Silicom ( Nasdaq - SILC ) -- Big Data Yields Big Growth

Silicom (SILC $60.00) reported better than expected Q4 results.  The company is the leading provider of auxiliary products used in server farms to improve performance and reduce costs.  Volume responded in the period as several programs achieved broader distribution.  Sales advanced 52% to $25.4 million.  Earnings jumped 104% to $.94 a share.  Overhead costs were spread over a higher than predicted level of sales, propelling pretax margins to 28% in the quarter.  The trend towards cloud computing amplified demand.  Customers rely on Silicom's technologies to offload routine tasks onto special purpose cards, enabling their servers to accommodate more traffic.  A recent acquisition promises to reinforce that trend in upcoming periods.  That technology (data virtualization) helps cloud computing data centers manage huge information repositories more efficiently.  Meantime, Silicom's core technologies are continuing to proliferate into more systems.

Silicom is co-opting its only true competitor, Intel Corp.  The giant chip maker used to provide some of the technologies that Silicom offers as a bundled feature in certain semiconductor products.  In December Intel signed a deal with Silicom to work together on a series of new offerings.  Further collaboration is possible down the road if Intel elects to rely on Silicom's industry standard products instead of reinventing the wheel themselves.  The only other direct competition that Silicom currently encounters is from in-house design teams.  Many manufacturers of specialty computers still attempt to design 100% of the functionality of their products internally.  Silicom increasingly is replacing those efforts when new products are developed.

Several factors promise to sustain growth at a superior rate.  The industry itself is continuing to expand.  Big data, mobile, and cloud computing are expanding much more quickly than the computer industry as a whole.  Silicom already is well entrenched in those segments.  The data virtualization expansion is likely to reinforce that momentum.  Unit volume in existing programs should benefit directly.  Silicom also is adding new customers.  Over 90 companies currently rely on the company's technologies to some degree.  And those customers are engineering Silicom's technologies into a greater number of new designs.

We estimate 2014 sales will surge 25%-35% to $90-$100 million.  Income, excluding the affect of non-cash stock option expense, could reach $2.75-$3.25 a share.  Cash flow remains positive.  Silicom has expanded inventory levels to ensure the best possible response time when customers place orders.  Even so, a hike in the cash dividend is possible.  There's plenty of cash on hand, moreover, to purchase additional technologies.

Note - Older reports about Silicom can be found in the "Archives" in the "Israeli Growth Stock" section, which appears at the end.  Those companies now are followed in this blog, "International Growth Stocks."

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Coastal Contacts ( Nasdaq - COA ) -- Loses Focus

Coastal Contacts (COA $4.75) reported Q2 (April) results that were significantly below our expectation.  The company is a leading provider of contact lenses and eyeglasses, sold over the Internet.  Contact lenses account for 2/3 of revenues, but the greatest growth potential lies in the virtually untapped eyeglass segment.  Contact lens sales slowed modestly from the immediately preceeding quarter.  But that was a normal fluctuation influenced by re-order timing.  The overall trend remains intact.  Eyeglass sales, on the other hand, were much slower than anticipated.  Pricing increased, an indication that promotional discounts were relied upon to a lesser extent.  Even with that adjustment volume should have been considerably higher.  Coastal Contacts raised $20 million in fresh equity earlier in the year.  About 25% of that was spent in the April quarter to accelerate growth.  It could be the extra spending will produce higher results in the current quarter.  Demand is likely to be reinforced by a wider selection of brand name frames and sunglasses, and a more streamlined website.  Coastal Contacts elected not to provide a sales forecast, though, so there remains considerable doubt about what the immediate future will bring. 

The long term outlook remains positive.  The on-line eyeglass category holds enormous potential.  Even if only 10% of the eyeglass market goes to the Internet that business will equal the on-line contact lens industry.  Coastal Contacts faces competition at the high and low ends.  But the company remains the leader in the mid-range segment.  Downside risk is limited by the company's acquisition potential.

