The “two-tier” stock market we have been expecting for the past year is finally here, and along with it comes heightened volatility now that companies are competing for a more finite amount of investor capital. In simplest terms that means good companies benefit at the expense of bad ones, amplifying price movements in both directions.

Such has been the case with FireEye, which we identified last December as “The Once Tech Stock to Own in 2015”. Since then it has been both the beneficiary and the victim of this phenomenon, nearly doubling in value during the first of the year and then losing more than half its value the second half. The net effect is that is now down about 20% from our original purchase date price.

However, the tech sector is rife with companies that have seen their stock prices exhibit similar behavior, only to surge to new heights later on. For example, only two years ago Apple saw its share price drop nearly 40% after quadrupling in value the previous four years; since then it has doubled in value again, vindicating its long term shareholders.

So I asked Rob DeFrancesco to discuss recent events at FireEye (below), and confirm his opinion of it. We know it’s painful to hold a stock that is experiencing this level of volatility, but we also know that the rewards for riding it out can be substantial.

By Jim Pearce

Next Wave Portfolio Update—FireEye

By Rob DeFrancesco

Shares of FireEye (FEYE) last Thursday were hit hard after the provider of cybersecurity solutions reported disappointing third quarter revenue and issued a conservative outlook for the fourth quarter.

After previously raising 2015 revenue guidance twice this year, FireEye was forced to reduce its top-line outlook to a range of $620 million to $628 million (down from $630 million to $645 million previously), representing growth of 46% at the midpoint. In terms of billings, the latest 2015 outlook of $780 million to $800 million is down from previous guidance of $840 million to $850 million.

FireEye is clearly struggling a bit in the short term, but the top-line growth rate remains strong for an organization this size, and most of the issues are company-specific and fixable. While risk levels are elevated at this time, FireEye remains well-positioned over the longer term as a significant provider of enterprise security solutions. It has a broad set of products and subscription services needed to prevent and repair breaches. On Friday, FireEye CEO Dave DeWalt purchased 22,500 shares and CFO Michael Barry bought 13,500 shares.

In the third quarter, revenue rose 45% year over year to $165.6 million, but fell short of the consensus estimate of $167.1 million. Billings of $210.6 million were up 28%, but missed the low end of the guidance range by 6%. There were three main factors behind the shortfall: (1) reduced average deal sizes on enterprise transactions; (2) weakness in Europe (representing 15% to 20% of revenue) caused by poor execution by a still-inexperienced sales force; (3) and lower average contract lengths in the U.S. The overall U.S. business in the September quarter remained solid, but did not fully compensate for the shortfall in Europe.

On the positive front, product subscription and support revenue in the third quarter advanced 64%, with professional services revenue up 52%. The company’s newer FireEye-as-a-Service offering experienced growth of 59%. FireEye added 299 new customers, up 17% from the year-ago quarter. There were 34 deals worth more than $1 million each, an increase of 31% from the same period last year. More than 60% of the large deals included multiple products, while six of the top 10 deals involved new customers. Deferred revenue of $454.9 million rose 61%, with the current portion up 65% to $265.9 million. The overall customer renewal rate remains above 90%.

It may take one or two quarters for FireEye’s enterprise business to re-accelerate and for the European sales force to get fully up to speed. There are concerns about cybersecurity spending patterns returning to more normal levels after a number of widely publicized breaches caused a surge in emergency spending. However, organizations continue to increase their overall security budgets in order to upgrade their infrastructure after years of under-spending. With 10 major product lines in the latest quarter achieving more than $10 million in billings, FireEye has plenty of potential growth levers going forward.

On a valuation basis, FireEye shares now trade at 6x the 2015 consensus revenue estimate of $625.7 million. On the 2016 consensus revenue estimate of $820.5 million, the forward multiple of 4.6 now looks inexpensive relative to the expected growth rate of 31.1% as well as the valuations of other leading security providers.

FireEye remains a ‘Hold’ in the Next Wave Portfolio.

