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Intuitive Surgical Inc
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Ladies and gentlemen, thank you for standing by. Welcome to the Intuitive Surgical Third Quarter 2018 Earnings Release Conference 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, Mr. Calvin Darling, Senior Director of Financial Investor Relation, Intuitive Surgical. Please go ahead.
Thank you. Good afternoon, and welcome to Intuitive Surgical's third quarter earnings conference call. With me today, we have Gary Guthart, our President and CEO and Marshall Mohr, our Chief Financial Officer.
Before we begin, I would like to inform you that comments mentioned on today's call may be deemed to contain forward-looking statements. Actual results may differ materially from those expressed or implied as a result of certain risks and uncertainties. These risks and uncertainties are described in detail in the Company's Securities and Exchange Commission filings, including our most recent Form 10-K filed on February 02, 2018 and 10-Q filed on July 20, 2018. Our SEC filings can be found through our website or at the SEC's EDGAR database. Investors are cautioned not to place undue reliance on such forward-looking statements.
Please note that this conference call will be available for audio replay on our website at intuitive.com on the Latest Events 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 third 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 third quarter financial results. Then I will discuss procedures and clinical highlights, and provide our updated financial outlook for 2018. And finally, we will host a question-and-answer session.
With that, I'll turn it over to Gary.
Good afternoon and thank you for joining us on the call today. The third quarter of 2018 was a strong one for Intuitive with continued clinical adoption of our products and positive steps in product launches. As we mentioned last quarter, we believe acceptance of da Vinci in general surgery in the United States, growth internationally and appreciation of our generation-four platform underpins our recent performance. Our team introduced sophisticated new products into the market this quarter as we seek to advance our goals of improving the quality of surgery and decreasing its variability.
Global procedure growth was approximately 20% in the third quarter of 2018, compared with the third quarter of 2017, increasing modestly from our Q2 growth rate. Trends present in the first half of the year have continued with the United States showing particular strength in hernia repair, colorectal procedures, and practice related general surgery procedures, including cholecystectomy.
Mature procedure growth in the United States, including prostatectomy and hysterectomy was solid again in the quarter. In Japan, procedures grew above 40% year-over-year, while our team is onboarding customer-facing staff and optimizing training logistics to support market growth. European procedure performance was generally in line with our expectations again this quarter with particular strength in the UK. Calvin will review procedure trends in greater detail later in the call.
Our capital placement performance in the third quarter was strong with growth in total placements over Q3 of 2017 rising 37% from 169 to 231 this quarter. Net of trade-ins and retirements, our da Vinci installed base grew 13% over Q3 2017. The mix of system placements between our flagship Xi System and our value X System aligned with our strategy regionally. Capital placements have been historically lumpy and we anticipate variability in placements going forward.
As we indicated on prior calls, we are seeing increased customer interest in alternative capital acquisition approaches, including leasing and usage-based models. This quarter, the proportion of new systems placed under lease increased over prior quarters. We believe it is in both our customer's interest and Intuitive’s to offer alternative financing models for qualified hospitals. We have expanded these programs accordingly.
On the investment front, we are building our organization and making investments to deepen both our technological and regional capabilities. Fixed cost spending in the quarter was slightly lower than we planned, largely due to timing issues that we anticipate will catch up in future quarters. Use of our products has increased over the past year and we are in the early stages of several important product launches. Speaking directionally, we are investing to drive technology strength and to build operating and supply capability in support of our future growth.
Financial highlights for our third quarter results were as follows; revenue for the quarter was $921 million, up 14%. Pro forma gross profit margin was 71.5% compared to 71.8% in the third quarter last year. Instrument and accessory revenue increased to $486 million, up 21%.
Total recurring revenue in the quarter was $660 million, representing 72% of total revenue. We generated a pro forma operating profit of $391 million in the quarter, up 12% from the third quarter of last year and pro forma net income was $337 million, up 4%, with the difference in growth rate between operating profit and net income largely driven by a one-time tax benefit in Q3 of 2017. Marshall will take you through our finances in greater detail shortly.
Delivery of substantive technology and service improvements are core to continued progress in surgery. We measure our innovations by their ability to positively impact outcomes in the hands of our customers to be used efficiently, while lowering the total cost of treatment per patient episode and for their positive impact on the experience of surgical patients and the professional who treat them.
As we've said in the past, we design our product systems, instruments and software to work together seamlessly as an ecosystem that enables a holistic approach to a surgical procedure. We obtained FDA clearance for our da Vinci SP Surgical System for urologic surgical procedures in Q2 this year and we submitted our 510(k) application for transoral procedures for SP this quarter.
We shipped 3 da Vinci SP Surgical Systems in the quarter all in the United States. These first access sites will focus on clinical data generation and customer feedback. Surgeon and team feedback from first cases has been extremely encouraging. That said, we are in the very early stages of a multi-year pathway for SP and our focus is on satisfying our early customers, expanding clinical indications, improving our processes and technologies, and further refining our supply chain.
Our team is progressing to plan on Ion, our flexible robotics platform, initially targeted to address the acute need and diagnosis of lung cancer, one of the most commonly diagnosed and most lethal forms of cancer in the world and for which early detection is particularly important.
As we announced last month, we submitted our 510(k) for its first indication. We showcased our Ion system at the CHEST conference this month. Feedback from physicians relative to existing in recently announced alternatives has been strongly supportive of our efforts. Our team is focused on working towards clearance in readying the product for its first phase of launch.
