Microchip Tanks on Preliminary Q3 2014 results

Microchip issued a press release today:

MICROCHIP TECHNOLOGY ANNOUNCES PRELIMINARY NET SALES FOR SECOND QUARTER FISCAL 2015

It is not pretty, but I believe the market over-reacted.

First, second quarter fiscal 2015 for Microchip ended September 30, so it is Q3 2014 for the rest of us.

Second, it was a bad quarter only in respect to prior guidance. Microchip has been on a tear this year, and guided to $560.0 million to $575.9 million for revenue.

The preliminary revenue estimate  $546.2 million, which is well below the low end of guidance. But it is up from $492.7 million year-earlier. That is a nearly 11% y/y increase. Part of that increase is from the ISSC acquisition, but even excluding ISSC revenue is $529.3 million, which is up over 7% y/y.

What does it mean? Does this bode ill for the future?

Of course it is hard to say. Microsoft sells microcontrollers and analog chips to a very large number of customers. On a regional basis the demand was worst, compared to expectations, in China. Is there a problem in the Chinese domestic market, or a problem with end demand in Europe or the United States? Or are manufacturers just being cautious? For now, I am leaning to the just being cautious camp, because I believe Europe and China will rebound sooner rather than later. But I could be wrong.

I may even be more optimistic than Steve Sanhi, Microchip's CEO, who stated "We
believe that another industry correction has begun and that this correction will be seen more broadly across the industry in the near future.”

Rather, my guess is any problems are device specific. End markets for microcontrollers include automobiles, medical and industrial equipment. Maybe the sanctions against Russia a backfiring to hit U.S. investors.

After closing yesterday at $45.54, Microchip dropped as low as $39.02 today, but as I write it has recovered to $40.57. Microchip is a strong cash generator and pays a dividend that amounts to over 3.1% at the price I just quoted. It last paid the dividend on September 4.

Microchip has a trailing P/E ratio of 24.7, which is quite reasonable even taking into account the newly announced, slower annual growth rate.

I don't like it when a stock I own goes down, or misses guidance, but Microchip has a great long-term track record, so I see no point to selling my holdings. It will be interesting to see if the bulk of the semiconductor industry is seeing the same pain, or if it is specific to Microchip. It is very possible that demand in Q4 will make up for any slack in demand in Q3.

Cantel Medical (CMN) record quarter

Cantel Medical (CMN) had a record quarter. Cantel specializes in infection control, which is a very cost-effective form of health care.

I own stock in Cantel Medical. For all my previous reports and articles on Cantel see Openicon Cantel Medical.

Here are my notes on today's analyst conference:




Basic data (GAAP):

Revenue was $118.3 million, up 4% sequentially from $114.0 million and up 19% from $99.7 million in the year-earlier quarter.

Net income was $11.2 million, up 10% sequentially from $10.2 million and up 17% from $9.6 million year-earlier.

EPS (earnings per share) were $0.27, up 8% sequentially from $0.25, and up 17% from $0.23 year-earlier.

Guidance:

No specific guidance (Cantel never has provided specific guidance). But noted the January quarter has fewer sales days than the October quarter.

Conference Highlights:

Cantel Medical delivered record sales and earnings. All three major business segments showed good performance. Organic sales growth was 10%. Cantel continues to benefit from its investments in development, sales and marketing programs.

The medical device tax impacted by almost $1 million; there was none year-earlier.

Realigning reporting segments were changed, adding some formerly "other" revenue to Water Purification/Mar Cor segment.

Endoscopy segment (Medivators) revenue was $43.6 million, down 2% sequentially from $44.5 million, and up 19% y/y. Launching new and improved lines for 2014 and adding to sales team. Recently acquired Jet Prep for its specialty colonoscopy catheter.

Healthcare Disposables (Crosstex and SPS) sales were $26.2 million, up 32% from year-earlier. Organic growth was 4%, the rest was from the SPS acquisition. 40% y/y increase in operating products with improved gross margins. Sterility assurance is a growth area, as are international sales.

Water Purification and Filtration segment (Mar Cor) revenue was $39.8 million, up 11% sequentially from $35.7 million, and up 20% y/y. Heat-based and portable systems see continued acceptance. Orders exceeded shipments, so backlog hit a record. Siemens customer transfers are going well.

Therapeutic Filtration (formerly Dialysis) segment sales were down 11% y/y. Now represents only 8% of operating profits, but still important to Cantel, with growth possible in international markets. Proposed U.S. 9% cut for dialysis treatments has been postponed to 2015.

43.5% gross margin, up sequentially from 43.1%.

Cash and equivalents balance ended at $28.5 million, down sequentially from $34.1 million. Debt ended at $82 million; net debt was reduced $13 million to $53.5 million. Cash flow from operations $10.8 million. Cap ex $2.2 million.

EBITDAS was $24.1 million, up sequentially from $21.6 million and up from $21.0 million year-earlier. EBITDA was $23.0 million. Stock based compensation was $1.1 million.

Cost of sales was $66.8 million, leaving gross profit of $51.5 million. Operating expenses were $33.2 million consisting of: $15.8 million selling; $15.2 million general and administrative; $2.3 million research and development. Interest expense $0.7 million. Income taxes $6.5 million.

36.7% effective income tax rate. R&D credit set to expire at end of year, but hopefully will be renewed.

$0.045 semi-annual dividend to be paid in January.

For 2014 plans substantial investments in the three major business segments. Adding international teams, notably in China and Singapore. Will continue to look for acquisitions.

Q&A:

Priorities for international markets? China received most of the investment in 2013; infection control is a top priority for the government there. Just hired first manager in Germany. Then the U. K., where we already have a present. Then Australia, where we already have a high market share. Many second-tier markets, like Latin America and Eastern Europe.

We are not likely to do acquisitions in China, but could in Europe to help enter established markets.

How much could you spend on acquisitions? We are in good shape. We have over $50 million available in the revolver, plus the opportunity to add an additional $50 million.

Expects 2015 to require investments equal to 2014, then operating leverage going forward after that.

We are not in markets that are growing at over 10%; we are growing faster than the underlying markets. Success depends on new products and on sales efforts. We would say 10% organic growth is a goal, not a prediction.

We would be willing to make an acquisition outside of our 3 core areas as long as it was within infection control.

The Real Debt Ceiling

The Federal Government of these United States of America is partially closed down. Congress is divided against itself: the Republican-controlled House of Representatives can't agree with the Democrat-controller Senate on how to reopen.

More ominous, all pundits agree, is that the national debt will hit the debt ceiling sometime soon, with October 17, 2013 frequently given as an estimate. Since the federal government continues to run a budget deficit, its debt is increasing. The ceiling is $16.7 trillion.

The debt ceiling is artificial in the sense that it is legislated by Congress (and signed into law by the President). It can be raised or lowered by Congress. Those who believe the national debt is not a problem (or, misinterpreting Alexander Hamilton and John Maynard Keynes, is actually an asset) might want to just abolish the ceiling, or set at at $30 trillion and forget it for a couple of years.

There is a real debt ceiling, however. It does not have a definite number on it, but it is real enough.

Consider, as an analogy, propeller-driven airplanes. Each model of airplane has a ceiling, because air thins are you climb to higher elevations. The better designed and lighter the airplane and the more powerful its thrust (from the engine and propeller system), the higher the ceiling. But at some point every airplane stalls: its propeller cannot push enough air to give enough thrust to get it higher.

Likewise where the real debt ceiling is for the federal government of the United States depends on a variety of factors. For instance, if the government could raise more in taxes (by raising rates or because of an expanding economy), it would have a higher ceiling than if revenue from taxes fell.

If the federal government offers higher interest rates (which are set at auction), then investors should be willing to loan more money to it.

Investors, in fact, are the key actors. There are all sorts of investors who buy federal debt. Since the Great Recession began they have accepted very low rates of interest. More investors might buy federal debt if interest rates on the debt were higher.

But no matter how high interest rates go, there is still a ceiling. Even a loan shark charging interest (at perhaps 100% per year) to the federal government would stop loaning if it became clear that the loan could not be repaid. And who's going to break the legs of the federal government?

If the annual interest on the federal debt begins approach a high share of annual federal revenues, the federal government would go into a Death Spiral. Say the interest reached one-half, or 50% of annual revenues. Policy makers would have three basic choices. They could prioritize interest payments by cutting federal spending. But that would hurt the economy, resulting in lower tax collections the following year, plus there would be political fallout from the many Americans who depend on federal spending.

A second choice when interest on the debt reaches 50% of annual revenue would be to increase taxes so that spending could be maintained along with interest payments. The problem with that is that such taxes would have to be broadly based. The economy would go into a depression, lowering tax collections.

