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Intuitive Surgical (ISRG) Gary S. Guthart on Q1 2016 Results - Earnings Call Transcript

Intuitive Surgical, Inc. (NASDAQ:ISRG)

Executives

Calvin Darling - Senior Director-Finance, Investor Relations, Intuitive Surgical, Inc.

Gary S. Guthart - President, Chief Executive Officer & Director

Marshall L. Mohr - Chief Financial Officer & Senior Vice President

Patrick Clingan - Finance Director

Analysts

Robert Adam Hopkins - Bank of America Merrill Lynch

Tycho W. Peterson - JPMorgan Securities LLC

David R. Lewis - Morgan Stanley & Co. LLC

David Harrison Roman - Goldman Sachs & Co.

Ben C. Andrew - William Blair & Co. LLC

Rick Wise - Stifel, Nicolaus & Co., Inc.

Matt O'Brien - Piper Jaffray & Co. (Broker)

Lawrence Keusch - Raymond James & Associates, Inc.

Jason R. Mills - Canaccord Genuity, Inc.

Vijay Kumar - Evercore ISI

Tao L. Levy - Wedbush Securities, Inc.

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the Intuitive Surgical Q1 2016 Earnings Release Call. At this time, everyone joining is in a listen-only or muted mode, and later we will have a question-and-answer session and instructions will be given at that time. As a reminder, the conference is being recorded.

And I'll now turn the meeting over to our host, Senior Director of Finance, Investor Relations, Calvin Darling. Please go ahead.

Calvin Darling - Senior Director-Finance, Investor Relations, Intuitive Surgical, Inc.

Thank you. Good afternoon, and welcome to Intuitive Surgical's first quarter earnings conference call. With me today we have Gary Guthart, our President and CEO; Marshall Mohr, our Chief Financial Officer; and Patrick Clingan, Senior Director of Finance.

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 2, 2016. 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 first quarter results as described in our press release announced earlier today followed by a question-and-answer session. Gary will present the quarter's business and operational highlights. Marshall will provide a review of our first quarter financial results, Patrick will discuss marketing and clinical highlights, and I will provide our updated financial outlook for 2016. And finally, we will host the question-and-answer session.

With that, I'll turn it over to Gary.

Gary S. Guthart - President, Chief Executive Officer & Director

Good afternoon and thank you for joining us on the call today. Our first quarter company performance was strong with excellent global procedure growth, solid capital placements, improving product margins and important new product launches.

Turning first to procedures, global procedure growth for the quarter was nearly 17%, led by growth in general surgery, growth in the use of da Vinci Surgical Systems outside the United States, continued growth in U.S. urology and modest growth in U.S. gynecology.

Trends in U.S. general surgery growth continued with strong growth in inguinal hernia repair and ventral hernia repair followed by continued growth in colorectal surgery. Customer feedback and commitment to the use of da Vinci in performing inguinal hernia repair for complex conditions has been encouraging in the quarter, increasing our confidence in its long-term acceptance.

Procedure growth was variable by country in Europe, with solid performance in the United Kingdom and Germany offsetting slower growth in the Nordic countries. Performance in the quarter was helped by an extra procedure day in some regions relative to Q1 of 2015. Patrick will review procedure trends in greater detail later in the call.

We placed 110 da Vinci Systems in the quarter, up from 99 in Q1 of 2015. Customers continue to purchase our Xi Systems over less expensive and less capable Si models by a factor of approximately three to one. Capital performance was strong in United States, offsetting capital softness in Europe and the exploration of our quota in China.

Lastly, customer leasing and lease to own arrangements are making up a greater percentage of new system placements. Marshall will take you through our finances in more detail later in the call.

Our operations teams remained focused on optimizing our manufacturing, design and supply chains for our newer products. Our teams continued to execute against their goals with steady improvements in reducing product costs for our new systems, advanced instruments in the quarter.

Product cost reductions exceeded our expectations, and we expect them to continue to improve in 2016 and 2017. Our offerings make up an ecosystem designed to meet our customers' needs in building and running outstanding robotic surgery programs.

This ecosystem includes systems and instruments and accessories, training technologies and peer-to-peer course work, service offerings, and program optimization and analytic support. As a result of the set of products and services that surround our systems, recurring revenue in the quarter comprised 75% of total company revenue.

Highlights of the first quarter operating results are as follows. Procedures grew nearly 17% over the first quarter of last year. We shipped 110 da Vinci Surgical Systems, up from 99 in the first quarter of 2015. Revenue for the quarter was $595 million, up 12% over the prior year. Pro forma gross profit margin was 70% compared to 65.6% in the first quarter of last year.

Instrument and accessory revenue increased to $322 million, up 16%. Total recurring revenue in the quarter was $447 million, representing 75% of total revenue. We generated a pro forma operating profit of $229 million in the quarter, up 24% from the first quarter of last year, and pro forma net income was $170 million, up 27% from Q1 of 2015.

