Intuitive Surgical Inc (ISRG) — Q2 2018 Earnings Call Transcript

Thank you. Good afternoon. And welcome to Intuitive Surgical's second 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 the Company's Securities and Exchange Commission filings, including our most recent Form 10-K filed on February 02, 2018 and 10-Q filed on April 18, 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 on 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 second 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 second quarter financial results. Then I will discuss procedures and clinical highlights, and provide our updated 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. Our second quarter of 2018 was a strong one in pursuit of our mission to improve the availability and quality of minimally invasive surgery. Customer use of our systems and procedures exceeded our expectations in the quarter with good performance in new system placements and increased system utilization at existing customer sites. We believe acceptance of da Vinci in general surgery in the United States, growth internationally and appreciation of our generation-four platform by surgeons underpins our recent growth. That said we’re neither satisfied nor comfortable. There is substantial opportunity for improvement in surgery, and our customer base has demonstrated sustained interest in our new approaches to old problems. Global procedure growth was approximately 18% in the second quarter of 2018 compared with the second quarter of 2017, accelerating from our Q1 growth rate. Regionally, the United States showed particular strength with healthy growth in hernia repair and colorectal procedures. Mature procedure growth in the United States, including prostatectomy and hysterectomy, continue to top our expectations. Our first quarter aggregate procedure growth in Japan, after reimbursement listing, was in line with our expectations. European procedure growth was generally in line with our expectations with particular strength in the UK and mixed performance elsewhere. Calvin will review procedure trends in greater detail later in the call. Our capital placement performance in the second quarter of 2018 accelerated relative to 2017 with growth in total placements rising 33% from 166 to 220. Net of trade-ins and retirements, our da Vinci install base grew 12% over Q2 of 2017. The mix of system placements between our flagship Xi systems, our Value-X system and refurbished X SI systems align with our strategy regionally. Capital placements have historically been lumpy and we anticipate volatility in placements for the remainder of 2018. Turning to operating performance. Our teams executed its plan with manufacturing and quality costs meeting our goals, and average selling prices within our expected ranges. On the investment front, we are building our organization and making targeted infrastructure investments to deepen both our technological and regional capabilities. Fixed costs spending in the quarter was slightly lower than we anticipated, largely due to timing issues that we anticipate will catch up in the back half of the year. Highlights for our second quarter operating results are as follows; procedures grew approximately 18% over the second quarter of last year; we placed 220 da Vinci surgical systems, up from 166 in the second quarter of 2017; our install base grew 12% from a year ago; revenue for the quarter was $909 million, up 20%; pro forma gross profit margin was 71.1% compared to 71.4% in the second quarter last year. Instrument and accessory revenue increased to $476 million, up 20%. Total recurring revenue in the quarter was $643 million, representing 71% of total revenue. We generated a pro forma operating profit of $389 million in the quarter, up 23% from the second quarter of last year. And pro forma net income was 327 million, up 42%. Marshall will take you through our finances in greater detail shortly. Delivery of substantive technology and service improvements are core to continued progress in surgery. We measure our innovations by their ability to positively impact outcomes in the hands of our customers to be used efficiently, while lowering the total cost of treatment per patient episode and for their positive impact on the experience of surgical patients. With increased interest in da Vinci from general surgeons, we have added our 60-millimeter SureForm surgical stapler to our product portfolio, with 510 (K) clearance this month joining its prior CE Mark. Our second-generation cut and seal instrument, Vessel Sealer Extend, is in its first quarter of U.S. launch with outstanding customer feedback. And we have submitted our 510 (k) for enhanced grasper for hernia repair. As we've said in the past, we design our product systems, instruments and software to work together seamlessly as an ecosystem, to enable a holistic approach to a surgical procedure. These latest instruments and software releases are optimized for our generation-four platform and general surgery. We obtained FDA clearance for our da Vinci SP surgical system for neurologic surgical procedures in Q2 this year, and we are finalizing our transoral clinical IDE for SP this quarter. We plan to launch the da Vinci SP surgical system in the United States in phases with first customer shipments expected to begin late Q3 or early Q4 this year. Our first access sites will focus on clinical data generation and customer feedback. Surgeon interest in SP is high and we believe SP to be a platform technology with potential application in a number of surgical specialties. Consistent with our history, we will engage surgeons and regulators in clinical assessments for new applications of SP and anticipate filing additional 510 (k) applications over the next couple of years. Our team is progressing to plan on our flexible robotics platform, initially targeted to address the acute need in 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 remained strongly supportive of our efforts. We anticipate submitting our 510 (k) in this back half of 2018, and are working through final design validations and to ramp up our supply chain. As our approach to surgery has gained traction, organizations large and small are hurrying to participate in the market. Their entry is an inevitable reaction to positive change in the operating room. Customers appreciate options from Intuitive and others, and we anticipate customers will evaluate alternatives as they appear. At Intuitive, we are sharply focused on understanding our customers’ world and providing them with products and services they value highly. To take a simple example, our systems are available to start and able to complete cases with remarkable predictability, considering their use of a wide range of sophisticated technologies. This is a consequence of our holistic design and integration principles, the capability of our staff and our deep commitment to understanding the surgical team’s world. We believe this sets a high bar for new entrants in the eyes of the thousands of surgeons who use da Vinci weekly. For the balance of 2018, our focus remains in completing the tasks we 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. I’ll now turn the call over to Marshall who will review financial highlights.

