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Small-Cap Confidential
Undiscovered stocks that can make you rich

Cabot Small Cap Confidential 219

Today’s recommendation is a small company, and there are no analysts following the stock. But it has big clients for which its products are absolutely critical. The stock has been on a wild ride this week. I have a hunch I know why, and we’re going to step in and to try and grab shares at a discount, starting with half a position.

Cabot Small Cap Confidential 219

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THE BIG IDEA

July 31, 2017: Anthem, the second-largest U.S. health insurance company, says a partner exposed health information data for over 18,000 Medicare enrollees. Just one month earlier, it agreed to a $115 million settlement related to a 2015 data breach. Hackers gained access to 80 million customer accounts, including names, Social Security numbers, employment information and income data.

July 27, 2017: HBO executives learn company networks were breached in a cyberattack targeting 1.5 terabytes of data and content, including episodes of Game of Thrones, Ballers, Insecure and Room 104.

February 29, 2016: The IRS says the data breach it announced in 2015 was worse than feared by a factor of seven. Over 700,000 American taxpayers had their information hacked, most likely by Russia-based hackers.

September 22, 2016: Yahoo! announces an unbelievable 500 million accounts were hacked in 2014 by overseas operators. Three months later, the company upgraded the number to one billion accounts.

November 2015: JP Morgan Chase and 14 other financial institutions reported the largest theft of customer data in U.S. financial institution history. Over 100 million customers had personal information stolen as hackers tried to manipulate stocks and access payment-processing apps.

These are just a few of the major data breaches over the past three years; there are too many to count. Comcast, Hilton Worldwide, TD Ameritrade, T-Mobile, Verizon, United Airlines, CVS, the U.S. Department of Justice, LinkedIn, Oracle, Dropbox … the list goes on and on.

Last year, reported data breaches increased by 40%. So far in 2017, the trend is toward more varied attacks, including malicious mobile and social media, malicious URLs, display name spoofing and text message phishing.

As consumers, we know we must to be careful with our data. But we don’t have ultimate control since a lot of it resides in corporate and government databases. Keeping it secure is a massive challenge for these entities, especially given the phenomenal growth in internet use, e-commerce and cloud computing.

An insane amount of data is moving around the world on a nearly continuous basis. If you could peer into an ethernet cable at any given second and read the data flow, you’d be able to read digital health records, stock market transactions, payroll information, retail point of sale data and government records, not to mention trade secrets, patents and even multimillion dollar blockbuster films.

Remember a couple of months ago when Disney CEO Bob Igor revealed that hackers got their hands on Pirates of the Caribbean: Dead Men Tell No Tales? They were threatening to release it if not paid a ransom in Bitcoin! That was crazy. But the latest HBO hack is even crazier in that it was bigger, came in through multiple points, and no ransom has been requested.

Businesses face an immense data security challenge. They need to transfer data securely, all around the world, on schedules of their own choosing, over both public and private networks, and into and out of a huge variety of cloud-based apps. The fact that a lot of data is sent to customers, suppliers, partners, employees and regulators, each with their own preferences, makes it even more complicated.

What can companies do to maintain the security of data at rest? What about data in motion? How do they adjust on the fly, and move away from the jumble of homegrown and legacy systems that are often the backbone of their IT environments? These systems weren’t designed for today’s data needs, let alone tomorrow’s!

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The answer sounds simple enough. Companies need managed file transfer (MFT) solutions that are designed for the modern, cloud-based internet. MFT software helps organizations protect their data, meet regulatory requirements for managing and transferring sensitive data, and overcome software integration roadblocks. User-friendly web interfaces also help companies maintain oversight, control and reporting of the data transfer process.

MFT solutions are not glamorous to talk about. Nobody’s going to hang out with you if you bring them up at a cocktail party (except for the software engineers). But MFT solutions are essential, especially for today’s regulated companies. They are always there, running in the background, out of sight and out of mind, except to IT departments, and a few very well-informed investors.

Managed File Transfer is a must-have technology in a world where a big data can often lead to financial and reputational ruin. Today’s Cabot Small-Cap Confidential Candidate specializes in MFT solutions. Despite its small size, it’s a leader in the industry. And it’s in the early stages of launching new products to capitalize on MFT opportunities arising from a cloud-enabled world.


