In this issue:

• FireEye Beats its Slump
• Medidata Solutions (MDSO): Short Sellers and Insider Sales Raise Red Flag
• Special Situations News & Notes

FireEye Beats its Slump

By Benjamin Shepherd

Investors weren’t pleased when FireEye (NSDQ: FEYE) announced earnings on May 6. As I wrote at the time, the company’s quarterly GAAP net loss widened unexpectedly and the company announced CEO Dave DeWalt would be resigning. But I also said that those two issues weren’t particularly worrisome.

The GAAP loss widened mainly due to a way of doing buisness: “FireEye-as-a-Service.” Instead of receiving one-time payment for its services, with FaaS the company collects quarterly payments under a service agreement. That results in an initial slump–as other companies who have made the change have shown–but eventually revenue smooths out and growth becomes more predictable.

DeWalt’s resignation also wasn’t bad news as he was promoted to executive chairman of the board. His replacement, Kevin Mandia, had served as the company’s president since 2015 and has been with the company since December 2013, so it’s not as though an outsider was coming in to the right the ship. Mandia was also founder of the computer security outfit Mandiant in 2004, which was acquired by FireEye, and has extensive experience in the security field.

The market has come around to my way of thinking on this. After plunging 21% in the week following the May 6 announcement, FireEye’s shares are now up by nearly 7% since the day before the news broke.

At the same time, FireEye has continued doing what it does best: securing sensitive computer networks.

Security researchers at the company announced last week they had discovered malware, which they’ve dubbed “IronGate,” that targets industrial control systems made by Siemens AG. Those systems are used in manufacturing plants, and they’re also key to sensitive infrastructure like dams and other power plants. They’re not systems you want to see hacked.

The malware hasn’t done any damage so far, apparently, but it is lurking on networks.  Researchers think that the hackers responsible for it are still in an “R&D” phase. That said, the vicious Stuxnet malware appears to have lurked on networks for several years before coming to widespread attention in 2010, so the threat can’t be ignored. That’s especially true since IronGate seems to share several similar features to Stuxnet.

FireEye seems to have discovered the new malware early and is widely publicizing it. Cybersecurity is an oddly collaborative field, with security researchers typically trumpeting their findings so that they and other researchers can develop “fixes” for newly discovered malware. That way bugs like IronGate that seem innocuous at first hopefully stay that way.

FireEye is over the slump following what seemed like disappointing first quarter results and remains a buy under $22.

Medidata Solutions (MDSO): Short Sellers and Insider Sales Raise Red Flag

By Joe Duarte 

It’s time to raise the sell stop on Medidata Solutions, the leading cloud-based provider of data and clinical trial management software for biotech and large pharmaceutical companies.  We have concerns about that its upcoming earnings report may be leading to insider selling and a rise in short sellers betting against the stock. 

We bought Medidata Solutions (MDSO) in March 2016 and the stock is up over 25% as of the market close on June 3.  But recent events are making us cautious.  First, three insiders, two directors and the vice-chairman sold shares on May 25, 2016.  Second, short sellers increased their positions by nearly 11% based on figures released last week.  And the third is the overall financial environment for the healthcare sector is generally negative, raising the potential for unpleasant surprises as research budgets are at risk of being pruned in response to Medicare payment cuts to hospitals.   Without any other badnews about Medidata, as of the close on June 3, we have to be concerned about the only known major calendar event, the release of earnings on July 16.

Priced for Perfection

The stock may be close to being priced for perfection as nine out of twelve analysts that follow it give it a “Buy” rating, two analysts rate it “Hold” and one rates it “Sell.”   When viewed as a contrarian would, this type of overwhelmingly bullish analyst opinion makes the stock vulnerable to any negative news.  One scenario that could lead to an earnings miss is the potential for one or more of Medidata customers to have  a bad clinical trial that shuts down the study and results in cutting the need for the company’s services.  Such an event, or a quick succession of similar developments, could hit the company’s earnings.   Just recently, Biomarin  Pharmaceuticals  wrote off a $680 million project on a muscular dystrophy drug it bought from a small biotech company just 18 months ago.  Teva Pharma. (TEVA) just had a $3.2 billion set back when the FDA rejected a neurologic drug that the company had predicted would be on the market in 2016.  Neither is listed as a client of Medidata, but these types of events are not uncommon these days.

Another area of vulnerability for the stock is the wide discrepancy between the GAAP and non-GAAP earnings numbers that it delivers.  GAAP numbers are unfiltered raw numbers while non-GAAP numbers are adjusted through accounting gimmicks that often obscure a more negative picture that can cause problems for companies down the road.   The recent earnings report (Q1 2016) beat the non-GAAP numbers handily with net income of $0.25 per share but its GAAP net income was $0.10 per share.  Estimates for the current quarter average $.23 (0.$19-$0.26)per share on a non GAAP basis, with GAAP earnings estimated at $0.14 cents per share.  So far the market has been forgiving in this area for MDSO. But that could change.   

All is not Lost

To be sure, we still like the stock enough to hold on to it with a higher sell stop. We just don’t think it’s a good time to buy it now.  One reason not to sell before knowing more is that MDSO has a history of growing its top line, having doubled its yearly revenues from 2011 to 2015.  And Medidata’s business book is still growing, with the company listing its total customer base at 630 clients, a 22% year over year growth rate in its most recent quarter.  It also continues to sign high profile clients with Bristol Myers Squibb (BMY) being the most recent addition to the client roster. 

