Sometimes, it hurts a whole lot less if you just get it over with and rip off the bandage. Unfortunately, it probably doesn't feel that way right now to Intuitive Surgical, (NASDAQ:ISRG) shareholders, who watched their stock drop more than 10% in Wednesday's early trading after the company issued preliminary first-quarter results.
So what gives?
First, Intuitive Surgical now expects first-quarter revenue to fall 24% year over year, to $465 million. Analysts, on average, were modeling significantly higher sales of $537.9 million.
Ironically, however -- and to Intuitive Surgical's credit -- their expected number does reflect a $26 million deferral associated with a customer trade-out program for the new da Vinci Xi Surgical System. Specifically, the deferrals reduced system and instruments revenue by $24 million and $2 million, respectively.
That's fair enough, especially considering Intuitive only announced FDA clearance for the da Vinci Xi last week. In short, certain customers, who recently purchased an older da Vinci Si system and related instruments, were given the opportunity to exchange them for their newer counterparts.
And why wouldn't they? The da Vinci Xi offers a number of significant improvements over its predecessor, including greater range of motion from thinner arms and newly designed joints, a more compact endoscope digital architecture for better clarity, a new overhead instrument architecture removing the need to reposition the system during multi-quadrant surgeries, and longer instruments for greater operative reach.
But even without the deferrals, simple arithmetic tells us revenue would have still fallen 20%, to $491 million.
So why the discrepancy? Once again, most of the blame lies with weak U.S. system sales, which plunged 59%, to $106 million. Keep in mind, though, that this does include the aforementioned $24 million deferral. All told, Intuitive Surgical shipped 87 systems worldwide, including just 45 in the U.S. This time last year, Intuitive had shipped 164 systems, including 115 to stateside hospitals.
Finally, Intuitive announced a pre-tax charge of $67 million, reflecting estimated settlement costs for legal claims brought against the company. Most of these claims are related to "alleged complications" during surgeries that used certain versions of Intuitive's Monopolar Curved Scissors instruments that were recalled last year, as well as a first-gen MCU tip cover for the product, subject to a market withdrawal in 2012.
The silver lining
But there was one bright spot in the announcement: First quarter instruments and accessories revenue is expected to fall just 2%, to $255 million. That might sound bad at first glance, but it's primarily because of the $2 million deferral, and a reduction in stocking orders from declining system sales.
Those declines were offset by higher instrument and accessory sales, driven by 7% higher procedure volumes. It would appear, then, that surgeons still have no problem utilizing Intuitive Surgical's platform.
Don't be surprised
So what's an investor to do?
First, and putting aside the fact the deferrals make Intuitive's numbers appear worse than they are, yesterday's announcement shouldn't be particularly shocking. After all, in January, Intuitive's management declined to give specific 2014 revenue guidance because of limited visibility in the wake of our changing health-care market. Instead, they vaguely stated, "It is likely that we will sell fewer systems in 2014 than the 546 systems sold in 2013" thanks to "limited visibility regarding the capital side of our business."
What's more, investors should take solace knowing Intuitive is putting some of its legal troubles behind it by settling those legal claims. Keeping in mind it has already won other cases alleging complications from its systems, Intuitive isn't admitting to wrongdoing here. Rather, they carefully weighed the costs and risks of litigation, and determined that settling some cases was simply the most appropriate path.
Finally, given the nature of Intuitive Surgical's business, and the hundreds of thousands of procedures performed each year using its technology, we'd be naive to think that these kinds of legal challenges aren't par for the course.
In the end, Intuitive Surgical is definitely going through a rough patch right now, but I think it's the wrong time to write off this promising business. When the dust settles, and Intuitive is finally back on track, patient long-term investors will be there to reap the rewards.