Portfolio Update – Medical Profits
By J. Duarte MD

In this issue:

• The Big Picture: Changing Investor Behavior. It’s a Market Of Stocks – Not a Stock Market
• In Depth: New EBIS Pick – Cambrex Corp. (CBM) – Rallies Big Despite Earnings Miss?
• Trading Portfolio Positions Rally. Alexion (ALXN) Hits Sell Stop.
• EBIS Portfolio Update: DYAX Gets Buyout Offer. EBIS Portfolio Rallies on Earnings News
• News Update: Eli Lilly (LLY) and Merck (MRK) Are Under Investigation for Medicaid Related Drug Pricing Practices

The Big Picture: It’s a Market of Stocks – Not a Stock Market

Biotech investors should consider looking at individual stocks instead of the traditional “basket trade” approach that has worked well in the past. Charts don’t lie. The Nasdaq Biotech Index (NBI) is lagging the S & P 500 (SPX). But index charts don’t always tell the whole story either.

If you look at NBI you are more likely to be bearish on stocks than if you look at the S & P 500. Here’s why. NBI is making lower lows and lower highs, is below its 200 day moving average, and looks as if it could fall below its 50 day moving average. Those are all signs of weakness and are clear indications that the likelihood of lower prices is higher than average.   The S & P 500, on the other hand, is above both the 50 and 200 day moving averages and seems to be ready to take a shot at making new highs from its August and September double bottom. Finally, ROC, a measure of the current trend in momentum (bottom pane in both charts) shows that SPX momentum may be turning higher, while NBI looks to be weakening.

Yet, if you look at the individual stocks on our EBIS and Trading portfolios, you can see that those stocks resemble the S & P 500 more than NBI. More interesting is the fact that the earnings reports on our EBIS stocks were pretty good, but not great. Some companies missed their revenue estimates, while others missed their income or sales estimates. See below for individual details.

This, in our opinion, is an important change in investor behavior, which may be explained by the fact that the market could be betting on a merger and acquisition spree in biotech as well as responding to concerns over government investigations into drug pricing. Here is an example of the merger dynamic. One of our recent EBIS picks, DYAX was taken out on November second for a nice profit. We recommend sale of those shares if you haven’t done so already. Dr. Duarte sold his shares.

Our point is that even though the tendency in the biotech sector, as viewed through the NBI and other sector indexes, may be toward weakness, individual companies in the sector are now the focus of money flows from investors based on specific company fundamentals and expecations. This is contrary to past behavior in biotech where mutual funds and ETFs were the easy way to profits as the sector was viewed as a basket in which one stock was not much different than any other.  See our News and Analysis section below for more information.

Conclusion:

1. Pay close attention to our new Trading Buy Recommendations and our new EBIS picks as these are our most solid picks at the moment.
2. Monitor the price of all current positions in your biotech portfolio.   Check our weekly updates or any special alerts, if issued, for any changes. If your stocks are holding their own, keep them in your portfolio and add to positions as they re-enter their buy ranges from lower prices as they recover.
3. Pay attention to news items, especially as related to products, mergers and takeovers. Always monitor your portfolio’s response to the market and to any news events and only sell stocks that are showing significant weakness and fall below their sell stop.
4. Consider using BIS to hedge your biotech portfolio during periods of weakness for the market and the biotech sector. BIS is hugely volatile but is still above our sell stop recommendation. See below for details. Our July 27^th, 2015 update has an excellent tutorial on how you may go about doing this. Also, see below for our latest BIS recommendation. For further reading on portfolio protection techniques and risk management also consider a copy of Dr. Duarte’s “Trading Options for Dummies.”
5. If you choose to buy new stocks, be cautious. A good method for building positions in a volatile market is to buy small lots of stock over a few weeks to months, depending on the overall trend. When this is coupled with a long term time horizon it’s much easier to weather the volatility.

Trading Recommendations

Our trading recommendations are doing well except for one. Alexion hit its SELL Stop on the week that ended on 11/6/15. See below for full details. Also note that the sell stops on open positions have been adjusted to reflect the closing prices of the week that ended on 11/6/15.  

Trading stocks are only recommended as trades based on technical analysis.   These are not stocks meant for long term holding periods.

• Trading stocks are not EBIS type stocks. This means that they are more volatile and that any moves by these stocks, up or down, can be very fast and treacherous.
• Follow the trading guidelines and recommendations issued with each stock in detail.
• Trading guidelines are not applicable to our longer term holdings in the EBIS portfolio.

