Can U.S. Surgical Make A Full Recovery?

Who's on first? That's the question being asked in the $800 million market for the instruments used in minimally invasive surgery. U.S. Surgical Corp. invented the industry in 1989 and still claims to be No.1. But now Ethicon Endo Surgery Inc., a unit of giant Johnson & Johnson, says it has seized the lead.

U.S. Surgical's feisty Chief Executive Leon C. Hirsch declined to talk to BUSINESS WEEK, but he has disputed J&J's contention. "We are close to parity, but they are still No.2," Hirsch recently told Wall Street analysts. That there's even debate shows how far the Norwalk (Conn.)-based U.S. Surgical has fallen.

In many ways, U.S. Surgical is the classic small growth company. It built a better mousetrap--then got complacent as customers beat a path to its competitor's door. Sales went from $291 million in 1988 to $1.2 billion in 1992 on the strength of its new technology for endoscopic surgery, which allows doctors to perform operations with only a small incision. But when J&J entered the market in 1992 with a fierce price war, U.S. Surgical plummeted. From earnings of $138 million in 1992, U.S. Surgical fell to a loss of $138 million in 1993--and by early 1994, it faced a liquidity crisis.

A NEW GAME. Now Hirsch is proclaiming a turnaround. After being forced to renegotiate much of its debt and issuing a $200 million private equity placement early this year, U.S. Surgical has cleaned up its balance sheet. And over the past year, the company has undergone a massive retrenchment, cutting the workforce 20%, to 6,200, slashing its dividend, and chopping research spending by one-third. After losing another $8 million in 1994's first quarter, the company has posted two consecutive quarters in the black.

U.S. Surgical is also learning to play by a new set of rules. Once, it sold directly to surgeons. Today, hospitals use purchasing groups to negotiate hefty discounts--and they're forcing the company to sell through distributors who keep a hold on inventories. And with J&J'S Ethicon in a fight for share, customers can drive hard bargains. "We have seen U.S. Surgical willing to hold prices," says Alicia Smith, senior vice-president of purchasing at Shared Services in Atlanta. Last year, Smith says U.S. Surgical offered a five-year contract with no price increases.

But the company still faces questions about its long-term independence. With the hospital business undergoing consolidation, price pressures are building. While Hirsch has stopped U.S. Surgical's market-share free fall, it's not winning back ground from Ethicon. Revenue is off 13% for the first nine months of the year. Most of the earnings improvement in the third quarter came from reduced expenses. "Going forward, they are going to have to find a way to increase revenues," says Piper, Jaffray Cos. analyst Thomas J. Gunderson.

To boost sales, U.S. Surgical is counting on products now being introduced, such as an optical instrument that will improve surgeons' ability to see into the abdominal cavity. It also wants to broaden the use of its products into new areas, such as bladder and lung surgery, where endoscopy is not yet common.

Such prescriptions worked when U.S. Surgical had the market to itself. With J&J around, the prognosis isn't as clear.

Before it's here, it's on the Bloomberg Terminal.