We also initiated our early launch of our SureForm 60-millimeter stapler for use with our fourth generation systems this summer. Customer feedback has been encouraging at these early sites with hundreds of procedures performed today. The SureForm 60 brings the surgeons class-leading articulation and perception with computer measured and controlled stable firing.
Collectively, our SureForm 60-millimeter stapler joints, our forced bipolar grasper and Vessel Sealer Extend advanced energy instrument to provide an optimized set of tools for general surgeons, particularly in hernia, bariatric and colorectal procedures. Our Vessel Sealer Extend launched into Q2 this year and our forced bipolar instrument launched in Q3. Feedback on these instruments has been outstanding. We anticipate expanding our rollout of SureForm 60 in 2019, broadening the set of tools available to general surgeons on our fourth generation platform.
For the balance of 2018, our focus remains in completing the tasks we set for ourselves; first, continued adoption of da Vinci in general surgery; second, continued development of European markets and access to customers in Asia; third, advancing our new platforms, imaging, advanced instruments, da Vinci SP and our Ion platform; and finally, support for additional clinical and economic validation by global region.
I’ll now turn the call over to Marshall, who will review financial highlights.
Good afternoon. I’ll describe the highlights of our performance on a GAAP and non-GAAP or pro forma basis. Our results are also posted to our website. Third quarter 2018 revenue of $921 million grew 14% compared with third quarter 2017 revenue of $808 million, and increased 1% compared with the second quarter of $909 million.
Third quarter 2017 revenue included $21 million that had previously been deferred in connection with a customer trade-out program that the Company had offered certain first quarter 2017 customers. Excluding the $21 million, revenue grew 17%. Third quarter 2018 procedures increased approximately 20% compared with the third quarter of 2017, and were relatively flat compared with last quarter.
Procedure growth continues to be driven by general surgery in the U.S. in neurology worldwide. Calvin will review details of procedure growth later in this call. Instrument and Accessory revenue of $486 million increased 21% compared with last year, which is higher than procedure growth, reflecting increased usage of our advanced instruments.
Instrument and Accessory revenue realized per procedure was approximately $1,900, an increase of 1% compared with the third quarter of 2017 and an increase of approximately 3% compared with last quarter. These increases primarily reflect increased advanced instrument usage in customer buying patterns.
Systems revenue of $275 million increased 5% compared with the third quarter of 2017, primarily reflecting higher system placements and higher lease related revenue, partially offset by the recognition of $21 million of previously deferred systems revenue in the third quarter of 2017, a high number of system placements under operating lease arrangement in slightly lower ASPs.
We placed 231 systems in the third quarter of 2018 compared with 169 systems in the third quarter of 2017 and 220 systems last quarter. 58 operating lease transactions representing 25% of total placements were completed in the current quarter compared with 20 or 12% of total placements in the third quarter of 2017 and 44 or 20% of total placements last quarter.
We provide financing alternatives to hospitals that are well positioned in their markets, including some usage-based options as we believe these alternatives aligned with customer objectives enabling faster market expansion.
As of September 30, we had 279 operating lease and usage-based arrangements outstanding with a net present value of their future revenue stream being approximately $250 million. We expect the proportion of these types of arrangements to increase long-term.
28% of current quarter system placements in bulk trade-ins, reflecting customer desire to access or standardized on our fourth-generation technology. This is an increase compared to 26% in the third quarter of 2017 and lower than the 34% trade-in rate realized last quarter. Trade-in activity can be lumpy and difficult to predict.
68% of systems placed in the quarter were da Vinci Xi and 28% were da Vinci X systems compared with 72% da Vinci Xis and 21% da Vinci Xs last quarter. Many of the X systems were placed with cost sensitive customers in Europe, and with customers in Japan where we obtained X approval this past May. Three of the systems placed in U.S. were ASP systems.
Our install base of da Vinci systems increased 13% year-over-year and our average system utilization grew in the mid single-digit range. Globally, our average selling price, which excludes the impact of operating leases, lease buyout and revenue deferrals was approximately $1.45 million, compared with $1.47 million last year, and $1.42 million last quarter. The change is compared with prior periods primarily reflects the mix of X systems in trade-in transactions.
Outside of the U.S., results were as follows. Third quarter revenue outside of the U.S. was $244 million increased 15% compared with the third quarter of 2017, and decreased 8% compared with last quarter. Compared with the prior year, instruments and accessories revenue increased $30 million or 34% and systems revenue decreased $5 million or 6%.
The increase in instrument and accessory revenue relative to the prior year was primarily driven by procedure growth and customer buying patterns. The decrease in systems revenue was driven by an increase in number of operating leases, lower ASPs reflecting product mix, and the impact of trade-in transactions.
The decrease in OUS revenue relative to the previous quarter reflect seasonality and was driven by a decrease in a number of systems placed, a higher number of system lease transactions and lower procedures partially offset by customer INA buying patterns. OUS procedures grew approximately 23% compared with the third quarter of 2017 and decreased 1% compared with the second quarter.
Outside the U.S., we placed 75 systems in the third quarter compared with 62 in the third quarter of 2017, and 82 last quarter. Current quarter system replacements included 30 into Europe and 30 into Japan. 36 of the 75 systems placed in the third quarter were X systems.
