Lilly Eli & Co filed their quarterly 10-Q statement with the SEC on August 4th, which outlined their current financials and also brought to light the magnitude of lawsuits coming as a result of their two blockbuster drugs Zyprexa and Prosac. The company is also involved in several other lawsuits, including a class action lawsuit and corporate lawsuits involving insurance coverage.

The company was slammed back in 2005 when the U.S. Attorney General announced that it was investigating the company for Medicaid fraud. The government argues that Lilly illegally promoted Zyprexa for unapproved uses, and seeks to recover millions of dollars on behalf of customers. This case is still pending and, the company warned, could expand from Zyprexa to include other company drugs. The company also stated that it settled 10,500 Zyprexa-related lawsuits last year; however, 7,600 remain with 850 tolled claims. Both of these cases are still pending. The problem now is that insurance companies are attempting to reduce their liability in the matter. In their 10-Q filing, the company stated:

"We have insurance coverage for a portion of our Zyprexa product liability claims exposure. The third-party insurance carriers have raised defenses to their liability under the policies and are seeking to rescind the policies. The dispute is now the subject of litigation in the federal court in Indianapolis against certain of the carriers and in arbitration in Bermuda against other carriers. While we believe our position is meritorious, there can be no assurance that we will prevail."

Later in the filing, the company also notes:

"We have experienced difficulties in obtaining product liability insurance due to a very restrictive insurance market, and therefore will be largely self-insured for future product liability losses. In addition, as noted above, there is no assurance that we will be able to fully collect from our insurance carriers on past claims."

The company recorded a net pre-tax charge of $1.07b during the second quarter of 2005 to cover the Zyprexa lawsuits and reserves "to the extend that they can formulate a reasonable estimate of". While all pharmaceutical companies often experience a number of lawsuits centered around their drugs, Lilly's $1.07b charge was above average. And, the company could face even higher charges in the future if it fails to defend its right to insurance payouts, loses insurance coverage, or fails to defend itself in the large government and class action lawsuits that are currently pending. The result will either be a cheap buy, if the company prevails when the dust settles; or, it could mean a potential diseaster for the company. Either way, it is definitely something to keep an eye on.

Liberation has had an eye on Multimedia Games (MGAM) since late May of this year when it began quietly acquiring shares on the open market. Since then, the investment group has amassed an 8% stake in the company and has begun an activist campaign to increase shareholder value.

In Liberation’s initial June 30th filing with the SEC, they stated that they had met with Michael Maples, Chairman of the Board of the Company. During the meeting, the two parties discussed ways in which to maximize shareholder value. In particular, the investment group “urged the company to focus on a transaction or restructuring to monetize the Company’s participation arrangements with Native American tribes in the State of Oklahoma and use the proceeds to implement a substantial stock buyback or otherwise create a mechanism to deliver maximum value to shareholders”. Finally, the group warned that if the company did not demonstrate “in the near term” that it has made progress towards these goals, it would pursue all available alternatives.

Well, in a recent amendment to their original filing yesterday, the group stepped up their campaign by announcing:

“Unless the Company promptly articulates a strategy to maximize shareholder value, the Reporting Persons intend to solicit shareholders to call a special meeting of shareholders for the purpose of electing new directors to the Board. If a special meeting is called, the Reporting Persons intend to nominate individuals for election to the Board who will actively pursue strategies to maximize shareholder value consistent with, but not limited to, those described above. The Reporting Persons also intend to solicit proxies in support of the election of such directors at the special meeting.”

The company threatened to install its own board capable of action, or even resort to more extraordinary measures such as M&A activities or liquidation. Overall, this stock is definitely worth watching. The stock is currently trading at only $8.89. This investment group has averaged in from $11 down through $9 a share, and therefore would likely seek strategic alternatives that would recoup all or more of their investment, which represents a 10% to 20%+ premium from the current market price.

Delcath Systems (DCTH) has been involved in a long battle with hedge fund Laddcap Value Fund for over a year. The fund is seeking to replace the company's board and possibly put the company up for sale. While this would result in a nice short-term spike for investors, the company argued that its long-term prospects would pay off. The company continued its battle against Laddcap Value Fund today by announcing a lawsuit alleging that the fund failed to disclose critical details about its proposed replacement board. Their PRE-14C filing with the SEC today shed some interesting details on the funds owners and motivations.

