Intuitive Surgical Inc

NASDAQ:ISRG

Earnings Call Analysis

Company Refines Financial Guidance for 2023

The company updated its financial outlook for 2023; procedure growth is now expected to be 21-22%, up from a previously forecasted range of 20-22%. This reflects ongoing uncertainties related to healthcare trends and macroeconomic conditions but does not account for significant supply chain or hospital capacity issues. Pro forma gross profit margin estimates have been narrowed to 68-68.5%, while operating expense growth projections were adjusted to 12-14%. Noncash stock compensation expenses are predicted to be between $600 million to $610 million, and other income expectations were raised to $190 million - $200 million, reflecting increased interest rates. Capital expenditures are projected to be $900 million - $1 billion, and the pro forma tax rate forecast has been refined to 22-23%.

System Placements and Procedure Growth Drive Revenue Upsurge

The company experienced substantial growth in Q3, with system placements increasing to 55 Ion systems, up from 50 in the same quarter the previous year, marking a 10% growth. They performed approximately 14,500 Ion procedures, a notable 125% surge compared to last year's third quarter. This substantial procedure growth, particularly in SP systems, is pivotal as system utilization spiked by 21%, hinting at increasing adoption and efficiency of the company's offerings.

Financial Health Highlighted by Solid Profit and Growing Margins

The company's financial metrics were solid, with pro forma gross margins at 68.8%, just a notch below the previous year's figure of 69.8%. The slight decrease dealt with a change in revenue composition favoring the Ion business which has lower margins compared to the da Vinci business and the impact of lower system average selling price (ASP), although these were partially offset by price increases in other areas. They managed an impressive pro forma net income of $524 million or $1.46 per share, up from $429 million the prior year. Equally telling is the disciplined control over operating expenses which only rose by 8% from the previous year despite increasing their workforce significantly to support growth.

Optimistic Adjustments to Full-Year Forecasts Signal Confidence

Looking ahead, the company raised the lower end of its 2023 procedure growth outlook from 20% to 21%, now expecting to end the year between 21%-22%. This ambitious revision likely reflects the company’s confident stance on procedure volume resilience amidst potential macroeconomic headwinds. Additionally, there's a prudent refinement in operating expense growth projections, now forecasted to be between 12% and 14%, pared down from an upper limit of 15% priorly indicated. Their keen attention to efficiency and growth prospects is clear in these targeted adjustments.

Market Expansion and Pricing Dynamics Reveal Strategic Foresight

The company is adapting to a dynamic global market environment, with currency exchange rates—particularly in Japan—having an impact on ASPs to the tune of 30%-40% due to the strong U.S. dollar. Meanwhile, competition, especially in China, prompted some competitive pricing adjustments. Notably, these geopolitical and economic forces shape the company’s strategic pricing, as they balance between expanding current market penetration and entering new geographic locales.

Gross Margin Improvements Hinge on Operational Efficiencies

Looking into the midterm, the company strategically aims to surpass 70% gross margin. This goal reflects an upbeat future where potential supply chain relaxations and cost-saving initiatives would bear fruit. The company's dedicated plans to lower product costs anticipate these improvements as supply chain stresses abate, ultimately contributing positively to their overall profit structure.

Earnings Call Transcript 2023-Q3

[Operator]

Thank you, everyone, for standing by. Welcome to the Intuitive Surgical Q3 2023 Earnings Release. [Operator Instructions]

I will now turn the conference over to your host, Head of Investor Relations, Intuitive Surgical, Brian King. Please go ahead.

[Brian King, executive]

Good afternoon, and welcome to Intuitive's Third Quarter Earnings Conference Call. With me today, we have Gary Guthart, our CEO; Jamie Samath, our CFO; and Dr. Myriam Curet, our Chief Medical 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 our Securities and Exchange Commission filings, including our most recent Form 10-K filed on February 10, 2023, and Form 10-Q filed on July 24, 2023.

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 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, Jamie will provide a review of our financial results, Myriam will present clinical highlights, and I will discuss procedure details and provide our updated financial outlook for 2023. And finally, we will host a question-and-answer session.

With that, I will turn it over to Gary.

[Gary Guthart, executive]

Thank you for joining us today. In this third quarter, we saw a strong growth in procedures performed by our customers, solid new system placements and healthy growth in utilization amid market conditions that remain largely consistent with Q2.

Our new platforms continue to gain ground with Ion installs and procedure growth continuing, SP installs and procedure growth modestly accelerating and healthy growth in customer use of our digital tools.

Turning first to procedures. da Vinci procedure growth in the quarter was 19%. Areas of strength included general surgery for benign conditions, particularly in the United States and broad regional growth with Germany, Japan, the U.K. and India standouts. China procedure growth was in line with our global average in the quarter. U.S. dermal surgery procedure growth was led by cholecystectomy and colon resection.

Ion procedures showed continued strength with 125% growth in the quarter. SP procedure growth accelerated with 54% global growth in the quarter driven by strength in the United States.

