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Intuitive Surgical, Inc.'s Slow Earnings Growth Masks Deeper Strength

By Brian Stoffel – Updated Jul 25, 2017 at 10:48AM

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Procedures continued their strong march ahead despite constraints in Asia.

One look at the bottom line from Intuitive Surgical's (ISRG 3.16%) earnings release and you might think that the company had hit a speed bump. With the stock trading at 42 times trailing (non-GAAP) earnings, investors rightfully expect heady growth. But that wasn't the case: earnings jumped just 6%.

But that masks serious strengths at the company. Even as outside forces hold back growth in Asia, the most important metric of all -- procedure growth -- continued to blow by management's estimates.

To put this strength in perspective, let's remember that management had guided for a midpoint of 11% growth in procedures worldwide. Instead, we've seen the first and second quarters clock in with 18% and 16% growth, respectively.

Procedure Growth at Intuitive Surgical
Create column charts

Let's dive into the weeds and see how the company notched this growth.

Intuitive Surgical results: The raw numbers

A good place to start is the headline numbers.

Metric

Q2 2016

Q2 2017

Year-over-Year Change

Revenue

$670 million

$756 million

13%

GAAP EPS

$4.71

$5.77

23%

Non-GAAP EPS

$5.62

$5.95

6%

Data source: Intuitive Surgical investor relations. All percentages rounded to nearest whole number.

That huge jump in GAAP EPS is more of a mirage, as it was helped out by a one-time tax consideration.

Earnings growth lagged revenue growth because of the company's continued aggressive investment in future growth. Headcount at the company jumped 19% from the same time last year; research and development spending concurrently jumped by 55%.

It's also worth breaking out how the company's three divisions performed.

Division

Revenue

Year-over-Year Change

Instruments

$398 million

17%

Systems

$216 million

7%

Service

$142 million

11%

Data source: Intuitive Surgical investor relations.

Now is also a good place to point out that while systems revenue grew by just 7%, the number of daVinci machines placed globally jumped from 130 last year to 166 this year. That's a 28% jump, so why was revenue growth so slow?

It all comes down to the fact that Intuitive introduced yet another new machine, the daVinci X. The machine costs less than the more-popular daVinci Xi, but has much of the same functionality.

The daVinci Xi

The daVinci Xi. Image source: Intuitive Surgical.

With a lower price point, the thinking goes, Intuitive can convince more hospitals to make the initial investment necessary to get them in the company's ecosystem. That means trading short-term losses for long-term gains -- procedure growth is the long-term driver for this razor-and-blades model company, and the more daVincis placed globally the more procedures will take place.

What else happened during the quarter

Beyond the procedure growth and the new daVinci machine, there were a number of other tidbits of note:

  • Procedure growth was driven by gains in U.S. General Surgery, with particular strength from hernia and, to a lesser extent, colorectal procedures, as well as international urology.
  • Growth has been constrained in China as the government has yet to release new quotas for how many new daVinci's can be placed in the Middle Kingdom.
  • Growth was also constrained in Japan, where reimbursements from the country's healthcare providers have yet to be straightened out.
  • Development and testing of the company's single port (Sp) daVinci continue, and management expects to file for permission to sell it in the back half of this year.

Looking ahead

Taking the past two quarters of growth into consideration, Calvin Darling -- Senior Director of Finance -- announced that expectations for the full year were being bumped up:

"Based largely upon continued strong results in US growth and mature procedure categories in China, we are increasing our estimate for 2017. We now anticipate full year 2017 procedure growth within a range of 14% to 15%.

During the second half of the year, we expect our procedure growth rate to moderate, in part, due to one fewer operating day during the third quarter. As we move into the second half of the year, we also expect contributions from China and Japan to temper until we obtain a new quota and place additional systems in China and obtain additional procedural reimbursements in Japan."

In other words, even though these two growth countries are going to be constrained, management still expects very healthy growth. That should be great news to investors' ears.

Brian Stoffel owns shares of Intuitive Surgical. The Motley Fool owns shares of and recommends Intuitive Surgical. The Motley Fool has a disclosure policy.

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