Thursday, December 22, 2011

Amerigon ( Nasdaq - ARGN ) -- Legal Entanglement Delays Merger

Amerigon (ARGN $14.50) suffered an adverse legal ruling concerning its W.E.T. acquisition.  The target company is based in Germany.  Amerigon purchased 76% of the stock in direct transactions earlier in 2011.  The remaining 24% is subject to highly regimented German securities laws.  Amerigon had hoped to follow a path that would have allowed it to force the remaining shareholders to sell, or at least give Amerigon operational control of the company.  A court ruling blocked that avenue and steered the company to a slower resolution.  Amerigon is likely to complete the deal in 2012.  But it won't be able to obtain operational control until the transaction is entirely finalized, probably late in the year.  That will prevent Amerigon from quickly integrating the two operations, which promised costs savings, R&D innovations, and cross selling opportunities.  We have reduced our 2012 earnings estimate by a dime, accordingly.  Investors are advised to wait for greater clarity before re-establishing positions.

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Friday, December 16, 2011

Boingo Wireless ( Nasdaq - WIFI ) -- In a Hot Spot

Boingo Wireless (WIFI $8.75) is a leading provider of Wi-Fi software and services that connect mobile devices to the Internet.  The company installs and manages complete "venue" systems, like in airport terminals, which are available to the public on a per diem basis.  Boingo also sells monthly subscriptions which provide access to a worldwide network of more than 400,000 hotspots.  Revenues additionally include advertising income, usually connected with venue systems.  Boingo currently operates more than 80 venue projects.  Demand for Wi-Fi systems is rising due to surging data traffic on mobile phone networks.  Wi-Fi provides a less expensive alternative in many cases.  It also simply provides access during peak periods.  Cell networks often get bogged down, particularly at concerts, sports events, transportation hubs, and shopping malls.

Venue deals are characterized by revenue sharing contracts.  Some sites provide free access as a marketing tool.  But Boingo still earns transaction fees and other payments on those deals.  Traditionally users have paid modest fees to get on a Wi-Fi network, airport terminals being the most prevalent example.  The popularity of mobile devices is causing demand to accelerate.  And Boingo has shifted its focus, accordingly.  Targets include stadiums, arenas, malls, shopping centers, and quick service restaurant chains.  International locations, which currently account for 15% of revenue, provide further opportunity.  Revenues already are climbing at a brisk pace and promise to keep rising as more locations are added and existing sites handle greater amounts of traffic.

Margins are likely to widen as recurring revenue builds up.  Revenues are poised to advance only 16% in 2011 despite a sharp improvement in venue related (wholesale) business.  Individual subscriptions have declined with the advent of less expensive cellular contracts.  But the churn rate on that segment has diminished, preventing a significant fall-off in revenue.  Still, the venue segment will drive performance over the next several years.  Boingo typically pays to install those systems and then earns a share of the revenue stream over multi-year contracts.  Those deals typically are renewed on favorable terms.  As the installed base rises profitability is likely to expand.  We estimate 2012 revenues will improve 24% to $115 million to provide a 40% increase in non-GAAP earnings to $.35 a share.

In 2-3 years revenues could reach $175 million.  Earnings could attain $.60 a share.  Boingo pays an unusually steep tax rate.  If that levy is reduced to 35% income could benefit by an additional $.05 a share.  Applying a P/E multiple of 25x suggests a target price of $15 a share, potential appreciation of 70% from the current quote.

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Thursday, December 15, 2011

Cyanotech ( Nasdaq - CYAN ) -- Catches a Wave

Cyanotech (CYAN $8.25) is a leading producer of nutriceutical products used by high performance athletes and other health conscious consumers.  The company's products are derived from algae, which is harvested from a network of growing ponds in a Hawaiian industrial park.  Cyanotech's leading product historically was Spirulina Pacifica, a dietary supplement that provides energy, cardiovascular benefits, and antioxidents that delay the aging process.  That line is a favorite of distance runners and other high endurance athletes to raise performance and enhance recovery.  A second algae based line, BioAstin, was developed more than a decade ago.  That product offers a wider range of benefits including skin, eye, and joint support and reduced inflamation, along with an even greater level of antioxidents.  Demand never gained momentum, however, due to intense competition for shelf space and the lack of a major marketing effort. 

All that changed early in 2011.  BioAstin was featured on the popular Doctor Oz television show.  The segment was repeated two additional times at 2-3 month intervals.  The claim was made that BioAstin was the #2 supplement in the world, right after Vitamin D.  Demand immediately rocketed after the television broadcasts.  And volume has continued to build.  Repeat business has been strong and new consumers continue to try the product.

Most astaxanthin (BioAstin's central ingredient) sales historically were made to bulk buyers.  Part of the output was used by salmon farmers to color the meat like wild fish.  The farmed version comes out white without the additive.  The rest was sold to bigger supplement companies that included astaxanthin in a variety of consumer offerings.  Cyanotech sold some BioAstin directly to retailers in Hawaii, including Costco.  It also landed a few accounts on the mainland, and operated a small direct sales operation.  Prior to the Doctor Oz breakthrough, though, most revenue was generated by the Spirulina Pacifica line.  Overall growth was moderate.  Profitability was okay.  But there wasn't any real excitement in the picture.

Cyanotech kept a low profile during the initial blast-off.  New management had just taken the helm.  And the company wanted to make sure the increase wouldn't be short-lived.  Demand has continued to build, alleviating those concerns.  Measures now are being implemented to capitalize on the burgeoning opportunity.  Physical capacity is being expanded by 33%.  The poor economy has enabled Cyanotech to obtain space inside its existing office park, simplifying logistics.  Productivity at existing ponds is improving, too.  And less output is being directed to bulk purchasers.  New retail distribution is being arranged instead, at higher selling prices.  An advanced processing unit is slated to go on line over the next 18 months, moreover, boosting turnaround time and margins.  A new name for BioAstin is being evaluated, as well, to lift consumer appeal.

Sales advanced 54% in the June period to $5.95 million.  Fully taxed earnings climbed 40% (excluding stock option expense) to $.07 a share. In Q2 (September) sales jumped another 56% to $5.99 million.  Earnings improved 86% to $.13 a share.  Revenues depend on the amount of algae produced.  And that volume typically declines in the winter because there is less sunlight.  In the year ago December quarter Cyanotech had inventory in reserve to keep revenues intact.  This year the shelves are bare due to the surge in demand.  So a less vibrant comparison may be in the cards.  Cyanotech also is beefing up marketing and other business development activities.  So margins also might get compressed by those additional costs.  The company has a lot of scientific talent on hand, though, so output might turn out to be better than historical metrics would suggest.  Astaxanthin prices are rising, moreover, a trend that's likely to continue and reinforce performance in future periods.

We estimate fiscal 2012 (March) earnings will finish around $.30 a share (fully taxed).  Next year $.45 a share represents a realistic target.  A variety of risks will be encountered over the long haul.  BASF and a slew of Chinese chemical producers are developing synthetic versions of astaxanthin.  The initial target is the fish farming industry.  But over time the lower cost (lower quality) competition could affect Cyanotech's consumer operations.  The industry itself is incredibly competitive and flighty.  Dietary supplements come and go all the time.  It's extremely hard to establish a recurring business, and the marketing costs to sustain demand are steep.  Spending increases that coincide with temporary demand decreases are capable of generating dramatic earnings reversals.  Weather vagaries and other logistical issues present a danger, as well.  On top of that new chairman could take over the two Congressional committees that oversee diet supplements.  Those individuals are considered less supportive of the industry, so regulatory hurdles could become more pronounced.

