Intuitive Surgical, Inc. (ISRG) Q2 2015 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by. Welcome to the Intuitive Surgical Quarter Two 2015 Earnings Release Call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will be given at that time. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to our host, Calvin Darling, Senior Director of Finance for Intuitive Surgical. Please go ahead.

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. Note that Patrick Clingan, who has participated on these calls in recent quarters, will not be with us on the call today due to minor illness. We expect him back in the office next week. 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 5th, 2015, and 10-Q, filed on April 22nd, 2015. These filings can be found through our website or at the SEC's EDGAR database. Prospective investors are cautioned not to place undue reliance on such forward-looking statements. Please note that this conference call will be available for audio replay on our website at intuitivesurgical.com, 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 procedure and clinical highlights and provide our updated financial outlook for 2015. And finally we will host a question-and-answer session. With that, I will turn it over to Gary.

Thank you for joining us on the call today. In the quarter, growth in procedures was healthy, maintaining the rate of growth we experienced in the first quarter and showing solid performance in several specialties and geographies. Our capital performance improved in the quarter, as did our margins. Starting with procedures, year-over-year growth in the second quarter was just under 14% compared with Q2 of 2014. Utilization trends present last quarter continued, with strength in hernia repair, solid growth in colon and rectal resections, continued recovery in prostatectomy, and stable trends in hysterectomy. Growth in the use of our products was broad-based and included the U.S., Europe, and key markets in Asia. Procedures grew strongly in China, and growth was solid in Japan and Korea. Calvin will review procedure trends in greater detail later in the call. Turning to capital sales, we placed 118 systems in the quarter compared to 96 in the second quarter of 2014. The United States and Japan accounted for most of the growth in system placements year-over-year. We see interest across our product line, from our multi-quadrant Xi system to our Si system, with customers choosing the system that best fits their program's needs. In Japan, clearance of the Xi system unlocked some system demand and we sold 13 systems in the quarter compared with five a year earlier. Procedure growth in Japan remains healthy, given the current state of reimbursement. As we've said on prior calls, the growth of the market in Japan will be paced by continued progress on reimbursement. Clinical investigators have submitted their partial nephrectomy data to MHLW for review, and ISI continues to work with key stakeholders in the reimbursement for additional procedures. We have no assurance of additional procedure reimbursement at this time. Turning to margins, our operating teams are focused on reducing product costs for our new products and we're managing our fixed expenses carefully. This quarter was a step in the right direction on gross margin, though an early one. We will continue to focus on improvements over the next several quarters. Marshall will take you through this and other financial performance in greater detail later in the call. In summary, our operating performance for the second quarter is as follows. Procedures grew just under 14% over the second quarter of last year. We placed 118 da Vinci Surgical Systems, up from 96 in the second quarter of 2014. Total pro forma revenue for the quarter was $586 million, up 16% from the prior year, and up 20% year-over-year on a constant currency basis. Total pro forma instrument and accessory revenue increased to $297 million, up 13% over prior year. We generated pro forma operating profit of $228 million in the quarter compared with $196 million in the second quarter of 2014. And pro forma net income was $173 million compared to $140 million in Q2 of 2014. In product development, we are rounding out our Xi system offering by launching additional EndoWrist instruments, integrating table motion with Xi, and developing Single-Site for Xi. In Europe in the second quarter, surgeons have performed the first clinical cases using integrated table motion with Xi with enthusiastic feedback. We recently submitted our 510(k) for software that enables table motion with Xi. We anticipate filing our 510(k) for Xi Single-Site in the second half of the year. We have also broadened the roll-out of our white reload for our da Vinci Xi Stapler. Feedback on its utility has been positive. Additional Xi EndoWrist instruments have been released in the quarter, continuing to round out our instrument offering for Xi. For da Vinci Sp, our dedicated single point of entry architecture, development is progressing with system integration and laboratory testing in progress. Stepping back and looking at the business at the midway point of the year, we're focused on expanding the application of da Vinci in general surgery, particularly colorectal surgery and hernia repair; filling out our product line for da Vinci Xi and launching in key markets globally; developing our organizational capabilities in markets in Europe and Asia; improving our gross margins; and advancing our technologies to improve surgery. I will now turn the call over to Marshall, who will review our financial performance.

