Medical device companies are in for a rough road in 2013, even if the fiscal cliff doesn't come to pass. With the Patient Protection and Affordable Care Act's 2.3% excise tax on medical device revenues slated to hit next year, some high-profile companies in the industry could see a major upheaval in business going forward. After the IRS released its final guidance on the tax earlier this week, investors and companies now have a better idea of what's coming in 2013 -- and your favorite medical robotics manufacturers will need to brace for the worst.
What's taxed, what's not -- and how it affects robotics
While many medical device companies and spokespersons tried valiantly to implement changes to the tax, their voices went mostly unheard. The IRS' guidance took few of the suggestions made by industry players to heart, making only slight adjustments that largely leave the tax intact. There are a few exemptions in the tax that clear some products to avoid the hit, however.
Any device slated to be sold to consumers, rather than professional medical settings, are exempt in order to protect the sales of items such as contact lenses. That's good for consumers, but does nothing to help out the likes of Intuitive Surgical (NASDAQ: ISRG ) or fellow robotics manufacturers, which sell their products to hospitals and medical professionals.
That's not all: The IRS also offers an exemption on the tax for medical devices that are "a material in the production of, or component part of" other devices -- that is, unfinished products. The tax goes into effect when the finished product is sold to a final buyer; while it's possible the sale of robotic system accessories and parts will fall under this category, the IRS isn't being too specific in that department. Considering how little the organization has considered industry opinions in delivering guidance, don't count on tax relief here.
Finally, there's a tax exemption on exports: Any product sold to foreign buyers isn't taxed. Here, robotics companies get a break for any international sales, but with most buyers here in the U.S., it's a small victory at best.
So who's going to be hit worst by this tax come 2013?
The impact around the industry
Let's start with the shining star of medical robotics, Intuitive. For 2012, Intuitive expects full-year revenue growth of 20%-23% over 2011's $1.76 billion number. If we take the conservative approach and call for 20%, that would give Intuitive full-year 2012 revenue of $2.11 billion. Add another 20% in revenue growth for 2013 -- which is fully possible, given Intuitive's great prospects -- and the company's looking at $2.53 billion in revenue for next year.
That's not all sales of da Vinci surgical systems, however: Much of Intuitive's sales come from accessories and services for the systems, so some of that figure won't be affected by the tax. In all, Intuitive's management stated during the most recent quarter's conference call that it expects the tax to inflict a 1.1% hit on full-year 2013 net revenues.
What's Intuitive's potential final bill for the excise tax? Just a cool $27.8 million -- ouch. Fortunately, Intuitive's a very profitable company that will be able to pick up that bill.
The tax isn't so easy to shrug away when seeing its impact on rival medical robotics makers -- particularly those like MAKO Surgical (UNKNOWN: MAKO.DL ) and Hansen Medical (NASDAQ: HNSN ) that aren't profitable. That won't stop the IRS from beating a path to their doors.
Since MAKO hasn't provided an estimate on the tax's hit, let's estimate it ourselves. Out of the company's total 2011 revenue of more than $84 million, just under $44 million of that came from 48 RIO sales that could be taxed (the rest from procedures and services -- which won't be hit by the law). And 44 of the 48 RIOs sold during that time were in the U.S. and are thus taxable; if sales figures are attributed equally per system, then domestic RIO sales accounted for $40.2 million in revenue.
MAKO also sells implants and disposables used in its MAKOplasty procedures that fall under the tax's guidance. In total, the company’s sales of these products amounted to $34.7 million in revenue for 2011.
While MAKO is on pace for a decline in system revenue this year, if 2013 numbers manage to match 2011's, then the company's full-year estimated tax burden comes to just over $1.7 million. That might not seem like much compared to Intuitive’s lofty figure, but it's enough to push MAKO's 2011 net loss up by more than 4.7%. For a company struggling to reach profitability, that’s a high price to pay and one that certainly won’t help its progress.
Combined with the possibility of the fiscal cliff and its drastic impact on hospitals and medical robotics makers, 2013 could be grim indeed for MAKO.
Prepare for taxes
The medical device tax will hit Intuitive hard, but not enough to shake the company's foundations in any meaningful way. It's the companies struggling for growth like MAKO and Hansen that will take the worst hit, even if the dollar amount will be less; because the tax hits revenue and not profit, smaller companies will face even greater odds to succeed in medical robotics and around the device industry. While there's a slim chance the tax could be repealed, if the IRS' guidance is to be believed, get ready for the worst come 2013.
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