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

Okay. Welcome back. I'm Larry Biegelsen, the med tech 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, Executive Vice President, CFO and Enterprise Technology Leader; and Dan Connally, Head of Investor Relations. The format is a fireside chat. Jamie -- and Dan is going to read the safe harbor statement first.

Just real quick comments. Today's session may 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 our Securities and Exchange Commission filings, including our most recent Forms 10-K and 10-Q which you can find through our website at intuitive.com or at the SEC's website. Investors are cautioned not to place undue reliance on such forward-looking statements.

Thanks Dan, and thank you for being here.

Yes. Happy to be here.

So Jamie, I wanted to start with procedures with the focus on the U.S. And we've seen U.S. procedure growth slow recently. And your comment about law of large numbers I think, concern some investors to be candid. So my question is what framework would you use to help people estimate U.S. procedure growth going forward?

Yes. I appreciate the question, and I know there's a lot of focus on the U.S. business right now. Let me zoom out for a second. So I'd say our focus first is on global procedure growth and on all procedure types. So including eye on. And that's how we think about how we do capital allocation, how we incent our sales force. And we have significant opportunities to drive the global U.S., about 60% of our business, and it's decelerated as you've described. We said on the Q2 earnings call, there was a modest impact from lower ACA subsidies. But the way we think about the U.S. business is procedure by procedure. And so -- and we draw adoption curves for each of them. And so if I think about that business, you have prostate in the fourth quartile of adopter -- of adoption you have cholecystectomy, the largest procedure category in the U.S. in the second quartile, you have appendectomy the first quartile. And so we model each procedure on an adoption curve, and it also then ties to how we focus and how we invest, where they are relative to the size of the market. And the total U.S. procedure growth then is a summation of each of those procedures and where they are. We think that we have a significant opportunity in the U.S., particularly benign general surgery. We have a couple of procedures that are early and have just been put on the beginning points of adoption in cardiac and nipple sparing mastectomy. And over time, we think we have the opportunity to add additional procedures to the beginning of the funnel. And so, the way that we think about the market is a significant and attractive opportunity for us. And we think that we can continue to bring procedures to the beginning of that funnel. Of course, there are dynamics in the marketplace right now, ACA, as I described.

That's helpful. So which are the procedures that are going to drive the most growth in the U.S., let's say, over the next 2 to 3 years?

Yes. I think broadly, just thinking about 2026, expected growth drivers to be consistent year-over-year. So like Jamie mentioned, general surgery, and specifically, continued growth an after-hours procedure, so chole, hernia repair. And then in addition to that, obviously, we have some procedures at earlier stage opportunities like Jamie mentioned, cardiac and nipple sparing mastectomy as well as significant operation remaining in general search.

I guess, could we see -- let me just ask a blunt question. Can we see U.S. procedure growth dip below 10% in the second half given the tougher comps in the ACA subsidies expiring?

I'd just say, obviously, we don't guide at the region level. What we did in our last earnings call was provide the guidance range of 13.5% to 15.5%. Again, that's global, and we said it's likely to be towards at point of that range. That range does reflect more difficult second half comps compared to the prior year. And obviously, we incorporate our best estimate of the kind of ACA dynamic that we described on the Q2 call. And so again, we're focused on the global total and the U.S. component is reflected in that range. .

I was surprised when you talked about U.S. procedures, you didn't mention the ACA -- ASC opportunity. Sorry, I mean, I know that's not a specific procedure, but it seems like a big opportunity for Intuitive.

Yes, I think we've described that starting in January of this year on the fourth quarter call as an opportunity over the long run. It's not going to be linear, but I think that's a significant opportunity, kind of enabled by growth in reconditioned Xi, right? And so we've had 2 quarters of that thus far. And I think in Q2, we placed 27 systems into ASCs, which was more than cumulatively over the prior couple of years, 20 of those were XiR. So certainly supportive of growth in the mid- to long term in that side of care.

That's helpful. Okay. Let me -- we'll probably come back to procedures in the context of the extended use program, but I wanted to ask about capital equipment. There's obviously concerns about the capital equipment environment just given the profitability issues at hospitals today, given some of the policy changes. So what's kind of your view of the state of the capital equipment environment maybe U.S. and globally? And how are you thinking about the outlook?

Yes. So through Q2, U.S. capital has been stable and relatively strong I think OUS has been a little bit more mixed and kind of market by market. In Q2, in the U.S., we placed 267 systems. That was up 24% year-over-year. I'd say enabled by continued adoption of da Vinci 5 and also system upgrades. We had 28 Xi reconditioned in the U.S., 20 of those into ASCs. I think some customers looking back, have expressed concern caution over ACA enrollment. That's not new. We've been describing that as potentially having some impact, but we have not seen that again through Q2 in the U.S. I'd say part of that is as a result of only a small portion of customers in the U.S. acquired their systems outright via purchase arrangement, so roughly 70% to 75% of the systems that are going out in the U.S. typically have been on a nonpurchase arrangement. Outside the U.S., it's more market by market. So in Q2, I think we placed 201 systems, that was up 12% year-over-year. Asia was up 9%; Europe, up 8%; Rest of World, up 27%. So fairly broad-based. It's early outside the U.S. on da Vinci 5 customers are responding. They're also responding, let's say, to increase availability and around XIR and X. And so getting the opportunity to have Gen 4 capabilities in their technology as they start programs.

