Calvin Darling - Senior Director of Finance
Gary Guthart - President, Chief Executive Officer, Director
Marshall Mohr - Chief Financial Officer, Senior Vice President
Aleks Cukic - Vice President, Strategy
Ben Andrew - William Blair
Tao Levy - Wedbush Securities
David Roman - Goldman Sachs
Amit Hazan - SunTrust
John Demchak - Morgan Stanley
Tycho Peterson - JPMorgan
Intuitive Surgical, Inc. (ISRG) Q2 2013 Earnings Call July 18, 2013 4:30 PM ET
Ladies and gentlemen, thank you for standing by. Welcome to the Intuitive Surgical Q2 2013 earnings release conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a questions-and-answer session. Instructions will be given at that time. (Operator Instructions). As a reminder, today's conference is being recorded.
I would now like to turn the conference over to our host Calvin Darling, Senior Director of Finance for Intuitive Surgical. Please go ahead, sir.
Thank you. Good afternoon, and welcome to Intuitive Surgical's second quarter earnings conference call. With me today, we have Gary Guthart, our President and CEO, Marshall Mohr, our Chief Financial Officer and Aleks Cukic, our Vice President of Strategic Planning.
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 4, 2013 and our Form 10-Q filed on April 19, 2013. These filings can be found through our website or at the SEC's EDGAR database. Prospective investors are cautioned not to place undue reliance on such forward-looking statements.
Please note that this conference call will be available for audio replay on our website at intuitivesurgical.com on the audio archive section under our Investor Relations page. In addition, today's press release has been posted to our website. Today's format will consist of providing you with the highlights of our second quarter's results as described in our press release announced earlier today, followed by a question-and-answer session.
Gary will present the quarter's business and operational highlights. Marshall will provide a review of our second quarter financial results. Aleks will discuss marketing and clinical highlights. Then I will provide an update to our financial forecast for 2013. Finally, we will host a question-and-answer session.
With that, I will turn it over to Gary.
Thank you for joining us today. As we previously announced, our second quarter has been a challenging one. Capital sales fell 5% from the prior year with the shortfall concentrated in the United States. We attribute this primarily to slower than expected da Vinci benign gynecology procedure growth in the United States. Taken globally, overall procedure performance in the quarter was solid rising 18% over prior year in the face of several headwinds.
Summarizing procedures in the United States strong general surgery growth continued centered within single site cholecystectomy and colon and rectal resections. In gynecology, DVH for malignant conditions was solid, while DVH growth for benign indications grew more slowly than expected. Urologic procedures continued to be stable.
In Europe, procedures grew sequentially over Q1, led by urology and early growth in malignant dVH. Growth was strongest in the U.K. and Nordic countries, moderate in the core countries and weakest in the south. Procedure growth in Asia was strong off of a small base, led by growth in urology and general surgery with particular strength in Japan, Taiwan and China.
Turning to systems, we sold 143 systems, 7 fewer than Q2 of 2012, with sales of new systems in the United States totaling 90, down from 124 a year ago. We believe the slowing of our growth in benign gynecologic procedures in the United States to be a significant contributor to weaker than expected system sales.
There appear to be a couple of underlying causes for slower than expected U.S. benign dVH growth. Overall admissions for benign gynecology appear to be under pressure in the first half of 2013, since we are a significant share of hysterectomy, our growth rate in dVH is sensitive to these admissions.
Second, our MCS notification and negative press occurred in the quarter and may have pressured growth in utilization, although estimating their impact on procedure volume is difficult. Given that the average da Vinci system is used for hundreds of procedures per year, a change in da Vinci patient admissions can free capacity on existing systems and pressure new system sales. This appears to be the case this quarter. Looking towards the second half of the year, we see increasing pressure on U.S. system sales.
Globally, our business in Asia has continued to build. In Japan, system sales were strong in the quarter, showing continued interest in da Vinci surgery. Our work with surgical societies is ongoing and there are efforts to obtain national reimbursement for procedures beyond prostatectomy. Currently, it appears unlikely that additional procedures will receive national reimbursement in April 2014 insurance revision, given recent guidance from MHLW.
As we said in the past, we continue to expect Japan system sales to be highly variable from quarter-to-quarter. We are investing in building our team in Japan with a view towards long-term performance.
Capital sales in Europe have grown over the past few quarters in a difficult environment. As we have said on prior calls, sales force changes in Europe have made a positive difference. We are gathering European clinical and reimbursement data and expect these investments to increase in the future. Given macroeconomic stresses in Europe and government processes, we expect reimbursement efforts to be a long-term endeavor.
