NBF's Waterloo Bus Tour turns up some nuggets

Back in the day, I organized a Waterloo bus tour for Toronto VCs, in conjunction with the local technology association Communitech. We saw some good private names, including DSP Factory, Meikle Automation, Handshake, etc. over a five year period. Once I left investment banking, the ground went fallow for awhile. I’m pleased to hear that the tech research team at National Bank Financial has picked up the idea, even if it is focused on Waterloo’s public companies, and the audience was likely local fund managers. Getting RIM Co-CEO Jim Balsillie was a great coup!

Most interesting was the comment – if reported correctly – from the always delightful Dalsa (DSA:TSX) Chairman Savvas Chamberlain that he’ll tackle the Digital Cinema business if it doesn’t start to produce some results (see prior post “Takeovers to come“, April 15-07 and “Digital Cinema is coming“, April 1-07).

Here’s their note from today:

Waterloo Tech Tour: Bullish meetings tempered by rising CDN$

The NBF Tech team recently held a Technology Bus Tour, meeting with companies in the Waterloo area. The timing could not have been any better as interest in Technology is at the highest level in several years with the Nasdaq hitting six-year highs. Overall, the companies (RIM, COM DEV, Sandvine, DALSA and Descartes) were bullish about the market and spending on technology. That said, some of the bullishness was tempered by the rising Canadian dollar – now over parity. Below is a summary of our meetings. Please feel free to follow-up with us for more details.

Research in Motion (Deepak Chopra, RIM-TSX/RIMM-Q; Outperform, Target: US$130)

• CEO Jim Balsillie and Head of Investor Relations Edel Ebbs provided a very bullish view on the company’s near-term and longer-term opportunities.

• Overall, the company characterized the current smart phone market as “very hot” and awareness (partly due to Apple) picking up substantially.

• The company indicated that BlackBerry service pricing should continue to come down over time and reinforces our view that T-Mobile’s recent $9.99 BlackBerry e-mail only plan is just the beginning in lower priced plans to target the prosumer market. Recognizing the massive profitability that BlackBerry is driving, mobile operators are looking to expand BlackBerry into the larger cell phone market versus just targeting the enterprise space. We expect BlackBerry service pricing to come down as the company launches new versions of its Pearl.

• In the near-term, the company indicated that the pipeline remains very robust on both the hardware and software/content fronts.

• RIM indicated that we should see new devices in the near future. While we already know that the company is launching new versions of its Pearl (CDMA and the next generation GSM) in late October and early November, we believe the company is poised to launch 3G devices in early 2008. Note the recent extension of RIM’s licence with InterDigital, which now includes 3G
patents.

• Given all the recent speculation that RIM is working on a touch screen device, we asked the company whether it would ever launch such a device. At this point (as we expected) the company did not indicate it was working on a touch screen device, but did indicate that it was not “dogmatic” to any particular input interface. We continue to believe that as BlackBerry evolves beyond e-mail to other services like video and music, we could see RIM add touchscreen devices to its portfolio to tailor its solution to markets where e-mail or text messaging is not the primary focus.

• Software innovation should also accelerate. RIM indicated that BlackBerry Unite! should be out shortly and be widely available. At this point only Telefonica is offering the software (to be released in early November), however, we do expect North American and other European carriers to be offering it before year-end or early in 2008. We expect that the software will be launched with the launch of the next generation Pearl in various markets.

• On the enterprise side, the company indicated that its next version of BES software (which we believe will be out in spring 2008) will include the Ascedant fixed mobile convergence solution as Wi-Fi adoption is accelerating.

• With the company generating significant free cash flow, RIM indicated that the Board of Directors is investigating different options for its excess cash such as potential stock buy-backs or dividends.

Sandvine (Richard Tse; SVC-TSX; Not Rated)

(NOTE: NBF does not cover this company and hence does not offer any target or rating on its
stock.)

• Dave Caputo (CEO) and Scott Hamilton (CFO) provided our group with a general update and some examples of where the company’s products have been used to provide intelligence to carriers.

• According to the company, while its PTS8210 Policy Traffic Switch (1 Gbps) has sold the most volume to date relative to its other products, the company continues to believe its edge comes from its PTS14000 Policy Traffic Switch (10 Gbps) where they claim they are 15 months ahead of its competitors.

• Sandvine reiterated its view that margins can vary meaningfully given their new business model that comes from a heavy software focus. The increase in margins during the first half of this year was the result of an unusually higher proportion of software licence sales from existing customers and the company held its view that it does not anticipate this to continue as it expects the product mix to return to its former ratio of hardware and software licence
sales.

• With customers migrating from the PTS8210 to PTS14000, Sandvine believes it would maintain the same level of margins going forward.

• With respect to the company’s outlook, management is targeting 70%+ gross margin, 20-25% R&D, and 30-35% SG&A. In particular, the company expects to continue spending on R&D and increase its sales force. The company believes it needs to increase the size of its salesforce to drive growth given the number of opportunities. As such, the company expects SG&A to increase in the near-term.