On the capital front, we placed 312 systems in Q3 compared with 305 systems in Q3 of last year. Our clinical installed base now stands 8,127 multiport da Vinci systems, 490 Ion systems and 158 single-port da Vinci systems.

Overall, our capital placement trends reflect demand for additional capacity in multiport, continued greenfield interest in our Ion system and a modest acceleration for placements of SP. The proportion of leases for new capital placements accelerated in the quarter with the U.S. using the highest leasing rates. We think the acceleration in leasing reflects the convenience of our leasing program and the maturity of our Generation 4 multiport systems.

While leasing reduces in-quarter revenue relative to capital purchase, total economics are healthy for our customer and for us. Leasing allows our customers to build clinical capacity when and where they need it and provides predefined pathways for our new technology as it enters the market.

The growth rate in system utilization, defined as procedures per installed system per quarter was 6%, down from 9% last quarter while still above historical growth rates.

Strong procedure growth and increased proportion of use in benign indications shortens average procedure times and needs of scheduling. Higher utilization increases our customers' return on invested capital and is economically healthy for us.

Turning to our finances. Our revenue grew 12% in the quarter and our operating expenses were within our spend guidance. Our spending reflects continued investments in research and development to support the growth of our platforms and digital tools, expansion of our manufacturing and commercial footprints and capital amortization.

Looking at the broader picture, our fourth-generation da Vinci platform is operating at global scale and embedded in a robust ecosystem of instruments, accessories, training and services. Customer acceptance of our Ion platform is strong. Acceptance of our da Vinci SP is accelerating with new indications in the pipeline, and our digital tools are building momentum through their early stages.

We welcome Dr. Myriam Curet, Intuitive's Chief Medical Officer to this call, and she will take us through our clinical perspective and some of the work we're doing to expand indications.

Our operations teams did a fantastic job supporting our customers through the supply chain shocks of the past several years. This unavoidable effort diverted resources away from product cost reduction and as supply chain stresses ease, we're now pivoting our attention to once again lowering our product costs.

Areas of opportunity include our Ion program, our SP accessories portfolio and our multiport accessories in advanced instrument lines. Given the timing of facilities completion, manufacturing efficiency improvements for new products and other complex projects, we expect variability in gross margin over the coming quarters as we work through these programs.

Turning to our digital offerings, customer use of our digital tools and channels is growing nicely. Our SimNow surgical simulators are installed at the majority of our customer sites and subscription renewal rates are outstanding. Routine use of My Intuitive app by over 10,000 da Vinci surgeons grew by 140% year-over-year and is receiving strong Net Promoter Scores that continue improving over time.

Our Intuitive Hub media management and telepresence system installations grew 58% in the quarter, and Hub captured surgical cases grew 61%.

In closing, core demand is healthy. We're focused on in our ecosystem internationally and driving our product cost down, particularly for our newer platforms. We are dogged in pursuit of significant long-term opportunity to improve the quadruple aim using our integrated ecosystem powered by analytics, and we are pacing our investments to catalyze that opportunity.

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

[Jamie Samath, executive]

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.

Core metrics continue to be healthy in Q3, with global procedure growth of 19% and an increase in the installed base of da Vinci systems of 13% and an increase in average system utilization of 6%. Our key financial indicators were also healthy. Third quarter recurring revenue grew 21%. Pro forma operating margin was 36%, and pro forma earnings per share increased 23% over last year.

Procedures in the U.S. grew 17%, reflecting a lower benefit from patient backlogs as compared to the first half of 2023.

Last quarter, we highlighted that our growth rate in bariatric's procedures in the U.S. had slowed given patient interest in weight loss drugs. In Q3, we continued to see double-digit growth albeit at a modestly lower growth rate as compared to Q2. Bariatric's procedures represent between 4% and 5% of total global procedures.

Based on third-party data, we believe we continue to gain market share in the bariatric surgical segment.

OUS procedures grew 24% with relative strength in India, Germany, the U.K. and Japan. Procedure growth in China was consistent with our expectations, lower than last quarter due to a strong base period given the recovery from COVID-related lockdowns in the year ago quarter.

Consistent with recent trends, growth in non-neurology procedures outside of the United States was accretive, growing at approximately 31%. Within the larger cancer categories, our fastest-growing OUS procedure is colon resection, a high-value procedure led by adoption in Japan, Germany and the U.K.

With respect to capital performance, we placed 312 systems in the third quarter as compared to 305 systems last year. As a reminder, system placements in Q3 of last year benefit from a delay in the shipment of approximately 15 systems from June into July as a result of supply chain challenges we encountered in June of last year.

Late in Q3, we started to see delays in tender processes in China, primarily as a result of anticorruption efforts by the central government, resulting in lower system placements in China in Q3. We expect tender delays to continue to impact system placements in China in Q4.

Q3 revenue was $1.7 billion, an increase of 12% year-over-year. Q3 revenue growth was driven by procedure growth, partially offset by an 11% decline in systems revenue due to the significant increase in the mix of operating lease arrangements.

