Intuitive Surgical, Inc. — Q3 2013 Form 10-Q
Business and period: Unaudited results for the three and nine months ended September 30, 2013, compared with the same periods in 2012. Intuitive designs, manufactures, and markets da Vinci surgical systems, instruments and accessories, and related service.
Key financial metrics
| Metric | Q3 2013 | Q3 2012 | 9M 2013 | 9M 2012 |
|---|---|---|---|---|
| Revenue | $499.0M | $537.8M | $1,688.9M | $1,569.5M |
| Gross profit / margin | $356.7M / 71% | $390.1M / 73% | $1,196.2M / 71% | $1,132.4M / 72% |
| Operating income / margin | $174.2M / 35% | $211.4M / 39% | $643.9M / 38% | $630.0M / 40% |
| Net income | $156.8M | $183.3M | $504.8M | $481.7M |
| Diluted EPS | $3.99 | $4.46 | $12.46 | $11.72 |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $650.9M | $587.4M |
Liquidity and balance sheet: At September 30, 2013, cash and cash equivalents were $586.8M, short- and long-term investments totaled $1,945.5M, and total cash, cash equivalents, and investments were approximately $2.5B. Total liabilities were $433.1M; the balance sheet reports no debt. Current assets were $1,733.5M and current liabilities $367.3M. Cash, cash equivalents, and investments declined $494.9M during Q3, primarily due to share repurchases.
For the first nine months, investing activities provided $322.2M, largely reflecting investment sales and maturities exceeding purchases; financing activities used $940.2M, principally for $1,109.2M of share repurchases. Cash and cash equivalents increased $33.1M over the period. The company said current resources and expected operating cash flows should meet liquidity needs for the foreseeable future. It had no plan to repatriate foreign-held funds; $565.9M of cash, cash equivalents, and investments were held by foreign subsidiaries.
Material changes and operating trends
- Q3 revenue fell 7% year over year as system revenue declined 32% to $158.5M and system sales fell to 101 from 155. Instruments and accessories revenue rose 10% to $239.1M; service revenue rose 15% to $101.4M.
- Recurring revenue increased 11% in Q3 to $340.5M, or 68% of revenue, from $305.8M, or 57%. The installed base reached 2,871 systems, versus 2,585 at year-end 2012.
- Q3 da Vinci procedures grew approximately 16%; nine-month procedure volume grew approximately 18%. Nine-month revenue increased 8%, helped by 17% growth in recurring revenue, despite lower system sales.
- Nine-month U.S. revenue was approximately flat at $1,244.7M, while international revenue rose to $444.2M from $320.9M. U.S. revenue represented 74% of nine-month sales, down from 80%.
- Operating income declined 18% in Q3 while SG&A increased 8%, primarily reflecting business expansion and higher legal costs. Nine-month SG&A rose 14%. R&D expense declined 13% in Q3 and 2% for nine months; management expects R&D expense to increase in the future.
- Product gross margin declined year over year, reflecting the U.S. medical-device excise tax and lower initial margins on newer products. The tax added $4.9M to Q3 and $17.6M to nine-month product costs. Service margins improved, mainly due to lower service-parts consumption.
Outlook, risks, contingencies, and unusual items
- No quantified revenue or earnings guidance is provided. Management expects growth in benign procedures to remain below 2012 levels and says it could decline further, citing hospital admissions, payer behavior, health-care reform, and other factors. It expects recurring revenue to become a larger share of total revenue.
- Management cited PSA-screening recommendations and increased non-surgical management as pressures on prostatectomy procedures. U.S. prostatectomy volume declined about 6% year to date, although Q3 volume was approximately level with Q3 2012. Slower benign gynecology growth, negative media coverage, and hospital capital-spending caution also weighed on demand and system sales.
- The company reported about 50 individual product-liability lawsuits and a Louisiana purported class action. It cannot estimate the possible loss or predict outcomes. A separate securities class action remained pending; related derivative cases were stayed. The company says it intends to defend the matters vigorously.
- An FDA Warning Letter dated July 16, 2013 followed an inspection that cited four observations; the letter sought further corrective action on two. The company submitted plans and supporting responses, but cannot assure the FDA will accept its actions. The warning letter can limit issuance of certain export certificates. The FDA also increased scrutiny of malfunction reporting; the company said the additional reports largely concern instruments and do not involve reportable injuries or deaths.
- A field notice and shipment pause addressed potential micro-cracks in certain Monopolar Curved Scissors; replacement products began shipping May 31, 2013. The company reported no confirmed related patient injury and no material effect on procedure volume.
- Tax expense included discrete benefits from reversals of unrecognized tax benefits and, in the nine-month period, a $7.5M benefit related to reinstatement of the 2012 federal R&D credit. These items contributed to effective tax rates of 12.0% in Q3 and 23.1% for nine months. Gross unrecognized tax benefits were $77.6M at September 30.
- The company repurchased $1,109.2M of stock in the first nine months, including a $500M accelerated repurchase program; approximately $1.0B remained authorized at quarter-end. Share-based compensation expense was $127.3M for nine months.
Important facts for investors to verify
- Whether recurring-revenue and procedure growth can offset weaker system sales, particularly in the U.S.
- How benign gynecology adoption, prostatectomy trends, hospital capital spending, and international demand develop.
- Progress and regulatory consequences of FDA corrective actions, field-action reporting, and any follow-up inspection.
- Developments in product-liability and securities litigation, for which the company cannot estimate potential losses.
- Effects of the medical-device excise tax, newer-product margins, share repurchases, and tax benefits on future earnings, cash, and per-share results.