Thank you, Gary. I will be describing our results on a non-GAAP or pro forma basis, which excludes the impact of our prior year Xi trade-in programs, legal claim accruals, stock-based compensation, amortization of purchased IP, and investment impairments. We provide pro forma information because we believe that business trends and operating results are easier to understand on a pro forma basis. I will also summarize our GAAP results later in my script. We've posted reconciliations of our pro forma results to our GAAP results on our website so that there's no confusion. Pro forma second quarter revenue was $586 million, an increase of 16% compared with $507 million for the second quarter of 2014, and an increase of 10% compared with last quarter. Pro forma revenue for the second quarter of 2014 excludes net revenue associated with offers made in 2014 to trade out Si product for Xi product. All trade out offers were either fulfilled or lapsed in 2014. Second quarter procedures of approximately 162,000 grew nearly 14% compared with the second quarter of 2014 and approximately 8% compared with the first quarter of 2015. Revenue highlights are as follows. Pro forma, instrument, and accessory revenue grew 13% compared with the second quarter of 2014 and increased 7% compared with the first quarter 2015. The increase relative to the prior year reflects procedure growth and customer buying patterns, partially offset by the impact of foreign exchange. The increase relative to the prior quarter primarily reflects procedure growth. Instrument and accessory revenue realized per procedure including initial stocking orders was approximately $1,830 per procedure, approximately the same as the second quarter of 2014 and similar to the approximately $1,840 last quarter. Pro forma system revenue of $176 million increased 27% compared with the second quarter of 2014 and increased 25% compared with the first quarter of 2015. The increase relative to the prior year reflects increased unit sales, partially offset by the impact of foreign exchange. The increase compared with the first quarter primarily reflects increased unit sales. 118 systems were placed in the second quarter compared with 96 systems in the second quarter of 2014, and 99 systems last quarter. 64% of the systems placed in the second quarter were Xis compared with 52% in the second quarter of 2014, and 76% in the first quarter of 2015. We sold more Sis in the quarter than the previous quarter, reflecting seven Si system sales under a contract with the Department of Defense, and eight Si system sales in Japan. We expect the mix of Xi to Si product to fluctuate quarter-to-quarter. Service revenue of $113 million increased 6% year-over-year and decreased $1 million compared with the first quarter of 2015. The year-over-year increase reflects the increase in our installed base. The decrease compared with the first quarter reflects the timing of service contract renewals and changes in foreign exchange rates, partially offset by an increase in our installed base. Globally, our system ASP of $1,500,000 was approximately the same as the second quarter of last year, and increased relative to the first quarter ASP of $1,480,000. Relative to the second quarter of 2014, higher ASPs were primarily associated with higher mix of Xis, offset by the impact of the strengthened dollar. The increase in ASPs relative to last quarter reflects geographic mix and lower trade-in activity. ASPs will fluctuate on a geographic and product mix, trade-in volume, and changes in foreign exchange rates. Hospitals financed approximately 21% of the systems placed in the second quarter, up from 14% last quarter. We directly financed 12 systems, of which five were structured as operating leases. Several customers bought out previously leased systems in the quarter. Although revenue associated with the buyouts are included in total revenue, we've excluded this revenue from the computation of system ASPs. We have also excluded these buyouts from the system placement number. In the U.S., we placed 72 systems in the second quarter, compared with 61 systems in the second quarter of 2014 and 63 systems in the first quarter of 2015. As previously noted, second quarter system placements in the U.S. included seven systems sold under our Department of Defense contract. In general, the increase in system placements relative to the prior year reflect growth in procedures and market acceptance of the Xi system. Outside of the U.S., results were as follows; second quarter pro forma revenue outside the U.S. of $168 million grew 25% compared with $135 million for the second quarter of 2014, and grew 12% compared with $150 million last quarter. The increase compared with the previous year reflects higher Japan system revenue, higher instrument and accessory revenue reflecting procedure growth, partially offset by foreign exchange. The increase compared with last quarter reflects higher Japan systems placements, geographic mix of system placements, and procedure growth. Outside the U.S., we placed 46 systems in the second quarter compared with 35 in the second quarter of 2014 and 36 systems last quarter. o-US system placements reflect 13 systems into Japan this quarter compared with five systems in the second quarter of 2014, and one last quarter. We obtained Xi approval in Japan in late March, and five of the systems sold this quarter were Xi systems. European system placements grew to 22 systems this quarter compared with 19 last year and 18 last quarter. We placed no systems into China this quarter compared with one in the second quarter of 2014 and eight last quarter. As we have indicated in the past, and consistent with our history, system placements in our o-US markets will fluctuate quarter-to-quarter. Moving on to the remainder of the P&L, pro forma gross margin in the second quarter of 2015 was 68% compared with 69.2% for the second quarter of 2014 and 65.6% for the first quarter of 2015. The decline in gross margins relative to the second quarter of 2014 is primarily attributable to foreign exchange and a higher mix of newer products, including Xi and stapling. The sequential improvement in gross margin is primarily attributable to the completion of activities that resulted in one-time charges in the first quarter and cost of sales efficiency gains. In 2014, we recorded pretax charges of approximately $82 million, representing the estimated cost of settling a number of product liability legal claims under a tolling agreement. During 2015, we have refined our estimate of the overall cost of settling claims and recorded additional charges of approximately $7 million in each of the first and second quarters. These charges are excluded from our pro forma results and are included in our GAAP results. We will continue to refine our estimates as we proceed through the negotiation process. Pro forma operating expenses, which exclude the reserves for legal claims, stock compensation expense, and amortization of purchased IP, increased 10% compared with the second quarter of 2014 and increased 4% compared with last quarter. The year-over-year increase of pro forma operating expenses primarily reflects headcount additions and higher incentive compensation. Our pro forma effective tax rate for the second quarter was 25.6% compared with an effective tax rate of 29.8% for the second quarter of 2014 and 28.9% last quarter. The effective tax rate for the second quarter of 2015 benefited from approximately $8 million, or the equivalent of $0.21 per share of discrete items, including the release of reserves specific to tax years where we recently completed audits. Our tax rate will fluctuate with changes in the mix of U.S. and o-US income, and will not reflect a federal research and development credit, unless such credit is reinstated. Our pro forma net income was $173 million or $4.57 per share compared with $140 million or $3.73 per share for the second quarter of 2014 and $135 million or $3.57 per share for the first quarter of 2015. As I indicated earlier, pro forma income provides an easier comparison of our financial results and business trends. I will now summarize our GAAP results. GAAP revenue was $586 million for the second quarter of 2015 compared with $512 million for the second quarter of 2014 and $532 million for the first quarter of 2015. GAAP net income was $135 million or $3.56 per share for the second quarter of 2015, compared with $104 million or $2.77 per share for the second quarter of 2014 and $97 million or $2.57 per share for the first quarter of 2015. We ended the quarter with cash and investments of $2.9 billion, up from $2.7 billion as of March 31, 2015. The increase was primarily driven by cash generated by operations and proceeds from stock option exercises, partially offset by stock buyback. During the quarter we repurchased approximately 100,000 shares for $49 million at an average purchase price of $494 per share. And with that I would like to turn it over to Calvin who will go over our procedure and clinical highlights and provide 2015 financial guidance.