If Cyanotech avoids those pitfalls sales could reach $50 million in 2-3 years.  Earnings could attain $.75 a share.  Applying a P/E multiple of 20x suggests a target price of $15 a share, potential appreciation of 80% from the current quote.

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Thursday, December 8, 2011

Stratasys ( Nasdaq - SSYS ) -- Turnaround on Track

Stratasys (SSYS $29.00) is likely to produce solid on target Q4 results.  The company is the leading producer of direct digital manufacturing "printers" that take CAD-CAM designs straight from a computer and immediately make the part, without any set-up.  The technology enables customers to manufacture low volume products for the same cost as a mass produced item.  Stratasys got its start by serving the engineering market.  Development teams used the systems to make prototypes directly from computer generated designs, eliminating the need to build models from clay or in the shop.  Over the past few years the company has launched larger units aimed at manufacturing customers.  Those higher cost systems have begun to catch on and have become Stratasys's primary growth driver.  The company also sells consumables (a variety of plastics used as raw material).  Demand for those products tends to be greater in manufacturing applications than in engineering.  So that segment is accelerating, as well. 

The legacy engineering business currently is stalled due to economic factors and a dormant partnership with Hewlett-Packard.  The company originally had high hopes for its H-P relationship (which was aimed at the engineering segment) but the larger company dragged its feet, holding back performance.  Last summer Stratasys essentially threw in the towel and reinstituted its own marketing efforts in lieu of H-P.  That program is gaining momentum but probably won't make a meaningful contribution until next year.  Even so, growth in the manufacturing segment promises to keep overall performance on an upward slope in Q4.  Faster gains are possible in 2012 as the engineering unit returns to life.

Direct digital manufacturing has the potential to become a disruptive technology.  The industry remains in an early stage of development.  But profitability already is well established.  And new avenues for growth are opening up.  Stratasys has several new products in the pipeline.  Enhancements are likely to include larger capacities, faster throughput, lower costs, and a wider range of material inputs.  Streamlined user interfaces promise to broaden the market further.  A series of inflection points could be reached through the rest of the decade, enabling Stratasys to dislodge entrenched manufacturing techniques in a wide range of applications. 

We estimate 2011 income will rise 22% to $1.00 a share.  Next year profitability might be impacted by the shift away from H-P to the company's own marketing efforts.  Economic factors are likely to weigh on performance, as well.  Nonetheless a 15%-20% advance to $1.15-$1.20 a share represents a realistic target.  Growth promises to accelerate beyond as the economy recovers and the internal marketing program builds momentum.  In 2-3 years earnings could approach $2.00 a share. 

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Thursday, December 1, 2011

Simulations Plus ( Nasdaq - SLP ) -- Sheds Non-Core Business

Simulations Plus (SLP $3.00) reported unexceptional Q4 (August) results.  Performance was impacted by the non core Words Plus text to speech line.  The company sold off that operation on November 30th, the final day of Q1 2012.  Combined non-GAAP earnings (excluding stock option expense) slipped 50% in the August period to $.01 a share.  Sales were down, as well, by 4% to $2.12 million.  The high potential pharmaceutical simulation software line posted a 7% revenue gain in the August quarter.  The year earlier period included a non-recurring project fee ($350,000) which skewed the comparison.  Excluding that software revenues advanced 40%. 

Margins promise to expand in the upcoming year.  Simulations Plus is the leading provider of simulation tools used by drug developers to identify promising molecules.  The technology speeds up time to market by narrowing down the search so laboratory testing and clinical trials can focus on the highest potential candidates.  The discontinued Words Plus operation produced about 25% of total sales but was lucky to break even.  Without that drag non-GAAP profitability is poised to soar into the 45%-50% area (pretax).

Organic growth of 15% or more is likely to be maintained.  Simulations Plus sells its software on an annual subscription basis.  The renewal rate was 93% in fiscal 2011 (August) and historically has been above 90%.  New customers accounted for 22% of software sales.  That trend is likely to continue as additional divisions of large drug companies adopt the technology, existing users purchase additional modules, and smaller biotech and academic users come on board. 

Only a small portion of the potential market has been penetrated to date.  Organic growth could accelerate as the technology's productivity benefits become more widely known.  Faster computers, greater reliance on parallel processing, and easier to use interfaces could reinforce growth.  Near term hurdles are the poor economy, which is having an effect on drug company profits; and the growth in regulatory uncertainty.

We estimate non-GAAP income will advance 22% in fiscal 2012 (August) to $.22 a share.  Sales could advance 15% to $10 million, excluding the discontinued Words Plus operation.  Cash flow continues to build.  In the year just ended Simulations spent $2.0 million to repurchase stock.  The company also is investigating potential acquisitions.  Several targets are believed to be in the company's sights.  Past negotiations have stalled due to valuation concerns.  The current environment might bring prices more into line.  Simulations Plus has a great platform that it could leverage with additional niche products.  Growth could accelerate with an effective transaction or two.

In 2-3 years non-GAAP earnings could reach $.30 a share.  Applying a P/E multiple of 20x suggests a target price of $6.00 a share, potential appreciation of 100% from the current quote.  Faster gains are possible if the technology gains wider adoption.  Acquisitions could yield further leverage. 

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Friday, November 18, 2011

Acacia Research ( Nasdaq - ACTG ) -- Market Leader Reinforces Position

Acacia Research (ACTG $32.75) appears on track to produce excellent Q4 results.  Acacia is the leading provider of intellectual property monetization services.  The company teams up with inventors and other patent holders to enforce their IP rights against infringing companies.  Outside legal firms are hired on a contingency basis and typically collect 15%-20% of the winnings.  Acacia and its partners divide the remainder.  Each deal is unique but the company normally keeps a little more than half of the balance.  Over the years Acacia has acquired a patent portfolio of its own.  In those situations it retains 100% of the settlement, less what it paid to outside counsel.  Targets generally are large companies that don't have time to conduct extensive patent searches when developing new products.  Before Acacia came along small inventors often were stymied by expensive and time consuming legal maneuvering.  Acacia provided the deep pockets to withstand those delays.  Over the years the company's partner list has expanded to the point where it now licenses more than 200 patent portfolios encompassing hundreds of thousands of individual patents.  That's expanded the number of companies it can sue.  It also has made it possible to sue many companies for multiple infringements, boosting its average award size.

In 2010 Acacia agreed to "structured settlements" with Oracle and Microsoft.  Those deals provided those giants with licenses to all of the patents under Acacia's control, plus all the new ones it would bring in, for a three year period.  Oracle paid $25 million; Microsoft, $40 million.  In Q1 Samsung paid the company $45 million under a similar arrangement.  A portion of that money was paid to the company's partners.  Even so, earnings jumped dramatically in each of the quarters those deals were signed.  Patent values have escalated in 2011, fueled by several major transfers in the smart phone space.  That surge has made it more difficult for Acacia to reach agreements on additional structured settlements.  Infringing companies have been waiting for the dust to settle before committing such large amounts of capital. 

The rise in patent values also has prompted many corporations to figure out ways of monetizing their own patent portfolios.  Acacia is negotiating with several companies, including the three it already made structured deals with, to license large swaths of their patent portfolios.  The arrangement could offset some or all of the money they're paying in infringement cases.  It also will hide the originating company's identity when prosecuting those rights, allowing it to do keep doing business without acrimony.  Judicial pressure might be mitigated, as well.  Acacia probably won't be accused of anti-competitive behavior. 