A combination of cutting spending and raising taxes might work today, but would just cause a depression if we wait until interest hits 50% of revenue.

A third choice is to simply let the debt balloon. But as the debt balloons, the interest would also balloon. Interest rates would have to go even higher. The necessity for defaulting on, or writing down, the debt would be obvious. The debt would quickly hit the real debt ceiling, but that would not stop the death spiral. If 50% of federal revenue were assigned to just pay the interest, it would not be enough. Bonds (federal debt) come due at intervals: the principle would have to be repaid. Just to replace the bonds would require higher interest rates, so the interest would soon consume 51% of revenue, then 52%, and on up to 100% of revenue.

Clearly the three choices above would lead to the end of the United States as we know it. A fourth possibility would be allowing inflation to reduce the real value of the debt. Long-term bond holders would just have to eat their losses. But even this would not likely work because it also would hurt the economy so badly that we would have a depression, which would be deflationary, defeating the purpose of allowing goods and services to inflate in dollar value.

The real debt ceiling is likely somewhere between where we are now and where the interest on the debt reaches 50% of federal revenue. Federal revenue in fiscal 2013 was budgeted at $2.9 trillion. 50% of that would be $1.45 trillion. If the average interest on federal debt rises to 5% (a conservative figure, but above what the feds paid during the recession), the debt ceiling in the scenario above would be 29 trillion dollars. Way above the current legal limit.

But if investors lose confidence in the federal government (which they should have by now) and the interest on the debt rose to an average of 10% (admittedly higher than it has been yet), the scenario of the death spiral would occur at $14.5 trillion dollars.

That is right. A death spiral is possible, if enough investors lose confidence, at below the current $16.7 trillion debt limit.

So where the real debt limit lies depends on where real investors, as a group, draw the line.

It would be interesting to ask a few people like Janet Yellen, Ben Bernanke, Lawrence Summers, Barack Obama, Jacob Lew and John Boehner exactly what they think the real debt limit is.

Even the GAO thinks "Debt held by the public at these high levels could limit the federal government's flexibility to address emerging issues and unforeseen challenges such as another economic downturn or large-scale natural disaster. Furthermore, in both the Baseline Extended and Alternative simulations, debt held by the public continues to grow as a share of GDP in the coming decades, indicating that the federal government remains on an unsustainable long-term fiscal path." [GAO Long Term Outlook]

I predict we are in for stormy fiscal weather. Today the government pays interest at a rate from practically zero on short term notes to 3.75% on 30 year bonds. I believe the Federal Reserve has gone to great lengths to keep interest rates low not just because that encourages an economic recovery, but because it puts off the day of reckoning on the real cost of the national debt.

The Republicans are right, we need to cut spending. But we have to cut spending in a way that minimized the hurt to both people and the economy. That means cutting subsidies to the rich, the upper middle class, and in particular military spending and foreign aid. But the Republicans want to cut payments for seniors and the poor.

The Democrats are right, we need more revenue, which means more taxes. We need a higher tax rate on people earning more than $50 million per year and on large inheritances. We need to close every loophole. We need to legalize and tax "street" drugs. But tax increases do result in less spending and less capital deployment, so they should be reasonable. And the Democrats, too, have been reluctant to cut military spending.

The American economy has been badly hurt by both parties and both branches of Congress and by the President these past few years. By protecting their turfs, including the Pentagon budget, they are weakening the long-term viability of the United States.

Both parties should agree to balance the budget in fiscal 2015 and start paying down the national debt in fiscal 2016. The pain will be shared by everyone, but to the extent it can be targeted by law, it should be dished out to those who have benefited most from the American economy.

Biogen Idec Too High Too Fast?

Biogen Idec (BIIB) is now off its 52-week high of $226.18 (reached earlier today) but up from a 52 week low of $126.39 (of June 4, 2012). At $218.84 it has risen 73% off the low.

I began following BIIB in the first quarter of 2006, but did not acquire stock until February 2008, when I picked it up at $61.57 per share. In the short run I overpaid, but I picked up more later that year at $46.97. I person with perfect timing could have picked up shares at $40.27 on November 28, 2008. Biogen then  rose to $67.05 by the end of 2010, and looks like it invented an anti-gravity machine this January.

Biogen did so well that it became too large a percentage of my portfolio (according to my portfolio rules) so I sold half of my position on May 16, 2012 for $137.19. Now of course I wish I had violated my portfolio rules and kept the stock longer, but I had other situations where those same rules kept me out of major trouble (they were the main reason I sold most of my Dendreon stake before the price collapsed).

Even though my remaining Biogen stake is well within my portfolio rules I have to ask: is BIIB overpriced? Should I sell it and look for a better value proposition?

There were reasons Biogen was priced where it was in 2008 through 2010, the big one being a disease called PML (progressive multifocal leukoencephalopathy) caused by the JVC virus. Biogen's specialty is multiple sclerosis MS therapies. Its Avonex was the most prescribed MS therapy, but the new wonder drug was supposed to be Tysabri. MS is an autoimmune disease; MS therapies work by selectively suppressing the immune system. Turned out, the JVC virus lurks in the brains of about 1/2 the population, generally doing no harm except when the immune system collapses, when it causes PML, and often results in death.

Tysabri use led to some PML cases, and in a few instances to death. Not knowing what the rate was, nor what treatment could be given for PML, the FDA revoked Tysabri's marketing license. The immediate solution turned out to be to monitor for PML and stop giving Tysabri if there were symptoms. The FDA re-approved Tysabri provided a monitoring program was in place. While Tysabri was so effective that sales ramped back up substantially, naturally there was concern by doctors, patients, and investors that we might see more PML deaths and a permanent ban on Tysabri.

Nevertheless in Q1 2008 Tysabri sales were $115 million, total Biogen revenue was $942 million, and GAAP EPS was $0.54. It being the recession, investors were risk-adverse, and it seemed no amount of good news on Tysabri, revenue, or profit could do much for the stock until late 2010.

So much of the run up in the price was just investors catching up to the new reality: a highly-profitable biotechnology company with a strong pipeline of potential future blockbusters. But in the same way investors lagged reality before 2011, perhaps so many momentum players have jumped on the BIIB bandwagon that the stock has gotten ahead of its fair valuation.

By the beginning of 2013 we had pre-screening for JVC and better treatments for PML, reducing the risk of PML mortality to statistically close to zero. We have substantial Fampyra revenues, though that therapy had also had its issues.

Plegridy (peginterferon beta-1a) for relapsing MS pivotal Phase III data has met all primary and secondary endpoints after 1 year cutoff of a two-year study. Biogen expects to file with FDA and EMA (Europe) by mid-2013

Daclizumab-HYP Phase III data readout expected in 2014. It is also for relapsing forms of MS.

Biogen also filed for approval with FDA for Hemophilia Factor 8 for A and 9 for B, based on significant Phase III trial results.

A number of other therapies are in Phase I, II, or III trials. See the Biogen-Idec product pipeline for more details.

So we can figure that the most likely scenario is that Biogen Idec will see substantial revenue and profit growth over the next few years and new therapies come to market. It is unlikely that everything in the pipeline will get good results and FDA approval, but Biogen has a lot of shots on goal.

You can build spreadsheets (and I have, and sell-side analysts certainly do) guessing at revenue and profits from future therapies based on patient populations, competing therapies, and guesses about pricing. But experienced pharmacology and biotechnology investors know that promising therapies often fail, and unexpected side effects can show up even after FDA approval. Picking winners of competitive races is also more guesswork than science.

So a good hard look at the latest quarter should keep us anchored in reality, and then some P/E ratio points can be added to reflect optimism about profit growth in the next few years; add as many points as you are comfortable with.

Biogen reported on the first quarter of 2013 last Thursday. Revenue of $1.415 billion was up 9.5% from Q1 2012, which is quite good and means a fair P/E ratio should be above the market average. GAAP EPS was $1.79, up 43% y/y; now that should be worth some a P/E ratio well above market. Ballpark it at 30 to 1.

Guidance is for 2013 GAAP EPS of $6.69 to $6.90. Given that non-GAAP guidance is $7.80 to $7.90, let's use $7.00 and multiply by 30. That gives us $210 per share, not much off today's auction price.

So my ballpark estimation is that even at this price BIIB is still a good value. Included in the price are estimated 2013 profits. The pipeline of new drugs revenue and profits won't kick in substantially until 2014. I would expect BIIB to end 2014 in a higher price band, depending on the details of new product ramps.

