Background:
SonicWALL, Inc. (ticker: SNWL) designs, develops, manufactures, and sells network security, content security and business continuity solutions. They also sell value-added services for their security appliances, such as content filtering, anti-spam protection, client anti-virus protection, integrated gateway anti-virus, anti-spyware, email protection, off-site data backup, and intrusion prevention.

SNWL’s products and services are sold, and their software licensed, through a two-tiered distribution model: first to distributors and then to resellers, who provide complete solutions using SNWL products, services, and software to end-user customers. Much of the company’s value-added services are provided on a subscription basis, equaling roughly 50% of the company’s revenue in a given time period. This predictable revenue helps to lower the volatility of the company’s quarter-to-quarter financial performance.

SNWL was incorporated (as “Sonic Systems”) in California in 1991. The company’s headquarters are in San Jose, California. SNWL hardware products are manufactured and assembled by Taiwanese contract manufacturers. As of March 31, the company had 847 employees as of March 31, 2010. The company has a market capitalization of $533m and trailing 12-month revenue of $209m. Two thirds of SNWL’s revenue is generated in North America; EMEA accounts for 21% of revenue with the balance from Asia/Pacific and Latin America. International revenues grew 37% year-over-year in SNWL’s March quarter, outpacing the 11% y/y growth in North America.

Rationale:
SonicWALL is in The Crabtree Fund primarily because it passed our quantitative model, which we use to find companies that we believe are generating cash, gaining or maintaining market share and executing on their business plan. We originally purchased our SNWL position during our quarterly re-balance in August, 2009. Recently, on April 23, SNWL reported its first fiscal quarter. The company beat expectations for both EPS and revenue. Moreover, many of the other metrics (gross and operating margins, deferred revenue, cash flow from operations, DSOs) were not only positive but also showed improvement from prior periods. Because of this performance, SNWL continues to pass our quantitative model and thus remain in The Crabtree Fund.

Let’s look at how SonicWALL fares when viewed through our three key Crabtree attributes: cash flow, market share and management execution.

Analysis: Cash Flow
As for cash flow, SNWL generated $40.6m in cash flow from operations in the trailing four quarters ending March, 2010. On a revenue base of $209m over the same period, this means the company has operating cash flow margins of 19.5%. This is well above average for a technology company. SWNL is moderately capital intensive, averaging about $5m annually over the past five years. And while they have made five acquisitions (DBAM, Aventail, MailFrontier, Lasso Logic and enKoo) in the past five years for a total consideration of $77.6m, these transactions have been paid for with a mix of cash and stock. Thus, SNWL has not only been able to remain debt-free, but also has accumulated $213m in cash and equivalents, or $3.87/share.

Analysis: Market Share
SonicWALL has a variety of competitors across the four primary segments in which it competes:
• Enterprise firewall software: Check Point, Microsoft, and Symantec;
• Network equipment: Cisco Systems, Lucent Technologies, Nortel Networks and Nokia;
• Security appliances: WatchGuard Technologies and Juniper Networks.
• Content security: Barracuda Networks and Secure Computing Corporation.

SonicWALL’s primary product line is enterprise firewall technology. It holds the #1 market share in the low end (e.g., the $500-$1500 price point) of that segment. According to market research firm Infonetics, SNWL’s mid-range firewall market share doubled from the first quarter of 2009 to the fourth. And while quarterly gross margins went from 72% to 69% during that nine month stretch, they rose again to 73% in the first quarter of 2010. So we remain reasonably sure that SonicWALL’s market share is not being driven by unusually aggressive variable pricing. Rather, it appears to be driven by product quality, which has been enhanced over the past year as the company refreshed its product line.

Thus, we believe that SNWL is doing what it should for a company of its size and maturity: utilizing its cash flow to prudently maintain or gain market share of the overall security market. They are maintaining or taking share in their core traditional firewall market through product innovation, and building share in new markets (such as the SSL-VPN market) through acquisitions like Aventail.

Analysis: Management Execution
SonicWALL’s management execution can be viewed in two ways. First, by the company’s ability to meet its own and Street expectations for revenue and earnings. In the last four reported quarters, the company has beaten Street expectations, including its March 2010 quarter where it exceeded EPS estimates by $0.02. So SNWL scores well on that management attribute. Another way execution can be seen is in the five acquisitions the company has made since 2005, all while under the same CEO, Matt Medeiros. We’re not aware of any serious integration issues during that time.

