Reading the Q3 Tea Leaves
Board: MAKO Surgical
After consecutive precipitous declines in MAKO's stock price following consecutive disappointing system sales totals in Q1 and Q2, I started wondering what to look for out of Q3.
First, I looked at the history of system sales, as reported by company.
[See Post for Tables]
Next, I looked at what percentage of total system sales per year each quarter has represented (note: percentages may add up to 99 or 101 for a year due to rounding), and then calculated the average each quarter has represented over the first three years of the RIO system.
Obviously, this remains a small sample size, so take the results with a grain of salt, but it's interesting to note that the proportion of average system sales from Q1 to Q2 (14/21) is exactly the proportion of system sales in Q1 and Q2 of this year (6/9).
So the results of Q1 and Q2 both predict the same total system sales for the full year 2012 if the proportions of the past three years apply: 43 (actually 42.8).
Full-year sales of 43 would be at the lower end of the lowered guidance of 42-48, and would represent a decline from 2011. That's the bad news. Without proportional representation from Q3 and Q4 greater than the historical average, MAKO will have an indisputably disappointing result in new system sales in 2012, which will have at least three possible explanations five years from now:
-- The predicted hiccup in the technology adoption curve.
-- The beginning of the end of a medical device company that never made it to mass adoption.
-- The result of poor internal sales execution addressed by the company at mid-year when it fired its director of sales.
If system sales in Q1 and Q2 represent roughly the historical averages of those quarters over the past three years, and sales in Q3 represent roughly its historical average, sales in Q3 will be 11.6 Since you can't sell six-tenths of a RIO system, that rounds to 12. Sales in Q4 would be 16 (16.3).
So the number I'm looking at as sort of an over/under for system sales in Q3 is 12.
If that's the number, MAKO is on track for 43 for the year, a disappointing result but one which the market has arguably priced in. The stock is down about 60 percent since the first of the two quarterly reports this year.
If the number is greater than 12, it might signal that sales execution was indeed the issue, which would be the least profound and therefore most bullish explanation for the declines in Q1 and Q2.
If the number is less than 12, the prospect for further downdrafts in the stock becomes very real as it would suggest that even the reduced annual guidance might prove too high.
Lastly, I wondered if there were any clues that might suggest any action with reference to the stock -- long or short -- in anticipation of Q3 earnings, which MAKO has announced historically within the first 10 days of the second month following the end of the quarter. This would put the Q3 earnings announcement sometime between Nov. 1-10. Yahoo has it on Nov. 1. I don't know if Yahoo actually knows that or if it's guessing based on Q2 results, which were announced Aug. 1.
We can probably conclude that MAKO does not intend to warn again. In Q2, it warned on July 9, so one would think a warning would have come within the first two weeks of October. Of course, the failure to warn doesn't necessarily tell us anything. They may be tired of watching the stock get hammered. They may be afraid of what a warning would do in the context of the considerable short interest, although bad results would have their effect soon enough in any case.
But if we assume that the absence of a warning means they are at least on track to meet their reduced guidance, then 11 or 12 system sales would be pretty much the minimum requirement. Any number greater than this would move the projection up into the middle of the reduced guidance at a minimum and might signal a reversal in momentum for the stock.
If you believe in analyst mid-term reports, which I generally don't, MAKO will at least meet expectations:
Finally, there is the greed/fear factor. Both the stock price and the short interest tell you that the crowd hates MAKO right now, for obvious reasons. It has underperformed in two consecutive quarters. But the reason the crowd is often wrong is because it always expects whatever has happened recently to continue happening. Sometimes it does, but whenever it doesn't, the crowd will be on the wrong side of the trade. It will take some nerve to buy in advance of earnings this quarter, but if it turns out the problem in Q1 and Q2 was internal execution, it could be a propitious moment to be greedy while others are fearful.