Illumina (NASDAQ:ILMN) and Intuitive Surgical (NASDAQ:ISRG) recently reported second-quarter earnings that were better than industry watchers' forecasts. These two game-changing healthcare companies could enjoy long-haul tailwinds, but they face different circumstances.
While Illumina is fending off competition and positioning itself to ride a wave of demand tied to personalized medicine, Intuitive Surgical is leveraging its installed base of robotic-surgery systems by developing new tools allowing its use in more procedures. Is one of these two companies executing on its strategy better than the other?
Illumina's success is in its genes
The ability to sequence genes is leading to incredible medical discoveries that are resulting in next-generation personalized medicine. At the forefront of gene sequencing is Illumina, a company that dominates the market for gene sequencers, with over 7,500 systems installed globally.
Last year, Illumina's sales and profit slowed because budget constraints in the EU and U.S. negatively impacted research spending at universities. However, the company's newest machine -- NovaSeq -- appears to have reinvigorated demand.
In the second quarter, sales of Illumina's systems and the instruments used to sequence genes jumped 10% year over year, to $662 million. That was $20 million better than industry watchers were expecting, and it outpaced the 7% growth that management was forecasting. Net income grew more slowly, up 7%, yet adjusted earnings per share (EPS) of $0.82 still did better than the $0.69 that analysts were hoping for.
According to management, the better-than-expected performance in the quarter was driven by NovaSeq. The company plans on selling two versions of NovaSeq, but so far, it's only launched the more expensive NovaSeq 6000, which costs nearly $1 million. In Q2, the company got 230 orders for NovaSeqs, which was 30% higher than management's internal forecast. A somewhat cheaper NovaSeq 5000, which still carries a list price of $850,000, should be available soon.
It's not just systems sales that are the key to Illumina's success, though. It makes a lot of money selling the instruments and consumables necessary to sequence genes, and that provides a steady stream of margin-friendly sales. As a result, more installed machines have resulted in consumables now representing 61% of Illumina's total revenue.
Clearly, Illumina's numbers were encouraging -- they were good enough for management to boost its guidance (more on that in a minute) -- but there was one trouble spot in the quarter. Operating margin slipped to 22.1% from 27.2% last year because of product mix and investments. While EPS beat estimates, $0.82 was still below the $0.86 reported in Q2, 2016.
Nevertheless, management is offering up an optimistic outlook for the remainder of 2017. Previously, it was expecting sales to grow between 10% to 12%; now it expects revenue to grow 12%. Since sales are forecast growing more than previously thought, management thinks it can offset margin headwinds, so it's keeping its EPS guidance for the year at between $3.60 to $3.70.
More procedures means better performance
Intuitive Surgical is the market-leading player in robotic surgery. It's da Vinci systems are deployed at major hospitals and surgical centers globally, and like Illumina, a big installed base means that it generates a nice, steady stream of cash from sales of instruments used in surgical procedures.
In the second quarter, da Vinci system installations and instrument sales caused Intuitive Surgical's sales to climb 13% year over year, to $756 million. Instrument revenue benefited from a 16% year-over-year increase in procedures done using a da Vinci, and that was better than management's forecast for growth of around 11% this year. Intuitive Surgical installed 166 systems last quarter, up from 130 last year, and its instrument and accessory revenue increased by 17%, to $398 million.
The company's sales mix, however, wasn't as profit-friendly as it's been in the past. That, plus spending increases, caused EPS to grow more slowly than the top line. Selling, general, and administrative (SG&A) spending climbed 8.8% year over year, while spending on research and development (R&D) climbed nearly 55%. Overall, Intuitive Surgical's adjusted EPS was $5.95 in Q2 2017, up 6% from last year.
Nonetheless, the solid procedure volume in the quarter led Intuitive Surgical to up its procedure-volume growth estimate for this year to between 14% to 15% -- and as long as procedures keep climbing, this company's financials ought to benefit.
Did one do better than the other?
It's hard for me to imagine that more genes won't get sequenced, or that more surgeries won't employ the use of robotic systems. Illumina's NovaSeq machines could drive the cost of gene sequencing down to as little as $100 from about $1,000 today, and Intuitive Surgical's R&D efforts are already paying off as more surgeons use da Vinci in new ways, including for hernia and colorectal procedures. In short, long-term tailwinds suggest both of these stocks should be core holdings in growth portfolios.
Nevertheless, if we're only grading these two companies on their second-quarter performances, then I give a slight edge to Intuitive Surgical. Why? Because while both companies are smartly investing in R&D that will drive sales and profit up over time, Intuitive Surgical's 34% operating margin is miles higher than Illumina's, and unlike Illumina's operating margin, Intuitive Surgical's ticked higher in the quarter.