Friday, August 9, 2013

Ellie Mae ( Nasdaq - ELLI ) -- Builds Momentum

Ellie Mae (ELLI $30.00) reported excellent on target Q2 results.  Earnings advanced 33% to $.24 a share (fully taxed).  Revenues gained 45% to $34.3 million.  Average shares outstanding increased 21%, mainly as a result of last year's public offering.  Margins improved despite accelerated spending on sales, technology, and customer support.  Ellie Mae originally had planned to add resources evenly throughout the year.  It decided to speed up the program to reinforce the company's competitive advantage.  Ellie Mae is the industry leader by a substantial margin.  It's market share is continuing to widen as existing customers add more users and new customers are acquired from competitors.  Financial performance is being bolstered as more services are provided per loan, and users of the company's legacy on-site products switch to superior on-demand versions, which generate higher margins.  Even if total industry mortgage volume declines in upcoming periods Ellie Mae is likely to maintain a superior rate of growth.  Market share gains combined with rising revenue per loan promise to keep performance intact.  The company also is developing relationships with large banks to create a standardized format for handling mortgage applications.  Those banks will continue to perform the actual processing.  But Ellie Mae will earn usage based fees on that order flow.  As the big banks force their constellation of data providers to use Ellie Mae's format, the company's software customers will more easily integrate with those providers, as well.

Our 2013 estimates are unchanged.  We estimate income will reach $1.00 a share (+33%) on revenues of $135 million (+33%).  Next year earnings could attain $1.35 a share on sales of $175 million even if industry volume contracts in response to higher interest rates.  In 2-3 sales could reach $250-$300 million as average revenue per loan expands to $250 from $125 today.  That probably would require some acquisitions of data providers, like appraisals.  Most of that information currently is purchased separately by the company's customers who generate the complete mortgage application.  Ellie Mae has ample cash reserves to make several deals like that.  The company could establish royalty arrangements instead, reducing risk but also limiting profit potential.  Assuming the royalty strategy is the dominant one, margins probably would remain similar to where they are today.  In 2-3 years income could hit $1.75-$2.25 a share under the latter scenario.

Ellie Mae's leading market share in mortgage origination software might leverage a larger corporation's performance.  The company has been approached on a regular basis in the past by banks, data providers, servicing companies, and technology suppliers as a prospective acquisition target.  In light of the company's low risk profile, high cash generation, and international potential Ellie Mae could command a price of as much as $50 a share, in our view.  Rumors are circulating that the process might be underway.


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Saturday, July 27, 2013

Simulations Plus ( Nasdaq - SLP ) -- New Product Momentum

Simulations Plus (SLP $4.50) reported good on target Q3 (May) results.  Sales improved 12% to $3.09 million.  Earnings rose 17% to $.07 a share.  Demand for consulting services increased most briskly, benefiting from the company's in-house malaria project.  Last year Simulations Plus conjured up seven molecules to treat malaria using its software, without any laboratory testing at all.  All of the drug candidates generated by the software showed activity in subsequent testing.  That demonstration caught the attention of several pharmaceutical makers who are trying to cut R&D costs and improve their pipeline.  More hired Simulations Plus to help implement the process.

Margins on product sales remained elevated.  Simulations Plus sells its software on an annual basis.  The renewal rate typically is 95% or higher.  That measure dipped in the first (November) quarter due to a series of customer mergers.  Some licenses don't renew when individual scientists who use the software move to new positions or retire.  Absent corporate reorganization factors, virtually every license renews each year, creating a rising recurring revenue stream as new customers are added.

Product upgrades and expansions promise to accelerate growth.  A collaboration with Bayer recently was completed, creating a sizable new database to sell.  The key GastroPlus line recently was upgraded, as well.  Pricing changes could implemented soon, too, enabling the company to penetrate niche markets more easily.  A general hike also is possible.

We estimate income will advance 15% next year to $.23 a share.  That assumes a rising level of selling expense and R&D outlays.  Faster gains are possible if revenue gains outpace the cost increases.


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Thursday, June 27, 2013

Cyanotech ( Nasdaq - CYAN ) -- Barrels Back

Cyanotech (CYAN $5.75) reported excellent on target Q4 (March) results.  Sales improved 15% to $6.90 million.  Earnings (fully taxed) advanced 80% to $.09 a share. Figures published by the company also included a non cash deferred tax asset adjustment worth $.34 a share.  Production issues that created a setback of $.14 a share for the year were resolved during the period.  Output has been maintained at full capacity in the June quarter, moreover.  The company thinks the problems are unlikely to reoccur.  That differential alone accounts for most of the earnings improvement we are estimating for fiscal 2014 (March).  Revenues promise to advance by 20% as well to $33 million as volume rebounds and average selling prices increase.  Cyanotech traditionally sold most of its astaxanthin and spirulina in bulk for use in other companies' retail products.  Over the past few years Cyanotech has developed its own retail brand, gaining a 50% market share in the segments it serves.  Those programs are being expanded, laying the groundwork for further gains.  On average retail sales generate 200% more revenue per kilogram than bulk shipments.  Approximately 40% of the company's physical output now is sold through retail channels.  Margins could widen as the transition continues.

Capital spending is on the rise.  Several growing ponds were modified last year to produce astaxanthin, Cyanotech's fastest growing product line.  An extraction facility also is being built, to remove the key ingredients from the algae grown in the ponds.  Currently, the material is shipped to outside vendors who perform the work.  Plans are being developed to increase the number of ponds, as well.  Cyanotech borrowed money to finance the first round of capacity improvements.  If the sales and profitability outlook remains bright a stock offering could be pursued in the future.

Legal costs reduced income by $.06 a share in fiscal 2013 (March).  Cyanotech was sued for patent infringement a few years ago.  The company researched the claim and unearthed a litany of errors, casting doubt on its validity.  Costs may continue to be incurred as the battle continues, perhaps for another two years.  But the data appear persuasive in Cyanotech's favor.  Our estimates reflect a similar hit to earnings in the upcoming year.

A variety of initiatives could accelerate growth.  A new round of media publicity could bolster demand if an upcoming book about astaxanthin's benefits builds momentum.  Direct television marketing will be tested, as well.  A blitz in San Diego will be tried, in addition to that.  Cyanotech plans to duplicate the comprehensive marketing approach it already uses in Hawaii.  The 50th state is a huge user of Cyanotech's products with some estimates placing penetration at 10% of the adult population.  Success in San Diego could foreshadow a move into Los Angeles.

Cyanotech remains a high risk investment.  The nutritional supplement business is highly competitive, and consumer tastes can be whimsical.  Even well designed marketing programs can fail.  Capital requirements aren't astronomical but they are significant.  Very few companies make it big.  The ones that do succeed can make it really big, however.  Cyanotech has two exceptional products that are less vulnerable to competition than most supplements, because it has the best growing conditions and the best quality.  In 1-2 years earnings could reach $.75 a share.  Applying a P/E multiple of 20x suggests a target price of $15 a share, potential appreciation of 160% from the current quote.


