Intuitive Surgical Inc (ISRG) — Q1 2018 Earnings Call Transcript

Thank you. Good afternoon and welcome to Intuitive Surgical's first quarter earnings conference call. With me today, we have Gary Guthart, our President and CEO, and Marshall Mohr, our Chief Financial Officer. 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 2, 2018. Our SEC filings can be found through our website or at the SEC's EDGAR database. 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 first 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 first quarter financial results, and I will discuss procedure and clinical highlights and provide our updated financial outlook for 2018. 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. Intuitive is dedicated to the mission of improving the availability and quality of minimally invasive surgery. We had a strong first quarter in pursuit of our mission with customer use of our systems at the top of our growth range, continued momentum in new system placements, and stepwise progress in the development of markets outside the United States. While we're pleased with our performance in the quarter, the opportunity for improvement in surgery is substantial and much work remains to be done. Global procedure growth was approximately 15% in the first quarter of 2018. Underpinning this growth was increased use of da Vinci in general surgery in the United States, continued growth in urology in Europe and Asia, and multispecialty growth in China. General surgery growth was led by hernia repair and colon resection. Mature procedures in the United States, including prostatectomy and hysterectomy for malignant conditions, grew above expected rates again in the quarter. European procedure growth was mixed by country, partially as a result of headwinds in the number of business days relative to Q1, 2017. Lastly, additional procedures were granted reimbursement by the Ministry of Health in Japan effective April 1, 2018, at reimbursement rates equivalent to laparoscopy. Calvin will review procedure trends in greater detail later in the call. Our capital placement performance in the first quarter of 2018 accelerated relative to 2017, with growth in total placements rising 39% from 133 to 185. Net of trade-ins and retirements, our da Vinci installed base grew by 13% over Q1 2017, from approximately 4,023 to approximately 4,528. Placement performance was strong globally, particularly in the United States. Capital placements have been lumpy, and we anticipate volatility in placements for the remainder of 2018. Turning to operations, our performance in the first quarter met our expectations with good performance in product quality and cost reductions while average selling prices were stable. Investments to deepen our regional capabilities and to develop new technologies and services continued to be important in the first quarter. They will be so for the next several quarters as we progress through the launch of several products and build the capability country-by-country. We are also investing to strengthen our corporate infrastructure and position ourselves to benefit from increased scale. Highlights of our first quarter operating results are as follows: Procedures grew approximately 15% over the first quarter of last year; we replaced 185 da Vinci surgical systems, up from 133 in the first quarter of 2017. Our installed base grew 13% from a year ago. Revenue for the quarter was $848 million, up 25%. Pro forma gross profit margin was 71.6% compared to 72% in the first quarter of last year. Instrument and accessory revenue increased to $460 million, up 21%. Total recurring revenue in the quarter was $623 million, representing 73% of total revenue. We generated a pro forma operating profit of $346 million in the quarter, up 30% from the first quarter of last year, and pro forma net income was $288 million up 46%. Marshall will take you through our finances in greater detail shortly. Our da Vinci Xi surgical system is our most capable multiport platform. We added our da Vinci X surgical system in 2017 which offers fourth-generation imaging, robotics, and instrumentation for focused quadrant surgeries at an attractive value. The da Vinci X surgical systems received regulatory clearance from PMDA in Japan this month and were showcased at a large surgical society meeting JSS shortly thereafter. Combined with reimbursement approvals mentioned above, we're pleased with recent progress in Japan. As we've discussed on prior calls, we plan to expand our Gen 4 family with a new capability in the form of da Vinci SP. We submitted our 510(k) for the current SP design in Q4 of '17 and have received questions back from the FDA. We're preparing our response and overall SP is progressing to plan with a phased launch anticipated in 2018. Also, in the fourth quarter of 2017, we submitted our 510(k) application for our 60-millimeter surgical stapler for Gen 4 systems. We've received the first round of questions from the FDA and are in the process of responding to their requests. Our Gen 4 systems have received growing use by surgeons globally and by general surgeons in particular. Including the 60-millimeter stapler, we're hard at work completing our advanced instrument offerings. We continue to make 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. Feedback from physicians evaluating our technology relative to existing and recently announced alternatives has been strongly supportive of our efforts. Our design and operations teams are working to incorporate their feedback, complete its production design and supply chain optimization, and complete validations for regulatory submissions. We anticipate our 510(k) submission in 2018, and we have initiated the build of our commercial team, an outstanding and focused team of professionals. I believe the opportunity for innovation in support of physicians in the flexible interventional space is substantial. That said, adoption will require clinical and economic validation given the availability of multiple competing approaches in the market. Lastly, our imaging teams continue to develop new ways to identify tissue including progress in our molecular imaging program as well as improvements for our endoscopes and image processing algorithms. We have been introducing improvements in our imaging hardware routinely and expect to continue to do so in the remainder of 2018. We expect our lead molecular agent to enter phase 2 trials in the second half of the year. Stepping back and looking at the broader marketplace, our team’s experience in robot-assisted surgery started decades ago at research groups predating the formation of the company. Over this period, the rise of mechatronics, powerful computing, improved sensing, microfabrication, and molecular imaging has enabled new approaches to old problems. Intuitive has been investing in innovation both incremental and revolutionary with this in mind since our inception and with increased intensity for the past several years. This opportunity to improve surgery using advanced technologies is now being recognized broadly, particularly in the past several years, and we anticipate the entry of additional systems by competitors into some regions of the world over the next several quarters. To help our customers, Intuitive products and services are organized in generational families. Shared design principles, operating methods, user interfaces, and product training allow surgical teams and hospitals to more quickly integrate new technologies and can deliver a significantly improved framework to training environments. As consolidation has progressed in health systems, standardization across surgical platforms can decrease variability and inefficiency from residency and fellowship programs to academic and community settings. Our fourth generation of surgical platforms offers our customers a fully enabled ecosystem of products and services in support of their programs. In closing, during 2018, our focus remains on completing the task 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 flexible catheter platform. And finally, support for additional clinical and economic validation by global region.

