Good afternoon. I'm Larry Biegelsen, the Medical Device Analyst at Wells Fargo. It's my pleasure to host this session with Intuitive Surgical. With us, we have Jamie Samath, Senior Vice President and CFO, and Brian King, Treasurer and Head of Investor Relations. In terms of format, it's going to be a fireside chat. If anyone has a question, please raise your hand. We'll come around with the mic. Jamie and Brian, thanks so much for being here.
Thank you for having us.
For having us.
Let's start off with a couple of big-picture questions here.
Hey, Larry?
Yes. Oh, I'm sorry. Sorry, Brian.
Really quickly read off our forward-looking statement disclosure here. So comments made in today's meeting may be deemed to contain forward-looking statements. Actual results may differ materially from those expressed or implied as a result of certain risks and uncertainties. These risks and uncertainties are described in detail in our SEC filings, including our most recent 10-K and 10-Q. Investors are cautioned not to place undue reliance on such forward-looking statements. With that, Larry, I'll turn it over to you.
Thank you. Sorry about that.
Yeah. No, it's okay. It's good.
So, Jamie, how would you describe the operating environment today versus this time last year?
Yeah, if I look at two highlights in terms of positive changes. So staffing levels, particularly in the U.S. and particularly in nursing, look to have improved, particularly into the beginning of this year. And then I think we've seen patient flow, increased patient admissions into hospitals as patients kind of return to normalized healthcare routines, into diagnostic pipelines, and that kind of resulted in higher admissions and positively benefits da Vinci surgery, at least in the first half. I'd say the capital environment is relatively similar to a year ago. From our perspective, we see customers being cautious. They have constrained capital budgets. We see them tend to invest when they have growing programs, and they understand their economics pretty deeply.
And then there are two areas that we're watching that we called out on the last earnings call, developments in China, which many of you have asked us about today, and our second favorite question, developments in GLP-1s and the impact on bariatric surgery.
Okay. All right. Well, we'll thank you for that, and we'll get to all of that, I think, in this discussion. The first half procedures, you talked about good, you know, trends there with staffing and patients. 22% procedure growth in the second quarter, after 26% in the first quarter, and you raised your guidance to 20%-22% for the first, for the full year. What gave you the confidence to raise the guidance for the second time this year?
You know what? I'll take that. So, you're right, Q1, 26%, Q2, 22%. Midpoint, essentially 24%, right? I think as you're looking at the second half, you have a range of essentially 16%-20%, and it really contemplates a number of factors, right? It's really, you know, what's happening with the backlog. Clearly, there's been an elevated number of, I'd say, patients in the healthcare system. And taking into consideration, potentially the moderation of a backlog, right, in the second half. In addition to some assumptions on bariatrics, on growth rates in particular, and then also, macroeconomic challenges that could impact either hospital spending or patient spending.
One of the things that we've been calling out, in particular in the second half, is at the low end of the range for bariatrics in particular, you know, we're making an assumption that the growth rate continues to decline, right, from the second quarter. At the high end of the range, we're making an assumption that that growth rate just continues or stays at kind of the range that we saw in Q2. I think taking all those factors into consideration gives us the confidence in the 20%-22% procedure.
That's helpful. And the diagnostic pipeline running above pre-pandemic levels, how, how sustainable is that?
That's... It's hard to tell. It really is hard to tell. The data that we look at is a bit lagged. So if we look back to the second half of last year, it was a bit elevated. I think, but looking forward, it's really hard to know what's going to happen there.
Okay. So, Jamie, I mean, you've given a lot of color, helpful color on bariatric procedures in terms of your exposure to the ASP. We know, you know, approximately how many procedures are done and where the penetration is for robotics. So we can kind of back into, call it, about $200 million, it's about a $200 million, you know, business for you. Is that close, based on the numbers you've given us?
I'm going to let you do the math. I think you pointed out the things that we're comfortable disclosing, which is it's 4%-5% of global procedures and what the revenue I&A, ASP per procedure is. So I'll let you do the math. Sorry.
