Intuitive Surgical Inc (ISRG) — Q4 2017 Earnings Call Transcript

Thank you. Good afternoon and welcome to Intuitive Surgical's fourth quarter earnings conference call. With me today, we have Gary Guthart, our President and CEO, and Marshall Mohr, our Chief Financial Officer. Note that Patrick Clingan, who has participated in these calls in the past, will not be joining us today. Patrick's scope of responsibility in the company has grown over the past couple of years, and going forward, he will be dedicating less time to Investor Relations. Before we begin, I would like to inform you that comments mentioned on today's call 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 Securities and Exchange Commission filings, including our most recent Form 10-K filed on February 6, 2017, and 10-Q filed on October 20, 2017. These filings can be found through our website or at the SEC's EDGAR database. Prospective investors are cautioned not to place undue reliance on such forward-looking statements. Please note that this conference call will be available for audio replay on our website at intuitivesurgical.com in the Audio Archive section under our Investor Relations page. In addition, today's press release and supplementary financial data tables have been posted to our website. Today's format will consist of providing you with highlights of our fourth quarter results as described in our press release announced earlier today, followed by a question-and-answer session. Gary will present the quarter's business and operational highlights, Marshall will provide a review of our fourth quarter financial results, and I will discuss procedure and clinical highlights and provide our financial outlook for 2018, and finally, we will host a question-and-answer session. With that, I'll turn it over to Gary.

Good afternoon and thank you for joining us on the call today. As you know, Intuitive is dedicated to the mission of expanding the availability of minimally invasive surgery, increasing its efficacy and decreasing its invasiveness. The fourth quarter completed a solid year in pursuit of this mission. During the year, we made progress in several areas, including accelerated use of our system and the related growth in our installed base along with the achievement of significant milestones in variable market access and product development. While we're pleased with our progress in the year, the opportunity for improvement in surgery is substantial and much work remains to be done. Global procedure growth was strong at approximately 17% in the fourth quarter and 16% for the full year. Growth patterns and procedures were largely consistent through the year, with increased use of da Vinci in general surgery in the United States, continued growth in neurology in Europe and Japan, and multispecialty growth in Korea and China. General surgery growth was led by hernia repair and colon section, while mature procedures in the United States, particularly across the discectomy, outperformed our expectations, predominantly due to macro trends in the prostate cancer market. Procedure growth in several countries, including Germany, Korea, and China, was healthy throughout the year, and adoption in Japan was solid for those procedures that have been reimbursed. This month, the Ministry of Health in Japan listed for reimbursement 12 procedures in which da Vinci could be used, in addition to prostatectomy and nephrectomy, which are already reimbursed. While this is clearly a positive step regarding interest in da Vinci procedures in Japan, the final level of reimbursement has not been communicated. Calvin will review procedure trends and Marshall our progress in Japan in greater detail later in the call. Turning to capital placements, we expanded our da Vinci system offering this year with the launch of our da Vinci X surgical system. A response to customer need, da Vinci X delivers our fourth-generation robotics, imaging, and fully articulated instrumentation at an attractive entry price with logical upgrade pathways. Reception to the X has been positive, catalyzing interest in robotics programs in price-sensitive markets. Taken together, our generation four products da Vinci X, da Vinci XI, and our future da Vinci SP, which is not yet cleared, represent a balance and upgradable portfolio of choices for customers building or extending their robotic surgery programs. Overall, our capital placement performance in 2017 accelerated relative to 2016, with growth in total placements rising 27% from 537 in 2016 to 684 in 2017. Net of trade-ins and retirements, our da Vinci install base grew 13% over 2016, from 3,919 to 4,409. U.S. capital placements stood out in the year, and the fourth quarter was largely driven by growth in general surgery. European placement performance in the fourth quarter was strong, and placements in the fourth quarter in Japan were also healthy, perhaps a one-time uptick in anticipation of broader reimbursement. Capital placements overall have been lumpy, and we anticipate volatility in placements in 2018. Operating performance in the fourth quarter and for the full year exceeded our expectations, with strong performance in manufacturing efficiency, product quality, and cost reduction projects, and with average selling prices as expected. Investments to deepen our original capabilities and to develop new technologies and services were important in the past year. As our business