Good afternoon. I will describe the highlights of our performance on a GAAP and non-GAAP or pro forma basis. Our results are also posted on our website. First quarter 2018 revenue of $848 million grew 25% compared with first quarter 2017 revenue of $680 million and decreased 5% compared with seasonally stronger fourth quarter revenue of $892 million. In the first quarter of 2017, we deferred approximately $23 million of revenue associated with the da Vinci X tradeoff program that we offered certain first quarter customers. This revenue and related costs are recognized in the third and fourth quarters of 2017. Our comparison to 2017 results reflects a deferral as recorded. We also have adopted the new revenue standard as required under GAAP and retroactively restated prior period results. We have updated the supplementary financial tables posted on our website to reflect this restatement. The adoption of the revenue standard effectively increased first quarter 2017 total revenue by approximately $5 million and net income by approximately $1 million. The impact on the annual results for 2017 was insignificant, increasing total 2017 revenue by approximately $9 million and increasing net income by $11 million. Revenue also benefited by approximately 2.5 percentage points from a weaker dollar. Excluding the impact of the revenue deferral and currency changes, revenue grew 18% relative to the restated 2017 first quarter. First quarter 2018 procedures increased approximately 15% compared with the first quarter of 2017 reflecting last quarter. Procedure growth continues to be driven by general surgery in the US and neurology worldwide. Calvin will review details of procedure growth later in this call. Instrument and accessory revenue of $460 million increased 21% compared with last year, which is higher than procedure growth primarily reflecting increased usage of our advanced instruments and customer buying patterns. Instrument and accessory revenue realized per procedure was approximately $1,930, an increase of 5% compared with last year, primarily reflecting advanced instrument usage, customer buying patterns, and the impact of a weaker US dollar. Systems revenue of $235 million increased 46% compared with the first quarter of 2017, primarily reflecting higher system placements, the revenue deferral of $23 million in the first quarter of 2017 and a weaker US dollar, partially offset by an increase in the number of operating leases. We placed 185 systems in the first quarter of 2018 compared with 133 systems in the first quarter of 2017 and 216 systems last quarter. 43 operating lease transactions, representing 23% of total placements, were completed in the current quarter, compared with 16% of total placements in the first quarter of 2017, and 19% last quarter. While the number of leases is difficult to predict in the short term, we expect the proportion of these types of arrangements to increase long-term. 31% of the current quarter system placements involved trade-ins, reflecting customer desire to access or standardize on our fourth-generation technology. This is an increase in the proportion of trade-ins compared to 21% in the first quarter of 2017 and 26% last quarter. However, trade-in activity is lumpy and difficult to predict. 76% of systems placed in the quarter were da Vinci Xi’s, and 16% were da Vinci X systems, compared with 67% da Vinci Xis and 24% da Vinci Xs last quarter. Our installed base of da Vinci systems ended the quarter at 4,528 systems, up 13% year-over-year, and average system utilization grew in the low single-digit range. Globally, our average selling price, which excludes the impact of operating leases, lease buyouts, and revenue deferrals, was approximately 1.49 million, which is slightly higher than the 1.47 million in the fourth quarter. The increase reflects a higher mix of Xi systems, a weaker U.S. dollar, partially offset by geographic mix. Outside of the U.S., first quarter revenue of $275 million increased 49% compared with the