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

Hey, everybody. I'm Travis Steed, medical device analyst at Bank of America Merrill Lynch, or Bank of America Securities now. And welcome, Calvin Darling and Brian King, Investor Relations, Intuitive Surgical. If you want to start with an opening statement?

Thanks, Travis. Thanks, everyone, for being with us today. It really is a pleasure to be live and in person with everyone here at this event. Thanks for being here. Before we get started, I'd like to mention that comments mentioned today 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. Investors are cautioned to place -- not to place undue reliance on such forward-looking statements.

Great. I guess I wanted to start, a lot of things to talk about here, but start with the Q1 procedure growth. I think it surprised everyone how strong it was. Trying to get a sense for how much of that strength came in March and some of the trends in April and into May as have you seen the recovery happen and play out.

As you think of our business and really the procedures are at the core of what we're trying to accomplish here. We had 19% procedure growth in the first quarter, which frankly exceeded our expectations. Particularly when you think about where we were with Omicron in the beginning of the quarter in January as we reported our year-end results. We saw the Omicron cases wane and hospitalizations declined during the quarter. And as the hospitalizations declined, we saw a very strong rebound in da Vinci procedure performed, which is kind of the pattern we've seen with other COVID waves. But it was -- we felt it was very encouraging to see how quickly the cases came back during the first quarter.

Yes. And when you think about like April into May, just from a high level, have you seen that pressure from COVID continuing to release and things will continue to improve? Or was March going to come back to where -- more normalized levels?

I think you got to get back again to the hospitalization rates. And so far, at least in the U.S., hospitalization rates have remained pretty moderate, similar to how we ended the quarter. So that's a favorable environment for continued procedures being performed. Now you take a look around the globe. And of course, there are other areas of the world where there are outbreaks. Specifically, you look into China, Korea, other areas of the world where there have been localized slowdown or shutdowns in their economies, which have affected procedures in these areas. Specifically China, about 5% of our worldwide procedures are performed there.

Is China growing roughly 2x in a normalized environment?

Well, China is a very important market for us. As I mentioned, it's about 5% of our worldwide procedures. As we continue to place systems in China related to our quota, that expands the capacity and those systems are used significantly more in terms of the utilization rates as we see in U.S. and other areas of the world. So the growth rates in China are significantly above the OUS overall rates and the U.S. rates, yes.

Sure. When you look at the Street modeling 11% procedure growth, you've got a tough comp going from 19% down to 11%, tough comp. You have the China impact in the quarter. I'm just trying to -- did the Street get the message on Q2 and procedures?

You look forward into Q2, and it is a tougher comp. You look back to Q2 of 2021, and that was a particularly strong quarter. You look at the utilization, there was -- there was a recovery in that order, I think for some of the cases that were deferred during the first year of the pandemic as we were fairly open in Q2 of 2021 for the first time. That becomes the basis of comparison. Now you do have the issues that we're facing in certain areas of the world, with China and so on. So it becomes a tough comp when we're talking to investors and others who may be looking at what to expect. I think the best strategy is really to calibrate the procedure expectations, not so much with a year-over-year growth rate, but with a rate of utilization per system in the field that would be reasonable on a seasonal basis from year to year.

Okay. Sounds like Q1 is probably not going to be quite as -- not going to be 19% again, though, that's fair to say, but probably could be 11% to 12%.

No, I think if you're looking at our full year guidance, what we took up on the last call from 11% to 15% to 12% to 16% that particular rate, the implications there, if you balance it out by quarter with normal seasonality, you're not going to get to 19%.

Right. Okay. Fair. And then on the CapEx environment, I think there were some new comments from -- definitely some new comments from you guys on the CapEx environment, which have had a lot of investors concerned. Kind of came out on a bad day when there was some other news that came out as well. So a little bit more of a reaction maybe than you've expected. But when you think about -- like you mentioned more of the funnel, where it wasn't a slowdown in the CapEx environment yet, but more -- the funnel would slow down a little bit into the quarter. How has that funnel played out? Are you seeing a little bit of a pickup as some of the macro stuff, maybe like the war in Ukraine, has kind of gotten not as new anymore? Like have you seen the hospitals at least sit down and open up to being more interested in capital?

