Volcano's Mixed 2Q, Guides Down

Zacks

Volcano Corporation (VOLC) reported EPS of 6 cents in the second quarter of fiscal 2012, ahead of the Zacks Consensus Estimate by 2 cents, but lagging the year-ago quarter’s EPS of 9 cents. Revenues for the quarter he to climbed 13.6% year over year to $95.4 million, just missing the Zacks Consensus Estimate of $96 million.

Revenues in the Medical segment increased 13% during the quarter to $92.1 million on the back of a 38% growth in FFR (Fractional Flow Reserve) disposable business and a 3% rise in IVUS (intravascular ultrasound) disposables business. After a disappointing performance in the last few quarters, the Industrial segment recorded an 18% year-over-year increase in Industrial revenues to $3.3 million in the second quarter.

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 11% in IVUS disposable sales, with US and Japan recording growth rates of 4% and 6%, 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. Economic uncertainties in southern Europe adversely impacted the company.

Volcano Corporation recorded a 170 basis points (bps) contraction in gross margin to 66.5% in the quarter. However, with both selling, general and administrative, and research and development (R&D) expenses increasing by 18% to $41.9 million and 4.2% to $13.8 million, respectively, the company recorded a 220 basis point drop in operating margin to 7.9% (excluding amortization of intangibles).

Outlook

Volcano Corporation lowered its outlook for fiscal 2012 to reflect the several headwinds currently under play. The company now expects to report revenues of $384–$390 million (previous expectation $392–$399 million) and lowered the previous EPS guidance by 3 cents at both ends to 18–21 cents. The revenue outlook has been lowered to include adverse currency movements ($2 million), slowdown in certain Southern European countries ($2 million) and lower Industrial revenues due to continued softness in the telecom sector ($4 million).

The revised outlook missed the current Zacks Consensus Estimates of $393 million in revenues and EPS of 22 cents. On a positive note, gross margin is now expected to be around 65–66% (64–65%). The outlook for operating expenses has been raised to 58−59% (57−58%) of revenues.

Recommendation

Volcano Corporation continues to execute strategies to drive sales in the IVUS/FFR 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. 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 margins that have 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. Besides, economic uncertainties in Europe remain an overhang for the company. 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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