Thanks Marshall. Let me begin with the review of our procedure results. As mentioned earlier, total second quarter year-over-year procedures grew just below 14% with U.S. procedures growing approximately 10% and international procedures growing approximately 27%. In the U.S. trends observed during the first quarter largely continued through the second quarter. In urology growth in da Vinci Prostatectomy and kidney cancer procedures continued at a similar rate as the first quarter. We continue to believe that our Prostatectomy volumes have been tracking to the broader U.S. prostate surgery market. In U.S. gynecology, procedures were flat year-over-year with growth in malignant and complex hysterectomy, offset by declines in benign procedures. In recent quarters an increasing proportion of total hysterectomy procedures have been performed by gynecologic oncologists. During the second quarter general surgery remained the primary contributor to U.S. growth. With robust growth in hernia repair and solid contribution from colorectal procedures, being partially offset by continued declines in cholecystectomies. During the first half of 2015, ventral and inguinal hernia repair contributed the majority of the increase in the U.S. general surgery procedures. The contribution to first half U.S. growth for mature procedures in highly penetrated markets such as da Vinci Prostatectomy and da Vinci malignant and complex hysterectomy has exceeded our expectations. In the second half of 2015 growth in da Vinci Prostatectomy is likely to slow as we anniversary into higher prior year growth rates. Looking aboard during the second quarter, international procedure growth was led by a modest acceleration in the global adoption of da Vinci Prostatectomy with solid contributions from kidney procedures, malignant hysterectomies and colorectal resections. During the first half of 2015 growth in international da Vinci Prostatectomy was approximately 20%. Let me take a few moments to provide a bit more color around China. Over the past year we've sold 20 systems under tenders from among 38 civilian hospitals authorized by the government’s required da Vinci system. Procedure adoption has been broad based in urologic, gynecologic, general and thoracic procedures. While we are encouraged by these developments, future system placements are dependent on completion of the Central purchasing tender under the current authorization which is said to expire at the end of 2015. It is not certain whether the tender process will be completed or when future governmental authorizations and approvals may enable system placements in 2016 and beyond. Procedure growth rates are likely to be governed by the timing of additional system placements. Moving on to clinical and economic validation. A recent publication from Saarland University by Professor Stöckle and team evaluated the cost effectiveness of da Vinci Prostatectomy compared to open Prostatectomy from a German payor perspective in a 1,400 patient study, partially supported by Intuitive. From a clinical perspective the robotic patient population showed fewer positive surgical margins and required fewer intraoperative transfusions with the reduction in hospitalization of approximately six days. In the economic analysis the study showed that the robotic patients were roughly €3,000 per patient less expensive as measured by the period from date of surgery to two years post operation. The authors concluded that the improved clinical outcomes led to the reduction in post-operative cost. In the quarter there was considerable interest in colorectal clinical data with the initial outcomes reported from the ROLARR study. In addition, several other notable studies were published during the quarter. Let me take a moment to highlight two studies from large scale state-wide general surgery registries published in Surgical Endoscopy. The first study was published by Dr. Cleary and team from Saint Joseph Mercy Health System in Michigan. After reviewing over 2,700 minimally invasive colorectal surgeries from the Michigan Surgical Quality Collaborative registry, the authors found that conversion rates were lower with robotic compared to laparoscopic procedures for rectal resections and hospital length of stay were shorter with robotic procedures compared to conventional and hand assisted laparoscopic colon procedures. The second study was published by Dr. Altieri and colleagues from Stony Brook University in a broad based study of nearly 170,000 minimally invasive general surgeries from the New York Statewide Planning and Research Cooperative System, the authors found that robotic assisted procedures had lower rates of complications and hospital length of stay compared to laparoscopy across several general surgeries, with the lower rate of complications for colectomies. They concluded “robotic approaches may facilitate safer adoption of minimally invasive approaches in areas where penetrance of conventional laparoscopy is low such as in colorectal surgery.” This concludes my procedures and clinical commentary I will not be providing you with our update financial outlook for 2015. Starting with procedures, on our last call we estimated full year 2015 procedure growth of 8% to 11% above the approximately 570,000 procedures performed in 2014. We are now increasing our procedure estimate for 2015. We now anticipate full year 2015 procedure growth within a range of 11% to 13%. Turning to gross profit, our outlook for gross profit margin has modestly improved compared to last quarter. We expect our second half 2015 pro forma gross profit margin to be within a range of 67% to 68% of revenue. Note that this range is a bit lower than our second quarter gross margin as Q2 benefited from favorable product and regional system mix and Q3 and Q4 will likely face stronger foreign exchange headwinds. Our actual gross profit margin will vary quarter-to-quarter depending largely on product and regional mix, systems production volume and foreign exchange rates. Turning to operating expenses, consistent with our last call, we continue to expect to grow pro forma 2015 operating expenses towards the lower end of a range of between 7% and 10% above 2014 levels. We now expect our 2015 non-cash stock compensation expense to come in towards the lower end of the $170 million and $180 million range forecast on our last call. Fairly flat compared to $169 million in 2014. We expect other income, and just comprise mostly of interest income to total between $16 million and $18 million in 2015. With regard to income tax, for the reminder of the year we continue to expect our 2015 pro forma income tax rate to be between 28% and 30% of pre-tax income depending primarily on the mix of U.S. and international profits. This forecast does not assume the reinstatement of the R&D tax credit in 2015. That concludes our prepared comments. We will now open the call to your questions.