Trading Recommendation: Celldex Therapeutics (CLDX) Trading Buy Range $12-14. Sell Stop at $10. (Buy range entered – 11/6/15 closing price $13.77. Sell stop at $11. For every dollar of price increase, raise the stop loss by $1. This is almost an EBIS stock. The company is working on a vaccine for aggressive brain cancers. It has plenty of money on its balance sheet but is high risk and has not been able to make money consistently. In this market, it may be worth exploring on a trading basis.

Trading Recommendation: Edwards Life Sciences (EW) – (Initially recommended 10/19/15- Bought 10-27-15 at $153) Trading Buy Range $153-156 – 11/6/15 closing price $157.17. Sell Stop at $143. For every dollar of price increase, raise the stop loss by $1.

Trading Recommendation : Alnylam Pharmaceuticals (ALNY) – Trading Buy triggered at $85 on 10/9/15. 11/6/15 closing price $101.53 – Sell Stop adjusted to $94 for 11/9/15 update. For every dollar of price increase, raise the stop loss by $1.

Alert (Sell Stop Triggered) Trading Recommendation – Alexion Pharmaceuticals (ALXN) – (Issued 10/12/15 – Bought at $169 on 10/26/15.- High of $180.76 reached on 11/2/15. The stock fell on news that the U.S. Justice Department is investigating the company for possible irregularities in its grant program. 11/6/15 closing price $172.15 ) Our sell stop was at $166. The stock gained 11 points since our buy was triggered. Our rule on trading stocks is to raise the sell stop by one dollar per point that the stock gains. That puts the sell stop that was triggered at $177 for a potential 8 point gain (4.73%) on the trade.

In Depth: New EBIS (Emerging Biotech Investment System) Pick: Cambrex Corp. Rallies Beyond Buy Point.

Alert: New Buy Recommendation: Cambrex Corp. (CBM) – Buy Range $45-47. Bought 10/20/15. 11/6/15 closing price $52.35. Sell Stop raised to $47.(Updated 11/9/15).

Cambrex Corp – Overlooked and Underpriced Generic Drug Manufacturer

CBM entered its Buy range on 10/20/15. CBM reported its 11/3/15 before the bell. The company reported net income of 40 cents per share and revenues of $91.7 million in the period. Analysts estimate $101.09 million in revenues and 38 cents per share in earnings.

This is peculiar behavior given that revenues missed by almost S11 million and the stock showed significant strength. In the current climate, this could be a sign of merger rumors or other surprises in the future.

Cambrex Corp. manufactures active pharmaceutical ingredients for brand name and generic drugs that treat pain management, cardiovascular, central nervous system, endocrine, gastrointestinal, skin, respiratory and urinary conditions. The company specializes in all areas of development and manufacturing from the transition from research and early stages of FDA approval to the full industrial ramp up stage of drug marketing.   Cambrex offers a huge library of compounds that include commonly prescribed drugs as well as potent anesthetics and mood influencing drugs.

Here are the EBIS details:

The EBIS Score for Cambrex (CBM) is + 9 (BUY) based June 30, 2015 data.  

• Cash on hand: (+1) Cambrex reported $62.6 million in cash compared to $26.5 million in September 2014.
• Cash on Hand growth (year over year) (+1): The year over year cash grew by 31%.
• Revenues (present or not): (+1): Cambrex reported $106.635 million in revenues in its June quarter.
• Revenue growth (10% or greater)(+1): Revenues grew nearly 31% on a year to year basis.
• Trailing Total Liabilities/Current Assets (<1=+1 , >1=0): (+1) CBM has a 0.94% ratio, which means that it cover all its expenses in the case of a catastrophic hit to the company.
• Earnings (Present or Not Present): (0): CBM has steadily growing earnings.
• Net Income Growth (Year over Year): (0): CBM had a 18.9% earnings growth year over year.
• Products on the market: (+1): DYAX offers a wide array of products on the market.
• Pipeline Strength: (+1): CBM has several important products in late stages in its pipeline.
• Late Stage Clinical Trials and Product Launches: (+1): CBM has several important products in critical stages

The EBIS system consists of eleven fundamental criteria that are updated every quarter after the earnings results for each company are published. Each criterion gets a value of +1 or zero. A total of 8 or more points earn a Buy rating. A total of 5-7 points earn a Hold rating. Less than 5 points delivers a Sell or Avoid rating. EBIS was introduced in the June 15, 2015 issue of the Biotech Report.

