Recall Clouds Outlook for Advanced Medical

Shares plunged Tuesday after the company's multi-purpose contact lens solution was linked to a rare infection that can cause blindness

Shares of Advanced Medical Optics (EYE) plunged May 29 after the company announced a voluntary recall of its Complete MoisturePlus products after U.S. health officials linked them to a rare amoebic infection that can cause blindness. The recall news, which hit late May 25, is the second piece of bad news to hit makers of multi-purpose contact lens solutions in nearly a year.

Advanced Medical's shares were down 11.9% at $35.40 on jitters about a blow to earnings for the Santa Ana, Calif., company as a result of the recall. The company said the product generated $106 million in revenue in 2006 and $30 million in the first quarter of this year.

"It does take out a pretty big chunk of their solution sales," said Mark Millikin, an analyst at Piper Jaffray & Co. "Those products [generate] high 60% to low 70% gross margin." That means the hit to earnings will ultimately depend on how much cost Advanced Medical can pull out of its sales, general and administrative expenses on its income statement, he added.

Millikin projected the recall could reduce Advanced Medical's 2008 earnings by 25 to 50 cents per share. The next-generation multi-purpose solution that the company is scheduled to bring to market early next year and its ability in the meantime to switch manufacturing back to the older Complete MPS solution will factor into the 2008 earnings, he added. Advanced Medical plans to hold a follow-up conference call next week to update financial guidance.

In a May 29 research note, Goldman Sachs agreed that the recall could drive a significant reduction in earnings, citing the unlikelihood of Advanced Medical's being able to easily or quickly switch manufacturing to its older products.

Advanced Medical announced the recall after receiving information from the Centers for Disease Control of a possible link between the Complete MoisturePlus solution and Acanthamoeba keratitis. The CDC said it had received reports of 138 cases of the infection since January 2005, and that 39 of 46 patients it had interviewed wore soft contact lenses and 21 reported using Complete MoisturePlus products. The CDC estimates the risk for users of the lens solution are seven times greater than for those who don't use it.

Notwithstanding Advanced Medical's belief that there was no contamination at the manufacturing plant and that improper lens-care practices are to blame for the infections, Standard & Poor's said in a note that it expects a shift by consumers to other brands of multi-purpose solution, as well as increased usage of daily disposable lenses. S&P estimated the recalled product accounts for 5% of Advanced Medical's total sales.

Rival manufacturer Alcon Inc. (ACL) was seeing gains May 29, with shares up 2.4% at $139.42, while Bausch & Lomb (BOL) was off 3.5% at $68.06.

Advanced Medical's recall comes a year after Bausch & Lomb withdrew its ReNu with MoistureLoc solution because of its potential cause of eye infection and more permanent damage through corneal staining. But this is the first time the public is hearing about a possible link between multipurpose solution and an infection that can cause blindness.

"It raises the broader question about safety of multipurpose solution overall," and could potentially lower investor confidence in Bausch & Lomb and Alcon, said Millikan at Piper Jaffray.

The Food and Drug Administration is almost certain to ratchet up its scrutiny of the solutions market overall and may even start to take a more active role in how these products are labeled, requiring clearer warnings about proper contact lens care and no longer allowing manufacturers to say the solutions don't require any rubbing for lenses, Millikan said.

Increased oversight by the FDA could push more patients and optometrists to use daily disposable lenses, which don't require a solution. The expense of disposable lenses is not that much greater when the cost of multipurpose solution is factored in, Millikan said.

Beyond the immediate market share and earnings concerns, the recall could also hamper Advanced Medical's ability to consider an acquisition of Bausch & Lomb, analysts said.

Earlier this month, Bausch & Lomb agreed to a buyout by affiliates of Warburg Pincus for $65 per share but asked for a 50-day period during which it could consider more attractive alternative offers (see, 5/16/07, "Bausch & Lomb: Out of the Public Eye"). Judging the Warburg Pincus offer to be undervalued, Advanced Medical said it was looking for a partner in order to make a higher bid.

That's a long shot now that Advanced Medical's future revenue from Complete MoisturePlus is in question. The company is already constrained financially after boosting its debt load in early April to fund its $808 million purchase of IntraLase Corp., which manufactures a more precise laser for eye surgery, Millikan said.

On Tuesday, he affirmed his market-perform rating on Advanced Medical but cut his one-year price target to $37 from $41 per share.

Millikan doesn't own shares of Advanced Medical, Bausch & Lomb or Alcon and Piper Jaffray doesn't have investment banking ties with any of these companies. Goldman Sachs does and seeks to do investment banking with the companies it covers in its reports.

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