Finally, in its April earnings release the company reported a $261 million subscription backlog, which is basically potential revenue that has yet to be deposited in the bank. If more of this soft money makes its way to the top and bottom line  earnings  could be better that expected.  And since the company notes that it has a 100% retention rate for its customers and there have been no reports of any contract cancellations, there could be a nice bump in the revenues.  Management has not changed its full year guidance and still expects robust revenue growth of up to 21% at $450-$474 million non GAAP total yearly income between $54.5 and $59.0 million on a year over year basis. Based on current estimates, this would equate to GAAP net income between $16.5 and $21.0 million.

Being Cautious May Pay Off in the End

Short sellers and insiders often have access to information that is not yet public. And when the two groups seem to agree it pays to be concerned.   For one thing insiders often sell because it’s part of their estate planning or for general income reasons.  And if the short sellers are wrong, the stock could gain significantly as they buy the stock to cover their short positions; which is why it’s best to remain patient, hold on the stock and raise the sell stop in order to preserve our current profit if things turn south.

Alert – Medidata Solutions (MDSO) – Rating changed to HOLD.  Sell Stop changed to $42. Bought on 3/7/16 at $36 –  6/3/16 closing price $45.28.  Dr. Duarte owns shares in MDSO.

Breakthrough Tech Portfolio Summary

This Week’s Changes:

Alert – Medidata Solutions (MDSO) – Rating changed to HOLD.  Sell Stop changed to $41. Bought on 3/7/16 at $36 –  6/3/16 closing price $45.28.  Dr. Duarte owns shares in MDSO.

No Changes in the following positions:

Amgen (AMGN) – Buy until $161 – Bought 2/1/16 at 152.75. 6/3/16 closing price $159.19. Sell Stop $149.

Biorad Laboratories (BIO) – Bought 5/16/15 at $146.25.  6/3/16 closing price $148.30–  Raise sell Stop to $138.

Celldex Therapeutics (CLDX) – Buy $4-$7.   6/3/16 closing price $4.56.  Dr. Duarte owns shares in CLDX.

Cerus Corp. (CERS) – Buy Range $5-$7. This stock was initially recommended 11/16/15. Bought 11/16/15 at $5 – 6/3/16 closing price $5.52; Dr. Duarte owns shares in CERS.

Emergent Biosolutions (EBS) Buy $39-$43 – Bought 5/16/16 at $39.44.  6/3/16 closing price $43.71.  Dr. Duarte owns shares in EBS.

Medidata Solutions (MDSO) – HOLD.  Sell Stop changed to $42. Bought on 3/7/16 at $36 –  6/3/16 closing price $45.28.  Dr. Duarte owns shares in MDSO.

Meridian Biosciences (VIVO) – Buy range expanded to $19-23 – 6/3/16 closing price $19.44.  Stock initially recommended on 6/29/15.  Dr. Duarte owns shares in VIVO

Novo Nordisk A/S (NVO) – Buy $55-59 (4/7/16).  Sell Stop to $49.  Recommended 12/21/15.  Bought at $55 on 12/21/15 –  6/3/16 closing price $56.59.   Dr. Duarte owns shares in NVO.

White Wave Foods Company (WWAV) – Buy range expanded $42 up to $46.  6/3/2016 closing price $45.87. Dr. Duarte owns shares in WWAV.

Rollins Inc. (ROL) – Buy at $27-29. Bought 2/22/16 at $27.38. 6/3/16 closing price $28.68. Raise Sell Stop at $24.  Dr. Duarte owns shares in ROL.

Special Situations News & Notes

By Jim Pearce

Cloud company Covisint Corporation (COVS) received a letter on June 2 from Dialectic Capital Management LP expressing its “serious concerns with Covisint’s strategic direction, [and] recent performance… under the direction of its current management team and Board.” The letter goes on to announce that Dialectic is nominating its own slate of Directors for consideration at the company’s next Annual Meeting.  

Shares of COVS initially jumped nearly 20% on this news, from $2.00 to $2.40 before settling at $2.27 by the end of the week. Dialectic is a hedge fund that owns 5.5% of the outstanding shares of COVS, so it will not be able to pull off this coup without the support of other shareholders which is why its letter openly appeals to other shareholders to join them in ousting the current management team.

This type of negotiating ploy by hedge funds is not unusual, but is rarely successful in overthrowing the current management team. Instead, some form of compromise agreement is usually reached, with one or two representatives from the investor group joining the board to give it a voice in major decisions, but not a clear majority.

Covisint is releasing its fourth quarter and full-year fiscal 2016 earnings results after the close of business today, which Dialectic believes was intentionally delayed a week by the company so that this information would not be made available by last week’s deadline for board nominations. Depending on the quality of today’s earnings report, we may see heightened pressure applied by Dialectic to gain control of the board in the weeks to come.

Regardless, Covisint’s management team is now on notice that it needs to find a way to increase shareholder value sooner rather than later. What form that may take is unclear, so at this point we advise holding onto COVS shares until there is greater clarity as to its near term strategic direction.

Shares of biopharmaceutical company Juno Therapeutics (JUNO) are up today after the company announced over the weekend “encouraging clinical data from JCAR015” which will “support its strategic approach towards the commercialization of its first CAR-T therapy.” What this means in plain English is that one of its cancer treatments is working better than expected so the company will move forward with its plans to begin selling it once the trial results are complete.

Juno is presenting its clinical trial results this week in Chicago at the Annual Meeting of the American Society for Clinical Oncology, so there should be further media coverage of this development in the days to come. Juno’s share price bottomed out below $25 four months ago, and at $47 is now halfway back to its peak price of $69 achieved last June.

Juno is one of three cancer immunotherapy stocks held in our Special Situations portfolio, along with Argos Therapeutics and Ziopharm Oncology. This area of cancer treatment has been the subject of favorable press lately, and is rapidly gaining investor attention. However, it is still not clear which specific forms of treatment will end up being the most effective so we recommend buying all three stocks to improve the odds of owning at least one of the eventual long term winners.