I am inclined to hold my BIIB and, if I need to sell stock because I spot another opportunity as good as Biogen was in 2008, I could probably find something else to sell. Most likely I will leave BIIB off the leash until it again becomes a risk management problem from being too large a percentage of my portfolio. If I am wrong and it falls in the short run, or becomes a smaller percentage of my portfolio again because something else runs up, I might even buy more.

Keep diversified!

Disclaimer: I own share of BIIB and reserve the right to sell them or buy more at any time, even though I currently have no plans to change my position.

See also:

My Biogen Idec main analyst conferences page.
My BIIB Q1 2013 conference notes
www.biogenidec.com

Applied Materials, Process Nodes, and Future Profits

Applied Materials (AMAT) makes capital equipment for semiconductor chip manufacturing. Demand in that sector has not been robust these last couple of years, although it has come off the bottom that lagged after the recession. This article will look at AMAT as a long-term investment, not a short term trade. Given that, the first thing to note is that it pays a dividend, which is currently $0.10 per quarter, or 3.1% per year at the current $13.06 stock price.

I believe the largest factor determining future AMAT revenue and profit will be the ongoing trend towards new, small process nodes (indicated by the size of the lines used to put transistors in chips. 32 nanometer is older than 28 nm.) But let's start with where we are now.

AMAT last reported on February 13 for the first fiscal fiscal quarter of 2013, which ended January 28, 2013. Against an overall global semiconductor capital equipment spending drop of 16% in 2012, AMAT reported revenues of $1.57 billion, down 5% sequentially from $1.65 billion and down 28% from $2.19 billion in the year-earlier quarter. That is discouraging, for certain.

Applied's core semiconductor equipment business saw a Q1 y/y decline to $969 million from $1.34 billion, a decline of 28%. Its display screen segment did better, but the solar segment did worse. Display revenue dropped 17% y/y to $87 million from $104 million, which was already low by historic standards. Solar revenue dropped 77% y/y to $47 million from $206 million. There is a glut of solar supply in the market, so no turn around is expected until at least 2015. Display may see some rebound in 2013 as screen sizes start to increase in developing markets and new screen technologies are adapted.

The bulk of Applied's revenue and profit comes from the semiconductor segment. It is well known that demand for PCs has been down, and it is hard to predict where the bottom may lay. Demand for tablets and smartphones has been increasing. Overall demand is dampened because smartphones simply contain far less silicon than PC's do. They have weaker processing chips and far less memory.

Does that mean Applied and other semiconductor equipment manufacturers should be written off as dinosaurs? I think not. I think overall computational demand will continue to increase rapidly for at least the next two decades. To cram more computation into portable devices (and the computers in the cloud that serve those devices) the industry will continue to move to smaller process nodes.

Right now demand is still high at the 28 nm node. Most chips, which work in legacy, non-mobile applications, are still made at much older nodes. For high-end graphics chips from AMD and NVIDIA, 28 nm is the cutting edge. Intel is already manufacturing its newest CPUs at 20 nm, and new memory-chip production at Samsung is just started at 10 nm. Memory process nodes typically can be smaller than computing process nodes. The most advanced ARM-based chips were recently taped out at 16 nm at TSMC.

Smaller (newer) process nodes mean that more capability can be built into mobile devices (and also non-mobile devices). Transitions to 14 nm and 20 nm are almost entirely ahead of the industry. To some extent moving to these nodes may open up capacity at 28 nm, but there is a lot of technology out there that has yet to migrate to 28 nm.

The other factor is overall demand, and that depends on the global economy and the frequency of consumer upgrades. There is a lot of old equipment out there, as seen by the high percentage of PCs still running Windows XP. With the exception on Intel, Samsung, IBM, and a few others, most chip makers are now really chip designers who send their designs to foundries like TSMC and Globalfoundries for actual production. These foundries don't want to have capital equipment sitting idle, but neither do they want to lose business because of insufficient capacity.

Generally capacity has been lean since the recession, which is one reason why there has been a shortage of 28 nm capacity. The other reason 28 nm has been tight is it was harder to get it working with good yields than had been expected There is quite a bit of impatience right now among the more cutting-edge designers because of a lack of sub-28 nm capacity.

Anything under 28 nm is far more expensive to make than 28 nm. Only Intel and Samsung have had the vast capital resources to simply move to the lower nodes without concern about how much demand would be there at startup. Even Intel announced it was cutting back capital equipment spending by $1 billion in 2013 due to lower demand projections.

But what is bad for foundries is good for AMAT and other equipment manufacturers: future nodes will require far more spending on capital equipment. One reason is that some 20 nm chips will have a 3-D structure. This means a move away from lithography defined shrinking to process-defined, where with precision engineering AMAT claims a considerable advantage.

In addition to reporting revenue, AMAT reports orders for each quarter. The good news for Q1 was that orders of $2.11 billion were well above revenue and up 31% from orders in Q4, as well as up 5% y/y.

Guidance is for Q2 fiscal 2013 revenue to be up 15 to 25% sequentially. Non-GAAP EPS is expected between $0.09 and $0.15.

While Applied Materials has substantial competition in each of the types of tools that are needed for semiconductor manufacturing, it is second in overall sales revenue only to ASML in an industry where scale matters. ASML is not much bigger: it had sales of $7.9 billion in 2011, AMAT had $7.4 billion. Another American competitor is KLA-Tencor, which had $3.1 billion in sales, placing it fourth globally.

On the whole, I think it is likely that 2013 will be a year of improvement for AMAT, and with major gearing up for 20 nm in 2014, that will be a very good year. How much improvement depends on the degree of strengthening global demand for semiconductor chips.

Disclaimer: I am a long-term investor in AMAT. I also am long AMD, but do not own any other company mentioned in this article. I will not buy or sell AMAT stock for one week following this article's publication date.

See also:

My main AMAT analyst conferences page.

My Q1 2013 AMAT analyst conference notes

www.appliedmaterials.com

Akamai (AKAM) 2013 Outlook Bright

"Some experts mutter dark warnings about the Spamularity: the global Chaos
that will ensue once the first distributed spamming engine achieves
human-equivalent sentience."—Rule 34 by Charles Stross

Akamai was one of the survivors of the original Internet bubble, and for years was characterized by the volatility of its stock price. Specializing in Internet content acceleration, over the years it became the IBM of this field. Money was being made, and so there was intense competition, and shorts sometimes heralded the fall of Akamai. AKAM always stayed a footstep or two in front of its competition. More importantly, it branched out.

Content acceleration has always been important to AKAM, but for years it has been adding other services to its repertoire. Content acceleration is a volume-driven, price sensitive business, with a record of constant declining y/y prices, much like mass-market semiconductors. Akamai's new services, notably Internet security, are also competitive, but have offered much better profit margins that should hold up at least in the near term.

So why is AKAM priced today around $34.71, well off its 52 week high of $42.52 on January 1, if well above its 52 week low of $24.90 on June 5, 2012? In the past AKAM was a playground for momentum players; it was a relatively small company, and you might see PE ratios swing wildly between say 20 and 60. Lately the stock is behaving more like IBM, more stable, with a much smaller but still impressive market cap of $6.2 billion. At the price quoted above the PE is 31.1 trailing, which is higher than most tech stocks at the moment, but easily justified by a history of growth and the outlook for 2013.

For the latest reported quarter, Q4 2012 ending December 31, Revenue was $377.9 million, up 9% sequentially from $345.3 million and up 17% from $323.7 million in the year-earlier quarter. GAAP net income was $68.3 million, up 42% sequentially from $48.2 million and up 14% from $60.1 million year-earlier.

Akamai just re-issued guidance for Q1, which this late in the quarter should be pretty reliable. Revenue is expected between $352 and $362 million. On a sequential basis that may seem disappointing, but keep in mind that Akamai gets a yearly Q4 bump from the increase in e-commerce in the quarter. Compared to year-earlier revenue of $319.4 million, we get an annual growth rate of 10% at the low end and 13% at the high end.

The dynamics of the business appear to be favoring Akamai. Cloud infrastructure revenue, rather than content acceleration, was 60% of total revenue in Q4. The security component of that was up 5x from the previous year. A major rival, AT&T, has thrown in the towel and is becoming a reseller of Akamai services, which should add substantially to revenue in the second half.

Even the underlying trend for the content acceleration business shows no sign of ebbing. Akamai was founded in 1998. It is just 15 years old. Humans in that age bracket are in an always-connected culture dominated by video and cloud services that often require data packets to be sent from a vast assortment of geographically diverse server farms. The amount of data being served will continue to increase, and Akamai essentially runs a private toll road system within the Internet for those who want the fast service that is essential to capturing customers and converting views to sales.

I like Akamai at this price. I expect it will blow through its current 52-week high some time this year as revenue and profits from the relatively new cloud security business and other new value-added cloud services ramp.