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Xplore Technologies ( Nasdaq - XPLR ) -- Low Cost Android System on Schedule

Xplore Technologies (XPLR $3.50) reported good on target Q4 (March) results.  Sales declined year to year due to unusually large deliveries on a contract to ATT last year.  That relationship subsequently stalled when ATT had to pay a $4.0 billion break up fee after its proposed acquisition of Sprint fell through.  The giant carrier curtailed spending across the board.  A recent $1.0 million order for more rugged tablets in the current (June) quarter suggests a new round of buying is getting underway.  Business other than to ATT was robust in the March quarter.  All of that was generated by Xplore's ultra rugged tablet products.  Those units can withstand almost anything including 6-8 foot drops, vibration, dust and sand, and being submerged under water.  They also are designed to accommodate a wide range of specialized add-ons to customize the systems for particular industries and applications.

A new low cost Android line is slated for introduction on July 10th.  That unit will be far sturdier than consumer tablets like the iPad and Galaxy but won't be as highly engineered as the company's current offering.  Pricing is expected to be 50%-70% lower, potentially opening up substantial new market opportunities.  A dozen major enterprise customers are expected to test the Android unit in field trials.  Those tests could extend 6-12 months before broad based orders are placed.  A wide range of other customers are expected to purchase the systems, as well, laying the groundwork for a substantial near term revenue gain building to larger advances down the road.  Panasonic had developed a competitive system which has been plagued by mechanical problems.  But that company is the leader in rugged notebook computers.  So it's likely to win a large share of the market despite those issues due to strong marketing and software development.  Xplore's technology advantage promises to generate a strong showing, nonetheless, particularly among other computer companies looking for a rugged tablet to sell to their customer base.  OEMs that need a rugged system as a component in bigger systems are likely candidates, as well. 

A lower cost Windows system is tentatively slated for launch in January.  That product probably will cost more than the Android system.  But it could attract a bigger potential market because many large enterprises standardize on Windows.  Xplore's current ultra rugged system operates on Windows.

We estimate sales will advance sharply in the current fiscal year (March) to $50 million.  Fully taxed income could triple to $.30 a share.  Explosive gains could follow in subsequent periods as Xplore's two upcoming lines gain momentum and tablet computers replace notebooks and other devices in a proliferating range of applications.


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Sunday, June 16, 2013

Health Insurance Innovations ( Nasdaq - HIIQ ) -- Keeps its Edge

Health Insurance Innovations (HIIQ $10.00) launched a series of low cost ("skinny") policies last week.  The company is a leading provider of short term medical plans.  Those products generally provide the same coverage as conventional major medical insurance.  But they are exempt from regulatory features that tend to drive up prices like guaranteed issue (can't reject an applicant), guaranteed renewability, and mandated coverages (chiropractors, fertility clinics, etc.).  HII's prices are substantially lower as a result, particularly for young and healthy customers.  That group is slated to take it on the chin when the Affordable Care Act goes into effect in 2014.  The Government and the insurance carriers are trying to create the impression that anyone without medical insurance will have to buy it through an "exchange," or pay a steep fine.  Those products are designed to be way over-priced in relation to risk for healthy young Americans.  A loophole in the law is allowing the carriers to offer cheaper deals for that group, for 2014 only, by letting them sign up by December instead of in January.  The insurance companies began exploiting that provision in April, the idea being to get that healthy group on board now and then escalate the rates in 2015.

HII recently launched an even lower priced set of policies to thwart that competitive threat.  Coverages were reduced in response to the insurance companies' "skinny" offerings.  The main difference is a cap on daily hospital payments at $3,000 instead of the local "customary" rate.  Prices are about $80 a month for a healthy 30 year old man.  That's about half of what the insurance companies are offering today with their introductory pricing, and 25% of what a comparable exchange plan will cost down the road.

The latest initiative is likely to re-establish HII's sales momentum.  Margins are expected to be similar to the company's existing offerings.  Solid gains are likely this year and in 2014 as healthy consumers opt for the company's low cost policies.  With the new law, moreover, if a customer does come down with a catastrophic disease he can move to the exchange and buy a guaranteed issue plan.  That removes the one big negative that used to impact HII's business in the past.

There are two principal long term risks.  The first is that HII and the rest of the short term medical industry become too successful and the Government outlaws their business.  The other is a change in pricing by the Government so healthy people pay a number more consistent with their risk, like every other kind of insurance.  Neither appears likely to happen.  Even simple corrections to the law aren't being made due to political factors.  Major changes lie far in the future.  And it's likely that short term medical plans will prove to be a positive element in the overall scheme by getting more people covered.

Growth could be explosive as the new insurance environment takes effect.  In 2-3 years revenues could reach $175 million to produce income of $2.00 a share.  Applying a P/E multiple of 20x suggests a target price of $40 a share, potential appreciation of 300% from the current quote.


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Tuesday, June 11, 2013

Acacia Research ( Nasdaq - ACTG ) -- Government Poses New Threat

Acacia Research (ACTG $25.00) has endured regulatory pressure since Barack Obama was elected  in 2008.  The technology industry has been a bedrock supporter of the President.  He's returned the favor in a variety of ways, including legislation designed to provide a degree of protection from patent infringement claims.  The Administration recently announced another round of initiatives aimed at reducing the lawsuit threat.  It also sent a series of bills to Congress.  Acacia's stock price originally fell on the news.  The stock already was down 30% in the wake of last year's regulatory attack.  That legislation actually bolstered Acacia's competitive position, presaging the biggest intake of patent portfolios in the company's history.  The latest government efforts are likely to have a similar effect.  Acacia usually partners with the original patent holders to recoup royalty fees from infringing companies.  Giants like Apple Computer routinely complain when they have to pay those fees, claiming it impairs its creative spirit.  But large companies rarely conduct patent searches when developing new products.  Time to market parameters are too tight.  So they just go ahead and make the products the best way they can.  Frequently, the intellectual property rights of others are stepped on.  Companies like Apple normally wear down small inventors with expensive legal proceedings that extend for years.  Acacia teams up with those kinds of companies and individuals, providing the staying power to go the distance.  That tends to generate reasonable settlements.

Nothing is likely to change under the new regime.  The Obama Administration seems to be targeting frivolous lawsuits, often for small amounts of money that are cheaper to settle than defend in court.  Acacia normally has a high financial threshold when it takes on new accounts.  Small claims aren't worth its time any more.  In fact, many new partners are Fortune 1000 companies with extensive patent portfolios.  Key technologies they retain for themselves.  But a growing number are partnering with Acacia to generate a return on their non core patents.  The company has been expanding beyond the computer and communications area over the past few years, moving into medical, energy, and automotive in particular.  It usually takes 12-18 months to analyze a new portfolio and develop a strategy to monetize it.  Several large programs now are entering the royalty producing stage.

The outlook remains bright.  Rising cash flow probably will be reinvested in additional patent portfolios, dividends, and stock buybacks.


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Thursday, May 23, 2013

Professional Diversity Network ( Nasdaq - IPDN )

Professional Diversity Network (IPDN $5.00) is a leading provider of Internet based employment services.  The company specializes on Hispanic and African-American recruiting.  Less trafficked websites serve women, gay, military veterans, and disabled job candidates.   Organizations that seek to hire minority workers pay Professional Diversity annual fees to post their offerings on those sites.  Those deals also allow the organizations to search the company's resume database to find people with particular skills and backgrounds.  A variety of technical services are provided, as well, both for the hiring organizations and the more than 2.5 million job seekers that use the company's websites.  Revenues are augmented by advertising, primarily by on-line education provider Apollo Group.