I wouldn't say that they're not interested in capital necessarily. I do think Gary wanted to really emphasize sort of some of the discussions that he was having with other hospital CEOs. So when we were coming, I'd say, probably the end of last year coming into the beginning of this year, our focus, obviously, we had, as Calvin has already mentioned, this -- looking into an environment where Omicron was adding a lot of uncertainty. So we're really focused on making sure that we can meet the demands of the quarter. As we ended up getting to the end of the quarter, definitely recognizing that there was a little bit of a softness, I'd say, in the overall capital pipeline. Gary was pretty specific, right? He has conversations with CEOs. I know we talked to others that are here in this room, but he has conversations with other CEOs. And basically, it's like don't -- let's -- I'm not going to have a conversation with you about Intuitive. It's just from one hospital CEO to the next. What are some of the things that you're seeing? What are the things that you're thinking about your business? And so Gary will get feedback and did get feedback that, hey, we're concerned about things that we're seeing out in the future, right? You have a much more challenging macroeconomic environment. You have higher inflation and higher labor costs. And so I think Gary was really trying to highlight that. I wouldn't say that it's -- it probably gets a little bit more important, especially as you were suggesting, right. You have some news that comes out the following day that probably emphasize, I think, a bit more of what Gary was saying. But I wouldn't say that it's a hospital saying that they're not going to invest. I think when you look at our overall procedure guidance, it from 11% to 15% to 12% to 16%, a normal part of our business is as procedures grow, essentially they're placing capital, right. But I think Gary just wanted to really highlight what some of those challenges are going to be.

So it sounds like it wasn't anything like you're seeing. You're following the actual metrics or those metrics are slowing down. It was more like conversations that Gary was having, the tone of those conversations with hospital CEOs, their mood had changed a little more negative. And that was more of the message. Like, hey, wait a minute, like the mood of these CEOs have turned.

Definitely more -- contemplating more of what's looking ahead.

Right. The most like -- it seems like a lot of these hospitals like have budgets kind of set for this year. I don't know if you would agree with that. And so like the CapEx budgets for this year are probably okay. The question is going to be when they start setting budgets for 2023. Where do those go?

I think it's fair to say that, yes, budgets could be set. I mean it depends on the start and the end of their fiscal year. But I think it's fair to say that. But I think if you are looking at it -- and if you're a CFO, you're probably going to ask, "Hey, I have an environment that I am investing in. If things change, how am I going to change my investing?" Now we're not saying that, that's specifically highlighting something in particular to Intuitive. I think just overall, I think they're contemplating, hey, there are some challenges out there right now.

Yes. And how do hospitals view, in your mind, robotic surgery versus some of the other capital that's out in the hospital, like hospital beds, infusion pumps, whatever it may be? It's like some of my hospital conversations, they're like we're willing to invest in things that drive procedures and drive profits to the hospital. Which to me seems to fall right directly to you. I don't know, but in those conversations like maybe the CapEx environment may be slowing down. But maybe for robotic surgery and procedures are growing, like it may not impact you as much.

Yes. I would probably -- you make a great point. And I think we've seen the same surveys you have, and I think you guys have even done a survey in -- on maybe what hospitals are saying as far as our CapEx environment is concerned. For us, we try to make sure that we're centering everybody on procedures drive capital. But there has been, I'd say, strong investment by hospitals, really investing into robotic-assisted surgery. As they're coming out of the pandemic and as you see procedures growing, you should hopefully see corresponding capital placements. But I think it's still fair just to highlight that it's a much different environment today than it was yesterday as we're looking ahead at some of the challenges.