We continue to enable our Xi platform with new product launches. Our launch of intraoperative table motion is proceeding well with order flow that has met our expectations and with strong customer feedback on its utility, particularly in general surgery. In the quarter, we also launched our 30-millimeter Xi stapler designed to facilitate stapling in thoracic procedures and our Xi Single-Site instrument and accessory kit. Both are 30-millimeter stapler, and our Xi Single-Site instruments have started clinical use with positive feedback on their utility. Our Sp program remains on track.

As our business has strengthened, we have increased our mid- and long-term investments in research and development. We have been increasing our investments in imaging, analytics and new product architectures based on our belief that substantial opportunity exists to enable better outcomes and to expand our access to our technologies globally. Calvin will take you through our projected spending later in the call.

As we move forward in 2016, we're focused on the following: first, expanding the use of da Vinci in general and thoracic surgery, particularly colorectal surgery and hernia repair; second, advancing our ecosystem including expanding our Xi line and taking our Sp product into initial clinical use; third, driving our organizational capabilities end markets in Europe and Asia; and finally, assisting our customers in their efforts to maximize the comprehensive value of their programs.

I'll now turn the call over to Marshall who will review financial highlights.

Marshall L. Mohr - Chief Financial Officer & Senior Vice President

Thank you, Gary. I will be describing our results on a non-GAAP or pro forma basis which excludes legal settlements and claim accruals, stock-based compensation, and amortization of purchased IP. We provide pro forma information because we believe the 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 have posted reconciliations of our pro forma results to our GAAP results on our website so that there's no confusion.

First quarter revenue was $595 million, an increase of 12% compared with $532 million for the first quarter of 2015 and a decrease of 12% compared with the seasonally stronger fourth quarter of $677 million.

First quarter 2016 procedures of approximately 176,000 increased nearly 17% compared with the first quarter of 2015 and decreased slightly compared with the fourth quarter procedures of approximately 177,000. Year-over-year procedure growth was driven by general surgery and procedures in the U.S. in urology worldwide and otherwise likely benefited from an additional calendar day associated with leap year.

Revenue highlights are as follows. Instrument and accessory revenue of $322 million increased 16% compared with last year and decreased 1% compared with the fourth quarter of 2015. These changes generally reflect changes in procedures. Instrument and accessory revenue realized per procedure, including initial staffing orders, was approximately $1,830 per procedure. This metric continues to fluctuate in a tight range from approximately $1,830 and $1,840 per procedure. Relative to the first quarter of 2015, the current quarter reflects higher sales of advanced instruments, offset by the impact of customer buying patterns in foreign exchange.

System revenue of $148 million increased 5% compared with last year and decreased 36% compared with last quarter. The increase relative to the prior year primarily reflects increased revenue associated with operating lease activities and slightly higher average systems selling prices. The decrease relative to the fourth quarter primarily reflects seasonally lower unit sales and slightly lower ASPs, partially offset by increased revenue associated with operating lease activities.

110 systems were placed in the first quarter compared with 99 systems in the first quarter of 2015 and 158 systems last quarter. Approximately 77% of the systems shipped in the quarter were Xis which is comparable to prior quarters.

Hospitals financed approximately 37% of the systems placed in the first quarter, up from 17% last quarter. We directly financed 31 systems, including 19 operating leases. As of the end of the first quarter, there were 62 systems out in the field under operating leases.

We generated approximately $4 million of revenue associated with operating leases in the quarter compared with $1 million in the first quarter of 2015 and $3 million in the fourth quarter. We also generated approximately $6 million of revenue during the quarter from lease buyouts compared with $2 million of revenue in the fourth quarter and no lease buyout revenue in the first quarter of last year.

We excluded the impact of operating leases from our system ASP calculations. Globally, our average system price of $1,500,000 was approximately $30,000 higher than the first quarter of 2015 ASP and approximately $50,000 lower than the ASP last quarter. Relative to the prior year, the increase reflects a proportionately lower trade-in volume in favorable geographic mix, partially offset by an unfavorable product mix. The decrease relative to the fourth quarter reflects proportionately higher trade-in volume and lower mix of Xi dual consoles, partially offset by favorable geographic mix.

Service revenue of $125 million increased 9% year over year and increased approximately 4% compared with the fourth quarter of 2015. The year-over-year and quarter-over-quarter increases reflect growth in our installed base of da Vinci Systems.

Outside of the U.S., results were as follows. First quarter revenue outside of the U.S. of $164 million increased 9% compared with $150 million for the first quarter of 2015 and decreased 25% compared with seasonally stronger fourth quarter up to $219 million. The increase compared with the previous year is comprised of a 14% growth in recurring revenue, which is driven by procedure growth of 22% and increased systems revenue of 2%. The decrease compared to the fourth quarter reflects seasonally strong fourth quarter systems placements, partially offset by a 5% growth in recurring revenue.