Placements outside of the U.S. will continue to be lumpy as some of the OUS markets are in early stages of adoption some markets are highly seasonable, reflecting budget cycles or vacation pattern, and sales into some markets are constrained by government regulations.
Moving on to the remainder of the P&L. The pro forma gross margin for the third quarter of 2018 was 71.5% compared with 71.8% for the third quarter of 2017 and 71.1% last quarter. The decrease compared with the third quarter of 2017 primarily reflects lower system ASPs partially, offset by higher mix of INA.
The increase compared with the last quarter primarily reflects higher system ASPs and higher production levels. Future margins will fluctuate based on the mix of our newer products, the mix of systems and instrument and accessory revenue, system ASPs and our ability to further reduce product cost and improve manufacturing efficiency.
Pro forma operating expenses increased 16% compared with the third quarter of 2017, and increased 4% compared with last quarter. Overall, our spending was below our annual guidance, reflecting the timing of expenditures. We expect to continue to invest in key technologies and OUS market expansion and expect spending to increase next quarter and into 2019. Our pro forma effective tax rate for the third quarter was 18.5% compared with our expectations of 19.5% to 20.5%.
Our tax rate will fluctuate with changes in the mix of U.S. and OUS income, changes in taxation made by local authorities and with the impact of one-time items. Our third quarter 2017 pro forma tax rate of 9.7%, reflected $68 million of tax benefits associated with the expiration of statute of limitations.
Our third quarter 2018 net income was $337 million or $2.83 per share compared with $325 million or $2.78 per share for the third quarter of 2017 and $327 million or $2.76 per share for the second quarter of 2018. Our third quarter 2017 net income benefited from the $21 million of deferred revenue net of costs and $68 million of tax benefits associated with the expiration of statutes to limitations or a total $0.68 per share.
I will now summarize our GAAP results. GAAP net income was $293 million or $2.45 per share for the third quarter of 2018, compared with GAAP net income of $299 million or $2.56 per share for the third quarter of 2017, and GAAP net income of $255 million or $2.15 per share for the second quarter of 2018. The adjustments between pro forma and GAAP net income are outlined and quantified on our website, it included excess tax benefits associated with employee stock awards, employee equity and IP charges and legal settlements.
Note that the IRS has not issued final tax regulations associated with the recent U.S. Tax Legislation. Therefore, impacts of the U.S. Tax Cuts and Jobs Act reflected in our results and our projection of future tax rates, represent our best estimates of the impact of the U.S. Tax Cuts and Jobs Act, and could change as tax regulations are finalized and further interpreted.
We ended the quarter with cash and investments of $4.6 billion, compared with $4.3 billion at June 30, 2018. The increase generally reflects cash generated from operations. We did not repurchase any shares in the quarter and have approximately $718 million remaining under the board buyback authorization.
And with that, I would like to turn it over to Calvin who will go over procedure, performance and our outlook for 2018.
Thank you, Marshall. Our overall third quarter procedure growth was 20% compared to 15% during the third quarter of 2017 and 18% last quarter. Our Q3 procedure growth was driven by 19% growth in U.S. procedures and 23% growth in OUS markets. In the U.S., procedure performance across general surgery, gynecology and urology, all exceeded our expectations with Q3 year-over-year growth rates increasing modestly across these largest categories as they did in the second quarter.
Q3 procedure performance was again driven by growth in general surgery led by hernia repair and colorectal procedures. Hernia repair both ventral and inguinal continue to contribute the most incremental cases in the quarter. Cholecystectomy, bariatric and other practice-based general surgery procedures all had strong growth in the third quarter. In U.S. gynecology, third quarter 2018 year-over-year growth increased to mid single-digits driven by higher benign hysterectomy volumes.
In the third quarter, we continue to see favorable surgical consolidation trends as our da Vinci surgery data indicate that practicing da Vinci surgeons perform more da Vinci hysterectomies and an increasing proportion of U.S. gynecology procedures are being performed by higher volume physicians that specialize in complex benign and cancer surgery.
Q3 U.S. urology procedures had growth rates consistent with 2017 and year-to-date 2018, driven by prostatectomy volumes. As a mature procedure category, we believe that our U.S. prostatectomy volumes have been tracking to the broader prostate surgery market, which has benefited from recent macro trends. In other U.S. procedures, adoption of lobectomies and other thoracic procedures was again solid during the third quarter.
Our overall U.S. procedure growth rate likely benefited from a weaker Q3 2017 comparison. Q3 OUS procedure growth trends were largely consistent with Q2. Third quarter OUS procedure volume grew approximately 23%, compared to 23% for the third quarter of 2017 and 22% last quarter. Third quarter 2018 OUS procedure growth was driven by continued growth in dVP procedures and earlier stage growth in kidney cancer procedures, general surgery and gynecology.
Procedure growth in Japan again accelerated as procedures were performed within the set of 12 additional procedures approved for reimbursement effective April 1. Procedure growth in China again moderated in Q3, as da Vinci system capacity expansion is constrained by system quota requirements, the most recent of which expired at the end of 2015. In Europe, procedure results vary by country with continued strength in the UK.
Adoption of our products is ultimately based upon differentiated patient outcomes and procedure economics compared to alternative therapies. Intuitive supports the generation of high-quality clinical evidence through collaborative research initiatives. We work with clinicians, hospitals and medical and surgical societies to study da Vinci clinical outcomes, while maintaining a patient's first mindset. Intuitive is currently supporting comparative multi-center studies for several key procedures, including hernia repair, lobectomy and right colectomy.
