Cancer Blaster vs. Surgical Robot?

The stock market is presenting all kinds of buying opportunities that are making me interested this week, but the one dynamic that stands out most today is the dramatic difference between the performance of two companies in my portfolio that sell high tech products that both do essentially the same thing ... though in very different ways.

Accuray (ARAY) is the maker of the Cyberknife, a targeted radiation machine for cancer treatments that has been called the "Cancer Blaster" by newsletter touts who enthusiastically recommend the stock. Though useful for all kinds of radiation treatments, the argument for this more advanced machine is that it can track moving tumors and spare nearby tissue -- making it particularly popular for prostate and lung cancers (since the lungs, you know, move, and the prostate is in, shall we say, a very delicate area of the body).

Intuitive Surgical (ISRG) is the maker of the da Vinci surgical robot, whose core market is prostate surgery (though other surgeries, including mitral valve heart surgery and gynecological applications, are growing fast). The strongest rationale for fast growth in the use of this robot a couple years ago was that prostate surgery with the da Vinci spared those same "delicate areas" near the prostate in a way that open surgery often did not ... though it certainly also has other advantages over open surgery, and, depending on the surgeon (and who you ask) over traditional laparoscopic surgery.

Accuray is up close to 10% today, Intuitive Surgical is down about 8% as of my last check. Why is that?

Well, it's certainly true that ISRG is much more steeply valued, being one of the top performers on the Nasdaq for all of last year, and there are huge numbers of shareholders, myself included, who have a cost basis several hundred percent below the current price -- that makes these shares a target for profit taking when shareholders start to panic that we're entering a recession and/or a prolonged bear market. Even the most enthusiastic shareholder would have a hard time arguing that ISRG is a bargain, even down $70 from its high, with a forward PE of about 60.

And Accuray is, on the face of it, much cheaper -- this much newer public company (IPOd over the summer last year) has much lighter penetration in the marketplace, and has some competitors who offer somewhat similar products (as opposed to the da Vinci, which has the multipurpose surgical robot space more or less to itself). And it trades at a forward PE of about 20, though there's no track record to encourage investors to believe that those analyst estimates are anywhere near accurate (earnings have fluctuated widely, as has the stock for its brief history).

ISRG got a downgrade today from Wachovia, which noted that hospital capital spending might be at some risk this year and that expectations for this highflier are quite optimistic. That's probably the most immediate reason for the price cut today, though general analyst concern and valuation jitters are probably the reason for the overall price cut from the high of $350 back in December to today's price around $280. ISRG still depends on sales of new systems for much of its revenue, though their recurring revenues from parts and services are growing faster and will be the future engine of the company -- so if they have a bad quarter and sell fewer systems than predicted, it would not be at all surprising if the shares fell dramatically, it has happened several times before.

And I'm not sure about any specific impetus for the ARAY move, though I do know that at least one newsletter is still actively pushing it, and the CEO did speak at the big JP Morgan conference in LA this morning (that conference has been moving stocks right and left, as usual, so that's probably the main move -- I haven't been watching, but perhaps they got a mention on CNBC). Add to that the general urge of investors to move to healthcare as a defensive move, and I guess ARAY is riding the trend.

I'm holding shares in both of these companies because companies that fight cancer will be facing a huge secular tailwind with the aging population over the next thirty years, and devices that are more advanced are popular with hospitals even when they cost millions of dollars -- I've seen the da Vinci advertised by hospitals for years by proud owner hospitals, which has clearly pressured their competitors to pick up the robot, too, and more recently I'm also seeing some ads for the Cyberknife from hospitals around the country. At this stage in their growth, with a more expensive machine that is in many fewer hospitals, I presume that Accuray is likely to get more of a boost from the fact that the Cyberknife still truly gives hospitals a dramatic competitive advantage in drawing oncologists and cancer patients.

So I still like both firms -- ISRG seems to me to be the company with a more dominant presence, though they don't compete directly, and they have a much steadier potential earnings stream due to the importance of "disposable" attachments and accessories for the da Vinci that must be replaced frequently, and they're priced accordingly. ARAY seems to me to have a higher growth potential because, if the value of the Cyberknife continues to be borne out through more studies, they have a huge green field of hospitals who will need to buy it -- but they're cheaper because they have more direct competition, they're newer, and the rely almost entirely on device revenue and have far less hope of a strong recurring income stream from accessories and attachments (though there is some).

