Intuitive Surgical Inc

NASDAQ:ISRG

Earnings Call Transcript 2022-Q2

[Operator]

Ladies and gentlemen, good afternoon. Thank you for standing by as today's conference assembled. Welcome to the Intuitive Surgical Quarter 2 2022 Earnings Release. At this time all lines are in a listen-only mode. Later, there will be an opportunity for your questions. [Operator Instructions] And as a reminder, today's conference is being recorded.

At this time, it's my pleasure to turn the conference over to our host, Head of Investor Relations with Intuitive Surgical, Mr. Brian King. Please go ahead.

[Brian King, Head-Investor Relations]

Thank you. So good afternoon, and welcome to Intuitive's second 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 3, 2022, and Form 10-Q filed on April 22, 2022. 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 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 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, Jamie will provide a review of our financial results, and I will discuss procedure and clinical highlights and provide our updated financial outlook for 2022. And finally, we will host a question-and-answer session.

And with that, I will turn it over to Gary.

[Gary Guthart, Chief Executive Officer]

Thank you for joining us today. Our Q2 results reflect both environmental and Intuitive's specific headwinds accompanied by underlying business strength. Procedures in the quarter grew 14% over last year despite pressure from COVID-driven lockdowns in China, our second largest market. Capital placements slowed from a year ago due to a combination of factors we described last quarter and which I will review shortly. Overall pressure from COVID lockdowns impacted procedures in the quarter modestly while reduced trade-ins and supply chain timing impacted our capital placements more significantly. The leading indicator of the health of our business, procedure demand, remains healthy.

Starting first with procedures. I am encouraged by 14% growth in the quarter, reflecting strength in U.S. general surgery and solid growth extending beyond urology outside the United States. U.S. procedure growth was led by bariatric surgery, cholecystectomy and colorectal procedures with continued growth in hernia repair. In OUS markets, procedures grew 22% in the quarter in spite of the COVID lockdown in China.

Outside the U.S., we are seeing strength in urology now accompanied by diversified growth in other procedures. For example, in Japan, growth was strong in general surgery, including rectal resection. In the U.K. and Ireland, growth was strong in gynecology and general surgery. And in France, gynecology and general surgery experienced solid growth. System utilization in several OUS countries has been increasing in recent quarters as procedure adoption diversifies increasing value for our customers and for Intuitive. This is a result of the investments we made in key country markets starting several years ago.

Turning to da Vinci capital placements. We placed 279 systems in the quarter, down from 328 in Q2 2021. In the da Vinci business, we see three causes for the decline in placements relative to a year ago. As our customers have standardized on generation four da Vinci systems, the installed base of third generation systems has declined, lowering the trade-in population, particularly in the United States. Next, supply chain disruption continued in the quarter with semiconductor component delays impacting the timing of system builds, leaving us challenged to match some customer orders at quarter end. Lastly, we've seen hospital capital spending pressure grow in our part of the capital equipment space over the past two quarters, incenting customers to seek efficiency gains on existing capital before acquiring new capacity. Component supply constraints remain a risk, and our operating teams are working hard to shelter our customers for most of these pressures.

Capital placements in more mature markets are a mix of core demand for procedures and trade-in opportunities. The need for high-quality robotic-assisted surgery remains healthy. Incremental capital demand at the customer is a function of system utilization and procedure growth. On the system utilization side, our compound annual growth rate remains at historic levels of 5% over the past three-year period. System utilization in the U.S. over the past year was slightly down as procedure growth rate over the past year roughly matched the system installed base growth. In contrast, system utilization in many OUS markets has been rising as procedures diversify. Overall, we prioritize system utilization growth for customers as it increases the value to them of their investments and is aligned with long-term health for Intuitive.

Turning to our innovation engines and new products and services, we placed 41 Ion systems, up from 20 in Q2 of last year. Given its stage of maturity, Ion capital demand procedure growth as hospitals seek to build initial capability. With the ION clinical installed base now at 204 systems ION utilization has been growing nicely along with encouraging early capital replacements. We received 510(k) clearance for our integration of ION with Siemens Cios Spin cone-beam CT. This combination improves registration and targeting precision for ION in the lung and is being well received by our customers. We remain focused on strengthening clinical outcomes in lung care, a fantastic customer experience and operational excellence in the ION program.

In our multiport ecosystem we initiated our first phase U.S. launch of our eight millimeter stapler designed to work in small anatomical spaces, for example, in thoracic surgery. Early customer feedback has been encouraging. In China, we're preparing to launch our SureForm 45 and 60 millimeter staplers and our latest endoscope, Endoscope Plus. All three will continue to support growth in general surgery and thoracic procedures.

For da Vinci SP we have expanded the number of colorectal IDE sites to help accelerate accrual. And we submitted another regulatory package for SP imaging and accessories in Japan, as we work on the necessary clearances to support an SP launch in the country. For our digital tools, Intuitive Hub installs grew nicely again in the quarter, and we're focused on ensuring outstanding customer experiences with data capture and media management, along with increasing utilization over time.

On spending, we are committed to our innovation programs because we believe the forward opportunity for our products and services are important to our customers and to the company.

We have some natural shock absorbers that decrease some of our variable spending as a result of the slowdown in da Vinci capital placements. We are also planning for decelerating spend growth after we complete some infrastructure projects, we need to support the company's expansion. Given our confidence in the future of our business, we have also returned cash to shareholders in the form of buybacks in the quarter.

