Stocks Under $10 Weekly Summary

Before digging in to the weekly update, we would like to wish all of you and your families a happy and safe Memorial Day weekend. The markets are closed on Monday, so we will be back in action on Tuesday.

Continued strong merger-and-acquisition (M&A) activity was not enough to push the major indices higher this week, as strong economic data indicated the Federal Reserve is likely to hold interest rates steady in the short term. Record-high gasoline prices also have investors taking profits because of fears that consumers could cut spending heading into the summer months.

The M&A market had another eventful week: Goldman Sachs (GS) and TPG Capital offered $25 billion to acquire Alltel (AT) ; General Electric (GE) sold its plastic division for $11.6 billion to Saudi Basic Industries; and Hologic (HOLX) bought Cytyc CYTC for $6.2 billion.

On the economic front, Thursday's report on new-home sales for April showed a jump of 16.2% from the previous month. While growth is usually seen as a positive, stocks headed lower because of concerns that the Fed would likely leave interest rates unchanged.

Although we've been saying for the past six months that we don't expect the Fed to ease interest rates until 2008, this report does not mean the housing correction has bottomed. Even with the increase, new-home sales are down more than 10% year over year, while the average home price plummeted 11% from last April. In other words, the strong number was due to reduced prices.

Despite the steady decline in the housing market, most of the major indices -- including the Russell 2000 -- are hovering near record highs. Also, high oil and gasoline prices have not resulted in a slowdown in spending on the consumer level -- so we could see additional upside momentum for large- and small-caps in the short term.

For the week, the Dow fell 0.4%, the Nasdaq lost 0.1 %, the S&P 500 declined 0.5% and the Russell 2000 rose 0.8%.

Turning to the model portfolio, it was a quiet but very positive week for most of our holdings. On Monday, we sold out of our remaining position in Move (MOVE) , and also pushed Hudson City Bancorp (HCBK) to a Two rating because of a lack of catalysts in the short term.

On Wednesday, Taser TASR reported that another product liability lawsuit challenging the company has been dismissed. Then on Thursday, the company announced four new contracts, totaling about $2.4 million. We also sent out an update on DynCorp (DCP) , Home Solutions of America (HSOA) and Grey Wolf GW as all three climbed to key levels this week.

Turning to our Watch List, we made no additions this week. However, we deleted Energy Metals EMU, which is now trading well above our $10 threshold.

We are also watching the following names for positive catalysts or attractive entry points: Actuate (ACTU) , Bisys Group BSG, Diversa DVSA, Dynegy (DYN) , Energy Metals EMU, eSpeed ESPD, Idenix Pharmaceuticals (IDIX) , International Coal (ICO) , Jamba (JMBA) , Kosen Biosciences (KOSN) , Level 3 Communications (LVLT) , LSI Corp (LSI) , MRV Communications (MRVC) , Packeteer PKTR, Seattle Genetics (SGEN) , Stec (STEC: Nasdaq) and Vical (VICL) .

Now let's take a look at the portfolio and some of the moves we made this week.

One quick note: Ones are stocks we would buy now, while Twos are stocks we would buy only on a pullback from current levels, or stocks we are looking to sell. And as a reminder:

-- A Game Breaker is going to change the landscape of an industry, as Intel, Microsoft and Wal-Mart did in their sectors. Investors can make big money in these stocks by getting in before the crowd.

-- Inflection Point stocks have a broken business model that's on the mend but has yet to be recognized by the market. Investors who recognize a turnaround early can pocket strong returns.

-- Stealth Stocks are often unknown names to the general public but can be hugely profitable investments, especially when they have catalysts to boost their share prices.

ONES

Denny's (DENN:Nasdaq, $4.44; 1,500 shares; 5.25% of the model portfolio; Inflection Point): The company owns and operates more than 1,500 restaurants primarily in the U.S., with about one-third of the family-style restaurants company-owned. The company continues to strengthen its balance sheet by selling off franchised owned stores and underperforming restaurants. Since the beginning of 2006, Denny's has reduced its net debt by 20% and lowered its interest expense by 23% year over year. The company could see some short-term pressure as Florida and California -- Denny's target markets -- have seen large declines in home prices, which could create a downward trend in consumer spending. However, our long-term thesis remains intact, and the restaurant chain could see private-equity interest as its financials become stronger. Although shares have been in a very tight trading range over the past three weeks, we believe they have 20%-plus upside potential over the next 12 to 18 months.