Thank you. [Operator Instructions] We will first go to line of Bob Hopkins with Bank of America.

Hi, thanks. Can you hear me okay?

Can.

Can.

Congratulations on a good quarter. Wanted to ask two quick questions. First on the gross margin side, I appreciate the specific guidance for the near-term and the back half. But Gary and Marshall, I was wondering if I could just get your views on a little bit longer term. Because gross margin is definitely a major issue for investors as they consider your Company and the stock. So is the back-half level that you're talking about here, 67% to 68%, as you think about the long-term, is that a level that you view as sustainable when you think about all the different puts and takes? Would just love a comment on long-term gross margin. Thank you.

We don’t -- as we look at long-term, we don’t see huge changes form that range. There are lot of puts and takes that make it hard to call. So as we get scale along some of the newer products, we get some benefits in terms of cost and cost reduction. There are regional variances so there is mix changes in regions in terms of regional pricing. There are some things that will make it go up and down. Longer term we will benefit from some cost advantages, but also depending on the changes in the marketplace and the scale of some of our customers, there are other pressures. So we think where we are today that's a pretty good number to think about.

Okay. And then as a follow-up, two other quick things. You've said a -- it sounds like another good quarter on the hernia side. I was just wondering, now that we're a good, solid couple of quarters in, any kind of commentary from you on -- your views on the sustainability of hernia growth over time, now that you are learning a little bit more. And I also just wanted to understand the specifics around your comments on Sp, and when we should be thinking about a formal launch of that as we look forward.

Sure. So on the hernia side, as you mentioned we are seeing good early growth. I recognize that hernia is both more than one kind of procedure, abdominal hernia, or ventral hernia and inguinal hernia and even within those there is variations in both technique and patient population. So clearly right now there is a mixture of sustained use by our customers and people who are learning and trialing the technology. What that mix looks like in the near-term is actually very hard to determine. We do see some early evidence of strong clinical benefit in some of the categories and segments and we think that's long-term durable. Our calling right now how big those total available markets are going to be is still premature. So we have some basic estimates we are working them down. As the quarters go by here we will able to increase our certainty of what those long-terms look like. With regards to Sp, we are not predicting the ship date at this time. We are on track in our technical developments. We are in conversations with several surgeon groups as well as regulators about where both long-term value can be and what regulatory pathways are and as those firm up we will share them with you in the future.

