Intuitive Surgical Earnings Preview: Market Concerns, Low Procedure Volumes To Weigh On Sales

Intuitive Surgical (NASDAQ:ISRG) reported disappointing results last quarter, with net income stumbling about 77% year-over-year (y-o-y) to just over $44 million from $189 million in Q1 2013. Total revenue for the first quarter was about $465 million, down 24% on a yearly basis and about 20% sequentially. An increase in sales of da Vinci instruments was offset by lower stocking orders owing to a 47% y-o-y decline in da Vinci system unit sales. Services provided the only saving grace, with revenues increasing by about 11% to $104 million. ^[1]

When the company announces its 2014 second quarter earnings on July 22, we expect overall sales to continue to remain under pressure owing to lingering concerns surrounding its da Vinci robotic surgical system and a reduction in the number of robot-assisted surgical procedures. Considering the concerns surrounding its da Vinci system and recent adverse reports about the safety of power morcellators (also used in da Vinci surgeries), Intuitive Surgical lowered its guidance for growth in the number of procedures from 9-12% to 2-8% for 2014. A lower number of procedures generally results in a longer replacement cycle for instruments and accessories, which leads to lower instruments and accessories revenue.

On the cost side, the company’s gross margin in Q1 2014 was 67.9% compared to 71% in the same period last year. We expect gross margins to decline further in the near term due to higher costs owing to overall lower production and the company’s focus on new products such as the da Vinci Xi and da Vinci Sp (which have slightly lower margins). However, we expect margins to improve in the long run as production volumes increase and its new products gain more acceptance.

We currently have a price estimate of $455 for Intuitive Surgical, which is about 20% ahead of the market price.

See our full analysis for Intuitive Surgical

Market Concerns

The company’s performance has been negatively impacted in the last few quarters by a number of factors such as concerns over the efficacy and cost effectiveness of da Vinci systems, a change in institutional capital-spending priorities because of the Affordable Care Act in the U.S., and negative publicity due to increasing liability lawsuits against the company.

Intuitive Surgical currently faces about 3,000 lawsuits related to alleged complications from da Vinci surgeries. In addition, several law firms filed class action suits against the company in May, alleging that it issued misleading statements to investors regarding the financial impact of safety issues with its surgical robotic system. ^[2]

The company reported $67 million in estimated litigation expenses in its earnings release last quarter and expects litigation costs to rise going forward. More than costs, we expect the lawsuits to continue to negatively impact market sentiment surrounding the company and its systems. Appropriately dealing with the legal cases and effectively addressing patient concerns is likely key to winning patient and investor confidence back.

How Much Will Xi Contribute To da Vinci Unit Sales?

A comprehensive study conducted by Columbia University in 2013 suggested that surgeries performed using the da Vinci systems may cost more than standard minimally invasive procedures, without any major benefits. The American Congress of Obstetricians and Gynecologists also echoed these research findings and questioned the lack of clinical data to demonstrate the efficacy of robotic hysterectomies over cheaper laparoscopic procedures. ^[3]

The negative sentiment surrounding da Vinci systems was reflected in its unit sales figures, which declined from 164 in Q1 2013 to 87 in the first quarter this year. In a bid to combat the declining sales, Intuitive launched its new da Vinci Xi system in April, priced between $1.85 million to $2.3 million. The advanced new model priced similar to its predecessors (such as the da Vinci Si) was appreciated by investors, which resulted in an 8% uptick in the company’s stock price on the day of the launch (April 1).

Although the new system is likely to help improve da Vinci system sales going forward, we expect its uptake to be slow in the near term as implications of the Affordable Care Act on robotic surgery remain unclear and also because the company has yet to come out with all the relevant instruments and accessories for the Xi robotic system. In addition, the da Vinci Xi has only recently received approval for sale in the European Union and Japan, and the contributions of these regions to second quarter sales are likely to be negligible with respect to the new model. ^{[4] [5]}

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1. Intuitive Surgical’s CEO Discusses Q1 2014 Results – Earnings Call Transcript, Seeking Alpha, April 22 2014 [↩]
2. A flurry of bad publicity for Intuitive Surgical, Robohub.com, May 5 2014 [↩]
3. Robot Surgery Isn’t First Choice for Uterus Removals, Bloomberg, March 16 2013 [↩]
4. Press Release, Intuitive Surgical, June 25 [↩]
5. Press Release, Intuitive Surgical, July 1 2014 [↩]