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

We've got Intuitive Surgical. Got Brian King, Vice President Treasurer, Head of Investor Relations. We also have Brandon Lamm up here from Investor Relations as well. Thanks for joining us.

Thank you for having us.

Thanks for having us.

I think you wanted to do an opening forward-looking statement.

Yes. Thanks. Just as a reminder, comments 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.

Thanks, Brandon.

Great. Thanks a lot. So I wanted to start with the Q1 procedure growth, just kind of start there, level set. It came in, I think stronger than most people thought, 16% on a really tough comp. Just curious what happened, what kind of drove the upside in Q1? And how much of that is kind of sustainable strength here?

Yes. So Q1 essentially had 16% procedure growth versus a comparison of the prior year at 26%, right? We had really been emphasizing last year that we saw the benefit of patient backlog, which we assume has actually moderated through 2023. And what do we see in Q1 of 2024? We really saw strength in areas where -- we continue to see strength in, let's say, globally in areas like cholecystectomy, foregut procedures, colon resection, for example and in the U.S. in particular, which was 14% procedure growth, you saw nice growth in general surgery. And then outside of the U.S., continued growth in countries like China, Germany and the U.K. In hindsight, when you look back at the quarter, you do ask yourself, right -- when you look at, I'd say, the long-term compound annual growth rates for Q1, were essentially in that, say, mid-teen range or so historically. But what do we see in Q1, we were a bit higher than that globally. You could assume that a portion of that is some backlog that potentially was in the system. But it's really hard to know exactly what that is. Hence, the reason why in our -- when we're talking about our guidance in the low end or the high end of the range, what the impact of backlog could be.

It seems like there's also some sort of kind of acceleration in robotic procedures. There's kind of -- the penetration has been a little bit faster than before in some of the benign procedures coming through. Is there some of that going on as well?

It's definitely a focus for us to drive adoption penetration into a number of different procedure categories. But I don't know if there's anything that's structurally different. I think we'd stick to our procedure guidance 14% to 17% is essentially what we said. And we're -- I think that's probably our most responsible best estimate of what we think procedure growth will be and further into penetration.

And then system placements were really strong, the installed base still grew kind of 14%, kind of the highest growth of spend in a while even with dV5 launch. So -- our hospital checks also are pretty strong, people are buying a lot of Xis right now. I'm curious what you're seeing in the field there from systems.

Yes, we had a good capital quarter, right, in Q1. I think the 313 systems that were placed. I think Jamie at the start of the year, provided some -- a little bit of cautionary commentary on the expectation is that capital placements could be lower in 2024. We started off the year strong. I think part of that is there was uncertainty around timing of when we would get regulatory approval for da Vinci 5. But yes, I'd say a nice strong capital placement growth. Really what drives growth in capital is procedure growth, right? You have demand for procedures to be done. You have hospital systems that are getting utilization off their existing installed base. If procedure demand exceeds utilization, you then have growth in your installed base. And so a 16% procedure growth, you had utilization of 2%, essentially 14% growth in the installed base. So that's kind of the dynamic that we ended up seeing. But to your point, I do think it was a nice capital quarter. At the end of the quarter is when we ended up getting da Vinci 5 clearance. So we'll see what happens for the remainder of the year.

It seems like hospitals that are still kind of willing to kind of buy through a replacement cycle and buy kind of ahead of dV5 availability just because they need the capacity. Is that fair, what we're seeing?

Yes. And so really emphasizing that point again, as you have demand for procedures or as hospital systems have demand for procedures, they're looking to add incremental capacity to be able to meet that procedure demand. And so that's important. And so you have Xi, which is an incredibly capable system, which can do a broad set of indications. And so they're looking to still, let's say, expand their programs to be able to meet that procedure demand.

So total like procedures kind of come at the higher end of the guide, the installed base, kind of new system placements maybe potentially grow year-over-year?

Say that again.