I'll now turn the time over to Jamie who will take you through our finances in greater detail.

[Jamie Samath, Chief Financial Officer]

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. A reconciliation between our pro forma and GAAP results is posted on our website.

Q2 procedure growth of 14% reflected an increase in U.S. procedures of 11% and OUS procedure growth of 22%. As a reminder procedures in the U.S. in the second quarter of last year included a recovery of procedures that were delayed as a result of the significant impact of Omicron variant. Brian will provide additional procedure commentary later in the call.

We placed 279 systems in the second quarter as compared to 328 systems in the second quarter of 2021 and 311 systems last quarter. Q2 system placements were 15% lower than the second quarter of 2021, primarily due to a significant decline in trade-in transactions. There were 56 trade-in transactions in the quarter as compared to 125 in Q2 of 2021, reflecting the decline in the number of SIs remaining in the installed base.

The supply chain environment continues to be challenging and during the quarter we experienced delays in the supply of certain semiconductor components that caused manufacturing output of da Vinci systems to be later in the quarter than historical norms. As a result, a number of systems that we would have expected to place in the latter part of June experienced minor delays and were shipped and installed in July.

We indicated on last quarter’s call that we had experienced softening in the U.S. capital pipeline. That softness persisted in Q2. Financial pressures have increased on hospitals, given higher inflation, increasing interest rates, supply chain challenges, and continued staffing shortages. Some of the larger IDNs have indicated that as a consequence of the financial pressures they face, they are lowering their capital investment plans and tightening operational budgets.

We expected demand for capital, particularly in the U.S., will be impacted while macro conditions remain challenging. Where a particular hospital requires additional da Vinci capacity, given growth in their programs, we will leverage our flexible acquisition models to meet the financial objectives of our customers.

Given the system placements in Q2, the installed base of da Vinci systems grew approximately 13% year-over-year. Utilization of clinical systems in the field measured by procedures per system increased approximately 1% compared to last year. Using a three-year compound annual growth rate second quarter utilization grew almost 5%, which is in line with historical averages.

In more mature markets like the U.S. capital demand is sensitive to procedure growth. And therefore we monitor changes in system utilization closely. As a result of our procedure and capital performance, Q2 revenue was $1.52 billion, an increase of 4% from the second quarter of 2021. On a constant currency basis second quarter revenue grew approximately 6% over last year.

It is worth highlighting that recurring revenue grew 14% year-over-year to $1.24 billion representing 81% of total revenue. Additional revenue, statistics and trends are as follows: in the U.S., we've placed 150 systems in the second quarter lower than the 213 in Q2 of 2021, reflecting a decline of 59 systems associated with trade-in transactions, a softer demand environment, and the delay of some system placements into July. The remaining installed base of SI systems in the U.S. is approximately 230 systems. Outside the U.S., we placed 129 systems in the second quarter compared with 115 in the second quarter of 2021.

Current core assistant placements included 78 into Europe, 18 into Japan, and 15 into China, compared with 63 into Europe, 16 into Japan, and 19 into China in the second quarter of 2021. As of the end of Q2 2022, there were 48 systems remaining under the current quarter in China, which is also available to competitors that have received local regulatory clearance. Globally, trade-in transactions represented 20% of placements in the quarter, compared to 38% for full year 2021 and 48% for full year 2020.

As we have previously indicated, given the lower number of older generation systems in the field, we expect the volume of trade-ins to be significantly lower in 2022, as compared to last year. Leasing represented 42% of Q2 placements compared with 35% last quarter and 33% in the second quarter of 2021, the higher lease mix primarily reflected an increase in the proportion of O-U.S. customers that lease a system in the quarter versus purchased, driven in particular by customers in Europe. While leasing will fluctuate from quarter-to-quarter, we continue to expect that the proportion of placements under operating leases will increase over time.

Second quarter system average selling prices were $1.50 million slightly lower than the $1.54 million last quarter, although system ASPs were roughly flat, lower trade-in volumes benefitted Q2 ASP, offset by an unfavorable impact from the stronger U.S. dollar and a higher mix of lower price Xi systems, primarily driven by customers in Europe. We recognized $22 million of lease buyout revenue in the second quarter compared with $16 million last quarter and $26 million last year. Lease buyout revenue has varied significantly quarter-to-quarter and will likely continue to do so.

Instrument and accessory revenue per procedure was approximately $1,900 per procedure, compared with $1,870 last quarter and $1,940 in the second quarter of 2021. The year-over-year decrease primarily reflects the benefit of stocking orders in Q2 of 2021 associated with the launch of our extended use instruments program and an unfavorable FX impact from the stronger U.S. dollar. The sequential increase reflects a higher proportion of stapling and advanced energy revenue. Revenue for these categories combined grew 22% as compared to the second quarter of last year.

We placed 41 Ion systems in the quarter as compared to 20 Ion placements in the second quarter of last year. The installed base of Ion systems is now 204 systems of which 90 are under operating lease arrangements. Second core Ion procedures of approximately 5,200 increased 251% compared to the second core of 2021. Ion is in the new MDR regulatory review process in Europe and our efforts to pursue a submission in China continue to make progress.