strengthened, we increased some investments through 2017 to strengthen our corporate infrastructure and position us to benefit from increased scale. Turning to highlights of our fourth quarter operating results, procedures grew approximately 17% over the fourth quarter of last year. We shifted 216 da Vinci surgical systems, up from 163 in the fourth quarter of 2016. Revenue for the quarter was $892 million, up 18%; proforma gross profit margin was 72.3% compared to 71.1% in the fourth quarter last year. Instrument and accessory revenue increased to $457 million, up 18%. Total recurring revenue in the quarter was $618 million, representing 69% of total revenue. We generated a proforma operating profit of $384 million in the quarter, up 20% from the fourth quarter of last year. Proforma net income was $298 million, up 23% and we concluded our accelerated share buyback program initiated in Q1 of 2017 at a weighted average price of $310 per share. Highlights of the full year 2017 are as follows: Procedures grew approximately 16% over 2016; we installed 684 systems in 2017, up from 537 in 2016. Revenue for the year was $3.1 billion, up 16%. Pro forma gross margin was 71.9% for the full year compared to 71.6% for 2016. Total recurring revenue for the year was $2.2 billion, representing 72% of total revenue. Pro forma operating profit for the year was $1.3 billion, up 13.1% from 2016, and pro forma net income was $1 billion, up 19%. Marshall will take you through our finances in greater detail shortly. While Intuitive completed its 22nd year in 2017, I firmly believe that computer system medical advancements are in their infancy. A careful read of the clinical literature makes clear the need for more effective, less invasive, and lower total cost-to-treat solutions to many disease states. The rise of robotic technology, powerful computing, improved sensing, micro fabrication, and molecular imaging enable new approaches to old problems. We have been investing in improvements, both incremental and revolutionary towards the same and anticipate continuing this investment trajectory in 2018. The opportunity to improve surgery using advanced technologies is now recognized broadly, and we anticipate the entry of additional competitive systems into some regions of the world over the next several quarters. Customers appreciate choice, and it is possible that sales cycles lengthen in some countries as customers evaluate more options. Our company is anticipating increased competition, and we are focused on understanding the market’s needs and selling and delivering products and services today and in the future that meet them. Turning to our da Vinci SP system, we submitted our 510(k) for urology last month. We call it SP as a platform technology that allows high dexterity access with great 3D vision to confined surgical spaces. As we’ve discussed on prior calls, we plan first markets to include urologic surgery, head and neck surgery, and colorectal surgery. In 2017, SP was used in human trials in the United States and Hong Kong, completing cases spanning initial target procedures. We anticipate a phased launch of SP in 2018 pending clearance. We are also making good progress on our flexible robotics platform, first targeted to address the acute need in the diagnosis of lung cancer, one of the most commonly diagnosed forms of cancer in the world, and for which early detection is important. Our program hit its milestones in 2017, completing its first clinical experience in Australia. Preliminary results were reported at the CHEST Conference in Q4 of 2017. Feedback from physicians evaluating our technology relative to existing and emerging alternatives has been strongly supportive of our efforts. Our design and operations teams are working hard to incorporate feedback, complete its production design and supply chain optimization, and complete validations for regulatory submissions. We do not expect revenue from our flexible robotics program in 2018. Our fourth-generation product platform has enabled greater access to our legacy advanced instruments. Use and satisfaction with our stapling and imaging products has been rising as Gen 4 products have increased in the installed base. Both stapling and imaging instruments are important to surgeons, and we’ve been investing in broadening our product line and incorporating customer feedback in both areas. In the fourth quarter of 2017, we submitted our 510(k) applications for our 60-millimeter stapler for da Vinci X and Xi. Lastly, our imaging teams continue to explore new ways to identify tissue, including good progress in our molecular imaging program, as well as improvements to our endoscopes and image processing algorithms. We have been introducing improvements in our imaging hardware routinely and expect to continue to do so in 2018. Molecular imaging agents are long-term investments. We expect our lead agent to enter Phase 2 trials in 2018. In closing, as we start 2018, our focus remains on completing the tasks we’ve set for ourselves. First, continued adoption of da Vinci in general surgery. Second, continued development of European markets and access to customers in Asia. Third, advancing our new platforms, imaging, advanced instruments, da Vinci SP, and our diagnostic platform. Finally, support for additional clinical and economic validation by global region. I'll now turn the call over to Marshall, who will review financial highlights.