Okay. And in terms of, what impact, so what's the latest on what your expectations are for the impact of the GLP-1s short term and long term? I mean, you probably know, we did a survey. It was actually encouraging, even short term, even though I think it was encouraging overall. What else can you share with us on how you're thinking about GLP-1s and bariatric procedures?
Yeah, I'll tell you the process we went through. Our CMO is a currently practicing bariatric surgeon. We talked to bariatric KOLs in our customer base, and we obviously read a number of the research that's been done, including one today from one of your competitors, Larry. That called for a 20%-30% reduction in bariatric volumes in the short term. And so I think there's a lot of data points out there. Our essential conclusion at this point from Intuitive's perspective is, honestly, it's too early to tell. We think that there's likely some impact in the short term, as reflected in the guidance that Brian described.... And we see the same data as you all do. Recidivism, recidivism rates are relatively high.
Once you come off the drugs, you tend to put the weight back on. Once the weight goes back on, you can imagine patients still want to treat their obesity and come back to surgery pipelines. For longer-term impacts, we've seen analysis that says it could be complementary to bariatric surgery. We've also seen hypotheses that actually GLP-1s positively impact overall surgery volumes because lower BMI means you have more candidates for surgery that wouldn't otherwise have been. So for us, I think this is an area that we're going to watch carefully. It's an important market for us, obviously, but it's too early to tell what the longer-term impact is going to be.
The 20%-30% decline, without putting a finer point on the timing there, do you think that sounds reasonable, or do you think that sounds overly pessimistic?
Based on the market data that we've seen and what we see in our own numbers, that seems pessimistic to us. But we'll see.
And that was-
I think-
That's U.S. you're talking about?
U.S., and I just highlight that to show how varied the analysis is at this point between, you know, various sources as to what the impact may be.
Okay. Okay. Anything else on bariatric? You, you've gotten a lot of questions on this, I'm sure, today. Anything else, you want to highlight on it before we move on, that you think would be helpful for people?
No. I just reiterate it's an important market for us. We're watching it carefully, and, obviously, we'll provide updates on each earnings call as things progress.
But -20% to 30% down sounds overly pessimistic to you?
From our perspective, based on what we've seen so far, yes.
And why aren't you willing to say long term that it brings more patients in the funnel, that it's a net positive?
I think there's so much yet to develop in terms of new drugs, how patients react, what happens to drug supply, where does insurance coverage go for patients, given the high cost of the drugs? I think there's so many variables at play that you've got to see. Give those dynamics some time.
The 45%, 45% global procedures is what you said.
Yes.
Is that predominantly U.S., or is it, do you also have a significant amount outside the U.S.?
No, the vast majority is in the U.S.
Okay, thanks. You know, why don't we just cut to the chase and go to China?
Yeah.
It sounds like that's a good idea. You got a new quota a few months ago, a big quota, which is good news. But obviously, people are most focused right now, and then you have procedures recovering. I think you talked about on the second quarter call. Obviously, people are worried about the anti-corruption initiatives that we've heard about. How are you thinking about China at a high level?
Yeah, I think there's four risks that we've talked about extensively today, a couple of which we called out on the last earnings call. So we see some pricing pressure that's predominantly on Ion. We see increased competition, at least if we look back over the last year. There's now five local competitors. We see obviously increasing risks to the economy, and then there's the anti-corruption set of actions by the government. We see that as an activity that's going to last about a year. They're going to look at potential for corruption, particularly by decision-makers in hospitals that have procurement responsibility. There's the risk that that could be disruptive to administrative processes. What we've seen very recently is the start of delays to tenders that we are involved in.
So we expect that to have some modest impact to capital placements in China in the short term, and other companies have mentioned that they've seen the same. Obviously, there's a defined period for which this set of activities is going to occur, and you have a quota to fulfill, and so that just delays the time at which you'll be able to address that quota.
Okay. The pricing, is there anything, just to tick those off, anything new there? That was kind of, something I think you talked about on the Q2 call. I know you've talked about it before. Is there anything, anything new there?