The lull in signing new structured deals has caused the stock price to retreat over the past few months.  Those transactions provide immediate earnings boosts which investors thrive on.  Income from stand alone settlements has been advancing sharply over the past two quarters, though.  And Q4 comparisons should be positive even if no structured deals are consummated.  Our estimates assume that scenario.  They are unchanged.  Acacia indicates it is continuing to pursue structured transactions.  It also is bringing in rafts of new patents which might take 1-2 years to prepare, but promise to bolster income growth in the future.  The company additionally is looking to buy key patents in partnership with major companies, giving them a license and then suing everyone else.  That might keep the partner off the judicial radar screen.  Earnings could follow a number of paths to sharply higher levels over the next several years.  Our 2-3 year target price is unchanged at $100 a share.

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Tuesday, November 8, 2011

Amerigon ( Nasdaq - ARGN ) -- Achtung Baby !

Amerigon (ARGN $15.00) reported excellent on target Q3 results.  Performance was slightly ahead of our estimate due to good European sales by the recently acquired W.E.T. business, and a somewhat lower tax rate.  That stemmed from Amerigon's entry into the European market, as well.  Amerigon is the leading provider of automobile seats that can be both heated and cooled.  The company employs a patented technology that allows passengers to dial up whatever seat temperature they want.  Competitors can heat seats as well as Amerigon does.  But nobody else can deliver air conditioned comfort.  Alternative seat cooling systems recycle ambient ("ventilated") air.  Over the past few years Amerigon has extended its technology to cup holders which actively cool or keep drinks warm.  It also has a deal with a bed manufacturer. 

Earlier in 2011 the company commenced a two stage acquisition of a major German manufacturer of heated seats.  That transaction also brought some related product lines, like heated steering wheels.  Amerigon bought 76% of W.E.T.'s shares in the first go around.  It now is going to court in Germany to force the holdouts to sell the rest.  Once the transaction is complete the two companies' operations will be integrated.  That could boost pretax margins by 1%-2% directly.  Product development and cross marketing opportunities could yield additional leverage. 

Q3 performance was solid despite the fact W.E.T. had to be run as a completely separate company.  New auto platforms continued to be added.  Costs were kept under control.  And sales to existing customers remained vibrant in spite of the weakening European economy.  Earnings (excluding stock option and acquisition related costs) advanced 55% to $.17 a share after deducting W.E.T.'s minority ownership's share.  Revenues reached $125.7 million.  Factoring out the acquisition's contribution, Amerigon's sales advanced 15% to $35 million.  (The company redirected $4.5 million of that to W.E.T.'s production facilities.)  Fourth quarter results usually dip sequentially due to seasonal factors.  Still, we are raising our full year sales estimate by $5 million to $360 million.  We also have lifted our earnings estimate by a nickel to $.55 a share.

Margins should widen in 2012 if the remaining W.E.T. shares are bought in.  Earnings also will benefit from a full year of the combined company's sales.  We estimate they'll reach $500 million to provide earnings of $.90 a share.  (See "Accounting Notes.")  Organic revenue growth of 15% appears sustainable over the long haul.  Earnings could rise more rapidly if margins keep widening.  Cash flow probably will be applied to repaying debt incurred to make the acquisition. 

Development of another high potential product is in the pipeline.  Amerigon has been working for years on a system that captures waste heat and recycles it into electricity.  It recently began testing a redesigned system on Ford and BMW vehicles in conjunction with the U.S. Department of Energy.  The previous generation produced 700 watts of output.  The new less cumbersome version delivers similar power but is being streamlined to fit into standard engine blocks.  Fuel efficiency could improve by 2-3 mpg.  If the project succeeds gigantic sales could develop in the auto industry directly.  The technology also offers huge potential in a range of other industrial applications.

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Sunday, November 6, 2011

Ansys ( Nasdaq - ANSS ) -- Gains Momentum in Q3

Ansys (ANSS $58.00) reported excellent on target Q3 results.  Non-GAAP earnings (excluding non cash stock option and acquired intangible expenses) advanced 29% to $.66 a share.  Revenues climbed 27% to $177.9 million.  Ansys completed its purchase of Apache in August.  That unit was consolidated for two months.  Excluding that contribution organic growth was 20% year to year.  Apache is a leading provider of engineering silulation software for power management applications, like smart phones and tablet computers.  Its revenues are virtually all derived from annual subscription licenses.  That pricing scheme has become more popular among Ansys's other product lines, too.  Recurring revenues amounted to 70% of the total in Q3.  The renewal rate topped 95%.  A substantial though undisclosed amount of revenue was generated by existing customers that expanded their relationship with the company.  Ansys already has penetrated most of the Fortune 100.  But it still has plenty of opportunity to expand by selling its software to additional business units.

Ansys said backlog remained robust despite the questionable economy.  Fourth quarter performance is likely to be excellent, fueled by the Apache transaction and a growing proportion of recurring revenues.  Demand is continuing to rise in huge industries including automobile manufacturing, electronics, and energy production.  Geographic strength is stable, as well.  Demand for engineering simulation technology is poised to keep growing well into the decade.  Competition is compelling companies to invent products with original features, lower costs, and greater reliability.  It also is exerting pressure on turnaround time.  The software itself is improving with the help of academic research and internal efforts.  A bigger factor, though, is the ongoing improvement in parallel processing.  Strings of high power computers now work together on extremely complex problems, sharing intermediate solutions as they go along, and also updating common databases.  Instead of working through problems in a linear manner it's become increasingly feasible to break them down into separate parts and arrive at "go -no go" decision points more rapidly.  Ansys also has improved user interfaces so problems can be set up quicker and more accurately. 

The trend away from physical testing to computer simulation is likely to continue.  Ansys faces competition in several niche markets.  But the company is unrivaled in its overall breadth.  Small users may select a competitor for particular applications.  Large companies with more extensive requirements probably will continue to standardize on Ansys.

Solid gains are likely in 2012.  We estimate sales will increase 19% to $825 million.  Earnings could rise 14% to $2.90 a share.  Our outlook assumes a relatively dismal economic scenario.  Margins probably will finish higher if the environment is livelier.  Order growth could moderate if conditions weaken.  But a solid performance is anticipated nonetheless.  Ansys's customer base is likely to emphasize simulation if their own businesses soften, as a tool for enhancing profitability and market share.  They also will have the money to pay.  Longer term, internally generated growth of 10%-20% appears sustainable.  Ansys throws off substantial amounts of cash flow which should enable it to make further acquisitions without dilution.

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Pros Holdings ( NYSE - PRO ) -- Pricing Software Leader Accelerates Growth

Pros Holdings (PRO $16.25) reported excellent on target Q3 results.  Earnings (excluding non cash stock option expense) advanced 83% to $.11 a share.  Sales climbed 34% to $25.2 million.  The company still sells its software exclusively on a perpetual license basis.  The target market at this point remains large Fortune 500 type customers, with a particular emphasis on international airlines and other customers with a high number of variable pricing transactions.  Most U.S. airlines operate their own internally developed pricing schemes.  Initial selling prices approach $1.0 million and sometimes expand from there as customers extend the technology to additional business units.  Maintenance contracts, which provide the latest software updates when they become available, are 15%-20% of the current selling price.  In the September period more than 95% of the maintenance contracts that came up for renewal were continued.  Incoming orders demonstrated greater end market diversification.  More industries are adopting pricing (revenue management) software to enhance profitability in a slow growth environment.  Pros already is the industry leader and appears to be lenghtening its advantage by boosting R&D and marketing.  The company is developing specialized applications for niche markets.  It also has boosted the sales force by 50% this year.