Good afternoon. Overall, our fourth quarter financial performance was strong. I will start by describing highlights of this performance on a GAAP and non-GAAP or pro forma basis. I will also take you through our analysis of the impact of the key U.S. 2017 tax cuts and jobs act on our financial results. As a reminder, our results are also posted on our website. Consistent with our preliminary press release on January 10, fourth quarter 2017 revenue was $892 million, an increase of 18% compared with $757 million for the fourth quarter of 2016 and an increase of 11% compared with third quarter revenue of $806 million. In the fourth quarter, we completed the da Vinci X tradeoff program offered to certain first quarter customers. The impact of this program was to increase fourth quarter revenue by approximately $2 million and third quarter revenue by approximately $21 million. As mentioned earlier in the call, fourth quarter 2017 procedures increased approximately 17% compared with the fourth quarter of 2016 and increased 12% compared with last quarter. Procedure growth continues to be driven by general surgery in the U.S. and in neurology worldwide. Calvin will review details of procedure growth later in this call. Instrument and accessory revenue of $457 million increased 18% compared with last year, which is slightly higher than procedure growth. Instrument and accessory revenue realized per procedure was approximately $1,910, which is relatively unchanged compared to last year, reflecting increased advanced instrument usage mostly offset by customer buying patterns. Systems revenue of $283 million increased 20% compared with the fourth quarter of 2016, primarily reflecting higher system placements. We placed 216 systems in the fourth quarter of 2017, compared to 163 systems in the fourth quarter of 2016 and 169 systems last quarter. 40 systems replaced under operating lease transactions in the current quarter, compared with 13 systems in the fourth quarter of 2016. Systems placed under operating leases represented 19% of systems placements compared with 8% last year. Our installed base of da Vinci systems ended the year at 4,409 systems, up 13% year-over-year. Consistent with recent trends, average system utilization continues to grow in the mid-single digit range. Globally, our average selling price, which excludes the impact of operating leases and lease buyouts and revenue deferrals, was approximately $1.47 million, which is similar to the fourth quarter of 2016 and the same as last quarter. 51 or 24% of the systems placed in the quarter were da Vinci X systems compared with 16 or 9% of systems last quarter. We are seeing demand for da Vinci X from cost-sensitive customers as well as customers switching to upgrade to or standardize our fourth-generation technology. We believe that flexible financial programs like operating leases have allowed us to be more agile in meeting customer needs for systems. While the number of leases is difficult to predict in the short term, we expect the proportion of these types of arrangements will increase over time. Outside of the U.S., results were as follows: Fourth quarter revenue outside of the U.S. of $248 million increased 17% compared with both the fourth quarter of 2016 and the third quarter of 2017. OUS procedures grew approximately 21% compared with the fourth quarter of 2016. Outside the U.S., we placed 86 systems in the fourth quarter, compared with 63 in the fourth quarter of 2016 and 62 systems last quarter. The current quarter's system placements included 47 in Europe and 22 in Japan. 25 of the 47 systems placed in Europe were X systems. Placements outside of the U.S. will continue to be lumpy as some of the OUS markets are in the early stages of adoption; some markets are highly seasonal, reflecting budget cycles or vacation patterns; and sales into some markets are constrained by government regulations. As Gary indicated, a committee of MHLW in Japan has recommended 12 procedures for reimbursement. It is anticipated that by the end of this quarter, MHLW will determine the reimbursement levels for each procedure. The applicable opportunity for da Vinci surgery within this set of procedures is difficult to estimate at this time due to the uncertainty in reimbursement levels as well as the perceived value of da Vinci relative to alternative surgical approaches. With nearly 300 systems installed in Japan, the level of system expansion over the year or so, over the next year or so, is difficult to predict. We expect system expansion in Japan to be modest in 2018. Moving on to the remainder of the P&L, the pro forma gross margin for the fourth quarter of 2017 was 72.3% compared with 71.1% for the fourth quarter of 2016 and 71.8% for the third quarter of 2017. The increase compared with the third quarter primarily reflects lower manufacturing costs, partially offset by a seasonally higher proportion of systems revenue. Future margins will also fluctuate based on the mix of our newer products, the mix of subsystems in instrument and accessory revenue, system ASPs, and our ability to further reduce product costs and improve manufacturing efficiency. Pro forma operating expenses increased 19% compared with the fourth quarter of 2016, an increase of 13% compared with last quarter. The increase compared with the third quarter reflects increased variable compensation. Our spending was consistent with our plan, reflecting investments in da Vinci SP, catheter-based robotics, imaging in advanced instrumentation, and expansion of our OUS markets. These investments involve multiyear commitments. Our pro forma effective tax rates for the fourth quarter were 24.9% compared with our expectations of 26.5% to 28.5%. Now I will take you through the items included in our GAAP tax rate, including impacts of the U.S. tax act in a minute. Our tax rates will fluctuate due to changes in the mix of U.S. and OUS income, changes in tax rates made by local authorities, and with the impact of one-time items. Our fourth quarter 2017 pro forma net income was $298 million or $2.57 per share compared with $242 million or $2.03 per share for the fourth quarter of 2016, and $324 million or $2.77 per share for the third quarter of 2017. All per share amounts reflect the three-for-one stock split effective in October. Third quarter 2017 GAAP and pro forma net income per diluted share benefited by $0.9 per share from the recognition of $21 million of deferred revenue net of costs and income tax, and by $0.59 per share related to the tax reserve reversal of $68 million. I’ll now summarize our GAAP results. Inclusive of the impacts of the U.S. Tax Act, we incurred a GAAP net loss of $39 million or $0.35 per share for the fourth quarter 2017 compared with GAAP net income of $204 million or $1.71 per share in the fourth quarter of 2016, and GAAP net income of $298 million or $2.55 per share for the third quarter of 2017. The following items are excluded from our fourth quarter pro forma net income but included in our GAAP net loss: $270 million or $2.41 per share reflecting a 14% one-time tax for historical OUS earnings and profits under the U.S. Tax Act; $48 million or $0.42 per share for the write-down of net deferred assets to reflect the reduction in the corporate tax rate under the U.S. Tax Act; $20 million or $0.18 per share of excess tax benefits associated with employee stock rewards; and $57 million of net charges or $0.51 per share associated with employee equity charges, IP charges, and legal settlements. Note that the IRS has not issued final tax rate regulations associated with the recent U.S. tax legislation. Therefore, the impacts of the U.S. Tax Act reflected in our fourth quarter results and our projection of future tax rates represent our best estimates of the impact of the U.S. Tax Act and could change as tax regulations are finalized and interpreted. We ended the quarter with cash and investments of $3.8 billion, approximately the same as at September 30, 2017. During the quarter, cash generated from operations was mostly offset by a final payment of $274 million associated with the accelerated share repurchase agreement we entered in the first quarter. Under that agreement, we purchased 7.3 million shares at approximately $310 per share. We have approximately $718 million remaining under the Board buyback authorization. As a result of the 2017 Tax Act, we have the option to repatriate OUS cash with minimal tax impact. We have significant opportunities for growth outside of the U.S. We will evaluate the need to repatriate cash relative to our business and overall environment over time. And with that, I would like to turn it over to Calvin who will cover procedure performance and our outlook for 2018.