Yes. No, that's fair. How -- like if you do go on a slower CapEx environment, like I can go back and look and see what happened last time. But your business model has completely changed since then. Your recurring revenue, you're much more flexible with customers, like doing leases. So how do you think your business will hold up this time in a slower CapEx environment because of all the things that you're doing with customers?

Yes. We have a lot of confidence in where we stand right now. I think the value of da Vinci surgery became all the more clear to our hospital customers during the pandemic in terms of very top-tier, high-level minimally invasive surgery performed in a very predictable way with minimalization of use of hospital resources. So all that very, very positive on that front.

Yes. No, that makes sense. I guess to kind of think about some of the other things that you called out, kind of this long replacement cycle and playing around with some of the numbers. If the CapEx environment is stable, historically, you've added about 650 systems a year of kind of greenfield systems. And even look at 2021 and 2020 and take the average of those 2, it's right at 650 as well on a 2-year basis. Is that the right number to think about? Like capacity of like -- if procedures are growing kind of the rate they are, that's going to be the pull through of the systems behind it, roughly kind of 600 to 700 systems a year?

Yes. I think I'd look at it more along the lines of utilization. So most forecasts are going to start. Business planning forecasts are going to start with the procedure model, and you're going to have an estimate. We're guiding 12% to 16%. Everyone's going to have their own view. Based upon that number of procedures, it's going to imply with the utilization on installed base that's required to perform those procedures, you take your current installed base, how many more do you need to add? And that's how many you're going to sell in either to new customers or existing customers adding capacity to do those systems. And what we're seeing, as we enter this year, the capital cycle as it relates to customers trading in older da Vinci models for Xi is going to be softer than last year. We've been highlighting this for at least 1.5 years or so. We're looking at -- customers have been trading in their Si models for Xi. Last year, we had about 500 total trade-ins in our capital sales of over 1,300 sales. So a significant portion were upgrades. Now we look at our installed base of SIs, and we're down to about 268 in the United States. So the math -- we're not going to all those aren't going to be traded in either. So we're going to have a lesser contribution to gross capital sales from the trade-in cycle. But as Brian has indicated, there's no reason to think that continued procedure growth and, again, higher procedure expectations will continue to drive the other side of the capital cycle.

Right. No, that's fair. On the trade-ins, like what's a good like way to think about, like, there's a natural trade-in cycle, right. Obviously, this trade-in cycle have made -- the third gen to the fourth gen will slow. But if you go back to like 2013, there was still like roughly 4% to 5% of the installed base that would trade in. Is that how we should think about the trade-in cycle over the next couple of years for a natural trade-in cycle?

Yes. I think it's really managing how many of the older generations are out there and estimating the pace at which they would be traded in. As I said, we're about 268 in the U.S. And over time, most of those will come in. And we're over 500 outside of the U.S., but they tend to have longer holding periods on capital and should be a more extended tail.

Yes. I think -- and Gary has talked a lot about innovation, improvements -- incremental improvements in Gen 4. If you look at the limitations of the Gen 4 platform today, like what are the biggest limitations there? Like where are the areas for potential improvement?

Yes. The Xi is a very excellent platform. We launched it back in 2014 with a number of the features and capabilities very much aligned with the needs of general surgeons, things that would make da Vinci surgery more attractive to general surgeons. And you look at the progress we've made in that category in the subsequent 8 years, it's been very, very successful. Since the launch of the Xi, we've introduced a number of new feature sets, enhancing our advanced instrument set, our visualization instrumentation as well as the ecosystem surrounding the system itself. So the system -- the Xi you buy today is not the same one you were buying 8 years ago. The systems are upgraded in the field. So Gary mentioned on the call that we're always working on next-generation system technologies, and that's absolutely true. These are multiyear efforts. And at some point, there will be a new system out there. I'm not going to sit up here and tell everybody what that may look like. I can say that if you look back at our past cycles, we would generally very elegantly integrated a lot of the new features and enhancements made since the last launch. We're always emphasizing workflow and efficiency within the operating room and providing more information to surgeons to do the best possible job in their surgery. So these are key pillars really of the Quadruple Aim, which is the basis of all of our innovation. As you know, it's patient outcomes, better patient outcomes, better patient experience, better care team experience while reducing the total cost to treat. And I'd say from a product development standpoint, also expanding our markets. And so we continue to move those things along, pursuing the Quadruple Aim and stay tuned.