• Management indicated that its wireless opportunities should begin to start bearing some fruit over the next year.

COM DEV Int’l (Deepak Chopra; CDV-TSX; Outperform, Target: $8)

• CEO John Keating provided a bullish outlook on COM DEV and the satellite business.

• The company indicated that satellite operators are starting to order more commercial GEO satellites. Drivers include higher capacity utilization as HDTV and other services are gaining meaningful traction and the replacement cycle is accelerating given the aging satellite fleet. These comments support our analysis that the number of satellite orders should increase from the low-20 level in 2006 to more than 30 in 2008 and potentially as high as 35 in 2009 or 2010.

• With COM DEV’s equipment on 80%+ of all commercial satellites launched and having 60%+ market share in switches and multiplexers, the company is poised to see this higher demand translate into more revenues. Commercial revenues today represent 40-50% of their business but could expand beyond that figure in the near term. The company is also working on expanding its commercial product portfolio as it is working on the next generation of switches and multiplexers to handle higher power levels.

• To move up the value chain, the company is starting to offer payload integration services and also potentially looking at doing Bus work in the nascent nano satellite market.

• It is interesting to note that the company also believes that the number of transponders per satellite will move higher in the coming years, expanding the dollars per satellite that COM DEV could win even further. We estimate that COM DEV generates $3 to $4 million per GEO satellite. To deal with the pipeline, the company’s expansion of the first phase of its 38,000 sq. ft. in
Cambridge (or 23% more capacity) is nearly complete.

• In the U.S., the company is on track with its expansion in California with a 46,000 sq. ft. facility to address the U.S. military market with its UHF products. Production at its U.S. facility should kick-in mid to late f2008. COM DEV reiterated that the military and civil markets are each four times bigger than the commercial market (US$20 billion vs. US$5 billion).

• The recent weakness and more importantly the velocity of the move in the U.S. dollar is an issue that the company has to deal with in the near-term and could limit margin expansion in the next quarter. While the impact of the rising Canadian dollar is meaningful – we estimate $0.01 EPS impact for every $0.01 move – the company’s exposure is reducing as U.S. dollar revenues have declined from 85% of sales several years ago to 50% now. Canadian dollar costs represent about 85% of the total, but should also come down as the company’s U.S. facility becomes operational.

DALSA (Deepak Chopra; DSA-TSX; Sector Perform, Target: $12)

• It was all about Digital Cinema.

• Chairman Savvas Chamberlain, President of Digital Cinema Rob Hummel, CFO Wajid Ali, and Director of IR Patrick Myles focused much of their presentation on the company’s restructuring and their Digital Cinema initiative.

• President of Digital Cinema, Mr. Hummel, enthusiastically talked about the tipping point that the industry is on the verge of as digital cameras are poised to gain share in the film industry. The company indicated that it was close to signing up an independent feature film.

• That said, the Chairman, Mr. Chamberlain, indicated that the Board of Directors at DALSA are looking at strategic options if Digital Cinema does not turn around. We have not heard this before.

• With the outlook of its core flat panel display and semi capex equipment markets deteriorating, the company indicated – similar to its Q3 warning – that the H2 2007 will be weaker than originally expected.

• The recent restructuring (there will be a charge in Q3) should help the company move back towards its stated business model of 40% gross margins, 30% operating expense and 10% net margins in its Digital Imaging and Semiconductor segments. Management indicated that the recent restructuring (8-9% of work force) should help it recover half the margin required to get to its targeted net income level.

• A big part of the restructuring is to retire its older CMOS wafer processing line, divest its Colorado Springs x-ray products targeted for the health sector and transfer R&D to Montreal.

• The Canadian dollar continues to wreak havoc on Dalsa’s operations as one-third of its costs are denominated in U.S. dollars and has impacted gross margins by 5% to 7%, with the near-term range being in the mid to high 30% level versus 40% to 45%.

Descartes Systems (Richard Tse; DSGX-Q; DSG-TSX; Not Rated)
(NOTE: NBF does not cover this company and hence does not offer any target or rating on its
stock.)

• Art Mesher (CEO) provided our group with an update of Descartes.

• Descartes now serves over 3,000 customers worldwide with approximately 297 employees and processes all U.S. shipments over $5,000. Its application suite is available in 14 languages.

• The company is targeting 20% EBITDA margin from its recurring revenue.

• The company indicated that FX is having a considerable impact on its operating costs, which could weigh on margins in the near-term. Descartes is continuing its strategy of being an industry consolidator. The company indicated that it’s still looking for acquisition candidates with the criteria being that they process the same information or serve the same markets; however, they are avoiding large acquisitions. Since the company has a lot of capacity today, it does not foresee significant capital expenditure in the near-term.”

MRM