Thank you, Marshall. Our overall fourth quarter procedure growth was 17% compared to 15% during the fourth quarter of 2016 and 15% last quarter. Our Q4 procedure growth was driven by strong results globally and 16% growth in U.S. procedures reflecting broad-based strength across our procedure categories. Q4 likely benefited modestly from cases deferred out of Q3 due to hurricanes. In total, approximately 877,000 entry procedures were performed in 2017, up about 16% for the year. In the U.S. general surgery on a run rate basis has surpassed gynecology as our largest specialty. Approximately 246,000 U.S. general surgery procedures were performed in 2017, up 32% compared to 2016. 2017 growth was again driven by hernia repair, ventral and inguinal combined, which continued to drive the most incremental cases, and continued da Vinci adoption in colorectal procedures. Early-stage adoption in bariatric procedures and growth across the general surgery category also contributed to growth. In U.S. gynecology, fourth quarter and full year 2017 procedures grew modestly year-over-year, with growth led by hysterectomy. We continue to see an increasing proportion of U.S. gynecology procedures being performed by physicians that specialize in complex benign and cancer surgery, who tend to be users of da Vinci systems. U.S. urology procedures exceeded our expectations for the fourth quarter and the year driven by prostatectomy volumes. As the mature procedure category, we believe that our U.S. prostatectomy volumes have been tracking to the broader prostate surgery market, which has benefitted from recent macro trends. In other U.S. procedures, adoption of lobectomy and other thoracic procedures was again strong during the fourth quarter and full year. This set of procedures is particularly well served by our da Vinci XI system and surgical staplers. Outside the United States, approximately 233,000 procedures were performed in 2017, up approximately 21% in the fourth quarter and approximately 23% for the full year. Growth was driven by the continued adoption of da Vinci prostatectomy, with solid contributions from kidney procedures and earlier-stage growth in general surgery and gynecology. Fourth quarter all U.S. procedure growth was slightly lower, largely reflecting leveling system utilization and moderating growth in China as we anticipate future system sales quota. The value proposition regarding any da Vinci procedure is based upon the differentiated clinical value that can be offered to clinicians compared to other treatment alternatives, including economic factors. Since the introduction of the da Vinci system, over 15,000 clinical papers have been published involving da Vinci surgery, including approximately 2,300 in 2017 alone. As I mentioned in my procedure discussion, long procedures in the U.S. have contributed to recent procedure growth. In November 2017, a team of investigators from the University of Southern California, the University of Michigan Ann Arbor, Penn State Health, and Intuitive published a large-scale study titled 'Robotic-Assisted, Video-Assisted Thoracic and Open Lobectomy: Propensity Matched Analysis of Recent Premiere Data' in the Annals of Thoracic Surgery. In this study, the Premier healthcare database was analyzed for open video-assisted thoracic or VATS and robotic-assisted lobectomies performed between January 1, 2011 and September 30, 2015. The results from this study show a continued increase in the number of robotic-assisted lobectomies during the study period. The combined total of robotic-assisted and VATS approaches accounted for more than half of the lobectomies in the U.S. database, indicating a strong trend towards adoption of minimally invasive approaches. While the proportion of VATS remains virtually unchanged during the study period, the robotic rate grew as open declined. After propensity score matching, which controls for heterogeneity of patients in hospitals, the robotic-assisted cases were compared to VATS procedures and a sample size of 2,775 in each group, and robotic-assisted cases were compared to open with 2,951 patients in each group. Compared to open surgery, robotic-assisted lobectomy demonstrated statistically significant lower post-operative complication rates, shorter hospital stays, higher percentages of patients discharged to home, and lower hospital mortality rates. Compared to VATS, robotic-assisted surgery demonstrated statistically significant lower rates of conversion to thoracotomy, lower post-operative complication rates, shorter hospital stays, and a higher percentage of patients discharged to home. As we've said in the past, we continue to invest in clinical research in our key geographic markets to assess da Vinci surgery outcomes and help educate the market. We support large-scale data registries, including those managed by the American Hernia Society Quality Collaborative and the Society of Gynecological Oncology clinical outcomes registry. As large da Vinci data sets accumulate in these registries and are compared to baseline results, the value of the da Vinci surgery can be evaluated. We also support clinical research grants at sages, AFTRs, and the European Colo-Proctology Society, as well as da Vinci fellowship programs with several surgical societies, which often yield clinical studies. I will now turn for our financial outlook for 2018. Starting with procedures, as described in our announcement earlier this month, 2017 total da Vinci procedures grew approximately 16% to roughly 877,000 procedures performed worldwide. During 2018, we anticipate full year procedure growth within a range of 11% to 15%. We expect 2018 procedure growth to continue to be driven by U.S. general surgery and procedures outside of the United States, where we're still in earlier stages of adoption. We expect similar seasonal timing of procedures in 2018 as we've experienced in previous years, with Q1 being the seasonally weakest quarter as patient deductibles are reset. In Q1, we expect a modest procedure headwind compared to Q1 2017 as a result of our estimates of working days, mostly due to the timing of the Good Friday holiday. With respect to revenue, as we've mentioned previously, capital sales are ultimately driven by procedure growth, catalyzing hospitals to establish or expand robotic system capacity. Capital sales can vary substantially from period to period based upon many factors, including U.S. healthcare policy, hospital capital spending cycles, reimbursement and government quotas, product cycles, and competitive factors. Within this framework, we'd expect 2018 capital placement seasonality to generally follow historical patterns by quarter. During the fourth quarter of 2017, 40 of the 216 systems shifted, or 19%, were under operating leases. In 2018, we'd expect the proportion of systems placed under operating leases to trend modestly up from there with variation by quarter. Turning to gross profit, our full year 2017 gross pro forma gross profit margin was 71.9%. In 2018, we expect our pro forma gross profit margin to be within a range of between 70% and 71.5% net revenue. We are projecting a modestly lower gross profit margin in 2018 reflecting higher costs associated with new products; our actual gross profit margin will vary quarter to quarter depending largely on product and regional mix. Turning to operating expenses, as Gary and Marshall described, in 2018 we will continue to make substantive investments in several strategic areas that are poised to benefit the company over the long run. As a result, we expect to grow 2018 pro forma operating expenses between 16% and 18% above 2017 levels. We expect our non-cash stock compensation expense to range between $225 million and $235 million in 2018 compared to $209 million in 2017. We expect the other income, which is comprised mostly of interest income, to total between $45 million and $55 million in 2018. With regards to income tax, incorporating projected impacts of the new U.S. tax law, we expect our 2018 pro forma income tax rate to be between 20% and 22% of pre-tax income. Note that in the future, if the IRS issues additional guidance and interpretation of the new tax law, our estimated rate may be impacted. Our share count for calculated diluted EPS pro forma EPS in Q4 was 117.4 million shares. In Q1, we expect our diluted share count to range between 117.6 million and 118.4 million shares. The actual diluted share count will depend on several factors including share price. That concludes our prepared comments. We will now open the call to your questions.