THE COMPANY/PRODUCT


Globalscape is a $96 million market-cap company that sells software to help businesses and consumers exchange, transfer and share important data securely. The industry term for this market is managed file transfer (MFT), which Gartner estimates to be a $700 million market, with potential to double over the next three years. Globalscape has developed a brand name platform that it calls Enhanced File Transfer (EFT), which it sells primarily to large and mid-sized business with extremely high data privacy and confidentiality needs. The company has over 13,000 customers around the world, and has won numerous awards over the years. It’s located in San Antonio, Texas, and has been in business for over two decades.

The MFT market sprang up quickly as internet use exploded in the 1990s. It became a more robust version of what was previously known as the file transfer protocol (FTP), which set early standards for transmitting data over networks. Pioneers in MFT realized that enterprises needed extremely robust security, auditing, reporting and performance-monitoring capabilities when sending confidential information beyond their protected IT borders. Globalscape was in the mix, initially debuting a consumer-oriented solution it called CuteFTP, which has sold over a million copies, and is still available today (though much improved from its original version).

Many of Globalscape’s customers are strictly regulated and/or governed by legislation, including the Health Insurance Portability and Accountability Act (HIPPA), the Federal Trade Commission Red Flags Rules, the Gramm-Leach-Bliley Act (GLBA) and the European Union Data Privacy Directive. In other cases, industry best practices, such as the Payment Card Industry Data Security Standard (PCI DSS), drive businesses toward Globalscape’s EFT platform.

The company has been a consistent revenue grower, and has been profitable in seven of the last eight years. Revenue growth isn’t as fast as many of our covered companies, but that’s one of the reasons I like Globalscape now. It’s growing revenue by around 11% annually, generates annual EPS of around $0.20, and even pays a dividend (just over 1% annual yield). The stock can be a bit volatile, but the long-term trend is undoubtedly up. I believe it’s a rare opportunity to invest in a financially stable micro-cap company that will increase its growth rate through new strategic initiatives (which we’ll discuss in some detail in a minute).

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Electronic File Transfer: The Solution to a Global Data Problem

Globalscape’s EFT platform gives its clients a number of ways to protect proprietary information, intellectual property, trade secrets and consumer data. The platform also reduces the risk of potentially devastating reputational risk associated with security breaches. In short, Globalscape’s EFT Platform makes sure that the right people have access to the right data, in the right format, in the right place and at the right time, and that they go through the proper security clearances to get it.

Enhanced File Transfer (EFT)

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Enhanced File Transfer, or EFT for short, is the brand name of GlobalScape’s award-winning platform, and accounts for the vast majority of product sales. It provides enterprise-level security so that users can securely send data in any type of file, of any size, and in any configuration to their business partners, customers and employees, all over the world. The product is often used to transmit financial data, medical records, transaction activity and customer, vendor and personnel files within and between network infrastructures. In addition to working on any type of device (laptop, mobile, server, smartphone, etc.), it also provides administrative tools so users can manage, monitor and report on file transfer activities. Customers frequently purchase it to replace insecure legacy systems and homebuilt server environments.

Major selling points of EFT include information privacy, data replication, continuous backup and recovery, accelerated file transfer, sharing and collaboration tools, and the ability to efficiently track and audit transactions. EFT is offered in either an on-premise or subscription (cloud) basis, and in configurations for small businesses (called EFT SMB) and larger enterprises (called EFT Enterprise).

Kenetix (New in 2017!) – Integration Platform as a Service (iPaaS)

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Kinetix is Globalscape’s newest offering, and its most significant product launch since EFT was launched in the middle of 2014. The product was designed to address the growing need for companies to quickly and securely integrate data across different cloud-based platforms (Salesforce, Marketo, Basecamp, etc.), Internet of Things (IoT) devices, and third-party app interfaces. Kenetix helps Globalscape’s clients maintain security, reliability, transparency and control over all the data floating around these disparate solutions. Pricing starts around $900 per month.

The platform is a natural extension of Globalscape’s EFT platform since it makes it much easier to securely integrate apps, share data and automate business processes. And since it uses a drag and drop interface, an enterprise’s IT department isn’t called on to do a lot of heavy lifting—the average worker can connect apps ranging from social media, to mobile, to IoT and to ERP systems themselves. Globalscape says simple integrations can be done in mere minutes, while extremely complex integrations can happen in as little as two weeks. As with the rest of the company’s solutions, security, data logs, reporting, and multi-user support are top priorities. And the solution can be purchased as either a cloud-based or on-premise solution.

Mail Express

Mail Express is currently a stand-alone solution installed in a client-server environment, and allows users to send and receive secure, encrypted e-mail and attachments of almost unlimited size. It has won awards, and will soon be integrated into GlobalScape’s EFT platform.