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

See also: Akamai Investor Relations
My main AKAMAI analyst conferences page.
My conference notes for the Akamai Q4 2012 analyst conference

Microchip Record Revenue should be Topped in March Quarter

Microchip (MCHP) yesterday reported December quarter (fiscal Q3 2013) results slightly above analysts' consensus and in line with the mid-range of its prior guidance. Normally the March quarter is seasonally down from the December quarter, but in its guidance Microchip predicted sequential revenue growth. As a result in Microchip, which closed at $33.94 before reporting results, has climbed to $36.60 so far today. Microchip's current 52 week low is $28.92, and its 52 week high is $37.50.

Part of the strong revenue results resulted from the acquisition of SMSC. The same acquisition led to charges that hit GAAP profits pretty hard, but excluding those items non-GAAP profits and free cash flow were strong.

Microchip's model involves a focus on microcontrollers and related analog functions (touch screen control, wireless, and power management), with a wide variety of parts available to meet specific customer needs. Record revenue in quarter reflected a broad-based uptick in demand across industries and geographies. Revenues were $416.0 million, up 9% sequentially from $382.3 million and up 26% from $329.2 million in the year-earlier quarter.

Guidance to March quarter revenue of between $420.2 and $432.7 million, despite the usual hit from Chinese Lunar New Year, is based both on a continuation of the underlying trend and on design wins. Quite a number of design wins were announced in 2012; these are now resulting in orders that should ramp through 2013.

Microsoft has been a reliable dividend payer. At today's price the dividend yield is 4.15%.

Normally I use GAAP profits as a baseline, but non-GAAP numbers can be more informative for the long run when GAAP is affected by acquisition charges, as was the case in calendar Q4.

GAAP net income was $10.2 million, up sequentially from negative $21.2 million and down 87% from $77.5 million year-earlier. GAAP EPS (earnings per share) were $0.05, up sequentially from negative $0.11, but down 87% from $0.38 year-earlier.

In contrast non-GAAP net income was $84.5 million, EPS was $0.41, which is an improvement on, but consistent with, prior quarters. Free cash flow was $123.2 million, of which Microchip paid $68.7 million in dividends.

Microchip is still recovering from the cautious buying and weak end demand earlier this year. Inventories were reduced in Q4 and will continue to be reduced through June. On the customer side inventories are believed to be extremely lean, which could also result in increased buying if final demand shows signs of improving with the global economy.

I first invested in Microchip in 2006, based largely on my familiarity with their microcontroller products. It has been a reliable source of dividends and appears to have a first-class management team. I would recommend the stock to almost any class of investor.

Disclaimer: I own Microchip stock. I will not trade MCHP for at least 1 week after this story is published.

See also:

www.microchip.com
My main Microchip analyst conferences page.
My Microchip February 2013 analyst call notes

Celgene (CELG) 2017 Guidance: Two Times 2013 Revenue

Celgene, based in Summit, New Jersey, is a biotechnology and pharmaceutical company best known for its Revlimid therapy for multiple myeloma (MM). At its analyst call to discuss fourth quarter 2012 results, CEO Robert Hugin projected that revenue would hit $6 billion in 2013 and grow to $12 billion by 2017. He believed profits (non-GAAP EPS, earnings per share) would grow even faster, at an average of 25% per year through 2017.

Last night I heard a high-level twit on NPR's Marketplace say that he would not buy stocks at this level because they have gone up so much in the last year, and in over the years since the 2008 collapse. Would he say the same about Celgene in particular?

Celgene's stock price took a hit during and following the 2008 selloff, reaching a low of $38.33 in 2009. Here are end-of year closing prices since then:

2009: $55.68
2010: $59.43
2011: $67.60
2012: $78.47

A naive investor might think that after a run up over four years buying at $78.47 would be a very risky thing to do. But in less than a month Celgene jumped to Friday's closing price of $99.76.

This is not idle speculation. Celgene stock has risen because revenue and profits have risen. It will rise further if revenue and profits continue to rise. So the question an investor should be asking is not what the price history is, but what reasonable projections can be made about profits.

The rise of Celgene to a top-level company has been driven largely by Revlimid sales, which accounted for $1.0 billion in revenue in the fourth quarter, or 70% of overall revenue of $1.42 billion. That might indicate a risky concentration in a single drug. Drugs typically pick up competitors over time, and eventually go generic. Should we discount the value of profits coming from Revlimid?

Revlimid's original approval was not for MM, but for MDS, myelodsplastic syndromes, and it is still used for that indication. Revlimid received FDA approval for MM in 2006, so it is a relatively new drug. Revlimid revenue is projected to continue to mount for three reasons. Revlimid has not yet fully penetrated the global market for its current label, which is for second line therapy, in other words for "patients who have received at least one prior therapy." There are still nations in the process of approving the therapy, of approving reimbursement, or of ramping commercially. A bigger factor is clinical trial data suggesting that Revlimid should have its label expanded to include first line therapy, which would give it a bigger share of the MM market. The length of therapy has been increasing and should bet a good bump from the shift to first line. Longer therapy means more revenue per patient.

Yet most of the projected expansion of Celgene revenue does not come from Revlimid. Revenue in Q4 from Vidaza was $216 million; from Abraxane was $106 million; and from Thalomid was $73 million. Except for Thalomid, all these therapies should see revenue growth. Abraxane, in particular, has clinical data showing it is effective for two hard-to-treat cancers, pancreatic and melanoma, in addition to its current label for breast cancer and its recent FDA approval for non-small cell lung cancer. FDA approvals are likely some time in 2013.

Apremilast for psoriasis and psoriatic arthritis, ankylosing spondylitis, and rheumatoid arthritis will likely be a blockbuster, with good clinical data in psoriatic arthritis likely leading to FDA approval this year. and Istodax has already received FDA approval and will generate revenue in 2013. Pomalidomide is in a Phase III trial for myelofibrosis and reported good results for MM. The FDA should complete its review by February 10, 2013.

Beyond these leaders, Celgene has a potential product pipeline so deep I'll just suggest you click on the link and gape at it.

Of course, the future could hold twists we cannot foresee. Celgene's Hugin is not guaranteeing a certain level of profit for 2017, or any particular stock price.

I find Celgene's 2017 revenue and earnings guidance quite credible. Given that, the price per share in 2017 should be in the $200 to $230 dollar range, given a typical stock market with typical price-to-earnings ratios. Also assuming that in 2017 it looks like there is more growth ahead.

Celgene is in the Nasdaq 100 and S&P 500, so several index funds include it. It is in most biotechnology funds as well, for instance the Nasdaq Biotechnology Index (IBB).

Remember, no matter how good you think a single company's future look, diversified portfolios can provide much more safety while retaining a high degree of potential growth. Keep diversified!

See also:
www.celgene.com
My Celgene main analyst conferences page.
My Celgene Q4 2012 conference notes

Disclaimer: I have owned Celgene stock since 2007. I will not trade in CELG for at least 3 days from this article's publication date.

AMD sure of turnaround in 2013

AMD hit revenue guidance for the final quarter of 2012, but the numbers were still dismal. Revenue was $1.16 billion, down 9% sequentially from $1.27 billion, and down 32% from $1.69 in the year-earlier quarter. Guidance is for Q1 2013 revenue to be down around another 9%. Net income was $473 million in the red on a GAAP basis, and even on a non-GAAP basis was $102 million short of break-even.

Despite that AMD CEO Rory Read were surprisingly upbeat about 2013, predicting the a return to profitability in the second half. Of course we've heard that kind of optimism from AMD before, only to be let down. Are AMD's claims of a turn-around ahead credible?

AMD is currently known for making CPUs that compete with Intel's for personal computers (notebooks and desktops) and servers. In addition AMD makes stand alone graphics chips (GPUs), competing mainly with NVIDIA. AMD has not done well in the server space these last five years, and the PC space has started to shrink, in part because tablets and smartphones have become more popular and mostly use ARM based CPUs, rather than the more capable and power-hungry x86 coded chips made by AMD and Intel.

In 2012, in an effort led by the remarkable vice president of global business units Lisa Su, AMD started to re-target its intellectual property development towards growth sectors. The acquisition of SeaMicro acted as an entry to the dense server space, where AMD's graphics expertise could eventually help with highly-parallel computations, and Opteron technology is a better fit than Intel's server chip designs. In addition, AMD has announced it will use ARM technology when appropriate in this field. Although the complete new system will not be available for some time, Rory reported that Q4 SeaMicro revenue grew.