Portfolio Update: Earnings Report Week Arrives for EBIS Portfolio

Our EBIS portfolio has been more volatile of late. Generally speaking it makes sense to see if these stocks develop some type of sideways pricing action before adding to any position aggressively. Details below:

DYAX Corp (DYAX) – POSITION CLOSED – Speculative Buy changed to $22-25 on October 5, 2015. Original recommendation: September 21, 2015. DYAX bought 10/7/15 at $22. 11/6/15 closing price was $34.52.

Alert: DYAX received a $5.9 billion dollar buyout offer from Shire Pharmaceuticals. The stock, early on Monday morning, 11/2/15 was trading above 36 per share, a nearly 33% premium over the 10/30/15 closing price. We recommend sale of the shares.

DYAX reported earnings on 10/28/15. The company reported a loss of $11.7 million, or 8 cents per share, missing analyst expectations. Revenues of $24.7 million also missed expectations of $25.6 million. The stock ended the week unchanged, a sign of relative strength and rare investor patience in the current market. DYAX was added to the NYSE Arca Biotech Index (BTK) on October 15.

DYAX is getting very close to having a real shot for FDA approval for DX-2390, a treatment of Hereditary Angioedema (HAE), a genetic disorder that occurs in 1 in 10-50,000 people.   HAE causes swelling of tissues in the body in response to antigens. DX-2930 is a monoclonal antibody that blocks kallikrein, a key substance in the chemical reaction in the body that leads to the swelling. In some cases HAE, especially of the tongue or the airway, can be very serious or deadly.   DYAX already has one product on the market, also aimed at treating HAE; Kalbitor.   Sales for Kalbitor in the second quarter of 2015, at $17.8 million, a 7.2% increase measured year over year.

Alert- Masimo Corporation (MASI) – Buy at $40-44. (Buy issued July 20, 2015. MPP: $40.65). 11/6/15 closing price: $43.12. Stop Loss: Raised to 38 11/9/15). Dr. Duarte owns shares in MASI.

Update: MASI beat earnings on 11/5/15. Earnings came in at 36 cents per share on revenues of $152.6 million. Analysts estimated an average of $149.31 million in revenues and 31 cents per share in earnings. MASI beat expectations and gave upward guidance for the future. The company recently received good marks on its anesthesia monitoring equipment at the recent American Society of Anesthesiologists meeting in San Diego.

Masimo manufactures equipment modules that monitor vital signs during difficult clinical and logistical circumstances.   Masimo pioneered Signal Extraction Technology (SET) a process that lets the pulse oximeter measure the oxygen content of blood without punctures of arteries at states of low blood pressure, where it become a most critical piece of data.

This is the second straight quarter that the company beat expectations. The company raised its full 2015 guidance to total revenues of $621 million, up from $608 million and earnings per share from $1.48 to $1.51.   The stock remains well within its buying range of 40-44 and keeps a 9.5 EBIS rating based on its June 2015 quarter. MASI is a well run company with plenty of cash on its balance sheet and a growth agenda. We like Masimo because it has innovative products, an excellent growth rate, and a nice stash of cash on its balance sheet which it could use to make acquisitions or to plow into research and development.

Meridian Biosciences (VIVO) Buy $18- 21 – 11/6/15 closing price $20.54. Dr. Duarte owns shares in VIVO. Stock initially recommended on June 29, 2015.

Meridian delivered a mixed earnings report on November 5, 2015, beating on revenues at $47.5 million and missing on its net income by one cent at 20 cents per share. Estimates averaged $46.64 million in revenues and 0.21 cents per share for earnings.  This was a reversal of the previous quarter, as we note in the history below.

The stock pays a 20 cent dividend and yields 4.4%.

