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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