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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