On a constant currency basis, third quarter revenue growth was also 12%. Given recent movements in exchange rates, at current rates, the U.S. dollar is approximately 3% stronger on a revenue-weighted basis as compared to the average rates realized in Q3. Revenue denominated in non-USD currencies represent approximately 24% of total revenue.

Additional revenue statistics and trends are as follows: in the U.S., we placed 159 systems in the third quarter compared to 175 systems placed last year. Outside the U.S., we placed 153 systems in Q3 compared with 130 systems last year. Current quarter system placements included 60 into Europe, 32 into Japan and 10 into China compared with 54 into Europe, 32 into Japan and 15 into China in Q3 of last year.

62 of the 312 systems placed in Q3 were trading transactions compared to 71 trading transactions in the third quarter of last year. As of the end of Q3, there are approximately 440 SIs remaining in the installed base, of which 85 are in the U.S.

Operating leases represented 52% of third quarter placements compared with 37% last year. In the U.S., 70% of system placements in Q3 were under operating lease arrangements compared to 48% last year. Of the 163 operating lease placements in the quarter, 93 were usage-based arrangements, an increase compared to 54% last year, reflecting customer preferences, particularly in the U.S.

While leasing may fluctuate from quarter-to-quarter, we continue to expect that the proportion of placements under operating leases will increase over time.

Q3 system average selling prices were $1.4 million as compared to $1.39 million last quarter from $1.5 million last year. The year-over-year decrease in system ASPs was primarily driven by lower pricing and geographical mix. We recognized $17 million of lease buyout revenue in the third quarter compared with $12 million last quarter and $17 million in Q3 of 2022.

da Vinci instrument and accessory revenue per procedure of approximately $1,830, compared with approximately $1,840 last quarter and $1,800 last year. On a sequential basis, lower I&A per procedure reflected the impact of customer ordering patterns, partially offset by a full quarter impact from the I&A price increase that went into effect halfway through last quarter.

Turning to our Ion platform. In Q3, we placed 55 Ion systems as compared to 50 in Q3 of 2022. Third quarter Ion procedures of approximately 14,500 increased 125% as compared to last year. 16 of the systems placed in the third quarter were SP systems, 12 into the U.S. and 4 into Korea. SP procedures grew by 54%, and average system utilization growth continued to accelerate growing 21% compared to Q3 of last year.

Moving on to the rest of the P&L. Pro forma gross margin for the third quarter was 68.8% compared with 68.5% last quarter and 69.8% last year. As a reminder, pro forma gross margin in Q3 of last year included a onetime benefit of approximately 50 basis points related to the favorable conclusion of certain indirect tax matters.

The remaining year-over-year difference in pro forma gross margin is primarily due to a higher mix of the Ion revenue, which currently carries significantly lower margins as compared to the da Vinci business and lower system ASP, partially offset by the I&A price increase.

Inventory increased to approximately 180 days in Q3, higher than historical averages, driven by 2 factors: first, we have modestly increased our inventory targets given supply chain stresses over the last couple of years; and secondly, given significant capital investments we are making in manufacturing facilities and capacity, we are building bridge inventory to facilitate an elevated number of line transfers to new locations. As a result, we expect higher levels of inventory relative to historical norms into 2025.

Third quarter pro forma operating expenses increased 8% year-over-year, driven primarily by higher headcount-related costs.

During the quarter, our head count increased by 489 employees, of which approximately 275 were for our manufacturing operations in support of revenue growth. SG&A expenses as a percentage of revenue were lower by 100 basis points as compared to Q3 of last year and largely reflected planned leverage in our enabling functions.

Pro forma other income in Q3 was $58 million compared to $42 million last quarter and $7 million last year. Other income primarily consists of interest income and the increase as compared to last quarter was driven by higher interest rates and higher average cash and investment balances. Pro forma other income in Q3 of last year also reflected higher than typical foreign exchange losses resulting from remeasurement of the balance sheet as a result of the strengthening U.S. dollar.

Capital expenditures in Q3 were $256 million, primarily comprised of infrastructure investments to expand our facilities footprint and increase manufacturing capacity. Our pro forma effective tax rate for the third quarter was 22.5%, consistent with our expectations.

Third quarter pro forma net income was $524 million or $1.46 per share compared with $429 million or $1.19 per share for Q3 of last year.

I will now summarize our GAAP results. GAAP net income was $416 million or $1.16 per share for the third quarter of 2023 compared with GAAP net income of $324 million or $0.90 per share for the third quarter of 2022. 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 $7.5 billion compared with $7.1 billion last quarter. The sequential increase in cash and investments reflected cash from operating activities and proceeds from employee stock exercises partially offset by capital expenditures.

And with that, I would like to turn it over to Myriam, who will discuss clinical highlights.

[Myriam J. Curet, executive]

Thank you. Now turning to the clinical side for our business. Each quarter on these calls, we highlight certain 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.

In addition to relaying the results of one of these studies, I'd like to start by describing the status of some important Intuitive research projects underway that support our company's belief in the potential value of da Vinci systems specifically our single-port system for procedures requiring refined access to tight or difficult to reach anatomical areas.

