Description

BDY, trades at under 6X 05’ earnings and about 3.3X 05’ EBITDA on an EV/EBITDA basis. It trades at a significant discount to its fair value by any valuation metric. I acknowledge the hair on BDY, but believe from a risk/reward perspective your downside is very limited and your upside potential here is quite significant.

BDY- $9.50- 16M Shares Fully Diluted = $152M MCAP
Cash = 70M (as of 9/30/04)
Debt = 112M (as of 9/30/04)
EV= $194M

On January 12th, management lowered guidance for 05’ from $190M in rev and $1.90 in EPS to $173M in rev and $1.63 in EPS. Stock didn’t sell off too much because the analysts had taken their numbers down a week earlier and had already thoroughly beaten up the stock. Management’s new guidance came only 3-4 months after their previous guidance. They claim they saw increased competition in 2 of their products (one of which they expect to be patent protected later this year).

Then, on Monday 2/28, BDY announced that SEC has an informal investigation into the company’s revenue recognition and capitalization of certain payments. The SEC staff stated that the "inquiry is confidential and non-public" and "should not be construed as an indication by the Commission or its staff that any violation of the federal securities laws has occurred, or as a reflection upon any person, entity, or security."

Lastly, on Friday 3/11, BDY announced class action litigation, 10-K delay and guidance withdrawal. I viewed this press release as a non-event (although the market disagreed with me). Management only withdrew their guidance because of the cost uncertainties associated with the lawsuits, SEC inquiry and additional audits. I believe management is still confident in their revised revenue and EPS guidance minus these one-time events. In terms of the lawsuits, it is interesting to note here that management did not sell any stock even when it hit $30 this summer. In fact, over the past year management has been acquiring stock through option exercises and 401k plans. Management’s interests seem to be fully aligned with those of shareholders through its 13% ownership position. I would also note that I don’t believe any fraud whatsoever occurred at BDY.
I believe BDY’s business over the past few weeks has continued to remain on track, as evidenced by strong third party weekly prescription data published weekly by NDC. Data from the 4 weeks ending March 4th suggests BDY is on pace to hit its revised revenue guidance. The prescription data suggests that Carmol’s sales decline has stabilized and some of BDY’s newer products are starting to take off.

In August 2004, BDY bought Bioglan from Quintiles Corporation for $188M in Cash. I believe this is an important part of the equation as the whole of BDY now has an Enterprise Value almost equal to the cash they just recently spent to acquire Bioglan. I believe that the Bioglan sale was a competitively bid process and there were multiple bidders. I also believe that BDY did not bid much higher than their second closest bidder. Unless you believe multiple bidders were mistaken, it seems hard to argue that BDY should be trading here.

Company Description
Bradley Pharmaceuticals, Inc. is a specialty pharmaceutical company that acquires, develops and markets prescription and over-the-counter products in select markets. The Company's subsidiary, Doak Dermatologics, promotes its core branded dermatologic and podiatric products including Bradley Pharmaceuticals' Adoxa, Keralac, Solaraze, Carmol40, Lidamantle, Rosula and Zoderm product lines, primarily to dermatologists and podiatrists. Its Kenwood Therapeutics division promotes the Company's core branded gastrointestinal products including Anamantle HC, Pamine, Pamine Forte and Flora-Q, primarily to gastroenterologists and colon and rectal surgeons, and, to a lesser extent, it also markets nutritional supplements and respiratory products. The Company's products are manufactured by third parties and are distributed through wholesalers to retail pharmacies and healthcare institutions throughout the United States and select international markets.

BDY has a large short position in the stock. The shorts argue that BDY has a fundamentally flawed business plan. Some of their products face and will face generic competition. BDY has been in business for almost 20 years and has proven they can execute on their business plan of enhancing and growing. Management has a bunch of product additions and extensions planned for this year. They are well aware of generic competition and assumed it in both their acquisition of Bioglan as well as their 05’ guidance. Over the years BDY has done very well growing brands and seems to know how to market their product. Management also realizes that their longer-term goal is to move as much revenue as possible into patent protection. Most of senior management comes from various large pharma operations and all of them who came to BDY over the last 2 years or so seem very convinced that this company has significant growth over the next few years and specifically left large pharma because of the growth opportunities they saw within BDY.

BDY has a very solid business model. Going forward they should have 91-92% gross margins. In the near term EBIT margins should be in the mid to high 20s (Q3 showed a 26% EBIT margin). Management’s goal over the next few years is to get those margins into the low to mid 40s. They will do those both through revenue growth and cost savings from the Bioglan acquisition implemented over the next 12 months. Cost savings from good integration of the acquisition and better sourcing could add up to $5-8M or $.20-$.30 in earnings over the next 12 months.

BDY also has strong free cash flow as they have minimal Cap Ex. Based on run rate earnings assumed from prescription data, I think BDY’s balance sheet may look materially better today almost 6 months after its last reported quarter (9/30/04). It is reasonable to assume based on that data that BDY may have generated $15-20M in cash over the last 6 months. This would equate to another dollar of value in the stock price.

I think 06’ should be at least $200M of rev and $2+ in EPS. BDY has a good balance sheet and has a stock buyback in place (although this is on hold pending the investigation). For the record, in the summer the stock traded at 20X 04’ (current year) earnings and 17X 05’ (projected). Based on those multiples your upside in this stock could be at least a triple. If I use the Bioglan acquisition multiple (3.3X trailing 12 months sales and again this was a competitively bid process) as a guideline, then BDY should be worth $30-40. As opposed to other situations that have that kind of upside, BDY is extremely compelling from a risk/reward perspective as the fundamental value of the business protects you from much downside in the stock at $9.50.

Catalyst

Filing of Q4 numbers and Form 10K which should allow the company to continue its share buyback
Ending SEC inquiry
Announcing Q1 numbers, which will get people to start to believe management’s previous guidance
Continued strength in weekly prescription data
Large short position