The volatility continues, although it is starting to feel more like a game to force the Fed to cut rates on September 18 than a real reaction to some new news. You see, the plunge on Tuesday came out of the blue, and the commentary was all about old issues, followed by “the Fed had hoped their actions so far would stabilize markets, but that hasn’t happened.” Then yesterday’s big rally was attributed to hope that the Fed will cut the ever-important Fed funds rate on September 18 “or even sooner.” These hopes were ignited when Chairman Bernanke sent a letter to Senator Chuck Schumer saying that the central bank would “act as needed” if the economy appeared to be imperiled by the troubles in the financial markets.

Note that he didn’t say that the Fed would act just because of the troubles in the financial markets. But for Wall Street mucky-mucks and hedge fund managers, those are the only troubles that matter — yearend bonuses are imperiled! So, strategists on CNBC were saying that a Fed rate cut is “imperative,” and you can bet that if tomorrow’s Bernanke speech at the annual Jackson Hole conference doesn’t say something to acknowledge these financial pressures, the market will tank again.

So, let’s assume that the Chairman is backed into a corner and cuts rates. Then what? The dollar will plunge, but it won’t affect most Americans because they don’t travel to Europe. Today’s June-quarter GDP revision up to +4.0% shows that the economy is OK so far, and Wall Street already expects growth to slow to +2.0% in the current quarter. Surveys show that both consumer and business spending will grow in the December quarter, although at a slowing rate. Earnings will be OK, in part thanks to the falling dollar. The VIX Fear & Greed Index, which dropped less than three points yesterday while the S&P 500 gained more than 30, is still high enough to power a 200-point rally. So, as you can see, we’re not at a point where we need to be panicking and throwing stocks out the window.

The breathtaking round-trip for the SPX over the past few days was just the expected test back down to the last breakout level at 1430, although it seemed like a bigger deal because we are in a much larger pattern than we’ve gotten used to over the last year. That’s good, because it keeps the possibility of a parabolic upturn intact. Tuesday’s drop and Wednesday’s rise looked very similar to the Friday drop and Monday rise back on August 3 and 6, when the S&P broke back over 1455 and ran to 1503. Here we are again.

This is a critical balance point, and we will either get one last panicky test down to 1405 before heading up, or just break out right now. It depends on how the news goes in the economy, housing, a sub-prime mortgage bailout to buy votes for the 2008 election and the Fed. But even if we get the panicky test, I think that the market is setting up for a big run. With virtually everyone looking for weakness or a possible crash in the dreaded September to October period, what better trick for the market to play than rally right through that and on into March 2008?

The August 16 bottom looked like a major low to me, and if that’s the best that the bears can do before the Fed rides to the rescue, the next easy direction is up. We should see the S&P get over 1479 and then break through 1530, 1555, 1610 and 1710. At any or all of these levels there could be quick, scary declines or periods of consolidation to build energy for the next upleg.

If the market does go down first in the traditional September to early-October weakness, it will be weaker earnings news and preannouncements that drive it. One market analyst swears that stock market crashes often start with a lunar eclipse, which we had before dawn on Tuesday, and said that the sharp Tuesday drop didn’t surprise him. I haven’t seen his comments, if any, on the offsetting Wednesday rally. Predictions like this need to be taken with several grains of salt.

Our best course of action is to stay calm, take advantage of weakness here and there to add to positions, and wait for the market to tell us if it really wants to go down substantially from here. My read is still that a big rally is coming, possibly a parabolic move up, and we need to stay fully invested. So, I have redone the Top Buy list this week to focus on the stocks that I think can move the most over the next few months in an up market.

With that said, let me just point out one thing. I know it’s hard to watch our holdings take a beating when the market is having a down day. But it’s important to remember that we are focusing on development-stage companies in emerging industries. So these companies are bit more susceptible to the market’s down days because they are riskier positions. In the long run, though, these companies have the potential to dramatically outperform the market because they are operating in areas of rapid real growth, often in MegaShifts that are happening on a worldwide basis.

Now, let’s take a look at what’s been happening in our MegaShifts this week.

Biotech MegaShift

Amgen (AMGN) scored two straight wins in their patent lawsuit against Roche, and the next big win for the company will be with the FDA on September 11. The Federal District Court in Boston ruled that Roche’s CERA drug clearly infringes on one of the five patents that Amgen alleged, and the court granted Amgen’s motion for summary judgment. This was the same composition-of-matter patent that Amgen used to beat Transkaryotic Therapies, before the same judge. The judge also ruled against Roche on a number of its other defenses. A trial starts on September 4 on the other patents, if Roche really wants to fight an endgame before settling and paying legal costs and royalties.

On September 11, the FDA’s Cardiovascular and Renal Drugs Advisory Committee and the Drug Safety and Risk Management Advisory Committee will hold a joint meeting to consider the risks and benefits of Aranesp, Epogen and Johnson & Johnson’s Procrit in kidney dialysis. The agenda will be available about 48 hours prior to the meeting. I do not expect any change to the current treatment recommendations, but these types of meetings can be unpredictable. So, I’ll keep you posted on the outcome of the meeting.

The new Medicare rules on when Aranesp and Epogen will be reimbursed when used for cancer patients have been out long enough for the medical community to come to a consensus: They are unworkable and will not save any money. Private payers, which account for 60% of cancer reimbursement, are likely to adopt an 11 grams per deciliter (g/dl) cutoff for hemoglobin before using the drugs, down from the current 12 g/dl but more practical than Medicare’s 10 g/dl limit. At some point, Medicare will be forced up to 11 g/dl due to stresses on the blood supply and poor patient outcomes, but that could take a year or two.

With the patent win, the September 11 meeting soon to be behind us and private payers about to adopt a less damaging hemoglobin policy than Medicare, Amgen’s stock should be ready to recover. Plus, the company’s cost reduction program will protect earnings, and they have a terrific pipeline of new drugs. Buy the AMGN January 2009 $70 LEAP calls (VAM AN) up to $12.50 for my $25 target — over 13X on your money from current levels.

Content on Demand

Akamai (AKAM) has several officers selling stock under distribution plans filed with the SEC, and that caused Peter to ask: “This stock seems to have a large overhang of ‘Planned Sales’ by a bunch of management. Why buy when they are saying sell?”

There are two reasons that these sales don’t mean anything. The first is that technology managements get a large percentage of their compensation in stock options, to align their interest with ours: Do well, and get the stock up. It makes no sense for them to hold every share, because they would be terribly underdiversified with most of their assets in one stock, and their job is also dependent on that one stock.

So, it is normal for all tech companies to have a steady stream of small insider selling. What used to make people angry was when the selling accelerated just before bad news came out. This led to the plaintiff’s bar suing every company that had a problem and a declining stock, alleging that the stock sales before the bad news were based on inside information. So, companies implemented Planned Sales, where a management person commits to selling a fixed number of shares every month, regardless of the price or news. Usually, the amount sold is trivial compared to the amount owned.

So to sum up the second reason and this long-winded answer to your question is: Planned Sales don’t have any information in them, because by definition the stock will be sold whether the coming news is good or bad. They aren’t saying sell — they aren’t saying anything. The company lawyers won’t let them. I am taking AKAM off the Top Buy list because it has gone over my buy limit, but I still would buy it on any dips under $30 for my $60 target.

QuickLogic (QUIK) was the subject of an article in EETimes Online that focused on the company’s change in strategy from competing with Altera and Xilinx to selling Customer-Specific Standard Products. But the reporter put a negative spin on it, saying that the company chose the wrong technology for the older PolarPro line introduced in late 2005.

The truth is that QUIK’s one-time programmable PolarPro only fits a few niches in the traditional Altera/Xilinx markets of telecom, storage and networks, but it is a natural for the consumer handheld device market. So, QUIK has introduced the ArcticPro with a controller included. They can sell the customer a low power-using, ready-to-go chip that is specific for a customer’s core platform, and the chip can be easily modified to add or subtract the features that create a full line of products. Thus, a line of music players could include one with hard disk storage, one with removable flash memory, one with a Wi-Fi connection, one with a Wi-Fi and a Bluetooth connection, and so on — all based on the same QUIK design. The chips would all have long battery lives, instant-on use and any kind of copy protection (or none). By using these chips in their products, QUIK’s clients can get to market quickly, keep introducing new variations of the product and adapt to their new customer demands.

With the holiday product building season starting directly ahead, now is the time to complete your QUIK position. I’d hoped to get the second half of our positions closer to $3, and it did trade down to $3.06 for a minute at the August 16 bottom, but otherwise this stock has been very stable between $3.25 and $3.50 during the whole decline. I am making the stock a Top Buy and raising the buy limit to $4. I want you to build a full position now. My target remains at $8.

New Energy Technology MegaShift

Energy Conversion Devices (ENER) reported a pretty good quarter and gave decent guidance, but an analyst downgrade clipped the stock. The company reported sales up 29% from last year to $36.0 million, of which United Solar Ovonic accounted for $29.5 million, up 36%. They lost 16 cents a share before restructuring and retirement charges, compared with the consensus for a 12-cent loss. Some of those retirement charges are because founder Stan Ovshinsky is retiring on Saturday, and Bob Stemple is handing over the CEO slot on Sunday, while keeping his spot as Chairman of the Board.

The company guided for $40 million to $45 million in sales for the September first quarter, higher than the consensus for $41 million. For the June 2008 fiscal year, they are looking for $220 million to $245 million, compared with an average estimate of $228.4 million. Gross profit margins will remain under pressure as they dramatically expand their solar production capacity, but the restructuring program will start to pay off, and there will be a second round of cost reductions before the end of 2007. It looks to me like they are headed in the right direction, but the Cowen & Co. analyst said that he expects profit margins to fall as the company introduces new products, and they won’t be profitable until fiscal 2009. That’s what clipped the stock.

I am still looking for them to turn profitable this fiscal year, in the March or June quarter. In addition to expanding their existing solar facility to 58 megawatts capacity, their new 120-megawatt facility is on schedule. They are moving some assembly to China and Tijuana, with the latter facility also on schedule and budget.

The new CEO, Mark Morelli, was President of the Carrier Commercial Refrigeration unit of Carrier Corporation and has a good reputation as a nuts-and-bolts manager. With Bob Stemple still in the ambassador-at-large position to the auto industry, the Cobasys joint venture with Chevron should continue to roll. ENER and Chevron are looking at “strategic alternatives,” and I expect them to take it public in the next six months if the market is as good as I expect.

I think the decline in the stock is a temporary reaction to a negative analyst, and this is a buying opportunity to get ENER well under my $35 limit for the $55 target.

FuelCell Energy (FCEL) jumped after they reported June-quarter results and announced two contracts that may finally open Wall Street’s eyes to what is really going on here. First, the numbers. Revenues hit $13.5 million, up 55% from last year and well ahead of the $11.9 million consensus estimate. That included product sales of $7.8 million, up 45%. They lost 24 cents a share, down from 37 cents last year and better than the 33-cent loss consensus estimate.

The first contract that FCEL won is with Ford Motor, which is buying a fuel cell for a Canadian plant. It will reduce paint solvent emissions from painting cars. The plant produces about 200 pounds of volatile organic compounds per hour in the painting process, and Fuel Cell Energy will feed those compounds into their fuel cell to produce electricity! It is scheduled for startup in early 2008, and if all goes well, I expect Ford and other auto makers to install many more units.

The second contract with the Turlock Irrigation District here in California will use methane from wastewater treatment to drive a 1.2 megawatt fuel cell power plant, producing electricity to run the District’s pumps. In both of these cases, an emissions problem became the feedstock for a power plant. It is not just about hydrogen any more.

FCEL’s Direct Fuel Cell stationary plants run at a 47% efficiency rate, well above conventional power plants, and a combined cycle plant where the customer can use the waste heat approaches 80% efficiency.

In Connecticut, all of FuelCell Energy’s 68 megawatts of clean energy projects were submitted by two utilities for consideration by the Connecticut Department of Utility Control, which is expected to render its decisions on which projects to fund by December. When FCEL breaks above resistance at $10, it is going to soar. There are 14.5 million shares sold short, or 31% of the float. Buy FCEL while it is under $11 for my $22 target.

Ocean Power Technologies (OPTT) drew a question from Scott: “What do you have to say about OPTT that would make me hold it rather than selling at a loss of over 20%? It is now down to 63% of your Buy Up To price and 32% of your target price. Why is it not a Top Buy? Is it going to continue heading the other way?”

I have liked the way OPTT has acted during this volatile period, as it seems to have a rock-solid bid at $12, except for the August 16 panic dip. I think that we saw the bottom that day. But the reason to hold OPTT is that they are winning new contracts and pilot installations, and wavepower is about to take its rightful place with geothermal and onshore wind as an alternative energy technology that does not need subsidies to be practical today. Chevron just filed for a wavepower farm off the Mendocino coast of California, and I am going to follow the permitting process with great interest. This is just the sort of demonstration project that could turn Governor Schwarzenegger from solar to wavepower as California’s main alternative energy source.

Ocean Power is not a Top Buy because there is no near-term event to be the catalyst for a sharp recovery in the stock. It deserves to be in the mid-$20s, and it will get there. But every stock on the new Top Buy list has a major catalyst coming before the end of the year to drive it much higher. Still, OPTT is a superb buy at current levels and, as Scott pointed out, all the way up to $20 for my $40 target.

Robotics MegaShift

iRobot (IRBT) will introduce two more types of home robots on September 27 at the Digital Life Expo in New York. Management is being coy, just saying that they are “very cool” and “very different” from the Roomba and Scooba. The CEO said: “They’re not floor-cleaning robots. They’re not lawn mowers, and they’re not butlers. But that’s all we’ve said so far. These robots are going to make you think.”

That made me think that I should try to find out exactly what they are, and I found one in an FCC filing: A gutter-cleaning robot. iRobot has to get FCC approval because there is a remote control antenna on it, and they filed the whole owner’s manual.

I don’t know where “Looj” came from, but this looks just like the toy that your Dad wanted when he was five years old. Will this be the Dad holiday gift of the year? It has two cool treads, a handle to put it in position that detaches to become a remote control (requiring FCC approval), and a very cool “distruptor/ejector/sweeper” auger assembly out front for clearing out the drains. Then a 500 RPM rotating sweeper scrubs the gutter. The manual says that it does one gutter at a time, so it has to be moved by hand at any gutter junction. It has a belt clip to make it easier to move around — how can your local Tom The Toolman hold up his head if he doesn’t have a Looj on his belt? I want one, and I have gutter covers.

I haven’t been able to find the other new product — laundry? Ironing? Walk the dog? The company released the Verro pool cleaning robot in April, so they could be going in any direction. “These robots are going to make you think.” Hmmm — will it be a chess robot? A football coach robot? We’ll see on the 27th.

Roomba is one of the most successful consumer robots ever made, with well over 2 million units sold. The new Roomba 500 series that tops out with the Roomba 570 for $400 is the first major revamp since 2004, and it is getting great reviews. It has double the suction power, lasts up to five times as long because all the components are modular and can be replaced by the owner, can automatically clean multiple rooms using a “lighthouse” guidance system, shuts off when it gets to tassels on the edge of a rug, and can get itself out of most jams. It includes a voice tutorial built in to the vacuum, which you can watch here.

iRobot managed to sell off its inventory of the last models ahead of this release, so there shouldn’t be a hit to earnings this quarter other than the usual introduction expenses.

Even as the consumer business starts to grow again, the military side looks great. PackBot robots have saved many, many soldiers’ lives in Iraq, and the Department of Defense now wants a next-generation Small Unmanned Ground Vehicle to let soldiers remotely conduct reconnaissance and get real-time intelligence while remaining out of harm’s way. For example, a soldier could toss one of these robots through a window to search a building for enemy combatants, instead of sending in troops. iRobot is working with Boeing to develop SUGV Early, and they will deliver the first prototype early next year. It will be a lighter and smaller version of the 60-pound PackBot, coming in around 30 pounds. The CEO said: “That’s going to be a huge new leg on the government and industrial side” of iRobot’s business. Market researchers believe that the market for PackBot-class robots over the next three to five years is about 2,000 to 3,000 units, but the market for SUGV-class robots is about 10,000 to 20,000. They’ll also be bought by SWAT teams and possibly commercial security firms. Incidentally, iRobot has other robotics projects underway with Lockheed Martin, Taser and Deere (the robotic organic farmer?).

The stock is above my buy limit, after the big jump earlier this month following their increased guidance. I don’t want to raise the buy limit because at this point I can’t see more than $30 for a target price, but buy IRBT on any dip under my $19 buy limit for the $30 target price.

Security MegaShift

SiRF Technology (SIRF) is getting cheaper and cheaper for absolutely no good reason, so I am making SIRF a Top Buy for the next several months. It’s trading at the same levels that it did two years ago, but earnings are 4X higher now than then. The Price/Earnings ratio is about half of its growth rate. This is a gift.

I think Wall Street is worried about SIRF’s market share and their exposure to Motorola’s (MOT) cell phone business. Competitor STM Microelectronics won a design at Garmin for a chip with an integrated processor. SiRF will use technology from their recent Centrality acquisition to introduce a similar product. But SiRF already has integrated the RF (radio frequency) functions, and STM Microelectronics has not. It will be much easier for SiRF to add an integrated processor than it will be for STM to add RF.

The point here, though, is that the market and applications for GPS technology are exploding, and both SIRF and STM are in the right place. Wall Street is focused on design wins, when they ought to be looking at overall market growth. I want you to add SIRF to your portfolio immediately, with a $22 buy limit and a $40 target.

It’s been quite an interesting August. Typically, during the dog days of summer the market putters around without much news to drive it in any particular direction, as many institutional investors scurry to the beaches for one last vacation. But this year, as you know, it has been different — the S&P plunged almost 40 points at the start of the month, shot back up seven days later to 1503.89, dropped to a low at 1404.36 mid-month and then darted back up to close at 1462.50 today. That’s as far from puttering as you can get.

So the question that I’m sure is weighing on every investors’ mind is: what can we expect next? So far, the Flash Alert that I sent you on Monday regarding the “Bernanke Put” has been spot-on, as the S&P 500 has moved up 93 points from last Thursday’s intraday low. Now that it has broken through the 1455 level, I would not be surprised to see a few more days of consolidation like today, and even a quick test or two back down. But as long as the S&P doesn’t close under 1452, I think the move back to 1530 is underway. Also, it’s important to note that the VIX Fear & Greed index is coming back down slowly, which suggests that there is enough negative sentiment to complete the run to 1530. In fact, as soon as there is an event that says “the scary, emotional period is over,” look for the Dow Jones Industrial Average to jump 400 to 500 points in a day, with the S&P 500 up at least 40 points.

After that, who knows? My suspicion still is that we will go much, much higher as the Fed prints money and cuts rates to bail Wall Street and the banks out of the sub-prime mess that they created. One clue to watch is the ever-weakening dollar, especially after Labor Day. If the markets are going to succeed in forcing the Fed to cut rates, it will show up early in a rapidly declining dollar. A break below July’s low level of 80 could trigger a minor collapse, sending gold, silver, oil, stocks and even real estate soaring again. In some ways, it would be the simplest path for the Fed to rescue the real estate market.

(Incidentally, if you meant to book a trip to the International Space Station, don’t delay. Earlier this year, Space Adventures was charging $25 million for a seat, but they just raised it to $30 million. They’ve already said it will go to $40 million in 2008. Their reason: The falling value of the dollar.)