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3-S Bio - Acquisition of the Company is Complete

Computer Modelling Group ( Toronto - CMG ) --

Computer Modelling Group (CMG.to $23.00) reported excellent on target Q4 (March) results.  The company is the leading provider of simulation software used by energy companies to maximize production of heavy oil, tar sands, and other complex reserves.  Customers purchase the technology either on a perpetual basis or year to year.  Perpetual licenses generate more immediate revenue.  Deals that renew annually tend to yield greater lifetime income.  In the latest quarter Computer Modelling booked fewer than normal perpetual deals, resulting in a muted year over year comparison.  But recurring revenue improved by 23%.  Earnings increased by a penny to $.20 a share despite the 33% decline in perpetual license sales.

Demand remains vibrant.  Computer Modelling continues to fare best in the North American market.  Activity in Calgary and North Dakota is continuing to expand at a superior pace.  The U.S. oil fracking market is thriving as costs come down, helped in growing measure by broader software use.  Tar sand costs are falling, as well.  Each of those areas is believed to possess potential reserves that are bigger than Saudi Arabia's.  A price collapse in the oil market remains a significant risk.  In theory worldwide demand for petroleum should be exploding as Third World countries modernize their transportation systems.  The ongoing recession has muted demand, though.  And most OPEC producers depend on their oil income, making it unlikely they'll cut production.  Prices have held up so far because the Obama Administration has virtually eliminated Iran from the picture.  The U.S. and Canada have picked up the mullahs' market share.  Further output increases could start putting pressure on prices, though, unless economic activity rebounds.  Fracking and tar sand costs are declining, so a bigger cushion is being created.  But a big acceleration in sales probably won't emerge until unit volume demand accelerates, forcing energy producers to develop even more challenging fields. 

Natural demand promises to advance in the Middle East.  That's been Schlumberger's province for decades.  And the French oilfield services giant probably will continue to supply a sizable share of the software market over the long haul due to its tight customer relationships.  But even in the Middle East oil has become increasingly difficult to recover.  Computer Modelling has the best technology for exploiting difficult reserves.  The company already is working with Halliburton in North America.  If worldwide demand takes off Computer Modelling could make some direct forays in the Middle East as those kingdoms try to rebuild their own reserve bases.  A collaboration with Schlumberger, while it's unlikely at this point, could develop.

The company's next generation system is slated for launch in the December quarter.  That project was funded equally by Shell and Petrobas, which also supplied part of the engineering team.  Computer Modelling retains exclusive ownership and marketing rights to the technology.  Shell and Petrobas get first shot at using the software.  It should be a pretty big deal.

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Coastal Contacts ( Nasdaq - COA ) -- Deploys New Capital

Coastal Contacts (COA $5.75) appears on track to produce good Q2 (April) results.  Of greater importance, the company raised $18 million in fresh capital during the period.  Three million shares were sold at $6.00 apiece.  That money is being gradually deployed to support the company's penetration of the U.S. on-line eyeglass market.  The template for that business in Canada remains strong.  That operation has been in place for the past few years.  Selling eyeglasses on-line is challenge because new customers are wary of the process.  Once they do place orders, however, the far superior pricing drives repeat business and referrals.  Returning customers are accounting for an increasing share of Canadian orders, generating better margins.  At present the company is focusing on first time buyers in the United States.  As that base starts re-ordering margins promise to surge there, as well.

Large deals with health care insurance companies could amplify growth.  Coastal Contacts provides eyeglasses at approximately 50% lower cost than conventional retailers.  That's opening up opportunities among managed care providers that want to provide eye car insurance at low costs. 

The company's contact lens business continues to grow at a 5%-10% rate.  That segment had been starved for advertising funds before the recent stock offering.  Business in Northern Europe and Canada had held up well despite that lack of marketing effort.  Renewed spending promises to reinforce the company's competitive position in upcoming quarters.

In 4-5 years pretax margins could reach 20%-25%.  We project they will attain half that level by 2014-2015 as marketing costs continue to rise quickly, laying the groundwork for further sales improvements.  In 2-3 years sales could reach $325 million to provide fully taxed earnings of $.75 a share.  In 4-5 years income could hit $2.00 a share.

 

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