There's nothing new. This started back in sometime last year, where we saw a couple of smaller provinces implement caps on the amount that a patient could pay for a procedure in China. Most of the da Vinci procedures in China are paid for by the patient, and so the risk there is really the potential for other provinces to adopt that same cap on patient pay. And so our response in that situation is likely to be to adjust our pricing.
No, but those provinces only represent, don't represent a big part of your business there.
Those that have adopted that so far, that's right.
Jamie, remind us again how much, China represents to you. I think you've said 5% of procedures?
5%-6%, yeah.
Okay. And the anti-corruption, you think it's going to last a year? What, what-
The set of activities government will do will last about a year, yes. The impact or disruption to tender processes, likely shorter than that, but we'll see.
Do you think this is just if there? You talked about some capital being impacted short term. Is this something where it's a delay and/or could there be lost sales? In other words, if it's delayed from third quarter, maybe it's pushed into fourth or first quarter.
The view of our team at this point is it's a delay.
Okay. So if there is, and if there's an impact, could you, would you call that out? Would you be able to quantify it in an earnings call, how much you think it impacted your business?
Certainly, we'll consider that. It obviously depends on, on the significance of it. If you look at recent placements in, in China, it's in the 15%-ish systems per quarter. So that gives you kind of the scope of what a delay might be, and not all of them obviously are going to be delayed. So it's, it's not a large number with respect to total placements, but we felt like given the dynamics in China, it was worth referencing today since our teams have, have recently said they've started to see delays in tender processes.
The five competitors, there's a couple more. I knew there were some new competitors there. When we look at the old quotas, you—I, I don't know if you know the percent or can disclose it, but I assume you've gotten a high percent of prior quotas. Now you've got a big one, 559%, I believe. How—how are you thinking about your ability to capture your, you know, what, your, that quota?
We believe that given preferences for local champion or local manufacturers, they will win some portion of that quota. They've already got a handful of systems. But we know that surgeons, users care about capability, feature set, clinical performance for the robotic systems, and we believe we're significantly differentiated both on the robotic perspective and for the ecosystem. And so, our objective would be to win the significant majority of the quota, but we'll see how that plays out.
Anything on the macro side? You mentioned, you know, four risks there. Anything, you know, on the macro side that could impact your business?
Yeah. It's a relatively low risk currently. Maybe the risk is growing over time, but the risk is really that the economy in China gets to a point where the central government starts to cut budgets, and that impacts hospitals' ability to buy systems under the quota.
Okay. So if we think about these, you talked about some tailwinds and some headwinds at the beginning of your remarks. The bariatric concern is not new, and that was factored into your guidance. I heard you at least say you don't think it's going to be as bad as negative 20%-30%, but I don't know what the high and low end of your guidance assumed. I mean, did you assume that bariatric procedures turned negative within your guidance, or what more can you say?
No, it's similar to what I was saying before, within our guidance, it's really does bariatrics stay, or do we have a similar experience to what we saw in Q2? Excuse me. Or which would essentially be at the high end of the range and at the low end of the range, assuming that it continues to moderate, kind of what we've seen...
Right.
... between, say, Q1 to Q2 into the second half.
Right.
And so that, that's really what's assumed there.
On China, I only heard you talk about capital. It doesn't sound like you think it will impact procedures, the anti-corruption initiative.
Yeah. At this point, our team does not, does not anticipate an impact to procedures.
Okay. We saw, at least through Q2, procedure growth recover in China.
Yeah. Q2 growth was strong. Part of that was on a soft comp, and part of that was recovery. But yes, it was strong.
Okay. Okay. I mean, I think, is there anything else you guys want to add on those, those two? I'm sure you've gotten a lot of questions from investors on it. Is there anything you feel that's pertinent that I didn't ask?
No, I think we covered it.
Okay. We can get back to the other stuff. So I mean, the capital equipment environment, it sounds like it's relatively stable. Is that fair?
Yeah.
In general, outside of China.