The company begins by pointing out that the current board has witnessed a 916% increase in the share price over the past three years - this kind of performance does not justify shareholder action to replace the board. The company then shed light on the funds management and proposed slate of directors:

"Ladd Defendants have failed to disclose is that one of their director nominees, Paul William Frederick Nicholls, filed Chapter 7 personal bankruptcy in 2002. Among other items, Mr. Nicholls amassed credit card debt of $105,349.75 on nine credit cards, including cards issues by such luxury retailers as Bloomingdale's, Bergdorf Goodman and Macy's. They failed to disclose that another nominee, Fred. S. Zeidman, served on the Audit Committee for Seitel Corporation, a company that restated its financials for seven quarters and subsequently filed for bankruptcy. The Ladd Defendants failed to disclose that Mr. Zeidman was named in seven lawsuits arising out of the restatements. They failed to disclose that Michael Karpf, M.D. sat as Vice Provost of the UCLA hospital system through its period of financial woes, necessitating the hiring of an outside firm to ascertain what went wrong. And certainly, the Ladd Defendants have failed to disclose the abysmal performance of the Laddcap hedge fund run by Mr. Ladd."

Now, Delcath shareholders are faced with a choice. If the proposed consent solicitation garners enough interest for a proxy battle and Ladcapp is able to take over the company, they are likely to attempt to put the company up for quick sale. This hunch is based on the fact that they demanded that the company contact an investment bank several months ago to explore strategic alternatives - an attempt which ended up failing after lawsuits were filed. If current managements remains in place after a proxy battle, the stock price is likely to appreciate also due to the added security that current management will remain for long-term growth. If, however, the lawsuit and solicitations are dropped (which has been what has happened in the past), the uncertainty and the threat of takeover remains which may be a drag on the stock price in the near term. Overall, this situation warrants a close watch, as a proxy vote of any kind could mean a catalyst to a quick increase in the stock price.

Verizon announced in 2005 that is was exploring strategic alternatives for its Yellow Pages business. Recently on July 7th of this year the said that they would be spinning off their Yellow Pages and Directories business in their Form 10 filing with the SEC. Under the terms outlined in this filing, current Verizon shareholders will receive one share of the new spin off, Directories Corp, for every twenty shares of Verizon that they own along with cash for any fractional shares. As the pending spin off comes closer to reality, let's take a look at how you can benefit from this spin off!

First, let's take a look at what we know. The new spin off would create the world's second largest yellow pages directories publisher in the United States along with the largest yellow pages directory on the Internet. The company's products would include print yellow pages, print white pages, an Internet yellow pages directory (SuperPages.com), and an information directory for wireless subscribers (SuperPages On the Go). These products had an estimated market share of about 72% in the top fifteen metro areas in the U.S. We also know that the company makes 90% of its revenues from sale of advertising in print yellow pages, 4% from sale of advertising in print white pages, and 6% from Internet Yellow Pages advertising. Finally, the Form 10 filing also noted a pro forma net income of over $1 billion and strong cash flows but also warned of "substancial debt". This debt includes a note receivable from Verizon of $507m and the issuance of up to $9.1b in debt comprised of senior term loans and other debt securities. More of the financial information can be found in the Form 10 filing.

Next, let's take a look at why the spin-off took place. In the Form 10, the company gave the following reasons:

• Enhance Directories Corp's ability to execute a potential acquisition strategy.
• Permit Directories Corp to enhance the efficiency and effectiveness of equity based compensation.
• To allow each company to determine its own capital structure.
• To allow each company to focus on its own core business.

The first two reasons listed here are of interest - we can see that the company is interested in pursuing a potential acquisition strategy and that the new owners have a big interest in making this happen (as much of their compensation is in equity based compensation, both from this event and from their holdings that came as a result of the VZ spin off itself). By carefully watching insider buying and selling after the sale, we will be able to tell how confident and vested owners are in making this happen. Following insiders, especially when they have a large stake in the success, is always a good idea.

