Stratasys ( Nasdaq - SSYS ) -- Demand for Direct Digital Manufacturing Systems Remains Solid

Stratasys (SSYS $23.00) appears on track to produce reasonably good Q3 results.  The company signed a distribution pact last year with Hewlett-Packard covering Stratsys's low cost 3D printing systems.  H-P hoped to sell the line to its installed base of engineering customers who'd use the high potential technology to make physical prototypes, replacing clay and other model making techniques.  At that point in 2010 Stratasys shifted its own marketing gears to emphasize larger systems for manufacturing applications.  Those customers employ the technology to make actual production parts in limited quantities.  Traditional manufacturing methods normally involve a lot of retooling and set-up time.  The Stratasys approach produces end products straight from a digital design created on a computer, without any significant machine adjustments.  In short runs the approach can be highly cost effective.

Distribution to the engineering market has stalled because of the lack of follow through by Hewlett Packard.  In the June quarter Stratasys finally through its hands up and began laying plans to resume its own distribution efforts in that segment.  That program might take a year or longer to bear meaningful fruit.  In the interim business with high end manufacturing customers is gaining momentum.  Those products cost 20x as much as the engineering models, so a handful of incremental sales could make a big difference on financial performance.  Stratasys also sells consumables (different types of plastic) that are used by the machines.  Demand for those materials have remained vibrant so far in Q3.

Stratasys hasn't commented on how the latest changes in strategy are affecting its results.  Our estimates involve an unusually high amount of guesswork as a result.  It looks like the macroeconomic downturn hasn't impacted business to date, though.  Sales of high end systems and consumables look like they're doing well, perhaps accelerating.  And while the H-P contribution remains negligible Stratasys still operates a sizable sales network of its own aimed at the prototype segment.  It would have been larger by now if the company hadn't wasted time with Hewlett Packard.  But it's still meaningful.

The stock entails considerable uncertainty.  The price has fallen dramatically, though, from where it was after the H-P relationship originally was established.  Venturesome investors realistically can tiptoe into the stock at current levels.  The long term outlook remains terrific.  Stratasys continues to be the industry leader.  Finances are solid.  Near term earnings might not be fantastic but a major catastrophe appears unlikely.

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Carbo Ceramics (NYSE — CRR) -- Bridging the Gap

There is a sizeable gap between current energy and the renewable sources that aim to one day replace them. Wind and solar power don’t produce harmful byproducts, but the cost is much higher than fossil fuels, even with government incentives in some countries. Natural gas is a cheaper, cleaner alternative to oil and coal, respectively. Huge deposits found in shale rock around the world have led many to believe that natural gas can bridge the energy gap.

Carbo Ceramics (NYSE: CRR $130.00) is the leading provider of ceramic proppants used in hydraulic fracturing (“fracking”), the technique used in shale rock gas and oil drilling. Wells are typically drilled 8,000 feet down, and then another 6,000 feet horizontally. Charges are used to break apart the rock. Then water, chemicals and proppant are pumped in under high pressure to further break apart the rock and release the gas or oil. As the water is pumped out, the proppant remains to keep the shale open and allow the raw fuel to escape back up the pipe.

The company offers three primary types of proppant: sand, ceramic and resin-coated versions the two. Sand is the cheapest and most commonly used; ceramic is more expensive up front, but used in the right situation it yields more gas and thus more cash flow. The resin-coated proppant is used in scenarios that risk proppants flowing back up the well and interfering with machinery.

Acacia Research ( Nsadaq - ACTG ) -- Patent Valuations Still Climbing

Acacia Research (ACTG $33.00) appears on track to produce excellent on target Q3 results.  The company recently turned down two prospective "structured" deals that would have generated significant one time payments.  In light of the recent surge in patent activity throughout Corporate America, the company thought those transactions might be undervalued.  New patent portfolios continue to be added.  Two major ones are in negotiations.  Acacia has identified several companies that own patents worth far more than their market capitalizations.  Thought is being given to purchasing those targets for the intellectual property, and then spinning off the base businesses.  A variety of other strategies are being evaluated. 

Demand for the company's services is poised to expand in upcoming periods.  Earnings and access to capital are declining, prompting potential partners to license patents via Acacia to generate cash.  Direct competition has not developed to date.  These shares continue to hold tremendous potential.  Operating income could climb at above average rates well into the decade.  A series of one time hits could amplify performance, perhaps dramatically.  Our estimates assume Acacia will sign one structured transaction in each of the next six quarters at revenue amounts consistent with previous deals.

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Simulations Plus ( Nasdaq - SLP ) -- New Product Lifts Outlook

Simulations Plus (SLP $3.00) appears on track to report good Q4 (August) results.  The company generates most of its revenue from software subscriptions which come up for renewal on an annual basis.  Fewer deals originally were signed in the summer period, so fewer now come up for renewal each year in Q4.  Still, we estimate performance will rise on a year to basis, bringing non-GAAP income for the fiscal year up to $.20 a share.

