Saturday, December 31, 2011

2012 U.S. Economic Outlook

Of course a wise person will hedge his or her bets ...

In 2011 the U.S. economy took everything that nature and venal politicians could throw at it and still managed to grow overall. It could have been a banner year, but the tsunami in Japan, the politics of Washington, high oil prices due to Libya, the Euro crisis, and finally flooding in Thailand all took a toll.

I think the most likely scenario for the U.S. economy in 2012 is moderately strong growth. I don't think turmoil in Europe will hurt the profits of very many American companies; the worst effects will come from converting the Euro to dollars for multinationals, if they have substantial European sales and the dollar continues to strengthen. Keep in mind that the alarmist view of Europe may not pan out, in which case a rising Euro could have the opposite effect.

2011 was also the year in which almost every professional economist in the U.S. predicted a new recession, which did not happen, despite the best efforts of Congress. Where do they find these guys?

In fact, I would hazard that strong U.S. economic growth is now more likely than another recession, in 2012. Demand is out there: consumer demand for autos and housing, which are big economic drivers, is strong. Credit is a constraining factor, but there is still plenty of stimulus from the Fed and the deficit.

We are clearly in the virtuous cycle where demand leads to more employment and profits, which in turn creates more demand. It might even give bankers and other major capitalists enough confidence to invest in expansion. I'm not advocating going back to bubble days, but there is as much danger in being too cautious as there is in pretending there is no such thing as a risky investment or loan.

That should mean the stock market is heading up, but stocks are bought by by individuals, one decision at a time. Companies with the best track records for generating profits are already attracting investors. It is hard to find an overvalued stock today, although I could name a few. Undervalued stocks are plentiful, just pick a flavor, do thorough research, and avoid the wooden nickels.

Will the bond market fall? It should, but it won't as long as enough people are willing to accept almost no returns on their capital, as long as the capital is preserved and reasonably liquid. Once the bond market starts falling, if the economy is getting strong, watch out. Get out quick, while the getting is still good.

The gold bubble seems to have popped. I never liked gold as an asset (See The Gold Bubble [November 18, 2009]), but enough fools bidding on a Beanie Baby can make it seem valuable, until the auction fever dies. Gold has no intrinsic value. It just sits there, useless. Its price depends on the whims of jewelry consumers and irrational investors.

It would be helpful if the price of petroleum came down, but oil prices are geopolitical, for the most part set where the dictator of Saudi Arabia wants them set.

Inflation is dead in the U.S. for the moment, but high prices for agricultural commodities are giving some state economies a good boost. Wages will remain dead in the water until more unemployed workers are soaked up, so I don't intend to worry about inflation until 2013.

The main fly in the ointment is potential political suicide. Most investors know that the national deficit needs to be brought under control. The best way to do that is to freeze or even reduce federal expenditures, then allow for economic growth to increase tax revenues to the point the budget is balanced, and then start reducing the deficit. Counter-cyclical federal budgets were a major key to U.S. economic success ever since the Great Depression. Deficit spending during booms is as stupid as cutbacks during recessions. In no case does a train wreck in Washington help the situation.

Investors and the nation (and its government) need a long term outlook. It will take years to get to a balanced budget, and perhaps decades to significantly reduce the national debt. That takes planning and discipline. The Communist Party of China could accomplish that. Could we do it? Sure, we could. Will we? Only if long term, public-spirited investors insist on it.

Here's an outside opinion: the U.S. could become the driver of the global economy again in 2012, for the first time since 2006. We are still a big, rich, creative, and occasionally hard-working nation. Our natural direction is up.

Monday, December 12, 2011

Cantel Medical Record Quarter

Cantel Medical (CMN) had a record fiscal Q1 2012 ending October 31, 2011, driven by organic growth and acquisitions.

Cantel Medical has been a good stock to hold so far in 2011, closing today at $26.91, up 18% from $22.81 a year ago, with a 52 week high of $28.50 and a 52 week low of $19.02. Not a bad showing in this tough market.

Cantel Medical is a smallish company (market capitalization today ended at $483 million) specializing in infection control through sterilization and disposables. Infection control is more cost effective than treatment for infection, which has become a much larger problem because of the evolution of multiple-antibiotic resistant bacteria.

Cantel is not a well-known name, even in hospitals, partly because it operates through named divisions. Minntech makes and markets endoscope and dialysis equipment sterilizers. Crosstex is the disposables business, working mostly in the dental market, but also moving into the general medical market. It makes face masks, sterilization patches, and other single-use items. Mar Cor makes machines to purify water, often for specialized medical needs. A smaller division is Saf-T-Pak, which produces specialty packaging for transporting specimens, and related materials.

For the latest fiscal quarter, Q1, Cantel reported revenue at $93.3 million, up 8% sequentially from $86.0 million, and up 29% from $72.0 million in the year-earlier quarter. GAAP net income was $6.2 million, up 32% sequentially from $4.7 million, and up 24% from $5.0 million year-earlier. GAAP EPS was $0.35, up 30% sequentially from $0.27 and up 21% from $0.29 year-earlier.

The latest acquisition was of Byrne Medical, announced August 2, 2011. Byrne manufactures products that act as replacements in gastrointestinal endoscopy procedures, eliminating the need for sterilization before reuse. The price of $100 million for a company with trailing annual revenues of $38.6 million seemed high on a revenue basis, but trailing annual pre-tax profits were $8.6 million. Cantel expects to increase gross margins in the business, which had a historical growth rate of over 20%. Byrne Medical had a 30% y/y increase in sales to $11.5 million in Q1 and is already accretive to earnings and cash flow.

Cantel has been fueling its growth with acquisitions. As a result, it ended the quarter with $116.5 million in debt, as against a cash balance of $19.6 million. If you, like me, have been burned occasionally by the poor acquisition strategies of other companies, you might not take this as a recommendation. However, for the few years I have followed Cantel they have done very well with acquisitions. They don't pay too much and sometimes acquire a division of a company they want, rather than the whole company. Then they cross-sell the new products with their established sales force. They have made it work well so far.

Meanwhile, the water purification business also keeps growing. The disposables business should ramp up when (or if) the unemployment rate tweaks down. People have been avoiding doctor and dental visits for economic reasons. When they have the dough to head back in for a checkup, the run rate will pick up again, meaning more use of infection prevention disposables.

So, in summary, the overall anti-infection story is a good one. Cantel is a pure infection play, and it has top-notch management. Should you be cautious because the stock is up 18% y/y? My guess is that the stock is currently priced about right for the short term, although the stock could make another run for its 52 week highs, if the overall market firms up. The trailing P/E ratio at the end of today was 22 (per NASDAQ), which is reasonable for a company with a strong track record of growth. In the longer run I expect continuing profit growth will compell a higher stock price. Cantel Medical should be attractive to long-term investors looking for diversification in the healthcare space.

As a kicker, the dividend was recently raised to $0.14 per year, paid semi-annually.

For more details on quarter results, see my Cantel Medical Q4 fiscal 2011 analyst call summary.

Disclosure: I am long Cantel and will not change my position in the next 2 weeks.

Keep Diversified!

Friday, December 9, 2011

Applied Materials See Cycle Bottom

Applied Materials (AMAT), the semiconductor capital equipment maker, had a very difficult fourth quarter of fiscal 2011 ending October 30th. The stock is trading trading today around $11.20 per share, less than 8 times earnings and not that much above its 52 week low of $9.70 touched on October 4.

Yet revenue for the fiscal year set a record. Applied Materials and other semiconductor equipment makers tend to be very cyclical because demand for new equipment is only strong when semiconductor end use is ramping. It looked like calendar 2011 would continue to be part of a strong up cycle that started in 2010, but global economic turmoil and weak consumer electronics end demand has made chip makers and the foundries that serve fabless chip makers reluctant to increase capacity.

Sales continue because even during slow periods there are advantages to moving to new process technologies that put more transistors on any given area of chip surface. Applied Materials also derives considerable revenue from related services. Its services division contributed $629 million in revenue in the quarter.

Total Q4 revenue was $2.18 billion, down 22% sequentially from $2.79 billion and down 25% from $2.89 billion in the year-earlier quarter. GAAP net income was $456 million, down 4% sequentially from $476 million and down 3% from $468 million year-earlier. GAP EPS (earnings per share) were $0.34, down 6% sequentially from $0.36 and down 3% from $0.35 year-earlier.

Non-GAAP net income was $271 million, down sequentially from $467 million and also down from $476 million year-earlier. EPS $0.21. The vastly lower non-GAAP than GAAP earnings were mostly due to a $203 adjustment to the prior-year's income tax filings.

Despite the poor quarter, cash flow from operations was near $700, or about $425 million excluding the income tax refund. Cash and equivalents were over $7 billion.

The stock pays a dividend of $8 per quarter per share. Management reiterated that they are committed to increasing the dividend, but stock buy backs are the preferred method of returning profits to shareholders. The acquisition of Varian Semiconductor will put a temporary crimp in cash, but is a good long-term move.

Which brings us back to the question of where we are in the cycle. To some extent that depends on the global economy. It is also sector-specific, as capacity utilization and end demand growth differ for sectors like RAM, Flash memory, application-specific chips and display technology.

Applied Materials management has had decades of experience with these cycles. They expect the first half of their fiscal year 2012 to be difficult. In particular Q1 fiscal 2012 (ending January 30th) guidance was for revenues down sequentially another 5% to 15%. However, they believe they are already past the bottom of the order cycle. Because we are talking about capital equipment, when the order cycle starts trending upward it can be six months before actual revenues start trending back up.

Flash and mobile processor capacity utilization are already high, so any further increase in demand should generate equipment orders. However, RAM capacity is plentiful, so we probably won't see a big uptick in revenues until demand catches up to capacity in that segment, probably later in 2012.