Good afternoon. I’ll describe the highlights of our performance on a GAAP and non-GAAP or pro forma basis. Our results are also posted on our website. Second quarter 2018 revenue of $909 million grew 20% compared with second quarter 2017 revenue of $759 million, and increased 7% compared with first quarter revenue of $848 million. The year-over-year revenue growth benefitted by approximately 100 basis points from the weaker dollar. Second quarter 2018 procedures increased approximately 18% compared with second quarter of 2017, and increased 8% compared with last quarter. Procedure growth continues to be driven by general surgery in the U.S. and in neurology worldwide. Kevin will review details of procedure growth later in this call. Instrument and accessory revenue of $476 million increased 20% compared with last year, which is higher than procedure growth, reflecting increased usage of our advanced instruments, partially offset by customer buying patterns. Instrument and accessory revenue realized per procedure was approximately $1,850, an increase of 1% compared with second quarter 2017 and a decrease of approximately 4% compared with last quarter. The increase compared with last year reflects increased advanced instrument usage and the impact of the weaker dollar, partially offset by customer buying patterns. The decrease relative to last quarter primarily reflects customer buying patterns, partially offset by an increase in advanced instrument usage. Systems revenue of $277 million increased 25% compared with the second quarter 2017, primarily reflecting higher system placements and increased lease-related revenue, partially offset by lower ASPs and an increased number of operating leases. We placed 220 systems in the second quarter 2018 compared with 166 systems in the second quarter of 2017, and 185 systems last quarter. 44 operating lease transactions, representing 20% of total placements, were completed in the current quarter compared with 16% of total placements in the second quarter of 2017 and 23% 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 in the long-term. 34% of current quarter systems placements involve trade-ins, reflecting customer desire to access or standardize on our fourth-generation technology. This is an increase in the proportion of trade-in transactions compared to 20% in the second quarter of 2017 and 31% last quarter; however, trading activity can be lumpy and difficult to predict. 72% of the systems placed in the quarter were da Vinci Xi and 21% were da Vinci X systems compared with 76% da Vinci Xis and 16% da Vinci Xs last quarter. Our install base of da Vinci systems increased 12% year-over-year and our average system utilization grew in the mid-single-digit range. Globally, our average selling price, which excludes the impact of operating leases, lease buyout and revenue deferrals was approximately $1.42 million, which is lower than $1.46 million last year, and $1.49 million in the first quarter. The decrease primarily reflects a higher mix of trade-in transactions. Outside of the U.S., results were as follows. Second quarter revenue outside of the U.S. of $265 million increased 28% compared with the second quarter 2017, and decreased 4% compared with last quarter. The increase compared with the prior year reflects increased systems revenue of $25 million or 32% growth, and increased instruments and accessories revenue of $27 million or 31% growth. The increase in systems revenue was driven by an increase in the number of systems placed, partially offset by lower ASPs, reflecting an increase in the number of trade-in transactions. The increase in instrument accessory revenue was primarily driven by procedure growth and customer buying patterns. The decrease in our OUS revenue relative to the previous quarter reflects the higher number of systems leased transactions, lower system ASPs reflecting increased trade-in transactions and customer buying patterns related to INA. OUS procedures grew approximately 22% compared with the second quarter of 2017. OUS procedures were positively impacted by the timing of holidays in 2018 compared to 2017. Outside the U.S., we placed 82 systems in the second quarter compared with 63 in the second quarter of 2017, and 73 in the first quarter. Current quarter system replacements included 39 into Europe, 13 into Japan and nine into Australia. 30 of the 82 systems placed in the second quarter were X systems. Placements outside of 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 or vacation patterns, and sales in the sub-markets are constrained by government regulations. Moving on to the remainder of the P&L. The pro forma gross margin for the second quarter of 2018 was 71.1% compared with 71.4% for the second quarter of 2017 and 71.6% last quarter. The decreases primarily reflect lower system ASPs and revenue mix. Future margins will fluctuate based on the mix of our newer products, the mix of systems and instrument and accessory revenue, system ASPs and our ability to further reduce product cost and improve manufacturing efficiency. Pro forma operating expenses increased 14% compared with the second quarter of 2017, and decreased 1% compared with last quarter. The decrease relative to the first quarter primarily reflects the impact of payroll taxes. Overall, our spending was below our annual guidance, reflecting the timing of expenditures. We expect spending to increase in the last half of 2018 consistent with our guidance. Our pro forma effective tax rate for the second quarter was 19.7% compared with our expectations of 20% to 21%. Our tax rate 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 second quarter 2018 pro forma net income was $327 million or $2.76 per share compared to $230 million or $2 per share for the second quarter of 2017, and $288 million or $2.44 per share for the first quarter of 2018. I will now summarize our GAAP results. GAAP net income was $255 million or $2.15 per share for the second quarter of 2018 compared with GAAP net income of $223 million or $1.94 per share for the second quarter of 2017, and GAAP net income of $288 million or $2.44 per share for the first quarter of 2018. The adjustments between pro forma and GAAP net income are outlined and quantified on our website, and include excess tax benefits associated with employee stock awards, employee equity and IT charges and legal settlements, including the previously announced second quarter 2018 charge of $42.5 million. Note that the IRS has not issued final tax regulations associated with the recent U.S. Tax Legislation. Therefore, the impact of the U.S. Tax Cuts and Jobs Act reflected in our 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 tax regulations are finalized and further interpreted. We ended the quarter with cash and investments of $4.3 billion compared with $4.1 billion at March 31, 2018. The increase reflects cash generated from operations of $220 million. We did not repurchase any shares in the quarter and have approximately $718 million remaining under board buyback authorization. In the quarter, we repatriated $1.4 billion of cash to the U.S. since the earnings have previously been taxed under the U.S. tax reform act of 2017, and there were effectively no foreign taxes assessed under repatriation. We’ve not changed our capital deployment strategy or plan. And with that, I would like to turn it over to Calvin who will go over procedure performance and our outlook for 2018.

