Sonosite Delivers Revenues and Earnings Below Estimates

Ultrasound manufacturer Sonosite $SONO gave results which were below analyst forecasts and also below the company’s internal forecasts. Although this is a disappointment, it is not as bad as it superficially appears and looks to be part of the usual ‘variance’ that happens with fast growing companies. Nevertheless, I would expect the stock to be marked down.

Firstly, turning to the results

• Rev 72.7m vs. 73.8m forecast
• EPS of -8c vs. 10c forecast
• Full year guidance maintained as per conference call

In other words this is a 17c miss on earnings and revenues were light. This is not a good headline but delving deeper into the results and conference call, it looks like this is more to do with a timing of orders than any protracted weakness.

Sonosite’s Missing Orders

Essentially, the management is saying that there were $4-5m in orders in Q2 which were delayed and are due to be rolled over in the next quarter. Now, if I had a dime for every time I’ve heard that sales that hadn’t been booked were just about to ‘come in’ I’d probably have enough to make up Sonosite’s shortfall myself! The market will approach the issue with the same level of skepticism. As for the earnings shortfall, this is explained by the fact that Sonosite has over 70% gross margin, a few million lost in sales will drop through heavily into the bottom line. Had the orders come in, then Sonosite would have handily beaten estimates.

Skepticism aside and having listened to the conference call, I thought that Sonosite were very specific about these orders and were quite willing to put credibility on the line in outlining their belief that they were part of a non systemic and incongruent sequence of events. For example, 25% of the shortfall was due to VisualSonics (VSI) and this amounts to just three orders. Moreover, most of the shortfall has subsequently come in and only $300k has ‘evaporated’. According to the management, if there was a systemic weakness, it was to be found in the UK. In addition, guidance has been kept the same for the full year, so clearly they are expecting to beat pre-existing forecasts for the next quarter.

Sonosite’s Opportunities in the Second Half

The results in the first half were categorized by an increase in R & D costs and SG & A which saw total Operating Expenses rise to 66.2% of sales from 64% last year. This increase in expenses is largely due to integrating Visual Sonics and too the launch of new products as part of the three year strategic plan. Indeed, the management concluded the conference call by pointing out that margin improvements were due to take place in the second half.

One cause for concern is the rising working capital requirements. This is natural in a business that is about to accelerate revenues, but as shipments were lighter than expected in the quarter, Sonosite saw inventories rise. In conclusion, if there is a pronounced correction on the back of this result than a decent buying opportunity could be being created. GE $GE gave results recently and reported good growth in compact ultrasound shares and with Sonosite affirming that it had -at least- retained market share in the US, this looks like a timing of orders issue rather than a cause for sustained weakness.

Compact Ultrasound Sales Seen as Rising 11% Globally, Good News For Sonosite

Ultrasound manufacturer Sonosite $SONO is a stock that has been in the doldrums recently, but a disciplined investor will take the opportunity to buy more provided he continues to believe in the earnings prospects.  I do, and I think I am, so I bought some more! Sonosite was featured at length in an article linked here and I think it has good earnings potential as well as being a potential bid target.

Furthermore, an interesting report was recently released which adds strength to the potential for this stock to go higher. In a report produced by Harvey Klein of Klein Biomedical Consultants, the compact ultrasound market is predicted to grow at 13% per annum over the next five years. In the US the market is forecast to expand from $276m in 2010 to $505m in 2015. Outside of the US, the market is expected to grow at 10%

In addition, the report cites Sonosite's 2010 US market share as being 42% and an investor only has to look at the next two players (GE & Philips) to find potential acquirers of Sonosite. If the market plays out as expected, Sonosite's US sales (provided they keep market share) could rise to at least $212m by 2015.

Given the recent analyst upgrades, now looks like a good time to pick some up. I bought some more.