A cushy deal with Monster recently was terminated by the company, allowing it to address a substantially larger potential market.  The on-line diversity recruiting industry is estimated to be $250-$500 million annually in the United States.  Demand is growing in response to greater regulatory requirements.  Federal hiring practices require "good faith" diversity hiring efforts.  Federal contractors are subject to similar rules.  Natural demand is expanding, moreover, as the U.S. population becomes more diverse.  Consumer oriented companies in particular need that expertise to serve increasingly complex markets.  The poor economy is dampening volume at present.  Still, many companies are expanding their diversity efforts to comply with stricter government regulations, bolstering the segment's growth beyond the pace of new hiring overall.

The Monster deal paid Professional Diversity $4.0 million a year as a fixed fee.  Monster did all the sales and marketing work under an exclusive contract with the company.  Professional Diversity handled the technical operations.  The company earned additional advertising income from Apollo Group.  That relationship has continued.  Apollo advertises on the company's websites, driving job seekers to its career development educational offerings.  Professional Diversity decided to end its relationship with Monster in 2012.  It's initial plan was to establish a direct sales force of its own and retain all of the income generated.  Its confidentiality agreement prevents the company from revealing how much was being left on the table with its Monster contract.  Professional Diversity has indicated, though, that the incremental amount was considerable.

A high potential deal with Linked-In was initiated in January, 2013.  Professional Diversity was approached by the social networking giant last fall.  Linked-In has become the largest job recruiting service in the country over the past few years.  But it doesn't have a specific application for diversity hiring.  Under the Linked-In deal Professional Diversity will receive $2.0 million a year in guaranteed payments plus additional fees based on volume.  The guaranteed payment covers the first $10 million of sales generated by Linked-In.  Anything above that produces an additional 20% commission to the company.  (Above $50 million that rate declines to 15%.)  Linked-In was given a restricted list of 1,000 customers that it has exclusive rights to.  About 200 of the Fortune 500 companies are on that list.  The remainder of the market is available for Professional Diversity to address directly with its own sales force.

Reported results will decline in 2013 during the transition.  Commission payments from Linked-In are deferred 60-150 days under the contract, except for the $500,000 per quarter guarantee.  The two companies sum up Linked-In's sales performance 60 days after the close of each quarter and settle any commissions due at that point.  Professional Diversity's own sales are deferred for accounting purposes, as well.  Most contracts are prepaid, non-cancelable, and extend for twelve months.  But revenues are recognized one month at a time, pushing income into the future.  Expenses are written off as incurred.  The sales cycle tends to be lengthy, moreover, due to all the bureaucratic and compliance factors involved.  Orders also tend to be seasonal, with the greatest activity occurring in Q3 and Q4.  We estimate Professional Diversity will incur a modest loss in 2013 as Linked-In and the company's internal sales force (21 people) build momentum.

Profitability is likely to climb rapidly as volume improves.  In 2014 we estimate revenue will triple to $15 million to produce fully taxed earnings of $.30 a share.  Margins probably will remain below potential as the technology is built out and sales and marketing costs keep rising.  In 2-3 years sales could attain $30-$45 million.  Payments from Linked-In are likely to cover Professional Diversity's entire cost structure, allowing overall margins (pretax) to advance into the 25%-33% range.  Fully taxed income could reach $.75-$1.50 a share.  Applying a P/E multiple of 20x to the midpoint suggests a target price of $22.50 a share, potential appreciation of 350% from the current quote.

 
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Sunday, May 19, 2013

Carbo Ceramics ( NYSE - CRR ) -- Sees Better Days Ahead

Carbo Ceramics (CRR $70.00) appears on track to produce unexceptional Q2 results.  The same factors that drove down performance in the March quarter are continuing to exert an impact.  Drilling activity remains depressed, the result of natural gas prices that still are below production cost.  Oil drilling is constrained by infrastructure bottlenecks.  Direct competition from lower quality Chinese proppants continues to pressure prices.  Carbo has scaled back prices to preserve and expand its market share.  That's had the perverse effect of preventing the Chinese stockpiles from winding down.  Imports of fresh Chinese proppants have virtually stopped.  Most of that output now is being used in China itself.  But inventories built up in 2011 remain elevated.  Margins have been depressed further by Carbo's own distribution problems.  The company has been forced to expedite deliveries to North Dakota and other emerging territories.  Marketing expenses are up, too.  Carbo has been engaged in an extensive education campaign with prospective customers to demonstrate the superior rate of return its ceramic proppants deliver.  Those field trials typically involve deep discounts, plus extensive consulting services.

Volume should rebound in the September quarter.  Chinese inventories are expected to slide, opening up new customer opportunities while alleviating price pressure.  Distribution costs are coming down, moreover, now that depots, rail links, and other fixed assets have been deployed.  Field trials are likely to lead to full margin sales.  A second product line -- resin coated sand -- is gaining business from raw sand users, too.  Raw sand now represents 75%-80% of the entire proppant market but drilling companies are gravitating toward the resin coated variety, due to its greater strength.  New wells increasingly are deeper and create higher pressure on the proppants, which hold the rocks open during the fracking process so natural gas and liquids can escape to the surface.

A surge in natural gas drilling is possible if the federal government allows LNG exports.  Several facilities are under construction around the country.  Other existing energy plants could be modified to handle "liquefied natural gas" exports.  Natural gas sells for $4.00 per Mcf in the United States.  In Europe the tab is closer to $10.00; in Asia, $15.00 is common.  Even at those prices the Btu content is higher per Dollar than petroleum.  The Obama Administration has declined to approve natural gas exports to date for a variety of political reasons.  If the okay is given drilling activity is sure the increase.

A new proppant technology could widen Carbo's competitive advantage.  The first application will occur later this year in a deep offshore well, under extreme pressure.  Development is underway to apply the new technology to Carbo's standard product line, enhancing price performance.  A larger market share could result.  Those upgrades could hit the market in 2014.  Long term performance could be amplified by international demand.  Fracking is primarily a U.S. technology at present.  But China, Eastern Europe, and other regions are learning the ropes.

 
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Saturday, May 18, 2013

Health Insurance Innovations ( Nasdaq - HIIQ ) -- Battle for Healthy Insurance Customers Intensifies

Health Insurance Innovations (HIIQ $11.25) reported excellent on target Q1 results.  Earnings were flat with the year ago quarter at $.06 a share.  Average shares outstanding -- Class A and B combined -- were up 55% as a result of the company's initial public offering in early February.  Revenues improved 47% to $12.5 million.  Margins widened as overhead costs stayed relatively steady.  Health Insurance Innovations is a leading provider of "short term" medical insurance for healthy Americans.  The policies are exempt from the new national insurance law scheduled to take effect in 2014.  The policies are designed for individuals and families that are outside of group plans.  Typical buyers are self employed individuals, divorcees, students leaving school, part time workers, and other non-welfare type of individuals.  A quick series of questions is all that is required to sign up.  Anyone with an expensive medical condition normally is rejected.  The policies are not automatically renewed, either.  If a customer acquires a serious condition the policies cover it for the duration of the plan.  But they typically are not renewed.  The key advantage is sharply lower prices.  On average Health Insurance Innovations' plans cost 50%-60% less than conventional major medical plans, with identical deductibles, co-pays, and coverages.  The primary difference is the lack of "guaranteed issue."

