• Fisher Investments on Technology
• Warren Buffet’s 2010 Letter to Shareholders [PDF]

Stay tuned for a portfolio review.

• Bolt — air guns. Major competitors are ION Geophysical and Sercel
• A-G Geophysical — cables. Major competitor is ION.
• Real-Time Systems (RTS) — controllers and synchronizers. Major competitor is Seamap (subsidiary of Mitchum Industries)

The guns are connected to the controllers via the cable, and Bolt sells the whole setup. Theoretically, then, these three segments produce highly complementary goods. It’s worth noting that none of the other competitors sell all three together, which provides some added value for going with a full Bolt solution. It’s also worth noting that ION Geophysical is a major competitor and a major customer, representing 15% of revenues in fiscal 2009 (listed as Compagnie Generale de Geophysique-Veritas, of which ION is a subsidiary). Clearly, then, Bolt provides some compelling technology but also faces some significant risks with respect to its customer base. In fact, 40% of its sales in FY 2009 was to three customers.

Before talking about why this company is worth investing in, let’s look at some numbers:

• 96m Market cap, of which 34m is cash. The company has no debt, and its total liabilities are 2m. Net income in FY 2009 was 10.5m. This means that, ex cash, this company is trading at some preposterous 6x earnings from FY 2009. There have been two 10-Qs out since the end of FY 2009, and the TTM net income was 7.8m. Not as great as I would have hoped, but it’s to be expected since increased oil/gas exploration would logically lag an economic recovery. Still, that’s a compelling 8x TTM earnings.
• Adequate accruals ratio (6-10% depending on method) indicates that most of the earnings are not coming from accruals. This is reinforced by the fact that FCF is strong and even exceeded net income on a TTM basis.
• Inventory is a concern, outstanding for 220 days in FY 2009, which is 45% up from 2008. There is about $1m of product in inventory that are more than 5 years old. This isn’t necessarily a huge deal since this is industrial equipment and part of the inventory is replacement parts for old guns (Bolt makes a not-insignificant portion of its revenues from selling spare parts).
• Profit margin has been over 20% since 2007. Clearly the lack of competitors in this space is beneficial.
• Using a very rough estimation of their operating leverage, their degree of operating leverage stands at around 1.6 (compare that to ION’s DOL of over 2.4). 1.6 is a pretty low number in general and for a company so levered to oil prices, having lower operating leverage is definitely a good thing.

So it’s not a perfect company, but it’s a very good one at a very attractive price — provided that oil prices remain high. So here’s a brief macro analysis:

• Pushing prices up:
  • If you look at the oil/gold ratio, you can see that the value of oil is (slightly) below its long run average. This, of course, could also be because gold is overvalued. The same pattern holds with oil/silver.
  • The economies of China and India have largely recovered. These developing economies will continue to require hydrocarbons to power their growth.
• Pushing prices down:
  • A possible Greek default could have contagious effects on the Eurozone. Eurozone instability has also pushed up the dollar.
  • Green technologies are gradually supplanting oil in favor of alternative energies and cleaner burning traditional hydrocarbons like natural gas. Bolt stands to benefit from gas only if prices are high enough to justify offshore exploration.
  • Asset bubbles in China could burst, which could reduce demand for oil.
  • US housing industry continues to struggle.

Buying Bolt is a bet that China will continue to grow and that oil demand will continue to remain high. At 11.22, this bet seems advantageously priced.

• $311m revenue (15% growth)
• $1.92 EPS (5% growth)
• $106m cash

Sales by segment:

The following table summarizes net sales by segment (dollar amounts in thousands):

        The following table summarizes percentage of total net sales by segment:

TRLG delivered an impressive performance in 2009. Sales were up due to the stellar growth in the consumer direct portion of the business (branded stores and website). This is partially due to increasing store count from 42 to 70 — a 66% increase. In 2010, TRLG will open 27 new stores in the US and 3 more overseas (roughly 50% increase). Let’s say this adds 30% more to sales from the consumer direct segment after accounting for the substitution from the other segments. That’s an addition $40m to sales, which gets us most of the way to the project 2010 revenue of $360m.