Even a break back to 1430 or 1405 would not mean that the bull market is over, but it would be a hard test for many short-term investors to stay bullish. Barring a hurricane or geopolitical event, that much of a test is unlikely at this point. Everyone knows Washington Mutual and National City Bank are in deep trouble, and there will be massive additions to loan loss reserves in the September-quarter reports. But the banking and brokerage stocks with major real estate exposure have already been decimated — that’s what caused a big part of this decline. So, I don’t think any of the credit headlines will have the ability to pull the S&P back down to the low 1400s. We’ll watch and see, though, and continue to base our actions on what the market is telling us to do.

As things quiet down, and earnings reporting season tails off, I want to take this week to update a few stocks that have significant news and answer some subscriber questions. Many of these concerns focus on one company or another, so we’ll cover those stock questions in their respective MegaShifts. Before we get to those, though, I’d like to start with a general question from Irv: “Right now I’m holding a total of 33 stocks you have recommended to buy. Of these stocks only eight are in a positive situation. Some of these down stocks are so far negative that it will take a long upsurge up just to get back even. Are you still standing by your belief we will get these losses back?”

On most of the stocks that you are referring to, the answer is yes. In the market that I see coming through the 2008 elections, we will be selling many of these at a profit. There are some, like QLT (QLTI), UTStarcom (UTSI), Zhone Technologies (ZHNE) and MobilePro (MOBL), where there isn’t enough time to get them profitable before a serious bear market sets in. In those cases, I am tuning my advice to reduce losses. But the vast majority of them has improving fundamentals and will hit their target prices before the macroeconomic outlook forces us to sell.

Biotech MegaShift

Amgen (AMGN) is waiting for the September 11 FDA meeting that will review the use of Aranesp and Epogen for kidney dialysis. We have already seen the impact of the review of their use for cancer, especially in high, off-label doses. I don’t think there will be any change in the use for dialysis, which is an on-label use that has had massive amounts of data and clinical study, both before and after approval. But subscriber Marti wrote: “Unfortunately AMGN goes down and down and there is no end in sight! Now there is a meeting with the FDA on September 11 and I am afraid of the stock’s reaction after that! Are you still sure that AMGN will be at $75 by the end of the year? What happens if there is bad news for AMGN?”

Marti, I think AMGN put in a bottom at $48 a few days ago, but, of course, it has to go back there and test it before we will know for sure. I feel your pain on this one, but as I said above, I don’t think anything bad will come out of the September 11 meeting — and that alone could drive a $10 relief rally. If I’m wrong about that, the stock will get hit hard.

But if I’m right, in a good market I still think that we’ll see $75 by the end of this year. However, that is not the right time period to look at. We are buying January 2009 LEAPs because we want the extra cushion of another year to let Amgen right their ship. They have already announced dramatic cost reductions to protect their earnings, and they can accelerate clinical programs to get new drugs on the market faster than Wall Street currently expects. So my eye is still on $95 by mid-January 2009, which would make the $70 LEAPs worth $25. Continue to buy the Amgen January 2009 $70 LEAP call (VAM AN) up to $12.50, with a $25 target price. I think you want to own these before the September 11 meeting, and if you are nervous about that, buy out-of-the-money September 2007 puts to hedge your position.

Dendreon (DNDN) jumped this week for a silly reason — they reported Phase I trial results for Neuvenge for breast cancer in the August 20 issue of the Journal of Oncology. Neuvenge was “safe and well-tolerated” and “stimulated significant immune responses” in the18 patients in the trial. The study included patients with aggressive metastatic breast cancer who had failed to respond to chemotherapy. According to the article, four of the patients (22%) had evidence of anti-cancer activity, including three whose illnesses did not deteriorate for more than a year

Surprise. Neuvenge is Provenge by another name, and I’m not sure why Wall Street thought this was worth gapping the stock up 7% on Monday. About half the gain has stuck, probably because so many shares are sold short. The shortsellers can be counted on to keep you in a state of panic until the interim results for Provenge come out next year or the company signs a European marketing agreement. Those are the only two things that really matter right now.

The stock drew a couple of recent questions, the first from John: “I recently read that DNDN will sell a 4.75% convertible note, yielding 10 million shares. How will this dilution affect us? Negatives surround DNDN and growing, not value?”

Biotech companies have to raise money until they get their product on the market, and selling the convertible note was pretty cheap financing. Dendreon raised $85 million. The extra potential shares will not matter for the next few years, because when a company is running at a loss, extra shares reduce the loss per share, so companies are not allowed to calculate the per share loss using the extra shares. In my opinion, the $85 million will let the company build shareholder value quicker by funding some small Phase II trials for Neuvenge. And even though the positives are growing, not the negatives, the shorts will try to keep you blind to that fact.

Which brings me to Steven’s question: “What is the true value of DNDN? I’ve received recommendations to buy puts on this stock with the notation that it is worth $2 to $4.”

Dendreon will be worth $40 a share when Provenge is approved. If the interim peek does not show statistical significance next year, the stock may well go to $2 or $4 for a while. Then, after the Provenge trial wraps up in 2010, the stock will go to $40. So don’t chase it on meaningless news that it did well in a Phase I trial. Instead, buy DNDN on dips under $7 for my $40 target.

Isolagen (ILE) was the subject of a question from Fred: “I blindly jumped into ILE and that seemed to be the kiss of death as it has moved from $4.50 to under $2.00. Is this just another chance to double up?”

Isolagen dropped after they put an important clinical program on hold, and although they have not restarted it, they are about to. Here is the full story: Isolagen has two major strategic programs, Aesthetics and Therapeutics. We are primarily interested in the Aesthetics program, which means cosmetic medicine for baby boomers. The Therapeutics program is important as an additional way to create value from their technology, but it will take longer.

In Aesthetics, they have two clinical programs: Wrinkles/Nasolabial Folds for the lines that run from the nose to the corners of the mouth, and Full Face Rejuvenation for finer lines and wrinkles anywhere on the face. It was the Nasolabial program that had a problem.

The company’s troubles came from two identical pivotal Phase III trials that the FDA approved in October 2006 under a Special Protocol Assessment, which means if they hit statistical significance, they get approval. Each trial includes 200 patients, and all the patients were enrolled and injections started in early 2007. But then ILE ran into a manufacturing problem that messed up the schedule, so they had to go back to the FDA and file an amendment to the study protocol and their manufacturing and control submission. So, of course, the stock took a hit. But the FDA approved that amendment on July 11, and injections will begin again shortly and be completed in October. We should get results early in 2008.

The Full Face Rejuvenation trial is a Phase II open label study (no placebo) in 50 patients, spread across five investigators. About 45 of them have been enrolled, and they will be followed for six months following their last injection. We should hear the results on this around mid-2008, and it could move the stock sharply due to the headline-grabbing impact of “look 20 years younger.”

In Therapeutics, Isolagen has four clinical programs targeting acne scars, restrictive burn scars, acute burn scars and dental papillary recession. The acne scars program is about to enter a Phase III trial, pending FDA approval of the program Isolagen filed in July. I am expecting approval after Labor Day, and this trial will begin shortly thereafter.

The restrictive burn scars trial is a Phase II program. The company filed for approval to go forward in February, and it is about to start a 20-patient demonstration trial with two investigators. Isolagen thinks that they can reduce or eliminate restrictive burn scars, which cause a permanent tightening of the skin that can affect the underlying muscles and tendons to limit mobility and possibly damage nerves.

The acute burn scars prevention program will be entering a Phase II trial, but the company has only had preliminary discussions with the FDA so far, and there is no approved trial design yet. Isolagen wants to use their therapy about six weeks after the burn event — which is just about when scar formation begins — to prevent the formation of both restrictive burn scars and hypertrophic (red, thick, raised) scars. We will know this program is progressing when Isolagen files a formal IND for the Phase II trial.

The dental study targets the problem of receding gums, as measured by the gap at the lower part of each tooth. In the second quarter of 2005, they completed a Phase II trial and found that both investigators and patients saw improvements that were statistically significant four months after treatment. But that was on a visual scale, so then they took actual measurements and the results were not statistically significant. So in 2006, they started an open-label Phase II study in 11 patients who will be followed for a longer period of time, with the trial completed and data evaluated in the first half of 2008. If the trial results are good, they will probably do another, larger Phase II study before proceeding to Phase III, so the payoff from this program is a ways away.

Clearly, the key to the stock in the near-term is the Phase III Nasolabial program, which was a successful treatment in Phase II trials, and I don’t see any reason that won’t follow through to Phase III. We should hear the results in the next six to eight months, and a successful outcome will guarantee approval under the Special Protocol Assessment. The company had proposed raising $50 million in new stock and convertible debt, in part to pay off some old convertibles. But they withdrew that filing and this morning completed a registered private placement, raising $13.8 million to get them through this period.

A successful Nasolabial product will have a huge market, and the total market capitalization of ILE has fallen under $80 million. The manufacturing issues were a management stumble (the Chief Medical Officer was replaced in February and the CFO promoted to COO in June), but that is behind them now that the FDA has greenlighted resuming the study. And I think they were wise to raise a smaller amount of money with the stock so low. So, Fred, this long-winded answer to your question is: Yes, double up now or buy ILE under $4.50 for my $9 first target, on the way to $25. And isn’t it nice that it seems to have bottomed and is back up near $2.50?

Rochester Medical (ROCM) got some stunningly good news. Medicare established new rules last week to withhold additional payments to hospitals for treating preventable medical errors and hospital-acquired infections. The rules go into effect after October 1, 2008, and payments will be withheld from hospitals for treating catheter-associated urinary tract infections and other problems, like bed sores. Catheter-associated urinary tract infections account for 38% of hospital-acquired infections, or 561,000 cases last year. The easiest way to prevent them is with Rochester’s Release-NF silicone catheter incorporating nitrofurazone.

Nitrofurazone is a broad-spectrum antibacterial agent, and I had a great question at the San Francisco Money Show from a doctor subscriber who challenged my statement that it is not an antibiotic. You may recall that one of Rochester Medical’s allegations in the lawsuit against C.R. Bard, Tyco, Premiere and Novation was that those companies told hospitals that Rochester used an antibiotic that might lead to antibiotic resistance. The doctor subscriber said that as far as she was concerned, nitrofurazone may not technically be an antibiotic, but it was just as bad.

I really like feedback like that, and I take it very seriously. I spent several hours researching nitrofurazone and discovered that even researchers throw around the phrase “antibiotic” very casually. I read several scientific papers that called nitrofurazone an antibiotic.

But I also learned the difference between an antibacterial and an antibiotic. Medicinal chemists call antibiotics any drugs that kill bacteria and come from natural sources like molds. So penicillin G is an antibiotic, because it is produced by fermentation of Penicillium chrysogenum. Completely synthetic organic compounds that have structures very similar to natural antibacterials are also designated as antibiotics. So even though Ceftriaxone is made synthetically, it is also called an antibiotic, because Cephalosporium molds produce compounds with the same fundamental structure.

But not all antibacterials are antibiotics. Synthetic antibacterials that are not similar to natural antibiotics are not classified as antibiotics, and there are a lot of these, including the quinolones, oxazolidinones and sulfa drugs.

Furthermore, some antibacterials, whether classified as antibiotics or not, may be called antimicrobials, because they are also effective against viruses, funguses or parasitic microorganisms. That’s why penicillin G is the drug of first choice for syphilis, which is caused by a spirochete, not a bacterium. And tetracyclines are preferred against the rickettsia that cause typhus.

So, I called Jim Conway, the CEO of Rochester Medical, to confirm all this and get his perspective. He pointed out that because the nitrofurazone is in the silicone and slowly comes out into the urethra, it never enters the bloodstream and therefore it is unlikely to create resistant bacteria. Also, nitrofurazone appears to have two mechanisms of action against bacteria, and it is very difficult to have a mutation that protects against both mechanisms of action at the same time. Finally, the drug was used for years in chicken and cattle feed without developing any resistant bacteria. (It was banned because traces of it were found in the animals after slaughter.)

My conclusion is that it is technically correct to say that nitrofurazone is not an antibiotic and, even more important, it is very unlikely to cause bacteria to mutate to a resistant strain.

With the upcoming change in Medicare rules, Rochester’s future is made. Tyco spun out its healthcare subsidiary as Covidien, and I expect a settlement of the remaining antitrust lawsuit against Covidien and Novation any day. This is a stock that you have to own at current levels. This company has a lot of great things going for it, and I expect the stock price to continue to move up, so I recommend that you get onboard now. ROCM remains a Top Buy up to $23 for my $40 target.

ViroPharma (VPHM) was clobbered when Wyeth stopped dosing hepatitis C patients in the Phase II study. ViroPharma’s drug, HCV-796, is partnered with Wyeth, which stopped the trial because 8% of the patients taking the drug were experiencing higher liver enzyme levels, compared to only 1% of the patients in the standard of care arm of the trial. Higher liver enzyme levels are an early indicator of liver-related disorders for any drug, and they are a bigger problem than usual here because hepatitis C affects the liver to begin with. The FDA says that elevated liver enzyme levels are the #1 cause of all drug adverse events and, worse, of all new drug application rejections.

The only positive from all this is that the truncated study results showed good activity in eliminating hepatitis C for certain patients who previously failed treatment with the standard of care. Fully 23% of those patients had undetectable levels of the virus in their bodies after only 12 weeks of treatment, and there are no other good treatment options for these non-responder patients. But that would be a much smaller market than VPHM, Wyeth or Wall Street was looking for, so the stock was hit. I got numerous emails on this, and David asked for the bottom line: “What do you feel should be done with VPHM after this steep drop.”

First, this caught me by surprise, as it has not been an issue in previous trials. Of all the hepatitis C polymerase inhibitors, HCV-796 was the furthest along in clinical trials and could have been a big win. I have taken it out of my model completely, although it may get approved for patients who have failed everything else.

But remember that this was a Phase II trial, and ViroPharma has the antiviral Camvia in two Phase III studies now enrolling — one to protect stem cell transplant patients from infection with cytomegalovirus, and the other to protect liver transplant patients from the same infection. Data from the stem call Phase III is due in the second half of 2008.

Of course, ViroPharma is still fighting the generic Vancocin war (and winning, it appears to me), so getting replacement products into and through the pipeline is vital to winning buy recommendations from Wall Street. At this point, with the stock bouncing back about 25% in the last week, the company has a market capitalization just under $700 million. It will have operating income of at least $100 million this year, and it had over $260 million in net cash at the end of the June quarter. June-quarter earnings easily beat Wall Street estimates and the company raised 2007 sales guidance for Vancocin.

I think that they will take their cash hoard and the remaining cash flow from Vancocin before generic competition hits in 2009 or 2010, and make a strategic acquisition of an approved or near-approved product to replace the Vancocin revenues. That has been the strategy all along — we bought the stock knowing Vancocin would go away in 2009 or 2010. This is a really superb management team, and while the clinical failure of HCV-796 is a big negative, the reaction in the market has been way overdone. I am lowering my buy limit on VPHM by $1 to $12 to reflect the HCV-796 failure, and lowering the target price by $3 to $25. That means the stock is an excellent buy at today’s prices.

China MegaShift

UTStarcom’s (UTSI) dip to the $3 area has depressed many, including Barry, who asked: “UTSI down another 12% today, and off 90% since the buy recommendation. Where do we go from here? Or do we wait for the stock to disappear from the Board?”

UTSI needs to change its CEO and show continued orders in Internet Protocol Television and broadband data access to get Wall Street liking it again. I’m not too worried about the orders, but when UTSI will change the CEO is a lot less certain. The stock is very cheap relative to sales, and that alone may spark a takeover offer. Given the recent firing of the heir apparent, my numbers are too high, so I am reducing the buy limit on UTSI to $4 and the target price to $10. But I still think it can be bought, as it seems completely sold out at these levels.

Content on Demand MegaShift

Intel (INTC) may have a capacity problem supplying enough computer motherboards in the second half of the year, according to rumors. If so, this is testimony to the acceleration of the Vista upgrade. It’s going to be a good year for PCs, and I don’t think you have much longer to buy the Intel January 2009 $22.50 LEAP calls (VNLAX) under $5. My target price is $12.50 at expiration, based on INTC hitting $35 over the next 17 months.

Motorola (MOT) should see some action shortly, as Carl Icahn bought 45.9 million more shares, more than quintupling his stake to 55.3 million shares, or 2.4% of the company. Shareholders are probably sorry that they didn’t vote him on to the Board in the recent proxy fight. I am expecting CEO Ed Zander to either resign or find a white knight to acquire the company, possibly taking it private. Icahn’s moves will accelerate that timetable. The Motorola January 2009 $17.50 LEAP calls (VMAAW) remain a buy up to $4 for a $10.50 target ($28 on MOT minus the $17.50 strike price) in January 2009.

Silicon Image (SIMG) drew several subscriber questions, ranging from Michael K’s: “What on earth is going on with SIMG?” to Michael C’s: “A few months back you addressed a question from a subscriber (me) regarding potential competition to SIMG’s HDMI technology. At the time you said you were going to continue to research the issue and provide an update in the near future. I haven’t seen the update yet and was wondering if a) you had completed your research and are ready to share your findings with us and b) if the recent huge slide in SIMG represents a good opportunity to double down on our investment. Please advise and thanks.”

Seward also asked: “Would you please discuss Silicon Image’s business prospects in greater detail? I bought the stock last year at $8.85, enjoyed the move up to $14.50, but now am seemingly going down with the ship. I understand that the selling in the stock is probably exacerbated by the market’s overall weakness, but your analysis seems off. Analyst estimates for revenues and earnings have been trimmed repeatedly this year and the company is guiding down. Since hitting a 52-week high of $14.68 in October of last year, the stock has lost 67% of its value. It appears as though the market thinks that SIMG’s supposed technological advantage is either shrinking or has disappeared. I thought that this was a bottleneck technology but now believe that I was wrong. Your price target seems hopeless at this point.”

Let’s start with Michael C’s question on the potential competition from IBM’s DisplayPort standard, which is free of royalties. That is attractive to some low-end personal computer manufacturers. But it has no other advantages over HDMI — they both have the same 10 gigabit bandwidth, and thus the same resolution, and they both transmit audio, video and data on the same cable. The difference is that HDMI is in hundreds and hundreds of consumer products already, and it is not likely to be displaced.

So, will DisplayPort take over personal computers? On the one hand, companies like Advanced Micro Devices have said that they will supply DisplayPort-compatible graphics cards in 2008 to any PC manufacturer that wants them. But in my book, most PCs are consumer electronics and will need to deal with peripherals like HD-DVD and Blu-ray disk players. DisplayPort cannot deal with digital rights management software, and HDMI can. To me, it makes more sense for an LCD panel manufacturer to stick with HDMI, which can be used as a TV or computer display, than to go to DisplayPort for their computer displays. It also makes more sense for the consumer to buy the more flexible display, considering the very low price differential.

So, moving on to one of Seward’s questions, I think HDMI is still a bottleneck technology. SIMG stock came down 30% in two days after the company beat the upper end of its revenue guidance by nearly a million dollars, beat the upper end of its gross margin guidance by 0.7 points, and guided for double-digit growth with less price pressure and better margins in the second half of the year. Here’s what CEO Steve Tirado said:

“We expect to see another quarter of double-digit growth in our unit demand. … We also expect to see average selling price pressures begin to moderate given our expected product mix with a focus on product margin improvements in the second half of 2007. We believe that our second-half 2007 product gross margin will experience a modest improvement relative to our second-quarter 2007 product gross margin.”

