking institutions have not developed the systems and infrastructure required to service adequately these equipment dealers on high volume, low-balance transactions. We focus on establishing our relationships with independent equipment dealers to meet their need for high-quality, convenient point-of-sale lease financing programs. We provide equipment dealers with the ability to offer our lease financing and related services to their customers as an integrated part of their selling process, allowing them to increase their sales and provide better customer service. We believe our personalized service approach appeals to the independent equipment dealer by providing each dealer with a single point of contact to access our flexible lease programs, obtain rapid credit decisions and receive prompt payment of the equipment cost. Our fully integrated account origination platform enables us to solicit, process and service a large number of low-balance financing transactions. From our inception in 1997 to December 31, 2008, we have processed approximately 620,000 lease applications and originated nearly 270,000 new leases.

Reorganization and Initial Public Offering

Marlin Leasing Corporation was incorporated in the state of Delaware on June 16, 1997. On August 5, 2003, we incorporated Marlin Business Services Corp. in Pennsylvania. On November 11, 2003, we reorganized our operations into a holding company structure by merging Marlin Leasing Corporation with a wholly-owned subsidiary of Marlin Business Services Corp. As a result, all former shareholders of Marlin Leasing Corporation became shareholders of Marlin Business Services Corp. After the reorganization, Marlin Leasing Corporation remains in existence as our primary operating subsidiary.

In November 2003, 5,060,000 shares of our common stock were issued in connection with our initial public offering (“IPO”). Of these shares, a total of 3,581,255 shares were sold by the company and 1,478,745 shares were sold by selling shareholders. The initial public offering price was $14.00 per share resulting in net proceeds to us, after payment of underwriting discounts and commissions but before other offering costs, of approximately $46.6 million. We did not receive any proceeds from the shares sold by the selling shareholders.

Competitive Strengths

We believe several characteristics may distinguish us from our competitors, including the following:

Multiple Sales Origination Channels. We use multiple sales origination channels to penetrate effectively the highly diversified and fragmented small-ticket equipment leasing market. Our direct origination channels , which historically have accounted for approximately 69% of our originations, involve: 1) establishing relationships with independent equipment dealers; 2) securing endorsements from national equipment manufacturers and distributors to become the preferred lease financing source for the independent dealers who sell their equipment; and 3) soliciting our existing end user customer base for repeat business. Our indirect origination channels have historically accounted for approximately 31% of our originations and consist of our relationships with brokers and certain equipment dealers who refer transactions to us for a fee or sell leases to us that they originated. In 2008, we took steps to reduce the portion of our business that is derived from the indirect channels to focus our origination resources on the more profitable direct channels. As a result, indirect business represented only 19% of 2008 originations, while direct business represented 81%.

Highly Effective Account Origination Platform. Our telephonic direct marketing platform offers origination sources a high level of personalized service through our team of 86 sales account executives, each of whom acts as the single point of contact for his or her origination sources. Our business model is built on a real-time, fully integrated customer information database and a contact management and telephony application that facilitate our account solicitation and servicing functions.

Comprehensive Credit Process. We seek to manage credit risk effectively at the origination source as well as at the transaction and portfolio levels. Our comprehensive credit process starts with the qualification and ongoing review of our origination sources. Once the origination source is approved, our credit process focuses on analyzing and underwriting the end user customer and the specific financing transaction, regardless of whether the transaction was originated through our direct or indirect origination channels.

Portfolio Diversification. As of December 31, 2008, no single end user customer accounted for more than 0.07% of our portfolio and leases from our largest origination source accounted for only 3.5% of our portfolio. Our portfolio is also diversified nationwide with the largest state portfolios existing in California (13%) and Florida (9%).

Fully Integrated Information Management System. Our business integrates information technology solutions to optimize the sales origination, credit, collection and account servicing functions. Throughout a transaction, we collect a significant amount of information on our origination sources and end user customers. The enterprise-wide integration of our systems enables data collected by one group, such as credit, to be used by other groups, such as sales or collections, to better perform their functions.

Sophisticated Collections Environment. Our centralized collections department is structured to collect delinquent accounts, minimize credit losses and collect post charge-off recovery dollars. Our collection strategy employs a blend of proven methods, including a life-cycle approach, where a single collector handles an account through its entire delinquency period, and a delinquency bucket segmentation approach, where certain collectors are assigned to accounts based on their delinquency status. The life-cycle approach allows the collector to communicate consistently with the end user customer’s decision maker to ensure that delinquent customers are providing consistent information. The delinquency bucket segmentation approach allows us to assign our more experienced collectors to the late stage delinquent accounts. In addition, the collections department utilizes specialist collectors who focus on delinquent late fees, property taxes, bankrupt and large balance accounts.