Indeed, the newsletter touts talk about ARAY as the "next ISRG," and in some ways that argument is compelling -- ARAY is, by some measures, where ISRG was a few years ago. Whether it will ever get to where ISRG is today is another matter, but I've got a bet in place that both will do very well over the coming decade.

full disclosure: In case it's not obvious, I do own shares of both ARAY and ISRG and do not intend to trade in either in the next week.

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A Bigger Market for Prostate Surgery? (ISRG)

An interesting study was released this week in the Journal of the American Medical Association that might mean the market for prostate surgery is going to get bigger -- which would mean good things for the makers of the da Vinci surgical robot, Intuitive Surgical (ISRG).

The Washington Post ran a good story about the study today, and the basic findings were that treatment may be a good option for prostate cancer sufferers even in the later years of life.

This is significant, because although aggressive treatment (radiation or surgery) has for some time been the agreed-upon standard for younger men with prostate cancer diagnoses, for the most part elderly men (60 and over) have been advised to "wait and see" because prostate cancer generally moves so slowly that many of these men will die of something else before the cancer becomes dangerous.

Now that "wait and see" policy is in some dispute, thanks in part to this new study -- men who received treatment even at more advanced ages had a 30% chance of a longer life, and that is a dramatically significant number.

The study is in some dispute, because it was conducted using patient records instead of actually examining patients -- so it's certainly possible that other factors came into play (though the authors said they tried to correct for other health problems that might have skewed the results).

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But regardless, this is potentially important news for Intuitive Surgical going forward. I have owned ISRG for well over a year now, buying both above and below today's price (my cost basis is about $99). While the markets for the da Vinci are continually expanding, particularly in mitral valve repair and in gynecology, the lions share of da Vinci surgeries are da Vinci prostatectomies, and this is the first robotic surgery that is really being accepted as significantly better than its laparoscopic or open counterparts.

ISRG is shooting for roughly a 35% market share in prostatectomies this year, last time I checked, a share that has increased very rapidly over the last few years.

So if their share of prostatectomies continues to climb ...

and the number of prostatectomies performed continues to climb (not only because of this study, but also because the baby boomers are entering their prostate trouble years) ...

The overall number of da Vinci prostatectomies that are performed should climb almost exponentially.

And with procedure growth being a key component to ISRG's growth prospects moving forward (they need high utilization rates to encourage hospitals to buy multiple robots, and they make money with every surgery thanks to service and accessory sales), this can't help but be good news.

There are lots of moving parts in this equation -- if drugs to fight prostate cancer prove to eventually be better than surgery, that's bad news for ISRG ... then again, if they take hold in hysterectomies the same way they have in prostatectomies, the sky's the limit (I looked at the da Vinci volume drivers here). I'm just pleased to see that the potential market for people who can be helped by the da Vinci's minimally invasive solution is growing.

full disclosure: I do own Intuitive Surgical shares as of this writing, I last wrote about the company in detail after their last quarter's conference call.

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Intuitive Rollercoaster (ISRG)

Here's what I think was the most important quote from the Intuitive Surgical conference call last week, from the CFO: "Growth in procedures masked what is otherwise a seasonally slow quarter."

Intuitive Surgical (ISRG), maker of the da Vinci surgical robot, had a wild ride over the 24 hours surrounding their earnings release last week -- they released market-beating earnings after the market close on Thursday, which brought an immediate bump up by about 20%, then Friday morning the shares fell from the previous closing by about 10% after an analyst downgrade -- a swing from about $112 at closing yesterday, up over $120 in the after hours, then back down to about $100 ... and they opened lower today, hovering just under a hundred dollars a share.

This isn't that new for ISRG -- system sales can be quite lumpy from quarter to quarter, and management has a history of issuing pretty conservative guidance and then beating it, so each time they issue fairly tepid guidance the shares collapse a little, only to (usually) climb again by the time the next quarter is released.

So what was the bad news in the conference call that brought the shares down? The analyst who cut his rating to hold argued that the shares are now fully valued given their growth rate, and that's certainly a defensible position to hold (even if it's not mine).

