Volcano Corporation (VOLC) reported an EPS of 10 cents in the third quarter of fiscal 2010, surpassing the year-ago quarter’s adjusted net loss per share of 5 cents and the Zacks Consensus Estimate of 1 cent. Revenues increased 35.3% annually to reach $72.9 million with strong growth in Intravascular Ultrasound (IVUS) and Functional Measurement (FM) single-procedure disposables. Revenues were higher than the Zacks Consensus Estimate of $71 million.

Medical segment’s revenue grew 34% to $66.7 million driven by increased penetration of the IVUS and FM markets. Barring revenues derived from Consoles ($8.1 million), which declined 5% annually, sales from IVUS single-procedure disposables ($42.6 million), FM single-procedure disposables ($11.3 million) and Other business ($4.7 million) witnessed a growth of 36%, 52% and 34%, respectively. The industrial segment recorded a 47% growth in revenues to $6.2 million.

Growth in the Japanese market for IVUS disposables jumped 76% year over year. Japan is the largest IVUS market in the world and the establishment of a direct sales force should allow the company to provide more focused service and support to the market. Meanwhile, the US market recorded a growth of 16% in IVUS disposable sales.  Europe and ROW countries posted growth rates of 5% and 69%, respectively. In Japan, FM sales increased a whopping 346% to $0.8 million, with strong growth recorded in other regions.

Volcano Corporation has decided to end its distribution agreement with Fukuda Denshi Co., Ltd., in Japan, effective December 1, 2010. Consequently, the company will be addressing 95% of the current business in Japan on a direct basis, which should further drive revenues derived from this region in future.

Gross margin of Volcano Corporation was 64.4% in the quarter, compared with 59.6% in the third quarter of 2009. This was primarily due to an 18.8% rise in cost of revenues, much lower than 35% revenue growth. Excluding one-time items, operating expenses increased 6% to $39.75 million. We expect operating expenses to increase in the forthcoming period due to increased spending in Japan, expansion of sales and marketing programs in other geographies and new product launches.

Outlook

Volcano Corporation continues to expect $286–$290 million of revenues in fiscal 2010 with gross margin of 62-63%. However, the company has raised its EPS guidance to 14-16 cents compared to the previous guidance of 2-4 cents. In addition, operating expense margin should be around 59-61% from the prior guidance of 58-60%.

Recommendation

Volcano Corporation continues to execute strategies in driving strong top line growth in the IVUS/FM markets helped by new product launches, product enhancements and strong R&D emphasis. The company believes that IVUS and FM markets remain under- penetrated and expects its core IVUS and FM businesses to grow by over 20% annually.While tight hospital budgets could restrict growth in the near-term, we believe that increasing demand for the company’s products should drive revenues.

We maintain our Neutral recommendation on the stock for the long term.

 
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