Access to Multiple Funding Sources. We have established and maintained diversified funding capacity through multiple facilities with several national credit providers. The opening of our wholly-owned subsidiary, MBB, provides an additional funding source. Initially, FDIC-insured deposits are being raised via the brokered certificates of deposit market. Our proven ability to access funding consistently at competitive rates through various economic cycles provides us with the liquidity necessary to manage our business. (See Liquidity and Capital Resources in Item 7) Experienced Management Team. Our executive officers average more than 18 years of experience in providing financing solutions primarily to small businesses. As we have grown, our founders have expanded the management team with a group of successful, seasoned executives.

Disciplined Growth Strategy

Our primary objective is to enhance our current position as a provider of equipment financing and working capital solutions, primarily to small businesses, by pursuing a strategy focused on organic growth initiatives while actively managing credit risk. We have responded to recent economic conditions with more restrictive credit standards, while continuing to pursue strategies designed to increase the number of independent equipment dealers and other origination sources that generate and develop lease customers. We also target strategies to further penetrate our existing origination sources.

Personnel costs represent our most significant overhead expense and we actively manage our staffing levels to the requirements of our lease portfolio. As a financial services company, we are navigating through the current challenging economic environment. In response to this, on May 13, 2008, we reduced our staffing by approximately 14.7%. This action was part of an overall effort to reduce operating costs in light of our decision to moderate growth in fiscal 2008. Approximately 51 employees were affected as a result of the staff reduction. On May 13, 2008, we notified the affected employees. We incurred pretax costs in the three months ended June 30, 2008 of approximately $501,000 related to this action, almost all of which was related to severance costs. The total annualized pretax cost savings that are expected to result from this reduction are estimated to be approximately $2.6 million.

We continue to be impacted by the current challenging economic environment in 2009. As a result, we have proactively lowered expenses in the first quarter of 2009, including reducing our workforce by 17% and closing our two smallest satellite sales offices (Chicago and Utah). A total of approximately 49 employees company-wide were affected as a result of the staff reductions in the first quarter of 2009. We expect to incur pretax severance costs in the three months ended March 31, 2009 of approximately $500,000 related to the staff reductions. The total annualized pretax salary cost savings that are expected to result from the reductions are estimated to be approximately $2.3 million. Although we believe that our estimates are appropriate and reasonable based on available information, actual results could differ from these estimates.

Asset Originations

Overview of Origination Process. We access our end user customers through our extensive network of independent equipment dealers and, to a much lesser extent, through relationships with lease brokers and the direct solicitation of our end user customers. We use a highly efficient telephonic direct sales model to market to our origination sources. Through these sources, we are able to deliver convenient and flexible equipment financing to our end user customers.

Our origination process begins with our database of thousands of origination source prospects located throughout the United States. We developed and continually update this database by purchasing marketing data from third parties, such as Dun & Bradstreet, Inc., by joining industry organizations and by attending equipment trade shows. The independent equipment dealers we target typically have had limited access to lease financing programs, as the traditional providers of this financing generally have concentrated their efforts on equipment manufacturers and larger distributors.

The prospects in our database are systematically distributed to our sales force for solicitation and further data collection. Sales account executives access prospect information and related marketing data through our contact management software. This contact management software enables the sales account executives to sort their origination sources and prospects by any data field captured, schedule calling campaigns, fax marketing materials, send e-mails, produce correspondence and documents, manage their time and calendar, track activity, recycle leads and review management reports. We have also integrated predictive dialer technology into the contact management system, enabling our sales account executives to create efficient calling campaigns to any subset of the origination sources in the database.

Once a sales account executive converts a prospect into an active relationship, that sales account executive becomes the origination source’s single point of contact for all dealings with us. This approach, which is a cornerstone of our origination platform, offers our origination sources a personal relationship through which they can address all of their questions and needs, including matters relating to pricing, credit, documentation, training and marketing. This single point of contact approach distinguishes us from our competitors, many of whom require the origination sources to interface with several people in various departments, such as sales support, credit and customer service, for each application submitted. Since many of our origination sources have little or no prior experience in using lease financing as a sales tool, our personalized, single point of contact approach facilitates the leasing process for them. Other key aspects of our platform aimed at facilitating the lease financing process for the origination sources include:


• ability to submit applications via fax, phone, Internet, mail or e-mail;

• credit decisions generally within two hours;

• one-page, plain-English form of lease for transactions under $50,000;

• overnight or ACH funding to the origination source once all lease conditions are satisfied;

• value-added portfolio reports, such as application status and volume of lease originations;

• on-site or telephonic training of the equipment dealer’s sales force on leasing as a sales tool; and

• custom leases and programs.