I continue to believe that Intuitive is a few years away from having a truly spectacular ongoing revenue stream, with or without massive growth in the sale of new systems ... and that as long as I can focus on the longer term (not quarter to quarter), I'll be very pleased with the growth of the installed base of systems as well.

So far, system sales (the sale of the actual da Vinci surgical robots) still make up the majority of revenue -- about 55% -- but utilization is growing so quickly that the installed base is beginning to require a significant number of new instruments and significantly more doctor training ... and instrument and accessory sales are already growing slightly faster than system sales.

There were 42 new da Vinci surgical robots added to the worldwide installed base in this last quarter, three more than in the quarter before -- so there are now 509 systems installed worldwide (there were also four "trade-ins", so you may see totals of 46 for the quarter in some places, but those also removed four older machines from the market). It seems likely that their ability to forecast system sales is going to suffer further, as the sales cycle is getting a bit shorter. Their cycle is down to six months or even less in some cases, and some sales have less than a quarter lead time.

Each procedure done with a da Vinci generates somewhere between $1,500 and $2,000 in sales, primarily for instruments that are only usable for a limited number of procedures (and that doesn't count the instrument and accessory sales that accompany new installations). And while there is a huge range of utilization rates across different hospitals, procedure growth continues to be dramatic, and more and more hospitals are adding second, third or (in one case) fourth robots (12 of the sales this quarter were to hospitals with multiple machines) -- which leads me to believe that this recurring revenue stream should soon eclipse the systems sale revenue.

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But it really seems to me that investors are conditioned to focus only on the "units sold" number and on sequential growth ... and in that light, Intuitive didn't look that spectacular this quarter. They sold 39 robots last quarter, and 40 in the fourth quarter last year, so the 42 sold this quarter don't jump out as a dramatic growth indicator. Since the summer quarter is a pretty soft one for sales, according to management, and year over year growth was dramatic, I don't see anything significant to be concerned with at this time -- that strong and steady procedure growth noted by the CFO is much more significant than the quarter to quarter system sales.

Here are a few of the other things I thought were notable in the conference call:

Gross profit margin declined to 66% from 69.2% as a result of writeoff of inventory, and increased overhead with manufacturing expansion. They expect margins to improve by 100 basis points in the fourth quarter, which is promising. The expansion of their manufacturing capacity is complete, and they're now expanding engineering and product development space.

Non-cash stock options expenses are still pretty high, 7 million this quarter -- much of that is credited to their sales force, which has been expanded over the past year, and as long as they're in hyper growth mode and pushing sales of the systems to expand their footprint, I'll consider that to be reasonable. Right now, stock options reduce their gross margin by about one percentage point (still in the high 60s, so it doesn't bite too much yet).

52 hospitals now have multiple robots -- the biggest news this quarter was that Penn purchased 2nd, third and fourth systems to bethe first hospital with four robots as they build out a "center of excellence" in robotic surgery. Nine other customers now have three systems. (As I've written before, the goal is to have three robots each in all 1,500 of the largest US hospitals, which would bring the installed total to roughly ten times today's number ... and make a lot of people very rich.)

Clinically, they're seeing solid sequential procedure growth. Gynecology had the largest sequential percentage growth (though from a small base), followed by urology. New robotic surgical societies, publications, and conferences continue to sprout up and spread new techniques and procedures.

Results of clinical studies continue to show that cancer control and physical recovery are much better for da Vinci prostatectomies than for open prostatectomies -- after following this story for a couple years, it now seems to me that traditional open prostatectomies are almost never appropriate for standard cases (I'm not a doctor, that's just my impression).

In the key gynecology market (key for future growth, anyway), the da Vinci hysterectomy run rate will exceed 2% this year (5,000 of a projected 250,000 target market). This will continue to place demand on hospitals to increase their capacity to perform these surgeries, as one can only imagine the competition between urologists and gynecologists for the available machine time. Three papers were published on the da Vinci hysterectomy this quarter, but there has not yet been a big, influential, data-driven study published that might push the envelope on these procedures. Several such studies are underway, however.

For comparison purposes, ISRG exited 2002 at 1% and 2003 at a 3% run rate for prostatectomies -- and for 2006 they'll be at 2% for hysterectomies (prostatectomies should be near 35%). There are some significant differences between the specialties, but it's encouraging that gynecology is doing well out of the gate so far, since the hysterectomy market is so much larger.