Risk Factors:
There are no serious risk factors associated with SonicWALL at this time, but of course that can change. One issue we are monitoring is the company’s market share gain. While we believe strongly that it is largely driven by product quality, we are mindful that SNWL is "on" a product cycle versus two of its largest competitors, Cisco Systems and Juniper Networks. As we get into the latter half of 2010, we expect those two competitors to refresh certain elements of their own product line and we’ll be on the lookout for any share loss at SNWL. Another issue to watch is that days of inventory rose slightly in the March quarter. This caused inventory turns to fall to 7.6 in Q1 from 9.3 in the prior quarter. Again, not dire and not yet a trend, but a single negative data point and one to watch going forward.

Financial Analysis: DCF
In support of this written analysis, we’ve created a complete five-year discounted cash flow (DCF) model for SonicWALL, which we have included below. Our assumptions are as follows:

Cash Flow Growth Rates: SonicWALL’s trailing 10-year Operating Cash Flow CAGR is 9.43%. In order to diminish the impact of year-to-year cash flow volatility, we compared three year average free cash flows of 2008, 2009 and the trailing four quarters with the average free cash flows of the years 1998-2000. Based on this we have conservatively projected 8% annual cash flow growth rates for the next five years, followed by 4% growth rates in perpetuity for the purposes of calculating a terminal value.

Discount Rate: According to work done by Ibbotson, the long-term return on stocks is 7% with a 2% premium for smaller cap stocks. Since SNWL has a market cap of $533m, it’s appropriate to use 9% as our discount rate.

Starting Cash Flow figure: We’re using a calculated Free Cash Flow (net operating cash flow less capital expenditures) from SNWL’s trailing four quarters, ending 3/31/10.


5-Year DCF Model:

Year (3 Yr. Avg.): 1999 2009
SNWL CFfOps: $12.060m $31.904m
CapEx/PPE: ($1.223m) ($5.214m)
DCF Cash Flow: =$10.837m =$26.690m

10-year DCF Cash Flow CAGR: 9.43%

Initial DCF Cash Flow: $35.326m
Near Term Cash Flow Growth Rate: 8%
Discount Rate: 9%

Year: 0 1 2 3 4 5

Future Values: $35.326m $38.152m $41.204m $44.501m $48.061m $51.905m

Discounted Future Values: $35.002m $34.681m $34.363m $34.047m $33.735m

Sum of Discounted Future Values: $171.828m

Long Term Cash Flow Growth Rate: 4%

Terminal Future Value: $1079.634m

Discounted Terminal Future Value: $701.688m

Total Discounted Future Value: $873.516m

Total Cash and Marketable Securities: $213.089m

Total Debt: $0.0m

Equity Value (DCF Fair Value plus Cash less Debt):
$1086.605m

Current Share Count: 57.140m

Fair Value per Share: $19.02

Thus, our five-year DCF model calculates a “true value” for SonicWALL shares of $19.02.

Conclusion:
We are very comfortable with our investment in SonicWALL. Through our DCF model, we have credible evidence that SNWL’s true value is nearly double that of its current price of $9.67/share.

Background:
Measurement Specialties Inc. (ticker: MEAS) designs, develops and manufactures sensors and sensor-based systems for OEMs and end user customers. End markets include automotive, medical, consumer, military/aerospace, and industrial applications. MEAS is based in Hampton Virginia and was founded in 1981. The company has a market capitalization of $236m and trailing 12-month revenues of $191m. The company has 2,184 employees and manufacturing facilities in six countries, among them the United States (46% of F09 revenue), China (20%) and France (13%).

MEAS’s products include pressure sensors and transducers, linear/rotary position sensors, piezoelectric polymer film sensors, custom microstructures, load cells, accelerometers, optical sensors, humidity and temperature sensors. MEAS spends approximately 5% of its revenue on research and development annually and its portfolio of technology includes some very sophisticated product offerings, including micro-electromechanical systems (“MEMS”), piezoelectric polymers and negative thermal coefficient (“NTC”) ceramic sensors.

