Healthstream ( Nasdaq - HSTM ) -- Margin Haitus

Healthstream (HSTM $23.00) reported solid Q1 results.  Revenues advanced more rapidly than expected, rising 28% to $23.7 million.  Earnings declined 25%, however, to $.06 a share (excluding non cash acquired amortization and stock option expense).  Dilution from a 3.6 million share public offering last November accounted for two-thirds of the earnings setback.  An annual customer conference represented the balance.  That meeting occurred in Q2 last year.  Operating margins were affected by higher employee costs.  That spending is likely to pay dividends in the future.  Product development efforts were accelerated.  Sales and marketing were expanded, as well.  Still, margins are unlikely to rebound materially in upcoming quarters.  Absent that leverage 2012 income is likely to be relatively flat with the year before, due to the offering's dilution.  We are reducing our full year estimate by a nickel to $.35 a share, accordingly. 

The long term outlook remains favorable.  Organic revenue growth is likely to be sustained at a 20%-25% rate well into the decade.  A simulation based joint venture promises additional impetus.  And the cash horde obtained from the offering could be applied towards accretive acquisitions.  Until those inflection points are realized these shares may trend in a sideways manner, though.  Downside risk is limited by Healthstream's own appeal as a potential takeover candidate.

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Acacia Research ( Nasdaq - ACTG ) -- Ready for Blast-Off

Acacia Research (ACTG $40.00) reported excellent on target Q1 results.  Fully taxed earnings jumped 154% to $.99 a share (excluding stock compensation expense).  Revenues improved 62% to $99.0 million.  Margins improved because a higher proportion of revenue was generated by Acacia's own licenses, rather than 50-50 partnerships.  Historically the company earned most of its money by teaming up with small inventors.  As its financial reserves have grown Acacia increasingly is investing those funds in patent portfolios of its own, enabling it to retain all of the proceeds when a license is signed.  Margins also benefited from more out of court settlements, which reduced legal outlays.

Several intellectual property acquisitions are in the pipeline.  Acacia normally arranges a few large settlements at a modest discount when it obtains patents for its own account, to minimize risk.  So further acquisitions could presage another near term revenue surge.  Volume in the company's normal course of business also is climbing as patents obtained over the past few years -- both owned and partnered -- start to be enforced.  It usually takes 1-2 years for Acacia to prepare a new portfolio for commercialization.

Large structured transactions could return to the scene, as well.  In the past Acacia has licensed big chunks of its patent inventory in return for large one time payments.  Last year when patent values escalated the company held off on making new deals for fear of underpricing them.  Values now have stabilized, creating a greater likelihood of agreements being reached.

We are raising our 2012 earnings estimate by 10% to $1.65 a share.  Next year $2.25 a share remains a realistic target.  Acacia has penetrated only a small portion of its potential market to date.  And that potential is likely to expand as more intellectual property is brought in house.  In 2-3 years these shares could reach $100 a share.

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Simulations Plus ( Nasdaq - SLP ) --

Simulations Plus (SLP $4.35) reported excellent on target Q2 (February) results.  Earnings were flat with the year ago period at $.06 a share.  Several one costs were incurred during the quarter associated with the sale of a non core subsidiary, and the pursuit of an acquisition which failed to materialize.  Comparisons were skewed by the absence of the sold off division.  Sales from continuing operations posted a 6% increase.  The company's entire product line was being prepared for an upgrade in the quarter.  That probably impacted new business somewhat.  Those new releases are slated for introduction in Q3 (May).  Our full year estimates assume a fairly level showing compared to the first six months.  But a stronger performance appears possible.

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Napco Security Systems ( Nasdaq - NSSC ) -- Computerizing Home Security

Napco Security Systems (NSSC $3.00) is a leading provider of home security products, which are re-sold by distributors and local installation companies.  The company has developed relationships with most of the industry's leading re-sellers.  In the past the company focused primarily on standard access control and alarm systems.  At the peak of the market in 2008 Napco purchased a leading lock manufacturer ("Marks"), which expanded its product line but saddled the company with debt obligations.  Napco was able to keep its head above water while sales nosedived during the recession, helped by a low cost manufacturing base in the Dominican Republic.  Well established relationships with major dealers like ADT enabled Napco to maintain pricing and market share, as well.  The Dominican operation also provides for a reduced tax rate.  Most of Napco's competitors retrenched during the downturn to conserve capital and wait for better days.  The company took the opposite approach.  Product development activities were accelerated.  Marketing programs were broadened.  The company now is launching a series of computer-based products that promise higher profit margins, broader customer adoption, and potential cross marketing opportunities.

A wireless communication device offers the greatest immediate potential.  In the past most home security systems sent alarms to police and other monitoring stations using conventional telephone lines.  A rising number of households don't have landlines any more.  Napco recently introduced a wireless transmitter to fill the void.  Those devices also make it impossible for thieves to cut the phone line before going in.  Napco's system costs significantly less than competitive wireless offerings, providing attractive margins for its re-sellers.  They also usually generate recurring revenue that is divided between Napco and the re-sellers.  Unit volume has been doubling every quarter since the product line was launched last fall.  A remote monitoring package holds equally large potential.  That software enables customers to control their house from a cell phone, performing tasks like turning the heat up and down, managing the lights, and watching what's happening through a series of webcams.  As more appliances become computerized that technology could become increasingly popular.  A television advertising campaign featuring NCIS's character Timothy Magee (the geek) is reinforcing consumer demand.

Commercial demand is advancing, too.  Napco integrated its fire and security systems into a single package to simplify installation and management.  It also upgraded the locking systems obtained in the 2008 Marks acquisition.  The expertise required of its commercial offerings is being transferred to Napco's consumer products in a systematic fashion, moreover, driving quality up and costs down.

Earnings are on the upswing.  We estimate non-GAAP income (which excludes acquired intangible amortization and stock option expense) will double in fiscal 2012 (June) to $.25 a share.  Next year $.40 a share represents a realistic target.  Margins promise to keep widening as volume climbs in subsequent periods.  We estimate income will approach $1.00 a share within 2-3 years on sales of $100 million.  Applying a P/E multiple of 15x to those earnings suggests a target price of $15 a share, potential appreciation of 400% from the current quote.

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