What about this 340B program. It's not super familiar to med tech investors, but it's kind of been bubbling up as a concern. Is that something when you think about changes to that program that you feel it could have an impact on capital?

We -- I think it's early. We've been obviously reading everything the same as you all. I think there's kind of 2 schools of thought. The first is that related to pharma, there will be less funding that has an impact on hospital financials and therefore, perhaps indirectly on what they put in their capital budgets. On the flip side of that, it's likely that outpatient surgical reimbursements go up for CMS. And so obviously, that could have a beneficial effect for Intuitive and those in the surgery business. I think it's too early to really kind of say what the dynamics may be in terms of an impact. And then, of course, we're also watching what happens to Medicaid funding over time, but we're not making any specific comments about how that might impact our business because it's just too early.

That's understandable. Let me just switch gears to competition. And just we've had some recent news, give you a chance to respond. Ottava, obviously, got cleared in the U.S. Just, I guess, 2 questions. One is just reaction to kind of their feature set. Do you think it will resonate with some customers. And in terms of pausing, you've always talked about competition could elongate the selling cycle. What are your expectations?

Yes, I'd just say first, the basis of competition from our perspective is not just the robot, it's the full ecosystem, it's our software capability and the ability to update the software over time. It's the AI feature set. So it's the full integrated product portfolio that's the basis of competition. In terms of that architecture, we've looked at many architectures, including table-mounted over the years, and we've made conscious choices with respect to the trade-offs between the various architectures. I think we feel good about our product portfolio. We have a segmented system portfolio that I think gives us some advantages. In the U.S., da Vinci 5 has resonated strongly. And da Vinci 5 gets better over time, we do about a major software update once a year. And so I think we're competitively positioned again, both with da Vinci 5 and its capability and the full ecosystem. And so I think we feel good about our ability to be successful in the U.S.

And so what is it about Table Mountain that you said you'd look at it that you think might be a disadvantage versus what you offer the boom based?

Yes. The physics of it, at least from what we've looked at is the way in which the arms deploy and get configured can give you restrictions on patient size and on what the breadth of procedures you can do? And the [indiscernible] architecture, the exon da Vinci 5, we think there's an advantage there.

That's helpful. And then reaction to the Medtronic Cornerstone agreement, which is more international.

Yes, I'd say we with our -- in conjunction with our JV in China, we've looked at basically all of the competitive systems in China. Many of them are X or Xi, kind of, look alikes in terms of their form. I think we feel good about our product portfolio and our ability to compete economically and feature-wise. I'd just say for an arrangement like that, you have to think through how the profits get shared, how do the ecosystem converge, how do you do product development jointly. And I think that those can be challenging attributes of an arrangement like that.

Makes sense. Jamie, international, I know we focused a lot so far on the U.S. International has been strong, as you mentioned. But there is like increasing competition out in the U.S. as well. And you can kind of add up the placements from some of these companies. It's pretty significant in the aggregate. So the question is, can you continue to drive strong growth outside the U.S. in light of this?

OUS is a significant focus for us. We think the opportunity is also significant. It has obviously lower relative penetration from a procedure perspective. I think we have a number of competitive advantages internationally segmented system portfolio with X and XiR is a good fit for many of those markets because they're cost constrained and a number of them are unfunded health care systems where, obviously, there are budget pressures and we have da Vinci 5 for the premium accounts. Extended-use instruments 2.0 that we're going to talk about, I think, also gives us an opportunity, along with XiR compete effectively where there are cost constraints, where economics are a greater proportion of how they make the decisions. There are obviously a number of players internationally. Many of them are, let's call them, local players there's some desire locally for those companies to succeed, so you have to compete with that. Competition is intense in China, which we've talked about and obviously, to some extent, manifested therefore, in our capital placements, along with just much slower tender activity. We have the full ecosystem. Many of those players do not. And so I think we're well positioned.

Back to the topic question. I asked about elongation in the selling cycle. Is it just too early? Obviously, 27 is going to be a kind of a limited launch for them.

In the U.S., obviously, we've seen Medtronic launch with urology clearance, and we haven't yet seen any change in selling cycles. And obviously, we'll see what happens with Ottava.

Okay. I could -- it could. You think 27 would be too early just given limited launch or...

I think they'll do -- it sounds like they'll do a measured launch. They don't have the full ecosystem. So it sounds like it will be a couple of years for them to get going.