So there's an idea where you could just continue to do incremental improvements in the Gen 4 platform, and our customers could upgrade slowly. But you would never have this whole replacement cycle, again, like you did with Gen 3 to Gen 4. Or there's an idea that you may, at some point, not saying when, but in the future, there probably would be a new system that could drive a whole new replacement cycle, right. Would you be willing to comment one way or the other, if there was like potentially in the future, there's going to be another system that you could have a whole trade-in cycle, kind of what we saw with Gen 3 to Gen 4?

No. I mean, again, at some point, there will be a new system that comes to market. And we endeavor to make these compelling for when they become available. We're going to sit here and talk about timing. Not going to sit here and talk about what features it may or may not have.

For new systems, if you think about some of the limiting factors for bringing innovation to market, like there's obviously R&D and some of the internal capabilities. Now their supply chain is probably an inhibitor as well, and there's -- the regulatory environment has gotten tougher. How would you characterize each one of those, like, limitations right now for getting innovation to the marketplace?

Yes. No, I think first and foremost, it is the actual innovation of the product. And the engineers do a real work to bring things into reality. These other things are part of the environment that make it incrementally more challenging in today's environment.

Right. And so I guess, versus 3 months ago or 6 months ago or a year ago, the supply chain environment would somewhat limit bringing something to the market. So you have to almost wait for that to ease.

Yes. I don't think I'd say these things are limiting factors, right. I think -- but if you look at what we have with our established core base business, we've got a lot of challenges in supply chain now that we're managing on a day-to-day business -- day-to-day basis, making sure we have the parts needed to supply the demand that's out there. These are established products. You start moving earlier, newer technologies, our new platforms, the Ion and the SP, we're still in the phase where we're making our supply chains more robust. If you take another step back into the development phase, it's all at a much, much earlier phase.

And a lot of talk about digital surgery from not only you and everybody in surgery. Like how do you see digital surgery from an Intuitive standpoint? And how would you define that?

Yes. It's -- digital surgery, right? It's such a I don't know if it's a cliche already, but it's kind of a term that's very widely used that really describes a lot of different elements for us within the ecosystem of da Vinci surgery. And again, increasingly is it's not really talking about just the robot itself. It's the entire ecosystem surrounding the robot, of which digital is -- it's our largest area of incremental investment within R&D. These areas of investment within digital we think have very high leverage as it relates to that Quadruple Aim that we talked about earlier. So when we look at it, when we think of 3 main buckets within the areas of digital it would be operational efficiencies for customers. So things like the custom hospital analytics or the My Intuitive app. Then there's learning technologies, so again, My Intuitive has a role to play there as well. The telepresence technologies showed very high value during the technology. Simulation is really progressing to a very high level. And then the third category would be clinical insights. So providing key information to surgeons and the care team before, especially during and after cases. That, again, direct line of more information to the surgeons to make better decisions during the case. So things like Firefly would come into that particular category and some of the other items. And they're clear line of sight to Quadruple Aim.

Right. And how do you think about integrating some of these technologies into the Gen 4 platform versus just kind of waiting for a new system that kind of -- it tells all the stuff in one -- in one place.

Yes. On its surface, these things are fairly platform agnostic, right. We're bringing a lot of these things to the market now. Like I said, in previous new generations, we've taken the opportunity to make the interfaces more elegant, as I think it's just reasonable on that.

And one thing I do want to ask was haptic feedback. Like that's something we've talked about for -- since I've covered Intuitive. I'm just curious, has your view on that changed at all?

Yes. Haptic feedback hasn't come up in quite a while.

I want to -- yes.