So I think before you were talking about system placements, originally, were going to be down potentially, now it's kind of moved to choppy. If procedures come in strong, is there still kind of the potential for systems this year to kind of be up year-over-year?

Let's see how that goes, right? Within our procedure guidance of 14% to 17%, you can make an assumption on what you think installed base growth will be. I think really what Jamie has been emphasizing, and what we're seeing is you have a lot of customers who've now had exposure to de Vinci 5, right? They've -- were at Intuitive Connect, which just kind of like our [ Macworld ] in a sense, we you bring in hospital administrators, surgeons to really I would say, almost 2,000 or so that were doing test drives. You have SAGES, a lot of exposure there. And there's a -- maybe a behavior of individuals who will say, "I'm really interested in de Vinci 5. I like it. I'm curious about it, maybe I hold off on expanding our installed base." Maybe they don't. And I think that's where we're saying there potentially could be some choppiness with capital placements for the year.

So what's been some of the kind of the feedback from hospitals on dV5 and if it's more of a "Hey, this is an incremental upgrade. I don't -- I can wait." Or is it, "Hey, this is a big step change. I want to upgrade the entire fleet," and just kind of talk through some of the initial feedback there.

So initial feedback, there's 8 systems that have been placed, right? So that's -- it's probably too soon to really speculate on how aggressive or how interested customers are. I'd say the feedback has been very positive. We're encouraged by that. I think getting direct feedback from surgeons, there's been a lot of positive feedback, in particular, in a number of different areas. And so you have workflow efficiencies, you have ergonomic changes or differences. You have visualization that has actually improved. And so we get a lot of really nice feedback there. Then we believe Force Feedback is a differentiated technology. And so we're still getting feedback from surgeons there. But if you sort of double click into it a bit, right? What is the feedback that we're getting on specific areas. Again, early on, we had surgeons that were supporting us through the clinical trial. We now have 8 systems that have been installed as of the end of Q1. The feedback has been, "I think I can do more procedures in the same amount of time. I think I can do the same procedures faster." And we saw that in early clinical data. I think over time, we'll have to see how that data plays out as surgeons are continuing to do more procedures and we're evaluating that information with them. But specific product features, I'm just going to jump into a couple of those. Workflow efficiency has been, I'd say, somewhat surprising, I think, for surgeons. So there's over 150 or over 100 or so design changes, some of the ones that we hear a lot about are the integrated insufflation and with smoke evacuation, the surgeon being able to look through the UI that they have on their screen, right, and being able to adjust that on their own has been fantastic. The feedback has been good. The ability to swap between instrumentation between arms. They can now do that digitally with the double click of their fingers. And then also care teams who are, let's say, changing out instruments to put into a different arm, there's now a guided tool change which allows those care teams to essentially know with very little risk on where they're going to insert that instrument to make sure there's nothing that they shouldn't be hitting. So it's stuff like that, that you're getting this great feedback on product features, and then we'll have to see over time what happens with Force Feedback.

And how are you thinking about kind of the limited launch versus the full lunch and kind of the cadence, so 8 in Q1, how that steps up and kind of capacity to move into kind of all the demand that you might have into '25.

Yes. So we will continue to stay in a phased launch, as we've been emphasizing for at least the next several quarters. We did place 8 systems at the end of March. It was actually quite remarkable. I'm actually really proud of our teams who were able to make this happen. You ended up getting approval from the FDA in the beginning or actually sort of the middle of March, you're able to bring that system on to your [ APO ] and then from there being able to engage all the teams to be able to install those systems. So it's quite remarkable to get the 8 done. I can't really comment on Q2. I'd say there is a strong interest for procuring da Vinci 5, in particular, incremental systems for those customers. We'll see how that goes. So I can't really -- I'd probably be speculating at this point to say what that ramp would look like, and we'll tell you more as time goes along. I would really emphasize, though, we are in a phased launch, and there are specific reasons why we're doing that.