Despite unevenness, we are still in a global economic ramp with billions of consumers set to acquire smartphones in the next 3 years (600 million in China alone). Everyone wants devices that do more with less power, and the only way to get that is with new semiconductor manufacturing capabilities. It does not matter who wins the smartphone race; everyone needs the kind of semiconductor manufacturing solutions Applied Materials provides.

For more details about Q4 results, including questions by analysts, see my Applied Materials Q4 2011 Analyst Call summary.

Disclaimer: I have a long position in Applied Materials (AMAT), with a long term view. I have no plans to change my position anytime soon.

See also:

And keep diversified!

Monday, December 5, 2011


Back in February I warned that "at $25.48 [per share], you might want to consider that it could take NVIDIA [NVDA] a couple of years of outstanding growth to justify this price."

Maybe it is just the stock market and macroeconomic turmoil, but NVDA closed today at $15.48.
What I think about the pricing of a stock is only loosely linked to what I think of a company. As to engineering and execution, I have long believed NVIDIA is one of the best technology companies in the world. As the long-term leader in computer graphics chips (GPUs), however, it is now at a crossroads where the old rules no longer seem to apply. It is a time of both tremendous opportunity and tremendous danger, which makes predicting future profit streams mainly guesswork.

NVIDIA reported fiscal Q3 results and held its analyst conference call on November 10, 2011. Note the quarter ended October 30, so its not a calendar quarter and chips going into consumer products for the holidays pretty much had to be out the door by the end of the quarter. Q4, ending January 30th, is historically a slower quarter for NVIDIA. Note also that rivals AMD and Intel had quarters ending September 30.

Revenues were $1.07 billion, up 5% sequentially from $1.02 billion and up 26% from $840 million in the year-earlier quarter. Net income was $178.3 million, up 18% sequentially from $151.6 million and up 110% from $84.9 million year-earlier. EPS (earnings per share) were $0.29, up 16% sequentially from $0.25 and up 93% from $0.15 year-earlier.

That is pretty strong growth over the past year. However, from a licensing deal and litigation settlement with Intel, NVIDIA got roughly $60 million in royalties it did not get a year earlier (the royalties run about another 5 years). That had some impact on revenue and a huge impact on net income and EPS. It is real money, but it did not come from chips sales.

At this point NVIDIA has two games going. One is in its classic discrete GPU chips, which are now also used as math and application acceleration co-processors. Its only real rival in that market is AMD.

The other is combining its graphics engine with ARM chip designs for mobile devices. That results in a chip called Tegra. The first version was interesting but did not generate much revenue. Tegra II sold a lot better, and has powered a number of smartphones and tablets. Tegra III, or Kal-El, became available in the quarter, so a few devices are available now and it will be widely available in 2012. NVIDIA management did not break out Tegra revenue for the quarter.

The NVIDIA vision is not just to dominate the smart phone and tablet markets. Future versions of Tegra are supposed to be powerful enough to go into notebooks, desktops, and even servers.

The problem with being in the ARM market is that anyone can license the ARM design. Graphics and cell phone connectivity chips and designs are available as well. NVIDIA seems tight with Google, but any ARM-based design can run the Android software.

Competitors each have some advantages. Apple, of course, is the perceived frontrunner. There is no guarantee that the iPhone is ultimately going to be defeated by Android-based phones or less likely competitors.

When it comes to ARM based chips for tablets and phones, each competitor brings some serious advantages to the court. Qualcomm has far more extensive experience in cell phone chips than NVIDIA does; so does Texas Instruments. Among a host of other contenders, Marvell (MRVL) should be noted, since they generate a lot of cash each quarter and have a lead in China, a much bigger market to fight over than the U.S. market. Then there are the Koreans, and Japanese, and numerous small innovators.

Another problem for NVIDIA is the lack of a x86 CPU chip design. AMD and Intel both are incorporating graphics into their base designs, eliminating the need for NVIDIA's GPU chips for most users. This already appears to be hurting them in the notebook segment. It will take some time and at least a couple of die shrinks before the pure GPU chip dies (except in specialty markets), but that time is coming at a fairly predictable clip.

So far profit margins have been good at the leading edge of smartphone and tablet processors, but at some point pricing could become more competitive.

2012 is likely to be a make or break year for NVIDIA. If they are able to dominate the Android phone market they might become the dominant semiconductor company, a position Intel has had for a couple of decades now. Myself, I am not willing to make that bet, but I'll keep a close watch. However, I do believe NVIDIA's price is now pretty reasonable, everything taken into account.

See also my Q3 NVIDIA analyst call summary.

Disclaimer: I have no position in NVIDIA and will not take a position for at least 2 weeks following the publication date of this article.

Keep Diversified!

Tuesday, November 29, 2011

SGI Supercomputer Revenue Growth Continues

Looking for the technology company that reported calendar Q3 2011 revenue that was 58% higher than its Q3 of 2010? That would be Silicon Graphics International (SGI), manufacturer of high-performance technical computers (supercomputers) and high-efficiency server systems for datacenters and cloud computing.

GAAP revenues for fiscal Q1 2012 ending September 30, 2011 were $178.9 million, down 8% sequentially from $195.5 million, but up 58% from $112.9 million in the year-earlier quarter. GAAP net income was negative $2.7 million, improved sequentially from negative $12.1 million and improved from negative $11.2 million year-earlier. EPS (earnings per share) were negative $0.08, improved sequentially from negative $0.39, and also improved from negative $0.37 year-earlier.

While in the red on a GAAP basis, on a non-GAAP basis (mostly eliminating non-cash expenses like stock-based compensation) SGI managed a profit of $2.2 million, or $0.07 per share. SGI has gone through a period of investing to introduce new products, and also expanding its sales force. Profit margins could improve as further ramps in revenue should not require similar ramps in operating expenses.

While not giving guidance by quarter, for fiscal year 2012 (running to June 2012) revenue is expected between $740 and $780 million, up to 24% over fiscal 2011.GAAP EPS is estimated between $0.15 and $0.30. Non-GAAP EPS expected between $0.60 and $0.80.

How are they achieving such stellar growth while other computer makers are lagging? SGI specializes in expensive computers used for scientific research, as well as large systems for cloud computing and Web farms. These are all areas that continue to grow quickly. While there is competition from the likes of IBM, HP, Dell, and Cray, the newest systems introduced by SGI, notably Altix UV, are better at addressing the needs of their markets.

Nor is SGI resting on their laurels. They are introducing computers that run large scale systems running Windows SQL Server. They have improved their compatibility with Hadoop and Red Hat Enterprise Linux. They continue to be a major supplier for Amazon's cloud system. They also have started acquiring small companies that specialize in supercomputer application software. SGI expects that the ability to sell software as well as hardware will be a major advantage for verticals they service, with higher profit margins.

Finally, they ended the latest quarter with $115 million in cash with no debt. They did use $30 million of cash to build inventory in the quarter, but the systems built had been pre-ordered and should be shipping this quarter.

Because of the size of the systems involved, some quarter-to-quarter lumpiness is to be expected.

If you read what scientists are saying about Altix UV, you will realize why management has become very confident in SGI's future. On the analyst call they stated the next big SGI milestone will be $1 billion in annual revenue, which should bring between $1.75 and $2.00 non-GAAP EPS per share.

The recent growth has been in the face of a lot of uncertainty and a poor macroeconomy. Even so, if the doomsayers are right about global slowdown or meltdown scenarios in 2012, that could impact sales. I am more concerned about competition, but it does seem that for now SGI has found a niche where it can outcompete far larger companies.

For more details on calendar Q3 results, see my SGI Q1 fiscal 2012 analyst call summary.

Disclaimer: I am long SGI. I won't change my position for at least one week from today.

The usual risks apply, so keep diversified!

See also:

Monday, November 28, 2011

Microchip (MCHP) Inventory Correction End May Be Near

There is no way to describe Q3 2011 as a good quarter for Microchip (MCHP). The maker of microcontroller and analog chips reported revenues of $340.6 million, down 9% sequentially from $374.5 million in Q2 and down 11% from $382.3 million in the year-earlier quarter.

GAAP net income was $79.3 million, down 20% sequentially from $99.3 million and down 24% from $104.7 million year-earlier. GAAP EPS were $0.40, down 18% sequentially from $0.49 and down 26% from $0.54 year-earlier.

Given that and the general stock-market and macroeconomic malaise, the main thing propping up Microchip's stock price (closing today at $33.07) is the dividend, now running at $1.392 per share per year, or 4.3% at today's price.

As to the outlook, Q4 guidance was week, with revenue in the range of flat to down 7% from Q3.

I don't think that Microchip is failing to compete in its market segments. It continues to be the world's leading microcontroller provider. Economic uncertainty caused weakend demand, which in turn caused OEMs to tighten up their inventories.

Then again, the picture could be brighter for Q1 2012. The first quarter is typically seasonally slow for semiconductor chip makers, but within that seasonality Microchip's management, as early as the analyst call on November 3, foresaw an uptick, predicting that "shipment rates in December will be below the consumption rates of our customers."

Here it is important for analysts to note that, unlike most chip manufacturers, Microchip does not recognize revenue when it makes shipments to distributors. Because of the nature of Microchip's business (selling a large number of parts to a large number of OEMs), a lot of sales are through distributors. Microchips recognizes the revenue when the distributors have shipped the chips to end customers.

This means that Microchip tends to see results (reported revenue) of general semiconductor trends, both up and down, a quarter earlier than its peers. While there can be differences in results because of focus and competition for market share, a Microchip revenue downturn is a fair predictor of a sector downturn one quarter later, and the same for upturns.

If this December shapes up to be a good one for electronics sales in the U.S., and if Europe holds together, January may look very different than most investors would have expected until recently. If end sales cause inventory shortages at OEMs, the pace chip sales in Q1 could be strong, compared to the usual range from seasonality.

