Healthstream ( Nasdaq - HSTM ) -- Excellent Q1 Results

Healthstream (HSTM $9.25) reported better than expected Q1 results.  The health care learning segment posted a 27% revenue increase to $13.1 million.  The research business regained momentum in the period, as well, climbing 22% to $5.4 million.  Total revenue of $18.5 million was up 25% year to year.  Margins improved despite a final dose of start-up costs associated with the high potential Sim Ventures line.  Non-GAAP earnings advanced 60% to $.08 a share.  Healthstream still has approximately $20 million of unused tax loss carryforward benefits to apply against future income.  For financial reporting purposes the company applied a 41% tax rate.

The Sim Ventures line will begin rolling out in May.  That business is an equally owned joint venture between Healthstream and the worldwide leader in computer-controlled patient simulator mannequins (Laerdal Medical).  The venture plans to hook up those mannequins to remote computers via the Internet to evaluate how well a particular task is performed.  The interactive software will enable video replays, detailed analysis, demonstrations of correct technique, and other feedback in addition to scoring and record keeping.  Laerdal's dummies currently contain electronics but aren't linked to external software programs.  Healthstream holds 40%-45% of the U.S. hospital training market and will be responsible for marketing the new technology to that base.  Laerdal is well established internationally.  Incremental revenue is likely to be modest in 2011 as the software hook-ups are completed and customers familiarize themselves with the new approach.  Substantial growth is possible in subsequent years, reinforced by the absence of direct competition.

Meantime, the core business remains vibrant.  Existing hospitals are adding more software modules to their training programs.  The trend towards certification continues to increase, moreover, prompting more health care workers to take the courses.  Pricing is firm.  Market share is rising, fueled by Healthstream's superior delivery system (Internet versus CDs and books).  Margins probably won't expand to their maximum potential in the short run as technology upgrades are pursued and the sales force expands.  But profitability is likely to widen in 2011, nonetheless.  We are raising our full year earnings estimate 7% to $.30 a share.  We also have raised our sales estimate 4% to $80 million.  The new figures represent year to year gains of 36% and 23%, respectively.

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Data I/O ( Nasdaq - DAIO ) -- Follow-up Report

Data I/O (DAIO $5.75) reported good Q1 results, consistent with our expectation.  Sales rose 13% to $7.04 million.  Non-GAAP earnings declined 17% to $.05 a share.  Escalating product development costs foreshadowing an acceleration in financial performance clipped income by $.03 a share.  Those projects are software related, and could be sold into Data I/O's installed base of semiconductor programming machines (in addition to new hardware customers).  The technologies are focused on security and parts identification and could attract broad based demand.  Overall margins are likely to widen due to the inherent profitability of software products.  Q1 results also were affected somewhat by gang violence in northern Mexico.  That area historically has been a major semiconductor programming center but business recently has started to shift to Asia and other parts of the world because of the criminal activity.  Data I/O kept most of its lost Mexican orders.  But some of those customers didn't set up at their new locations in time for the revenue to be recognized in Q1.

Our 2011 earnings and sales estimates are unchanged.  We think sales will finish around $30 million to yield non-GAAP earnings (fully taxed) of $.30 a share.  The new software promises to drive margins higher in the second half of the year.  Hardware demand is likely to stay robust, moreover, fueled by the ongoing boom in mobile devices and other consumer electronics.  In 2012 fully taxed earnings could achieve $.50 a share on sales of $35 million as Data I/O enjoys the benefits of a full year of software sales along with a levelling off in R&D expense.  Cash totals $19.0 million ($2.11 a share).  Those funds could be invested in acquisitions of complementary products and services.  Downside risk exists.  The semiconductor industry is cyclical and Data I/O would be exposed to a severe decline.  But the company already controls a leading share of the market and that figure could expand in the future as device complexity keeps increasing, forcing low-end Chinese competitors to either keep pace technologically or abandon the business.

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Image Sensing Systems ( Nasdaq - ISNS ) -- Red Light

Image Sensing Systems (ISNS $12.00) said Q1 results will be significantly short of its internal target.  Sales are likely to finish in the $6.0 million range, approximately $2.0 million below what the company ordinarily would realize.  A non-GAAP loss in the $.10 a share vicinity is likely to be reported, $.30 a share below normal.  External economic conditions were not responsible for the shortfall.  North American and European sales of Image Sensing's traditional machine vision systems remained solid.  Problems emerged in the company's radar unit, which was acquired in 2009.  The general manager of that operation resigned after completing his earnout.  Sales might have been pushed forward to achieve that goal, leaving an empty pipeline in Q1.  Image Sensing's high potential Asian business fell flat, too, leading to another management change.  A replacement still hasn't been hired so further soft results in that region are possible in upcoming periods.