And I kind of want to walk through how dV5 kind of impacts the model. There's a lot of new revenue streams, higher ASP, I don't know if there's a way to think about kind of how the 30% higher ASP kind of flows through the leasing and the trade-in credits start there.

Yes. And so if I missed something, just let me know. Maybe actually, I want to go back on a point because it actually relates to what I'm going to tell you now. So during the phased launch, we've essentially said over several quarters we will have a phased launch. And so there are things that we'll be -- essentially 3 areas where we're really going to be focused on, say, getting customer from -- getting input from customers, feedback from them on features. There are supply chain work that we're doing to essentially optimize the supply chain. And then from there, there's just plans sort of upgrades and changes that we're making to the system. So all of that is -- why I'm saying that is that you'll have several quarters of just time where you have an unlimited -- your unlimited launch. So early on, you're not going to have a significant impact to your financials, right? New products, in particular, right? da Vinci 5 is not at the same, let's say, margin levels as we are experiencing with Xi. We intend for those for da Vinci 5 to get back up to those levels. But there's a lot of work that needs to be done, right, to get there. But it's what we're focused on. I'd say accretive revenue from our other new platform also has an impact to that. Now how it works. So if a customer is interested in acquiring a da Vinci 5, essentially, the ASP is 30% higher than the current cost for an Xi. But when they take into consideration some of the items that are essentially integrated into da Vinci 5, really, the value is about 15% higher versus Xi. So from a customer perspective, they essentially look at it and say, "It's about 15% higher." When they take into consideration things like the integrated insufflation, generator, handheld camera hub, simulation, a number of different factors, right, that go into that -- a number of different features. So the customer at that point has an opportunity to either enter into a lease for a new system or to purchase. If they purchase, they essentially have the ability to have a trade-in right for -- if they purchase an Xi today and they say, "Hey, I want a da Vinci 5 tomorrow." There is a trade-in credit that we recognize, we recognize Xi revenue. There's a trading credit that's essentially a contra revenue amount that after a year or so starts to amortize back into revenue, right? So that's how the purchase transaction works. For the operating lease, they enter into an operating lease, essentially 2 ways. They can either get into a straight rental or a pay-per-use arrangement. Essentially, they're getting access to that Xi. You have the lease transaction that goes over the term of the Xi lease, and there's a trade-in right, essentially the ability to come in and negotiate with Intuitive. And I'll stop here in just a second to make sure I'm -- but when we are able to get that system back and there's supply availability for that customer, we can then bring that Xi back and then install a da Vinci 5, and you'll see the value difference between the Xi and the dV5 essentially carried over the life of the lease. Very similar as well with the pay-per-use arrangement.

And so the -- if you think about the lease revenue, there's kind of 2 leases, one, you kind of do over 5 years, kind of pay as you go and there's another one kind of pay as you go, pay-per-click. Do we think about that as like 30% higher, like in terms of like your lease payments or pay-per-click model being 30% higher with the new system?

That's right. So that value difference will essentially carry over, over time. So the difference in the Xi and the da Vinci 5 value essentially will carry over those years. And it is that ASP difference.

When you think about some of the other ancillary revenue, how should we think about maybe the service line -- service per system changing and some of the stuff that could potentially go into that line?

So with da Vinci 5 and even with Xi as part of the ecosystem, there are some digital products that actually are subscription-based. And those subscriptions will essentially run through our service revenue line.

So one of those is Case Insights, I did see a slide like [ $70,000 ] per system -- per Case Insights. And so should we think about like all the systems that turn on a Case Insight is going to -- after the 1 year free that that's going to roll through per system and the service line kind of in addition to the service revenue that you had?