Thanks very much. Appreciate the opportunity to ask a few questions here. So, maybe just to start out on the product side. Just want to make sure I have a good sense of what you’re saying. So here I guess on the flexible endoscope platform I realize you said no revenues in 2018. But is there a scenario where you have any regulatory approvals for flexible endoscope in any major country, maybe toward the end of 2018?

Hi, Bob. We are not calling the clearance date yet for the flex platform. I am pleased with where we are. We are working to plan. Our tradition with you has been to let you know when we do a submission, and that gives us a little bit better estimate of timelines rather than a guess in this setting. So, we are feeling good about it, but I don’t have a date for you yet.

Okay. Feeling good about it, does that mean the potential for submissions in ‘18?

No, I am feeling good about the progress of the team and their ability to deliver on what we think this is capable of doing.

Okay. And then on your comments on Japan. I am just curious, what do you assume for Japan in the current 11% to 15%? And maybe said another way if reimbursement comes into way you would hope, does that suggest the potential for the higher end of that 11% to 15%?

We haven’t baked a lot of growth in there. Again, we don’t really know at this point what the reimbursement levels are going to be, and therefore, that could vastly impact the number of procedure adoption curve. So, there's not a lot in there, but even then, the magnitude of Japan relative to the total world is not substantial. And the highest growth drivers for us for next year really are general surgery procedures in the U.S. and urologic procedures outside of the U.S. With these clearances, our reimbursement will significantly contribute to building a foundational time for us. We are making large investments and will continue to focus on training surgeons and developing our teams. Therefore, in 2018, it's more about establishing a solid foundation for the future rather than expecting immediate contributions to growth.

And then Gary just real quickly. Given the success you’ve had as a company in 2017 on the procedure side, I want to ask one quick question on how you view the market opportunity. Because in 2016 and 2017 your slide decks talked about 4 million accessible procedures worldwide for proved technologies. And I'm just curious if you could update us on your latest thoughts on kind of the adjustable procedures, where you stand today relative to that 4 million. Given that you guide SPE coming along with obviously other technologies.