Another advantage of this spin off situation is the fact that the stock is usually undervalued shortly after the spin off occurs. This comes as a result of the spin off process itself - shares of the new company are automatically distributed to all holders of VZ stock. More often than not, these VZ investors are not interested in the new spin off, and therefore immediately sell their shares. Also, some instituational holders are not allowed to hold the new stock. This results in a massive sell off that typically drives the price below its proper valuation.

All of this creates not only a short-term buying opportunity for swing traders, but also may be an opportunity for long-term investors to get in cheaply.

Apple Computers is the latest in a long series of headlines relating to the SEC's crackdown on backdated option grants - an issue potentially affecting a number of public companies, primarily in the tech sector. Apple recently launched its own internal investigation which uncovered several violations which may significantly impact the valuation of their stock. In an 8k filing with the SEC dated August 4th, Apple stated:

“Apple’s financial statements for the fiscal years ended 2003, 2004 and 2005, the interim periods contained therein, the fiscal quarters ended December 31, 2005 and April 1, 2006, and all earnings and press releases and similar communications issued by Apple relating to periods commencing on September 29, 2002 should no longer be relied upon.”

The company also notified investors that it would likely delay its 10Q filing with the SEC until further notice. Many other tech companies are also feeling the heat as the SEC cracks down. Among the potentially affected companies are Broadcom, Rambus, Sycamore Networks, and McAfee. Currently, Brocade is the only company facing criminal charges by the SEC. If found guilty, company officers involved in the crime can face up to 20 years in prison and $5 million in fines.

What Are Backdated Option Grants?

Option backdating occurs when a company grants a call option (a right but not obligation to buy at a certain price) with an exercise price below the price of the stock on the day of the grant. This means that the owner is entitled to an immediate gain on paper if he/she decided to immediately exercise their option. Now, as surprising as it sounds, this is not illegal. In fact, it is perfectly legal for a company to backdate options; however, the option grants must be classified as being backdated.

The SEC recently got involved when it discovered that several companies were classifying these backdated option grants as a type in which the exercise price is the same as the stock price on the day of the offer. This enabled companies to hide millions of dollars of expenses from the public, which in turn artificially boosted net income by reducing operating expenses. As a result many companies may be forced to restate many years worth of earnings due to the manipulation of net income. This will force investors to revalue (to the downside) the companies based on the new lower net income levels. Needless to say, these investigations will have a material effect on the offending companies.

In October 2001, Computer Associates, one of the world's largest software companies, reported pro-forma income of $359M for its fiscal 2nd quarter, nearly a 60% increase over the previous year. The impressive numbers were the result of a new business model, which stretched software revenues over the entire year. At the same time, the company reported to the SEC a loss of $291M for the quarter using GAAP. This story underscores the importance of always relying on GAAP-based SEC filings and also illustrates one of the most common genres of creative accounting - revenue recognition.

Revenue recognition is simply when a company books its sales. Most companies book their sales when delivery has occurred or services have been rendered, while others do it when the company receives payment. Some companies, however, book sales more creatively or outright fraudulently. Although Computer Associates technically did nothing illegal, but their new results were misleading to some investors. Some more fraudulent companies might go the extra mile and actually book future sales as current revenue. This happened at Xerox in the late 1990s and into 2000 when they accelerated the revenue recognition of leasing equipment over four years. This time, even the GAAP financial statements showed a higher net income. So, how can investors see through this smoke screen?

The key is looking at the one thing that most accounting tricks cannot change - cash. The simple check is this: Compare net income from the balance sheet to cash from operations on the statement of cash flows. If these two numbers do not correlate, then something is amiss. When Xerox showed a net income of over $100M and operating cash flow was -$8M, clearly something was wrong! By using this simple five-minute check, investors can avoid many of the most common types of accounting fraud.

Where do you find this information? A company's financial statements can be found quarterly in form 10Q and yearly in form 10k, usually under Section 1. A company's net income can be found towards the bottom of the Income Statement, and indicates how much the company "made" - that is, all revenues minus all operating expenses. The company's cash from operations can be found in the statement of cash flows, in the first section "cash flow from operating activities". The number we are looking for is "net cash provided by operating activities" or simply "net operating cash". This number takes all cash receives and subtracts all cash expenditures. Even if a company claims a future sale on net income, they could not have possibly received cash for it - and that's how we can tell! For an example of a 10Q statement, check out Microsoft's latest filing.