Five of the systems placed in the second quarter were SP systems, resulting in an installed base of 111. Second core SP procedures grew approximately 28% year-over-year. One of the areas of potential clinical differentiation for SP is in narrow access surgery. For example, in transoral robotic surgical or TORS procedures, for malignant TORS procedures based on the last four quarters, we estimate SP market share in the U.S. to be just under 20%. Growth of the SP platform will continue to be gated by additional clinical indications and clearances in markets beyond the U.S. and Korea.

Moving on to the rest of the P&L, pro forma gross margin for the second quarter of 2022 was 69.2% compared with 71.7% for the second quarter of 2021 and 69.8% last quarter. Pro forma gross margin was lower primarily as a result of the stronger U.S. dollar, higher logistics costs, increased component pricing and increased fixed cost relative to revenue. As we invest in our infrastructure and manufacturing capacity to serve our long-term needs. Pro forma operating expenses increased 23% compared with the second quarter of 2021. The increase in second quarter operating expenses from a year ago, reflected an increase in headcount, higher R&D-related project costs and higher travel costs, including the impact of inflation.

Given the early stages of our newer platforms, Ion and SP and our digital ecosystem, we expect to continue to invest in R&D, given the return profile of these investments. Spending in SG&A will be more closely linked to our procedure and revenue performance, and we will continue to pursue plans to invest in infrastructure and business process automation to ensure we can efficiently and effectively scale.

Pro forma operating margin for Q2 was 35% as compared to 40% for the full year 2021. As compared to the second quarter of last year, the net impact of FX, inflation and manufacturing inefficiencies associated with the supply chain environment is a reduction in operating margin of approximately 2%. Our pro forma tax rate – effective tax rate for the second quarter was 22.3%, in line with our expectations.

Second quarter 2022 pro forma net income was $415 million or $1.14 per share compared with $475 million or $1.30 per share for the second quarter of 2021. Capital expenditures in Q2 were $131 million, primarily comprised of infrastructure investments to expand our facilities footprint, increased manufacturing capacity and automation of certain production lines.

I will now summarize our GAAP results. GAAP net income was $308 million or $0.85 per share for the second quarter of 2022, compared with GAAP net income of $517 million or $1.42 per share for the second quarter of 2021. 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 gains and losses on strategic investments.

We ended the quarter with cash and investments of $8.2 billion, compared with $8.4 billion at the end of Q1. The sequential reduction in cash and investments primarily reflected share repurchases and capital expenditures, partially offset by cash from operating activities.

Our capital allocation priorities remain consistent and are as follows: first, to organically invest in the business, given the significant opportunities we see to develop differentiated technology and drive adoption of our products. Second, to acquire external technology that creates value for our customers and/or accelerate development timelines or acquisitions that accelerate our growth.

Third, we return excess cash to shareholders and look to do so efficiently. In Q2, we repurchased 2.2 million of our shares at an average price of $224 per share for a total expenditure of $500 million. Concurrent with today’s earnings release, our Board of Directors have improved an increase to the share repurchase authorization to $3.5 billion.

With that, I would like to turn it over to Brian, who will discuss clinical highlights and provide our updated outlook for 2022.

[Brian King, Head-Investor Relations]

Thank you, Jamie. Our overall second quarter 2022 procedure growth was 14%, compared to 68% for the second quarter of 2021, which we believe benefited from a number of procedures which had previously been deferred due to COVID-19. The three-year compound annual growth rate was 16% between the second quarter of 2019 and second quarter of 2022.

In the U.S., second quarter 2022 procedure growth was 11% year-over-year, compared to 77% for the second quarter of 2021 and 16% last quarter. On a three-year compound annual growth basis, U.S. procedure growth was 14%. Q2 procedure growth continued to be driven by general surgery, with particular strength in bariatrics, cholecystectomy and colorectal, while hernia and foregut were also strong contributors.

Growth in mature urology and gynecology procedures also continue but at a moderate pace in the low-single digits. Outside of the U.S., second quarter procedure volume grew approximately 22%, compared with 51% for the second quarter of 2021 and 25% last quarter. Despite COVID-related restrictions in China, on a three-year compound annual growth basis, procedure growth was 20%.

Turning to Europe. Procedure growth was led by strong growth in Italy, UK and Germany. In all three regions noted, procedure growth was strong in general surgery and gynecology. In Italy, growth in these procedures outside of urology was led by general surgery, specifically in colorectal and HPV procedures.

In Germany, growth in these categories was led by early stage growth in colorectal surgery and benign hysterectomy. Year-over-year procedure growth in these non-urology procedures was almost 3 times higher than urology. While in the UK, benign hysterectomy and colorectal resection experienced strong early-stage growth.

In Asia, we experienced strong growth in Japan, while in China, procedures remain below expectations as government restrictions continued due to COVID infections that persisted throughout most of the quarter. In Japan, growth in general surgery and gynecology continued to be strong with robust growth, specifically in benign hysterectomy, rectal resection and gastrectomy.

In addition, prostatectomy continued with solid double-digit growth, reflecting a recovery when compared to the prior year, which was constrained by COVID. Further contributing to procedure strength was early growth in the adoption of newly reimbursed procedures namely colon resection and nephrectomy procedures.

In China, second quarter procedure growth continued to be negatively impacted by regional lockdowns due to ongoing COVID infections that affected many large cities throughout most of the quarter. Despite the restrictions, China experienced modest year-over-year growth and began to show signs of a return to normal run rates in June.