So keep an eye on Microchip's Q4 results and Q1 2011 results. In the meantime, if you are holding MCHP, enjoy the dividends.

Keep in mind that the semiconductor industry, including its microcontroller and analog segments, is very competitive.

Disclaimer: I am long MCHP and have no plans to change my position this year.

See also:

Tuesday, November 22, 2011

Hansen Medical: Slow Magellan Ramp Planned

Hansen Medical Inc. (HNSN) manufactures catheter based medical robots. It is effectively still a startup company, since it typically loses money each quarter. When it has shown a profit is has been from licensing its technology, not from robot sales. However, this is a well-understood business model. Research and development has to be done upfront. The FDA and other national medical agencies must approve each application of the technology. At the moment one application, electrophysiological exploration, is approved both in the U.S. and Europe. Two other applications have been approved in Europe, but have not yet produced revenue.

The difficulty of guessing the future value of this technology is why (along with overall market volatility) the stock price of Hansen has been all over the map this year. The fifty-two week high was $5.28, the fifty-two week low was $1.24, and the stock was up $0.15 today to close at $2.37. If Hansen continues to burn through its cash, $1.24 might be generous. If it starts selling significantly more surgical robots at a good profit margin, $5.28 will seem like nothing two or three years out.

I expected Hansen to trade higher after the new peripheral vascular surgical system, Magellan, was approved in Europe back in Q3. I expected it would take time to ramp up sales since these robots are big ticket items. The November 2, 2011 analyst call about Q3 results, however, tempered my short term hopes. The first working Magellan had been installed in St. Mary's Hospital in London, but Hansen wanted to take things slowly. One might hope their salespeople would have ten or more sales lined up for Q4, but instead they wanted to do a number of actual surgeries at St. Mary's and study the results.

Based on earlier trials they expect good results, but more data would not only help to drive sales. Experience is something that can be shared. Getting the surgeon's experiences at St. Mary's should help future surgeons and the Hansen employees who train them. That means better outcomes for patients and a better argument for the value of robotic vascular surgery.

Investors, of course, want their results this quarter, not sometime in the vague future.

If Hansen continues to move cautiously it may be a couple of quarters into 2012 before we see significant sales of the new Magellan system. Also Hansen, after an earlier accounting practices muck-up, now only recognizes revenue when doctors are trained and successfully operating a system. So the ramp will probably be in deferred revenue before it hits the actual revenue line.

Nor are the current Sensei robots for electrophysiology likely to come to the rescue. Only two systems were shipped in Q3, although revenue was recognized on five systems. Hansen lost $10.1 million in the quarter on revenue of $5.4 million.

Management seems confident that the new Magellan system will turn the company around. Hansen ended the quarter with $26 million in cash and just $3.6 million in debt. Answering an analyst question about running out of cash, management said they would get another $3 million from their licensing agreement with Philips. That should get Hansen through Q2, the commercial launch in Europe, and FDA approval for Magellan in the U.S. They are considering strategic financing similar to the Philips financing as well as debt or equity financing. They said they were confident of their ability to raise capital. A few days later they raised $10 million selling stock to existing investors.

Market capitalization ended today at $130 million. While that sounds high for a company with a $22 million annual revenue run rate and a history of losses, I know I am not the only person who thinks the future value of this technology is much higher. Earlier this year Philips paid $29 million for non-exclusive rights to use one of Hansen's technologies.

Start up costs for surgical robotics are high, but we are reaching a point when Magellan sales should start pointing us in the right direction. Buying in now has its risks, but so does waiting until later in 2012 when buying in is likely to be much more costly. The price can be very volatile because this tends to be traded in large blocks by aggressive traders.

I have owned Hansen Medical stock since July of 2009, after starting posting Hansen analyst call summaries in February of 2009.

Disclaimer: I am long HNSN. I will not trade in the stock for 1 week following this post.

Monday, November 21, 2011

Onyx Pharmaceuticals (ONXX) Sees New Product Upside

Onyx Pharmaceuticals (ONXX) was one of the few stocks that were up today, closing up $0.63 to $37.86. Still, it is well beneath it's 52-week high of $45.90.

Management thinks the full year will be non-GAAP EPS positive, based largely on a $160 million payment from Bayer this quarter. Bayer sells Onyx's Nexavar for kidney and liver cancer, splitting the after-costs profits. The $160 million was to buy-out the rights for Nexavar in Japan, which has been ramping up to be a lucrative market because of the high incidence of liver cancer there. This was part of a larger deal to end litigation for a Nexavar-related drug, Regorafenib. Under the settlement Onyx will get 20% royalties if the drug makes it to market.

Regorafenib recently had positive Phase III data for metastatic colorectal cancer. Like Nexavar, it appears it may be a useful therapy for a variety of cancers.

The predicted annual positive non-GAAP results were hard to predict before the deal announcement because in most quarters so far Onyx's own operating expenses have been sufficient to wipe out the receipts from Bayer. For Q1 non-GAAP net loss was $14.2 million, for Q2 net loss was $27.2 million, and for Q3 net loss was $19.5 million. One reason for the net losses is that both Bayer and Onyx have been spending large sums on running Nexavar through a set of clinical trials that have shown it may be effective for other forms of cancer, and to strengthen its role in liver caner. If you subtract out the research and development (R&D) costs, in most quarters Onyx would have shown a profit. Onyx has started recruiting patients for Nexavar Phase III trials for breast cancer and thyroid cancer, and has Phase II trials underway in colorectal and ovarian cancer.

Fortunately Onyx Pharmaceuticals has been able to maintain a high cash balance despite the regular losses, ending Q3 2011 at $530 million. Assuming the $160 million payment is a Q4 event, cash at the end of the year should approach $675 million.

I would not expect Regorafenib revenue until at least 2013, and like any drug it could fail for a currently unknown reason.

Carfilzomib is still the key to Onyx's value in the 2012 to 2015 time frame. Carfilzomib is a proteasome inhibitor that had positive data for relapsed and refractory multiple myeloma in a Phase IIb trial. In fact the data was good enough that it is being submitted to the FDA for approval. At the same time two Phase III trials have been initiated. More detailed data from the Phase IIb trial will be presented at the American Society of Hematology (ASH) Annual Meeting, December 10-13, 2011. While there is an outside possibility carfilzomib will not gain FDA approval, the main question is when it will get approval.

If both Regorafenib and carfilzomib are approved by the FDA, the nature of Onyx's model will change. It should be possible, starting in 2013, to have a vigorous R&D program to continue expanding the indications for Nexavar, carfilzomib and other pipeline candidates without actually throwing the bottom line into the red.

I believe that there is always risk in biotechnology stocks from competition, the need for FDA and other national medical agency approvals, and from failure to execute.

However, with expanded indications for Nexavar, plus likely revenues from carfilzomib and royalties on Regorafenib, in the next few years Onyx should become a highly profitable company. I do not think the current stock price reflects full value.

Disclosure: I am long Onyx Pharmaceutical. I have no plans to sell or buy ONXX in the immediate future.

Keep Diversified!

Monday, November 14, 2011

TTM Technologies (TTMI) Sees E-Reader PCB demand

TTM Technologies (TTMI) makes PCBs (printed circuit boards) for the communications, industrial, medical, and consumer electronics industries. It owns plants in the U.S. and in China. The U.S. facilities generally do small runs of PCBs for prototypes and specialized, low volume products. Chinese facilities do larger PCB runs for computer and communications equipment, cell phones including smartphones, and more recently tablet computers and e-readers.

Q3 2011 was a no-growth quarter. Revenues were $358.3 million, down 2% sequentially from $366.1 million, and about flat against $356.8 million in the year-earlier quarter. GAAP net income was $24.5 million, up sequentially from negative $20.3 million, but down 16% from $29.1 million year-earlier. Q2 profits were hit by a one-time non-cash accounting charge for writing off some obsolete factory equipment. So, switching to a non-GAAP view of net income, we have: Q3 2011 $31.0 million, Q2 2011 $32.9 million, Q3 2010 $35.0 million.

While growth has been stagnant this year, profits have remained healthy. Annualizing Q3 non-GAAP EPS gives a P/E ratio is about 7.2 at today's closing price of $11.01 per share.

Because TTM has a broad array of end customers and a global presense, to a large extent its fortunes reflect those of the electronics industry as a whole. For that industry Q3 was a slow quarter in a slow year. Everyone is worried about end demand because of the economy. I believe TTM's ability to make a profit in this environment means it is a reliable cash generator. If the electronics industry picks up again in 2012, there is upside potential.

In the Q3 conference call on November 2nd management noted that some orders were pushed out past the end of the quarter. Cash flow from operations was $42.6 million. The cash and equivalents balance ended at $207.7 million. Long term debt ended at $366.7 million. TTM made capital expenditures of $28.3 million, mostly for new high-end manufacturing equipment in China.

It is notable that debt still exceeds cash. The debt was used to build and expand plants in Asia. So far it has been a good use of debt, but it does create some risk if there is an extreme economic slowdown. Paying down debt has been a priority use for cash.

TTM tracks end markets into 5 segments. For the quarter aerospace and defense was below trend. Cell phones were strong, particularly smartphones. Computers and related were weak and are expected to continue to be weak in Q4. The medical and industrial segment was flat. Networking and communciations, which accounted for 38% of revenue, is expected to be soft in Q4. There is also an "other" category, which saw growth because they are producing the PCBs for a new e-reader for an unspecified customer.

The top five customers were: Apple, Cisco, Ericsson, Huawei and ZTE. Only one of them accounted for more than 10% of revenue.

I believe that as the global electronics industry recovers TTM will continue to pay off debt and eventually be better positioned to use cash for buy-backs and dividends.

Disclaimer: I am long TTMI. I have no plan to change my position this quarter.

