Friday, March 30, 2012

Ellie Mae ( Nasdaq - ELLI ) -- Clear Sailing

Ellie Mae (ELLI $11.00) appears on track to report excellent on target Q1 results.  Industry mortgage volume topped forecasts in period, due to rising refinancing activity.  And the company's market share continued to widen, fueled by its "success based pricing" model.  Ellie Mae has been transitioning to that pricing format for the past two years, charging lenders for its software on a per-loan basis.  Some customers still employ the seat licensing model but a majority of revenue now is being generated by the variable approach.  Ellie Mae acquired its leading competitor in the technology space last year.  That integration has gone better than predicted.  Not only did Ellie Mae gain order flow, it also has been able to take advantage of a number of technology innovations.  No new competitors are on the horizon.  Plenty of fax-and-phone competition remains.  But Ellie Mae is steadily turning up the pressure, investing in additional software applications and communication networks.  It's services are likely to become increasingly cheaper, faster, and more accurate.

We're maintaining our (fully taxed) 2011 earnings estimate at $.25 a share.  Ellie Mae is ramping up employment and infrastructure spending to separate itself from the pack even further.  So even though mortgage volume might exceed industry forecasts this year all that spending probably will prevent margins from expanding much beyond our target.  Significant leverage is possible in 2013.  Average revenue per mortgage is likely to keep climbing.  The number of deals per customer is likely to improve, as well, as users essentially throw away their fax machines and go entirely electronic.  If the Government implements a mortgage re-write program further gains could be realized. 

The housing industry remains at extremely depressed levels.  Even if it never bounces back Ellie Mae promises to sustain above average growth by gaining market share, boosting revenue per transaction, and leveraging its fixed costs.  If housing activity returns to normal substantial further gains are possible.  A collaboration with Wells Fargo, which still is in early stage of development, could yield further impetus.

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Acacia Research ( Nasdaq - ACTG ) -- Raising Estimates

Acacia Research (ACTG $41.50) appears on track to produce booming Q1 results.  That trend could continue in subsequent quarters.  The company spent $160 million to acquire several patent portfolios (Adaptix) in the December period.  As part of that process Acacia negotiated substantial licensing deals with Microsoft and Samsung, which were consummated the first week of January.  Acacia had previously signed "structured contracts" with both companies, umbrella deals that provide access to a large amount of intellectual property that Acacia controls or might gain control of in the future.  The Adaptix patents fell outside of those protections.  In February Acacia announced that it already had generated licence income (revenue) of $75 million in Q1.  A large slug of that is believed to have come from the Adaptix deals.  Acacia hasn't signed any more Adaptix licenses since the Microsoft and Samsung contracts.  Those deals probably were arranged on friendly terms, in light of the companies' past relationships, future business opportunities, and the potential leverage the agreements created against other infringers.  Subsequent to the February announcement Acacia has delivered a drumbeat of additional deals, including a recent one with Amazon.  The company still hasn't gotten anywhere with Apple Computer.  That's the biggest infringer of them all, with billions of dollars on the table.  "You can run but you can't hide."  As they say.  Meantime, business is continuing to gain momentum.  New patent portfolios are being acquired.  A major acquisition is in the pipeline.  Competition is declining.  Infringement is increasing.  And large patent holders are becoming more active in trying to monetize their holdings.  Some of them will do it in-house but a growing number are kicking the tires to go partners with Acacia Research.

We are increasing our (fully taxed) 2012 earnings estimate from $1.25 a share to $1.50 a share.  Our revenue estimate also is going up, from $275 million to $325 million.  Neither reflects any contribution from the acquisition Acacia currently is working on, which might generate more firepower than the Adaptix deal.  The company completed a private placement in February to finance the acquisition.  Our earnings estimate includes that dilution but none of the prospective upside. 

