Intuitive Surgical, Inc. — 2023 Q2

Yes. Well, I'll start on AI. Let's talk about what it is. For us, it's a suite of digital tools that rests on a baseline and then can be built upon using various machine learning techniques including computer vision. We've been at it for some time. We started the Internet-of-Things for surgical robots over a decade ago. We built the baseline of cyber secure privacy-compliant pipes that allow us to get access to the data. So there's some foundational work that was important. That's kind of step 1.

Let me talk a little bit about, I think, the patient population that moved to the sidelines during the pandemic, and then I'll turn the assessment over to Jamie. On the kind of the pandemic response, it's hard to exactly estimate how many folks would have been in diagnostic pipelines that did not get their tests. We do look at the data that's available to do that. I don't think it will clear in just one quarter. I think our past experience on these things is that lower utilization happened over a several year period, and it will probably take many quarters for it to fully recover. How long that is, I think it's very, very hard to estimate. So far, so good.

Yes. What we saw in Q2 was that growth rate slowed. We have some input from customers that the level of patient interest is such that patients are now considering drugs versus surgery. It's unclear yet based on that set of inputs from customers the duration of that evaluation by parents and patients and obviously, it's layered. So what we did for our guidance was we just said at the high end for the remainder of the year, the bariatrics growth rate in the U.S. is consistent with what we saw in Q2. And at the low end, we said that the growth rate continues to slow a little bit over the course of the year as patients become increasingly educated about the weight loss drugs. And obviously, there's a number of factors that patients have to consider with respect to those drugs, cost, side effects, what happens if they come off the drugs and regain weight, et cetera. But I think from our perspective, we're early in understanding what the longer-term impact will be.

I did want to ask about China and the China quota and how you think the opportunity is now that there's more local players, but you also have the local version of Xi and on the bariatrics, just a quick follow-up on that, too. Is that around 100,000 procedures. Just trying to think about sizing that their active surgery opportunity or impact?

We've set the market size in the U.S. is about 200,000 procedures annually for what we think is a good mesh for robotics. And in terms of where we are in penetration, we're kind of at the -- if I put it in quartiles, we're at the beginning of the second quartile. What was your first question, Travis?

It was on China and the China quota and how to think about that opportunity there versus last quarter, given there's more local players, but now you have the local version of Xi.

Yes. I mean, obviously, there's increased opportunity in the sense that this quota is 559 systems relative to the prior quota of 225 systems, but you also have now 5 local players. There will be government interest in success of local players. We do believe the surgeons care about capability and feature set and so the extent to which da Vinci continues to be differentiated, I think, is to our advantage.

Great. And a question for Gary. Just I heard the comment on hospitals leasing more to preserve the upgrade option for the next-gen system. So maybe just talk high level, the pipeline comments on the FDA and kind of supply chain bottlenecks that you saw last year? And then and how you're thinking about incremental upgrade to the Gen 4 versus kind of new platforms?

Sure. On the supply chain health side, we are seeing fewer pockets of challenge, but some pockets nonetheless. So there's been significant focus and attention to make sure that we're supplying our customers what they need as we go through a pretty nice procedure growth curve. So they're calling out improvement in the breadth of supply chain challenge, but cautioning that there are still some pockets that need attention or require attention.

Yes, I'm not going to be specific on the prototype expense and it's distributed across a number of programs. Prototype expenses tend to be lumpy within Q2 relative to the comparison point. It just so happened to be a quarter where that was one of the direct drivers of our expenditure. Nothing more than that, I would say.

With respect to capital allocation, I think our priorities are consistent for how they've been for some time now. Our first priority is to invest in the business, both in capital expenditures, which as you've seen by our guidance are relatively high to our history this year and in organically investing in operating expenses.

You had a long list. I think several of those are important and things that we have talked about and have shared with the world. I think the idea of higher confidence ability to identify tissue in real time for the surgeon, and we can do that in a few different ways. So the florescence imaging, that you described and other advanced imaging technologies that give surgeons the ability to see beyond the surface of the tissue and beyond what you can see with normal white-light imaging, we absolutely think that's helping clinical outcomes and we're excited about and investing in image fusion or data fusion, and that's the CT overlay, the segmentation of preoperative MR and CT scans and the ability to use that in real time during the case, we think, can change outcomes and change efficiency in the OR.

It was largely implemented in Q2, Rick. It wasn't effective at the beginning of the quarter, I'd say, roughly half of the quarter benefited from the price increase. Our estimate for the impact of the price increase is consistent with what we said last quarter, roughly about $100 million impact to revenue and profit for the year. Again, you get kind of half an impact in Q2 and the full impact in Q3 and Q4.

A reminder, our motivations on that, we've been quite conservative on pricing. Our input pricing in the last few years has gone up in terms of raw material and labor content. We have offset most of that through efficiency and scale advantages, but we felt like it was time to share some of that with our customers, and that was what was behind the price increase.

