Intuitive Surgical, Inc. (ISRG) Earnings Call Transcript & Summary

Thank you, everyone, for joining us today for the Morgan Stanley Healthcare Conference. I'm Drew Ranieri, one of the medical device analysts here. From Intuitive Surgical, I'm excited to have SVP of Finance, Jamie Samath; and Phil Kim, Head of IR, joining us today for a fireside chat. Before we jump into it, just a quick disclosure on our end for important disclosures. Please see morganstanley.com/researchdisclosures for facts about me. And if you have any questions, please reach out to your Morgan Stanley sales representative. I'm going to turn it over to Phil for just a quick disclosure on their end.

Thanks, Drew. Before we get started, I'd like to mention that comments made this morning 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, which are described in detail in our SEC filings. Investors are cautioned not to place undue reliance on such forward-looking statements. Thanks.

Thanks, Phil. And with that, Jamie, thanks for your time here today. Really appreciate Intuitive's participation in the conference again this year and looking forward to the discussion. But maybe just to start on Delta and the impact again. I know last week, Marshall discussed the Delta impact having an effect on regional hospital resources. I know we probably won't break too much new ground here, but just maybe coming at this at a slightly different angle. Maybe just help us better appreciate or better understand kind of what procedures are potentially seeing more outsized impact versus another. And just maybe parse out any key trends among procedure categories.

Yes. First, I'd say, Drew, thank you for having us. I really appreciate the opportunity to meet with you and the participants today. Yes. So what I would say is maybe just to reiterate a couple of things that Marshall said. So all of you have seen the resurgence of COVID caused by the Delta variant, and that has had a significant impact in certain regions, and that, in turn, impacts hospital resources, particularly over the last month or so. We do see that more pronounced in the South in states like Texas, Florida, Louisiana. And so as they start to consume hospital resources, you see indications that elective procedures, in particular, are getting delayed. And when hospitals, counties or states take actions where they delay elective procedures, then that's going to have an impact on da Vinci procedures in turn in that location. And so the elective procedures most likely to be deferred include hernia repair, cholecystectomy, benign hysterectomy, so the benign procedure set. And actually, if you recall back in Q2, one of the things that we saw last quarter was the benign procedures were particularly strong. And that was, we think, in large part a function of previously accumulated procedures that have been deferred through December, January, February that accumulated. And as the impact of COVID waned in March and into Q2, we saw customers recover those procedures pretty quickly. And so now you kind of see the opposite effect potentially in, again, those locations where we see consumption of hospital resources be impacted by the Delta variant.

Got it. And with -- not to pick on words, but with -- the guidance for a moment did not assume significant COVID disruptions, and Marshall noted there has been significant impact on hospital resources. So should investors now be thinking kind of the full year procedure growth guidance of 27% to 30%, we should be thinking at the lower end of that or sub 27%?

Yes. We don't have any specific comments on the actual impact at this point. And I think that's simply a function of the fact that the impact of the resurgence, which, as I said, is regionalized, is difficult to predict at this point. We -- it's difficult to predict, both the degree and the duration of that impact. So I think it best wait until we get to the Q3 earnings call. But no specific comments with respect to the guidance we provided on Q2 at this point. It's just too early.

And just one of your competitors -- or Stryker noted that there's some geographic areas that might be hitting peaks at this point. But does your data show any suggestion of that?

Yes. I guess I don't want to give any particular intra-quarter input. I think we see the same external models that you all can see. I think that if you look at those models in terms of case rates, consumption of hospital resources, in terms of forward-looking projections, there's a pretty wide range of scenarios, and that's one of the reasons why it's actually pretty difficult to estimate both the duration and degree of impact. Just what's going to happen from here is pretty wide in terms of predictions.

And then when you were touching on benign for a moment and the strong second quarter results, that was kind of a recovery rebound from prior procedures. And is there any reason to expect that we wouldn't expect as quick of a rebound maybe in the fourth quarter or early 2022, depending on the duration of Delta.

Yes. I would refer back to our historical experience. And so in previous waves, what you saw as COVID waned and as consumption of hospital resources declined, we actually saw customers recover surgery pretty quickly. There's nothing that I would point out that would structurally cause anything different than that.

Okay. And just we touched on the procedure side. Maybe we move over to supply for a moment and the impact. But just I think Marshall has had hand-to-hand combat on some of his prepared -- or some of his remarks last week at another conference. But can you just maybe help us better understand what you're seeing from supply constraints? Are you seeing more of an impact maybe on console or instruments? Is it still manageable at this point? Or has it become even more of a risk?