The stock was hit because their positive outlook was not positive enough — it was below Wall Street expectations. So on Monday, Steve Tirado bought 20,000 shares on the open market, increasing his position to 140,000 shares. For those of you who hate to see insider selling, the CEO buying that much stock should give you confidence. SIMG bounced 9% on Tuesday, and with the holiday season for consumer electronics just around the corner, the stock has probably bottomed. I still think that they deliberately guided low, and SIMG is a buy up to $13 — more than a double from today’s close –for a move to $20.

Telkonet (TKO) dropped a bit after naming their new Chief Operating Officer, prompting Jim to ask: “Recent ‘good news’ from TKO apparently has hurt the stock rather than help it, down 15 cents today. WAS this good news or should we take this reaction as a sell sign?”

Jim, this was really good news. No one may care until he is moved up to CEO, and I think that could happen in the next 60 days and will happen by the end of the year. The stock dropped 15 cents after they reported June-quarter results, with $3.7 million in sales and a loss of $4.6 million, or seven cents a share. Revenues were at the high end of their guidance and up substantially from the first quarter’s $1.25 million and last year’s $1.2 million, as several large programs got underway towards the end of the quarter. The loss was down from $7.6 million or 16 cents a share last year. Their energy management and Federal systems businesses will drive further revenue acceleration in the September and December quarters. They are targeting profitability in December.

So what did Wall Street not like? Eric Kainer of Thinkequity Partners, who has been negative on TKO since he was at Needham, came out and reiterated his “sell” recommendation. He has been right for the last year, and I have been wrong. But I think the accelerating revenues and the imminent change of leadership at the top make a big difference. With Google and DirecTV now blessing Broadband-over-Power Lines via investments in and deals with Current Group (private), TKO’s moment has come. Buy TKO up to $5 for my $15 target.

New Energy Technology MegaShift

Natural gas prices plunged more than 10% on Monday after Hurricane Dean turned away from the U.S., the biggest one-day drop in four years. Tuesday, prices fell another 3.2% after Dean weakened to a Category II storm, and September contracts hit $5.85. But prices came right back on Wednesday to climb back above $5.85, which held today. This sets up a good-sized rebound move at least to the $6.50 breakdown point.

The move in gas matches a corrective pattern in crude oil that started at the end of July and has brought prices down from $78 a barrel to just under $70. This is the same consolidation range that we saw in mid-June, before the breakout to $78, and I expect it to end the same way. These full tests down to the last breakout level shake out as many bulls as possible, before the trend resumes. In this case, summer driving season is coming to a close and there haven’t been any serious hurricanes, yet oil prices are still near $70 as we enter the heavy industrial use period in the fall. With China growing well above that government’s 10% target and world production flat to falling, it isn’t hard to see why we keep getting higher lows and higher highs in oil prices.

Infinity Energy Resources (IFNY) dropped after what I thought was a good conference call, drawing questions from Susan, Gabriel, Doyce and others. Doyce’s questions were representative: “Within the last month you were predicting Infinity would double by the end of summer. I assumed that you were talking about the summer of 2007 — is this correct? If so, what happened, since it is now worth only about 50 % as much as it was a few months ago. Did the quarterly report issued about a week ago have any good news in it? I didn’t see any and from the market response of the last week, it doesn’t appear to have impressed any buyers. If your recommendations are still favorable on this stock when can we expect a turnaround? I am an admirer of your logical presentation of financial advice, but the action on this stock make me wonder if you missed the boat here. I would appreciate an updated analyses based on the most recent quarterly results.”

I think the main problem with the stock has been the dramatic weakness in natural gas prices, which probably bottomed yesterday. I commented on the June-quarter results in last week’s Radar Report and, unlike Doyce, I saw lots of good news in it. Deals are in motion and will be announced, the management team is being upgraded, and they are about to start proving up their massive Nicaraguan oil lease concession. I think you will see the stock move when deals are actually announced, and those announcements are imminent. IFNY remains a Top Buy all the way up to $5 for my $10 target, based on their huge potential in Nicaragua.

Lighting Science Group (LSGP) drew a good question from Michael K.: “You recently recommended LSGP as a buy, and mentioned Iroquois Capital taking a significant stake. Is their arrangement like that of Cornell and MobilePro? Cornell and the naked shorts ran MobilePro into the ground, and it appears that LSGP cannot shake the naked shorts either. Is this because of LSGP’s financing arrangement with Iroquois Capital?”

Michael, I don’t think that these arrangements are the same at all. I work from a long checklist developed over the years from things that went wrong, and need to be checked. Before I recommended LSGP, I checked Iroquois’ status with the SEC and their reputation in the industry. They are one of the largest investors in private equity transactions for public companies, doing over 100 transactions a year. They seem to have a good reputation and don’t make money by running companies into the ground.

LSGP did make quarterly payments on its convertible bond in stock in 2006, but a big chunk was converted into common stock this year. They will continue to pay in stock to conserve cash, around one million shares for this year. That is not the kind of spiraling dilution that got MobilePro in trouble.

I don’t think this stock will be under 50 cents a share for long, so if this kind of very small company is your cup of tea, buy LSGP under 50 cents a share for a move to $1 in 2008, $2 in 2009, $3 in 2010, $4 in 2011 and $5 in 2012, when the California incandescent light conversion deadline hits.

U.S. Geothermal (UGTH) took a nice 40-cent jump on Monday and has been trading higher ever since. I don’t think you are going to get a chance to buy the rest of a position any cheaper, so I am raising the buy limit on UGTH to $3 and the target price to $6.

Robotics MegaShift

iRobot (IRBT) jumped over my $19 buy limit last week after The Associated Press broke a story that: “The Pentagon plans to purchase up to 3,000 additional robots to be used by U.S. soldiers in Iraq and Afghanistan to detect explosive devices and roadside bombs.” It’s a little more complicated than that, but this would be a big contract for the company, worth around $180 million based on iRobot’s selling price of $60,000 per PackBot. That’s almost as much as the company’s entire revenues in 2006. One thousand PackBots will be ordered this year, with 2,000 more to follow over the next five years. (Did you know that the Department of Defense is planning to be in Iraq and Afghanistan until 2012?)

One thousand robots, or $60 million, is still a big order, but iRobot may have to split it. Foster Miller, a subsidiary of Britain’s QinetiQ Group, makes the Talon bomb disposal robot with similar capabilities at about the same price. There’s even a chance Exponent’s MARCbot could get some of the business, even though it is not as advanced as the PackBot, as it is cheaper. Still, even sharing the contract will generate a nice chunk of change.

One company that is not likely to get a share of this contract is Robotic FX, formed by an ex-iRobot employee. They make a tactical surveillance robot called Negotiator that looks like the PackBot, but they claim will sell for only $20,000. iRobot has sued them in Federal and state court for patent infringement and misuse of confidential information.

Another threat to iRobot that I am watching is the new armed robot from QinetiQ’s Foster Miller. Only three of these bad boys have been deployed so far, but they are designed to wheel into combat or door-to-door searches and shoot people. According to National Defense magazine, the U.S. Army started putting Foster Miller’s SWORD armed robots into combat a couple of months ago, and it can get rid of roadside bombs in addition to (or possibly at the same time as) shooting people.

iRobot does not make an armed robot, and they’ve never talked about a development program. The Army says that reaction by soldiers has been so positive that they want 20 more SWORD robots immediately, part of an 80-unit purchase authorization. According to the Pentagon, robots will be 33% of our combat forces by 2015, as part of the $127 billion Future Combat System Program. I suspect this is a direction that iRobot has to go in order to keep up with competition.

With the holiday season coming, sales of Roomba and Scooba home vacuums should pick up. IRBT remains a buy on dips back under $19 for my $30 target.

Security MegaShift

SiRF Technologies (SIRF) drew a question from Sherry: “What is going on with SIRF? Is it still a buy?”

The second part of your question is easy to answer: Just go to the website anytime, 24 hours a day, and you will see my up-to-date recommendation. Any changes to my buy advice will be noted there, as well as in a Flash Alert or Radar Report. As for the first part, since I recommended the stock three weeks ago on the day that it broke to close at $20.09, it hasn’t done much but consolidate just below $20. SIRF has presented at a couple of technology conferences since then, and I think it is clear that Wall Street is waiting for the September-quarter results to decide if the next five points on the stock are up or down. I think they will be up, because so many consumer electronics products that will be gift items this year include GPS. So, SIRF remains a buy while it is under $22 for my $40 target.

WiMAX MegaShift

MobilePro (MOBL) said that the sale of Kite Networks to Gobility fell through after Gobility was unable to raise the required $3 million in capital by August 15. MOBL has the option to re-acquire Kite immediately, and the company is in discussions with other possible buyers. They also might sue Gobility for breach of contract, but good luck on that. If Gobility has no money, why sue them?

MOBL pointed out in their 8-K filing that if they can’t sell Kite, MobilePro will be on the hook to make substantial back payments to Kite’s equipment lessors. They also have sold their payphone and Internet service provider business to United Systems Access. These sales need regulatory approval before they can close, and United Systems Access is acting as the owner in the meantime, including paying some of the Cornell Capital interest. Assuming this deal closes, Cornell Capital will be paid off. However, if it doesn’t close, MOBL will not be able to continue as a going concern without restructuring the Cornell Capital debt. But I think the deal will close.

However, Kite Networks’ municipal Wi-Fi systems have run into the same problems as everyone else: Lower usage than forecast. These systems take time to get installed, due in part to regulatory and permit requirements, and they are expensive to build. Weak subscriber growth brings the whole business model into question.

I think we should give the company until the end of the year to close a deal to sell Kite, close the various sales to United Systems Access and get Cornell Capital paid off. We can then see what we have and decide whether the stock is worth more as a tax write-off or for a recovery. I am really sorry I got us into this one — I should have realized that Cornell Capital’s SEC problems meant that we should never have had anything to do with a company that they are involved in. Don’t ever wrestle with pigs — you both get dirty, and the pig enjoys it. For now, hold MOBL until their restructuring plays out.

Thanks for all your great questions. I have no doubt from reading what you ask and meeting so many of you at Money Shows that you are the smartest group of subscribers any investment newsletter writer could have, or wish for. Keep those questions coming!

Early Friday morning we all learned that there is a “Bernanke put,” although it is not as strong as, and it’s given more grudgingly than, the “Greenspan put.” In both cases the “put” is that if big financial institutions get in trouble, the Fed will bail them out. So, if you are a little guy who borrowed money on a sub-prime mortgage as your one shot to achieve the dream of home ownership, and now your monthly payment is resetting to the sky with zero chance of refinancing or selling at your cost, it is time to pack your stuff and get out — you lost.

On the other hand, if you are a big hedge fund, with good Wall Street connections, that overleveraged in sub-prime mortgages and need a few billion dollars to stay in business and collect your fees — Bernanke will bail you out. You are “too big to fail” as that would introduce “systemic risk” to the financial system.

It really is galling the way that Wall Street portrays itself as the last bastion of cutthroat capitalism, where the free market rewards the strong and crushes the weak. But, of course, once they get themselves into a hole, due to their own cupidity, out comes the beggar’s bowl asking for a bailout. And, as seen on Friday, they always get it.

The Bernanke put was cleverly done. Instead of cutting the Fed funds rate, which might lower rates for all the strapped individuals in adjustable rate mortgages, Bernanke cut the discount rate that banks pay to borrow from the Fed by a half a percentage point, or 50 basis points. Normally, this rate is a full percentage point higher than the Fed funds rate, so Big Ben just whacked the increment in half. Pretty smart. With Bank of America saying that they will no longer lend on real estate in Florida, the Fed can now call them up behind the scenes and tell them that they are expected to take down enough money at the lower discount rate to convince Bank of America to change their minds.

The reaction in the stock market on Friday to the Bernanke put was virtually instantaneous. The S&P futures shot up 50 points in less than two minutes. The message to anyone on the sidelines or, heaven forbid, actually short stocks, was mighty clear: Run! And run they did. If the Fed had done nothing, those 50 points probably would have been to the downside, hitting the 1326 weekly breakout point that I talked about in last Thursday’s Radar Report. On the other hand, if Friday wasn’t an options expiration day we might have seen an even bigger move up. As it was, the 1440 level that I’ve talked about so much acted once again like a magnet.

I’ve seen some talk that the VIX volatility index has to hit 40 before we can say that the downturn is over and a new upleg has begun. That is nonsense. The VIX hit 37.50 Friday and closed at 29.99. Those are high numbers, even for a bear market, and they should help provide enough energy to run the S&P up hundreds of points, if everything else lines up. I expect the S&P will now march up to the 1530 breakdown point, and what happens from there will depend on a lot of factors, including what the Fed does at their next meeting on September 18, any hurricanes that impact oil prices and, most important, how the internals of the S&P look when we get to 1530. I’m not saying that it is impossible to see the VIX go to 40 and the S&P crack back down, but that is not the most likely path and certainly not worth basing your actions on in advance.

As always, we should let the market tell us what it wants to do. Right now, it is saying: “I want to go up.” Don’t be surprised to see little dips back down like this morning, testing various minor support levels from the move up. Even a quick, scary decline back to 1404 would not indicate that the Bernanke put rally is off course. One of the keys that I will be watching is the VIX. If it comes down slowly, or even holds steady in this area, the rally could extend quite far. If it comes down rapidly, indicating that the hot money is getting complacent again, 1530 may be as good as it gets.

Either way, right now you should be fully invested. If you’re looking for a good place to put some money to work, I recommend that you start with my Top Buys list, the New Energy Technology MegaShift, the Biotech MegaShift and the Content on Demand MegaShift. My newest recommendations — Akamai Technologies (AKAM) and CombinatoRx (CRXX) are especially good buys right now.

It’s been a giant game of tug of war this week for the broad market, with the bulls pulling for higher levels and the bears yanking for lower levels. Through yesterday, the S&P 500 seemed magnetized to 1440, with any significant move below that level bringing out buyers, including the Plunge Protection Team on any sharp moves lower. But any significant move higher ran into news that housing is still in the dumps and the consumer is pulling back. So, the market dips back down again. Yesterday was quite remarkable in itself, with the S&P rallying to 1440 at 1:43 p.m. EDT and then plunging 34 points in two hours and seventeen minutes to a new closing low for this decline at 1406.

Not only was the speed of that plunge remarkable, but 1406 is a major support level, as it was the breakout level set on March 12 and then it was broken to the upside on March 20. That began the slingshot move that capped the bull run so far, and while it stopped Wednesday’s decline cold, it gave way this morning. The S&P was sitting near the lows of the day at 1377 with 49 minutes left to trade, when the Plunge Protection Team struck. The bears were congratulating themselves on knocking the market down 34 points in just over two hours yesterday, so the PPT ran it up 35 points in 49 minutes today, closing the index up for the day. Take that! Most of the upturn was panicky short covering ahead of tomorrow’s options expiration.

Now that the S&P has broken 1406 and then 1395, the big weekly breakout level at 1326 has moved to center stage. It has never been tested, but that could happen very quickly if we go back down next week and break today’s 1371 low. Let’s focus on that.

Crash or No Crash?

I define a crash as a drop of 15% or more in 90 days or less — sometimes as little as one day. I know that the current market certainly feels like a crash in slow motion, but let me give you some perspective that comes from 37 years of being in the stock market every day.

First, even if the S&P goes down to test 1326, that would be a 14.7% drop from the highs set in mid-July (and a 6.1% drop from today’s close). True, a few more points would make this an “official” crash, but it would be very, very difficult for the market to drop much below 1326 unless the whole credit system comes apart right now. Even that level would be well up from the double bottom around 1200 seen in June and July 2006, which makes for a bullish chart even though it certainly doesn’t feel that way right now.

Second, it’s been four years and four months since the S&P had a 10% correction, which finally happened today when the S&P traded under 1398. The last time we saw a 10% correction was during that long period of January through March 2003, which bred complacency that showed up in a low volatility index — the VIX. Well, as you know, volatility is back. It jumped this past February after the Chinese markets tanked, and it has been at a higher plateau ever since. Yesterday, the VIX spiked up to 30, a level last seen in March 2003, at the bottom of the last 10% correction, and today the VIX closed up another point at 31.70. So, it has also been over four years since we’ve had this much fear in the market.

We had a 7.5% correction last summer, but with no hurricanes and falling oil prices, the broad market was able to stage its big rally into 2007. Then we had a 7.9% correction from the July 19 high to when the S&P hit 1433 on August 3. Since then the market has rallied and subsequently fallen sharply, but as of today, we are only down 1.5% from the August 3 close. I know it doesn’t feel that way, because Tuesday, Wednesday and most of today were brutal. But the markets are very oversold — there have been five days since June when more than 90% of the stocks were down for the day: June 7, July 24, July 26, August 3 and August 14.

Four years and four months is a long period to go without a correction of this magnitude — it’s only happened three other times in the last 110 years. And after each of those three runs, there was a very serious correction. A 10% correction is a normal event in a healthy bull market. There is a reason why it took so long for this correction to occur, and it continues to be one factor that is confusing the markets at this time: The weak U.S. dollar. European investors have seen a couple of 10% corrections in the U.S. market in euro terms in the last few years, but in nominal dollar terms it hasn’t happened yet. That’s because a weak dollar props up equity prices.

My third point is that bull markets don’t end with spike tops. They sell off sharply, as in the March 2000 to June 2000 period, and then rally back near the top, as in July and August 2000, before finally breaking down. In fact, they often drop and rally back a few times in a complex topping/consolidation pattern before breaking down. At worst, we are currently experiencing the first drop, and we will likely see a rally back to the 1550 area before a bear market really begins in earnest. At best, that rally will blow right through 1550 and then 1600, and the bull market will resume. So, we should still see higher levels from here no matter what scenario plays out.

In trying to identify the likely short-term bottom for prices to bounce from, it bothers me that the big weekly breakout level at 1326 has never been tested. Normally, markets will go back down to touch the breakout level before spring boarding to new heights. We are probably about to find out if the support level is 1326 now or later. In a crash, we could get to 1326 in one day.

So there are two possible scenarios that could play out: One, the S&P could be poised to build on today’s recovery back over the 1395 or 1406 breakout levels, or two, it could be getting ready to spiral down. There isn’t any way to predict which way it will go, as that depends on the news flow, what the Fed does, whether some big hedge funds collapse, and if we get into either a panic selling cycle that feeds on itself, like the October 1987 crash, or a panic buying cycle that feeds on itself, like the Gulf War I rally in January 1991.

If the first scenario occurs or if we go down and the 1326 level holds, whether it is hit in a crash tomorrow or, more likely, in early October, there would be overwhelming negative sentiment and revitalized short selling hedge funds to provide the energy for a parabolic rally over 1800 by the 2008 elections. Plus, a VIX in the 30s can push the S&P up hundreds of points as it falls back towards 10.

But if the second scenario plays out and 1326 doesn’t hold, the economy would almost certainly go into recession (there are no signs of that yet in the leading indicators) and business capital spending would follow consumer spending into the tank. That’s the classic way a business cycle ends, and it usually takes big Fed interest rate cuts to revitalize the housing sector, which normally leads us out of a downturn.

