Seeking Alpha
What is your profession? ×
Research analyst, long/short equity, tech
Profile| Send Message|
( followers)

Intuitive Surgical's (NASDAQ:ISRG) Q1 results, released on Tuesday, were consistent with the preliminary financial results released by the company on April 8. Net profit dropped about 77% year-over-year (y-o-y) from $189 million in Q1 2013 to just over $44 million in Q1 2014. Total revenue for the first quarter was about $465 million, down 24% on an yearly basis and about 20% sequentially. Sales of its da Vinci systems declined about 59% from the prior-year quarter to $106 million on account of sluggish growth in U.S. procedures. Instruments and Accessories revenues declined about 2.3% y-o-y to $255 million in the quarter. 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]

On the cost side, the company's gross margin in Q1 2014 was 67.9% compared to 71% in the same period last year. This decline is attributed to a higher proportion of new products (which have slightly lower margins) in the total sales mix and higher costs due to overall lower production. The company expects its gross margin to decline further in the near term as it focuses on new products such as the da Vinci Xi. However, it expects margins to improve in the long run as production volumes increase and its products gain more acceptance.

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 in the U.S. and in anticipation of a new da Vinci system by healthcare institutions. Owing to such uncertainties, the company has not provided any revenue guidance for the remainder of the year. However, it expects operating expenses for full year 2014 to increase 12-15% over 2013 levels. Going forward, we expect the company to benefit from sales of its new products and growth in number of procedures.

We have a price estimate of $456 for Intuitive Surgical, implying a premium of about 10% to the market price.

Concerns Over da Vinci Systems Impacting Sales

Intuitive Surgical's da Vinci systems have been under intense scrutiny over their cost effectiveness and efficiency claims in the past year. A comprehensive study conducted by Columbia University in 2013 suggested that surgeries performed using the systems may cost significantly 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. [2]

Intuitive Surgical also received a warning letter from the FDA which warned the company for not sufficiently reporting patient "adverse events" relating to its da Vinci systems. The company currently faces about 3,000 lawsuits related to alleged complications from da Vinci surgeries. It reported $67 million as estimated litigation expenses in its Q1 2014 earnings release and expects litigation costs to rise going forward.

This 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. Going forward, we expect sales to remain subdued owing to the unfavorable sentiment surrounding the systems and cautious customer spending due to the Affordable Care Act in the U.S. Even for the new surgical robotic system - da Vinci Xi, the company expects a slow uptake since it is still in the process of developing all the relevant instruments and accessories for the system.

Procedure Volumes Show Sustained Growth

Intuitive Surgical reported a 7% increase in number of procedures driven by consistent growth in general surgery and urology, 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.

New Products Likely To Drive Growth

The company received FDA clearance for two new surgical systems in the last few weeks - da Vinci Xi and da Vinci Sp. The da Vinci Xi system is aimed at multi-port procedures with better mobility and ease-of-use. It also boasts a better imaging system with 3D and high-definition visuals. The company said that initial customer response has been positive and expects it to gradually gain acceptance in the market. On the other hand, the da Vinci Sp surgical system is designed specifically for single-port surgeries such as urology procedures. It is relatively smaller in size and is aimed at faster and cost-effective procedures using a high-definition camera and a couple of instruments.

The company stated in its Q1 earnings call that it does not intend to commercialize the da Vinci Sp system and it would be sold as part of the da Vinci Xi system. Although these products are expected to gain acceptance in the market very gradually, we expect them to significantly contribute to sales in the next few years.

Disclosure: No positions.