In June 2021, Intuitive launched an FDA-approved clinical study focused on complex colorectal procedures, such as low anterior resection or right colectomy, performed using the SP platform. Currently, enrollment is complete with 60 patients across 9 sites in the U.S. and Korea.

Another FDA-approved trials for rapid procedures in pulmonary lobectomy and thymectomy performed using SP completed enrollment in June of this year with 32 subjects enrolled across 6 centers in the U.S.

We believe that Intuitive single-port technology will enable thoracic surgeons to perform uniportal lobectomy, something that may be difficult using a VATS approach. Intuitive intent to submit data from these 2 studies to the FDA after the patient follow-up outlined in the study plan and the data analysis has been completed.

Now I'll turn to a notable study published in the Annals of Surgery this past August. This study was not sponsored by Intuitive. Dr. Yogita Patel of McMaster University in Canada published early results from the RAVAL trial in a manuscript titled Robotic Lobectomy is cost effective and provides comparable health utility scores to video-assisted lobectomy.

This study describes results from a multicenter, multinational, blinded, randomized controlled study comparing the da Vinci and VATS approach to pulmonary lobectomy. It analyzed 164 subjects, 81 in new robotic-assisted group and 82 in the VATS group. And all robotic-assisted lobectomies were performed with a da Vinci multiport platform.

Notably, the health utility score was significantly higher in the da Vinci arm at 7 weeks and 12 weeks post procedure, which suggests the quality of life for patients who underwent a da Vinci lobectomy was better than for patients undergoing the VATS procedure.

Interestingly, and related to quality of life outcomes, the authors analyzed the incremental cost-effective ratio or ICER for the robotic group relative to VATS and reported the robotic group was associated with a gain of approximately $11,000 per quality adjusted life year.

In addition, the median number of lymph nodes examined and sampled were significantly higher in the da Vinci Group.

To summarize, the authors conclude that, "Early results from the RAVAL trials suggest that robotic pulmonary lobectomy is a cost-effective intervention, which is associated with comparable patient-reported health utility scores when compared to VATS lobectomy."

And with that, I would like to turn it over to Brian who will discuss additional procedure highlights and provide our updated outlook for 2024.

[Brian King, executive]

Thank you, Myriam. Our overall third quarter procedure growth was 19% year-over-year compared to 20% for the third quarter of 2022 and 22% last quarter. In the U.S., third quarter 2023 procedure growth was 17% year-over-year compared to 18% for the third quarter of 2022 and 19% last quarter. Q3 growth was led by procedure strength within general surgery, with particular strength in cholecystectomy and colon resection.

Outside of the U.S., third quarter procedure volume grew 24% compared with 24% for the third quarter of 2022 and 28% last quarter. OUS growth was led by procedures beyond urology, which now make up approximately 50% of total OUS procedures.

General surgery growth was strong, primarily in colorectal procedures followed by growth in gynecology procedures. Growth in urology continued to be healthy, led by kidney procedures, along with continued double-digit growth in prostatectomy.

In Europe, we experienced strong growth in Germany, the U.K. and Spain. In each of the regions noted, procedure growth was led by general surgery, primarily from colorectal procedures and specifically in Germany and the U.K., hysterectomy procedures also contributed to strong growth.

In Asia, growth was led by Japan. More than half of the incremental procedure growth in the country was led by strong growth in general surgery procedures, consisting largely of colorectal and gastrectomy procedures. In China, procedure growth was consistent with our expectations for the quarter.

Growth was driven primarily in neurology, notably by prostatectomy and kidney procedures.

In India, while in the early stage of adoption, saw strong growth in general surgery procedures, namely cholecystectomy and hernia repair and growth in gynecology procedures.

I will now turn to our financial outlook for 2023. Starting with procedures. On our last call, we forecasted full year 2023 procedure growth within a range of 20% to 22%. We are now raising the low end from 20% to 21% and expect full year 2023 procedure growth of 21% to 22%. The low end of the range reflects uncertainty around the duration of elevated procedure volumes with patients returning to health care, a continued slowing of bariatric growth rates in the U.S. and macroeconomic challenges that could impact hospitals and patient spending.

At the high end of the range, we assume macroeconomic challenges do not have a significant impact on hospital procedure volumes, and bariatric growth rates in the U.S. continue at the rate we experienced in Q3. The range does not reflect significant material supply chain disruptions or hospital capacity constraints.

Turning to gross profit. On our last call, we forecast our 2023 full year pro forma gross profit margin to be within 68% and 69%. We are now refining our estimate of pro forma gross profit margin to be within 68% and 68.5%. Our actual gross profit margin will vary quarter-to-quarter depending largely on product, regional and trade-in mix 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 12% and 15%. We are adjusting our estimate and now expect our full year pro forma operating expense growth to be between 12% and 14%. We are also refining our estimate for noncash stock compensation expense to range between $600 million to $610 million in 2023, lowering the range from our previous estimates of $600 million to $620 million.