Still, every procedure has a different adoption curve ... typically, cervical cancer is more urgent than prostate cancer and doesn't necessarily provide the time for consideration of many options, which leaves less time for shopping around and finding out about the da Vinci hysterectomy. And hysterectomy patients are likely to have a close provider relationship with a primary gynecological caregiver, so that doctor will strongly influence what they do -- most men don't have a urologist as a primary doctor, so and prostate cancer generally provides more of a lead time for action, so they are more comfortable with shopping around to find out about alternative procedures if their urologist doesn't offer the da Vinci prostatectomy.

Heart surgery is growing well, too -- at least one surgeon is reporting dramatically better mitral valve repair results (95% success versus 50% success in traditional mitral valve repair), and lots of new clinical interest in da Vinci for revascularization

One analyst asked what kind of utilization rate would force hospitals to upgrade to a second machine, and there was no precise answer -- but management's sense is that once a machine starts getting used for one surgery per operating day that begins to put pressure on the system -- so once 250 or so procedures are done a year, the pressure will grow to get additional machines. That threshold may be lower if the machine is shared across several specialties, which is getting more common.

All this leads me to be just as confident in this company as before -- and perhaps a little tempted to add to my position again now that the shares are hovering right around my average cost per share. And to ice the cake, they also improved their outlook -- ISRG had expected 50-55% sales growth, now projecting 58-60% overall sales growth, with all segments growing. 62-64% expected growth for instrument revenue leads the pack, as procedure growth continues to build this recurring revenue stream.

They could easily sell 50 systems and post blowout numbers in the fourth quarter and see their share price rocket ... or they might sell 35 systems, miss the numbers, and see the price halved. In the long run, though, I think their monopoly position in their niche and their growing installed base will drive them to many years of strong growth.

Full disclosure: As of this writing I own shares of ISRG, purchased at $112, $109, $90, and $70.

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What are the da Vinci volume drivers? (ISRG)

Intuitive Surgical's (ISRG) primary business is the manufacture, sales and service of the da Vinci surgical robot. The da Vinci is the only widely capable surgical robot approved by the FDA, and essentially enjoys a monopoly position in its niche.

Robot-assisted surgery stands every chance of becoming the standard for several different types of surgeries, in my opinion, and is already making inroads in several areas. There are a few key things that will impact ISRG's development, including insurance reimbursement rates, FDA approvals, encroaching competition (eventually), and the health of hospital capital budgets.

But the key for ISRG is going to be new surgery approvals, patient awareness, and physician adoption.

Surgery volume and patient demand is by far the most important driver of the economic success of the da Vinci system -- the machines cost well over a million dollars and require the ongoing purchase of regular maintenance contracts and proprietary accessories, so it is important to have both growth in the number of machines sold, and in the number of procedures performed. The lumpy earnings the company has experienced over the last year or two (though mostly they've reported blowout earnings) have related to the uneven timing of purchases of da Vinci robots by hospitals. Moving forward, the installation income will become less and less significant and the ongoing instrument and service income will become the core of ISRG's earnings.

And the only way to get instrument sales up is to build a bigger network of the machines and the doctors who are trained to use them, and to build public awareness among both doctors and patients about the virtues of the system to keep the utilization rates high.

So far, that has really already happened with prostatectomies -- da Vinci has steadily been taking market share in these surgeries, to the point that they expect to see the da Vinci used in 35% of all prostatectomies performed this year, roughly twice as many as last year. In many ways, prostatectomies have been an easier sell than some surgeries might be, since in addition to the benefits conferred by all minimally invasive surgeries (less blood loss, less chance of infection, shorter hospital stay, less pain), da Vinci Prostatectomies have been shown to have fewer complications and a good chance of regaining urinary function and sexual function faster than with traditional prostatectomies. That has led to men actively seeking out and demanding the da Vinci, and I expect the market share will continue to grow ... as will the market size, since the baby boomers are just now entering their prime prostatectomy years.