In hernia repair, we are supporting a perspective multi-center comparative study evaluating outcomes associated with open laparoscopic and robotic-assisted inguinal and incisional hernia repairs in up to 900 subjects. This study is designed to collect outcomes related to pain, quality of life and recurrence for up to three years post procedure. Capturing patients reported outcomes through direct electronic or phone follow-up.
We are supporting a prospective comparative study for right colectomy, comparing outcomes associated with extracorporeal and intracorporeal anastomotic techniques and up to 300 subjects, collecting information related to patient quality of life parameters, including but not limited to gastrointestinal quality of life and incidence of incisional hernia rates.
Intracorporeal anastomosis by the robotic approach may be amenable to more surgeon skill sets than the laparoscopic counterpart. Indeed, the degree of difficulty of the sutured laparoscopic anastomosis has limited wide application of this approach.
In this year, where lung cancer is the leading cause of cancer death among men and women in the United States, a gradual decline is noted in the percentage of lung cancer surgery performed by an open approach from 43% in 2015 to 31% in 2017. The literature supporting the use of minimally invasive approach both vast and robotic-assisted colobectomy is incrementally growing with the majority of them attributed to the treatment of early stage lung cancer.
Intuitive is conducting a retrospective comparative multi-center lobectomy study evaluating both the short-term and long-term outcomes across both early stage and locally advanced lung cancer in up to 5,000 patients. You can find a full description of all of these studies on the clinical evidence page of our new website.
I will now turn to our financial outlook for 2018. Starting with procedures, on our last call we forecast full-year 2018 procedure growth within a range of 14.5% to 16.5%. We are now increasing our forecast and estimate full-year 2018 procedure growth of 17% to 18%.
In regards to Q4 system placements, consistent with historical patterns, we anticipate seasonally strong fourth quarter system placements. However, we do expect some moderation from the 30% plus growth in system placements we’ve realized in recent quarters. Furthermore, we expect that the proportion of systems placed to be operating leases in Q4 will increase further from the 25% in Q3.
Turning to gross profit, on our last call, we forecast our 2018 pro forma gross profit margin to be within a range of between 70% and 71.5% of net revenue. We are now retiring the lower end of the range and expect pro forma gross profit margin to be between 70.5% and 71.5% of net revenue. Our actual gross profit margin will vary quarter-to-quarter depending largely upon product, regional, and trade-in mix and the impact of new product introductions.
Turning to operating expenses, last quarter, we guided 2018 operating expense growth of between 16% and 18%. We are now adjusting this range lower and expect to grow 2018 operating expenses with a range of between 15.5% and 17% above 2017 levels. We are adjusting upwards our estimate for non-cash stock compensation expense to a range of between $255 million and $260 in 2018 compared $245 million to $255 million forecast on our last call.
We continue to expect other income, which is comprised mostly of interest income to total between $70 million and $75 million in 2018. With regard to income tax, on our last call, we forecast our 2018 pro forma income tax rates to be between 19.5% and 20.5% a pretax income. We are now shifting our estimate slightly lower to a range between 19% and 20% of pretax income.
That concludes our prepared comments. We will now open the call to your questions.
Thank you. [Operator Instructions] Okay. We have a question from the line of Bob Hopkins with Bank of America. Please go ahead.
Thank you and good afternoon. I actually want to start if okay with a question on capital allocation. Obviously, the business trends are very strong right now. I think you mentioned that you've got $4.6 billion in cash and the authority to buyback stock. Maybe if okay, if you wouldn’t just mind commenting on why are you not buying back stock right now and does that suggest that potential for some M&A opportunities out there? Thank you.
Hi, Bob, it’s Marshall. We've not modified our capital deployment priorities and so they're consistent with what we've said before. First, organic investment and substantial growth opportunities that are available to us. Second, acquiring technologies and talent that will ensure that we can accelerate our growth; and then third, using efficient long-term focus vehicles to return cash to shareholders.
In that regard, we have done stock buybacks. You’ve seen us doing periodically. We do them opportunistically based on our assessment of the market. I think the market will continue to be volatile as it – has been recently, and as it provides opportunities to purchase at the right price. You will see us do something.
Thank you. And we have a question from the line of David Lewis with Morgan Stanley. Please go ahead.
Good afternoon. Gary, couple questions for me. I guess the first is, Marshall touched on this, but obviously leases suppressed revenue in the quarter, but net placement numbers in the U.S., were the best we’ve seen as well as system utilization, both those numbers are the best you’ve seen in years, and 20% procedure growth, obviously reflects another quarter, I think the third straight quarter momentum acceleration. I guess, thinking about these U.S. box and procedure trends, can you just walk us through some of the drivers that you're seeing specifically in the U.S. for these dynamics?
I think the procedure demand is of course the topline. And as we called out in the script, the sustained strength in some of the mature categories in urology and gynecology as well as general surgery really rising has been strong. I think the box placements in response to that increased procedure demand. From our perspective, we're happy to see utilization go up.
We really view capital placements in mature markets as a way to enable the procedure market and so you're seeing that. Leases are then kind of fallout of that philosophy or hospitals that have good positions in their markets and are well run then we think giving them access where and when they need it at the terms that work for them and work for us helps facilitate the market and we've been willing to do that.
Thank you. And our next question will come from the line of Amit Hazan with Citi. Please go ahead.
