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Small-Cap Confidential
Undiscovered stocks that can make you rich

Cabot Small-Cap Confidential Weekly Update

All but two of our positions are showing positive gains, and all but four have outperformed the Russell since they were recommended. On average, each position is outperforming by around 10%.

Despite everything that is going on in the three branches of the U.S. government (and let’s throw the media in there as well), the stock market continues to show inspiring resiliency. Small caps were up modestly this week, and are still holding onto the majority of their post-election rally.


There have been plenty of reasons to cheer stocks as earnings roll in. Even reports from European stocks suggest the first year of growth in the E.U. could be upon us as we enter 2017. Earnings from those companies that have reported in the Euro Stoxx index show 5.05% growth in Q4 2016. You have to go back to Q1 2013 to find a quarter of growth, and it was only 2.75% growth at that. Might it be time to dip a toe into small caps with Eurozone exposure?

Here at home, it was Trump making headlines again (and again and again and…), stating that his goal of lowering taxes for businesses was moving “ahead of schedule.” Sounds vague to me, but the market responded by going higher. Rumor has it that he’ll get more specific on his February 28 address to Congress. What’s not vague is the growing bullishness on the part of analysts as they begin to roll out 2017 and 2018 estimates. I’ve seen large jumps in expected revenue and earnings for health care, financials, energy and industrials. Estimates are on the rise for tech, utilities and consumer stocks as well, though to a lower degree.

The bottom line is that the economy seems strong and getting stronger. We’ll need it to strengthen to validate the lofty valuations of many stocks!

As you can see in this chart, stocks haven’t done a heck of a lot in 2017. Small caps are flat, while the S&P 500 is up 2%. We’ve seen nice gains in sectors like tech and health care, but large divergences between asset classes in other sectors (consumer stocks, utilities, financials, materials). This is only six weeks of performance, so don’t read too much into it.

csc-perf-ytd 2-10-17

Perhaps more interesting is performance by asset class and sector since the election. The chart below shows a 16% rally in small caps versus a 7.8% rally in large caps. Small has beaten large in all sectors.

csc-perf-election 2-10-17

And this last chart is perhaps my favorite one. Here I’ve plotted the performance of each of our open positions since they were recommended (the green bars, labeled “Current Gain”). I’ve also plotted each position’s performance relative to the Russell 2000 Index (the blue bars, labeled “Performance vs. Russell 2000”). This latter measure shows how each position has performed relative to the Russell since the position’s recommendation date. For example, we have a current gain of 35% with MindBody (MB), and the stock has outperformed the Russell 2000 by 22.8% since I recommended it.

csc-performance 2-10-17

As you can see, all but two of our positions are showing positive gains, and all but four have outperformed the Russell since they were recommended. As one would expect, most of the underperformers are more recent recommendations. On average, each position is outperforming by around 10%. I think that’s good performance given the broader strength in small caps.

We had two positions report this week, MindBody (MB) and USA Technologies (USAT). I move USAT to Sell today after a 20% rally yesterday. And we have a few more stocks that announced earnings dates. Details below.

Airgain (AIRG) Shares dipped slightly over the past week but remain in their upward-trending channel. There are no fundamental updates to report. Earnings are due out next Thursday. BUY.
Announced earnings release date: February 16

Aspen Aerogels (ASPN) Shares continued their slide early in the week as the price of oil fell by $2. They firmed up just above their 50-day moving average line. Earnings will be out in two weeks and I don’t expect any major moves in the stock until that event, unless there is a meaningful press release. I continue to think the potential upside is greater than the potential downside in the near term so keeping at buy. BUY.
Announced earnings release date: February 23

Everbridge (EVBG) Shares enjoyed a bump yesterday as the broader tech sector moved higher. The trend here is still sideways, however. And it will likely continue on that course until earnings come out in just over two weeks. Recall that we’re expecting revenue growth in the neighborhood of 27% in Q4. The stock continues to trade at a discount to its high-growth software peers so if earnings are good, I expect to see a move back above 20. BUY.
Announced earnings release date: February 27

LeMaitre Vascular (LMAT) Health care and biotech stocks enjoyed a little boost over the past week and shares of LeMaitre are up in four of the last five sessions. Earnings are out in two weeks. HOLD HALF.
Estimated earnings release date: February 24

LogMeIn (LOGM) Trading volume has cooled off a little but is still higher than it was pre-merger. I expect we’ll settle at a new normal of around 500,000 to 800,000 shares traded daily. Note that LogMeIn now has a market cap of $5.8 billion, which means it’s officially no longer a small-cap stock. However, I’m more interested in the return potential now than the market cap size, so am continuing to recommend holding your remaining position. We’ll have a lot to talk about in three weeks when earnings are out. HOLD HALF.
Announced earnings release date: February 28