Momentum is likely to continue in Q4.  We estimate full year earnings will rise 40% to $.35 a share.  Revenues appear headed for the $96 million mark (+29%).  Pros is rolling the dice a bit with respect to 2012.  The company does have several large companies nipping at its heels in the pricing space, including Oracle and Accenture.  Those behemoths are validating the technology among a far greater customer base than Pros addressed in the past.  So the company plans to keep spending at an elevated level next year to retain its competitive lead and capture a lot of new business.  All that spending is likely to prevent margins from expanding, however.  Pros also is launching a cloud based computing service aimed at smaller mid-market customers in 2012.  That initiative is likely to crimp profitability further.  Gross margins on incremental sales remain unusually high, so Pros will have plenty of latitude to work with.  Despite the escalated spending plan our estimates reflect a modest improvement in 2012 pretax margins.  If economic conditions contract in any serious manner, though, the leverage process could shift into reverse.  With the P/E multiple already at a steep valuation the stock could be a volatile performer if economic conditions deteriorate.

We estimate 2012 sales will improve 20%-30% to $115-$125 million.  Earnings could end up in the $.40-$.50 a share range.  The long term outlook remains bright.  Economic growth in Japan, the United States, and Europe is likely to remain muted for several years.  But corporate income promises to stay robust.  So companies will have an incentive to apply pricing technology to their relatively slow growing operations.  And they'll have the cash to pay for it.  Penetration of the mid-market segment promises additional leverage.  Sales to emerging markets promise to reinforce the long term trend.

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Thursday, November 3, 2011

Convio ( Nasdaq - CNVO ) -- Adoption Rate Grows Among Non-Profits

Convio (CNVO $9.25) reported excellent on target Q3 results.  Earnings (fully taxed) were flat year to year at $.08 a share.  Revenues improved 18% to $21.0 million.  Margins were affected by the cost associated with rolling out the high potential Luminate product line.  Efforts to move mid-size customers to a cloud computing format also impacted short term profitability.  Both of those programs are likely to bolster margins in future periods as recurring revenue expands.  Convio's computer based donation management technology is gaining market share among non-profit organizations.  The system coordinates all activities so donor activity can be monitored more efficiently.  Historically, charities have maintained separate databases for mailings, telemarketing, events, and other activities; making it difficult to quickly assemble a complete picture of each donor's involvement.  The better analytics also help non-profits target new solicitations more effectively.

Performance is being impacted by the weak economy.  Convio earns a piece of the donations it raises in addition to the money it makes on software sales and service.  The company is gaining a larger portion of its existing customers' money raising activities.  It's also adding more clients.  But overall donation volume is stalled due to economic factors.  Still, organic growth of 10%-15% appears sustainable in the current climate.  Two small acquisitions completed earlier in the year are providing an additional 5% revenue boost.  Changes to the tax code by the "Super Committee" theoretically could impact giving over the long haul.  Liberal members have proposed deductibility limits to divert money from non profits to government welfare agencies.  President Obama is believed to favor that approach.  Change seems unlikely but if the current policy was altered investment risk would elevate.

We estimate 2012 income (fully taxed) will advance 60% to $.40 a share.  Revenues are poised to expand 15%-20% to $92-$96 million.  Our estimate assumes the low end of the range.  International expansion promises to reinforce growth over the long haul.  A rebound in the U.S. economy could reinvigorate donation volume, providing further leverage.  In 2-3 years sales could reach $150 million to provide earnings of $1.00 a share.  Applying a P/E multiple of 20x suggests a target price of $20 a share, potential appreciation of 115% from the current quote.

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Wednesday, November 2, 2011

Ellie Mae ( Nasdaq - ELLI ) -- Let's Rewrite Those Mortgages

Ellie Mae (ELLI $5.25) reported excellent on target Q3 results.  Performance was affected by the acquisition of the company's largest competitor during the quarter.  Ellie Mae had to foot the bill for the new company's operating expenses.  But FASB accounting rules prevented it from recognizing the subscription income the company brought to the table.  The official accounting rules viewed that as a reduction in the selling price.  So revenues associated with the new business essentially were zero in Q3 while the corresponding expense came in at $1.2 million.  Earnings were understated by $.04 a share as a result.  Ellie Mae netted $.05 a share (fully taxed) in the period, nonetheless.  That was achieved despite the fact U.S. mortgage originations declined 20% year to year to a generational low.  Revenues from the company's pre-merger business advanced 23% to $14.7 million.  That figure was diminished, too, by Ellie Mae's ongoing program to convert customers from perpetual software licenses to a per-mortgage fee structure.  Upfront revenue is substantially higher on license sales.  That makes the deal attractive to banks in the current climate.  But income potential to Ellie Mae is greater over the long haul as the recurring revenue stream builds up.  An even greater windfall could develop if the mortgage market returns to a normal level of activity.

The HARP program could provide a lift in 2012.  That's the scheme the Obama Administration recently unveiled to help underwater borrowers refinance at today's lower rates.  Industry experts predict the new rules could generate 1.0 million successful mortgage refinancings over the next two years.  Currently, 50% of the market is controlled by approximately 20 giant banks.  Ellie Mae doesn't participate in that segment.  Those institutions use their own automation software.  With its recent acquisition the company has taken over about 60% of the remainder, though.  So an extra 300,000 deals could go the company's way between now and the end of 2013.  In theory, that could amplify revenues by $20-$30 million a year.

Assuming flat mortgage origination activity, we estimate 2012 revenues will advance nearly 40% to $70 million.  Approximately two-thirds of that is expected to be generated by the recently acquisition.  The balance could come from greater use by existing customers, and the addition of more revenue generating services per mortgage.  Margins are nearly certain to improve as the revenue from the acquired company starts to be reported, not just the expenses.  Some genuine operating leverage is possible, as well.  We estimate fully taxed earnings will advance more than 100% to $.25 a share.  A stronger showing is possible if the HARP program delivers a boost or the overall housing industry picks up.

We think the housing industry will improve in 2012.  Most economists have predicted rebounds in each of the past three years.  They now forecast further malaise.  That is the trend, so they might prove to be correct.  But American households have de-leveraged over the past few years.  Debt to income ratios are down.  There's tremendous pent-up demand to move for personal, business, or retirement reasons.  And the foreclosure overhang is winding down.  House prices probably won't surge.  But real estate activity has the potential to move sharply higher.  Each new mortgage is an opportunity for Ellie Mae.  The company already is well positioned to perform well under depressed conditions.  Income could fly if volume picks up.

In 2-3 years earnings could reach $.75-$1.00 a share.  Applying a P/E multiple of 20x to the low end of the range suggests a target price of $15 a share, potential appreciation of 185% from the current quote.

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Friday, October 28, 2011

Carbo Ceramics ( NYSE - CRR ) -- Shrugs Off Competitive Threat

Carbo Ceramics (CRR $140) reported excellent on target Q3 results.  Sales advanced 41% to $167.1 million.  Earnings climbed 81% to $1.61 a share (excluding stock option expense).  Carbo is one of the two leading manufacturers of ceramic proppant used by oil and gas producers in shale production.  The tiny spheres are inserted into the rock after it's been fractured to let the oil or gas flow to the surface.  Most wells are drilled horizontally and typically are 10x longer than straight up and down wells.  So more material is required.  The proppant is injected into the well with a mixture of water and a jello like material.  The water drives it in.  The jello keeps it in place until everything settles.  Then it disolves.  Since the proppants are round plenty of area remains for the oil or gas to flow back up the well bore. 