That lack of renewabity has limited demand to date.  The advent of the Affordable Care Act requires all 50 states to establish insurance exchanges were anyone can buy a policy no matter how sick they are.  The company expects to see demand for its products surge in that environment because healthy customers can qualify for the company's lower cost plans; and if they do get sick, they can move to the exchanges and buy a guaranteed issue policy from a different insurance company.  Approximately 95% of the company's customers (or their family members, if on a family plan) don't get that sick and renew at the cheaper price.  But the fail safe option has held back lots of potential customers in the past.  The potential market itself is expected to expand in size as small and large businesses alike abandon their own group plans and send their employees into the individual health insurance market.  Some estimates put the new potential market at around 100 million individuals, up more than 600% from today's 14 million.  The company's pricing advantage may widen, too, if sick indivudals flock to the new exchanges.

Established insurance companies that will be subject to the "guaranteed issue" rules have begun to recruit healthy customers more aggressively.  The Affordable Care Act is designed to cap overhead, marketing, and profit at 20% of total premiums collected.  But a loophole has allowed the companies to over spend on marketing until the end of 2013.  Several of those companies have lifted commission payments to independent agents, causing them to steer business away from Health Insurance Innovations.  The Obama Administration is planning a series of high profile marketing events of its own to persuade young Americans to buy insurance through the exchanges, even if they are healthy and qualified to buy less expensive "short term" policies.  The Administration's goal is to over charge younger Americans to subsidize the older segment of the population.  Health Insurance Innovations is a small company that operates in a niche market that few Americans are familiar with.  The relentless publicity and marketing by the giant insurers and the Obama Administration is likely to make it more difficult for the company to attract business.

On the plus side, Health Insurance Innovations actually does have a better mousetrap.  It operates an automated platform that keeps costs low.  Distribution is handled through a network of independent agents who are paid commissions that are not limited by the 20% limit.  So the company will be able to pay higher rates over the long haul while keeping its consumer prices at least 50% below the exchange norm.  (Welfare buyers on the exchange will quality for government subsidies.  Health Insurance Innovations concentrates on middle income Americans.)  The policies themselves are underwritten by AAA insurance companies.  It has no underwriting risk.  Those insurers, like ING, service the policies.  Health Insurance Innovations watches its order flow carefully and communicates with its agent network on a regular basis, helping it develop new products quickly.  A new offering recently was launched to combat the more aggressive pricing by the major medical providers.  (To date only a small percentage of the conventional insurers have lifted commissions above the expected norm.)

Our 2013 revenue estimate is unchanged at $60 million.  We have reduced our earnings estimate by a nickel to $.35 a share to reflect the higher marketing costs the company likely will endure.  Our 2014 estimates are unchanged.  That environment promises to be phenomenally beneficial to the company.  No regulatory threats are on the horizon, either.  Over the long haul the regulatory framework may change.  With 100 million Americans in the individual health insurance market, though, it's doubtful the government will interfere significantly with a company like Health Insurance Innovations that is filling the void.

The outlook remains bright.  Near term comparisons promise to remain positive.  The long term opportunity hold exceptional potential.


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Tuesday, May 14, 2013

Cyanotech ( Nasdaq - CYAN ) -- Production Rate Improves

Cyanotech (CYAN $5.00) appears on track to report reasonably good Q4 (March) results.  Production setbacks curtailed output earlier in the fiscal year.  The fourth quarter typically is Cyanotech's slowest growing season, moreover, due to less and weaker sunlight.  The technical problems appear to be resolved.  Output has been up year to year for the last four months.  While limited inventories may have prevented March period sales from achieving their full potential, a solid performance appears achievable.  Sales and marketing efforts continue to bear fruit.  That's shifting output increasingly toward the retail channel and away from bulk customers, boosting profit margins.  Our estimates are unchanged.  A stronger performance could be realized next year if the current trends are sustained.


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Napco Security Technologies ( Nasdaq - NSSC ) -- College Lock Downs Lift Outlook

Napco Security (NSSC $4.25) reported good on target Q3 (March) results.  Performance was impacted by the after effects of Hurricane Sandy.  The company sells its home security line through independent dealers.  Many of those were preoccupied with other parts of their business, like replacing heating and air conditioning systems that were destroyed in the storm.  Several dealers merged during the quarter, as well.  That also interrupted order flow.  Napco's traditional door lock business gained momentum, though.  Part of that stemmed from internal management changes that were put into place last year.  A pick up in new construction activity provided further impetus.  Overall, sales were flat at $17.2 million.  Income dipped year to year to $.01 a share.

Napco landed a major order ($1.5 million) from a university for a campus wide lock down system.  The technology employs wireless communication, so it can deployed without tearing apart any walls.  A wide range of controls will be included, allowing officials to remotely lock down in seconds whatever doors are appropriate.  If necessary, the entire campus can be locked.  The potential for additional campus security business is strong.  Universities tend to be well financed.  Students and their parents are increasingly concerned with security.  And Napco's technology is designed for the task, unlike competing products that require substantial customization.  The company offers lower cost options for public schools, as well.  School security systems have the potential to become substantial profit contributors in fiscal 2014 (June) and beyond.

Napco's high potential digital home security line was launched in the current quarter (June).  Those systems allow residents to control, with a mobile device, their home's security systems, lighting, heating, and webcams.  Earlier in the year Napco introduced a wireless connection to the central monitoring station, eliminating the risk of thieves cutting the telephone line.  Those units have been particularly attractive to customers without land lines.

Fourth quarter (June) results promise to be solid.  The big college campus order should offset any continued weakness from last fall's hurricane.  (A large portion of Napco's business is in the affected area.)  Our estimates are unchanged for both fiscal 2013 and fiscal 2014.


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Sunday, May 5, 2013

Ellie Mae ( Nasdaq - ELLI ) -- Mortgage Automation Leader Shifts to a Higher Gear

Ellie Mae (ELLI $24.00) reported excellent on target Q1 results.  Earnings were higher than normal due to a reduced tax rate caused by the Government's delay in renewing the R&D credit.  All of last year's benefit was recognized in this year's March quarter.  Other than that, financial performance was consistent with our expectation.  Revenues climbed 48% to $30.9 million.  Earnings (adjusted to a normal tax rate) advanced 50% to $.21 a share.  The R&D credit added another $.03 a share, boosting the official reported figure to $.24 a share.

Market share continues to expand.  Approximately 50% of all new U.S. mortgage loans are originated by the country's 20 largest banks.  That part of the industry remains off limits to Ellie Mae's automation software.  The giant banks have in-house programs that are integrated to an array of other software components.  The remainder of the industry is served by regional and local banks, and independent mortgage brokers.  Ellie Mae holds 50% or more of that segment.  Half of the company's users still employ a hosted version of the software, which resides on their own computers.  The other half uses a more modern cloud based edition which is easier to maintain, and which is priced on a success based model.  Whenever a mortgage is written with Ellie Mae's software the company earns a piece of revenue generated, typically $100-$125 out of the $750-$1,000 total.  That approach is proving to be very popular because it eliminates financial and technology risk, and it it is easier to update because Ellie Mae automatically adjusts the software for compliance and regulatory changes.  The on premises version requires a programmer to install any changes.

