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Volcano Reaffirmed at Neutral

Zacks Equity Research

We have reaffirmed our Neutral recommendation on Volcano Corporation (VOLC) following its fourth-quarter 2011 results. The company’s fourth quarter adjusted EPS of 14 cents exceeded the Zacks Consensus Estimate. While revenues increased 14% on the back of robust growth in its Medical segment, the Industrial segment did not recover from its declining trend due to lower spending in the telecommunication sector.

The San Diego, California-based company derives a major part of its revenues from its intravascular ultrasound (“IVUS”) product portfolio. We believe sales of IVUS products will continue to account for a significant portion of the company’s revenues going forward. IVUS technology is widely used for determining the placement of stents in patients with coronary disease. While the IVUS penetration rate in Japan is quite high (more than 70%), the penetration rate in the US (16%) and Europe (5%) for the same type of procedure is relatively low. The low penetration rate in the US and Europe provides better scope for market share expansion.

Favorable industry trends should provide strong momentum to the company’s core offerings of IVUS and functional measurement (“FM”) products. These products aim to enhance the diagnosis and treatment of vascular heart disease by improving the efficiency of existing percutaneous interventional ("PCI") therapy procedures in the coronary or peripheral arteries. The company believes that personalized medicine is increasingly driving clinicians to use tools for the diagnosis and treatment of patients. Moreover, clinicians and hospitals are facing increasing pressure to justify the medical necessity of PCI therapy.

Japan is a significant market for Volcano Corporation as it derives more than 30% of its revenues from this region. The company continues to expand its presence in Japan through direct sales program or introduction of new products. With the transition of its distribution agreement with Johnson & Johnson’s (JNJ) Cordis, Volcano Corporation would address 100% of its business in Japan on a direct basis. The company should benefit from this transition as Japan is the largest IVUS market in the world.

However, capital spending by hospitals has been affected by the weak economic scenario. Besides, a weak macro environment has negatively impacted PCI volumes in US, Europe and Japan. Based on these factors, the company’s guidance for 2012 was lower than our estimates.

Our recommendation is backed by a Zacks #3 Rank (Hold) in the short term.

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