We are increasing our estimate for other income, which is comprised mostly of interest income, to total between $190 million and $200 million in 2023, an increase from our previous estimate of $160 million and $180 million. The increase primarily reflects the rise in interest rates.

With regard to capital expenditures, we are narrowing our estimate to range between $900 million to $1 billion, primarily for planned facility construction activities. With regard to income tax, we are also refining our estimate for the 2023 pro forma tax rate to be between 22% and 23% of pretax income, reducing the previous estimate of the upper end of the range from 24% to 23%.

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

[Operator]

[Operator Instructions] We go to the first question from the line of Robbie Marcus, JPMorgan.

[Robert Marcus, analyst]

Congrats on good quarter. Maybe to start, it's hard to escape it. GLP-1 is becoming a very big topic in med tech. And your -- it's impacting bariatric surgery here. It doesn't seem to be impacting anything else, particularly in the pipeline. But just wondering your thoughts overall, could GLP-1s ultimately be a positive as more people try weight loss surgery and come in the funnel? And any other impacts good or bad that you foresee on business?

[Gary Guthart, executive]

Thanks, Robbie. I'm going to ask Dr. Curet as a bariatric surgeon to go ahead and weigh in on that first part of your question, and we'll talk about the broader implications after that.

[Myriam J. Curet, executive]

I think you are correct. I think in the short term, we will see patients who are considering or are in the pipeline for bariatric surgery going to try the drug. However, given compliance issues, costs, side effects, we expect that many of them will not stay on the drug for longer than a year or 2. And at that time, we'll consider bariatric surgery. So I think overall, we'll see an increased interest in bariatric surgery, but that will get delayed in the short term.

[Gary Guthart, executive]

Robbie, any follow-up you wanted on GLP-1s?

[Robert Marcus, analyst]

No, I had a financial question for Jamie, if that's okay, after.

[Gary Guthart, executive]

Please.

[Robert Marcus, analyst]

Jamie, it looks like the fourth quarter gross margin is ticking down a bit, and you're talking about the increased depreciation cost and some of these new investments here. I was wondering if you could size the amount, and I'm really looking for how to think about into next year with depreciation, so we could get our gross margin set based on whatever expansion or contraction we're all forecasting.

[Jamie Samath, executive]

Yes. For Q4, you're not really seeing significant depreciation and expense reflected in the range that we provided. That's really more next year as some of the manufacturing capacity in facilities come online.

What you're seeing in Q4 really is a little bit of FX given how the rates have moved, a little bit of slower progress in some of the line transfers and product cost reduction plans that we have, that's not a large delay. It's just slightly slower than we had planned. And then there's some mix dynamics reflected in Q4. They now to be relatively small, but those are the dynamics as to why gross margin range for the year is at the midpoint, slightly lower than what we had previously.

With respect to how '24 is shaping up, what I would just say is, as Gary said in his prepared remarks, we'll see some variability in gross margin over the next several quarters is the depreciation expense and the ongoing efforts to improve our product costs, particularly on the Ion side. And frankly, there are some accumulated inefficiencies just in our global manufacturing operations. They built up over COVID and because of the supply chain issues that we encountered that we're addressing. And a number of those will take time for us to resolve.

So I'd say let us give you '24 guidance for gross margin when we get to January because I think we still have to work through those plans.

[Operator]

We'll go to the next line, Travis Steed, Bank of America.

[Travis Steed, analyst]

I guess to follow up on that. I know on the prepared remarks, it sounds like Gary said, manufacturing improvements for new products and other complex projects. So just curious if you could elaborate on some of those new products and complex projects and what those are that's impacting the gross margin.

[Gary Guthart, executive]

Yes. On the product side, we have real work to do on Ion. Ion is well accepted by the customer base, growing quickly. We need to iterate and drive manufacturability and manufacturing costs on Ion. So that was mainly what I was referring to.

Some of the accessories in the SP line are real opportunities. We want to be assertive there. So on the product side, that's most of what the reference is.

[Jamie Samath, executive]

Just one other element. We are in-sourcing a high-volume accessory on the multiport side as part of in-sourcing that there's some differential automation in the line there. And so ramping that, there's some work to get that to be at our targets.

[Travis Steed, analyst]

Great. Helpful. And coming into this year, on the procedures, some of the swing factors were China, staffing pressures and COVID. And I imagine like going into '24, there's bariatrics in China, some of the swing factors. Maybe you could just talk about some of the swing factors on 2024 procedures, pluses and minuses and do you think China and bariatrics are still going to be growing and adding to the growth in procedures in '24?

[Brian King, executive]

Travis, this is Brian. I guess thinking of 2024, nothing really to share at this point. Clearly, I think when we get into January, we'll be able to give you a bit more insight. But I guess I'll just leave it at that for now.

[Gary Guthart, executive]

Let me just pick up 2 topics you hit. On the China side, I think the procedure demand side remains robust. I think there's some government policy activity that's putting a little bit of a chill in the market. Some of that is economics, so price caps and value-based pricing and some of it is in any corruption probe that is giving hospitals some pause moving forward with other new programs.