The shift to success based pricing is driving results.  Ellie Mae is converting its installed base of legacy users to the new model, which is more profitable for the company.  It also is bringing in users who formerly employed competitive products.  Average revenue per loan is rising, moreover, as customers rely on the software for more features.  A year or two ago most mortgage bankers performed their own income verification or fraud detection work, and plugged the results into the software.  Now Ellie Mae provides an integrated service.  Performance is poised to keep improving sequentially as more users adopt the success based model and average order size continues to rise.

Reduced mortgage activity might slow down the growth rate.  A big part of the mortgage boom has been generated by refinancing activity.  That aspect might decline if interest rates stabilize or go up.  There still are millions of homeowners with relatively high interest mortgages, though, people who to date have been unable to refinance due to low credit ratings.  If housing price appraisals keep improving that segment of the market could be unlocked.  Weak income growth throughout the economy in general might precipitate a rise in cash out mortgages, too.  And merger activity among local banks is starting to increase.  That could boost Ellie Mae's potential if the larger entities standardize on the company's industry leading technology.

Earnings have the potential to keep rising at a fast pace.  We estimate income will advance 33% in 2013 and 30% next year.  Product development could support higher revenue per loan ratios.  Acquisitions of competitors offer further leverage.  It might take 1-2 years to convert those user bases to Ellie Mae's technology, but the effect would be to expand the company's market share over the long haul.


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Saturday, May 4, 2013

Ansys ( Nasdaq - ANSS ) -- Software Re-Write Cycle Dims Growth Outlook

Ansys (ANSS $75.00) reported lower than expected Q1 results.  The company also reduced its financial outlook for the remainder of 2013.  Sales improved by 8% year to year to $199.5 million.  That figure included contributions from recent acquisitions, though.  Organic growth was 5%.  Earnings increased 8% to $.71 a share.  Performance was retarded by a $10 million negative currency swing in Japan.  Sales force additions failed to contribute as expected, moreover.  And a significant number of orders were delayed or scaled down as a result of economic conditions.  Margins remained at superior levels but they did decline in response to the revenue shortfall.  Renewal rates remain solid.  As the industry leader in engineering simulation software that recurring business will keep Ansys extremely profitable in coming periods.  But growth is flattening out.  Acquisitions could reinforce the company's growth trajectory.  But the underlying technology has begun to change in the industry, making consolidation more difficult.

Ansys's legacy software platform is approximately 10 years old.  The company has made a series of acquisitions during that time to address new markets.  The purchased technologies were modified to work with Anysys's existing programs.  Those integration efforts required a tremenous proliferation of software code, making subsequent updates increasingly complex.  The more modern cloud based computing approach has created a superior alternative.  Updates are distributed consistently from a central repository, instead of requiring each location to install those updates individually.  Most of the individual sites have unique features that require special attention, unlike the more streamlined cloud based format.  Ansys has been shifting elements of its software to cloud computing but most customers still rely on the older arrangement.  Cloud based competitors are starting to arise, nibbling away at corners of Ansys's market.  The company remains the dominant participant in the industry.  To preserve that advantage over the long haul a re-write of the software likely will be necessary.  That project could last several years, divert resources, and make additional acquisitions more difficult to integrate in the short run.

Under more dynamic economic conditions Ansys probably could sustain above average growth while updating its software technology.  As things stand, a more muted growth curve is likely.  The company has terrific cash flow and a sturdy balance sheet.  So the stock could advance in response to some sort of financial engineering.  Substantial appreciation potential appears limited, though, due to the near term pressure on organic expansion.  Our advice is to close out positions and reinvest the proceeds in a different Special Situation stock with better defined prospects.


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Thursday, April 25, 2013

Carbo Ceramics ( NYSE - CRR ) -- Market Share Expands Despite Intense Competition

Carbo Ceramics (CRR $72.00) reported lower than expected Q1 results.  Unit volume improved 7% even though the number of drilling rigs in operation declined by 12%.  Margins were compressed, however, as a result of renewed international competition.  That arose both from China and Brazil.  Prices fell 14% due to the pressure from lower quality competition.  Earnings finished at $.81 a share in the March quarter (excluding stock compensation expense), off 40% year to year.  Besides the need to discount prices profitability was impacted by high distribution costs in North Dakota and other oil producing regions.  Slow drilling activity is likely to keep a lid on financial performance in the June quarter, as well.  Natural gas activity is at a 15 year low, due to ongoing oversupply conditions.  Oil drilling remains fundamentally robust but is likely to moderate temporarily due to seasonal factors.  The natural gas segment is poised to start recovering later in 2013, bolstered by improved supply-demand conditions and rising market prices.  Fracked wells tend to deplete faster than conventional reserves, moreover.  The paucity of drilling over the last two years may cause existing output to diminish, requiring new efforts just to maintain supply.

Technology improvements are in the pipeline.  Carbo's existing line already yields better flow rates than competing products.  It's next generation is expected to enhance output further, and facilitate drilling in more difficult formations.  Pricing will remain an issue over the long haul due to the competitive nature of the energy industry.  But Carbo should be positioned effectively to blunt lower cost competitors by delivering superior performance, enhancing its customers' return on investment.  The fracking industry currently exists mainly in North America.  Expansion to other parts of the world is likely.  Weak economic conditions have delayed the energy industry's rebound, which in turn has affected Carbo's performance.  The long term outlook remains bright, though.


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Monday, April 22, 2013

Health Insurance Innovations ( Nasdaq - HIIQ ) -- The Affordable Alternative

Health Insurance Innovations (HIIQ $14.00) is a leading provider of short term medical insurance plans for individuals.  The policies are underwritten by several major insurance companies that Health Insurance Innovations has longstanding relationships with.  The company doesn't possess any underwriting risk.  Those plans are offered through the company's website to individuals who don't have serious pre-existing conditions, and who need coverage for 6-12 months.  Unlike traditional plans, those offered by Health Insurance Innovations are not automatically renewable.  If a customer comes down with a serious disease or condition the policies will cover it through the end of the policy's term.  But the policy won't be renewed.  The fact that most of Health Insurance Innovations' customers are healthy keeps prices low, however.  Individuals typically pay 50% or less of what a traditional major medical policy costs.  To date most customers are healthy individuals who need short term coverage against catastrophe.  Most are small business owners and their employees, recent graduates, divorcees, early retirees, military discharges, unemployed, seasonal workers, and temporary employees.  Health Insurance Innovations relies on a network of brokers and sales agents to distribute its products.  Most policies are issued the same day the application is made.  Payments are made by credit card or similar method, eliminating bad debt risk.  The company offers a variety of related products, moreover, such as pharmacy cards, dental, vision, hospitalization, and cancer/critical disease plans.  Those cost less but enhance profitability by sharing overhead costs.

The new U.S. national health insurance law promises to accelerate growth.  The legislation takes effect in 2014.  It requires individuals to carry health insurance or face tax penalties.  It also forces employers with 50 or more workers to provide insurance or face tax penalties.  It prohibits traditional major medical insurance companies from denying coverage for pre-existing conditions.  And it requires them to spend at least 80% of premiums on clinical services.  Industry analysts predict the individual health insurance market will expand from 14 million Americans currently to 100 million or more as a result.  The short term policies offered by Health Insurance Innovations are exempt from the new regulations.  The company already is boosting distribution by offering higher commissions, better web services, and increasingly customized plan designs.  Many prospective customers will be able to purchase one of the company's plans for little more than the fine they'll pay under the new scheme for not having any coverage.  Additionally, if customers are afflicted with serious medical issues they will be able to switch to a major medical plan later, because those offerings will be required to accept all pre-existing conditions.

