Investors in Intuitive Surgical (ISRG) can't catch a break. The lack of guidance for 2014 is creating discomfort among investors who suffered from severe losses over the past year while equity investors in general had a great year.
The quality name now trades at appealing earnings multiples given the historic growth trajectory, yet FDA investigations and general scrutiny surrounding the da Vinci robot is causing severe doubts among investors. I remain on the sidelines, awaiting clues about the firm's prospects.
Fourth Quarter Highlights
Intuitive Surgical announced fourth-quarter revenues of $576.2 million, down 5.4% on the year before. Despite the year-on-year negative growth rates, revenues were up by 15.5% compared to a weak third quarter. As a result, revenues came in ahead of consensus estimates at $551 million.
Reported earnings came in at $166.2 million, or at $4.28 per diluted share. While net earnings fell in actual dollar terms compared to last year, earnings per share rose by three cents on the back of sizable share repurchases.
Earnings comfortably beat consensus estimates at $3.79 per share.
Diving Into The Results
The declines on an annual basis are caused by lower system sales, while the continued growth of the installed basis resulted in higher service as well as instruments and accessories revenues.
System revenues fell by 22.8% to $204.6 million, now making up 35% of total sales. System sales fell from 175 to 138 units, at an average price of close to $1.5 million per machine.
Instruments and accessories are the major revenue category, generating $268.2 million in revenues which is up by 5.7% on the year before. Service revenues inched up very nicely by 14.1%. This growth was driven by a 12% annual increase in surgeries performed through the da Vinci in the quarter.
Gross margins were under pressure a bit on the back of lower sales, falling by 280 basis points to 69.1% of total sales. The company managed to keep operating expenses stable in dollar terms, but combined with lower revenues, expenses rose by 170 basis points to 32.9% of reported sales.
On the back of lower effective tax rates and a reduction in the outstanding share base, the company managed to grow earnings per share slightly.
2013 In Review
Despite the fact that 2013 has been a very difficult year, Intuitive Surgical managed to grow annual revenues by some 4.0% to $2.27 billion. Reported earnings growth slowed down to just 2.2% with earnings coming in at $671 million.
After shares lost about 30% of their value during the past year, they showed a massive underperformance versus gains of about 30% in the wider equity market. The drop to $410 per share, reduced the value of the business to some $15.7 billion. This values the company's operating assets at around $13 billion given the solid net cash position of roughly $2.7 billion.
After backing out the cash being held by the company, shares trade at roughly 20 times last year's earnings.
Is Pressure Building?
Over the past week the company has been notified by TRC Captial Corporation which made a tender offer to buy 250,000 shares of the company for $405 per share, in order to buy a 0.65% stake in the company. The board recommended stockholders to reject the "mini-offer" as it was below the company's share price at the time. It is not unthinkable that activist pressure might build, given the underperformance of the shares.
Disappointing system sales are important and an immediate drag on revenues while the installed machine base continues to grow, although at a slower pace. As can be seen below, roughly two-thirds of total revenues now result from services, instruments and accessories, as the company is rapidly becoming less dependent on system sales. Of course, system sales remain a big driver for the long-term success.
What's Driving The Sell-Off?
Despite the 6% sell off on Fridays, shares are still up 7% for the start of the year as the company already pre-released these numbers more than a week ago. The fact that the company is not giving a formal outlook for 2014, or the coming quarter is causing some uncertainty among investors.
The number of procedures performed is set to grow between 9 and 12%, which is a bit disappointing after showing 16% growth over the past year. Furthermore take notice as the company expects to sell fewer da Vinci robots this year.
There are a lot of uncertainties surrounding Intuitive's stock. This includes uncertainty regarding the affordable care act for hospitals and the debate about possible adverse events as a result of using the da Vinci robots.
While the company stresses that the usage of the da Vinci robots results in lower mortality rates, fewer complications and a shorter admission stay for prostatectomy, hysterectomy and colon resection, the doubts by the markets and investigations remains a big pressure on the shares.
With US penetration levels already really high, except for colon resection the growth potential remains in Europe, Japan and the rest of the world, on top of which comes the potential for using the robot for other kinds of surgery.
Takeaway For Investors
Intuitive Surgical has a great product, which fueled shareholder returns over the past decade. Shares have retreated by a third from their highs despite the market setting fresh highs after the FDA is surveying surgeons about the safety of the device. This was followed by a warning letter of the agency over the past summer, summoning the company to improve administration of device corrections and adverse patient outcomes.
This severe scrutiny follows the questions about the cost-effectiveness of the robots which cost about $1.5 million initially and result in per procedure costs of about $2,000 per surgery.
All of this combined with a lack of guidance for 2014, while the company again foresees lower system sales, makes investors very cautious.
The market is still split between the pros and cons. On the one hand, a quality growth stock is trading at just 20 times earnings despite vast growth potential both domestically and internationally. On the other hand, competition and possibly adverse effects of using the robot and concerns about cost-efficiency might weigh on shares. Yet I undoubtedly believe the long-term trends favor robotics and the company remains a major player in this industry.
I remain on the sidelines, not having great insights about the company's prospects or any possible FDA verdict.