Wednesday, February 29, 2012

Cyanotech ( Nasdaq - CYAN ) -- Cranks it Up

Cyanotech (CYAN $8.25) reported excellent Q3 (Dec.) results, above our expectation.  Earnings (fully taxed) leaped to $.15 a share versus a breakeven performance the year before.  Sales advanced 71% to $6.71 million.  The company shifted a little of its astaxanthin output to higher margin retail customers.  But a big chunk was shipped to longstanding bulk buyers.  The transition to retail generally lifts per-pound selling prices by 100%-200%.  As more product moves into retail distribution revenues and margins promise to benefit directly.  Most of the period's revenue was derived from algae that was grown in earlier periods.  That material is sent out for processing at a variety of third party locations.  New production was pretty good, under the circumstances.  Volume was robust in October, fueled by abundant sunshine and technology enhancements.  November and December were unusually cloudy, though.  So there might be a drop-off  in upcoming periods as Q3 output goes into circulation.

The trend towards higher margin sales promises to keep profitability on a rising slope.  Cyantotech is gradually weaning its bulk buyers away from its astaxanthin production.  That output currently is being redirected to U.S. mainland specialty retailers.  Those stores typically are run by knowledgeable proprietors who are up to date on all the latest nutriceuticals.  The wave of publicity that cast Cyanotech into the limelight in 2011 still is resonating with that group.  The company also is drumming up business in Europe.  And demand is being reinforced with a significant investment in social media marketing.

The Costco relationship might expand.  Cyanotech has supplied astaxanthin to Costco stores in Hawaii for several years.  One of the chain's specialties is nutriceuticals.  Test marketing on the mainland could begin this year.  That test marketing alone could exert a noticable impact on Cyanotech's financial performance.  If the results are good and the rollout goes national substantial further leverage could emerge.

Cyanotech is tooling up to meet rising levels of demand.  A 33% expansion in growing capacity is nearing completion.  Those new ponds won't all produce at 100% right off the bat.  It might take six months to make all the necessary adjustments.  Still, unit volume should improve as the additional capacity starts to come on line in the June quarter.  Cyanotech also plans to expand its processing capacity so it won't have to send the raw algae out for extraction.  That build-up probably will take 18 months to complete.  Once in place turnaround time should improve, along with profit margins.

We are raising our fiscal 2012 (March) earnings estimate by a dime to $.40 a share (fully taxed).  Next year $.55 a share represents a realistic target.  The transition from bulk to retail distribution is likely to sustain growth at above average rates well into the decade.  More growing ponds could be added, supplying additional impetus.  Astaxanthin is believed to be one of the few nutriceuticals now on the market which produce genuine health benefits.  Cyanotech will have to maintain an effective marketing effort to keep that message in front of consumers.  Re-order rates always have been remarkably high by industry standards, though.  Once new customers are added those recurring revenue streams tend to stay in place.  In 2-3 years fully taxed earnings could reach $.75 a share.  Applying a P/E multiple of 20x suggests a target price of $15 a share.

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Ansys ( Nasdaq - ANSS ) -- On-Target Q4 Results

Ansys (ANSS $63.00) reported excellent on target Q4 results.  Earnings were reduced $.05 a share by a one time tax adjustment, relating the company's Japanese subsidiary.  That was a non cash item.  Future earnings and cash flow will benefit from a reduction in Japan's corporate tax rate.  Despite the charge non-GAAP income rose 5% to $.68 a share.  Sales advanced 22% to $202.9 million.  Performance was solid across Ansys's entire product line.  The automobile industry was especially strong, bolstered by the development of hybrid and more fuel efficient gasoline engines.  Energy, electronics, and aerospace also outpaced the corporate average.  Geographic demand remained steady.  Reported numbers bounce around from period to period because a lot of customers are multinationals that shift work around the globe.  But Ansys didn't experience any material change in actual purchase decisions.

Product line enhancements promise to enhance the company's already commanding advantage.  Competition remains limited to niche markets.  Acquisitions of leading up-and-comers have been made in the past.  That strategy is likely to be repeated in the future, reinforcing growth.  Cash flow generation continues to be abundant.  Operating margins are in the 50% range and produce far more money than the company requires for working capital and fixed asset investments.

Our 2012 estimates are unchanged.  Earnings appear headed towards $2.85 a share (+13%) on sales of $825 million (+18%).  Costs associated with an acquisition completed in 2011 are the main reason earnings will climb less briskly than revenue.  Long term organic growth of 15% annually appears sustainable.  Acquisitions promise to contribute additional leverage.