Yeah, that's fair.
Okay. And the interesting thing we saw was system utilization growth, you know, 9% in Q2, and I think it was like 13% in Q1. So that was a difference. And that is something you guys... an important metric because you talk about mid-single digit utilization growth to help us model capital placements. What do you think happens, Jamie, with utilization?
Yeah. If I go back to the first half, a large driver within that, significant utilization numbers you just referenced is the procedure growth itself. 26% and 22% are above long-term trends, and what you see reflected in there is hospitals responding to patient backlog, given they have better staffing. And for some hospitals, they actually adjusted their protocols so that they could increase capacity to deal with the backlog. And so we think that is a driver, particularly in a constrained capital environment. They're maximizing throughput on the assets that they have. And if you look at kind of the procedure trajectory, it's 22%, 26% in Q1, 22% in Q2. Second half decelerates again to 18% in the midpoint. And so we don't think that utilization continues at the 9%, say, we saw in Q2.
At some point, as you work through the backlog, as you get more normalized procedure growth rates, then you'll see utilization normalize. We don't know when the backlog is resolved. We don't have a good estimate of how much that is and when it resolves. We do think that the procedure mix had an impact in the first half, higher mix of short-duration, benign procedures. We think that continues, given the remaining opportunity and the way that we expect those procedures to grow. And so utilization could settle a little above the long-term historical average.
Okay. You know, bariatric has been a big growth driver for you in the U.S., bariatric procedures. What else is, you know, driving strong growth? If people are sitting there worried, well, bariatric is going to slow, I don't know how much, because of GLP-1s. What can make up for that? What other procedures are, you know, driving strong growth for you?
In the U.S., it's cholecystectomy, hernia repair. Those have been strong procedure categories for us for some time. We see decent growth in colon procedures, an opportunity to take that procedure growth up if we can improve our commercial execution there. And then there's the other general surgery bucket contains HPB procedures, liver and pancreas, foregut procedures, hiatal hernia. As an aggregate bucket of procedures, it's a number of procedures, but the growth rate there has also been quite nice, and so there's an opportunity for us to continue to drive that.
Okay. And I know I'm jumping around here, but leasing, I remember, was really strong for you in Q2. How do you see? That's correct, right, in the US? Yeah.
Yeah.
How do you see that playing out?
While it may fluctuate from period to period, we expect it to continue to climb as it has done for some time now, reflecting customer preference, constrained capital environments, and to some extent, as we said in the Q2 call, customers that, like investors, are wondering when the next system may be. They're using leases because of the technology obsolescence clauses that they contain to protect them from a big capital investment versus entering into a lease arrangement where they have the right to upgrade.
So Jamie, one question I've gotten is, when there is another upgrade cycle, a new system, if a lot of these. If, what's the benefit to Intuitive if most of these, the installed base is under a lease, or the ones that are under a lease and someone upgrades, what are the implications for Intuitive? You follow? If the customers own it and then they upgrade, we understand the economics for you, that's pretty clear. But if someone has, if someone's leasing a system and they want to upgrade, what are the economics for Intuitive?
Yeah. So the technology obsolescence clause gives them the right to negotiate an upgrade. That clause does not have any specified pricing in it because you're not able to, since the feature set of any next-generation system is unknown. If they were to exercise that clause, the lease stream for the current system then ends, and they enter into a new lease. The amount they're paying for that lease depends on where that next system is positioned with respect to price, so it may or may not be a higher lease rate. 83% of our revenue today now is recurring. That's been growing over time. What comes with that is, in any upgrade cycle, more of your revenue is now, when it's through a lease transaction, recognized over time versus in the period of the trade-in.
Okay. That's, that's helpful.
But what the lease arrangement does is it allows customers to make the upgrade decision more easily. They're not having to fork out the upfront purchase price, net net of the trade-in credit. They don't have to consume their capital budget to execute that trade-in transaction. So it could be that customers have the opportunity to upgrade more quickly than they otherwise would. We'll see.
