Intuitive Surgical (NASDAQ:ISRG) has faced significant headwinds in the past year owing to several factors - concerns over the efficacy and cost effectiveness of its flagship da Vinci surgical robot system, changed 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.
Owing to the aforementioned factors, Intuitive Surgical's net income dropped about 77% year-over-year (y-o-y) to just over $44 million in Q1 2014. Total revenue declined about 24% y-o-y to $465 million in the same period and 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. 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. (Intuitive Surgical's CEO Discusses Q1 2014 Results - Earnings Call Transcript, Seeking Alpha, April 22 2014 )
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. Although market concerns are likely to continue to weigh on its performance in the near term, we expect the company to gradually benefit from sales of its new products - da Vinci Xi and da Vinci Sp, especially in international markets such as Europe and Japan.
We currently have a price estimate of $455 for Intuitive Surgical, which is about 25% ahead of the market price.
FDA Concerns and Lawsuits
Intuitive Surgical received a letter from the Food and Drug Administration (FDA) last year, warning the company for not sufficiently reporting patient "adverse events" relating to its da Vinci systems. The letter also cited violations related to inadequate safety communication to patients concerning the optimum use of certain accessories and their maintenance. Following the FDA warning letter, Intuitive Surgical worked for about a year to address the concerns and it finally received a confirmation from the FDA last month that it had successfully addressed all issues cited in the letter. 
The company 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 earlier this month, alleging that it issued misleading statements to investors regarding the financial impact of safety issues with its surgical robotic system.  Intuitive Surgical reported $67 million as estimated litigation expenses in its Q1 2014 earnings release 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 to be key to win patient and investor confidence back.
Slow Uptake Of New Products Expected
The company received FDA clearance for two new surgical systems in the last few months - 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 gradually, we expect them to significantly contribute to sales in the next few years.
Disclosure: No positions.