Great. But that’s still a 2016 event, right?

We have not anchored on when we are launching.

Okay. Thanks for taking the questions.

Thank you. We will move to line of Tao Levy with Wedbush.

Great. Thanks. Good afternoon.

Hey, Tao.

Hi. So maybe the first question, we think about Japan and next April on the reimbursement and I know you mentioned that you've submitted sort of the kidney data to the regulatory authorities there recently. Are there any other clinical data that either required or that you’re going to be submitting between now and I guess reimbursement decision time?

Yeah. So technically, by the way, the submissions are done by the clinical investigators not by Intuitive. We don’t see another clinical data submission between now and April. On the other hand, the pathway that partial nephrectomy went through is something called [indiscernible] uro. That is not the only pathway that have a conversation with the government. So the one dataset that we see going in at that time is partial nephrectomy. But there are other conversations ongoing that don’t necessarily have the same pathway. And with nothing has been assured, we can't anchor you on any particular pathway. But we are having multiple conversations.

Okay, perfect. Just to reiterate that, just because there are no other studies, it doesn’t mean that you can potentially get reimbursement in other procedures.

Right. There are other methods besides just this one. Right.

Yeah. We are not anchored on that April 2016 timeframe either. I mean these other methodologies could occur anytime.

Okay.

Having said that they are uncertain and they take real work and…

I understand that. So, my next question, if you think of the instruments that you've recently gotten approved, some of the more advanced disposables -- whether it's stapling and you've got now on the Xi, the energy -- or I guess you had that last year. But as you think about penetration of the applicable type of procedures where those types of instruments are commonly used laparoscopically, what type of penetration should we be thinking about today?

So the stapling products that we have in the market today are primarily focused on colorectal surgery and we are seeing really nice adoption in that procedure. That's what they were designed for. Staplers are typically used in those procedures and the adoption of Intuitive’s product in that case has been good. So we've been pleased with that. Things like vessel sealing are used more broadly and so we see increasing penetration of our vessel sealer in a variety of procedures from general surgery to gynecology and others. So they’ve been good products for us. I think they are meeting customers’ needs and we've seen growth.

But in terms of the percent of times that the surgeon would use an assistant port, for example, for a stapler or a sealer while doing a da Vinci procedure, are there any metrics around that that you've looked at?

So we do track how often they use ours. I don’t think we've gotten to a place of disclosing what the breakouts are for each of those subunits.

Thanks a lot.

Thank you. We will go to line of Tycho Peterson with JP Morgan.

Hey, thanks. Gary, I'm wondering if you can elaborate a little bit on some of the developments for the back half of the year, in particular, around the interoperable table motion for Xi. Just trying to understand does this open up more complex procedures. How do you think about the opportunity set? And then similarly with Single-Site for Xi, how do we think about the initial rollout?

Sure. With regard to table motion, just the value of it, why do it, the value of integrated intraoperative table is that it allows the surgeon to position the patient using gravity. It’s something that they do frequently. It also allows the anesthesiologist an easier interaction to help manage the patient. And the power of the integration we've done with our partner has been that it allows it to be done quickly and efficiently. So it’s fast. So the real value here is to speed up procedures. It allows them to do it seamlessly. And so we don’t think it’s so much opening a different market as it is making it easier on lower barriers. The feedback too, they’ve been now used in dozens of cases in Europe where it has CE Mark. Feedback has been really good and the implementation done by the team is very, very good. So that looks good and we are encouraged. We've submitted the 510 (k) just recently, answer FDA’s questions as they come and work through that. It really is rounding out. It’s one of the features that rounds out the Xi platform. Intraoperative table motion is a strong beneficiary for general surgery procedures where folks are wanting to move around the abdomen, helps a lot in that setting. And so the fact that they can do that dynamically is powerful. Turning to Single-Site on Xi, Single-Site is already available, of course, as you know on the Si. There is nothing that's a technological limitation from putting it on Xi. It’s really been doing the work and getting the clearances. What that will enable is the mid-sized hospital that owns one platform; they may have an Si now. They are doing Single-Site and they want to upgrade to an Xi, that’s completes the set for them so that they don’t have to step away from something on their Si system when they move to Xi. And so that's really the opportunity for us there and we are meeting our technical milestones and working through the set of validations that will be required to get clearance. So we are excited about it.

Great. All right. And then a question on ROLARR, now that we've seen the data, I'm just wondering how the discussions with surgeons has evolved. Has this opened up some doors for you, potentially showing equivalency with laparoscopic? And yes, just wondering how you are marketing that to your physician base.