Most wells are 8,000 feet or more below the surface, far below the water table.  Occasionally natural gas escapes towards the surface during the fracturing process.  When that happens it can mix into the water supply.  Technically speaking the jello material is made from chemicals, though it isn't much different than actual Jell-O.  That gets loose once in a while, too.  The Environmental Protection Agency has moved aggressively against those contamination issues, blocking natural gas development in large sections of the country.  The EPA additionally has blocked Carbo from building new production facilities in some areas.  For all the hoopla the amount of actual damage is negligible in relation to the volume of energy produced.  So while expensive remediation efforts might be required the industry appears likely to keep growing at a brisk pace well into the future.

Growth is accelerating in the oil shale segment.  Carbo got its start in shale gas.  Its ceramic proppants worked better than conventional sand at keeping those new age wells open.  Sand continues to be used in straightfoward applications because it's less expensive.  But operators increasingly are switching to manufactured proppants to maximize the flow rate.  In the shale oil segment, that conductivity advantage is even more pronounced.  Drilling activity is surging because the market price of petroleum is 5x greater than natural gas on a Btu equivalent basis.  The potential profit is much greater.  In 2011 an estimated 32,500 oil wells will be drilled in the U.S., up 75% from the year before.  The entire increase is coming from the shale oil segment.  Natural gas wells are seen coming in at 19,500, up 5%.  At this point Carbo is sold out and can't keep up with demand.  New capacity is being brought on line, the EPA notwithstanding.  But the tight supply situation has caused drillers to seek alternative sources.  The resulting advent of new competitors has created some question marks about Carbo's long term outlook.

Saint Gobain, the other leading producer of ceramic proppant, is expanding capacity.  More ominous is a build-up in Chinese production.  The Chinese have entered the market with lower quality products but they've offered lower prices, as well.  The surge in industry demand has allowed Carbo to maintain margins and keep expanding to date.  And that trend could continue if the international market begins to adopt shale drilling.  For now the technology remains a North American specialty.  At some point the number of drilling rigs could max out, or energy prices might skid and cause some rigs to go out of service.  If proppant capacity keeps jumping an oversupply situation could develop.

Today, performance remains vibrant.  We have lifted our 2011 earnings estimate by $.15 a share to $5.65 a share.  A stronger showing is possible if the customary Q4 industry slowdown fails to develop.  Next year $6.60 a share (+17%) is a realistic target, in light of the economy and the Administration's efforts to promote green energy at the expense of fossil fuels.  New manufacturing capacity is in the pipeline.  If prices and margins aren't disrupted earnings could keep advancing at a 20%-30% rate well into the decade.

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Thursday, October 27, 2011

Stratasys ( Nasdaq - SSYS ) -- New Products Fuel Surprising Q3

Stratasys (SSYS $30.00) reported better than expected Q3 results.  Earnings surged 81% to $.29 a share.  That figure excludes a loss of $.02 a share on the sale of an investment security.  Revenues climbed 31% to $39.7 million.  Stratasys is the leading producer of direct digital manufacturing printers that take CAD-CAM designs straight from a computer and make the part directly without any set-up.  The systems create their own molds on the fly and apply layer after layer of various plastics to create a finished product.  The machines come in a wide range of sizes and performance levels.  Low cost U-print and 3D printers typically are used by engineers to create prototypes.  Larger Fortis machines are employed in everyday manufacturing situations.

A joint venture with Hewlett Packard went haywire last year.  Stratasys signed up H-P to distribute its lower cost systems to the engineering market, where it already had a strong presence with blueprints, plotters, and an assortment of related products.  H-P has fiddled around with the technology in five small European countries to date.  Stratasys was hoping it would expand its efforts worldwide.  The hiatus in expanding the market caused sales of the less expensive machines to stall in 2011.  Fortunately, Stratasys maintained control over marketing its Fortis line for manufacturing applications.  Those sales are soaring.

A lower cost manufacturing machine achieved widespread penetration in Q3.  Stratasys also enjoyed rising sales of its consumables, particularly among its manufacturing customers.  A service business the company operates posted solid gains, as well.  A high end Fortis machine was introduced this year, moreover.  That unit is providing further momentum.

The near term outlook is unclear.  Stratasys obviously produced superior financial results in Q3.  But costs are expected to rise significantly in Q4 as marketing efforts ramp up to fill in the gap left by H-P.  Sales commission accelerators are likely to lift expenses, too.  We are raising our 2011 earnings estimate ($1.00 a share) by a dime to reflect the powerful Q3 showing.  But a large sequential improvement appears unlikely.

Margins may continue to be constrained in 2012.  Still, a 15% earnings gain to $1.15 a share appears achievable.  One of the company's few competitors, 3D Systems, recently announced lower than expected Q3 results.  So the overall climate may not be as robust as Stratasys' numbers might suggest on the surface.  The long term outlook remains bright, though.  The share price appears a little elevated at current levels.  If Q4 results stall a lower entry point might become available.

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Tuesday, October 25, 2011

Healthstream ( Nasdaq - HSTM ) -- Plenty of Operating Room

Healthstream (HSTM $14.00) reported excellent on target Q3 results.  Non-GAAP earnings (fully taxed) advanced 80% to $.09 a share.  The company netted an additional $.03 a share in tax benefits.  Revenues improved 24% to $20.6 million.  Performance dipped slightly on a sequential basis due to summer related seasonal factors.  Healthstream is the leading provider of e-learning solutions to the health care industry, serving more than 2.5 million workers with a recurring SAAS ("software as a service") delivery format.  The company's Internet platform enables third party content providers to sell state of the art instructional material to both medical and administrative employees in a more convenient and productive manner than traditional CD-based and classroom approaches.  Healthstream books the revenue and pays royalties to the authors.  The company also provides research surveys and other data services, representing about 33% of revenues.  Most of that business is performed on a subscription basis, too. 

A joint venture with industry giant Laerdal Medical is advancing the technology into the simulation area.  Laerdal is the leading producer of medical mannequins.  The two companies have teamed up to computerize those models so health workers can practice their skills and receive immediate feedback on how well they're doing.  Currently, a teacher usually has to supervise the performance.  The core e-learning business is growing due to market share gains, the addition of more content per subscriber, and continued growth in the market's overall size.  The simulation segment is just getting off the ground but promises to deliver substantial leverage in upcoming years.  Expansion into international markets has been modest to date but the combination with Norway-based Laerdal could provide a sizable boost in that direction, as well.

Mobile applications are slated for introduction in Q4.  That technology will enable users to obtain content on phones and tablets, in addition to personal computers and notebooks.  The mobile links also may facilitate access to databases for everyday reference, moreover, besides just studying.  Additional simulation components will be launched over the next two quarters.  Healthstream also recently gained exclusive access to several high potential accreditation programs.  Those packages will be available only through the company's e-learning platform.  Revenues should benefit directly from the captive audience.  Being the sole source for that material also could attract new customers to Healthstream's other offerings.

We estimate 2011 income will finish in the $.35-$.37 a share range.  (See "Accounting Notes.")  Hiring is slated to accelerate in Q4 to prepare for a major expansion next year.  So margins may not widen in the period despite further sales gains.  Next year $.45-$.50 a share remains a realistic target.  Faster gains are possible in subsequent years as margins continue to improve, international markets are exploited, and the simulation line becomes a bigger factor.  Periodic bursts could amplify results.  In 2013, for instance, new hospital billing procedures are scheduled to take effect as a result of the national health insurance law.  Healthstream will distribute a series of courses designed to train administrative personnel in the revised scheme.