During the quarter, FDA conducted an on-site audit of ISI and issued a set of four observations in Form 483, previously reported in June. Yesterday, we received a warning letter from FDA as a follow-on for these audit inspection findings asking for additional steps to resolve two of the observation. These concerns are addressable and we are in the process of doing so.
Turning to operating performance for the second quarter, procedures grew approximately 18% over the second quarter of 2012. We sold 143 da Vinci surgical systems, down from 150 during the second quarter of last year. Total revenue was $579 million, up 8% over last year. Instrument and accessory revenue increased to $265 million, up 18% over Q2 2012. Total recurring revenue grew to $363 million, up 18% from prior year and comprising 63% of total revenue.
Net income was $159 million, up 3% over last year and we generated an operating profit of $257 million before non-cash stock option expense, down 1% from the second quarter of last year and representing 45% of Q2 revenue. We ended the quarter with $3.270 billion in cash and investments, down $89 million from last quarter. In the quarter, we generated $189 million in gross cash flow from operations, which is 119% of our reported GAAP net income. And, finally, we repurchased $270 million of our stock.
Before turning the time over to Marshall, it is worth taking a step back and looking at a longer-term view of da Vinci technology in surgery. We remain deeply positive on the value da Vinci can bring to surgery now and in the future. The benefit da Vinci brings as an alternative to open surgery has been demonstrated in hundreds of peer-reviewed clinical papers and is widely accepted by our customers.
Though some da Vinci procedures mature in the United States, we are increasingly exposed to volatility in patient admissions for our core procedures and the consequent lumpiness in capital sales. Viewed over the long-term, da Vinci surgery contributes to a trend in surgery for consolidation of procedures into fewer surgeons with higher volume. We believe this consolidation is good for patients, surgeons, hospitals and Intuitive. We are still early in the global adoption of da Vinci enabled minimally invasive surgery as applied to complex conditions.
In recent quarters, we have seen building interest in the use of da Vinci in general surgery, stand-in procedures from the pelvis to the upper gastrointestinal intestinal tract. As we expand our offerings in technologies like vessel sealing, stapling and Firefly, we are seeing increased utilization and efficiency in general surgery procedures that are otherwise very difficult to perform.
Taking a recent example, EndoWrist vessel sealers are now installed in roughly half of our U.S. customers. These technologies also open the door to additional clinical applications such as thoracic surgery where long-term additions to stapling can bring benefits to procedures that are often difficult to perform through small incisions. Looking at single incision surgery, single site cholecystectomy chips have been purchased by approximately half of our U.S. customers 18 months after launch. This procedure is currently growing faster than any prior da Vinci procedure. Early adopting clinical sites have been progressing in refined procedure choreography with single site hysterectomy as well.
Furthermore we are investing in expanding single site technology and expect to bring to market additional single site instruments as well as integration with other da Vinci technologies including Firefly and simulation. As our product suite develops further, we anticipate pursuing additional clinical indications for single site. Considering trends in healthcare policy around the globe, a long-term intention to move away from fee-for-service and towards single payment per treatment event can advantage those approaches with fewer complications and fewer readmissions.
Also the trend towards public transparency of individual surgeon and hospital outcomes has the potential to shift patient dynamics toward those programs, showing the best outcomes. Again while we cannot predict future implementations of policy, we believe their direction made set up well for da Vinci surgeons, their patients and hospital programs.
In summary, we continue to see a long-term opportunity to fundamentally improve surgery and are focused on the following. Extending the benefits of minimally invasive surgery using da Vinci in gynecology and urology worldwide, building da Vinci capability and supporting its use in general surgery, disciplined execution in our stapling and single site product launches and finally, continuing to invest in our capabilities in international markets, particularly Europe and Japan.
I will now pass the time over to Marshall, our Chief Financial Officer.
Thank you, Gary. Our second quarter revenue was $579 million, up 8% compared with $537 million for the second quarter of 2012 and down 5% from last quarter. Second quarter revenues by product category were as follows. Second quarter instrument and accessory revenue was $265 million, up 18% compared with $224 million in the second quarter of 2012 and up 1% compared with the first quarter of 2013.
The year-over-year increase in instrument and accessory revenue was driven by procedure growth of 18%. Sales of new products including single site, vessel sealer and Firefly partially offset by lower instrument and accessory stocking orders associated with lower second quarter system sales. The 18% increase in da Vinci procedures for the quarter reflected strength in general surgery procedures and slower growth in benign gynecologic procedures.
As Gary indicated, the slowdown in benign gynecologic growth reflects a number of factors including, but not limited to, weaker hospital admissions for benign da Vinci procedures. Our second quarter 2013 U.S. dVP procedures were approximately 5% lower than the second quarter of 2012 and 2% lower than the first quarter of 2013. The sequential increase in instrument and accessory revenue compared with last quarter was driven by higher procedure volume partially offset by lower instrument and accessory stocking orders.
