Business context and reporting period
Intuitive Surgical, Inc. designs, manufactures, and markets da Vinci surgical systems, instruments and accessories, and related services. This unaudited Form 10-Q covers the quarter and six months ended June 30, 2014; comparisons are with the corresponding 2013 periods. Amounts are in millions of dollars except per-share data.
The company launched the da Vinci Xi in the U.S. in April 2014. Its installed base reached 3,102 systems at quarter-end, including 2,153 in the U.S.
Financial results and liquidity
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Revenue | $512.2 | $578.5 | $976.9 | $1,189.9 |
| Gross profit / margin | $344.4 / 67% | $405.2 / 70% | $659.8 / 68% | $839.5 / 71% |
| Operating income | $143.0 | $218.5 | $199.6 | $469.7 |
| Net income | $104.0 | $159.1 | $148.3 | $348.0 |
| Diluted EPS | $2.77 | $3.90 | $3.87 | $8.47 |
| Operating cash flow | Not provided quarterly | Not provided quarterly | $320.3 | $447.1 |
- Q2 total revenue fell 11%, operating income fell 35%, and net income fell 35% year over year. For the first half, revenue declined 18%, operating income 58%, and net income 57%.
- Q2 product revenue was $405.6, including $143.7 of system revenue, down 33%, and $261.9 of instruments and accessories revenue, down 1%. Service revenue increased 9% to $106.6. Recurring revenue rose 2% to $368.5 and represented 72% of revenue.
- Systems shipped totaled 96 in Q2 versus 143 a year earlier. Da Vinci procedure volume increased approximately 9% in Q2 and 8% in the first half.
- Q2 product gross margin was pressured by the launch mix of newer products, lower-priced product mix, and lower system production volume. Total operating expenses rose to $201.4 from $186.7, including a $9.6 product-liability charge.
- At June 30, cash and cash equivalents were $507.6; short- and long-term investments were $471.0 and $1,064.8. Total cash, cash equivalents, and investments were approximately $2.04 billion, down $710.5 from year-end. The balance sheet reports no borrowings or other debt.
- Current assets were $1,533.4 and current liabilities $495.9; total liabilities were $582.2. First-half investing cash flow was positive $308.3, including $416.1 net proceeds from investment sales and maturities, offset in part by $81.2 for acquisitions. Financing cash outflow was $903.4, primarily reflecting a $1.0 billion accelerated share repurchase.
Material changes, outlook, and risks
- System sales weakened substantially: first-half system revenue declined 47%, largely reflecting fewer shipments, especially in the U.S. Management cited moderating procedure growth, hospital capital-spending uncertainty and economic pressures, and customer transition to the Xi.
- The Xi launch included customer trade-in rights. At June 30, $19.9 of revenue remained deferred, with recognition expected as systems and related products are shipped and accepted; the program was expected to be substantially completed by September 30, 2014.
- First-half procedure growth slowed versus 18% in the comparable 2013 period. Management cited pressure on U.S. benign gynecologic procedures, slower cholecystectomy growth, and seasonality. U.S. benign gynecologic procedures declined at a low-single-digit rate year over year; U.S. prostatectomy procedures were approximately 4% lower.
- Management expected R&D spending to continue increasing and said current cash, investments, and expected operating cash flows should meet liquidity needs for the foreseeable future. No quantitative revenue or earnings guidance is provided in the supplied filing text.
- Product-liability matters are a significant uncertainty. The company recorded $77.0 of charges in the first half and had $72.4 accrued at June 30. It could not estimate any reasonably possible loss above the amount accrued; ultimate costs could differ materially. Approximately 95 individual product-liability lawsuits were pending, alongside claims in mediation and related insurance litigation.
- Other risks include adverse publicity and litigation affecting adoption and sales; regulatory clearances and field actions; reimbursement and hospital-spending trends; and successful transition of Japan sales, marketing, and service operations after reacquiring distribution rights from Adachi. The FDA closed its 2013 Warning Letter observations in April 2014; a later inspection identified five observations for which the company submitted a corrective-action plan.
- Other unusual items: a $4.2 impairment charge on a cost-method investment in Q2; $4.7 of associated costs deferred with the Xi trade-in revenue; and a $1.0 billion accelerated repurchase for which final share settlement was expected by early November 2014. The company had used all amounts then authorized under its repurchase program.
Important facts for investors to verify
- Whether procedure growth and system shipments recover, and whether Xi adoption supports sales without sustained margin pressure.
- How much of the deferred $19.9 trade-in revenue is recognized by the program deadline and whether additional returns or allowances arise.
- Whether product-liability settlements exceed the $72.4 accrued balance, and the status of insurance coverage and related disputes.
- Progress in Japan following the Adachi transition, including execution, regulatory clearances, and potential reimbursement of additional procedures.
- Cash generation after the substantial repurchase, and the final shares and average price settled under the accelerated repurchase agreement.