Dreams Inc.'s December Quarter: Reiterate Buy Rating

Excerpts from Gilford Securities analyst Casey Alexander's recent note to clients on Dreams Inc. (DRJ):

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Dreams, Inc is engaged in multiple aspects of sports entertainment and memorabilia industry through a variety of distribution channels. The Company operates in four business segments: retail, manufacturing/distribution, franchise, and athlete representation. The firm was incorporated in Utah in 1980. Dreams, Inc has grown through internal and vertical growth and acquisitions of brands that have been carefully selected with the intent of creating synergies between them that would allow Dreams to achieve business objectives of a broad and unprecedented scope...

1. Dreams Inc. Reports December Quarter EPS

Dreams Inc. reported quarterly results for the quarter ended December 31, 2007. Dreams reported a profit of $0.07 per share on revenues of $36.5 million. Revenues grew 47% over the same quarter in 2006. Dreams is changing from a fiscal year ended 3/31 to a calendar year, so this quarter is the final quarter of a stub year ending December 31, 2007. We are maintaining our estimates for the full year 2008 of revenues of $88.4 million and EPS of $0.10 per share.

The quarter continued Dreams production of strong revenue growth, while continuing to spend more than normal in order to fund future growth. We continue to believe that we are nearing an inflection point where the revenue growth begins to leverage sustained profitability and produce excellent returns for long term investors.

2. Dreams Opening of FansEdge Store Scheduled for April

Dreams will be opening the first FansEdge brick and mortar store in April in the Chicago metro area. Dreams is leveraging the FansEdge online success by extending the brand into a brick and mortar presence. Future site selection for expansion of the FansEdge format includes the Las Vegas market.

The expansion of the brick and mortar model using the FansEdge merchandising mix makes a great deal of sense to us, as it broadens the merchandise from collectibles into apparel and accessories. The FansEdge stores are developing a unique inventory management system, with in-store computer kiosks that will allow customers to access the entire enterprise inventory base from one location without every piece of inventory necessary to be on sight. Anything sourced through the computer kiosk can be drop- shipped to the customer that day, allowing for tremendous inventory utilization of each location. This could change the model for retailers, and it can only work because today’s current customers are used to shopping for items by computer and having them shipped to their home.

3. Dreams Internet Division Reports $20 Million in Sales for the Quarter

Dreams Internet division, led by FansEdge.com, reported a record $20 million in sales in the December quarter. The division was also proactive on price, giving up 2%-3% in gross margins to make sure that inventory moved through the channel. This strategy not only reduces ultimate carrying costs of inventory, but creates repeat customers as well. It also brings more attention to the brick and mortar FansEdge format, as internet customers will begin to identify the brand as a viable shopping entity.

4. Full Year 2008 Estimates and Price Target

The stub year is thankfully over, and now we can begin to measure Dreams based upon calendar year results. For the new Calendar Year 2008, we will maintain our EPS estimate of $0.10 per share on revenues of $88.5 million.

Any way you slice it, this estimate suggests revenue growth well in excess of 20% annually and EPS growth of better than 100%. The big question is “What’s the right way to value this growth”? Price to Sales ratio is kind of the easiest way out, but also the least substantiated. In any case, when revenues are growing at a consistently high rate, it seems unlikely that Dreams would forever trade at a discount to sales. So this should provide at least a valuation floor of one time sales, or $2.32 per share.

Dreams has pretty consistently traded at a P/E multiple in the 60X EPS area. With year to year 100% EPS growth, suggesting that the P/E could contract to 50X EPS could be considered taking a conservative approach, and this would offer a valuation of $5 per share. EBITDA growth is on the neighborhood of 63%. Perhaps an EBITDA multiple that is one quarter of the EBITDA growth rate would be considered a conservative figure. This valuation method would offer a price target of approximately $3.70 per share. This figure lies smack in the middle of the three valuation schemes, and represents an approximate a triple from the current share price.

When the Dreams Inc. 10-k comes out and we have a little more specific information about depreciation rates and interest costs we will massage these numbers a little bit and publish an updated model, but it hardly seems likely that Dreams is going to be anything but severely undervalued. Therefore we are reiterating our buy recommendation.

Risks to Achieving the Price Target

Line of credit facility – The Company’s line of credit facility imposes significant operating and financial restrictions which may limit their ability to finance future operations or capital needs and pursue business opportunities, thereby limiting growth.

Future acquisitions - Integrating an acquired business requires large expenditures and also takes time. Failure to successfully accomplish future acquisitions or to manage and integrate completed or future acquisitions could have a material adverse effect on the company’s business, financial condition and results of operations.

Rapid Growth - Failure to keep up with rapid growth and recruiting employing experienced executives might pose a threat to the company’s future growth and management.

New retail store - Lack of available retail space and/or rising rents in malls and other retail shopping areas could also inhibit the company’s ability to grow.

Change in consumer tastes and trends - A failure to anticipate changes in consumer preferences for these products could result in lower revenues, higher inventory markdowns and lower margins. A misjudgment of the popularity or staying power of a sports team or an athlete, may cause over-stocking unpopular products and force inventory markdowns that could have a negative impact on profitability.

Relationships with athletes – Given the nature of the type of goods that Dreams sells, it is imperative that the company form and maintain relationships with popular athletes. The failure to identify, form and maintain relationships with these athletes could adversely impact the company’s business.

Dreams buys a significant portion of our inventory from a few vendors - Dreams does not enter into long-term contracts or arrangements with most of its vendors and is therefore exposed to the risk that some of its current vendors might stop selling to it on acceptable terms.

Interest Rate Risk - Borrowings under its credit facility with Comerica Bank are based on variable market interest rates. A significant increase in the market interest rate will significantly increase interest expense and reduce the company’s cash flow.

Intangible Asset Risk - Dreams has a substantial amount of intangible assets and performs goodwill impairment tests when events or circumstances indicate that the value of these assets may not be recoverable. An economic downturn, sluggishness in the business that Dreams operates in or the company’s relative performance could cause the value of the assets to be written down to their fair values, which could result in material changes that could be adverse to the company’s operating results and financial position.

With an increasing amount of Dreams’ revenues coming from its e-commerce operations it is more exposed that ever to the risks that arise in the course of normal business through the internet.

The Company’s e-commerce business is subject to regulations and laws specifically governing the Internet and e-commerce. A change in the existing laws and regulations may impede the growth of the Internet or other online services.

A fundamental requirement for e-commerce is the secure transmission of confidential information over public networks. Failure to protect consumer information and prevent fraudulent credit card transactions and other security breaches, may adversely affect Dreams’ e-commerce operations.

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ANALYST CERTIFICATION

I, Casey Alexander, certify that all the views expressed in this research report accurately reflect my personal views of the subject company (ies). I also certify that I have not and will not receive compensation with respect to the issuance of this report.

REQUIRED DISCLOSURES

In the normal course of business, Gilford Securities seeks to perform investment banking and other services for various companies and to receive compensation in connection with such services. As such, Gilford Securities intends to seek compensation for investment banking services from the subject companies in the next 3 months.

The analyst owns and manages a hedge fund in which Dr. Philip Frost (a 14.7% shareholder of DRJ) is an investor.