Earnings season is here, and expectations are low enough to make me think that it will be regarded as a mild positive for stocks. A number of companies have already announced first-quarter earnings that were better than expected, giving a nice boost to those companies’ shares.
We’ve only had one reporting company before today and that was Intel (INTC), which did very well as discussed below. But the pace will be picking up pretty quickly, as Energy Conversion Devices (ENER) gave a “business outlook update” and Packeteer (PKTR) and Zhone Technologies (ZHNE) presented March-quarter results after the close today. My brief take on these three reports is below, and I will send you a Flash Alert on any news that might require a fast update. And then next week, the floodgates open.
But before we move into updates on our holdings, let’s take a brief look at how the markets have been acting recently and what we can expect throughout the rest of earnings season. Last Friday, the S&P 500 finished above its closing price from the day before the big global sell off on February 27, so that whole decline has finally been recovered. The market has been rallying nicely, but it is due for a rest to consolidate these recent gains and build up more bearishness, which will then drive the next leg upwards to 1510 on the S&P 500. It may just go sideways for two or three weeks until earnings season is over, maybe dipping to the 1462 breakout level, or it could retrace all the way back to 1438 and still just be consolidating. But, as we just saw, a quick, scary decline like the February 27 free-fall often turns out to be an extremely bullish sign. So, I’d rather see the retracement, because that is more likely to be followed by a slingshot move up to 1510.
If we see 1510 or better by the end of May, I am mindful of the old saying: “Sell in May and go away.” The trouble is, so are a lot of other people. So, if the S&P can get that high that quickly even with other people selling, it may mean the upside pattern is expanding as excess liquidity (dollars from the Fed printing press) pours into assets. The dollar is getting hammered day after day, and the British pound just went over $2 for the first time since September 16, 1992. Money fleeing the weak dollar heads for assets like gold, oil, metals, real estate and stocks, and that could set up a blow off to 1800 on the S&P this year. We surely do not want to miss that.
So, my inclination right now is to stay invested until the market tells us a more serious correction is in front of us. If that occurs, then we may sell very selectively to reduce our exposure and the number of positions in the New World Investor portfolio. I still have new recommendations that I’d like to make, but none of them are urgent and I’d like to be able to swap old positions for new ones rather than just keep adding to the list. The trouble is that most of our existing positions are too well positioned to sell. So, for now, I’m going to hold off on making any new recommendations, but when the opportunity arrives to take some profits off the table and roll that money into another exciting company, I’ll be sure to let you know. Now, let’s take a look at some of our current holdings.
Biotech MegaShift
Affymetrix (AFFX) and 30 leading European cancer researchers launched the Collaborations in Cancer Research Program, an alliance to use Affymetrix equipment to study new approaches to 10 different cancers. There will be regular meetings to exchange information, which will be easier with all the researchers using the same platform. This is a way for AFFX to leverage their own R&D by discovering what the researchers need, and then creating those products.
The company will also co-market a new system from NuGEN Technologies that should create significant new demand for Affymetrix gear. There are millions of old tissue samples in storage embedded in paraffin, many of them small and/or degraded over time. Researchers can’t use existing RNA amplification techniques to get enough material to study. NuGEN’s system amplifies and labels the nucleic acid in these samples, which can then be analyzed using standard Affymetrix equipment.
Affymetrix will announce earnings after the close next Wednesday. I am looking for $90 million in sales and five cents a share, both above the consensus, due to accelerating shipments of their newest microarrays. The stock has stayed above even my raised buy limit, but before I raise the limit again, I think we should see the numbers and hear the guidance. This is also the kind of stock that is subject to a “summer swoon” and may give us a chance to buy more shares under the current $26 limit for no reason other than general market weakness. Of course, if they say anything negative and the stock drops, I want you to buy AFFX on any dips under $26 for my $40 target.
Amgen (AMGN) was up $2.31 today after a clinical trial failed! What a strange story. The widely anticipated “145″ study was designed to evaluate whether increasing or maintaining hemoglobin concentrations with Aranesp in combination with chemotherapy increased survival in small-cell lung cancer patients. It failed to show a statistically significant difference in progression-free survival, although it did demonstrate a significant change in hemoglobin concentration in favor of Aranesp that might be useful in other venues.
But the reason the stock went up was that the trial clearly showed that the risk of death did not increase in patients who were given Aranesp, compared with those who were given a placebo. Aranesp’s safety has become the largest overhang on the stock, so the market paid more attention to the safety data than the efficacy data.