Thank you, Marshall. Our overall second quarter procedure growth was 18% compared to 16% during the second quarter of 2017 and 15% last quarter. Our Q2 procedure growth was driven by 17% growth in U.S. procedures and 22% growth in OUS markets. In the U.S., procedure performance across general surgery, gynecology, and urology, all exceeded our expectations with Q2 year-over-year growth rates accelerating modestly across these largest categories. Q2 procedure performance was again driven by growth in general surgery. Hernia repair and colorectal procedures continued to lead the way as these categories again added the most incremental cases. As usage of da Vinci in the U.S. general surgery expands. Other general surgery procedures contributed larger numbers of incremental cases than previous quarters. In U.S. gynecology, second quarter 2018 growth was consistent with 2017 and Q1 2018 trends as procedures in this mature category grew modestly year-over-year with growth led by hysterectomy. We hypothesize our growth in gynecology to be driven by favorable surgical consolidation trends. As our da Vinci surgery data indicate, an increasing proportion of U.S. gynecology procedures are being performed by higher volume physicians that specialize in complex benign and cancer surgery. Q2 U.S. urology procedures also had growth rates consistent with 2017 and Q1 2018, driven by prostatectomy volumes. As a mature procedure category, we believe that our U.S. prostatectomy volumes have been tracking to the broader prostate market, which has benefited from recent macro trends. In U.S. other procedures, adoption of lobectomies and other thoracic procedures was again solid during the second quarter. Utilization of our da Vinci Xi systems and surgical staplers, which helped to optimize robotic thoracic procedures, has been increasing. Second quarter OUS procedure volume grew approximately 22% compared with 22% for the second quarter of 2017 and 18% last quarter. Second 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. As expected, Q2 OUS procedure growth was higher than Q1, benefiting from more operating days, resulting from the timing of holidays, including Easter. Procedure growth in Japan accelerated as initial cases were performed within the set of 12 additional procedures approved for reimbursement effective April 1st. Procedure growth in China again moderated in Q2, as da Vinci system capacity expansion is constrained by system quota requirements, the most recent of which expired at the end of 2015. In Europe, procedure results vary by country with particular strength in the UK. Over the years, the discussions surrounding da Vinci surgery have been centered around the clinical patient benefits. In addition, we believe there is substantial opportunity to create surgeon value as well by improving the ergonomic characteristics of surgery. In 2017, in the Annals of Surgery, Dr. Chantal, CJ Alleblas, et al, published an analysis entitled, prevalence of musculoskeletal disorders, MSTs, among surgeons performing minimally invasive surgery, a systemic review. This metastudy reviewed 35 articles, including over 7,000 surgeons. The authors characterize the risk factors associated with lab surgery to include static body posture, repetitive upper extremity movements, and forced exertion from adverse positions. Moreover, the workload has increased by the high level of task precision and time pressure. Physical demands differ between open and laparoscopic surgery, and comparative studies have reported higher prevalence of physical complaints for laparoscopic surgeons. Recent studies report MSD prevalence rates of 73% to 88% among specialists in MIS. Relative to the general population, these numbers are excessively high. In their study, the authors found a 74% prevalence of physical complaints among laparoscopic surgeons. However, the low response rates and the high inconsistency across studies leave some uncertainty, suggesting an actual prevalence of between 22% and 74%. Fatigue and MSDs impact cycle motor performance. Therefore, these results warrant further investigation. While pain ratings are subjective, we think there is an opportunity to improve ergonomics for surgeons. With our recent bariatric surgery indication and SureForm 60 millimeter stapler 510 (K) clearance, we are better positioned to serve bariatric surgeons. 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 12% to 15%. We are now increasing our forecast and estimate full-year 2018 procedure growth of 14.5% to 16.5%. 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. Our actual gross profit margin will vary quarter-to-quarter depending largely on product, regional and trade and mix, and the impact of new product introductions. 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 continue to expect our non-cash stock compensation expense to range between $245 million and $255 million in 2018 as forecast on our last call. We expect other income, which is comprised of mostly interest income to total between $70 million and $75 million in 2018, up from $55 million to $60 million forecast on our last call. With regards to income tax, on our last call, we forecast our 2018 pro forma income tax rate to be between 20% and 21% of pretax income. We are now shifting our estimates slightly lower to a range of between 19.5% and 25.5% of pretax income. That concludes our prepared remarks. We will now open the call to your questions.