A second major line of attack is embedded SoC chips. This is a bit of a vague term; as used by AMD, it seems to amount to the non-PC sector. SoC, System on Chip, typically means that the chip is not a stand-alone CPU. In reality, even what we now call CPUs are not stand-alone CPUs: AMD has been a leader in moving critical components that "glue" the CPU to the rest of the system, like memory controllers, onto a single chip. Embedded SoC in this case means customized for a particular application. Rory indicated AMD would be looking only at relatively high-volume applications as margins have been too low in some low-volume systems. Examples of possible embedded AMD chip use would be for advertising displays, casino machines, industrial and medical use.

AMD does not currently break out embedded revenue, but the goal is to raise it to 20% of revenue by the end of the year. No word on whether that is 20% extra revenue or 20% replacement of eroding PC revenue, and Rory made it clear no details would be announced until the OEMs are ready to announce them.

The PC business, of course, is still critical, as is the entry into tablet computing. Rory made a point that AMD engineers are executing well, making their timeline, and in one crucial area are about 6 months ahead of Intel. Along those lines, AMD has demonstrated working Temash and Kabini silicon. These APUs will be quad core SoCs for the tablet and mobile markets. They also already introduced the new Richland A series APU, upgrading a sweet spot in their line.

This morning as I write AMD has popped from its pre-conference and results close of $2.45 up 9% to $2.67. Obviously no one knows if AMD will be able to execute its plan or if, once products are available, they will sell well enough to bring AMD back to profitability. It has the look and feel of a good plan and a big turnaround to me, but I have been wrong about AMD in the past, and the sands of silicon are shifting rapidly and unpredictably. Before getting bullish on AMD, I'd like to see the 2013 products, the revenue, and the profits.

Disclaimer: I have long been long AMD and will not trade the stock for 3 days after the publication of this report.

William P. Meyers

See also:

www.amd.com

My main AMD analyst conferences page.

My AMD Q4 2012 analyst conference notes

TTM Technologies (TTMI) Updates Q4 Guidance

TTM Technologies (TTMI), the largest American manufacturer of printed circuit boards (PCBs), saw a sharp drop in its stock price to $7.37 on Tuesday, January 15 after a story of a downgrade from an analyst at Stifel Nicolaus was circulated.

The company responded by updating its fourth quarter 2012 guidance on Thursday, coinciding with a presentation to investors that had already been scheduled. These results were equal to or better than the guidance TTMI gave when reporting Q3 (See TTMI Q3 2012) . The stock had recovered to $7.98 by market close today.

Q4 revenues are expected to be between $360 and $380 million, with GAAP earnings of $0.07 to $0.14 and non-GAAP earnings of $0.14 to $0.21.

In addition CEO Kenton Alder told investors that the high rate of capital expenditures of 2011 and 2012, which was required to meet high demand for the most advanced technology PCBs, would trend downward in 2013, from about $120 million to closer to $100 million. That will free up cash flow for other uses.

In Q3 2012 TTM's largest customers had been : Apple, Cisco, Ericsson, Huawei, and IBM, which together accounted for 31% of total sales. The largest customer, Apple, accounted for 14% of sales.

There has been much talk of a slowdown in demand for Apple products, which may have caused some analysts to assume TTMI would have a poor quarter, or poor growth in 2013. Mr. Alder pointed out that Apple is a relatively new customer for TTMI, and as such the PCBs made for Apple are for the iPad, not the iPhone. He said there had been no decrease of orders so far for iPad PCBs. He explained that as the newest PCB supplier to Apple, with the newest technology available, TTMI is gaining share from other suppliers of PCBs for Apple.

He also said TTMI makes the PCB for the Amazon Kindle Fire. Because it is a global company with a broad array of customers, TTMI is not particularly vulnerable to reduced demand from any particular client.

He also said that networking sector orders picked up in the quarter, but he was not yet ready to say this was a trend.

According to NASDAQ, of institutional (sell-side) analysts covering TTMI, 2 rate it as a Strong Buy, 1 as a Buy, and 4 as a hold.

Disclaimer: I own TTMI and will not trade the stock for 3 days after the publication of this report.

William P. Meyers

See also:

TTM Technologies investor relations

My main TTMI analyst conferences page.

Go to TTMI Q4 call notes to bookmark for February 5, 2013 analyst call

SGI Q2 Deals Slip from Fiscal Cliff

SGI (Silicon Graphics International) today announced preliminary December 2012 (fiscal Q2 2013) results that exceeded earnings guidance while falling short of revenue guidance.

Based in Fremont, California, SGI manufactures supercomputers that are used in science research, Internet-based businesses, security, and other computation-intensive businesses. Revenues for the quarter were near $171 million, well below guidance of $180 to $195 million. CEO Jorge Titinger attributed the shortfall to three large deals with government agencies that normally would have closed in the quarter. In total the deals represented $15 million in revenue, and two of the three have closed since the quarter ended. The delays were due to agency concerns about their budgets due to the fiscal cliff standoff.

Despite the revenue shortfall, profits came in above prior guidance. This was due to better management, including closer attention to profit margins on individual supercomputer sales. On a GAAP basis net income is expected to be between break even and $1 million, or zero to $0.03 per share. On a non-GAAP basis net income is between $3 million and $4 million, for $0.07 to $0.10 earnings per share (EPS).

SGI ended the quarter with $128 million in cash, up $17 million in the quarter. Titinger and the new management team have started requiring deposits and milestone payments on the more expensive supercomputer systems, resulting in better cash flow.

It a presentation to investors, Titinger emphasized SGI's expertise in Big Data and Scale-Up Computing, as well as innovative storage solutions for massive amounts of data that need to be available for analysis. He talked about how SGI computers can do complex security checks for credit cards in real time (as they happen), something that used to take days to do.

As a sweetener SGI will used $15 million of its cash to buy back shares.

SGI stock ended the day at $10.87, up $0.34 for the day or 3.2%. That gave SGI a market capitalization of $360 million.

Disclaimer: I own SGI stock and will not trade the stock for 3 days after the publication of this report.

Dendreon's Provenge Revenue Trends

After finally getting FDA approval for prostate cancer therapy Provenge in May 2010, Dendreon's management thought their main problem would be setting up enough manufacturing capability to meet patient demand. Instead, and largely due to the FDA's unconscionable approval delay, by the time Provenge was available prostate cancer competing therapies were coming to market, from companies with larger and more experienced sales forces.

So revenue did not ramp as fast as Dendreon expected. Worse, they leveled off this year. Here are the numbers:

Provenge revenues, millions	2011	2012
Q1	$28.1	$82.0
Q2	$49.6	$80.0
Q3	$65.8	$78.0
Q4	$77.0	$81.6

The Q4 2012 Provenge revenue is preliminary, and excludes a $3.8 million favorable adjustment to chargeback reserves which had built up in prior quarters.

Provenge seems to be in a run rate of $320 million per year, which would be a pretty successful drug if its cost of production were more normal and if it was one of many therapies of a corporation. But at $320 million per year it makes Dendreon a money loser.

The Q4 $81.6 million is suggestive of a trend. Provenge therapy is a bit complicated, so a quarter with major holidays like Q4 might be expected to show some seasonal decline. Q4 2012 is improved $4.6 million or 6% over Q4 2011. It is also up sequentially $3.6 million, or 5%.

On the other hand, the peak so far is back in Q1 of 2012. Also, a number of factors might make revenue slop in or out of a particular quarter.

Even as we await the analyst conference and official numbers for Q4, our minds move to Q1 2013. I would put the goal post at $85.0 million for calling a trend. That would give us 4% annual growth and a record quarter. Even 2 up-trending quarters is not enough to go out on a limb on, but it might start to restore confidence in the financial future of Dendreon.

Disclaimer: I am long DNDN and will not trade the stock for 3 days after the publication of this report.

William P. Meyers

See also: www. dendreon.com

My main Dendreon notes page.

Dot Hill Hopes for 2013

Dot Hill (HILL) stock has been one of the worst performers in my portfolio lately. It is trading today at $0.88 per share, versus a 52 week high of $1.65 and 52 week low of $0.72. I have been invested in HILL for years, but more so than for most of my portfolio it has been a stock I have traded in, rather than just holding.

Dot Hill is a specialty data storage (SAN) solution equipment manufacturer, with many companies rebranding and selling its products, and HP as its by-far single largest customer. Looking at the past few years, management has continually indicated that prosperity (solid profits) is just around the corner, 2 or 3 quarters out, but the profits never have materialized. Hence credibility is low, and so is the stock price.

But maybe this time for sure. HILL is rolling out new products and has a number of new customers, some announced and some yet to be announced. The recent numbers look bad, however, because each customer requires some customization of the stock product. This increases R&D expense, which can only be recaptured in later years if product sales ramp and if gross and operating margins allow for it.