Growth already was robust under the existing rules.  Sales advanced 40% in 2012 to $41.9 million.  Earnings improved 39% to $.25 a share.  Health Insurance Innovations sold 5.3 million shares at $14.00 apiece in February, raising an additional $69 million in fresh capital to finance growth.  A recent acquisition is likely to enhance margins.  (That transaction will result in a non-recurring write-off, reducing GAAP earnings in Q1.  Our estimates exclude that impact.)  Additional funds are being advanced to some distribution partners the company has proven relationships with, to help them prepare for the enlarged opportunity created by ObamaCare.  Health Insurance Innovations' web based technology promises to yield rising margins as volume expands, as well.

We estimate sales will rise 43% in 2013 to $60 million to provide earnings of $.40 a share (+60%).  Next year $100 million (+67%) represents a realistic target.  Earnings could climb 87% to $.75 a share.  A stronger performance is possible if awareness of the short term plans proliferates.  In 2-3 years sales could attain $150-$200 million to support income of $1.50-$2.50 a share.  Applying a P/E multiple of 20x to the midpoint of the range suggests a target price of $40 a share, potential appreciation of +185% from the current quote.  Limits are advised.

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Thursday, April 18, 2013

Acacia Research ( Nasdaq - ACTG ) -- Apple Settlement Disappoints

Acacia Research (ACTG $29.00) reported lower than expected Q1 results.  The company settled its patent infringement case against Apple Computer in the period.  That involved fundamental smart phone technology originally invented for the Palm Pilot.  The company received $50 million, a small increase from the payments received from Samsung and Microsoft.  Acacia spent most of those proceeds on legal preparation costs and royalty payments to the original inventors.  Only a modest profit was realized.  That might prove to be a positive outcome in the long run if Apple becomes more receptive to working with Acacia in the future.  The company already is working with several major corporations to establish something of a patent exchange, with Acacia serving as the nucleus.

Future quarters promise to demonstrate higher profit margins.  Acacia spent heavily to prepare its case against Apple.  Legal expenses are likely to diminish as more settlements are realized via negotiation.  The company's growing inventory facilitates those types of transactions because the counter parties can resolve all their loose ends at once,  Acacia substantially expanded its patent portfolio over the past two years, laying the groundwork for an acceleration of deals in upcoming periods.  We have reduced our 2013 earnings estimate to reflect the higher than expected costs associated with the Apple settlement.  But a strong performance appears to be in the cards, nonetheless.  Growth is poised to remain vibrant in 2014 and beyond as the company's newer portfolios start producing income, and new technology is added.  Legislative threats appear insignificant despite periodic bursts of rhetoric.


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Wednesday, April 10, 2013

Simulations Plus ( Nasdaq - SLP ) -- Steady Growth Re-Established

Simulations Plus (SLP $4.00) reported good Q2 (Feb.) results.  Earnings rose 17% to $.07 a share.  Sales improved 12% to $3.12 million.  The renewal rate was 93%.  Eighteen new customers were added.  The company had hoped to land a big contract with the Gates Foundation in the period.  That proposal was rejected.  Other funding partners are being pursued for the company's malaria project.  New software products will be launched over the next two quarters, expanding the potential market.  Simulations Plus remains reluctant to make acquisitions, which would provide a more dynamic growth opportunity.  Investors can realistically stay invested although appreciation is likely to be muted in relation to the company's inherent potential.

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Acacia Research ( Nasdaq - ACTG ) -- Apple Computer Settles

Acacia Research (ACTG $29.00) appears on track to report excellent Q1 results.  The company settled its case with Apple Computer before the quarter ended.  That transaction likely was higher than previous deals with Microsoft and Samsung.  Apple also indicated it was considering further transactions with the company, including partnerships with Acacia to enforce its own patents.  Several other large deals were concluded in the March quarter.  Another major partnership was established in early April, moreover, laying the foundation with further growth beyond.  Most of Acacia's business continues to derive from the wireless and computer areas.  New initiatives begun over the past year in medical, automotive, and energy technology promise to kick in as 2013 goes along.  Our estimates are unchanged.  But a stronger performance is possible.

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Friday, March 22, 2013

Xplore Technologies ( Nasdaq - XPLR ) -- Rugged Tablets

Xplore Technologies (XPLR $3.60) is a leading manufacturer of rugged tablet computers.  The company has been in business since the 1990s.  Success was limited until Apple Computer invented the iPad, which made tablet computers popular.  Xplore makes rugged tablets which compete with rugged laptop computers.  The leading producer of rugged laptops is Panasonic, maker of the ubiquitous Toughbook.  Sales are directed primarily to corporate, government, and military customers that use the computers in the field.  Xplore's current line can withstand drops onto a concrete floor from 6-10 feet.  They also can keep working despite being submerged in water for up to half an hour.  Panasonic has attempted to develop a rugged laptop of its own.  Those efforts, two years old now, have yet to bear fruit.  Other competitors exist.  Xplore has the greatest experience with the technology and replicating that know-how is proving to be difficult.

New products are in the pipeline.  Xplore designs its systems to accommodate a variety of options, depending on customer requirements.  Stripped down versions cost $4,000 compared to $5,500 for a rugged laptop computer.  Most systems include add-ons which lift average pricing to the $4,500-$5,000 range.  The current technology runs on the Windows operating system.  A new lower cost line will be unveiled in April.  Volume production is scheduled for the summer.  The new unit will survive drops from 3-4 feet and last for a minute or two underwater.  It also will cost $1,500.  Googles's zero royalty Android operating system will be included, helping to keep the cost down.

A second new product is slated for early calendar 2014.  That unit will be Windows based, which will facilitate sales to organizations that use Windows exclusively.  Current plans include a somewhat more rugged design and a $2,500 price tag.  But if the low cost line rolling out this summer creates an industry standard the next system might replicate that from a hardware perspective, and just run on Windows instead.

December quarter performance was a negative surprise.  Xplore sold 2 million shares during the period at $5.00 a share to raise capital in support of its growth initiatives.  During the roadshow the underwriter told investors its estimate for Q3 (Dec.) sales was $9.2 million.  The actual figure came in at $5.9 million.  That didn't bother us.  We bought the stock after the deal.  The shortfall did raise concern among investors, though, driving the stock price substantially lower.

March quarter performance is likely to improve sequentially.  Xplore's largest customer, ATT, scaled back orders in Q3 after a court ruling forced it to pay a $4 billion break-up fee when its proposed acquisition of T-Mobile was thwarted by the Obama Administration.  That caused ATT's operating budgets to decline across the board.  ATT remains happy with the product and is likely to resume purchases later in 2013.  But Xplore will continue to suffer in the meantime from that spending freeze.  Even so, the company recently landed a big military order.  By itself that deal could produce Q4 (March) revenues of $4-$5 million.  The oil and gas industry is getting more involved with the technology, too.  Other telecom companies are testing the systems, moreover, now that ATT has proven the benefits.  And Xplore has developed a growing third party distribution system to reach a widening number of additional niche applications.