Thanks. Well, looking like we're getting about one question each here, so I'm going to…
Yes. We'll give David a chance to jump back in queue a little later, but go ahead, sorry about that.
No problem, I’ll ask mine on Japan that was obviously some improved numbers in Japan that drawn procedures and installations, and so I'm just curious if that surprises you, that you got back the reimbursement, and if you could just give us some more on how you're seeing that market react and develop post the new reimbursement and whether it's sustainability of that growth that we’re seeing now look more realistic to you after this quarter? Thanks.
We're pleased with the progress in Japan. The – kind of the settle down growth rates are going to be a little bit hard to predict. Right now demand looks really good and I think the – it’s really the pipeline of activities from demand to clinical cases and up and running programs that’s the [limiting] step, some of that is training capacity and logistics, some of it is field support on our side, some of it is the depth of the surgeon proctoring network.
Not all of the procedures that were reimbursed will adopt it, the same rates, nor will pursue them all at the same rate. And so there's a little bit of shakeout here as the priorities firm up. So far so good, but I really think there's a few quarters to go before this settles into a kind of a more predictable cadence. And if you have a follow-up, go ahead.
Sure. Yes, so I'm going to add – maybe ask about hiring. So from the numbers that you guys reported that’s obviously really strong, it's up to 50 to 100 headcount now, that’s about 700 increase so far this year. So maybe give some color on where the heavy areas are in which those heads are being allocated. And then how you're thinking about that headcount growth as we think about the next year or two? Thanks.
Good question. Some of the headcount growth is – roughly tracks to the procedure momentum that we're seeing. So there's field support that's required. There's the production side of instruments and accessories and there's training resources that go into product training. And so those things are kind of ratable and we get a little leverage out of them, but we want to make sure that we support our customer really well.
So that's where you see the bulk of the hiring. And as procedure growth goes, we expect a little leverage there, but not a ton. There are also new platforms coming. We talked about in the script, SP and Ion, and those are deep technology efforts, supply chain efforts and so, some of the heads have gone into support of that set of activities as we go. It may well be the limiting step for growth of the Company is really the onboarding capability of really good people. So we watch it really carefully and care about it.
You bet.
Thanks Amit.
Okay. Thank you. And our next question will come from Tycho Peterson with JPMorgan. Please go ahead.
Hey, thanks. I’ll ask a couple on some of the emerging procedures. On bariatric, I’m just wondering if you can comment on some of the market development efforts now that you've got the SureForm stapler out there. And how should we think about the sleeve gastrectomy versus bypass versus maybe other procedures? And then separately, I noticed you both Calvin and Gary talked about chole. I'm just wondering if that's coming back a little bit relative to what we’ve seen in the past.
On the bariatric front, long-term we're really enthusiastic about, and in the near-term, we're optimizing a few things. We are optimizing the product portfolio in terms of some of the instruments that I mentioned in the script. So the Vessel Seal Extend and the SureForm 60. We're still in our first phase launch, which is building capacity in the supply side as well as working through our customer preference feedback.
That will start to expand into 2019 and it will be a measured launch. In part, to make sure that our supply capabilities match demand and in part, to make sure that our salesforce is well balanced in terms of supporting general surgery customers in hernia, which is growing nicely and colorectal, which is growing nicely, so that we have a balanced approach to the general surgery market.
So I wouldn't overbuild the near-term on it. I think in the long-term, it looks quite good. With regard to resolution on the quite – kind of the clinical approach question you asked underneath, sleeve versus bypass, a little too soon for us to work through it. Clearly, there's a mix in the market. How that mix applies to robotics? I think that's a question for future quarters.
On cholecystectomy, just touching that. We have seen strength in multi-port chole, a decline in Single-Site cholecystectomy made up for – more than made up for by strength in multi-port. For us, it's hard to know how much of that is a part of new general surgeons coming in versus how much of it is surgeons adopting or changing their practice pattern for patients that they think are well suited to robotics.
There is clearly a mix of both, and separating those two in terms of intent is very hard. So we mentioned it because growth numbers have been substantive. The sustainability of that growth, we're not ready to call yet.
Okay. And then if I can just ask one more clarification. Can you comment on the difference between the usage-based model and then operating lease for those systems that are kind of undertaking one of those?
Sure. Marshall?
Sure. Operating leases, frankly, we structure these things to meet customer needs and operating leases come in various flavors, including that we will do your traditional four-year lease with a bargain buy-out at the end. We also do short-term rentals to get them over budget cycles. And again, so we're ultimately pretty flexible on the leasing programs. The usage based programs really are based on time and usage over a period and we've done that with a few hospitals as we said that are well positioned in the market and are serious robotic users.
And in terms of reporting, Tycho, we are including these alternative structures in with the operating leases, right. So they're all included in the overall operating lease number. They’re just – think of it as another form of operating lease.
Okay. Thank you.
Thank you. And our next question will come from the line of Larry Biegelsen with Wells Fargo. Please go ahead.
Good afternoon. Thanks for taking the question. Two for me, I’ll just ask him upfront. Gary on the Q2 call you said hernia is moving to a different phase and it’s worth thinking through that phase? Can you elaborate that maybe you talked about some themes you're seeing in hernia?
And then separately, obviously with the CHEST meeting at AATS, the two robotic bronchoscopy platforms got more Wall Street attention. Gary, the differences seem to be between the two systems, the camera capability and the size of the working channel. How would you compare and contrast the two systems with respect to those differences? Thanks for taking the questions.