Fair question. As you described, I think for current products in the market and current countries in which we operate, I think our estimates that we're not yet recorded penetrated. So even with what our commercial teams have to do, we have plenty of upside. I think as you move whenever you talked about full available market, I'll tell you how we think about it. We look at how start with, where do we see differentiated clinical value by procedure given what we can bring and try to get an estimate of what segment or population of our customer base that can make a positive impact. And we, you know us start conservatively. And what tends to happen over time as we get clinical data and our customers use our products, we get a better clear view of TAM. Often the TAM has increased; not always some TAMs have decreased, but mostly they've increased. And so that's how we look at it. SP is clearly an opportunity for us to explore some procedures and patient populations that we have not gone a lot. And that I think is why we're excited about it. And Flex, I think opens a new set of opportunities for us, that's why we have done the investments. I think flexible technology we are pursuing in the pulmonology space and the thoracic cavity. And we'll be focused on that for the next few years. But as you know, we really are excited about platform ideas. Things that have generic capability that can be broadened over time; and we think flex robotics diagnostics and other interventions can do that as well. We don't have a crystal ball as to those TAMs and we're not ready yet to describe how big we think they can be, partly because our estimates are large ranges that could be quite a lot of variability. But we invest in them because we think they bring real opportunities for outcome improvements in the hands of customers, decreases in variability across the customer base, and as a result an opportunity to grow the footprint of Intuitive going forward.

Good afternoon. A few quick questions from me. First, Gary, just coming back to the pipeline. Just on SP is there are change we get additional level approvals or submissions for head and neck and colorectal this year on SP? And is second half of the year a decent timeframe to think about the 60-millimeter stapler approval?

So, let's discuss the 60-millimeter stapler. Regarding the SP, we are not ready to comment on the timing of labeling in case we pursue additional indications, especially with the FDA process taking time. It largely depends on the data requirements we face and how our discussions go. Right now, our focus is on the first indication. In terms of clinical capability and feedback from customers, we feel quite positive. Therefore, I believe our discussions with the FDA should be straightforward and reasonable. However, we aren't ready to predict the timeline yet. For the 60-millimeter stapler, we’ve experienced back and forth with approvals over the years. I don’t anticipate significant changes in what we can expect, and I think our historical approval timelines are likely good indicators for the 60-millimeter stapler. I remain hopeful that we will see progress this year.

Okay. And just a couple more for me, Gary, just one on spending. I think you are wisely investing away some of the tax benefit, but you know, year-on-year it's probably $150 of incremental OpEx and $50 million more than we expected for 2018. If you could just sort of give us a sense of where some of the key investment dollars are going here in 2018 and then you mentioned this last quarter but not this quarter, in terms of hiring the management team for the China JV, where are you on CEO, CFO and what are their near-term priorities? Thank you.

Fair question. On the investment side, as the business has strengthened over the last couple of years, we've increased our investments. I think rationally they have been focused on a couple of things. One has been building depth in OUS markets; our market presence and penetration in places like Japan and China and Germany, France, UK and so on are less than they are in the U.S. We think there's real opportunity for value creation in those markets, and we want to make sure that we're not under-investing there relative to the opportunities. So that's one segment. The next segment is, I really believe, computer-assisted surgery, I think has moved from an interesting part of minimally invasive surgery department to a kind of an essential part of the portfolio. And as that happens, I think more and more opportunities, competitors and interest are being generated, and we want to make sure that Intuitive is investing for the long-term. I think you all will hold us to the quality of those investments. Mostly the challenge here has not been identifying opportunity; it's been making sure that we invest in something that we have the skill and capability to deliver with excellence. So, we've been investing behind things that we think are good opportunities. And I think over time, the wisdom of those decisions will play out. So, that’s one mark. I think the last thing for us has been the business has accelerated. We see opportunities for taking advantage of scale and efficiency, and we think that will serve the company well and our customer base well in the future. So as volumes go up, we can convert some capital investments into operating efficiency. You've seen us doing that and I think that allows us to share with the customer some of those efficiencies; it drives better quality performance in our products. We think that's important as well. And so, as we've seen strengthening, we've loosened some of those dollars and I have to thank our operations team who've done a beautiful job investing them wisely. Marshall, I want you to take the JV and China question and I'll fill in behind.

Sure, in China we have hired a CEO, we actually also hired the CFO and a few other key members of the management team. Right now, they are focused on building out that management team and getting prepared for the eventual launch of the business itself. Of course, the gating factor there is, we're still working on the development of the catheter-based product here in the United States and as that's completed, then elements of it and the business will start to be handed over to the JV.

The early performance of that team as they’ve entered the organization is encouraging. The human capital that they were bringing to the Board was pretty strong. So that has been a positive set for us in ‘17.

Hey, thanks. I guess first question on Japan, I know you don’t want to comment on reimbursement levels at this point, it’s a bit of wind game here. But if we think about the 12 procedures that you got approval for, are there ones you want to call out that may be more exciting than others and maybe could you talk about what percentages of those are done open versus lab of 12 that have been approved?

It's difficult to identify which procedures are generating the most excitement when we are uncertain about reimbursement levels. You have the list and can assess the potential market opportunity for yourself, but I must emphasize that we won't have a clear picture until the reimbursement details are revealed. As Calvin mentioned, there is also a component of adoption that involves establishing the sales force and developing training capabilities. Additionally, as I pointed out earlier, there are alternative surgical methods to consider in the adoption process. Once we gain insights into the reimbursement and delve further into the specifics after April 1st, we might be able to discuss particular procedures in more detail.

