Volcano Corporation (VOLC-NASDAQ)

Transcription

1 January 07, 2015 Volcano Corporation (VOLC-NASDAQ) Current Recommendation SUMMARY DATA NEUTRAL Prior Recommendation Date of Last Change 08/10/2007 Current Price (01/07/15) $17.95 Target Price $ Week High $ Week Low $9.90 One-Year Return (%) Beta 0.11 Average Daily Volume (sh) 5,972,212 Shares Outstanding (mil) 52 Market Capitalization ($mil) $933 Short Interest Ratio (days) 9.68 Institutional Ownership (%) Insider Ownership (%) 4 Annual Cash Dividend $0.00 Dividend Yield (%) Yr. Historical Growth Rates Sales (%) 11.6 Earnings Per Share (%) Dividend (%) P/E using TTM EPS P/E using 2015 Estimate P/E using 2016 Estimate Zacks Rank *: Short Term 1 3 months outlook 3 - Hold * Definition / Disclosure on last page SUMMARY Following the announcement of its acquisition by Phillips and subsequent shareholders approval, Volcano s share price has touched its justified high. As a result, any further upside in the stock s movement is limited. In regard to its financial results, Volcano reported third-quarter 2014 adjusted loss of $0.04, 20% narrower than the Zacks Consensus Estimate. The bottom line also improved from the year-ago reported loss by 50%. Revenues of $97.5 million were up 1.7% at CER, driven by strong growth in FFR and IVUS. The top line also beat the Zacks Consensus Estimate by a whisker. Volcano witnessed growth in its FM business in Europe and Japan. Volcano s pipeline development is also impressive. However, a negative foreign currency impact in relation to the Japanese yen adversely affected overall growth in the reported quarter. We thus remain Neutral on the stock. Risk Level * High, Type of Stock Mid-Blend Industry Med Instruments Zacks Industry Rank * 98 out of 267 ZACKS CONSENSUS ESTIMATES Revenue (In millions of $) Q1 Q2 Q3 Q4 Year (Mar) (Jun) (Sep) (Dec) (Dec) A 101 A 96 A 103 A 394 A A 103 A 97 A 101 E 395 E E 105 E 99 E 105 E 401 E E Earnings Per Share Estimates (EPS is operating earnings before non-recurring items, but including employee stock options expenses) Q1 Q2 Q3 Q4 Year (Mar) (Jun) (Sep) (Dec) (Dec) 2013 $0.02 A $0.03 A -$0.08 A -$0.29 A -$0.31 A $0.12 A $0.01 A -$0.04 A -$0.03 E -$0.17 E $0.02 E $0.01 E $0.01 E $0.02 E $0.01 E 2016 $0.22 E Note: Quarterly figures may not add up to the annual figure due to rounding Projected EPS Growth Rate - Next 5 Years % Zacks Investment Research, All Rights reserved North Canal Street, Chicago IL 60606

2 OVERVIEW San Diego, CA-based Volcano Corporation (VOLC) engages in the development, manufacture, and commercialization of a broad suite of precision guided therapy tools including intravascular ultrasound (IVUS) and fractional flow reserve (FFR) products. These products augment the diagnosis and treatment of vascular heart disease by improving the efficiency and efficacy of existing percutaneous interventional (PCI) procedures in the coronary or peripheral arteries. While FFR technology is used to determine whether or not a stent is necessary, IVUS is used to guide stent placement and optimization. The company markets its products to physicians and technicians who perform PCI procedures in hospitals and to other personnel who make purchasing decisions on behalf of hospitals. The company manufactures consoles and disposables at its facility in Rancho Cordova, CA. In Nov 2012, Volcano inaugurated its Costa Rica manufacturing plant, the first outside the U.S. Earlier this year, the company received clearance from the U.S. Food and Drug Administration (FDA) and accordingly commenced manufacturing of disposables at this plant. This facility is expected to receive CE mark approval in the fourth quarter and regulatory clearance in Japan early next year. Segments Volcano currently generates revenues from two reporting segments: Medical and Industrial (formerly Telecom). The Medical segment represents the company s core business in which revenues are derived primarily from the sale of multi-modality and FFR consoles and IVUS and FFR single-use disposables and others. The Industrial segment derives revenues from the sale of Axsun s micro-optical spectrometers and optical channel monitors to telecommunication companies. IVUS Product Portfolio Volcano s IVUS products comprise ultrasound consoles, single-procedure disposable phased array and rotational IVUS imaging catheters and additional functionality options such as virtual histology (VH) IVUS tissue characterization and ChromaFlo stent apposition analysis. The company markets its IVUS consoles as stand-alone units or customized units that can be integrated into a variety of hospital-based interventional surgical suites called catheterization laboratories (cath labs). The IVUS consoles have been designed to serve as a multi-modality platform for Volcano s phased array and rotational IVUS catheters, FFR pressure wires, and Medtronic s Pioneer reentry device. FFR Product Portfolio FFR disposables are single-procedure disposable pressure and flow guide wires used to measure the pressure and flow characteristics of blood around a plaque, thereby enabling physicians to gauge the plaque's physiological impact on blood flow and pressure. The company is now the market leader in the U.S. FFR market. Per management, the company is also enhancing its market share in other countries at a rapid pace, approaching 50% share in Japan and nearly 50% in Europe. REASONS TO BUY Equity Research Page 2