DynCorp (DCP:NYSE, $16.54; 500 shares; 6.52%; Stealth Stock): DynCorp is an outsourcing and infrastructure company that provides services to the U.S. and foreign governments. Shares have been volatile this week, trading between $15.70 and $17.25, on very little news. In the next few weeks, we expect to hear the Government Accountability Office's (GAO) response to L-3 Communications' (LLL) protest of the award of a $4.6 billion Army linguistics contract to DynCorp in December. The Defense Department has asked the GAO to reconsider its earlier decision that backed L-3's protest. We remain confident that DynCorp will retain this contract, and shares will head toward $20. However, in the shorter term, the company reports earnings on June 7, and results could come in on the light end of estimates because the prior linguistics contract is being extended for L-3 while the protest is taking place. We've already added to our DynCorp position at the current price level, and if shares fall following the earnings report, we would look to add more.

Flow International (FLOW:Nasdaq, $12.75; 800 shares, 8.05%; Stealth Stock): Flow is the world leader in the development and manufacture of ultrahigh-pressure (UHP) waterjet technology, which can cut virtually any hard material, including metal, composites, stone, plastics, rubber and glass. Last Friday, investment firm Cathay Financial initiated coverage on Flow with a buy rating and mentioned that if bought, the company could fetch a price from $15 to $18 a share. Third Point -- Flow's largest shareholder -- suggested a few weeks ago that the company put itself up for sale. Management responded last week and said that Flow would be better off remaining a public company. Over the next three years, Flow's waterjet business is expected to grow 30% annually, and new industries continue to adopt this more-efficient and less-costly cutting technology. Also, we are seeing a secular bull market in industrial and machinery stocks, which could spark a bid from competitors as well as other private-equity firms. We believe that Flow will eventually be sold for more than $13.50 a share.

Grey Wolf (GW:Amex, $7.88; 600 shares; 3.73%; Stealth Stock): The company drills for oil and natural gas in the continental U.S., primarily in the Ark-La-Tex, Gulf Coast, Mississippi-Alabama, southern Texas, Rocky Mountains and midcontinent markets. Shares touched $8 this week as gasoline prices hit a new record high. The drilling environment remains favorable, and most drillers -- including Grey Wolf -- are likely to benefit in the short term. Financially, Grey Wolf has more than $300 million in cash flow and $275 million in cash, with shares trading at just eight times 2007 earnings. Also, given all these positives, Grey Wolf's fleet of more than 115 drilling rigs could attract a larger competitor interested in consolidation. We believe the stock offers solid risk/reward potential and has at least 15% more upside from the current price.

Home Solutions of America (HSOA:Nasdaq, $6.97; 1,700 shares; 9.35%; Stealth Stock): The company offers recovery, restoration, rebuilding/remodeling and specialty interior services to owners of commercial and residential properties in the U.S. Home Solutions is now up more than 40% since reporting earnings results May 9. Last week, the company's Fireline Restoration subsidiary signed a contract worth $100 million that was not figured into our previous estimates. This marks $180 million in new contracts for Home Solutions in only three months, which is significant considering the company's total revenue over the past 12 months was $147 million. In addition, we saw a rally in homebuilders this week after Treasury Secretary Henry Paulson said in a TV interview Wednesday that the slump in housing is "largely over." These catalysts -- as well as predictions for an active hurricane season and that fact that New Orleans projects are finally beginning to receive funding -- should continue to push Home Solutions shares higher in the short term. Our target price on the stock is $10.

JetBlue (JBLU:Nasdaq, $10.84; 350 shares; 2.99%; Inflection Point): The company is a low-cost passenger airline that primarily offers point-to-point flights in the U.S. with high-quality customer service. Weak first-quarter results and high fuel costs have brought shares of JetBlue down to levels that we believe offer compelling upside for aggressive investors. Earlier this month, the company announced the departure of longtime CEO David Neeleman, and former Chief Operating Officer Dave Barger has taken the reins. The move illustrates JetBlue's commitment to turning its business around, and we believe the stock offers 25% or more price appreciation over the next nine to 12 months as the market begins to focus on the company's measures to improve its financial performance.