Richard Newitter here. Jamie, maybe for you on the guidance, 20% to 22%, very healthy. I'm just curious on thinking about the low end of the range there. You specifically mentioned you contemplate bariatric surgery growth trends, eroding a little bit from the 2Q levels. What's the pace of erosion there that you're thinking about that would get you to the low end? Like how much erosion, how did you establish a baseline for yourself?

Yes, I don't want to get too specific there, Rick, given just the relative size of bariatrics in the U.S. to our overall procedures. We can obviously see the progression between Q1 and Q2, I'd call it a moderate, steady progression in the model in Q3 and Q4. The overall impact on that is obviously a function of the size of the bariatrics business for us. It's not some dramatic falloff.

Okay. That's helpful. And just maybe sticking on the same topic here on bariatrics. Just thinking about the areas that you could offset that as we think of procedure categories geographically or by category that could be nearing an inflection point like Bariatric got to several years ago, what procedure categories or geographies would you call out that you think could lead to overage there to offset any potential incremental slowdown in bariatrics, if any?

I'm not going to answer that in terms of overage, but I'll say where we're seeing healthy growth. If you take our largest 7 markets, which is a focus for us, so China, Japan, South Korea, Germany, France, U.K. and Italy, what you're seeing in those markets is generally a progression beyond urology into the next set of cancer procedures. It's market by market. But generally, that's hysterectomy, thoracic and colorectal procedures. And we're seeing them on the early stages of an adoption curve, and that's why we've talked about our OUS business now is about half outside of urology or beyond urology. This quarter, it grew 35% that subset. That's consistent with what we saw in Q1. That subset also grew 35%. So I think we're excited in those larger markets where we have that focus and continue to drive the adoption curve in that next set of procedures.

Just I want to just step back a little bit on bariatrics, we've had a few questions on it and just make a point. As we go out and talk to surgeons, we talk to obesity physicians and pharmacologists, which we do in terms of our diligence. The sense here is that the market is going to adjust to the change in treatment pathway as it relates to drugs. However, it doesn't look like the drugs are a cure and may not be a fast path to cure and a strong consensus among those we speak to, including people who are not surgeons, physicians who are not surgeons is that the surgery and other interventions are going to remain an important part of the interaction.

Maybe one for Jamie. On the expense management standpoint, I mean, procedures are going up a little bit faster than expense -- OpEx guidance by about 50 basis points or so in and so I'm just wondering, Jamie, kind of what your views are on expense management and letting some of that leverage flow through as we think about not just the back half of the year, but into '24 versus maybe reinvesting that in R&D?

Yes. For this year, we have specific objectives with respect to leverage in our enabling functions, which we've described previously. And that's a set of objectives that I think we intend to fulfill.

Okay. That's very helpful. And then I noticed, and this is kind of directed at Gary, you commented on this a little earlier, but you disclosed for the first time, I believe the proportion of lease agreements that are usage-based versus fixed operating lease agreement. And I'm wondering, Gary, what that says and the trends that we see there about the health of our customers and what their preference is over time?

Yes, it's a good question. I think we see that one size doesn't fit all. There are some folks for whom they still remain happy about capital purchases. They see it as the cheapest way for them to access systems. They have high confidence and they're going to buy. There are some folks for whom capital is tight, scarce and or they're interested in future technology protection clauses, and they would rather lease. And there are some folks who are looking at expansions, are a little bit unsure about how fast volume might ramp and for them, usage-based arrangements give them some protections about ramp timing and speed.

The motivation by the way, for the new disclosure was simply the rate at which those adoption of those models have grown, we felt, okay it was important to be transparent as to what portion of operating leases and placements that structure was. If you kind of assess all of our usage-based arrangements in aggregate life today relative to usage patterns and economic objectives in total, on average, they're slightly above our expectations. So they performed well so far. That's obviously a blend across different customers and systems. Some are overperforming, some are underperforming. But I think part of the way that we've operated the program is to look carefully. Is it actually reducing barriers for accelerated growth of our customers? And is it producing the economic results for us and our customers and as we and customers have gained confidence, that's part of the reason why it's expanded the way it has.

Maybe just one other follow-up question on bariatrics, but maybe a different angle. I mean, we've talked to some general surgeons too, that mean they're kind of suggesting that these new drugs might even open up potential procedure categories where these patients might not have been suited to have surgery. Gary, kind of like what are your views on this? Do you see some near-term disruption from GLP-1s on the bariatric side but maybe this opening doors for other procedure categories?

Yes. That's a little bit of the narrative we're hearing too. We go out and canvas our customers pretty widely. There may be a role for kind of new adjuvant use of drugs and then as you say, that may condition some patient populations to be beneficiaries of surgery downstream. There may be folks who start the drugs, get the benefits that they were hoping for, but either the side effects or the cost or the change lifestyle that the drugs are implying, make it hard to sustain. There's a fair amount of that in the literature. So that may -- that population may look for other solutions.

Is there any procedure categories that are coming up in your conversations that stand the most benefit?

It's a good question. We're probing probably too soon for us to give you a definitive answer.