Wide Area File Services (WAFS)

WAFS is a software solution for synchronizing data within a wide area network or local area network. It helps employees collaborate on complex files and access them from anywhere. It brings in a little cash flow, but probably won’t be around for too many more years.

CuteFTP

CuteFTP was Globalscape’s first product back in 1996, and it’s still a recognized brand in the marketplace. It’s a consumer and small business-oriented file transfer program that offers simple and secure file transfer in a more sophisticated product than free options currently on the market. Cost ranges from $40 (Mac OS) to $60 (Windows). The company will continue to sell it (but do little to change it) until market demand peters out.

Professional Services, Maintenance & Support (M&S)

Like most software companies, GlobalScape provides Professional Services, Maintenance & Support (M&S) to customers who have purchased on-premise and SaaS solutions. Typical Professional Services are product customization, system integration, education and training. M&S is provided on a contract basis, and covers technical support via email and phone. Most customers purchase M&S contracts annually, and pay around 20% to 30% of the software license.

Leading Global Brands Select Globalscape

Companies around the world are realizing that they need more than a basic MFT solution to facilitate secure data transfer, and stay off the front page of Data Breach Weekly! Sure, they can go out and get a really cheap, or even free, MFT solution with basic security, monitoring and reporting functionality. But do you think J.P. Morgan Chase, RBS, Novartis, Thomson Reuters, Fox and PayPal really want to try and slide by with a bare bones data security solution?

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Here are a few specific examples of customers that are succeeding with Globalscape:

The Centers for Medicare & Medicaid Services: In the first quarter of 2017, the organization within the U.S. Department of Health and Human Services that administers the Medicare and Medicaid programs selected Globalscape.

Blue Cross Blue Shield subsidiary: Also in Q1 2017, one of the largest BCBS subsidiaries that delivers healthcare services and long-term care insurance across the U.S. elected to go with Globalscape’s EFT solution.

Dealertrack Holdings: Dealertrack is a subsidiary of Cox Automotive and handles electronic document transfer for vehicle titles and loan originations. The company recently integrated Globalscape’s technology into its Digital Document Services solution.

U.S. Army: The Army has been a Globalscape customer for over a decade. Its Standard Army Management Information System (STAMIS) relies on Globalscape’s EFT platform, which ensure safe delivery of mission-critical logistics and maintenance data around the world.

Plotting a New Course: Globalscape’s Three-Pronged Growth Strategy

In May of 2016, Globalscape embarked on a new strategic path. The company wanted to accelerate growth and better address the needs of its customers in an IT world increasingly dominated by cloud computing. And it felt some new blood would help it do so.

The first thing it did was promote its Chief Operating Officer, Matt Goulet (who joined the company in 2013), to become the new President and CEO. The second thing was to promote Daniel Burke (an Enterprise Sales Manager since 2013) to VP of Worldwide Sales, and Adam Snider (a VP of Sales since 2008) to VP of Operations.

The team began hammering out their vision of the future, which they planned to reveal on the year-end conference call. Prior to that event, two men who helped capitalize Globalscape in 2002 sold a sizable portion of their holdings (around 15% of shares outstanding) to a Dallas, Texas-based institutional investor, 210 Capital, LLC. Along with the management shake-up, that transaction helped to change the leadership of the company and, in my opinion, helped illustrate the future growth potential. Otherwise, why would 210 Capital make its biggest investment ever?

On its Q4 2016 conference call, Globalscape’s management team revealed a three-pronged growth strategy. The existence of a strategy doesn’t guarantee success, but I love it when companies communicate with investors this way because it gives everybody something tangible to focus on. And it gives us a way to assess progress toward goals that, if they weren’t written down, could easily fade into the background as day-to-day activities take over.

How is Globalscape doing? It’s been a little over a year since the management shake-up, and a few months since the team began communicating its growth strategy with the market. But so far, so good. Here are the three components of the growth strategy Globalscape laid out, and what the company has done recently on each initiative.

Strategy #1: Accelerate organic growth

Globalscape believes it can accelerate organic growth by enhancing and leveraging its EFT platform. One initiative was to begin offering cloud-based solutions in addition to its on-premise solutions. This should widen the net of companies that can benefit from its technology, including smaller businesses, which have a lower price point than most current customers. Additional initiatives were to launch a customer experience program (to help incorporate feedback in new and existing products), launch a new website (focused on organic lead generation), launch a new account-based marketing strategy, and direct more resources to cultivate relationships with value-added reseller (VAR) partners. While performance metrics for these types of “soft” initiatives are hard to value, Globalscape said leads in Q1 2017 were up 150%.