I want to start with the U.S. procedure growth. You’ve had about 300 basis points sequential acceleration. Can you maybe just talk a little bit more about that? I mean, hernia has obviously been doing well for a while, but you really seem to have an inflection here. So can you talk to maybe the sustainability of what you saw here in the quarter?

We approach procedure enablement by designing system, instruments, and imaging and software elements with surgeon feedback, and with the introduction of our Xi systems and our next-generation advanced instruments and refinements imaging software. Our customers are seeing real value in general surgery, particularly with the gen-four systems. And you mentioned hernia repair and colorectal, they’ve been leading adoption. And we’ve seen organic interest from bariatric surgeons as well as our SureForm 60 stapler comes to market and with the addition of gen-four labeling in bariatric so far to serving those opportunities as well.

One of the aspects we monitor is the relationship between stick rates and reorder rates to determine whether our users are continuing to trial and remain with our products. In hernia repair and colorectal procedures, we are observing encouraging stick rates. This gives us a sense of growing momentum. Additionally, there have been unexpected increases in prostatectomy and urologic procedures, as well as gynecologic procedures in the U.S., although I lack confidence in the sustainability of these trends.

And then thinking a little bit ahead on pipeline. Can you talk a little bit about the data roadmap for flex cath? Obviously, you’re doing a lot of the optimization work on the manufacturing side. But how should we think about incremental data coming out ahead of the launch?

Nothing new to report for you there. Certainly, as it starts coming into the market, you'll see early sites start to take broader data collection and so on. With regard to what regulators want to see, we’ll see what happens with regard to their feedback to our submission when that occurs. So I don't have anything to point you to at this time.