The customer will want to -- if it's something that they agree to, they'll have to sign up for that subscription service. It doesn't automatically turn on and say now you're automatically going to have Case Insights. They're going to want to subscribe to that service. So our hope is, is that customers find value with Case Insights, and they'll want to subscribe to that service. And maybe it would be helpful for everyone if -- do you know what -- maybe I should talk a little bit about what Case Insights is, just quickly. Our view is with Case Insights, is essentially how do you make surgeons better at what they do faster, right? So you're taking information from the robot, kinematic information, essentially economy of motion. So if you're looking at activity that the surgeon is doing with, say, camera insertion, moving around instrumentation within the body identifying objective performance indicators or OPIs that correlate to better patient outcomes, right? So a surgeon can actually look at their information on Case Insights and say, "How do I compare to an expert surgeon. What are the things that I need to do either through instrument choreography or through how they perform a surgery to actually improve." And so the idea and the benefit for Case Insights is really give them information on targeted training to actually help them get better, faster. We think that, that provides value for the hospital system. We think it provides value for the surgeon and also for the patient. What are you trying -- what are we trying to accomplish? You really want to ensure that you're minimizing variability of outcomes for patients, right? And if you can do that through targeted training to make them better, faster, there's value there. And so we think there's value for Case Insights for customers.

And does -- the kind of the digital capabilities, is there kind of other things you can kind of turn on over time that's going to drive incremental revenue streams like Case Insights or...

There will be other areas too, and I think these are things we'll talk about over time. An area that we've talked a little bit about is around 3D modeling, being able to take a preoperative image and do a high -- create a highly colorized 3D model where you can, over time, at some point in the future, overlay as surgery is being done during surgery to be able to get -- let's say, augment the vision for surgeons. Those types of, let's say, revenue items that I think you would see coming through service over time. Now -- yes, things like that.

So a lot of opportunity there?

There is opportunity there. I mean we have a platform where we've added a lot of compute power, a lot of processing power, and it is in order to enable features like that over time.

And then the I&A revenue line, haptics impacts that. I think the smoke installation, evaluation installation impacts that. What else is kind of impacting the I&A revenue line? And is that enough to start to see that line start growing versus flat to down?

I think we were really emphasizing with Force Feedback, for example, if you had Force Feedback used across all procedures. I think you'd see potentially a 9% increase in I&A revenue per procedure. Our view, though, with I&A revenue per procedure is that we would expect it to essentially trend down over time. A lot of that has to do with mix. A lot has to do with the types of procedures that are actually being performed. And then in particular, what we saw this past quarter was us working with our customers and our customers really kind of managing through some of their inventory to kind of be a bit more real time. But I would say there are opportunities where we will make enhancements to instrument and accessories, which could increase value. But across 2 million-plus procedures, I think our view is that it will continue to decline modestly over time.

Did I miss any other important kind of revenue line items before...

Well, no.

Did you want to talk -- anything that you want to talk about on kind of the trade-in credits and how that works?

Sure. So over time -- so our expectation with da Vinci 5 is that you're essentially providing incremental capital for customers. It's not trying to take in a lot of trade-ins upfront, right, to get in and then swapping those out for da Vinci 5. But there will be trade-ins that will come in over time, and especially as you're in broad launch, our hope would be is that customers will want to trade in their fleet and convert them over to da Vinci 5. But we'll see, really the focus is on incremental today. So what happens with that trade-in credit? We talked about the upfront purchase in a customer that is interested in purchasing a da Vinci 5, but they take an Xi today. We recognize a essentially a contra revenue amount, trade-in value. But what ends up happening is, say, 2 years down the road in that contract, that customer who has that specified trade-in right, they know how much value they're going to get for that system. And so they'll essentially trade in that system. We'll pay them for that, and it's an offset against the da Vinci 5 cost. If that makes sense. If you look at it over the entire transaction for that customer, it's still higher, right, because they're essentially purchasing a da Vinci 5. But that's essentially how it works. The value of that trade-in credit will vary depending on the system, the age of that system, how new it is, if it was 1 that's a year old versus 1 that's 7 or 8 years old, right? There's going to be a value difference between that. And as we get closer to where we start to see trade-ins, we'll let folks know what we think those trade-in credit amounts will be.