Of our 284 total employees as of December 31, 2008, we employed 86 sales account executives, each of whom receives a base salary and earns commissions based on his or her lease and loan originations. We also employed 8 employees dedicated to marketing as of December 31, 2008.

Sales Origination Channels. We use direct and, to a much lesser extent, indirect sales origination channels to penetrate effectively a multitude of origination sources in the highly diversified and fragmented small-ticket equipment leasing market. All sales account executives use our telephonic direct marketing sales model to solicit these origination sources and end user customers.

Direct Channels. Our direct sales origination channels, which have historically accounted for approximately 69% of our originations, involve:


• Independent Equipment Dealer Solicitations. This origination channel focuses on soliciting and establishing relationships with independent equipment dealers in a variety of equipment categories located across the United States. Our typical independent equipment dealer has less than $2.0 million in annual revenues and fewer than 20 employees. Service is a key determinant in becoming the preferred provider of financing recommended by these equipment dealers.

• Major and National Accounts. This channel focuses on two specific areas of development: (i) national equipment manufacturers and distributors, where we seek to leverage their endorsements to become the preferred lease financing source for their independent dealers, and (ii) major accounts (distributors) with a consistent flow of business that need a specialized marketing and sales platform to convert more sales using a leasing option. Once a relationship is established with a major or national account, they are serviced by our sales account executives in the independent equipment dealer channel. This allows us to leverage quickly and efficiently the relationship into new business opportunities with many new distributors located nationwide.

• End User Customer Solicitations. This channel focuses on soliciting our existing portfolio of approximately 92,000 end user customers for additional equipment leasing or financing opportunities. We view our existing end user customers as an excellent source for additional business for various reasons, including (i) retained credit information; (ii) consistent payment histories; and (iii) a demonstrated propensity to finance their equipment.

Indirect Channels. Our indirect origination channels have historically accounted for approximately 31% of our originations and consist of our relationships with lease brokers and certain equipment dealers who refer end user customer transactions to us for a fee or sell us leases that they originated with an end user customer. We conduct our own independent credit analysis on each end user customer in an indirect lease transaction. We have written agreements with most of our indirect origination sources whereby they provide us with certain representations and warranties about the underlying lease transaction. The origination sources in our indirect channels generate leases that are similar to our direct channels. We view these indirect channels as an opportunity to extend our lease origination capabilities through relationships with smaller originators who have limited access to the capital markets and funding.

In 2008, we took steps to reduce the portion of our business that is derived from the indirect channels to focus our origination resources on the more profitable direct channels. As a result, indirect business represented only 19% of 2008 originations while direct business represented 81%.

Sales Recruiting, Training and Mentoring

Sales account executive candidates are screened for previous sales experience and communication skills, phone presence and teamwork orientation. Due to our extensive training program and systematized sales approach, we do not regard previous leasing or finance industry experience as being necessary.

Each new sales account executive undergoes a comprehensive training program shortly after he or she is hired. The training program covers the fundamentals of lease finance and introduces the sales account executive to our origination and credit policies and procedures. It also covers technical training on our databases and our information management tools and techniques. At the end of the program, the sales account executives are tested to ensure they meet our standards. In addition to our formal training program, sales account executives receive extensive on-the-job training and mentoring. All sales account executives sit in groups, providing newer sales account executives the opportunity to learn first-hand from their more senior peers. In addition, our sales managers frequently monitor and coach sales account executives during phone calls, providing the executives immediate feedback. Our sales account executives also receive continuing education and training, including periodic, detailed presentations on our contact management system, underwriting guidelines and sales enhancement techniques.