Gary, you mentioned interest in SP beyond the initial opportunities you've discussed. Can you share some insights on those areas? It seems there is interest in cardiology based on what others have done. How common is that in your early discussions?

I have been pleased with the interest that SP is generating among our customers in exploring where it can create real value. We’ve noted some interest in urology and believe there will be significant interest in colorectal surgery and transoral surgery as well. We have had initial discussions in several other specialties. However, it’s too early to direct our investors toward any specific area just yet. That said, SP offers a different access to the body compared to Xi, which uses instruments in a different way. We initiated this approach because we believe it will spark interest and create value in various other areas. As we gain experience and as our products are introduced to the market, we will keep you updated.

This is Jamie on for Amit, can you hear me okay?

Yes.

So first the question is just on system features. When you think about the benefits and challenges of an open console and also separately the benefits and challenges of a system with arms mounted on a table. How do you guys think about those types of features that your competitors are starting to talk about?

Just zooming out for a minute, I think the way we think about it for customers is what allows for smooth operations across a population of patients and a broad set of procedure types from neurology, to gynecology, to general surgery, to thoracic surgery and so on. And as we think about those things, we've been at this for a long time. The idea of mounting things to tables, the idea of mounting them to floors, of having them to be modular of using open consoles versus consoles that have immersive viewers, have been around quite a bit. And we have evaluated and tried a lot of them. We came to these decisions not based on white board analysis, but on building things and talking to our customers and working through it. So it doesn’t mean that we’re right, it could certainly mean that somebody else did something slightly different and they evaluated it differently, but we were not casual about this. And we did it with serving a population of patients, the population of surgeons across procedure set in mind. With that I'm comfortable with where the Company has made its investments.

And then a question on the imaging side, with what you guys are working on for the first-generation launch of that. Is that basically going to be pretty off images only, or is there a possibility to do real-time imaging in that first-generation launch? Just help us understand the technology roadmap from here and timing expectations.

I'm not quite sure when you say first gen imaging. We have done a lot of things in imaging for a lot of years, so perhaps a little clarity on what…

For the imaging only side of things…

In terms of image fusion, we are discussing the integration of preoperative images such as CT scans or MRIs with endoscopic images. These technologies have been available for many years. Currently, customers can utilize a method to compare preoperative images with real-time data. There are advancements underway that will allow for a more seamless integration of these images. However, we have not set any expectations regarding timelines or future developments yet. We possess significant technological capabilities and will launch something when we believe it will truly benefit surgeons, enhancing their efficiency or enabling better outcomes. While there is potential for progress, I have no updates to share regarding timing.

Gary or team, I want to start with systems momentum in the first half of the year. So last quarter, we saw increased trade-ups and again this quarter. So I just wonder how are the dynamics in your mind different this quarter than last quarter, what are your thoughts on sustainability of these systems trends? And maybe concerns on driving SP here in the back half of the year as you’re also aggressively driving customers to the gen-four platform? And then I have a quick follow-up.

We don’t see a real change in terms of momentum from one quarter to another, in our first quarter and second, other than as you indicated. You see a higher percentage of trading. The fourth-generation products have some features in it, I think that we’re seeing excitement from the general surgeons about utilizing for the procedures we talked about earlier, colorectal procedures, thoracic procedures. And I think hospitals and surgeons want to avail to that technology, so we're seeing trade-outs. We're also seeing some desire to have standardization within the hospital where they only have one set of instrumentation to manage rather than two. And so tradings are difficult to predict as to where we are in a particular cycle or how much will happen in any particular quarter. But what we have seen is a slight increase in those trades.

Two things on that, one is customer use and efficiencies with the generation-four platform is quite good. So we are pleased to see their interest and to the extent that we’re going to be flexible and help them move in the gen-four we will. With regard to SP, our initial thought here on the phase one of launch is not to do an enormous capital placement of SP. It’s really to establish local data centers and build out the value story as we go and to really begin the early collection for next indications. Over time as we build out that experience base, our interest in expanding the SP footprint will increase but that's a multi-quarter conversation, not a really quick turn. SP long-term and I think we’ve talked about it. In beginning, SP will go out as full systems. But as we build out the evidence base, it will be part of the gen-four platform that will be easy to upgrade and configure as part of gen-four, and that’s been part of our thought process for some time.