We estimate fully year (March) sales will reach $31-$33 million to provide fully taxed income of $.15-$.20 a share.  Next year $50-$60 million and $.30-$.60 a share represent realistic targets.  In 2-3 years sales could attain $100 million to support fully taxed earnings of  $1.00 a share.  That assumes the sale of an additional 2 million shares to support growth.  Applying a P/E Multiple of 15x suggests a target price of $15 a share, potential appreciation of 315% from the current quote.  Limits are advised when placing orders.

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Wednesday, March 20, 2013

Ansys ( Nasdaq - ANSS ) -- War Chest Expands

Ansys (ANSS $80.00) reported excellent on target Q4 results.  Performance was affected by the slowing worldwide economy.  The company is the leading provider of engineering simulation software used in a wide range of industries and applications.  Poor conditions In Europe constrained results.  Sales climbed 15% to $808 million for the year.  In the quarter they rose 11%.  Earnings advanced 15% to $2.91 a share for all of 2012.  In the December period they improved 16% to $.79 a share.  Part of the favorable comparison resulted from share repurchases.  Cash increased $105 million during the year despite the buybacks.  Ansys also paid off $75 million in debt, leaving just $53 million to go.  Pretax margins remained around the 50% level. 

Organic growth is likely to remain below average in 2013.  But the build up in cash could lay the groundwork for another acquisition.  The company has a proven record of identifying key technologies and folding them in to its industry dominant platform.  Per share income could be amplified by further buybacks, as well.  The long term outlook remains positive.  Engineering simulation remains in an early stage of development.  Today's technology is likely to demonstrate incremental improvement over the next few years.  But it promises to reach a wider audience as hardware costs come down and emerging market customers make greater use of it.  The mathematics are likely to take several leaps forward before the industry achieves a long term plateau.  Presented with little direct competition, Ansys should capitalize on those breakthroughs and keep income rising at a fast pace well into the future.

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Tuesday, March 19, 2013

Cyanotech ( Nasdaq - CYAN ) -- Demand Accelerates

Cyanotech (CYAN $4.70) appears on track to produce reasonably good Q4 (March) results.  The company is the leading producer of algae used in natural supplements used by high endurance athletes and other health conscious consumers.  Over the years Cyanotech was scientifically focused.  Resources were devoted to enhancing quality and production.  Marketing was given short shrift.  Until the current management arrived on the scene most output was sold in bulk quantities to other nutrition companies that combined it with additional ingredients, and resold it at a big mark-up.  The new management team took the scientific side of the business and put their efforts into developing Cyanotech's own direct sales channels.  That project is working.  The company's branded products have gained the leading market share in the independent health store channel.  That percentage is over 33% and it's continuing to rise.  New products are being developed to expand that penetration.  New brand names are in the works to allow the company to move into the high volume chain store segment without disrupting the specialty business.

Last year the scientists let the company down.  Production snafus curtailed production.  That in turn affected margins.  And it all took place at a time when marketing costs were accelerating.  That was a dangerous combination that sliced the stock price in half.  The damage was contained because a rising percentage of sales were shifting from low margin bulk customers to higher priced retail channels.  The retail initiative remains in an early stage of development, though.  Only 33% of the company's physical output is sold at those higher prices currently.  The rest is still sold to bulk customers.  But the future was uncertain because of the production problems.  They had to be resolved before Cyanotech could put the pedal to the metal on the marketing front.

It looks like the setback has been fixed.  Output has blossomed over the past month.  And there appears to be a logical explanation for the problem, and the solution.  Fourth quarter performance will be impacted by the temporary slowdown in production.  It takes several months to turn around an algae crop.  But output promises to rise in upcoming months as the changes are implemented and more sunshine lifts output further. 

The long term outlook remains bright.  Cyanotech has two products with leading market shares in high growth segments.  The natural products industry continues to expand overall.  The areas targeted by the company are growing 10%-20% a year.  And pricing to the retail channel brings Cyanotech 2x-3x the revenue it garners from bulk sales.  As the 67% of output now devoted to bulk converts to retail pricing both revenue and margins promise to expand.  Production capacity might be expanded, as well. 

We estimate sales will improve 10%-20% in the coming fiscal year to $30-$33 million.  Demand already is outstripping supply.  Cyanotech's high octane marketing program is poised to deliver further impetus.  Production probably will be the limiting factor.  That's a complete reversal from past years.  Our single point estimate assumes some lingering effects.  Earnings should climb nonetheless on the strength of expanding gross margins.  Overhead costs are likely to be constrained, moreover, until the rebound in output demonstrates greater certainty.  Income could reach $.50 a share.  In 2-3 years sales could attain $50 million to provide income of $.75 a share.  That figure assumes the sale of an additional 2 million shares to support growth.

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Wednesday, February 27, 2013

Cyanotech ( Nasdaq - CYAN ) -- Production Miscue Intensifies

Cyanotech (CYAN $4.25) has been battling poor Spirulina yields over the past year.  That's the company's legacy product.  Overall growth is being generated by the high potential Astaxanthin line, despite the setbacks in Spirulina output.  That segment continues to gain momentum, both in terms of consumer demand and better than expected production volume.  Cyanotech thought it had the Spirulina issue fixed during the December quarter.  Harvests improved in response to some modifications in growing cycles, returning nearly to previous levels.  Spirulina recently took a new turn for the worse, though.  Sufficient material is being produced to keep up with packaged goods demand.  But the excess that Cyanotech customarily sells in bulk to other packaged goods producers has been lost, at least temporarily.  That's relatively low margin business so the impact on financial performance is likely to be modest.  But the fact the problem has not been resolved creates uncertainty about Spirulina's future.  Draining those production areas and starting over would be expensive.  Converting them to Astaxanthin also would incur expenses.  Cyanotech has been building up retail demand for Spirulina, hoping to fill the pipeline with multiple products, not just Astaxanthin.  Our estimates are unchanged for the moment.  But they could could down if the issue is not resolved in a timely fashion, and with a high degree of confidence.

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Friday, February 22, 2013

Acacia Research ( Nasdaq - ACTG ) -- Risk and Reward Increase

Acacia Research (ACTG $29.00) reported excellent on target Q4 results.  The company completed two large settlements in the period.  A string of smaller deals were signed, as well.  Revenues advanced 219% to $66.3 million.  Earnings topped our estimate, coming in at $.31 a share (fully taxed).  Margins expanded more than anticipated because few royalties were paid to Acacia's partners.  Most patents are jointly owned by the company and the original inventor.  In the past licensing proceeds usually were divided equally, after expenses were deducted.  Over the past year, though, Acacia has begun to frequently pay inventors some upfront cash in exchange for a higher percentage of any future payouts.  No money is paid to the partners until that upfront fee is recovered first.  A number of deals in the quarter reflected that arrangement, creating the appearance of higher margins.  An alternative accounting method would show those payments simply as a return of capital.  Acacia's method is the one used by GAAP accounting rules.

Spending on patent purchases surged in 2012.  Acacia spent $328.3 million to acquire intellectual property rights in 2012, compared to $14.7 million the year before.  Some of those purchases resulted in 100% ownership, eliminating the need to pay future royalties altogether.  The rest were partner deals where the inventor received upfront cash.  Under the old model risk was limited to the cost of prosecuting patent infringers.  The use of upfront payments heightens risk because that cash needs to be recouped before true profits can be realized.  The potential rewards are greater, as well, because once break even is achieved Acacia is in line to earn a higher percentage of the subsequent winnings.