Lawson Software (LWSN:Nasdaq, $8.71; 500 shares; 3.43%; Inflection Point): Lawson is a leading provider of enterprise resource planning (ERP) software that integrates data from different departments within a company and makes it accessible for quick analysis. The company is our favorite name currently in the software sector, as it offers an attractive alternative to larger competitors Oracle (ORCL) and SAP (SAP:NYSE ADR). Our thesis for this position revolves around healthy software spending by businesses around the world, as well as Lawson's strong position in its core customer areas of health care, retail and manufacturing. Also, the company recently expanded its relationship with IBM (IBM) to target the fashion, food and beverage, banking, and insurance industries, which could drive unexpected additional revenue growth going forward.

Sun Microsystems (SUNW:Nasdaq, $5.16; 1,200 shares; 4.88%; Inflection Point): The company offers network-computing solutions, including servers, storage, software and services worldwide. Last week, Sun announced that it plans to buy back $3 billion in stock, and shares moved higher on the news. The buyback plan should not have come as a surprise to subscribers as we have mentioned this possibility in past Weekly Summaries. Meanwhile, the company continues to cut costs, and that coupled with its buyback announcement and a $700 million investment from Kohlberg Kravis Roberts -- one of the oldest and most experienced private-equity firms -- provides support to our long-term bullish thesis on Sun. We believe shares offer a favorable risk/reward at their current levels for investors.

Taser International (TASR: Nasdaq, $10.29; 600 shares; 4.87%; Stealth Stock): The company sells electronic control devices for use predominantly by law enforcement, military and security personnel, as well as for personal protection. On Wednesday, Taser said that it had won its 45th straight product liability court case on a summary judgment, making its record 45-0. Then on Thursday, the company announced it has received four new orders for Tasers -- including one international order worth more than $1.4 million. Now that litigation risk is subsiding, the company is firing on all cylinders. Over the next 12 months, we expect Taser to continue to receive new orders for law enforcement stun guns, as well as cartridges. Also, the new C-2 guns for consumers and the Taser Cam, which is a camera attachment that is added to the law-enforcement model, could be growth drivers as well. We believe shares have 20%-plus upside potential from the current price.

ViaCell (VIAC:Nasdaq, $6.00; 1,000 shares; 4.73%; Inflection Point): ViaCell provides services to parents who want to preserve their newborns' umbilical cord blood for future use in treating potential diseases later in life. The company conducts research to develop therapeutic uses for the stem cells derived from umbilical cord blood. In this way, ViaCell has distanced itself from other biotech companies that work with embryonic stem cells, which remain a contentious political topic in the U.S. In addition, while shares of other stem-cell plays like Geron (GERN) remain volatile because of their uncertain prospects, ViaCell offers a growing revenue stream that generates cash that helps fund its research operations. In the short term, investors' focus will be on ViaCell's umbilical cord blood business as the company investigates stem-cell based applications to treat diabetes, cardiac disease and cancer. We are also fans of ViaCell's relationships with major biotech and pharmaceutical players, including Amgen (AMGN) , Genzyme (GENZ) and subsidiaries of Johnson & Johnson (JNJ) . At the current quote, we believe shares remain attractive for risk-tolerant investors.

Xoma (XOMA:Nasdaq, $3.35; 2,500 shares; 6.61%; Stealth Stock): Xoma, a biopharmaceutical company, researches and develops therapeutic antibody treatments for conditions ranging from psoriasis to cancer. The company boasts an attractive set of large-cap partners, including Genentech (DNA) , Schering-Plough (SGP) and Novartis (NVS:NYSE ADR), as well as a number of other companies with which it has research and/or licensing agreements. Although there has been limited news to drive shares recently, this highly volatile, speculative stock rallied sharply early in the week along with the rest of the biotech space, before giving back its gains to finish about even for the week. However, we believe a number of catalysts exist that could benefit shareholders over the next 12 months. According to management, contract revenue will almost double during 2007 due to Xoma's collaborations, particularly with Schering-Plough and Japanese drugmaker Takeda. Additional research deals, as well as positive news regarding Xoma's numerous treatments that are still in the early stages of testing, could provide upside to shares.

