Intuitive Surgical (ISRG 1.06%), the runaway leader in robotic surgery, reported second-quarter earnings after market close on Thursday. The results were familiar: solid growth in just about every category.
But a key change in the company's business model continues to emerge. While the effects of this change have been small over the short term, they have the potential to make the company even more powerful in the long run.
Image source: Getty Images.
Intuitive Surgical earnings: The raw numbers
We'll get to the details of that business model change in a minute, but first, let's review how the company performed on the headline numbers.
| Metric | Q2 2019 | Q2 2018 | Change |
|---|---|---|---|
| Revenue | $1.099 billion | $909 million | 21% |
| Earnings per share* | $3.25 | $2.76 | 18% |
Data source: Intuitive Surgical. *EPS presented on non-GAAP (adjusted) basis.
While it's never exciting to see earnings growing slower than revenue, it's important to put this in context: Intuitive is ramping up its investments in international opportunities, its informatic (read: helpful data) capabilities, and its manufacturing scale. The latter is both to meet customer demand, and to increase inventory to hedge against trade wars.
Given those spending increases -- operating expenses jumped 31% on a non-GAAP (adjusted) basis -- the fact that the company was able to increase earnings at the clip it did seems much more reasonable.
Breaking the revenue growth down by the company's three segments looks like this:
| Segment | Q2 2019 | Q2 2018 | Change |
|---|---|---|---|
| Instruments and accessories | $579 million | $476 million | 22% |
| Systems | $344 million | $277 million | 24% |
| Service | $176 million | $156 million | 13% |
Data source: Intuitive Surgical IR.
Digging deeper
But there are two story lines even more important to follow. The first has to do with the all-important procedure growth -- or the machines being used in more and more types of operations. At its core, Intuitive Surgical stock is only as valuable as the da Vinci machine's continued ability to help better patient outcomes in evermore procedures.
Showing 17% growth during the quarter, the exceedingly positive results continued.
Data source: SEC filings. Chart by author
On the conference call, management said that U.S. procedure growth was 16%. The largest driver of that growth was "General Surgery" -- a catch-all category for everything outside of prostate, gynecology and urology procedures. While hernia and colorectal procedures continued to be two of the largest contributors within General Surgery, their growth rates slowed for the first time in a while. In their stead, bariatric (stomach and intestines) and cholecystectomy (gall bladder) saw procedure growth accelerate.
Outside of the U.S., procedure growth clocked in at 20%, with particular strength in Germany and France.
The other major piece of information came from the fact that -- of the 273 da Vinci systems that were placed during the quarter -- 88 were placed using alternative financing, like operating leases and usage-based agreements. This was twice the number of such agreements from the same time last year, and brought the total to 486 systems with alternative financing.
That means that roughly 9% of all systems are now under such agreements. While these agreements don't necessarily help juice returns in the short term, they have three distinct advantages:
- They provide a steady stream of reliable income. Those 486 systems brought in $25 million in recurring systems revenue.
- They get da Vinci machines into the hands of hospitals and doctors faster than the company otherwise can, given the large up-front costs (over $1 million) of da Vinci systems.
- They widen Intuitive Surgical's moat: If hospitals don't go through upgrade cycles (there are no sunk costs for upgrading), there's never a clear opportunity to switch to a competitor. The users of these agreements are likely locked in for the long-haul.
All things considered, it isn't hard to see why management is excited about the long-term potential of this business model shift.
What else happened during the quarter?
Here are some of the other tidbits from the report:
- Instrument revenue increased at a faster pace than procedure growth -- something that normally doesn't happen -- because customers were buying higher-end instruments.
- The company repurchased roughly 400,000 shares at an average price of $477 per share.
- Intuitive Surgical ended the quarter with $5.1 million in cash and investments.
- Of the systems placed, 74% were the da Vinci Xi, while 20% were the da Vinci X.
- A total of 34 Sp (single port) systems have been placed globally, with the greatest concentration being in Korea -- where doctors have clearance to use the tool in a range of applications. This is one of Intuitive's newest platforms and because there's only a single port, it offers an even more less-invasive option.
- Ion -- which helps analyze lesions for lung cancer -- was in use in three locations and had been used for 50 procedures. The platform will be commercialized later this year, but will likely not contribute meaningfully to sales this year.
- The company announced the acquisition of Schoelly Fiberoptic's robotic endoscope business.
Looking ahead
Management nudged its estimates for the rest of the year up slightly. The midpoint of procedure growth went from 16% to 16.5% -- but if history is any indication, this is probably lowballing it. It also said that it would continue spending heavily on growth opportunities, with capital expenditures of over $250 million for the year.
In the end, it was another solid quarter, which investors have become all too familiar with over the past five years.