Government regulation has become a factor.  Concern that technology companies have used patents to corner their markets led to the passage of the America Invents Act in 2010.  Compliance with those rules has raised the price of pursuing patent claims.  The U.S. Department of Justice also has begun hearings on the potential for using third party companies, like Acacia, to accomplish the same purpose.  Key patents could be licensed to an intermediary, shielding the original holder from liability while still enabling it to corner its market.  Acacia says the law is helping its business by knocking out less well capitalized competitors.  It also says the Justice Department's investigation probably has merit but doesn't directly affect any of the company's licensing programs.

Revenues and reported earnings are poised to advance sharply in 2013.  Acacia's growing inventory of patents is boosting its average revenue per settlement, particularly in the technology industry.  Margins are improving, too, because it's almost as easy to negotiate a 15 patent deal as it is for a single patent.  Legal expenses are falling, moreover, as more deals are settled instead of going to court.  With multiple patents available to work with, quantity discounts ("structured transactions") become more feasible.

But the court room remains an option.  On April 8, 2013 the company will square off with Apple Computer to enforce its smart phone patent portfolio.  Acacia already has won large settlements from several companies, most recently Nokia.  Based on valuations proposed by Apple itself during its recent court case with Samsung the potential payoff to Acacia and its partners could be several hundred million dollars.  Samsung is a licensee of Acacia's technology.  If Acacia prevails Apple no doubt will challenge the verdict and try to delay payment.

We estimate fully taxed 2013 income will rise 38% to $2.00 a share.  Revenues could advance 34% to $335 million.  Performance could vary considerably from those estimates.  New industries -- medical technology, energy, and automotive -- are being addressed.  Those patent portfolios are being built up currently.  They could yield significant leverage down the road.

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Monday, February 18, 2013

Proto Labs ( NYSE - PRLB ) -- Margins Near a Peak

Proto Labs (PRLB $47.00) reported excellent better than expected Q4 earnings.  Sales were on target at $33.6 million (+31%).  Income widened 94% to $.31 a share.  That was $.07 a share above our estimate.  Fourth quarter results ordinarily are seasonally pressured due to the holiday season.  This year performance was impacted by weakening economic conditions in Europe, too.  Demand surged among U.S. customers, though, offsetting the headwinds.  Gross margins leaped 3% beyond the high end of Proto Labs' target range (60%-62%).  A portion of that was consumed by start up costs associated with several key new materials the company is introducing.  For the year income finished at $1.07 a share, up 19%.  Average shares outstanding rose 23% due to a pair of public stock offerings.

Margins could stay elevated.  Proto Labs manufactures small production runs for engineering groups and makers of specialty products.  The company is expanding the variety of materials it works with to deliver real parts customers can evaluate and use, not mock-ups like 3-D printers tend to make.  Orders fluctuate unpredictably, though.  While Proto Labs manages order flow with innovative techniques, invariably there are times when personnel are underused or required to work overtime.  Those expenses were on the low side in Q4 but are likely to stay in the expected range over the long haul.

Volume is mounting.  Existing customers are sending in more requests.  And new customers are being added with clever marketing techniques.  We are raising our 2013 earnings estimate by a nickel to $1.30 a share.  A stronger showing is possible if margins remain at an elevated level.  Above average growth appears likely to continue well into the decade.  Performance is not immune to poor economic conditions, though.  It's been four years since the last recession.  Another slowdown could interrupt Proto Labs' earnings progression.  Even a brief reversal could blast the stock price in light of its high P/E multiple.

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Sunday, February 17, 2013

Ellie Mae ( Nasdaq - ELLI ) -- The Mortgage Automation Leader

Ellie Mae (ELLI $21.50) reported excellent on target Q4 results.  Pretax margins widened to 31.4% to deliver earnings a nickel above our estimate at $.22 a share.  Revenues were as anticipated at $29.9 million (+60%).  The company built up its sales force and network operations earlier in 2012.  As those costs subsided margins improved on a sequential revenue gain.  Ellie Mae is the leading provider of computer based mortgage production services.  At year end 74,000 mortgage professionals subscribed to its software.  Approximately 190,000 potential users exist in the U.S., excluding the nation's 20 mega banks which rely on their own systems.  (Mega banks account for 50% of the industry's volume.)  Existing customers are pumping more business through Ellie Mae's network.  New users continue to be added.  And a sizable backlog of users are still being converted from legacy systems.  Those users were brought on board when Ellie Mae acquired its primary competitor in 2011.

Average order size is rising.  Most mortgages are processed through Ellie Mae's "success based pricing" format.  That's a cloud based system.  Originators are charged only for mortgages that get funding.  No money is generated when applications are rejected.  A declining share of the volume still is done with on premises software.  Customers purchased those programs years ago and are not required to pay per unit fees.  Many of the latter are converting to the variable pricing model, nonetheless, because software updates are delivered automatically via the cloud.  Software running on a local computer needs to be serviced individually, creating delays.  Demand for reliable updates is surging in response to the proliferation of mortgage regulations.  Five groups within the Obama Administration are now involved.  All 50 states are ramping up oversight, too.  Revenue per loan is increasing as more elements of the lending process flow through Ellie Mae's system.

More billable features are being added.  So far Ellie Mae has steered away from providing its own credit reporting and other key services.  Moving directly against existing partners could provoke retaliation.  High tech innovations are in the pipeline, though.  Allowing home owners to provide information directly from smart phones and computers could be implemented before long.

Larger banks are signing up.  In the past most of Ellie Mae's software customers were small banks and mortgage brokers who didn't have the resources to manage their own technology.  Larger institutions have become candidates, mainly as a result of the Obama Administration's regulatory crossfire.  Those banks haven't junked their existing systems yet.  And that may never happen in many cases because they want to retain an in house technical staff.  Some offloading has begun, though.  And that trend is likely to continue as the need for fast turnaround time grows in a complex regulatory environment.

Mega banks have become customers, too.  Wells Fargo and Citibank both are using Ellie Mae's data structure to collect mortgages from outside originators.  Many of those originators use Ellie Mae's systems to begin with, making it easy to structure the data the way the big banks want it.  Ellie Mae currently generates about $125 per loan from the origination side.  Another $25 per loan is being collected from the mega banks, kind of as a license fee for using the company's standard format.  That business remains unprofitable due to the start up costs associated with implementing the systems inside the mega bank's IT departments.  But some profits are likely to emerge in 2013 as the programs exit the testing phase.  Bigger impacts are possible beyond.

Our estimates assume that refinancing activity will decline in 2013.  Those loans have dominated the industry over the past two years.  New construction and resales may pick up some of the slack.  Volume has the potential to increase even if refinancing rates stay flat or rise.  Most home owners simply have rolled over existing balances to date.  If home values climb new cash out loans could become a more significant factor.  Assuming a falling mortgage market, we estimate sales will advance to $135 million to produce earnings of $.90 a share.  Market share gains are likely to continue over the next several years.  Average order size promises to expand.  And the $25 fees from the mega banks could escalate, forming another river of recurring revenue.

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