Marrone Bio (MBII) It was another quiet week for Marrone during which shares slipped down to 2.12. They’re just below their 50-day moving average line but still within their sideways trading channel. No specific earnings date has been released yet, but I estimate it will be around April 1. Marrone will be hosting a webinar with Western FarmPress on Thursday, February 23. I suspect it will be more about the market and products than financial information, which could be a refreshing big-picture take on Marrone’s opportunity. You can register for the webinar here. BUY.
Estimated earnings release date: April 1

MindBody (MB) MindBody reported Q4 2016 results this week highlighted by in-line revenue growth of 35.1% (to $38.2 million) and an EPS beat of $0.04 (a loss of $0.04). Management also provided Q1 2017 and full-year 2017 guidance implying revenue growth of roughly 31.5% and 30%, respectively, using the mid-point of guidance. It also achieved EBITDA profitability in the quarter, a full year ahead of schedule. In short, it accomplished what was expected, and said it will continue to do what we all thought it would! I noticed a number of analyst upgrades (to the 27 to 30 range) that appeared to be adjustments factoring in higher valuations that the market appears comfortable paying, as well as greater confidence that MindBody will be comfortably profitable in 2018 (it should deliver an EPS loss of around $0.10 in 2017 and a gain around $0.16 in 2018).
Management has talked in previous quarters of weeding out some low-value customers and it made that official by eliminating its lowest priced offering “Solo” on January 1, 2017. That had the effect of subtracting around 600 subscribers in Q4 (some of the more significant customers moved up to the “Starter” product for $75). But the company added 2,400 higher-value subscribers, for a net gain of 1,800. I think focusing on high-value customers is a good strategy. The business has matured to a point where it needs to focus attention on customers that generate a greater return through more transactions, and higher profit margin transactions (gross margin was 71.2% in Q4, up from 65.3% a year ago). To this end, management said redirecting sales staff to focus on selling more high-value fitness and salon/spa customers is paying off.
The company did suffer some revenue loss, as one of its largest API partners adjusted pricing by removing an unlimited bookings tier of service. I wonder if management is talking about an acquisition here since the company has over $80 million in cash (we don’t know who the partner is). It’s optimistic about the partnership with Google (Reserve with Google), which is now in pilot stage in three cities. Management said the partnership with Under Armour (MyFitnessPal) hasn’t borne fruit yet, and that long-term, Google is likely to be a more lucrative partner. An example of how this will work when it’s up and running is that a consumer will type into Google search something like, “Pilates in Boston,” and up will pop a number of studios. When the consumer gets to the point of wanting to look at available classes and clicks on those links, then the backend technology will switch over to running on MindBody’s technology, which will provide all the scheduling and booking functionality. Google will get a 10% marketing fee (I believe), which sounds like a good deal for the studios, from what MindBody has said. I think this has the potential to be a very significant partnership and it’s impressive that MindBody has scaled enough to have an entire API team working with programmers at Google to build this system. Apparently, Google’s near-term goal is to ensure that MindBody’s platform is robust enough to handle the traffic they hope to generate. That sounds like a significant partnership to me.
Management said something interesting about MindBody’s market opportunity. It sounds like only around half of the available “seats” in many fitness classes are booked. That’s like flying a half full plane around the country. One of the huge selling points for MindBody is that it can help fill the plane, so to speak. And it costs customers very little to get incremental business through MindBody. I think that moving forward, management will be talking more about “yield management” in the fitness/spa industry. Think about how Priceline and Expedia completely changed the bookings industry for hotels, flights, etc. That’s what MindBody is doing for fitness/spa/etc. It’s fundamentally changing the industry by building the technology to permit dynamic pricing. That’s powerful stuff.
Shares sold off yesterday after the report on more than three times normal volume. That suggests to me there could be some shuffling of institutional position size going on behind the scenes. I believe it will even out within a couple of weeks and shares will head higher. I’m not formally moving to Buy, but I would be tempted to pick up some shares on any weakness over the coming weeks. I think a few years from now, this stock will be significantly higher. HOLD.
Earnings: DONE

NanoString (NSTG) Shares continued their strong performance from last week and are now back above 19 and up in eight of their last 10 sessions. Even so, I’m keeping at Hold through the next earnings release. HOLD HALF.
Estimated earnings release date: March 1

Ooma (OOMA) The stock is still trying to push above 10 and is up in 13 of the last 16 sessions. It’s dirt-cheap on an enterprise-value-to-forward-revenue basis as compared to fast-growing software peers. That reality might be dawning on fund managers looking to add software exposure without having to pay the hefty premiums for stocks that have already run. I see at least 20% near-term upside. BUY.
Announced earnings release date: March 7

Primo Water (PRMW) The stock is finally taking a breather after a monster run to 15 from 12. That 25% move has us sitting on a better-than 70% paper gain. I moved it to Hold last week and am sticking with that rating today. While I love the stock long-term, there’s just too much potential for a dip here for me to be comfortable recommending you buy more. We’ll have our first earnings report out since the Glacier acquisition in early March. HOLD.
Estimated earnings release date: March 8

