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Intuitive Surgical (NASDAQ:ISRG), the developer of robotic surgical system da Vinci, is set to release its Q2 2013 earnings on July 18. Revenue growth is expected to slow down to mid-single digits as indicated in the preliminary results announced a few days ago. Overall revenues are expected to grow by 7%, well below the historical high-teens growth witnessed by the company (see "Intuitive Surgical Plunges Over 15% As da Vinci Sales Decline Unexpectedly"). This is attributed mainly to a decline in da Vinci sales after a delay in purchases by a number of hospitals in the U.S. Overall margins are expected to remain stable, however.

We currently have a $600 price estimate for Intuitive Surgical, which is now about 40% ahead of the current market price after a recent plunge in the stock price. We will update our model after the Q2 earnings release and management commentary. Below we take a detailed look at the key trends observed during Q2.

da Vinci Surgical Systems Sales to Decline

Overall sales of the da Vinci Surgical System are expected to decline for the first time in many years. This is mainly due to a delay in purchases by U.S. hospitals, which are the largest buyers of the system, amid cost-benefit concerns. Insurers are pushing for more conservative treatments, such as laparoscopic procedures, and hospitals seem to be hesitant in purchasing these systems as a single one costs a whopping $1.5 million. Insufficient confidence in the economic recovery story is also being blamed for this.

We will be closely watching earnings results to gauge management's response to the slowdown witnessed in the quarter before revising our price estimate. We will also look out for steps being taken by the company to fend off these concerns. While one way would be to aggressively cut prices to woo customers, this will significantly hurt its gross margins, which are around 70%. In Q2 Japan and Europe, however, continued to add more systems following strong marketing and sales efforts from the surgical system maker. During the last couple of months it increased its sales force in Japan in addition to opening two training centers in 2012.

Procedures to Show Growth in Q2, but Eyes on the Future

The number of overall procedures should continue to increase at a double-digit rate due to continued uptake in general surgery procedures. Furthermore, U.S. prostatectomy (prostate surgery) procedures performed through the system have stabilized after witnessing a decline for the last couple of quarters. The U.S. Preventive Services Task Force had earlier recommended against routine PSA screening (Prostate-Specific Antigen test to screen Prostate cancer) before being diagnosed as it did not benefit patients. Prostatectomy procedures in international markets also continue to grow strongly.

Nonetheless, we will keep a keen eye on U.S. hysterectomies (uterus surgery) and other gynecological procedures, which have come under pressure of late. A recent detailed study conducted by researchers at Columbia University indicated that the cost/benefit ratio of using the robotic surgical system to perform hysterectomies is not favorable. This was followed by similar observations from the American Congress of Obstetricians and Gynecologists, an influential group that represents over 56,000 U.S. physicians. Since the gynecological procedures constitute a significant portion of overall procedures, any decline here could hurt the revenue growth significantly going forward. Management has earlier expected procedures growth to remain around 20% for 2013.

The company also sells instruments and accessories that facilitate the use of da Vinci Surgical Systems. Demand for instruments and accessories is directly proportional to the existing base of da Vinci systems and number of procedures. These instruments and accessories have a limited life and need to be replaced periodically. Over 2,650 da Vinci systems were placed globally by the end of Q1. A greater number of procedures performed speeds up the replacement cycle. Higher sales of new supplementary products like vessel sealers and single-site kit will lead to an increase in average instrument and accessories spend, lending support to revenue growth.

Disclosure: No positions.

Source: Intuitive Surgical Earnings: Slower Growth And Guidance In Focus