Which is more important to raising the top line, growth in product sales or royalty payments from licensing technology? In the second quarter, cosmetic-laser maker Palomar Medical Technology (NASDAQ:PMTI) had a stellar performance in the former, but investors couldn't look past the lack of the latter.
Revenues were down 11% for the quarter year over year. The company points out that the second quarter last year contained a huge royalty payment from Cutera (NASDAQ:CUTR) for a patent license agreement. Therefore, it would like investors to subtract the payment before comparing the two quarters.
Investors weren't buying it. The stock has dropped 18% since its pre-earnings release close on Wednesday last week. The problem is that royalty payments are becoming a substantial part of Palomar's business. Just last April it added Alma Lasers to the list of companies that pay it royalty payments -- the rest of the list includes Cynosure (NASDAQ:CYNO) and Laserscope, a subsidiary of IRIDEX (NASDAQ:IRIX).
If you do discount the large royalty payment, the second quarter looks pretty good for Palomar. Product revenues were up 31% year over year. Its new StarLux 500 seems to be performing well with many existing customers trading up from the StarLux300. Product revenues were also driven by increased growth outside the U.S. Sales shifted from 14% foreign sales in the second quarter last year to 29% in the most recent quarter.
There is something to the company's argument that sales growth is the more important measurement. I'd rather see a company growing sales substantially than growing revenues through licensing its technology. The patents on that technology will eventually run out and then what's the company going to do?
Between the sales growth and all the royalty payments, Palomar has nearly doubled its cash and securities from a year ago and now has $121 million in the bank. The company should probably use some of that money to pick up new technologies that might complement its current lasers. It's also developing mass-market consumer products in combination with Johnson and Johnson (NYSE:JNJ) and Gillette, a division of Procter and Gamble (NYSE:PG), so some of the money could be used for increasing research and development of home-based products.
Given the downturn in the stock price, Palomar could also use some of its free cash to buy back stock. For investors who thought Palomar was a good company, but hadn't bought because its value seemed too high, this major price cut may be a good time to take the plunge.
For more Foolishness:
The Fool's market-beating Rule Breakers newsletter has picked three medical device companies. Click here to find out which ones and take a look at all our recommendations with a free 30-day trial.
Fool contributor Brian Orelli, Ph.D., doesn't own shares of any company mentioned in this article. Johnson and Johnson is an Income Investor pick. The Fool's disclosure policy is rock solid.
