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

Good morning. Welcome back. I'm Larry Biegelsen, the Medical Device Analyst at Wells Fargo. And it's my pleasure to host this session with the management team from Intuitive Surgical. With us, we have Jamie Samath, the CFO and Brandon Lamm of Investor Relations. In terms of format, it's going to be a fireside chat. If anybody has a question, please raise your hand. We'll call on you. Jamie and Brendon, thanks so much for being here.

Happy to be here.

So before we jump to questions, Brandon wanted to read the forward-looking statement.

Thanks, Larry. 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.

Great. So Jamie, let's start with da Vinci 5. So in the first -- in the second quarter -- you placed 70 systems, which were well ahead of expectations and accounted for almost half of your total system placements in the U.S.

Yes.

What about da Vinci 5 is resonating most with surgeons?

Yes. So I'd say the 70 systems were actually in the range of our manufacturing output plans, it was at the higher range, but that's kind of within our plans. We have so far in terms of where we place systems, it's with experienced da Vinci surgeons. We did that intentionally because we wanted have surgeons that could provide good feedback on the launch. And so what we've heard so far is customers really respond well to the level of integration, the surge in autonomy they get from integrated installation from the way they can control certain aspects directly where they operate in the console like integrated energy, precision, imaging, ergonomics. Those are where we see the strongest reaction so far -- we have technologies also with this launch in Force Feedback and Case Insights. And those are areas where Intuitive will develop that capability over time. We have supply constrains in for Force Feedback, in particular, and what we hear from those experienced surgeons is great interest in what they're seeing and experiencing so far, a recognition of the potential of that technology, and of course, we'll have to mature those technologies over time. We'll refine them -- we'll educate them. But early feedback on those 2 technologies are real long-term potential, which is consistent with our own expectations.

That's helpful. So how should we think about the ramp in the U.S.? On the call, Q2 call, you talked about modest increases quarter-by-quarter. What does that mean? And do you expect da Vinci 5 to be greater than 50% of your U.S. placements in the second half?

Yes, I would -- answer it the same way you asked the question, which is second half, we'd expect modest progressive increases in supply. I don't think we get more specific than that. In the second half as we we do have a planned hardware and upgrade. That's something that you want to do actually quite carefully to manage the customer experience. You have to obviously be ready from an engineering and manufacturing perspective. And so we've said modest increases in supply in second half, with respect to them, what that does to mix in the U.S. It wouldn't be that bigger at this point.

And Jamie, what are those software -- planned software and hardware upgrades that you mentioned?

Yes. So they include the integration of our Hub technology into the Vision Tower. Hub is our kind of media management capability allows you to take images and video during the procedure, you can use that to integrate into the hospitals packs, and EMR systems and it also has tele-presence capabilities. We're going to integrate that into the system, and we're going to integrate the skill simulator capability into the surgeon console. That's where -- when the system is not in use, surgeons can actually -- using virtual reality technology actually practice skilled drills to enhance refine and develop their technique. The software change are really a response to feedback that we've heard from the surgeon so far, and they're mostly around usability.

Jamie the tele-presence software?

The tele-presence capability is in Hub.

Yes. Historically, that was used -- I think you had a third party supplying that. Is it that the same vendor? Or is this an in-house tele-presence capability?

No, actually, our tele-presence capability for some time has been in-house. We primarily use it for case observations, but that's been in-house for some time.

Okay. And how should we think about -- the limited launch you said into early 2025, I believe. How should we think about customers pausing new system purchases ahead of the full rollout in the U.S. and outside the U.S.?

