Monday, April 28, 2014

Zix ( Nasdaq - ZIXI ) -- Building a Secure Future

Zix (ZIXI $3.35) is a leading provider of e-mail encryption that protects sensitive information during transit.  The company sells its technology on a recurring revenue basis.  Customers who send encrypted messages pay the company approximately $20 a year per user for unlimited messaging.  Recipients can receive encrypted e-mails without charge by registering in the company's directory.  Any code can be broken if sufficient computer horsepower is applied.  From a practical standpoint, though, Zix's technology is safe from hacking.  Healthcare and financial institutions represented 72% of revenue in the latest quarter (March).  Renewals represent about 90% of revenue.  The renewal rate is approximately 100%.  New seats at existing customers offset losses.  Organic growth is 10%-15% a year.

A re-seller agreement with Google has caused performance to slow.  The huge search engine provider also sells an anti-spam and virus protection service to corporate clients.  It licenses Zix's email encryption technology to include in the bundle.  Google reorganized that service early in 2013.  A variety of back-end issues arose, causing sales of Zix's products to decline from 20% of Zix's annual sales to less than 10% in the latest quarter.  The infrastructure appears to have been reestablished.  But Google still is handling new orders by hand, for select large accounts, rather than through automation.  The system is ready to be turned on again.  But it remains to be seen when the Google channel will resume full speed.

A high potential new product remains in an early stage of development.  Last fall Zix launched a cloud based "bring your own device" (BYOD) security package.  The software allows employees to use their personal phones to send and receive company email, without any of it actually being stored on the phone itself.  That way if the phone is lost no proprietary information is jeopardized.  Several alternative technologies already are on the market.  Those are software packages that reside on the phone.  Besides creating privacy issues, pricing is higher because different software has to be written for hundreds of phone models.  Zix's is a single platform that operates in a cloud computing format.

Only 68 companies have been signed up to date.  Most still are in the testing stage.  Pricing is similar to email encryption, around $20 per user per year.  Zix boosted its sales force by 40% last year to get the new "ZixOne" line rolling.  A large number of evaluations are underway.  If the technology gains general acceptance the user population could jump into the millions, similar to encryption.  Margins could widen on the incremental volume, moreover, leading to superior earnings gains.

For now, the Google problem combined with the uncertain "ZixOne" rollout has exerted pressure on results.  Earnings probably will decline modestly in 2014 due to the greater sales effort.  Even if new business is generated Zix's recurring revenue model will spread those payments out into the future.  Revenue is recorded as earned, month by month.  Success could lay the groundwork for superior growth in future years.  If the new line pans out and Google gets back in gear, sales could attain $75-$100 million in 2-3 years to provide fully taxed earnings of $.20-$.30 a share.  Our advice is to wait for a lower entry price or more clear cut proof that "ZixOne" will realize its potential.

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Sunday, April 27, 2014

Vapor ( Nasdaq - VPCO ) -- Smokin' Hot or Up in Smoke ?

Vapor (VPCO $6.50) is a leading manufacturer of electric cigarettes.  The new smoking technology actually eliminates the carcinogenic smoke that causes cancer in conventional cigarettes.  Instead, the devices employ a battery and an electronic control system to vaporize liquid nicotine that's stored in a plastic cylinder.  The vapor is inhaled, delivering the nicotine along with some flavoring.  The amount of nicotine can be varied.   Electric cigarettes are sold both in disposable and reusable formats.  The latter is becoming more popular because it costs less, and consumers can fill their units with custom blends that are unique to them.  The technology is believed to be safer than conventional cigarettes due to the absence of tar and other cancer causing chemicals.  It also doesn't generate second hand smoke.  Opponents are trying to prevent e-cigarettes from gaining widespread adoption.  Some fear the new format will provide a gateway to regular tobacco use.  Others don't like the way they look.  The more serious want to slow down the market's growth until more scientific evidence becomes available.

Vapor was an industry pioneer.  It entered the business more than five years ago.  Manufacturing relationships were established in China, where the technology was invented.  Brand names were created.  Distribution channels were opened up.  A series of snafus impacted performance in 2011-12, though, just as the industry began to roll.  Several major tobacco companies entered the industry via acquisitions as the same time.  Those companies used their marketing muscle to capitalize on the industry's 100% annual growth rate, leaving the company behind.  At present Vapor's sales are approximately 10% of those generated by the industry leaders.