So far, the Fed is remarkably complacent about the market’s current situation, and I think that we should give them credit for that. Alan Greenspan would have cut the Fed funds rate by a half or three-quarters of a point by now, letting Wall Street exercise the “Greenspan put” to bail them out of any predicament. Not only did the Fed not cut rates at last week’s meeting, they didn’t even say anything to give comfort to their Wall Street buddies, who are in extreme pain as their leveraged hedge funds implode. Yesterday, St. Louis Fed President Bill Poole actually added to the pain, saying that the financial market chaos has not undermined the U.S. economy, and there is no need for the Fed to rescue the market with an emergency rate cut. Here are a few telling quotes:

“It’s premature to say that this upset in the market is changing the course of the economy in any fundamental way. Obviously, there could be an impact, but we have to rely on some real evidence.” Of course, by the time there is “real evidence” reported on the economy, it is already too late to prevent a recession, because the Fed’s tools work with about a six-month lag on employment and output. (But they work with a much shorter lag on the credit and stock markets, which is why the stock market is the best predictor of the economy.)

Poole said that the credit crunch would extend the housing slump, and it is not clear how long the downturn will last or how deep it will go. But, he added: “The issue for me is whether it’s going to spread into business fixed investment and the consumer segment more broadly. I don’t see evidence that that’s taking place.” Again, he wants “evidence” on a lagging indicator — business fixed investment — and a coincident indicator — consumer spending. The Fed should be looking at leading indicators due to the six-month lag between when they do something and when the results can be seen in the real world.

“I have not changed, fundamentally, my outlook. As I talk to companies, their capital spending plans are intact.” Capital spending is another term for business fixed investment, a lagging indicator.

“If the data confirm the market’s view that the economy is sagging, we’ll have to decide whether to share that view.” Wow, not only will they not act until we are in a recession, they may not even believe the data at first!

He also said that while U.S. inflation was “moving in the right direction,” the “job is not done.” Translation: Sorry, guys, can’t ease yet.

Then Poole said that, barring a “calamity,” there was no need for the Fed to consider cutting interest rates before their next regular meeting on September 18, even though the Fed funds market has been pricing in an earlier cut. Everyone on Wall Street is looking for the Fed to aggressively cut rates to bail out the market, but the Bernanke Fed may not be so quick to cut rates each time the market declines. Maybe they want to send a message to the market that this is not the Greenspan Fed, and Wall Street might be on its own for a little while.

Also, the yen surged 2.0% yesterday to a 12-month high against the dollar, which probably means that some of the hard-pressed hedge funds are getting out of the yen carry trade, where they borrowed cheap money in Japan and bought sub-prime mortgage debt on 10% margin. I have been saying that the weakness of the dollar in 2006 and the first half of 2007 was against the euro and the pound, and in the rest of 2007 and 2008 will be against the yen (and the yuan, of course). The dollar hit a new multi-year low yesterday. If you believe as I do that a decision has been made to drop the value of the dollar dramatically against our trading partners, thereby dropping the value of all the dollar assets they hold, then maybe the current situation suits Chairman Bernanke just fine.

The flight from stocks has also brought 10-year Treasury note yields down to 4.66%, lowering the cost of selling new debt to finance the Iraq war deficit. That’s another beneficial side effect for Bernanke.

Bill Poole is a voting member of the Fed, but he is also more of a monetarist than the other members, and, ultimately, it will be Chairman Bernanke who calls the tune. But if the Fed doesn’t roll someone out quickly to stake out a different position from Mr. Poole, the markets will assume silence is assent. Banks have already stopped lending, consumers are slowing spending, and you can bet that capital spending for 2008 will get whacked during the budget-setting sessions that start right after Labor Day.

The biggest negative that I see is that taking a recession in a Presidential election year is called the Jimmy Carter Strategy, and I’m not sure how the Republicans plan to beat Hillary Clinton if they have the country in both a religious civil war and a recession at the same time. Perhaps Karl Rove has it all figured out.

So the risk is that 1326 doesn’t hold and the credit crunch drags the economy into a recession while the Fed watches and moves too late to stop it. And that’s the reason why I am continuing to focus on the non-cyclical medical and energy technology sectors for most new recommendations, while planning our exit from the more cyclical areas at the next market top. This is not a time to think about selling anything, as that would just put you on the side of the lemmings who are either panicking or being forced to sell by their margin clerks. In this type of environment, big stocks go down on big volume because they are liquid and the margin-squeezed hedge funds have to sell something. Small stocks go down on little volume because the market makers don’t want to hold any inventory — actually, they want to be short — in a declining price environment. So, they just cut their bids as fast as they decently can.

The VIX is the Fear & Greed Index, and you have to remember to sell Greed and buy Fear. So, when you get that bad feeling in the pit of your stomach, that is the time to put more money to work in stocks and industries that should be immune to whatever is worrying the market. In this case, that is housing, a credit crunch and a slowing U.S. economy.

In the last issue, I mentioned a few stocks that I have been waiting to buy if we saw a continued decline: Cnet (CNET) in Content on Demand, CombinatoRx (CRXX) in Biotech, Cree (CREE) in LED lighting and Mindray (MR) in China and Biotech. Another stock that I have been watching is Akamai (AKAM) in Content on Demand. So, since the decline has continued over the past couple weeks, in this issue I am going to pull the trigger on two of these companies: Akamai and CombinatoRx. And if we do get a crash to 1326, we should get a chance to buy the rest of them.

Speedynet

The idea for Akamai Technologies (AKAM) was developed in 1998 at MIT when Internet pioneer Tim Berners-Lee challenged a group of students to figure out a way to get around bottlenecks on the Internet. The goal was to develop algorithms that could act like a helicopter traffic report, seeing traffic bottlenecks well before the data traveling along the Internet gets to them. Bypassing the bottlenecks makes data — video, voice, music or whatever — travel faster and smoother. The algorithms also needed to spot denial of service attacks by hackers and crooks, and stop them. Student Daniel Lewin developed and patented the answers, and used that as the basis for a business plan that he entered in MIT’s annual entrepreneurs’ competition. He won, formed Akamai and took it public in October 1999. The stock went to $350 in early 2000. I loved the business plan, but I couldn’t recommend it at that absurd valuation.

Akamai used their dotcom IPO money to deploy their first round of EdgeComputing servers, and then the company barely survived the dotcom crash as the stock got as low as 70 cents in October 2002. But they turned profitable in 2004 and have never looked back. Tragically, Danny Lewin died in the 9/11 attacks, but the company he founded went on to become the largest content delivery network in the world, with a 60% market share. They deliver content from the edge of the network, where costs are lower and capacity is high, instead of forcing it all through the core of the Net. With shoppers typically giving a site less than seven seconds to load before clicking away, the quick delivery of a web page from an Akamai edge server can make the difference between a sale and no sale. AKAM counts more than two-thirds of the top 100 retail sites as customers, simply because the Akamai sales force can demonstrate a very high return on investment.

Today, most of their customers are in digital media distribution and storage, or content and application delivery. But they have expanded into on-demand application performance services, like Salesforce.com’s online customer relationship management software-as-a-service that substitutes for the customer having to buy their own software. Salesforce.com has to be ready for unpredictable levels of Internet traffic, and Akamai can provide the computing power on demand, so Salesforce.com doesn’t have to install a huge server farm that stands idle much of the time, waiting for spikes in traffic. Because Akamai sees all the customer clicks, they also offer Web site intelligence services.

They filed a patent suit against their major competitor, Speedera, and then acquired them in 2005, so now about 20% of all Internet traffic flows through their servers. For example, they deliver all of the iTunes music and videos for Apple. Akamai has located over 25,000 servers in nearly 3,000 locations in over 70 countries all over the world, staging them near more than 750 cities that are heavy users of the Internet. The company then contracts with big government and private providers of Internet content to store part or all of their web pages and digital content on each server to be delivered quickly to surfers, so users get a much better Internet experience.

Akamai is growing more than 30% a year, and they should continue to grow that fast for at least five years. More and more Internet content is videos, pictures, streaming music, games and other high-bandwidth data that needs to get to the user smoothly and quickly, and I expect AKAM’s share of Internet traffic to increase from 20% to 30% or more over the next five years, even as traffic itself is growing 20% to 40% a year. Akamai gets paid according to the amount of bandwidth its customers use, and their business is operationally leveraged — they deploy a lot of expensive servers and then have low incremental costs against all that increasing traffic. They are in the midst of another $60 million round of server upgrades and expansion to serve their more than 2,000 customers, including numerous Fortune 500 global companies.

Only about 14% of the world’s population has broadband Internet access today. Fifty million of the 300 million in the U.S. have it (17%), but according to the Organization for Economic Co-operation and Development (OECD), there are only 128 million broadband subscribers in the other 29 most industrialized nations. There are another 122 million in China, or 75% of their 162 million total Internet users. But 162 million Internet users is only 10.4% of their total 1.3 billion population, so they have tremendous room for growth, requiring much more capacity to deliver video and other rich media. Only 3.5% of the 1.1 billion Indians are Internet users, and the country is determined to catch China. That’s all great news for Akamai.

Akamai’s competition for this huge, fast-growing market includes Internap Network Services (INAP), Level 3 Communications (LVLT), VeriSign (VRSN) and privately-held BitTorrent. Limelight Networks (LLNW) raised $200 million in an initial public offering on June 7 at $15, ran to $22, and promptly tanked on August 9 when they gave much bleaker guidance than they had on the road show. Even their underwriter, Goldman Sachs, downgraded the stock from buy to neutral. Akamai has sued Limelight under the MIT patents, and they are in the same court with the same judge as when they sued Speedera. So, I’m expecting the same positive results.

Akamai did three quick acquisitions between November 2006 and April 2007 that should maintain their competitive advantage against all comers. Last December, they bought Nine Systems for about $180 million in stock and cash. Nine Systems sold a media management framework to content providers to produce and then publish rich media content online. Then Akamai picked up Netli in March for $178 million in stock. Netli is a complimentary network infrastructure service provider that focuses on the application acceleration solutions like Salesforce.com. Finally, in April they snagged Red Swoosh for $15 million in stock. Like Netli, Red Swoosh had client-side tools for publishers to manage and distribute media files. They can also securely and predictably borrow compute cycles from Web-connected PCs and set-top boxes, giving AKAM peer-to-peer distribution technology like BitTorrent.

The company did $152.6 million in sales in the June quarter, up 52% from last year, while earnings per share rose 55% to 30 cents. They met, but did not beat, the consensus, and they did not raise guidance. They reiterated guidance for 43% to 46% revenue growth this year, to a range of $615 million to $625 million, and they will do 32 cents to 33 cents a share in the current quarter. Wall Street knocked the stock down because they didn’t guide higher, and some of the analyst questions on the call were hilarious versions of: “Well, you usually beat guidance, and this time you only matched it, so what went wrong?” Management patiently and repeatedly said that they guide for what they think they can do, nothing went wrong, and if they beat guidance in a quarter that is a pleasant surprise to them as well as Wall Street.

Akamai should be able to hit $825 million in 2008, up 32%, and earn $1.70 a share. They have a great balance sheet with no net debt, and after they finish the current round of server expansion, their free cash flow will explode. Even at a price/earnings multiple of 35X, just a bit higher than their growth rate, the stock will get to my target price. As their share of Internet traffic grows from 20% to 30%, while Internet traffic is growing 20% to 40% every year, they can grow revenues much faster than they will have to grow costs. I want you to buy AKAM under $30 for a $60 target in 12 months. Every subscriber should own some of this stock, so I am making it a Top Buy.

Unlock Profits By Knowing The Combination

I spent a lot of time analyzing two medical technology companies for this issue, but only one made the grade. The other one had what sounds like a dynamite product — a super-oxidized water that can kill bacteria, viruses and fungus, including Methicillin-resistant staph and Vancomycin-resistant enterococcus. The company makes it by the electrolysis of sodium chloride and water. Using a patented multi-chamber electrolysis process, these molecules are pulled apart and ions are formed. The electrolyzed oxidizing water is “super-oxidized.”

Trouble is, remembering that my chemistry is getting a little hazy, that’s roughly the way to make a very dilute solution of sodium hypochlorite, or ordinary laundry bleach. Adding a little vinegar or lemon juice would make it slightly acidic, and most of the hypochlorite would be in the form of hypochlorous acid. That is indeed a bactericide — the same one produced when chlorine is used to disinfect municipal drinking water.

The product is currently approved for washing vegetables, but it is more expensive than water with a little vinegar in it and may have the same problem that chlorine has in drinking water: It is an oxidizing agent that can react with organic components to produce potentially carcinogenic byproducts. The company also has this product approved for dermal wound care and burns as a cleaning agent, but I really wonder if it will prove to be any better than soap and water, or a dilute solution of vinegar. We’ll know soon enough, as they are presenting Phase II results with a placebo arm in September.

So as I wandered through their SEC filings, noting that the company came public this year and had to do a private placement last month just to get a year’s worth of burn rate on the balance sheet, I was remembering how many of these kinds of companies I’ve looked at in the last 25 years, and how many have flamed out — most, fortunately, without me and my subscribers as shareholders. That’s why this company didn’t make the grade. Plus, what I really wanted to find you was a development-stage drug company that didn’t have to bet the farm on a Phase II or Phase III trial, but still had all the upside of a biotech home run. And here it is.

CombinatoRx (CRXX) — pronounced Com-bin-ah-tore’-icks — was founded in 2000 by Alexis Borisy, a then 28-year-old Harvard chemistry PhD dropout, and several of his coworkers from the lab of a leading chemical biologist, Stuart Schreiber. What sets CombinatoRx apart from most biotech companies is that they have a very different drug development model. Instead of looking for the magic bullet for a disease by finding that one great molecule that targets a specific, single genomic target, they take all the drugs that are already approved and find out which combinations of drugs work much better than either treatment by itself. It’s a simple, powerful idea, and not so easy to do. So, how do they do it? CRXX developed special high-speed assay equipment to look for these synergistic combinations, which may be two drugs already approved to target the same disease, or one drug that targets a disease and another approved for an entirely different indication, or even two drugs that are approved for other indications but, put together, are effective against an entirely different disease.

Many diseases affect the body through multiple biological pathways. The activity of one drug targeting one pathway can be ineffective because biological systems often compensate by using a secondary pathway. By targeting multiple pathways, combination drug candidates can create synergistic therapeutic effects, which results in improved treatments for many diseases.

You have already guessed what this means — CRXX has found a unique business plan that benefits from all the hard work that other biotech companies have already accomplished. Almost all of the toxicity issues were taken care of during the two drugs’ Phase I and Phase II trials. All of the data has been published and analyzed, and all the FDA concerns are on the table. So all that CombinatoRx needs to do is be sure that there are no unfavorable drug interactions in preclinical work and a combined drug Phase I trial, and they need to do Phase II and III trials to show effectiveness. But they are working with molecules that are already demonstrated to be effective and safe, which takes a huge amount of risk and expense out of the picture. Yet, they can still patent the combination.

The best way to run this kind of company would be to discover combinations and license out the patents on most of them, while focusing on only one or two areas for combination drugs to be retained and developed internally for the company’s account. And that is exactly what CombinatoRx is doing.

The average small biotech company has one or two drugs in its pipeline and won’t take any more, as it costs $300 million to $800 million to get a drug to market. CRXX has seven drugs in their pipeline and spent $100 million on R&D last year. Phase II trials typically involve 50 to 250 patients so they are relatively cheap, yet can be powered to show statistical significance against a placebo or the standard therapy. Their drug candidates include:

• CRx-102, which contains the cardiovascular drug dipyridamole plus an unconventionally low dose of prednisolone, a steroid. CRx-102 works through a novel mechanism of action because dipyridamole selectively amplifies prednisolone’s anti-inflammatory and immunomodulatory activities without amplifying its side effects. In Phase IIa clinical trials, CRx-102 demonstrated a statistically significant anti-inflammatory effect with rapid onset of action in patients with osteoarthritis and rheumatoid arthritis. It will begin Phase IIb trials shortly.
• CRx-139, another oral selective steroid amplifier, in a Phase IIa trial for rheumatoid arthritis.
• CRx-170, a once-nightly dual-action analgesic that has successfully completed a Phase IIa trial in asthma and will go into Phase II this year for chronic low back pain.
• CRx-191, a topical selective steroid amplifier, using an antidepressant to amplify a mid-strength steroid. It goes into a Phase IIa trial this quarter for psoriasis.
• CRx-197, a topical synergistic cytokine modulator also going into Phase IIa this year for atopic dermatitis. It is based on loratadine, an allergy medicine, and nortriptyline, an antidepressant. Neither of these is indicated for the treatment of atopic dermatitis on its own, but CombinatoRx has shown that they act synergistically in preclinical models of inflammation.
• CRx-026, a dual-action anti-tumor drug candidate that completed Phase I/II in multiple tumor types. It is a combination of chlorpromazine, which is approved for treatment of psychotic disorders, and pentamidine, approved for the treatment of some infectious diseases. Again, neither of these is indicated currently for treating cancer. But the company’s preclinical studies suggest both regulate and inhibit cell proliferation — the process that causes tumor growth. CRx-026 appears to have a favorable side effect profile compared with other anticancer drugs, and it also has strong synergistic anti-tumor activity with many other approved anti-cancer drugs.
• CRx-401, an anti-diabetic agent entering Phase IIa this quarter for Type 2 diabetes.

The company has R&D collaboration agreements with the Spinal Muscular Atrophy Foundation, Accelerate Brain Cancer Cure, SAIC (Science Applications International Corporation), Angiotech Pharmaceuticals, the National Institutes of Health, Cystic Fibrosis Foundation Therapeutics, HenKan Pharmaceutical Company, Gene Network Sciences and Fovea Pharmaceuticals. They have 55 issued patents and around 455 pending patent applications.

There are only a couple of competitors following the combination drugs path, and each is focused on only one area because they do not have the custom, high-speed assay technology that CRXX has. Pozen (POZN) has a combination drug for migraines, but they just got their second “approvable” letter from the FDA, with the problem being some indications in toxicology tests that the drug causes unexpected changes to DNA. Orexigen (OREX) is working on a combination drug for obesity.

CombinatoRx has a much broader clinical portfolio than its competitors, which reduces our risk, and the technology to continue to develop combination drugs at a rapid clip. They had $101 million in cash as of the end of the June quarter, and they have been burning about $10 million a quarter. I expect that to increase towards $15 million as more Phase II clinical trials begin. The company expects to end the year with $70 million to $80 million in cash, including a $7 million milestone payment that they will receive in early October. They will not take most of these drugs into Phase III trials on their own, so I don’t expect their expenses to accelerate much next year. Their licensing fees and milestones should grow every year, and, eventually, they will have a large annual royalty flow to fund the development of their own drugs.

CombinatoRx has traded between $5.88 and $14.50 over the last couple of years, and at today’s close of $6.61, the company had a total market value of only $192 million. It’s down from $9 in March but really has not been hit in the recent decline. Most days you can buy stock under $7. I want you to buy CRXX under $7.50 for a $16 target this time next year, when they will have results from several of the new Phase II trials and should be announcing partners for Phase III trials.