From a clinical perspective, there are several exciting dynamics and discussions happening within the surgical societies. Marshall noted that laparoscopy has a significant presence in certain markets in Japan, where laparoscopic surgeons are highly skilled. Despite this, there remains strong interest in our technologies, which I view as a positive sign. This suggests that there is a demand for clinical advancements and improvements in tools over time. Areas like hysterectomy are particularly interesting to us, although it’s challenging to predict the outcomes, given the high penetration and expertise in laparoscopic procedures in Japan. Nevertheless, the strong interest is noteworthy, and we are closely studying this situation. I look forward to seeing how things develop as this will influence our approach to market analysis, especially concerning the balance between laparoscopy and robotics. Additionally, there are thoracic opportunities in reimbursement and other areas such as GYN oncology, which present mid to long-term potential in Japan. I have confidence in the capabilities and thoughtfulness of Japanese surgical societies and surgeons, making it a promising market. However, it is essential to remember that success goes beyond just reimbursement. We need to establish technology, training, and resources, along with developing a robust network and close relationships with our customers. In the short term, there will be challenging work ahead, but this does not dampen my enthusiasm for the long-term prospects.

Okay, that’s helpful. And then a question on older systems, kind of two parts here. One, you had a bit all U.S. trade-in number. Was that just the function of the end of the X trading program? And then you're still selling a number of SI systems, I think it was 20 this quarter. Why are customers opting for that versus the X?

So, it's less than first, for SI products, there are countries where we did not yet have regulatory approval for X. And therefore, we're still selling SIs. There are also some customers with SIs already, and they don't want yet to move away from a world where they have two sets of inventories and two sets of training protocols and so forth. And so, they would rather step into an SI. And then there are some countries where reimbursements are not so high, and they're looking for a cheaper option; and a SI fits that bill. But you probably will see the number of SIs we sell decline over time as we get regulatory approvals and we're able to move Xs.

Yeah on the system retirement side, I think there were 21 total, 18 retired in the field plus 3 that were lease returned. It's been higher than we've been running. But it's really an expected part of our business cycle. And as you know when a customer elects to stop using a particular system, they're really going to trade it in, purchase a new system, or just hire it up there in the field. And most of them end up being traded in, but some end up being retired in the field, and we saw that. In Q4, we were able to confirm that there were 18 of these 4,400 in the field, mostly older models, that were no longer to be used. So, we just removed them from our installed base count.

Yeah, you were also asking about Europe and trade-ins in Europe, is that correct?

Yes.

Yeah. Trade-ins in Europe, even despite what I said about some customers don't want to enter into a world where they have two sets of inventories. There are those customers that want to standardize on the fourth-generation product. And there is also a larger installed base of Xs and SIs in Europe in terms of mix relative to, as I've said in the United States. And so, we can see a number of customers in Europe trade out their SIs for X parts to get into the fourth-generation product and have access to the latest instrumentation.

Okay. And then last one, thinking about the mature procedures in particularly dVP in the U.S. Anything in the '18 that would change the trajectory relative to what you saw in '17. I think you've mentioned you're back to the market growth rate there, but just curious. I mean I think there has been this expectation that it will decelerate a little bit for a while. Curious as your thoughts.

The results in 2017 surpassed our expectations. Urology grew by 8% for the year, with dVP contributing to that growth. As the standard for surgical treatment of prostate cancer, we anticipate moving alongside the overall incidence rate, which is likely in the low single digits. Therefore, we expect some moderation in the U.S. market in 2018, both at the low and high ends of our guidance.

Good afternoon thanks for taking the questions guys. One on China and one on the flex catheter and just on the tax rate as well. So, on the Chinese quota, where you guys are in the process there. if you have any visibility and if it's too late at this point to impact 2018. On the flex catheter Gary, it's on the last call, you sounded maybe optimistic that the chest data would be enough for FDA clearance in the U.S. Do you have confirmation of that at this point or any clarification? And just lastly, Marshall, on the tax rate. I thought it would be a little bit lower than 20% to 22%, is there some conservatism there, you know, given the uncertainty or is there something else that we maybe didn't factor into some of the estimates we had. Thanks for taking the questions guys.

Thanks, you wanted to take that first one Marshall.

There is no news on the quota. I mean we sit here waiting as we do for news as to, as to what the quota will be. On, China, we don't have any indication that is either A, Intuitive specific or something that we should be foundationally worried about. So we're not looking at it and thinking something's wrong here or there's an Intuitive-specific indication; nothing works like that. You asked the question is that too late to impact 2018, I don't think so yet.

It's hard to know how long the tender process will take at the hospitals; last time we got a quota approved, quota was approved in 2013 and we didn't see many of the systems sold until the end of 2015. I don't know whether that same timeline will apply here.

Moving to the flex question, no change in my opinion about data requirements either way, I wouldn't read anything in my comments last time or this time, would indicate a change. And go to tax.

The tax rate we gave it our best estimate, you said that you thought it would have been lower; clearly, a greater portion of our revenue is still generated in the United States. So more at the higher end. There are, you know, there are elements of the tax stack that add additional taxation on top of that. And so, we've given you the range that we think will, is the best estimate of what it is. I wouldn't call it conservative.