Right. Okay. All right. So the extended use program, I guess there's really 2 questions. One is any framework, anything you can offer? I know you it was too early on the Q2 call. Anything you can offer to size it relative to the last one you did, which we know, number one; and number two, help us understand the return on investment? And why it's going to be positive and it's going to stimulate, I assume, procedures and offset some of the costs.?

Yes. I just maybe zoom out to the strategy for a second. And so we talk often about the Quintuple Aim. And that's, from our perspective, an expression of our customers' objectives, and we integrate that into our strategy and how we allocate capital. And one of the elements of the Quintuple Aim is that you lower total cost of tree over time. And obviously, that's a function of the financial pressures broadly in health care systems. And so we invest there. And we look to lower total cost to treat through many ways, you can do it by lowering complication rates by saving on finite resources through innovation in your products and you can do it through price. And we'll do any combination of those. The extended use instruments have been investments from our engineering teams over a number of years, and we generally apply the experience curve theory to how we think about product costs. As volumes grow, and we've been growing every year, basically except COVID, in 2020. As volumes grow, you should get benefits from economies of scale and through the accumulated experience of manufacturing your product to allow you to lower product cost. And so then for us, that gives us an opportunity to pass it on to customers, particularly where there's elasticity. And so that's a core part of our strategy. And I think that's a trade and true strategy across many industry segments. And so we think it's, in many regards, an obvious thing to do because you pass on a competitive advantage to your customer in places where it really matters. The 2027 program is directionally similar to the 2020 program. It will lower I&A per use cost for our customers. That will be mostly targeted at those procedures and markets where they are more cost sensitive and therefore, where we think we can get an elasticity response. And so then in terms of the 2020 program, how do we judge success? When we look at 3 things, what happened to procedure trends before and after; second is the actual economics of those procedures post the change; and third, customer feedback. And so we kind of put that together. You don't have, obviously, AB testing, so you can't do a perfect ROI analysis. But the combination of those data points gives us pretty high confidence that it was the right decision. And I think from a strategic perspective, the virtuous cycle is obvious strategic opportunity to follow.

Just to clarify, directionally similar to 2020, you're saying basically that...

In terms of construct of the program, I'm glad you asked that. Quantification, we haven't provided yet and we'll do so on the Q3 call. When I say similar, it's in terms of construct, the impact we're talking about Q3.

Okay. So you did not mean -- directionally similar to 2020 did not mean the quantification?

Yes. Correct.

Maybe you can tell us what -- maybe then you can answer that one. So it's too early, you'll say...

It's too early. We're going to...

Q3 call.

Q3 call.

Okay.

And the reason for that is, as you know, we did a press release with an integrated set of capabilities that were coming to customers. And that press release was targeted at customers just given the size of the number of customers that we have. And we included extended use instruments in there knowing it was coming in '27 because that then gives us the opportunity to engage customers in how that program is going to work. We wanted to make sure we had the opportunity to engage and reflect the feedback in the OMA exact kind of prescription of how it would operate, including the benefit to customers.

And back to -- so the procedure growth question earlier, is this -- could the extended use program be stimulate procedure growth in the U.S.? Could this accelerate procedure growth?

That's the intention of it. And that's why we focus it on those areas where we think there's elasticity and not just in the U.S. but globally.

Right. So people who may be concerned and you know a lot of investors are about the deceleration of the U.S. growth this could be a tailwind?

This is one of the opportunities to have an elasticity response that has a benefit to procedure growth, yes.

Okay. I got it. And then sticking with INA, remanufactured instrument. What are you seeing in the field? I think at SRS in the video we did, some of Dave's, your CEO's commentary suggests that, look, there is some cost matters, there's some interest in this. What can you say about what you're seeing in the field?

Yes, for the data that we have, usage is growing. I'd say it's growing from a relatively small number to still a small number. From our perspective, we think that the reliability, product quality the product safety embedded in our products as customers value that. And we have and will continue to innovate. And I think that, that gives us a good basis to compete effectively.

Does the extended use program change the attractiveness of third-party alternatives?

I think to the extent the economics are a dimension of the relative decision making between the two, then it must have some impact, yes.

And we've gotten asked this question. I'm curious to hear your view, could Intuitive -- because we've seen it, I think, in other industries, could Intuitive come out with its own remanufactured instruments?

There's no plans that I'd highlight at this point. We think the product set that we have allows us to compete effectively.

Okay. All right. Switching gears to the endoluminal GI system. The FDA summary has been posted. So we know a little bit more. I guess my question is kind of what's next in terms of the process and the time line, what can you share?

Yes. Really, it's around remaining engineering work, what the associated regulatory pathway would be once we start to get through that, you have to develop clinical evidence in programs like that, you may also have to do work on reimbursement. And so we're not being specific about time lines yet because it's too early. I think as we knock down our internal milestones and make progress, we'll provide updates accordingly.

So it doesn't have instruments yet or any kind of disposables that we're aware of. Is there going -- is it going to be like a razor, razor blade model like you have with other systems?