In terms of -- haptic feedback is really interesting. It's something that we understand very, very well. There's a lot of capability on these technologies in the company. We've got teams looking at haptic capabilities. At the same time, again, as we're prioritizing projects and looking at where we're going to have the biggest impact on Quadruple Aim, a lot of folks new to robotics would really kind of -- especially lap surgeons who are used to that tactile feedback, would think it's something they really want. But the more experienced da Vinci surgeons, with that very acute visual connection to the surgical field, the 3D HD, their brain is kind of processing that view into the haptic feedback into their hands. And so in terms of incremental benefit to the outcomes, yes, it hasn't been the clearest line of sight, especially in light of a lot of the other innovations that we've brought to market. And furthermore, when you talk about the fourth pillar of the Quadruple Aim, lowering the total cost to treat, this will take adding sensors and chips and other technology into the products, which, by definition, adds more cost. Now over time, we've seen these prices come down on sensors over time. So over time, it may be more and more of a closer connection with viability from the cost standpoint. So it's something we continue to look at. It could be interesting at some point, but it hasn't been the priority up until now.

Okay. No, that's fair. I was just hearing a little bit more about it from people, so I wanted to see if your view had changed. If you think about the ASC today, like procedures is obviously moving more into the ASC. Like how big is your ASC business today, of Intuitive? Like 10% would be my guess.

Yes. So ASCs, pandemic, it's been a little bit of a trend, just the separation of points of care for surgery versus COVID care and other interventions in the hospitals. And within our customer sets, we've seen increasing numbers of cases being performed outside of the main ORs, right, maybe in -- within our IDN customers and hospital-owned outpatient facilities and increasing numbers in ASCs. It's still a relatively small number relative to the overall case volume that we do, but growing. And one of the challenges with the ASCs particularly are the reimbursement rates. And I think our system is designed with the -- we talked about workflow, but just the task of surgery is right at the core of how we designed our systems and capabilities, performing whatever surgery it is. And the best tool doesn't change when you move from the main OR to any other point of care. So I don't think we're preempted from being in any point of care. It's a matter of -- especially how the IDNs and providers of health care want to set up their capacities in different points of care and refer their patients around for the best care and maximizing their efficiency and profitability frankly.

Right. Is that an area where Intuitive's focused on innovation and like trying to figure out -- solve some of those problems for ASCs?

Again, I don't think there's a big gap. Because surgery is surgery, and the da Vinci tool is designed around the task of surgery. We're always working on things like workflow and that's -- but that's the same. That's the same everywhere. And the size of the system, people say, well, can you move it? There's no issue with the size of the system.

Okay. No, that's helpful. And thinking about like next procedures, like I remember when hernia was like brand new, and it's driven growth for 7 years now. Like where is the next procedures that you see a potential where robotic surgery could open up?

Gosh, we're sitting here now, we did 1.5 million, almost 1.6 million procedures last year. We see clear line of sight to 6 million procedures. The procedures that are already adopting that we are focused on, which we'd say is in the realm of possibility towards capturing in a total addressable market of around 20 million procedures for soft tissue surgery, not including things with Ion or other areas of SP. So when we talk about our opportunity, which is large, and we're investing into, it is mostly -- we're focused on these procedure categories that are driving growth now. So specifically general surgery in the United States, as you know, driven by hernia repair, cholecystectomy. Bariatrics has been driving outsized growth in recent quarters. Colorectal rectal surgery had a great first quarter. We're still in the early, middle innings, let's say, in general surgery in the United States with a large runway ahead of us. So these are big growth areas, right. And then you turn your sights outside the United States, where our focus is moving the procedure base increasingly beyond urology, which has been the starting point in a lot of the core countries into other areas. So colon and rectal procedures, thoracic procedures, other general surgery, gynecologic oncology, and we're making progress there. Now over half of our OUS procedures are beyond urology. And so those are big areas of emphasis and points of growth. Now new areas of -- I'd say new areas of surgery, there's not like this big, soft tissue area that we're missing out on. People ask us about things like orthopedics or spine or brain. We'll always be looking at these areas where maybe our core technology may have a role. But where do we end up? We look at our technologies and strength in area like very precise tissue interaction navigation. We ended up with a product like Ion, which is a robotically controlled flexible catheter system moving beyond the surgery realm into the diagnostic application for early-stage lung cancer diagnosis. By definition, anything we do with Ion, either in diagnostics or nonsurgical therapeutics, are going to be beyond the $20 million that I mentioned earlier and really taps strongly into our core strengths.