Instrument and accessory revenue realized per procedure including initial stocking orders was approximately $2,020 per procedure, which was roughly equal to the second quarter of 2012 and lower than the approximately $2,110 last quarter. The decrease compared to the first quarter reflected lower stocking orders and the timing of orders.
Second quarter 2013 systems revenue of $216 million decreased 6% compared with $229 million for the second quarter of 2012 and decreased 16% compared with $256 million last quarter. Overall, we sold 143 systems in the second quarter of 2013, compared with 150 systems in the second quarter of last year and 164 systems last quarter.
We sold 90 systems into the U.S. market in the second quarter of 2013, compared with 124 systems last year and 115 systems last quarter. The lower second quarter 2013, U.S. system sales reflected among other things, the impacts of moderating growth U.S. benign gynecologic procedures and increased economic pressure on hospitals.
During the second quarter of 2013, we sold 53 systems into international markets, including 21 into Europe and 20 into Japan, compared with 26 in international markets in the second quarter 2012, which included 13 the Europe and 7 into Japan and 49 systems in international markets in the first quarter of 2013, which included 16 into Europe and 25 into Japan.
Our second quarter average sales price per system was $1.5 million, compared with 1.53 million realized in the second quarter of 2012 and the 1.55 million realized last quarter. ASPs include all da Vinci models, all simulators and Firefly when configured with the system and exclude upgrades.
Our second quarter 2013 ASPs were lower than the first quarter due to a lower proportion of dual console configuration and slightly higher proportion of sales involving trade-in. 43 of our second quarter 2013 system sales involved trade-in, comprised of 39 da Vinci Ss and four standard models. 35 of our second quarter 2012 sales involved trade-ins and 39 of our first quarter 2013 sales involved trade-in.
Service revenue increased to $98 million, up 18%, compared with $83 million last year and up 4% compared with $94 million last quarter. The growth in service revenue was primarily driven by a larger system installed base.
International revenue results were as follows. Second quarter revenue outside the U.S. was $158 million, up 56% compared with revenue of $101 million in the second quarter last year and up 3% compared with $153 million last quarter. Our higher year-over-year international revenue growth was driven primarily by higher da Vinci system sales into the Japanese and European markets.
Our higher sequential international revenue was driven by higher European system sales, partially offset by lower system sales into Japan. Second quarter 2013, international procedure volume was approximately 23% higher than the second quarter of 2012 and 6% higher than the first quarter of this year.
Moving on to remainder of the P&L. Gross margin in the second quarter 2013 was 70%, compared with 72% for the second quarter 2012 and 71% for the first quarter 2013. Our lower margin percentage compared to the second quarter of last year resulted primarily from the impact of the medical device excise tax enacted beginning in 2013 and product. Our lower gross margin percentage compared to last quarter was driven primarily by cost associated with the MTS recall, lower system ASPs and product mix.
Second quarter 2013 operating expenses of $187 million were up 16%, compared with the second quarter 2012 and up 2% compared with the first quarter this year. Our higher year-over-year operating expense increase was driven by headcount additions. Our increase compared to last quarter was driven by headcount additions and higher legal costs offset by lower incentive compensation.
Second quarter 2013 operating income was $219 million, or 38% of sales compared with $225 million or 42% of sales last year and $251 million or 41% of sales last quarter. Second quarter 2013 operating income included $39 million of non-cash stock compensation expense compared with $33 million last year and $38 million last quarter.
Our effective tax rate for the second quarter was 28.6%, compared with 32.4% for the second quarter 2012 and 26.1% last quarter. Our second quarter rate was a bit lower than the midpoint of our 28% to 30% guidance range, primarily reflecting a higher proportion of international pre-tax income. Our net income was $159 million or $3.90 per share, compared with $155 million or $3.75 per share last year and $189 million or $4.56 per share last quarter.
Now, moving to cash flow. We ended the second quarter with cash and investments of $3 billion, down $89 million compared with March 31, 2013. The decrease was driven by $270 million used to repurchase our common stock and $25 million of capital and IP acquisition, partially offset by $189 million in cash flow generated from operation. During the second quarter, we bought back approximately 546,000 shares at an average price of $493 per share. We ended the quarter with approximately 900 million authorized by the board for share buyback.
And with that, I would like to turn it over to Aleks, who will go over our sales, marketing and clinical highlights.