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Friday, October 21, 2011

Acacia Research ( Nsadq - ACTG ) -- Outlook Keeps Improving

Acacia Research (ACTG $38.00) reported excellent on target Q3 results. The company didn't sign any structured deals in the period.  In the year ago quarter it concluded at $40 million transaction with Microsoft.  So while Acacia earned some large settlements in the period its revenue was produced entirely from regular business.  Revenues declined 21% to $50.6 million.  Excluding the Microsoft deal, though, they were up 111%.  Reported earnings (fully taxed) were down, as well, at $.24 a share.  But that was a record for any quarter in which Acacia didn't sign a structured transaction.

We originally set our $1.10 a share full year earnings estimate based on the assumption three structured deals would be completed this year.  Acacia did complete one deal in Q1 with Samsung for $45 million.  But that's been it to date.  Our estimate is unchanged but now assumes no further structured deals.  The potential value of any such transaction has increased dramatically due to the addition of more high value patents to the company's portfolio.  So if a transaction or two are consummated in Q4 a substantially stronger showing is possible.

New partners are signing up at an accelerating pace.  Acacia teams up with patent owners to enforce those rights more efficiently than the owners can do it themselves.  Activity is rising because more large corporations are trying to monetize their R&D efforts.  Those companies also are trying to offset payments they have to make.  It normally takes two years to fully prepare a new patent portfolio for commercialization.  So much of the intellectual property now flowing into the company won't turn into revenue until 2013 or even later.  But Acacia already has been bulking up over the past few years and now controls 192 portfolios, 70 of which still haven't even begun to earn anything.  The upward progression is likely to be maintained well into the decade.

We estimate income will advance 27% in 2012 to $1.40 a share (fully taxed).  A stronger showing is possible if the company realizes it's implied target of signing four structured agreements.  In 2-3 years income could top $2.50 a share and keep rising at a superior rate beyond.

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Data I/O ( Nasdaq - DAIO ) -- Economy Hinders New Product Acceptance

Data I/O (DAIO $4.50) reported lower than expected Q3 results.  The company launched its next generation hardware line in the period.  Data I/O is the leading provider of semiconductor programming systems.  The machines take blank semiconductors produced in large volumes by companies like Texas Instruments and loads them up with specific applications.  One batch might be programmed to control a Camaro's brakes; the next could be for a Cadillac.  Data I/O also introduced a series of software products that provide new features, particularly in the inventory control and security areas.  The company had hoped to sell those software packages to its installed base, in addition to including them on new machines. 

Slowing sales of semiconductors around the world impacted demand.  Most of the company's customers are independent middle men that customize chips for a wide range of end users.  Data I/O's new systems offered those customers the ability to boost throughput and provide more value added functionality.  The downturn in economic conditions encouraged Data I/O's customers to stick with the tried and true, however, slowing the sales cycle and adoption rate.  Start up costs should decline in upcoming quarters.  So earnings are likely to improve over the unusually low Q3 level.  But a major acceleration in 2012 appears less likely than before.

Earnings (fully taxed) fell 71% to $.02 a share in the September quarter.  Sales improved 7% to $7.05 million.  Even with an expansion in profit margins in Q4 we've reduced our fully estimate by 33% to $.20 a share.  Next year a gain to $.35 a share appears attainable.  We estimate next year's sales will climb 14% from $29 million to $33 million.  Data I/O is a well financed company with an industry leading market share.  Downside risk is limited as a result.  Value investors realistically can maintain positions with an eye towards an industry recovery over the next 2-3 years.  Aggressive investors are advised to close out positions and reinvest the proceeds in a Special Situation with more dynamic growth prospects.

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Thursday, October 13, 2011

Ellie Mae ( Amex - ELLI ) -- Automating the Mortgage Industry

Ellie Mae (ELLI $5.00) is the leading provider of software used by lenders to automate the mortgage origination process.  The company provides a wide range of products and services that enable lenders to enhance productivity, reduce costs, comply with regulatory requirements, improve accuracy, and connect directly with various funding sources and investment outlets.  Ellie Mae is the industry's largest independent software provider.  About 50% of all new mortgages written in the U.S. currently are produced by 20 mega-banks.  Those giants handle their technology needs internally.  The rest of the market is served by smaller banks and a host of mortgage brokers.  Ellie Mae focuses mainly on the banking segment (90% of sales), which has been gaining market share at the expense of mortgage brokers (10% of sales) since 2007.  They now generate 39% of all mortgages written, compared to 11% for brokers.  Total industry volume remains depressed, of course, so many banks have reduced personnel over the last three years despite their relatively better performance.  Demand for Ellie Mae's software has climbed as result as customers replace labor with technology to boost productivity.

A recent acquisition cemented Ellie Mae's industry leading position.  In mid-August the company purchased Del Mar Datatrac for $17.2 million in cash, plus $8.0 million in contingent payments.  Before the transaction Ellie Mae's technology was being used to originate 20% of all U.S. residential mortgages.  That figure is expected to reach 30% with the Del Mar acquisition.  Since the mega-banks account for half the total market Ellie Mae actually now holds 60% of its addressable market.  Reported earnings will be impacted by the combination over the next two quarters because GAAP accounting rules prevent the recognition of deferred revenue by an acquiring company.  Ellie Mae will be responsible for the associated cost of fulfilling the backlog, though, putting the squeeze on margins.  Once that obligation is worked off margins should revert to normal, then benefit from economies of scale.

A shift in pricing strategy is restraining near term profitability, as well.  Until two years ago Ellie Mae licensed its software at a fairly high upfront price, and earned additional income from software upgrades and  a variety of transaction fees.  Following the real estate crash the company switched to a success based model ("software as a service") where customers pay each time a mortgage closes, the exact amount depending on how much software is used.  Last year 29% of its customers employed the SAAS model.  By Q2 that figure had risen to 42%.  Within 2-3 years Ellie Mae hopes to convert 90% or more to that transaction based approach.  The reduction in upfront licensing fees is affecting short term profits.  But long term income will benefit from the enhanced recurring revenue stream.

Superior growth is likely even if the housing industry remains depressed.  Only 1% of all loans presently are produced 100% electronically.  Revenue per loan promises to expand as more elements are computerized.  Costs to the originating mortgage banks are likely to decline as a result of that greater productivity, even as the revenue to Ellie Mae expands.  Direct competition is scant, following the Del Mar purchase.  R&D spending is being maintained at elevated levels (25% of sales, enabling the company to enhance its competitive advantage while broadening its revenue potential. 

Mortgage activity could triple from current levels if it returns to the long term trend line.  Mainstream economists have predicted a housing market recovery in each of the last three years.  Now they've thrown in the towel, predicting further malaise in 2012.  Two factors make that unlikely.  First, there is a tremendous pent-up demand to move for job-related and retirement purposes.  After three years of price declines and foreclosures the market now has cleared in many parts of the country, making those moves possible at last.  And second, it's virtually certain the Federal Government will enact legislation allowing homeowners who are current on their loans to refinance at today's lower rates, even though they technically don't qualify due to income or collateral reasons.  A mammoth surge in mortgage activity could rise from the ashes next year and continue to climb well into the decade.

Any pick-up will reinforce demand among lenders.  Most already have cut staff to the bone.  Even servicing today's low level of activity is a strain without computer assistance.  Once the surge begins the rush to automate is virtually certain to accelerate.  With 60% of the market and the best technology available Ellie Mae is likely to be the prime beneficiary.