Outside the U.S., we placed 36 systems in the first quarter compared with 36 in the first quarter of 2015 and 75 last quarter. Current quarter system sales included five into China and eight into Japan. System placements outside of the U.S. will continue to be lumpy, as some of these markets are in their early stages of adoption. Some markets are highly seasonal, reflecting budget cycles or vacation patterns, and sales into some markets are constrained by government regulation.

Moving on to the remainder of the P&L, the pro forma gross margin for the first quarter was 70% compared with 65.6% for the first quarter of 2015 and 69.6% for the fourth quarter of 2015. Compared with the first quarter of 2015, the higher gross margin reflects reduction of product and product repair costs, improved manufacturing operation's efficiencies, the elimination of the medical device tax, lower costs associated with product field actions and related inventory charges, and a higher mix of instrument and accessory revenue.

The medical device tax has been suspended for the next two years and reduced our 2015 gross margin by approximately 70 basis points. Future margins will fluctuate based on the mix of our newer products, our ability to further reduce product costs, manufacturing efficiency, costs associated with product field actions, and in the long-term the potential reinstatement of the medical device tax.

Pro forma operating expenses, which exclude legal settlements and accruals for legal claims, stock compensation expense and amortization of purchased IP increased 14% compared with the first quarter of 2015 and increased 5% compared with last quarter. The increases over prior periods reflect increased investments in advanced imaging, advanced instrumentation and next-generation robotics, increased head count, and higher payroll taxes associated with stock option exercises.

Our pro forma effective tax rate for the first quarter was 27.4% compared with an effective tax rate of 28.9% for the first quarter of 2015 and 24.9% last quarter. In late December 2015, Congress retroactively approved the 2015 federal research and development credit and made the R&D tax credit permanent going forward. The entire 2015 R&D tax credit was included in the fourth quarter, while no benefit was reflected in the first quarter of 2015 and a proportional benefit is reflected in the first quarter of 2016.

Other than the impact of the R&D credit, fluctuations in our tax rate between this quarter and the first and fourth quarters of 2015 primarily reflect changes in the mix of U.S. and OUS income.

Our first quarter 2016 pro forma net income was $170 million or $4.42 per share compared with $135 million or $3.57 per share for the first quarter of 2015 and $224 million or $5.89 per share for the fourth quarter of 2015.

Note that fully diluted shares outstanding increased by approximately 400,000 shares relative to the fourth quarter resulting primarily from the increase in our share price. 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 $595 million for the first quarter of 2016 compared with $532 million for the first quarter of 2015 and $677 million for the fourth quarter of 2015.

GAAP net income was $136 million or $3.54 per share for the first quarter of 2016 compared with $97 million or $2.57 per share for the first quarter of 2015 and $190 million or $4.99 per share for the fourth quarter of 2015.

We ended the year with cash and investments of $3.8 billion, up from $3.3 billion as of December 31, 2015. The increase was primarily driven by proceeds from stock option exercises and cash generated from operations. As our cash builds, we will continue to evaluate our approach to capital allocation.

And with that, I'd like to turn it over to Patrick who will go over our procedure and clinical highlights.

Patrick Clingan - Finance Director

Thanks, Marshall. Of our first quarter procedure growth of nearly 17%, U.S. procedures grew approximately 15% and OUS procedures grew approximately 22%.

In the U.S., even though growth benefited from favorable operating days in the quarter, procedure growth outpaced our expectations. First quarter growth in our mature procedures continued at levels similar to the second half of 2015 generating majority of the procedure outperformance relative to our expectation. General surgery procedure growth also exceeded our expectations.

In U.S. urology, first quarter growth in da Vinci Prostatectomy and kidney procedures continued at similar rates at the second half of 2015. We continue to believe that our U.S. prostatectomy volumes have been tracking to the broader prostate surgery market, and we expect the prostatectomy group to return to levels similar to prostate cancer incident rates over time.

In U.S. gynecology, first quarter procedures grew modestly year-over-year, with growth led by malignant and complex hysterectomy. Continuing the trend from 2015, we estimate a larger proportion of da Vinci Hysterectomy procedures were performed by gynecologic oncologists during the first quarter. Similar to the fourth quarter, U.S. Single-Site gynecology procedure growth declined compared to the first quarter of 2015.

First quarter growth in U.S. general surgery procedure adoption remains strong, led by a robust growth in hernia repair and continued adoption of colorectal procedures. Cholecystectomy procedures were roughly flat in the quarter, with growth in multi-port procedures offsetting declines in Single-Site procedures.

Q1 was another quarter with a large number of clinical publications evaluating da Vinci Surgery. Of these, I have selected a couple studies that you may find interesting. With the launch of our 30-millimeter stapler, surgeon interest in...


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