Thank you, Marshall. During the second quarter, we sold 143 da Vinci systems. 90 in the United States, 21 into Europe and 32 in to the rest of world markets. As part of the 143 system sales, four standard da Vinci systems and 39 da Vinci S systems were traded in for credit against sales for new da Vinci Si systems. We finished the quarter with a net 89 system additions to the installed base, bringing to 2,799 accumulative number of da Vinci systems worldwide. 2,001 in the United States, 443 in Europe and 355 in rest of world markets. 61 of the 143 systems installed during the quarter represented repeat system sales to existing customers. In total, 140 of the 143 systems sold represented da Vinci Si or S-e systems which included 27 dual console systems. The 53 system sales internationally included 20 in Japan, four into Russia and three into the countries of France, Germany, the U.K., And Australia and Taiwan.
Clinically, Q2 year-over-year procedure growth was approximately 18%, led by the category of general surgery paced by cholecystectomy, followed by colon and rectal resections. Other general surgery procedures showing strong growth included gastric, pancreatic and achalasia procedures. Overall urology growth was solid and included strong OUS dVP growth with continued stability in U.S. dVP.
As Gary stated, our benign GYN procedure growth moderated for the second quarter in a row, which had an adverse effect on our U.S. system sales. We believe that our U.S. procedure opportunity within benign GYN remained solid though we do recognize that the procedures remaining on the back half of the adoption curve will be more difficult to consolidate. The slower adoption within the benign GYN segment will most likely lead to continued lumpiness in U.S. system placements.
Recently released new products continue to perform well. Through Q2, we sold single site instrument and accessory kits to approximately 740 U.S. customers. Our vessel sealer product sales were strong, with most of the interest coming from the specialties of colorectal, advanced general and GYN surgery. The customer adoption for both da Vinci simulator and Firefly continues to expand with 96 customers purchasing a da Vinci simulator and 76 customers purchasing Firefly systems as part of their initial system purchase this quarter.
In addition, we have expanded our phased rollout of both the da Vinci surgical stapling system and single site hysterectomy products to several new sites. These rollouts will be expanded in a measured fashion, so we do not expect them to contribute materially to 2013 revenue. During the quarter, several hundred robotic abstracts and papers representing a variety of surgical specialties were published within various peer-reviewed journals while quarterly clinical conferences produced several live da Vinci procedure transmissions, postgraduate robotic courses, podium presentations and clinical poster sessions. So, I will take a few moments to summarize a couple that provide interesting perspectives within the area of general surgery.
The rate of surgical conversions from a laparoscopic procedure to an open surgery is most often related to the complexity of the procedure. We describe this relationship within our urologic and gynecologic procedure businesses and believe it applies to all surgical specialties in which we participate. This past quarter, several peer-reviewed general surgery studies described da Vinci surgery within this very context.
A colorectal study colorectal study published in the Journal Surgical Endoscopy, compared 84 consecutive minimally invasive low anterior resection, 47 incorporating da Vinci and 37 employing traditional laparoscopy technique. The study emanated out of the division of colorectal surgery at Yonsei University Hospital completed in 2010, had a median follow-up of 31 and a half months. Within their review, the authors describe overall safety and efficacy as similar within the two cohorts. However, the differences in the conversion rate from MIS to open and overall hospital stay were considered significant.
Within the laparoscopic cohort 16.2% of the patients had required conversions to open surgical technique as compared to 2.1% within the da Vinci cohort. Though both techniques are minimally invasive, the requisite hospitalization for patients undergoing a da Vinci colorectal resection was reduced by two days.
The authors stated, and I quote, "We compared the long and short-term results for patients who underwent robotic and laparoscopic low anterior resection and coloanal anastomosis. Robotic coloanal anastomosis had short and long-term outcomes comparable with those of laparoscopy. In particular, we found that patients in the robotic group demonstrated significantly lower rate of conversion to open surgery and had shorter hospital stay than the patients in the laparoscopic group. A lower rate of conversion to open surgery has a very important impact clinically, because the conversions often are associated with high complication rate and a poor prognosis."
In the Annals of Surgery, a study conducted at the University of Pittsburgh entitled robotic assisted, minimally invasive distal pancreatectomy is superior to laparoscopic technique compared to results of the department's first 30 da Vinci distal pancreatectomies to a historical cohort comprised of their last 94 laparoscopic distal pancreatectomies. The patients in the study demonstrated equivalent age, sex, race, ASA scores and tumor size.
Within their comments, the authors noted, to their surprise, that the operating time between the two cohorts showed a substantial reduction of over 75 minutes in favor of the da Vinci technique. In addition, they reported that the rate of conversion to open surgery was 16% for the laparoscopic patient versus zero among the da Vinci patients, this despite a greater probability for malignancy within the da Vinci group. Also noteworthy was more pancreatic ductal adenocarcinomas were approached robotically. 43% than laparoscopically at 15%.