How could 2013 be different than 2012? Let's use Q3 2012 as a baseline. Revenues were $48.2 million, up 1% sequentially from $47.8 million, and up slightly from $48.1 million in the year-earlier quarter. GAAP net income was negative $3.0 million, improved sequentially from negative $5.0 million, and much improved from negative $12.2 million year-earlier. GAAP EPS (earnings per share) was negative $0.05, up sequentially from negative $0.09, and also up from negative $0.22 year-earlier.

Market capitalization is about $49 million, despite cash holding of $40 million, with just $2 million in debt, at the end of Q3.

Two new storage systems are sampling in Q4, the 4000 series and 5000 series. These newer systems will allow Dot Hill to serve a broader section of the market. Currently Hill's systems are used mainly for small businesses and the value end of the enterprise market.

The AssuredSAN 4000 series works with 8Gb Fibre Channel and 6Gb SAS (serial attached storage), the same as the 3000 series, but has optimized features adding extra speed for video streaming and broadcast, HPC (high performance computing), and post-production work.

The AssuredSAN Pro 5000 series works with 8 Gb Fibre Channel or 10 GbiSCSI and adds automated tiered storage software, thin provisioning, SSD acceleraton and other high-end features.

An important aspect of both new products should be improved margins, coinciding with the mid-market end use. Both build on top of the successful AssuredSAN 3000 series, which is a leader in the low-end market. The new 4000 and 5000 series are meant to be both feature and price competitive, so there is reason to hope for strong sales as 2013 progresses.

While there is a fear of investing in the hard disk drive (HDD) market right now, it is important to note that Dot Hill products are used in corporate datacenters and for cloud computing and big data. The use of smartphones and tablets is causing the need for rapid storage build out for the Internet, and the move to video is creating huge data storage demand.

Can Hill and its partners compete successfully in this market? Based on the past five years of experience, the answer would be just barely. But Hill was a train wreck when it got dumped by its biggest (then) client, Sun Microsystems. It has remained standing while a number of competitors were absorbed into larger companies. While it competes with EMC, it has an alliance with HP and a large number of smaller OEMs and value-added retailers. Dependence on HP has decreased. Autodesk is among the list of important new customers. Feedback on the new products has been very positive.

Right now HILL is more of a bottom-fishing play than anything else. To see the stock back at the $4 to $5 range management will have to deliver both improved revenues and improved margins. The possibility of achieving that makes it is a stock that is worth watching in 2013.

Disclaimer: I am long Dot Hill. I won't make HILL trades for 1 week after publishing this article. I do not have positions in any of the other companies mentioned.

See also: www.dothill.com

Gilead Sciences Pipeline Value

Gilead Sciences (GILD), has had a good year so far. On January 3, 2012 it opened at $41.46. Today it closed at 74.61, fairly near its 52-week high of $76.28. So up 84% this year. I used to write about Gilead more often during the years 2007 to 2011, arguing that it was undervalued. After finally getting a solid run up, is it time to bail out, hold, or buy more?

The forward-looking story is now largely about curing Hepatitis C, but first the latest backward-looking numbers.

In Q3 revenue was $2.43 billion, up 1% sequentially from $2.41 billion and up 14% from $2.12 billion in the year-earlier quarter. GAAP net income was $675.5 million, down 5% sequentially from $711.6 million, and down 9% from $741.1 million year-earlier. GAAP earnings per share (EPS) were $0.85, down 7% sequentially from $0.91 and down 10% from $0.95 year-earlier. Non-GAAP net income was $788.9 million, up 3% sequentially $767.3 million, and down 1% from $795.2 million year-earlier.

Profits did not keep pace with revenue growth because of costs from the Pharmasset acquisition from earlier in the year and a significant increase in R&D expense. Gilead is currently rolling out its newest HIV drugs like Stribild, which is helping revenue, but the R&D is not so much for HIV. The new R&D research is focused on hepatitis and oncology.

Why the emphasis on hep c? While Gilead Sciences has branched out into treatments for cardiovascular diseases, its primary expertise in in anti-viral drugs, particularly for HIV infections. Because of the effectiveness of its single-tablet, multi-drug combinations, Gilead dominates that market. Gilead also markets Viread for Hepatitis B. The past generation of Hepatitis C therapies have limited effectiveness, have a number of side effects, and cannot be administered orally.

Before the Pharmasset acquisition Gilead had four hepatitis drugs in phase II trials, and three in phase I, and said they would likely be made into a successful combination therapy. Pharmasset added Phase III candidate PSI-7977 (now Sofosbuvir), Phase II candidate Mericitabine, and Phase II candidate PSI-938, all for hep C. Pharmasset also brought candidates for HIV and hepatitis B treatment.

The latest set of results is for Sofosbuvir. The Phase 3 POSITRON study showed a response rate of 78% for hepatitis C (HCV) genotypes 2 and 3 when Sofosbuvir was combined with Ribavirin. It is notable that this is an all-oral regimen which does not include the using old standard, interferon. In tracking HCV note that a drug combination that works well with a particular genotype may not work with others. After 12 weeks of therapy and then an addition twelve weeks to see if the virus returned, HCV was not detected in 78% of patients. For those who are keeping track, Sofosbuvir used to be GS-7977.

Better still were the results from Sofosbuvir combined with GS-5885 and Ribavirin for genotype 1 HCV patients. Following 12 weeks of therapy and then 4 weeks without therapy, the response rate was 100%. Used with just ribavirin, Sofosbuvir had mixed results ranging from 84% for genotype 1 patients with no prior treatment down to only 10% response for genotype 1 patients who had not responded to prior treatments. For genotype 2 and 3 mixes, the range of responses was 60% to 68%.

Note that 100% cure rate is not necessary for FDA approval. As long as a combination can be found that does well with previously-untreated patients or that helps patients who were not helped by current therapies that include interferon, with about a 40% cure rate, the drugs could fulfill an unmet medical need.

At the same time it is a race, since other companies are also trying to break into the all-oral hepatitis market. It is a huge market. An estimated 150 million people world-wide have chronic hepatitis C, with the U.S. figure likely somewhere between 3 and 6 million (many people have undiagnosed HCV). For a less positive spin on the overall competition in hepatitis, I try Lessons from the Liver Meeting at Seeking Alpha.

Using the standard trailing 12-month ratio, Gilead's current P/E is 23.3. That is up quite a bit from earlier in the year. Conservative investors may want to wait until Gilead has actual FDA approval for a hepatitis C before extrapolating their chickens. As usual, the problem is by that time the stock may be priced even higher.

I don't think the current market has even priced in the true future value of Gilead's current drugs, much less the potential of a Sofosbuvir cocktail. In my particular case I feel comfortable with looking to the continued appreciation of my current holdings. I might still buy if the hep C data keeps getting better without a corresponding rise in the stock price. I have portfolio rules that restrict any stock to a maximum percentage of the entire portfolio, and could be forced to sell some if the stock rises too rapidly in price, though that seems unlikely at present.

Even with a great growth potential Gilead has, there are the usual risks from competition, macroeconomics, failure to receive FDA approval, etc.

Keep Diversified!

Disclaimer: I am a long-term investor in Gilead Sciences. I will not trade in the stock for a week from today.

See also:

my Gilead Sciences Q3 2012 analyst call summary

www.gilead.com

Dendreon on the Ropes

Back on April 29, 2010, Dendreon announced that Provenge had been approved by the FDA. That day DNDN opened at $40.09 and closed at $54.58. On March 6, 2009, it had opened at $2.77 per share. Today DNDN closed at $4.45. Was FDA approval really that meaningless?

Recent Q3 sales results for Provenge were down sequentially from Q2, which is not reassuring, although not as bad as some of the anti-Dendreon crowd had predicted.

Dendreon still has a couple of shots at getting off the ropes and becoming a valuable company, but a further drop in Provenge sales, or even stasis, could lead to bankruptcy. Investors have mostly erred on the side of safety, and abandoned hope. This means there is more upside than downside at today's price, but the downside risk is still considerable.

Provenge is an immunotherapy that is approved by the FDA for asymptomatic or minimally symptomatic metastatic castrate resistant (hormone refractory) prostate cancer. Like most cancer therapies it is not a cure, but has demonstrated statistically significant benefits in survival times for patients. Unlike many cancer therapies, it has relatively minimal side effects.

Dendreon's past management made a number of strategic mistakes, but that is only knowable in retrospect. When Provenge should have first been approved by the FDA (in my opinion), competing new drugs were a couple of years from potential approval. By the time Provenge was finally approved, competitors were on the verge of approval. Management's primary concern was building out the facilities needed to produce Provenge (treating patients white blood cells to recognize cancer antigens) as rapidly as possible, which was a capital intensive prospect.