The pace of patent acquisitions is accelerating.  Acacia pushed aggressively into the medical device area in 2011.  Recent diversification efforts include automobiles and energy.  In the past Acacia always was a little pressed for capital, so it insisted on 100% payments when infringers agreed to pay a license fee.  Now that liquidity is higher the company is starting to arrange payment terms, spreading out income over a period of time.  Acacia also is negotiating a higher percentage of deals without going to court.  That promises to smooth out quarterly revenue, as well.  Huge spikes are likely to persist, however.  Amplifying that trend is the likely re-focus by the company on "structured deals."  Acacia backed away from those arrangements last year as the intellectual property market took off.  The company didn't want to lock itself into deals that undervalued the intellectual property involved.  Now that valuations have stabilized a new round of structured deals could be in the cards. 

We estimate earnings will keep rising at a fast pace in 2013.  A larger patent portfolio combined with more out of court settlements, less competition, and more structured deals could propel (fully taxed) earnings to $2.25 a share.  Above average growth could be sustained well into the decade.

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Wednesday, March 28, 2012

Simulations Plus ( Nasdaq - SLP ) -- Proof in the Pudding

Simulations Plus (SLP $4.25) reported a remarkable degree of success with a demonstration project.  The company is a leading provider of simulation software used by pharmaceutical companies to identify promising drug candidates.  The technology enables scientists to try large numbers of prospective molecules against specific disease targets.  Those tests need to be done in the laboratory otherwise, a slower and more expensive process.  Simulation Plus's systems measure a variety of practical issues, as well, like how successful the drugs will be traveling through the stomach.  Despite the high potential, adoption rates have been grudging throughout the pharmaceutical industry.  In an effort to accelerate demand Simulations Plus recently conducted a test of its own, running its software to identify promising candidates to treat malaria.  Seven potential molecules were selected.  Those designs were sent to an independent laboratory, which manufactured them. 

Four out of the first five tested showed positive results.  The final two molecules still are being produced and will be tested shortly.  One of the created molecules showed particularly strong efficacy, potent enough that it could be considered for further testing as a therapeutic agent.  The others probably aren't going to be commercialized.  But as a demonstration of the technology, those molecules provide a lot of supporting evidence that the company's software in fact does zero in on specific targets.  Simulations Plus thinks the final two molecules, which are still being synthesized, could prove even more effective.

Conceivably, the test could result in a malaria treatment.  That's a real possibility based on the initial results.  Even if that doesn't happen the fact that a bunch of software engineers could come that close on a lark could open some eyes to the technology.  Simulation has penetrated less than 5% of its potential market to date.  This is a compelling story that could help Simulations Plus accelerate its sales growth.  At present the company is expanding license income about 15% annually.  Comparisons are skewed because it sold off a non core subsidiary last year.  That unit operated around break even, so earnings comparisons are okay.  But that operation did generate about 25% of total revenue through the end of fiscal 2011 (August).  So sales numbers will be convoluted through end of the current fiscal year.

If nothing else, we think consulting revenue will increase.  Hence our 20% revenue growth target for fiscal 2013.  Simulations Plus has a third leg of the stool coming on line, moreover, so faster expansion is possible.  The company has been collaborating with the F.D.A. to computerize toxicology testing and analysis.  The Government itself may walk away from the project.  But if the technology is productive there's a good chance personal care, food, and drug producers might implement the software to minimize risk.

Simulations Plus recently implemented a $.05 a share quarterly dividend.  That provides a nice underpinning to the stock price.  Better than that is the company's 95% renewal rate.  The only renewals it doesn't get are companies that get bought out or go out of business.  Cloud computing companies are in high popularity these days, not because of the technology, but because of the pricing model.  Simulations Plus lets its customers use the software on-site.  But it does price like a cloud company (one-year subscriptions).  Unlike most of its compadres, Simulations already has reached profitability.  In fact, pretax margins now are running at about 50% following the sale of the non-core business.

Management owns 40% of the stock.  These shares have the potential to rise substantially from current levels.