Now turning to the clinical side of our business. Each quarter on these calls, we highlight certain recently published studies that we deem to be notable. However, to gain a more complete understanding of the body of evidence, we encourage all stakeholders to thoroughly review the extensive detail of scientific studies that have been published over the years.

Earlier this year, Dr. Sarah Diez and Robert Cleary from St. Joseph Mercy Hospital Ann Arbor, along with Doctors Young Jin Lee and Amira Basara from the Swedish Cancer Institute in Seattle, Washington and in collaboration with Intuitive, published a real-world body of evidence comparing health care utilization outcomes and payer/patient expenditures associated with open and minimally invasive colectomy for benign disease. Notably, this analysis also included a comparison of laparoscopic and da Vinci approaches.

Utilizing the IBM MarketScan commercial claims and encounter database, this study included over 10,000 adult patients who between January 2013 and December 2018 underwent an elective inpatient colectomy for a benign condition with over 2,500 patients in the open group and over 6,000 subjects in the laparoscopic group and over 1,000 patients in the da Vinci Group. Through an inverse propensity treatment weighted analysis, the minimally invasive approach demonstrated a lower total health care expenditure across all time frames analyzed from the surgical procedure through 365 days post procedure, with lower average total expenditures ranging from $2,300 to $8,100.

With regards to resource utilization, the minimally invasive approach demonstrated an approximately two-day lower length of stay with these patients less likely to be readmitted, visit the emergency department or visit the outpatient department within 365 days from the procedure. The reduction in health care use among minimally invasive patients translated to an additional savings over $5,700 and over two fewer days missed from work for health care visits.

Within the MIS category when comparing laparoscopic and da Vinci approaches, da Vinci had a 70% lower risk of conversion to open with over a half day shorter length of stay and patients were less likely to have an outpatient hospital visit within one year of the procedure.

Of note, patients who had a conversion to open had a longer length of stay, higher hospital payments and were more likely to have a readmission for hospital visit within one year of the procedure. The reduction in conversion is translated to an additional savings of approximately $4,800 and 1.5 fewer days of missed work due to health care visits.

The authors concluded in part that minimally invasive colectomy is associated with lower mean health care expenditures and less mean health care resource utilization compared to the open approach for benign disease, with a shorter mean length of stay and conversion to open rate observed with the da Vinci approach.

I will now turn to our financial outlook for 2022. Starting with procedures. On our last call, we forecast full year 2022 procedure growth within a range of 12% to 16%. We are now increasing our forecast and expect full year 2022 procedure growth of 14% to 16.5%. This range continues to reflect the uncertainty associated with the course of the pandemic. The low end of the range assumes increasing COVID hospitalization and staffing pressure at hospitals for the remainder of the year.

At the high end of the range, we assume COVID-19-related hospitalizations around the world continue to decline throughout the remainder of 2022, and there are no additional significant impacts from further resurgences. The range does not reflect significant material supply chain disruptions or hospital capacity constraints similar to what we experienced at the start of the pandemic.

While procedure growth so far in the first half of 2022 has been healthy, the capital pipeline in the U.S. has been softer than in prior periods, mainly due to a lower number of SI systems in the installed base available for trade-in and macro-related headwinds creating pressure on the hospital capital spending. Capital placements in more mature markets are a function of procedure demand that is moderated by system utilization growth and trade-in opportunities.

While trade-in opportunities have declined, the core demand for procedures continues to be healthy and system utilization has been increasing. With a three-year compound annual growth rate in procedures of 16% from Q2 of 2019 to Q2 of 2022 and installed base growth of 11% over the same period, utilization of installed systems has continued to increase through the pandemic and first half of 2022. This is increasing the value derived from the existing installed base for our customers and for us. As we look ahead, we expect these capital dynamics to continue for the foreseeable future.

Turning to gross profit. On our last call, we forecast our 2022 full year pro forma gross profit margin to be within 69% and 70.5%. We are now refining our estimate of pro forma gross profit margin to be within 69% and 70% of net revenue. Given the ongoing impact of higher input costs related to supply chain and the impact from a stronger U.S. dollar, we would expect to be towards the lower end of that range. Our actual gross profit margin will vary quarter-to-quarter depending largely on product, regional and trading mix, fluctuations in foreign currency rates and the impact of new product introductions.

With respect to operating expenses, on our last call, we forecast pro forma operating expense growth to be between 23% and 27%. We are refining our estimate and now expect our full year pro forma operating expense growth to be between 23% and 25%. We are refining our estimate for noncash stock compensation expense to range between $520 million to $540 million in 2022. We are also refining our estimate for other income, which is comprised mostly of interest income, to total between $60 million and $70 million in 2022, an increase from our previous estimate of $50 million and $60 million. The increase primarily reflects the continued rise in interest rates.

On last quarter’s call, we forecast 2022 capital expenditures within a range of $700 million to $900 million. We are now refining estimated capital expenditures for 2022 to be in the range of $700 million to $800 million. With regard to income tax, we continue to estimate our 2022 pro forma tax rate to be between 22% and 24% of pretax income.

That concludes our prepared comments. We will now open the call to your questions.

[Operator]

[Operator Instructions] And we’re going to begin today with Larry Biegelsen representing Wells Fargo. Please go ahead sir.