The next generation "hybrid" intersection management system is on schedule for a Q2 release.  That line combines Image Sensing's machine vision technology with the radar capability to see the traffic situation in all kinds of weather conditions, allowing intelligent changing of the lights.  That product also may include the company's Citysync license plate reading technology, which allows police and security forces to track vehicles as they drive around town without an actual tail.  It also notifies officials when stolen cars and other on-the-lookout type vehicles show up on the grid.  That segment remains a modest part of the overall business but it's growing fast and could help leverage sales of Image Sensing's other offerings.

We are reducing our 2011 non-GAAP earnings estimate 25% to $1.00 a share.  (See "Accounting Notes.")  We also are lowering our 2011 sales estimate to $35 million.  A timely and problem-free hybrid introduction will be required to achieve those reduced numbers.  The hybrid line is unique in the industry and has the potential to reignite growth over the next several years.  The internal missteps should be viewed as a warning, though.  Aggressive investors are advised to close out positions until the management questions are resolved.  Value investors can take heart from the recent addition of Econolite's CEO and principal owner to Image Sensing's board of directors.  (Econolite is the company's exclusive U.S. distributor and is believed to control the largest share of the North American market.)

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Acacia Research ( Nasdaq - ACTG ) -- Follow-up Report

Acacia Research reported excellent on target Q1 results.  Revenues jumped 54% to $61.1 million.  That included a $45.0 million payment from Samsung for a three year license to use all of the patents currently in Acacia's portfolio (over 170 families).  In the year ago period the company was paid $25.0 million by Oracle under a similar arrangement.  Excluding those "structured" transactions, revenues increased 9% year to year.  Margins declined primarily because of higher royalty payments to original inventors.  Acacia takes ownership of the technology when those partnerships are formed but is required to split the winnings under whatever formula is negotiated.  Last year Acacia signed a huge deal with one of the five largest semiconductor manufacturers encompassing more than 40,000 patents.  The royalty rate on that arrangement is secret but probably is higher than normal.  Earnings were essentially flat at $.39 a share despite the rise in revenue due to those payments and a rise in general business expenses geared to sustaining growth at a fast pace in upcoming periods.  The company also raised equity ($175 million) in the quarter, which also added to overhead expenses.

Acacia plans to invest up to $200 million to purchase patents for its own account.  Several large corporations have approached the company either to represent them in pursuing infringers of their technology, or to take non-core patents off their hands for cash.  Last year Acacia formed a hedge fund to invest directly in patents.  That operation is designed to employ capital supplied by outside investors, augmented by a small amount of Acacia's own money.  The new investment program will be conducted outside the fund.  Partners might be lined up for particular patent acquisitions.  But most of the action will be for the company's own account.

Two more large "structured" deals are likely to be completed in 2011.  Those transactions could be similar in size to the Samsung transaction, perhaps higher if Acacia can bring more intellectual property into its portfolio before the deals are signed.  We are raising our 2011 revenue estimate by 7.5% to $215 million to reflect the accelerating deal momentum.  Our non-GAAP earnings estimate (see "Accounting Notes") is unchanged at $1.15 a share due to the uncertain royalty rate outlook. 

Growth could remain explosive in 2012.  Acacia hopes to consummate four structured transactions next year.  The volume of regular business promises to keep expanding.  And the payoff from the company's direct patent investments could yield further leverage.  Non-GAAP share earnings have the potential to advance into the $1.50-$1.75 range.  Growth could be maintained at above average levels beyond as Acacia reinvests its burgeoning cash flow at superior rates of return.

