Immucor Inc. (BLUD)

June has been an exciting month for Immucor (BLUD). The company operates on a fiscal year ending May 31, so this month kicks off a new year and already the company has received FDA approval for its newest product that will drive revenue for the next several years.

The new product is called Echo and it is basically a smaller version of the company's flagship product Galileo. Both machines are used to test blood samples and are unique in that the process is fully automated, drastically reducing the human error effect which can be so dangerous in the high stakes medical testing market. While Galileo can run 60 to 70 tests per hour, the new Echo is only about to process about 16 per hour. This makes the machine only marketable to small to mid size labs, while the Galileo is typically installed in hospital labs with much higher volume.

The company has guided us to expect 250 orders for the Echo machine in the first 12 months after approval. They estimate the worldwide opportunity to be 6,000 instruments so the potential for this product could keep them busy for quite some time. Currently the company has manufacturing capacity to turn out a bit over 20 machines per month, but they are investing in additional capacity and expect to ramp up to 30-35 machines a month shortly.

Investors should expect a bit of a financial blip as the company begins selling Echo. Accounting standards have the firm booking the full cost of the machine when the order is completed, but the revenue stream is spread out over the next 5 years of useful life. Additionally, the company makes good margins on the reagents or consumable products that go with the machines. It is expected it will take a bit of time for the reagent orders to start pouring in as labs generally take a bit of time to get started using the new kits.

With all this excitement, one would expect the stock to be making new highs. In fact, the stock has been weak on some concerns popping up on the horizon. For starters, Bio Rad Labs (BIO) just announced they are purchasing a Swiss company (DiaMed) which also makes laboratory tests including blood kits. This could be seen as a potential shot across the bow and may impact some of the positive pricing power Immucor currently enjoys.

Another point of concern revolves around whether small labs will be quick to sign up for the new product. While it is clear the product is effective and efficient, there is a pretty significant investment needed to be made in order to acquire the machine as well as the time it takes to train staff to use it. Many smaller labs will likely choose to stick with what continues to work until it is clear they need to buy the new machine to keep up with technology.

Finally, the CFO resigned effective 8/31/07 and while there doesn't appear to be anything negative forcing this resignation, it always raises a red flag and if nothing else, will be distracting to executives as they fill the position and get the new person up and running. The stock is not trading at a valuation that discounts strong growth and if there is a hiccup in that growth trajectory, it will likely face a multiple contraction. I would avoid the stock at this point and I am considering taking a short position if the timing is right.

BLUD notes

FD: Author does not have a position in BLUD

Moody's Corp. (MCO)

It seems they create a new way to lose money every day. From options in the 80's to futures in the 90's to the proliferation of asset backed securities this decade, there are always new variations of investment vehicles to speculate on.

Moody's Corp. has risen with the tide as the premier ratings firm for many of the new issues being brought to investors. While the company does not have direct liability to the leveraged debt vehicles that have filled the news headlines lately, it does make much of its revenue by researching and rating these securities. In 2006, over half of MCO's revenue has come from global structured finance products which includes both residential and corporate Mortgage Backed Securities (MBS).

The global economy has been characterized by low interest rates in much of the developed world over the last 3-5 years. This has paved the way for corporations and individuals alike to take on new debt and increase leverage. This has been a definite positive for MCO as the securities are usually bundled by the originators and sold as packaged deals to investors. In order to get a good price for the debt obligations, originators hire Moody's or Standard & Poors (or both) to rate the debt and conduct due diligence on the structured product. So the low interest rate environment has benefited Moody's tremendously.

Another positive trend in the industry revolves around the Leveraged Buyout (LBO) boom. As private investment companies issue debt to finance new purchases, Moody's is called upon to research these deals as well. It is easy to see how MCO has been able to string together so many quarters of increasing sales and earnings.