Earnings/Dividend history: VIVO met its earnings expectations on 7/23 but fell short on its revenues estimates. The company delivered net income of $9.1 million, 22 cents per share on revenues of 48.2 million vs. expectations of 48.9 million.

On September 9, management adjusted expectations for the full year of revenues of $195 to $200 million and expects revenue growth in the 3-5% range with earnings in the .86 to .90 cents range for the full fiscal year.

VIVO develops, manufactures, and markets diagnostic testing kits focused on gastrointestinal infections, virus detection, and parasitic illnesses. It also produces reagents and key testing and DNA amplification and enzyme related materials used in research. It has recently released a new product, the Para Pak single vial transport system for parasite testing which simplifies the transport of samples to the lab by using one vial instead of the more complicated multiple package systems that are currently on the market.

Alert: Emergent Biosolutions – Downgraded to HOLD based on technical trends and sluggish sales, which suggests possible earnings and revenue problems in the future.

Emergent Biosolutions (EBS) (Buy 5/11/15 MPP* $30.63 – 11/6/15 Closing price $34.85 – Sell stop at $30 issued 11/9/15) Dr. Duarte owns shares in EBS.

EBS reported its latest earnings on November 5 after the close and beat expectations delivering 83 cents per share in net income on revenues of $164.9 million. Estimates average $151.42 million in revenues and 56 cents per share.   EBS has a history of positive surprises. The company reported earnings of 36 cents per share for its second quarter of 2015 beating analyst estimates of 26 cents. Revenues climbed 14% from the year-ago period to $126.1 compared to an estimate of 124.25 million.   The company also announced that it will spin off its biosciences unit, whose focus is oncology to investors.  

Sales of BioAnthrax, a preventive anthrax vaccine and is working on a new generation of the vaccine were strong in the quarter while overall bio-defense sales slumped. Dr. Duarte owns shares in EBS.

Update: Trend Following ETF Model

Alert – New Entry point established for PowerShares Dynamic Biotech ETF (PBE) – Bought at $48 on 10/23/15 – 11/6/15 closing price $50.46. Buy Range: $48-51. Sell Stop at $46.

Alert – ProShares Ultrashort Biotech ETF (BIS) was stopped out at $32. Buy at $34-36. Sell stop adjusted to $30.

Alert– ProShares Ultrashort Biotech ETF (BIS) was stopped out at $32. ProShares Ultrashort Biotech ETF (BIS) – (Buy issued 7/27/15 @ MPP* $27.99. 10/27/15 closing stopped out at $32 – Return + 14.3%.

*MPP – Median Purchase Price

News Update and Analysis – Eli Lilly (LLY), and Merck (MRK) Are under Investigation for Medicaid Related Drug Pricing Practices

Two more companies, Eli Lilly (LLY) and Merck (MRK) are the latest U.S. drug companies in the crosshairs of the U.S. government for drug pricing allegations.   While these two are not being perceived as out and out price gougers, reports surfaced last week that the investigations have been ongoing since September and that they are related to drug prices related to wholesalers and distribution to Medicaid programs.

According to Nasdaq.com: “The Justice Department is pursuing several inquiries into whether drug makers have properly reported pricing information to Medicaid programs, which are jointly funded by states and the federal government. It has conducted a long-running investigation of allegations that Pfizer Inc.’s Wyeth unit overcharged Medicaid programs by not reporting its best prices for the heartburn drug Protonix. Pfizer has said the allegations have no merit.”

This remains a significant trend in the pharmaceuticals sector. Interestingly investors have yet to openly react violently to what is clearly not an isolated set of allegations against Valeant, the company whose pricing practices have been most widely scrutinized.   It does explain, however, why the entire biotech sector, as seen in the chat of NBI (above) may be mired in a down trend compared to the S & P 500.

If anyone of these investigations leads to findings of guilt and give rise to large settlements with drug companies, it will likely lead to a continuation of the down side action for the entire sector. It is still very early in the process. But already, the once thriving biotech bull market is clearly on the defensive.

NASDAQ Composite Index:                                                                       

Friday, November 06 = 5,147.12                                                  

Year to Date = + 8.9%                                        

Trailing 4 Weeks = + 5.4%

Trailing 7 Days = + 1.8%           

Weekly Portfolio Performance