Yes. So in Q2, what you saw with the 70 placements and the overall capital placement performance for the quarter, we placed 341 systems globally. That's up about 18% on a net new basis. So if you adjust for trade-ins, which should be coming down, because at the end or towards the end of the SI trade-in cycle. That capital placement performance we characterize as relatively healthy. So we didn't see any discernible impact from customers pausing to evaluate da Vinci 5. We can't say that, that will be the case in the second half. I think it's too early to tell. You are in a little way skewed in Q2 by again, customers that are early adopters and IDNs that want to have access to latest technology, and so we'll see how that progresses in the second half. OUS, I'd just say in Europe, we did see placements in Q2 be actually lower than the year ago period. That was mostly a reflection of pressure on government health budgets, that then trickled down to healthcare budgets. We saw that in Germany and the U.K. in particular. But it is the case that in Europe, they have obviously awareness of da Vinci 5 and they may choose to evaluate da Vinci 5. And they also have the opportunity to evaluate SP given that's cleared in Europe. And so there may be some impacts we saw in Europe. It's not clear. In the other OUS markets, no impact that we would discern, but I think we have to watch what happens in the second half.

And Jamie, when are you going to start accepting trade-ins for da Vinci 5?

Yes. Generally, I'd say we wait until we get into broad launch which we said is the middle-ish of 2025. That gives customers, obviously, greater exposure to da Vinci 5. Many of them will have had divestments as incremental systems. They'll have some experience with -- and that gives us the opportunity now to evaluate their programs in terms of -- based on their procedure mix, their site of care strategy and what they see as the economic benefits of da Vinci 5, how would they like to start to progress in any particular trade-in cycle. I think that will be different customer by customer based on their strategy and their economic objectives. At this point, I'd see the trade-in cycle that's something that's progressive over time.

And Jamie, I just want to make sure we don't miss the forest for the trees. Big picture on da Vinci 5, any surprises good or bad?

Nothing yet, I'd say of significance. I do think, so far, customer reaction to efficiency benefits and what they're seeing in terms of reduced time, I think that's been quite positive, and I'd say slightly surprising.

Positive. On the positive side?

On the positive side, yes.

Okay. And Jamie, sticking with systems, you said on the Q4 call, the total system placements would likely be down year-over-year. So far, system shift have been up about 2% year-over-year. Do you still expect systems to be down year-over-year in 2024? And if not, what has changed?

I'm going to turn that to Brandon.

Yes. No, I think when we kind of entered the year, clearly, there's uncertainty around the timing of da Vinci 5 launch and what that could mean for customers who potentially are looking to acquire this system. And in some cases, there could be customers who paused to evaluate da Vinci 5, as they kind of make their considerations for capital. At this point, to your point, we haven't seen much in terms of customer pausing just yet, but I think still looking into the second half of the year, we'll have to kind of see how this plays out. And so I wouldn't update those comments at this point. I think those comments in part just reflected kind of our viewpoint starting the year.

Got it. And is there any evidence that the haptic feedback is bringing new surgeons over to robotics?

We don't -- we can't say that yet, mostly because those that have used the Force Feedback instruments so far have been really experienced surgeons. And generally, what you see in experience da Vinci surgeons is that they develop what's called visual haptics. They actually -- by looking through the endoscope and seeing how tissue moves, they kind of develop a substitute for Force Feedback. But what we've heard from those surgeons is that they can imagine that surgeons now being trained on da Vinci, whether it's a surgeon that's chosen not to adopt robotic or it's a new surgeon developing their skill. They see that Force Feedback relative to developing visual haptics could be an opportunity to both, be the final step that causes the holdouts to convert, but also shorten the time to efficiency in the training period. I think we have to get to broad launch. We have to get the system into the hands of those newer surgeons or those surgeons have not yet converted. And I think we'd look to actually generate evidence to that fact.

And Jamie, in Q2, ASPs were up about 4% year-over-year grounded. Should we expect mid-single-digit increases in the system ASP going forward from da Vinci 5? I know -- we know what the ASP increase is, but just on an aggregate basis, if you will. I'll let Brendon take it.

Yes. I think at this point, I wouldn't necessarily kind of see -- hold what you saw in Q2 and kind of run that forward. The system ASP that we report is reflective of purchase systems only. And so if I just look at this last quarter, about 70 placements of da Vinci 5, only 11 of the 70 were outright purchases. And so there'll be a kind of mix component that will affect the kind of that reported ASP. So we'll have to kind of continue to see how that progresses looking ahead.