But I think Intuitive Surgical really needs more procedure growth in additional areas -- and while use is growing for mitral valve repair and other heart surgeries, and for gastric bypass surgery, I expect the next key market share move will be in gynecological surgery, specifically in hysterectomies. Hysterectomies are relatively complex surgeries, I've been told, and they are fairly standardized and extremely common (about five times as many hysterectomies are performed each year as prostatectomies), which makes them well suited for minimally invasive robot-assisted surgery and a great growth market for Intuitive Surgical.

The benefits, for those unfamiliar with robotic surgery, are laid out nicely in this table, borrowed from the da Vinci explanation at Women's Specialty Health Centers, P.C.:

	Gynecologic Surgery with the da Vinci Surgical System1	Open Abdominal Surgery
Incisions	5 1-inch incisions	1 8 to10-inch incision
Surgery Time	2-3 hours	1-2 hours
Hospital Stay	1-2 days	3-5 days
Recovery Time	1-2 weeks	4-6 weeks
Pain Medication	Motrin/Darvocet	Vicodin/Percocet

So what has been going on with gynecological surgery and the da Vinci since I last did some "channel checks" in April?

Well, there have been plenty more machines written about in the press, and plenty of hospitals advertising their robots for hysterectomies ...

For example, here's a UNC page advertising their "high precision" robotic surgery options for women in cervical cancer, for hysterectomies, and other applications.

And one from St. Johns Mercy Hospital in St. Louis.

And Sarasota Memorial.

And Lankenau in suburban Philadelphia.

There have been stories about surgeons doing gynecologic surgery using the da Vinci for the first time in hospitals around the country, like this one from Memphis.

And if you're not too squeamish, you can watch a da Vinci hysterectomy here. The market machine is in full swing.

But what I've been thinking about lately is the advance of research, and whether the volume of research studies has any predictive power vis a vis the adoption of the da Vinci. According to the company, it took about two years of intensive research study and publication to make the benefits of the robot clear, to make physicians aware, and to therefore build the da Vinci's market share in prostatectomies.

So I thought I'd look at the number of research reports involving the da Vinci in prostatectomies over the last several years, and in hysterectomies more recently, and see if the information is at all valuable.

Here's what I found:

The FDA approved the da Vinci for laparoscopic prostate surgery in June 2001 (just about a year after the first approvals came through for the da Vinci in other applications), and for laparascopic gynecological surgery in April of 2005.

I used the Medline database to analyze the number of articles that mentioned either prostatectomies or hysterectomies (broadly defined) and mentioned the da Vinci system, Intuitive Surgical, or robotic surgery in each of the past several years.

Prostatectomy
1999 -- 7 articles
2000 -- 11
2001 -- 13
2002 -- 13
2003 -- 29
2004 -- 47
2005 -- 77
2006 -- 84 so far

Hysterectomy
2002 -- 3 articles
2003 -- 4
2004 -- 3
2005 -- 10
2006 -- 4 so far

That's a pretty underwhelming comparison, and my guess is that it's going to take another couple years of positive research studies (I've seen nothing negative about the da Vinci in gynecological surgery yet, aside from cost issues) before hysterectomies can take off in the way that prostatectomies have for Intuitive Surgical.

That's too bad, but with new indications for the robot coming along every day I think we can afford to be patient with gynecology -- it took the da Vinci Prostatectomy five years to get a 30%+ market share ... if the da Vinci Hysterectomy can get even a third of that (10% of the hysterectomy market) within its first five years (that would be mid-2009), that would be another huge growth driver ... though unless studies give a clear preference for the da Vinci hysterectomy over other laparascopic, vaginal or open surgeries (as studies in the past couple years have done for the da Vinci Prostatectomy), it's possible that 10% might even be too optimistic a target.

I'll be keeping an eye on the performance of the company, their sales of new systems, and their instrument income ... but what I'll really be looking for, and the company is great about covering these details in their conference calls, are additional inroads into gynecological and other non-urological procedures.

It's always possible that keeping an eye out for other procedures will cause us to lose sight of the critical near-term driver of da Vinci usage, however. I need to remind myself that the da Vinci has come to prominence and proven its supremacy at possibly an ideal time, just before what may be a perfect storm in the world of prostatectomies: The cusp of the baby boomers are just entering their early 60s with good general health and an interest in maintaining a high quality of life (of which peeing and having sex are some key elements); the average prostate cancer diagnosis is now made in the late 60s (and declining); and prostatectomies have more than quadrupled in number in the last 20 years as diagnosis and treatments have improved.