That's helpful. For instruments and accessories, you recently implemented a price increase of about 5% in the middle of the second quarter, I think. You talked about how far along that was on the second quarter call, I believe. How has this been received by customers? Has there been any pushback? They're never happy to get a price increase.
Yeah.
But how has that generally been received?
They are not surprised, not particularly happy. They understand the rationale. They've had a number, generally had a number of suppliers that have done a price increase. We're largely fully executed, and I think we're in a place where customers have accepted the price increase and moved on.
Okay. And believe it or not, I actually feel like I gotta go back to one thing on China. The 15% per quarter, you talked about there could be some short-term disruption there in terms of the tender process. And the duration of that, I can't remember if you mentioned if that's the year or how long you think that disruption might go on.
Yeah, I said I think it's less than a year. That's based on the best inputs our team have at this point. They're obviously predicting how this may play out, but I don't think the disruption occurs for the entire period the government is executing their activities.
I got it. Thanks. I apologize for jumping around, but back to procedures and INA. How are you thinking about capturing more of the economics related to the procedure? So there's some procedures use other companies' technology, so for example, you know, smoke evacuation and insufflator products. Are you guys thinking about being able to... How are you thinking about capturing more of the economics?
Yeah, so I'm not gonna make specific reference to smoke evacuation or insufflation, but I'll describe the process, the way we think about it. So we believe the ecosystem is the basis of competition, and we think we have a wide moat with respect to the comprehensiveness and capability in our ecosystem. When we think about adding to the ecosystem, first question is: Can we be differentiated relative to the alternative? And if we can, second question is: What return can we generate by developing that ourselves? If we can be differentiated and generate a return, then we'll... we would put it in our R&D pipeline and stack it up in terms of relative priority. If we can't be differentiated, then we'd look to partner.
Okay. Okay, and no comment on that specific area?
Not at this point.
Okay. Okay. I mean, I guess there is a company out there, a public company, that says, I think they've said that they... I guess they haven't said if it's you, but they've talked about, you know, a product in that area, partnered with a robotic platform. I guess what we don't know is who the robotic platform is. Is that correct? You don't. I mean, okay. You mean, no, it's Novanta-
Right.
but you, you can't comment on that.
Yeah, we're not gonna comment on it at this point.
Okay. Okay, fair, fair enough. So just moving on here, and I, I'll scan the room in case I'm missing something here. Cool. P&L?
Yep.
You're still the CFO, right?
I am.
Okay. So you've talked about, Jamie, top-tier margins between 35%-40% over time. How should we be thinking about the timeline to achieve, you know, those goals, and expectations, any expectations to return to pre-COVID levels?
Yeah, so framing last year, we did about 35% gross margin. Q2 just passed, we did 35% gross margin, and we've said that we don't have a management objective to be above 40%, so that's kind of the range that you referenced, Larry. In the nearer term, we think gross margin is choppy. We have a set of accumulated stresses from the pandemic that's kind of in our global operations, impacting gross margin. We have some work to do with respect to the product cost structure in Ion. Gross margins there are dilutive to corporate averages. So that set of activities within gross margin is impacting obviously operating margin, and that will take us some time to work through. We do have significant CapEx this year that will turn into depreciation next year.
Those are longer-term investments, particularly for facilities and manufacturing capacity, so they have a period of underutilization with respect to that depreciation expense. We expect to leverage our enabling functions next year. We start to see the benefit of the activities we described in Q2, and we should see the benefit of that in the remainder of the year. So we have an expectation that we can get to gross margins of 70% over time, and then we can have operating margins above 35% over time. Not ready to put a timeline on it, in part because of the environment we find ourselves in and the set of activities and actions that we have to execute. But we have a management commitment to, at some point, be above 35%.
Jamie, you talked about prototype costs on the Q2 call. People have obviously gone back and looked kind of historically, you know, when prototype costs have gone up and what that means in terms of timelines for new systems. Is there anything you can say about kind of, you know, precedents, and is it reasonable to look at precedents, or every situation is different?