This is the first step towards getting the stock back on track. The next step is the April 23 earnings conference call, followed by the May 10 Oncologic Drugs Advisory Committee meeting at the FDA to consider safety, at which this data should play the deciding role. That means if you have been on the fence about buying the AMGN January 2009 $70 LEAP call (VANAM), now is the time. It jumped $1.12 or 19.6% today, but VANAM is still a great buy up to $12.50 for my $25 target.
Dendreon (DNDN) retraced all the way back below $16, not quite getting under my new $15 buy limit. I doubt all the shorts have covered, and there is still a lot of negativity surrounding the May 15 FDA approval date. For all the reasons I went into last week –Provenge combination therapy with Taxotere and the current FDA Commissioner — I still think Provenge will be approved.
I’ve had a lot of questions about what to do now with DNDN. So, I’d like to address a number of these concerns now.
John wondered: “Can you let me know how often the short interest position is updated, as the last date I can find is March 12th (approximately 32%) and I’m wondering how big or small that position is now, which will clearly be an influence as whether to buy, hold or sell before May 15. At some point we shall have to revert to fundamentals to value the business.”
Short sale data is collected once a month, as close to the 15th as possible. The exchanges report the data about a week later, and NASDAQ reports it a few days after that. I believe the April data will be as of the 16th, and NASDAQ will report it between April 25 and April 27.
Aneil asked: “Do you think FDA approval is priced into Dendreon at this point? What is a realistic price forecast for DNDN after the FDA approves the drug and shorts start to cover? How many short positions do you think are covered by now? Ameritrade does not even allow me to short DNDN at $18 a share.”
FDA approval definitely is not priced into the stock at this point — I would say the stock will hit $25 or $30 on that news. A marketing partnership or two (one for the U.S., one for Europe) would add another $10 a share or so. Short covering is just gravy. My guess is that about half of the shorts were covered by April 16, which is the next “as of” date. But the fact that Ameritrade won’t let you short suggests they can’t borrow the stock, and if that is true, very few shorts have covered. Knowing how the shorts behave, though, I find that hard to believe.
Incidentally, did you know that at most firms you can short the stock in your margin account while owning it in your cash account? That way, you can put on or take off a short position for price protection, without disturbing your cost basis on the underlying stock.
Michael H. asked a crucial question: “Does the potential approval of Provenge represent a paradigm shift for the FDA in its approval process, and does its rejection of Pharmacyclics’ Xcytrin reveal a struggle within the FDA over this shift? Or was the data for Xcytrin significantly poorer or different that it can be distinguished from Provenge in a way that the FDA can avoid setting a confusing or conflicted precedent? Your thoughts and evaluation would be appreciated.”
Indeed it does mark a paradigm shift, and the new FDA Commissioner is behind it. There is a real struggle between the process-oriented, old-line bureaucrats in the oncology division and some of the newer folks in biologics, led by the Commissioner. The data for Xcytrin was no worse than for Provenge, but the oncology division won’t even consider the application because it barely missed statistical significance. Pharmacyclics said that they will file anyway under protest to force a review. I know Richard Miller, the M.D. and ex-Stanford radiologist who founded and still runs the company, and without even talking to him, I can tell you that he is furious. He is in this business to reduce suffering and save lives.
Xcytrin treats brain metastases from non-small cell lung cancer, in combination with radiation, and a 554-person study showed a 5.4 month improvement in time to neurologic progression, when memory loss started getting worse. Nothing else has worked in these patients. And the treatment has a great safety profile. This is just the kind of — you should pardon the expression — crap that the FDA Commissioner is trying to derail. But the oncology division is a notorious quicksand pit for both useful drugs and Commissioners, so I’m sorry to say that I don’t think Pharmacyclics will get very far, even if the FDA does review the drug.
Pete asked: “Could you comment on Cell Genesys? I’d like to know what you think about their prospects for approval of the prostate cancer drug that they have under trial. The results seem to be better than what Dendreon had with Provenge. Might this be a company worth investing in? I’d like to know your opinion.”
Cell Genesys is developing a vaccine for advanced prostate cancer, but it is many years away from the market. By the time the company does their Phase III trial, the standard of care will be Provenge, not a placebo. By then, Dendreon’s “Phase IV” trial in 500 men will be done, and if the results are good enough, Cell Genesys may not have the efficacy needed for approval. I’m also not sure how the company is going to get through the next three years to a potential approval, as they burn close to $30 million a quarter and have only $125 million in cash.