We estimate 2011 sales will advance a modest 16% to $50 million.  The Del Mar acquisition is likely to contribute little to the top line due to the backlog accounting rules.  Income may in fact decline 23% to $.10 a share (see "Accounting Notes") due to acquisition related costs, elevated R&D spending, stepped up marketing efforts, and 22% more shares outstanding.  The company went public in April, issuing 5.0 million shares at $6.00 apiece.  We estimate revenues will advance 40% in 2012 as the Del Mar acquisition kicks in, margins improve, and further market share gains are realized.  A stronger performance is possible if the mortgage market generally improves.  Our estimates assume a flat comparison with 2011.

In 2-3 years revenues could attain $125-$150 million as the industry rebounds.  Income could reach $.75-$1.00 a share as recurring revenue builds, revenue per loan expands, and R&D costs fall as a percentage of sales.  Applying a P/E of 20x to the low end of the range suggests a target price of $15 a share, potential appreciation of 200%.

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Thursday, October 6, 2011

Pros Holdings ( NYSE - PRO ) -- The Price is Right

Pros Holdings (PRO $14.00) is the leading provider of pricing and margin optimization software.  The company's systems combine huge databases with advanced mathematics to help large enterprise customers manage complex product lines.  The technology takes a wide range of inputs into account to set prices dynamically.  In the past many companies could handle pricing decisions without significant computer analysis.  The advent of worldwide competition, commodity price swings, floating exchange rates, and a host of other factors have made those decisions increasingly difficult.  Pros' scientific approach enables its customers to keep pace in a fast changing world so they can better maximize their return on sales.

The company got its start in the airline industry.  That area continues to be its largest segment.  All of the major American carriers have their own pricing systems and are likely to stay beyond Pros' reach.  But the company has been very successful with Far East carriers.  It also handles pricing for several smaller American and European carriers.  Several years ago Pros diversified into the manufacturing, distribution, and leisure industries.  Industrial customers tend to use simpler versions of the company's technology, although their return on investment in Pros' software tends to be at least as high as more transaction oriented users.  At this point the average selling price is in the $2.0 million vicinity.  Pros generates recurring revenue by selling more products to existing customers and by collecting annual maintenance fees which average 20% of the current price.

Margins were crushed during the 2008 recession.  New business dried up.  Add-on sales were scaled down.  But Pros decided to keep moving forward to improve its competitive advantage.  Growth in spending on R&D and sales personnel was maintained at the long term trend line.  Prior to the crash pretax margins were in the 25% range.  Last year they were about half that level.  Now that sales have perked up they are beginning to expand again.

Sales advanced 34% in the June quarter to $23.8 million.  Pros front loaded its sales force expansion this year so costs jumped as well in the period.  Even so, income improved by 80% to $.09 a share.  (See "Accounting Notes.")  International customers represent 60% of sales, so the recent downturn in worldwide economic activity threatened the company's momentum in the September period.  Order rates remained intact despite the storm clouds.  Large corporations generally are well capitalized these days.  Most seem willing to keep investing in products and technologies that produce superior returns.  Demand promises to remain solid even if the macroeconomic picture deteriorates further.  We estimate full year earnings will climb 40% to $.35 a share on a 28% improvement in sales ($95 million).  A stronger performance is possible.

A new cloud computing product recently was introduced.  That "software as a service" offering is aimed at smaller companies.  Pricing will be variable depending on usage but Pros is targeting average annual revenue per customer in the $100,000-$250,000 range.  Performance won't be as high powered as the company's top of the line systems.  But most mid-size customers probably won't require that much firepower.  The actual delivery mechanism might change over the long haul.  It doesn't necessarily have to be cloud computing.  But penetration of the mid-size market could amplify results substantially down the road, no matter how the technology is implemented.

We estimate 2012 earnings will keep rising and finish at $.45 a share (+29%).  Sales could attain $115 million (+21%).  Start-up costs associated with the cloud computing initiative may limit margin expansion.  Pros also has been willing in the past to give customers a break when they encounter tough times.  That's probably going to happen next year so price concessions may also prevent margins from widening to their full potential.  Still, despite the headwinds Pros could top our estimates.  The payback period on the technology is remarkably quick in most cases.  And companies have surplus cash to spend.

The long term outlook is promising.  The cloud computing business probably will keep overall margins from returning to the mid 25% level over the next 2-3 years.  Once it gets established, though, the potential for even greater margins will be created.  Plus, Pros has penetrated only 5%-10% of the potential market to date.  And that market is likely to keep expanding as companies in India, China, Russia, Brazil, and elsewhere scale up.  Maybe they'll have their own mathematicians.  Chances are Pros will capture a big share of the market, nonetheless.

In 2-3 years sales could reach $175 million to produce earnings of $.75 a share.  Applying a P/E multiple of 40x to those earnings suggests a target price of $30 a share, potential appreciation of 115% from the current quote.  Downside risk is moderated by Pros' acquisition potential.

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Wednesday, October 5, 2011

Stratasys ( Nasdaq - SSYS ) -- Wait 'till Next Year

Stratasys (SSYS $18.50) appears on track to report unspectacular Q3 results.  In 2010 the company formed a joint marketing relationship with Hewlett Packard in the expectation the larger company would quickly expand distribution of Statasys's 3-D printing systems.  Hewlett Packard is the leading producer of engineering tools and the company's rapid prototyping systems looked like a natural fit.  H-P rolled out its marketing effort in five minor European countries, but never expanded into more prominent foreign markets or the United States.  While that was going on Stratasys abandoned its own program of recruiting independent distributors.  The company did build up its sales efforts for larger production units.  But the lack of contribution from Hewlett Packard left overall results short of potential.

This summer Stratasys threw in the towel and reinstituted its own U.S. sales efforts.  The company hit the ground running and has been successful at recruiting new distributors.  But it takes time to train those people and get their sales efforts up to speed.  So the lull in reported results is likely to continue through the end of 2011, perhaps a bit into 2012.  Growing economic headwinds are presenting an additional hurdle.  Our estimates are unchanged although a somewhat lower performance is possible.

The long term outlook remains bright.  The H-P snafu cost Stratasys some time.  But the company kept up its R&D efforts and remains the technology leader by a wide margin.  The direct digital manufacturing industry remains in an early stage of development.  The potential market is enormous.  Direct competition remains scant.  Professors, students, engineers, and entrepreneurs all are using the company's technology to leverage their innovations.  Large corporations are testing it out, as well.  The idea is to make one off products just as cost effectively as mass produced parts.  Stratasys already has gotten pretty effective using a variety of plastics.  The company now is adding more materials as inputs.  It's also making the machines easier to use, more directly compatible with CAD/CAM software programs, faster, and less expensive.  The technology will remain in the hands of engineers for the foreseeable future.  Someday, though, it could become possible for consumers to design whatever product they want using their own computer.  Stratasys has some short term problems but it's ultimate business potential remains unusually high.

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Tuesday, September 27, 2011

Acacia Research ( Nasadaq - ACTG ) -- Inventory of Patents keeps Expanding

Acacia Research (ACTG $40.00) appears on track to produce excellent on target Q3 results.  Financial results are hard to predict because the company earns its money by enforcing patent rights.  Those settlements happen when they happen.  Estimating quarterly results is impossible.  But when looking at longer periods financial comparisons become more meaningful.  Measuring the 12 months ended September 2011 against the prior twelve months, a good showing is likely.  If Acacia consummates a "structured" agreement with a large corporation during the last three days of the quarter, a fabulous report would be likely.  Patent values have escalated over the last year.  So the value of a structured deal would likely go up commensurately.  To date Acacia has signed three structured contracts.  Those deals give the counter party (Oracle, Microsoft, and Samsung so far) free use of all the company's patents for a three year period in exchange for a fixed fee.  Given the recent upswing in patent valuations, those buyers probably got a 50% discount compared with today's valuations.