And then Gary or team, just on Asia-Pac strategy broadly, didn’t hear much about Japan in this particular transcript. How are you encouraged by the early traction in Japan? Is that on plan or ahead of plan, maybe comments there? And then Gary, you’ve talked about before I think you made some statements that, at a certain point of the year, the absence of the China quota obviously reduces the likelihood this year. Any updated thoughts on the likelihood of China this year and any impact on just tariff rhetoric on getting that deal done? Thanks so much.

On Japan, first quarter here after the listing, we’re pleased with the interest of the customer base. Our training facilities are busy, we’re pleased with that. We are really testing the capabilities now of our new reformed or newly grown team in Japan to really execute. So I think a little early to tell the ultimate performance there, first steps looks fine. I think there's more to do. And so our team and we are focused on really executing, it’s not a big strategy question it’s getting the training pathway, the factoring pathway, the follow-up pathway, the support onsite really built and operating well. And that’s what we’ve asked the team to focus on and we will be focused on. The first step of demand generation looks really good. So moving to China, I’ll speak briefly to the quota. I’ll ask Marshall to speak briefly to the impact, potential impact of tariffs. On the quota side, we have no real update to supply with. We are awaiting an initial quota. No news there. Overall, I think the atmospherics that are going on globally do not help that conversation. I don't have anything specific to tell you there. But generally speaking, I think the atmospherics of those conversations are not helping the quota generation. We do see, as we have told you in last calls that a procedure upside is going to require additional capital if we think the demand is there. And so there is a problem we need to solve. China is important to us, as a market and for joint ventures. We are committed to it. And we are going to have to work through current macro challenges that are out there. Marshall, you might speak to that.

The tariff situation is clear for us. The initial round of tariffs has affected some components used by our suppliers. We are currently assessing this and believe the estimated impact on our product costs will be modest. We do not intend to pass these costs on to customers at this time.

I want to start with SP. Gary, you mentioned that interest in SP is high. Could you provide more details on which types of accounts are showing initial interest? Also, if a center is interested in SP, will you impose any restrictions on them? I would like to understand your thoughts on SP a bit more.

There is significant interest across various segments regarding accounts. Initially, we have specific clearances that will facilitate access for us to begin, followed by further data collection for additional clearances. These factors will shape our early access strategy, primarily based on the clearances we possess and those we aim to pursue later. We anticipate being supply limited for the first few quarters, which means there will be some waiting period before we can roll out this initial set. As we obtain further clearances and become more proficient with the technology, the process should become much smoother. However, the rollout will be designed carefully at the beginning.

Also you made a comment in prepared remarks about the potential for volatility and capital for the rest of 2018. Is that just because there can always be volatility in capital, or is there something specific that you’re referring to?

No, nothing specific, it's really just in general, it’s hard to predict capital given budget cycles, given government regulations, in the case of China and just seasonality. And so it's just hard to predict when hospitals will actually purchase, and so you can see it be lumpy over time.

What happens also is the aggregate reporting of course averages a lot of lumpiness that happens underneath. So even if the aggregate looks smooth, regional variances can be reasonably high. And so it's just as Marshall properly said, nothing specific but the general dynamics that are out there.

Particularly on stapler and vessel sealing. If you’re successful with those launches, should we start to see upward momentum in your revenue per procedure? I realized there is a lot of things that affect that line, but those are two pretty chunky products. And just curious if you’re successful with those launches, should we expect that line item to start to move higher?

When you look at revenue per procedure overall, there is clearly some variance quarter-to-quarter. We talked a lot about customer timing, order timing and things like that. So quarter-to-quarter, you see those things. And we are seeing an increase in contribution from advanced instruments, including our stapling products, which are getting more usage, as well as vessel sealing. We introduced a new version of our Vessel Sealer Extend in the last quarter. And now the 60-millimeter stapler that we’ll be rolling out here in the third quarter with expanded access available in the fourth quarter. That just serves to expand this category further around our product line a little further for stapling and provide a more optimized tool within the category of bariatric. So the simple answer is yes that that will just be more on our advanced instrument side of things that that element will serve to be a tailwind for revenue per procedure.

You did I think 16.5% procedure growth in the first half of the year, if I’m doing the math right. So just my question is, Calvin, what gets you to the low and gets you to the high and what are some of the assumptions that would get you to the high and low end there? And I have one follow-up.