While the macro picture has been rosy for quite some time, it now appears that Moody's will face more challenges than it has had to deal with recently. Interest rates have begun to push higher as inflation concerns stubbornly refuse to go away. This is making debt issuance less and less attractive both for corporations, and individuals (think about fewer people re-financing because of higher rates). Furthermore, we have seen less and less LBO activity in the last few weeks which may not be a trend yet but is definitely noticeable. Finally, since the company is having to look overseas more and more for growth potential, it is learning that price is of more importance to emerging market customers than to US customers who are interested in the blue chip name that Moody's has to offer.

Moody's hosted an analyst day at the beginning of the month and during that time modestly raised guidance for 2007. However, it seemed the tone was much more on dispelling rumors of economic trouble than outlining growth potential for the company. Shortly after the meeting, rates began ratcheting up higher and the Bear Stearns hedge fund crisis began. All of this has pushed the stock lower which should get chart readers attention as well as fundamental investors.

All of that is to say I am concerned with the prospects for this company. MCO is using free cash flow to buy back shares which should help boost EPS to some degree on an individual share basis, but I'm not sure if it is enough. With the company spending capital to expand and the global economy potentially hitting the brakes, it seems the risks outweigh the rewards at this time.

FD: Author does not have a position in MCO

Carmax (KMX)

Please see my original post on KMX from earlier this month...

Carmax reported yesterday morning and met most analysts expectations. Sales were $2.15b up 14% and comparable stores sold 6% more units than last year. Total unit sales were up 15% representing new store volumes as well. Net Income was up 15% but EPS was not up nearly as much (30cents versus 27) due to dilution from options exercised.

In regard to financing, the company said they continue to see stable credit availability both through CAF (Carmax Auto Finance) as well as through third party lenders. However, it was a bit alarming for me to hear that CAF delinquencies were higher but the company does not expect this to translate to higher losses. This way the company doesn't have to book any additional expense in "provisions for loan losses" which makes their numbers look a little better. Banks have been known to play with this particular accounting measure to make earnings look better.

New stores are on schedule with the company opening 3 new locations this quarter as well as an additional pure car buying store (for customers to bring in cars they want to sell). The company affirmed their goal to open 13 stores this year and it looks like the majority of these stores will be opened in the second half (November and February quarters)

Surprisingly, the stock is up today on the announcement. I'm never one to argue that the market is wrong so I had discipline and covered a part of my short position to manage risk. CSFB had an interesting report that contends the stock is experiencing a relief rally that includes a good bit of short covering (yes that would be me). They are still uncomfortable with the stock as it may not fully discount the danger of a potentially weakening consumer, and the effects of a more difficult financing environment. I continue to be short a smaller position but will not stick around if the stock continues to show strength.

updated KMX notes

FD: Author has short position in KMX

The Knot Inc. (KNOT)

It's June and the weather is shaping up, flowers are in full bloom, and wedding bells are ringing. This time of year usually brings good tidings to investors in KNOT as the second quarter often is the busiest for brides planning their wedding. The company's flagship website (www.theknot.com) helps brides plan for the big day with helpful articles, links to florists, photographers, and caterers; and other helpful content. Revenues for the company come primarily through its advertising partners who find the website to be frequented by motivated buyers in a very specific demographic.

Although its a key time of year for the company, executives are spending more time trying to control damage than lauding the company's great success. That is because many of the advertisers have recently pulled their business from KNOT or simply decided not to renew contracts. The problem stems from one of the other company's websites The Wedding Channel which has not lived up to promises the company made to advertisers. The problem caused concern for the customers many of whom have pulled back not only from wedding channel but also from theknot.com and other sites the company runs.

Analysts have touched on the issue recently saying the company is getting things back in line and expect ad revenues to pick up next year and bring the company back into growth status. Apparently investors are drinking the cool aid because the stock is trading at nearly 40 times expectations for 2008. Assuming the company is able to right the ship and earn $0.55 cents next year (62% above this year) there will still be an incredible premium on the shares. This seems a bit aggressive considering the barriers to entry are very low in this type of business - especially when you know the major potential customers are unhappy with the performance of the industry leader!

