Intuitive Surgical, Inc. — Q3 2014 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2014. Amounts are in millions of dollars, except per-share data and where noted. The company designs, manufactures, and markets da Vinci surgical systems and related instruments, accessories, and services.
Financial performance
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Total revenue | $550.1 | $499.0 | $1,527.0 | $1,688.9 |
| Gross profit | $360.6 | $356.7 | $1,020.4 | $1,196.2 |
| Income from operations | $159.1 | $174.2 | $358.7 | $643.9 |
| Net income | $123.7 | $156.8 | $272.0 | $504.8 |
| Diluted EPS | $3.35 | $3.99 | $7.18 | $12.46 |
| Gross margin | 65.6% | 71.5% | 66.8% | 70.8% |
| Operating margin | 28.9% | 34.9% | 23.5% | 38.1% |
| Net margin | 22.5% | 31.4% | 17.8% | 29.9% |
Q3 revenue rose 10% year over year, while operating income fell 9% and net income fell 21%. For the first nine months, revenue declined 10%, operating income 44%, and net income 46%. Q3 revenue included $16.0 of previously deferred revenue associated with da Vinci Xi trade-out offers.
- Revenue mix: Q3 product revenue was $441.6 and service revenue $108.5. Instruments and accessories revenue rose 14% to $272.8; systems revenue rose 6% to $168.8. Recurring revenue was $381.3, or 69% of Q3 revenue. For the nine-month period, recurring revenue was $1,108.5, or 73% of revenue, up 5% year over year; system revenue fell 34% to $418.5.
- Systems and procedures: The company shipped 111 systems in Q3 versus 101 a year earlier; nine-month shipments were 294 versus 408. Q3 procedures increased nearly 10% year over year, while nine-month procedure growth was approximately 9%, slower than the prior-year comparable period’s 18%.
- Cash flow: Nine-month operating cash flow was $470.9, down from $650.9. Investing activities provided $49.6, including net proceeds from investment transactions, partly offset by $82.9 for acquisitions and $40.4 for property, equipment, and intellectual property. Financing used $808.8, principally for share repurchases.
- Liquidity and capital: Cash, cash equivalents, and investments totaled approximately $2.263 billion at September 30, down $491.2 from December 31, 2013, primarily due to the $1.0 billion share repurchase. Current assets were $1,591.9 and current liabilities $480.5. Total liabilities were $567.3; the balance sheet does not show a debt balance or separately identify borrowings. The company reported $728.5 of cash, cash equivalents, and investments held by foreign subsidiaries and said it did not plan to repatriate foreign earnings.
Material changes and unusual items
- Product gross margin declined to 66.0% in Q3 from 71.8%; management attributed pressure to newer, lower-margin products, product mix, trade-ins and lower system average selling prices, recall costs, and costs related to the Japan distribution-rights acquisition. Service gross margin was 63.9%, down from 70.1%, partly due to timing of parts consumption, training, and incentive compensation.
- Nine-month SG&A increased 25% to $531.0 and included a $77.0 pre-tax charge for estimated settlements of product-liability claims ($67.4 in Q1 and $9.6 in Q2). No additional charge was recorded in Q3. Of the charge, $56.7 remained in accrued liabilities at quarter-end.
- The company repurchased $1.0 billion of shares through an accelerated repurchase program, receiving and retiring 2.5 million shares. The program authorization was fully used; no shares were repurchased during Q3.
- Acquisitions included Luna assets and employees and the reacquisition of Japanese distribution rights from Adachi. Cash used for acquisitions was $82.9 for the nine months; the transactions were not material enough to require pro forma results.
Outlook, risks, and contingencies
The filing gives no numerical revenue or earnings guidance. Management expected continued substantial investment in product development and procedure adoption, and believed cash, investments, and operating cash flow would fund requirements for the foreseeable future. It also anticipated R&D expense would continue to increase.
- Management cited slower procedure growth, pressure on U.S. benign gynecology, slowing U.S. cholecystectomy growth, seasonality, hospital capital-spending uncertainty, and the pace of da Vinci Xi adoption as factors affecting demand. The company also noted payer and reimbursement dynamics and the potential impact of healthcare reform.
- The company was named in approximately 93 individual product-liability lawsuits and reported thousands of claims associated with tolling agreements and mediation. It said additional losses beyond the $77.0 accrual were reasonably possible but could not be estimated; ultimate costs could materially exceed the accrual and adversely affect results or cash flows.
- In September, the company stopped shipments of the EndoWrist Stapler 45 for da Vinci Si and advised customers to suspend use while it investigated the reported malfunction. The observed field rate was reported as 0.023%; management did not then expect a material financial impact, subject to further assessment.
- The da Vinci Xi launched in the U.S. in 2014, with additional international clearances pending. The filing describes regulatory, product-liability, media, and safety-related risks that could delay purchases or procedure adoption. It also reports that the FDA closed its 2013 Warning Letter observations in April 2014, after a follow-up inspection had identified additional quality-system observations for which the company submitted a corrective-action plan.
- A 2013 securities class action continued on claims surviving a partial dismissal. Other product-liability and shareholder derivative matters remained pending. The company said it could not estimate probable losses for most material litigation matters.
Important facts for investors to verify
- Whether procedure growth and system shipments recover, particularly in the U.S., and how much Q3 revenue growth depended on Xi trade-out revenue recognition.
- Whether gross margins improve as newer products scale and whether lower system pricing, trade-ins, and product mix persist.
- The ultimate resolution and cash cost of product-liability claims, including potential losses beyond the recorded $77.0 charge and the status of insurance coverage disputes.
- The root cause, remediation, and financial impact of the Stapler 45 suspension, along with any further regulatory actions or clearances.
- Cash and investment levels after the substantial repurchase, foreign-subsidiary liquidity and tax implications, and the effect of future capital returns or acquisitions.