A new product could bolster performance in fiscal 2012 (August).  Membrane Plus will be a high priced adjunct to Simulations Plus's core Gastro Plus line.  Introduction is slated for Q2.  Attach rates probably will be gradual at first but a significant portion of the installed base could adopt the product as customers familiarize themselves with the software.  Most new sales are made by Simulations Plus's scientific staff who demonstrate the technology face to face.

A new Words Plus product could boost margins.  That segment remains a marginal contributor to financial performance.  But the new machine will cost 75% less to produce than the current hardware sold by the company to speech impaired users.

The project to develop new molecules from software alone is making progress.  Most scientists use the company's programs to evaluate potential drugs that already have gone through some laboratory work.  Simulations Plus is trying to create a candidate for malaria from scratch, just using the software.  A promising design has been created.  Laboratory testing now is being arranged to confirm that potential.  Success could encourage R&D outfits to rely more extensively on the company's expertise.

Work with the FDA on a toxicology application is continuing.  That line probably will take a few years to develop but it could generate significant diversification over the long haul.  Acquisitions continue to be pursued but nothing appears imminent.

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Zagg ( Nasdaq - ZAGG ) -- Breakneck Expansion Elevates Risk

Zagg (ZAGG $16.00) reported excellent Q2 results, above our expectation.  Excluding nonrecurring costs associated with a recent acquisition income advanced 111% to $.19 a share.  Sales climbed 158% to $38.8 million.  The i-Frogz acquisition boosted performance by a modest amount since that contribution was included for only two weeks.  The Invisible Shield line represented 63% of total revenue.  Most of the rest was provided by keyboard and related accessories for the Apple iPad.  That line will be outsourced to Logitech in upcoming periods in exchange for a volume based royalty.  Zagg will continue to sell the iPad edition on its website, and will recognize the full revenue amount on those sales.  The i-Frogz accessory line will amplify revenue performance in upcoming periods.  Greater penetration of Europe should provide further leverage.  And Zagg recently expanded its U.S. distribution system for its bread and butter mobile phone covers, which could generate further momentum.  We've raised our 2011 earnings estimate by a nickel to $.75 a share.

Risk has increased.  The company added $62 million in debt so far this year to purchase i-Frogz, buy patents related to the Invisible Shield, invest in an unrelated technology (HZO), and expand fulfillment capacity.  Those deals lifted intangible assets to $90 million, an amount equal to shareholders equity.  Tangible equity was reset to zero.  The proliferation of Android mobile phones has forced Zagg to produce a more diversified inventory, moreover, creating greater potential for write-offs on slow selling models.  The debt load constrains future manoeuvrability, as well.

Zagg could continue growing at above average rates.  The mobile device industry is expanding at a 35% pace and could remain vibrant well into the decade.  Zagg is trading at a higher P/E multiple than Apple Computer and Google, though, the two industry leaders which have stronger balance sheets and better control of their futures.  Our advice to investors seeking exposure to the mobile phone industry is to switch into those stocks.  Zagg is coming off a smaller base and could deliver higher appreciation if the company doesn't slip along the way.  But downside risk is significantly greater.

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Ansys ( Nasdaq - ANSS ) -- Raising Estimates

Ansys (ANSS $48.00) reported excellent Q2 results.  Results topped our published forecast, although the rising momentum had been evident in the company's order rate since last fall when its latest software upgrade was released.  Non-GAAP earnings increased 24% to $.62 a share.  Revenues improved 18% to $162.2 million.  An acquisition announced on the last day of Q2 should reinforce the trend in upcoming periods.  That deal ensconced Ansys as the leader in mobile phone component simulation.  Power management is the new line's bread and butter.  That know how is likely to spread to additional energy saving applications in the computer field.  Demand was robust in all geographies except Japan, traditionally Ansys's second most important market.  Activity remains muted there but probably will recover over the next 1-2 years as the effects of the earthquake wear off. 

We are raising our full year earnings estimate by 6% to $2.50 a share.  Next year $2.75-$3.25 a share represents a realistic target.  The breakdown between annual and perpetual license sales, plus any impact by the economy, will influence the final amount.  Additional acquisitions may be pursued, creating the potential for additional leverage.  The long term outlook remains bright.  Ansys is the leader in simulation software used by engineers and product designers.  Organic growth is running in the 10%-15% range despite the relatively weak economic environment.  Overall growth is being amplified by the company's ability to reinvest cash flow (50% pretax margins) in complementary acquisitions.  Penetration of emerging markets could provide further impetus.  Downside risk is mitigated by the scarcity of direct competition and a high degree of recurring revenue from existing customers.

