Why I remain bullish on EZchip Semiconductor

The Undervalued Growth Companies portfolio continues to lag behind the Russell 2000 and the S&P 500. All the stocks in the Gehman portfolio are special situations. I believe the managements of the companies are working diligently to develop their businesses, but the stock prices haven’t moved significantly.

I believe that each one of the investments could, and should, trade at significantly higher prices, but it won’t happen until it happens.  Below is my short analysis of each company.

EZchip Semiconductor (EZCH)

EZCH is my largest holding with the most exciting potential. On November 6, the company announced a record quarter for revenues and earnings.

EZCH expects all its customers who plan to use the NP-4 (Fourth Generation Processor) to be in full production by the end of 2013. The fifth generation processor, NP-5, is now sampling and is expected to go into production in 2014. The company says the NP-5 “doubles the NP-4 performance and port density, reduces the price per port for our customers and is expected to sell at approximately 50% higher ASP compared with NP-4.”

Of greater importance, EZCH has developed and will start sampling their revolutionary New Processor for Smart networks in 2014, with customer product prototypes in 2015 and production in 2016. This NPS processor will provide superior performance, integration and flexibility to process “data plane” information at high speed – all on a single chip.

The greatest criticism that analysts make about EZCH is their customer concentration. The NPS will greatly expand EZChip’s customer base because the NPS will provide unique processing to “our traditional customers, the carrier Ethernet router vendors, from the data center network appliance and switch vendors and from large carriers and data center operators that are innovating self solutions.”

Cisco (CSCO) has been a great customer for EZCH, but the NPS will reduce the company’s dependence on Cisco and the limited size of the edge router market.

In their latest NPU market report, The Linley Group said that EZCH “became, for the first time, the overall NPU market share leader, with 23% market.”

EZCH’s customers, five of the seven edge router providers, are extremely secure because of the significant time and money they spent to integrate EZCH processors into their systems.

Evidence of this is that Juniper first used the NP-2 in 2005, but Juniper’s orders for this chip were larger in 2013 than in 2012.

For eight years or more, all routers that are built with EZCH processors will add more line cards (thfnsat use EZCH processors) to keep up with the gigantic demands for broadband capacity.

EZCH increased their cash position by $8.7 million, even though the company spent $4.5 million for R&D. EZChip’s cash position has been building steadily with no significant debt.

Eli Fruchter, CEO, in the third-quarter earnings call said “now that NP-4 is in production with all customers, our continued growth rate depends on our customer’s success with their NP-4 based platforms and on carrier spending that seems to have improved in recent quarters.” Many reports show edge router sales robust and carrier spending, (e.g., ATT, Verizon, China Mobile) increasing.

I believe that EZChip’s market dominance, future products, secure growing customer base and strong financial position should allow EZCH to trade at a much higher multiple.

Anadigics (ANAD)

The best way to describe Anadigic’s future is to quote Ron Michels, CEO,  final remarks on the third-quarter conference call:  “Leveraging our leading edge semiconductor technology and RF design prowess strong relationships with the industry leaders and world-class manufacturing capabilities, we believe that ANADAGICS is well positioned for long-term profitable growth.”

The company backs up these remarks with a solid quarter: $37million revenue that was 7.1% above their last quarter and 29.2% above the year-ago quarter.

Gross profit was $4.4 million, or $2.5 million higher than their last quarter, with a gross margin of 11.9% which was 640 basis points better than last quarter.

The EBITDA loss was $5.9 million, a sequential improvement of $2.5 million mirroring the revenue and gross profit improvements.

The good news is that ANAD has done a decent job of improving product mix and productivity so that gross margins are improving. The company projects revenues in the fourth quarter of 2013 to be flat to down 5% sequentially, but gross margins are expected to improve.

The next big test is when ANAD can break even. The company has pushed out the projected date a quarter or so to “mid-year 2014.  The company has $32 million in cash, $16 million in accounts receivable. The big story is the improving gross margins, which Ron Michel’s called “phenomenal.” Originally, break-even was going to require revenue of $45million, but now could be lower.

Anadigics has come a long way to rebuild its operation.