Yeah, I would not look at precedents. Obviously, we have now three platforms, and we have other elements of the ecosystem beyond just robotics, and so I wouldn't make any directional linkages between that commentary on prototype expenses and any next-gen system.
Anything to think about for next year, headwinds, tailwinds, that we should be cognizant of?
Well, I think, I think overall growth drivers will be consistent. It's general surgery in the U.S., it's going beyond urology in our international markets, and then it's our newer platforms, Ion and SP. I think those growth drivers remain consistent. We will see the incremental depreciation that I described, and we will look to leverage our enabling functions, and we're watching carefully the risks we've described in China and in bariatrics.
And, Ion and SP we didn't touch on. SP continue, I mean, Ion, I'm sorry, continues to do very well. You know, you give us the system placements. You're also, I think, giving us now the procedure numbers.
Yep.
What's the outlook for Ion, especially outside the U.S., where you're just starting to launch?
Yeah, I think if you look at Ion performance today, it's really a function of three things, the clinical differentiation with respect to diagnostic yield and rates of pneumothorax. Second is the Intuitive ecosystem and our brand in robotics, and third is commercial execution. Our teams have done really well with respect to Ion. It's a dedicated commercial team. We placed our first system in Europe last quarter, as you know. That's gonna be a measured kind of rollout. We need to build clinical and economic evidence in Europe, and that is gonna be market by market. So I wouldn't expect that to be a significant ramp. We have to take the time to build the evidence.
Reimbursements in Europe for a lung cancer biopsy are about half the rate of the U.S., and so we have work to do there to position that product for wide adoption.
How far is China away? I mean, part of the rationale for doing it was a big opportunity in China. You have a joint venture there.
So we have, we're in regulatory submission for Ion in both China and Korea. China's in the Green Channel process for Ion. We don't have a specific timeline. Regulatory timelines in China are the longest in the world. We wouldn't expect a clearance in either of those markets this year.
Okay, and SP, you know, it's done well in some international markets, a little slow in the US. What gets that going?
It's really geographical clearances and additional clinical indications. And so you have SP submitted in Europe, recently cleared in Japan. We're working on China. We've completed the IDE in the U.S. for thoracic and for colorectal, have not yet submitted 510(k), but those are all effectively licensed to sell.
Colorectal and thoracic...
Yes.
-completed but not submitted in the U.S.?
That's right.
Which one do you think is the bigger opportunity for SP?
With respect to clinical value, likely, thoracic. Colorectal or colon will be a trans-abdominal procedure. Our value prop for SP is narrow access or alternative access. And, the way you would use SP in a colon procedure as cleared, would be conventional extraction surgery. So if you could do that procedure transanally, which is something that we're looking at, you get to leverage the, a natural orifice. You could see value there, but that's something over time, not in the plan today.
Jamie, anything new outside the U.S., from a competition standpoint, excluding China, any themes you can share, and how does that vary by geography?
Yeah, we see two players, active intenders in Europe, and India, and a local player in Japan. If I kind of take a one-year view, win rates are relatively consistent, and we're pleased with what our win rates are. We think that we do have differentiation that's relatively significant, including the ecosystem. They don't have advanced instruments, for example. The large company is obviously highly capable from a marketing perspective. They have significant presence in a number of accounts, but I think that we're well positioned, and the fact that we have X and Xi, SP, I think positions us well from a segmentation perspective.
The partnership between J&J and CMR, what are you seeing from that?
Nothing that I would highlight at this point.
Okay.
There's no commentary from our commercial team in terms of an impact there.
We're at the two-minute mark. Jamie, I wanted to just give you the last word here. Any closing comments? Anything we didn't cover that you wanted to highlight?
No. I just thank you all for your time and attention, and appreciate your support. I know we had a lot of questions on China and bariatrics. I think, for us, we're excited about the medium and long-term future, and we think the opportunity is significant. We do have a focus on operating margin, which many of you have asked about. And I'd ask you to be patient. That's going to take us some time.
All right. Thank you very much for being here.
Thank you.