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We have reaffirmed our Neutral recommendation on Volcano Corporation (VOLC - Analyst Report) with a target price of $28.00 following its third-quarter 2012 results. The company reported earnings per share (EPS) of 4 cents in the quarter, in-line with the Zacks Consensus Estimate. However, the result lagged the year-ago quarter’s EPS by a penny. Revenues for the quarter climbed9% year over year (up 12% at constant exchange rate or CER) to $93.7 million, but missed the Zacks Consensus Estimate of $95 million.

The San Diego, California-based company 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 improve the efficiency of the percutaneous interventional (“PCI”) procedures in the coronary or peripheral arteries.

IVUS products have a significant contribution to the company’s revenues. Volcano Corporation witnessed mid-single-digit growth in IVUS disposable revenues in the U.S. However, revenue trends in Japan as well as in Southern Europe, particularly Spain, were not so encouraging. The company is expecting mid-single digit growth in IVUS disposables going ahead based on softness in PCI procedures in the U.S., price cuts in Japan, difficult economic conditions in Europe and its transition to a direct-sales force in Spain. Meanwhile, we favor the company’s strategy to drive growth based on market penetration, share gain and pricing growth with the introduction of more advanced IVUS catheters and related technology.

Volcano Corporation now maintains a strong portfolio due to the recent launch of several new products, which is expected to generate growth in the long term. In August 2012, the company’s Valet Micro catheter received the CE Mark approval followed by a limited market release in Europe. Volcano is expecting an early 2013 approval of Valet in Japan.

Pipeline development is also progressing. The next-generation IVUS technology called FACT (Focused Acoustic Computed Tomography) is slated for commercial launch in the U.S. and Europe in mid-2013 and in Japan a year later. Besides, a full market release for Volcano Corporation’s Eagle Eye Platinum catheter is expected in the fourth quarter of 2012. Moreover, within the Forward-Looking Intra-Cardiac Echo (FL.ICE) program, animal trials have been completed and management is on schedule for the first-in-man clinical work in 2013.

Volcano Corporation continues to expand its presence in Japan through direct sales programs or introduction of new products. The termination of several contracts in the past few years has made the company strengthen its position to address 100% of its business in Japan. The benefits of the transition to a direct sales force in Japan have encouraged the company to go direct in Spain as well.

The company, however, had to lower its outlook for fiscal 2012 to reflect the several headwinds currently at play. Due to the weak domestic PCI market and the transition to a direct sales model in Spain, the company now expects to report revenues of $380–$384 million (previous expectation $384–$390). Moreover, capital spending by customers like hospitals has been affected by the weak economic scenario. The company also faces tough competition from players such as Boston Scientific (BSX - Analyst Report) and St Jude Medical (STJ - Analyst Report).

Our long-term Neutral recommendation is backed by a Zacks #3 Rank (Hold) in the short term.

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