Intuitive Surgical Earnings Preview: Procedure Volumes In Focus

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Intuitive Surgical

Intuitive Surgical (NASDAQ:ISRG) is expected to announce its Q3 2014 results on Tuesday, October 21. In the previous quarter, the da Vinci robot maker surprised the market with better-than-expected results, although both the top and bottom line continued to decline. Net income dropped about 35% year-over-year (y-o-y) from $159 million in Q2 2013 to $104 million in Q2 2014. However, this was an improvement of about 136% over the income reported in the first quarter ($44 million). Total revenue for the second quarter was about $512 million, down 11% on a year-over-year basis but up 10% sequentially. This was also about 2% ahead of the analyst consensus compiled by Thomson Reuters. The spike in revenue and earnings on a sequential basis was attributed to the greater-than-expected rise in total procedures, which increased 9% y-o-y and 8% over the first quarter. ((Intuitive Surgical’s CEO Discusses Q2 2014 Results – Earnings Call Transcript, Seeking Alpha, July 22 2014 )) ((Press Release, Intuitive Surgical, July 22 2014))

When the company announces its third quarter earnings, we expect overall sales 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 for 2014 from 9-12% to 2-8% in the first quarter before slightly revising it to 5-8% in Q2. 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 Q2 2014 was 67.1% compared to about 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.

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We currently have a price estimate of $455 for Intuitive Surgical, which is in line with 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 its da Vinci systems, changed institutional capital-spending priorities because of the Affordable Care Act and anticipation of a new da Vinci system. However, it revised its guidance for yearly growth in operating expenses for 2014 from 12-15% to 10-13%. Going forward, we expect the company to benefit from sales of its new products and growth in the number of procedures.

The company reported about $77 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.

Procedure Volumes In Focus

In the last quarter, Intuitive Surgical reported a 9% increase in procedures driven by consistent growth in general surgery, urology and colorectal procedures, partially offset by declining gynecology procedures in the U.S. A greater number of procedures generally means a greater number of instruments and accessories, as well as a shorter replacement cycle. Therefore, the number of procedures directly impacts the company’s revenue.

We expect procedures to increase going forward as the company focuses on promoting the use of da Vinci systems in gynecology and urology procedures worldwide. A focus on rolling out the low cost Single-Site kit of instruments and accessories, and expansion of the da Vinci Stapler in the U.S., could also positively impact procedure volumes for the company in the coming quarters. Looking at the improvement in procedure volumes this quarter, Intuitive Surgical adjusted its procedure growth forecast from 2-8% to 5-8% for full-year 2014. The total number of procedures performed  in 2013 was 523,000.

How Much Will New Products Drive 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. [1]

The negative sentiment surrounding da Vinci systems was reflected in its unit sales figures last quarter, which declined from 307 in the first half of 2013 to 183 in the first half of 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. In its Q2 2014 earnings call, the company reported that out of the 96 da Vinci systems sold in the second quarter this year, 50 were da Vinci Xi models.

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 received approval for sale in the European Union and Japan only a few months back, and it will be interesting to see how these regions performed with respect to sales of this new model. [2] [3]

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Notes:
  1. Robot Surgery Isn’t First Choice for Uterus Removals, Bloomberg, March 16 2013 []
  2. Press Release, Intuitive Surgical, June 25 []
  3. Press Release, Intuitive Surgical, July 1 2014 []