CPNE finally got their Q2 numbers filed late yesterday, at the absolute deadline. I spent this morning going through the numbers, and dug up the alarming trend that has investors concerned.The top line was about $11 million- pretty darn good for a company trading at a market value of $35 million.The company managed a $2 million pretax profit, $1 million post tax- which translates to $.02 per share. This means annual EPS are somewhere in the $.08 range as the company operates today after paying taxes-meaning the stock is trading at a forward looking PE of about 8. Pretty darn cheap for a company with these kinds of margins.

On the plus side, their upsell and lead generation divisions are showing quite nice gains despite only being about 20% of their sales.

Here’s the Rub- the big negative the market hates- chargebacks and complaints. It appears their Q4 ’06 and Q1 ’07 marketing partners got them into trouble. There is mention of the “Quality” of subscribers many places throughout the document. In short, they hired marketing companies to find them paying subscribers. These partners slammed unsuspecting consumers into the program, who apparently didn’t understand what they were doing, and there were a lot of complaints.

As a result, the processing banks are taking a much dimmer view of the company, and setting more money aside in reserve that CPNE can’t get for six months. Here’s a quote directly out of the 10Q:

The higher chargeback volume as a percentage of gross transaction volume has been viewed as a potential credit risk by our merchant processing banks. The unfavorable credit risk assessment resulted in increased transactional fees and penalties, and higher reserve requirements during the three month period ended June 30, 2007. The reduction in chargebacks that we have experienced during the period has improved our risk assessment and allowed us to pursue more favorable relationships with our merchant processing banks. We expect that chargeback volumes will continue to decline and return to nominal levels because of the actions we have taken however, if chargeback volumes return to a high rate as compared to gross transaction volume, our merchant processing banks may determine that we are too high a credit risk and decline to continue to provide payment processing services which would impact our ability to bill and collect payment from our membership customers.

There’s the problem, and that’s what has the market pricing the company at such an absurdly low valuation.

Here’s the hard numbers: In Q1 the banks set aside $3.5 million in reserves. It shows on the balance sheet, net of historical default rates. In Q2 the banks raised that number to $4.9 million- a huge increase.

So, this is the problem the market is freaked out about, and perhaps rightly so.

In addition, the trend to lower margins is also alarming the market. Ultimately, the prospect of the banks cutting them off is the real big enchilada.

Consider the following- according to their disclosure, the problem is getting better- not worse. However, the market appears to be unwilling to accept that fact.

Here’s what the company needs to do, and until they do or until we get through another quarter, this stock will continue to trade poorly:

The company needs to hold a conference call right now and publicly answer questions about the state of its business. This head in the sand mentality is clearly not working. Look at the price. Perhaps the management would care to explain why they were out pumping themselves as they were dumping big quantities of stock at $1.90 to a fund manager who has gotten killed. According to their disclosure, they knew the chargebacks were happening.

Secondly, the company needs to publish performance guidance for Q3- they already know how they are doing as August is nearly at an end, and August revenues are July sign ups, and September should be easy to predict.

All in all, if the company continues to perform at current levels, the stock is worth far more than where it is trading. However, the management team has proven they have no idea how to manage the information flow through a troubling time.

I’m looking for the door on this one. I have better places for the money. I made a mistake hanging in there this long. It’s not the first time, and it surely won’t be the last. A move to more public disclosure could turn me around. That’s my biggest problem with these guys

Comments and questions are welcome.

CPNE finally had the decency to give investors a look at how Q2 numbers are going to come in, and a look at just how much damage the fraudulent credit cards actually hurt the company’s numbers.

CPNE has been in a free fall since making its new all time high at the end of February, and the value of the stock has been pretty much decimated. Investors have known for some time about the challenges they have had with chargebacks in Q1, but the company has refused to quantify the damage until this morning.

Personally, I feel the company’s “head in the sand” mentality is atrocious- For months now the market has been pricing in a “worst case” scenario. Finally, when the stock has been beaten down to a small fraction of its value just a few months ago, the management lets the public know the extend of the damage. In short- simply horrendous communication.

Public companies routinely issue earnings “guidance” well in advance of final earnings releases. Here’s the way I see it- CPNE should have issued guidance a long time ago and let investors decide for themselves if they wanted to hang in there. In the absence of information, you had to take your cues on the financial health of the company from the way the stock was behaving. If you looked at the chart, you had to assume the company was near bankruptcy.

Today, just prior to the open, CPNE issued a press release stating they would deliver about $11 million in revs and $2 million in operating income. Take out $500k for taxes, and whatever non cash charges are out there, and you have probably about $1 to $1.5 million in profits- or EPS in the $.02 to $.03 range.

The top line compares favorably with Q2 of 2006- They did about $7 million in the same quarter one year ago. However, the bottom line is taking a hit- last year they made $1.4 million on the $7 million in sales- margins have dropped from 22% to about 13% depending on where the final figures come in.

So, now we have a reasonable estimate on the hard numbers- and you can decide for yourself if you want to continue being a shareholder or become one. Personally, while I was impressed with what these guys have achieved in the past, I am extremely disappointed in their shareholder communications.

Something changed with this management team as we rolled into 2007. In the latter half of 2006 the company provided a constant stream of updates concerning their financial health and subscriber base. There were monthly subscriber number updates, and the stock traded very well. In 2007 they have chosen to remain mute about everything but new expansion programs. Some investors take these new initiatives as a sign they have already passed the steepest part of their growth curve.

Let’s look at the stock:

At today’s price of $.90, the stock market is saying the company is worth $45 million. Based on Q2 numbers, they should be delivering about $50 million in annual revenues, and earnings of around $5 million, or $.10 per share.

If margins do in fact come back in Q3, you would be looking at more like $.30 to $.40 EPS. Then, we would go back to the absurdly undervalued argument.

Clearly, CPNE has experienced a bump in the road. Whether or not it derails the company completely has yet to be determined.

I have no issue with the corporate performance- all companies suffer set backs. Some recover and go on to prosper- some don’t.

However, I do have an issue with the way they have handled their shareholder communications through the downturn. If you know what’s going on, you can make an informed decision about how to handle it. If you don’t you can lose money unnecessarily.

Here’s the bottom line- I will be looking to get out of this one if and when the stock improves. I can’t say the worst is behind, but the stock has lost 75% of its value since the end of February. It doesn’t seem like the company is worth 75% less, but that’s the way the market is valuing it for now.

The market has priced in a worst case scenario, and it’s not all that bad. However, I like being a shareholder of a company that lets you know what’s going on. I know I could end up selling at the bottom, but how would I ever know what’s going on so I could make an informed decision? I’ll be looking to get out on surges.

Comments and questions are welcome.