I guess, one thing I want to go back and focus on was like I was thinking like, historically, launching new innovation, a lot, you did it at SAGES or conferences. But now we've had COVID, world is more virtual. Like how do you think about, given the new environment, launching innovation and selling that to customers. Does it have to be at a big conference? Or are you more decided doing it at any point in the year?

No. Our mindset is we're investing heavily into the research side. And any products that we can bring to market when they are ready and when they are cleared, we're bringing them to market. That's what we've done all along. It just so happens with Xi, it aligned well with SAGES. The previous generation, the Si, it was launched in 2009. It came straight into the teeth of the Great Recession. And a lot of the similar conversations here is like people like, well, why did you introduce something right into this? We're like, well, it was ready, so here we go. So I think that's the mentality is when the product is ready, we'll be -- when any, I mean, we're not talking just systems here. Any product, when any product is ready, we'll be launching it.

Okay. That's helpful color. And then kind of on the P&L real quick before we run out of time. Like this year, 23% to 27% OpEx growth. Like when you move into 2023, like should we still think about OpEx growth being higher than revenue growth? Or are we going to get more leverage in the P&L? Just trying to think about how much flexibility have or how much willing you share in -- willing to invest in into going forward longer term?

Yes, the 2022 guidance, the 23% to 27% is higher than we've been in recent years. And we've talked a lot about our areas of investment on research and development and go into the list. But our opportunity is extensive, and we're investing into it, right. And we're going to continue to do so. From a capital allocation standpoint, that's our absolute top priority, investing into our capabilities in markets outside the United States, very high priorities. We're in early stages in what's possible in robotic surgery there. And when you look at this year, the commercial side of the business, I think, recovered pretty strongly last year from COVID. The expense side of the business is more recovering here in 2022. So the percentage when you do that comparison, looks a little higher here in 2022. So that's just the way the numbers work out. We're going to continue to work -- invest into the business. There's no doubt about it. And where we have opportunity, we will invest. I'm not here to say whether it's going to be a higher or lower percentage next year, but we may be in a little more level playing field as it relates at least to the expenses coming back from COVID.

Right. And then kind of last question here before running of time is on buyback. Last quarter, you bought back stock for the first time in a while. And I think the average price is $268, and stock's been below that and kind of a volatile tape. So why not go out and do a big ASR? Like Intuitive has done that before historically.

Yes. The last time we did ASRs was 2014. I think we did $1 billion in 2017. I think it was about $2.2 billion or $2 billion ASR. We did buy back about $100 million worth of stock, $107 million last quarter. You do see the market today, obviously, we're down to $210, $211. We think -- we spend a lot of time with our Board on capital allocation. We talk a lot about all the things that Calvin was talking about, just investments in the business, organic investment, also looking at sort of market opportunities that are available to us when you think of technologies that are out there. Today, the market for -- the IPO market is not great. I'd say the SPAC market is probably a little bit more challenging these days. And so we look at that as, let's say, probably the second area that we're really focusing on capital allocation.And then third is really around allocating capital back to shareholders. We want to be as efficient as possible when we're doing that. So we're constantly evaluating, obviously, today's stock price, if there's any market dislocations. And so we obviously can't say what we're going to do before we actually do something, but it is a conversation that we're having regularly.

So definitely ASR could be on the table. It's at least being talked about and discussed.

Share repurchase is part of that capital allocation discussion.

All right. Great. I will end with there. Thanks a lot.

Appreciate it. Thank you.

Thank you for having us.