If you look at economics aside from whether it's an upfront purchase or a lease, then you have two dynamics that kind of play out over time. The pricing of da Vinci 5 is, of course, ahead of Xi as we've described. And so as DV5 becomes a greater proportion of the system mix both as you get into broad launch and as you expand into other geographies, then you have positive impact to unit economics, whether upfront or over time in a lease arrangement. But I think the second factor to just consider from a modeling perspective is as you get past broad launch and you start to see trade-ins pickup, trade-in credits from the next item to DV5 be quite a bit larger at least in the first couple of years relative to recent periods where you're upgrading from Si to Xi. And so you have two competing dynamics there, that affect unit economics, whether in system ASP is up front or over time in the lease.

So historically, an Si trade-in, I think you've said maybe $500,000 credit?

In recent periods, no, it's been more like $200,000 to $300,000 credit.

$200,000 to $300,000 credit. So the Xi credit. Are you willing to say what that might look like?

Not yet. I think it's too early, and I think we wouldn't say it because customers may be listening. And so that's subject to negotiation. But quite a bit higher.

Quite a bit higher. Jamie, while we're on it, again, I don't want to miss the forest for the trees. Capital equipment environment. Any color on that? Big picture?

Yes. I'd say U.S. has been stable and relatively healthy, less exposed to capital budgets per se because I think last quarter, 77% of placements in the U.S. were lease arrangements. And so in most cases, then they're kind of bypassing the capital budget process. So a little less sensitivity in the U.S. In Europe, we did see some stresses. Placements were down year-over-year. I think 5 systems, that was predominantly government budget related. Again, I think I said this trickled down to kind of health care budgets. So we'll see how that continues, but there's certainly some stress in terms of budget deficits in Europe. I think we've talked about China very dynamic placement have been a little lower in terms of recent periods versus when the anticorruption efforts started when domestic competition started to have a greater impact. For the rest of Asia, I think, has been healthy so far.

China bounced back to 14 systems in Q2 and 14 is where you were before anti-corruption.

Yes. I -- I wouldn't call it a bounce back per se, I think that given the size of the remaining quarter, I think 14 reflects delayed tenders, particularly for anticorruption and kind of slowly increasing win rate from domestic competition. So I wouldn't characterize it as a bounce back per se.

And the Anti-corruption challenge -- initiatives, which are almost a year ago, still having an impact. I think a year ago, you thought it would probably be done by the end of the second quarter?

Yes. There was -- was indications from written government documents that it would be through June of this year. Our team on the ground in China are saying it's now extending into next year in terms of that set of activities.

For anticorruption initiatives?

Yes.

Got it. And the Stimulus, you -- I know -- I asked about that on the Q2 call. You don't think that's something that's going to benefit robotics?

Our team has not seen an impact or a benefit from that, and they are not predicting that there will be a benefit. So I know other players have indicated there may be a benefit, but we don't see that.

And on utilization, it was about 2% in the first half, I believe. That's a little bit lower than the mid-single digit that you point us to? Is there a reason -- do you expect it to bounce back?

Yes. I think, yes, both Q1 and Q2 utilization about 2% growth there. I think for -- what that really is reflecting is -- really strong procedure growth in the first half of the year ago period and so in Q1 last year, 26%, Q2, 22%. And so I think you had kind of a strong comparator there. I think looking ahead, we would expect utilization growth to start to revert back towards more historical averages in the low to mid-single-digit range as you start to see those procedure comparisons start to normalize as well.

Understood. And you had 70% procedure growth in Q2, as you mentioned, after 22% growth a year ago. And you raised -- the question is, what gave you the confidence to raise the bottom end of the guidance range for procedure growth?

Yes. I think the increase in the bottom end of the range really just reflects the procedure performance that we saw in the first half of the year. So if I kind of took Q1 and Q2 together and look at that, you're sort of close to that midpoint of the guidance range that we provided. So I think that's sort of what's kind of contemplated there. Obviously, in terms of the range as a whole, we've also contemplated scenarios for what happens with bariatric procedures in China and Korea, given prolonged physician strikes in Korea and then the delayed tenders impacting capital in China and, therefore, procedure growth. So those are sort of the scenarios or things that we've kind of contemplated in the range.