Traders may be tempted to think this is a good spot to add shares as the stock has dropped well over 30%. I would caution against this type of thinking as there is a firm reason why this drop has occurred. The stock was even more expensive at one time but that was because everyone believed the company had the potential to ramp earnings at these accelerated rates for the forseeable future. While I don't think the company is going to quit making money, I think investors who are pricing in a continued geometric earnings increase will be disappointed.

This recent rise to test the 50 day average may be just the chance holders of the stock need to turn out shares. If the stock drops below this level I would treat any holdings very carefully as it will probably send the last weak holders scurrying for the exits and invite short players to take another stab at the name. Remember, capital preservation is the name of the game so know the risk you are taking and have an exit plan if things don't turn out as you expected (long or short).

FD: Author has short position in KNOT

Quality Systems Inc (QSII)

Medical records have sparked some interesting debates in Washington. President Bush has announced a goal that every American would have a EMR (Electronic Medical Record) within 10 years. As lawmakers point out the virtues of doctors knowing which medicines a patient is taking to reduce errors and provide more accurate diagnostics, privacy advocates wonder how the information will be kept secure and who will have access to pull this information.

The business side of this issue has plenty of questions as well. Who will fit the bill when it comes to establishing such records? What type of equipment is necessary and how will doctors interface with such databases? And what incentives should be offered to private physicians to help get the ball rolling on implementation?

Quality Systems (QSII) provides technology and information solutions to small and mid size physicians groups and dental practices. The company has benefited from the increased publicity surrounding electronic records, but still the market is largely under-penetrated. It is estimated that only 25% of all practices have implemented or are in the process of implementing an EMR system. Small practices are especially difficult for QSII or competitors to sell to because they usually don't have a significant benefit from installing such systems and the time it takes to learn the process would take valuable time away from their patients. Thomas Wiesel speculates that government support for EMRs will have to pick up in order for adoption to accelerate.

QSII trades at a bit of a discount to peers in the same business. Some of this discount is due to the fact the company does not issue any guidance. It is hard to model what the future earnings will look like and because of that risk, investors demand a bit more premium hence the lower stock price. On the positive side, the company has a significant amount of cash and recently paid a special dividend to shareholders. It has no debt and just initiated a regular quarterly dividend of $0.25 which is roughly a 2.6% yield. Some speculate that the company would be in great financial shape to make an acquisition although the company states that their priority is organic growth. That growth could potentially stall if there is not sufficient encouragement from regulatory bodies for small practices to install such systems.

One issue that has pressured the stock relates to the CFO's trading of stock before an earnings announcement. The SEC has begun a formal investigation to see if there were any improper trades. The company is cooperating with the SEC but also stated that they have hired a third party law firm to look into the matter and after exhaustive research they did not find any improprieties. This matter will continue to be a damper on the stock until the SEC announces their findings.

Although I don't have a position at this time, I am thinking hard about selling stock short. I think the overall industry will be a bit stagnant as the presidential cycle is winding down and the competition in this area is fierce. Competitors include GE, SI, MCK and CERN. It may be worthwhile to put on a pairs trade going long CERN and short QSII to hedge against a broad move in the overall industry. One caveat is that if the SEC finds no problems with the insider trading, it will likely cause the stock to move up quickly and possibly shake out a short investor before likely trading back in line with the overall trend.





QSII notes

FD: Author does not have a position in QSII

Coach Inc. (COH)

I'm not a big shopper so this one may just be way out of my league. However, I'm concerned that COH may have begun to show signs of beginning to moderate. Yes I know they sell to the high end customer who is not as affected by economic troubles. Yes I know their guidance continues to point to higher EPS. I even know that most Wall Street analysts have it rated the equivalent of buy or strong buy.