Timothy asked: “What odds do you give for outright approval of Provenge? I was at the panel meeting and although the final tally was great, that didn’t happen until the chairman got the definition changed from “establish” to “substantial,” and his admonition that this isn’t a black and white vote. Doesn’t this give the FDA a lot of wiggle room for the decision?”
You are right about what happened, but the FDA already has all the wiggle room it needs if it wants to turn down Provenge. If my read on what Commissioner Andrew von Eschenbach is trying to do is wrong, or he doesn’t have enough power to pull it off, the FDA could turn it down. But following last week’s analysis, I think the odds of approval are as high as 90%.
Mike wrote: “I have a long position in DNDN that I plan to hold through approval and beyond. What I am wondering is if I should be trying some sort of option strategy (betting on approval of course) to further capitalize on what I think is a very safe bet. Please respond ASAP (time is of the essence) with how to make this play and what the ramifications would be. Also, in your opinion, what are the odds the FDA give their approval before the 15th of May.”
Mike, if you are talking about buying calls, I would not buy the May contract. I don’t think there’s much of a chance that the FDA will make a decision before May 15 — that just isn’t their style — and they could easily delay a decision for a week or two. That would make May contracts, which expire on May 18, worthless.
Given that, the most attractive contract today probably is the August $15 call (UKOHC), which sells for just over $6 and expires on August 17. But if you already own a good-sized position in the common stock, it may be smarter to put less money on the table and buy the August $22.50 contract (UKOHX) for around $3.75.
I expect the stock to appreciate towards $20 as the date approaches, and at that time it may make sense to buy an insurance put. At that time, the May $15 put (UKOQC) should be under $2 and the $10 put (UKOQB) around 50 cents. You could buy the May put contract, because if the FDA doesn’t speak by May 15, the bears will pound the stock. At this time, though, I am not officially recommending any Dendreon options in New World Investor. But if you get the chance before May 15, I recommend that you buy DNDN under $15 for a $40 target.
Isolagen (ILE) drew a couple of questions, especially about their UK operation. Miles wrote: “I have two questions about ILE. First, what is the timetable for Phase III to be completed? And for data to be submitted to the FDA? Second, if the product is so great, why shut down their UK operations? Was it not profitable? Why not? Why should we expect a U.S. operation to be profitable, but a U.K. one was not? This, I think, is what’s holding me up from buying this one. I believe these questions may be in the minds of many of your readers.”
First, the current Phase III trial is for wrinkles and nasolabial folds, and it is being done under a Special Protocol Assessment, which means neither the company or the FDA can change the trial requirements without consultation and agreement. And if ILE hits statistical significance in the trial, they automatically get approval.
The October 2006 agreement was for two identical trials, with 200 patients in each trial. They have already completed enrollment of both studies and started injections. However, they have encountered some scheduling problems and a manufacturing variability problem, and they are talking to the FDA about agreeing on some changes to the trials. Both sides have to agree. This delay probably means that the trial will not conclude until the end of the summer, with follow-up studies and data in the first half of 2008. I’d expect a filing for approval in 2008.
ILE is also about to file to do a Phase III trial for acne. They submitted a protocol to the FDA last December, met with the agency on March 2, and based on that meeting, they will file for the Phase III. That trial should start before the end of the year, with results in 2008 and approval in 2009.
Regarding the UK operation, the prior management of ILE and the management in London simply blew it. The product was approved with marketing restrictions, and the company’s expected improvements in manufacturing and cost reduction never materialized. They offered doctors large incentives to try the process, and in England’s government-paid health care system, that was an effective incentive. The trouble was that the doctors kept expecting to collect the incentive with every procedure. That meant ILE had negative gross margins, so they were selling the product at a loss.
On top of that, ILE did an informal survey of patient satisfaction, probably intending to collect testimonials, and found a small number of patients (149) who were not happy. The London management offered to retreat them for free, and most of them were happy with those results.
But then the doctors told other patients who had not been surveyed, and those patients started bombarding the company for a free second procedure. The company tried to resist, and then the doctors began bad-mouthing them — big surprise, given that the doctors would collect another incentive fee for the retreatment. The whole thing mushroomed out of control, and ILE London finally decided to offer a $1,800 payment or a free retreatment costing the company $3,600. They took a $700,000 reserve to cover the costs.