We'll see. I think the China side is likely to -- some pressure on the China side is likely to persist for several quarters.

On the bariatric side, I think we'll find a new normal in the next few quarters. It's hard to predict exactly when that will happen. We'll see that play out in the marketplace.

[Operator]

We go to next line, Larry Biegelsen, Wells Fargo.

[Larry Biegelsen, analyst]

Gary, your usage-based leasing program has gotten some scale. Can you talk about the utilization rates on those systems relative to the average? And any other themes you could share?

[Gary Guthart, executive]

Sure. I will turn to Jamie here on kind of utilization rates. So why don't you kick that off?

[Jamie Samath, executive]

Yes. There's 2 ways to look at it, Larry, what is the absolute utilization rate compared to a regular leasing compared to a purchase arrangement. They are very similar. Actually, the tightness on the mean between those 3 structures is very tight.

Within those arrangements, you generally have a target procedure level that reflects success of the program for the customer and the economic objectives that we have. And if you accumulate again, the portfolio they run at slightly above the targeted procedure levels that we have embedded in the contracts. So they have run very well so far, and it's one of the reasons why we and the customer have expanded those so quickly in recent times.

[Larry Biegelsen, analyst]

That's helpful. And leasing in the U.S., where do you see that going? I mean, it was almost -- it was over 70 this quarter and last quarter. Have we plateaued? Or does that continue to go higher?

[Jamie Samath, executive]

On a global basis, we expect the proportion of placements that are leased to continue to find. U.S. is pretty high, as you pointed out, Larry, 70% this quarter, 78% last quarter. There will be some larger IDNs that just routinely prefer to purchase just because of how that affects the metrics that are important to them. But even in the U.S., I think there's some room for that to continue to creep up a little bit, obviously, running out of room. We found a number of U.S. customers have really appreciate that as a way to manage through what are totally managed capital budgets.

[Operator]

Next, we have Brandon Vazquez, William Blair.

[Brandon Vazquez, analyst]

Maybe my first one, I wanted to talk a little bit about general surgery, that's obviously been a nice growth path for you here in the U.S. My understanding is it's a little less penetrated international. What do you think needs to happen in the international markets to kind of get on that steep part of the adoption curve for general surgery as well? Are they kind of seeing time lines and catalysts in the U.S?

[Gary Guthart, executive]

Sure. Thank you for the question. On -- one way to think about it is that general surgery comprises both procedures that are done where cancer is the underlying cause and others that are benign indication.

On the cancer as an underlying cause, we're seeing nice early growth in several OUS markets. So there, I think that's healthy, and we're enthused. I think reimbursements are generally in place in many of the places that we are operating. I think that's what good in clinical data coming out has been supportive.

I think that as you think about benign indications, we're seeing some of the beginnings of benign indications in some markets, there may be reimbursement work or education of insurers that has to be done for those to progress further. So in that setting, we'll have additional work to do as it plays out.

[Brandon Vazquez, analyst]

Great. And then maybe last one for me as a follow-up, I think last quarter, you guys were talking a little bit about launching, I believe it was called Case Insights, kind of the software AI platform. Any kind of updates on that end? How are things going so far? And maybe what's in the future for that program?

[Gary Guthart, executive]

Yes. Thank you for the reference. So Case Insights is our machine learning AI program that looks at surgical science. We have our first installs and first cases going. We had talked about it with you last quarter. So far, early feedback, and it's super early. We're really in the early innings here is very good. Case Insights builds on some prior research that we had done with academic centers on something that we have described as a computational observer. So we have some pretty good scientific underpinnings for it.

We expect over time that, that program will feed insights into different parts of the hospital's analytic system from giving specific guidance to learning surgeons and care teams about where they might improve their technique and skills to giving suggestions to programmatics about efficiency and total cost management, to giving other insights for the company about how to improve procedures in the OR.

So we think it's a long-term set of investments around really the science of surgery. We remain extremely excited about it. While we do have some revenue for it, we don't expect it to be a serious revenue driver. We think it is an ecosystem complementor. And we look forward to describing it more to you as time goes on.

[Operator]

We'll go next to Matt Miksic, Barclays.

[Matthew Miksic, analyst]

So I had one question on -- follow-up on kind of the bariatric trends and one on sort of the system leasing effect on pricing. So bariatric, if you could maybe talk about -- you mentioned the global percentage of procedures that bariatric represents maybe just the growth trajectory of that business in the second quarter and the third quarter and whether that's something you expect to grow at a similar trajectory or bottom out given your comments on folks getting on the drug or getting off saying a year or 2 to kind of suggest maybe a longer path to stabilization in that business line within. And then I'll just follow up briefly with the question on ASPs, if I could.

[Gary Guthart, executive]

Yes. Jamie, you might speak to kind of what the size or percentage of that business is for us and a little bit of the acceleration or deceleration trend.

[Jamie Samath, executive]

Yes. And I want to make sure I got it right, Matt. So come back to me if I have the wrong questions. But our total bariatric business represents about 4% to 5% of global procedures. What you saw in Q2 was in the U.S., which is where the majority of our bariatric procedure volumes are, in the U.S., the growth rate declined to about the U.S. average and then what we saw in Q3 was it modestly decline a little further in Q3. Were those your questions?

