The only big surprise regarding Encore Medical's ( ENMC) earnings release Monday was the volatility in the shares. After closing at $6.01 on Friday, the stock opened at $6.04, spiked to $6.45 and plunged to $5.80 within the first 15 minutes of trading. It closed right where it opened at $6.04.The volatility was a bit unexpected because the company's earnings release didn't contain any surprises or even guidance. Investors had to wait for Monday morning's conference call, which was held at 10 a.m., to receive 2006 projections. In the fourth quarter, Encore earned 6 cents per share on revenue of $75 million. EPS was right in line, while revenue was shy of expectations by less than $700,000. The company said earnings in 2006 would be between 27 cents and 30 cents per share, below the consensus estimate of 31 cents. That figure does include one-time costs related to the Compex Technologies acquisition. Projected revenue of $415 million to $425 million, however, is expected to be significantly higher than the consensus forecast of $350 million. Encore's management provided some color regarding the Compex purchase, which closed Feb. 24. One of the big takeaways is that Encore needs to figure out what to do with Compex's U.S. consumer unit. Some of Compex's products, such as Slendertone, which firms abs and other parts of the body, are sold on The Home Shopping Network and in General Nutrition Centers and don't fit well with Encore's other business units. The segment was unprofitable for Compex in 2005. However, Davis Henley, Encore's vice president of business development, said Compex devoted a significant amount of resources toward the group in the first half of 2005 and that the business was nearing break-even level in the latter half of the year. Henley is right. In the six months ending Dec. 31, 2005, Compex's U.S. Consumer unit lost $39,000 vs. a profit for the entire company of $14 million.
Encore has hired advisers to look at options, which include selling the unit or closing it. It is expected that a sale of the consumer business would not have a meaningful impact on earnings, but would positively affect cash flow due to the large amounts of accounts receivables. The integration of Compex will be critical to Encore's performance this year, both from a revenue and expense standpoint. I'm not too worried about the revenue side of the equation. I have confidence that Encore will be able to deliver what it says it will on the top line. The expanded sales team should give the company coverage into territories in which it historically has not had much of a presence. Additionally, Compex's sales force has direct exposure to doctors, whereas Encore's focus is on therapists. Expenses, on the other hand, could be key. Encore expects some integration-related expenses, such as those attributed to IT, to ramp up in the latter half of the year and into the first quarter of 2007. Keep an eye on the timing of those kinds of issues. If they happen sooner than expected, 2007's numbers could be positively impacted. If some of those expenses get pushed out until further quarters, you'll likely see next year's numbers get dinged. It could also suggest other integration problems. At this point, I'm not suggesting that will happen. In fact, Encore's management has proved itself in this arena before, but I do want to point out potential concerns. While the focus of the conference call was on the acquisition of Compex, Encore's core business produced some pretty stellar numbers. Its surgical-implant division saw revenue spike 22% in the fourth quarter. Companywide margins improved significantly, indicating management's skill at integrating acquisitions, as Encore acquired electrotherapy-system provider Empi in late 2004.
So, not much has as changed since my
original column on Encore. The company's surgical-implant business is going well and its acquisition of Compex Technologies is expected to pump up revenue and earnings right away. Because there were no substantive changes, I'm sticking with my bullish thesis and $7 price target.