Does it kind of follow a typical kind of 7-year depreciation cycle or...

I would say 5 years. I think it's -- for us, essentially 5 years.

Okay. That's helpful. The Xis that are traded in, I'm trying to talk about how hospitals and how you yourself can potentially kind of redeploy those assets.

Yes. So Xi is an incredibly capable system, right? We've been making a number of design changes to Xi. It has a lot of procedure indications that we think customers really value. Our intent is as we get Xis back from customers, we will refurbish those systems and being able to offer those systems to maybe more price-sensitive customers or more price-sensitive economies where we can really make a difference by applying a -- let's say, a multi-quadrant surgical device, Xi, to be able to serve those local communities or those communities. We think it's powerful. We think Xi is, again, incredibly capable, and we think customers will appreciate that.

Then -- so that's a potential way that procedures potentially accelerate with da Vinci 5.

Let's see as we get closer and as those systems come back and as we're able to place those systems. I mean our hope is as part of -- as we talk about our TAM, is that we're moving into various economies over time, right, to move from the 7 million to the 21 million.

Is it more into like ASCs? Or is it more into like lower-priced community hospitals or geographic countries?

I think it will be a combination of all those. I think probably more into other geographies that are a bit more price sensitive. But also being able to support those local community hospitals and others that want to adopt robotics that are not doing it today.

And then I kind of wanted to talk about margins as well, both kind of shorter-term when you're thinking through the launch of dV5 initially -- kind of at what point does this become kind of breakeven on the margin? Is that when you flip into full launch that you're breakeven? Or is it 6 months to a year after launch -- into full launch?

Yes. It's too soon to say today. And I think part of that is because of the work that we're doing on optimizing the supply chain, I think other -- and this is specific to dV5. Other work that we're doing on some of the product enhancements and as we're bringing up facilities for manufacturing as you're adding scale, right, you're able to leverage off those investments. I would say it's probably too soon to say. Our goal and the intent is to really get da Vinci 5 back up to Xi levels as fast as we can, but there's work that needs to be done as you're sort of ramping up that product. So it's too soon to say that, Travis.

Is the -- the kind of the gross margin hit that you saw with Xi, is that a good corollary to look at? Or is dV5 going to be a lot different for some reason?

I would say it's probably fair to look at that as directionally right, what happened with margins when Xi was released. I think, again, just give us some time there are some pretty unique features that have some really critical subcomponents, and you want to make sure that you've optimized the supply chain to enhance your margins.

Kind of longer term, if you look at where your margins are today versus where they were kind of 2018, 2019, there's still a pretty big gap today.

That's right.

And kind of think through what that gap is, kind of what drove that gap even before the dV5 launch between investments and inflation and how that can kind of recover over the next couple of years?

A lot of pressure on margins, gross margins, in particular, were just lingering effects or just challenges you had during COVID, right? You have lingering effects of the supply chain, for example. And so we believe we have plans that are -- that we're executing on today that can improve margins. I think you've seen us do it previously. We believe we can do it -- still do it today. As you are driving additional volume on instrument and accessories on your product platforms, you have an opportunity to work with your suppliers to be able to bring down costs. As you're considering how you're placing systems around the world, you have the opportunity to manage how you're shipping with freight. For example, in COVID, you had very limited opportunity, right, on where you were going to ship stuff. So you're shipping stuff here, just use that as an example, or you can lower cost methods of shipping. And so there's activities that we're engaged in today to really improve margins, the gross margin side. That, coupled with the activities that we have to improve margins on Ion, SP and also with da Vinci 5 should help us get back to what we've committed to over time, over the next, say, 3 or 5 years over the medium term to really improve margins back up to that 70% level or 70% plus level.

How should we think about kind of the leverage on the SG&A and kind of the OpEx growth, R&D kind of going forward? Is -- historically, you can kind of grew that either in line or slightly below procedure growth, but post dV5 and some of those investments rolling off. We kind of see that more -- a little bit more leverage on the OpEx.