Okay, I think the conversation we had last quarter was a kind of question of what inning are we in hernia, and I think we're still in the first half of the game, but out of the first couple of innings. And why do I say that? I think you're starting to see a fair amount of data that's being collected and things like registries that’s able to show clinical benefit.
And we're seeing a fair amount of reorders from existing customers that does not appear that a lot of is just trailing. It looks like it’s – for those who have adopted their commitment to it appears to be pretty good. How deeply that goes into the total market in terms of what the total number of hernias out there is.
We still are struggling a little bit understand what fraction of the total available market of hernias will settle into robotic-assisted surgery in terms of size of the herniation and bilateral versus unilateral inguinal hernia repair and so on some of the segments of the underlying market are not yet resolved. And so that's uncertain. We'll see as we go forward. But the data, so far and the surgeons taking this has been good. So that's what we were seeing last quarter, I think that that holds up this quarter.
Turning to our Ion platform and as it relates to other products in the market. We made some decisions early on that that were really driven around, but we viewed as the clinical problem in pulmonology, which was the early detection of distal, meaning on the peripheral – on the further distant branches within the lung of suspicious lesions that are, give or take, a centimeter in size.
And to do that, you need a really good sensing, which we did that was through our shape-sensing technology and some of the first partnering that acquisition and development of Luna sensor. And then it was depended strongly on the size of the catheter. So we make that decision based on understand the physiology of the lung. Understanding where those nodules were and hoping to understand what dimensional pulmonologists and thoracic surgeons really needed.
That's what drove our architecture. We feel good about it. It’s possible technologically feasible to make a bigger catheter, making a bigger ones easier than making a smaller one, putting a permanent camera and if we needed to do that was all something that could be done and we chose not to. We chose to make it small and time will tell whether that was the right decision. I feel good about it.
Last point, I'd make about the long space is that this is a space that has been looking at early diagnosis of lung cancer for some time and forward several commercial teams have gone in and promoted products several of which have disappointed. So I don't think it's a market that will move on what's said. I think it's a market that will move based on true capability and clinical evidence, and that's where our focus is. We feel good about where we are and we show what we think we can and I think that will determine success for us.
Thanks for taking the questions.
Thank you. Okay. Our next question will come from Brandon Henry with RBC Capital Markets. Capital Markets please go have.
Yes, thanks for taking my question. Can you discuss any challenges you expect to face with the Ion rollout? And who will be selling these systems to pulmonologists? Will it be a separate salesforce or the existing Intuitive Salesforce? And then I have a follow-up?
I would anticipate the kinds of challenges that are related to that sort of complex product launches that we specialize in. So I think the early launches will be a couple of things it will be engaging with sites that have a long-term commitment to clinical progress, data collection that's associated with that clinical progress. Stabilizing supply chains or these kinds of technologies is non-trivial. It's hard and it's important.
And so we will do that for Ion for sure and stable supply chain allows you to support a larger customer base and also get your costs in line, and so that is routinely an exercise we need to do, and then building your technology training pipelines and the proctoring networks that are required to really expand launch. So those things are all in front of us in terms of Ion. That’s the challenge. The good news is that we have a history of engaging those challenges, and I think we’ll work through. And I miss the second part of the question.
And then who's the salesforce, that will be the existing salesforce or we have to build out a completely new salesforce? And just how will that look?
Yes. We have a small specialty team within our existing force. Right now, that’s deeply trained in this space and linked to our other key account leadership and management, so they are deep where they need to be and connected where they need to be.
Okay. And then as a follow-up separately, could you provide an update on some of the opportunities to enhance Intuitive’s vision and informatics portfolio? And specifically, could you touch on the recent – health agreement and where the company is at with its augmented reality technology? Thanks.
Sure. As we've said before for the last several years, we've increased our investments in imaging. I think imaging is important. I think it can really help change outcomes. And we do that routinely. We do it in the image sensors, in the endoscopes. We do it in the software that we use to process those images. In the way we tune images, we do it in our displays in our user interface. We are investing in molecules to expand our Firefly platform as you know. Molecules are just a way to increase the signal to noise for surgeons to detect structures they care about. Whether the things they want to take out or things they want to leave in and not disturb.
Informatics works hand in hand with that, certainly in OR informatics. So we have built cloud capabilities over the years. As you know, we've been the Internet-of-Things for surgical robots for a decade now. Over 90% of our systems are Internet connected.
So we have big data capabilities that we've built and we’ll continue to build. That allows us to do offline Informatics processing. And increasingly, we could use machine learning techniques and other things to do real-time capabilities. And of course over time that will give us the opportunity to do mixed reality or augmented reality features.
How fast they come and where are the first markets are? We're not prepared to discuss yet. I think it's interesting and a long-term pathway. And so that's a step in that direction. We've known InTouch and have worked with them together for many years and this was a just the deepening of that relationship and the ability for us to build some real strength internally to Intuitive as we accelerate our cloud capability.
All right. Thank you.
And our next question will come from Bob Hopkins with Bank of America. Please go ahead.
Thanks for letting me sneak back in. I just wanted to ask a question on Ion and flex catheter lung. Gary, how long will it take filing the approval of the product to generate the kind of efficacy data that you need to really drive broad adoption of the therapy?