Product Offerings

Equipment Leases. The types of lease products offered by each of our sales origination channels share common characteristics, and we generally underwrite our leases using the same criteria. We seek to reduce the financial risk associated with our lease transactions through the use of full pay-out leases. A full pay-out lease provides that the non-cancelable rental payments due during the initial lease term are sufficient to recover the purchase price of the underlying equipment plus an expected profit. The initial non-cancelable lease term is equal to or less than the equipment’s economic life. Initial terms generally range from 36 to 60 months. At December 31, 2008, the average original term of the leases in our portfolio was approximately 48 months, and we had personal guarantees on approximately 46% of our leases. The remaining terms and conditions of our leases are substantially similar, generally requiring end user customers to, among other things:


• address any maintenance or service issues directly with the equipment dealer or manufacturer;

• insure the equipment against property and casualty loss;

• pay or reimburse us for all taxes associated with the equipment;

• use the equipment only for business purposes; and

• make all scheduled payments regardless of the performance of the equipment.

We charge late fees when appropriate throughout the term of the lease. Our standard lease contract provides that in the event of a default, we can require payment of the entire balance due under the lease through the initial term and can take action to seize and remove the equipment for subsequent sale, refinancing or other disposal at our discretion, subject to any limitations imposed by law.

At the time of application, end user customers select a purchase option that will allow them to purchase the equipment at the end of the contract term for either one dollar, the fair market value of the equipment or a specified percentage of the original equipment cost. We seek to realize our recorded residual in leased equipment at the end of the initial lease term by collecting the purchase option price from the end user customer, re-marketing the equipment in the secondary market or receiving additional rental payments pursuant to the contract’s automatic renewal provision.

Property Insurance on Leased Equipment. Our lease agreements specifically require the end user customers to obtain all-risk property insurance in an amount equal to the replacement value of the equipment and to designate us as the loss payee on the policy. If the end user customer already has a commercial property policy for its business, it can satisfy its obligation under the lease by delivering a certificate of insurance that evidences us as a loss payee under that policy. At December 31, 2008, approximately 57% of our end user customers insured the equipment under their existing policies. For the others, we offer an insurance product through a master property insurance policy underwritten by a third-party national insurance company that is licensed to write insurance under our program in all 50 states and the District of Columbia. This master policy names us as the beneficiary for all of the equipment insured under the policy and provides all-risk coverage for the replacement cost of the equipment.

In May 2000, we established AssuranceOne, Ltd., our Bermuda-based, wholly-owned captive insurance subsidiary, to enter into a reinsurance contract with the issuer of the master property insurance policy. Under this contract, AssuranceOne reinsures 100% of the risk under the master policy, and the issuing insurer pays AssuranceOne the policy premiums, less a ceding fee based on annual net premiums written. The reinsurance contract expires in May 2009.


CEO BACKGROUND

John J. Calamari has been a Director since November 2003. Mr. Calamari is Executive Vice President and Chief Financial Officer of J.G. Wentworth, a position he has held since joining J.G. Wentworth in March 2007. Prior to that time, Mr. Calamari was Senior Vice President, Corporate Controller of Radian Group Inc. where he oversaw Radian’s global controllership functions, a position he held after joining Radian in September 2001. From 1999 to August 2001, Mr. Calamari was a consultant to the financial services industry, where he structured new products and strategic alliances and established financial and administrative functions and engaged in private equity financing for startup enterprises. Mr. Calamari served as Chief Accountant of Advanta from 1988 to 1998, as Chief Financial Officer of Chase Manhattan Bank Maryland and Controller of Chase Manhattan Bank (USA) from 1985 to 1988 and as Senior Manager at Peat, Marwick, Mitchell & Co. (now KPMG LLP) prior to 1985. In addition, Mr. Calamari served as a director of Advanta National Bank, Advanta Bank USA and Credit One Bank. Mr. Calamari received his undergraduate degree in accounting from St. John’s University in 1976.

Lawrence J. DeAngelo has been a Director since July 2001. Mr. DeAngelo is a Managing Director with Roark Capital Group, a private equity firm based in Atlanta, Georgia. Prior to joining Roark in 2005, Mr. DeAngelo was a Managing Director of Peachtree Equity Partners, a private equity firm based in Atlanta, Georgia. Prior to co-founding Peachtree in April 2002, Mr. DeAngelo held numerous positions at Wachovia Capital Associates, the private equity investment group of Wachovia Bank, from 1996 to April 2002, the most recent of which was Managing Director. From 1995 to 1996, Mr. DeAngelo worked at Seneca Financial Group, and from 1992 to 1995, Mr. DeAngelo worked in the Corporate Finance Department at Kidder, Peabody & Co. From 1990 to 1992, Mr. DeAngelo attended business school. From 1988 to 1990, Mr. DeAngelo was a management consultant with Peterson & Co. Consulting. Mr. DeAngelo received his undergraduate degree in economics from Colgate University and his MBA from the Yale School of Management.