[Larry Biegelsen, Wells Fargo]

Good afternoon. Thanks a lot for taking the question. Gary, maybe if I could start with the supply constraints that you talked about, could you quantify how much you think that negatively impacted Q2? It sounds like they’ve been resolved. And Gary, obviously, people are worried about the impact of a recession. How are you better positioned this time compared to the last recession we saw in 2008, 2009? And I have one follow-up.

[Gary Guthart, Chief Executive Officer]

Okay. On the supply constraint side, I’ll give you a qualitative perspective and Jamie you can fill in a little bit of a quantitative perspective. What’s happening is semiconductor suppliers and some other raw material suppliers giving us choppy delivery time lines. So estimates that are sometimes moving around and that can bring product in late in the quarter. When we assemble that product, it can sometimes make it hard at very quarter end to match system configurations to customers and that’s largely what happened in Q2. Jamie, you want to add to that?

[Jamie Samath, Chief Financial Officer]

Think about the impact to Q2 placements roughly in the 5%-ish range in terms of without those supply constraints, those delayed semiconductor components the incremental systems that would have been delivered in Q2.

[Gary Guthart, Chief Executive Officer]

That continues to be choppy, and we expect, certainly for Q3 and perhaps forward that we’ll continue to fight those fights in terms of timing of supply. On the second question – the second part of your question on recession, clearly, our hospital customers are under financial pressure. We have seen that at the end of Q1 and had communicated with you at that time.

I think relative to where we were as Intuitive a decade ago, the size and strength of the installed base, the relative position that we have in terms of centrality to surgery and multiple disciplines and the expression of that in recurring revenue, the percentage of our business that’s in recurring revenue, I think gives us a little bit better shock absorption and predictability in terms of a large part of the revenue of the business. And gives us a few more degrees of freedom in terms of how we make our investments and time those investments relative to 2008, 2009.

We are close with our customers. I am personally in contact with many. The trends that we’ve been describing to you, I think we understood pretty well the size and duration of those trends in terms of pressure, very hard for any of us to predict. And you had a follow-on.

[Larry Biegelsen, Wells Fargo]

Yes, that’s all fair. Again, I’m going to push my luck a little bit here. FDA seems to be requiring clinical data for new systems. We know you have a new system in development. So my question is, do you know yet if FDA is going to require clinical data for your new system before approval? And if so, what can you share? Thank you.

[Gary Guthart, Chief Executive Officer]

Looking at two things, I think let me broaden the question. Looking at the regulatory environment globally and in particular, in the United States and Europe, we have seen a trend in medical device and in robotic-assisted surgery for increasing data requirements. Sometimes those are trials, sometimes there are other kind of data. That trend has continued, and it’s impacting all of us in the market, including Intuitive.

You can expect that we will improve the Gen 4 product that’s out there. We can get good ideas and technologies into our existing customer base hands and improve their utility, we will do that. We are, of course, working on next generations. And as I’ve said before, generations after that, without answering your question specifically, the deeper the technologic opportunities and the clinical impact, the more likely you have a deeper validation work to do. And we’re not afraid of that work. I’d rather do things that are really clinically meaningful for the customer. And if we have to do the work, then we’ll do the work.

I will say for everybody on the call, it’s clear that relative to a decade ago, the investment trough and the time lines for new systems have both increased. The time lines have increased because of the changing regulatory environments in several countries. And as a result, the amount of investment that has to go into that has also changed. It’s also increased. I think, and this is a prediction that it will also extend the useful life of products that we design. So it’s taking a little longer to get to market than it used to, maybe more than a little, it’s costing us more to get there. But that change in environment also means that really well-designed systems probably have longer use for life in the field. And I think we’re starting to see that early evidence of that as well. So thank you for the question, Larry.

[Larry Biegelsen, Wells Fargo]

Thank you.

[Operator]

And next, we’ll go to the line of Amit Hazan representing Goldman Sachs. You’re open.

[Amit Hazan, Goldman Sachs]

Thanks and good afternoon. Maybe to come back to the supply chain question. I want to maybe ask it lends as kind of a bigger picture here, just given all the challenges you’ve gone through in the past year and a half or so. Do you have plans that change strategically in terms of evolving towards maybe regionalization or domestication of the supply chain? And how do we think about that and incremental costs that might come with that, if that’s the plan? Or do you just plan to kind of ride this out and expect a more normal environment next year?

[Gary Guthart, Chief Executive Officer]

I’ll start. And Jamie, you can lean in. First, I want to acknowledge our operating teams and the supply chain teams. They have done a spectacular job in the number of components that we manage in a robotic surgery system, both on the capital side and on the instruments and accessories side and the management of those supply chains is remarkable, perhaps bigger than most people expect relative to the size of our company. They have been really good at being proactive and thoughtful about supply chain, robustness about strategic reserves and about the ability to pivot into alternative components when we need to. And that has really been a spectacular performance.

That’s a long way of saying that they have been proactive. They will continue to be forward-looking and design for supply chain robustness. What that looks like depends a lot on the underlying product, whether it’s creating second sources or using alternatives or thinking about regional deployment. We have been working through regional deployment prior to the pandemic, and we’ve done that work as we’ve gone on. That does incur some costs. We’re thoughtful about it. And Jamie, why don’t you provide your perspective?