Strategy #2: Expand Strategic partnerships

Expanding strategic partnerships is really a sub-category of Strategy #1, but it’s helpful to break it out since each sizeable relationship can add material results to Globalscape’s top and bottom lines. These are the major tech players the company has cultivated relationships with lately.

Microsoft (MSFT) Azure: To be a player in the age of cloud computing, your software must run on the major platforms. Globalscape’s EFT solution is Azure-certified and became available in the Azure Marketplace last year. This means organizations that are moving their data from on-premise to the cloud can use EFT to begin securely transferring data within minutes. And they can pay for it on a subscription basis.

Amazon (AMZN) Web Services: Globalscape EFT became available in the Amazon Web Service (AWS) Marketplace last October.

Hewlett Packard Enterprise (HPE): Globalscape joined the HPE Partner Ready program last November. This March, to meet the growing need to manage corporate data, Globalscape and HPE began to offer midsized businesses the Unified Communications Backup Appliance, which consists of a HPE ProLiant Server deployed with Globalscape’s EFT solution. The combination gives a previously overlooked market segment a solution to implement a secure file transfer and compliance solution, without the need for expensive IT support.

Cisco (CSCO): Globalscape is a preferred solution provider in the Cisco Partner Ecosystem. In March, the company announced that its EFT solution achieved its second Cisco Compatibility Certification. The certification stamps EFT as a reliable technology to securely backup and transfer Cisco call log and voicemail data.

Strategy #3: Develop and Acquire Technologies

Another subset of Strategy #1 is to develop and acquire technologies that broaden Globalscape’s product offerings and reach into markets that are complementary to its EFT focus. These include products to help customers in the areas of data movement, data integration and data security.

Kinetix: As I mentioned above, Kinetix is Globalscape’s newest offering. It was just released on June 27, 2017. I won’t repeat what I’ve already said about it. Suffice it to say, the management team (and investors) have high expectations for the product.

EFT Insight: Globalscape’s current customer roster is tilted toward large, enterprise customers. But the company sees a lot of opportunity with underserved, mid-market businesses. That’s led to the development of EFT Insight, an analytics solution that allows companies to examine patterns in the data that flow into and out of their organizations. The solution was developed in concert with customers, and was released in early June. It will help companies investigate issues with their data by drilling down through the data, monitor server health, generate reports and comply with security and service level agreements (SLAs).

The Business Model

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Globalscape sells software and related services primarily to large businesses in regulated industries. Maintenance, support and professional services (see quarterly revenue breakdown chart) contribute over 60% of total revenue, and represent recurring revenue streams. License revenues make up the rest. Subscription revenue isn’t yet broken out so we don’t know how material this source is (I expect it will be broken out within a few quarters). The company’s retention rate is over 90%, which is very good. There is some seasonality in the business, with the first quarter typically the slowest, and momentum growing throughout the year.

The company sells through internal sales teams and third-party resellers. Resellers (including industry leader CDW Corporation) brought in 38% of revenue in 2016. Just under a quarter of sales come from outside the U.S. Globalscape is just beginning to offer more cloud-based solutions that are sold on a subscription (SaaS) basis (Kenetix, and a cloud version of its EFT solution). As the SaaS business grows, the business model will evolve. I’ll talk more about the business model transition over time in my Weekly Updates.

The Bottom Line

Globalscape has been a consistent revenue grower (average of 11% over the last seven years) and consistently profitable (average EPS of $0.17 over last four years). Revenue growth in 2016 was a little light at 9% (to $33.4 million), which was a deceleration from 15% in 2015. Recall that in the middle of 2016, the company made the strategic decision to refocus on its core EFT products, and that led to some improvement in the back half of the year. This year got off to a good start with revenue in Q1 2017 up 12% to a new record of $8.3 million. EPS of $0.18 in 2016 was down from EPS of $0.21 in 2015, mainly due to some R&D credit dynamics resulting in a higher effective tax rate. But again, Q1 2017 was a good start to the year with EPS of $0.03 up from $0.02. Cloud solutions sales were up 36% in 2016.

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Given Globalscape’s increased focus on expanding its ETF platform, it wasn’t surprising that ETF platform products (which exclude Mail Express, WAFS and CuteFTP) made up 95% of revenue in Q1 2017 (up from 92%). All in, EFT platform revenue was up 16.2%. The company has no debt, and has $13.2 million in cash.