So U.S. bariatric was down mid-single digits in Q2 after I think being flat in Q1. Jamie, when do you think it troughs?

You mean when does bariatrics....

Bariatrics stabilizes? Yes.

So this is a conversation we have regularly with our bariatric KOLs. And the sum of it is they can't predict when it will stabilize. I've heard commentary from others that they think it's stabilizing. That's not the indication we're getting both from our field and from our KOLs. And so I think at this point, we're saying it's just too early to predict.

And you're still doing better than the market. So the market is worse than down mid-single digits.

That's right. I think it's down in the teens -- mid-teens sort of range.

So too early to call?

In terms of when that market stabilizes and then therefore stabilizes for us, we don't have any basis for calling stabilization.

But obviously, the comps are going to start to get easier?

Yes. It will.

Okay. Okay. And then I guess the big surprise really on the Q2 call, besides da Vinci 5 placements, was also the margins. And so maybe talk about what drove the strong margins, particularly the gross margin and why the gross margin takes a step down in the second half of '24, please?

Yes. So [indiscernible] gross margin on a pro forma basis was 70%, now it's quite a bit ahead of our expectations. We did have some onetime recurring items that we described on the call. If you adjust for that, it would have been 69.5%. That's still relatively strong performance. We did see relative to expectations, better pricing for components from our suppliers, and we also saw better freight rates and logistics costs in the quarter. That's been an area of focus for the teams. We didn't expect it to materialize that quickly. If I just take a first half, second half for you, first half pro forma gross margin was 68.8% implied by the midpoint of range for the year. Second half would be 68.8% or so -- flattish. And so what you see in the second half is increasing depreciation expense, then partially offset by those things I mentioned in terms of improved supplier performance and improved logistics. You also see a little bit of impact from a continual growth in the proportion of the revenue mix, this new products that carry lower margins.

And Jamie, thinking about next year, what are some of the puts and takes we should consider maybe starting with the top line?

Yes, I'd just say overall in terms of let's say, areas to watch there could be a headwind. I'd highlight four things. And none of them are surprised. Bariatrics -- we have to continue to watch. As we said, we don't know if and when that stabilizes, the China market continues to be dynamic. We don't have great visibility in terms of then how that plays out over time. We don't know enough yet to see when that may change. We have increased depreciation that we've talked about, both in the second half and on a more significant basis next year, again, given our CapEx. And then maybe we're starting to see some yellow flashing lights with respect to the macro, the market a little volatile right now, we're acting to kind of every economic data point. So I think we'll watch the macro capital. In terms of then what could drive our business in positive ways, obviously will take da Vinci 5 to launch. And our newer platforms Ion and SP are getting clearances in a set of geographies and will drive then the launch and over time, the adoption of those new platforms.

Bariatrics -- could the Korea strike, if it ends, could there be a bounce back?

We would expect so. We think a portion -- a fair portion of those patients haven't been treated, so there's probably an accumulating back there. I think those patients would have intended to in order to get to da Vinci Surgery. And so you could see some recovery for when that strike starts to resolve. We don't have indications yet from the field we can predict when that might be. But yes, that could be a benefit. It's a smaller market. But yes.

An Ion is approved in China now?

Ion is approved in China, where in a couple of tenders right now, we have not placed our first system but we expect to in the second half.

And you've been providing no disclosure on Ion procedures and systems. Is there a plan at some point to provide more disclosure on the contribution.

We are looking at what we would do for next year, we haven't decided yet. We do that each Q4. So we'll provide you that update in terms of what now becomes big enough for us to expand our disclosures, but haven't decided yet.

And Jamie, on 2025, sticking with that, maybe on the P&L, what are some of the considerations like you went through on the top line if you can?

I think beyond the ones I've described, I just reiterate that the depreciation expense is significant. We've spent just over $1 billion of CapEx based on this year's guidance over just over $1 billion the prior year. And so that's going to now really start to show up in depreciation expense not yet ready to say directionally, what happens to gross margin. We'll do that in January when we finish our planning process. We'll obviously provide the outlook in January. But -- there's a period where you have elevated depreciation expense. Much of that CapEx is for facilities that provides capacity on a manufacturing basis over a multiyear period -- to grow in and then growing and leverage that depreciation expense.