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Tuesday, February 28, 2012

Ellie Mae ( Nasdaq - ELLI ) -- Meet HAL, Your New Mortgage Broker

Ellie Mae (ELLI $8.25) reported better than expected Q4 results.  The company is the leading independent provider of computerized mortgage origination services.  Results topped our estimate due to a pick-up in overall mortgage activity in the December period.  Ellie Mae's market share widened, as predicted, which amplified results further.  Still, non-GAAP earnings declined year over year to $.07 a share despite the sequential improvement in mortgage volume.  Compared to the year before industry activity still was down on the order of 20%.  Revenue advanced 48% to $18.8 million, enhanced by the company's acquisition of its closest competitor.  Costs jumped, however, as Ellie Mae integrated the new operation.  Shares outstanding also rose as a result of the company's IPO earlier in the year.

Reported earnings are as depressed as they can be.  Interest rates have been steady for a while and are unlikely to go down further.  So refinancing activity is dormant.  Resales are perking up, but they remain far below normal levels.  New housing is trying to rally but that still is a tough go with the foreclosure market hanging over the industry.  House prices declined again in January, moreover.  Despite all that Ellie Mae is poised to expand sales by 26% in 2012 to $70 million.  Faster gains are possible if the market improves.  The key is computerization.

Ellie Mae spent 23.4% of revenues on R&D in 2012.  The previous year the company developed a cloud computing software service that provided lenders with a variable "success based" pricing model.  Before that Ellie Mae sold its technology as a perpetual software license.  The new format charges customers each time they write a mortgage, aligning costs with revenue.  Recorded revenues suffered during the transistion process, since the company used to collect more money up front.  That process is continuing but more than 50% of sales now are coming in from the recurring revenue model.  The 2011 R&D program expanded the number of services Ellie Mae could offer.  Average order size widened as a result.  That trend is likely to continue as more parts of the mortgage process are automated.  Ellie Mae currently is pulling in about $200 per mortage.  That figure could climb to $300-$400 over the next few years.

Demand is rising at short-handed banks.  Approximately 50% of the mortgage market is off limits to Ellie Mae.  That part is controlled by the nation's 20 largest banks, which perform their own automation services.  (Ellie Mae is working with Wells Fargo on a pilot program.  So it's conceivable the company will break into the major market, as well.)  At this point, though, regional and local banks are the company's primary customers.  Many of those instuitutions have laid off a large part of their work force since 2008.  If volume expands they'll have few alternatives beyond computer automation to satisfy demand.  Ellie Mae's service guarantees they'll get the work done, and earn a profit on each transaction.

We estimate income will advance modestly in 2012 to $.25 a share (fully taxed).  Longer term, margins promise to expand meaningfully as volume grows.  Higher revenue per transaction could generate further leverage.  In 2-3 years income could attain $.75-$1.00 a share on sales of $125-$150 million. 

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Sunday, February 26, 2012

Acacia Research ( Nasdaq - ACTG ) -- Another Acquisition in the Pipeline

Acacia Research (ACTG $41.00) reported Q4 results that were below our expectation.  The company's financial performance is impossible to predict over the short term, though, because it rarely if ever discounts the value of the patent settlements it negotiates.  Acacia does own some patents outright, which the company is free to price any way it wants.  But most of the intellectual property it manages is handled in partnership with the original inventors.  Royalties on those patents entail a fiduciary responsibility to maximize value, eliminating any potential for managing short term results.  In Q4 Acacia generated $20.8 million of revenue, which was well below our estimate.  We thought the company and some of the large corporations it was dealing with might settle up before year end.  By and large, that didn't happen.  Non-GAAP fully taxed income finished at a loss of $.02 a share.  For the year income declined 19% to $.69 a share.

Volume has accelerated so far in 2012.  Acacia indicated that revenue hit $75 million in January alone, fueled by the recent Adaptix acquisition and a series of other settlements.  Further gains appear to be in store as a lot of the patents Acacia picked up in 2010-11 start to be asserted -- it usually takes the company 6-18 months to develop and implement a money making strategy.  Activity in general is increasing, moreover, as more companies become involved with IP licensing.  Patent valuations may have reached a plateau.  But more transactions are being generated per patent, lifting the potential market.

Acacia recently signed a letter of intent to purchase a private company that holds an extensive patent portfolio.  To help finance the deal the company recently issued 6.12 million shares in a private placement at $36.75 apiece, raising $225 million in fresh capital.  The contemplated acquisition is scheduled to be finalized in April.

Our 2012 estimates are essentially unchanged.  We have reduced our earnings estimate by $.15 a share to $1.25 a share to reflect the dilution from the recent stock underwriting.  But our view of revenue, margins, and taxes remains the same as before.  (Note - We use a normal 35% tax rate when calculating estimated earnings.  Acacia still has $100 million in net loss carryforwards, however, so cash outlays in 2012 will be lower.)  A stronger showing could emerge if the proposed acquisition is finalized.  Acacia usually prices new patent portfolios aggressively at first to recoup its cash outlay quickly.  Once the initial investment is retrieved the company then tends to adopt a less conciliatory attitude.  The company's ability and willingness to wait it out often yields significantly higher paydays.  Interestingly, that track record is beginning to persuade infringing companies to settle earlier.  A growing number of deals are being completed without litigation.  Both sides also benefit by avoiding the legal fees involved. 

