MAKO: 'Less Bad' Is Good

| About: MAKO Surgical (MAKO)
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After posting disappointing results for most of last year, MAKO Surgical (NASDAQ:MAKO) confirmed its previous pre-earnings announcement during its Q4 2012 earnings release last Wednesday. In the subsequent conference call (transcript of which can be found here), management provided flat guidance for the placement of new systems for 2013 but indicated that they felt the recent softness in sales and procedures was largely behind them.

Q4 Is "Less Worse"

During the fourth quarter, Mako sold 15 RIO systems versus 18 for the prior year quarter. This brings total commercial systems installed to 156. For the year, 45 systems were installed worldwide, vs. 48 systems in 2011. Looking to the books, the company lost $32.6 million on revenue of $102.7 million as compared to a loss of $36.1 million on revenue of $84.5 million in 2011.

Of specific concern is inventory on hand, which increased to $25.1 million on Dec. 31 from $24.6 million on Sept. 30 - This however, is likely an overhang of excess inventory that was manufactured earlier in the year on anticipation of stronger placement sales than never materialized. The company took a $1.2 million expense in the fourth quarter on this excess inventory.

In addition to the RIO systems, eleven MAKOplasty Hip applications were placed, of which 8 were sold in conjunction RIO systems sold at the same time. A total of 47 MAKOplasty Hip applications were sold in all of 2012, and at the end of the year, 62% of MAKO's worldwide commercial installed base had the MAKOplasty Hip applications, up from 44% at the end of 2011.

After YoY declines in the March and June quarter, the company seems to have stabilized placements, although at a rate well below what was first anticipated by management at the start of the year.

As further evidence that demand in robotic surgery is strong, 10,304 procedures were performed using the equipment. This is a 47% increase from the 6,932 performed in 2011. However, somewhat troubling is a YoY decline in utilization rates from 7.2 in Q4 2011 to 6.6 in Q4 2012.

The Plan for 2013

Of course due to the pre-announcement, the actual financials were a bit anticlimactic. The real question of the day was what guidance would management provide for 2013? Here, despite lowered expectations, the company still managed to underwhelm with their estimate of 45-48 system placements, which is just about flat with 2012 sales numbers. They were a little more optimistic about procedures, calling for between 13,500-14,500 (+32%-+42%) but even here, they were on the very low end of the already lowered consensus expectations. Although, when you stop to think, the numbers make sense in light of the slower rate at which MAKO grew its installed system base in 2012.

By dividing an average 14,000 procedures by the base of installed units plus 20 or so to account for some use by 2013 installed systems, I calculate a utilization rate of only 6.6. While this is (barely) above the average rate for all of 2012, it is well below the utilization rate of 2H 2011 and 1H2012.

What About the Other Guys?

During the call, CEO Maurice Ferre said the company has plenty of room to grow as it has installed bases in 13% of the 1200 total possible sites in the U.S. Of course this also leaves a lot of room for competitors like Stryker (NYSE: SYK), and Intuitive Surgical (NASDAQ: ISRG) to gain market share as well. Intuitive Surgical's da Vinci robots can be used by surgeons to perform dozens of different soft-tissue surgeries and this model continues to gain in popularity as surgeons can become more familiar with a single device for several different types of surgeries. As a result, da Vinci robots had a monthly utilization of around 13 procedures per system in 2012. For those of you keeping score, that's twice the utilization rates of MAKO. Of course, this is a metric that is not lost on hospital administrators looking to maximize ROI.

MAKO management, while curiously denying that competitive technologies and/or pricing is a concern in the placement process, has implemented a strategy to increase utilization of existing units. Although no specific targets for utilization were given, it seems clear that this area will receive at least as much focus in 2013 as does the placement of new systems.

What Can Investors Expect?

Recent weakness in quarter-to-quarter sales have made this a volatile stock to own, but MAKO has a strong management team with a strategic plan to grow unit sales and procedural usage. Despite its recent challenges with slowing sales, these problems seem to have reached a base from which the company can now grow. With the stock still trading in the low teens, now might be a good a time to snap up a few shares cheap. Long term investors - meaning those with investing time horizons of longer than 3 years might want to consider a core and satellite strategy. Using this strategy, you keep the "core" long-term holdings and trade a small (typically no more than 10% of total) satellite" position, selling into rallies and buying on dips. This way you can take advantage of short-term temporary pullbacks while leaving your core long-term holdings in place to play out over time.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.