Bausch & Lomb's Blurry Sales Picture

The company is chasing new growth markets, but investors are losing patience

Dr. Michael Shapiro, an ophthalmic surgeon in Madison, Wis., couldn't wait to get his hands on Bausch & Lomb Inc.'s hot new laser. The company got U.S. approval in February for its Technolas 217 laser, a device well known overseas. It uses a scalpel-like light beam that works on a bigger portion of the cornea, leaving it smoother than older machines. That cuts the chances of winding up with blurry night vision--a common post-surgery complaint. The excitement has even reached patients, who call asking: "Are you the one with the flying spot laser?"

Such enthusiasm is in short supply, however, when it comes to Rochester (N.Y.)-based Bausch & Lomb these days. Chief Executive William M. Carpenter has been banking on hot new businesses like lasers to juice up the company's results. But while Carpenter's recent moves to rejuvenate Bausch & Lomb were gaining support on Wall Street, investors got a nasty reminder on July 19 that the company is far from transformed. Although Bausch & Lomb had been targeting sales growth in the upper single digits for 2000, second-quarter revenue growth was flat. The numbers made it painfully clear that while Carpenter has been busy chasing new growth markets like lasers, the company's biggest business, contact lenses and lens-care products, remains a major drag.

The bottom line: Sales in 2000 are expected to be up just 5% this year, to $1.84 billion, according to McDonald Investments Inc. analyst Hans von der Luft. And while net income from continuing operations is expected to jump 28%, to $169.8 million, much of that hike is due to lower interest expense following major cuts in the company's debt. "People were reminded there's a long time before the growth kicks in," says SG Cowen Securities Corp. analyst Peter Bye.

CREDIBILITY GAP. Already, Carpenter is seeing support erode among analysts and investors. The stock dove nearly 22% on the earnings news, to 61 3/4. Part of the reason for that steep slide was that many investors feel management misled them about the company's weak sales growth when it gave a glowing mid-quarter briefing to Wall Street. "The company lost some credibility with the quarterly results," says Lehman Brothers analyst David Gruber, who downgraded the stock on the earnings news. Carpenter insists the extent of the problems, which include weak sales in lens solutions, only became apparent late in the quarter. Equally disturbing was Carpenter's plan to buy a promising ophthalmic drug business, a deal that will depress earnings through 2001. "I don't like dilutive acquisitions unless there's a very good reason," says John Doney, co-manager of the Oppenheimer Total Return Fund, which owns 150,000 Bausch & Lomb shares.

Until recently, Carpenter got high marks for bringing order to a company roiled by scandal. He took over in 1997, two years after former CEO Daniel E. Gill retired under a cloud. Under Gill, the company resorted to questionable accounting to meet double-digit growth targets. Among the practices revealed by a 1995 Business Week cover story was the shipping of unwanted lenses to distributors at the end of 1993 with the promise that those customers wouldn't have to pay until the lenses were sold. A Securities & Exchange Commission investigation followed, with the agency determining that the company had overstated 1993 net income. The SEC issued a 1997 cease and desist order to bar Bausch & Lomb from any future earnings misstatements. Under the terms of the settlement, Bausch & Lomb did not admit or deny the agency's findings.

ROOTS REVIVAL? Carpenter, a 14-year Johnson & Johnson veteran who earned his stripes overseeing that company's response to the 1982 Tylenol poisonings, set out to return the company to its eye-care roots. He raised $1 billion last year by selling off slow-growing and noncore businesses like Ray-Ban sunglasses. And he pushed into faster-growing businesses, including the 1997 acquisition of Chiron Vision Corp. Chiron had developed a new generation laser, already the market leader in Europe, and new technology for delivering eye medications.

But even before the fallout from the accounting debacle of the mid-'90s, Bausch & Lomb was falling behind in the core contact lens business. Contact lenses and lens-care products account for nearly 60% of sales. But while Bausch & Lomb had been the market leader in contact lenses back in the '80s, it now trails Johnson & Johnson, which beat it to the market with disposable lenses. Recently, new lens launches have hurt margins. And in the second quarter, Bausch & Lomb saw weaker-than-expected growth in Japan. The reason? Johnson & Johnson came out with a two-week disposable lens that analysts say is easier to put in and performs better than Bausch & Lomb's product. "There's no doubt they'll lose market share" to J&J, predicts SG Cowen's Bye.

The popularity of disposable lenses may also pose a long-term problem. In the recent quarter, the high-margin lens-solution business remained weak. The company says the weakness is a short-term problem stemming from the move by drugstore chains and mass merchandisers to cut lens-solution inventory to increase shelf space for more popular items like vitamins. But analysts are wondering if the weakness in lens solutions is a sign that the rising popularity of disposable lenses is seriously eroding that business.

Carpenter insists he's fixing the problems. In addition to launching four new lenses in two years, he cut $30 million in annual costs from the lens business last year, in part by streamlining manufacturing. One setback: Carpenter failed earlier this year in his hostile bid for Wesley Jessen VisionCare Inc., maker of more profitable specialty products like color contacts.

HIGH HOPES. The recent push into the fast-growing laser market is one of the few bright spots. Laser eye surgery has seen exponential growth, with some 1.4 million people expected to undergo the procedure this year, up from just 344,000 in 1996. In addition to the technology edge with its new laser, analysts say Bausch & Lomb will benefit by being able to bundle that product with other items in its broad eye-care portfolio.

That's why although Bausch & Lomb is coming late to the market, analysts have high hopes. About 65% of vision-correction operations are performed on machines from Visx Inc., of Santa Clara, Calif. But investors expect Bausch & Lomb to grab share quickly--laser surgery, just 10% of sales today, should hit 20% in three years. "Ophthalmologists are more receptive to Bausch & Lomb's laser than Visx's," argues Michael Yellen, senior portfolio manager of AIM Funds, which holds 700,000 Bausch & Lomb shares.

Perhaps even more promising is Carpenter's push into pharmaceuticals. In 2003, the company is expected to roll out revolutionary implants that would deliver drugs to control diseases like age-related macular degeneration. Such conditions affect about 6 million people worldwide and can cause blindness. The company's announcement on July 21 that it would pay $228 million for French ophthalmic drug company Groupe Chauvin was aimed in part at expanding its European distribution network in anticipation of the new eye-drug delivery system.

While the deal may have value over the long term, it's coming at a steep price. The acquisition is expected to shave 12 cents to 14 cents off earnings per share this year and another 10 cents next year. No wonder investors are seeing red.

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