Crailar Technologies Inc. (CRFRF)

Crailar produces bast fibers, cellulose pulp and their by-products from flax, hemp and other bast fibers. Their unique process creates soft fabrics from hard, cheap, materials that substitute for cotton cloth at much cheaper prices.

The company has arranged long term financing, and has long term contracts with Levi Jeans and other companies.

Crailar was able to purchase a fabric dye factory in Europe that immediately allows production of 250,000 pounds of Crailar Flax fiber per week with the room to expand to 1 million pounds per week. Completion of the plant in South Carolina will be postponed.

Like any new company, there will be peaks and valleys, but there are extremely positive trends with Crailar that should benefit the stock price.

DragonWave  (DRWI)

A lot of things going on with DRWI.  Last year, DRWI purchased its largest customer, Nokia Siemens Networks (NSN) microwave radio group. NSN was significantly larger than DRWI, and it was losing money. As expected, it is taking time for the new organization to sort out integration problems.

This makes the analysis of DRWI extremely complex. The critical point is that DRWI must grow its sales significantly. DRWI expects significant growth in the wireless backhaul for outdoor small cell networks. India is a bright spot and the Middle East and Africa are expected to make strong contributions. A pilot project with a major Asian service provider is underway. Also, DRWI is streamlining its sales relationships in the U.S.

Cash is the issue. According to fiscal second-quarter results: “The company ended the second quarter of 2014 (ended August, 2013) with $9.8million of cash, cash equivalents and restricted cash, compared to $23.4 million at the end of the first quarter of fiscal year 2014. Our cash position decreased by $13.5 million in the second quarter. The uses of cash were a cash adjusted loss of $8.3 million, an increase in working capital of $4.6 million; the purchase of capital assets in software of $0.3 million; and $0.3 million from payments of capital leases.” Additional funds are available from a $23 million (net) financing that closed on Sept. 23, 2013.

DRWI does have a bank line and over $8 million of debt to Nokia, but if sales increase as expected, it should be able to work around those loans.

The company must get to break-even within a reasonable amount of time. Peter Allen (CEO, President and Director) said in the fiscal Q2 conference call: “I continue to be pleased with our strong focus on integration restructuring and cost-control activities, and these activities have now resulted in a 50% reduction in operating expenses compared to Q2 of last year. Our journey to reach the cash flow breakeven point from operations through the combination of cost-base realignment and a strong focus on funnel development continues, as described previously. Our recent financing puts us in a position to execute on these plans. “

The market is keeping pressure on the stock amid speculation that DRWI will have to raise funds again.

There is risk, but if the company can work steadily toward breakeven, the stock should move up.

Finisar (FNSR)

Finally, Finisar  shares are doing what they are supposed to do.

First quarter, 2014 revenues were $266.1 million, an all-time record for Finisar – an increase of $22.7 million or 9.3% over the prior quarter and an increase of $45.5 million or 20.7% over the first quarter of the prior year.

First quarter non-GAAP income was $31.3 million or $.31 per diluted share compared to $19.8 million or $.20 per diluted share in the prior quarter.

Jerry S. Rawls (Chairman of the Board and Co-Principal Executive Officer) concluded the Q1, 2014 conference call with the following remarks:

“We continue to be optimistic about our fiscal year 2014. The second quarter is looking good. We expect revenue and operating income to grow for the fifth consecutive quarter and to again set a new company record for revenue…. We expect the growth rate for telecom to accelerate and both datacom and telecom revenues to increase over the first quarter. We expect non-GAAP gross margins to continue to improve to approximately 36 % ……Non-GAAP earnings per diluted share are expected to be in the range of $0.37 to $0.41% a share.”

“2013 is a significant year for Finisar. It  is our 25th year of operation, and we will surpass $1 billion in revenue for the first time our current fiscal year….”

“Finisar’s revenue was driven primarily by growth in the world demand for bandwidth and for the ever increasing distribution and use of video, images and digital information. Another important trend that is benefiting us is that data centers are becoming larger with an increasing number of longer, higher-speed connections. This increases the optical content in data centers and creates more bandwidth capacity. We believe Finisar is uniquely positioned with our broad product line; extensive customer engagements; profitable, vertically integrated business model; and strong balance sheet to capitalize on these market opportunities.”