Good question. I don't really know the answer right now. I think we'll get some early data that will be out of a few sites that will be quarters not years. There are multi-center studies that integrate that up and go through peer review cycle of course will be years not quarters. So I think you'll see as we have in the past, increasing cadence of publication just depending a little bit on what the complexity of the process.
And then if demand for SP is really high, do you have the capacity to meet that demand? I mean, I know you want to go slow and focus on the long-term, but if demand is high, can you meet it?
Yes. I think the focus upfront is two things. One is to work on expanded indications site. As you know, SP is a platform technology from our point of view. We have the first set of indications in neurology we submitted for the second set. In TransOral Robotic Surgery, we think there are other indications that will be important. So the first thing is to really make sure that we're putting systems out that will help us develop those indications over time. So that is important to us.
Second thing is that SP is amongst the most sophisticated products. I've ever been personally associated with, certainly that Intuitive has brought to market, and making sure that that we really understand and well characterized what our technologies are, and we have a really good stable supply chain before we go abroad is really important to us.
My enthusiasm over the long-term and the customer enthusiasm for its capabilities is very good. But I think we'll be measured in this next set of quarters. As indications come and as our confidence builds then of course we can always accelerate supply chain capacity, but we're going to take it in steps.
Great. Thank you very much.
Thank you. And our next question will come from David Lewis with Morgan Stanley.
Hi David. Welcome back.
Good afternoon. The suspense is killing me. I don't know that my question will live up to the suspense. This is terrible. But Calvin had mentioned in the prepared remarks the systems moderation in the fourth quarter just is there anything fundamental behind that other than just harder comps and obviously the increase implications of higher leases?
Yes. I think it's really – I mentioned comparisons in the prepared remarks. We actually kind of crossed over that 30% growth in placements threshold last Q4. And so now, this is the first quarter we’re comparing against that kind of comparison. And so this is a little tougher, but like I said, we still expect seasonally strong fourth quarter.
And Gary just you've got a lot of questions on this call on SP and Ion. I wondered just – a lot investors are focused on these platforms. From a commercial perspective, if I compare SP and Ion, which one is going to require greater channel development? And how would you compare the near and long-term opportunity for system placements and revenue across these two systems? Thanks so much guys.
As I think about it, SP is more familiar customer base. I think it has really interesting core clinical capability, which is the ability to work in small spaces and parallel access. And I have been pleased with surgeon response which has been – now that I have a raw capability like this. There's some different approaches that maybe available to us and they're interested in developing the data that helps that. But I think that that’s – our visibility on that is probably a little better because we know the customer base quite well.
As you look at Ion, I think Ion first is a diagnostic initial application that will have a little bit different set of dynamics for us as a company over time. I think the platform itself will have long legs. If you think about the ability to navigate tortuous pathways and inspect things using preoperative images which is kind of the core technology underneath. There are a lot of things that in the body could be interesting there.
But it'll take some time to develop it and given that those are a different set of procedures that are different call points for us, that will take more development for us and frankly for the competitors in the space as that develops out. So that's a more nascent market. I think very interesting in long-term possibility. You kind of ask how bigger the total available markets for these two different things and how do we think about future market capacity.
Those are highly uncertain. We of course, have models on them, we look at them. But as you know with us for years here that capability ultimately determines the total opportunity in the market and as capability is established with these things, we'll know better. As we get a little experience with them, we'll start to share with you our thoughts as the uncertainty starts to come down a little bit.
Great. Thanks so much.
Thank you. Our next question will come from the line of Larry Keusch with Raymond James. Please go ahead.
Yes. Hi, good afternoon. Gary just wanted to see if there are any observations or learnings from China over the last three months since the 2Q call?
Generally, no big change. As we've said before, we think demand in China for our products is real. And we're excited about it, and we think the long-term opportunity there is great. We think the macro trade environment is pressured, and we think that that pressure does not help us. And so incrementally, a little more headwinds on the micro side at the – on the ground side, we continue to make incremental progress and we keep working within the environment we have to work.
So I take it not a whole lot more visibility on just the process and in the quote itself.
Correct.
Okay. And then secondly, I know you obviously, choose your words carefully in the prepared comments and I think in the part around the 60-millimeter stapler you indicated that the sort of unusual feedback was encouraging. And I guess as I listened to that, I was wondering if that is meaning that look this is getting out there and people are starting to use it and it will take some time to you build the capabilities to get out there to drive more demand or does encouraging mean that perhaps you're seeing some things where you may actually need to tweak it a little bit before it's really ready for if you will prime time in 2019?
In terms of customer response has been quite good. The things that we're pacing – if you ask another way to answer your question is what's pacing launch? And there are really two things that are pacing us. One is, staplers are sophisticated devices to make and you want to make sure that as you expand your supply capacity that you're doing it in a very high quality level. So we're doing that.
The second one is that, we don't want to overwhelm our salesforce with enormous amounts of new and different products simultaneously. We want to give them time to be deep and be able to address customer interest and demand as it happens. Those are really the two pacing items.
Okay, perfect. Thanks very much.
And we have a question from the line Richard Newitter with Leerink Partners. Please go ahead.
Hi, thank you. Just in light of the operating expense growth coming in a little bit later than kind of what you were forecasting is when we’re operating leverage this year clearly. I was wondering if you could offer some thoughts on maybe some of those projects you say were getting deferred or it's a timing issue and maybe some color on how we should be thinking about operating leverage potential in 2019 with respect to spending?