Is there any way to look at your CapEx spending and to try to estimate what the increased depreciation could be? Or is that impossible?

You probably could, but I would recommend against. I would just give us till January let us work through the details, and let's provide you the update in January. And I think we'll look to give you some sense of incremental depreciation as part of describing our outlook.

And are there offsets to that?

Progressively. In gross margin progressively. We're looking to improve product costs in Ion and SP. That's a multiyear plan. We've seen some improvements so far this year, but that continues over the next couple of years. But how that all shakes out in terms of gross margin for next year, again, I'd wait until January.

Right. But you're not saying one way, whether up or stable or down. I mean, depreciation is obviously a headwind, but there could be offset. So it could be flat. It could be up. You're not saying one way?

Not going to say it. We'll say it in January.

But it could be all three of those scenarios. Is that possible? Or are you saying directionally, it's probably stable to down?

Yes, I'm not giving you the direction.

Okay. I'm just -- yes, it could be all 3 of those? I just wanted to confirm.

Yes.

Okay. And what about -- just in recent years, you've grown OpEx slower than procedures. Is there any reason why that might change next year, some big launches you've chosen to grow OpEx faster?

Yes. I'd say that we have a priority to continue to prioritize R&D. And that's because we balance the opportunity for growth, which we think is significant in terms of -- from a strategic perspective, robotics and computer-rated interventions -- we think that's a strategic opportunity for us. The opportunity is large. And so we're balancing growth and profitability, and we'll prioritize R&D. From an SG&A perspective, subsets of SG&A continue to have the opportunity to leverage -- and so I'm not going to say yet whether that means what you describe changes in terms of what you've seen recently. Again, we'll do that in January. But kind of those are the two dynamics that we're prioritizing.

And you've talked about having top-tier margins between 35% and 40% over time. By our math, you don't guide to the margins, but we get to about 35% for 2024. Do you feel like you're in the -- solidly in the 35% to 40% range? Or is there anything that could go backwards? And maybe it's some of the factors you've already articulated today?

So maybe framing, last year '23, our margin was 34% first half of this year so far is 35%. If you look over the medium term, not '25 medium-term let's say, 3 to 5 years, there's kind of 3 drivers. You have the opportunity to drive trade-ins at some point from the launch of da Vinci 5, once you get a broad launch. Secondly, we have said we have an aspiration to get gross margin to 70% versus where it's at today, let's say, in the 68% range. So that then obviously falls through to operating margin. And over that period, we continue to see the opportunity again the subsets of SG&A to drive some leverage for '25 again, I think the key thing to consider is depreciation expense and a portion of that depreciation expense and operating expenses.

And the Xi trade-ins, Jamie, is that a good guy or headwind to the margins? You mentioned three things. One being the first thing you mentioned was trade-ins. Are trade-ins a tailwind or a headwind to margins?

Over a multiyear period, they become a tailwind because you get the incremental revenue -- there's periods where you have to obviously contemplate what's the degree of trading credit that likely declines over time. If you look at kind of the midterm, a tailwind to margins.

Got it. I lost my train of thought. But -- all right. I'll come back to it. da Vinci 5, remind us of what you've said when the I assume right now is dilutive to the gross margin. What if you said on timing, when that can be or I don't know if it's ever accretive to the gross margin because it's capital, but when does it become kind of consistent, call it, with the gross margin of Xi?

Yes. It's actually within the 70% objective over the next 3 to 5 years. In that period, we think we can get the dedincify gross margins to be similar risk to Xi. And so that's different than saying similar risk to the corporate average because capital generally is below the corporate average at target and close to Xi in the next 3 to 5 years.

But right now it's below. It's a drag.

Yes.

It's below XI?

Yes. On a percentage basis.

Right. Got it. Understood. And we didn't talk about procedures. Just maybe remind us of what the key growth drivers are? Where you are? Hernia has been probably the biggest in general surgery in the U.S. What inning are we in, in the big procedures? And what are some of the new ones that are coming on?

