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EZChip: My Struggling Core Holding May See Better Days

The performance of the Covestor Gehman Capital Solutions Undervalued Growth Companies portfolio is getting “worser and worser,” as they say. Is the model “failed”?

I do not believe so, but it takes a lot of conviction to stay with small cap (story) stocks when market forces are against them. The savior is that the future price moves to the upside can be just as dynamic as the moves to the downside.

My biggest price problem is my largest investment is EZChip (EZCH).

On February 13, 2013, the company announced Q4-2012 earnings . The market drove the price up the stock price from the $32 area to the $36 area. During the subsequent conference call, the stock dropped from the 36 area to the 24 area. I believe the EZCH business model is still intact, but the “short sellers” and some investors have decided to sell the stock with a vengeance.

The Chairman, Eli Fruchter, announced that he was lowering forecasted revenue in 2016 from the $250 million to $150 million because (1) carrier spending on infrastructure was not growing as fast as he expected and (2) all future revenue from one account, Huawei, was being removed because EZCH had not yet received expected production orders on their new NP-4 network processor product.

Regarding carrier CAPEX spending: Eli said that …. “service providers are running their networks hotter and it’s only a matter of time until they increase capital investments in routing infrastructure.” Infonetics Research reports that CAPEX spending has stabilized in many of the worst areas (Europe and Africa) and is starting to pick worldwide.

Regarding Huawei:  Eli believes that “Huawei is planning to offer a lower-end, in-house solution. EZCH’s NP-4 is a high-end solution that does not have any current competition in the market. Huawei is not a significant customer now, but was projected to become a 10 to 15% customer in the future.

It seems that Eli’s projections were extremely severe because he said “so we are taking a conservative approach in forecasting our growth potential that we will be happy to adjust upward if the service provider environment continues to improve and our NP-4 ramp with Huawei will be better than we currently expect.”

In my opinion, the company’s business has been developing extremely well. In Q4-2012, Cisco, EZCH’s biggest customer, accepted delivery of $1 million more NP-4’s than was anticipated. Four of the seven router manufacturers are ordering production shipments of the NP-4 and are expected to commit to the next generation NP-5 later this year.

NP-5 processors are expected to generate revenue in 2014 that should last for eight years. EZCH has also developed the NPS processors that should be in production in 2016 and performs tasks in new markets with new customers that people did not even envision a few years ago.

Eli’s extremely negative forecasts gave the “short sellers” a chance to attack with vigor.  Some investors have also “lost heart” because the volume has been very large on the downside. I believe that EZCH is an extremely attractive investment.

The company has no debt and over $5.00 per share in cash. I believe EZCH could earn over $1.20 a share in 2013. Net of cash, the stock is trading around 15 times earnings.  EZCH still projects earnings growth of over 30% per year.  EZCH stock is extremely over-sold and I believe should move up in price significantly.

This year has been a disappointing one for the Gehman covestor portfolio. As of March 8, the model  is down 16.7% (net of fees) compared to a 10% increase in the Russell 2000 and 8% in the S&P 500 Index.

Each company in the Gehman portfolio has a different story. Small companies grow in fits and starts. In almost all cases, I am satisfied with the performance of my companies. Below, I have made a brief description of where they stand, and why I believe each one could move up in price in a short period of time.

Anadigics (ANAD) is a “leading provider of semiconductor solutions in the broadband wireless and wire line communications market.” Three years ago, the company jeopardized a tight relationship they had with a giant customer. That relationship has now been repaired.

In my opinion, ANAD has worked hard to (1) continue developing unique products, (2) build cutting edge, expandable, production facilities and (3) cut expenses. Their fourth quarter 2012 results were in line with analysts’ projections. I believe ANAD is a high risk-high reward situation. If the company performs as expected, the stock price should trade significantly higher in my opinion.

Crailar Technologies (CRLRF) is the new name for Naturally Advanced Technologies Inc.  Crailar produces bast fibers, cellulose pulp and their by-products from flax, hemp and other bast fibers. Their unique process creates soft fabrics from hard, cheap, materials that substitute for cotton cloth at much cheaper prices.

The company has arranged long term financing, is starting production from their new plant and has long term contracts with Levy Jeans and other companies. This is a start-up process and start-up company. The technology is proven. With time, this stock should trade significantly higher in my opinion.

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

On 3/4/13, DRWI reduced their estimated revenue for the quarter ending  Feb. 28, 2013 to $30 million from $45  to 40 MM. They said that reduced sales from their NSM unit were responsible. The company said they are working on a plan to reduce expenditures and expand sales, but nothing definite was announced.  The company hopes to reach cash flow break-even in Q2, 2014.  Today’s announcement is a problem. The stock is only trading at $1.73. I will monitor this investment closely.

Finisar (FNSR) generates profits from fiber-optics products for data communication and telecommunication networks applications. The business requires a high fixed cost structure. It is expected that carrier CAPEX spending will increase through 2013, so FNSR business should increase and profits increase in multiples in my opinion.

On January 18, 2013, Jeffries published a report on FNSR with a price target of $5.00 to $20.00 based on different scenarios. It recommended selling the stock because the company faces increased competition from Intel (INTC) and Cisco (CSCO), according to this report by Bloomberg. I believe the world economies and FNSR’s market will improve through the year and the stock will trade at much higher levels.