3 Positive Takeover News Boosts Investor s Confidence: In an attempt to bolster its position in the global image-guided therapy market, Volcano decided to get sold off to Royal Phillips a Netherlands-based diversified technology company; around mid-dec This divestment is expected to remain a strategic and financial fit that will provide more productive sales operations leading to higher growth and operating leverage. It is also estimated to enhance commercialization opportunities in new, adjacent segments. In image-guided treatments of the heart and blood vessels, which has been in vogue lately, an increasing trend to use advanced catheters that can produce IVUS or perform FFR has been observed. Now Volcano is the only company in the industry with a leading position in both IVUS imaging and FFR measurements, while Phillips has emerged as a leading image-guided therapy business. With this acquisition, the new combined entity will be capable of bringing in innovative as well as developed IVUS and FFR products in the global market. Once the merger is over, management expects that the revenue for the combined company s image guided therapy business will grow by high single digit rate by Moreover, the combined sales forces will have the ability to capture cross selling opportunities while the joint R&D teams will be engaged in developing new products that will address significant unmet needs in the minimally invasive treatment of cardiovascular diseases. IVUS growth remains strong: Volcano derives a major part of its revenues from the IVUS product portfolio. The company remains a leader in the U.S., Japanese and European IVUS markets and holds 50% of the global share in this space. In the last reported quarter, the company s improvement in the said market was primarily due to market share gains in IVUS in all of Volcano s key geographic locations barring Japan, and nearly 60% growth in the U.S. peripheral IVUS business. The company experienced consistent market share gains in Europe, wherein year-over-year IVUS disposable revenue growth was an impressive 24%. We believe the company s technology and products have the desired value and competitive advantages to gain market share in the IVUS market. While IVUS coronary activity is strong, the company is also experiencing success with IVUS in the peripheral market which is still massively underpenetrated. Volcano is the only company to offer IVUS catheter specifically for use in the peripheral as well as Pioneer Re-Entry catheter, the Crux IVC filter and Valet Microcatheters. During the last reported quarter, Volcano experienced continued adoption of its peripheral imaging and Pioneer Re-Entry products. The company also initiated the limited market release of its Phoenix Atherectomy System that is used in the treatment of peripheral artery disease (PAD). Management believes that this will advance Volcano s overall penetration of the peripheral market. Moreover, growth in these areas will help the company offset the continued softness observed in the U.S. coronary IVUS market. Management remains optimistic to receive positive reimbursement for IVUS in This huge market opportunity boosts our confidence regarding the company s growth prospects in the IVUS business, despite several near-term challenges. Favorable trends leading to growth: According to Volcano, the broader market for intra-body imaging and sensing products is expected to grow from $332 million in 2006 to $2.7 billion by 2021, representing a CAGR of 15% approximately. Within this broader market, the current market for IVUS, FFR and Axsun products will only take up $750 million reflecting high growth potential in the coming period. The company considers that these markets, together with that for Axsun products, have the potential to grow to more than $1.1 billion over the next 5 years. Management expects that the divestiture of Axsun will provide a benefit of roughly 200 basis points to the company s gross margin, over the next 1 year. Specifically, Volcano noted that the FFR market alone has grown at a CAGR of more than 30% from 2008 to 2013, primarily as a result of published findings from the FFR versus Angiography for Multivessel Evaluation, or FAME, and FFR-Guided PCI versus Medical Therapy in Stable Coronary Disease, or FAME 2, studies. Equity Research Page 3