In less than 12 months the stock has doubled from just over $25 to well over $50. That doesn't even touch the returns seen in 2002 through 2005 so the name shouldn't be new to anyone who traffics in growth stocks. The company has done a superb job of increasing its brand awareness both domestically and now abroad as it cements its strong foothold in Japan and looks toward China and the Middle East for further growth. The company now has something for everyone, as even measly middle class shoppers can get a handbag at one of the factory stores for less than $400. The company still makes an absurd margin on these cheaper bags and customers think they got a discount!

But has the company gone too far, too fast? With all these stores opening, one begins to wonder if its such a special thing to own a Coach handbag anymore. As middle class moms pass heiresses holding the same or similar purses on the sidewalk, I begin to think that the mystique could be wearing off. Celebrities may have to find a new way to spend their money that draws attention to their deep pockets and purses than buying.... purses.

So no, I don't think COH is going out of business anytime soon. I actually expect their sales to increase this quarter and for EPS to meet and maybe even exceed street expectations. But I would keep a close eye on margins to see if the company is still able to sell $1,200 bags that are available down the street for much less. I would look at their metric as to what percent of sales are from the category of $400 or more items and watch to see if the average revenue per transaction softens. The company may laud the fact that sales in the factory stores is up over 30% again but the skeptic in me would be wary that this is just another name for outlet sales that could not be sold at full retail price in the main stores.

I do have a short position in COH and it is on a short leash. I realized that I could be very early to this game and I don't want to hold it if we resume the pattern of hitting new highs, but at this point I believe the risks far outweigh the potential gains for owning this stock. If you own the stock, why not sell it and go use the cash to buy a nice leather bag?






FD: Author has short position in COH

Las Vegas Sands (LVS)

"Beep beep beep, Crash bang pound, cha-Ching!!" There is a lot of noise surrounding Las Vegas Sands as they ramp up building projects in Macau, Cotai, Las Vegas, Singapore, UK and possibly a few more I left out. Their financial statements also have more than their share of noise and take an extra cup of coffee or two to get through. It was well worth the extra joe, however, as I found some nuggets that haven't been explained by any analysts I have read so far.

The biggest concern that I found was the fact that although the company is sinking billions of dollars (that's with a "B"!) into developing the Sands Macau, a few years down the road, the company may not have anything to show for it. On page 35 of the annual report for 2006, the company mentions almost in passing that in 2022 the Macau government may exercise its redemption right. According to the company: "Unless our sub concession is extended, on that date, all of our casino operations and related equipment in Macao will be automatically transferred to the Macao government without compensation to us..." It gets worse. If the government so chooses, in 2017 the government may exercise their redemption right by paying LVS "fair compensation or indemnity."

I was talking with another fund manager who was very excited about LVS prospects. Much like Jordan Kahn this gentleman was bullish on LVS and excited about the strength in the overall sector. When i mentioned the property issue, his remark was "that's in 10 years - i don't care what happens 10 years from now." But any investor SHOULD care what happens 10 years from now because the market prices that in!

From a valuation standpoint, LVS is trading at 80 versus consensus earnings of 1.43 this year. Let's say the company beats and hits $1.50. That's still a 53x multiple! "OK Zach but think about future growth" The estimate for 2008 is $2.74 after most of the new casino's are open. That's STILL a 30x multiple over 2 years out! So if the stock grows 12% a year (which would be a big disappointment to the bulls) it will be just over $100. at that point it will trade at 36 times current earnings and the bulls will still be looking to growth to justify this high multiple. But wait - now the mountain ahead is getting closer - will Macau exercise this right? How do you discount that possibility? What about the $2.5 Billion it took to build the resort? These are questions that are relevant TODAY because they factor into the long-term discounted cash flows of the company.

