FORTUNE DIVERSIFIED INDUSTRIES, INC (OTCBB FDVI) Reiterated Buy by tyh12035

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									                                                                                  Sr. Analyst: Kipley J. Lytel, CFA
                                                                                       Kipley@SpelmanResearch.com
                                                                                        Jr. Analyst: Alexandru Vozian

                                                                                                         01/18/2005




  FORTUNE DIVERSIFIED INDUSTRIES, INC: (OTCBB: “FDVI”)
                       Reiterated Buy Rating and $2.40 Price Target
                                                Share Statistics
                                   Symbol                             FDVI.OB
                                   Last Trade (01/14/05)               $ 0.62
                                   52wk Range                        $0.46-1.60
                                   Average Volume (3m)                 20,454
                                   Market Capitalization             $63.53 Mn
                                         Source: Yahoo Finance, SEC Filing

Analyst Comment & Rationale:
We maintain our Buy Rating on FDVI based on latest announcements of Q1FY05 results and
reaffirm the $2.40 per share price target. FDVI announced stellar ‘yoy’ revenue and earning
growth of 145% and 200% in Q1FY05, respectively, further confirming its successful transition
from a small niche firm to a mid-sized player following a successful aggressive organic and
rollup growth strategy.

FDVI met our revenue estimates for Q1FY05 in all business segments except “Manufacturing
and Distribution Segment.” We believe this discrepancy has a minor impact on FDVI
valuation as we are expecting the major revenue and earnings stream to start from Q3FY05.
The reported earnings were $0.01 per share meeting our estimate for Q1FY05.

We anticipate ongoing robust revenue growth in the next quarters as FDVI is actively seeking
new investment opportunities in the Company’s core business segments. We expect gross and
net margins to improve as a result of better integration of recent acquisitions, synergies and
of benefits from vertical integration.

We consider the recent failure to meet certain debt covenants as incidental. Moreover with
our forward-looking strong growth, positive operating cash flows and expected returns from
recent acquisitions, we expect FDVI will comply with imposed covenants.


Recent financial results:

      $ million      Q1FY04          Q1FY05       % chg          Our
                                                              estimates
  Revenue                   10.2         25.0         145%            26.3
  Net income                0.23         0.70         200%           0.84

  Gross margin          27.0%           19.5%     -7.5% pts         26.8%
  Net margin             2.3%            2.8%    +0.5% pts           3.2%
  EPS, $                $0.00           $0.01          n/m          $0.01




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Segment information:

                     $ million                    Q1FY04       Q1FY05     % Chg.
Total net revenues                                   10.2         25.0      145%
  Business solution segment                           2.8           4.7       65%
  Wireless infrastructure services                     1.9          2.7      45%
  Wireless infrastructure products                       -         12.0          -
  Manufacturing and distribution segment               5.5          5.7        3%

Gross margin                                         27.0%       19.5%       -7.5%
  Business solution segment                           19.7%       21.5%         2%
  Wireless infrastructure services                    21.0%      33.4%         12%
  Wireless infrastructure products                       n/a      11.6%         n/a
  Manufacturing and distribution segment              32.7%      28.0%         -5%

•    Manufacturing and Distribution Segment
Revenues for the Q1FY05 increased 3% to $5.7 million due to initiation of FDVI’s Commercial Solutions, which
began sales activity starting in February 2004. However the other two units from the segment Kingston and
Nor-Cote reported decrease in revenues by 29% and 6%, respectively; primarily due to the reduction of
customer base and loss of three large customers by Nor Cote.

The segment’s gross profit margin decreased by 4.8% pts to 28% due to lower margins of Commercial Solution
unit compared to Kingston and Nor-Cote units.


•    Wireless Infrastructure Segment (Products and Services)
Revenues for the Q1FY05 ended November 30, 2004 were $14.7 million compared to $1.9 million for Q1FY04.
The increase in revenues is mainly due to the acquisition of JH Drew on April 30, 2004.

The FDVI’s JH Drew subsidiary represents the segment's largest contributor to revenue, reporting $12.0
million in Q1FY05.

With additional capital investment by wireless carriers in the wireless communications industry, FDVI has
experienced increased revenues in its PDH, Cornerstone Wireless and Cornerstone Construction subsidiaries.
In addition to increased activity in the industry, the FDVI ‘s acquisition of ITC in May 2004 and Magtech in
November 2004, further increases the FDVI 's ability to offer turnkey services to wireless carriers.

The lower gross margins of the JH Drew and Cornerstone Construction units decreased overall margins of the
segment and company.

•    Business Solutions Segment
Revenues for the Q1FY05 increased 65% to $4.7 million, mainly due to acquisition of PSM in October 1, 2003
and only reported two months of activity for the quarter end November 30, 2003. Also PSM has increased its
customer base over the last year and opened a new office in Dayton, OH in the Q4FY04. Gross profit margin
improved by 2% pts yoy during the same period mainly due to economies of scale.