4 In addition, the company has made its full U.S. market release of Verrata, its new everyday FFR wire. Further, the FDA approval of IFR will lead to upgrading of more than 90% of its installed base of multi-modality systems with IFR. Volcano believes that the continued rollout of IFR and the Verrata wire are facilitating the company s FFR share gains and growth, both in Europe and Japan. Volcano has also witnessed some favorable trends in the industry in the form of greater clinical and economic pressure to prove the benefits of PCI procedures. According to management, the PCI market is stabilizing, and currently Volcano is generating growth in FFR and peripheral imaging and therapy. With this, the company is addressing markets that will grow to more than $1.6 billion over the next 5 years, and decrease Volcano s dependence on coronary PCIs in Japan. Volcano is confident that the favorable industry dynamics will provide strong momentum to its core offerings, particularly FFR, and will mitigate any short-term variances in PCI activity. Direct sales in some countries to benefit: Volcano continues to expand its presence in Japan through direct sales program or introduction of new products. With termination of several distribution agreements over the past few years, the company is now well placed to address 100% of business in Japan on a direct basis. Notably, Volcano has recently appointed a new Vice President of Sales for its Japanese business, with an aim to expand its market presence in the region. Japan continues to offer an important IVUS growth opportunity for the company despite a high penetration level of nearly 80%. Despite several ongoing headwinds in the form of reimbursement cut, foreign exchange headwind and slower-than-expected adoption of FFR in Japan, FFR revenues grew 55% at CER in fiscal We believe reimbursement for FFR during diagnostic angiography in Japan has acted as a catalyst as there are approximately twice as many diagnostic angiographies as PCI procedures in Japan. We are encouraged to see that the company is working with clinicians to tap the opportunity latent in reimbursement, though any material impact is not expected in the near future. The company noted that with its direct sales program, it is growing its market share in Japan at a rapid pace and is close to approaching 50% share in the region. Having witnessed the benefits of transition to a direct sales force in Japan, Volcano is working toward operating directly in Spain and Poland. With five direct personnel already in Spain, the company is on track with the transition. On the whole, by the end of the last fiscal, Volcano had more than 325 direct sales and support professionals, including 179 in the U.S., 81 in Japan, 58 in Europe and the remaining in other geographies. Despite some near-term challenges from this strategy, we expect the company to benefit in the long term. REASONS TO SELL Difficult global economy to pose challenges: The current market environment continues to remain challenging for Volcano. The final reimbursement reduction in Japan that came into effect from Apr 2014 saw an approximate 5% reduction for Volcano s Imaging Disposables and an approximate 2% cut for FFR disposables. These reimbursement cuts will be in effect for the next two years. Moreover, the Japanese government has mandated a 3% consumption tax increase in addition to the reduction in reimbursement. According to the company, this has led to a 7.5% reimbursement decline beginning Apr 2014, in line with the company s expectation. Moreover, foreign currency rate related to Japanese yen had an unfavorable impact of $941,000 on Volcano s top line in the third quarter. This, in turn, has affected the operating results of Volcano in the third quarter. Equity Research Page 4

5 Intense competition: Volcano faces intense competition for both its IVUS range of products and its FM products. While the company s primary IVUS competitor is Boston Scientific, it also competes with Terumo Corporation in Japan. Meanwhile, St. Jude Medical is the company s main competitor in the FM market. St. Jude has acquired LightLab and its OCT technology which has increased competition for Volcano. Volcano s FFR products compete with the products of St. Jude and ACIST Medical Systems. Increased competition could result in pricing pressure and reduced margins, inducing an adverse impact on the company s performance. Customer spending under pressure: Capital spending by customers like hospitals has been affected by the weak economic scenario. While the economic scenario has improved, lower spending by customers could result in reductions in the sales of Volcano s products, longer sales cycles, and slower adoption of new technologies by customers, which would materially and adversely affect the company s business. In addition, customers and suppliers liquidity, capital resources, and credit may be adversely affected by the current financial, which could adversely affect the company s ability to collect outstanding invoices and lengthen collection cycles, or limit Volcano s timely access to important sources of raw materials necessary for the manufacture of consoles and catheters. RECENT NEWS Volcano Agrees for Sellout to Philips to Aid Global Expansion Dec 17, 2014 Volcano recently entered into a definitive merger agreement with the Netherlands-based electronics major Royal Philips, in an effort to create a prominent position in the global market for image-guided therapy. Per the deal, Philips will acquire Volcano for $18.00 per share (or a total equity purchase price of $1 billion). The total transaction value will stand at $1.2 billion through a combination of cash on hand and the issuance of debt. Volcano, which has unanimously approved the deal, expects the transaction to be completed in the first quarter of Volcano Posts Narrower-than-Expected Q3 Loss, Guides Low Nov 10, 2014 Volcano reported third-quarter 2014 adjusted loss of $0.04 per share, 20% narrower than the Zacks Consensus Estimate. The adjusted loss bettered the prior-year quarter's loss by 50%. Year-over-year improvement in the adjusted loss results was owing to the positive revenue growth compared to the third quarter of However, without these adjustments, the company reported net loss of $8 million or $0.16 per share, compared to the year-ago net loss of $8.5 million or $0.15 per share. Revenues Revenues climbed 1.7% year over year to $97.5 million, beating the Zacks Consensus Estimate of $97 million by a whisker. On a consolidated basis, foreign currency exchange rates had a negative impact of roughly $700,000 on revenues, in the reported quarter. The year-over-year top-line growth was driven by solid double-digit growth at Volcano's IVUS (Intravascular Ultrasound) peripheral business in the U.S., coupled with solid expansion of the FFR Equity Research Page 5

