Cyanotech ( Nasdaq - CYAN ) -- Barrels Back

Cyanotech (CYAN $5.75) appears on track to report reasonably good Q2 (September) results.  The high potential astaxanthin line has continued to build momentum.  New growing ponds have entered production.  And average selling prices are drifting upward as output is diverted from bulk sales to higher margin packaged products.  The legacy spirulina line continued to encounter problems, though.  That segment still represents more than 50% of Cyanotech's growing capacity.  A variety of production issues have curtailed volume.  That's put a crimp in sales directly.  It also has incurred extra costs, as the company strives to fix the problem. 

Margins may be affected by the addition of two sales and marketing executives.  That's laying the groundwork for a pick-up in direct to consumer sales, via social media and other techniques.  It also is boosting distribution to a broader group of specialty retail stores.  Legal expenses will impact margins, as well.  Cyanotech is battling it out with a bulk customer that is trying to force the company to keep selling astaxanthin at abnormally low prices.  That issue probably won't be resolved for another two quarters, although there's little reason to think Cyanotech will be forced to continue the arrangement once the existing contract expires.

Meantime, worldwide astaxanthin demand still exceeds supply.  Industry growth has begun to moderate, following last year's surge.  But plenty of opportunity remains.  A large majority of specialty health food retailers don't carry astaxanthin products.  Large potential exists in the chain store segment, as well.

Our estimates are unchanged.  Near term performance is hard to predict due to the spirulina problem.  How fast Cyanotech can transition to higher margin retail products is another unknown.  The impact of legal and personnel expense is another question mark.  Still, a strong showing is likely due to the underlying strength in demand.  New competition has not emerged.  Astaxanthin and spirulina are complicated products to grow.  The long term outlook remains bright.  In 3-5 years sales could reach $50-$100 million to produce income on the order of $1.00-$2.00 a share.

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Acacia Research ( Nasdaq - ACTG ) -- Major Patent Acquisition

Acacia Research (ACTG $27.00) obtained the rights to a valuable patent collection from one of the world's largest medical device manufacturers.  The acquisition amplifies the company's burgeoning medical operation, which was bolstered by a similar deal in the June quarter.  The latest arrangement is a partnership where Acacia Research will divide any winnings generated with the manufacturer.  Many large companies are seeking ways to make money on their intellectual property.  Joining forces with Acacia Research is becoming a popular way of accomplishing that.

A string of settlements likely provided strong Q3 financial results.  Acacia Research doesn't reveal the size of individual payments.  But based on previous deals and the size of the infringing companies a potent performance looks realistic.  Our full year estimates are unchanged.  December period results could accelerate if Acacia Research can unlock the potential of its recent acquisitions without delay.  The company also is working on several "structured agreements."  Those are unusually large deals that typically involve Acacia Research's entire portfolio.  Past agreements have been made with Microsoft, Samsung, Oracle, and Cisco. 

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Simulations Plus ( Nasdaq - SLP ) -- Wins Another Government Contract

Simulations Plus (SLP $4.75) landed a contract with the U.S. Army.  The company is a leading provider of drug simulation software.  The military laboratory will use the technology for toxicology testing.  That's a similar application to one already underway at the F.D.A.  Simulations Plus already is widely known in the drug industry, with a particularly strong customer base among larger companies.  The Government business promises direct benefits.  It also is likely to reinforce demand among commercial users, since the software has a de facto stamp of approval. 

Fourth quarter revenue was pre-announced by the company.  Sales were up 15% to $1.64 million, excluding last year's contribution from a non core business that subsequently was sold off.  Earnings were not commented on.  But we continue to estimate full year income of $.20 a share (+11%).  The fiscal year just ended (August) was affected by a downturn in third party collaboration revenue, and a fall-off in consulting activity.  Both of those segments are poised to re-accelerate in the upcoming year.  License sales continue to grow at a 15% pace, moreover.  We estimate income will improve 25% to $.25 a share in fiscal 2013.  The market opportunity remains lightly penetrated.  Above average gains could be sustained well into the decade.

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Napco Security Solutions ( Nasdaq - NSSC ) -- Next Generation Rolls Out

Napco Security Solutions (NSSC $3.25) reported Q4 (June) results that were slightly below our expectation.  The company is a leading provider of security systems used by homeowners and commercial customers.  Both segments remain depressed by the weak domestic economy.  A broad line of new Internet based products has been in development over the past two years.  Those units have started to hit the market.  The new technology promises to create a competitive advantage over the next decade.  Most of Napco's competitors scaled back R&D efforts during the recession, leaving the company with an open field with the high potential cloud based applications.

Earnings rose 22% to $.11 a share in the quarter.  That figure was helped by a lower tax rate, though, which resulted mainly from higher R&D tax credits.  Sales were a little below our estimate at $19.9 million.  The combination of new product contributions and an improving real estate climate promises to reestablish sales growth in fiscal 2013 (June).  We estimate sales will bounce up to $80 million (+13%), to provide a 76% increase in income ($.30 a share).  Napco operates with a fairly high level of fixed costs, so margins have the potential to expand meaningfully on higher volume.  The company also renegotiated its long term debt late in fiscal 2012.  That will result in lower interest expense, as well.

The long term out look is bright.  The technology platform Napco has created is likely to support a broad base of Internet based security systems.  That structure also should make it relatively easy and inexpensive for the company to add features and make other improvements as the industry evolves.  In 2-3 years sales could attain $100 million to provide earnings of $.50 a share or more.

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Ellie Mae ( Nasdaq - ELLI ) -- Mortgage Rates to Stay Low

Ellie Mae (ELLI $28.00) appears on track to produce excellent on target Q3 results.  Future performance is apt to remain robust, as well, following the Federal Reserve's decision to artificially reduce mortgage interest rates.  Approximately 65%-70% of Ellie Mae's business now is accounted for by refinancing.  If rates had been allowed to rise there was a possibility the company's unit volume might have slowed down as refinancing activity moderated.  Business continued to boom in the September period before the Federal Reserve got involved.  Ellie Mae continued to add new customers, and it continued to generate higher revenues from the ones it already had.  The company now generates 25%-30% of all the mortgages written America.  That percentage is likely to keep rising as Ellie Mae becomes the industry standard.  Average revenue per loan is likely to continue rising, as well.  Our estimates are unchanged.

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