Oncologic outcomes in these cases were superior for the robotic-assisted group with higher rates of margin negative resection and improved lymph node yield for both, benign and malignant lesions. In their summary, the authors wrote and I quote "Robotic distal Pancreatectomies were equivalent to lap distal Pancreatectomies in nearly all measures of outcomes and safety, but significantly reduced the risk of conversion to open resection despite a statistically greater probability of malignancy in the robotic cohort. We concluded that robotic assistance may broaden indications for minimally invasive pancreatectomy".
This concludes my remarks and I will now pass the time over to Calvin.
Thank you, Aleks. I will be providing you with an update to our financial forecast for 2013 on a GAAP basis. I will also provide estimates of significant non-cash expenses starting with procedures. On our last call, we projected full year 2013 procedures to grow towards the lower end of a range of between 20% and 23% from the base of approximately 450,000 procedures performed in 2012. Now, based upon moderating growth rates for U.S. benign gynecologic procedures, we are adjusting our projection for full year 2013 procedure growth to a range of between 15% and 18%.
Moving to revenues. As has been discussed earlier on this call, capital sales of da Vinci systems are highly sensitive to changes in procedure growth patterns. Moderating procedure growth has led to increased capacity in our installed base. Given this sensitivity, it is challenging for us to forecast the number of systems we expect to sell in the second half of this year, so we have widened our guidance range. Given the significant portion of our revenue that is derived from system sales, we now expect total 2013 revenue to range from approximately flat to 7% growth compared to full year 2012.
Turning to operating income. On our last call, we forecast operating income to fall within a range of between 38% and 39% of net revenue. At this point, given our reduced revenue expectations, we are taking steps to scale back expenses. We do not intend to make short-term spending cuts in areas that would compromise our longer-term expansion strategies. As a result, we now anticipate full year 2013 operating income to fall within a range of between 37% and 38% of revenue.
Now with regard to non-cash stock compensation expenses. On our last call, we forecast 2013 total stock compensation to total between $184 million and $192 million for the year. Based upon our current stock price, we are reducing our forecast to a range of between $164 million and $172 million for the year. Timing of recognition should follow a quarterly pattern similar to 2012. We expect other income which is comprised mostly of interest income to total between $17 million and $19 million in 2013. With regard to income tax, our Q2 tax rate was 28.6% of pretax income. Our rate for the remainder of the year will likely be close to that level.
Our share count for calculating EPS in Q2 2013 was approximately 40.8 million shares. Directionally, in Q3, our share count will likely modestly decline from the Q2 level. The actual share count will depend on several factors including the magnitude and timing of share buybacks.
That concludes our prepared remarks. We will now open the call to your questions.
(Operator Instructions) Our first question comes from the line of Ben Andrew with William Blair
Ben Andrew - William Blair
I wanted to follow up on a couple of points, I guess, to start. Gary, you talked about the fact that system growth would likely be lumpy over the course of the coming quarters. Can you give us some sense of what your inputs have been lately from the field and from customers relative to how lumpy and what that mix between new customers and existing customers is likely look like going forward?
I think the commentary is pretty much as we have outlined it for you. We see really an issue in the U.S., so the existing customers looking at capacity. We don’t see existing customers walking away from the technology or the opportunity but more a question of timing for them. So it feels more like delay than otherwise. As we have said in the past, I think that capital sales are really driven by three underlying drivers. One of them is additional capacity and existing customers. One of them is technologies or new features that they would like to get. The third are customers that are not yet da Vinci owners who are interested in engaging.
We have had good success with the new technologies that we are bringing out. So we see that is as proceeding. I think the growth rate on benign gynecologic procedures has come in the second quarter grew, but grew at a slower rate than we were expecting. There is a multiplier effect there on capacity. So the capacity constraints in existing accounts will take some quarters to work out.
Ben Andrew - William Blair
Gary, can you may be give us comments or perhaps, Aleks, on this about any correlation between the volume of benign GYN cases and physician visits because we heard some noise back and forth about flattish or even sometimes declining patient volumes overall. Does that appear to be part of it as may this historically it was being utilized less frequently and other things like that around the procedure growth is obviously a big change in hysterectomy growth. Has this happened to you in the last couple of quarters?
Yes. I think in terms of total in-patient admissions as a whole, and then people coming and seeking, women coming and seeking hysterectomy. As you know in-patient admission data broadly lags for a while, so we get out that by more or less the same way you do by talk to our customers, by looking at survey data and trying to look at other analysis. It's clear that in the first quarter total in-patient admissions were lower than people had expected them and in some cases and some institutions negative as a total.