Biotech MegaShift

Amgen (AMGN) announced a reduction in force of 12% to14%, or 2,200 to 2,600 people. This is in response to lower Aranesp revenues, and they are trying to increase operational efficiency without cutting most R&D programs. It is an 18-month program, targeting pretax savings of $1.0 billion to $1.3 billion. The pretax restructuring charges will be in the $600 million to $700 million range.

The company gave detailed guidance on what it might lose under the new National Coverage Determination rules that Epogen and Aranesp will not be reimbursed by Medicare unless red blood cell counts fall below 10 grams per deciliter (g/dL). They would expect to lose 10% to 15% of the patients that never fall below 10 g/dL. They also could lose half of the 10% to 15% that are poor responders. The remaining 70% to 80% of Medicare patients will bounce around 10 g/dL, going below, getting Aranesp to get better, then going above and having their Aranesp cut off. Amgen thinks that the use of Aranesp in this population could fall by two-thirds. In total, their overall Aranesp revenue would be cut by about one-third, assuming non-Medicare payers do not adopt the same schedule.

The remarkable thing about this schedule is that there is no obvious clinical or policy rationale for it, and it clearly is bad for patients. There is absolutely no clinical experience in managing hemoglobin this way, and both doctor and patient organizations are up in arms about it. It will drive the number of whole blood transfusions up 50%, and no one knows where that blood will come from. I believe the answer is “nowhere,” and the blood banks simply will run dry. Then a doctor will be faced with a patient that is obviously anemic, has a 10g/dL and can’t get Aranesp, but there’s no blood available. Interesting policy. There may be a “technical correction” to raise the hemoglobin level to 11 g/dL, which would help Aranesp sales considerably.

The company also announced that adjusted earnings per share guidance for 2007 has been changed from $4.28 to a range of $4.13 to $4.23, excluding restructuring charges. That’s a trivial reduction of only 1.0% to 3.5%. In other words, they are maintaining cash flow and preserving earnings in spite of the pressures on Aranesp and Epogen. Now that we know the real extent of all the Sturm und Drang on the bottom line, I believe the stock has bottomed. Buy the January 2009 $70 LEAP call (VAMAN) up to $12.50, for a $25 target price when AMGN stock hits $95, on or before the LEAPs expire in January 2009. If you want to be more conservative, buy the January 2010 $50 LEAP call (WAMJX) for around $12.

Crucell (CRXL) reported second-quarter revenues up 82% to $52.9 million, bringing them to $100.1 million for the first half of the year. They reiterated guidance for $295 million to $302 million for the year, so they expect to do two-thirds of the year’s sales in the second half as the flu season begins. For the quarter, they lost 38 cents a share, better than last year’s 59-cent loss. CRXL also repeated their goal to be cash breakeven for the year. And the vaccine division is about to turn profitable. On the human cell line program to replace eggs in vaccine production, their partner Sanofi Pasteur will give a presentation on their flu program in a September 17 company meeting and will discuss how successful Crucell’s PER.C6 technology was. CRXL remains a buy up to $28 for my $50 target.

New Energy Technology MegaShift

Oil prices have been in another volatile market, selling off 3.9% at one point today, but it looks like the $65 to $75 range will be the new level, unless there is a major hurricane in the next few weeks.

Energy Conversion Devices (ENER) got a three-year, $20 million contract with the Department of Energy to develop low-cost photovoltaic systems for buildings. This is part of the new Advanced Energy Initiative to make solar energy cost-competitive with conventional forms of energy by 2015. ENER gets their research covered to slash production costs — that’s a win.

Hybrid cars and delivery trucks are going to be an important initiative in China to lower pollution, and Cobasys, ENER’s joint venture with Chevron, is signing deals to take their battery technology to China. This will develop into a bigger market than either Japan or the U.S. Buy ENER under $35 for my $55 target.

Infinity Energy Resources (IFNY) held an excellent conference call. They have a new Chief Operating Officer and a new Chief Financial Officer. They are cash flow positive again, and the asset sales will happen shortly. Unfortunately, they are going to sell some assets in the Rockies, which is the original reason that we bought the stock. But they are retaining enough to keep it on the list as an oil shale investment, and the Nicaragua concession is starting to look huge. Management said that they will start actual work on the seismic data “in the near future.” IFNY is a Top Buy up to $5 for my $10 first target.

Rentech (RTK) reported last Thursday, and I had time to get the numbers into last week’s Radar Report, but not the conference call. Rentech reported revenues of $50.4 million and a loss of four cents a share, compared with $17.3 million and nine cents last year.

The biggest news on the call was that they are adding biomass as a feedstock to their process to produce ultra-clean synthetic fuels. They entered a joint development agreement for a 1,500 to 3,000 barrels per day standalone biomass facility with Solena Group — a global power production company that builds, owns and operates renewable clean energy plants. They have already identified the site and the fuel stock in Northern California that will turn biomass into jet fuel and naphtha, utilizing Solena’s proprietary gasification and Rentech’s proprietary Fischer-Tropsch technology. This will be the first commercial biomass-to-jet fuel production facility in the country. The Department of Defense has certified the use of the fuels for the B-52, and it intends to qualify the C-17 fleet next year.

Rentech’s demonstration plant in Colorado will be completed on schedule by the end of September, and they will add synthetic gas as an alternative source by the end of 2007. They will produce the first fuels in the spring of 2008, for delivery to potential customers for testing.

All of the other programs are on schedule. The Medicine Bow, Wyoming, project with DKRW is in the front-end engineering and design phase, with funding scheduled for completion by mid-2008. Construction is scheduled to start in the second quarter of 2008 and the facility is expected to be up and running in 2011. The facility will initially produce 13,000 barrels per day of clean diesel and a small amount of naphtha. Sinclair Oil has a long-term contract to purchase the diesel, and surplus power will be sold to the local utility grid. The captured carbon dioxide of this facility will also be used for enhanced oil recovery in the region. This is all great news for Rentech, and it remains a Top Buy up to $5 for my $11 target.

This morning, the Federal Reserve said that they will pump as much money as needed into the U.S. financial system to stop the sub-prime mortgage-related credit crunch. Their brief statement used the same language as when they intervened in similar situations before: They will “provide reserves as necessary to facilitate the orderly functioning of financial markets.”

Translation: That means the discount window is open for banks to borrow as much money as they want at 5.25%. The Fed did not cut the discount rate, because that isn’t necessary. Cutting the discount rate would weaken the dollar, and the issue right now is not the price of money, it is the availability of money and credit. So right now, behind the scenes, the Fed is calling banks and telling them that they have to borrow. And that’s leaving the backs with two choices: one, the banks can either leave that money idle, costing them 5.25% and hurting quarterly earnings, or two, put it to work. If quarterly earnings are hurt, the stock might go down and the CEO’s stock options might be worth less. So the banks will put it to work.

Welcome to the real world of why it is so hard to be a secular bear — the guys who print the money don’t want the stock market, the economy or the society to collapse on their watch. There are voluble bears on all three of these stances, with all of them having excellent reasons as to why they are right. And, as I said at the recent San Francisco Money Show, many of them are right on the fundamentals. The sub-prime mortgage experiment is a disaster. Housing values are falling. Consumers are in hock up to their ears. The Clinton-era budget surplus is a fading memory, and the trade deficit is an intractable problem. Huge amounts of debt need to be liquidated around the world. There’s only one big issue that the bears are wrong about:

The stock market is going to go up anyway.

How? After listing all the fundamental reasons why the market should go down and after the topsy-turvy, gut wrenching week that we’ve had, it wouldn’t seem feasible for higher prices to be on the horizon. But there’s one little thing that the bears aren’t accounting for: The Fed.

“Don’t fight the Fed” is a market shibboleth that I only forgot once, during the S&L crisis in the 1980s, when I could prove to you that Wells Fargo and Citicorp were bankrupt if they marked their loan portfolios to market, as they were required to under the law. I was short Citicorp all the way down to $8 and waiting for the bankruptcy announcement when some sheik in the Middle East bought a couple of hundred million dollars worth of the stock. The Fed decided to “provide reserves as necessary to facilitate the orderly functioning of financial markets,” and that is why today that sheik is a multibillionaire and I am not.

The Fed did not say anything comforting on Tuesday, and that has proved to be a huge mistake. The shortsellers immediately began pounding stocks, but the Plunge Protection Team stepped in and turned the market up. On Wednesday, they rolled out President Bush to say that he believes the markets would have a “soft landing,” and the Dow rose 154 points.

But then the shortsellers regrouped and came back in force. After the Wednesday night/Thursday morning announcement by the French bank BNP Paribas that they could no longer value three large sub-prime funds due to a lack of accurate prices — convenient timing, wouldn’t you say? — the European Central Bank freaked out and pumped $130 billion into their financial system. Yesterday, our market opened down on the news, so the Fed pumped in $24 billion in temporary reserves. But the market dived anyway. The shortsellers finally won a round, as the Dow suffered its second-worst decline of the year.

The Fed does not like to lose, so today they opened the discount window. How much money will they pump in? Whatever it takes to stabilize stock prices and get the junk bond market operating again, so that almost all the leveraged buyouts can go forward. Remember that after 9/11, the Fed used the discount window to extend billions of dollars worth of emergency loans to banks to keep the financial system functioning. This is not new territory for them. And this marks the first time that the U.S., European and Japanese central banks have taken such action together since 9/11, plus the Australian, Hong Kong and Canadian central banks have also joined in this time around.

Also remember that this is the biggest test yet for Chairman Bernanke, and he can’t afford to lose, period. The ECB pumped another $83.8 billion into their system last night, and the Fed’s $19 billion injection this morning came in the form of an offer to buy mortgage-backed securities. I feel like I’m watching a surgeon wielding a very precise scalpel in a bilateral orchiectomy on the bears. The Fed refuses to lose this round.

So, what does this all mean for us? In yesterday’s Radar Report, I said that I thought we could see the S&P 500 back to 1440 or even last Friday’s low of 1433 pretty quickly. That happened this morning, as the S&P bottomed at 1429.74. The only question now is how far prices will slingshot to the upside from this level, pushed by a flood of Fed liquidity. The first 100 points to 1530 should be easy, just based on how much money is caught short or on the sidelines. And this could be the start of the big run over 1600, or maybe over 1700, with the parabolic move over 1800 still a possibility. As I said yesterday, once we see this rally get started, we’ll be selling a number of our holdings and rolling our profits into companies that will do well in a cyclically slowing economy. So stay tuned and remember:

Love ‘em or hate ‘em, don’t ever fight the Fed.

The stocks that will probably move first and fastest include:

• SXC Health Solutions (SXCI)
• Harmonic (HLIT)
• Quick Logic (QUIK)
• Silicon Image (SIMG)
• Intel January 2009 $22.50 LEAP call options (VNLAX)
• Energy Conversion Devices (ENER)
• U.S. Geothermal (UGTH)
• SiRF Technologies (SIRF)
• TowerStream (TWER)

But you should feel confident buying any recommendation below its buy limit, as even the non-cyclical areas like healthcare will rise on this flood of liquidity that lifts all the boats.

Whew! This is a tough, volatile market, with the Dow dropping 281 points last Friday, regaining 286 points on Monday — its biggest point gain in five years, and biggest percentage gain in four — and then tanking right after the Fed decision on Tuesday, setting a V-shaped bottom, and skyrocketing into the afternoon. Then yesterday saw the Dow up 190 points at 2:30 p.m. EDT, followed by a one-hour, 210-point swoon into negative territory based on a rumor. This was then followed by a 30-minute, 172-point rally that almost completely reversed the drop by the closing bell.

Today the Dow was down 387 points and closed near its low, with no rally in sight. This sets up a big bear trap if the overnight markets in Europe are up sharply, because just a little push in our markets on Friday will set off spectacular short covering before the weekend. And any major merger deals over the weekend could lead to a very strong Merger Monday. If you are a hedge fund manager, you don’t get to sleep tonight.

It may seem odd to you that today I’m focusing on the Dow’s recent action, as I normally talk about the S&P 500. But my reasoning behind the switch is simple: If someone wanted to manipulate market psychology, it is the Dow that is sure to get mentioned on every commuter’s radio and on the nightly TV news. That’s why it’s easy for short sellers to start a rumor like yesterday’s “bad news coming from Goldman Sachs,” and send the Dow tumbling. And while I can’t prove that the Plunge Protection Team — which I think has been operating since the Clinton era — has been active, it sure is strange the way that we got several big last hour rallies last week until the Friday bloodbath. Here’s an important observation from that plunge: Looking at the market internals, the Dow should have crashed down 700 points or so last Friday, yet it was only down 281.

Then came Monday’s big rally, set off by…what? Bargain hunting? I don’t think so. Big rallies are almost always short-covering in the face of news…but there was no special news. And while the initial reaction to the Fed’s no-rate-cut decision dropped the Dow 100 points in 15 minutes, someone decided to start buying and ran it up 206 points over the next 15 minutes, on no more volume than it took to drop it. Yesterday, when the short sellers challenged the Plunge Protection Team to a fight by starting the Goldman Sachs rumor, someone decided to start buying and ran the Dow up 172 points right into the close. The S&P 500, which dropped from 1503 to 1478 in an hour, bounced a full 20 points in the final half hour to close at 1497.49 — just above the crucial 1495 mark, which was set on the market’s move up in late April and provided strong support once in May and twice in June.

So, based on all this, I suspect the Plunge Protection Team is very active right now, and they will do anything to prevent stock prices from falling rapidly. Their main tool is to print money and make credit easily available, while publicly saying that they support a strong dollar, are worried about inflation and see no need to lower interest rates. But they also intervene both directly and by calling selected funds and trading desks to offer a blank checkbook to purchase stocks. Because each of these funds knows that the others are being called, too, it’s a first-come, first-serve basis for some easy money. Anyone who is short covers immediately, causing the V-shaped bottoms that we’ve been seeing over the past week.

And it’s not just in the U.S. After the bad sub-prime news came out in Europe this morning, the European Central Bank injected $130.8 billion in liquidity to calm money markets after banks appeared less willing to lend in a jittery market. Central bankers around the world are playing with paper money as if it was just so much — well — paper. We’ll see how all this plays out tomorrow and over the weekend into Monday.

To spot these types of money supply and currency manipulation, watch for these signs:

• Sudden strength in the gold and silver markets
• Announcements that the leveraged buyouts already underway will be able to sell their debt after all
• Another round of very large, leveraged buyouts at relatively high valuations
• Increased pressure on the banks for payment moratoriums for homeowners facing ARM resets, which an accounting change to permit them to list “scheduled” mortgages as current as long as there is at least one payment in the last 12 months.

What to Expect Next

After the recent emotional panic, it is normal to think that stocks are vulnerable to a straight-line downturn. But that is not how markets work. They almost always go back up to the breakdown point — in this case, 1530 on the S&P 500 — and then either reverse into the real decline or break through and head for the next energy level up. Seeing three very volatile but ultimately up days in a row, like Monday through Wednesday, is rare, and usually happens either at the beginning of really big upside moves or quick fake-out retracements that turn out to be part of a bigger down pattern.

So, I can’t even take my “parabolic” scenario off the table yet, as breaking through 1530 and then the all-time highs around 1555 would get us over 1600 pretty quickly. The next stop from there is just over 1700, and if the M3 money supply keeps growing at a 13% rate and dropping the value of the dollar, the market could go over 1800 in a parabolic move. That would probably set up a very serious downturn from, say, October into next spring.

But if we can’t shake off today’s downturn right away and go up to break 1530, I think we’ll see the S&P 500 back to 1440 or even last Friday’s low of 1433 pretty quickly. Breaking that, the next big target is the weekly breakout level at 1326. That would probably set up quite a fourth-quarter rally into the spring of 2008. We have to watch, see which scenario plays out and let the market tell us what to do.

In regards to the hits that stocks have been taking over the past couple weeks with the market’s decline, subscriber Irv pointed out that: “Some of these down stocks are so far negative that it will take a long upsurge just to get back even. Are you still standing by your belief that we will get these losses back?”

Yes, many of them will recover in the next leg up, and go on to do very well as their dominant positions in various niches finally pay off. If we see the rally first, we will be selling stocks that hit their targets and stocks where the fundamentals have weakened enough to believe that they can’t recover before the 2008 elections. We’ll hold the others for a recovery lasting well into 2008. If we get the longshot parabolic move, we’ll be selling darn near everything outside of the New Energy Technology MegaShift, and maybe also some of those depending on the price of oil and natural gas.

If we see the decline first, I have just a few more stocks that I’d like to get us into, including Cnet (CNET) in Content on Demand, CombinatoRx (CRXX) in Biotech, Cree (CREE) in LED lighting, and Mindray (MR) in China and Biotech. There are many other companies that I like, such as Intelligent Surgical (ISRG), but they are not going to get cheap enough to buy even in a 10% to 12% market drop from current levels.

You see, one crucial factor that I look for in picking new companies, and even in my recent recommendations, is that they are not exposed to the business cycle, either because of their industry or their size. We own a lot of stocks that should do well even in a cyclically slowing economy, if that is what we are in for, because they operate in the very newest areas like video, WiMAX, security or LED lighting that will not be impacted by macroeconomic events. But I also want to boost our alternatives in the non-cyclical areas like healthcare, and this week a stock that I have been watching for some time was hit hard after a mild quarterly disappointment. I often talk about the opportunities in healthcare beyond developing great new biotech drugs and cool medical devices — opportunities like slashing administrative costs, which account for roughly 25% of our healthcare bill. That’s what these folks do.

A Sexy Business Model

SXC Health Solutions (SXCI), which recently changed its name from Systems Xcellence, is a pharmacy benefit manager, or PBM. Through their informedRx suite of pharmacy benefit management services, they operate prescription drug programs for managed care organizations, employers, government agencies, e-health companies, independent and mail-order pharmacies, and retail pharmacy chains. SXCI can negotiate bulk purchase prices on drugs, take advantage of seasonal markdowns, find effective generic substitutes and even monitor potential drug interactions. They are experts at rebate management, and they have a radical new idea: Pass the rebates on to the customer. By saving their clients money, SXCI gets to keep the business and then layers in more customers every year.

The really intriguing thing about SXCI, and what sets them apart from their peers, is that they started as a software technology company, writing a complete PBM system that they still sell to clients, including large companies and hospitals that want to manage their pharmacy benefit programs internally. Take a look at their PBM software offerings:

• RxCLAIM is an online transaction processing system for management and review of third-party prescription drug claims at the point of service, plus payment and billing support.
• RxTRACK is a data warehouse and analysis system for online analytical processing.
• RxMAX is the rebate management system that they use themselves, designed to assist health plans in managing relationships with drug manufacturers. This includes managing contracts, keeping accurate records, calculating market share, and creating billing details and summaries.
• RxSERVER manages the collection, control and sharing of prescription information between pharmacies.
• RxPORTAL is an Internet-based solution for pharmacy benefit management.

In addition to their PBM software, SXCI sells a retail pharmacy management system and they have a complete pharmacy practice management application — RxEXPRESS — that provides information processing and workflow solutions for pharmacists, as well as pharmacy services like patient refill orders, compliance and profile applications; electronic prescribing and refill authorizations; pharmacy website hosting, interfaces and complete mail service; out-patient pharmacy management inventory control, and pricing management.