6 (Fractional Flow Reserve) and the IVUS disposable businesses in Europe and the FFR business in Japan. However, this growth was partially offset by the continued slowdown observed in Volcano's U.S. coronary IVUS market. Geographic-region wise, Volcano experienced strong growth in Europe and the Middle East, where FFR and IVUS disposable revenues, each, increased 24% year over year. The company also experienced solid 24% growth in the Japanese FFR market. Segment Analysis Revenues from Volcano's medical segment rose 2.1%, up 3% in constant exchange rate (CER) to $95.7 million in the third quarter, driven by solid 13.3% sales growth (up 13% in CER) in FFR single-procedure disposables. However, this improvement was partially offset by a 2.4% decline (down 1% in CER) in sales of IVUS disposables and 13.6% decline (down 13% in CER) in sales of consoles. FFR disposable sales increased 28% at CER in Japan, 23% in Europe, 2% in U.S., and 40% in Rest of World, thereby contributing to the double-digit sales growth in overall FFR disposable sales. On the other hand, revenues from IVUS disposables grew 23% at CER in Europe, 9% in U.S. and 21% in Rest of World, while the same declined a significant 21% in Japan, leading to an overall decline in the segment's sales. While sales from console placement improved in the U.S. (up 5% at CER), the same declined in Japan, Europe and the Rest of world (down 57%, 30% and 45%, respectively) compared with the year-ago quarter. Industrial segment revenues declined 14.3% (down 14% in CER) to $1.8 million in the reported quarter. Margins Gross margin contracted 340 basis points (bps) to 61.7% in the third quarter due to higher manufacturing variances compared to the prior year, costs related to duplicate capacity, and unfavorable foreign exchange rates. Selling, general and administrative expenses spiked 4.2% year over year to $47.4 million, primarily driven by higher selling costs, costs associated with the expansion of Volcano's peripheral sales force and marketing costs associated with the peripheral business. On the other hand, Volcano's research and development (R&D) expenditure fell 18.7% year over year to $13.5 million, reflecting the impact of the strategic prioritization initiative implemented last year. However, new spending related to the Phoenix Atherectomy device partially offset this reduction in R&D expense. Adjusted operating loss was $0.7 million in the reported quarter, compared to adjusted income of $0.3 million in the year-ago period, owing to lower gross profit. Financial Position Volcano exited the third quarter with cash, cash equivalents and short-term investments of $172.8 million compared with $338 million at the end of During the third quarter, cash used in operations was $5.6 million, compared to cash provided by operations worth $9 million from the prior-year quarter. Outlook Equity Research Page 6

7 For the full-year 2014, the company has lowered its revenue expectation to the range of $393 $397 million from the previous guidance of $397 $401 million. Volcano also lowered the upper end of the previous adjusted loss per share guidance range to $0.16 $0.18 in 2014, as against the earlier guided loss of $0.16 $0.19 per share. The Zacks Consensus Estimate for adjusted loss of $0.17 in 2014 lies within the company's expectations. Meanwhile, the Zacks Consensus Estimate for revenues of $397 million coincides with the upper end of the company's guidance. Management has retained its projection for gross margin in 2014 in the band of % but has updated its guidance for operating expenses, including restructuring charges, to the range of 65 66% (prior guidance: %) of revenues. VALUATION Amid a challenging macro-economic scenario, Volcano delivered impressive third-quarter 2014 financial results, beating the Zacks Consensus Estimate on both lines. Despite the coronary IVUS business performing poorly in the U.S. market, the notable performance delivered by IVUS peripheral, FFR and IVUS disposable businesses allowed Volcano to outperform expectations in the reported quarter. Reimbursement reduction in Japan and the unfavorable impact of foreign currency exchange in relation to the Japanese yen poses tough challenges for the company, going forward. Moreover, the continued slowdown in the company s coronary imaging market in the U.S. adversely affected Volcano healthy growth. On the bright side, the company s penetration in the peripheral market and IVUS business showed signs of stability, as it did in the U.S. and global PCI markets. While we are impressed with the company s pipeline development program, margins still remain under pressure. Given Volcano s leading position in both IVUS imaging and FFR measurements, its merger with Philips will lead to a combined entity, capable of bringing in innovative as well as developed IVUS and FFR products in the global market. Volcano s product portfolio will complement Phillips market leading position in the image-guided therapy business. We believe this buyout will give the combined company competitive leverage in the medical equipment market. Although the impending merger news excited investors at the initial level, any further upside in the stock s price remains limited. Accordingly, we maintain our Neutral recommendation on the stock with a target price of $ At present, the P/B multiple of the stock remains at 3.0 compared to the Industry Average of 5.0 and 5.1 for the S&P 500. Over the last five years, Volcano s shares have traded in the range of 1.7x to 5.8x its P/B multiple. Our target price corresponds to a P/B multiple of 3.2. Equity Research Page 7

