Tuesday, July 24, 2012

Healthstream ( Nasdaq - HSTM ) -- Market Share Keeps Expanding

Healthstream (HSTM $27.00) reported excellent on target Q2 results.  Earnings advanced 12% to $.09 a share despite 18% greater average shares outstanding.  The company sold stock earlier in the year.  Sales climbed 23% to $25.8 million.  The learning segment expanded 34%, accounting for most of the increase.  Healthstream also provides surveys and related research services, which experienced an unanticipated slowdown in the period.  The core learning segment is gaining as hospitals realize that computer based systems improve employee performance, reduced costs, and enhance compliance.  New subscriptions beat the company's target in the period.  Average order size expanded.  And backlog widened, laying the foundation for further gains in the future.  More high level content providers joined Healthstream's distribution system.  The company uses its platform to distribute that know-how to hospital employees. 

The long term outlook remains positive.  Healthstream controls about 50% of the U.S. hospital market.  That share is poised to keep expanding as more content providers are added and marketing efforts are enhanced.  New products are rolling out.  A joint venture with Norway based Laerdal Medical could provide substantial leverage.  Ultimately, Healthsteam is well positioned to help the U.S. medical industry improve productivity through computerized instruction and other automation technologies.  Expansion into related markets like surgery centers could reinforce growth.  International opportunities provide further potential.  The stock is trading at a high price in relation to earnings.  But Healthstream remains a small company with key advantages in an enormous industry.  Further appreciation is possible.

( Click on Table to Enlarge )

Friday, July 20, 2012

Acacia Research ( Nasdaq - ACTG ) -- Outlook Becomes Uncertain

Acacia Research (ACTG $35.00) reported Q2 results that were below our expectation.  The company's deal flow continued to accelerate.  It also acquired a substantial inventory of new patents to enforce.  A major settlement with Cisco Systems yielded less money than expected, though.  We had raised our estimates earlier in the year in anticipation of that deal, plus some additional large agreements that are in the pipeline.  In the past Acacia Research licensed virtually all of its patents when it made these so-called structured transactions.  Previous deals were made with Oracle, Microsoft, and Samsung.  This time only a portion of Acacia's portfolio was included, yielding a smaller one time payment.  Even so, earnings came in at $.21 a share on sales of $50.5 million. 

We are maintaining our full year earnings estimate at $1.65 a share (excluding stock option expense).  Margins on Acacia Research's regular business continue to improve as fewer cases are resolved in court, reducing litigation costs.  More revenue is being produced by the company's fully owned patents, as well.  Historically, Acacia Research partnered with small patent holders, dividing the winnings after deducting expenses.  When the company enforces patents that it owns by itself, all the proceeds are retained.  We have reduced our revenue estimate, however, by $25 million to $300 million, to reflect the smaller structured settlement payouts.

The long term outlook remains generally positive.  One reason Acacia Research agreed to its arrangement with Cisco Systems was to establish a business relationship where the two companies would enforce Cisco patents against other corporations.  The details of how that will play out remains to be seen.  But the deal could serve as a template for additional Fortune 500 partnerships. 

Serial infringers like Apple Computer are trying to persuade the U.S. Congress to reduce their liabilities.  The big cell phone maker recently won a surprising court verdict in a case brought by Eastman Kodak, as well.  It remains to be seen if that decision (which also included Nokia) sets a meaningful precedent.  Acacia Research earns a lot of its current income from wireless patents.  If that intellectual property becomes more difficult to enforce income could be affected negatively.

We estimate 2013 income will advance 36% to $2.25 a share.  Above average gains appear achievable well into the decade.  Those figures assume the company's patent inventory has not been impaired by Apple Computer's recent court victory.

( Click on Table to Enlarge )

Monday, July 16, 2012

Healthstream ( Nasdaq - HSTM ) -- Supreme Court Ruling Solidifies Outlook

Healthstream (HSTM $26.25) appears on track to report excellent on target Q2 results.  The company has accelerated spending on sales and marketing to amplify future performance.  So margins may narrow a bit.  Healthstream also sold stock earlier in the year, increasing dilution.  Earnings comparisons are likely to be muted as a result.  Momentum is likely to build in subsequent periods as new products start contributing, market share expands further, and Healthstream's complementary research services perk up again.  A recent acquisition isn't likely to boost results materially, although the software obtained promises to reinforce the company's current line up.

The Supreme Court decision to uphold the Affordable Care Act promises to boost demand.  Most of Healthstream's sales currently are generated from hospitals that use the technology to train personnel.  More patient traffic at those facilities promises to reinforce what already is an upward trend in demand.  Our estimates are unchanged.  New products and acquisitions hold the potential for faster growth in future periods.

( Click on Table to Enlarge )

Simulations Plus ( Nasdaq - SLP ) -- Higher Costs Hit Earnings

Simulations Plus (SLP $4.00) reported reasonably good Q3 (May) results.  Year to year comparisons were impacted by the sale of a non core subsidiary earlier in the year.  Revenues declined on an as reported basis due to the spin off.  The remaining pharmaceutical simulation software line exhibited a 6% increase to $2.77 million.  License sales rose 15% and represented virtually the entire amount.  In the year earlier period the company also generated some consulting and grant income, which wasn't replicated this year.  Almost all of Simulations Plus's software licenses are sold on an annual basis, creating a predictable recurring revenue stream.  Renewal rates typically are in the 95%-100% range.  The occasions when licenses aren't renewed relate to customer mergers, facility relocations, and employee job changes.  Even then, the deals tend to reemerge elsewhere as new business.  Margins narrowed somewhat in the quarter as a result of higher R&D spending.  Marketing and sales costs advanced, too.  And overhead was spread over a smaller revenue base, due to the subsidiary divestiture.  All the same, pretax margins were 47.8% in the period (excluding non cash stock option expense), far above the industry norm.