The PBM Business

The PBM side of SXCI’s business is attractive for the company’s stable growth. About half of all Americans take at least one prescription drug every day, which is why pharmaceuticals are a $200-billion-a-year business. The insurance companies, pension plans and federal and state government health plans that pay for most of those drugs need someone to check and process the claims, negotiate prices and rebates, and provide a myriad of reporting and accounting services, including several required by the Department of Health and Human Services. It’s a complex business, and a company like SXCI — which has bulletproof systems to handle the business and reporting, plus an interesting marketing model that passes drug rebates through to their customers — can build steadily-growing, repeat revenues based on multi-year contracts.

The company is about to announce a dramatic improvement in PBM — passing all of the rebates and discounts that they get through to their customer. They’ve been testing this with a large university client that has a drug benefit program covering almost 80,000 people, and SXCI was able to pass through $4.5 million to them in 2006. Based on this, the university booted Caremark (CVS), the #3 pharmacy benefits manager, and gave SXCI a multi-year contract.

On the June-quarter conference call, SXCI talked about several of the contracts, like the university one, that they’ve won recently:

• They received a $6.9 million, five-year contract with the Department of Veterans Affairs, which has completed the usual protest process by those who lost and been upheld as a win for SXCI. It covers 250,000 people and will launch in early 2008.
• They also have a $23.4 million contract with the State of Georgia to administer their Medicaid program, which is on track. Another Medicaid contract with the State of Washington has been delayed, and it was one of the causes for the company’s small shortfall in the quarter. But I expect it to kick in later this year and add to earnings.
• They got a new three-year contract with a major supermarket chain covering almost 450,000 people.
• Another contract is with AMERIGROUP Community Care of Georgia for 226,000 people and that will began in July.
• Plus, and this is the big one, SXCI has an unannounced customer where they have been notified of a potential contract award for a whopping $27 million over the next four years. You definitely want to own this stock when they issue the press release confirming that one.

SXCI has also booked a lot of renewals so far this year, including a five-year renewal with a prescription drug company that covers four million people in all 50 states, and another multi-year renewal with an Ohio Medicare provider.

When SXCI wins contracts, and renewals, like these, it helps keep the company’s business stable, so they always have a high percentage of recurring revenue. In the June quarter, total revenue grew 25% to $23.1 million. Revenue from recurring sources accounted for 75% of that, or $17.2 million, up 37% from last year. The main driver of their recurring revenue is transaction processing revenue — actually filling prescription orders — and that grew 46% to $13.1 million. So, the biggest, most attractive part of their business is growing the fastest. We love recurring revenue, because those are sales that come in just because you got up in the morning — no big sales push required.

Sequentially, transaction processing volumes declined slightly from 97.3 million transactions in the March quarter to 94.7 million in the June quarter, but based on several new customers who went live on July 1, SXCI will resume sequential growth in the current September quarter.

Of the $5.9 million in non-recurring revenue, professional services (consulting and the like) was $3.3 million, down 11% from last year. This quarter’s number is actually pretty typical for the company. The reason for such a gap between last year and this year is because in 2006 SXCI had a lot of Medicare Part D drug reimbursement program-related consulting and implementation activity.

The Software Business

Like all software companies, a lot of their sales close in the last few weeks or even days of the quarter, or slide into the next quarter. That happened to SXCI in this quarter, when several deals slid, and they reported only $2.6 million in system sales. While that was up 18% from last year, it was still a disappointment. Growth in the high teens is nothing to apologize about, though; it just looks slow compared to their blistering growth rate on the PBM side. And software does contribute to the company’s recurring revenue in the form of maintenance fees, which hit $4.1 million in the June quarter, up 14% from last year.

Earnings and Valuation

SXCI reported 14 cents a share compared to 12 cents last year, below expectations, due to the sliding software deals and slightly sequentially lower transaction processing revenues. Their book of business, which is management’s estimate of the total revenue expected to be recognized over the next three years from existing in-place contracts, increased to $230 million at the end of June, up 43.8% from last June’s $160 million. They have $74.7 million in cash.

SXCI has a conservative management team, and due to the dip in transactions and slip in some software sales, they revised their 2007 guidance down to revenues between $95 million and $97 million, with earnings of 63 cents to 68 cents a share. Wall Street was looking for $100 million and 75 cents, and that is what knocked the stock down about 25% to $20.25 last Friday ($19.70 was the intraday low). It’s regained less than a buck since then. Using the midpoint of their guidance for this year, the stock is selling for 32X earnings. My model for 2008 calls for another strong growth year, hitting $120 million in sales, up 25%, and 95 cents a share. So, the stock is selling for only 22X next year’s earnings…mighty cheap for a company growing 25% or better, with three-fourths of that from recurring revenues.

This is the simplest healthcare business that I will probably ever recommend to you, and possibly the safest small cap stock on NASDAQ. PBMs buy drugs in bulk and distribute them under contracts. It’s a cash cow. There are no clinical trials, no failed drugs and no erratic FDA to spoil the story. It doesn’t matter what happens to the economy, and aging Baby Boomers guarantee that their available market will be growing by leaps and bounds for years to come. SXCI is already growing fast, winning major new contracts and pushing its way into the top tier of PBMs, which as a group have consistently been among the best investments in the world.

Bigger PBMs like Express Scripts (ESRX) and Medco Health Solutions (MHS) have been sensational stock market performers, with the kind of smooth, up-and-to-the-right charts that long-term investors love. ESRX is up more that 12,000% since it came public in 1992, and MHS has tripled since it went public in 2003. SXCI has doubled since its IPO last year, but I think that is just the beginning.

I expect every contract — especially the $27 million one — and the growing demand for prescriptions from the Baby Boomers to boost the stock up to much higher levels over the next year and a half. Buy SXCI under $23 for a move up to $30 by the end of 2007 and my target of $46 by the end of 2008.

Avian Flu MegaShift

BioCryst (BCRX) reported June-quarter results this morning. Thanks to the contract with Health and Human Services for the development of peramivir, revenues of $13.4 million were up sharply from last year’s $1.6 million, and the net loss was reduced to $7.0 million, or 24 cents a share, from $10.1 million, or 35 cents a share, last year. That was in spite of a big jump in R&D spending from $11.2 million in last year’s June period to $19.0 million this year.

The company has $42.5 million in cash and is about to complete a $65.3 million private placement, giving them enough resources to advance the peramivir clinical trials far enough to see if it works and can be approved. This pending private placement probably is one big reason for the stock’s recent decline, as the hedge fund wise guys short almost any stock ahead of the deal and cover their shorts the second the deal is done, after which the stock recovers.

Enrollment in the Phase II intramuscular study of peramivir for seasonal flu has picked up due to widespread influenza activity in Latin America. Their plan was to follow the flu season around the globe in order to get their 300 patients and complete this Phase II trial quickly. And they were able to catch the Southern Hemisphere flu season before it took off.

BCRX will start enrolling the required 1,000 patients in the Phase III trial of intramuscular peramivir for seasonal flu as soon as flu season starts in the U.S. and Europe. They will also conduct the Phase IIb trial of oral Fodosine in patients with cutaneous T-cell lymphoma under a Special Protocol Assessment with the FDA, making that a pivotal trial that can lead directly to approval without a Phase III. The first of 100 patients should enroll this quarter.

Their psoriasis program with Roche entered Phase IIa testing, but I don’t have much hope for it — psoriasis is a difficult disease with a big psychological and dietary intake component that makes it difficult to get to statistical significance in a clinical trial. But BioCryst has a lot of milestones coming up with all these Phase II and III trials, so I expect positive reports from any of them to drive the stock higher.

Subscriber M.T. wrote: “The fall in BCRX has made me very nervous. Are there any signs in the next two to three months that this stock may see a turnaround?”

Yes, M.T., there sure are. They have to reveal the Phase II peramivir trial results before the FDA can bless a Phase III trial design. Although the timing is awfully short, direct questions to management on this point are always answered: “We are talking to all parties concerned all the time, and we will be ready to start the Phase III trial when the flu season starts, just in case it is a light season, as we want to accrue all the patients in one season. We will again follow the flu to the Southern Hemisphere if we have to.”

So there is major clinical news coming soon that I expect to move the stock up substantially. BCRX remains a Top Buy at current levels, with a $19 buy limit (a double from here) and a $30 target.

Biotech MegaShift

Dendreon (DNDN) reported a $20.9-million loss for the quarter before the non-cash stock option charge of $1.9 million. After the recent $72.5 million infusion from the convertible offering, they have $143.7 million in cash. They’ll spend about $45 million of that for the rest of this year, and they only need another $50 million to get through all of 2008. This gives them a little wiggle room with Provenge, as well as new indications beyond prostate cancer. On the conference call, management said that they are beginning to establish regulatory strategies for Provenge outside of the United States, in parallel with their ongoing partnering discussions. I still think that they could announce a deal for European distribution any day.

DNDN is also considering which of the pipeline programs that they put on hold can move forward now that they have some resources. So, I expect an announcement in the near future that either head and neck cancer or breast cancer programs will come off the shelf and go back into the clinic. The company is also evaluating additional studies of Provenge in different settings and stages of prostate cancer, as they look forward to expanding the label.

Regarding the current Impact trial for Provenge, DNDN said that they are on target to complete patient enrollment in the second half of this year, and the study will conclude in 2010. They said that they will complete the interim analysis for survival “in the middle second half of next year,” which is a short delay from the April time frame that they implied previously. They repeated that they think there’s a reasonable possibility that the interim results could let them proceed to FDA approval. DNDN remains a buy on dips under $7 for my $40 target, which we should see after Provenge is approved.

Content on Demand MegaShift

Semiconductor prices are a little softer than what I was looking for, so even though unit volumes are good, I am going to slightly reduce my dollar sales forecast for the year. The weakness is in memory chips, especially DRAM (Micron) and NAND flash (SanDisk) — commodity chip producers that we don’t own. There are plenty of reasons to think DRAM and NAND flash prices could stabilize or even go up a bit, but it hasn’t happened yet. Year-to-date total semiconductor sales through June were $120.9 billion, up only 2.1% from last year. January was up 10.8% over January 2006, but the year-to-date comparison has been declining ever since.

I had thought semiconductor sales would be up 7% this year, but I think it is prudent to trim that back to +5% until I see memory prices firming, which will probably happen when the demand for PCs and consumer electronics picks up. That would get us to $260 billion for the year instead of $265 billion. I know that seems like a trivial change, but it is the first downward revision of a semiconductor forecast that I have had to make in more than three years. It could be a straw in the wind, especially if high gas prices or credit problems inhibit holiday spending.

Harmonic (HLIT) has been weak recently, and the only reason that I can see is an earnings disappointment at a competitor, BigBand Networks (BBND). The funny thing is that Harmonic is probably causing those disappointments, so I don’t follow Wall Street’s thinking. BigBand was early into Switched Digital Video (SDV), a new niche, and Wall Street ran the stock up. But as we’ve discussed before, in the current Comcast (CMCSA) trials, Harmonic is the only supplier of SVD gear. BBND was knocked from $14 to under $10 on their earnings news, and Wall Street seemed to think it meant that the SDV market isn’t real. Wrong!

Since surprising Wall Street to the upside with their earnings announcement and guidance after the close on July 25, HLIT stock has gone from roughly $9.50 to $8. What gives? There is no doubt that the whole world, including the U.S., is in the midst of a massive change in who delivers video, how they deliver it and where it goes. Cable TV, telephone and Internet service provider businesses are all up for grabs, and if you snooze, you lose. The only sure winners in this arms race are the equipment suppliers, and of the Big Four, only one is independent — Harmonic. Motorola (MOT) bought General Instrument in January 2000 for $17 billion, Cisco bought Scientific-Atlanta in February 2006 for $7 billion and Ericsson bought Tandberg TV in March of this year for $1.4 billion, outbidding Arris Group. Harmonic has a market capitalization under $700 million, yet it is worth more than Tandberg in an acquisition.

To guess who might want to buy Harmonic, look at the markets that they serve. Their satellite customers, DirecTV and Dish Network in the U.S., have the advantage of very high bandwidth and very low incremental cost of delivery, once a satellite is in orbit. But they can’t easily deliver video on demand, and I can tell you from experience that the best thing you can say about their two-way Internet service is that it is not as slow as dial-up. “Not As Slow As Dial-Up” is not a compelling marketing message, especially at $99 a month.

So, the satellite companies are playing to their strength by quickly increasing their High Definition content, and then selling on better quality against the cable and telephone fiber-to-the-premises systems. Some satellite companies are promising 150 or more High Definition channels in the near future. That requires a move to the latest MPEG-4 compression standard, from MPEG-2. In the most recent Diamond Technology Review, four Harmonic products were awarded “Outstanding–Four Diamonds” ratings, the highest ratings ever awarded until they tested Harmonic’s Electra7000 MPEG-4 encoder. It got their first ever “Perfect” score.

Cable TV companies are also upgrading. Currently, they have one-way coaxial cable systems installed in each customer’s house. Those networks have to be upgraded to two-way, fiber optic networks, either all the way to the customer’s premises or to a fiber loop connecting a few (under 33) houses. They already had the right-of-way and were under no obligation to share it. So once they upgrade, they can easily offer voice, video and true broadband data services, as well as content on demand. Their alternative is a hybrid delivery system, with optical fiber to the last mile, and then either coaxial cable (for cable TV companies) or copper lines (for telephone companies) to the premises. That still provides easy two-way communications for voice and data, as well as on-demand programming, but it limits bandwidth. Limited bandwidth is a competitive disadvantage when the satellite guys are selling large amounts of High Definition programming.

These companies can deal with the limited bandwidth problem by transitioning from MPEG-2 to MPEG-4, but that will be done slowly due to the requirement to also change all the customers’ set-top boxes. Harmonic has decoders that can handle both compression standards, so companies can deploy them now to handle the current networks and then make the switch later without having to replace all the decoders.

Another alternative is to slowly and steadily replace existing hybrid systems with pure fiber to the premises, but that is expensive and only Comcast and Verizon seem eager to spend the money.

So, their best choice is to use Harmonic’s NSG9000, the BigBand competitor that combines SDV and other technologies, to reduce the costs of the upgrade by moving the channel change upstream to a point in the system where there is optical fiber. Instead of sending all 150 channels to every customer’s set-top box, wasting most of the bandwidth, the provider only has to send the one channel per set that the viewer wants to see. If the channel can change fast enough — 50 milliseconds, equal to 50 thousandths of a second — the customer won’t care where the switching is happening. At last week’s CableLabs Summer Conference for cable TV execs, the NSG9000 was voted the “best new idea that is most likely to succeed.”

You may remember last year when I was disappointed that AT&T — then SBC — picked Scientific-Atlanta to provide all the equipment for the first phase of its fiber-to-the-home buildout. Word on the street is that the Scientific-Atlanta encoders are so poor that AT&T can’t deliver two High Definition channels at the same time. Cisco might be able to fix this problem by throwing research money at it, or the customer may insist that they go to Ericsson/Tandberg or Harmonic and buy better encoders. Or Cisco may just buy Harmonic, combining HLIT’s advanced video delivery technology with Scientific-Atlanta’s set-top box expertise.

Harmonic just completed the acquisition of Rhozet, a private video software company, for $15.5 million. Rhozet specializes in “transcoding,” which is converting a video input meant for one device, such as a TV, and converting it to display on another device, like a computer or cell phone. Their customers include Amazon, CBS, ESPN, MSN, MTV, Sony and Yahoo, plus over 100 other broadcasters or providers of downloadable videos. I expect Harmonic to add Rhozet’s software to its encoders, and possibly some other head-end equipment. Transcoding also can reduce bandwidth usage in the last mile and reduce the cost of video archival storage. This is just another way that Harmonic is improving their products and making the company even more attractive to others that could potentially put a bid on the table. HLIT remains a Top Buy under $10 for my $16 target, or even more in a buyout.

Motorola (MOT) seems to have found a bottom around $17. Remember that my thesis on this stock is that their cell phone market share will continue to fall for another few quarters, before they introduce their new products and leapfrog Nokia, as Nokia leapfrogged the Razr. Surveys show that Apple’s iPhone is gaining about as much share as MOT is losing. MOT remains the market share leader with 31% of the market, but that is down a couple of more points since the last quarter. The public’s intentions to purchase a MOT phone are down from 33% in October 2006 to just 14% in the most recent survey.

The reasons that this is good news for us are first that the outlook is more likely to precipitate a management change, large stock buyback or private equity takeover, and second that the news seems to be in the stock, with the recent weakness related more to broad market moves than these survey results. The Motorola January 2009 $17.50 LEAP calls (VMAAW) remain a Top Buy up to $4 for a $10.50 target ($28 on the stock minus the $17.50 strike price) in January 2009.

Telkonet (TKO) drifted down towards $1.25 a share before gaining 20 cents yesterday and again today. I’ve received a number of emails regarding TKO in the past week, and today I’d like to a few minutes to address the questions weighing on your minds.

In regards to the company’s recent lows, subscriber Larry took the cheap shot: “Hey Mike — Got to ask — TKO continues to hit new lows — is it time to ‘TKO’ this stock and move on?” And Jim wanted to know: “With no apparent info that would cause TKO to continue to drop, is it your belief the continued slide in TKO is just a result of the overall market and that we can expect it to rise with the market should that happen as you predict?”

I think this is what happens when Wall Street sours on a management, and then a big downturn hits. There are so many other ideas to buy, why would they step up to the plate for a CEO who doesn’t go to the office every day?

Jeff picked up the recent 8-K filing and asked: “What happened to TKO today (8/1/07)? Are 8-K disclosures good or bad news for companies?” He is referring to the July 30 filing regarding a $1.5 million bridge loan, carrying 6% interest and payable out of the company’s next financing, or by January 28, 2008. The lender, GRQ Consultants, got a $25,000 fee and issued five-year warrants for 359,712 TKO shares at $4.17 a share. Those are not onerous terms, and this is not a toxic convertible. I think it’s neutral to mildly positive news.

Rich wrote: “Telkonet has been an unmitigated, disastrous call on your part. It’s time you own up to making a huge mistake in recommending this stock. As a result, I have lost a tremendous amount of my hard earned savings on this bust of a stock. Please keep us informed very PROACTIVELY on this company, so I can bail if need be before it goes belly up, and at least salvage a few pennies.”

I obviously made a mistake in timing my recommendation, because the stock is down. The company has won the potentially huge EDS/Department of Defense contract that I was looking for. They’ve overpaid for an acquisition and then taken their medicine by spinning it off. The main problem is that the CEO is trying to run the company from hundreds of miles away, which may work OK with an Internet start-up, or even a Fortune 500-size enterprise (John Malone of cable TV fame did it for years), but it is no way to run a small-cap public company. I don’t think that TKO is going broke, as evidenced by the terms of the recent $1.5 million bridge loan. And I know that they are the leader in in-building Broadband over Power lines, and have won key contracts against their competitors.

What I don’t know is when the Board of Directors will replace the CEO. I was encouraged by yesterday’s announcement that the Board has appointed Jason Tienor, the founder and CEO of recently-acquired EthoStream, as Chief Operating Officer, and he’ll be responsible for Telkonet, EthoStream and Smart Systems International. That’s all the operating divisions of TKO. He reports directly to the current CEO. I found the press release language interesting:

“Having worked closely with Jason for the past year, he has proven to be an exceptional business leader and a strategic planner, coupled with strong technical expertise. He has excelled by developing, from the ground up, one of the largest hospitality networks in the U.S. with unparalleled, end-to-end customer support. With Jason’s drive, expertise and dedication to quality, Jason is highly qualified to drive our sales and take the company to the next level.”