8 Key Indicators P/E F1 P/E F2 Est. 5-Yr EPS Gr% P/CF P/E P/E 5-Yr High P/E 5-Yr Low VOLCANO CORP (VOLC) N/M N/M N/M N/M Industry Average N/M N/M 33.3 S&P Cepheid (CPHD) N/M 19.0 N/M N/M N/M Globus Medical, Inc. (GMED) Accuray Incorporated (ARAY) N/M 61.4 AngioDynamics Inc. (ANGO) TTM is trailing 12 months; F1 is 2015 and F2 is 2016, CF is operating cash flow P/B Last Qtr. P/B 5-Yr High P/B 5-Yr Low ROE D/E Last Qtr. Div Yield Last Qtr. EV/EBITDA VOLCANO CORP (VOLC) Industry Average N/M S&P Equity Research Page 8

9 Earnings Surprise and Estimate Revision History Equity Research Page 9

10 DISCLOSURES & DEFINITIONS The analysts contributing to this report do not hold any shares of VOLC. The EPS and revenue forecasts are the Zacks Consensus estimates. Additionally, the analysts contributing to this report certify that the views expressed herein accurately reflect the analysts personal views as to the subject securities and issuers. Zacks certifies that no part of the analysts compensation was, is, or will be, directly or indirectly, related to the specific recommendation or views expressed by the analyst in the report. Additional information on the securities mentioned in this report is available upon request. This report is based on data obtained from sources we believe to be reliable, but is not guaranteed as to accuracy and does not purport to be complete. Because of individual objectives, the report should not be construed as advice designed to meet the particular investment needs of any investor. Any opinions expressed herein are subject to change. This report is not to be construed as an offer or the solicitation of an offer to buy or sell the securities herein mentioned. Zacks or its officers, employees or customers may have a position long or short in the securities mentioned and buy or sell the securities from time to time. Zacks uses the following rating system for the securities it covers. Outperform- Zacks expects that the subject company will outperform the broader U.S. equity market over the next six to twelve months. Neutral- Zacks expects that the company will perform in line with the broader U.S. equity market over the next six to twelve months. Underperform- Zacks expects the company will under perform the broader U.S. Equity market over the next six to twelve months. The current distribution of Zacks Ratings is as follows on the 1025 companies covered: Outperform %, Neutral %, Underperform 4.7%. Data is as of midnight on the business day immediately prior to this publication. Our recommendation for each stock is closely linked to the Zacks Rank, which results from a proprietary quantitative model using trends in earnings estimate revisions. This model is proven most effective for judging the timeliness of a stock over the next 1 to 3 months. The model assigns each stock a rank from 1 through 5. Zacks Rank 1 = Strong Buy. Zacks Rank 2 = Buy. Zacks Rank 3 = Hold. Zacks Rank 4 = Sell. Zacks Rank 5 = Strong Sell. We also provide a Zacks Industry Rank for each company which provides an idea of the near-term attractiveness of a company s industry group. We have 264 industry groups in total. Thus, the Zacks Industry Rank is a number between 1 and 264. In terms of investment attractiveness, the higher the rank the better. Historically, the top half of the industries has outperformed the general market. In determining Risk Level, we rely on a proprietary quantitative model that divides the entire universe of stocks into five groups, based on each stock s historical price volatility. The first group has stocks with the lowest values and are deemed Low Risk, while the 5 th group has the highest values and are designated High Risk. Designations of Below-Average Risk, Average Risk, and Above-Average Risk correspond to the second, third, and fourth groups of stocks, respectively. Analyst Copy Editor Content Ed. Lead Analyst QCA Reason for Update Aparajita Dutta Anindita Sinha Urmimala Biswas Urmimala Biswas Aniruddha Ganguly Earnings Equity Research Page 10