Keep diversified!

Monday, November 7, 2011

Celgene Q3 shows model strength

Celgene provides a double dose of growth potential: further growth of its currently approved therapies and a rich pipeline with some therapies closing in on FDA approval and commercialization. Since I last wrote about Celgene on August 2, its stock price has risen from $57.29 to today's close of $64.29. Celgene's 52 week high is $68.25 reached on October 24th.

Consider Celgene's Q3 earnings reported last week. Revenue was $1.22 billion, up 3% sequentially from $1.18 billion and up 41% from $886 million in the year-earlier quarter. GAAP net income was $373.0 million, up 34% sequentially from $279.2 million and up 33% from $281.2 million year-earlier. GAAP EPS were $0.81, 37% sequentially from $0.59 and up 35% from $0.60 year-earlier. Non-GAAP EPS was EPS $1.02.

Most of this rapid growth was based on a single therapy, Revlimid for multiple myeloma (MM) and myelodysplastic syndromes (MDS). Revlimid revenues grew 28% from a year earlier. Expansion is largely international now, with Russia, China and Brazil still ahead. In addition various clinical trials have indicated Revlimid will be beneficial in other types of cancer. Revlimid is in Phase III trials for CLL (chronic lymphocytic leukemia), NHL (non-Hodgkin lymphoma) and prostate cancer.

Thalomid is ancient and had revenues $83 million, down 12% y/y.

VIDAZA for multiple myeloma revenues were $191 million, up 35% y/y. This is despite losing exclusivity in the United States.

The bit new revenue generator is ABRAXANE for breast cancer. Abraxane is also in clinical trials for treating lung, pancreatic, bladder, skin, and ovarian cancers. ABRAXANE revenues were $114 million, up 20% sequentially, that is quarter over quarter; Celgene did not market it a year ago. A Phase III trial comparing it to decarbazine for metastatic melanoma is expecting to read out data in mid 2012. Phase III Pancreatic cancer trial should complete enrollment in Q1 2012. International revenue continues to ramp. For instance, in the quarter Celgene received reimbursement permission for Abraxane in in Greece and the Czech Republic.

Earlier in the pipeline Celgene displays depth-of-field. Of course most pre-clinical drugs don't make it through all the clinical phases and FDA approval; there are likely to be some losers. Celgene's pipeline is so broad and important you could write a book about it.

In Oncology/Hematology we have pomalidomide in Phase III trials for myelofibrosis and nearing the end of Phase II for multiple myeloma. There is Amrubicin, in Phase III for small cell lung cancer. In Phase II we also have ACE-011 for CIA and ABI-008 for prostate cancer. In Phase I we have Tork Inhibitor and ABI-009, both for solid tumors. There are two additional pre-clinical ABI variants for solid tumors.

Apremilast completed enrollment of patients in Phase III trials for psoriasis and psoriatic arthritis, with three more Phase III trials to complete enrollment by year-end. Phase II trial data for ankylosing spondylitis will be presented in November. In inflammation and immunology we also have JNK CC-930, CC-11050 and PDA-001 in Phase II.

Pomalidomide Phase II data for relapsed and refractory myeloma will be presented at ASH in December. The company is conducting a broad clinical program to support global registrations for pomalidomide.

Beyond that Celgene lists over a dozen agents in discovery and pre-clinical phases.
Of course, what will affect Celgene's stock price soonest are the late stage candidates. The first big movers is likely to be expanding the label for Revlimid to first-line (initial) treatment of multiple myeloma. The second would be Abraxane for non-small cell lung cancer, with FDA submission in second half of 2011 and a decision likely in the first half of 2012.

In general it is a very good time to invest in biotechnology, even given the known risks. Celgene is a cash cow that also has unrealized value in its pipeline. Small, risky biotechs aren't commanding the high premiums they used to, which is good because many of their drug candidates don't work out. With the larger biotechs like Celgene if a drug candidate fails it is disappointing and the stock can lose some momentum, but cash flow can be used to buy and develop more candidates. Celgene's cash and equivalents balance ended at $2.58 billion. Cash flow from operations was $602 million. $885 million was spent on share repurchases in the quarter.

Hopefully some time soon Celgene will start paying out a dividend, which is the true gold standard for today's investors.

Keep diversified!

Disclaimer: I am long Celgene. I have no plans to buy or sell Celgene in the next two weeks.

Friday, November 4, 2011

Dendreon Capitulation

Following the announcement of Q3 results on November 2, 2011, Dendreon (DNDN) stock capitulated. One can only surmise that those who came to the Dendreon game late and hoped to make easy profits, thereby showing their lack of understanding of cancer drug introductions or poor choice in momentum stocks, are now out of the stock. It would be interesting to know who now owns all that stock. Dendreon's 52-week high was $43.96, but it actually hit a post-FDA approval of Provenge for prostate cancer high of $55.43 on May 10, 2010. Its 52-week low was on November 3, at $6.46, with a dead cat bounce today bringing it up to $6.69 at the close. That represents a market capitalization of just under $1 billion.

Q3 results were about what any reasonable person would expect. On August 9, 2011, I guesstimated Q3 revenue at $66 million. It came in at $64.3 million. That included $3 million in non-Provenge royalty payments. Which puts Provenge at $61 million, up 23% from $49.6 million in Q2. Where else would that be a slow ramp?

For those who baled there were two major factors. Revenues were not ramping as quickly as they hoped, and there is a not-unreasonable questioning of where Provenge revenues might peak. In a mere 12 months we have gone from wildly optimistic to deeply pessimistic projections.

What are reasonable projections for Provenge revenues? You have the number of patients covered by the label annually, less those who don't try the therapy. There is no financial reason to not try the therapy since it is covered by Medicaid and Medicare, as well as all major private health insurance plans. The current label constitutes a window through which most prostate cancer patients whose disease progresses will pass, but currently you have to wait for the window. If you a different therapy during the window and wait long enough you can find yourself off label. There is no good reason for a rational patient (or physician) to let that happen. Provenge is very safe and takes only 1 month to administer. It should be the first therapy tried when a patient enters the window. Other therapies can then be tried before waiting to see if Provenge is working, a good strategy given the low percentage of men it provides complete remission for.

33,000 men are expected to die of prostate cancer in 2011, but not all of those go through the Provenge label window because the cancer can become symptomatic before becoming castrate-resistant. I estimate that 15,000 men in the United States will reach the stage of hormone-refractory, non-symptomatic or minimally symptomatic, metastatic prostate cancer each year. This estimate is less that the over 30,000 deaths from prostate cancer each year, since not all men go through the window before dying. Men who knowingly hit this stage usually have already had surgery or radiation therapy plus hormone therapy, but many are not diagnosed until after they have passed the window. Provenge therapy costs about $90,000. If 10,000 men per year try Provenge revenues would be $900 million per year. (There will be 240,890 new prostate cancer cases in the U.S. in 2011 according to the National Cancer Institute, but most men are cured by surgery or radiation or die of something else before their cancers become metastatic.)

I can only conclude that the $61 million for Provenge in Q3, annualized to $244 million, is just the beginning of the ramp. Add to that European patients. Add to that the rest of the world. Add to that the possible expansion of the label. Provenge works by getting immune cells to attack cells presenting PAP (Prostatic Acid Phosphatase). It is present in symptomatic disease and during the hormone dependent phase. It would not be surprising if Dendreon were able to extend the label following clinical trials targeting off label phases.

Guaranteed? Of course not. It may make sense to prescribe Provenge, but that does not mean doctors will universally make that a practice. Competitive therapies may prevail, and we can expect new therapies to come down the pipeline until something really can cure the great majority of metastatic prostate cancers.

Dendreon won't stand still either. In addition to global expansion and Provenge label expansion, we can expect other immunotherapies to be developed. Each cancer type that has an appropriate immune system target should be addressable by this paradigm.

Will this happen over night? Of course not. Management was way overconfident in their projections in early 2011. Now they seem to have received the message and are digging into the task of educating patients and physicians. Q4 will not see much of a revenue ramp, but that is because patients and doctors are not likely to start a complicated, month long procedure during the holidays.

Just guessing, but I would expect Q1 2012 to show a better revenue ramp, probably to between $75 and $80 million. Management won't give guidance, and it is really up to the doctors who deal with prostate cancer. I think as word gets out about successes from Provenge, the process will become demand driven. How long that might take, I am not willing to guess.

In any case Dendreon is a stock for patient investors, as has been keenly demonstrated several times in the last 5 years.

Disclaimer: I am long Dendreon. I won't trade the stock for at least 3 days after this article is posted. I am likely to be a buyer at today's price.

Wednesday, November 2, 2011

Biogen Idec: Q3 Clues to Value

When I wrote "Biogen Idec PML Test Approved in Europe, Changing Tysabri Outlook" on March 15, 2011, the price per share of BIIB was $69.56. When I wrote "Biogen Idec, Is there more Value?" on July 11, 2011, it closed at $105.53, having backed off its recent 52 week high of $109.63. Quite a run. It is headed up today after closing at $114.23 yesterday, so at least those wise people who are in the stock market these days think the answer is yes, there is still more value to be had from Biogen.

So, the eternal investor questions: did something change? Does the run up reflect value that was already there back in March? Could this be another momentum run unjustified by fundamentals? Could there be even more value in the stock?

We have had a number of recent data points to inform our views. BG-12, an oral agent for multiple sclerosis (MS), produced Phase III clinical results that should gain marketing approval from the FDA (of course, there is no guarantee of that). Biogen is generally held to sell the most effective MS drugs, but recently Gilenya by Novartis, became the first oral agent on the market.
In addition Daclizumab HYP showed good Phase 2b trial results. Dexpramipexole for Lou Gehrig's (ALS) disease Phase III trial became fully enrolled recently.