[Matthew Miksic, analyst]

Yes. No, that's very helpful. And then I guess, just your expectation -- you framed out in terms of your guidance, but I mean, is this -- I mentioned it just because one of the other competitors actually saw a decline, I guess, in laparoscopic bariatric or some [indiscernible] open in the third quarter, single-digit decline, but it doesn't seem like you're in that zone, right? You're still at or slightly below your average growth rate in the U.S. Is that -- am I hearing you answer correctly?

[Jamie Samath, executive]

Well, if you take our procedure growth in bariatrics relative to market, we're taking share and have been for some time. So the fact that we had double-digit growth in Q3 relative to another company that had a decline, that's just a reflection in part of the fact that we are taking share in bariatrics and continue to do so even though there's an impact to overall bariatric surgery because of GLP-1s.

[Matthew Miksic, analyst]

Got it. That's very helpful. And then the other -- just ASP, I understand the system ASP you give is not -- does not -- as your U.S. leasing goes up, as I understand it, those leased systems in the U.S. are not included in that ASP calculation. So if you could maybe just speak to -- I don't know, the way in which the increased leases have affected ASP or whether this is straight up year-over-year decline that suggested in sort of the overall numbers that you provide, if that's a clear question.

[Jamie Samath, executive]

So everything you described is correct. Generally, although there can be exceptions for mix effect, generally U.S. system ASPs when purchased are accretive to the global average. So in effect, as leasing has grown significantly in the U.S., that in and of itself has an adverse effect for calculated system ASP.

The other thing that you see then with now a greater proportion of systems used to calculate that system ASP being international FX can have an effect if you look on a 2-year horizon. So for example, the exchange rate in Japan based on how the U.S. dollar has strengthened, there's a 30% to 40% impact over a 2-year basis on system ASP in Japan as translated. So there is a geographical effect.

And if you look at a long enough horizon, there's an FX effect in what we described in Q3 was in terms of the year-over-year decline in ASP, also a dynamic relative to pricing and that's really just as we expand our existing customers who are looking for a third, fourth, fifth system, those tend to be slightly lower ASPs than you've seen previously when they were greenfield accounts.

I would say that in China, we do see some competitive dynamics with respect to pricing just given the number of lower local players. And so there's been some competitive effect on system ASPs in China specifically. We don't really see that in other markets to this point.

[Operator]

And we'll go to the next line. Jayson Bedford, Raymond James.

[Jayson Bedford, analyst]

Gary, I think you've expressed your views on the role of bariatric surgery in a GLP world. I'm just wondering if these views have changed in any way over the last quarter or 2? I know it's not a lot of time, but the adoption of this class of drugs is obviously ramping quickly. And then just as kind of a related follow-up, getting back to Robbie's question on the potential impact of GLPs beyond bariatrics. Do you expect an impact from some of your other procedure categories as GLPs get adopted?

[Gary Guthart, executive]

On the first one, I think Myriam described it well. Our position on GLP-1s as it relates to bariatric surgery, I think she hit it well at the start of the call, no reason to reiterate it here.

On the issue of potential impact beyond bariatrics, there may be some, although I think as you think through the analysis, I think it will be modest.

And here's how we think about it. If you look at obesity and diabetes is risk factors in other domains and other diseases for which surgery is performed, they are sometimes positive correlated risk factors for that disease. In some weird cases, they are negative in cases that it's actually protective against disease. So it's not entirely obvious.

In most of the diseases that we treat as we look at it, it is not the dominant risk factor. So as we look out and think about what could it be like in our TAM, we can kind of do a back of the envelope analysis. It is really early. I don't think anybody knows the exact number. What I can say is that it's not the dominant risk factor in most things that we look at. And we have a very large unpenetrated TAM. I think that we're still in the early innings of what we're trying to work on. So if these drugs are highly effective at avoiding other types of diseases, we will cheer. I still think we have a lot of upside opportunity to pursue.

[Operator]

And we'll go to next line. Ryan Zimmerman, BTIG.

[Ryan Zimmerman, analyst]

I think you spoke about some of the new indications in SP. If I'm not mistaken, I think there's a 30-day follow-up on the thoracic trial. But I'm curious if you could expand maybe when complex colorectal and thoracic cases potentially could become growth drivers for SP adoption and when you expect those -- not just those trials to wrap up, but potentially clearances in the U.S. with that?

[Gary Guthart, executive]

Sure. Myriam, I think you're best to answer.

[Myriam J. Curet, executive]

Yes. So we are hoping to submit everything in the foreseeable future. After that, as you know, there's at least a 90-day turnaround for the IDEs and then -- excuse me, for the clearances. And then after that, we will have to put training together and the launches together. So I can't really give you a time line for when that would be, but we know what the work is that needs to be done, and we are starting and moving forward on that.