The conversation has generally been positive. As you know ROLLAR is really studies a little subgroup, right? So the trial design is such that it’s comparing advanced laparoscopists, highly laparoscopists to new robotic surgeons in rectal cancer. What's not said in that study is that the dominant treatment modality in rectal cancer is open surgery. So to show good data upfront as they presented, showing equivalence and leading towards some potential benefits even in that early stage in the small subgroup that is minimally invasively treated today, I think that's generally been seen as a positive. And so I don’t think it’s been ground shaking in either direction. But I think it’s generally been well received by our customer base.

And then just last one going back to the original question on the margins, on Sp in particular, I think part of your reason -- the original delay occurred was to get the engineering right and the manufacturing right. Are you able to just talk a little bit about how you are thinking about the margin profile of Sp when it comes out? Shouldn't it be additive to the overall base you are talking about?

Yes, as we think about Sp and margins, in total really we're looking for those procedures where we can really show significant outcome value. And I think there are some really interesting potentials out there. Sp is a fundamentally different way to deliver the instrumentation relative to multiport. We have some experience in single port with Single-Site, but Sp allows us some different opportunities. That said it's a little more complicated. Now, the engineering side has done a great job. The engineering team in terms of getting both the cost structure and the performance where we want it has been very good. What we want to do is match that up with potential clinical outcomes that really are strong beneficiaries of our approach. That's really what the clinical side of work has been, and I'm feeling positive on it. I think that the design is really enabling.

Okay. Thank you.

Thank you. We'll go to line of Ben Andrew with William Blair.

Good afternoon guys. Thanks for taking the question. If you think about the improvement we've seen versus the earlier guidance, primarily coming from gross margin and I know, Gary, you guys have been investing aggressively in Europe and overseas for quite some time now. Can we see some of that taper, and see more of the upside flowing through the operating margin over the next year or two?

On the time horizon, it depends a lot on which part of the world you are in. I think that as we've talked about in Japan, we now have a direct team there starting to perform more effectively. I think as they're integrating, that looks really good. There are barriers and other things that have to be overcome structurally. And how quickly those resolve I think will determine the pace of the commercial business, and we've talked about it already; things like reimbursement. In Europe, I think we're seeing a nice performance in several countries. The barriers are a little bit different, depending on which country it is. Not every country is working at the same pace. But we're seeing some of the return on the investments in Europe, and we expect both better performance out of Europe in future quarters, and some continued investment.

But I think you were headed towards -- is there additional leverage? And I think that although those are providing return, we'll continuously be investing in overseas markets. As we've characterized before, there's a really large opportunity out there and we have other things we have to get done.

Okay. And then just a quick check the box question. The procedure guidance, is that consistent o-US, U.S., versus what we've seen year-to-date?

Yeah, I mean I think in the commentary on the call, we talked about the second quarter really being a continuation of the first quarter trends. And I think that when you talk about the second half of the year, we are talking about a continuation of what we saw in the first half, both domestically and internationally. And the variance in the range really has more to do with just the magnitude of those key drivers that we went through.

Okay. And then last for me today, please. Gary, if you think about pocket share or revenue per procedure in usage and I know it's potentially variable with Sp, but how does that evolve over a three to five-year window? Because you've got vessel sealing, you've got the stapler; those are relatively underpenetrated versus where they could go. You've been running kind of flattish, even with some erosion in procedure potential, if you will, in the number of instruments. You're running flattish on revenue per case. Where does that go? Are you just hoping to hold it steady? Or do you see a lot of rich targets out there to grab additional pocket share?

I think in the mid-term, there will be some trades here of some efficiency gains realized by hospitals and some increased penetration of advanced instrumentation. I think in the longer term, the efficiency gains will find a bottom and the advanced instrumentation will continue to grow.

And I think you look at where Q2 came in terms of revenue per procedure, at the $1,830 level. About what we would've expected, consistent with the last quarter and the last year. But there were some trade-offs. I think foreign exchange hit us harder and we did have some benefit from the newer products that we've talked about that largely offset it, so, a lot of moving parts. As we look into the second half, we'd probably assume something similar we've seen in the first half on instrument accessory revenue per procedure. But to offset the exchange, you're probably going to have to have some favorability in other areas.

Great. Thank you.

Thank you. We'll go to line of Matt Taylor with Barclays.

HI, thanks for taking the question. I guess I wanted to ask about some of the drivers here that could lead to system sales. I know you don't give guidance there. But could you talk about the importance of the movable table, the instruments, and those other factors that you've talked about in driving the sales and whether you may see some sequential uptick over the next couple quarters?