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Saturday, March 3, 2012 ( Nasdaq - STMP ) -- The Empire Strikes Back (STMP $25.00) reported excellent on target Q4 results.  But the company indicated that its rate of growth probably would moderate in 2012. effectively penetrated the small and medium sized business market last year.  The company's traditional consumer operation has been leveling off for several years, though, mainly because individuals use the U.S. Postal Service less than they used to.  The office market was picking up the slack, along with a boost in high volume shipping accounts. created a substantial backlog of commercial accounts, frequently consisting of large companies with branch offices scattered around the country.  Those deals came on line, by and large, when existing contracts to use Pitney Bowes postage meters expired.'s Internet download service provided a significantly less expensive alternative.

The churn rate in the consumer segment is threatening to increase.  So is planning to boost marketing efforts to retain existing users and replace the ones that leave.  That spending is likely to affect profit margins in the short run.  More ominous is Pitney Bowes's development of a competing Internet service.  That program hasn't been formally introduced yet.  But the market leader did recently hire a former marketing executive to lead the charge.  Longer term, the new strategy at Pitney Bowes could work to the company's advantage by shifting the whole industry to an Internet format.  For now, though, it probably will become more difficult to persuade Pitney Bowes customers to switch vendors.

We have reduced our 2012 earnings estimate by 14% to $.90 a share (fully taxed).  We have lowered our sales estimate by $10 million, as well, to $115 million.  Those figures could be revised upward if's enhanced marketing program delivers strong results, or Pitney Bowes either drags its feet or fails to launch a competitive service.  The stock is likely to be a lackluster performer until some clarity emerges.

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Friday, March 2, 2012

Boingo Wireless ( Nasdaq - WIFI ) -- Captain Data Crunch

Boingo Wireless (WIFI $9.50) reported excellent Q4 results, higher than what we estimated.  Earnings (excluding the customary non cash charges) increased 5x to $.10 a share.  Sales widened by 21% to $25.9 million.  Boingo is the leading provider of private WIFI networks.  The company also sells subscriptions to individuals so they can access the company's affiliates around the world.  Those deals price out around $8-$10 a month and let mobile phone, tablet, and laptop users access more than 425,000 WIFI hotspots that otherwise would be off-limits because they required a password.  Revenues are divided about 50%-50%.  The private network market is growing faster at the moment.  Boingo is building WIFI networks for restaurant chains, arenas, shopping malls, and other consumer oriented facilities.  Every deal is different.  Boingo itself collects income based on traffic volume.  Sometimes the facility pays the freight, allowing its customers to use the WIFI without charge.  Other times users have to pay a fee of some kind.

Growth is accelerating because the cell phone companies can't keep up with demand.  Back in the old days most operators thought they were minting money by selling unlimited data access at $25 a month.  Now that video downloads are becoming more widespread, that equation no longer solves.  Limits are being applied, driving customers to free non-cell WIFI networks.  Those networks aren't actually free, of course.  Starbucks or whatever provider it is has to pay Boingo for the cost of delivering the goods, plus a profit.  But the incremental cost is acceptable and the trend is likely to continue.

Bigger gains are possible if the mobile carriers sign explicit deals with Boingo.  Up to this point it's all been pretty loosey goosey.  But most cell phone companies are getting swamped with data traffic.  Deep packet inspection companies like Allot Communications are enabling them to implement more profitable pricing models.  Boingo is likely to benefit, as well, by keeping the networks going.

We estimate 2012 fully taxed income will reach $.35-$.40 a share.  After that, it will be interesting to see.  Further gains of some magnitude are virtually certain.  But the company still has some cards to play before it hits the big time.  Boingo is the industry leader, so the potential looks good.  In 2-3 years income could attain $.75 a share. Applying a P/E multiple of 20x suggest a target price of $15 a share.  Boingo is a small company with a key position in a gigantic industry.  A substantially higher result is possible.