In Q2, we are hearing mixed feedback on total. For hysterectomy as a whole, our customers are seeing a pressure both, in Q1 and in Q2. Quantifying that in Q2 is tough just because the data likes and so qualitatively we have seen some pressure there and there are some things that are just hard for us to handicap in terms of intuitive specific events and their impact on benign test. Thing like the MCS notification are just harder for us to quantify what that impact was.
Ben Andrew - William Blair
Sure. Then Calvin, I guess, very briefly on the procedure guidance the 15% to 18%, does that assume that benign hysterectomy rose sequentially in the back half versus the first half. I know you've got some year-over-year comparisons there as well. So, I mean, maybe well a different versus year-on-year.
Yes. I think when you look at the overall guidance and the revised range, we are talking about general surgery performing well and in line with our earlier guidance. And similarly on urology side and international, so I think the change overall really is very much attributable to the benign gynecologic procedures in the U.S. And, so I think, we are still talking about growth. It's a moderating growth pattern and the trajectory for the quarters ought to follow a similar pattern to what we've seen historically.
The next question comes from the line of Tao Levy with Wedbush Securities. Please go ahead.
Tao Levy - Wedbush Securities
On the warning letter that you received, it seems rather fast for the FDA to come in June and then few weeks later give you guys a warning letter. Can you maybe go into little more details as to what they are looking for?
The consent of the letter is really a reflection of the concept that was in 43 Form that was issued in June. There were four observations. There are two mentions in warning letter become public, but two mentions of things that like additional insight into. One of them had to do with the procedure by which recall is classified and their participation in that classification that was kind of the first bullet in that.
And the other bullet, they want additional information on has to do with user input and design elements having to do a particular product. I think those are addressable. We are working on addressing them. I think we can address them quickly and move on.
Tao Levy - Wedbush Securities
Did the letter mention anything about having to come back and revisit the facility or audits?
There is a mention that they will come back and audit specifically around recall classifications.
Tao Levy - Wedbush Securities
And, you also mentioned about Japan and not expecting and any additional reimbursed procedures, so in the next cycle but the MHLW kind of mention to you guys about that?
They are. MHLW is working on guidance documentation for reimbursement, but more broadly than us for new technologies that's outline the data requirements for what that like to see in Japan, Japan specific data. For prostatectomy, we are able to use global data and had a good interaction with MHLW given current guidance, again, I think it is a class of products more broad than us. They are looking for additional data collection in Japan specifically. That's going to vary by procedure. The data requirements appear to vary by procedure having to do with maturity of clinical data and so it's not all locked down yet.
We are continuing to work with surgical societies who in turn work with MHLW but given the visibility we have on it now, it looks like there will be partial reimbursement followed by national reimbursement on a timeline that has to be decided based on their daily requirements. As we get additional insight and understand it deeper, we will share that with you.
Tao Levy - Wedbush Securities
Okay, lastly sort of a decadence on system sales throughout the rest of the year. Is the pressure that we should model that primarily just U.S. based. Is that right way to think about it or do you see anything else in sort of Europe, rest of the world, Japan as well?
I will start with a broad answer and let Marshall color it is as well. In the U.S., I think the dynamics that we saw in the second quarter may persist for the back half of the year. In terms of OUS, we are pleased with the progress we are making in Europe but as you know Europe can be really lumpy. Likewise in Japan. I think that that Japan has had some boluses of pent-up demand and what that looks like in future quarters is likely to not be stable. I don’t think I would use past couple quarters to predict the future next quarters. Marshall?
Specifically in Japan, we introduced type in the beginning of the year. I think that helped drive increased system sales and we don’t see that level continuing and as Gary said, Europe will be lumpy, particularly Q3 is a vacation period for them, and so historically we have seen lower sales in Europe in Q3.
Our next question comes from the line of David Roman with Goldman Sachs. Please go ahead.
David Roman - Goldman Sachs
Thank you for taking the question. Gary, both in your and Aleks' prepared remarks you referenced the volume of data that continue to come out regarding the da Vinci system but as you think about some of the headlines out there that have materialized in the past six and half months and the rising concerns, potentially from payers as it relates to hysterectomy. To what extent have you started to rethink the need or potential need for a large-scale randomized clinical trial to really definitively put a line in the sand on the value proposition of da Vinci, that a multicenter multi-hundred patient clinical trial, even if it is sponsored by the company?
That’s a good question. Going forward, I think clearly, large-scale studies are, or multi-institutional, multi-surgeons are powerful and are important. Speaking to the headlines a little bit, I think that headlines often confound the differences between complex procedures and simples ones and the use of da Vinci as an alternative to open versus the da Vinci as an alternative to laparoscopy. I think there is a lot of very strong data for the use of da Vinci as an alternative to open surgery.
