Is This Do or Die for MAKO Surgical?

Steve is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Mark your calendars Fools! MAKO Surgical (NASDAQ: MAKO) is scheduled to announce Q3 2012 earnings on November 5, and I can almost sense a palpable increase in nervous ticks from frustrated long investors everywhere.

To that end, can you blame them?  Anyone who bought MAKO shares four months ago is down to the tune of nearly 40%.   If you pulled the trigger six months ago, you've endured an even more gut-wrenching 60% drop.

Did I mention I'm one of those people?

I got excited along with everyone else when MAKO crushed estimates with their Q4 2011 earnings announcement.  I watched as the stock ran up near $40 per share in February, and read one headline after another extolling the virtues of MAKO.  I imagined the revenue MAKO could generate by one day selling over 100 RIO systems per quarter like its soft-tissue cousin, Intuitive Surgical (NASDAQ: ISRG). Luckily, because I fully expected MAKO to be a roller coaster as they continue to work toward sustainable profitability, I remained sane and started with a small position averaged around $40 per share.

Nonetheless, my heart sank when MAKO got crushed after posting disappointing Q1 2012 earnings.  I managed to keep my wits about me, reassessed my reasons for owning the stock (more on that below), and decided MAKO wasn't yet firmly derailed from its path to success.  I doubled down at $25 and promptly watched in horror as MAKO fell another 40% overnight after reporting another dismal quarter. 

But are things really that bad?  Is this quarter do or die for MAKO Surgical?

In short, I don't think so and here's why:

Despite the sales lull, procedure growth remains robust.  

When MAKO showed us the second consecutive quarter of year over year declines in RIO system sales, some worried it would go the way of Hansen Medical (NASDAQ: HNSN) with its Sensei X Robotic Catheter System. However, Hansen's catheter procedure count has stagnated along with its system sales.  In contrast, while MAKO increased the installed base of its RIO systems by 46% between Q2 2011 and Q2 2012, the number of year-to-date procedures increased an even more impressive 71% from the same year-ago period.  Existing RIO systems, then, are being utilized more often, which can likely be attributed to the continuously-increasing number of surgeons trained on the platform.  According to a 10K filed by MAKO in March and an agreement signed in May, the company has even leased an additional 15,000 square feet of space as an "intended training facility" to ensure they can meet demand through at least 2016.

Hip procedures continue to ramp.  

At $100,000 each, selling a new THA (Total Hip Arthroplasty) application to a hospital that already spent $850,000 on the RIO system can't be easy.  Still, customers are buying as MAKO continues to improve the software interface with their "hip 2.0 application upgrade" being rolled out in Q3 and Q4 of this year.  MAKO is also building an impressive base of clinical research to support the viability of their MAKOplasty THA solution. Since the THA commercial launch less than a year ago, MAKO has convinced over half the installed RIO system base to add the hip application.  Why is it, then, that only 11.2% of the year-to-date MAKOplasty procedures were hip surgeries?  Are we really to believe several dozen hospitals would shell out an extra $100,000 for the hip application to let it collect dust?  I think these hospitals are just getting started.  As the software updates are completed this year and more surgeons are trained on the system, don't be surprised if we see a dramatic rise in the number of MAKOplasty THA procedures performed.  Relatedly, this will improve the monthly utilization numbers even more and prop up MAKO's recurring revenue stream.  On that note, this means...

MAKO won't run out of cash anytime soon.  

With just over $35 million in cash left in the bank and an untapped $50 million credit facility agreement with Deerfield Management, MAKO won't run out life-sustaining cash for quite awhile.  During the Q2 conference call MAKO's CFO, Fritz LaPorte, stated they expect to have a year-end cash balance of around $23 million. Simple arithmetic, then, tells us MAKO only plans to drain another $12 million from their coffers during the second half of this year.  That may sound bad, but after MAKO reported net cash used in the amount of $11.5 million in the second quarter alone, this projected slowdown should serve as welcome relief.  You can be sure analysts will scroll down quickly in the Q3 2012 report to verify cash burn is slowing as much as Mr. LaPorte claimed.

Potential for a shoulder application (?)  

To be clear, I won't be betting the house on seeing a MAKOplasty shoulder application anytime in the near future.  Can't a guy dream, though?  While the word "shoulder" is nowhere to be found in MAKO's quarterly reports, with a little digging we can see it's definitely on the company's mind (pardon the anthropomorphism!).

In the Q2 earnings transcript, for instance, Mr. LaPorte threw investors a little nugget as he explained the increased R&D costs, saying they were "[...] primarily associated with the continuous improvement of the RIO system platform and MAKOplasty applications, including the recently launched MAKOplasty 'Total Hip Application' and the development of potential future products."  However vague, could these "potential future products" include a shoulder application?  Total Knee solution?  Both?

Another interesting exchange happened during an August Q&A session with San Francisco Surgery Center Administrator, Jeff Wong.  When asked where he saw robotic technology in surgery centers headed in the future, part of Mr. Wong's response included "While we have focused exclusively on partial knee replacements up till now, we anticipate leveraging the robot for hip replacements and possibly shoulder repairs in the near future."  Something tells me Mr. Wong isn't simply hoping for a shoulder solution.  He's expecting one, and I'm betting the folks at MAKO Surgical will be more than happy to oblige as soon as possible.

Don't get me wrong; MAKO has more than enough risk to go around.  If MAKO's November 5 earnings don't show a marked improvement in RIO system sales and they can't convince the world of their ability to meet already-lowered guidance, it shouldn't be difficult for the stock to blast through the $12 low we saw in early August.  After all, MAKO has already disappointed us twice amidst the most challenging economic climate in recent memory.  What's to keep them from making it a hat trick?

Consider me a skeptic of the skeptics as I remain unconvinced of MAKO's impending demise.  With MAKO trading at current levels, and with most signs pointing upward, I feel like we've been given a gift.  This is a chance to buy MAKO at prices we haven't seen since the middle of 2010...when the future was much less certain for this pioneering Rule Breaker.

symie5 owns shares of MAKO Surgical. The Motley Fool owns shares of Intuitive Surgical and MAKO Surgical. Motley Fool newsletter services recommend Intuitive Surgical and MAKO Surgical . Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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