Third quarter (Q3) results released on October 28, along with the analyst conference call, demonstrated that current therapies are still ramping revenues. Biogen Idec's two multiple sclerosis (MS) blockbuster drugs are Avonex, with revenues in Q3 of $682 million, up 6% y/y, and Tysabri, with revenues of $277 million, up 26% y/y. Avonex has been around a long time and dominates the market, but its sales had flattened until the PEN was recently introduced, which makes administering it much easier. On June 22 Biogen had announced the EU approved including JCV status as a risk factor for Tysabri, which we presumed would happen in March. The risk of death or severe injury from PML, a result of JCV getting out of control when immune responses are suppressed (immune responses are the cause of MS), had been a big problem for Biogen. Now patients can test to find out if they are infected with JCV or not and with the help of their doctors make appropriate decisions about the risks versus the benefits of Tysabri.

Given all this good news and the big run up in 2011, are we at a just-right stock price? Of course next year's price will depend on how revenues and profits ramp (or don't) in 2012, and what the outlook looks like for 2013.

I will be surprised if Tysabri revenue growth does not accelerate in the second half of 2012 if BG-12 comes online. I am would not sell the stock in the current price band, and believe BIIB is currently a good bet for new money. However, in aside to the usual macroeconomic and stock market risks, all therapies run some risk from new adverse reactions being discovered and from current and future competing products.

At this point Biogen pays no dividend, but is certainly a profitable enough company that it could. It would also show management's confidence in the company's future. They spend a lot on R&D, over $300 million (GAAP) in Q3, and have a lot of cash, $2.9 billion, and a lot of non-GAAP net income, $395 million in Q3. They do use cash for stock buy backs and to acquire promissing pipeline candidates.

Disclaimer: I am long Biogen Idec. I have no plans to buy or sell in the next 3 days, but do sell stocks I feel have become overpriced.

See also

Tuesday, November 1, 2011

Akamai Grows with Internet

Akamai Technologies' (AKAM) stock price is $26.43 as I write. Before (Wednesday, October 26, 2011) Akamai's Q3 results announcement and analyst conference call the price ended at $23.77, and its peak the last few days was $28.28 on Friday. Clearly the results and outlooks pleased more traders than they displeased. What can we learn from the results and conference call?

Akamai is best known from the boom bust era, when it soared in price before it started showing profits. During the last decade its earnings have grown pretty steadily on a year to year basis. Its stock price and P/E ratio has been pretty well-aligned with reality. Today the trailing 12 month P/E is 26. Non-GAAP earnings for Q3 were up 10% y/y, and revenues were up 11%. The P/E is a bit high for this market, but the almost the entire market is undervalued due to fear still triumphing over greed.

Akamai's core business is content delivery, speeding up web page and file delivery from originators to consumers. Increasingly its income and profits are derived from "value-added" businesses, including security for cloud datacenters and DSA (dynamic site acceleration). It is also involved in accelerating the delivery of content to mobile devices.

As the amount of data delivered by the Internet, including cellular networks, grows, so does Akamai, presuming it maintains its large market share in the business. But prices also drop on a per unit basis as volume goes up. Akamai management believes that the delivery of video content is going to drive up volume, revenue and profits. While video data delivery is growing rapidly, it has not yet started to accelerate at rates that would compensate for Akamai's aggressive pricing to its clients.

There is always concern about competition, but mostly competitors have had to compete on price to win customers, making their profit margins thin or non-existent.

Akamai has $1.2 billion in cash and equivalents and generated $116 million in cash flow from operations in the quarter. They invested $47 million in capital expenditures. It is hard to compete with that, as I wrote in Akamai or Limelight? in January of this year.

At this price I am holding my Akamai stock, believing that downside risks are mainly market risks while upside potential is present from both increased video delivery and broader adoption of Akamai's cloud services solutions. Another bright spot is international revenue, which grew 15% y/y. Akamai started in the U.S. and is still expanding its reach to developing economies.

I first bought Akamai for $17.56 per share in September of 2008 when everyone else was panicking. I have both bought and sold shares since then, as P/E ratios have swung rather wildly (the 52 week high was $54.65, 52 weak low was $18.25).

For more detail see my Akamai (AKAM) Q3 2011 conference call summary.

Disclaimer: I am long AKAM, but occasionally trim or expand my position. I don't plan to trade AKAM in the next 3 days.

See also:

Wednesday, October 26, 2011

Biogen Idec, Onyx Pharmaceutical score big

Today two of my biotechnology stocks, Biogen Idec (BIIB) and Onyx Pharmaceuticals (ONXX), are climbing on good results from clinical trials. In Biogen's case results are for daclizumab for multiple sclerosis and for BG-12 for MS as well. Onyx's results are for regorafenib for metastatic colorectal cancer, which is being developed by Bayer, but for which Onyx gets royalties.

This made me think about my now ancient Choosing A Biotech Stock 3 part series. I wrote Part I, the Overview, on September 3, 2007. Was my advice, which I followed, any good?

My hopes were high. I said, "I think some biotechnology stocks are going to be worth a lot more money (better than market returns) in a few years than they are now, and may make me filthy rich if I live to see the long run. I could spread the risk out by buying a lot of different biotechs, or going to a fund. But, well, while I would recommend a fund to anyone too lazy to do their own research, the problem with spreading risk broadly is that you can't get any alpha (profits above typical market) that way."

I already owned Celgene, Dendreon, and Anesiva (which went bankrupt later). I mentioned Gilead Sciences (GILD) and Biogen Idec (BIIB) as being the kinds of companies that I would look at. In Part 2 I took a close look at Gilead. In Part 3 I took a close look at Biogen, but then said that despite their pipeline, "Wow, they have a very strong pipeline (See BIIB pipeline page)," I would buy Gilead first.

Of course after that purchase we had the recession, when most stocks were oversold. I ended up buying Biogen and Onyx as well, and added to each position. The result, so far, has been a mixed bag.

I already owned Celgene, which I first bought in June 2007 for $59.34. I bought more as low as $38.59 in May 2009. As I write it is selling for $66.09.

I first bought Gilead in October 2007 for $42.23. I bought more for $46.55 in February 0f 2010. As I write it is selling for $41.06.

I first bought Biogen in February 2008 for $61.57. I bought more at a low of $46.67 in September of 2008. As I write it is selling for $117.87. Clearly this turned out to be the best investment in the group, so far.

I first bought Onyx in May 2008 for $34.87. My best purchase was for $26.20 in May 2010. As I write it is selling for $39.59.

Clearly Gilead has been the dog of the group, but my selection criteria were pretty good overall. That reminds me, and should remind all of us who are seeking alpha, to keep diversified, even when we have found a sound strategy for investing.

It also reminds me of the importance of patience when doing long-term investing. When a biotechnology company has value in its therapy pipeline, it helps to think in terms of 5 to 10 years, not 5 to 10 days.

Wednesday, October 19, 2011

Will Thailand Floods Hit Marvell Technology?

Marvell Technology (MRVL) makes semiconductor chips for hard disk drives (HDDs), cell phones, networking and other devices. Marvell's first product was a chip to control hard drives, and in its first decade it came to dominate that market. This year revenue from chips for hard drives has represented about half of total Marvell revenue.

This week massive flooding in Thailand caused Western Digital manufacturing facilities to be shut down there. Obviously this could hurt demand for Marvell's HDD controller chips, at least temporarily. How much trouble could this be for Marvell's Q3 and Q4 results? (its fiscal Q3 ends October 30th; Q4 ends January 31st)

Western Digital is currently Marvell's largest HDD customer. Earlier this year Western Digital acquired Hitachi's HDD division. Marvell is generally granted to have the best HDD controller chips, so it has been expected to expand its already substantial market share by increasingly supplying chips for Hitachi. It has also been becoming a more important supplier for another big HDD manufacturer, Seagate, which is acquiring Samsung's HDD division. In Q1 2011 Western Digital led global shipment in units, but Seagate led in revenues.

According to Western Digital, two of its Thailand facilities were shut because of flooding. In addition there has been flood damage to the supply chain for the plants. It expects a "significant impact" on its ability to meet demand in the December quarter.

Seagate's Thai factories were not directly affected, but it also expects supply chain problems of unknown magnitude.

While all this is sorted out Marvell will probably lose some October shipments, which may impact Q3 revenue, depending on revenue recognition timing. It is too early to predict how long beyond October the effect could last. In the longer run it is likely just a bump in the road. There is inventory at every stage of the chain. HDD sales have not been robust this year, so the inventory situation is probably not bad. PC manufacturers have inventory on hand, and there have been no reports that the flooding ruined any drives already made or in production. To some extent supplies and production could be shifted to other plants, which should have excess capacity, if not now (gearing up for holiday PC sales), certainly in December and January.

The situation is worth watching. If it takes months instead of weeks to get back to full production there could be a substantial impact on Marvell's Q4 results. On the other hand Marvell has been trending to be less reliant on HDD chip sales for its profits. Revenues from its Chinese smartphone chips, which should be ramping in Q3, are probably the best indicator of how well Marvell will fare in 2012.

Disclosure: I am long Marvell Technology (MRVL).

See also:
My August 18, 2011 Marvell (MRVL) analyst call summary
My May 26, 2011 Marvell (MRVL) analyst call summary
My March 2011 Marvell (MRVL) analyst call summary
Keep diversified!

Wednesday, October 12, 2011

Onyx Pharmaceuticals Gets $160 million for Nexavar, Plus Regorafenib Royalties

Onyx Pharmaceuticals (ONXX) today announced it is receiving a major cash infusion at a time when it is transitioning from being a successful biotechnology startup into a major player. The cash, $160 million from Bayer, is for the Japanese rights for Nexavar, a cancer therapy. The deal is in the context of settling litigation about Regorafenib, an analog of Nexavar developed by Bayer. Onyx will receive a 20% royalty on future worldwide sales of Regorafenib.

