Why Intuitive Surgical Is Increasing R&D Spending by Over 30%

By Danny Vena Markets Fool.com

When Intuitive Surgical, Inc. (NASDAQ: ISRG) reported earnings last week, it wasn't just your run-of-the-mill conference call. One of the more surprising aspects was the announcement that it planned to increase the amount it spends on research and development in 2017 by an additional $80 million dollars, a full 30% higher than in 2016. Considering that it had already increased R&D spending in 2016 by over 20%, this represents a significant additional investment. So what's driving those increases, and what does the company stand to gain?

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Intuitive Surgical is working on the next generation of robotic surgery. Image source: Intuitive Surgical, Inc.

The next generation surgical robot

The increased R&D budget is going toward a couple of ongoing initiatives Intuitive has in its efforts to produce the company's next generation of surgical technology. The first is the da Vinci Sp, or single-port, robot. While its flagship da Vinci Xi model typically can operate in numerous surgical entry points simultaneously, the Sp is designed to operate through a small incision and a single port the size of a tennis ball, which provides better access to what it describes as "confined surgical spaces". This is better suited for specific uses such as trans-oral surgery, which involves hard to reach places in the head and neck. It also uses a 3D high definition camera and three jointed arms for manipulating surgical instruments. The "wrists" on the SP system provide two degrees of greater flexibility than the Xi robot, which already bends farther than the human wrist, while still providing the ability to rotate.

Even though much of the technology is already FDA-approved for the Xi system, each new indication must have its own approval. As an example, even though the surgical tools have been approved for use with the Xi, new approvals must be submitted for use with the Sp model. Intuitive has been conducting clinical trials over the last several years and it is widely expected to release the Sp system sometime during 2017. This will be an add-on to the Xi platform that will not be compatible with the previous generation Si system and will generate incremental revenue.

A whole new market

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The second ongoing initiative was announced in September of 2016, when Intuitive formed a joint venture with its existing China distribution partner Fosun Pharma. The new venture was investigating a flexible robotics platform for the purpose of diagnosing and potentially treating lung cancer. This would present an entirely new addressable market for the company. The system in development would deploy computer-controlled catheters, as well as advanced imaging and sensors, that would be used in the detection of lung cancer. This system is in extremely early trials, but again requires significant investment to bring to market. The development of new technologies necessitates spending in a number of areas including prototypes, product testing, the running of clinical trials, and building out of the supply chain. These are expensive and can add up quickly. During the conference call, CEO Gary Guthart explained that "Bringing new platforms to the market represents a significant investment".

Ordinary and necessary?

In the accounting world, one of the reasoning models we use to test expenses is by asking if they are ordinary and necessary. Considering that these endeavors will be the linchpin for future growth, they should be considered necessary. They may not be ordinary in the strictest sense, but I would argue that Intuitive Surgical would have incurred these expenses eventually and that by accelerating them, actually stands to benefit by bringing these products to market sooner and gaining incremental sales. When taken in that light, these pass both the ordinary and necessary tests. As an investor, I appreciate when the management of a company exercises good judgment and looks at the longer term benefit, rather than whether it beats analysts estimates in a given quarter.

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Danny Vena owns shares of Intuitive Surgical. The Motley Fool owns shares of and recommends Intuitive Surgical. The Motley Fool has a disclosure policy.