What's Behind Intuitive Surgical Inc's Revenue Miss?

If surgical robot pioneer Intuitive Surgical (NASDAQ: ISRG  ) is going to keep its heady med-tech growth stock multiple, it has to do better than this. After logging just 4% revenue growth in 2013, Intuitive's announcement of a 24% drop to start 2014 is certainly not a step in the right direction. Some of the trouble may well be from transitory issues like weather and delays tied to hospitals awaiting new product rollouts, but Wall Street is not a forgiving place when high multiple growth stories stop delivering that growth.

The system shortfall seems explainable...
Intuitive Surgical warned the street that first-quarter revenue fell 24%, about 14% worse than the average sell-side estimate. Excluding deferrals tied to a system trade-out program, the revenue decline was more on the order of 19%, with the miss more on the order of 9%.

System sales were clearly a major component of the miss, as system revenue fell 59% in the first quarter (or 49% on an adjusted basis). U.S. system sales fell by more than half on a unit basis (45 versus 115). Anticipation of the new Xi system could have been behind some of this, but management also claimed that shifting U.S. hospital capital spending priorities with the Affordable Care Act was also a significant factor. I have my doubts about this, but reports from companies like Hologic, Stryker, GE, and Philips in the coming weeks should add some color to the hospital capital spending environment.

The procedures shortfall not so much
Capital equipment sales can be squirrelly, but the relative weakness in procedure volume growth is a little more problematic. Instrument and accessories sales declined 2% in the first quarter, with procedure volume growth of 7%. That was about 3% weaker than the sell-side expected, as well as a notable deceleration from the 12% year-over-year procedure volume growth in the fourth quarter.

U.S. gynecological procedure volume fell by low single digits, and it has to be asked whether the negative press about complication rates is starting to impact utilization. Neither Johnson & Johnson (NYSE: JNJ  ) nor Covidien (NYSE: COV  ) typically give mid-quarter updates, nor do they address specific procedure volumes (like gynecological procedures). That said, if these surgical business show the same sort of mid-to-high single-digit growth they've been reporting, it doesn't reflect so well on Intuitive's momentum.

The new Xi system looks like a winner
Intuitive did recently introduce a new system, the Xi, that has some real promise. This boom-mounted system uses very different architecture than the Si and Si-e systems, and it offers important advantages for general surgery like multi-quadrant capabilities and single port surgery (in the brochure, but not yet approved).

At a SAGES meeting that was pretty quiet for Johnson & Johnson and Covidien, Intuitive's Xi definitely got some attention. It is unlikely this system is going to replace the Si or Si-e, rather most hospitals will buy it to augment their existing robotic surgery programs and use it in more complicated cases.

Single port surgery is still an area where Johnson & Johnson and Covidien have a meaningful edge on Intuitive, but Xi could close that gap and drive more general and colorectal surgeries from Johnson & Johnson or Covidien tools to Intuitive Surgical. Johnson & Johnson, Covidien, and Stryker have all introduced single port tools that are considerably cheaper than Intuitive's approach, but there are familiar advantages to Intuitive's approach, including blood loss, recuperation times, and converting open procedures that otherwise could not be performed laparoscopically. With volumes in traditionally strong markets like prostate and hysterectomy having slowed so much, expanding the utility of the platform and gaining share in other procedures is an essential part of the Intuitive growth story.

The bottom line
If management can navigate the company through this rough patch and start driving adoption in under-penetrated surgical applications like general surgery, colorectal, and cardiac, the Street will forget about this rocky quarter. With Intuitive Surgical shares trading just below an EV/revenue of 8 times (a common multiple for high-growth med-tech names), it's hard to argue the stock isn't getting the benefit of the doubt.

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