first quarter of 2017 and increased 11% compared with last quarter. The increase compared to the prior year reflects increased systems revenue of $55 million, or nearly 100% growth, and increased instruments and accessories revenue of $30 million, or 32% growth. Systems revenue was driven by an increase in the number of systems placed, a lower number of operating leases, favorable product and geography mix, and a weaker dollar. Instrument and accessory revenue was primarily driven by procedure growth, a weaker dollar, and customer buying patterns. OUS procedures grew approximately 18% compared with the first quarter of 2017; OUS procedures were somewhat negatively impacted by the timing of holidays in 2018 compared to 2017. Outside of the U.S., we placed 73 systems in the first quarter, compared with 56 in the first quarter of 2017 and 86 in a seasonally strong fourth quarter. Current quarter system placements included 45 in Europe, nine in Japan, with 63% of the systems placed being da Vinci Xi’s compared with 54% in the first quarter of 2017 and 48% last quarter. Placements outside the U.S. will continue to be lumpy as some of the OUS markets are in early stages of adoption. Some markets are highly seasonal, reflecting budget cycles and vacation patterns, and sales in some markets are constrained by government regulations. Moving onto the remainder of the P&L, the pro forma gross margin for the first quarter was 71.6% compared with 72% for the first quarter of 2017 and 72.4% last quarter. The decrease relative to the fourth quarter primarily reflects higher fixed costs over the lower volumes. The decrease compared with the prior year primarily reflects product mix. Future margins will fluctuate based on the mix of our newer products, systems, and accessory revenue, system ASPs, and our ability to further reduce product costs and improve manufacturing efficiency. Pro forma operating expenses increased 17% compared with the first quarter of 2017 and reflect increases compared to the last quarter. Our spending is consistent with our plan, reflecting investments in da Vinci SP, catheter-based robotics, imaging, and advanced instrumentation, as well as expansion of our OUS markets. These investments involve multi-year commitments. Our pro forma effective tax rate for the first quarter was 20.1%, compared with our expectations of 20% to 22%. Our tax rates will fluctuate with changes in the mix of U.S. and OUS income, changes in taxation made by local authorities, and with the impact of one-time items. Our first quarter 2018 pro forma net income was $288 million, or $2.44 per share, compared with $197 million, or $1.71 per share, for the first quarter of 2017 and $305 million, or $2.60 per share, for the fourth quarter of 2017. First quarter 2017 GAAP net income was $288 million, or $2.44 per share, compared with GAAP net income of $181 million, or $1.57 per share, for the first quarter of 2017 and a GAAP net loss of $32 million, or $0.28 per share, for the fourth quarter of 2017. The adjustments between pro forma and GAAP net income are outlined and quantified on our website. They include fourth quarter charges related to the U.S. Tax Cuts and Jobs Act, excess tax benefits associated with employee stock awards, employee equity and IT charges, and legal settlements. Note that the IRS has not issued final regulations associated with the recent U.S. Tax Legislation. Therefore, the impact of the U.S. Tax Cuts and Jobs Act reflected in our fourth and first quarter results and our projection of future tax rates represent our best estimates of the impact of the U.S. Tax Cuts and Jobs Act and could change as the tax regulations are finalized and further interpreted. We ended the quarter with cash and investments of $4.1 billion compared with $3.8 billion at December 31, 2017. The increase reflects cash generated from operations of $280 million. We have not repurchased any shares in the quarter and have approximately $718 million remaining under board buyback authorization.