Earnings fell 29% to $.05 a share.  Besides the margin contraction, income was affected by a higher tax rate, as well.  The fourth quarter (August) usually is the company's weakest from a seasonal standpoint.  Activity tends to moderate over the summer.  A solid year to year comparison is likely, though.  For the entire year we estimate income will advance 11% to $.20 a share on sales of $10 million.

Next year faster growth appears achievable.  Software gains of 15%-20% are possible as drug companies endeavour to lower research costs.  Collaboration revenue could provide an additional 3%-5%.  And while consulting revenues have gone virtually to zero, meaningful improvement is likely in the aftermath of the company's self funded malaria project.  Simulations Plus took on that project to demonstrate its software's ability to identify promising drug candidates without any physical testing to accompany it.  The technology identified nine prospective molecules, all of which showed activity against malaria.  Pharmaceutical companies could hire out the company's experts to provide similar jump starts on their own projects.

Income could hit $.25 a share (+25%) next year on sales of $12 million (+20%).  A new product will be launched early in the fiscal year, which could yield further leverage.  Acquisitions also could be employed to leverage the company's broad distribution network.  The cash dividend is likely to be maintained at $.05 a share per quarter, delivering a 5% yield.

( Click on Table to Enlarge )

Tuesday, July 10, 2012

Ansys ( Nasdaq - ANSS ) -- Macroeconomic Headwinds

Ansys (ANSS $58.00) appears on track to report excellent on target Q2 results.  The company is the leading provider of engineering simulation software used in a wide range applications.  Sales are geographically diversified.  About 75% of revenues are recurring, as well.  New orders have been expanding at a 10%-15%, with an incremental boost provided by a recent acquisition.  Margins are being sustained at exceptional levels, providing plenty of ammunition for further transactions.  Organic growth may moderate slightly in upcoming periods due to slowing economic growth in the United States and Europe.  Asian demand remains robust, though.  And even in the more mature regions demand remains solid because companies require the expertise to stay competitive.  Above average gains are likely to be maintained in 2013 even if the economic slowdown lingers.  Our estimates are unchanged.

( Click on Table to Enlarge )

Monday, July 2, 2012

Argan ( NYSE - AGX ) -- Powers Up

Argan (AGX $13.75) is a leading producer of next generation electricity power plants.  The company has a proven track record of bringing natural gas and a variety of green energy facilities on line, usually earning bonus payments for timely completion and on-budget performance.  Electricity demand is rising in the United States despite the poor economy.  Much of that is due to growing computerization, greater air conditioning use, and the proliferation of electronic appliances.  Argan's performance has fluctuated in recent years due to the ebb and flow of government subsidies, which have been instrumental in moving green energy projects to fruition.  The company was an early participant in natural gas facilities, though.  That segment has kept profitability intact despite the government ups and downs.  Utilities have been shuttering coal and nuclear sites, moving instead to that abundant low cost fuel.  A recent deal to build two plants right in the middle of fracking country promises to lift results substantially over the next two years.  Performance could continue to surge if the economy starts to recover, and solar power achieves grid parity as expected in 2015.  The ability to meet rising electricity demand with low cost and low greenhouse gas facilities promises to drive earnings sharply higher through the end of the decade.

The weak economy is holding back the industry's development.  Electricity demand is predicted to expand 2x the rate of GDP growth under normal circumstances.  Since 2008 demand has climbed but growth has been below the long term trend line.  New construction has been driven primarily by expiring subsidies and replacement needs.  Argan encounters stiff competition under the current scenario.  Many contractors underbid projects to keep their own teams working.  But they don't pay their subcontactors.  Argan has a great record.  But a major acceleration is unlikely until the industry's economics recover.

Backlog stood at $415 million as of January 31st.  That was reduced by first quarter (April) revenue of $57.7 million.  (Argan also operates a  non core subsidiary that generated sales of $6.0 million during the period.)  A natural gas facility in California accounted for $268 million of the backlog.  Most of the rest was related to a wood chip burning operation in Texas.  In the past Argan has installed a variety of wind, solar, and biomass systems.

Argan is working to get the necessary permits and approvals to build two major natural gas facilities in Pennylvania.  The company is helping to finance the operator ("Moxie"), which plans to set up shop next to a major natural gas field and sell the elctricity into the northeast grid.  Argan recently agreed to front more money (a total of $9 million) in exchange for greater operational controls.  The ultimate contract could be worth $750 million to $1.0 billion. 

The upcoming presidential election is creating uncertainty.  The Democrats oppose natural gas because its low price undercuts other green energy options.  The Republicans curry favor with coal and nuclear interests.  Either way, we believe the United States will go with the best price performance option.  Argan is well positioned to thrive as natural gas and solar become larger contributors to the electricity mix.  We also believe the economy is capable of booming over the next decade, forcing utilities to expand generating capacity immensely. 

In 2-3 years income could reach $2.50 a share.  Applying a P/E multiple of 12x suggests a target price of $30 a share, potential appreciation of 120% from the current quote.  If electricity shortages ever become a concern, a substantially higher valuation could emerge.

( Click on Table to Enlarge )