You can find all of the SEC filings filed by a company, including their annual report and financial statements at SECFilings.com.

James River Coal Company (JRCC) is a coal company that mines, processes and sells regular coal (the kind used for energy). Back in February of this year, the company was issued an ultimatum by Pirate Capital (an activist hedge fund), who threatened to start a proxy war if the Board of Directors didn't comply with their demands to put the company up for sale or reform. In their 13D filing with the SEC on February 10th, Pirate Capital argued that the company's management were inexperienced and illequiped to run the company. Perhaps more importantly, Pirate insisted that the company was grossly undervalued:

"Pirate Capital has had significant discussions with investment
bankers and is highly confident that there are a number of strategic buyers
that would be interested in purchasing the Company at a substantial premium
to the current stock price.  We have been advised that such a strategic
transaction could provide existing James River investors an opportunity to
participate in the upside of a more diversified operator with a stronger
balance sheet and just as importantly, a deeper and stronger management team
better positioned to derive value from James River's assets."

And keep in mind this was written in February when JRCC sat in the $40s! At the end of their letter to the Board, they stated:

"Should the Board fail to meet Pirate Capital's demands, it is our
intention to provide the requisite advance notice to the Company of our
intention to solicit proxies to elect a slate of directors to gain control
of the Board at the Company's next annual meeting."

Well, it turns out that the board did fail to meet the demands, and Pirate released an intention to solicit proxies on July 5th through another 13D filing which provided a "Shareholder Notice of Intent to Nominate Persons for Election as Directors and to Move Certain Business" along with a "Demand for Right to Inspect Books" which would give Pirate Capital shareholder information that the need to solicit a proxy vote to institute four of their own directors. This potential hostile takeover is set to take place at the company's next annual meeting, which will be set after the company has completed analyzing Pirate Capital's proposals and intentions.

This is a great stock to keep an eye on - If a hostile takeover does successfully take place, Pirate Capital will have four of their own board appointees and will likely try and sell the company. This should result in a substancial premium over the current price, especially given Pirate Capital's average acquisition prices. Here are the filings for Pirate Capital and James River Coal Company (JRCC).

Have you ever wished you could look over the shoulders of Wall Street's best and brightest? Thanks to the SEC's ownership disclosure rule, it is possible for anyone to watch the most successful traders and investors in the market. This SEC rule requires anyone who acquires more than 10% of a company to disclose the number of shares they hold, the price they purchased at, and even their investment objectives. This rule applies to everyone from the successful activist hedge fund Pirate Capital to Warren Buffet himself! Let's take a look at how you can track some of today's top money managers...

The first step is finding an investor worth watching. Now, the downside of this rule is that these investors do not reveal ownership until their holdings reach 10%, so it is important to seek out those that care about the long-term, not those interested in making a quick buck (because they have already averaged in at much better prices while not disclosing ownership). One of the most popular groups to watch are activist hedge funds, like Pirate Capital or Steel Partners. These groups vigorously take over companies and work to unlock shareholder value by turning around the company, forcing share buybacks, forcing dividend payments, or selling off the company in pieces. This has resulted in 20% - 30% annual returns for Pirate Capital, and similar returns for Steel Partners. Often times savvy individual investors can catch a free ride on these forced liquidation events and dividends. Obviously the second most popular group to watch are market savvy individuals like Warren Buffet, and their companies.

There are several types of filings to keep an eye on:

• 13D-G will let you view when the investor acquires more than 10% of a company and also the investor's investment objectives.
  
• Form 4 will let you know each time the investor trades in the companies they own (more than 10%).
• 13F will show you a holdings report for the investor along with the amount, value, and voting power of the shares they hold.

In addition to this required content, these filings can also include things such as letters to management, letters to the board of directors, shareholder demands, calls for a proxy vote, and other material that can be of enormous interest to opportunistic investors. Therefore, it is always important to read any attached exhibits.

To keep up to date with all of these filings, SECFilings.com allows you to subscribe to instant e-mail alerts. Simply add the companies, funds, and investors of interest and instantly receive notice when they file paperwork with the SEC!

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