But the ill will from all this caused some doctors to avoid the process, and sales started dropping. In the September 2006 quarter, they did $1.2 million versus the $1.6 million the year before, and for nine months they were at $4.1 million instead of $6.2 million. So, the new management took a look at continuing to support an overseas operation that had botched the product launch, had negative gross margins and declining revenues, and said the heck with it. I’m sure it was fixable, but there is much to be said in favor of pursuing big opportunities, like the U.S. cosmetic dermatology market, instead of spending the same energy fixing small problems, like the UK mess. So, they shut it down. It was a gutsy decision, and makes me more confident that these are the right people to run the company right now.
I expect them to make an announcement when they have modified the Phase III protocol with the FDA, and that should start to move the stock back up. ILE remains a buy under $4.50 for my $9 first target.
Content on Demand MegaShift
Intel (INTC) unveiled 20 new products on Monday, and then followed up Tuesday by reporting March-quarter sales of $8.85 billion and 27 cents per share. While these were about in line with Wall Street estimates for $9 billion and 22 cents a share before a five-cent tax benefit, it is pretty impressive that the company could have a slight decline in revenues from last year, a slight decline in gross margins, and still grow earnings. The reasons include the $300 million tax reversal, their expense reduction program, employment down 11% from last year and their continuing share buyback program.
More important, Intel said that gross margins in the second half of the year will improve, with the fourth quarter better than the third. Wall Street had been worried that the slugfest with Advanced Micro Devices might cause price and profit pressures all year. But Intel said that they expect only normal seasonal price declines, and the company is reducing costs faster than prices come down, by implementing new manufacturing technology.
The stock moved up about $1 after the report, pushing our LEAP options up. Wall Street was pleasantly surprised by the gross margin guidance, and a round of upgrades is underway. The next good news will be an acceleration in PC sales, as businesses start upgrading to Windows Vista. I think Intel will earn around $1.20 this year, well above the Street estimate for $1.08, and at least $1.50 in 2008, where the Street is at $1.33. As this strength unfolds, I think the stock will trade up to $35, where our January 2009 $22.50 LEAP calls will be worth my $12.50 target price. They are a Top Buy under $3.50 and a steal at current prices.
Silicon Image (SIMG) drew a question from Mike that I am still researching: “I am quite concerned about SIMG after reading Needham’s recent report on the company. Needham has it as a hold because, among other things, they believe that SIMG management’s view that the market for TV chips will “dis-integrate” into front-end input processors and back-end video processors is wrong. They say competitors are scrambling to introduce single chip System-on-a-Chip (SoC) solutions and believe that the market will quickly adopt SoC. Are Needham’s argument’s legitimate, in your estimation? If not, why? Ultimately, do you still feel that SIMG represents a good investment for us or has it become too risky?”
I have some of my best industry contacts working on this, and I don’t have a hard answer for you yet. It’s a complex issue. Today, two separate processors provide much more power, but increased cost. The SoC solution will have to be a very big chip, and it isn’t clear how much cheaper it will be, assuming equivalent performance.
At the same time, we are at the inflection point for digital TV growth. During 2005 and 2006, the TV market adopted the HDMI standard and we saw an explosive growth rate. More than half of all digital TVs ship with HDMI. From 2007 through 2010, we will see 600% growth in annual unit shipments of HDMI-enabled devices, including virtually everything in the digital living room. No matter what happens with SoC, Silicon Image’s revenues are going to grow very rapidly. But I follow Andy Grove’s dictum that only the paranoid survive, and I will pursue this issue until I have a solid conclusion. As always, subscribers will be the first to know. For now, though, SIMG remains a Top Buy under $13 for my $20 target.
Zhone Technologies (ZHNE) reported after the close today, and the conference call starts in a few minutes. They did $43.1 million in sales and lost three cents a share. The consensus of four analysts was for $41.8 million and a loss of three cents a share, so they hit their number. DSL revenues grew 15% sequentially. I don’t expect the call to be a love fest — the stock is down 17 cents in the aftermarket — but this shows a promising base for resumed growth based on the DSL products. ZHNE remains a buy under $2 for a $5 target price.
New Energy Technology MegaShift
Energy Conversion Devices (ENER) is holding a “Business Update Call” in a few minutes. They preannounced a big revenue shortfall, apparently from everything except the now-profitable solar business, and an equally big restructuring plan. I think Wall Street will like it, but we will have to see tomorrow. It’s down $2.89 in the aftermarket.
ENER said that they will report about $27 million in sales when they file their 10-Q on May 8. The consensus was looking for $32.5 million. About $24 million of the revenues came from United Solar, with all the rest of the company contributing the other $3 million. So, they are consolidating everything into two operational units, United Solar and Ovonic Materials. Then they are cutting $17 million in annual costs in a first-phase restructuring that is already underway, which is to be followed by an additional second-phase that will begin in the September first quarter. Most of the cuts will be in the new Materials operation.