Lattice Semiconductor Corporation (LSCC) develops and sells “innovative, low cost, low power programmable design solutions for  wireless infrastructure and wire line access equipment as well as many other electrical applications,” according to the company .Last year was a transition year for the company, but momentum continues to build in consumer and non-consumer areas in my opinion.

In the Q4, 2012 conference call, the President and CEO, David Dillerbeck said “revenue was 65.9 million, in line with our revised guidance for revenue to decline 6% to 8% compared to Q3. Our results reflect …the challenging macro environment with broad  based weakness across nearly all market segments, geographies, except for..the.. consumer. We do not expect positive macroeconomic improvements in the short term; we are seeing some encouraging signs for the first half of 2013.”

 LSCC ended Q4, 2012 with cash equivalents, and marketable securities of $188.1 million, according to the financial data posted on its website.. In the twelve months before Feb, 2013, the company purchased 4.65 million shares of stock at a cost of approximately $20 Million.

On Feb. 27, 2013, the company announced a new program to repurchase stock worth $20 million. As the macro-economic environment continues to improve and the company continues to re-purchase equity through 2013, I believe the LSCC business and stock price should improve.

MicroVision (MVIS) was one of  the first micro-cap stocks I purchased. It has been a long road, but the company finally has developed products that can generate significant sales and profits. The company recently changed their business model to incorporate royalty payments for a new generation of display and imaging products for the mobile markets.

In my opinion, the company still has a lot of work to do because they need capital. Their new royalty model reduces the need for cash. However, they still need to write a significant licensing contract with a large company that will pay up front fees, or, they will be forced to sell more equity at low prices.  In 2012, MVIS announced a new royalty contract with Pioneer Corporation that displays a navigation system on automobile windshields. This contract is about 2/3 completed.

In addition, MVIS has shipped over 50 samples of their products to consumer product and automobile manufacturers. These products were delivered for evaluation and technical support and have now moved into the negotiation phase with MVIS’s top priority customers.

MVIS has established five determining attributes for their new customers: (1) Must be a blue chip company (2) Must have a strong business structure – with multiple sources of revenue – software and hardware (3) Must have a commitment to MVIS. Ideally, they would share risk with MVIS (4) The customer’s and MVIS’s expectations must be compatible and (5) MicroVision will negotiate for advance revenues in the form of license fees before the product comes to market.

The company now has patents on the highest quality Pico projectors (i.e. small projectors - the size of ½ dollar) that can be delivered at reasonable prices It may take some time, but I believe this stock could amount to something significant.

QuickLogic Corporation (QUIK) is a leader in low-power Customer Specific Standard Products (CSSPs), and is an exciting investment. The company develops sophisticated electronic components --concentrating on mobile devices. Historically, they have developed specialized products, but now are concentrating on developing “niche” products for mass production.

Last quarter, some technical problems delayed the successful delivery of new products. The company hired a specialist to deal with that problem and all future problems, so they should minimize similar problems going forward.

QUIK has announced a number of new production orders, with more emerging. The stock is trading at about $2.20 which is close to the low price since January, 2012. I believe that QUIK will continue to announce new production orders throughout 2013 and the stock should trade much higher by year end.

TowerJazz (TSEM) fabricates chips. They do not use “cutting edge” technology, but have been buying old equipment and manufacturing facilities at cheap prices and have been signing contracts with multiple tier-one customers throughout the world

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

In their Q4, 2012 conference call, the company said they were negotiating major contracts with their two existing national carriers that should generate significant revenue in Q1, 2013. The company has stated they are comfortable with their cash position. In my opinion, the stock price will probably not move significantly until these contracts are completed and announced. The company will have to sell stock if the contracts are not completed within a reasonable time frame.

Wave Systems Corp (WAVX) has developed a number of products that enhance security in the transfer of information. They use the “Trusted Computing” model that securely encrypts all data until the device trying to access the data is determined to be secure. Once secure devices are identified, they can operate securely within their closed, encrypted environment.

WAVX is one of the most frustrating stocks that I own. Over 600 million devices have the Trusted Computing chip, but WAVX only makes money when the owner of the device pays WAVX for the use of their products.

WAVX, a very small company, has established their position with giants such as Microsoft, HP, Dell, etc. in the Trust Computing network. The Trusted Computing Model is increasingly being promoted for information security.

The company has projected they will be cash-flow break even in Q4- 2012, which they will announce within a few weeks. If they are able to accomplish cash-flow break-even, I believe the stock will trade much higher.

Xoma (XOMA) develops drugs. They have a number of contracts with large pharmaceutical companies. If and when they develop a new drug, the price of the stock will move up significantly in my opinion.

The investments discussed are held in client accounts as of March 1, 2013. These investments may or may not be currently held in client accounts. The reader should not assume that any investments identified were or will be profitable or that any investment recommendations or investment decisions we make in the future will be profitable.

Gerald Gehman

Gerald Gehman

Gehman Capital Solutions, Ltd. is an investment management company based in New York City. Gerald P. Gehman founded the company

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