Daniel P. Dyer has been Chief Executive Officer since co-founding our Corporation in 1997. In December of 2006, Mr. Dyer also assumed the role of President of the Corporation. Mr. Dyer also served as Chairman of the Board of Directors of the Corporation from 1997 to March 2009. From 1986 to 1997, Mr. Dyer served in a number of positions, most recently as Senior Vice President and Chief Financial Officer of Advanta Business Services, where he was responsible for financial and treasury functions. Mr. Dyer received his undergraduate degree in accounting and finance from Shippensburg University and is a licensed certified public accountant (non-active status).

Edward Grzedzinski has been a Director since May 2006. Mr. Grzedzinski served as the Chairman and Chief Executive Officer of NOVA Corporation from September 1995 to November 2004, and Vice Chairman of US Bancorp from July 2001 to November 2004. Mr. Grzedzinski has 25 years of experience in the electronic payments industry and was a co-founder of the predecessor of NOVA Corporation, NOVA Information Systems, in 1991. Mr. Grzedzinski served as a member of the Managing Committee of US Bancorp, and was a member of the Board of Directors of US Bank, N.A. Mr. Grzedzinski also served as Chairman of euroConex Technologies, Limited, a European payment processor owned by US Bancorp until November 2004 and was a member of the Board of Directors of Indus International Inc., a global provider of enterprise asset management products and services until October 2004. Mr. Grzedzinski is also a director of Neenah Paper, Inc.

Kevin J. McGinty has been a Director since February 1998 and has served as non-executive Chairman of the Board of Directors of the Corporation since March 2009. Mr. McGinty is Managing Director of Peppertree Capital Management, Inc. Prior to founding Peppertree in January 2000, Mr. McGinty served as a Managing Director of Primus Venture Partners during the period from 1990 to December 1999. In both organizations Mr. McGinty was involved in private equity investing, both as a principal and as a limited partner. From 1970 to 1990, Mr. McGinty was employed by Society National Bank, now KeyBank, N.A., where in his final position he was an Executive Vice President. Mr. McGinty received his undergraduate degree in economics from Ohio Wesleyan University and his MBA in finance from Cleveland State University.

Matthew J. Sullivan has been a Director since April 2008. Mr. Sullivan is a Partner with Peachtree Equity Partners (“Peachtree”). Mr. Sullivan co-founded Peachtree in 2002. From 1994 to 2002, Mr. Sullivan held numerous positions at Wachovia Capital Associates, the private equity investment group of Wachovia Bank, the most recent of which was Managing Director. From 1983 to 1994, Mr. Sullivan worked in the Corporate Finance Department at Kidder, Peabody & Co. and previously with Arthur Andersen & Company where he earned his CPA (currently non-active status). Mr. Sullivan received his undergraduate degree in finance from the University of Pennsylvania and his MBA from Harvard Business School.

James W. Wert has been a Director since February 1998. Mr. Wert is President and CEO of Clanco Management Corp., which is headquartered in Cleveland, Ohio. Prior to joining Clanco in May 2000, Mr. Wert served as Chief Financial Officer and then Chief Investment Officer of KeyCorp, a financial services company based in Cleveland, Ohio, and its predecessor, Society Corporation, until 1996, after holding a variety of capital markets and corporate banking leadership positions spanning his 25 year banking career. Mr. Wert received his undergraduate degree in finance from Michigan State University in 1971 and completed the Stanford University Executive Program in 1982.

MANAGEMENT DISCUSSION FROM LATEST 10K

Overview

We are a nationwide provider of equipment financing and working capital solutions primarily to small businesses. We finance over 80 categories of commercial equipment important to businesses, including copiers, certain commercial and industrial equipment, security systems, computers, and telecommunications equipment. We access our end user customers through origination sources comprised of our existing network of independent equipment dealers and, to a much lesser extent, through relationships with lease brokers and through direct solicitation of our end user customers. Our leases are fixed-rate transactions with terms generally ranging from 36 to 60 months. At December 31, 2008, our lease portfolio consisted of approximately 113,000 accounts, from approximately 92,000 customers, with an average original term of 48 months, and an average original transaction size of approximately $11,000.

Since our founding in 1997, we have grown to $795.8 million in total assets at December 31, 2008. Our assets are substantially comprised of our net investment in leases and loans which totaled $670.5 million at December 31, 2008.

In November 2006, we announced the introduction of business capital loans. Business capital loans provide small business customers access to working capital credit through term loans. At December 31, 2008, the busine