Nexavar is sold by Bayer. Onyx, which discovered and co-developed the drug, gets a share of the profits after Bayer's expenses. But in most quarters so far Onyx's own operating expenses have been sufficient to wipe out the receipts from Bayer. An important treatment for liver and kidney cancer, sales of Nexavar continue to ramp globally. Liver cancer rates are far higher in Asia than in the West, but Asia is the last area Nexavar has become available, so sales are just beginning to ramp in China and other nations in the region.

Bayer and Onyx have been running Nexavar through a set of clinical trials that have shown it may be effective for other forms of cancer, and to strengthen its role in liver caner. If you subtract out these research and development (R&D) costs, in most quarters Onyx would have shown a profit. Onyx has started recruiting patients for Nexavar Phase III trials for breast cancer and thyroid cancer, and has Phase II trials underway in colorectal and ovarian cancer.

Fortunately Onyx Pharmaceuticals has been able to maintain a high cash balance despite the regular losses, ending Q2 2011 at $550 million. Assuming the $160 million payment is a Q4 event, cash at the end of the year should approach $700 million.

Regorafenib does not yet have its first FDA approval. It is in a Phase III trial for a type of stomach cancer, and will doubtless be tried for a variety of solid cancer types. I would not expect any revenue until 2014, and like any drug it could fail for a currently unknown reason, but the royalties are a great thing to have in Onyx's likely future.

Given the background of success with Nexavar, tempered with losses due to R&D spend, Carfilzomib is still the key to Onyx's value in the 2012 to 2015 time frame. Carfilzomib is a proteasome inhibitor that had positive data for relapsed and refractory multiple myeloma in a Phase IIb trial. In fact the data was good enough that it is being submitted to the FDA for approval. At the same time two Phase III trials have been initiated.

If both Regorafenib and carfilzomib is approved by the FDA the nature of Onyx's model will change. It should be possible, starting in 2013, to have a vigorous R&D program to continue expanding the indications for Nexavar and carfilzomib without actually throwing the bottom line into the red.

Yesterday Onyx ended with a market capitalization of $2.0 billion, at $31.91 per share. As I write the market cap has risen to $2.15 billion, with the stock price at $33.80. I believe that there is always risk in biotechnology stocks from competition, the need for FDA and other national medical agency approvals, and from failure to execute.

Disclosure: I am long Onyx Pharmaceutical. I have no plans to sell or buy ONXX in the immediate future.

Keep Diversified!

See also my notes on the Q2 2011 Onyx Pharmaceuticals analyst call
Onyx Pharmaceuticals home page

Sunday, October 9, 2011

Earnings Preview: AMD, AKAM, GILD, BIIB, CELG

Earnings season is upon us again. Of the stocks I watch most closely (in this case because I own some of each of them), Akamai (AKAM) has scheduled its analyst conference for October 26, and Advanced Micro Devices (AMD) is on October 27. Gilead Sciences (GILD), Celgene (CELG), and Biogen Idec (BIIB) should also report before month's end, but have not yet set dates.

While the information in analyst conferences comes from management, and so can be biased, it is still essential listening for serious investors. At the end sell-side analysts are allowed to ask questions (some micro-caps even let investors ask questions), and on occasion an answer to a question can give important insights into the company. I take notes while I listen and even post them on the web; listen to management for a couple of years and you may be able to tell a lot from the way they answer or evade questions. Going back a few years and checking on how management's predictions worked out can also be illuminating.

Akamai typically is a high P/E stock that has to justify that ratio by showing continuous growth. Many companies have tried to compete with Akamai at accelerated delivery of web content, yet over a decade later Akamai still has incredible market share and has branched out into adjacent businesses like cloud security. Pricing has been an issue lately. Look to see if Akamai's volume of business is growing fast enough to compensate for falling prices. Q3 is a slowish quarter for content delivery, with a big bump coming from e-commerce in Q4, so Q4 guidance is also a key indicator of the health of this business.

AMD already pre-announced, sending the stock price into free-fall. This was as I predicted in AMD at Earnings Crossroad, but worse. The good side of the news is demand for AMD's new server and APU chips is strong. What we want to know from management is how strong is the demand, and how quickly can they gear up chip production to meet the demand.

Biogen Idec (BIIB) guided to low to mid single digit revenue growth over 2011, which for Q3 would run to roughtly $1.2 billion. Tysabri sales over $280 million would be a positive indicator, but the key question is data or FDA approvals for late-pipeline drugs like BG-12 or Daclizumab for multiple sclerosis, which are likely to be announced on other occasions.

Gilead (GILD) is a cash cow that has a low P/E due to patents expiring on some of its anti-viral drugs over the next decade. If management would pay a dividend, the value of the franchise would be more obvious. They are doing a lot of research on new anti-viral compounds that could kick growth into high gear again if approved. Expect something over $2 billion in revenue, $940 million in cash flow from operations. The key issue would be timelines for Endurant and and the "Quad" regimen. Don't expect the stock to budge much in this market until they pay a dividend or announce positive Phase III data for a hepatitis C multi-drug therapy (they are only in Phase II, so it will be a while).

Celgene (CELG) is another cash cow, but with a rapid revenue and profit growth rate (and a higher P/E). Look for Revlimid revenues over $800 million, Vidaza over $165 million or Abraxane, their newest drug, revenues breaking though $100 million in the quarter. Celgene has a pipeline of potential drugs that is so extensive it would take several articles just to go over them. See Celgene drug pipeline for a list. Unless they mostly strike out, anyone who does not buy Celgene at today's price will wish they had in five years, but long-term investors are hard to find in this market.

Disclaimer: I am long in all of these stocks.

Wednesday, September 28, 2011

Cantel Medical Keeps Growing

Cantel Medical has been a good stock to hold so far in 2011, closing today at $21.28, up 30% from $16.38 a year ago, with a 52 week high of $28.29 and a 52 week low of $15.57. Not a bad showing in this tough market. Cantel is not a household word, so I thought I'd fill in my readers on what they do and why they might want to own a piece of this company.

Cantel Medical is a smallish company (market capitalization today ended at $366 million). Cantel specializes in infection control through sterilization and disposables. I know that infection control is more cost effective than treatment, and is becoming a much larger problem because of the evolution of multiple-antibiotic resistant bacteria. I watched Cantel for a while, then bought stock a couple of times when I thought the valuation was good.

Cantel is not a well-known name, even in hospitals, partly because it operates through named divisions. Minntech makes and markets endoscope and dialysis equipment sterilizers. Crosstex is the disposables business, working mostly in the dental market, but also moving into the general medical market. It makes face masks, sterilization patches, and other single-use items. Mar Cor makes machines to purify water, often for specialized medical needs. A smaller division is Saf-T-Pak, which produces specialty packaging for transporting specimens, and related materials.

When there are infectious disease scares Cantel gets bursts of extra revenue, so in evaluating the stock you might want to both zero-out such bursts to get a real trend line, and also figure that over time those bursts do add up.

Also, while Cantel does develop products and grows by increasing sales organically, they also grow by acquisition. If you, like me, have been burned occasionally by the poor acquisition strategies of other companies, you might not take this as a recommendation. However, for the few years I have followed Cantel they have done very well with acquisitions. They don't pay too much and they usually acquire a division of a company they want, rather than the whole company. Then they cross-sell the new products with their established sales force.

The latest acquisition was of Byrne Medical, announced August 2, 2011. Byrne manufactures products that act as replacements in gastrointestinal endoscopy procedures, eliminating the need for sterilization before reuse. The price of $100 million for a company with trailing annual revenues of $38.6 million seems high on a revenue basis, but trailing annual pre-tax profits were $8.6 million. Cantel expects to increase gross margins in the business, which has a historical growth rate of over 20%. The business is expected to be accretive over fiscal year 2012 ending July 31, 2012.

Since Cantel is already in the endoscopy business, cross-selling is a given. The combined endoscopy businesses will have 80 sales and marketing personnel. Acquiring Byrne is the largest transaction in Cantel's history. Even before the combination Cantel's recent endoscope sterilizer equipment sales had been ramping rapidly. The newer sterilization machines are called reprocessors; they do helpful things like inventory management that the aging machines can't do.

Meanwhile, the water purification business just keeps growing. Also the disposables business should ramp up when (of if) the unemployment rate tweaks down. People have been avoiding doctor and dental visits for economic reasons; when they have the dough to head back in for a checkup, the run rate will pick up again.

So, in summary, the overall anti-infection story is a good one. Cantel is a pure infection play, and it has top-notch management. Should you be cautious because the stock is up 33% y/y? My guess is that even in the short term the stock could make another run for its 52 week highs, if the overall market firms up. The trailing P/E ratio at the end of today was 18 (per NASDAQ), which is still reasonable for a company with a strong growth track record. Today's ending price seems fair to me and attractive for long-term investors looking for diversification in the healthcare space.

For more details on last quarter's results, see my Cantel Medical Q3 fiscal 2011 analyst call summary.

Disclosure: I am long Cantel, and have no plans to buy or sell in the next 2 weeks.

Thursday, September 22, 2011

Red Hat at Billion Dollar Run Rate

Red Hat (RHT) is poised to become the first open source software company with a billion dollar per year revenue run rate. Yesterday Red Hat released fiscal Q2 (ending August 31) revenue of $281 million, up 28% from the year-earlier quarter.

The alleged slowdown of the American and global economies has had little effect on Red Hat. This may partly be from the dollar store effect: Red Hat Enterprise Linux, or RHEL, is a much less expensive operating system than its main rivals, UNIX and Windows Server, yet is roughly as capable. Management, however, attributed the revenue growth to an expanded sales force and an expanded line of products to sell. The main products sold in addition to RHEL, are JBoss, their middleware product, and RHEV, their virtualization product. Also, as major customers expand their datacenters, they pay more for the number of copies of software necessary to operate the new hardware.