That said, going back to your comment, we are investing in large-scale studies. They are not always prospective randomized trials. Sometimes, they are registries. Sometimes they are occupational trials. Sometimes they are prospective randomized. There is a lot on the institutions that are doing them and the nature of the data they already have and the data they are collecting. But we are believers in indicated tests. We think that matters and over time, we will see more of that come out, both in hysterectomy and in other procedures.
David Roman - Goldman Sachs
And maybe just on the systems side, surely, I can appreciate that the slowing utilization or slowing procedure volumes will impact the rate at which you sell systems. But it seems like a pretty fast drop-off in system presence relative to what is, at least it looks to be in the quarter, a pretty modest slowing in procedure volumes. So am I reading that wrong if I say that there is already a lot of capacity out there as systems and a small tweak on the volume side is going to make a big impact on procedures or is it something that procedure worsen throughout the quarter so forward view is a little bit more cautious? Am I looking at that wrong?
I will separate it into two things. I think I am going to take the second part first. The idea of, did we see a softening at the back end of the quarter in terms of procedures and that driving additional conservativism or the back half the year. We did not see a strong fall off in procedures through the quarter. It wasn’t that. We got to the end and procedures were really ramping down or anything like that in terms of rates.
In terms of sensitivity, we came out of a strong fourth quarter of '12 both in procedures and in systems saw some mixed dynamics in Q1 across the industry us included. In terms of procedure volumes in-patient admissions and that's the benign hysterectomy for da Vinci. Growth rate really struggled to gain traction again in Q2 and I think that that has, added up to the sensitivity you are seeing in systems. I do think because systems are used for hundreds of procedures a year and we are doing a fair number of procedures in the U.S. that are benign hysterectomy procedures. There's the sensitivity that gets you to the capital number.
David Roman - Goldman Sachs
Okay. That's helpful. Maybe lastly, the guide, the flattest of 7% total revenue guidance for the year just roughly looking and it seems that you've taken a pretty conservative approach with respect to systems and almost it's like you are extrapolating second quarter trend in and close to flat running them through the balance of the year, so is that guidance meant to reflect the degree of uncertainty that might exist in both, the capital markets as well as the timing of any more correlation to slowing procedure volumes and flowing and that that this is a view based on what you know today and then sort of taking that forward that sort of give you some room on the overall performance of the business.
Yes. David, our wider range in the revenue guidance does reflect the slower growth in da Vinci procedures and really the uncertainty and the trend in dVH. Our underlying assumptions, we have seen roughly flat system utilization the back half of the year with a reduced growth assumption on procedures and the rest basically falls through. Again as we discussed, the capital sales are highly sensitive to changes the procedure growth trends in our guidance for materially fewer system sales in the second half of 2013 that the first couple other points on guidance while we are on the topic and we talk a lot about system ASPs.
It's probably likely the second half system ASPs maybe modestly lower than the first half based on a higher proportion of the sales that may involved trade-ins with the low volumes. Then secondly the second half. Instrument and accessory revenue per procedure will probably also directionally be a bit lower than we saw the first half just based upon fewer stocking orders associated with the lower system sales.
Our next question comes from the line of Amit Hazan with SunTrust. Please go ahead.
Amit Hazan - SunTrust
Thanks, guys. Just one question dVH side. One of the reasons you noted for weakness was the move of hysterectomy from the in-in patient to outpatient setting, but the data kind of shows pretty clearly kind of this has been an ongoing thing for years now, maybe about 5% or so a year consistently for a long time. So, I am wondering what has intuitive change now, particularly this quarter. (Inaudible) noted that kind of beyond that, already existing long-term trend.
Yes. I think there are a couple of underlying dynamics in the dVH space, and actually pulling them apart and putting numbers on them is very, very tough. One of them has been we have seen over recent quarters a pressure by payers on use of hysterectomy as a whole, and we are hearing that back through our surgeon channels. What it takes to authorized and hysterectomy and kind of conservative medical management before that we are also seeing their policies towards driving them into the regulatory setting versus in-patient settings.
After that the deductible dynamics and another macroeconomic trends and then some. Intuitive-specific dynamics around negative press and and/or MCS notification and you've guys set of things that the contributors sorting exactly which is which in real-time is a very tough. It really is going to be survey data retrospective analysis to figure out which of those is dominant. Some of them are increasing trends. Some of them seem to be episodic trends.