Thank you, Marshall. Our overall first quarter procedure growth was 15% compared to 18% during the first quarter of 2017 and 17% last quarter. Our year-over-year Q1 procedure growth was driven by 14% growth in U.S. procedures and 18% growth in OUS markets. In the U.S., overall, Q1 procedure performance by specialty closely aligned with patterns present in 2017. In U.S. general surgery, first quarter 2018 growth was consistent with 2017. Q1 growth was again driven by hernia repair which continues to provide the most incremental cases and continued da Vinci adoption in colorectal procedures. Early stage adoption in bariatric procedures and growth across the breadth of the general surgery category also contributed to growth. In U.S. gynecology, first quarter 2018 growth was consistent with 2017 trends as procedures grew modestly year-over-year with growth led by hysterectomy. We believe gynecologic procedure consolidation continues to drive modest growth as an increasing proportion of US gynecology procedures are being performed by physicians that specialize in complex, benign and cancer surgery who tend to be users of da Vinci systems. Q1 US urology procedures had growth rates consistent with 2017 driven by prostatectomy volumes. As a mature procedure category, we believe that our US prostatectomy volumes have been tracking to the broader prostate surgery market, which has benefited from recent macro trends. In other US procedures, adoption of lobectomies and other thoracic procedures was again solid during the first quarter. Utilization of our da Vinci XI systems and surgical staplers, which helped to optimize robotics thoracic procedures, has been increasing. First quarter OUS procedure volume grew approximately 18% compared with 23% for the full year of 2017. First quarter 2018 OUS procedure growth was driven by continued growth in DVP procedures and earlier stage growth in kidney cancer procedures, general surgery, and gynecology. The Q1 2018 OUS procedure growth rate was lower than the previous year, in part due to fewer operating days in Q1 2018 from the timing of holidays including Easter. Procedure growth in China moderated meaningfully in the quarter, in part because da Vinci system capacity expansion is constrained by the system quota requirements, the most recent of which expired at the end of 2015. We believe core demand for robotic surgery in China is meaningful. In Japan, Q1 procedure growth and prostatectomy and partial nephrectomy moderated as these procedures have achieved high levels of adoption. As Gary indicated, effective April 1, 2018, 12 additional procedures have been approved for reimbursement in Japan with reimbursements equivalent to laparoscopic surgery. The applicable opportunity for da Vinci adoption within the set of procedures is difficult to estimate at this time due to the uncertainty of the perceived value of da Vinci relative to alternative surgical approaches. With nearly 300 systems installed in Japan, the level and pace of system expansion in Japan over the year is difficult to predict, but it will likely be modest. Last week, we participated in the Annual Society of American Gastrointestinal and Endoscopic Surgeons or SAGES Meeting in Seattle. General surgery is our largest and fastest growing surgical specialty in the US and this event represents one of the largest gatherings of general surgery practitioners and thought leaders. As more general surgeons adopt robotics in their practices, at this year’s conference, we continue to see increased numbers of robotic surgery presentations, clinical papers, and podium speakers. Included in the clinical data presented at SAGES was the result of a study recently accepted for publication in their Hernia Journal titled Open Versus Robotic-Assisted Transabdominal Preperitoneal Inguinal Hernia Repair, a multi-centered match analysis of clinical outcomes. Data from this study was presented by lead author, Dr. Reza Gamagami from New Lenox, Illinois. This study is one of the largest multi-centered evaluations of outcomes associated with robotic-assisted inguinal hernia repair cases compared to more experienced open cases from the same surgeons. In the MAST analysis of 444 subjects in each cohort, robotic-assisted inguinal hernia repair cases demonstrated statistically significant lower post-discharge complication rates through 30 days, with no re-operations related to the inguinal repair. A multi-varied analysis showed the open repair approach as a risk factor for complications within 30 days of the inguinal repair procedure. This study confirmed that a robotic-assisted approach to inguinal hernia repair may provide patients with the benefits of minimally invasive surgery with the authors who had variable laparoscopic experience among them, concluding that the robotic-assisted repair approach is a promising and reproducible approach which may facilitate the adoption of minimally invasive repairs of inguinal hernia. I will now turn to our financial outlook for 2018. Starting with procedures. On our last call, we forecast full year 2018 procedure growth within a range of 11% to 15%. We are now refining the range and estimate full year 2018 procedure growth of 12% to 15%. With respect to revenue, as we have mentioned previously, capital placements are ultimately driven by procedure growth catalyzing hospitals to establish or expand robotic system capacity. Capital placements 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. We had strong first-quarter capital placements driven by customer capacity expansion and bolstered by a higher volume of capital upgrade transactions involving trade-ins of older da Vinci models in recent quarters. In addition, as anticipated, a higher proportion of Q1 system placements were under operating lease terms, 23%. This proportion may fluctuate some in the near term, but may trend further upwards in the long-term. Turning to gross profit, we continue to expect our pro forma gross profit margin to be within a range of between 70% and 71.5% of net revenue. This is modestly lower than our Q1 result of 71.6%, primarily reflecting higher costs associated with new products we expect to introduce later in the year. Our actual gross profit margin will vary quarterly depending largely on products and regional mix. Turning to operating expenses, we continue to expect to grow pro forma 2018 operating expenses between 16% and 18% above 2017 levels, as we follow through on investments in several strategic areas intended to benefit the company over the long-term. We expect our non-cash stock compensation expense to range between $245 million and $255 million in 2018, compared to $225 million to $235 million forecasts on our last call. We expect other income, which is comprised mostly of interest income, to total between $55 million and $60 million in 2018, up from $45 million to $55 million forecasts on our last call. With regard to income tax, on our last call we forecast our 2018 pro forma income tax rate to be between 20% and 22% of pretax income. We are now refining our estimates to the lower half of the range between 20% and 21% of pretax income. Note that in the future, if the IRS issues additional guidance and interpretations of the new tax law, our estimated rate may be impacted. That concludes our prepared comments, and we’ll now open the call to your questions.