Yes. So as you know, supply chains have been constrained, particularly for products like semiconductors. What we said on the Q2 call was that lead times have extended and actually, even delivery performance from our suppliers had gone a little worse. That had not impacted through Q2 our ability to fulfill demand for customers. The environment is dynamic. It's challenging. And I think at this point, we're calling it out as a risk that customers -- suppliers rather may not be able to fulfill the needs that we have. We also see the risk that component costs could go up. We have seen an impact on freight costs as a function of logistics, routes and expedite fees. Freight is a relatively small component of our cost of sales. But I think at this point, we're calling it out as a risk just because of how dynamic the environment has been. Our supply chain teams have done a fabulous job, frankly, in terms of managing through the environment. And I think when Marshall refers to it as hand-to-hand combat, it's every week that we're dealing with various challenges within the supply chain.

So it doesn't necessarily sound like -- that the supply disruptions have impacted the top line and that at least on the bottom line, it's at this point a risk but manageable.

I think that's true through Q2. I think that the environment is pretty dynamic and we're just calling ours a risk.

Okay. And maybe moving to procedures and for a moment away from COVID. But Marshall, Gary and the Intuitive team has talked about diagnostic trends for procedures with longer diagnostic pipelines. Have you continued to see a return to normalized levels? Or are you now also seeing kind of another wave of diagnostic impacts?

Yes. So we had seen the diagnostic pipelines in the U.S. Think PSA tests for prostate cancer, colonoscopy for colorectal cancer. We have seen the testing volumes. We experienced year-over-year declines through February. In March, the market data we had saw that, that started to recover. We don't have any actually updated data points since our comments in July. In certain regions where you see high case rates and high levels of COVID-related hospitalizations, it's probably reasonable to assume that diagnostic testing could be impacted. Hospitals are going to be focused on managing through COVID and patients once again could put off clinic visits. We don't have evidence at that point. I think we would look to the Q3 earnings call to provide an update on what we see happening to U.S. diagnostic pipelines. But given the Delta variant and other potential variants, it's probably too early to predict when that starts to normalize.

Home procedures looking maybe longer term. I mean I think you were doing about 16.5% absent the pandemic or just over 2019 levels. I mean is this kind of the right midterm growth rate that we should be thinking about for worldwide procedures? Have you seen the pandemic really kind of accelerate the use of da Vinci and ultimately, procedures at large?

We don't provide longer-term procedure growth guidance. We'll give our updated views on '22 on our January call. Last quarter, we grew -- Q2 '21, we grew on a 2-year compound annual growth rate basis the 16.5% that you referenced. In part, we provided that in our commentary just because the year-over-year comparisons are distorted by the impact of COVID, particularly given the impact Q2 a year ago. Absent COVID, there's nothing structural that I would point to that has changed. To the question of whether the pandemic has accelerated adoption of da Vinci surgery, during the pandemic, we've seen some customers recognize the importance of high-quality minimally invasive care, particularly as it relates to length of stay. We've also seen customers' willingness to make capital investments, both to standardize on our fourth-gen technology and to expand capacity. And if I look back at Q4, Q1, Q2, the capital demand was actually a little higher than we expected in part maybe because of the funding available from the CARES Act and in part because customers were investing for a post-COVID environment, we think. That having all been said, given all the moving pieces and the significance of the impact of COVID, it's frankly difficult to conclude whether the pandemic itself has broadly accelerated the adoption of robotics. From our perspective, we continue to believe in the long-term opportunity. We think it's substantial, and you'll see us invest accordingly.

Okay. Got it. And with just the extended use program, you've talked about I&A revenue per procedure coming down over time. Just can you give any more detail there on maybe what you're seeing from demand elasticity? Are you seeing a step-up in demand and procedures relative to the extended use program or any pricing adjustments? Or is it still kind of too early to tell and we're masked here in COVID?

Yes. So we believe there is price elasticity, particularly in markets where reimbursements are low. There are some early indications that the extended use program in combination with our fourth-gen ecosystem lowers barriers to system access, and that's one of the important feedback items we've received from surgeons. The system access is a key driver for increased procedures for them. But I think that that's a combination of effects. So it's extended use instruments, it's access to our advanced instrument portfolio, it's the other benefits of the fourth-gen ecosystem working together. If I look at Q2, what we called out was particular strength in the benign procedures in the U.S., chole, hernia repair, benign hysterectomy, bariatrics. But if you look up actual data points there, many -- much of that strength looks to be procedures that are accumulated through December, January, February during that wave of COVID. And as COVID improved thereafter, we saw a catch-up in Q2. And so you look at that data set, it's hard to actually discern then the degree to which that's an elasticity response versus a backlog catch-up. And so it's too early just because of the confounding effects of COVID.

Got it. Got it. And just in terms of kind of the global rollout, U.S. has officially rolled. Out Europe, it sounds like it's progressing. But just to touch on China for a moment, kind of what are the time lines there? I know it's a longer regulatory environment, but can you put any goalpost out there for when you could have the full bag?

Yes. Let me let Philip weigh in. I think, Philip, you have the time line for China.