The obvious loser here is the US wholesale segment. The bad news is that it sucked in 2009. The good news is that the previous 3rd party sales agents have been fired and the whole business is being moved in house. This will increase costs somewhat into 2010. One good thing here is that TRLG has not lost any shelf-space at the majors — they just need to use that space more effectively. They are targeting to decrease spending to discounters by $10m in 2010 (it was $40m in 2009), which is a good step for long term brand value. They are also targeting boutiques, of which they currently serve around 800. This number could grow to 1600 in the next few years if their strategy of a specialized boutique sales force works out.

The upshot is that to reach the target of $360m, there needs to be continued growth in the consumer direct and international segments, aside from opening new stores. But the number sounds conservative and the increasing popularity of the brand will probably be enough to carry it the rest of the way (beyond the new stores) and then some.

Here are some points to watch:

• Still not getting traction on sportswear. New sales force should help here, but as long as TRLG remains a jeans company rather than an apparel company, it will be difficult for them to continue growing beyond the 1-2B market cap mark.
• Inventory is way up. Inventory turnover was 3.6 in 2009 compared to more typical numbers in the 4-6 range. This may be due to the increased focus on consumer direct rather than wholesale, but it’s definitely something to watch. If it falls much lower, it would be a serious concern.
• $173m in future purchase and operating lease obligations. Not too big a deal

Valuation:

• At $30 and $4.50 in cash per share, TRLG is trading at 13x EPS trailing and 12-13x EPS projected for 2010.

After going up some 40% from the last analysis, this is no longer the preposterously good deal it once was, but it’s definitely not expensive either.

STEC is a maker of high-end enterprise SSDs, namely the Zeus IOPS. They’re cheap, trading at some 10x trailing earnings and even lower forward. They recently fell by over 50%  due to news that their biggest customer, EMC, had an excess inventory, putting at risk STEC’s Q1 2010 sales. There are some shareholder lawsuits being filed, but it didn’t look like anything serious. The valuation looked good, the future of the industry looked good, and  it looked like a decent buy at a great price.

So what was wrong with it?

Well, first, management has been denying to anaylists that there are any competitors for Zeus IOPS. Granted, developing the technology to have sustained, high IOPS is nontrivial, and so is decent wear-leveling. But with so many competitors developing enterprise-level SSDs (including Intel, Samsung, OCZ, Western Digital, and Seagate), it’s hard for me to imagine that these guys are not eyeing the high-margin, high-performance business at the top of the value chain. How can you plan for dealing with the competition if you deny that they exist? Stragetically, then, this company is not well positioned for an invasion into their Zeus IOPS space by any of their potential competitors.

Second, I could find no evidence that the Zeus IOPS is actually a superior product. I found no benchmarks comparing these things, which is understandable since each drive costs well over $10k. But this means that I have to take management’s word on its awesomeness, and management has proven less than forthcoming.

Third, how large is this market, really? Zeus IOPS drives are for storage arrays, not even plain pizzabox servers. Thus, the biggest growth might be a level down, where all of its competitors have pretty good products. They’re sitting on top of the mountain, but there may not be enough business to be done up there. Their competitors can easily take the level below and then swallow them when the market for SSD storage arrays really matures.

The numbers look at the past, and in the past STEC has grown tremendously. But for the future, strategic considerations are much more important, and it is here that STEC falls short of my expectations. Of course, they may go on to do very well. But at the moment I am not comfortable holding that kind of risk when I know so little about the product and the market.

• 18.25 ($3b mkt cap)
• 6x FCF ($500m FCF)
• 8x forward EPS

I disagree with the negative views.