Sure. My preference would have been that we had spent our full allotment now rather than understand. On the other hand, I'd rather spend it wisely, and spend it because I have it. Most of the spending has to do with human capital bring on staff and we're doing well. But there's kind of a natural rate for bringing on staff and we'll do it where we are bringing on outstanding, people and integrating them well.
It's not so much a specific product or project that is impacted and it's not so much that prototype dollars just rolled from one spot to another. There's a little bit of that, but that is the dominant effect. But dominant effect is really modulating the growth of headcount and that has to do with the pipelines for bringing in town.
Okay.
You asked a little bit of what does that imply for 2019 and as we said in our prepared remarks, we're seeing good procedure momentum in the marketplace and good demand and we want to make sure that we're able to meet that demand at high quality. We are not setting ourselves up to try to drive leverage in the 2019 model. Now we haven't finished all of that and we will do our spending models for 2019 into the next call. But directionally speaking, we want to make sure we can satisfy more demand here.
Okay, and just following up on one comment you made earlier. You said China as expected without increased capacity is moderating the growth in China continues to moderate. I'm just curious you can characterize that kind of the pace of moderation in growth that you're seeing there relative to kind of what you would have expected, is it not slowing as fast as you would have thought or is it in line with your expectations maybe just a little color there, so we can think about kind of how much of a headwind that might present going forward?
We continue to make progress on utilization on the systems that are in China. Last quarter, we talked about the China growth rate and procedures being fairly in line with the overall OUS growth rate, the low-20s. We're at a stage now or the moderation is at a moderate pace, if you will. And so you're gradually moving down from there I think.
Okay. Thanks.
Thank you. And our next question will come from the line of Isaac Ro with Goldman Sachs. Please go ahead.
Good afternoon. Thank you. Two questions, one on equipment and one on investment in the business, on the first one I was curious with the Xi upgrade cycle if you need me qualify where you think we are in that process. You said to us you have still a fair amount of opportunity.
And then secondly, on the expense side, Gary, you mentioned a little bit about the opportunities for training and I think that is a bit of a competitive advantage for you guys and so if you could maybe contrast how you think training for your pipeline will evolve not only for new applications, but also globally if you expand to other countries where medical practice is different. I’d be interested in sort of some of the things you're doing on the training side? Thank you.
Sure. On the Xi upgrade cycle or the generation-four upgrade cycle, just roughly speaking, I don't know how many Si are out in the world, but give or take…
2,500.
So I don't know exactly what I would say it sort of depends when we're done. But there is an installed base of Si over 2,000, that’s an opportunity for us as we go forward. I think your implication behind your training question is exactly right.
Building train capability is heavy lifting. It's a combination of human capital, people who are good at training and what that looks like instead of processes to build that are valid and you have validated. And then proctoring networks and proctoring networks are your customers, our customers who are deeply experienced and have teaching capability and willing to teach others, and so we develop those things.
We have built a set of tools internally that allowed us to gain some efficiency and being able to spread that capability into new markets, and so that helps us. And we think that doing that well and doing that efficiently is something that does worth the investment and we have done so. What is its long-term competitive advantage? I don't know exactly. But I believe it's important for our customer and therefore important for the Company. Perhaps just one last question and then we will close here.
Thank you. Okay. So our last question will come from Vijay Kumar with Evercore. Please go ahead.
Hey guys. Thanks for squeezing me in and congrats on the – really impressive procedure number. So maybe Gary or Marshall, just starting on the procedure number, the guidance is 2018, right? So when you think about next year number of factors at play, just how do you think the procedure number is going to look like? Should we be thinking of a really strong number?
You made some comments on hernia. We're still at the very early stages of this hernia pick up. You have couple of new products coming in, so I'm just curious and how that number should trade-in. Just given lease, it looks like the percentage of lease is going to increase next year, right? So when we're thinking about modeling revenues for next year, if you could just explain the procedure how we should think about it? I think that would be extremely helpful. Thank you.
Yes. Hi Vijay, it’s Calvin. Obviously, we will give our specific procedure guidance on our next call in January, but we do anticipate the drivers of procedure growth and 2019 to be fairly consistent with what we saw this year in 2018 and last year in 2017, namely U.S. general surgery, U.S. thoracic surgery and OUS procedures, broadly speaking driving the lion's share of growth.
U.S. general surgery is now our largest specialty, yet as we’re describing, we’re in still fairly early stages for hernia repair with ventral and inguinal colorectal procedures as well and even earlier stages for some of the broader practice space procedures.
On the OUS side, we’re investing in growth in the larger European countries. Japan, China, Korea, OUS driving growth. And when we talk about what can lead to some of the variability and the potential range of growth, would be obviously the pace and breadth of that U.S. general surgery growth, U.S. mature procedure trends, any change in the China systems quota, positive or negative. And then in Japan, the pace of adoption on the 12 new reimbursed procedures.
End of Q&A
All right. Well, thanks Calvin, thanks Vijay. That was our last question. As we've said previously, while we focus on financial metrics such as revenues, profits, and cash flow during these conference calls, our organizational focus remains on increasing value by enabling surgeons to improve surgical outcomes and reduce surgical trauma. We've built our Company to take surgery beyond the limits of the human hand. And I assure you, we remain committed to driving about a few things that truly make a difference. This concludes today's call. 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.
Ladies and gentlemen, that does conclude our conference for today. Thank you for your participation and for using the AT&T Executive Teleconference service. You may now disconnect.