Finally, Finisar’s revenues are large enough to leverage its fixed expenses. It sounds like Jerry Rawls thinks the trend will last for awhile. The stock should move up accordingly.

Lattice Semiconductor Corporation (LSCC)

Momentum has been building for LSCC since 2012 when the company decided to leverage its expertise in the wireless, worldwide smartphone market.

On the third-quarter conference call, Darin Dillerbeck (President and CEO) said “ Q3 was another record quarter as revenue came in ahead of our guidance. Our gross margin stayed healthy 52.4% as we continued to see strength from our consumer with stability in communications. Industrial and other remained sluggish. Net-net, it was a great quarter and ended up pretty much where we expected. We’re differentiating our company and outgrowing the broader semi sector as we ramp our major customer wins.”

Lattice strives to enable creative solutions, being efficient and keeping costs down.

“We remain bullish on the opportunities before us. We are gaining momentum in our business and we continue to have a strong balance sheet with no debt.”

Joe Bedewi (Corporate VP and CFO) said that revenue from Q3 “was $87.2 million, an increase of 2.9% from the second quarter and an increase of 23% from $70.9 million in the year-ago period. ….. Net income for the quarter was $8.2 million or $0.07 per basic and diluted share as compared to net income of $5 million or $0.04 per basic and diluted share in the second quarter, and net loss of $2.2 million or a loss of $0.02 per basic and diluted share in the year ago period.”

Darin Dillerbeck concluded that “In summary our team’s done a great job through the first three quarters of the year. We’ll meet our Q4 objectives so revenue will grow around 15% this year our margin trends continue to improve. Our focus this year is to be – has been to win two or three top consumer-mobile OEMs and we’ve done just that. Our focus for next year is to continue to ramp our existing large OEM customers and win even more. …” He does project revenue in the fourth quarter, 2013 to be minus 5% to 9% compared to Q3, but that is a factor of product mix and specific flows of business, not the long term trend of the business.

The wind is in the sails for LSCC.  I think the stock can go much higher over an extended period of time.

MicroVision (MVIS)

MVIS was one of the first micro-cap stocks I purchased. The company develops ultra-miniature projection display technology. The most exciting development, among many, is the mass production of an artificial green laser that allows MVIS products to be offered at a reasonable price.

Of greatest importance, on April 3, 2013, MVIS announced a development agreement with a Fortune Global 100 company that included an up-front payment of $4.6 million in fees.

MVIS has developed and has patents on their Pico projector with probably the greatest brightness to power consumption. The projector can be about the size of a half dollar and can project an image two feet or 20 feet in perfect focus. The market for Pico Projectors is projected to be in the 100’s of millions.

Two factors could be weighing on the stock price. On Sept 19, MVIS announced an offering of stock and warrants which allowed it to raise $6.6 million. Also, Alex Tokman, CEO, said the company would like to sign more contracts with additional multi-product, large companies that will invest money with MVIS.

QuickLogic Corporation (QUIK)

Great news with QuickLogic. The company reported a break-out third quarter on Oct. 30.

Total revenue was  $9.1 million, was up 77% sequentially and up 148% compared to the third quarter of 2012. Of greater importance, new product revenues are $7.1 million which was up 131% sequentially. (Note: one order for about $1.5 million was moved from the fourth quarter).

“Samsung accounted for 68% of total revenue as opposed to 46% of total revenue during the second quarter.  New product revenue generated by other customers increased by more than 30% during the quarter,” the company said.

Many products and many orders contributed to this increased revenue. Andy Pease, CEO, on the conference call gave credit to the company’s “change in engineering strategy to increase the cadence of our silicon platform introductions and to fully fund an office of the CTO with the marketing and engineering talent necessary to establish a long-term strategic vision for QuickLogic.”

Max Maxfield wrote an article in the EE/Times titled “Touch Me, Feel Me: QuickLogic’s Sensor Fusion Solution.” The article describes our new world where sensors are being added to smartphones and tablets. He says that “next-generation devices will be both environmentally and contextually aware. They will know if we are walking, running, or riding a bike. They will know if they are in our hands, in a pocket or in a purse. They will know if we’ve fallen over or if we’ve been involved in a car crash.”