Yes. We used to think of it in the back half of next year.

Okay. Got it. And just with some of the procedures that you called out on recent calls that are growth opportunities, bariatric, chole and hernia, just wondering if you can give an update about where you are, what inning you're in, in terms of penetrating those 3 categories. Just where are we in penetration? You probably won't give where we're going. But I mean, do these fully evolve into robotic standard of care type procedures?

Yes. So within the U.S., we still characterize the opportunity within general surgery as early to mid-innings in terms of growth. So procedure categories like hernia that you talked about, bariatrics, we characterize as early to mid innings. But cholecystectomy, it's hard to predict exactly. It's highly lap penetrated. Ultimately, what percentage of these procedures will be done robotically, but we do think there's more growth opportunity there. For -- from an OUS standpoint, depending upon the geography, you have to look geography by geography, but there are broad opportunities for growth in thoracic, gynecology and general surgery.

Got it. Just looking at Intuitive's history and the ability to eventually convert a procedure to a standard of care on robotics, I mean, is there one procedure or a couple of procedures that you highlight that are -- have more potential than others to eventually become standard or care?

I wouldn't use the phrase. Go ahead.

No. Go ahead, Philip.

I wouldn't use the phrase standard of care, but I would say that each procedure category has an S curve of adoption that we've worked hard to drive working with KOLs and working with building the reimbursement and the clinical evidence within each procedure category. And within general surgery, each of the procedures that we just talked about, hernia, bariatrics and chole, still have significant opportunity for growth.

Look, it's a combination of a couple of factors, Drew. So it's the degree of laparoscopic penetration, the relative clinical differentiation that da Vinci has procedure-by-procedure and the economic characteristics. Where it's highly laparoscopic-penetrated like cholecystectomy as an example, then I think it becomes more challenging to estimate because you have to segment the market to understand what is ultimately robotically addressable, and that can change over time as you refine your product as you are able to execute what we call the virtuous cycle in terms of the economic attractiveness of our offering. And so to say standard of care for every surgery that's done for a procedure can be challenging. So what we focus on is what portion of what's addressable can we attain over time, and that's kind of how we model our S curves.

That's helpful. Maybe let's move over to capital for a moment. But Jamie, as you kind of pointed out, capital has been surprisingly strong in the first half of the year, even above your expectations. With Delta, you're calling out pressures on the procedure environment. And should we be expecting -- or are you seeing another period of kind of troubled hospital financing? Is it just too early to tell that at this point?

Yes. I mean, as you know, Drew, we don't give capital guidance. And certainly, we're not going to give any intra-quarter comments. I think if I reflect on the last 3 quarters of capital strength, what you're seeing is existing customers, particularly larger IDNs, reinvest. We've seen a number of multisystem deals. We see customers, particularly in the U.S., look to standardize on fourth-generation technology that's driven some of the trade-in numbers that we've seen. And then I think we've seen hospitals generally be financially better off even through a tricky period. Part of that may be a function of CARES Act funding. But part of that is, we think, customers investing for a post-COVID environment. And so no specific comments on Q3 capital environment, but those are some of the factors that drove the last couple of quarters.

And then just looking internationally for a moment, I mean, can you point to a few geographies that maybe you're more optimistic in or optimistic about longer term just on the capital side?

Yes. I mean our larger U.S. markets where we are direct are China, Japan, South Korea, Germany, France and the U.K. And then we serve Italy through a distributor. What we've seen in those markets to some extent is, as you might expect, the relative impact on recovery from each of the waves of COVID, but also how the local authorities react to COVID. So for example, in Japan, you see a relatively conservative set of measures put in place in local regions. And they do that quickly as they see tick-ups in COVID, and that can obviously affect how customers invest. If I look on a long-term view, China is an attractive market to us. It's large. It's underpenetrated, but it's restrained by COVID. As I think you know, Japan is a market where we've received a number of new reimbursements for procedures over the last several years. And we're relatively early in those new procedures, and that presents an opportunity for us. Korea has done well and has a broad set of procedures that have grown. They have demonstrated interest in SP, which has been used in a broad set of procedures. Europe is a little more cost-conscious. One of the reasons why we brought the X platform to Europe and some of the decisions we made with respect to the extended use instruments program reflected some of the cost-conscious challenges we see in Europe. So that will be how I would characterize our OUS situation at this point.

And just with capital again for a moment. Just in terms of the leasing programs and trade-ins, kind of what are -- what should we be kind of looking at? I know there's a limited number, a finite number of SIs remaining in the field. But how should we kind of think about maybe that progression over time and again, on leases?