Gary, a couple of strategic questions for you. The first is on leasing. So, there are more operating leases in the last two quarters than the prior four quarters. And it feels like the 23% number is frankly going higher. So, it's starting to feel this is much more company driven than customer driven, and so the question is really, to what extent does leasing make a lot more sense, as competitors are coming to market, and in what way can leasing be a very powerful defense?

Yeah, well first thank you. I think to the extent that we can help customers access robotics for their programs and do it in a way that fits their needs, we're happy to do it with leasing. I don't think it's a massive strategic change one way or another, vis-à-vis competition. From our point of view, we're confident in our products; we understand and are confident in the value they bring. If we can be flexible with customers and allow them to get access to the products they need when they need it, we can make it a little easier for them to do it sooner rather than later in terms of their finances, that helps us, and we're willing. I think over time, our customers are going to evaluate competitive systems. They're going to go look at them. And if somebody brings out a product that meets their needs better, I don't know that leasing one way or the other is going to make a difference. For us, it really is kind of a first principles thing. Do you believe in robotic surgery as a way to increase the availability and quality of minimally invasive surgery? If you do, and you're committed to it, and we can find the way to help you get a system, then we're happy to do it.

Okay. And then I'm curious, a question on the flexible catheter system as well. So, based on your timeline, I'm kind of assuming you're 9 months behind a recent competitive launch. So, I just wonder how concerned you are about this window, and you talked a lot about the ecosystem both at SAGES and again in this call. In what ways can sort of the multi-system ecosystem approach be a barrier to entry for new robotic entrants in this segment?

Yeah, I think in terms of any of the systems that we're going to place or somebody else places, I think the robot itself or the product itself is just the first step. You have to provide the robot, but you also need the instruments and accessories. You need to be able to help do product training, you need to build proctoring networks. You want to be able to help your customer do benchmarking and analytic analysis of usage patterns relative to what the rest of the world is doing. And so, I think they expect support beyond just dropping off a system at the backdoor. We have built that over years, we have come to understand it deeply, and I think it is valuable to our customer. And I think that helps us. Other companies have various degrees of enablement in that space. With regard to the flex catheter in particular, we have been investing in it as you know for years and years. This has been a long-term investment. We have built technologies and made decisions about our architectures based on first principles, not by looking over our shoulder at what other people are doing, but by really engaging customers deeply and understanding their clinical needs. That has driven us and continues to drive us. We have connections into the customer base because of those first principle investigations, and those folks visit us. They look at our technologies, they visit others and look at technologies on the market or soon to be on the market and they make decisions. We're going to make decisions based on clinical value and demonstrable outcomes. You’ve seen the early parts of that with regard to the publications at CHEST. I think there are advantages for people who are first movers, but I think they're short-lived. I think that in this space because there are a lot of alternatives in the marketplace and because it’s going to be a market that’s driven by clinical data over time, the best solutions are going to win and I am confident in our technology and even more confident in our team.

Great. Thanks for taking the question and good afternoon. So, as I looked at your print, obviously there are lots of big impressive numbers in this first quarter report, but one that really caught my eye was the system sales number. And I know historically that’s primarily driven by procedure volumes, and procedure volumes have been very strong. But I was wondering, given this was really the best growth I think you’ve seen in system placements since 2010, was there anything in particular that drove the strength this quarter? Just wondering if you could sort of tease that a little bit more, what happened in systems placements this quarter. Thank you.

Bob, you are absolutely right, systems placements are driven primarily by procedure growth, and you have to look at it over a period of time because systems can be lumpy in any particular quarter. If you look at 2017, the installed base grew 13% and procedures grew 16%. Those procedures were really driving that installed base growth. This quarter we had a little bit higher proportion of trade-outs. That reflects, I think, as I said in my script, customers wanting to avail themselves of fourth-generation capabilities. We also saw high sales of Xi validating that that system has features that really are driving adoption. So, I think it’s lumpy. I think it’s hard to make conclusions based on one quarter of increased trade-in volume, and I just would be cautious there. We expect to see some volatility, but overall, over a longer period of time systems will follow procedure growth.

Great. Thank you for that. And then I want to follow up also on one more question on flex catheter, just curious what’s left to do before you file with the FDA? And just maybe thinking a little bit longer term, but when do you think we might start to hear a little bit more about other potential indications for flex catheter beyond lung?