Good afternoon. Let me begin with gross margin guidance. Over the past two years, you've been close to the 72% range, and the situation is now somewhat favorable for you. Last year, you had significant revenue at a lower margin. It's implied that this might not happen again in 2018, which makes sense. I believe there was minimal revenue from new products, but as you discuss how to approach that ramp, why shouldn't the gross margin at least remain consistent with 2017, if not improve slightly?

I think, as we mentioned in our prepared remarks, the main factor will be the influence of new products. We plan to gradually introduce a new service to monitor its impact. Regarding the 60 million, as we discussed, there is a direct margin associated with the products, but we are also making investments in our operations and teams, as well as in the infrastructure needed to produce these products. These costs will be incurred before we see an increase in revenue.

And then just a follow-up on the U.S. trade-in. I'm kind of looking at the year, maybe a little bit surprised how I think trade-ins ended the year in the U.S. market, actually down 50 units year-over-year below even 2016 levels and I realize it's actually a positive the install ball and for procedures. But in terms of just thinking about the replacement opportunity given an aging installed base in the US, how do we best think about the next couple of years for trade-in?

Yes, that’s hard to estimate when the customers will get to where they want to, either standardized on the fourth generation product or avail themselves to the latest generation. I mean the SI drives a substantial amount of our procedures. It’s a very capable system. And in fact, even in situations where customers have suggested that they want to do a trade-in, at the end of the day they are keeping the SI for either an outpatient care meaning a point other than the surgery center or they decide that they just got volumes such as they want to keep it. So, I don’t know how to predict what the trade-in cycle will do over the next couple of years.

In terms of our intentions, we believe the fourth generation is quite strong. We see X as a good product and we can offer X to our existing customers in appealing economic packages. This presents an opportunity for us. The main question is how long it will take to realize this potential. We want to meet our customers' needs, and we believe we have a compelling offer for them.

And just last one, maybe I heard you wrong, just on imaging hardware for this year. How much more you tell us on what is expected in terms of timing of new products, is it possible to get introduced in ‘18 like augmented reality et cetera and what we might expect there in terms of potentiality?

Yes, a fair question. So, when we think about imaging, there’s three buckets that we think about investments we make. There is the hardware endoscope side, the sensors, the chips, the optics, the package. And we have been investing in that and routinely improving those things; sometimes in big steps, sometimes in small steps. Just as you would imagine, each release of cell phone has their camera systems we follow a similar idea and that’s been powerful. Those compound effects of improvements are pretty impressive. The second thing is image processing software, the algorithms themselves to shape the image have also been improving overtime and also, we can release in patches and updates. And then there's the contrast agents and molecules. And we work all of them, and we often talk about molecules; they are kind of the big thing to see. They are long-term investments. And I was reminding everybody here, there are other things going on too; the hardware and the underlying software is good. Augmented reality or mixed reality, the idea that you can take graphic images and manage them and get them in, we’re making nice progress there. I don’t expect material revenue in the year, but I do think that we’ll start getting increased customer feedback over the year. And yes, we get closer to customer, we will inform you more of where we are.

Good afternoon, guys. Thanks. Two questions on Asia, one on China. Just curious what you guys are doing to try and drive penetration while we are waiting for the quota. Are you better off waiting for the government to give official orders? Are there other avenues that you're pursuing there to try and drive access? And then secondly, on Japan, just appreciate all the comments you made earlier, but I am wondering how we should think about market development in that region as you get new applications; are there a couple obvious ways in which physician training and so forth need to be different and how we should think about your process there? Thank you.

So, for China, we have a number of systems, 38 systems I think is installed there, the public cost was subject to the quota. But our distributor is driving clinical adoption there, training surgeons, and moving it up, that's why you see why you heard us talk about increased utilization of those systems and increased number of procedures. The systems that are not subject to the quota really are those in the military hospitals in Hong Kong. We actually sold three systems this quarter; that's not nearly the market as the public hospitals. But nonetheless, we are making progress in those markets and continue to try to drive the expansion.

And when we think demand from Chinese surgeons and Chinese hospitals is very high. And so, education and engagement are something that we can continue to do. I'll answer the Japan question and operator, this will be our last question after that answer. With regard to Japan, I like to quote, history doesn't repeat, but it does rhyme. I think about what we need to do in Japan in terms of market development. Our team at Japan is quite capable and are engaged deeply in communication with surgical societies around what training pathways look like, what educational and outreach ought to look like. Things like scholarship programs and so on. And so, I don't think the work is a mystery. But it does take time in education; education of our own team and education of the market. I think we have a senior leader and our general manager in Japan. I think this is a team that's capable. So, we will give them time to make progress here, but I think I have a playbook they can work down and while it's not identical to the playbook that we used in the U.S. or the ones that we use in Germany. The main elements of engagement are present. As we conclude this call, that was our last question. As we've said previously while we focused on financial metrics such as revenues, profits, and cash flow during these conference calls. Our organizational focus remains on increasing value, by enabling surgeons to improve surgical outcomes and reduce surgical trauma. We have built our company to take surgery beyond the limits of the human hand. And I assure you that we remain committed to driving the bottleneck of few things that truly make a difference. This concludes today's call. I thank you for your participation and support on this extraordinary journey to improve surgery, and we look forward to talking to you again in three months.