Yeah, just speaking to the main levers here of system purchase decisions, there's really three levers that we've talked about and remain in place. One of them is upgrade. For a customer who has a system and is thinking about upgrading from an S or an Si or one of the prior systems, they are really looking out and saying, does Xi bring to them either outcome benefit or new service lines relative to prior products? That's where table motion and Single-Site can make a difference, particularly for single system hospitals. And so we think as those product lines fill out, that will help that upgrade pipeline. There are people who just buy purely on capacity. They have used the existing capacity of their system. As procedures grow, they look to do additional procedures; they will buy a second system or so. And the last one is really capacity, again, but often -- is it in the right place. If you are a larger institution or an integrated delivery network, you may be interested in moving the capacity to a different region or a different part of your service network. Sometimes they do that by moving systems; sometimes they do that by buying systems. So, capital decisions are really predicated on those three pillars.

Great, thanks. And one follow-up. Just you have a lot of kind of runway here in the general surgery arena. But we've heard other physicians talking about ENT and neuro and cardio. Can you talk about how you are looking beyond even the big opportunities here in general to other areas on the horizon?

We're always out scanning, really from the bottom of your feet to the top of your head, to think about where is current surgery difficult or outcomes suboptimal, and in a place where our kinds of technologies can make a difference. We're already participating in ENT with our Si product. We think Sp will have some real value to add in the ENT space over time. There are other things, of course, in our radars as we go. I think that thoracic surgery is something that's going to matter in the future and something that our kind of technology can make a difference in, in terms of things like lung cancer, mediastinal cancers and so on. And so we're looking at those things. And we have, of course, as you might imagine other things further out that as we get closer to commercialization we'll talk about.

Great. Thanks for the time.

Thank you. We'll go to the line of David Lewis with Morgan Stanley.

Hey good afternoon.

Hi David.

Gary, just two questions. The first is on procedures. The real improvement this quarter was international procedures, I think got better by 7% or so. Can you give us any additional color on where specifically that procedure growth is happening? And you had made this commentary last years about these reinvestments overseas. It certainly seems that those investments are paying off. So maybe just more color on where those investments are happening, and what specific regions the procedures are strong. And I had a quick follow-up.

Okay. Let me give Calvin the floor to just give a little color on the distribution of procedure growth and then we'll get back to it.

Yeah, I think it went a little beyond just international. I think on the U.S. side, as I mentioned in the prepared comments, we really had stronger than anticipated performance in the more mature procedures in the United States; I think continued strong growth in prostatectomy procedures. And then in gynecology, I think we anticipated somewhat of a pullback relative to Q1 -- or relative to the prior year, with a tougher comp. And really we were able to maintain the same -- similar level in that mature category. So, I think those exceeded our expectations and were part of the reason to raise the guidance. And then, as you say, international was driving it. I think Europe was in general tracking to trends and meeting our performance. The majority of our above-expectation growth was in Asia; as I mentioned, most notably China. We also had a very strong quarter in Korea.

And then, Gary, just a question on -- I know you get persistent questions on use of the balance sheet. But you've said historically that one of the drivers for using the balance sheet obviously is valuation, but the other driver really was just business visibility. And certainly as evidenced by this quarter, business visibility has markedly improved. So, why not use of cash for buyback? Why was the buyback not bigger last quarter? And how are you thinking about -- what's not a better use your cash than buying back your own stock, just given the improvement in visibility? Thank you.

Yeah, David, this is Marshall. We philosophically really haven't changed how we approach decisions around cash and utilization of cash or buybacks. And we do have an intention to return excess cash to shareholders through stock buybacks. But as you know, we've executed those opportunistically based on market valuations. The stock market and our stock specifically has been volatile over time. And it creates opportunities for us to purchase stock at favorable prices. And, in fact, if you go back over the last two and a half years, we've repurchased more than 2 million shares at an average price of under $420 a share. So, we're philosophically aligned with what you just said, and that's how we've executed it.

David, you said that visibility has improved. Performance certainly improved this quarter on the -- in terms of the how we manage our business and internally and procedures we have strong visibility; the procedures a little less so. But capital remains highly volatile, and just because of the way capital purchase cycles in different economies work.

Thank you. We'll move on to the line of David Roman with Goldman Sachs.

Thank you and good evening everybody. I wanted just to start with maybe Gary -- you are giving us just some reflection about what has transpired over the past four quarters. Because as I look at your business, this quarter really seems to represent a coming together of a lot of the key drivers, whether it's system placements, procedure volumes, global expansion, et cetera. Whereas in the past few quarters we've seen some of these things I think move in your favor, but not all of them. So, is there anything that you saw change in the external environment over the course of the second quarter, or in your own business that really led to a positive coalescence of the key underlying fundamentals here?

