Edwards Lifesciences Corporation (EW) has reported an adjusted EPS of 38 cents in the third quarter of fiscal 2011, a penny below the Zacks Consensus Estimate, and missing the year-ago quarter’s adjusted EPS of 43 cents. Revenues increased 18.3% to $412.7 million, exceeding the Zacks Consensus Estimate of $405 million.
Segments
Heart Valve Therapy remained the strongest segment at Edwards with an annualized growth of 22.7% to reach $246.1 million. Sales of surgical heart valves grew 7.7% to $163.5 million and transcatheter heart valves (THV) catapulted 69.1% to book $82.6 million. The other segments of the company, namely Critical Care, Cardiac Surgery Systems and Vascular recorded sales of $126.7 million (annualized growth of 14.2%), $26.9 million (up 13.2%) and $13 million (down 4.4%), respectively.
The robust growth in THV sales was primarily driven by strong procedure growth. Transapical sales, aided by the new 29 mm valve, comprised nearly half of total commercial transcatheter valve revenue. Edwards is confident about the imminent US approval of Sapien and expects $20–$25 million of sales in the first quarter of launch and $150-$250 million estimated for the first full year. For fiscal 2011, the company reiterated its THV guidance of $330–$360 million.
In the surgical heart valves category, Edwards witnessed increased competition and slower procedure growth. However, customers are shifting to the company’s premium products, which are witnessing a larger proportion of sales. Impressive sales of the company’s advanced monitoring products as well as pressure monitoring products continued to drive growth at the Critical Care segment.
Expenses
During the quarter, Edwards’ gross margin contracted 290 basis points (bps) to 69.6% primarily due to the adverse effect from foreign exchange (350 bps). At current rates, the company expects the negative impact from foreign exchange to wane in the fourth quarter and exit the year at 73%.
Higher expenses due to the anticipated launch of Sapien in the US coupled with an unfavorable foreign exchange movement led to a 24.4% rise in selling, general and administrative (SG&A) expenses to $165.5 million. Besides, SG&A expenses, as a percentage of sales, increased by 200 bps to 40.1%.
The company’s ongoing investments in the THV program led to a 17.1% rise in research and development (R&D) expenses to $61.7 million. However, R&D expenses, as a percentage of sales, remained almost flat at 15%.
Balance Sheet
Edwards exited the quarter with cash and cash equivalents of $451.1 million, up 13.9% from $396.1 million at the end of December 2010 and a debt of $175 million. Free cash flow for the quarter was $77.7 million and the company repurchased 1.4 million shares for $104.3 million.
Guidance
Michael A. Mussallem, CEO of Edwards, is confident that portfolio and geographic expansion should lead to enhanced revenue growth and higher operating margin in 2012. The company also tightened its revenue guidance for fiscal 2011 to $1.68−$1.72 billion (previous guidance of $1.66−$1.74 billion). The adjusted EPS guidance now stands at $1.97–$2.02 ($2.01–$2.07) while gross margin is still expected to be on the lower end of the 71–73% range. Edwards is also confident of generating $190−$200 million of free cash flow during the year.
Meanwhile, the company expects to report adjusted EPS of 57−62 cents in the fourth quarter of fiscal 2011, slightly lower than the current Zacks Consensus Estimate of 63 cents. Edwards also confirmed that any change in the timeline of Sapien approval in the US would affect fourth quarter earnings.
Recommendation
Edwards’ strong quarter was hinged on a robust performance of its Heart Valve Therapy products. In July 2011, Sapien received favorable recommendation from the advisory panel of the US Food and Drug Administration (FDA). However, the panel expressed concerns about vulnerability to neurological problems, particularly stroke, in patients treated with Sapien. Although the company is quite confident of the regulatory nod for Sapien, any hiccup would be a major disaster for the stock.
We also remain cautious as only in last month, Centers for Medicare & Medicaid Services (CMS) decided to initiate a National Coverage Analysis (NCA) of transcatheter aortic valve replacement (TAVR). Any unfavorable reimbursement decision from CMS could have an adverse impact on the potential market of the valve.
Moreover, in Europe, Edwards operates in a highly competitive environment with the strong presence of Medtronic (MDT). Moreover, Boston Scientific (BSX) is also working to enter the THV market banking on the acquisition of Sadra Medical.
We currently have a Neutral recommendation on Edwards, which corresponds to a Zacks #3 Rank (Hold) in the short term. Both Medtronic and Boston Scientific carry Neutral recommendations.
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