To me, “taking the company to the next level” means he will move up to CEO shortly, and that is the reason the stock went up 20 cents in today’s bloodbath. Jason is our White Knight, and we should stick with TKO and give him a chance to run it right. So to answer Larry’s question specifically, now is not the time to move on. I stubbornly maintain that TKO can be bought all the way up to $5, and eventually will sell for $15 a share — 10X its current price.

New Energy Technology MegaShift

Oil and gas prices have been falling as investors worry about the future health of the U.S. economy, and move to take profits on last week’s rally to record highs for oil. But with oil around $72 a barrel, it’s hard to call it a bear market. So, this is probably a normal retracement in an ongoing upturn. One factor that could push oil prices further down is the embarrassing replay of last year’s backpedaling on hurricane forecasts. Most of the long-range forecasters are no longer calling for a heavy season, and I’m beginning to wonder if it will even get to normal. So far this season there have been only two weak tropical storms. In 2005, by now we had five tropical storms and three hurricanes. Oil could head down to test the lower limits of the recent $60 to $75 trading range if there are no storms at all, but then even a normally cold winter would push it to higher levels again.

Connacher Oil and Gas (CLL.TO) completed construction on the Pod One oil sands processing plant. It cost $290 million and will produce 10,000 barrels of oil a day for 25 years — a total of about 90 million barrels of oil. When they actually turn the plant on, there will be a big press release that should boost the stock. In addition to the Pod Two project that they have applied for, they will build a pipeline that can handle 50,000 barrels a day — a pretty clear message as to where they are headed over the next five to seven years. CLL.TO remains a Top Buy up to $4.50 for my $7 near-term target.

Energy Focus (EFOI) retrofitted a Bath & Body Works store in Columbus, Ohio, with LED lighting to replace fluorescents. Bath & Body Works gets better looking displays, thanks to higher quality light that has no heat to run up air conditioning bills in the summer and an overall reduction in electricity consumption. Plus, they won’t have hazardous waste disposal costs due to the mercury in fluorescents — almost every component in an EFOI lamp can be recycled. This is just the start of businesses moving to more energy efficient lighting, and EFOI will continue to benefit as more installations are made. EFOI has been flirting with $6, and you should go ahead and buy the other half of your position while the stock is under $7 for my $15 target this time next year.

Infinity Energy Resources (IFNY) will announce earnings tomorrow and hold their conference call at 9 a.m. PDT. A lot of our questions about the timing of asset sales will come up, and hopefully most will be answered.

Lance pointed out: “There’s been dead silence from IFNY. The stock is trading ugly. Any comments?” Michael K. added: “Just wondering what you think (IFNY) recent weakness is due to?”

I think the stock has been weak because there haven’t been any follow-on announcements about specific sales. If we don’t get specific news tomorrow, we surely will get a rough timetable during their conference call. IFNY is a Top Buy up to $5 for my $10 target, and today may have started the long march up.

Rentech (RTK) reported June third-quarter results this morning, but the conference call is just starting now that the market has closed. They had record revenues of $50.4 million, well ahead of last year’s $17.3 million, thanks to the acquisition of the Illinois fertilizer plant. They are seeing improved pricing and higher demand for fertilizer due to the increased corn acreage that was planted to supply new ethanol plants. They lost four cents a share, which was better than the nine-cent loss last year. At the end of the quarter, they had $63.6 million in cash, plus an unused $30 million revolving line of credit.

The consensus was looking for only $35.0 million and a nine-cent loss, so the company soundly beat estimates. But the stock reacted very mildly, rising only seven cents on this big down day for the broad market. For the September fourth quarter, expectations are for $22.1 million in revenues due to the seasonal nature of fertilizer sales, with a loss of eight cents. I expect the company to meet or beat those numbers.

I’m not expecting anything dramatic on the conference call — I will certainly send a Flash Alert if there is — and I am mostly interested in the progress reports on their various projects with the coal companies and their owned plants in Illinois and Colorado. RTK is a Top Buy up to $5 for my $11 target.

Security MegaShift

American Science & Engineering (ASEI) shot up over $5 on Tuesday after they reported a record June first quarter, with sales hitting $44.5 million and earnings coming in at 66 cents per share, up almost 61% from last year’s 41 cents. The consensus was looking for only $37.1 million and 48 cents. Management said that a strong increase in international orders for X-ray inspection systems drove the top line.

Earlier, the company said that they would start paying dividends, and they declared their first quarterly cash dividend of 20 cents a share, payable on September 5 to stockholders of record on August 20. They must have quite a bit of confidence in the future path of the business to start with a payout ratio that high — 30%.

The company’s backlog remained high, over $100 million, due to strong orders. As demand for their products grow, I expect them to do $190 million in sales and $2.75 a share in the March 2008 fiscal year, well above the consensus outlook for $170 million and $2.32. We all had plenty of time to buy ASEI under my $59 limit, including as recently as last Monday before the earnings announcement. Don’t chase it, but buy ASEI on any market-related dip back under $59 for my $93 target.

WiMAX MegaShift

Sprint Nextel reported their quarter, and on the conference call management said that they spent $51 million developing their WiMAX network in the three months, and confirmed plans to begin rolling out the system in Chicago, Washington, D.C., and Baltimore by the end of the year. Commercial service will begin in the first half of next year, and they expect to cover 100 million people by the end of 2008. They said that technical discussions with their partners Clearwire and Google are underway, and there will be more details shortly. They are targeting a 60-day time period to negotiate the core operating agreement with Clearwire so they can make the necessary filings with the FCC and the Department of Justice around mid-September.

Intel (INTC) started shipping a chipset that includes WiMAX to computer makers for testing, but confirmed that laptop computers with built-in WiMAX will be in stores in late 2008, a full-year slip from their original target. Add-on cards are available and Intel is ready to go, but the networks are not there yet due to the original slippage by the WiMAX industry organization is certifying equipment. If Sprint Nextel and Clearwire stay on schedule, Intel may move the introduction date up a few months. Our Intel 2009 $22.50 LEAP calls (VNLAX) are still a good buy on any dips under $5 for my $12.50 target.

Airspan (AIRN) reported a weak-looking quarter yesterday after the close, but it really was not as bad as appeared. Revenues fell from $45.4 million last year to $22.1 million in the June second quarter, and that was due to both a rapid decline in non-WiMAX sales and the unusually high level of sales booked to Yozan in last year’s quarter. WiMAX accounted for 64% of revenues, or $9.0 million, while actual WiMAX product shipments hit $16.6 million, including $2.5 million of deferred revenue. Wall Street was looking for $22.5 million in sales and a 14-cent per share loss.

The company reported a loss of 29 cents a share, but that included a $5.9 million inventory write-off of non-WiMAX equipment. Due to the write-off, gross profit margins were reported at a measly 8%, compared to 19% last year. But adjusting for the write-off, the gross margin was up to a respectable 35%, and their operating expenses fell 19% year-over-year as they tightened their belt.

This is a transitional year for Airspan’s customers, who are making decisions to stop deploying proprietary high-speed wireless networks and switch to WiMAX. The company guided for $95 million in revenues this year, compared to expectations for $105.4 million. As a result, the stock fell 93 cents a share today. They still have $24.4 million in cash and a $20 million receivables credit line, on which they’ve taken down $7.5 million. With Alvarion (ALVR) still well above my buy limit, I think Airspan is the next WiMAX stock that’s likely to move, and want you to continue buying AIRN up to $5 for my $10 target.

Last week marked the worst weekly losses in five years, and while the last two weeks have not been my or your idea of fun, they sure have been instructive. They have given us some key levels to watch out for as well as some to look forward to. At the San Francisco Money Show last week and in Wednesday morning’s Flash Alert, I emphasized the line-in-the-sand importance of the 1440 level for the S&P 500. Let me now repeat and amplify what I said in the Flash Alert to help you make sense of this market:

“The S&P 500 may test 1440 today or tomorrow. I expect that level to hold and mark the bottom of this market for the next 18 months. There is a slim chance that the S&P will overshoot down to 1432, but there’s an even bigger chance that it doesn’t even get to 1445 before the bull market resumes. (We’ve already seen 1447 this morning.) The recent downturn has stoked up a tremendous amount of negative sentiment and cash on the sidelines, more than enough to slingshot the S&P up past the old highs around 1552 to the 1605 level. If this plays out as I expect, any money that you put to work in the next few days should be golden. If you want to be conservative, wait for a daily buy signal, with the S&P 500 closing back above 1474.

“At some point, the market will go down far enough to test the very important 1326 breakout on the weekly chart, but the odds are very high that the current drop is not that test — which may not come for one to three years. A solid close over 1474 will confirm that this major weekly downside target is off the table for now. So, as I’ve been telling you for the past few weeks, let the market tell you what to do.”

Before I sent out that Flash Alert on Wednesday morning, the S&P rose 18 points on Monday and fell 18 points on Tuesday. Then it fluctuated wildly yesterday before hitting 1439.57 about thirty minutes before the close, and then rocketing upward to close at 1465.81. The Dow Jones Industrial Average had a 258-point range for the day. Talk about volatility. The S&P five-minute chart showed a classic bear trap, with seven straight up candles at the end of the day, numerous gaps and the gloomsters falling all over each other to cover shorts. The drop last week was supposedly “caused” by the exact same bad news items that “caused” several drops earlier this year, and the jump yesterday came with not one of those bad news items resolved.

This market is not about news. If it was, the Weekly Leading Index (WLI) from the Economic Cycle Research Institute — a terrific early warning sign of trouble in the economy and the stock market – would show it. But right now we can actually look at the sub-prime mess and record oil prices and say: “Wow, even in this environment the WLI is still showing no problems on the horizon.”

Or, as the ECRI put it: “Despite market jitters, WLI growth is holding near three-year highs, providing reassurance about the resilience of the U.S. expansion.”

Even a better-than-expected report on pending home sales early yesterday didn’t start the rally. The $2.1 trillion global thrashing that stocks took last week — dropping U.S. stocks to only 15.4X earnings, their cheapest level in the 16 years since the January 1991 Gulf War low — set up the rally. Then the Fear Index, the VIX, went to multi-year highs on last week’s decline, even though the S&P only moved down to test the last major weekly breakout level. That’s why there is now enough fuel to run the S&P 500 up to 1605, and maybe even to 1710.

But I am not complacent about this. The 1534 level was important support that gave way on the bumpy ride down last week, and the S&P has to get back over that level without a lot of trouble to keep my bullish outlook intact. One possible scenario that could play out in the upcoming days: A strong move up from Wednesday’s low that peters out just below 1534 could be a classic rally back to kiss broken support, followed by a really nasty drop. I don’t think that it will play out that way, but as always, we will let the market tell us what to do.

It’s also important to remember that bear markets almost never start by losing lots of points in the early stages, as we saw last week, without making it almost all the way back up to the prior high. Even if the recent decline is something more than just a nasty correction in an ongoing bull market, we should still see the S&P 500 near 1534 again, or even close to the 1555 all-time high, before a real bear market starts in earnest.

Another thing that I’m not complacent about is what happens when the S&P reaches 1605, assuming that we get there. That is another level from which a bear market could begin, although, again, I think it is more likely that if we do reach 1605 we will see a sideways consolidation, a test back down to a prior breakout point like 1534 or 1555, and then a run to more record highs around 1710. But that is just my bias, based mostly on the plunging dollar. As always, Mr. Market may have other ideas.

Before we move into updates on our recommendations, there’s one more positive thing I want to note. It was also very important that today’s market did not eat into that long tail down to 1440 on yesterday’s daily chart, because if it had it would have brought into question how much support this market really could find. But we passed that test with a nice 6-point upmove in the S&P 500 today. As I said in Wednesday’s Flash Alert, a daily close over 1474 — which we were two points away from achieving today — is the key to getting back to 1534. So if you want to be conservative, wait for that daily buy signal before adding any more to your current positions.

Over the next days and weeks as we watch for the market’s next moves, I’ll continue to send you Flash Alerts around the critical levels that we discussed above, and let you know if there’s any action that you need to be taking regarding our MegaShift holdings.

Get Positioned For Profits

Even though I’m fairly positive that the market will continue its trek to higher levels, there is always the possibility of a downturn. So today, I want to discuss my latest addition to the Security MegaShift, SiRF Technologies (SIRF), because this is one of the stocks that I would be willing to hold through a bear market.

SIRF is currently transitioning from being a supplier of the world’s best Global Positioning System (GPS) chips for dedicated GPS products to providing the intellectual property and integrated chips needed as GPS itself transitions from a product to a feature in many products, particularly cellphones, laptops and vehicles. The “feature” market is much, much larger than the “product” market, and while this transition may play hell with GPS product manufacturers like Garman and TomTom, SIRF should, well, surf the new wave with few problems. SIRF has the patents, engineering talent and partner/customer relationships needed to dominate its market.

SIRF acquired Motorola’s (MOT) GPS operations last year, and they still have a close relationship with MOT. As you know from yesterday’s Flash Alert, SIRF said that one major cell phone customer had slower-than-expected growth in its new GPS-enabled products, and I think that was MOT. But what I didn’t tell you is that disappointment was partly offset by another large cell phone customer accelerating deliveries. That, I think, was Nokia, which has said that virtually 100% of all its handsets will include GPS as a feature. The cell phone industry will ship about 1.025 billion handsets this year — an impressive number in a world of 6.6 billion people, especially after subtracting those too poor to have one or too young to use one. SIRF said that it is working with NXP, the spinout of Philips Semiconductor, to put SIRF GPS technology into the NXP chipsets for cell phones. It takes time to qualify a new handset design on each cellular service provider’s network, but SIRF also said that this process is underway, and that the company is working with its handset customers to make sure that the GPS feature does not slow down qualification.

At the same time, just as cell phone cameras have not killed the high-end digital camera market, Garman and other manufacturers of portable navigation devices are adding features like 3D mapping, audio and video travel guides, location-based store coupons, online reservation access and so on. I would not be surprised to see some of the new iPods — coming in the next 60 days, according to the rumor mill — include mobile digital TV and interactive games. In Asia, games that incorporate GPS information are already very popular. To expand its footprint in this market, SIRF acquired Truespan to get handheld digital video broadcast technology, and they are also in the process of acquiring Centrality for application processors.

SIRF also just announced the reference design deal with Intel for the UltraMobile PC platform, and other unspecified mobile products. GPS will be a standard feature in the UltraMobile PC, and Centrality’s application processor technology also can be used in this product.

Although their September-quarter guidance disappointed the Street, even using their lowered profit margin outlook and accounting for the Centrality dilution this year, I think SIRF will report about $1.00 a share this year. Centrality will contribute to the company’s profits in 2008, when I expect SIRF to hit $1.25 to $1.30 a share, and then grow that to $1.60 or so in 2009.

Unit volume growth is over 50% and revenue growth is around 25% as prices come down in good Moore’s Law fashion. I think growth at that rate is worth at least 25X forward earnings, so the stock should get to 25X $1.60 by the end of 2008. I want you to buy SIRF under $22 for my $40 target price.

Avian Flu MegaShift

Crucell (CRXL) announced a non-exclusive PER.C6 and Advac technology license agreement with Wyeth for the usual up-front payment, milestone payments and royalty payments on future sales, with no specifics given. It’s another in a string of major-pharma deals to totally replace the way that we currently make vaccines, and CRXL will get paid for every shot. The stock has been clobbered in this decline, but if there is any group that is totally immune to the sub-prime mortgage implosion or private equity funds not being able to fund deals, it is biotech. CRXL is an excellent buy at these levels and up to $28 for my $50 target.

Biotech MegaShift

eResearch (ERES) reported after the close today, and I’ll be listening to the conference call shortly. They did $24.7 million in sales and eight cents per share, compared to consensus expectations for $24.3 million and six cents. They showed strong sequential growth and improved profit margins, with very strong bookings of $34.5 million. The backlog is up to $106.8 million, and I think we have finally hit the point where revenues will grow in line with bookings.

They guided in-line for the September quarter with sales between $24 million and $26 million, and seven cents to nine cents per share. The consensus is at eight cents on $26.7 million. ERES guided up a bit for the year, expecting revenues around the midpoint of their previous guidance of $95 million to $103 million, with earnings at the high end of their previous guidance for 25 cents to 30 cents a share. It certainly looks like a good quarter going into the conference call, and ERES remains a Top Buy at these levels that can be bought all the way up to $16 for my $30 target.

Geron (GERN) reported a June-quarter loss of $14 million or 19 cents a share, just as expected. They have $217 million in cash and no debt. With continued news flow about both their anti-telomerase “silver bullet” for all cancers and their stem cell research, particularly for heart disease and spinal cord injuries, GERN remains an excellent trading buy from current levels up to $9 for my $18 target.

Rochester Medical (ROCM) reported June-quarter results after the close on Tuesday, with sales up 56% from last year to $8.4 million and pro forma earnings of 10 cents a share. The stock traded down about $1 yesterday morning, and then got most of it back by the close. The trial against Covidien (COV), the spinout of Tyco Healthcare, is scheduled to start August 7. It may be postponed, or they may settle for another huge payment to ROCM. Or, even better, Covidien could buy Rochester Medical for $30 to $40 a share.

Covidien had 2006 revenues of nearly $10 billion, and they have more than 43,000 employees worldwide in 57 countries. It can afford to buy ROCM at a fat premium for lunch money. ROCM is a Top Buy based on the possibility of a potential settlement with COV. The buy limit is all the way up at $23 for my $40 target.

ViroPharma (VPHM) reported earnings yesterday before the opening, with the report clobbering estimates and the company raising guidance. The stock rose over $1.50 in response, but gave back 48 cents today.

VPHM did $56.1 million in sales in the June quarter, up 28% from last year to an all-time record, thanks to continued good sales of Vancocin, and they booked 39 cents a share in earnings, up 56%. The Street was looking for $50.6 million and 26 cents. Management raised 2007 Vancocin sales guidance from a range of $195 million to $205 million up to $200 million to $208 million.

During the quarter, VPHM began the Phase III trial of Camvia (maribavir) for cytomegalovirus in liver transplant patients; the Phase III trial of Camvia in stem cell transplant patients continues. They completed enrollment in the Phase II 500 milligram, twice-a-day dosing regimen for HCV-796, their hepatitis C drug, in combination with pegylated interferon and ribavirin, and got Fast Track designation for it from the FDA. They will present four-week treatment data this quarter and 12-week data next quarter.

Now, here is the situation with the FDA’s potential approval of a Vancocin generic, the issue that clobbered VPHM last year. I think there is clear evidence that it is not going to happen. The company has always believed that Vancocin does not meet the new criteria that would allow for a waiver of human clinical trials to show in bioequivalence. They communicated that to the FDA in filings last summer via the citizens’ petition process. To date, there has been no rebuttal filed to the data by potential generic manufacturers.

Second, the FDA recently released a list of the bioequivalence requirements for over 200 drugs. Vancocin is not included in this list, which at a minimum indicates that the FDA has not yet reached a conclusion on the bioequivalence requirements for Vancocin. Rather than taking Wall Street’s position that this is a done deal, namely that Vancocin bioequivalence can be shown in the test tube rather than in human trials, I think that the evidence is piling up that the agency has a problem with that argument. Sure, there is still a chance that they may eventually come down on the side of the generic companies, but it is going to be so late in the process that we won’t see generic Vancocin before 2009 — exactly when ViroPharma management expected it anyway! The company has plenty of cash to buy or in-license their next product, and they have looked at and rejected dozens, if not hundreds, of opportunities in the last 12 months.