That's the intent. That is the intent. So with operating margins, they are lower than they have been historically. It's not our -- or it's not a management objective to get back up to 40%. I would say our expectation is to be at the upper end of our peer set. We want to improve, we will improve from where we're at today. Some of that is just flowing down from gross margin. The other area, as you alluded to, is really on getting leverage off of your enabling functions. You can see that we've made a lot of investments into our business over the past few years. There have been IT projects, there have been head count, infrastructure. I think over time, we're looking to get leverage off of those investments.

And what about the margin and kind of the mix shift of the business over time and the impact on margins because I would think some of the kind of the service revenue coming over time could be kind of margin accretive?

Yes. I think margins for I&A are accretive. They're positive, same on service, capital is probably a little bit less than the others. I think as you're driving -- you have nice capital placements and procedure growth is growing along with additional items that you're adding to service revenue, those are going to help our margin profile.

Great. I did want to kind of step back a little bit and go back to kind of the integration of the lab tower. So customers are getting a full lab towers. There's the handheld cameras. Just kind of trying to think about kind of the Intuitive strategy from here by launching this kind of integration aspect and kind of your intent over time.

The intent for us is to integrate items into the ecosystem that are going to provide workflow efficiencies for surgeons, right, and for care teams and for hospitals. That was really the idea behind some of those integration elements that we've incorporated into da Vinci 5, integrated insufflation with smoke evacuation, along with, say, handheld camera and other things. Basically, the idea is you do not need a separate lab tower for a da Vinci procedure. That is really the focus. If you're going to do a da Vinci procedure, it's up to you, whether you -- a hospital system or a surgeon, if they want to use a different device, they can keep that tower there or they can utilize our product, our tower, essentially to do that procedure. We're not, I'd say, necessarily targeting lab towers. It's just we want to make sure that they have an integrated experience that the surgeon is able to control those features as part of that stack.

What about the kind of the imaging quality of kind of your tower kind of versus the competitors? And where that's going to go over time and some of the improvements you're going to see there?

It will continue to get better. I think we've made a lot of improvements with da Vinci 5. I think the feedback has been very positive. But we've talked a bit about the areas where -- whether we're talking about 3D models and augmenting what a surgeon can see and improving, I'd say, just visualization broadly, whether you're looking at different molecules or whether you're looking at other methods of I'd say, imaging enhancements are all things that we're working through. Time will tell.

So definitely some of the imaging molecules we could start to see.

It's an area we've been working on for some time.

Is that something we can start to see over the shorter term?

We'll talk about it more when we get closer.

All right. And what are the kind of -- like some of the improvements that you're making on dV5. Are you going to make some of those kind of before the full launch? Or are we going to see some of those probably kind of post the full launch?

We'll see additional enhancements made both digital or software-oriented and also hardware oriented. I think you'll see some elements of -- and we haven't been specific about what those are. You'll see some elements that get integrated into the existing platform. And then you also see some additional digital products that will be also incorporated into the system over this sort of planned rollout of the system. Basically, the system that's out today is version 1. It will be different tomorrow, slightly.

The hardware is the same, kind of changes on the margin of the software.

That's right.

And then kind of for the last minute, I did want to touch on Ion, it's a little bit underappreciated kind of opportunities. So just kind of a big picture Ion question.

We're really excited about Ion. I think it has done quite well. You've seen -- success here in the U.S. with really being very focused in the lung biopsy market. We think our -- we believe that our customers believe that it is differentiated technology, allowing them to get really far into the say the distal parts of the far ends of the lung to get really small nodules, get biopsy, really small nodules. You're seeing some expansion regionally, we're moving into Europe. We recently got approval to pursue China. And so -- we're excited by it. We're definitely excited by it.

Great. I think we're out of time. Thanks for coming.

Thank you for having me. It was great.

Thank you.