Acacia's stock might slip if the company doesn't complete a structured deal before the end of Q3.  Back when patent prices were lower Acacia said it planned to sign three structured deals in 2011 and four in 2012.  Samsung was completed in Q1, and no big deals were completed in Q2.  Most investors seem to want one in Q3 and another in Q4.  Our advice is to buy the stock if it sells off.  We think it's unlikely Acacia will sign a deal at the last second to "make the quarter."  That would create a bad precedent and diminish the company's income potential in future periods.  A big rebound in the shares could develop in Q4, particularly if Acacia were to sign two deals, both worth more than $100 million. 

Meantime, the company is continuing to build its patent portfolio.  Acacia added a valuable group of semiconductor patents today, going partners with a major chip producer.  Negotiations are underway with dozens of additional companies, most of which never would have considered monetizing intellectual property a few years ago.  Interest is especially keen at companies owned by private equity and other activist investors.  Many of them view Acacia has a proven commodity that's able to generate cash in a reliable and timely fashion.

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Data I/O ( Nasdaq - DAIO ) -- Fundamentals Intact

Data I/O (DAIO $4.75) appears on track to report excellent on target Q3 results.  The stock has declined 25% in price over the past two months, reflecting soft demand for semiconductor manufacturing equipment in general.  Data I/O probably is selling fewer new systems than it would under more dynamic economic conditions.  Business remains good, all the same.  Recent software introductions have improved the underlying equipment's competitive advantage.  Data I/O is the leading producer of systems that load data onto virgin computer chips so they can be used in the real world.  Flash chips for smart phones and tablets are a major end market.  The company also is a leader in providing automotive computer chips.  Both of those segments continue to expand. 

Data I/O also has begun selling its new software packages to its installed base.  Those highly profitable sales promise to widen margins in upcoming periods.  Inventory fluctuations, which hit the semiconductor industry after the Japanese earthquakes, may be causing customers to hesitate when placing new orders.  A decline in the overall economy probably will continue to keep sales below potential over the next 6-9 months, as well.  But the combination of market share gains and new high margin software sales promise to keep income moving higher even during the dark days.  Bigger gains are likely when conditions improve in 2012. 

Technically, hedge fund selling has exacerbated the stock's recent falloff.  That overhang may continue to weigh on the price.  Looking past that short term pressure, the long term outlook remains bright.  Large as it is, the semiconductor industry remains in an early stage of development.  Data I/O is well positioned to keep gaining market share as it boosts productivity, and perhaps makes complementary acquisitions with its cash horde.  In 2-3 years earnings could reach $.75 a share.  Applying a P/E multiple of 20x suggests a target price of $15 a share, potential appreciation of 215% from the current quote.

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Simulations Plus ( Nasdaq - SLP ) -- Acquisition Bid Falls Short

Simulations Plus (SLP $3.15) was outbid in its effort to purchase Entelos.  The target company provides simulation software that complements Simulations Plus's offerings.  Entelos ran into hard times over the past few years, though, and filed for bankruptcy.  Its principal creditor, a financial investor, decided to take control of Entelos rather than sell to Simulations Plus for less than it was owed.  The gulf was too wide for a compromise to be reached.  Simulations Plus is continuing to pursue acquisitions that it can pyramid onto its sales and marketing network, and which might offer technical synergies as well.  For now, though, the company will continue to focus on organic growth, which is being maintained in the 10%-20% range despite the slowdown in the economy.  Our estimates are unchanged.

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Wednesday, September 21, 2011

Amerigon ( Nasdaq - ARGN ) -- Delivering on its High Wire Act

Amerigon (ARGN $12.75) still needs to jump through a number of hoops before its acquisition of W.E.T. is finalized.  But a substantial payoff has grown more likely.  The company bought 76% of the German auto supplier in the June quarter and began consolidating results on May 16th.  W.E.T. makes heated seats for a wide range of European carmakers and intermediate suppliers.  It also manufactures ventilated seats, which have been an indirect competitor to Amerigon's air conditioned systems, and heated steering wheels.  At this point W.E.T is being operated as a separate company.  Cost saving and cross marketing initiatives haven't been implemented, and probably won't be until the remaining 24% of W.E.T.'s stock is acquired either in direct transactions or through the court system.  The latter is a lengthy  process.  While Amerigon is likely to get full control that might not occur before mid 2012.  Meantime, the  companies are informally working together and performing well in light of the contraction now underway in the world economy.  We estimate 2011 income will finish around $.50 a share, excluding acquisition related one time expenses.  Next year we think margins will improve even if an official consolidation doesn't occur.  Our earnings estimate is $.90 a share.  That assumes zero organic sales growth.  Our $500 million sales estimate reflects the two companies' current run rate.  A stronger performance is possible if the overall automobile market performs better than we expect (minus 5%-10%). 

Earnings leverage could be substantial after W.E.T. is consolidated from an operational standpoint.  Amerigon's air conditioned seats have been well received by American and Asian carmakers but have generated little penetration of the European market to date.  High end cars made in Europe typically employ ventilated seat cooling.  W.E.T. has strong relationships with BMW, Porsche, Volkswagon and other European producers.  That could open the door to Amerigon's more expensive but better performing systems.  Amerigon's new heated and cooled cupholders are growing rapidly in America and Asia, too.  The merger might speed up their adoption in Europe.  Amerigon's existing relationships might facilitate orders for some of W.E.T.'s systems, as well, particularly the heated steering wheels.

In 2-3 years sales could reach $675 million as the auto market recovers and Amerigon advances its own business.  Pretax margins could expand to 12%.  The company issued $65 million in preferred stock earlier this year to help finance the W.E.T. transaction.  Amerigon has the option to retire that obligation with either cash or stock over the next three years.  Our projections assume a big proportion will be paid in stock to preserve working capital.  Despite the higher share count income could reach $1.95 a share.  Applying a P/E multiple of 16x suggests a target price of $30 a share, potential appreciation of 135% from the current quote.

Amerigon also appears to be making progress with its BSST technology.  Funding from commercial partners and federal agencies continues to rise.  The technology is intended to convert waste heat into electricity.  If the company can approach the commercialization stage the stock could move on the prospect of substantial royalty income.  Of late, the company has become increasingly tight lipped in its comments about BSST, although what it has said is upbeat.

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Sunday, September 18, 2011

Ansys ( Nasdaq - ANSS ) -- Apache Acquisition Reinforces Momentum

Ansys (ANSS $54.00) appears on track to produce excellent on target Q3 results.  More than two thirds of revenue is reoccurring so visibility was high going into the quarter.  The Apache acquisition, which was completed on August 1st, will lift Q3 revenues by $3-$4 million, putting them in the $75-$80 million range.  Apache's annualized revenue run rate currently is around $50 million.  That company was preparing to go public when Ansys swooped in with a premium all cash offer.  Apache probably won't contribute to earnings much in 2011 but its technology -- simulating systems on a chip -- promises to become a major contributor over the next several years.  Meantime, new orders have remained solid despite the worldwide economic slowdown.  A deeper contraction might impact business in the future.  For now, though, customers continue to generate high rates of return on Ansys's technology.  Demand is broadly diversified both geographically and by industry.  Direct competition exists in spots but nobody provides the range Ansys delivers.  As product development becomes increasingly complex and interconnected that competitive edge is likely to expand even further.  Our estimates are unchanged.

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