[Jamie Samath, Chief Financial Officer]

From a strategic perspective or a long-term perspective, setting aside the current supply chain challenges, some of the things that we consider in our own long-term planning is the size of our business as it grows over time in the various regions that we serve, where you might locate, redundant capacity or incremental capacity. And in terms of the economic equation, you’re trading the potential cost of redundancy with savings on freight and logistics to the extent that you can supply them in region.

That economic analysis is relatively straightforward. And really, you’re just looking for the degree of redundancy you want and when does the regional businesses get big enough to warrant the economics. But certainly, what you described is something that we’re looking at carefully and have been.

[Amit Hazan, Goldman Sachs]

Thanks for that. And maybe just to hit on just earnings and going into the future with the components that you give us, it seems pretty clear this year, we’re probably not going to get earnings growth. You had some interesting comments. It sounds like R&D, you’re going to keep spending and you believe what you’re doing organically that makes sense. And sir, if you have more comments on SG&A, but just thinking through, okay, no earnings this year, in terms of your commitment to shareholders, is it okay for you not to grow earnings next year, too? Would that become a bigger focus for you just given how this year has gone? How do you think about earnings growth after kind of what this year is going to end up looking like? Thanks.

[Jamie Samath, Chief Financial Officer]

Yes. So, we’re not going to get specific about 2023 at this point. You’ll obviously see us provide our outlook on the January call. What we’re doing with respect to R&D currently is investing in multiyear projects and investments. You see that in our newer platforms, Ion and SP. We have obviously investments in digital, many of which are at an early stage. And we do continue to invest in the fourth generation ecosystem. And we look at the returns on those investments carefully and have confidence in them.

But in part because of the regulatory time lines that Gary described, they are multiyear investments and we think that the returns there are quite attractive. And so that’s why you see, for example, if you look at the first half, our R&D grew 30% relative to the overall growth of about 25% for OpEx. But if you take a multiyear view, given the growth opportunities that we see, you’d expect us to grow earnings over time. I’m not going to say whether that’s 2023 yet or not. And with respect to operating margins, specifically, what we’ve said is we look to be at the high end of our medtech peer set. And by medtech, that means high-growth companies that have growth opportunities as we see that we do.

I'll speak to – for a second on SG&A. We do have some infrastructure that is either needs to be built out to support the growth particularly in manufacturing or we have some processes in IT and in other parts of the business where we're long lived on our pavement and there's some repaving or potholes to fix that we will finish. We do expect to see highly targeted spending in that area going forward. And as we retire, some of that project spend will be thoughtful about where we go next. So we'll start to see some of that expense start to titrate into next year.

[Amit Hazan, Goldman Sachs]

Thank you.

[Operator]

Okay. Next in the line of Travis Steed with Bank of America. Please go ahead.

[Travis Steed, Bank of America]

All right. Thanks for taking the questions. Gary, I'd love a little more color just on the overall hospital capital environment. Are you seeing hospitals just being more cautious on the near term or do you think we're in for a longer duration CapEx, slowdown? I'm curious how you think the slowdown could range in terms of outcomes, if it's like, 2008, 2009 or 2013, 2014 or 2020 and also like leases ticked up to 42% this quarter, I'm curious where you think that could peak in the slower CapEx environment?

[Gary Guthart, Chief Executive Officer]

Yeah. Hard to predict the depth in duration of hospital pressure. So I won't, I will talk about what the – I think what the inputs are, what they're faced with. Clearly, they're constrained on labor and the labor costs because of that constraint have gone up. That's not something that will resolve quickly. They're also facing inflationary pressure in some of their materials that they purchase, and they don't have enormous flexibility to change pricing on their side. So I would expect profitability constraint on the hospital side to be present.

In light of that, one of their first tools in their toolkit is to try to get greater productivity out of existing assets and capital, and Intuitive will help them. If there's more productivity to get out of the products they already owned, we will help them do that. I still think there are hospitals out there that are going to be strategic that are in better financial condition. And if they want to build a new capacity and a new product line says SP or Ion or to branch out into a new region, then they'll do that. And we'll help them do that as well. I don't think this is a one or two quarter resolution. It's certainly going to be something longer than that.

With regard to change in lease and how do we think about leases going forward? Jamie, I'll ask you to take that.

[Jamie Samath, Chief Financial Officer]

Yeah. If I split between U.S. and O-U.S., what you've seen in the U.S. is relative maturity in understanding and acceptance use of our leasing program. It's been ticking up slowly over time while it will fluctuate quarter-to-quarter based on customer preference. I do think that will slowly continue to tick up just based on what we hear from customers.

In O-U.S. where we offer leasing, which is not in every market, we’re at an earlier stage. And so you're seeing growing understand and acceptance as leasing as an option as they acquire capital. And so I'd expect that to continue to climb over time.

[Travis Steed, Bank of America]

Great. Thank you. And I had one other question, Gary, listened to your talk a few weeks ago, and you mentioned the time it takes to get new parts to market is a couple of years longer. I think you said six to eight years before now, eight to 10 years. I'd love to kind of get in a little more detail on that assumption that you went through there. And kind of think is, I guess I assume it's mostly regulatory, but kind of dig into the comment a bit more and see how that's changed your strategic thinking in general of how you think about innovation and your product cycles at the moment?

