VOLC (MM)

Volcano Corporation (VOLC) reported break-even earnings in the first quarter of fiscal 2012, lagging behind the Zacks Consensus Estimate by a penny and the year-ago quarter’s EPS of 2 cents. Revenues for the quarter climbed 12% year over year to $90.4 million, nominally missing the Zacks Consensus Estimate of $91 million.

Revenues in the Medical segment increased 15% during the quarter to $88.4 million on the back of a 37% growth in FFR (Fractional Flow Reserve) disposable business and a 12% rise in IVUS (intravascular ultrasound) disposables business. However, performance of the Industrial segment remained challenging due to softness in telecom infrastructure spending in key geographies. This resulted in a 48% year-over-year decline in Industrial revenues to $2 million in the first quarter.

Management is impressed with the overall performance in US and Japan. Over the past few quarters, the company has been benefiting from a growing volume of data depicting improved patient outcomes and economic benefits from the use of functional percutaneous interventional (“PCI”) and the use of intravascular guidance to optimize and confirm the therapy during the procedure.

The European market recorded a decline of 2% in IVUS disposable sales, with US and Japan recording growth rates of 8% and 20%, respectively. The robust growth in Japan, the largest IVUS market in the world, is gratifying as Volcano Corporation has been trying to increase its penetration in the country through direct sales program and/or introduction of new products. The decline in Europe was due to a slowing economy and earlier-than-expected decision to go direct in Spain.

Volcano Corporation recorded gross margin of 67.3% in the quarter compared with 65.6% in the first quarter of 2011. However, with both selling, general and administrative, and research and development (R&D) expenses increasing by 25% to $44.3 million and 4.3% to $13.6 million, respectively, the company recorded a 250 basis point drop in operating margin to 3.1% (excluding amortization of intangibles).

Outlook

Volcano Corporation reiterated its outlook for fiscal 2012. The company still expects to report revenues of $392–$399 million (growth of 14–16% or 15–17% at constant currency) and EPS of 21–24 cents. The current Zacks Consensus Estimate of $395 million in revenues and EPS of 22 cents is within the company’s guidance. Gross margin is expected around 64–-65% with operating expenses coming in at 57−58% of revenues.

Recommendation

Volcano Corporation continues to execute strategies to drive sales in the IVUS/FM markets backed by new product launches and product enhancements. The company has been expanding its presence in Japan through a direct sales program and introduction of new products. The company is also benefiting from the transition of its distribution agreement with Johnson & Johnson (JNJ) that has enabled it to address 100% of the business on a direct basis. Over the long term, the company should benefit from this move as Japan has the largest IVUS market in the world.

However, we are disappointed with the decline in operating margin that has adversely affected the company’s bottom line. We believe the rise in expenses is primarily to support the various pipeline developmental programs and related to the transition to a direct sales force in Spain.

Capital spending by hospitals has been affected by the weak economy. Moreover, the company witnesses stiff competition from players such as St Jude Medical (STJ) and Boston Scientific Corporation (BSX).

The stock carries a Zacks #3 Rank (“Hold”) in the short term. Over the long term, we maintain our Neutral recommendation on Volcano Corporation.

 
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