The company doesn’t provide guidance, and there is virtually no analyst coverage. That means we don’t get much help forecasting revenue and EPS growth. At this stage, I’m conservatively assuming the company grows annual revenue by its historical rate (around 11% annually), which implies revenue will hit $37 million this year and $41.2 million in 2018. Let’s assume annual EPS in 2017 is around $0.20, but recognize that R&D costs, tax rate changes, etc. could easily make it far higher or lower. I expect to update this guidance once we hear how Globalscape did in Q2 2017.


RISK


Thinly Traded Micro Cap Stock: Globalscape has a market cap of around $100 million and is relatively thinly traded. This means the share price could swing wildly at times for reasons we don’t fully understand (as it has over the last couple of days). Catalysts leading to erratic trading could range from one shareholder increasing or decreasing his position, to a client reporting a security breach. Most of this news won’t hit the wires, and there is little to no analyst coverage. Bottom line: it’s not a stock for the faint of heart.

Transition to cloud-based solutions: Software is moving away from on-premise licenses and toward cloud-based SaaS solutions in most markets, and MFT is no different. As Globalscapes goes down this path, it needs to manage everything from pricing to customer service to software development resources very carefully. The transition to a new business model is a long-term positive, but investors must be aware that there will be changes that will affect quarterly and annual trends in revenue and EPS. The end result should be more customers, and a more stable revenue base. But in the early stages of the transition, we often see revenue decline as some on-premise licenses transition to subscriptions at a lower initial price point (they wind up being greater over time). I’ll update you to trends over time.

Reliance on third-party resellers: Last year, 38% of revenue came through distributors and resellers, and 14% of revenue came through Globalscape’s largest third-party reseller (which I believe is CDW Corp.). The company says it could replace this partner should the relationship deteriorate (no signs of that now), but it would probably take a few quarters.

Reliance on EFT licenses: Most of Globalscape’s revenue comes from sales of its EFT solutions and related services (93% in 2016). This isn’t necessarily a bad thing, but it means investors should realize that this is a pure-play EFT company. Its future success will rise and fall depending on how well it executes in this market.

Additional Reliance on Maintenance and Support (M&S) revenue: Though it’s transitioning to cloud-based solutions, Globalscape is still primarily selling on-premise solutions. That means it generates a lot of maintenance and support (M&S) revenue (56% of total revenue last year) as each on-premise client pays an annual fee. Clients aren’t obligated to pay for M&S (though most do), so a decrease in M&S revenue could be a sign that the business isn’t doing well.

Lumpy sales: Globalscape has very little control on the purchasing timeline of its customers. Sales often come in toward the end of a quarter. Until a greater percentage of sales are sold on a subscription basis, the company will remain exposed to customer purchasing timelines.


COMPETITION


Globalscape has a lot of competition in the managed file transfer software market, though each of its solutions has competitive advantages over the competition. Its small business and enterprise EFT products compete with solutions from IBM, Ipswitch, Axway, Linoma, Serv-U and JSCAPE. Its cloud-based EFT software primarily competes with Ipswitch, IBM and Accellion. Its consumer-oriented CuteFTP solution competes with file transfer solutions sold by Ipswitch, Serv-U and Van Dyke Software. WAFS competes with Panzura and Peer Synch. Mail Express competes with Leapfile, Zix and Biscom.


THE STOCK


Trading Volume: Globalscape has a market cap of $95 million and trades an average of 55,000 shares daily, which works out to between $250,000 and $300,000 worth. Our subscriber group can move this stock. Thus, you should average into your position, use limit buy orders, and spread your buy prices out (including a number that are well below the current share price) to help moderate the impact of new buy orders hitting the market all at once.

Historical Price: GSB has been public since 2002, and after a few years of little movement, participated in the 2006 to 2008 rally by soaring ever-so-briefly to 7. Shares fell apart when the recession hit and were at 0.46 in early 2009. By early 2013, GSB was trading at 1.2. The trend since then has been more consistent, and over the last four years, the stock is up over 200%. While there have been a few erratic spikes, the stock has traded mostly near its 50-day line. An extended consolidation period occurred in 2016, when shares repeatedly bounced between 3.14 and 4.2. Volatility cooled significantly in spring 2017, and momentum began to build following the Q1 earnings report in April. GSB broke out into a fresh trading range above 4.1 in late May, and migrated to a 52-week high of 5.51 in the second week of July. It dropped to 4.9 two weeks ago (right to its 50-day line) and was consolidating above that trend line until Thursday. Then shares broke through their 50-day line and fell over 10% to close near 4.5. Action was volatile on Thursday as well, with the stock dipping to near its 200-day moving average. We don’t know why shares dropped so much on Wednesday, but I believe news of the HBO breach could have driven some stock sales (Time Warner is a client, but we don’t know details of how it uses GSB’s software). Once GSB broke its 50-day line, that could have triggered a number of limit sell orders. Based on the stock stabilizing on Thursday, it looks like this drop should be short-lived. Though, to be perfectly clear, there could be other reasons for the volatility that aren’t yet public.