Yes. I think growth drivers kind of, as we see it, are pretty consistent with what we've described before, which are really in the U.S., focused in general surgery to your point. When you look at some of the large categories that we've talked to -- we're really in that second quartile of adoption across many of those categories today. So that includes things like cholecystectomy, hernia repair, colorectal procedures and even bariatrics. And so I think there's still opportunity to see for adoption in those procedures. And in addition, you start to see early stage growth in some other procedures like appendectomy, forgot procedures, other liver procedures as well, which is encouraging. I think outside of the U.S., our focus really is procedures beyond urology, particularly those malignant procedures. So our focus there really is in hysterectomy for cancer, thoracic procedures and colorectal procedures where we're seeing a lot of traction.

So appendectomy, we've heard that talked about before, but not a lot from Intuitive. I mean just more from physicians. That's a -- tends to be an emergent procedure. And so I'm curious, how big is that remind us? There's a lot. I mean it's a big category. And what are you seeing there in the U.S. given that it's an emergent procedure. And what are the economics? Is there an economic consideration there?

You take the market size if you have it. Do you have the market?

Yes, I don't think we've been specific just yet on kind of what that market -- but to your point, a portion of that is coming in emerging. And so maybe only a subset is applicable in terms of being addressed robotically, but we haven't been specific on the size.

We've seen our footprint expand in the acute care setting, so then providing the opportunity to have emergent care be treated through -- with da Vinci at both cholecystectomy and appendectomy. Appendectomy is growing at a fast rate but from a small base. In terms of economics, if I just do a CMS reimbursement reference, actually, the reimbursement under CMS is generally about the same as this cholecystectomy. And so therefore, the economics are similar to cholecystectomy. It skews a little bit to more complex cases at this point because both are in earlier stages of adoption, particularly appendectomy. But I think given now have a growing footprint that's available to the merchant settings, you're seeing that being used at an increasing rate.

That's helpful. And while we're on procedures, obviously, we're trying to figure out if there are new features that da Vinci 5 unlocks. Are we seeing any evidence that you can speak of right now that bring -- opening up new procedures?

Yes. It's too early. Our initial focus is driven by our view that da Vinci 5 and its capability actually allows us to go deeper in the procedures we're in. And as Brandon described, in many of those procedures were in the second quarter in the U.S. at much earlier stages of adoption in OUS markets. And so we think that we can go deeper in that existing set of procedures. Over time, we will look for additional indications given the capability of da Vinci 5, not ready to describe what those might be, and they'll likely take a little bit of time. But certainly, we see the opportunity for that. Over some period.

And Jamie, lastly, good competitive environment. Maybe walk us through what you're seeing in Europe and Asia, please?

Yes. So in Europe, particularly when compared to first -- started to enter the market. We did see selling cycles extend a little bit because they now start to participate in tenders that previously have been money intuitive. If you look at though our win ratio in tenders in Europe, it stayed high and consistent. So I think we're actually quite pleased with that win ratio and the fact that it's not changing. In Japan, you see a local manufacturer, the [indiscernible] System. Again, I think we like our performance there in terms of success rate or win rate. The place where I'd say we're seeing on a relative basis, more impact from competition is as we've described in China. There's a growing number of players that now have a system cleared. And again, there's local provincial practice you see for those players that are headquartered in particular in those provinces. But outside of China, I think the impact of competition to Intuitive is stable, and we like our win rates.

And you're going to be manufacturing locally in China. I know there was some development there recently?

Yes, we are. We started late last year, manufacturing a local system in in China, and that was so that we could participate in tenders that require a domestically manufactured system. Things that we're seeing in tenders is a requirement to have the system be manufactured in the province. And so then that's not an instance where we're likely to put manufacturing facilities in every province so that we can participate in the is, but it's what it is.

That's helpful. Jamie, we're almost out of time. We're just -- we are out of time, but I wanted to give you the last word. Any remarks?

No, I think the company feels good about our relative competitive position. I think we're excited about the launch of da Vinci 5 and getting to da Vinci 5, Ion and SP to either launch and/or additional geographies. Thank you for all of you, for your time and your support.

Thanks for being here.

Thank you.