RHT is a great example of the power of patience, and of the importance of avoiding buying anything in a bubble. Founded in 1993, and going public in 1999, it was caught up in the Internet Bubble, almost immediately reaching a share price of over $100 (implying a market capitalization of over $20 billion) despite being unprofitable and not even generating very much revenue at the time. After the bubble burst you could buy RHT for less than $4 per share.

Despite the crazy pricing swings of the stock, the underlying company kept at its mission of providing an enterprise-quality version of Linux. As years passed revenue grew, and even profits began to accumulate. The last time you could buy RHT cheap was around November 2008, when it was around $10 per share. Today it closed at $41.52.

Right now it is a good stock to hold, but the price-to-earnings (P/E) ratio could scare off many potential investors. At a time when many technology stocks showing revenue growth are trading at P/E's under 20 or even under 15, Red Hat has a (non-GAAP) trailing P/E of 70 and 1 year forward P/E of 54. That is partially justified by the rapid rate of growth; the danger would be if the rate of growth slowed.

I believe Red Hat software offers a tremendous value proposition for enterprises. While revenues are dwarfed by Microsoft Windows Server revenues ($5.9 billion in Q1 alone), and many companies have already converted from UNIX to Linux, the fact that Red Hat has such a small portion of the $50 billion annual server operating system market leaves plenty of room for growth. RHEL also competes with free Linux distributions. Given the staffing it takes to run a free Linux at the enterprise level, TCO can be cheaper when businesses pay for RHEL and the support services that go with it.

I expect Red Hat will continue to do well as a company. Since its product is software, it has high margins and earnings tend to grow faster than revenues. For Q2, GAAP earnings grew 67% over the year-earlier quarter, but it was an exceptional quarter.

Disclaimer: I don't own Red Hat and have no intention to buy or sell it in the next 3 days.

See also:

Red Hat home page
Red Hat investor relations page
My main Red Hat page
My notes on the Red Hat Q2 analyst conference

Monday, September 19, 2011

AMD at the Earnings Crossroads

AMD (Advanced Micro Devices) has only two competitors in its niche: Intel (INTC) for CPUs (computer processing chips) that run x86 software and NVIDIA (NVDA) for GPUs (graphics processing chips). How much market share it takes in the PC chip market, and what margins it receives on the chips it does sell, determines its levels of revenue and profit or loss.

Historically, while AMD has been innovative, it has come in a far second against Intel and NVIDIA. In the last two years it has lost ground to Intel and gained ground from NVIDIA. The picture has been complicated further by the emergence of ARM architecture based processors as the preferred basis for smaller mobile devices like smartphones and tablet computers.

After years of development (usually corresponding to quarterly earnings losses) this year AMD is selling chips that combine a CPU and a GPU. Intel, also, has appended graphics to its new line of CPUs, but their chips are remarkably inferior, incapable of running the current Windows graphics standard, DirectX 11. As a result AMD has been selling all the Fusion chips it has been able to make.

Why then, the lack of excitement and lack of upward momentum in AMD stock? Today AMD closed at $6.92, well off its 52-week high of $9.58 and with an astonishingly low P/E ratio of 6.4, the kind you would expect from a declining industry stock.

For the moment the most visible cutting edge technology is in smartphones and Apple and Android based small tablets. That pretty much sums up tech investor thinking about AMD: that a tidal wave of 7 inch screens are going to replace PCs, including both notebook computers and desktops that can run 60 inch displays.

Let's say you have discovered the limits of small screen computing and think there is still life left in the larger form factors. How should AMD be priced then?

First—even if the economy lags, even if consumers are careful with their holiday electronics purchases, even if the economies of India and China don't grow quite as fast in 2011 as they did in 2010—in Q3 and more so in Q4 AMD will get a significant boost in profits from its new Bulldozer CPUs for the server market. They began shipping in quantity earlier this month, with most of the early allotment going directly into the supercomputer market, where they will replace, or fill empty slots in, the prior generations of AMD Opteron processors. Profit margins are better for server chips than for PC chips. AMD has lost a lot of market share to Intel in server chips these last five years. The new chips should help regain market share. They have a different architecture than the Intel chips, and hence are very cost effective at certain workloads. Bulldozer is not a conquer-the-world chip, but it will keep AMD in the most profitable part of the server CPU game.

On the down side, there are so many rumors about yields (% of good processors on a die) being poor for the Fusion chips, that I think it is fair we can treat the rumors as true. At the next AMD analyst conference there should be a question about that. At the Q2 conference the closest answer we got was that margins were good on the Fusion chips. If both are true, and AMD was right about 2nd half margin improvements, then what we have is upside potential. Yields usually improve over time; if margins are already good, they should be great when yields improve. The problem was doubtless forging the CPU and GPU on the same die; traditionally these chip types used different silicon technologies. Bulldozer yields are rumored to be good, but then these server chips don't have a GPU component.

For now I would take Q3 guidance as a fair range. The economy might push revenues down, but yield improvements could push margins up. Guidance was for Q3 revenue to increase 8 to 12% sequentially. Note that because of holiday demand, Q3 is typically the strongest quarter for AMD.

The numbers, when reported, give us hard data, but the technology trends rule long-term value. I think AMD (and for that matter Intel) are over-discounted. I think both will be taking market share in the tablet market in 2012 and 2013. I think the PC market will stay healthier than most pundits predict. Consumers and businesses who skipped a desktop or notebook upgrade to buy a tablet and smartphone will get back on the upgrade cycle.

The combination of full-powered GPUs and CPUs on a single chip may be more revolutionary than the smartphone. Essentially, we are introducing desktop (or even notebook) parallel supercomputing. We are just beginning to see software applications that utilize either a CPU plus separate GPU or the new Fusion chips. So watch for companies like Microsoft, Adobe, and Autodesk, as well as lesser-known companies and startups, to take advantage of this new paradigm.

Disclosure: I am long AMD.

Thursday, September 8, 2011

Dendreon Restructuring Call

Mitchell H. Gold, MD, Dendreon's CEO, led a analyst conference call to discuss restructuring plans. This follows the month-earlier announcement that Provenge sales were ramping slower than expected.

About 500 employees are being laid off, out of about 2000. Restructuring costs are estimated at $21 million, including $5 million in non-cash stock-based compensation.. Savings from restructuring are estimated at $120 million per year. Most of these employees were in training to be ready to meet the (previously expected) demand ramp. Presumably if demand accelerated again they would have to be rehired, and the savings would not accrue.

For most mid to long term investors the key question is long term demand. Revenues for August were reported at $22 million, up 16% from July, which would put July around $19 million. Given a similar $3 million ramp in September, Q3 income would be $66 million, but management stood by its refusal to guide on revenue other than to say that it expects it to ramp slowly quarter by quarter in the immediate future. $66 million is up 32% sequentially from $50 million in Q2, which would be tremendous had expectations not been raised so high earlier in the year.

Approval of Provenge in Europe was painted as a 2013 event, so no revenue help there is likely until 2014.

Analysts' questions went every which way at management's statement that $500 million in annual revenues, or $125 million per quarter, would get Dendreon to cash-flow break even (but not to GAAP profits). They also believe they have enough cash to reach that point. They had $674 million in cash at the end of next quarter, and $600 million on August 31. Cash use should decline now that the 3 Provenge facilities have been certified by the FDA.

Aside from restructuring, the major effort is in sales. The good news is that the reported time for reimbursement for Provenge has dropped to around 30 days, from prior reports of 60 days or more. That means medical organizations with cash flow issues could treat twice as many patients with the same amount of capital. Also, a concerted effort to make sure prescribers understand the Provenge label and reimbursement availability has been made and is ongoing. We will see if this all has an affect if management keeps reporting revenues on a monthly basis.

Management still believes that the $90,000 per patient price is not an obstacle, and that other prostate cancer drugs will not prevent Provenge from being prescribed within its label, since it is very safe, with almost no side effects, and the course of therapy is much quicker than for most cancer drugs.

There seems to be little fodder for short term momentum plays up or down right now. A lot of risk has been incorporated into the current stock price. A slow revenue ramp with flattening in 2012 would probably keep the price in a range. A faster ramp and better evidence that end demand really can ramp well above $500 million per year would justify a higher stock price, maybe substantially higher, but that could take several quarters to see.

Disclaimer: I have been long Dendreon since 2005, but buy and sell according to my analysis of prospects versus the market capitalization. I added Dendreon shares in August 2011 and last sold shares in April of 2010. I have no plans to buy or sell Dendreon in the near term.

See also: Dendreon Press Releases

Tuesday, September 6, 2011

HP, Dead or Just Resting?

HP, as the Hewlett Packard Company likes to be known, (NYSE: HPQ), is on its last legs, if you judge it by its stock price. It is selling for less than six times earnings. It has become a symbol of technological failure lately, mainly because of the failure of its tablet computer offering and its lack of presence in the smartphone market. Also, it announced it wanted to sell or spin off its personal computer (PC) business, but apparently no one with that kind of bucks wants to buy the division.

But suppose the pundits and investors arranging for a funeral are reading the symptoms wrong. In that case it possible this is a buying opportunity for those who get an accurate view of the situation. After all, a PE under 6 means trailing earnings are about 17% of the stock price. That strikes me, on the surface, as a much better deal than 2% annual returns on risky long term loans to the United States government.

The most solid evidence that things are not so bad are actual GAAP results from fiscal Q3 2011, as reported on August 18, 2011. True, revenue was up only 1% y/y, and while GAAP net earnings were $1.9 billion, up 9% y/y, non-GAAP net earnings were $2.3 billion, down 11.4% y/y.