[Gary Guthart, executive]

Our biggest steps are get the data arranged, get it into the FDA and work with them to get clearances. And then as Myriam says, we'll go through a staged commercialization. So you can expect submissions in the first half of '24 and then response thereafter.

[Ryan Zimmerman, analyst]

One of the other things, and I don't know if it's direct to you, Gary or Jamie, but you did talk about an opportunity to lower product costs as supply chain stresses ease and I know there were some comments earlier about '24 gross margins. But stepping aside from that, can you quantify the opportunity potentially for what that looks like? Have you gotten your arms around -- I know Marshall has been kind of shepherd in these processes. But at what point can you give the Street more color on what that opportunity looks like to drive gross margin gains?

[Jamie Samath, executive]

We have very well detailed plans for each of the areas that we're focused on. The teams have the capability and skill. It's going to take some time. I think the best way I would answer the question is we see a path over time probably in the midterm to get back above 70% gross margin.

[Operator]

We go to next line. Anthony Petrone, Mizuho Group.

[Anthony Petrone, analyst]

Maybe one on China and one on pricing on instruments. When we think about the quota size that National Health Commission in China put out, its new quota is 559 systems. Just wondering on anticorruption, could that shift that number over time whether it be that just fewer capital dollars going to projects or just from a timing element because things are getting elongated.

And then the pricing question would be on instruments and accessories. The company put a 5% price increase in their first one in 14 years. Chairman Powell came out and said, look, inflation is going to be persistent and elevated for quite some time. If inflation stays high, could another 5% price increase beyond the table for 2024?

[Gary Guthart, executive]

With regard to the capital side in China, I'll jump into that. I think demand for our systems and for the procedures they support in China, raw demand is really high. So it's really being limited or titrated by policy. I don't see -- I haven't heard anything that says people want to go back and revisit or lower the quota, I think that would be resisted by customers who are looking for purchases.

So I think it's more around delay and a kind of a timing thing. How long it is hard to predict, but months, not weeks.

On the pricing side, I'll speak to a general principle rather than projecting '24. What we try to do is a couple of things. One is be an outstanding manufacturer, really get high quality at low cost and make sure that we can invest in manufacturing prowess to do that. I think that's really powerful for us, gives us enormous flexibility to meet the customers' needs, kind of where they are.

With regard to pricing, we look at a couple of things, certainly price to us, cost to us, but also price elasticity, what the customer can do and achieve and that varies by market. And I think we've become increasingly sensitive to and sophisticated at understanding pricing.

So raw material pricing and core inflation to us is an input to our pricing. That's why we took price up this last year but it's not the only thing, and you shouldn't expect us to be purely algorithmic tracking inflation on its own.

[Operator]

And we'll go to the line of Michael Polark of Wolfe Research.

[Michael Polark, analyst]

I have big picture one modeling long term. There's an investor presentation out earlier this year and it -- Intuitive identified 6 million procedures globally for multi and single port for which you currently have line of sight. And on that same slide, identified that there's 20 million soft tissue surgery procedures overall. And if I look at where you're today, you're approaching 40% of that 6 million. And so my question is the delta between the 20 and the 6 to 14 kind of -- how do you expand the 6 towards the 20? And what are the major unlocks that you expect over the next 3 to 5 years that will move the 6 towards the 20 and kind of your feel for the pace of addressing more of the global procedure pie?

[Gary Guthart, executive]

Yes, it's a good question. I think the general tools that we use to get from 6 to 20 are kind of 3 buckets. Some of them are clearances in new markets. So making sure that a market we can address has access to the technologies that we already have. So when you think about something like Ion, for example, Ion is not yet available in all the markets in which we operate as it operates that it starts to open what we can do. That's kind of one bucket.

New indications are another one that some of the work that Myriam described earlier. That starts to open a new opportunity for us as we broaden the applicability of our platforms to new types of surgery and intervention.

The third bucket or another bucket is reimbursement. There are places where we think additional data is required to get insurers to engage a little bit differently and open the market.

And then lastly, there are new products and technologies that we're working on that we are not yet described that we think allow us to provide new solutions that are competitive in the marketplace.

Each of those operates on a little bit different time line. So it's not -- I can't give you a simple synopsis of how fast each one runs. Some of them take a lot of years, some reimbursement things or long lead. A product development can be long lead. Other types of access can happen more quickly. But that's a set of plans that we lay out. We're pretty disciplined about laying out what we want to do over time over a multiyear time horizon. And that's how we start to open that market.

That was our last question. In closing, we continue to believe there's a substantial and durable opportunity to fundamentally improve surgery and acute interventions. Our teams continue to work closely with hospitals, physicians and care teams in pursuit of what our customers have termed the quadruple aim, better, more predictable patient outcomes, better experiences for patients, better experiences for their care teams and ultimately, a lower total cost of care.

We believe value creation in surgery and acute care is foundationally human. It flows from respect for and understanding of patients and their teams, their needs and their environment.

At Intuitive, we envision the 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.

[Operator]

Thank you, everyone. And that does conclude your conference. We do thank you for joining. You may now disconnect. Have a good day.