The Growth Factor

Needham Funds' Commentary

by John Barr

In This Issue
Needham Funds Investment Philosophy
Investment Criteria
Constant Contact
Edwards Group Ltd.
Oil-Dri Corp.
A.T. Cross Co.

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John Barr
Chris Retzler   



September 13, 2013

Needham Funds' Investment Criteria and a Few of Our New Stocks

In the fourth issue of The Growth Factor,  we reviewed Peter Lynch's classic investment book, One Up on Wall Street.  We lamented that individual investing is hardly discussed these days and made a case that individuals can use what they know to make money in the market, but it requires dedication and study.  Personal investing should be thought of as a second job.


In the same issue, we described our investment philosophy and highlighted how a few of our long-term holdings-PDF Solutions (PDFS), Exa Corp. (EXA), Precision Castparts (PCP), Apple (AAPL), Express Scripts (ESRX), ViaSat (VSAT), and Dick's Sporting Goods (DKS)-fit with our selection criteria.  We've also written about SoundBite Communications (SDBT), which was a long term, special situation, microcap holding of all of the funds that was acquired at a 72% premium this summer by Genesys Telecommunications. 


In this issue, I'd like to revisit our investment philosophy and selection criteria, and describe a few recent additions.  These are examples of the small-cap special situations that we love to find.  We continue to believe there is a big opportunity in SMALL CAPS.

Our Investment Criteria
  • Management teams that have previously created shareholder value, preferably at the company we are considering;
  • Businesses that participate in large markets with the opportunity to grow into much larger companies;
  • Attractive valuations;
  • Unrecognized product and margin expansion potential;
  • Post-IPO companies with venture capital backing; and
  • Companies with little Wall Street research coverage.
We highlight below four new investments and how they fit the Needham Funds' investment criteria.

Constant Contact

Constant Contact (CTCT)  is a leading supplier of email Software-as-a-Service (SaaS) for small businesses.  Constant Contact is a small-cap stock with a market capitalization of $660 million. CEO Gail Goodman joined the company in 1999, eight years before its IPO.  Harp Grewal, CFO, joined in 2010, bringing experience as CFO of and VistaPrint (VPNT).  The company has grown revenues from $50 million in 2007 to $250 million in 2012, and GAAP EPS have grown from $(0.07) in 2008 to $0.77 in 2011. Earnings dropped to $0.41 per share in 2012.


Constant Contact had fewer net customer additions in April 2012 and again in October 2012, creating a buying opportunity for us.  The stock fell from a high of over $30 per share in January 2012 to below $12 last October.  


My first exposure to Constant Contact came from attending the IPO lunch in 2007. Needham Funds became a customer of Constant Contact in early 2012. Throughout 2012, we did our research and we met with Harp Grewal in early August.  After the October earnings call, the stock fell to under $12. I did a conference call from home with Constant Contact the afternoon before Hurricane Sandy hit New Jersey.   The Needham Aggressive Growth Fund purchased the stock in the fourth quarter of 2012 and had just under a 1.0% position as of December 31, 2012. 


At $12 per share, Constant Contact was valued at an enterprise value/revenue of just over 1x. Even with the shortfall relative to its business plan, Constant Contact had positive quarterly earnings throughout 2012. Competitor ExactTarget (ET) is a marketing automation company that went public in March 2012 and was trading at about 5x EV/ revenues.  We believed that Constant Contact's customer base of over 500,000 small businesses and core email products justified a valuation above 1x EV/revenues.


In the spring of 2013, we visited Constant Contact headquarters in Waltham, MA, a number of times.  In June 2013, (CRM) bought ExactTarget at 8x EV/ revenues.  Constant Contact closed at $21.29 per share yesterday and is still valued at just 1.7x EV/ revenue.   

Edwards Group, Ltd. 

Edwards Group, Ltd. (EVAC) is a leader in vacuum systems used for general, industrial and semiconductor manufacturing purposes.  The company has operations around the world and is headquartered in Crawley, U.K.  The company had been purchased by two private equity firms, CCMP Capital Advisors, LLC and Unitas Capital Ltd., in May 2007. Edwards Group is a small-cap stock with a $1.1 billion market capitalization.