In 2-3 years fully taxed earnings (excluding non cash stock option expense) could reach $3.00 a share.  At that point Acacia realistically could have another $2.00 a share of potential annual income in the pipeline -- patents the company hadn't yet begun to enforce.  Acacia is the leading independent provider of intellectual property services, moreover.  A growing number of major corporations are just now starting to explore ways of enhancing their own IP portfolios.  Some of that will be done in-house.  But a sizable piece promises to be outsourced.  If that happens Acacia could keep expanding at an above average pace well into the decade.  Our 2-3 year target price remains $100 a share.

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Wednesday, February 8, 2012

Stratasys ( Nasdaq - SSYS ) -- Excellent Q4 Results

Stratasys (SSYS $37.00) reported excellent on target Q4 results.  Sales met our estimate, finishing up 28% at $43.6 million.  Earnings exceeded our forecast due to a lower tax rate, fewer than expected shares outstanding, and higher than predicted margins.  The ongoing shift to production systems from R&D units contributed to the higher profit margin.  Those systems also consume more raw materials.  Stratasys sells those plastics itself, which is highly profitable due to a lack of direct competition.  Income climbed 48% to $.31 a share.  For the entire year sales advanced 27% to $155.9 million.  Earnings (excluding stock option expense and amortization of acquired intangibles) improved 65% to $1.04 a share.

We have raised our 2012 earnings estimate a dime to $1.25 a share.  Our sales estimate is unchanged at $185 million.  The same mix of factors that helped Q4 are likely to boost income in the upcoming year.  The intermediate outlook continues to look positive.  Stratasys is the leading provider of 3D printing machines.  The industry is expanding at a 20%-30% rate.  Profitability is high.  And new products are in the pipeline.  The main risk facing Stratasys is that the company is moving too slowly to capture the immense opportunity 3D printing may hold.  By going it alone the company may be exposed if larger players enter the industry.  Establishing partnerships now could ensconce Stratasys as the center of the industry over the long haul.  The key is likely to be input materials.  If the company can join forces with gigantic metal and plastic producers to expand the number of products its systems can produce, who knows, this could be the next Microsoft. 

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Friday, February 3, 2012

Carbo Ceramics ( NYSE - CRR ) - Short Term Outlook Turns Cloudy

Carbo Ceramics (CRR $100) reported excellent on target Q4 results.  Our estimates had been below the Wall Street consensus, though, so the stock price declined substantially after the news was made public.  Sales advanced 32% to $158.1 million.  Earnings (excluding non cash stock option expense) rose 61% to $1.45 a share. For the entire year sales climbed 32% to $625.7 million.  Our estimate was $625 million.  Earnings finished at $5.75 a share (+64%), right on the mark. 

Q4 results were impacted by a sharp reduction in natural gas drilling caused by the warm winter.  That oversupply was exacerbated by a rapid build-up in production earlier in the year.  A lift in oil fracking offset part of the natural gas decline in the quarter.  Natural gas demand for Carbo's products is continuing fall, though.  And the company probably won't be able to keep ramping up oil market deliveries in the near term due to intrastructure problems.

That infrastructure build-out in the Dakotas is likely to start bearing fruit by mid-year.  Carbo is almost certain to benefit from the transition from natural gas to oil, once the company gets set up, because its superior technology works better on oil and the price of oil is apt to be less volatile since it's set by worldwide demand.  Natural gas prices tend to be affected by local supply and demand factors.  The company is building depots out west, and it's cultivating new and existing customers.  The technology already is well established.  Prospective customers are continuing to identify new drilling targets with computers.  And overall drilling costs are coming down with experience.

Chinese competition remains a threat of vague proportions.  Carbo is well positioned to deflect most attempts by the Chinese to break into the market.  Carbo is a domestic company and it understands how the oil patch thinks and operates, so it should stay ahead of the pack from a marketing standpoint.  Substantially lower costs naturally will attract attention, though.  And some shift to Chinese suppliers is bound to happen, especially in the natural gas segment where proppant quality isn't always a critical factor.  Chances are Carbo will become more of an oil play over time.  The company is aggressively developing lower cost proppant product lines, though.  It could remain a major factor in the natural gas area, as well.

Shale drilling remains in an early stage of development.  We've reduced our 2012 estimates to reflect the levelling off in oil drilling that's likely to occur in the first half of 2012.  Those logistical issues should be resolved by mid-year, opening the way for a resumption of above average growth extending well into the decade. Carbo also is developing several high potential software and spill containment product lines which could provide further leverage. 

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