When we bought this stock, we hired these guys to exploit Vancocin and use the cash flow to build a big specialty pharma company by picking up more products, and that is exactly what they are doing. They remind me a lot of Cephalon, a stock that I recommended in the teens many years ago — it now sells north of $70. VPHM has the same strategy. With $516.8 million in cash and no debt, I want you to buy VPHM on dips under $13 for my $28 target.

Content on Demand MegaShift

Silicon Image (SIMG) reported a few minutes ago, and I’m about to get on the conference call. Revenues hit $79.8 million and they did 10 cents a share pro forma, above the consensus expectations for $77 million and seven cents. Consumer electronics accounted for 75% of sales and grew about 25% both sequentially and compared with last year’s quarter.

SIMG issued conservative guidance for the September quarter of $81 million to $87 million in sales, compared with the consensus for $91.9 million. I think that they are sandbagging, as they also said that growth would be strong due to the holiday build out beginning in this quarter. They trimmed their outlook for the year to $305 million to $315 million, down from prior guidance of $325 million to $345 million, and the consensus for $331 million. That may cause the stock to dip tomorrow, but again I think that management is sandbagging.

The company said that the SEC has completed its investigation into SIMG’s stock option practices and everything is OK. If the stock gets nicked tomorrow, treat it as an opportunity — I may move it to a Top Buy. For now, SIMG remains a buy up to $13 for my $20 target.

China MegaShift

UTStarcom (UTSI) held an update conference call yesterday. Management has concluded their work on stock options backdating, but they can’t call it “final” until they file a 10-K with the SEC. They are coming down to the wire on the issue of recognition of revenues in China, and when that is done they can file restated financials and put this whole history behind them.

The call was not as contentious as I expected, primarily because they have hired an excellent Chief Operating Officer and said that the Board is committed to making him the CEO. He is Peter Blackmore, who has deep experience running operations at multi-product, multi-geography companies like Unisys and Hewlett-Packard. He will replace Hong Liu as CEO, and Hong will become the Chairman of the Board, where he won’t be able to do any more damage.

The company’s strategic review resulted in a decision not to sell anything, but rather to reclaim the value in their technologies by using a six-point plan:

1. Focus on their best products, technology and market opportunities in broadband infrastructure (where they are the leader in India and in the top tier in Japan), Internet Protocol TV (where they are the leader in China) and cellular/wireless.
2. Dramatically improve operational efficiency, especially in the supply chain, an area where Peter Blackmore knows what to do.
3. Get more partners and leverage them to become a virtual giant.
4. Serious expense reduction across all operating expenses, again a familiar area for the new COO.
5. Put in place a strong management team, which I expect the COO to do by the end of the year, especially in sales and marketing.
6. Increase their speed to act and react quickly, yet another task for Blackmore.

I think the turmoil at UTSI is coming to an end, as the managers who demonstrated incompetence are moved out or up, and the new kids have come to town. The stock is ridiculously cheap at current prices if Blackmore can pull off a turnaround. We should see some evidence in the next conference call, when they finally file their 10-K and can report quarterly results like any other company. I’d especially like to see accounts receivable collected, inventories come down, and some of the India broadband expertise start to translate to sales in China. I am going to leave my UTSI buy limit at $9 and the target at $15, even though the stock closed today at $3.53, because that is what any other company with their assets, sales and technology would be worth. It will take a few quarters to regain Wall Street’s confidence and get the stock up that high, and Blackmore has to be appointed CEO (which should happen before yearend), but the reward is well worth the risk at this level, not to mention the pain we have all gone through over the last few years with this stock.

New Energy Technology MegaShift

Oil closed at an all-time high of $78.21 yesterday, without any hurricanes or saber-rattling in Iran. Think where we’ll be if the Gulf gets hit with a Category 5 storm in the next six weeks!

Connacher Oil & Gas (CLL.TO) should benefit from Marathon Oil’s agreement to buy Western Oil Sands of Canada for $6.2 billion. Marathon is paying $3.6 billion in cash, $1.9 billion in stock and assuming $650 million in debt, and in return they get a 20% share of the Alberta tar sands project. The project covers 54,360 square miles, about the size of Florida, with more oil locked in the tar sands than all the Mid-Eastern countries combined.

But a normal oil deposit is mixed with gas under pressure — that’s why oil that comes spurting out of a successful well is the scene so beloved in Hollywood movies about Texas. It’s as if you shook up a can of beer and then popped the top. But imagine if you didn’t shake the can, eased off the top and then let it sit in the sun for a few months. Then you added a handful of dirt to the syrupy stuff that was left. That’s like the tar sands. Over millennia, the gas leaked out into the oceans that once covered Western Canada and all that oil is now locked in sand.

There are two ways to get the oil out of the dirt. Western Oil Sands uses the brute force method: Pit mining. Giant excavators dig a massive, environmentally destructive pit and load the sand into giant dump trucks with wheels the size of houses and a staircase up to the driver’s seat. Then the sand is washed in a giant factory that lets the oil rise to the top, and the process uses billions of gallons of valuable pure water, turning it into a contaminated mess that has to be remediated and disposed of. It’s a brutally expensive process, but the result is one of the best light, sweet crudes ever seen.

Or, like Connacher, you can use Steam Assisted Gravity Drainage to separate the oil underground with no giant pits and no water usage. CLL will turn on this clean, simple process at their Pod One production facility any day now, so CLL.TO is an especially timely Top Buy right now up to $4.50 for my $7 first target. When a major oil company like Marathon decides to pay up to get into the world’s largest untapped oil reserve, it can revalue all the other companies involved. So don’t be surprised if I raise our target price in the coming weeks.

Energy Conversion Devices (ENER) makes nickel-metal hydride (NiMH) batteries for hybrid cars through its Cobasys joint venture with Chevron. These are great batteries — I have them in my Toyota Camry hybrid — but Cobasys had to work hard to reduce this technology’s tendency to bleed oxygen at lower temperatures, and be susceptible to explosions at higher temperatures. Their reward for all their hard work has been to capture a large portion of the value-added in hybrids. Today, the percentage of the overall production cost of a regular car accounted for by electronics and software is about 20% (far more than the cost of the steel, incidentally), but 50% for a hybrid.

A new technology, nanophosphate lithium-ion batteries, is now on the market in the DeWalt portable saw. It takes only five minutes to recharge, does not emit oxygen at any temperature, and is unlikely to explode. For now, it is only applicable to smaller applications like portable power tools, but I think it will eventually scale up to hybrid car size. Combine that with the next generation of plug-in hybrids that can be charged by solar cells on your garage roof, and things could get interesting. Plugging into a service station outlet for five minutes isn’t any more onerous or time-consuming than filling up at the pump.

Don’t worry about these batteries threatening ENER, because the M1 battery in the DeWalt saw is made by a company called A123 Systems and…Cobasys. ENER and Chevron are making sure that if anyone obsoletes their current products, it will be them. ENER is a strong buy while it is under $35 for my $55 target, which I expect to see after the current restructuring is completed.

Gasco Energy (GSX) reported after the close last night and held their conference call this morning. They did $6.1 million in sales, up 6% from last year, in spite of sharply lower natural gas prices, and lost two cents a share before an impairment charge, which is an accounting requirement forced by assuming current prices for all future production. The company had record production of 1,124 million cubic feet of natural gas equivalent (MMcfe), up 30% from last year’s June quarter. But their average price received for sales of natural gas was $4.31 per Mcf, down 17% from last year.

GSX also announced a major partner for their Utah drilling program. NFR Energy, a private company created to invest in worldwide oil and gas exploitation opportunities, will participate in 30 wells drilled by Gasco in 2007 and early 2008 on 1,200 acres in the Riverbend Project. NFR can earn two-thirds of Gasco’s interest in each 40-acre drilling location in exchange for paying its share of the costs and a per-well location fee paid to Gasco as operator of the projects. So, the company will be able to keep three rigs busy.

The agreement covers substantially all of Gasco’s 2007 drilling program, retroactive for certain wells drilled year-to-date. It does not include the company’s assets in California, Nevada and Wyoming, and does not block Gasco from independently drilling other wells. GSX controls 75,000 net acres in the Unita Basin in Utah, so this program involves less than 2% of their total drillable land. This was one of the main reasons that the stock reacted as well as it did to its earnings announcement.

GSX will make steady production progress from here, and better gas prices will have a leveraged effect on the bottom line. Of course, the stock will soar on either major hurricanes in August or September, or a cold winter. GSX remains a strong buy from current levels up to $4.50 for my $9 target.

Security MegaShift

Packeteer (PKTR) got quite a write-up in The Wall Street Journal in a July 30 article on Deep Packet Inspection (DPI), which PKTR does better than anyone in the world. DPI gives the customer unprecedented visibility into what is traveling over their network, letting them decide which packets should take priority, which can be slightly delayed or compressed without any negative impact, and which should be stopped because they are computer worms or viruses.

Paketeer’s new iShaper is a “branch office in a box” that offers visibility, compression of data to save buying more hardware (while not compressing voice or video, to maintain quality, and acceleration of critical packets. The competitors are promising equivalent products, but only PKTR really has the goods.

The Journal article title and subhead were: “A Question of Priorities — Faced with clogged networks, companies and college campuses get more sophisticated about which online material gets in first.” Colleges are big users of DPI, because students are heavy users of high-bandwidth services like music, movie and video downloads that clog networks. A Ball State network engineer was quoted as saying: “I can’t imagine a university in the United States without some kind of DPI technology in their network. It’s just that important.”

Rawlings Sporting Goods turned to Packeteer to solve their problem, too. During the 2005 holiday season, they had a barrage of complaints from customers about Internet orders taking too long to go through. Rawlings engineers couldn’t figure out the cause of the problem until they tried a DPI demo system from Packeteer. It turned out that employees were eating up bandwidth by watching streaming videos. “The network was the last place I would have thought we had problems,” said Richard Truex, network manager for Rawlings.

By deploying the Packeteer system, Rawlings was able to improve the flow of network traffic without having to buy more bandwidth, leading to major cost savings. Packeteer’s system allowed Mr. Truex to create rules to guarantee bandwidth for important applications, like customer orders, and squeeze bandwidth for others. During peak business hours, streaming videos are nearly shut off to allow the flow of important data.

Knowing that PKTR has the best products for a serious problem does not guarantee that the stock will go up, though, or we would have hit my $20 target long ago. But now that there are a couple of activist private equity funds involved with PKTR, I think something will happen sooner rather than later.

Elliot & Associates already has written a letter to the Board asking them to solicit bids for the company. They own about 8% of PKTR, a big piece of their $120 million portfolio. Mostly, they hold large cap, S&P-type stocks, but they were the firm that tried to stop the sale of Lexar Media to Micron, and they’ve also been hammering on the management of Pier 1 Imports.

Chapman Capital targets undervalued companies that they believe are worth at least twice their current value, usually ones that have had a major negative event and that Robert Chapman thinks have weak management. Mr. Chapman is well-known for his nasty letters to management, including the Board of Directors, of companies that he is targeting. He’s been leading the charge to get Vitesse Semiconductor sold, and he forced the sale of timeshare resort owner Sunterra last year. PKTR is his third-largest holding at more than 7% of his $375 million portfolio. I wouldn’t doubt it if he starts knocking on their door next.

If PKTR had hit their numbers in the June quarter, it would be a Top Buy at current prices. Given their miss, I want to be a bit conservative and let them show me that they can execute before going that far, but I still think PKTR is a great buy under my $9 limit, and they will get to my $20 target through either operations or a takeover.

WiMAX MegaShift

This is turning into the Year of WiMAX, and one reason is how quickly and broadly world GDP is growing. With China, India and Russia fully participating (if not leading), world GDP growth is at a 40-year high of 5%. This is not just the U.S., Europe and Japan booming after World War II and the Korean War — over 120 countries will grow faster than 4% this year. Africa will grow faster than 6%; how long has it been since you thought of Africa as a growth region?

All of those fast-growing, less-developed countries have governments and people that want to get quickly into the 21st century, and that means high-speed Internet connections for data, voice and video anywhere. They may lay a few fiber backbones next to their highways, but most of the infrastructure has to be wireless, and WiMAX is their technology of choice. Because it is a standards-based technology, it will always be cheaper and develop faster than the hodge-podge of proprietary technologies they’ve been offered in the past.

Airspan Networks (AIRN) won a major contract with BigAir Group in Australia to install the first commercial WiMAX networks for businesses in Sydney and Melbourne, and the second network in Brisbane. This a huge win for AIRN, as BigAir plans to go nationwide. AIRN is a steal below my $5 buy limit, and I still think it can hit my $10 target by yearend.

Alvarion (ALVR) reported before the market open yesterday, and they announced that they had returned to profitability and raised revenue guidance for the year. Revenues rose 31% to $57.5 million, including record BreezeMAX revenues of $27.9 million, and they reported a tiny profit on a GAAP basis, compared to a 45-cent per share loss last year. On the more important pro forma basis, they did three cents a share compared with two cents last year.

They now expect September-quarter sales between $58 million and $62 million, well above the $56.7 million consensus estimate, with GAAP earnings per share between breakeven and a two-cent profit. Pro forma earnings will be between three cents and five cents, also well above the expectation for breakeven in both the September and December quarters.

Alvarion is seeing record revenues and strong gross profit margins in both WiMAX and non-WiMAX deployments, with strong orders for WiMAX. They shipped $34 million worth of BreezeMAX equipment, but only recognized $27.9 million as revenues. That brings them to cumulative shipments of $190 million, much more than any other company. The company now has 170 customer installations, up from 150 at the end of the March quarter, and the vast majority of these are in the early stages of deployment, with much, much larger follow-on orders to come. In addition, they are in 220 trials around the world, including 40 for mobile WiMAX. That’s about twice as many as any competitor is claiming.

For the year, they raised their revenue growth target to a range that’s 25% to 30% over 2006, much better than their prior targets of 15% to 20% — and most of the difference will be packed into the next two quarters. The higher percentage growth translates to a $227 million to $236 million range, compared to the consensus for $223.5 million for 2007.

First Albany raised the stock from neutral to buy this morning — welcome, belatedly, to the club — and I expect many more upgrades, with a positive spill-over effect on the whole WiMAX sector. With $122 million in cash, up $2 million in the quarter, and no debt, ALVR remains a buy on dips under $9 for my $18 target.

We all had plenty of time to buy ALVR at much lower prices, and for now I want you to put money into still-depressed AIRN first.

Long-time subscribers will probably recall one of my previous recommendations in the Security MegaShift — SiRF Technology Holdings (SIRF). I’ve recommended this company a few times in my newsletters, and the last time we bought it in 2005, it treated us very well. We went into this leading manufacturer of Global Positioning System (GPS) chips at $24.84 on October 27, 2005, and sold it for a 59% gain just four months later. I’ve been watching the stock ever since then for another buying opportunity, and I almost pulled the trigger a month ago when it traded down under $21 for a couple of days. But the stock rebounded and has been trading in the mid-$20s — until today. SiRF announced June-quarter earnings after the close last night and guided revenues down a bit for the year, so the stock is being hit this morning, down $2.50 to $20.90 as this Flash Alert goes out.

With just a bit of perspective, this situation looks about as silly as Wall Street ever gets. The company announced sales that were up 23.4% to $70.6 million, almost matching consensus expectations for $71.5 million. Pro forma earnings exactly hit the consensus at 23 cents a share, up 15% from last year.

SiRF said that they will report sales of $315 million to $325 million this year, compared with the Wall Street consensus of $315.6 million — and that was the “bad” news. About $15 million of that will come from their acquisition of Centrality Communications, which will be completed in the current quarter. That means their guidance for the current business was $300 million to $310 million, and their previous guidance had been $320 million to $330 million. Even though the Street consensus was below the low end of their prior range, that $20 million “shortfall” (which will be almost entirely made up by the contribution from Centrality after that deal closes) is one factor that is hitting the stock this morning.

The other factor is that Centrality will slightly reduce SiRF’s earnings in the September and December quarters, before adding to the company’s earnings every quarter next year. SiRF guided for $84 million to $87 million in sales this quarter, well above the $81.4 million consensus, but their 21 cents to 23 cents earnings per share estimate was below the consensus for 28 cents. That completed the one-two punch that is pummeling the stock today.

But let’s do a reality check. SiRF said that the shortfall in earnings guidance is due to a slower-than-expected ramp up of production by one of its wireless customers. A good guess would be Motorola (MOT), which, as you already know, I am expecting to turnaround next year based on new products. So once production hits full speed, which I am expecting later this year or early next year, it will be very positive to SiRF’s bottom line and they shouldn’t have much of a problem meeting and then beating the consensus figures.

In the meantime, the $283 million stock and cash purchase of Centrality significantly strengthens SiRF’s position in system-on-a-chip navigation semiconductors for automobiles and multi-function handheld devices like cell phones and personal digital assistants (PDAs). SiRF is already strong in specialized personal navigation devices (PNDs), and they will parley their reputation in PNDs to the very high volume multi-function market.

And SiRF is racking up some big contract wins in their field, as well. During the quarter, the company won the GPS slot in the Intel Ultra Mobile PC (UMPC) and Mobile Internet Device (MID) reference platforms. These are generic products designed by Intel to give manufacturers all over the world a quick start in these markets.

Several personal navigation devices using the SiRFstarIII architecture were also announced or went into high-volume production during the June quarter, from manufacturers like Garmin, Magellan, Mio, Navigon and Via Michelin. These products range from entry-level PNDs to high-end convergence devices with multimedia functions like Mobile TV.

• Renesas Technology, the leading in-vehicle GPS supplier in Japan, licensed SiRF’s technology for its new high-performance car information systems.
• The RIM 8800, a new and wildly successful Blackberry/GPS cellular handset that compares favorably to the Apple iPhone, uses the SiRF chipset.
• And yesterday morning, SiRF announced a joint-development agreement with Intel to create GPS products for a wide range of mobile consumer devices using Intel chips and licensed some technology to Intel to integrate functions at the chip level.

Today’s drop in SiRF’s share price puts this leading GPS chip company in the world on an early Labor Day blowout sale. I don’t know how long this can last — see my comments just below on the market — so I want you to buy SIRF under $22 for my $40 target price.

A Quick Market Outlook

The S&P 500 may test 1440 today or tomorrow. I expect that level to hold and mark the bottom of this market for the next 18 months. There is a slim chance that the S&P will overshoot down to 1432, but there’s an even bigger chance that it doesn’t even get to 1445 before the bull market resumes. (We’ve already seen 1447 this morning.) The recent downturn has stoked up a tremendous amount of negative sentiment and cash on the sidelines, more than enough to slingshot the S&P up past the old highs around 1552 to the 1605 level. If this plays out as I expect, any money that you put to work in the next few days should be golden. If you want to be conservative, wait for a daily buy signal, with the S&P 500 closing back above 1474.

At some point, the market will go down far enough to test the very important 1326 breakout on the weekly chart, but the odds are very high that the current drop is not that test — which may not come for one to three years. A solid close over 1474 will confirm that this major weekly downside target is off the table for now. So, as I’ve been telling you for the past few weeks, let the market tell you what to do.