Valuation and Projected Price Target: Valuing microcaps is always a squirrely proposition. But GSB has been around for a while, is a consistent revenue grower, is consistently profitable, and pays a dividend. That level of stability is rare in a company this small. Early this week, the stock traded at 2017 and 2018 EV/Sales multiples of 2.7 and 2.4, respectively, assuming revenue growth averages 11% over the next two years (the three-year average rate). That seems low to me. I think a target EV/Sales multiple of 4.0 is more appropriate. It’s not a super aggressive valuation since GSB lacks the rapid revenue growth and high percentage of SaaS revenue of “the best” cloud vendors. But that target valuation factors in continued, modest growth on both the top and bottom line. The implied target price of 8 is 50% to 70% above where it was earlier this week, and almost 80% above where it is now.

Buy Range (next two months): My wide preferred buy range is between 4.2 and 6. That allows roughly 20% to the upside and downside from where shares traded before Wednesday’s drop. The lower end of the range is bound by the 200-day line (currently at 4.18). A narrower range of 4.5 to 5.5 is the most likely buy range over the next week or so (depending upon when earnings are announced, what the reaction is, and if anything concrete emerges to explain the recent volatility). This narrow range is bound by a support zone established in late May, and the 52-week high struck on July 17. Given that we don’t 100% know why shares dropped on Wednesday, I strongly suggest averaging in to your position. For purposes of our portfolio tracking, my initial rating will be to buy half a position. BUY HALF A POSITION.

The Next Event: Management should be announcing Q2 2017 results within the next couple of weeks.

Globalscape (GSB) Financials

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Globalscape (GSB 4.50)
4500 Lockhill Selma Road
San Antonio, TX 78249
www.globalscape.com

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UPDATES ON CURRENT RECOMMENDATIONS


Due to the nature of the stocks recommended, it is to your advantage not to share these recommendations.

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Strong Buy means the stock should be bought immediately and is expected to move sharply higher in the very near future.
Buy means accumulate shares at or around the current price.
Hold means just that; hold what you have. Don’t buy, or sell, shares.
Sell means the original reasons for buying the stock no longer apply, and I recommend exiting the position.
Sell a Half means it’s time to take partial profits. Sell half (or whatever portion feels right to you) to lock in a gain, and hold on to the rest until another ratings change is issued.

The Dow is cranking and the S&P 500 is holding up just fine, but the Nasdaq and S&P 600 Small Cap Index are both under a little pressure. Small caps pulled back to their 50-day line this week, as this one-year chart shows.

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Tech stocks were particularly weak since I last wrote, and I noticed some big names that jumped on earnings gave back most, if not all, of their gains; Microsoft (MSFT) and Shopify (SHOP) in the large and mid-cap asset classes are two examples. And we saw a similar situation play out with our position LogMeIn (LOGM).

The takeaway from this action is that it looks to me like money is continuing to exit tech stocks and migrate elsewhere. I don’t think tech is done for, but I do think it makes sense to lower our expectations for a while after such a phenomenal run. Buying opportunities might start to come our way, so keep your eyes open!

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We had three positions report earnings this week, so let’s jump right into updates. And next week, we’ll have five more, with many reporting on Monday and Tuesday. I’ll send out Special Bulletins detailing the reports. Buckle in!

Updates

Airgain (AIRG) is floundering and Monday can’t come soon enough. We need a catalyst here, and earnings should provide one. At least it will give us an indication if I’m right in thinking the fundamentals are good, the recent acquisition is far from priced in, and shares have a ton of upside potential. Hopefully, we don’t learn that the market for Airgain’s stock actually is efficient and nobody wants to buy the stock right now. It will be an interesting day, and I’ll send you an update once the report is in and I’ve reviewed the results. I’m keeping at Buy since I think the downside is limited. BUY.
Announced earnings date: August 7

AppFolio (APPF) develops cloud-based software for property management firms and small law offices. The stock has been doing very well in this market, despite pulling back a little from its 52-week high (36.53) from two weeks ago. Monday will bring our first earnings report since I added the stock to our portfolio. Maintaining at Buy for smaller positions. BUY.
Announced earnings date: August 7