This is a serious attempt to become a sustainably profitable company, keeping R&D going on new solar and battery initiatives, while getting rid of excess R&D projects. If Wall Street reads it wrong and knocks the stock down tomorrow, take advantage of any opportunity to buy ENER under $32. I am not changing my $55 target — these moves actually bring it closer. If I hear anything out of line on the conference call, I will send you a Flash Alert early tomorrow, but I don’t expect to have to do that.
Gasco Energy (GSX) sold 10 million shares at $1.93 last week, and the stock has been mired around or just under $2 ever since. Glenn and many others asked if the stock sale changed my recommendation or target prices, and if GSX is still a Top Buy. I know this stock has been extremely frustrating, as it trades with natural gas prices, but my view of the likely course of energy prices has not changed, so GSX remains a Top Buy with an unchanged $4.50 buy limit and an unchanged $9 target price. Outrageous as it may sound, we are one geopolitical event, bad hurricane season or cold winter away from hitting the target price.
Ocean Power Technologies (OPWT, or OPT on the London AIM Exchange) drew a question from Vince: “I recently saw that there will be an IPO under the symbol OPTT. It seems to be the same company. Can you explain what’s going on? I really like this idea.”
I couldn’t find a pending IPO with OPTT as the symbol. There is a Bulletin Board company named Ocean Power that builds desalinization plants, but it is tiny and not trading right now because they are far behind on regulatory filings. I like OPWT, too, and I recommend that you buy it on any dip under $2 for my $4 target.
Infinity Energy Resources (IFNY) got the well back into production that had a fire in mid-March. The month-long outage, plus the costs, may impact the quarter a bit, but that is not the important factor. Within the next 60 days, IFNY will open the envelopes on bids for different parts of its business and, indeed, for the whole company. Recall that those assets include:
- One of the most productive oil fields in Texas, where this company’s wells lead in productivity due to their experience and technology;
- Natural gas wells in the Canadian Rockies to feed the utilities supplying power to the new Oil Shale Recovery Program, a source of domestic oil that can supply the entire U.S. needs for the next 100 to 200 years;
- And a fabulous 1.4-million acre oil concession off Nicaragua, where seismic studies show five or more monster oil fields.
The stock closed today at $3.47 with a total market capitalization under $65 million and little debt. After they open the envelopes, I expect INFY to trade at $8 to $12 in a matter of days. In fact, if we don’t at least double our money in this stock by the end of the summer, I will be shocked. IFNY is a Top Buy immediately up to $5 for my $10 target.
Security MegaShift
Packeteer (PKTR) reported after the close today, and their conference call also starts in a few minutes. They reported $34.7 million in sales, better than their preannouncement and the consensus $32 million, but lost nine cents a share pro forma, worse than the preannouncement and the consensus estimate of a one-cent profit.
Regarding the additional detail on the shortfall that management promised to provide, CEO Dave Cote said: “After reviewing the most recent quarter, we believe that the revenue shortfall resulted mostly from longer product evaluations and proof of concept trials performed by various customers. We believe this resulted from an increasingly competitive marketplace, and our inability to deliver several product enhancements to our acceleration product lines by quarter end. We currently expect to deliver these enhancements by mid May, and as a result expect a 5% to 10% sequential revenue increase in our upcoming second quarter.”
That would be $36.4 million to $38.2 million in sales, far above the $34.3 million the consensus was expecting.
Dave went on to say: “Along with modestly slowing our planned second- and third-quarter investments in various functional areas in the company, and continuing to accelerate the development and launch of several new products later in the year, we remain very optimistic about our long-term business opportunities. We also recognize the importance of returning to our target levels of profitability as quickly as possible, while delivering new products that are important to our customers and the expanding market.”
That is Cote-speak for “we have figured out the problem, know the solution, and will bounce back fast.” PKTR is a Top Buy up to $12 -It may jump tomorrow, but I would not hesitate to buy it for my unchanged $22 target.
Video iPod MegaShift
Burst.com (BRST) was the subject of an email from Pat: “Michael, any update on Burst.com? I can’t recall any recent comments with their litigation with Apple.”
There’s nothing to report. At this stage, whatever negotiations or discovery processes are underway tend to stay behind the scenes. I would not be surprised if we hear nothing until the day a settlement is announced. I still think that will happen, and BRST remains a buy on any dip under $1.15 for my $2 target.
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