TWOS

Arris (ARRS:Nasdaq, $15.22; 250 shares; 3.00%; Inflection Point): Arris is a leading provider of equipment that enables the delivery of data and voice services, such as Internet and voice-over-Internet protocol (VoIP). The company has been one of the major beneficiaries of the growth in spending at large cable companies -- like Comcast (CMCSA) and Time Warner (TWX) -- which make up the bulk of Arris' customer base. On Monday, investment bank UBS initiated coverage on Arris with a buy rating and $18 price target. The accompanying report pointed to the continuing strong trends in VoIP penetration at the cable companies, and their higher capital expenditures are important drivers for Arris. Also of note was UBS' assertion that a modem replacement cycle and new service offerings will maintain strong demand for Arris' products in 2008, when the rate of VoIP subscriber additions may begin to slow. The major cable companies are likely to continue spending heavily in a competition to meet the demands of customers for better quality service and high-speed data connections, as well as the need for increased bandwidth to handle applications like Internet video. We remain bullish on Arris but would need to see a pullback below $15 before considering adding to our stake.

Hollywood Media (HOLL:Nasdaq, $4.16; 1,300 shares; 4.27%; Stealth Stock): The company generates most of its revenue by selling online advertising -- alongside theater and movie tickets -- through its wholly owned subsidiary Hollywood.com and minority stake in MovieTickets.com. Hollywood's core Broadway ticketing business has consistently posted double-digit percentage revenue growth over the past year, along with impressive deferred revenue results that indicate the future remains bright for the company. We believe improvements in ad sales growth, which came in at a mildly disappointing 5.8% last quarter, will also help drive shares higher during 2007. Hollywood bolstered its ad sales staff during the first quarter, and we expect the effects to show throughout the rest of the year. The potential for a sale of a noncore business unit or the company's equity stake in MovieTickets.com would likely result in a boost in share price. At the current price, however, we do not believe the risk/reward profile merits further purchases.

Hudson City Bancorp (HCBK:Nasdaq, $13.17; 500 shares; 5.19%; Stealth Stock): The company provides banking services to New York-area clients in Long Island, New Jersey and Staten Island through its 111 branches. Shares have remained weak on little news. On Monday, we pushed the stock to a Two rating because of Home Depot's (HD) comments last week that the Northeast housing market is starting to weaken. This is Hudson's regional base, and a slowdown would likely result in a decline in mortgage loans. Thus far the company has successfully weathered the storm in the banking industry caused by the negative yield curve and the slump in the overall real estate market. However, unless the Federal Reserve eases interest rates or the bank gets taken over by a larger competitor, there are few short-term catalysts to drive its shares higher. We will look to exit this position on strength.

Online Resources (ORCC:Nasdaq, $11.86; 500 shares; 4.68%; Stealth Stock): The company is a payment-services firm that enables small and midsized financial institutions to offer online banking services to their clients. Online Resources is in an advantageous position, having direct relationships with both banking customers and bill-payment networks. We expect the company to post impressive financial results in 2007, as midsize banks and financial institutions expand their services to offer more bill-payment and related features to customers. In its first-quarter results, Online Resources posted sequential bill-payment transaction growth of 8% in its banks and credit unions segment, and 17% in its e-commerce division. We believe these numbers indicate a healthy demand for the company's services and bode well for the rest of the year. In addition, management has been adamant about boosting EBITDA (earnings before interest, taxes, depreciation and amortization) margins up to 30% by the end of 2007, from around 20% recently. We believe the achievement of this target would offer additional upside potential for investors. However, with shares trading at their highest level since October, we are more likely to take profits at current prices.

Vasco Data Security International (VDSI:Nasdaq, $20.97; 300 shares; 4.96%; Stealth Stock): The company is a leading supplier of token- and software-based security products that enable secure online financial and other transactions. Vasco's technology has been in high demand as banks and other financial institutions are using authentication devices and secure Web-based applications to protect themselves and their consumers from identity theft. This position has been one of the most successful in the model portfolio in 2007, with the company continuing to beat investor expectations by growing revenue at a double-digit percentage rate while keeping costs down. We remain fans of Vasco but believe that investor expectations are very high, resulting in a less attractive risk/reward scenario for subscribers looking to make a purchase. We will likely trim our position on strength, particularly as we add new names to the model portfolio.

Frank Curzio is a research associate at TheStreet.com.

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