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Simulations Plus ( Nasdaq - SLP ) -- Follow-up Report

Simulations Plus (SLP $3.15) reported Q2 (February) results that were somewhat above our expectation.  Revenues improved 14% to $3.35 million, consistent with the company's earlier announcement.  Pretax margins widened dramatically to 42.7% (excluding non cash stock option expense), propelling income to $.06 a share (+50%).  The stock option adjustment was modest, boosting margins by 1.1%.  Most of the margin expansion derived from reduced selling and overhead costs. A majority of the sales growth in the pharmaceutical modeling software line was provided by existing customers.  Renewals accounted for 63% of sales.  New license sales to existing customers added another 9%.  The renewal rate was 96%.  New business (28%) continued to reinforce Simulations Plus's growth trajectory, though, fueled by an active trade show and in-house marketing program.  The earthquakes in Japan didn't impact financial performance.

Substantial leverage remains possible if the company can acquire complementary products and feed them into its existing customer base.  Simulations Plus is exploring acquisitions, although at this stage the best fits appear to be larger organizations that might view the company itself as an appealing target.  Simulations Plus also plans to begin doing some original research, using its own tools to identify promising drug candidates.  That project isn't likely to yield actual products necessarily, but it should provide case studies that existing and prospective customers can refer to.  The non core text to speech line remains in a sideways pattern and isn't contributing materially to profitability.  Overall margins promise to keep rising as the pharmaceutical software segment continues to expand its share of total revenue.  Comparisons will be impacted a little by the absence of U.S. Government grants that pumped up prior year results.  For now we are maintaining our full year (August) estimates.  A somewhat stronger performance is possible.

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Zagg ( Nasdaq - ZAGG ) -- Logitech Licenses the ZaggMate

Zagg (ZAGG $8.15) licensed its tablet computer accessory, the ZaggMate, to peripheral manufacturer Logitech.  The company did retain rights to sell the product on its website, under the Logitech brand.  The ZaggMate generally carries a $99 retail price and comes with a wireless keyboard, screen protection, drop protection, and a viewing easel that lets users watch the screen in either portrait or landscape mode.  Logitech will assume all manufacturing and marketing responsibilities.  That promises to reduce production costs, broaden distribution, and allow the partners to respond quickly to unique design requests.  Zagg will earn an undisclosed royalty on Logitech's sales, which probably will be in the $50-$60 per unit range at wholesale.  We estimate the effect on Zagg's income will be neutral in 2011 compared to what the company might have done on its own.  Longer term, income could benefit as the tablet market grows, production costs decline, new distribution channels are penetrated, and other products are layered into the partnership.  Teaming with Logitech also will reduce Zagg's capital requirements, freeing up money for other initiatives.  Tax benefits are a possibility, too, if Zagg can steer royalty income through its recently established Irish subsidiary.

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Amerigon ( Nasdaq - ARGN ) -- Makes Acquisition Bid

Amerigon (ARGN $15.25) launched a friendly acquisition bid for German competitor W.E.T.  The target is a leading producer of heated auto seats, with especially strong distribution in Europe.  Revenues were $311 million in 2010.  Amerigon hopes to complete the transaction by paying $167 million, financed with a still undetermined combination of stock and debt.  The company has an agreement with holders of 76% of W.E.T.'s shares, but needs 95% altogether to proceed.  Antitrust clearance is required, as well.  If the deal goes through Amerigon's annualized earnings could benefit right away by $.25-$.50 a share, excluding one time expenses.  Financial leverage also would jump sharply, suggesting a lower P/E multiple might obtain in the short run.  If stock isn't used in the deal chances are Amerigon will tap the equity market at some point to restore a better balance to its capital structure.  The transaction offers tremendous potential from a sales standpoint.  Margins on W.E.T.'s heated seats are lower than what Amerigon earns on its air conditioned car seats.  But those could rise if the European automakers W.E.T. serves begin to adopt the American technology.  Operational efficiencies are possible, too.

Meantime, Amerigon's own results have stalled.  Q1 sales are likely to increase by a modest amount compared to the year ago period.  Costs remain elevated, particularly for tellurium, the key material in Amerigon's cooled seats.  R&D costs are pointed higher, as well.  Earnings may improve year to year, but a sequential decline appears likely.  Full year earnings are likely to approximate the 2010 figure, excluding any contribution from W.E.T.  Longer term, income could accelerate if the merger is consummated and the car market keeps rebounding.  Non-GAAP earnings in 2012 could attain $.75-$1.00 a share (please refer to "Accounting Notes") and set the stage for additional gains beyond.  Our advice is to wait for the acquisition process to play itself out.  Failure to complete the deal could result in a significant share price decline.  Upside from a positive resolution appears limited at the current valuation.