Intuitive Surgical, Inc. — Q2 2016 Form 10-Q
Reporting period: Three and six months ended June 30, 2016. Intuitive Surgical designs, manufactures, and markets da Vinci surgical systems, instruments, accessories, and related services. Financial statements are unaudited.
Financial performance
| Metric | Q2 2016 | Q2 2015 | H1 2016 | H1 2015 |
|---|---|---|---|---|
| Total revenue | $670.1 million | $586.1 million | $1,264.6 million | $1,118.2 million |
| Gross profit | $470.9 million | $386.5 million | $875.9 million | $723.3 million |
| Gross margin | 70.3% | 65.9% | 69.3% | 64.7% |
| Operating income | $245.4 million | $173.8 million | $424.4 million | $304.2 million |
| Net income | $184.5 million | $134.5 million | $320.9 million | $231.5 million |
| Diluted EPS | $4.71 | $3.56 | $8.25 | $6.14 |
Q2 revenue grew 14%, operating income 41%, and net income 37% year over year. H1 revenue grew 13% and net income 39%. Revenue growth reflected procedure expansion, higher system shipments and service revenue. Recurring revenue was $467.4 million in Q2 and $914.0 million in H1, representing 70% and 72% of total revenue, respectively.
- Revenue mix: Q2 product revenue was $542.0 million and service revenue $128.1 million. Instruments and accessories generated $339.3 million; systems revenue was $202.7 million.
- Margins and expenses: Q2 product and service gross margins were 69.4% and 73.9%, respectively. Operating expenses increased 6% in Q2, including 11% growth in R&D; H1 R&D increased 15% to $107.9 million.
- Cash flow: H1 operating cash flow was $458.2 million, versus $308.8 million in H1 2015. Investing used $429.1 million, mainly for net investment purchases; financing provided $448.9 million, primarily from employee stock-plan proceeds.
- Liquidity: Cash and cash equivalents were $1,193.5 million; short- and long-term investments were $990.3 million and $2,041.1 million. Combined cash, cash equivalents and investments totaled about $4.2 billion, up $877.1 million from year-end 2015. Current assets were $2,827.4 million and current liabilities $489.5 million. No borrowings or debt balance are reported on the presented balance sheet.
- Other balance-sheet items: Total assets were $5,780.8 million and stockholders’ equity $5,181.5 million at June 30, 2016. Net investment in sales-type leases was $89.4 million.
Changes and business developments
- Q2 da Vinci procedures increased about 16% to approximately 188,000; H1 procedure volume also rose about 16%. H1 U.S. procedures grew 14% and procedures outside the U.S. grew 23%.
- Q2 system shipments increased to 130 from 118 a year earlier; the installed base reached approximately 3,745 systems. System revenue increased 15% in Q2. Higher shipments, dual-console mix, lease buyouts and upgrades contributed.
- Recurring revenue rose 14% in Q2 and H1. Service revenue increased 13% in Q2 and 11% in H1, reflecting the larger installed base.
- Gross margin improved year over year, supported by manufacturing efficiencies, cost reductions, product mix and the absence of the medical-device excise tax. A federal moratorium exempted medical-device sales from that tax in 2016 and 2017.
- H1 financing included $448.5 million of employee stock-plan proceeds. The company repurchased approximately 16,000 shares for $8.1 million during H1; none were repurchased in Q2. Approximately $808.2 million remained authorized.
Outlook, risks and unusual items
- The filing provides no specific numerical revenue or earnings guidance. Management expects to continue substantial investment in R&D and anticipates R&D expense to increase. It expects the business to fund future growth from operating cash flow and believes available cash and investments plus expected sales will meet liquidity needs for the foreseeable future.
- Management expects OUS procedures and revenue to grow faster than U.S. business over time. Future placements and procedure growth are subject to regulatory approvals, reimbursement, government purchasing tenders and market adoption. China’s latest import authorization had expired at year-end 2015, and the timing of replacement authorization was uncertain.
- Management cautioned that service margins could decline in H2 2016 as it expands its service pool with new endoscopes. Lease buyout revenue is expected to remain volatile based on customer decisions.
- Product-liability exposure includes approximately 77 individual lawsuits and a multi-plaintiff action involving 55 patients. The company recorded $6.3 million of H1 2016 charges for tolled claims and accrued $26.1 million for those claims at June 30. It could not estimate potential losses above the accrual; additional claims or outcomes could materially affect results.
- Other legal matters include securities and derivative litigation and disputes with insurers over product-liability coverage. The company stated that it could not estimate probable losses or ranges for most material pending litigation; it did not believe resolution of the described matters would have a material adverse effect based on information then available.
- Effective tax rate was 27.2% in Q2 and 26.7% in H1, compared with 24.6% and 26.1% in the respective 2015 periods. Prior-year discrete tax benefits contributed to the increase. Gross unrecognized tax benefits were approximately $106.2 million at June 30.
- Principal risks identified include healthcare spending and reimbursement, procedure adoption, regulation, product safety and reputation, competition, manufacturing and supply, international expansion, and litigation. Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether procedure growth, especially U.S. general surgery and OUS adoption, continues and converts into recurring revenue.
- Whether improved gross margins persist after the temporary excise-tax moratorium and as new-product and service costs evolve.
- The timing of China import authorizations, Japanese reimbursement decisions, and other regulatory or tender approvals.
- The ultimate cost of tolled product-liability claims and the progress and coverage implications of pending litigation.
- The sustainability of cash generation and the effect of employee equity-plan proceeds, lease activity and investment balances on reported cash flows.