Edwards Group had an ignored IPO in May 2012. We attended the IPO luncheon. The IPO was filed at $10-12, but ultimately was priced at $8. We were attracted by the increasing necessity for vacuum environments in manufacturing.  We saw Edwards at SEMICON West, the largest semiconductor capital equipment conference, in July 2012. By the fall of 2012, the stock had dropped to $6-7 per share. We had a starter position in the Needham Aggressive Growth Fund by December 31, 2012.


In February 2013, Edwards appointed Jim Gentilcore as CEO.  Mr. Gentilcore had been on the Board of Directors for a number of years. We knew Jim from his previous experience as CEO of Helix Technology, which designed and manufactured advanced pumps for the semiconductor industry.  He successfully sold Helix to Brooks Automation in 2005. In March 2013, we attended a dinner with Jim and felt that he had a good grasp of Edwards' opportunities.


Edwards was followed by only a few research analysts and never really received institutional interest.  From August 2012 thru August 2013, Edwards rarely traded more than 20,000 shares per day.  Due to the lack of trading volume, it was difficult to purchase the stock, but we made all of our purchases under the $8 per share IPO price.  The Needham Aggressive Growth Fund built its position in Edwards to near 0.7% by the end of June 2013.  


In August 2013, Edwards Group agreed to be acquired by Atlas Copco of Sweden for up to $10.50 per share.  While we welcome the premium, we are disappointed Mr. Gentilcore did not have an opportunity to build the business and have Edwards achieve tenbagger status for us.  

Oil-Dri Corporation of America

Oil-Dri Corporation of America (ODC) develops, manufactures and markets sorbent products produced from clay, which are used for cat litter, industrial and automotive floor absorbents, fluid purification, animal health, and other applications. Their brands include Cat's Pride, Jonny Cat and Oil-Dri. The company is headquartered in downtown Chicago and is run by CEO Dan Jaffee, son of Chairman Richard Jaffee.  Richard's father started the company in 1941. The Jaffees control over 75% of the voting rights thru Class B shares and own stock valued at over $60 million. As public investors, we have a chance to participate alongside the Jaffee family.  

I've known Oil-Dri for about five years and was introduced by a friend who is a very smart small-cap investor.  In November 2012, while I was in Chicago for the Schwab IMPACT conference, I had a chance to visit with Dan Jaffee.  Dan joined the company in 1987 after a year with PriceWaterhouseCoopers.  He started as a product manager in the Industrial and Agricultural divisions and became CEO in 1997. Dan received an MBA from the Kellogg School at Northwestern in 2004 and speaks to how important that education was to his ideas on growth and strategy.

We'd like to highlight two of the key aspects of our investment thesis for Oil-Dri.  First, clay mines are scarce.  Oil-Dri has mines in Mississippi, Georgia, Illinois and California with 20 years of proven reserves and another 15 years of probable reserves.  They have a competitive advantage in that no one wants a new mine in their backyard.  Second, Oil-Dri has recently introduced new branded products, which bring a higher margin than the white label products manufactured for others.  In 2012, Oil-Dri increased spending on scientific research and marketing to introduce Cat's Pride Fresh & Light.  Fresh & Light provides 2x longer odor control and 25% less weight.  The formulation brings the buyer, which is typically a young woman, a lighter package to carry.  


As a result of the Fresh & Light product launch expenses, earnings were $0.85 per share in fiscal 2012 vs. $1.26 in fiscal 2011. Without research analysts and short-term stockholders to please, the stock was merely flat at near $21 per share for most of fiscal 2012. 


In fiscal 2012, Oil-Dri paid $0.69 of dividends per share and has paid dividends every year since 1990.  The common shareholders benefit from the Jaffee family's desire for dividends.  Oil-Dri has a market cap of just over $200 million.


Much to our liking, Oil-Dri is not followed by a single Wall Street analyst.  Management is focused on running its business, not on marketing the stock to investors.  Oil-Dri's 30-day average trading volume is under 15,000 shares per day.  The company and stock are under the radar screen of Wall Street.


The Needham Aggressive Growth Fund first bought Oil-Dri in the quarter ending December 31, 2012 and by June 30, 2013 had built a 0.7% position. We see margin expansion and revenue growth from the new branded products leading to higher earnings per share, which should lead to a higher stock price. 

A.T. Cross Co.

A.T. Cross Co.  (ATX) designs, manufactures and markets premium sunglasses under the Costa and Native brands.  Until last week, they also manufactured and marketed the famous Cross pens.  As a software salesman in the 1980s and 1990s, I used to buy Cross pens at 47th Street Photo for client gifts.  Last week, A.T. Cross sold its famous pen and accessories business for $54 million to private equity firm Clarion Capital Partners LLC.  The company is in the process of changing its name to Costa Corporation to emphasize the sunglass business.