Sure. For now, as we said earlier in the script, the teams are doing the product validations, they are doing the testing that supports our submissions. We are stabilizing the supply chain, and that’s important; when we launch we want to feel good about our ability to make the products and our sub-suppliers’ ability to make their parts. We are progressing. I think the team is doing a very good job. For starters, as I said in the past, I am excited about the flex catheter technology because I think it’s a platform and we will have other opportunities outside of the lung. Where we are today is focused on bringing this first product to market and satisfying the needs of the interventional pulmonologists and thoracic surgeons. I think that is a major opportunity. Perfecting the clinical pathways, the use of the product and data generation is important for us to focus on. So, our organization is tightly focused on that mission now.

Perfect. And then is there any update on China at all?

Marshall might address the quota, so I’ll let him elaborate on that.

We really don’t have much of an update on the quota; we still sit here awaiting the finalization of that quota. Just to give you the background of the quota, it applies to the years 2016 through 2020. It's part of the five-year planning budgeting process that the Chinese government goes through. The Central government has finalized the budget but has not yet done its negotiations with provinces and hospitals about who will get how many systems, and so we wait.

I think in general what's going on there doesn't appear to be Intuitive-specific. I think it’s more rolling through the centralized government processes. We think that the core interest by Chinese customers in our products and the company, and robotic surgery more broadly, is strong, and we feel slight forward progress in terms of the way the process has been moving. We just can't call what the timelines are, and so we’re at the limits of our ability to influence that outcome.

It looks like you guys had a 99%, almost 100% increase in the international system revenue, but about a 30% increase in the year-over-year systems shipped. Marshall, what drove the difference in those growth rates?

I mentioned a couple of key points. In 2017, we had six leases, while in 2018, we had only one. This decrease in operating leases impacted revenue since these leases don’t generate revenue. Additionally, we experienced a foreign exchange issue as the U.S. dollar weakened throughout the year, which also played a role. Moreover, our product mix was favorable, especially with a high volume of Xi sales internationally, which included outside the U.S. We also saw a beneficial geographic mix, with significant sales in Europe. However, it’s important to note that these figures can be uneven, so you can't generalize based on one region alone. In Europe, we performed well, although there was a slight drop in sales compared to the previous year in some lower-priced distribution markets. All of these factors combined contributed to the increase in revenue we experienced.

And then for my follow-up, we've been increasingly hearing that India did present itself as a large opportunity, potentially even becoming the number one international market. Could you talk a little bit about how you see that market developing this year and over the next few years?

We are hopeful that India will become a strong market in the long run, but we do not expect it to quickly become our second largest market, following our largest market. We have worked with a distributor there for many years and have installed around 40 to 50 systems in India. However, the procedures they generate account for only about 1% of our total revenue from all procedures, so it is not significant at this point. We are investing in this market because we believe it has long-term potential, but we are still at the very early stages.

We’re actually at 68 systems in India currently.

Maybe first question on emerging procedures. Bariatric got a little bit more attention at stages this year and Calvin you called that out in your comments. I know you're in the process of getting back to FDA with the questions on the Stapler. But Gary, can you maybe just talk a little bit how you think about this market evolving and how much market development you guys need to put behind once you get the Stapler out?

It's going to be an interesting one to see evolve. I think it's early for us to put much commentary on it. We see interest by surgeons; having said that, it's a highly penetrated procedure with laparoscopy. And there are a lot of highly skilled laparoscopists in that market. In that sense, it stands in contrast to prostatectomy or hysterectomy for malignant conditions, which were predominantly open procedures. So, we see some core demand and interest. Certainly, we want to complete the product offering in the Stapler. I think the real question there of where it could go over time, I'd like to answer in future calls as we get a few quarters underneath the belt.

Okay. And then thinking a little bit about Japan, with reimbursement coming out at peri and lap. Does that change your view on the adoption curve at all? And are there steps you can take to try to increase these codes over time and presumably that will require additional studies?

I believe that overall, reimbursement decisions are favorable for us, although not entirely positive. This will likely lead to greater adoption within larger centers, which we are equipped to support. We've made investments in data collection in Japan, and we plan to share the insights gained from this with surgical societies and the government as we demonstrate added value. This could be a factor the government considers for future reimbursement decisions. However, I would advise against marking any changes in reimbursement timelines just yet since there is still much to be determined. Having just returned from Japan, I noticed a strong interest in our offerings. Surgical societies view this as a positive endorsement from the government. The financial setup in the appropriate centers appears promising, which is exciting for our team in Japan. I'm eager to see them expand their business and connect with more customers.

Okay. And then lastly on SP. Are you willing to comment, were there any surprises with FDA questions from your perspective? And then as we think about the rollout, obviously, you've talked about the three initial application areas. It seems like there is already some interest in other use cases. So, I'm just curious about how much pent-up demand do you think there is out there today?