Now i know that Sheldon Adelson is no dummy. He's probably got me 10x on smarts and a few more times than that on net worth (he owns 184 million shares - you do the math) but I think there are some concerns that have not yet been brought to the surface. This is an incredibly debt intensive operation. The company owes over $4 billion and will add another $2.5 billion to that. They are at the mercy of the Chinese government on some of their key products and I'm anxious to see what happens to the "former" socialist country when the Olympic spotlight is through shining. Interest rates and liquidity are at very favorable levels now but that tide may be changing. And if the consumer begins to have less gambling money this could backfire quickly.

As always, I'm staying diversified and not putting too many eggs in this one basket, but I'm anticipating a further decline and waiting patiently to see what happens between 2017 and 2022.



FD: The author has a short position in LVS

PS - I recently came across a great blog dealing with Macau and all the development in the vicinity. It's definitely worth a read.

Resmed (RMD)

Resmed is a medical device company that makes sleep aid machines. Many people suffer from sleep apnea that is caused by constriction of air flow inhibiting breathing. This can have serious side effects if left untreated for a long time and RMD is one of the few companies addressing this need. According to the company’s quarterly report, the global market for sleep aid services is $2 billion and growing, yet this market has been less than 10% penetrated leaving ample room for growth.

The company competes primarily with Respronics Inc (RESP) and both companies have similar size as defined by market cap. RESP has recently gained market share by severely cutting prices on its masks and it is assumed that they lost money on each unit sold but were willing to do this to gain more inroads with doctors who prescribe these units for patients. Although one could consider the market a duopoly, there is intense competition right now which is having an effect on the profitability of each company.

RMD has run into some rocky ground as of late partially due to the fact that they found some of their units had a defect that could cause the machine power supply to overheat with the potential of a fire. A recall followed this discovery which is costing the company an estimated $60 million dollars (without the recall, the company would have made $42m pre-tax). The company is trying to make the best of this recall by highlighting their commitment to consumer safety, but this will likely drive more customers and physicians to try competitors products.

I am concerned that this stock trading at a 30 multiple is likely to lose its “growth” designation as sales growth seems to be easing and earnings are contracting even without the recall situation. While I applaud the company for spending significant amounts on R&D to beef up their product offering, that spending is eating into profits and in a severely competitive market, margins could contract to make it more difficult to spend as much on this development. If growth investors begin to get tired of this name or simply choose to focus more on RESP, the multiple on the stock could drop to 20 very easily which would mean prices south of $35.00.

A key data point will be next quarters earnings announcement. Analysts and investors will be listening to hear if margins are picking back up, if the recall is going to cost less than expected, and if there are any new products that will stimulate more demand. If all 3 of these points are not addressed I think you will see the stock slip quickly. I currently hold a short position in our fund and would caution investors to tread with caution in this name until more of these questions are answered.

RMD notes

Under Armor (UA)

If you're not familiar with Under Armor you may not get out much... Or maybe you're just not into sports. The company has done an incredible job building its brand recognition. Its apparel products feature synthetic material that wicks sweat away from the body keeping the athlete's body temperature better regulated both in heat or cool temperatures. The brand name is developing a cultish following from both active athletic individuals as well as people who just want to wear the latest hip styles.

The company has been public for less than a year and the stock has done remarkably well. Of course it helps to have sales growth above 40% for each of the last 5 quarters and earnings that constantly come in above last year's levels. Management has set long-term expectations for revenue to grow 20% annually and earnings to expand 25%.

Marketing is an important part of any consumer driven business and UA spends plenty of talent and money in this area. Prize athletes have been signed to exclusively wear UA product and these endorsements are often quite pricey. The official guidance is that marketing should comprise 10-12% of revenue but Q2 is expected to exceed this level. The higher marketing is likely due to the new line of cleated footwear that will be touted for baseball season after finishing a relatively successful launch of its football cleats this past fall. Footwear has lower margins but management is excited about this new endeavor as it helps to ramp sales in a new area less correlated with their typical apparel sales. The company has announced that they will launch non-cleated footwear in 2008.