It isn't that management thought Provenge would sell itself; they also had a sales force prepared to sell Provenge. However (and Provenge is by no means the only therapy this has happened to in the last few years) there were doubts raised in the medical community about the value of Provenge. More importantly, doctors are used to handing out pills or hooking up patients to IV's, and Provenge instead required taking white blood cells out of patients, shipping them to processing facilities, and then shipping them back to the doctors for re-infusion into patients. Provenge built three facilities in different areas of America so that the logistics would work out.

Provenge revenue was first reported for Q2 2010, $2.8 million for a partial quarter. Revenue then jumped in Q3 2010 to $20.1 million. After that there was a ramp that was slower than original guidance by Dendreon management, which finally peaked at $82.0 million in Q1 of 2012.

Q2 2012 revenue declined to $80.0 million, and Q3 revenue was $78.0 million. Management claims there is still considerable unmet demand for Provenge and revenue can be ramped to at least $100 million per quarter. To reduce costs employees have been laid off and one of the three manufacturing facilities has been closed. Management believe $100 million per quarter is cash flow break even.

Since debt ($554 million) exceed cash ($445 million), a few more quarters of revenue under $100 million could cause Dendreon to seek bankruptcy protection, wiping out shareholder value. The debt is in the form of convertible notes due in 2014 and 2016.

However, there are several positives going for Dendreon, which could increase revenue in both the short and the long run. Because it is an immunotherapy, there is an argument that Dendreon should be the first therapy tried once a patient arrives within its FDA label. Right now that does not yet appear to be the consensus within the set of physicians who are potential prescribers. Thus the future value of Dendreon stock currently highly dependent on the educational capabilities of the Provenge sales force and leading physicians who are advocates for the therapy.

There is potential expansion of the label, with clinical studies underway that could provide the factual basis for this. Even that is another double-edged sword. If studies fail to find statistically significant benefits for patients outside the current label, that might weaken physician interest for patients inside the label. If the studies are positive the expansion of the addressable patient base should easily take Dendreon past the $100 million per quarter line.

Finally, there is Europe. If you already own Dendreon stock, this is certainly worth waiting for. There should be an EMA decision around mid-2013. But it is not a sure bet. The EMA is not obliged to follow the FDA, although it typically does. The European health care system has shown more price-sensitivity than America, which could stall adoption or reduce margins. Finally, another capital-intense facility would need to be built. Maybe they can move the machines from the closed U.S. facility to Europe if approval is granted.

Dendreon is one of the most interesting stock stories in the past five years. It peaked at $55.43 on May 3, 2010, as brokers who worked with analysts had dismissed it a year earlier hyped it as the hot new stock. On March 6, 2009, it had opened at $2.77 per share. That was some ride. It was a great illustration of how auction pricing systems can get wildly out of touch with reality.

The way I look at it, there are three ways for Dendreon investors to win: if sales start ramping again in the U.S. within the current label; if the label is expanded in the U.S.; and if Provenge is approved in Europe. That is not bad odds, but the downside is potentially losing the entire investment. Market cap ended today at $687 million, which normally would assume profits can run something like $15 million per quarter in the foreseeable future. Since the future is not foreseeable, buying or selling DNDN at today's price comes down to how much risk investors are willing to take on.

Disclaimer: I am long Dendreon. I won't trade DNDN for 1 week following the publication of this article. I buy and sell Dendreon depending on my assessment of its statistically likely true value in comparison to its price.

Cantel Medical Acquisitions Fuel Earnings Growth

Cantel Medical (CMN) specializes in disinfection equipment for dental offices and medical centers. Its products range from face masks to complex endoscope sterilization machines. Today it closed at $26.31, up $0.40. Cantel's 52 week high was $28.97 on September 25th. Is Cantel's run up over? Should it be bought or held for its long-run potential?

Cantel has grown both organically and through acquisitions. Acquisitions are often not a plus for investors. In Cantel's case, however, the acquisitions have gone very well. The acquired companies were bought as reasonable prices. Cantel has been able to increase margins at the acquired companies, partly by using its existing sales forces to ramp sales. The process has left Cantel with some debt, but it is at low interest rates and there is a clear path to paying it off.

In fiscal Q4 ending July 31st Cantel Medical revenue was $98.7 million, up 2% sequentially from $97.2 million and up 15% from $86.0 million year-earlier. Net income was $9.6 million, up 17% sequentially from $8.2 million and up 104% from $4.7 million year-earlier. EPS (earnings per share) were $0.35, up 17% sequentially from $0.30 and up 94% from $0.18 year-earlier.

Last Friday a new acquisition was announced. It resembles earlier acquisitions: small enough to digest easily, complementing an existing business, and with a very fair price to earnings ratio. SPSmedical Supply Corporation does sterility assurance and monitoring, so it fits well with Cantel's Crosstex division. Cantel paid $32 million. EBITDA for the last year was $4.3 million, so it cost less than 8 time EBITDA. There will be some acquisition costs in the December quarter, including $3.5 million capital expense to buy the facility SPSmedical works out of. But in the March 2013 quarter it should add roughly $1 million to profits.

Cantel ended fiscal Q4 with $30 million in cash and $60 million in debt. After this transaction net debt should be around $65.5 million. Since cash flow from operations was $17.7 million in the quarter and should continue to rise in 2013, net debt should be approaching zero in 2014 unless more acquisitions are made or there is significant capital expense during 2013.

I have been watching Cantel Medical since early 2010. I was originally attracted to the infection control story, which I knew had become a serious problem in hospitals. Infection control spending has ramped considerably these last few years, but much remains to be done. Cantel has competitors in each of its areas of expertise, but it also tends to be a leader. It is a remarkably well run business with a frugal management that seems to be committed to working to build long-term value for shareholders.

Cantel is not exactly a cheap stock, with a P/E of 23.1 at today's price. The P/E has been justified by the quality of management and earnings, but there is no guarantee it will remain at the current level. Cantel pays a small dividend, with a yield well under 1%, which is fine for me as I am looking for long-term returns and feel cash should be used to pay off debt and to expand further.

Note that Cantel was affected by the recession, and its revenues are not immune to macroeconomic factors. It also has had some spikes in revenue during infectious disease scares, so it can be a bit lumpy from quarter to quarter and, to a lesser extent, year to year.

Cantel is suitable to conservative long-term investors at today's price.

Disclaimer: I own Cantel Medical. I will not make trades in CMN for one week following publication of this article.

Keep diversified!

Marvell (MRVL) Wins Microsoft Surface RT Wi-Fi slot

Marvell Technology Group (MRVL) won a slot in the Microsoft Surface tablet computer. According to Anandtech (Inside Microsoft's Surface RT Tablet, October 16, 2012), the WiFi chip on the tablet is Marvell's. NVIDIA won the main prize with its Tegra 3 ARM-based processing chip. Atmel also had chips in the design.

We don't know how many of the WiFi chips Marvell shipped to Microsoft in the summer quarter (Marvell's fiscal Q3 2013 ending October 27, 2012), but it was not enough to balance the damage in the hard disk drive (HDD) controller chip business. Marvell dominates HDD controller chips, but the problem is that the largest single use of HDDs in in PCs. It was a terrible quarter for PC sales, and little HDD makers Seagate and Western Digital could do about it.

Marvell had guided revenues to $800 to $850 million. The update issued on October 18 put revenues at $765 to $785 million. At the midpoint there is a $25 million miss on the low end of prior guidance. Just about all of that came from the HDD segment. Marvell also makes chips for smartphones, for networking (ranging from WiFi to high-end datacenter Ethernet), for Google TV and similar appliances, and for video processing in HD TVs. It is moving into new areas like LED controllers.

The fourth quarter is a big question mark. A lot depends on the global outlooks of OEMs. If they are pessimistic they may further shrink inventories. If holiday sales go well, they may have to expand inventories, giving chip manufacturers like Marvell a boost.

While there is a lot of uncertainty about Q4 and about 2013, Marvell is well set to manage their way through it and eventually expand into new businesses, as they have in the past. Even at the current level of revenue Marvell is a cash cow. At the current stock price, $7.755 at the close Friday, you are buying $0.75 in trailing 12-month earnings and dividends of $3.1% per year, plus a cash balance of $2.13 billion, or $3.82 per share. In the latest quarter cash flow from operations was $0.34 per share. It looks to me like the market over-reacted to the revenue miss. At this price Marvell stock is well worth the risk, in my opinion. But then I started accumulating Marvell stock years ago.