Asure Software (ASUR) is being moved back to Buy in advance of earnings, though we have to wait another week for results from our workforce management software provider. The stock has stabilized after two tough weeks that knocked it down by 13%. Recall that the CFO departed, but that there hasn’t been any other news. Given the recent acquisitions, revenue and EPS growth this year should be well over 50%, and we will likely see more acquisitions before the year is done. I think a lot of the buzz around Asure has died down, and shares look to be a good buy at this level. I won’t be at all surprised if they run higher next week given the potential for earnings to drive a big move in the stock. Moving back to Buy. BUY.
Announced earnings date: August 14

AxoGen (AXGN) is our peripheral nerve repair specialist, and it reported a good quarter this week with results coming in ahead of expectations on both the top and bottom lines. Revenue was up 46.1% to $15.2 million (beating by $800K) while EPS of -$0.06 marked a $0.03 improvement over Q2 2016, and beat by a couple of pennies. Volume growth and price increases drove the results. I’ve been looking for the company to maintain annual revenue growth of at least 40% over the next two years (revenues are up 48% through the first six months of 2017). Active accounts grew by 36% over Q2 2016 to 510, and are up almost 10% from 465 at the end of Q1 2017. This implies that AxoGen has penetrated roughly 10% of the U.S. market (around 5,100 nerve repair centers in the U.S.).

Management says it’s seen account revenue double six months after surgeons from active accounts attend its sponsored educational events. As a result, it’s expecting to complete 15 national programs by the end of this year (meaning seven more to go). On the clinical data front, it was granted permission to expand its Phase III pivotal study (comparing Avance Nerve Graft to manufactured conduits in hand injuries) by five centers, to a total of 20. It expects enrollment to be done by the end of 2018. This is a major study and will help it transition the product to a biologic (with potential approval by the end of 2021). That would give it many more years of patent protection and a big lead versus competitors. That’s good.

Management has also talked about expanding into new markets in the past. On the call, it mentioned it is expanding use of AxoGen products into oral and maxillofacial procedures (OMF), and more specifically for mandible reconstruction, which adds around $200K to its addressable market (bringing the total up to $2 billion). There’s no update on progress expanding into breast reconstruction neurotization or total joint replacement at this time. The company burned $2 million in the quarter, and ended with $23.9 million. I still see little risk of an equity offering.

The quarterly report confirms everything is on track, and there were no big surprises. That might have been a little bit of a letdown for a market that’s been rewarding big beats and punishing companies that fall short. AxoGen was right in the middle—it hit all the necessary marks, but didn’t offer up anything to make investors rush to buy more stock. That’s fine. This is a small company knocking on the door of big opportunities, but surgeons aren’t going to flock to new nerve repair products until they have a lot of confidence in them. AxoGen is building the confidence, and it’s a process.

The company will be very busy attending conferences though the fall, including one at Wedbush (August 15), Lake Street (September 13), Dougherty & Co. (September 19) and Cantor Fitzgerald (September 25). It will also host an Investor Day on November 20. These events should help improve visibility, but don’t be surprised if the stock bounces around for a while. That action should provide some buying opportunities. I’m keeping at Buy. BUY.
Earnings: DONE

BioTelemetry (BEAT) Our digital heart monitoring play drifted slightly lower this week. But we have an earnings date of next Tuesday, which will be very interesting given that the LifeWatch acquisition represents a major event for BioTelemetry. Keeping at Buy. BUY.
Announced earnings date: August 8

Everbridge (EVBG) knocked it out of the part in the second quarter with revenue and earnings both beating, and multi-deal bookings showing significant growth. Revenue was up 34.4% to $25 million (beating by $500K) and EPS of -$0.05 beat by $0.03. The company, which makes software that helps entities manage critical events, also provided 2017 revenue and EPS guidance (which is probably conservative) that was above consensus (revenue up 33% to 34% vs. previous guide of 31% to 33%. The strong revenue showing was largely a result of multi-product deals, of which it landed 60 in Q2 2017, an improvement from 54 last quarter and 45 in Q2 2016. Notably, non-mass notification product sales were up 36%, which shows the company’s effectiveness at expanding its market through new product launches. Many of the new deals were also relatively big; 12 were valued at over $100K.

