Here’s how our stock holdings performed in a very tough month

Author: Gehman Capital

Covestor model: Undervalued Growth Companies

Disclosure: Long EZCH, QUIK, FNSR, LSCC and TWER

This month, the market has taken a serious technical hit. I believe that this can be reversed quickly when we get some resolution of the European crisis. I believe that US stocks are extremely cheap by some measures.

I expect equity prices to be significantly higher by the end of the year. I believe the small/micro cap stocks in my Covestor portfolio will be much higher by year end.

Small Cap stocks are all about the risk/reward profile. My Covestor performance chart (as of 6/1/12) shows that Gehman Capital Solutions stocks have returned +2.4% for 2012 year to date. This compares with -0.5% for The Russell 2000 index and +1.6% for the S & P 500 index.

Here is a summary of the model’s major stock holdings.

EZChip Semiconductor Ltd. (EZCH) reported very solid revenue of $14.4 million dollars for the first quarter of 2012. Gross margins were at record high levels with $0.27 fully diluted EPS on a Non-GAAP basis.

The really good news was that their new NPU-4, which delivers double the profits of the NP-3, is now in production for Cisco (CSCO) with a number of other companies lining up to use the chip in production.

The stock is highly volatile. The company is projecting  revenue in 2016 that could be 4 to 5 times the $63.5 million revenue in 2011. There is a strong possibility these results can be achieved because most NP-4 customers are expressing strong interest in using the NP-5, which will sample at the end of 2012 and go into production in 2013.

There is a substantial short position in the stock. It appears that every time there is weakness in the overall market, the stock price is forced down – even with low volume. I am not trading the stock – I just close my eyes and keep waiting for the extremely attractive earnings that I hope will appear very shortly.

In late May, Anadigics (ANAD) announced significant design wins and production shipments with China’s two largest handset companies – Huawei (CN:002502) and ZTE (HK:763).

Prior management had production problems and stressed customer relationships. Current management continues to develop a superior product line and has gone a long way to re-build customer confidence.

ANAD’s new power amplifiers will generate high marginal profits. These expected profits and adequate cash reserves should hopefully lead the stock to higher prices.

DragonWave (DRWI) closed its purchase of Nokia Siemens Network (NSN) on June 1, 2012. DRWI is buying a much larger company that will now be a large “locked in” a very large customer for DRWI.

To date, DRWI sells pure broadband backhaul (wireless networks) in densely populated areas. The Nokia Siemens acquisition will provide opportunities to sell hybrid (not pure IP) radios that are frequently used in emerging markets and rural areas.

The market for broadband Ethernet backhaul (DRWI’s market) is growing substantially. This acquisition will significantly increase DRWI’s addressable market size.

On June 4, 2012, DRWI announced a restructuring following the merger.

The company will conduct layoffs in some areas, establish distribution capability in the Netherlands and staff new regional subsidiaries in Mexico and Brazil. These announcements are positive, especially if DragonWave can close some contracts in Latin America.

The market will probably wait to see how this significant merger develops. There is very good upside potential for business and DragonWave’s stock price.

Finisar Corporation (FNSR) builds a very competitive line of fiber optic products. Demand for 100 Gb/s transceivers is exceeding supply and will probably not equalize until later in 2012.

Demand is also robust for its reconfigurable optical add-drop multiplexer, where Finisar is gaining market share.

Late in 2011 and in the first quarter of 2012, demand for fiber optic products – internet backhaul, data centers, wireline telecom and wireless telecom – entered a “slow patch.” The market is starting to see increasing demand for broadband capacity that is forcing carriers to increase spending significantly in the second half of 2012.

Finisar has a relatively high ratio of fixed expenses. Higher volume will generate higher profits and FNSR’s stock price should move up.

Lattice Semiconductor (LSCC) competes in the programmable logic business. LSCC specializes in the low-power, low-cost, high-volume market – especially when they can add some low cost innovation. The company completed their acquisition of Silicon Blue for $62 million in cash on Dec. 16, 2011.

Over the last ten years, LSCC has delivered over one billion high volume chips. Customers operate in many industries including wired and wireless telecom, smartphones, laptops, digital cameras, TV’s and video processing, with no major customer concentration.

LSCC reported good results for the first quarter of 2012, that showed a recovery from the inventory glut in the last quarter of 2011.

The company is executing well. LSCC is a growth story that will benefit from the continuing recovery of the world economy.

Recently, there was big news at Microvision (MVIS). On May 31, 2012, the company announced purchase orders from Pioneer Corporation (JP:6773) for over $4 million. Pioneer is the first customer to purchase components and pay license fees and royalties for MVIS’s patented Pico projector.

Pioneer is utilizing MVIS technology to manufacturing a new projector that allows automobile drivers to view data, in all viewable conditions, in front of the windscreen.

For many years, MVIS has been developing their technology, filing patents, building reasonably priced component sources (especially green lasers) while generating very little revenue.

MVIS is generally acknowledged as producing the smallest and best Pico Projector (i.e., small projector). MVIS uses three lasers (green, red and blue) and a mirror to project automatically focused images on any surface at any distance. The Pioneer order is the first of hopefully many orders that will increase MVIS sales significantly.

Three factors will make MVIS Pico Projectors extremely attractive to consumers:

(1)  Projectors will be small enough to “embed” in cell phones.

(2)  QuickLogic is now marketing a chip with VEE/DPO technology that will lower power usage and significantly increase view ability for Pico Projectors.

