Intuitive Surgical, Inc. — Q3 2010 Form 10-Q
Reporting period: Three and nine months ended September 30, 2010; comparisons are with the corresponding 2009 periods. The company designs, manufactures, and markets da Vinci surgical systems, with revenue from system sales, instruments and accessories, and service.
Financial performance
Amounts are in millions except per-share data. Q3 and nine-month changes are year over year.
| Metric | Q3 2010 | Q3 2009 | 9M 2010 | 9M 2009 |
|---|---|---|---|---|
| Total revenue | $344.4 | $280.1 | $1,023.7 | $729.1 |
| Gross profit | $250.6 | $199.0 | $747.9 | $517.9 |
| Gross margin | 72.8% | 71.0% | 73.1% | 71.0% |
| Operating income | $132.1 | $104.5 | $401.5 | $249.0 |
| Net income | $86.6 | $64.5 | $260.6 | $155.0 |
| Diluted EPS | $2.14 | $1.64 | $6.45 | $3.97 |
- Revenue grew 23% in Q3 and 40% for the first nine months. Q3 operating margin was 38.4%, versus 37.3% a year earlier; nine-month operating margin was 39.2%, versus 34.2%.
- Q3 product revenue was $287.1 million and service revenue $57.3 million. Recurring revenue, comprising instruments, accessories, and services, was $184.8 million (54% of total) in Q3 and $541.0 million (53%) for nine months.
- Cash from operations was $404.1 million for nine months, versus $269.4 million. Investing activities used $373.4 million, including net investment purchases and $86.6 million of property, equipment, and intellectual-property acquisitions. Financing activities provided $130.3 million, including stock issuance proceeds and a $58.9 million share repurchase.
- Cash and cash equivalents were $382.0 million; short- and long-term investments were $1,238.6 million. Combined cash and investments totaled $1,620.6 million, versus $1,172.0 million at December 31, 2009. Current assets were $1,301.5 million and current liabilities $267.3 million. The balance sheet does not identify a separate borrowings or debt balance.
- Total assets were $2,351.8 million and total liabilities $343.5 million at September 30, 2010. Inventory rose to $85.0 million from $57.6 million at year-end.
Material changes and business developments
- Q3 system sales increased to 105 from 86; 90 were da Vinci Si systems. The installed base reached 1,661, up from 1,308 a year earlier. Management reported Q3 procedures grew approximately 33% year over year.
- For nine months, 317 systems were sold versus 228. Revenue growth reflected higher system and recurring sales, procedure adoption, and a higher mix of Si systems. Q3 2009 revenue included $6.3 million from recognition of previously deferred Si upgrade-offer revenue, a comparability factor.
- Gross margin improved, attributed to higher system average selling prices, material-cost reductions, lower excess-inventory charges, and greater manufacturing scale. Service gross margin for nine months declined to 61.8% from 63.7%, primarily due to increased service costs per system.
- SG&A rose 31% in Q3 and 32% for nine months, reflecting organizational growth, commissions, and stock-based compensation. R&D increased 9% in Q3 and 20% for nine months.
- The company adopted revised multiple-deliverable revenue-recognition guidance prospectively from January 1, 2010. For new arrangements, system revenue allocation uses estimated selling prices; management said the guidance would not have materially changed 2009 full-year revenue.
Outlook, risks, and unusual items
- Management expected 2010 procedures to grow approximately 35% from about 205,000 in 2009. It expects recurring revenue to become a larger share of revenue and said R&D expense is expected to continue increasing. No specific revenue or earnings forecast is provided.
- Management cited challenging hospital capital spending and economic conditions, particularly in Europe, and cautioned that European system sales may not continue increasing. In Japan, future demand may depend on obtaining reimbursement approvals for da Vinci procedures.
- Healthcare reform legislation includes a 2.3% medical-device excise tax beginning in 2013 and may affect reimbursement, hospital spending, and procedure volumes. Other stated risks include regulatory approvals, competition, product development and acceptance, manufacturing disruptions, and intellectual-property matters.
- A securities class action and two derivative suits concern alleged historical disclosures. The company said it could not reasonably estimate outcomes, recorded no litigation accrual, and believed resolution was unlikely to materially adversely affect it based on information available.
- Unrecognized tax benefits were $75.6 million at September 30, 2010; accrued related interest was $4.8 million. Management estimated a 2010 effective tax rate of approximately 37%, up from its prior estimate of 36%.
- The company retained $18.6 million of illiquid auction-rate securities classified as Level 3 and considered related unrealized losses temporary. It received $34.4 million at par from UBS for securities tendered under a rights offering.
- The company repurchased approximately 212,000 shares for $58.9 million in Q3; $241.1 million remained authorized. It also agreed to purchase Sunnyvale land and buildings for $33.0 million by June 2011 to support anticipated capacity needs.
Investor verification priorities
- Confirm procedure growth, system shipments, installed-base expansion, and recurring-revenue trends against subsequent filings.
- Assess whether elevated growth in inventory and accrued liabilities reflects planned expansion and normal timing, and monitor operating cash conversion.
- Review the investment portfolio’s liquidity and valuation, especially the remaining auction-rate securities and other Level 3 estimates.
- Track the progress and potential financial impact of the shareholder litigation, healthcare reform and medical-device tax, and Japanese reimbursement efforts.
- Verify the timing and cost of the planned property purchase, ongoing share repurchases, and the effect of stock-based compensation on reported results.