Acquisitions are integral to Measurement Specialties’ long-term strategy. The company has acquired 14 companies or divisions since 2004. We expect MEAS to continue to make acquisitions where such transactions can meet the company objectives of share growth and the leverage of existing manufacturing or research efforts. Since 2005, when MEAS

Rationale:
Measurement Specialties is in The Crabtree Fund primarily because it passes our quantitative model, which we use to find companies that we believe are generating cash, gaining or maintaining market share and executing on their business plan. Recently, MEASMEAS will continue to meet our three criteria for the near future.

Let’s look at how Measurement Specialties fares when viewed through our three key Crabtree attributes, cash flow, market share and management execution.

Analysis: Cash Flow
As for cash flow, MEAS generated $26.3m in cash flow from operations in the trailing four quarters ending December, 2009. On a revenue base of $191.3m in revenue of the same period, this means the company has operating cash flow margins of nearly 13.7%. While MEAS is moderately capital intensive, the primary use of cash is for acquisitions – 14 of them since 2004 alone for a total of $167m. Since the company has generated only about $60m in Free Cash Flow in that same time frame, the balance has come from the $20m it had in cash at the start of that period and the $80m in long-term debt (mostly in a revolver) that MEAS has taken on. Happily, during periods when the company has not made acquisitions (such as all of FY2010), it has reduced its debt load materially – by 23% in the first nine months of FY10 and probably by even more in the March quarter just completed. We’ll pick up the discussion of cash flow in the next segment on market share.

Analysis: Market Share
Measurement Specialties has no competitor with which it competes across all its end markets and all its technology. Thus, gauging market share is not straightforward. What is clear, however, is that MEAS is growing faster (26% y/y revenue growth in its most recently reported quarter) in general than the average company in the Technical Instrumentation segment (9% growth). While some of MEAS’s growth is due to its acquisitions, 17 percentage points of the 26% growth in FQ3 was organic, from operations that have been part of MEAS for more than a year. Moreover, the company itself reports that pricing has generally been stable during that time frame, giving us confidence that the company’s share in the segments in which it competes has not been won through aggressive (and margin-killing) pricing.

Thus, we believe that MEAS is doing what it should for a company of its size and maturity: utilizing its cash flow to prudently maintain or gain market share of the overall Technical Instrumentation market, via both acquisition and internal growth. As it happens, GEMEAS with its revolving debt (at a weighted average interest rate of 3.2%) restricted MEAS from entering into any acquisitions without their approval in FY2010 (just ended), this due to the weak overall economic environment (e.g. autos and trucks) in which MEAS competes.

Analysis: Management Execution
Measurement Specialties’ management execution can be viewed in two ways. First, by the company’s ability to meet its own and Street expectations for revenue and earnings. In the last two reported quarters, the company has beaten Street expectations by a sizeable margin, and in early April, the company pre-announced that it would beat March numbers as well. However, as recently as the first two calendar quarters of 2009, the company missed expectations. Even accounting for the difficult economic environment in early 2009, we’d have to give MEAS management an average grade on that issue. The other way execution can be seen is in the 14 acquisitions the company made between 2004 and 2009, all while under the same CEO, Frank Guidone. We’re not aware of any serious integration issues during that time, and the only divestiture has been of the household products business in 2005.

Risk Factors:
We are monitoring two risk factors at Measurement Specialties.

First, it’s very difficult to assess how much of the company’s recent revenue and bookings growth is coming from a) a return to normal economic and order patterns; or b) inventory re-stocking by MEAS’s OEM customers. Anecdotally, MEAS management believes that it is an even mix of the two, but which one is dominating is not clear. Something for us to monitor closely.

A second risk factor relates to an ongoing investigation of the company by the U.S. Department of State, related to the inadvertent export of technical data to China, without prior authorization. Measurement Specialties management is cooperating fully with the USDoS; however, there exists the possibility that the company could be subject to potential regulatory consequences ranging anywhere from a no-action letter all the the way to monetary penalties and/or criminal penalties.