Yeah, in terms of the nature of the questions that came back, I think it's within the kinds of conversations we've had with the FDA over the years. And so, I think our teams are working on it. I don't see commentary that I would signal to you one way or another, either particularly small questions or particularly big ones; I think it's right down the middle. With regard to potential applications over time, I think general interest in SP is high, which is exciting to me. One of the things that made us excited to invest in the first place is that it allows an approach to entry into the body that's a little more flexible than multi-port approaches. I think that will open some opportunities in the future for surgeons who are looking for alternatives. Of course, that takes time. We will have to do protocol developments and data collection to get additional clearances as needed. But it was not unanticipated; that was part of what we had thought in terms of investing in the platform. This year will be a limited launch as we build volume and as we start to do things like enabling the proctor network and pursuing the sequential indications that we’ve talked about. So far so good; I think the team is on plan. The clinical response we’ve been getting from surgeons who are evaluating the data looks really good.

Good afternoon, guys. I just had a couple of guidance questions and then one other for Gary. First on the procedure guidance. Just trying to understand the changes that you moved the numbers modestly, but not too much, that it was the toughest comp you had all year but at the nice 15% right at the top of your prior guide. Your installed base growth is still at 13%, holding really nicely. Just trying to understand what you are thinking about at the midpoint and low end of guidance now; is OUS returning to 20% that growth, or what else should we be thinking about both the low to mid-end procedure guidance?

Yes, the removal of the low end of the range is due to our performance in Q1, which includes ongoing growth in general surgery and colorectal procedures in the US, aligning with the trends observed in 2017. We also experienced growth in mature gynecology and urology procedures. Our current guidance suggests that on the US side, gynecology may shift to a low single-digit decline, which we believe corresponds with the overall benign hysterectomy market. We anticipate low single-digit growth in neurology and some moderation in general surgery, largely due to substantial figures with modest contributions from thoracic, pediatrics, and other earlier safe procedures. Outside the US, there is no system quota in China, which may impact capacity, and Japan is experiencing a slower ramp with the introduction of new procedures. On the higher end, trends in gynecology are still showing low single-digit growth, while urology may see slight moderation to mid-single-digit growth, alongside minimal moderation in US general surgery and continued positive trends in pediatrics and emerging procedures. We do foresee some moderation in China, but it is expected to be less pronounced at the high end of the range.

And then kind of a burning question here that I haven't asked in a while for Gary. I just wanted to ask, given the success you’ve been experiencing, what's the biggest risk you see for the Intuitive story today?

I believe the potential for advanced technologies in surgery is quite significant. There are many promising scientific developments in our field, combined with considerable demand. However, there are a few risks we need to manage. One risk is that daily operations required to meet customer demands can hinder our investment in necessary advancements. Balancing these is crucial, as we would miss a major opportunity if the systems implemented in the future resemble those of today. Another important factor is the complexity of these technologies; they demand exceptional talent and a corporate culture focused on customer satisfaction and performance. Neglecting our culture while pursuing growth can lead to challenges that must be addressed. Lastly, healthcare is localized; making progress outside the United States requires a deep understanding of the specific countries we operate in, along with the skills and capabilities needed. While the technology may seem similar, healthcare systems and their product valuation can vary significantly. Being superficial in our evaluations may risk underperformance. If we fall short, others will step in to meet the demand. These are the main risks I see.

I wanted to clarify your comments regarding guidance and the role of China. Calvin, you mentioned that the growth in China slowed in Q1, as you had indicated before. If this level of growth in China remains constant for the rest of the year, can you still reach the upper end of your guidance without any quota? In other words, how reliant is China on your current run rate and the latest data point to achieve the upper end of your guidance?

No, I think it’d be possible. Again, I think we are calling for some moderation in China, and just to put this in order of magnitude, the U.S. business, general surgeries are the largest category in the U.S. Gynecology is the large set of procedures and that mature category is urology, so I think those just have larger bases of business that kind of things impact. Then we’re going to have a bigger impact this year in terms of the growth rates.

And maybe just one follow-up on an earlier question on bariatric. One of the things that we continue to see in this market is the adoption of sleeve gastrectomy at the expense of gastric bypass, and I was just wondering are you guys feeling like the application of robots has a bigger appeal or a bigger unmet need in either one of those two and can succeed if the world goes the way of sleeve gastrectomy?

I understand the question; the difference in suturing is a lot in terms of the amount of suturing between those two. I think it’s too soon to tell right now what kind of the value statements are going to be in bariatric surgery over time. So, like I said, I think there’s some core interest here; the procedures are taxing on surgeons, they’re demanding procedures. There are differences between those two techniques, I think stay tuned is really the short answer here; we will let it play out over the next few quarters and report back.