The problem is that these sensors must be turned on at all times – and that takes too much power. QuickLogic has introduced an ultra-low power sensor hub solution that reduces power consumption to approximately 1% of the system power.

I think QUIK stock will move up significantly this year.

Tower Semiconductor (TSEM)

TSEM fabricates chips. They do not use “cutting edge” technology, but buy old equipment and manufacturing facilities at cheap prices. They don’t try to be on the cutting edge of technology, but sign contracts with multiple tier-one customers throughout the world at competitive prices.

Micron Technology sold its plant in Nishiwaki, Japan to TowerJazz in 2011. TSEM had supply contracts with Micron, but TSEM needs to replace those contracts with higher margin business going forward.

Even though TSEM has relatively low cost equipment, the business still incorporates a high fixed cost that needs to be covered with significant sales.

TSEM reports that they have multiple contracts that are being developed. Until that production gets reported, the stock will be under pressure.

TSEM has been approved to work on two major projects in India. These projects will utilize TSEM’s expertise and hopefully develop profitable business.

The stock trades very cheaply because the company converted a large amount of convertible bonds (capital notes) to equity and in June, 2013, TSEM sold common stock and warrants to clean up the balance sheet.

We await TSEM’s announcement of closing contracts they are negotiating.

Towerstream (TWER)

Towerstream is a developing story. The company now has two segments.

The Fixed Wireless business achieved cash flow profitability for the first time in Q1 2013. The other business,Hetnets Tower Corp, shared wireless infrastructure – revenue is derived from advertising and usage-based rental. This business will take advantage of TWER’s control of small cell base stations (wireless) in major US cities.

The company projects that revenue should build steadily through the year, but results were disappointing in Q2, 2013. Hopefully TWER’s projections will be more accurate for the second half of the year as they secure the first rent-based customers in their major markets.

TWER owns a very valuable commodity – real estate space on tops of buildings in 12 major cities in the US. They initially delivered fixed-wireless high-speed Internet to businesses, but now are using that same space to sell Wi-Fi and Small Cell sites.

Carriers are now starting to build their Wi-Fi and small-cell platforms – but spending is not growing as fast was thought originally.

Hopefully, TWER will close some major contracts soon and the stock will trade significantly higher.

Wave Systems Corp (WAVX)

I have decided to liquidate the position in WAVX. The company has gotten too small and it is taking too long for the business to “take off.” (Note: WAVX promoted its National Sales Manager, Bill Solms, to become the CEO.)

Mr. Solms conducted the Q3 2013 conference call on Nov. 7. His management approach is very impressive. He is conducting a total corporate review and believes that he can significantly increase sales and turn WAVX into a profitable company.


XOMA develops drugs.  On Nov. 1, 2013, Zoma presented Phase 2 Clinical Results.

The concluding remarks by John W. Varian (Director and Chief Executive Director) best summarize the company’s activities:

“We’ve gone through a great deal today. The data our investigators have generated in pyoderma gangrenosum and pustular psoriasis is compelling. We are now pursuing a pivotal gevokizumab study in neutrophilic dermatosis.

We started this call talking about our Day 84 EOA data and we are very encouraged by what we have seen today in this indication. When we analyze the full six-month dataset we will be able to make decisions about a Phase 3 EOA program. If all goes as we hope. We are very excited to move forward in all these indications as we believe gevokizumab could have a tremendous impact on these patient populations.”

This is a lot of scientific talk, but the important fact is that Xoma is moving ahead on some important drug discoveries.

The investments discussed are held in client accounts as of October 31, 2013. These investments may or may not be currently held in client accounts. The reader should not assume that any investments identified were or will be profitable or that any investment recommendations or investment decisions we make in the future will be profitable. Certain information contained in this presentation is based upon forward-looking statements, information and opinions, including descriptions of anticipated market changes and expectations of future activity. The manager believes that such statements, information and opinions are based upon reasonable estimates and assumptions. However, forward-looking statements, information and opinions are inherently uncertain and actual events or results may differ materially from those reflected in the forward-looking statements.