Vapor is attempting to mount a comeback in 2014.  Costs were brought back under control last year.  Operations were streamlined.  The products themselves were upgraded.  And a windfall distribution partnership was established with a Hollywood mogul (Ryan Kavanaugh) with big plans to make Vapor a success.  Kavanaugh is a self-made billionaire who has made a significant impact on the movie industry by focusing almost entirely on statistical and financial variables.  His productions consistently make money.  His company has developed a broad range of retail relationships to promote products that are connected with his movies.  The company also has connections with high profile celebrities, who might be recruited to promote Vapor's "Krave" brand on Twitter and other social media outlets.  Kavanaugh is committed to promote the company's products through a detailed contractual relationship.  It's thought he wants the effort to work as a matter of pride, as well.

Vapor has little chance of competing with the major cigarette companies without Kavanaugh's help.  But the fact of the matter is, he is on board.  (He's on the company's board of directors, in fact.)  Financial performance is likely to be unspectacular during the transition phase.  First quarter results probably will demonstrate little improvement on a sequential basis.  But sales and earnings could accelerate in the June period as new retail relationships go into effect.  Reinforcement on the social media front could provide additional impetus.  Overall industry sales are continuing to expand at a 100% rate, moreover.  Those gains actually could pick up speed as a result of recent publicity surrounding e-cigarette technology.


F.D.A. regulations could hamstring performance over the long haul.  A recent proposal contained little in the way of bite.  But the smoking vigilantes are likely to push for more stringent controls as time goes on.  State and local taxes could be applied, as well.  The technology currently costs more than tobacco cigarettes to produce but it enjoys a retail price advantage due to the absence of excise taxes.  If those are implemented demand could suffer.  Another long term factor is the possibility that e-cigarettes might veer in a completely non-corporate direction.  At this time a majority of e-cigarette revenue is produced by selling disposable units in conventional "packs" at conventional retail locations.  There has been a surge in small "vape" shops over the past year, though.  Customers go there and buy custom blends designed especially for them, which are used in reusable units.

Vapor is small enough that it might be able to take advantage of a development like that.  We think there is a good chance the industry could take on an anti-Big Tobacco flavor.  That sort of thing could happen in the marijuana industry, too, if that's ever legalized.  Imagine the head shops knocking off the Marlboro Man.

These shares trade at a high valuation.  Vapor competes with more established companies that already have greater market shares.  The government is on its tail.  And the industry remains in an early stage of development.  Things could go in any number of directions, with or without the company.  Our advice is to avoid the stock until a lower starting price emerges or the picture comes into better focus.  It's an interesting story, though.  Vapor deserves keeping an eye on.

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Sunday, April 6, 2014

Issuer Direct ( NYSE - ISDR ) -- Automates S.E.C. Compliance

Issuer Direct (ISDR $11.50) is a leading provider of disclosure management solutions used by publicly traded corporations to comply with S.E.C. regulations.  The company also provides a wide range of investor communication products and services.  Most of those were obtained in a recent acquisition ("PrecisionIR").  Those include investor outreach, webcasting, annual report distribution, and hotline services.  Demand is expanding as companies broaden their compliance and communication activities.  Issuer Direct is gaining market share, moreover, by bundling its recently acquired services together with its legacy products to provide customers greater convenience and better pricing.  The company has been developing a series of software products that it licenses to end users, moreover.  That segment is building momentum and promises to yield a greater contribution in the coming year.

The PrecisionIR acquisition more than doubled the revenue base.  PrecisionIR had been a leading investor relations company, but under private equity ownership it hadn't reinvested in new technology since the mid 2000's.  Issuer Direct bought the company last year and now is rebuilding those platforms.  The overall customer base more than doubled with the transaction.  Existing customers on both sides now are being cross sold the entire product line.  New customers are being added at a modest pace, as well.  Financial performance has accelerated as a result of the combined marketing effort.  Further gains are likely in subsequent years as products are enhanced and new offerings are introduced.

Margins already have widened to superior levels.  That trend could have farther to go as software becomes a larger part of the line-up.  Next generation offerings are likely to include more social media integration so that press releases and S.E.C. filings can be distributed more broadly.  Those products also may include interactive features and analytics that allow issuing companies to see immediately how its investor base is reacting.  Facebook and Twitter integration may help companies shape those responses.