Financial Analysis: DCF
In support of this written analysis, we’ve created a complete five-year discounted cash flow (DCF) model for Measurement Specialties, which we have included below. Our assumptions are as follows:

Cash Flow Growth Rates: Measurement Specialties’ trailing 10-year Operating Cash Flow CAGR is 12.0%. So we have conservatively projected 8% annual cash flow growth rates for the next five years, followed by 4% growth rates in perpetuity for the purposes of calculating a terminal value.

Discount Rate: According to work done by Ibbotson, the long-term return on stocks is 7% with a 2% premium for smaller cap stocks. Since MEAS has a market cap of $236m, it’s appropriate to use 9% as our discount rate.

Starting Cash Flow figure: We’re using a calculated Free Cash Flow (net operating cash flow less capital expenditures) from MEAS’s trailing four quarters, ending 12/31/09. We believe this is conservative, in that it includes a period of time encompassing both the worst of the recent recessionary environment, along with more a more normalized business environment toward the end of calendar year 2009.

5-Year DCF Model:

Fiscal Year: 1999 2009
MEAS Full Year CFfOps: $3.474m $22.032m
CapEx/PPE: ($0.898m) ($14.001m)
DCF Cash Flow: =$2.576m =$8.031m

10-year DCF Cash Flow CAGR: 12.04%

Initial DCF Cash Flow: $19.933m
Near Term Cash Flow Growth Rate: 8%
Discount Rate: 9%
Long Term Cash Flow Growth Rate: 4%

Year:                      0               1               2               3                4               5

Future Values $19.933m $21.528m $23.250m $25.110m $27.119m $29.288m

Discounted Future Values $19.750m $19.569m $19.389m $19.212m $19.035m

Sum of Discounted Future Values: $96.955m

Long Term Cash Flow Growth Rate: 4.00%

Terminal Future Value: $609.193m

Discounted Terminal Future Value: $395.943m

Total Discounted Future Value: $492.889m

Total Cash and Marketable Securities $26.303m

Total Debt: $80.191m

Equity Value (DCF Fair Value plus Cash less Debt): $439.001m

Current Share Count: 14.514m

Fair Value per Share: $30.25

Thus, our five-year DCF model calculates a “true value” for Measurement Specialties shares at $30.25.

Conclusion
In conclusion, we are very comfortable with our investment in Measurement Specialties. Through our DCF model, we have credible evidence that MEAS’s true value is nearly double that of its current price of around $16/share. divested itself of its consumer (e.g., kitchen scales) business, the company has focused exclusively on commercial end markets and OEM partnerships. positively pre-announced that its March 2010 quarterly results would exceed its own (and Street) expectations. This announcement bolsters our belief that Capital, which provides

A small adjustment today: out went VSEC and ATAC, in comes EGOV and PLT. VSE Corp (VSEC) and ATA Technology (ATAC) were two companies that in their most recently reported quarters, did not exhibit the primary characteristics required of Crabtree Fund holdings. I.e., they ceased demonstrating sustained execution, cash flow or market share gains. Thus, they are now gone. I have replaced them with two new holdings. First is Plantronics (PLT), a manufacturer of audio/video products in general and communications products (e.g. phone headsets) in particular. It was in the Crabtree quantitative model and thus is a logical addition to the portfolio. The other new holding is NIC Corp. (EGOV), which holds a monopoly on outsourced e-government services (e.g. renewing your driver's license on-line) in 23 U.S. states. While not in our quant model, NIC (like Ariba) is a dominant player in its space, generates prodigious cash flow that it returns to shareholders in annual special dividends and generally executes beautifully. With a forward P:E of ~28, EGOV is premium priced, but then high quality companies should cost more.

Big day today: the quarterly re-balance.
Sells included: AATI, CAE, CNMD, CPWR, KNDL, MANT, MFLX, NCIT, QTM, RADS, STAN, TNL, TTMI, UCTT and UIS
Buys included: PLXS, PRGS, MANH, MKSI, FARO, OPNT, ACTU, ACXM, SMOD, PRFT, MEAS, CPII, TZOO and ISYS.
Trims included: CRUS and WNI.

After the close VCLK and UCTT reported - will analyze and report later. Also, I still have enough cash for another position. I know what I plan to buy but if the UCTT number is sufficiently impressive, I may just buy that stock back.