You’re sitting six months into the year now. Year-to-date, procedures are actually rounding up to 17% as you described. And so it’s pretty straight forward. I think you look at it right now at the high end of the range. We are talking about a continuity of the trends we saw in the first half across geographies and procedure sets. Then at the lower end of the ranges, we are talking about moderation, Marshall talked a little bit about the mature procedures. And we continue to beat our expectations in these categories, urology and oncology, in the U.S. But some moderation in those categories would be considered at the low end. And even in general surgery, where we’ve been performing very strong just somewhat less robust growth in now our largest category in the U.S., contemplating the lower end.

And then for my follow-up, I think bariatric has been tough to convert because of good lab outcomes. What’s your strategy to penetrate this market, how meaningful is 60 millimeter stapler driving adoption? And what should we expect from an uptake standpoint? Thanks for taking the questions.

Our customers have identified bariatrics as an area of interest. There's a significant use of laparoscopy in this field, and the outcomes are generally positive. The question arises as to why there is organic interest in this area. As we've discussed previously regarding the adoption of procedures, there are distinct sub-segments within bariatrics, such as sleeve gastrectomy, gastric bypass, and revision procedures. These segments represent entry points of value that we will need to develop over time. We see strong interest from surgeons, especially in complex co-morbid cases for regional surgeries. Additionally, as Calvin mentioned, there are ergonomic advantages for laparoscopists, which may be appealing since bariatric surgeons typically perform a high volume of procedures that can be physically demanding. While we aren't in a position to define the market size for these sub-segments or pinpoint where value creation will occur, the organic interest is significant. We plan to engage our customers and follow their guidance. In short, stay tuned.

We noticed that several institutions are exploring new methods to increase the number of systems in their hospitals due to the demands from general surgeons who are constrained by their current resources. I'm interested in hearing your thoughts on possible creative strategies for placing these systems beyond traditional operating leases. For instance, would you consider minimum volume commitments tied to an upfront system model? In this scenario, if the volumes don't meet certain thresholds over an agreed timeframe, you would have the option to reclaim the systems. This is a model we've heard discussed, and I'm curious if this is being pursued or if there are other innovative approaches you might use to expand your presence before competitors enter the market.

The main goal is to deploy systems and ensure they are effective in improving surgery for patients. We have been adaptable with our leases, offering very short-term arrangements similar to rentals that align with budget cycles, as well as traditional five-year leases where the equipment remains with the customer after the term. We are open to being even more flexible. While we've discussed various models, we haven't implemented anything significant that would impact our results at this time, but we will remain open to different approaches to eliminate barriers related to capital expenditures.

The key factors we're focusing on regarding flexibility for customers include their long-term commitment to accessing the system and the importance of that access to them. We have confidence in our systems, so we aren't overly concerned about issues like returns. If the group recognizes the benefits of robotic surgery compared to other surgical methods, we are open to taking some financial risks, provided they are dedicated to how they plan to implement the program and train their surgeons.

And then just a quick follow-up, I think Calvin you had mentioned that SP and the phased rollout is initially only going to be sold as a standalone console, but then it eventually will be worked into the entire fourth-generation package. How should we think about the ASP on SP as we model out maybe the initial placements, is it like 20% to 30% premium to what SP will be as we move out beyond 2019? How should we think about that?

As a standalone systems there should be a slight premium to our Xi less than 20% to 30% more or like in the 5% range.

Just another question on Asia, I'm curious in Japan with the new coverage there. You talked about an acceleration, I'm wondering how you think that accelerating curve will play out over the balance of the year as it relates to your guidance. What's embedded in the Japan part of your outlook?

Let me do a just little bit of qualitative and then you can speak to the quantitative. Qualitatively, while we had, I think 12 traditional procedures some of which are sub-procedures of each other, added in terms of reimbursement listing. They will not all drive at the same rate concurrently. Some will take precedence over others in terms of priority for training and priority for development. The team is working through that now. So as we do our forecasting model, it's not a simultaneous event, its focus, and deliver, and really drive high-value through our teams to the customer. Calvin?

Just quickly as we move beyond the urologic dVP and prostatectomy into this broader set. As we described in the earlier comments, it’s a foundational building period. We’re very pleased and satisfied with one quarter’s activity is focused on training and new programs and all the support that they require on the field. But in terms of the pure numbers, this is not a big factor in terms of the high-end and low end of guidance that where we may project overall. The overall proportion of procedures in Japan relative to the worldwide is something in the two percentage range. So it's a phenomenal opportunity in the long run in Japan. But in the near term, it’s really more building programs and less of the impact that will have on full year procedure growth for the Company.

Follow up is on the hernia market, I think that’s obviously huge potential opportunity for you guys. And I think the thinking there has evolved over the years. And now that you’ve got I think a little bit of accelerated traction there. It would be helpful if you could maybe provide for us price some updated buckets or maybe chapters of market development that we can think through in terms of the types of procedures that you think are really driving the near-term adoption versus those that might be intermediate or long-term opportunities. Just anything help us segment what is clearly a very heterogeneous and larger opportunity for you guys. Thank you.

I appreciate the question, but we're not in a position to address it on this call. It's important to note that our perspective on these opportunities and markets changes over time as surgeons explore the capabilities of our systems and discover value in various areas. As we gain a better understanding of the different market sub-segments, our view does evolve. While we're not ready to provide a different forecast at this moment, we acknowledge that we are entering a new phase, and it's worth considering what that phase entails.

Gary, I couldn’t help but notice that in the U.S, I think it's 87% of the systems placed were Xi, which obviously suggest hospitals continue to go after the most capable system despite the availability of the lower-priced X. So could you talk a little bit about the trends there between Xi and X in the U.S.?

I think in a sense it comes down to how people think through this trade-off between clinical value and economic value, and where they see value relative to capital entry price. And in many, many places as you look at this deeply the capital price, the capital component is not the driving determinant of cost. If you look at total cost to treat per patient episode, which is in my opinion the most relevant economic question here, the total costs of caring for that patient are absolutely dominated by outcomes and dominated by human labor. And so the material costs that flows through tiny fraction of all of it. And for those folks capital access and who see that who’ve done analysis, I think what they really ask themselves is what’s going to give us the best outcomes and the highest efficiency and standardization. And they make that out of commitments and so that's what we see. And I think that results in acquisitions of Xi systems. If folks are capital constrained, and by the way that said of criteria can vary a little bit region-to-region. I do think total cost to treat per patient episode translates well across country boundaries. But different organizations have different approval processes and capital allocation processes. They may choose to get started with a lower capital cost system. If they want to do that, we're happy to support them and that's the next. So in our prepared remarks, we had talked about our allocation of these systems, fitting our view of the world regionally and that's why.

And then I guess the other question is, I know the SI is certainly around for a period of time. And there has been ability to offer refurbished systems at a discount for those that are really looking for less expensive capital equipment. But is there a place in the portfolio for a more de-featured system that would have even a lower capital cost? Do you think about that as also potentially part of the portfolio at some point?

We will listen extremely carefully to our customers’ needs, and recognize that customer needs are triple A, that outcomes efficiencies, workflow, standardization, and return on investment and the high responsiveness to patient need, a high patient centricity. Those needs we’re going to look for really carefully if in that set of analysis a further de-featured system makes sense of course we will pursue that, and we're always looking. I don’t think that it is obvious right off the bat that less capable systems at lower capital prices make those three aims a lot better, but we are constantly asking ourselves.

One of your robotic flex cath competitors has recently partnered with a division of J&J for its latest technology. Can you spend some time discussing how you see the future direction for the flex cath platform beyond lung biopsies? And specifically, what do you think is the right modality for ablative technology. And is this technology that Intuitive already has internally, or is it something that Intuitive will need to acquire in the future?

First thing as we have said before, we’re excited about flex catheter technologies, particularly in lung. I think it can make a big difference there. But it's a platform and we think it will have applications beyond the lung. We are focused on creating value in the lung to start that does not say that our vision will not extend further, that's step one. Step one, with regard to the idea of see entry. If you can go and do detection and then be in a position to treat it, things are very compelling in vision. And it's a vision we share, we think that's interesting. There are many different ablative technologies and approaches within technologies. Ablation has been around for quite some time. It's not a trivial or obvious therapeutic approach. It will take serious design and serious clinical validation to really understand where those things are. That's going to be a multiyear pathway for anybody. So we’re not surprised to see others’ interest in it that are not new to us, not a new thought for us. We think there are opportunities there. We think there are multiple pathways to good solutions. We are investing in those. Some of that is organic. Some of it is partnered. As we evolve, we will share more of that with you. All right. Well, thank you very much. That was our last question. As we’ve 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 we’ll remain committed to driving the vital few things that truly make a difference. This concludes today's call. We thank you for your participation and support on this extraordinary journey to improve surgery. And we look forward to talking with you again in three months.