• Digital downloads
  • HD size not big enough. No selling or lending of used games. No taking games to a friend’s house.
• Amazon
  • Used games work differently and is not convenient. Does not have a significant cost savings for new games. Does not have 0-day release, which is essential for enthusiasts.
• Big box retailers
  • Big box retailers typically don’t trade used games, and if they do, their collections will be nowhere near the size of GME. It takes time to build an inventory of used games and to develop an inventory system that will price them correctly. Big box retailers are not experts at this and unless they are willing to commit a large amount of time to it (unlikely — see other risks), they are unlikely to be competitive in this arena.
  • Big box retailers cannot compete on the price of new offerings, since everywhere prices new consoles and games the SAME.
• Casual gaming
  • Sitting at home on an iPhone while there’s an XBOX 360 waiting to be played?
  • Casual gaming may be the gateway to more immersive gaming — expanding the pie for everyone.

Strategically,

• Used games account for over 40% of gross profit. There is a network effect for used games, just like EBAY, and GME is the largest buyer/seller of used games.
• Fastest-to-market distribution of new games.
• Over 6000 stores. More expansion opportunities in Europe, where the ratio of potential revenue to stores is lower than other areas.
• Jolt — Entering casual gaming space with online offerings (though unlikely to contribute significantly to revenues for a while).
• Planning in-store kiosks for add-on digital content sales.
• Launch events, trained and knowledgable staff — value-added; customer service not matched by other (execpt maybe mom-and-pop) retailers.

In a nutshell, this is a buy because I don’t see brick-and-mortar gaming dying any time soon — the technology is not there. And I think that people will only buy games from two places: Amazon if they’re online, and Gamestop if they’re in a mall. If you want instant gratification, and price difference isn’t big (it’s not), why would you buy from Amazon?

• $600m market cap, $161m cash, 33m shares out
• 10x trailing (excl. cash)

Results

• $41m net income 2009
• $169m revenue
• 4th qtr revenue of $44.7m on 23.8b minutes ($.001878/min) vs 4th qtr 2008  ($0.001928/min) – 2.6% drop in price but 32% rise in minutes, mostly due to competition from Peerless, Hypercube, and Level 3
• Shares of mintues: 10% cable (down), 17% CLEC (down);  19% IXIC (up); 3% VOIP (down); 51% wireless (down)
• Expected 2010 revenue (excl EX): 185-200m; 8-18% grown off of 2009
• $25m buyback

Strategy

• 36 more markets in 2010
• Growing existing markets as well as new additions
• Retention rather than win-back for price competition
• Ethernet eXchange (EX) – only 2 competitors (Equinix and CNEX); needs new equipment but can use same locations; many potential clients already colocated; 2010 focuses on building network effect; expected to be higher margin than tandem business

TNDM is beginning a new phase of growth, transition from a phone tandem company into an IP-based data networking company. Its largest potential competitor is Equinix, which has over 4 times more revenue. But Equinix has fewer locations and other core businesses, not to mention $1.2b in debt already, which limits its ability to take on new debt for expansion.  On the other hand, Equinix has a much larger cash horde that it can leverage. It’s worth watching, but it sounds like TNDM will continue to grow, at least into next year, even with EX being a complete bust. Its other competitor is CNEX, which is a startup that does not have the contacts. Hence I think it is possible for TNDM to at least make some headway into the EX business for 2010.

It sounds like TNDM will be competing with this: http://www.equinix.com/data-center-services/interconnection/ethernetexchange/ Sounds like everyone is starting from a level playing field.

Feels like they have a lot of room to grow and that their stock is not priced accordingly.

Bad

• Revenues still declining, particularly in the core business
• Ad costs are sky high on TV.
• Retail rollout was a failure and will be mostly discontinued. $148 for a 14-day weightloss solution is not compelling next to $25 for 20-day solution with Alli.