                                                    -2-
Recent Acquisitions:

•    Ink Source assets acquisition

The FDVI’s Nor-Cote subsidiary acquired certain assets and assumed certain liabilities of Ink Source. Ink
Source provides technology in Ultra Violet point of purchase (POP) inks to round out the suite of ink products
provided by Nor-Cote.

Purchased assets include goodwill, customer lists, customer deposits, proprietary property and products,
prepaid expenses, software, furniture, equipment, machinery and other intellectual property. Ink Source will
move its operations from Wisconsin to Nor-Cote's facilities in Crawfordsville, IN. Nor-Cote accepted and
assumed $239,747 of specifically identified accounts payable and bank debt. In addition to the assumed
liabilities, FDVI paid $220,000 in cash offered 400,000 restricted shares of the FDVI’s common stock valued
at the closing price of the Company's stock on the date of purchase at $0.90 and signed a non-compete
agreement with the seller and additionally.

•    Magtech Services, Inc acquisition.
In November, FDVI acquired all of the assets and certain liabilities of Magtech pursuant to an Asset Purchase
Agreement effective November 1, 2004. The acquired assets include all fixed assets, accounts receivable,
customer lists, customer agreements, trade secrets, intellectual property, sales proposals and like documents
and contracts.

FDVI accepted certain specific accounts payable and all of Sellers' rights and executory obligations under the
Assumed Contracts to be performed after the Closing Date.

In addition to the assumed liabilities, the consideration given for the acquired assets was $445,213 cash and
484,500 restricted shares of the FDVI's stock. The 484,500 shares are valued at the closing price of the FDVI's
stock on the date of purchase at $0.70 share.

High level of debt raises concern about the FDVI’s solvency

$ millions                         31-Aug-04       30-Nov-04
Cash and marketable securities            5.7             6.8
Net Working Capital                       9.2             9.3

Debt                                      22.6              23.7
Equity                                    12.8              14.4

FDVI”S sources of liquidity include $6.8 million in cash and marketable securities and various lines of credit of
$17.4 million with availability of $1.6 million at November 30, 2004. The lines of credit are secured by
substantially all assets of the FDVI and by personal guarantees of the FDVI’s stockholders.

The various debt agreements contain restrictive covenants which limit, among other things, certain mergers
and acquisitions, redemptions of common stock, and payment of dividends. In addition, the FDVI must meet
certain financial ratios and is subject to annual capital expenditure limitations. At November 30, 2004 FDVI
was not in compliance with certain covenants, however, the bank has granted a waiver of default remedies with
respect to noncompliance as of that date.

The positive operating cash flows and expected returns from recent acquisitions make us confident about FDVI
capacity to comply with imposed covenants.




                                                      -3-
Management’s Strategic Advancements

Nor-Cote unit expects to launch new products in several new markets in the current and subsequent fiscal year.
The launch of new products is driven by a significant increase in research and development.

Also, Management anticipates continued growth in the FDVI’s Wireless Infrastructure segment. This growth is
expected to create the demand for increasing investment in working capital, which may require additional debt
or equity financing.

FDVI’s unit PSM will continue to expand other services like human resource outsourcing, employment training
and testing. The business variables that FDVI works to overcome include the volatile insurance industry,
government regulations on employment, etc.

Analyst: Kipley J. Lytel, CFA, is a senior partner with money management firm Montecito Capital Management. For over
three years, Mr. Lytel served as the lead securities analyst for M.L. Stern & Company. Previously, he performed portfolio
management and analyst coverage during his employment with two hedge funds, Pacific Strategic Fund Group and DD
Capital Management. His background has been marked by his experience as a Generalist, with analyst coverage spanning
numerous industries, including: telecommunications & wireless, health care, retail, consumer products, technology,
gaming and energy (E&P). Mr. Lytel has over fifteen years of investment finance experience, with expertise in equity
valuation, credit analysis, private placements, and buy/sell recommendations. He received his Masters of Business
Administration (MBA) with Honors from the Peter F. Drucker School of Management at Claremont Graduate University,
where he also received his undergraduate Bachelors of Arts (BA) degree in Economics. Mr. Lytel is a Chartered Financial
Analyst (CFA) and an active member of the Association of Investment Management and Research (AIMR). He has
frequently served as a Senior Grader for AIMR’s CFA Examination and has been a Regional Expert for AIMR's advisory
panel on investment management.

Spelman Research Associates, ltd, is an independent fee based research, publishing and distribution firm whose contract
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in this research report reflect the analyst’s personal views about the issuer and its securities. Opinions and
recommendations contained in this report are submitted solely for advisory and information purposes and are not
intended as an offering or a solicitation to buy or sell the securities mentioned above. The analysts are responsible only to
the public and this report is not a service to the company. We received a fee of $23,500 from the company for one year’s
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