I did some analysis of the valuation of ISRG last December, when the price was quite close to where it is now -- I thought it was reasonably priced then in relation to its growth, and I think it's even more reasonable now. For full disclosure, I do own shares of Intuitive Surgical, bought over the last year or so at $112, $109, $90, and $70, and my average cost per share now stands just a hair under one hundred dollars.

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One up for every one down (FORM, CKCM, AKAM, ISRG)

Many of my holdings have been moving in almost perfect mirror trajectories over the past couple of days, following earnings reports that either disappointed or encouraged investors.

Akamai (AKAM) did much better than I had expected -- and even though it showed accelerating growth, which is the holy grail for investors, I was shocked to see it climb back to within a hair of it's 52 week high. I thought the shares were already priced for some pretty dramatic outperformance, but clearly the wave of analyst upgrades following their earnings did their job as the shares zoomed higher by better than 20% yesterday. A nice surprise.

On the flip side, Intuitive Surgical (ISRG) shareholders reacted to strong growth and forecasts with much more anger -- we've gotten spoiled with ISRG, as with AKAM, and expect blowout growth every single quarter, so merely great growth isn't going to cut it if you're carrying a high multiple. Intuitive had very strong recurring revenue growth from their sales of instruments, which means procedure growth is very good. I think that's the most important thing to see, that surgeries using the da Vinci are continuing to grow, but clearly a lot of investors were looking for much more dramatic growth in system sales.

ISRG surprised everyone to the upside in the first quarter with 35 systems sold, many of them the newer, more expensive da Vinci S system, but even a 50% rise in systems sold year over year to 39 in this quarter was inadequate for many, even with a small-scale beat on earnings. I think folks expected a dramatic sequential climb in installations and didn't get it, but the growth there is still continuing and the second quarter can be pretty soft for big ticket purchases, so I'm not worried. I still think the key for ISRG will be procedure growth in Hysterectomies now that they have proven that they can build a dominant position in Prostatectomies, but it's early days still for the da Vinci in gynecological surgery.

And because my ISRG position is roughly twice as large as my AKAM position, they completely cancelled each other out yesterday.

The same thing happened today with two more volatile stocks -- Click Commerce (CKCM) disappointed due to a much higher tax rate and some slowing sales growth, and Formfactor (FORM) surprised with greater than expected growth in both earnings and sales.

I was a little disappointed with CKCM's performance, but not enough to sell my shares -- and frankly, given their low multiple, I think the shellacking the shares have taken this morning is quite overdone. Even if they were not growing very robustly, which they are even though taxes have taken a big bite out of earnings this quarter for the first time, they're being valued at a PE of about 9 on both forward and TTM earnings. That's just silly, and it implies an assumption that investors are assuming that their investments in R&D and in marketing will not allow them to build the business. They're priced for no growth now, but I expect good growth that will, within a couple quarters, come down to the bottom line. I am tempted to buy more but already have a large position, so I'll have to think about it a bit.

Formfactor, on the other hand, continues to delight. As I wrote a few weeks ago, the competition and innovation in the semiconductor industry is mother's milk for FORM as it allows them to sell a greater variety of testing probe cards, in higher volume. I don't see a significant downside even with overall semi volatility, given the remarkable diversity of customers and end user semiconductor applications that they serve. They managed sequential sales growth of 14% and YOY growth of 77% ... no complaints there, even though the year ago quarter was a low point. And more impressively, they turned that 14% sales growth into better than 20% sequential earnings growth. Unlike CKCM, FORM is priced now for significant ongoing growth, but I still like their chances. FORM is actually a relatively small position for me because I was never wise enough to double down last summer when the price was very enticing -- if it was one of my larger holdings I'd be tempted to take a small portion of my profits off the table given their high multiple, but as the situation stands it makes more sense to just hold and watch.

Formfactor's industry colleague MEMC Electronic Materials (WFR), by the way, is clearly confusing investors on a very fundamental level. They soundly beat the earnings estimates AND significantly increased their guidance for this year's earnings, and the shares actually went down. They're poised to invest in capacity to serve the solar power industry, thanks to an agreement with Suntech Power, and they continue to supply scarce wafers to the semiconductor fabricators at very nice margins. Given the average market multiple and their dramatica decline already over the course of this year (from $48 to below $28), I can only imagine that the reason WFR is falling is that everyone is terrified of the Intel/AMD problems. That's close to irrelevant for WFR, in my opinion, as long as chips continue to be required to run everything from laptops to cell phones to cars.