Good

• Nutrisystem D is a great success, contributing 10%+ to revenues
• Conversions up 30%
• Expanding ad mix to more channels
• New website

In particular, I think that the improved conversion rates, due to a better website and better scripts for the callcenter, is extremely good news and basically means that NTRI can now spend 30% less on ads to get the same results (or spend the same and get 30% better results). I think this quarter they were caught off guard with high ad costs, which is odd but I am betting it won’t be a pattern, and management is already taking steps to address this issue.

One thing to watch out for is that reactivations fall off sharply after 2 years.

Trading at 17x trailing 2009 earnings, 5.4x trailing peak earnings (from 2007). Using the basic growing annuity calculator, this company is priced to grow at around 12% over the next 10 years.

My only concern is that this pick is different from my thesis of quick recovery in the upper income class and slower recovery in the lower income class (which pretty much the clientele of NTRI). But I think that a broader recovery is coming and this stock is leveraged to that.

Note: 176M in food purchase obligations; 37M in operating leases, most of which is more than 5 years out.

This looks OK for some additional investment at this valuation.

Strategy

• Evloving men’s business
• Jimmy Choo collaboration on sheepskin boots
• Lifestyle imagery
• More styles, particularly spring styles, kids, and cold weather
• Opening 5-6 new US stores, 2-3 new Asia stores (Jpn + China)
• Cutting distributors out: DECK -> Retailer
• Opening 100 shop-in-shops internationally — good results so far.
• No compromising on quality for the kids line.
• Target marketing budget of 7% of sales
• Retailers will be the biggest source of sales; stores are more like showcases to create excitement; also allows you to test new products like UGG outerwear… clever — product mix, presentation, seasonality.

Positive Signs

• Of the consumers that have bought UGG footwear 70% purchased at least one pair during the past 12 months
• 63% of UGG buyers wear UGGs most often
• Same store sales up 30% in Q4, up 28% in 2009
• Building Teva brand: make a compelling value; getting full control of the brand. Was this an acquisition?
• Growing orders from Nordstrom for Simple.

Negative Signs

• UGG inventory is up slightly.
• Some overhead from opening of new stores.
• Seeking to acquire another brand. Noooooo!!!!!!! Doesn’t really know what to do with the growing cash stockpile (hint: dividend!) Possibly an apparel business.

Interesting Notes:

• Japan is #1 luxury market in the world (ex. Coach is very popular)
• Product company vs marketing company — who shapes the vision of what consumers want?
• How does social networking improve the dialog between company and customer?

Overall a very positive call for a very positive quarter. Can’t detect much to be negative about.

They are growing their product lines, expanding to men, and have no debt. They seem to have learned the lessons from several bad acquisitions in the past, and have no plans to acquire new companies.

Some things to note:

• A promising sign is that even during the recession, when customer starts declined, customer reactivations actually remained constant. This should indicate that customers continue to be satisfied with NTRI products.
• Continuing to invest in the website, which is good to see.
• Costs will go up with commodity food prices.
• CEO is also chairman of the board — corporate governance issues?
• Could face liability suits for health-related claims.

Sounds like a solid deal to me.

24x EPS means, roughly, an expectation of 25% LTG, or an EPS growth over five years of 250%. Let’s say that they do this only by selling more, not by buying back shares. With a current EPS of 7.49, the projected future EPS is 18.73. Assuming a conservative 15x multiple, that’s a $280 stock price. So 40% upside. Now, if they fail to gain traction with the iPad, and EPS stays where it is, using the same 15x multiple, it will be a $112 stock price. That’s a 40% downside.

Let’s consider what it takes for that 40% upside: assuming profit margins stay constant at 15% (it’s actually growing), the EPS of 18.73 means a revenue per share of 124.86 or $113 billion in revenue. Now, who makes $113 billion in revenue in tech? Not MSFT, not DELL. Only HP does, and just barely. But that’s a LOT of units to sell. It seems that AAPL at this point is fairly valued to grow a little over 5 years. There must be better deals out there.