A.T. Cross was founded by Richard Cross in 1846. The company was sold to Walter Boss in 1916. Russell Boss, Chairman, has been with the company since 1962 and oversaw the public offering in 1971. Boss family entities own Class A common shares and 100% of the Class B shares.  The Class B shares do not trade.  The family owns over 50% of the voting interests and has a like economic interest.


We first met the CEO Dave Whalen and CFO Kevin Mahoney several years ago at the Needham Growth Conference.  We understood the diversification and growth of the sunglass business, but the pen business seemed a major headwind.  Over time, we came to view the licensing opportunities in the pen and accessories business as potentially valuable.  Andrew Burns, D.A. Davidson's Active Leisure analyst, was one of the few analysts following the company.  In his July 2011 initiation, he argued for looking at A.T. Cross on a sum-of-its-parts basis.  He initially had a target price of $16. 


In February 2013, A. T. Cross announced that it would explore strategic alternatives for the pen business, which made our use of a "sum-of-its-parts" valuation even more relevant.   In March, I visited Dave Whalen at the headquarters in Lincoln, RI, and even shopped at the company store.  I believe few investors have visited Lincoln. The Needham Aggressive Growth Fund accumulated a 0.5% position during the first quarter of 2013 while the stock was $11-13.  The stock now trades near $20 per share.


A.T. Cross is now a pure play, specialty sunglass business with the great Costa and Native brands.  The company has a deliberate growth strategy, starting from its strength in the southeast and expanding into a few new states at a time.  With double-digit growth and expanding margins, the new Costa Corp. has a significant opportunity.  We believe it is likely to use the proceeds of the pen business divestiture to acquire additional brands.  We look forward to seeing how this cash is deployed.  Ultimately, A.T. Cross (Costa Corp.) will be a likely acquisition target for Luxottica (LUX), which has a market cap of $25 billion and owns Oakley, Sunglass Hut, LensCrafters, Pearle Vision, and many other optical brands.    


We are believers in fundamental equity research.  We love finding underfollowed, undervalued small-cap stocks like Constant Contact, Edwards Group, Oil-Dri and A.T. Cross.  We currently have a number of other stocks that are in the due diligence or starter position stages, and are constantly on the lookout for new ideas.  We are thrilled with the opportunity to research stock ideas like these for investors in the Needham Funds.


In a future Growth Factor, we plan to explore some of the lessons Chris Retzler and I learned from our pre-Wall Street years in software, medical equipment, finance, sales, marketing and operations, and how they apply to researching stocks.


Please call or email anytime if you are interested in talking stocks or investment philosophy. 
*The Needham Funds aggregate ownership as a percentage of net assets in the stated securities as of 6/30/13: PDFS 4.69%; EXA 0.04%; PCP 0.46%; AAPL 0.89%; ESRX 5.90%; VSAT 3.58%; DKS 0.92%; SDBT 2.21%; CTCT  0.30%; EVAC 0.17%; ODC 0.17% and ATX 0.19%. 
The information presented in this commentary is not intended as personalized investment advice and does not constitute a recommendation to buy or sell a particular security or other investments.
This message is not an offer of the Needham Growth Fund, the Needham Aggressive Growth Fund or the Needham Small Cap Growth Fund. Shares are sold only through the currently effective prospectus. Please read the prospectus and consider the investment objectives, risks, and charges and expenses of the Fund carefully before you invest. The prospectus contains this and other information about the Fund.


Investment returns and principal value will fluctuate, and when redeemed, shares may be worth more or less than their original cost. Shares held 60 days or less are subject to a short-term redemption fee of 2%. Past performance does not guarantee future results and current performance may be higher or lower than these results.  Current month-end performance and a copy of the prospectus is available at or by contacting the Fund's transfer agent, U.S. Bancorp Fund Services, LLC at 1-800-625-7071.


Funds holding smaller capitalized companies are subject to greater price fluctuation than those of larger companies. Also, the Fund's use of short sales, options, futures strategies and leverage may result in significant capital loss. Total return figures include reinvestment of all dividends and capital gains. Needham & Company, LLC, member FINRA/ SIPC, is the distributor of The Needham Funds, Inc.