[Gary Guthart, Chief Executive Officer]

Yeah, it was a kind of a directional comment more about averages than about a particular product line. So I discourage anybody looking at a particular product line and try to infer from it. We have a basket of things we do and on average, it's gotten longer. Strategically I think there are a couple of things that strengths in the business versus a decade ago that help us and give us more flexibility, more freedom. And that is both the deep penetration we have in the market, the large size of the customer base in terms of active users.

If we can get them a technology and increments, we’re not as dependent on capital revenue. And as years pass, I think, the recurring revenue side is a strength for us. If that increases productivity for the hospital, that’s great. It turns out that gives them better financial returns on the investments they made. But also our economic profile is stronger in repeat use utilization than it is in capital change. So what that means to us is bring capital change when it really is differentiated, when it really brings incremental clinical value or new market access to our customers. And that’s what we’re focused on.

With regard to the regulatory side, our goal is to be really good at it to get the right data we need at the right time to underwrite the first time and take care of it. And those types of requirements ebb and flow over time. And we’re in a particular state where the requirements are quite high and we’ll deal with it.

[Travis Steed, Bank of America]

Great. Thanks for the color.

[Operator]

And we’ll go to the line of Robbie Marcus representing JPMorgan. Please go ahead.

[Robbie Marcus, JPMorgan]

Great. Thanks for taking the questions. Maybe to start, a lot of your comments say, it feels like it’s a U.S. comment in terms of the capital equipment. I want to get a sense, is there any difference in geography just given the hospitals, most of them outside the U.S., are dictated by a single payer country networks. And then I’ll just ask the follow-up as well, pretty good OUS procedure number. How do we think about how much of an impact the shutdowns in China had and how should we be thinking about the ramp in second half on China, just given that the country is still not on a strong pathway to a reopening? Thanks.

[Gary Guthart, Chief Executive Officer]

Yes. Robbie, on that first question, it’s a good one. And I appreciate it. Clearly, the utilization of systems and the posture of hospital acquisition relative to systems differs by country based on the maturity of our markets and the depth of penetration of da Vinci. We tried to call that out a little bit in the script. Jamie, I don’t know if there’s additional color you’d like to apply.

[Jamie Samath, Chief Financial Officer]

Yes, I just say the softness in the U.S. capital pipeline is clear, and it’s been clear for two quarters. What you saw in placements in Q2 was actually OUS placements grew as compared to a year ago. We haven’t seen any clear and specific indications on capital weakness that I call out. Obviously, China had a challenging quarter with respect to procedures. But you look at the macro, you look at what’s happening in Europe. You could imagine that might be a challenge as you look forward, but nothing that I call out at this point.

[Gary Guthart, Chief Executive Officer]

On – you had asked kind of how do we expect China to proceed in procedures in the back half. Of course that’s impossible for us to predict what I might ask Brian is you might just reiterate some of your comments as what’s assumed in the model in terms of [indiscernible].

[Brian King, Head-Investor Relations]

Yes. So we have seen, I’d say at the end of Q2, we did see some improvement or recovery of procedures, I’d say probably closer to more normal levels. Over time, it’s really hard to predict what’s going to happen in China. I think they are our second largest market by procedure volume. It does have an impact when things do slow down, but you can see the procedure growth that we had despite the challenges in China. So I think it’s probably a bit too soon to really give any color and what’s going to happen there because there's just still so much variability and frankly, we were still really early in the quarter.

[Robbie Marcus, JPMorgan]

Great. Thanks for the color.

[Operator]

And we have a question from Rick Wise representing Stifel. Please go ahead.

[Rick Wise, Stifel]

Good afternoon, guys. Again, reflecting on history a little bit. When I think back to the end of the financial crisis to early last decade, obviously, there were periods of marked capital slowdown and yes, those – the recovery following that was in part of macro recovery. But it was also in 2014, the launch of the Xi, it was procedure volume uptake, expanded instruments. I mean, there were many drivers of the recovery under the umbrella of the macro recovery.

As we look ahead and think about the next few years assuming the macro recovery occurs, I was just reflecting that the mix might be different this time, but what’s the – on the procedure side and the system or instrument side, I mean, what are the drivers that get us back to that accelerated growth again? Is it international instruments and yes, inevitably a new system at some point, or how would you talk about the next few years in thinking about a recovery from this period?

[Gary Guthart, Chief Executive Officer]

Appreciate the question. In terms of drivers of growth, first kind of zoom out, we are in the thick part of the adoption curve in the United States in general surgery across multiple sub-procedures and there's real room there. I don't think we're saturated and response has been really good and our training numbers and adoption and the underlying capability of our Gen 4 products has been great; so that's one.

Two, we're seeing investments that we've made many years ago in rounded teams, rounded intuitive teams in key countries payback now, and that has been fantastic. So it starts with growth in oncology, oncologic surgical procedures outside of urology – in addition to urology, so we're seeing that but we're also seeing the early indications of adoption in benign surgery in our U.S. markets, which is frankly an exciting green shoot in the sense that that could follow a pathway that mirrors what we saw in the U.S.

So I think there's lots of opportunity there and, and that has to do with bringing our instruments, our accessories, our ecosystem, our training capabilities, our data capabilities into our priority country markets over time. So we've got that. We have outstanding innovations that are coming to market. Ion is doing really well in the U.S. Ion will go deeper into other applications. We're trying to bring it to Europe or in that process will bring it to Asia over time. SP, SP is having great success in Korea. We're bringing it to Japan. We're working on additional indications for the United States.