The headline this morning of the shooting at Dolores Park in San Francisco (3 people wounded) is yet another unfortunate reminder of why Everbridge is doing so well. Its software helps communities, companies and government agencies deal with these all-to-frequent events. The company has a good management team, the business is doing well, and shares are holding up reasonably well. Keep holding half. HOLD HALF.
Earnings: DONE

LogMeIn (LOGM) LogMeIn reported a very solid quarter last week, but along with many other software stocks, shares have drifted lower after reporting, despite a flurry of price target increases (most to around 135). The biggest new news is that the company acquired Nanorep for $50.1 million. Nanorep developed an AI-driven self-service customer service platform, and the acquisition should help LogMeIn expand solutions around customer engagement (Bold360). It seems like a good fit given that consumers are constantly visiting websites with increasingly complex customer service questions and companies would LOVE to have a computer answer them! If LogMeIn’s acquisition can help make this happen, it should contribute meaningful revenue. Keep holding your remaining position. HOLD HALF.
Earnings: DONE

MindBody (MB) Mindbody has also drifted lower in the week after reporting. As I said last week, don’t be surprised if we bounce around for a while before there’s any real trend in the stock price. Sit on your remaining position, and we should be in good shape when the stock starts to move again, probably once we get closer to the company getting through its business model transition in early 2018 (the transition means focusing on higher value subscribers and culling the lower value ones). HOLD HALF.
Earnings: DONE

Primo Water (PRMW) This has been a tough stock to get behind over the past two months, given that as soon as it starts to build momentum, it falls apart again. That was the story this week after it shed all the prior three weeks’ gains, and then some. Now we’re back to where the stock was in late April. The bottled water company will report next Tuesday, so we’ll finally have another major update. I still think the stock is cheap and the main thing holding it back is uncertainty regarding how the acquisition integration is tracking, what debt levels will look like, and how significant cross-selling opportunities are. Keeping at Buy. BUY.
Announced earnings date: August 8

Q2 Holdings (QTWO) had an interesting day yesterday after reporting quarterly results. In the first few minutes of trading, shares were down over 10%, I assume because of either a fat finger trading mistake or because a few traders (or algorithms) thought the headline EPS number quoted in a number of media outlets (including Seeking Alpha) was correct. It wasn’t. A few outlets quoted an EPS miss of $0.13 based on the second-quarter GAAP EPS result of -$0.19. Usually these outlets quote the non-GAAP EPS figure, which removes stock-based compensation, unusual items, etc. The non-GAAP EPS result was -$0.03, which was three cents better than what was expected!

In any event, shares tumbled at the open, but came roaring back very quickly and closed up almost 2% on the day. It was a very solid quarter. Revenue was up 32.2% and EPS of -$0.03 improved from -$0.11 in Q2 2016. Registered users increased by over 600K to 9.6 million, up 25%. Q2 is still only 50% to 60% penetrated in its customers’ userbases (bank and credit union customers), which leaves a lot of room for growth (banks like Bank of America are typically penetrated 85% or more). Management also provided guidance for the year, saying revenue should be up by around 30%. The company is tracking toward profitability in 2018, which will be a major milestone.

The management team said bookings in tier 2 and 3 banks and credit unions has improved meaningfully over a year ago, and that overall market conditions are improving. Cross-selling activity is picking up. Bigger deals are typically landed toward the end of the year, and that looks to be the case again this year. That said, lacking visibility on these larger deal bookings I think big investors will hit the pause button on Q2—they’ll want to see “tier 1 deals” before they put a lot of new money to work in the name. On the positive side, lack of big deal bookings in this quarter helped profitability (hence the EPS beat) since these deals carry higher implementation costs. On the new product front, Q2 SMART (intelligent targeting and messaging platform) and Q2 Open (API-based services) are both doing well. Mobile fintech company Qapital has adopted Q2 Open, and already has over 300,000 users.

Overall, it was a good quarter and Q2’s business looks very solid. That doesn’t necessarily mean the stock will go to the moon, and given what looks like a bit of shakiness in tech stocks and lack of visibility on tier 1 bookings, I’m glad we took partial profits a few weeks ago. Keep holding your remaining shares. I like Q2 and think if we hold it through some volatility, we’ll ultimately have a pretty big winner here. HOLD HALF.
Earnings: DONE

U.S. Concrete (USCR) Shares of our ready-mix concrete stock have been solid as a rock and have extended their consolidation phase for another week. Expect action to pick up next week when earnings come out. The market is expecting 24% revenue growth (to $341 million) and 60% EPS growth (to $0.86). Keep holding. HOLD.
Announced earnings date: August 8

Please email me at tyler@cabotwealth.com with any questions or comments about any of our stocks, or anything else on your mind.

Next Cabot Small-Cap Confidential issue is scheduled for September 1, 2017
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