Thursday, April 23, 1998
VISX Inc.
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Phone: 408-733-2020
Website: http://www.visx.com
Price (4/22/98): $41 1/8
HOW DID IT DOUBLE?
Laser vision correction can be eye-opening, but a strong quarter can be eye-popping. Leading laser manufacturer VISX likes both. After years of working a market that seemed always about to take off, VISX announced first quarter results on April 15 that sent it shares doubling in the blink of an eye.
Revenues soared 54% to $24.3 million as years of equipment sales began to pay off in huge per-procedure licensing fees, which rose 246% versus the first quarter of 1997. U.S. fees exceeded expectations, with March proving a record month. Service revenues also increased 50% year-over-year as lasers coming off warranty are generating new service contracts. The only down note was that the U.S. seems at least temporarily saturated with lasers, with system sales actually falling 25% due to lower U.S. unit sales and trade-ins that resulted in lower average selling prices.
Still, with total expenses flat year-over-year and down for the third consecutive quarter, operating income rose 460% to $10.4 million from $1.9 million a year ago. Earnings per share came in at $0.58 versus $0.17 a year ago and more than double the consensus estimate of $0.28 a share. Assuming income was fully taxed at a 40% rate, EPS would have been $0.45, up from $0.12 a year ago.
Chair/CEO Mark Logan appeared on CNBC on April 16 to tell viewers the market for refractive laser eye surgery was on the "brink of exploding." With VISX's equipment used in perhaps 70% of such procedures, investors spotted an opportunity and drove the stock up as much as 40% that day.
BUSINESS DESCRIPTION
VISX makes and sells proprietary excimer laser systems used for corrective eye surgery, mainly to treat nearsightedness and astigmatism. For $1,500 to $2,000 per eye, an ophthalmologist using a VISX system can remove layers of tissue from your cornea, reshaping the eye to improve your vision so you can perhaps dispense with glasses or contacts. The main procedures are known as photorefractive keratectomy (PRK) and phototherapeutic keratectomy (PTK).
About 157 million Americans suffer from vision problems, but only a fraction of these have turned to laser surgery. About 70,000 procedures were performed in 1996, the first full year following the Food and Drug Administration's (FDA) approval of PRK lasers. Analysts expect over 300,000 surgeries this year and perhaps half a million in 2000.
The VISX system has been approved by the FDA to correct mild to moderate nearsightedness (March '96), astigmatism (April '97), and higher myopia with or without astigmatism (January '98).
In March, the agency approved the new VISX Star S2 System to treat nearsightedness and astigmatism. This special seven-beam system is said to perform smoother ablations, leading to better visual acuity and quicker recovery times while getting the job done faster. This laser is already being used internationally to treat hyperopia (farsightedness) and hyperopic astigmatism. The company hopes for FDA approval for hyperopia by late '98.
VISX holds over 120 U.S. and international patents, but in 1992 it resolved a patent dispute with chief competitor Summit Technology <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: BEAM)") else Response.Write("(Nasdaq: BEAM)") end if %> by creating Pillar Point Partners (PPP), a holding company that sets the terms for use of the patents. Both companies pay PPP 6% of their equipment sales, which then all revert to VISX. But PPP also charges doctors a $250 royalty fee for each surgery, with $140 going to VISX, the rest to Summit.
In addition to Summit, VISX competes with companies such as Autonomous and Chiron, which have licensing deals with PPP and are expected to bring out new systems in the U.S. within the next year or so.
VISX insiders own just 3.4% of the stock.
FINANCIAL FACTS
Income Statement*
12-month sales: $77.2 million
12-month income: $24.4 million
12-month EPS: $1.55
Profit Margin: 32%
Market Cap: $641.6 million
(*Excludes FY97 litigation settlement charges of $4 million or $0.25 per share)
Balance Sheet
Cash: $106.6 million
Current Assets: $129.4 million
Current Liabilities: $24.3 million
Long-term Debt: N/A
Ratios
Price-to-earnings: 26.5
Price-to-sales: 8.3
HOW COULD YOU HAVE FOUND THIS DOUBLE?
The creation of Pillar Point meant that if PRK surgeries ever met up with the hyper-growth that was long expected, both VISX and Summit would benefit from some very high-margin royalty revenues, especially VISX. However, these two companies have been bitter enemies for years, and the creation of PPP offered new reasons for litigation. It also sparked price-fixing charges.
The Federal Trade Commission (FTC) initiated an investigation in October 1995 and on March 24 charged both companies with overcharging consumers by $30 million last year. The commission wants the companies to dissolve the PPP patent pool, arguing that this will spur greater price competition in the marketplace. The FTC also charged VISX with fraudulently acquiring a key patent.
Without delving deep into the utter soap opera that has built up around these matters, an investor might have found the FTC action quite worrisome. Shorter term, though, there was bullish news. On April 14, major VISX customer Laser Vision Centers <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: LVCI)") else Response.Write("(Nasdaq: LVCI)") end if %> reported a 310% sales jump in March from the 23 lasers it had in operation a year earlier.
Laser Vision added that it performed 3,000 surgeries in March. About 75% of those were in-situ keratomileusis (LASIK) procedures, known as a "flap and zap," where the physician cuts a flap on the cornea's surface, folds it over, burns away tissue to reshape the cornea, and then folds the flap back. Because LASIK surgeries are not FDA-approved, VISX gets to keep all the royalty money from these procedures, bypassing the PPP arrangement. Paying attention to a company's major customers can help you get a head start on other investors.
WHERE TO FROM HERE?
VISX says the FTC's patent charge is "without merit" and that the 1990 resolution of complicated patent interference proceedings was done according to Hoyle. The company says the validity of the patent isn't in dispute, just its enforceability, and that it may take up to 2 1/2 years before the matter is ultimately settled by the U.S. Circuit Court of Appeals.
VISX says it was unable to resolve issues with the FTC over Pillar Point because Summit has proven an uncooperative partner. So on February 17, VISX sued Summit in California Superior Court seeking to dissolve the partnership, which is also what the FTC wants.
VISX seems to believe its patent arsenal is complete enough, and its manufacturing and service offerings strong enough, that Pillar Point may actually be restraining its already fierce efforts to crush Summit. For its part, Summit CEO Robert Palmisano has said, "Summit believes now, as it did then, that the Pillar Point arrangements were lawful and pro-competitive."
The legal battles (and there are others mentioned in the 10-K) are an entertaining sideshow worth an investor's attention. But they don't appear to be a major short-term concern. VISX expects to see seasonal weakness through the middle of the year. Expenses will rise a bit, too, though the company doesn't expect major increases in its legal bills. The company also looks for a strong upgrade cycle to the new Star S2 system (current Star systems can be upgraded for $50,000), especially after expected FDA approval for farsightedness.
The current First Call mean earnings estimates have been recently raised to $1.64 a share for this year and $2.23 a share for FY99. So the stock trades at less than 25 times estimates, near the future growth rate but at a huge discount to the FY98 earnings growth these numbers suggest.
Trusting recent results more than the estimates, a Fool might see the opportunity for more upside surprises. In a market niche that has seen more than its share of unfulfilled hype over the years, that itself is a surprise.
-- Louis Corrigan
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