Good afternoon, Gary. Thanks for the awesome quarter. Just two questions from me. Maybe just a little more color for hernia adoption, for the hernia outlook. Obviously, it continues to go great. Just curious from your perspective, what inning do you think we are in terms of robotic adoption? How sustainable is this kind of growth you're seeing over the next few years? And maybe a little color on, I assume it is largely driven by incisional at this point, or is the inguinal catching up? Can you just help us reflect on the drivers as you look out over the next few years?

Sure. This is Gary. I think we're still in the early part of the game; I don't know exactly what inning, and whether there'll be extra innings or not. But we're not in the first inning; it's now becoming evaluated fairly broadly. Inguinal has been the primary driver in the hernia space to date. We think incisional hernias are also an opportunity and that may rise in the future relative to inguinal. So far so good. We look at, of course, clinical publications and presentations and value statements as reported by clinicians. We also look at reorder patterns and use; are they trialing or are they sticking with it? So far, the performance in terms of ongoing use and sticking, being consistent, sticking with the procedure once they've tried it is quite good in inguinal hernia repair and that's a good sign for us. We think we bring real value here. Customers are reporting back as much, so we look forward to the next several quarters.

Yeah. And just last for me, Gary, you have been kind enough in the past to be, I think, very frank and direct about the looming competition. I’ll be curious to hear your latest thoughts. The two larger companies since we last spoke in this kind of context. One of the competitors seems to be delayed. You now have a smaller competitor approved in the U.S. and in Europe. Just curious how all this is changing reflecting the market or selling discussions. Is it slowing down or is it a positive that they're slow down? Again, any updated perspective will be very welcome. Thanks again.

Yeah, as we said before, I think that need is clear. The opportunity afforded by the kind of the core technologies that are available are also clear. I think customers are always interested in choice. We can provide them choice within our ecosystem, but they'll look for choice outside that ecosystem also. I anticipate it, in my response to customers when they ask, is they should evaluate the alternatives. What I would say is the hardest thing to compete with is the power points that don't yet exist in a product and the concepts that can't really be evaluated. I think in general, the existence of competition validates the space. It signals to surgical societies the broader acceptance of the concept itself and I think that's generally positive. I think these organizations out there, that are large and small, all of that staffed by capable people. I think they're going to work hard and look at alternatives. To the extent that they come up with some really strong ones, I think that will change what’s happening at our customer base. So far, so good. I haven’t seen product concepts so far that Intuitive hasn’t either considered and built or considered and consciously passed on. It doesn’t mean that we’re not wrong; we could be. But I feel like we have a good team. My team thinks about the problems holistically and from the customers’ perspective. If we continue to do that, I think we will be well positioned vis-à-vis competition.

Thanks. Good afternoon. I appreciate that. So, quick follow-up on the outlook in Asia specifically Japan and China. So, in Japan, are you expecting any meaningful uptick in systems placements with a new reimbursement in place? And the reason for asking is it seems that you had a fair amount of what I would call idle capacity for existing placements prior to the updated reimbursement. So, I am wondering if you could help us map back what the new reimbursement means to incremental system demand.

Yes, I mean, we mentioned in our comments, Isaac. We are expecting it will probably be modest. We have got nearly 300 systems in Japan currently. I think there’s a lot of capacity that can be applied to this new set of procedures. These new procedures can involve a process here of bringing up the teams and going through training, and they are gradually building as we gain experience and confidence. I don’t think there’s going to be a tremendous need to expand capacity here in the early days. It is true that some of these new procedures in the general surgery and thoracic categories can definitely benefit from our fourth-generation technology, Xi technology; there will be some interest on the part of some folks to upgrade to the newer models. But for us right now, I think it’s really about building a foundation clinically in the market, and like we always say, eventually the capital will follow, but we are not predicting anything too dramatic this year.

Okay, thank you. And then I am trying to follow up there. It sounds to us like that there will be hopefully some kind of update at the federal or national level with essentially a number if you will for new quota. But can you help us think through your understanding of how that number will then disseminate to the provincial level and eventually convert to origin revenue, whether it be the order process, how it varies, timeline, anything to help us understand the translation of the quota to actual action?

It’s a negotiation that occurs between Central Government and the provinces, so we are not privy to that negotiation and I don’t really understand or know what the timetable is. I can tell you that last time the quota was approved, it took several quarters for it to translate into any kind of sale to us. If you recall, the quota last quarter we got was around 2013, and yet we saw most of the systems at the end of 2015. You go through that negotiation between the Central Government and provinces, and then you also then have a tender process with each hospital at the end of it, and that takes time. Alright. Well that was our last question. As we have said previously, while we focus 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 lot of a few things that should make a difference. This concludes today’s call. I thank you for your participation and support on this extraordinary journey to improved surgery, and we look forward to talking to you again in three months.