Intuitive Surgical (NYSE:ISRG), the developer of robotic surgical system da Vinci, has reported dismal earnings as revenues grew by 8% to nearly $579 million.  Gross margins declined significantly as sales of higher margin da Vinci system declined. Net profit increased slightly to $159 million, or $3.90 a share, from $155 million, or $3.75 a share, a year ago. While the lower growth was already expected following preliminary results announced a few days back, what again disappointed the market was a bleak forecast for near future. The company reduced its da Vinci sales forecast for 2013 as it continues to grapple with concerns around its da Vinci surgical robot systems (Read our note here for full details).
Further, it also lowered expected growth in the number of procedures performed by the system, for the second time. It now expects its procedure growth for 2013 at around 15%-18% down from 20%-23%.  Overall revenues for 2013 are now expected to see growth in the range of 0% -7%, way below the previous guidance range of 16%-19%. If all this was not sufficient, the company was dealt another blow in the form of a FDA warning letter, which could hinder approval of new products / procedures going forward. Owing to these concerns, Intuitive Surgical’s stock price has crashed by 15% to a new 52-week low of $360. We are revising our price estimate to incorporate the latest guidance and Q2 earnings. Below we discuss the key aspects observed during the earnings announcement.
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da Vinci Sales Decline, Weak Outlook
The medical devices maker sold 143 da Vinci system in the second quarter down from 150 in the same period last year. The decline in the sales was mainly due to weakness in the U.S. market. In the U.S., system sales declined to 90, down from 124 a year ago. While Japan and Europe both sold 21 and 20 da Vinci systems, respectively, up from the same period last year, this couldn’t offset the decline in the U.S. Recent cost-benefit concerns, coupled with a reluctance from health insurers in approving hysterectomies procedures, is weighing on the number of procedures. Intuitive Surgical has been marketing its da Vinci system mainly on the premise of lower costs and therefore hospitals are now wary of buying the system. Further, continued procedure growth is required to make the system financially viable for them as the initial cost of the system is a huge $1.5 million.
The warning letter from the FDA will only worsen conditions as it will make it harder for the company to sell the system. Additionally, the Patient Protection and Affordable Care Act (“PPACA”), which will come into full force beginning 2014, could have an impact on robotic surgery. As the act aims to reduce healthcare costs, the company may find it difficult to get reimbursement approvals, or even lose existing approvals for procedures using its devices, particularly if questions around da Vinci systems’ cost-effectiveness continue to be raised. Currently, our model incorporates continued growth in sales of da Vinci robotic surgery systems on the back of an increasing number of procedures and international expansion. However, recent developments warrant a change in our key drivers including lower sales of da Vinci system, which would lead to significant downside in our current price estimate.
Tepid growth in the number of procedures performed through surgery is another concern. While the number of procedures grew by 18% in Q2, the growth is slowing down. As aforementioned, the key surgery area of benign hysterectomies is witnessing huge pressure from cost-benefit concerns. The management expected procedures growth to decline to mid-teen levels from above 20% and this will weigh on revenues growth. The company sells instruments and accessories that facilitate the use of da Vinci Surgical Systems. A lower number of procedures would result in lower revenues (than we currently anticipate) from instruments and accessories since demand for instruments and accessories is directly proportional to the number of procedures. These instruments and accessories have a limited life and need to be replaced periodically.
Lower sales of high margin da Vinci system would also lead to lower gross margins ahead. While management has said that it would compensate by taking cost-cutting measures, we worry this may not prove to be sufficient. The company is expanding in international markets and therefore will need to continue to invest in its sales force. Further, to offset pressure in key procedures, it would need to pump money in R&D to expand the scope of the system to other surgeries. Any undue cost-cutting can hurt future growth avenues at the expense of increasing profitability.Notes:
- Intuitive Surgical Announces Second Quarter Earnings, Intuitive Surgical, July 18 2013 [↩]
- Intuitive Surgical’s CEO Discusses Q2 2013 Results – Earnings Call Transcript, Seeking Alpha, April 18 2013 [↩]