(3)  The cost of the projectors will be reduced significantly.

On June 1, QuickLogic Corp (QUIK) announced that they made a private offering of 4.5 million shares of common stock (with warrants and a possible over-allotment of 675,000 shares) at $2.50. This injection of $10-plus million is very helpful, since QUIK is projecting a cash burn of $2.5 million for Q2, 2012. (See my recent report on www.covestor.com that was posted on April 8 for more details.)

On May 1, QUIK reported earnings and business progress very much in line with my expectations. The company is bringing new chips to market and has a large number of customers sampling, and starting to go into production with their products.

QUIK has announced they received a contract to sell chips for the PoP Video projector (Pico) and has the opportunity to sell their chips to other Pico Projector manufacturers.

I believe that QUIK will report increased sales in the second quarter of 2012, but significant results will probably have to wait for the end of 2012 and possibly 2013. The management of QUIK likes to say the company is a venture capital firm wrapped in public cloth. The risks are high, but the potential rewards are very high.

Tower Semiconductor (TSEM) fabricates chips, and is a beneficiary of the trend for developers to outsource manufacturing because new chip manufacturing facilities are extremely expensive. TSEM purchased a production facility from Micron Technology (MU) earlier this year. Over time, production in this facility will shift from memory chips for MU to higher margin chips.

In May, the stock moved up a little in price with the rumor that the company was making progress in negotiating the retirement of Capital Notes that were issued in 2006.

On May 29, TSEM announced that Leumi Bank and Hapoalim Bank have asked TSEM to file a registration statement with the US Securities and Exchange Commission to register ordinary shares underlying a total of $85 million of Capital Notes from both holders.

Israel Corporation (IRLCF) holds about $304 million of the Capital Notes. Israel Corporation has informed TSEM of its intent to convert all of its Capital Notes into shares, but as a long term strategic shareholder did not ask TSEM to register its shares.

There are legal restrictions on Israeli banks that are stimulating some negotiating on the Capital Notes. In the worst case, 399 million new shares would be created to increase the total number of shares to 732 million. Hopefully, negotiations will result in fewer shares being created.

Since TSEM’s 2012 revenue is projected at $718 million. The stock is trading around $.75 per share, so could move higher when this Capital Note issue is resolved.

The company is executing well and is projecting increased revenues and increased gross profit margins. Hopefully we have seen the start of an upward move in the stock.

Towerstream (TWER) legacy business provides enterprise broadband service from rooftops. Their model is successfully utilized in high density cities such as New York, Chicago, and San Francisco.

In addition, TWER can leverage their real estate assets, which have established AC power, for wireless carriers to build Wi-Fi and small-cell base stations.

TWER announced its first “national” carrier contract on March 30, 2012 and their second on May 10, 2012, to provide Wi-Fi networks. TWER’s space is particularly valuable now because the carriers can provide seamless switching “from a cellular connection to a Wi-Fi connection and then back to the cellular connection.”

TWER has provided some projections for future build-outs, but to the disappointment of management and investors, the roll-out of additional business has been difficult to project and has taken much longer than expected. The reason is that TWER must integrate its contributions into the established network of much larger wireless carriers.

TWER’s model is a high fixed price model. Once revenues start to build, profits can be quite substantial, but the timing is definitely in question.

Wave Systems Corp (WAVX) provides software that helps solve PC Security problems. The software deals with strong authentication, data protection, network access control and the management of these functions.

WAVX is a founding member of the Trusted Computing Group that writes and promotes open standards for managing Trusted Computing chips that are embedded in over 500 million business computers and in encrypted hard drives that are becoming more common.

Corporations pay fees to WAVX when they “turn on” WAVX’s software to manage their trusted computing technology.

WAVX is the most frustrating stock that I own in my Covestor portfolio. The company has established a reputation and dominant products in the “Trusted Computing” space of internet security,  i.e., seminars, lectures, research reports, etc. etc.

WAVX has signed some large contracts, but have not convinced the world  to utilize “trusted computing” as their primary source of network security.

On May 29, 2012, WAVX filed a Form 8-K to announce they “signed a 15-year Software License and Distribution Agreement with Samsung Electronic (005930: SE).

WAVX will receive a per-unit royalty based on Samsung’s sales of products that are equipped with or include Wave’s software technology.”  There is no guaranteed minimum or maximum on shipped quantities or royalties.

Samsung is a gigantic company which provides significant revenue opportunities. WAVX has earned significant revenue from a similar type contract with Dell (DELL).

Every quarter, for years, Steven Sprague, CEO, has said that the company has a number of projects in the pipeline. WAVX has written contracts with General Motors (GM), BASF (BASFY) and Price Waterhouse, in addition to a number of small companies. However, they have never signed enough contracts to show a profit.

The company has consistently increased cash flow, but chooses to spend the increased funds on research. In Q1, 2012, revenue actually declined and expenditures increased because the company is spending to adapt their products for the “mobile” (e.g. cellphone, tablets, etc.) markets.

Wait, wait and wait some more. I don’t own many biotech stocks – anymore. XOMA Ltd. (XOMA) has a number of drugs in stages of development, testing and government approval. These drugs are therapeutic antibodies that treat inflammatory, autoimmune, infectious and oncological diseases.

If the drugs finally get approved, or XOMA can collect revenue from larger pharmaceutical companies, the rewards of success are significant but the odds are low. The waiting is painful.