Yes. With respect to leases, you -- while it fluctuates from quarter to quarter, you've seen the kind of medium-term trend for a greater proportion of our placements to be under a lease structure. We've seen that increase U.S. and in those OUS markets where we offer leasing. And it's really around us having options to match the financial objectives of our customers with some degree of flexibility. That gives customers optionality to expand their robotics programs more quickly without the constraints of capital budgets and also in conjunction with our X platform, gives customers that much more cost-conscious options to place da Vinci programs. And so it will fluctuate from quarter to quarter, but we do expect the long-term trend, at least for leasing, to be -- to continue to trend upwards. With respect to trading cycle, that's been a tailwind for us over the last year or 2. A significant portion of those trade-ins have been driven by the U.S. We have just under 1,200 SIs in the installed base as of the end of Q2, of which about 600 are in the U.S. And so as that installed base continues to decline in the U.S., then that, at some point, becomes a headwind to overall placements just because you'll be doing a lower proportion.

And just in terms of thinking about a next-generation system, I mean, it seems like FDA has over time meaningfully raised the bar for robotics. I mean does this change in any way your thoughts of introducing a new generation -- or next-generation system? Or would that be more tied to what the competitive landscape looks like down the road? I guess at this point, too, I mean, is it more important to differentiate Intuitive and the ecosystem through data and analytics? Or is hardware or next-generation hardware platform still going to be a critical component?

Yes. A couple of thoughts, maybe. So just for context, regulatory pathways have lengthened in key markets globally, and that does increase the time and cost to develop and introduce products to the marketplace. In particular, we see increased clinical data requirements. Our overall approach to product development and commercial launches continue to be driven by our core mission, as we said many times, to help hospitals achieve the quadruple aim. So we're focused on developing differentiated technology that improves clinical outcomes for patients and also focused, though, on lowering total cost to treat per patient episode. Those are core objectives for the company. And so I don't think that's specifically or directly impacted by the trade-in cycle dynamics that we've described. From a competitive perspective, we believe that we compete on an ecosystem level versus robot-to-robot. And you see that actually reflected in how the Xi platform was since launch back in 2014 with how we've enhanced that with advanced instruments and some of the other capabilities that have improved that platform as a whole. And so I think what we're driven by in terms of our overall kind of development activities and the associated timing is how do we compete on a differentiated basis in the marketplace.

And let's maybe go to some of the newer systems just with some of our remaining time here, but on SP and Ion. Maybe we'll start with Ion. But I mean, at this point, our operations and supply scaled up for Intuitive really to go on the offensive and diagnostic bronchoscopy.

Yes. So we're pleased with our progress that we've made on Ion. Clinical results have been positive and usage is expanding. As you know, in our last conference call, there were -- we talked about in the quarter, there were nearly 1,500 procedures that were performed and replaced 20 systems. But with regard to the ramp, we're setting the expectation that you should -- investors should think of it as steady sequential growth rather than any step function type of change. You've heard us say this before, but our focus is really on developing clinical experience, which we're doing through the PRECISE trial and refining pathways and our supply chain for the U.S. market.

So I think you did about 20 Ions last quarter. Is that kind of the right way to think about gradual?

Yes. I wouldn't guide you to a specific number or a quarter, but we're really focused on just driving the clinical experience.

And kind of what's -- has there been any change to PRECISE readout timing?

We've pointed people to the back half of next year for a final readout, and I think that's the right way to think about it from a timing standpoint.

Okay. And then with SP for a moment, just anything new on time lines or clinical trials? Any goalposts that you put around those?

Yes. No set time lines that we'd give you with respect to the SP colorectal trial. We talked about on the quarter how we completed our first cases, and that will play out through several next quarters as rolling through the trial. It's obviously a cancer procedure so there's follow-up, but nothing specific to provide for you today. Bigger picture, we think there's a lot of value with SP. We think SP brings differentiated value in applications where there's a tight parallel path of entry. And so you see that in TORS, you see that in colorectal, we talked about focusing on thoracic in the future. So there's a pathway for growth here. We're just going to continue to invest in various indications.

When can we maybe see an update or time line for the European opportunity? You're in Korea now. U.S. obviously, but what about Europe?

Yes. So with respect to Europe, we shared that we're working on regulatory filings, and it's under the EU's new medical device regulation framework. We don't have a good estimate for the clearance time line, but it's likely to be beyond 2022.

And just lastly on SP. I think you commented last quarter there's potential new instrumentation coming against energy and stapling. And should we be thinking that's also kind of a 2022 time frame? Or could that be even longer term?

Yes. Customers are asking us for advanced instrumentation, including energy and stapling instruments. We think we can bring some real value to customers and invest in the capabilities necessary to drive adoption. So for competitive reasons, we're not disclosing time lines at this time, but we continue to invest in advanced instrumentation and imaging capabilities and really building out the broader ecosystem for SP.

It looks like we hit the top of our time here. So Jamie and Phil, really appreciate the time today for the session. Thanks so much.

Thank you, Drew. Really appreciate the time.