I didn't see anything that looked really environmentally driven. As Calvin mentioned earlier -- I think moving with market trends tend to be things like prostatectomy and malignant hysterectomy, a little bit more mature, where those are probably more likely indicators of the total market behavior, rather than something specific to Intuitive. With regard to the major drivers that you've been talking about, really I think we've been working on them, in terms of new product launches, investments in Europe, investments in Asia, developing our team, and working on costs and margins. It's really been, roll up your sleeves and do the hard work. And we've had -- as you've said, some of those have come together a little earlier than others. I think one quarter is great. It doesn't make a trend, and our job is to keep doing it.

Okay. And as you think about the go-forward from here and understandably I think it's clear why you're not giving total revenue guidance. But what are the factors that you think could lead you to a point to conclude that what you're seeing this quarter turns into a trend? I understand results would be one of those things. But if you look at factors that you monitor, are we at turning port where robotic surgery growth is back on track versus some of the challenges you've faced over the past couple of years? Or are there nagging factors that you think still need to be addressed?

I think there are always things to be worked on, and we've talked about several of them. I think with regard to visibility and predictability of the financials of the business, I think that's really, as I said before, predominantly predicated on capital. I think there are some interesting things going in the market. I do think that market acceptance of robotic surgery is increasing. I think some of the debates of where it adds value are starting to be resolved. We see a different tone in some of the surgical conversations more broadly and I think that's a real positive. So, we feel good about that. Having said that, I think that working through reimbursement pathways, working through regulatory pathways, and building really capable organizations takes time. And that's what we're focused on, and that will be the biggest predictor of our long-term performance.

And maybe lastly, we've started to hear some discussion in the marketplace about potential competition for robotic surgery. Can you maybe just talk about either, A, what you're seeing; and, B, any actions that you're undertaking to position the business well should any new competitors potentially emerge in the next, call it, I don't know, six, 12, 18 months, et cetera?

We've been unwavering in our commitment to bringing value to surgery and our belief that we can. And, as such, we have really believed that increased competition is inevitable. It's validating in that it has other people putting their investments where they think it will bring value. And I think that actually increases the presence of robotic surgery in surgical societies and in the industry broadly. In terms of our competitive position, clearly we've anticipated the increase in competitors over the years and we've not been idle during that time. So, we've been thoughtful and have I think made some investments that will make our position long-term sustainable.

Okay, great. Appreciate all that perspective.

Thank you. I think we have time for one more question, please.

Thank you. We'll go to line of Rich Newitter, Leerink Partners.

Hi, good afternoon, this is Ravi in for Rich. He's on the road today. Thank you for taking the question. Got a question on the Japan sales mix; more Sis than Xis. I understand it's early for the Xi launch, but curious as in terms of what you see it would take -- what you envision that it would take in Japan for Xi to inflect more quickly. And then another one, staying o-US; I think you made a comment a little bit earlier regarding China, where you see procedure growth rates sort of system placement driving growth seems to be a little bit of the opposite of the U.S., where procedures appear to be driving systems. At what point does the former turn into the latter? And any sort of -- I mean, are there certain number of systems or penetration that you look at when evaluating that opportunity? Thank you.

Yeah. I'll let Marshall take the first one on Japan, and I'll take the--

Sure. So, in Japan what we said was that we had a split of eight Sis and five Xis. Now remember, Xi was just introduced -- or just approved, I should say, just approved in late March, so you've really had the opportunity to sell it in a three-month cycle. Selling cycles in Japan are much longer than that. In fact, they take multiple quarters to get systems done. That's why you see Sis getting done in the quarter, because the process for which the budget was established by the hospital and the purchase process takes a long time. And so this is just completion of deals that were already in flight months before this. And it will take time for Xi. And all of that should be caveated with the point that right now we have one reimbursement in terms of prostatectomy. We're hopeful to get other reimbursements. But until such time that occurs, system purchases are going to be spotty at best.

With regard to China, while we're pleased with the procedure growth and it has been strong, you're absolutely right, in early markets where there aren't a lot of systems placed, then system placements drive procedure growth. And in mature markets -- or more mature markets like the United States, where you have more capacity than procedure growth, turns around and drives the systems. You were asking, what's the pivot or the inflection point there? It really comes down to accessibility, vis-a-vis the patient population you are trying to treat. So, how many systems are in the neighborhood of the patients who can benefit from them? And so that's really how you have to back into it: start with the patient population that can benefit from them, and work your way backwards into systems. It's a regional model. We try to do that, but it's not always trivial because of data accessible.

Well, thank you. That was our last question. As we have said previously, while we focus on financial metrics such as revenues, profits, and cash flow during these conference calls, our organizational focus remains on helping surgeons increase patient value by improving surgical outcomes and reducing surgical trauma. We've built our company to take surgery beyond the limits of the human hand and I assure you that we 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 to you again in three months.