Source:

PR Web, 'Leading Industry Analyst Reports Record Highs In U.S. Compact Ultrasound Revenues For 2010'

Sonosite is a High Grow Healthcare Play

Sonosite $SONO is a leading player within a high growth niche area of healthcare. The company specialises in hand carried ultrasound systems and, is the leading player in the US in this area. SONO is competing with some very big companies like GE , Philips and Siemens but it has demonstrated the capability to lead this market. As such, this stock is a genuine takeover candidate for these companies or a larger company like Mindray.

Sonosite are involved in miniaturising and simplifying ultrasound for Point of Care (PoC) medicine. The company was spun out of a larger US company in 1998 and until now has established over sixty thousands installed users. The company's solutions are sometimes described as 'portable ultrasound' but this description does not allude to some of the growth drivers for Sonosite. Before going into them, it is useful to see how Sonosite is performing right now.

Sonosite SONO Q4 Results

Turning to the recent Q4 results

• Q4 Revenues of $89.3m vs. $83.7m estimates
• Including Non-Recurring Charges EPS was 41c vs. 36c estimates

Guidance

• Full Year Revenues of $310-325m vs. $312m estimates
• Full Year gross margins stable at around 71%
• Operational expenses of $184-186m
• Tax rate of 34%
• Analyst are forecasting EPS of $1.20 for 2011

Listening to the conference call the management are seeing a 50/50 split between international and US sales in 2011. International growth is seen as stable but low growth in Western Europe, however the emerging market and BRIC economies are seen as faster growing. A combination of organic revenue growth, new product launches in the second half and growing contribution from the Visual Sonics acquisition will increase the top line by 13-18% according to Sonosite.

One interesting aspect of this growth is that it will be more back end loaded, so investors can expect a 40/60 split of revenues in the two halves, with revenues in Q2 and Q3 being higher than in previous years. Margins are likely to stay stable because Sonosite is in-what the company sees as- the first of a three year sales cycle. Typically this means that sales costs, R & D and promotional activity are higher in the first year. After which, operating margins will expand in the next couple of years.

Sonosite estimates that it either held or gained market share in its major markets and the management do not appear to be planning any acquisitions for 2011.


Sonosite Growth Prospects

The growing usage of portable ultrasound for emergency procedures (where portability is an issue) is one area of growth as is increasing usage for certain medical procedures. In particular, advances in portable ultrasound technology are seen as creating a market for the machines to be used in procedures that would otherwise be covered by computed tomography (CT) or magnetic resonance imaging (MRI).

For example, patients who need on going antibiotics or chemotherapy will have a Peripherally Inserted Central Catheter (PICC) placed in them and, portable ultrasound is ideal for helping the nurse visually see how the instrument should be placed. Similarly, nurses use the machines to guide them in injecting anesthetics near peripheral nerves prior to surgery. For this type of hospital usage, Sonosite claims to be the clear leader with GE its main competitor.

Another growing usage is for detection of breast cancer, as ultrasound gives very high

Sonosite also cites Mindray as being a competitor in some of its markets and, they could be potentially an acquirer because Sonosite and GE have already settled a law suit. Furthermore, Sonosite should be attractive to the likes of Philips or Siemens who could immediately gain scale in the US by buying SONO.


Sonosite Evaluation

The stock trades at a share price of $36.94 which gives it a market cap of $498m and an Enterprise Value of $497m which makes it a small cap growth play. Analyst estimates are for EPS of $1.20 and $1.64 for 2011 and 2012 respectively. This hardly makes the stock cheap on a PE basis.  However, net income is only one side of the story, because SONO have been booking losses via buying back convertible debt. Furthermore, Sonosite is a highly cash generative business.

Given the numbers in the guidance above, it is entirely feasible that, for 2011, Sonosite will record $225m in gross margin and 40.4m in operating income. Assuming losses on debt repurchases similar to 2010 would give pre-tax profits of $29m and $19.1m in net income. Given traditional operating cash flow conversion, Sonosite could generate $33.5m in operating cash flow and around $31m in free cash flow (FCF).  This equates to a foward FCF/EV yield of  6.2% based on a current price of $36.94

This looks too cheap, so I bought some with a $45 price target.

Source:

iData Report, "U.S. Market for Ultrasound Equipment 2010"