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Earnings Season Thoughts (GOOG, WFR, AKAM, ISRG, VRTX)

This is very likely the biggest single day for me in earnings season -- several of my strongest performing stocks like MEMC Electronic Materials (WFR), Akamai (AKAM), Intuitive Surgical (ISRG), and Vertex Pharmaceuticals (VRTX) are releasing earnings after the close today.

So this seemed an apt time to check up on the earnings releases that I haven't yet mentioned.

Yesterday, Cemex (CX) released their earnings -- and no one was particularly happy with them. The stock split recently, but that didn't have any real impact -- no, the impact was from declining US sales. Cemex had great sales increases in every other major area, including Mexico and Spain, but US sales dipped significantly. I found this very surprising, given the continuing cement shortage in this country, but I expect commercial and infrastructure construction to continue growing over the long term here at home, and with the rest of their markets performing very well right now I'm not terribly worried about a blip in the US. In fact, the news out today that GM was buoyed by its Latin American division gives me a bit of hope that consumption is increasing in that region, and any increase in automobile sales should help push demand for improved road infrastructure. That's a bit of a stretch, but at least it's a stretch on the positive side.

And Google (GOOG), another of my larger positions that has already released earnings, surprised me a little bit as well -- not because they continued to beat estimates handily (beat by more than 12% this time), but because it brought in virtually none of the volatility we've come to expect from GOOG earnings.

Google's now trading at less than a 40PE on current year's earnings (reported and estimated) -- that's about as cheap as it's ever been, though it's certainly not cheap in relation to the rest of the market. I sold about 40% of my Google holdings earlier this year at close to a 100% gain and will be holding these, but I think investors are now so afraid of growth stocks and technology stocks that GOOG is getting attractive again -- over the past two years they have steadily increased earnings, kept their noses clean, innovated with new products that may be monetized eventually, and, most importantly, continued to take market share from all of their competitors around the world.

And Gol Linhas Aereas Inteligentes (GOL), another of my bigger holdings, is managing to maintain very solid margins and increase market share even while they grow their fleet considerably and grow earnings by about 50% -- they're subject to oil prices just like all the other airlines (though Brazilian prices are a lot friendlier than US for jet fuel, in general), but they are growing very quickly without sacrificing profitability. The ADRs have been subject to the strength of the Real, and more significantly the shares have been on a rollercoaster as Varig's restructuring has played out ... but I don't see anything happening to Varig that will hurt GOL significantly, and I think the only thing that will bring trouble to the company is a recession in Brazil that curbs demand for tickets.

Looking forward, we've got AKAM, ISRG, VRTX and WFR all reporting today.

WFR is a company I've written about quite a bit recently -- the collapse of their deal with Motech was disappointing, but the cessation of their supply agreement with Evergreen Solar (ESLR) was an indicator of the upward trend in their market, and the signing of a deal with Suntech Power (STP) today to supply solar silicon wafers for ten years in exchange for an up-front payment and a warrant for STP shares came earlier than expected but is also a strong positive.

And today, WFR will release its earnings after the close -- and they've beaten estimates the last two times out, if not by all that much. Analysts are expecting something in the low-40 cent range for EPS, which would be close to twice their year-ago earnings (a year ago is roughly when the company began turning things around and their shares began climbing). WFR has been much higher than this, at around $48 before the bottom fell out of the market, and is priced at close to a market multiple -- for this kind of growth, that seems a more than fair price to pay.

VRTX should be insignificant -- their earnings don't mean much, because no one is buying this company for their current royalties on a few antiviral drugs that are in production now. No, people are buying Vertex for VX-950, their anti-hepatitis compound that has show remarkable results in early clinical trials. Vertex has made some solid partnership agreements in the last few months and is very well financed to complete these trials, so unless there is news about VX-950 or VX-702 (and I don't believe there will be), I don't think we'll learn much from the earnings release.