Q2 Holdings (QTWO) We were up to 33 two weeks ago, then down to 30 last week. This week, we’ve split the difference with shares closing yesterday around 31.80. I’ve said it many times but I’ll repeat it again: this stock’s trading pattern favors buying on the dips and holding on the rips (or even selling a little, if you’re a trader). You may recall that two weeks ago, I moved the stock to Hold, and last week, I moved it back to Buy. With earnings coming up next Wednesday and the stock only up modestly from last week’s close, I’m keeping at Buy for aggressive investors. If you’re more on the conservative side of the spectrum, I suggest just holding for now. It’s always impossible to know what will happen to a stock around an earnings release. BUY.
Announced earnings release date: February 15

USA Technologies (USAT) The stock fell over the last couple of weeks heading into the fiscal Q2 2017 earnings report, but it’s been on fire since! Shares rose 20% yesterday on high volume as the market digested the report. Revenue of $21.8 million (up 17.6%) and GAAP EPS of $0.01 (up from -$0.02) were slightly better than expected and gave management the confidence to set 2017 revenue guidance at $95 million to $100 million (representing 26% growth at the midpoint) and project non-GAAP profitability. To get there, management expects to add 115,000 to 125,000 net new connections, bringing total connections up to 544,000 to 554,000. That seems doable given that over the first two quarters, it’s generated $43.3 million in revenue, added 40,000 net new connections (it added 21,000 in Q2) and currently has 469,000 total connections (up 27% since this time last year). It also added 500 customers in Q2, bringing the total customer count to 11,900 (up 12%).

I’ve been concerned about profitability, and more specifically, profit growth that matches revenue growth. The company didn’t knock it out of the park this quarter, but they were back in the black. That’s a modest achievement. One of the things that helped get them there was lower than expected Selling, General and Administrative (SG&A) expenses, which came in at $5.8 million, down $1.1 million from the previous quarter. Decreased spending on professional services related to the first-time Sox audit was the reason, but management sees a bump up around $6.5 million per quarter for the rest of the year.

There was a lot of talk about license and transaction revenue (L&T) on the conference call. This revenue stream makes up 74% of total revenue (and was up 22%), with equipment sales (up 6%) making up the other 26%. Management said they are giving some pricing concessions on monthly fees and bumping up the charge per transaction with some customers. This is a negotiating tactic that helps remove some of the fixed cost for the customer (the monthly fees) and increases the variable costs (the transaction charges). I’m glad management was pressed on the topic because understanding pricing trends is so important. It sounds like the customers that get a “break” are the large ones that will process a lot of transactions and those that are making a very large commitment to USA Tech by rolling the company’s platform out to 100% of machines. Management also talked about other costs associated with their service, saying they’re constantly talking to credit card processors (Chase, MasterCard and Visa) about lowering fees (these are typically contracted rates that can be negotiated at the end of the contract) and that, over time, they’ll see a benefit as volume increases.

USA Tech also landed six Pepsi bottlers in North and South Carolina, which will result in 2,000 new connections. It sounds like they bought out all the ePort Interactive units USA Tech had (the company released these units after integrating the VendScreen acquisition) and filled the rest of the order with ePort G9 units. Management said it thinks the Interactive units will account for roughly 20% of new units going forward. It also said it thinks USA Tech only provides connections to 20% to 25% of its existing customers’ machines. That implies its customers operate over two million units, which suggests a lot of potential room for growth with its existing customer base.

The bottom line here is that revenue growth appears to be accelerating and management appears to be more cost conscious, both of which are good things. It’s unclear to me exactly how much leverage there is in the business model given that spending on SOX compliance seems to be so significant. Given management’s tone, it seems reasonable to expect EPS of between $0.01 and $0.05 this fiscal year (two more quarters to go), but I don’t know if that should go to a range of $0.03 to $0.07 in 2018 or more like $0.05 to $0.10. It all depends on the number of transactions, how well USA Tech is able to maintain pricing power and what it has to spend on professional services—and if any unexpected things come up.

Shares were up 20% yesterday so we’ve padded our gain. I had the stock at buy heading into earnings thinking there was potential for a move like this. But now that it’s moved above 4.60, I’m moving to Sell. The stock’s trading pattern since last fall suggests to me that there is a lack of confidence in the company. And I’m dubious that earnings growth will come close to matching revenue growth. Management didn’t give me anything specific to go on that suggests a major cost cutting or margin improvement initiative. I’ll keep the stock on my radar since I love the big picture idea of electronic payments in unassisted point-of-sale machines. But today, let’s take advantage of the USA Technologies’ surge to book a 30% plus gain. SELL.
Earnings: DONE
U.S. Concrete (USCR) Shares have moved from 70 back to their 50-day moving average line around 63.75 over the past two weeks. This is an entirely reasonable retreat, so keeping at Buy. BUY.
Estimated earnings release date: March 8