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Data I/O ( Nasdaq - DAIO ) -- New Software Wins Acceptance

Data I/O (DAIO $5.75) appears on track to produce accelerating Q3 results.  That trend is likely to gain momentum and propel earnings to sharply higher levels in 2012.  The company launched its latest hardware product (RoadRunner) on August 1st.  That system contained all of Data I/O's new software packages that eliminate programming errors, enhance auditing, scheduling, and tracking, and make piracy substantially more difficult.  Inclusion of the software will boost revenues and margins directly.  The software also is designed to work with hardware already in the company's installed base.  Straight software sales to those customers could provide additional leverage.  More software programs are in development.  Data I/O continues to hold extensive cash reserves, moreover, so acquisitions of customers, other hardware lines, or complementary software products are possible, as well.  Our estimates are unchanged.

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Image Sensing Systems ( Nasdaq - ISNS ) -- Not Shovel Ready

Image Sensing Systems (ISNS $8.15) reported lower than expected Q2 results.  The company is the leading provider of machine vision systems used to regulate traffic at intersections.  Those machines also are used in tunnels to spot fires, and along highways to report jam-ups and accidents.  Image Sensing produced stellar performance under its previous management team, which retired a few years ago.  The new line-up has overseen a steady downturn in earnings, albeit under difficult economic conditions.  Two acquisitions have delivered less impetus than projected.  One of those units produces traffic control systems that employ radar to count the vehicles lining up at red lights.  That approach works better in certain lighting conditions.  Image Sensing additionally purchased a license plate reading technology last year.  The company also has invested aggressively to develop international markets, primarily in Asia and Eastern Europe.  None of the initiatives have been especially rewarding to date.  For the quarter income dropped 33% to $.12 a share.  Sales were up 23% to $8.10 million but most of that was accounted for by acquisitions that weren't included in the year ago figure.

U.S. highway construction hasn't picked up as expected.  In every recession since the automobile was invented government spending on transportation infrastructure expanded as a way to boost jobs while getting useful projects completed.  When the Obama Administration took office in 2009 it touted expansive plans to invest in a plethora of "shovel ready" highway projects.  The last three summers have seen little headway, though.  Image Sensing has been facing macro-economic headwinds, as a result, amplifying its internal struggles.  A near term improvement appears unlikely.  We are reducing our 2011 full year earnings estimate 35% to $.55 a share, accordingly.

A new product, developed internally, could restore a bounce in the company's step.  The line is aimed at Image Sensing's core intersection control market.  It combines the company's machine vision and radar technologies into a single package to produce superior results at a reasonable price.  With the error rate virtually eliminated competition should become less significant, helping margins.  Attractive pricing also should help Image Sensing knock out indirect competition provided by loops that are buried under the roadway.  Those systems are cheap but are expensive to install and repair.

The shares are unlikely to do much in the meantime.  The new line is slated for introduction in Q1 of 2012.  If Image Sensing can rehabilitate its foreign business during the interim performance could post dramatic gains next year.  Value investors can realistically maintain positions with an eye towards tripling the stock price within 2-3 years.

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Convio (Nasdaq — CNVO) -- Ahead of Estimates

Convio (Nasdaq: CNVO $10.30) reported Q2 results that were above our estimates. Revenue for the quarter totaled $20.7m, up 13% from the year before ($18.2m). Revenue for the full year is expected to range between $79.4m and $80.3m, ahead of our previous projection of $78m.

Due to the company’s accounting, actual sales are higher than what was reported. The company only reports revenues from contracts so far as they are guaranteed – customers can opt to cancel a contract after a certain amount of time has passed. Ninety percent of existing customers are retained, so most of that revenue will be collected in the future.

Convio clients raised $380m from online donations, a 21% increase from $314m the year before. The company’s collaboration with Constant Contact will make it easier for NPOs to contact donors, and should result in more donations, which Convio takes a cut of in most cases. The launch of Luminate, the company’s new cloud-based constituent engagement solution offers NPOs more integration while keeping track of data for an entire organization to easily access.

The company also named Patricia Hume the new vice president of worldwide sales. Hume has 29 years of experience in software and technology sales with companies including IBM, SAP and Avaya. She was formerly senior vice president of sales with SAP and GFI, and became vice president of business partner sales and marketing for a period at IBM.

“We are extremely excited to have Patricia join our team,” said Gene Austin, chief executive officer for Convio. “Patricia’s high energy, collaborative approach and track record of success are a great match for Convio as we execute on our growth strategy.”

Non-GAAP earnings per share were $0.09, a 12% increase from $0.08 a year ago. Share earnings for the full year are projected between $0.37 and $0.40.  Our estimate of $.30 a share assumes a higher (35%) tax rate.  Convio still holds about $50 million of tax loss carryforwards so cash payments are minimal. 

Convio’s future outlook could be hampered by the continually slowing economy. Short term results shouldn’t be affected too much, but the company could be troubled if the economy continues to slip. Charitable organizations would find it increasingly difficult to find donors in a tight economy.  

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