Marvell is large enough and diverse enough that if only moderate numbers of Microsoft Surface tablets get sold, that probably won't have a significant impact on Marvell revenue or profit. Then again, the Windows Surface is a really hot device, and may sell in more than moderate numbers. It is on my wish list.

Disclaimer: I am long Marvell and Seagate. I will make no position changes in them for a week after this article is published. I do not have a position in Microsoft, Western Digital or NVIDIA and also will not initiate one for a week. Also, I occasionally do freelance work for Microsoft.

Another Bad Day for AMD

AMD is plunging to new multi-year lows today. Egg on my face, I added to my position recently, so I just managed to add to my losses.

With all the bad news in the PC industry I did not expect AMD to make its previous guidance, which was for an essentially sequentially flat Q3, when Q3 is typically the strongest quarter of the season.

Preliminary Q3 results were released today, with revenue down 10% sequentially and a $100 million inventory write off. Ouch. Considerably worse than I anticipated.

Can AMD survive? It is a fair question. I still like AMDs graphics and graphics-integrated APUs (advanced processing units). I still think that desktop PCs with big screens can do a lot of things that mobile devices can't do. I am looking to buy a larger screen and an APU-based computer myself, and I think having massive parallel processing on the CPU (graphics really is parallel processing) is going to open some new doors. I am waiting for Windows 8 to be released so I don't have to install Windows 7 and then upgrade (I'll also be installing Linux since I increasingly use opensource software that runs better on it).

Intel is well set up financially to survive a slump in PC demand, but then they own their own fabs. AMD is fabless, so they just tell their foundries they want to produce less chips. Obviously in Q3 they both produced too many chips and also could not sell some of their older chips, implying they produced too many chips as far back as Q4 2011.

Might as well hold onto my AMD stock and see what happens, at this price. I often take riskier stock positions than I would advise for conservative investors. I've done really well with ONXX and FNHC lately, so the AMD decline won't hurt me that much.

Disclaimer: I am long AMD.

Microchip (MCHP) Pays Dividends

Microchip (MCHP) is one of the largest global manufacturers of microcontrollers, which are semiconductor chips incorporating computers and capabilities to receive data from sensors and send control signals to motors or other external parts. For investors the company is noted for its relatively high dividend and its ability to generate profits even during down cycles.

Today Microchip stock closed at $34.14, against a 52 week high of $38.87 and low of $30.07. At that price MCHP market capitalization is $6.6 billion, and the dividend yield is 4.05%.

Last week Steve Sanghi, the CEO, reported that after a sequentially up calendar Q1 and Q2, the business environment weakened towards the end of Q2, with Europe particularly slow. The situation has not improved, so Microchip is now guiding revenues to be about flat in Q3 compared to Q2, excluding the increased revenue from the recent SMSC acquisition. [Note calendar Q2 was fiscal Q1]

The SMSC acquisition closed August 2, at a value of $946 million. For fiscal 2012 SMSC had sales of $412 million and a non-GAAP operating margin of 12%. It will fit well with Microchip's product line, as SMSC is a specialist in smart mixed signal connectivity. Its revenues are 43% from microcontrollers and 57% analog products. These are used for automotive entertainment, wireless audio, and USB and Ethernet. Sanghi believes Microchip will be able to increase gross and operating margins of the acquisition closer to its own, high-marin model.

Microchip sells to a very diverse set of customers, including manufacturers of automobiles, household appliances, and medical and industrial equipment. Microchip also has an advanced touch screen set of solutions.

SMSC will provide a boost about 3 cents per share in the first partial quarter, then 6 to 7 cents in the first full quarter, fiscal Q3.

Steve pointed out that when Microchip bought SST it had not made a profit in five years, but has had good margins once integrated. He sees SMSC as a much less difficult business to integrate and profit from.

There is plenty of competition for microcontroller chips, but Microchip now has over 7% of the market, compared to under 2% in 1994, with the market share climb being pretty steady. In 2011 Microchip was the 4th largest player in the market after Renesas, Freescale, and TI. It is second in the 8-bit segment to Renesas, which moved ahead only when it absorbed NEC.

For fiscal Q2 2013, ending September 30, 2012, revenues are now expected between $12 and $430 million and non-GAAP EPS is expected between $0.50 and $0.52.

Given the high dividend, relatively low volatility of the stock price, and further opportunity for growth, Microchip remains a good core technology investment for long term investors. The main risk I see is macroeconomic.

Disclaimer: I have been long MCHP since 2006. I will not trade in the stock for at least one week from today.

See also: Microchip.com investors page; my Microchip fiscal Q1 call notes

Hansen Medical Runs Aground in Q2

Hansen Medical Inc. (HNSN) manufactures catheter based medical robots. Its stock price is in a major slump right now, opening today at $1.48, versus a fifty-two week high of $4.46 on September 20, 2011 and near its 52 week low of $1.42. Is this a buying opportunity, or a stock to be avoided even at this price?

For several years Hansen has marketed its Sensei robot for electrophysiology procedures, which measures electrical activity inside the heart. Meanwhile it has developed its robotic catheter technology for use in vascular (blood vessel) surgery. Last year its Magellan vascular robotic catheter system was approved in Europe. Late in Q2 this year the FDA granted approval for commercial sales in the U.S. Given that Magellan is believed to have an addressable market roughly ten times the size of Sensei, you might think the bulls would be running with the anticipation of future profits.

Financial results for Q2 2011, reported on August 8, are the reason for the slump. I don't think anyone expected HNSN to get to profitability, since there was no time to sell Magellan robots in the U.S. in the quarter. But sales were the worst in company history. Only one Robotic Catheter System was shipped, a Sensei, but two had recognized revenue, including the one that was shipped and one shipped in a prior quarter. Revenue was $3.5 million, down 26% sequentially from $4.7 million and down 34% from $5.3 million in the year-earlier quarter.

Net income was negative $11.5 million, up sequentially from negative $11.8 million, but down from negative $8.8 million year-earlier. EPS (earnings per share) were negative $0.19, up sequentially from negative $0.20, but down from negative $0.16 year-earlier.

Management claimed that talks are underway with hospitals in the U.S. and Europe, with multiple quotes out. While understanding that these are expensive robots that have to go through a lengthy review process before hospitals buy them, you have to ask what happened in the past that the old Sensei system sales dropped to just one in the quarter.

The Sensei systems that are already installed are being used, as indicated by 637 known EP procedures performed with them in the quarter. To try to compensate for the dismal sales results, Hansen brought into the analyst conference call Professor Cheshire of St. Mary's in London, the first hospital to treat patients with the Magellan Robotic System. He spoke on his team's collective experience in peripheral vascular, aortic, and other vascular cases. They discovered a number of useful robotic catheter techniques as they progressed from simple to more complex cases. They can now treat difficult cases. The had prior experience with the De Vinci surgical robot made by Intuitive Surgical. Cheshire believes robotics differentiates St. Mary's from competitors. Studies there showed the advantages of the Magellan system and other minimally invasive techniques. The robot is bringing patients in already.

So you are making a bet buying the stock even at this price. Are the negotiations for sales of Sensei and Magellan going to come through, and are they going to grow long-term? If your crystal ball says yes, you should scoop up all the Hansen Medical stock you can afford.

I don't have a crystal ball and I already own Hansen stock. I believe the technology developed by the company would have a great deal of value for other medical device players. So there is some low point of market capitalization that should trigger that kind of event. Market capitalization today is just $90 million. If I had that kind of money, and could buy all the stock without bidding up the price, I would do it. Then I would assess the sales pipeline. Ff I did not like it I would try to sell the business or the intellectual property to St. Jude (STJ), Intuitive Surgical, or a similar player.

Given that stocks are priced by auction, we may not be at the bottom, but I don't see a scenario where the stock is worth less than it is today if management is willing to break up or sell the company. If there really is a sales pipeline and we start seeing substantial increases in revenue in Q3 and Q4, then Q2 will seem like just a glitch and I'll be using Hansen in the future as an example of how short-sighted investors can be. And kicking myself for not buying more.

Hansen had a cash balance of $29.4 million at the end of Q2. If they don't ramp sales quickly they are either going to have to dilute the stock or borrow more money, neither of which is a pretty scenario.

Hansen Medical is not a stock for conservative investors. It has astonishing potential, long term, but it is also a long way from financing itself through profits. It should only be bought by investors who know how to manage risk.

Disclaimer: I am long HNSN. I will not trade in the stock for 1 week following this post. I have no position in ISRG or STJ.

Keep diversified!

See also:

Q2 2011 Hansen Medical Analyst Call Summary
Hansen Medical main page
my other Hansen Medical articles and conference summaries