Longer term, the addition of a more dynamic news release operation could help Issuer Direct attract privately held companies.  There are approximately 9,000 publicly traded U.S. companies.  The number of private companies that could be realistic targets for Issuer Direct's services might exceed that by a wide margin.

Meantime, revenue growth of 20% or more appears sustainable.  We estimate 2014 sales will advance 81% to $16 million, bolstered by the PrecisionIR acquisition.  Earnings could rise 33% to $.85 a share.  Official numbers will be lower due to recurring non cash (warrant) expenses associated with the acquisition.  Margins are likely to decline in the current year by comparison because the acquired operations are less profitable than Issuer Direct's legacy products.  Greater average shares (+19%) will be outstanding, too.  Organic growth is expected to be in the 15%-25% range, depending how the cross selling works.  Initial results have exceeded the company's expectation.

In 2-3 years sales could reach $23-$25 million to produce earnings of $1.25-$1.35 a share.  That assumes no margin expansion from our 2014 estimate.  Marketing and product development costs could offset the anticipated improvement in gross margins.  If they don't, income could expand more rapidly.  Applying a P/E multiple of 20x to the low end of the range suggests a target price of $25 a share, potential appreciation of 115% from the stock's current level.  Acquisitions of complementary products and services, penetration of the private company market, or better than predicted margin expansion could support a higher valuation.

Near term, the stock may mark time until a major shareholder unwinds its position.  Hedge fund Red Oak Partners helped to finance the PrecisionIR acquisition in August 2013 by purchasing a convertible note from the company that is exchangeable into 626,566 shares.  Until that overhang is resolved the share price may have a hard time advancing.

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Saturday, April 5, 2014

Xplore Technologies ( Nasdaq - XPLR ) -- Gets Tough

Xplore Technologies (XPLR $6.00) is a leading provider of rugged tablet computers used in industrial, commercial, and military applications.  The company's systems are used in challenging environments that conventional tablets are unable to withstand.  Many customers employ them in less hostile conditions.  Rugged units are less likely to break down.  Xplore got its start in the high end of the market.  The company recently expanded its product line with less expensive units, as well.  The first of its next generation systems was introduced in the December quarter.  That was an Android machine.  A new low cost Windows system is slated for introduction this month.  Demand for Xplore's high end (Windows) systems remains robust, providing a sound foundation for the company to build on.  As the new systems gain adoption results promise to accelerate.

Financial performance was impacted by two external events over the last year.  Xplore had a major supply agreement with ATT that was starting to take off when the telecom failed in its attempt to acquire T-Mobile.  A $4.0 billion break-up fee caused it to postpone a number of capital investments, including its deal with Xplore.  That relationship is expected to resume in late 2014.  Xplore also had cultivated a third party distribution arrangement with Dell Computer.  The computer maker planned to purchase rugged tablets and sell them under its own name.  That relationship was squelched when Dell went private.  Despite the setbacks Xplore continued to spend aggressively on product development and marketing.  A substantial contract for its Android system was signed with a different telecom provider.  Penetration of the military market gained momentum with the company's high end technology.  And more than a dozen high potential trials were initiated for its Android line, spanning several industries.  Xplore additionally expanded third party sales relationships both in North America (vertical markets) and internationally.

Introduction of the low cost Windows system could drive sales substantially higher.  Most companies still rely on Windows to run their information technology systems.  A minority are willing to integrate Android units with their central Windows operation.  Those are customers Xplore currently is conducting field trials with.  But most organizations prefer a full Windows coordination.  Xplore's upcoming low cost Windows tablet is slated for release this month.  Volume production will be achieved by the summer.  Prospective customers likely will test the machines in field trials that could last 3-12 months.  A decent off the shelf business could materialize right away.  As the core high end business is leveraged by the two new lines financial results could surge over the next 2-3 years.

We estimate income will rise 400% next fiscal year to $.25 a share on sales of $45 million (+29%).  A stronger showing is possible.  Organic growth could improve in subsequent years.  Margins promise to expand, also, as volume builds.  A third party relationship similar to the Dell plan could emerge, providing further ammunition.  Hewlett Packard represents a likely target.  In 2-3 years sales could achieve $80-$100 million to yield fully taxed earnings of $.75-$1.05 a share.  The high end of the range assumes the sale of 2.0 million additional shares to finance growth.  Applying a P/E multiple of 20x to the midpoint suggests a target price of $18 a share, potential appreciation of 200% from the current quote.

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