Intuitive Surgical, Inc. — Q3 2016 Form 10-Q
Business context and reporting period. Intuitive Surgical designs, manufactures, and markets da Vinci robotic surgical systems, instruments and accessories, and related services. This unaudited quarterly filing covers the three and nine months ended September 30, 2016, compared with the corresponding 2015 periods.
Financial performance and liquidity
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Revenue | $682.9 million | $589.7 million | $1,947.5 million | $1,707.9 million |
| Gross profit / margin | $487.0 million / 71.3% | $395.8 million / 67.1% | $1,362.9 million / 70.0% | $1,119.1 million / 65.5% |
| Operating income | $256.4 million | $189.9 million | $680.8 million | $494.1 million |
| Net income | $211.0 million | $167.3 million | $531.9 million | $398.8 million |
| Diluted EPS | $5.31 | $4.40 | $13.57 | $10.55 |
| Operating cash flow | Not separately provided | Not separately provided | $717.8 million | $488.5 million |
- Revenue mix: Q3 product revenue was $553.2 million, up 17%; service revenue was $129.7 million, up 10%. Recurring revenue was $477.8 million, or 70% of total revenue. Systems revenue was $205.1 million, up 18%.
- Operating expenses: Q3 SG&A was $168.0 million, up 8%, and R&D was $62.6 million, up 23%. For nine months, SG&A was $511.6 million and R&D was $170.5 million.
- Cash and investments: Cash and cash equivalents were $1.02 billion at September 30; short- and long-term investments totaled $3.54 billion. Cash, equivalents, and investments were approximately $4.56 billion, up about $1.2 billion from year-end 2015. The company reported no interest-bearing debt on the balance sheet presented.
- Cash flows: Nine-month investing cash outflow was $970.4 million, largely reflecting net investment purchases of $934.3 million; financing inflow was $558.6 million, primarily from employee stock transactions. Capital expenditures were $36.1 million.
- Balance sheet: Total assets were $6.17 billion and total liabilities were $632.9 million at September 30, 2016. Of cash, equivalents, and investments, $1.19 billion was held by foreign subsidiaries; the company said it had no current plan to repatriate foreign earnings.
Material changes versus prior comparable periods
- Q3 revenue grew 16%, operating income 35%, and net income 26% year over year. Nine-month revenue grew 14% and net income 33%.
- Worldwide da Vinci procedure volume increased approximately 14% in Q3 and 16% for the first nine months. The installed base reached approximately 3,803 systems, up about 9% year over year.
- Gross margin improved in both comparison periods. Management attributed the improvement to manufacturing efficiencies, product cost reductions, favorable product mix, and improved service efficiencies. Q3 and nine-month 2016 product gross profit included a $7.1 million benefit from an approved medical-device excise-tax refund claim.
- The effective tax rate was 20.9% in Q3 and 24.5% for nine months in 2016, versus 13.6% and 21.3% in 2015. The 2016 periods included a $15.8 million tax benefit; the 2015 periods included a $29.3 million discrete tax benefit.
Outlook, management commentary, risks and unusual items
- No numerical revenue or earnings guidance is provided in the filing. Management expects substantial continued R&D investment and anticipates R&D expenses will increase. It expects OUS procedures and revenue to grow faster than in the U.S. over time, while noting market-specific uncertainty.
- U.S. procedure growth was driven largely by general surgery, including hernia repair and colorectal procedures. OUS growth was led by urology and early-stage kidney cancer procedures. Management noted slower growth in U.S. benign gynecology and that U.S. da Vinci prostatectomy growth may track the broader prostatectomy market.
- System demand depends on procedure adoption, hospital economics and utilization, competition, product acceptance, regulatory clearances, reimbursement, and government purchasing processes. China’s most recent import authorization expired at year-end 2015; timing and scale of future authorizations are uncertain. In Japan, growth may depend on additional reimbursement approvals.
- In September 2016, the company agreed to form a 60%-owned joint venture with Fosun Pharma to develop and commercialize robotic-assisted catheter-based devices. The parties may contribute up to $100 million; the venture is subject to government approvals, is expected to incur losses before commercialization, and is not expected to generate revenue until after 2017.
- Product liability exposure remains significant: the company was defending approximately 74 individual lawsuits and reported additional claims. Accrued liabilities for tolled claims were $24.8 million. The company stated that possible losses beyond recorded accruals could not be estimated and could materially affect results.
- Derivative shareholder matters were subject to a confidential settlement in principle, pending finalization and court approval. A securities class action remained pending, with class certification unresolved. The company also faced an insurer dispute; the Navigators matters had been dismissed with prejudice following settlement, while the Illinois Union matter continued.
- Other unusual items include $6.3 million of product-liability charges and $6.6 million of total litigation charges during the first nine months of 2016. The medical-device excise tax was subject to a two-year moratorium for 2016 and 2017. Management said liquidity was sufficient for foreseeable needs.
Important facts for investors to verify
- Whether procedure growth, particularly in U.S. general surgery and OUS markets, continues to support recurring revenue and system placements.
- How much of the reported gross-margin improvement is sustainable after separating the $7.1 million excise-tax refund and other mix or efficiency effects.
- Developments in product-liability claims, the related accrual, and the shareholder and insurance litigation matters, including settlement approval and potential exposure beyond recorded amounts.
- China import authorization timing, Japanese reimbursement decisions, and the regulatory, funding, and commercialization progress of the Fosun joint venture.
- The implications of foreign-held liquidity and indefinite reinvestment of foreign earnings, as well as the impact of tax-benefit reversals or audits on future tax rates.