AKAM is feeling the pain of growth stocks everywhere -- it has gone up so much that it is hard to consider it cheap even on forward earnings. Add in the fact that now many folks are getting worried about Limewire, which has replaced Bittorrent and Google as Akamai's boogeymen, and I expect that the folks who are sitting on huge returns in this one have itchy trigger fingers. Limewire is actually a real competitor, with a similar business plan to Akamai's, but AKAM is so entrenched with their customers and has such a strong portfolio of clients that I think fearing the upstart is a bit premature right now. Still, any disappointment on earnings release this evening -- any worsening of margins that might bring in the specter of price cutting due to competition, or anything less than a big uptick due to heavy World Cup traffic, could bring another wave of selling. With the demand for faster commercial delivery of audiovisual files continuing to increase dramatically, I still think Akamai is a good place to be in the long run ... even if they get some competition in the space they have owned since they acquired Speedera. But it's not a slam dunk, and the shares aren't cheap right now in my opinion.

Intuitive Surgical has been actually fairly quiet lately. In the last few months it has recovered from the beating it took when they lowballed their first quarter sales numbers (especially since they then beat those lowballed estimates handily), but folks will certainly be watching very closely to see how many of the new Da Vinci S machines they sell, and what kind of penetration they're getting into the prostatectomy field (where they're shooting for 35% of the market by the end of this year) and, perhaps more importantly, into hysterectomies, where they are trying to build a presence in a much larger market. I looked into those with some channel checks in the Spring, but haven't followed up yet in any detail since the last earnings release eased a lot of my concerns. This company has the potential to revolutionize all kinds of surgeries in the years to come, but with hospitals generally hurting I'd be happy to see them just keep up with the sales they had in the first quarter -- in the long run, this will be a cash cow with lucrative instrument sales driving returns as more and more surgeries are performed, but in the short run the shares should bump up and down on the numbers of machines sold.

Should be an interesting day -- the next six hours will go a long way to determining whether or not my portfolio will shortly recover from the beating it has taken in the last two months, but so far I've heard nothing terribly disturbing from the companies I own, and I remain quite optimistic about their long term prospects.

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Intuitive Channel Checks (ISRG)

I've spend a fair amount of time lately trying to keep up on the news for Intuitive Surgical (Nasdaq:ISRG) -- this should be a pivotal year for them as their new system (the da Vinci S) gains customers and they expand the breadth of surgeries for which the da Vinci is commonly used. They'll be reporting their first quarter results two weeks from today, but with the price declining (perhaps thanks to Cramer once again jumping out?) and my constant temptation to buy more of this one, I hate to wait for the company to tell me how the marketplace is accepting their products.

It's hard to keep track of the number of new Da Vinci S systems Intuitive Surgical is selling, in large part because lots of newspaper and PR editors seem to think the S is a typo -- generally, you can guess that any ISRG robot purchased for more than $1.3 million this year is an S type, but unless they specify I can't be certain.

Thankfully, owning these robots is usually a competitive advantage for hospitals, and they like to brag about it. I've included links where they were available, but I pulled a lot of these articles from non-free web sources. I think these quotes and news items call attention to the demand for ISRG products, and the advantages of robotic surgery:

"Robert Carey, a urologist and robotic surgery expert at the University of Miami, is joining a local practice in part to use the newly upgraded robotic system, considered the most advanced on the market" -- Sarasota Memorial's newly purchased Da Vinci S, March 21.

"Between the demand and opportunity for heart surgery and lung surgery and what (the urologists) can do with prostate surgery, we had a backlog of cases waiting for the robot," Dr. J. Michael Smith said about Cincinnatti Good Samaritan purchasing the S as their second robot, on March 17.

Evanston Northwestern Healthcare got a da Vinci S as their first robot -- “My preference in the pelvic area and the prostate is to use the robot, because the area is a very small working area,” Johnston said. “We are looking where we are going as opposed to just feeling. We are doing a lot finer surgery and our whole goal with this is sparing the nerves,” according to Dr. William Johnston.

Spectrum Health in Grand Rapids, MI is the first in that city with the S -- “With this technology, Spectrum Health surgeons will raise the bar on performing complex procedures in a more timely, precise manner,” executive Matthew VanVranken said. “For example, cardiac surgery including bypass and valve surgery can be performed with smaller incisions and less pain. This less i