Nearly 80% of revenue is derived from wholesale channels as the company sells to established retail institutions who mark up the product for the end users. The Sports Authority and Dicks Sporting goods together comprise 37% of revenue. A disruption in either of these relationship would be extremely disruptive to UA. Expansion into Europe has begun with the opening of an office in Amsterdam, and the company believes there is ample opportunity to grow overseas.

While i fully respect the company, its growth, and it's products; there are a few issues that have me concerned. The first revolves around the apparel that the company has based its image off of. This fancy material is not patented and to my understanding, it is completely possible and probable that another competitor can make a product with all the same characteristics (without the trendy UA logo of course) and sell it at prices that compete directly with UA. Trends come and go, and UA cannot expect its popularity to remain forever without true product differentiation.

The second issue is the value of the stock. If the company beats expectations this year and earns $1.00 the stock is trading at a 48x multiple of forward earnings. If the company REALLY beats next years estimates and comes in at $1.50, the stock is still trading at over 30x 2008 earnings. Now it is foolish to short a stock just because of a high multiple, but some chinks are starting to show in the armor (pardon the pun - yes that was bad).

When the company announced earnings this quarter, the stock gapped down and traded lower for a full 2 weeks. This was after failing to break to a new high earlier in April. Since then the stock has traded up to just below the 50 day line and has seen resistance in this area twice. I believe at this point the odds are stacked against the stock and any bad news (and possibly good news that isn't good enough) will lead to a significant selloff. I would be cautious holding any long positions as the momentum appears to be broken and the stock definitely isn't at a point where value players are interested in taking a look.



UA notes

Carmax (KMX)

Carmax is in the business of selling used vehicles... Lots of used vehicles. In FY 2008 (ends Feb 28) the company sold over 1/2 million cars; 337k through their retail stores and 209k through their wholesale auction process. The company had record earnings of $0.92 per share and showed increasing margins.

The primary business for Carmax is selling used cars through their large retail stores. The process is much like buying a big screen TV from Best Buy. Prices are clearly marked taking the guess work and haggling out of the picture. The company prides itself on its customer service, making the car buying experience easy and enjoyable for their customers.

The gross margins is very similar on all their vehicles. This aligns the company's interest in moving product and best meeting customers needs instead of pushing individual vehicles that are high in profit but may not suit a specific customer. Most vehicles are bought directly from the public as Carmax guarantees they will buy any car regardless of its age or condition. Cars are then inspected and if they do not meet KMX standards, they are sold via a wholesale auction to other dealers. This way KMX can keep their brand name clean by selling quality cars while still offering this valuable service to customers who want to get rid of their old cars.

The company has some interesting accounting processes that have me a bit concerned. They have a fully owned special purpose entity (Carmax Auto Finance - or CAF) that securitizes their loans to their buyers but is supposed to be separate from the overall company if this credit facility were to go bankrupt. I'm not a lawyer, but i have questions as to how KMX would be affected if this entity were to get in trouble. Some analysts I have followed are worried that even if KMX does not have liability, any problems at CAF could detract from the company being able to find financing for customers who need loans to buy. Another analyst mused that KMX may have to increase their loss assumptions which would be detrimental to next quarters earnings.

A second issue that had me concerned was a poison pill i found in reading the fine print of the annual report. Basically if the company is purchased by a 3rd party, convertible stock will be automatically be issued to executives (if i read it right) diluting the overall stock. In today's market buoyed by takeout firms and private equity, this takes KMX out of that game and mandates a lower multiple than a comparable company fully available for sale at the shareholders discretion.

The stock has begun to reflect some of these concerns as well as the potential for a weakening consumer. While not expensive, the stock isn't trading at a cheap multiple either, and should the risk become more obvious, shareholders will be more likely to demand a higher expected return for taking that risk (thus pushing current prices lower). I would avoid KMX for now and in our fund, I have taken a short position expecting some of these fears to be realized in the market within the next few months.



KMX notes