SP has differentiated capability, and as those indications get added and it's hard work I think it will bring incremental procedures to our customers and then to us over time. And those are procedures that are either rarely done with daVinci or not done with daVinci at all. And I think that's another leg of opportunity and how many years does that take? Well, they will layer out – those things will layer out over time.

In terms of regional performance we have those opportunities in front of us right now. In terms of things like SP and Ion; SP is one of the more mature technologies in new platform. I think its economics are looking increasingly good for intuitive, and as they continue to knock down additional clinical indications I think that'll add strength. Ion has been growing like a weed. It's less mature in terms of its financial profile, but we're working hard on it and so I think those things will contribute as well. So I think we have irons in the fire that we have confidence in.

[Rick Wise, Stifel]

Okay. And just one last quick one for me, it's a little bit of a fishing expedition kind of question of just reflecting on your comments about partnering with hospitals. One aspect is financially and with leases, et cetera, but I know you have many initiatives underway in terms of data collection and management, any update in terms of your initiatives there? And is there anything on that side of the house we should be paying attention to? Thank you, Gary.

[Gary Guthart, Chief Executive Officer]

Thanks Rick. On the basics in our more mature daVinci markets, our data facility and in terms of the ability to collect, analyze and share insight with our hospitals has been really good. And they are the things that allow them to compare the efficacy and efficiency of their daVinci program. Relative to others in their own hospital group relative to national and international norms, it allows them to make decisions about where capacity are going, where there are opportunities for improvement within their system? We use that routinely. It is not a new idea; it's starting to become really baked into all the workflows and processes. We're automating a lot of that capability, so that's been fabulous.

At the other end of the spectrum we are engaged with hardcore healthcare researchers looking at what AI and our data sets can bring in terms of improved outcomes, personalized training, faster time to competency and the excitement level there is quite high, and we're continuing to invest down that pathway.

So in one set, it's used every day and another set, I think, it's in the innovation engines and its informing discovery. And I believe those discoveries, in a few years, will change the nature of surgery and some of the training that we do. So I think there's an opportunity on both sides.

[Rick Wise, Stifel]

Thank you.

[Gary Guthart, Chief Executive Officer]

Just one last question, please.

[Operator]

All right. Our final question today will come from the line of Richard Newitter representing Truist. You’re open.

[Richard Newitter, Truist]

Hi, thanks for taking the questions. Gary, just on that last answer. Can you give us any sense as to how if and maybe even when you might look to begin monetizing those types of – I don't want to say new alternative service models, things that might help hospitals become more efficient. Can we expect to see that filter into new sources of revenue streams and when? And are you already exploring that? And then I have one follow-up.

[Gary Guthart, Chief Executive Officer]

I – we've said this before, in our digital efforts in terms of digital tools, some of them are – the way we do our financial analysis, some of them are value creating through efficiency and labor savings on our side or on the hospital side and the investments are really a reduction in our cost to serve. So that's one category. There's another category that is around accelerated time to competency that lowers our cost to serve through having people get through their implementation and programmatic processes more quickly. The third category is direct revenue opportunity. We have things in the field working in all three of those categories. So none of them is empty.

In terms of pricing and customer acceptance of our value proposition, we are out in our training opportunities in some of our augmented reality spaces and in our Intuitive Hub starting to explore those. Some of them are very, very early. Some of them are reasonably mature in terms of what our pricing and other models look like. What I would tell you is that relative to other sources of revenue, these should be accretive to our bottom line because of some of the cost savings, but they won't be huge revenue lines in the near term. I would not set the expectation that all of that turns into big time revenue.

Our biggest thing and our focus is to help our customers, hospitals get to great, high-functioning, minimally invasive surgery programs using our products. If we do that, then they will find a way to pay us. And so far, that economic engine has worked well for them and it's worked well for us.

[Richard Newitter, Truist]

Great. And just – you guys mentioned TORS, I believe, where SP is gaining traction. You've got 20% penetration. I think you estimated – of U.S. estimated procedures. Just remind us, how big of a category is TORS? Can you quantify that for us? And where do you think something like that could go? Or where are some of your more aggressive users in terms of their penetration already? Thank you.

[Jamie Samath, Chief Financial Officer]

Yes. On the micro question, so that was malignant TORS. It's a small but high-value segment. Roughly TAM number of surgeries performed is in the 10,000 per year range. So a relatively small market. But like I said, for surgeons and patients, really high value. In terms of where it might go, I'll let Gary expand on that.

[Gary Guthart, Chief Executive Officer]

Yes. I think that SP and invasive surgery has opportunities to extend the kinds of procedures that are done robotically and we'll look to Korea as a guide in that they have broad clearances. And they're using it all over the body from gynecology to breast oncology and other things where they see value. And I think that as that clinical evidence comes through and as the clearances expand, you'll see incremental opportunity that is reasonable for us and, I think, exciting for our customer base. We'll detail those things further in future calls as that data starts to publish.

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 lane: 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 follows from respect for and understanding of patients and care teams, their needs and their environment. At Intuitive, we envision a care, 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 three months.

[Operator]

Ladies and gentlemen, that does conclude our conference for today. We thank you for your participation and using the AT&T Event Services. You may now disconnect.