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Thursday, March 1, 2012

Healthstream ( Nasdaq - HSTM ) -- Preparing for National Health Care

Healthstream (HSTM $20.00) reported excellent on target Q4 results.  Healthstream is the leading provider of Internet based training software for health care workers.  The company also operates a research service that helps hospitals identify their strengths and weaknesses.  Healthstream controls 45%-50% of the U.S. health care training market.  Most of its competition is provided by classroom instruction and disk based computer courses.  The company spent the past decade perfecting its authoring tools and delivery systems.  Those enabling technologies attracted the industry's leading content providers, who now earn handsome royalties from Healthstream's wide-ranging customer base.  Other on-demand software companies participate in the health care segment.  Those providers are general purpose technology companies that address a wide variety of industries.  Healthstream focuses on health care exclusively, which helps on the marketing front in addition to content acquisition and management.

Revenues improved 24% to $21.9 million in the December quarter.  Non-GAAP earnings improved 33% to $.08 a share.  The research survey business grew by a modest 9% and accounted for 29% of the total.  The key learning operation showed a 31% improvement and represented the balance.  Healthstream reinvigorated its research business during the last two years but that segment probably will level off somewhat.  The company ties those surveys in with its learning products, so as more customers are added the overall number of surveys promises to climb.  But unlike the learning unit same-store growth probably won't expand much.  Existing customers are increasing their learning business with Healthstream on a regular basis as products are enhanced, new courses are introduced, and more employees are hired.  Pricing has remained steady.  Revenue gains primarily are being driven by higher volume.

New simulation products offer substantial potential.  Most hands-on training currently is performed on mannequins or other students.  A joint venture with Norway based Laerdal is combining computerized dummies with the Internet to create measurable feedback so performance can be accurately assessed.  That project was in development for most of 2011 and was commercialized on a limited basis in Q4.  Revenue contributions are likely to be modest in 2012, as well, as the inventory of lessons builds up and marketing efforts expand.  Major contributions could emerge in the following year.

Software designed to teach administrative personnel how to deal with the new health care law holds additional leverage.  Procedures and codes are slated to change.  A plethora of other regulations will start to take effect in 2013, as well.  Healthstream now is developing the required software with its many content partners to facilitate the process.  Some cannibalization is possible but most of the upcoming products are likely to generate incremental revenue.

A recent stock offering bolstered Healthstream's financial position.  Internally generated cash flow has been sufficient to finance growth to date.  That trend probably will continue.  The additional funds likely are targeted for acquisitions.  Technology enhancements, specialized content, distribution, and international expansion are possibilities.  Absent a deal 2012 income growth will be slowed by the dilution stemming from the offering.  We estimate earnings will rise 18% to $.40 a share.  If Healthstream invests the money well and reestablishes its traditional return on equity metrics income could move up into the $.60 a share range.

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Pros Holding ( NYSE - PRO ) -- Pricing Technology Leader Builds Momentum

Pros Holding (PRO $17.00) reported excellent on target Q4 results.  Earnings (excluding non cash stock option expense) rose 37% to $.11 a share.  Revenues climbed 30% to $26.2 million.  Income was held back by the launch of the company's cloud based service for mid-market customers.  In the past Pros focused primarily on Fortune 1000 corporations.  The new line is priced lower to begin with.  It also will generate revenue on a month to month subscription basis.  So the build up in incremental sales will be gradual.  Demand for Pros's enterprise products remained robust in the period, propelling backlog to $124 million.  Existing customers placed new orders for affiliated business units.  And new customers continued to sign up, both in core applications and emerging industries and geographic markets.

We are raising our 2012 earnings estimate by a nickel to $.50 a share.  A higher tax rate will prevent income from advancing at an even faster pace.  Marketing and product development costs will be hiked, as well.  And the cloud based product line will impact margins in the short term, too.  Longer term, margins are likely to expand as volume builds.  Sales are poised to keep growing at above average levels.  In 2-3 years earnings could reach $.75-$1.00 a share on sales of $175-$200 million.

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