A company with $1.9 billion in GAAP earnings in a quarter is not on death's doorstep. So the low stock price must be based on opinions about something more fundamental than mere profits: technology trends.

I have been around long enough to see a lot of companies go out of business, especially in the PC space. I know it can happen. Margins are brutal when differentiation from competitors is difficult. That is why IBM turned over its PC business to Lenovo. On the other hand, Lenovo has done quite well since then, so maybe IBM's strategy was not so brilliant.

The main theory is that tablets and smartphones are going to eat PCs, just like PCs ate up minicomputers back in the 1980s. To buy that argument you have to include servers in the PC category, because what PCs ate up was dumb terminals. Servers, based on technology similar to PCs, are what actually killed minicomputers.

Digging deep into history, recall that PDAs were going to replace PCs. Instead MP3 players replaced PDAs, because more people wanted to listen to music than wanted to carry around a tiny crippled business tool. HP was a leader in PDAs, and a failure in MP3 players, yet it did not die from the experience.

HP has several segments; the future does not look the same for each segment. The printer segment does not seem to be disappearing. The business hardware segment, excluding PCs, includes servers, enterprise-level storage, and other datacenter components like switches, routers, and the software needed to enable and manage racks of equipment. Because people are increasingly relying on mobile information, these datacenters, aka the cloud, continue to expand. Competition with IBM, Dell, Cisco, Oracle and many other companies is fierce, but so far HP has competed rather well. Services for enterprise computing are also a major source of revenue and profit.

So if the consumer PC division is seen as a weakness, the worst case scenario should be that it gets spun off. Stockholders get the enterprise and printer gravy in one tray and the consumer business in another.

If HP is making a mistake, it is not seeing the further possibilities of the PC business (with PC broadly defined). Every few years since the PC was born it has been declared to have all the computational power it needs. I have made that mistake myself. These days the new AMD A-series chips can run a pretty good game without the need for a discrete graphics card. They can put HD video on a big screen. The end of innovation must be near, except for smartphones. And tablets.

If you think PC innovation is coming to an end, you have not talked to the visionaries at Microsoft, or AMD, or even at Intel. Amazing things are just beginning to be computationally possible. A good example is the Kinect device for Xbox 360 games. There is no reason similar technology can't be attached to PCs running 60 inch displays. In fact, hackers are doing that already, with Microsoft even offering a software development kit (SDK) to help.

Yes, you will be able to wave your hand in the air, talk a bit, and do everything from altering an accounting spreadsheet to running a tractor to manipulating DNA from the comfort of your chair.

You are going to want the latest smartphone when you are on the road. But in your den or office, you are going to want a PC with a big screen, input devices more intuitive than touchscreens, and a hairy advanced processing unit to make it all work in real time.

If Leo Apotheker is too dull to see the potential of HP's PC division, it is still going to be profitable for the foreseeable future, even if it is just a commodity manufacturer of innovation spun elsewhere. A spin off suits me fine. Wish I would run it, wish I could own it. In addition I would get shares of the enterprise segment, a gold mine in itself.

Wait, I can own a piece of it. That is the great thing about stocks, you don't have to buy the whole company all at once.

Disclaimer: As I write this I own no HPQ, but it is on my wish list to buy. I do own AMD stock. I do occasional subcontracted work for Microsoft. I also own stock an HP competitor, SGI, that specializes in technical computing.

Sunday, August 28, 2011

Marvell Ramping TD Smartphone Revenue

Marvell Technology (MRVL) makes semiconductor chips for hard disk drives, cell phones, networking and other devices. They have long dominated the HDD market, but have struggled in the smartphone market. In their second quarter of fiscal 2011 (Q2), ending July 30th, we probably saw an inflection point for smartphones based on Marvell chips. This space should be closely watched in Q3 and Q4.

Marvell's stock price is still at bargain levels, at about 10x non-GAAP trailing earnings. Partly this is due to macroeconomic fears affecting the entire market, but more particularly Marvell fell off a recent 52-week high of $21.89 on January 18 due to poor results in Q4 of 2010 and Q1 of 2011, when revenues fell to $802 million, which was down 6% y/y. A few weeks ago it hit $11.94; Friday it closed at $12.89.

That period of weakness was partly due to slower than expected sales of chips for hard drives (HDD) and networking, but most visibly was due to slow sales of chips for RIM's Blackberries. Given that Marvell execs have talked for years about conquering the smartphone market as they once conquered the HDD market, this led many analysts to conclude that Marvell was simply out of the race to provide CPUs for smartphones.

The smartphone chip market is certainly extremely competitive, perhaps the most competitive semiconductor segment today. Marvell has been competing in the U.S. against the likes of Qualcomm (leader in CDMA technology), nVIDIA, Texas Instruments, Samsung, and Apple, which makes its own ARM-based phone CPUs. They have spent years and vast sums of money on R&D, essentially subsiding smartphone chip development with profits from their HDD chips. In the U.S. smartphone market, except for being in a couple of BlackBerry designs and sometimes supplying non-CPU chips for phones (for Bluetooth and Wi-Fi), they have been an also-ran.

Meanwhile, Marvell produced the only one-chip solution for the Chinese communication standard called TD-SCDMA. China Mobile, the largest Chinese wireless company (600 million customers), invested vast sums to develop a TD-SCDMA network, now in place in most Chinese cities. Marvell has worked closely with Chinese companies on this project, bringing about 1000 engineers to the table. Also called OPhones, these smartphones run software on top of Android. Marvell is now referring to them as TD phones. The first generation of TD phones, released in 2010, were expensive and did not sell in large numbers. Essentially they tested the system.

Q2 2011 was when TD smartphones first shipped in sufficient numbers to be meaningful for Marvell investors. Over 20 models are available from manufacturers like ZTE, Motorola, Huawei, and Samsung. TD smartphone revenue roughly doubled in Q2, causing Marvell's wireless segment revenues to increase 18% in the quarter. For Q3 double digit revenue growth for TD smartphone chips is the expectation. Marvell is also sampling solutions for the LTE smartphone market in China. Again, expect fierce competition, but Marvell should win a share of Chinese LTE slots in 2012.

Meanwhile HDD revenue may be sluggish due to the slow PC growth rate, but it generates a lot of cash. Cash flow from operations in Q2 was $263 million. Free cash flow was $235 million. Cash and equivalents balance ended at $2.40 billion, up sequentially from $2.27 billion. Marvell repurchased $136 million, or 9 million shares, in the quarter and has authorized $1.5 billion for further repurchases.

The best cure for the low stock price, to my ears, was hearing that one use for cash could be starting to pay dividends. Compare Marvell's PE ratio to a semiconductor company like Microchip (MCHP) that does pay dividends, and you can see that semiconductor investors are more interested in dividends than they were a few years ago. However, it would be a big change for Marvell, so don't count on it.

Disclaimer: I am a long-term investor in Marvell stock

See also:

My August 18, 2011 Marvell (MRVL) analyst call summary

My May 26, 2011 Marvell (MRVL) analyst call summary

My March 2011 Marvell (MRVL) analyst call summary

Keep diversified!

Monday, August 22, 2011

SGI Sees Revenue Growth in 2012

Silicon Graphics International (SGI) sells data processing systems with a focus on technical computing. Their high-end systems are used to solve some of the toughest computational problems encountered by government and industry. They also provide datacenter equipment for cloud computing to companies like Amazon.

The new SGI is basically a combination of the old Rackable Systems, which specialized in datacenter server systems, and the old, bankrupt SGI, which specialized in high-performance science computing. I had my doubts when the two companies merged, but the new company turned out to be better at executing than either of the old companies.

The transformation of SGI is about technology, sales, and profit margins. In last Thursday's report on fiscal Q4 2011 (ending June 24) we saw record revenues for the typically slow Q4. Revenues were $195.5 million, up 36% sequentially from $143.7 million and up 92% from $101.6 million year-earlier. While GAAP net income was negative $12.1 million, non-GAAP net income was $3.9 million. Of course I would prefer to see GAAP net income in the black too. In this case the difference is largely due to non-cash operating expenses, restructuring, and software revenue recognition rules (because the computer systems have software bundled with the hardware). As a check on the merits of GAAP vs. non-GAAP, the cash balance was up $9.4 million in the quarter.

SGI is debt-free and had a cash and equivalents balance of $143 million at quarter's end. They can fund a strong R&D effort and could make acquisitions if needed.

The new Altix UV supercomputer line has no real direct competitors. It has a memory and processor model that make it very attractive to high-end technical users. Because of that profit margins are good. The rackable systems for server farms and cloud computing continue to offer innovative designs, but margins have been improved there as well.

The company is now truly international, which is important when your key products are supercomputers. Service revenue is also a key factor in the new, profitable business model.

In response to questions from analysts management went into some detail, and speculation, about technologies they are developing. They are working with Microsoft to expand the capabilities of SQL Server. They believe that for certain types of computing they will be able to deliver performance equivalent to Oracle's Exadata systems at about one-third of Oracle's current price. Considering how successful Exadata has been, both in terms of compute ability and revenue generation, that could be highly significant in 2012.

Analysts also speculated that with budgets thin, SGI might have difficulty selling its computers to government agencies. However, SGI has little or no exposure to state and local governments in the U.S. Federal agencies still seem eager to decrease their other costs by upgrading their compute capabilities. For industry, the total cost of the design process is decreased by buying more computational power.

While not giving guidance by quarter, for fiscal year 2012 (running to June 2012) revenue is expected between $740 and $780 million, up to 24% over fiscal 2011.GAAP EPS is estimated between $0.15 and $0.30. Non-GAAP EPS expected between $0.60 and $0.80.

For more details on quarter results, see my SGI Q4 fiscal 2011 analyst call summary.

Disclaimer: I am long SGI.

The usual risks apply, so keep diversified.

See also: