Intuitive Surgical Inc (ISRG) — Q4 2021 Earnings Call Transcript

Thank you. So good afternoon, and welcome to Intuitive's fourth quarter earnings conference call. With me today, we have Gary Guthart, our CEO; and Jamie Samath, our CFO. 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 10, 2021, and Form 10-Q filed on October 20, 2021. Our SEC filings can be found through our website or at the SEC's website. 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 intuitive.com on the Latest Events section under our Investor Relations page. Today's press release and supplementary financial data tables have been posted to our website. Today's format will consist of providing you with highlights of our fourth quarter results as described in our press release announced earlier today, followed by a question-and-answer session. Gary will present the quarter's business and operational highlights; Jamie will provide a review of our financial results; and I will discuss procedure and clinical highlights and provide our financial outlook for 2022. And finally, we will host a question-and-answer session. And with that, I'll turn it over to Gary.

Thank you for joining us today. 2021 required agility as we drove through significant headwinds to support customers and manage our supply chain. Our teams performed well, helping customers return to surgery when COVID allowed them and maintaining the integrity of our supply chain and workforce. Given our recent press release updating procedures, capital placements and revenues, I'll be brief in describing our full year 2021 results and spend a little more time outlining our plans for 2022 and beyond. Putting 2021 in context, demand for our robotically-assisted interventions has been resilient during COVID. While these interventions get delayed during COVID peaks, they return as COVID wanes, and that is encouraging. Pandemic stresses on healthcare systems emphasize the need for the kind of high-quality, minimally invasive interventions our products enable. MIS procedures allow greater use of ambulatory surgery, free up resources in ORs relative to other approaches and often enable faster patient return to home and overall recovery. In 2021, da Vinci procedures grew 28% compared to the full year 2020, reflecting a partial recovery in surgery after the first wave of the pandemic. Over the 2-year period, 2020 and 2021, the compound annual growth rate in procedures was 14%. Capital installs were healthy in 2021, with our team placing 1,347 da Vinci and 93 Ion systems in the year, driving da Vinci placement growth of 44% over 2020 and at a CAGR of 10% over the past 2 years. With a 2-year CAGR in procedures of 14% and installed base growth of 10% over the same period, utilization of installed systems continues to climb through the pandemic. We think this is good for our customers and good for us. Jamie will give regional capital trends and Brian will give detailed procedure dynamics later in the call. The past 2 years have stressed more than health systems. Our ability to attract, develop and retain outstanding staff remains a key focus for us. Our team has performed well, supporting our customers and each other. In the year, we added approximately 1,700 employees to our team with net headcount growth of approximately 180 in R&D, 920 in operations and 340 in our commercial force. Of the 1,700 net additions, 700 were outside of the United States. Looking out over the next decade, we believe that the method we have developed to identify clinical need, then design a technology-enabled ecosystem for improving the quadruple aim, then deliver and train customers on this ecosystem, can positively impact a broad set of minimally invasive interventions. The opportunity and challenge for Intuitive is to evolve our ecosystem to support our customers and ourselves at scale and to choose procedural opportunities and platform architectures that make sense. Turning to investments in the mid-term. Our priority for use of our capital is to reinvest in the business, to develop new opportunities that improve the quadruple aim and to strengthen our operating capabilities at a global scale. We are focused on driving a vital set of initiatives, and I'd like to describe the dynamics for you in a little more detail. In multiport, we believe our Gen 4 architecture is outstanding and we've been adding capability to this product line since launch, including significant expansion and upgrades to energy and stapling product lines, improved endoscopic imaging, the introduction of da Vinci X, the introduction of Extended Use Instruments, training technologies and finally, the introduction of new and upgraded connectivity and data management tools. Given the precision, robustness and overall performance of our Generation 4 robotics architecture, we will continue to innovate on this platform, bringing additional value to those customers who have standardized on Generation 4 fleets. We are also investing in new core capabilities for our multiport systems, both Generation 4 and beyond that we'll describe as they get closer to market. You should expect continued innovation from us here. Turning to Ion. Our first indication addresses a large unmet need in lung cancer biopsy and our focus is fully enabling our production capability and customer ecosystem for this indication. There is strong demand for lung biopsy, and we are working to expand manufacturing capacity of all processes for greater quality and lower costs at scale and run trials to address regulatory requirements that enable global expansion. Over time, we plan for total Ion program profitability to approach that of our corporate average as we execute against our volume, design and process improvement goals. We are pursuing additional applications for Ion, and we'll describe them as we get closer to market. For our single-port system, da Vinci SP has the opportunity to change the standard of care in 2 different types of soft tissue surgery: those that require the extraction of tissue that can be done through a small single port and those procedures that benefit from narrow entry into the body as a whole. Where Ion, at its current stage of launch, has a single indication that represents a large patient population, SP's opportunity is the aggregation of several midsized indications. For example, SP used in Transoral Robotic Surgery is growing steadily in the U.S. To broaden SP's applicability in the U.S. and other markets, we are undertaking clinical trials to support regulatory review. We believe that SP will serve several additional surgical specialties, which will allow our customers and us to leverage capital investments in the program. Like Ion, we plan for SP platform profitability to approach that of historical platforms over time, and we're encouraged by recent progress. Our customer digital efforts now represent roughly 5% of our total operating expenses and drive the business in 4 ways. First, the use of data and digital tools by customers to analyze their operations helps improve outcomes, reduce costs and increase customer satisfaction and retention. Second, digital and internal investments can decrease our cost to serving our customers. Third, some of our digital tools generate revenue themselves and finally, the use of data and analytics internally can help our teams make better decisions. Because digital and data tools span our platforms and are used externally and internally, we do not account for them using the same financial models as our platforms, nor do we break them out as stand-alone financial engines. That said, we do evaluate digital and data projects against internal strategic and return analysis. Over the past 5 years, the annual number of instruments we produce has grown roughly 200% and the annual number of systems we produce has more than doubled. The number of customer professionals trained annually has nearly doubled, and our engineering staff has nearly tripled. Our product volume growth has also allowed us to in-source some of our high-volume accessories while investing in automation. This has a threefold benefit: improving supply chain robustness, improving manufacturing quality and lowering unit costs. As our training, R&D and manufacturing efforts move to scale, we're investing in infrastructure, factory builds, training center expansion and automation. These infrastructure investments are lumpy, and our current growth cycle requires building capacity. These projects have been planned over the past couple of years and will start amortizing first moderately in 2022 and more substantially in 2023 and '24, then normalizing over the next few years. For example, over the next 4 years, we'll be growing and consolidating facilities for operations, R&D and customer training space in Atlanta; doubling our Mexicali manufacturing footprint; doubling our R&D design space and operations space at our California headquarters; and finally, consolidating and growing our commercial training operations and R&D space in Germany. In summary, we'll build on our Generation 4 capabilities in multiport while innovating in clinical utility for multiport surgery broadly. We'll continue to bring our flexible endoscopy platform Ion to scale and drive capacity, quality and cost improvements while seeking to broaden access to new markets. In SP, we expect to expand indications in regional markets while driving manufacturing quality and scale. We will invest in regional training, R&D and manufacturing centers globally to support the growth of the business and pursue opportunities for operating leverage, some of which we'll share with customers to catalyze elastic markets. Finally, we will continue to advance our digital efforts to enable fast, accurate and actionable decisions with our customers and for our company. Lastly, for 2022, particularly, we're focused on the following: first, outstanding customer support in the face of continued pandemic disruption; second, execution of our robotic and digital platform expansion in pursuit of new indications and new markets; third, general surgery growth in the United States; and finally, diversified growth outside the U.S. beyond urology. As we turn to our financial report, I'd like to formally thank Marshall Mohr, our outgoing CFO and new Head of Global Business Services, for his outstanding stewardship over the past 15 years, and turn the time over to our incoming CFO, Jamie Samath, who will take you through financial matters in greater detail.

Good afternoon. I will describe the highlights of our performance on a non-GAAP or pro forma basis. I will also summarize our GAAP performance later in my prepared remarks. Reconciliation between our pro forma and GAAP results is posted on our website. Q4 and 2021 revenue and procedures are in line with our preliminary press release of January 12. Before I dive into our Q4 results, let me start with a summary of our full-year 2021 performance. Given the significant impact of COVID, we believe it's appropriate to review our 2021 results on both a year-over-year and a 2-year compound annual growth rate basis. Procedures increased by 28% as compared to 2020 and increased by approximately 14% using a 2-year CAGR. We placed 1,347 systems with customers during the year, an increase of 44% as compared to 2020 and up 10% using a 2-year CAGR. As a result of this procedure and system placement performance, 2021 revenue increased by 31% year-over-year and increased by 13% using a 2-year CAGR. Key business metrics for the fourth quarter were as follows: fourth quarter procedures increased approximately 19% compared with the fourth quarter of 2020 and increased approximately 13% using a 2-year CAGR. During the quarter, procedures continued to recover in October and November from the impact of the Delta variant in Q3. However, in December, procedures were adversely impacted by the increase in hospitalizations in the U.S. and parts of Europe as the Omicron variant spread rapidly. This trend has worsened so far into January. Fourth quarter system placements of 385 increased 18% from the 326 systems placed last year. As a result, net of trade-ins and retirements, we expanded our installed base of da Vinci systems over the last year by 12%. On a 2-year CAGR, our installed base is up 10%. Utilization of clinical systems in the field, measured by procedures per system, increased approximately 7% compared to last year and increased approximately 3% using a 2-year CAGR. During the quarter, the supply chain environment became more challenging and remains highly dynamic. Our supply chain teams continue to work tirelessly with our supply chain partners to fulfill customer demand. In Q4, we experienced minor constraints in our ability to meet customer demand. For example, we had some limitations on the supply of skill simulators. While these constraints were relatively minor and were immaterial to our overall Q4 financial results, they highlight the risk of potential significant disruption to our manufacturing operations due to the current supply chain challenges. U.S. procedures grew approximately 16% over Q4 of 2020 with relative strength in bariatrics, cholecystectomy and hernia repair. The December impact of the current wave of COVID on U.S. procedures varied by region, with a greater impact in the Northeast and Midwest. Benign procedures such as benign hysterectomy experienced a more significant impact in December, reflecting the deferrability of certain elective surgeries. In Europe, the impact of COVID on procedures in December was most notable in France and Italy. Despite the fact that hospitals are generally better equipped to handle COVID patients today compared to the outset of the pandemic, COVID-19 resurgences like those currently being experienced in the U.S. and parts of Europe have challenged hospital resources and have negatively impacted da Vinci procedures. In the U.S., high COVID-related hospitalization rates have been exacerbated by staffing shortages. According to data reported by the Department of Health and Human Services, the proportion of hospitals reporting a critical staffing shortage doubled between July and December. In addition, delays in diagnosis and treatment of underlying conditions have and will also negatively impact da Vinci procedures. Q4 procedures in Asia were not significantly impacted by a resurgence in COVID, and we saw strong procedure growth across multiple specialties in China, Korea and Japan. While it is difficult to predict how long the current wave of COVID will last or the extent to which it will impact additional geographies, we expect that da Vinci procedures will be significantly adversely impacted in Q1. Brian will provide additional procedure commentary later in this call. Overall system placement results in Q4 were solid with U.S. placements of 235, up 20% from 196 in Q4 of 2020. System placements at greenfield customers were strong, up approximately 45% as compared to Q4 of 2020, driven by U.S. IDNs and new customers in OUS markets. Outside the U.S., we placed 150 systems in the fourth quarter compared with 130 in the fourth quarter of 2020. Current quarter system placements included 63 into Europe, 37 into Japan and 14 into China, compared with 54 into Europe, 22 into Japan and 13 into China in the fourth quarter of 2020. Capital strength in Japan was driven primarily by new customers in the private sector. As of the end of 2021, there were 63 systems remaining from the current quarter in China, which may be accessible to competitors should they receive local regulatory clearance. Globally, trade and transactions represented 30% of placements in the quarter, down from 40% last quarter and 49% for 2020. The remaining installed base of SI systems in the U.S. is approximately 343 systems. We expect the volume of trade-ins to be significantly lower in 2022 as compared to 2021. Macroeconomic conditions created by COVID, including supply chain constraints and staffing shortages, are challenging and could impact hospital capital spending. In addition, as competition progresses in various markets, we will likely experience longer selling cycles and price pressure. Additional revenue statistics and trends are as follows: total fourth quarter revenue was $1.55 billion, an increase of 17% from last year. Leasing represented 37% of Q4 placements compared with 41% last quarter and flat to Q4 of 2020. The lower leasing mix in Q4 relative to last quarter reflected higher multisystem placements with a couple of IDNs who prefer to purchase systems. While leasing will fluctuate from quarter to quarter, we continue to expect that the proportion of placements under operating leases will continue to increase over time. Fourth quarter system average selling prices were $1.45 million, similar to $1.43 million last year and lower than $1.57 million last quarter. The sequential decline was primarily driven by a higher mix of bulk buy transactions with large customers. We recognized $26 million of lease buyout revenue in the fourth quarter compared with $25 million last quarter and $14 million last year. Lease buyout revenue has varied significantly from quarter to quarter and will likely continue to do so. Instrument and accessory revenue per procedure was approximately $1,940 per procedure compared with $1,900 per procedure in the third quarter of 2021 and down 6% from $2,060 realized in the fourth quarter of last year. The year-over-year decrease primarily reflects the benefit of stocking orders in Q4 of 2020 and associated with the launch of our Extended Use Instruments program in the U.S. and Europe. The sequential increase primarily reflects continued growth of our advanced instrument portfolio. As we highlighted recently, revenue for our advanced instrument portfolio has grown over a 5-year period at a compound annual growth rate of 35%, and we are starting to see early and accelerating adoption in OUS markets. 10 of the systems placed in the fourth quarter were SP systems, including 3 systems placed at customers in Korea. Our installed base of SP systems is now 99. During the quarter, we further developed our SP ecosystem, receiving 510(k) clearance for our Firefly Imaging Technology. We also received 510(k) clearance for enhancements to our SP instruments, including an extension of lives to 6 of our 8 instruments. Growth of the SP platform will continue to be gated by additional clinical indications and clearances in markets beyond the U.S. and Korea. We placed 31 Ion systems in the quarter, bringing the installed base to 129 systems. Looking at the 93 Ion systems placed in 2021, 54% of those systems were placed under operating lease arrangements. For reference, the list price of our Ion system is $600,000 with ASPs generally a little below that level. As a reminder, Ion system placements and procedures are excluded from our overall system and procedure counts. The entirety of our Ion installed base is with existing da Vinci customers, the majority of which have large pulmonary and thoracic departments. Our Ion platform is also installed at the majority of accounts that have an IP fellowship program. We continue to be encouraged by customer feedback and look forward to the completion of our next major milestone, the full results from the PRECIsE study, which is expected in the second half of 2022. Moving on to gross margin and operating expenses. Pro forma gross margin for the fourth quarter of 2021 was 70.1% compared with 69.7% for the fourth quarter of 2020 and 71.3% last quarter. The fourth quarter of 2020 included higher period costs associated with lower production and higher excess and obsolete inventory charges. Pro forma gross margin was lower than last quarter primarily as a result of manufacturing inefficiencies and higher logistics costs associated with the supply chain environment, lower system ASPs and a higher mix of systems revenue. Pro forma operating expenses increased 27% compared with the fourth quarter of 2020. The fourth quarter of 2021 included a $30 million contribution to the Intuitive Foundation compared with a $25 million contribution in the fourth quarter of 2020. The increase in fourth quarter operating expenses from a year ago reflected an increase in headcount, increased variable compensation and higher travel costs. We finished 2021 with almost 9,800 employees, an increase of 21% from the end of 2020. We believe the opportunity in robotic-assisted interventions to be significant and are planning to increase our investments significantly in 2022. We are in the early stages of our newer platforms, SP and Ion, and we will continue to invest in our digital and data capabilities. Brian will provide operating expense guidance later in this call. As Gary described, we are also investing in our infrastructure to support our growth objectives and facilitate our ability to scale. In 2022, we expect a significant increase in capital expenditures in the range of $700 million to $1 billion for the year. A significant portion of this investment involves the construction of facilities to provide incremental space for growth, to consolidate operations to enhance efficiency and to replace lease spaces with owned spaces. These capital investments also expand our OUS footprint in support of growth opportunities in key international markets, where da Vinci procedures are in earlier stages of adoption. These are multiyear investments. Our pro forma effective tax rate for the fourth quarter was 19.5%, lower than our expectation, primarily due to a favorable U.S./OUS income mix. We expect that our pro forma tax rate will increase in 2022 due to a previous change in U.S. tax law that became effective on January 1, 2022. Brian will provide details later in this call. Our fourth quarter 2021 pro forma net income was $477 million or $1.30 per share compared with $434 million or $1.19 per share for the fourth quarter of 2020. I will now summarize our GAAP results. GAAP net income was $381 million or $1.04 per share for the fourth quarter of 2021 compared with GAAP net income of $365 million or $1.01 per share for the fourth quarter of 2020. 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 stock-based compensation, amortization of intangibles and IP charges, acquisition-related items, and legal settlements. We ended the year with cash and investments of $8.6 billion compared with $6.9 billion at December 31, 2020. The increase in cash in the fourth quarter primarily reflected cash generated from operations. We did not repurchase any shares during the quarter. And with that, I would like to turn it over to Brian, who will discuss clinical highlights and provide our outlook for 2022.

Thank you, Jamie. Overall procedure growth for the full year 2021 was approximately 28% compared to 1% in 2020 and increased 14% using a 2-year compound annual growth rate. Overall procedure growth was comprised of 27% growth in the U.S. and 32% growth in international markets. In the U.S., fourth quarter growth was driven by procedures within general surgery, with bariatrics, cholecystectomy, and hernia repair being the largest contributors. Fourth quarter international procedure volume grew approximately 28% compared to 11% in the fourth quarter of 2020 and 30% from the previous quarter. In 2021, non-urology specialties approached half of all international procedures and grew faster than urologic procedures. More specifically, in China, fourth quarter procedures showed broad-based growth in urology, thoracic, general surgery, and gynecology, with general surgery, thoracic, and gynecology procedures growing faster than urology and together outnumbering total urology procedures in the fourth quarter. In Japan, da Vinci prostatectomy has become the standard of care for prostate cancer surgery, and we have gained significant market share in other urologic procedures like partial nephrectomy and cystectomy. The robust growth in Japan is now linked to growth in general surgery, thoracic, and gynecology procedures that received reimbursement status after urologic procedures. In Europe, procedure performance varied by country, but outside of urology, growth was led by colorectal, hysterectomy for cancer, and thoracic procedures. Now, shifting to the clinical side of our business, I'll highlight two noteworthy recently published studies. However, to fully understand the body of evidence, we urge all stakeholders to review the extensive scientific studies published over the years. During the quarter, researchers from the University Hospital of Southern Jutland and the University of Southern Denmark published results from a systematic review and meta-analysis evaluating short-term outcomes of robotic-assisted versus laparoscopic colon surgery for cancer patients. This analysis included 20 studies from 2005 to 2020, comparing over 13,000 subjects with more than 1,500 robotic-assisted procedures and over 12,000 laparoscopic procedures. The analysis showed that the robotic-assisted approach had a 46% lower risk of anastomotic leakage compared to the laparoscopic method, along with a 69% lower risk of conversion to open surgery and a 15% reduction in overall complication rates, as well as a 7-hour reduction in time to regular diet. A subgroup analysis on right-sided hemicolectomies indicated similar favorable outcomes for the robotic-assisted approach in terms of anastomotic leakage, conversion rates, and length of stay. The authors concluded that robotic-assisted colon surgery showed advantages in surgical efficacy and morbidity compared to laparoscopic surgery. In November, Christopher Seder from Rush University Medical Center published a propensity-adjusted analysis comparing robotic-assisted and thoracoscopic lung resection in obese patients. Analyzing data from various national databases, over 8,000 subjects were included, revealing a 15% conversion rate to open surgery for VATS patients versus only 3% for the robotic cohort, indicating a 5-fold higher risk for the VATS approach. The robotic-assisted group also had a shorter length of stay, a lower risk of respiratory failure, and were more likely to go home after the procedure. This analysis is the first of its kind comparing VATS and robotic-assisted surgery in obese patients using contemporary international data. The authors concluded that obese patients with early-stage lung cancer undergoing VATS have a higher conversion rate to thoracotomy compared to those undergoing robotic-assisted surgery. Now, I will turn to our financial outlook for 2022. As noted in our announcement earlier this month, total 2021 da Vinci procedures grew approximately 28% year-over-year and 14% at a 2-year compound annual growth rate, reaching roughly 1,594,000 procedures globally. We expect full-year procedure growth in 2022 to range from 11% to 15%, reflecting the uncertainty associated with the pandemic. The lower end of this range assumes ongoing COVID pressure and staffing shortages, while the higher end assumes no significant new surges. This range also does not take into account any substantial supply chain disruptions throughout the year. We anticipate that 2022 procedure growth will continue to be driven by U.S. general surgery and expanding procedures in international markets where we are earlier in the adoption cycle. We expect a similar seasonal pattern in 2022 to previous years prior to COVID, with Q1 typically being the weakest quarter due to patient deductibles resetting. We also expect Omicron to significantly impact procedures in the first quarter. Regarding revenue, capital sales ultimately depend on procedure demand, which drives hospitals to establish or increase robotic system capacity. Variability can occur in capital sales based on numerous factors, including U.S. healthcare policies and hospital funding cycles. We expect 2022 capital placements to follow historical quarterly patterns but could also be influenced by staffing shortages and resource allocation. In Q3 and Q4, 40% and 30% of system placements involved trade-ins of older systems for our da Vinci Xi. We expect the volume of trade-ins in 2022 to be significantly lower than in 2021. In terms of gross profit, our pro forma gross profit margin for full-year 2021 was 71.2%. In 2022, we anticipate this margin to range between 69.5% and 70.5%, reflecting increased fixed costs from growth investments and higher supply chain costs. Our actual gross profit margin will fluctuate based on product, regional, and trade-in mix, as well as new product impacts. As for operating expenses, our pro forma operating expenses grew 19% in 2021. We expect them to grow between 21% and 27% in 2022 due to increased investment in R&D, expanding international capabilities, and the return of previously restricted spending due to COVID. Our noncash stock compensation is projected to range between $510 million to $550 million in 2022, compared to $452 million in 2021. We expect other income, mainly from interest, to total between $45 million and $55 million in 2022. For income tax, our pro forma tax rate in 2021 was 22.2%. We estimate a 2022 pro forma tax rate between 22% and 24%, primarily due to changes in U.S. tax treatment of certain expenditures that became effective on January 1, 2022. Lastly, our Annual Sustainability Report will be available after this call on our Investor Relations website, providing an overview of our sustainability strategy, areas of focus, key actions taken in the past year, and results achieved. That concludes our prepared comments. We will now open the call to your questions.

Two questions for me. Gary, I wanted to start with a high-level question. You started using the slogan at the point of possibility recently, and you've talked about being at the point of possibility to build what's needed next. Can you talk about why you started using this new slogan? And what are the needs you're trying to address? And I had one follow-up.

No, I believe we have a significant opportunity as a company to leverage our established methods for identifying clinical needs, designing and developing tech-enabled ecosystems to meet those needs, and collaborating with customers for delivery and training. Looking ahead, there is considerable potential in both existing and new markets to improve for the quad aim. Preparing this set of ecosystem investments is challenging and requires a multiyear commitment. However, we think we have demonstrated that it is achievable. What we are discussing here is our capacity to begin affecting other opportunities in international markets as we progress, with Ion being a prime example.

And it seems like so far, you've mitigated potential supply constraints well. How are you trying to mitigate them going forward? And would you describe the situation as getting better or worse? And how concerned are you about that?

Yes. I'll start by outlining three main areas. The first area involves specific products, particularly semiconductors. The second area relates to constraints in raw materials affecting our manufacturing process. The third area focuses on the logistics and movement of materials. Jamie, I'll let you expand on that.

Larry, we mentioned in our prepared remarks that the supply chain environment worsened in Q4, and we noted some minor constraints in our ability to meet customer demand. One metric we provided is that on-time delivery from our suppliers declined in Q4 compared to Q3. Looking ahead, visibility is still limited; we anticipate that Q1 will be similar to Q4, but we need to see what impact Omicron may have on our suppliers and the broader situation. We are continuing to navigate these challenges, and our supply chain teams are actively working with our partners every day.

Gary, you talked about being at the end of the replacement cycle for a little while now. And obviously, you're retiring the S models. I'm curious how we should interpret that comment about being near the end of the replacement cycle. And as we think about maybe where you could be headed from an innovation standpoint, is it all about kind of driving down the line of procedures, making procedures easier with less training and expanding into newer indications? Or maybe just I'm curious from a technology standpoint, if you could talk a little bit about at a high level where you're headed?

Yes. Let's discuss replacement cycles for a moment. I believe you're referring to the SI, which Jamie mentioned in his prepared remarks, and Brian touched on as well. Their points were clear, so I won't reiterate them. From a business model standpoint, we don’t believe we need to push capital upgrades on Intuitive's schedule to maintain a healthy business. Our focus is on driving the quadruple aim and effectively achieving that for our customers. We've been investing in our Gen 4 platform and its expansion, which I also mentioned earlier, and it has been beneficial for both our customers and us. While this is not our only initiative, it is an important one. You asked about our technology stack and the aspects we prioritize. Much of our focus is on what we can accomplish inside the body, in imaging, and in informatics that can significantly enhance outcomes or the experiences of patients and care teams. You can see this reflected in the innovations we've brought to market. We have excellent teams and are working on projects that we haven't yet discussed, which we believe will improve outcomes. It goes beyond just developing new indications or simplifying usage; both of those aspects are essential, but we also have other initiatives that can transform our interaction with tissue and further improve outcomes. Jamie, would you like to add anything about the SR replacement cycle?

I would just maybe give you some numbers. In 2021, globally, we did about 510 trade-ins. About 80% of those were in the U.S. U.S. has been driving those trade-ins. And so then if you compare that to the remaining installed base of 343, it's why we provided the commentary that we expect overall trading volume in '22 to be significantly lower than '21 just because the remaining store base is being depleted.

Okay. That's helpful. And speaking of innovation, can you touch on some of the SP enhancements? You talked about 510 clearance for extension of life for some of the instruments. Can you just clarify exactly what you got through?

Yes. So we've received, obviously, customer feedback along the way since we launched SP, and some of our customers have asked for greater ability to do extraction. That's really around the range of motion within the anatomy of our instruments that do extraction and grip strength. As you grasp tissue, we've had customer feedback that we could improve the grip strength. And so along with the extension of lives, we responded to customer feedback and improved the instruments accordingly, as described.

We've done some other things, too. We have, as you know, a dual console that helps with the training of new surgeons and teaching environments. We extended the dual console capability into the SP space. Recently, we've launched and then upgraded some of the accessories that go with SP. So part of the process, for those of you who've been with us for a while, is continuous innovation that these things don't end where they start, and that's been true for SP.

Great. One last one, just on the headcount. You started to call off highlighting all the additions last year. Should we think about a kind of similar magnitude of increase in '22?

I think if you look at the OpEx increase range that Brian provided, I think you can kind of draw a correlation between how headcount has kind of correlated to spending increase and I think that's a relevant starting point for '22.

We also gave you a mix in the script of kind of where they're headed, how much is R&D, how much is operations, commercial, and that's not a bad guide either as to kind of where the mix is going.

I'll start with a shorter-term question and then a longer-term one for Gary. Regarding the first quarter, I understand that the situation is fluid. Can you provide any insights into what you've observed so far? How should we model procedures in this environment? You mentioned a severe impact, but we need to quantify that. I'm interested in how much you can share regarding the status of procedures and their decline. Additionally, regarding capital spending, are you noticing any delays at the hospital level, and how should we view capital spending for 2022 compared to last year? What is your perspective on the current environment?

I mean I'll give you a couple of data points. So the greatest correlation we've seen historically on procedures is rates of hospitalizations. I believe that currently, U.S. hospitalizations related to COVID are beyond any of the previous ways. So I think you can kind of track how that has progressed so far and what some of the third parties are projecting for the remainder of the quarter. There's some modeling benefit to doing that. What I would point to is if you look at pre-COVID, so 2017, '18, '19, the sequential change between Q4 and Q1 was about even, meaning it was about the same Q1 as Q4. So that's in a normal quarter. Most of the current wave will be in Q1. The impact of Omicron in Q4 was kind of later in the quarter. So I kind of start with a normal quarter would be flat sequentially and then model the rest of Q1 based on just hospitalization rates. With respect to capital, there's nothing at this point that we would call out. I do think that the combination of what's happening right now with COVID, along with staffing shortages, along with the extent to which the supply chain environment broadly could impact hospitals could make it challenging for hospital capital spending. They may manage that more carefully in such an environment. But there's nothing specific that we would call out at this point.

I have a longer-term question for Gary regarding your comments. I'm curious about your general thoughts on a SaaS-type model, particularly concerning SimNow. We've spoken to some of your customers in the past year, and it appears that some are being charged around $20,000 annually for the SimNow software within the service line. I would like to know how you view that specific opportunity in relation to your installed base. Additionally, could you discuss the SaaS model more broadly and whether we can expect to see more offerings like this from you in the future?

Sure. Regarding recurring revenue or service models compared to one-time capital charges, we have adopted a flexible approach based on customer preferences. Transitioning to a recurring model has several advantages, as it allows customers to engage with us when they are ready without requiring significant upfront investments. In the case of services like simulation, it's less about the hardware and more about providing access to continuously improving modules tailored for competency-based training. Subscriptions work well because we focus on helping customers develop their training programs over time rather than just selling hardware. As we enhance our software, analytics, and digital tools, subscriptions may increasingly make sense. We are committed to earning our customers' loyalty consistently, which benefits both them and us by providing a steadier revenue stream. As long as our recurring revenue aligns with customer needs and financial considerations, we will continue to pursue it, while remaining open to other models if they show interest.

Gary, I thought I'd follow up on a couple of things. You highlighted very specifically for both Ion and da Vinci SP this concept of margins aren't where they will be. And over time, you're going to bring the business to scale. I was wondering if you could expand on that, maybe give us a flavor for where margins are now? And how do we think about is this 2 years away? Is it 5 years away? How do we think about the trajectory going forward there?

Thank you for the question. Regarding our direction, we are evaluating those architectures. Based on our experience and understanding of our supply chains, as well as the necessary iterations in engineering and manufacturing, we believe that both platforms should be able to achieve historical norms in the coming years, although not indefinitely. Currently, we are in the early stages, with lower volumes compared to where we expect to be, and we are also addressing some manufacturing process improvements and making capital investments to reduce unit costs. I will let Jamie provide more details on their current status. The SP product line is somewhat more mature in our hands in terms of manufacturing, and our GM and her team are effectively identifying opportunities and systematically addressing them over time, which gives us confidence. The other product is at an earlier stage and is experiencing a different growth trajectory, which means it will need time to progress through the necessary steps. However, we are optimistic about the core architectures, which supports our confidence in achieving our goals.

I would split the question kind of into 2 categories. There's gross margin and then there's, let's call it, the equivalent of operating margin. On a gross margin basis, kind of the actions that we have to take to get both Ion and SP to kind of, let's call it, target gross margins are well understood and it's really about execution over a period of time; a component of that will obviously be building scale. But I think those actions are well defined. They're a multiple-year effort. On the operating margin side, it's really, what's revenue in relation to the amounts that we're investing. And that's obviously going to be a function of, in the case of Ion, how we adopt in lung cancer biopsy over time. And with SP, it's the additional indications and new geographies in terms of clearances. I don't have a scale for when we might reach those corporate average margins. I would say, though, for '22, given that SP and Ion are newer products, the gross margins there are dilutive as you'd expect.

Yes, I have a follow-up question. It’s evident that you pointed out several ways Asia performed well this quarter, and if I understood correctly, you mentioned that procedures were robust. Considering this, along with your comments about investment strategies, it appears that many investments are focused on Asia. I’m curious if this indicates that you foresee more growth opportunities for Intuitive in the Asia-Pacific region over the next three to five years. How should I reconcile these two points and initiatives?

I'd characterize it a little bit differently, Rick. The starting point on Asia, it is clearly an interesting market, country by country. We are making investments in Asia. I don't think I'd say that they are the dominant investments, but they're substantial because we think there's substantial opportunity there to make a difference in those markets. So it's a leg of growth, but not the only one. There are opportunities for us in other regions, whether it's Europe or elsewhere. There are also opportunities for us in other clinical indications and some of the clinical trial work we're doing as well as the expansion of platforms and other technologies that we're working on. So I'd characterize it as one of the legs, not necessarily the dominant leg. Jamie, anything you would like to add?

I would just say both regions are attractive to us. It's fair to say that at least in the last couple of years, Asia procedure growth has been a little ahead of Europe. But on a strategic view, both of those regions are attractive, and we're investing accordingly.

So I wanted to ask one on innovation and one on competition. So on innovation, I appreciate some of the color that you gave on multiport. And I guess I've also noticed that you've, on your website, you've been hiring a lot of folks in kind of these endoluminal roles and looking at roles around things like node surgery. Could you talk about some of your investments there? Is there anything beyond what you're doing with SP and Ion that we should look out for? And overall, are there any bigger launches that we should expect this year? Even if you're not going to tell them what they are, could you characterize what the cadence could look like of any kind of system upgrades or launches?

Yes, in terms of forecasting future launches, we won't provide specific details at this time. We will launch products when we are ready. Regarding your question, we are consistently developing applications across our existing platforms, including bariatric and thoracic surgery along with new indications in SP. We are conducting trials in thoracic surgery and colorectal areas, exploring opportunities in flexible robotics and Ion, as well as other undisclosed platform investments. We will continue this work, and while some initiatives will succeed, others may require reassessment as we gain more insight. There is a lot happening. If you look at our hiring patterns and patent applications, you'll notice a wide range of areas we are interested in. This aligns with our earlier comments about exploring acute intervention opportunities across the body and evaluating potential improvements in the quad aim through a tech-enabled ecosystem. This drives much of our hiring strategy, which includes both immediate needs for current platforms and forward-looking investments in potential future developments. That’s our perspective on it.

Okay. And maybe just one on competition.

Matt, we'll give you one follow-up.

Okay. Just on competition, you mentioned there's a potential for that to prolong selling cycles. It certainly doesn't seem like you're seeing any of that so far. Could you characterize whether there's been any change in the competitive environment to date versus a few quarters ago?

Certainly, you can see the competition is active at accounts. I think we've characterized that mostly as kind of reciprocal arrangements with respect to training center investments or reciprocal research investments. I don't think we call out any specific significant impact yet on selling cycles. But certainly, you can see the potential for over time.

All right. Well, thank you all. That was our last question. In closing, we continue to believe there is a substantial and durable opportunity to fundamentally improve surgery and acute interventions. Our teams continue to work closely with hospitals, physicians, and care teams in pursuit of what our customers have termed the quadruple aim: better, more predictable patient outcomes; better experiences for patients; better experiences for their care teams; and ultimately, a lower total cost of care. We believe value creation in surgery and acute care is foundationally human. It flows from respect for and understanding of patients and care teams, their needs, and their environment. At Intuitive, we envision a future of care that is less invasive and profoundly better; where diseases are identified earlier and treated quickly so patients can get back to what matters most. Thank you for your support on this extraordinary journey. We look forward to talking with you again in 3 months.