Amit Hazan - SunTrust
Okay. Then back to the system side, I want to just kind of maybe touch on the deferral versus cancellation? Again, I think you guys were using the word deferral in your preannouncement, press release. Can you talk a little bit about the systems that maybe you are close to closing and didn’t, that were deferred because of the lower trajectory as expected growth of procedures, and whether you are hearing in large part that was a deferral and not necessarily a cancellation and then move away from that technology and are we have talking virtually pretty much all of the units that sell into that bucket or where there is some that you feel where cancellation, not really moving away from your technology?
So the pipeline entering the quarter, as we commented three months ago was strong and that, as you know, capital sales tend to be back-ended. So it wasn’t until the end of the quarter that thing started to drop off. The reasons that we were given for systems falling off included things like an inability to get financing, just additional levels of approval required within hospital systems. So it just felt like a harder environment, from an economic perspective. It did feel like a number of them were pushed off. Now, we see them being pushed off. Do they ultimately get done is really hard to predict. We don’t know as someone has intent to buy because of hospital dynamics or concerns about the economy whether they will still have those concerns for a quarter or two out or whether those will go away and capacity will catch such that they buy. So its really hard for us to predict which ones will come back and which ones will not. But the initial commentary that you we are getting from hospitals was they are pushing them up.
Amit Hazan - SunTrust
Okay, and just one final one for me on utilization. I think you mentioned you are assuming flat utilization in the back half. I am just wondering as we start to think about general surgery and especially cholecystectomy in there being a shorter procedure whether we should be considering utilization per system starting to go up a little bit more than it has been in trend?
It’s a very good point. As chole's and other simple procedures get done, they are faster. They also tend to be more schedulable. Benign disease patient can schedule into a slot often better or easier than in a case of a malignant disease. So as that becomes material and bigger, I think that utilization may well go up. I think ultimately that’s a good thing for hospitals and a good thing for us but it can create some uncertainty in terms of predicting where utilization ought to settle. Now, things like, just to add a point, colorectal procedures are also growing, our complex longer general surgery procedures and cancer procedures. So, you have both of those dynamics going on at once and so the mix change is the thing you have to predict to get to utilization and that’s how Calvin at his guidance on.
Yes, and I think as the trends have been, over the last few years, gradual growth. Low mid-single digit percentage growth in utilization per system. Now they are almost 2,800 systems out there now and they are all at the various stages of adoption. So my point is it’s a large sample size and that metric historically has moved very gradually in direction.
And just speaking for the long-term, looking out multiple quarters, our utilization is ultimately great for hospitals. They get a good return on their investment and it is great for the company. So over time if it heads that way then we will adjust.
Our next question comes from the line of David Lewis - Morgan Stanley. Please go ahead.
John Demchak - Morgan Stanley
Hello, this is actually John Demchak in for David. Thanks for taking the question. So you gave some numbers on the magnitude of growth rate for dVP in the quarter, but I didn’t really hear anything that’s specific towards dVH? So I was wondering if you could give us maybe additional color on the magnitude for malignant or benign? If not, if you could also maybe discuss how you are thinking about some of those pressures? If they are maybe more temporary or if you think they are more permanent and structural and maybe the total addressable market that you have previously discussed maybe needs to come down a bit?
Yes, I don’t think we are going to give specific percentage growth rates in the hysterectomy here but I think we are out of certain trajectory through 2012 and there was a noticeable change in the growth rate in Q1 that was continued out into Q2 and when we look at our guidance we are projecting out our growth rate at that lower trend.
Yes, and as far as the addressable market, again what we have created is really a construct for the way we think about the procedures that we can access. We talk about, in the case of dVH, it started with that complex beginning with malignant endometrial cervical cancers, et cetera. Then into the complex benign and we ultimately are going after what is open surgery. There may be some intersection between laparoscopic and so on, but really the primary target. We still stand by that.
We believe that that is our target market, but what we have really realized is that as you get to the back half of these adoption curves, accessing those procedures with the same sort of approach as you did on the front half of it is difficult. In other words, they don't consolidate same way at same pace.
So, we feel strongly about the opportunity still being there and fruitful, but the timing of it in the backend is going to be difficult to predict and therein lies the challenge that you saw in the first couple of quarters and the effect it had on the systems.
John Demchak - Morgan Stanley
Thank you. Very helpful. Kind of speaking more on the dVH side also. Will the dVH outlook maybe impacts any hiring that's going on the procedure side for general surgery or maybe effect of balance or disrupts that you have gain access in both areas.
As we think about opportunity, we look at it in terms of procedure growth regionally, so we look at U.S. and various regions and see what opportunity and penetration levels look like and they are non-uniform. It's not that the whole country is all at the same level of adoption. And as adoption is deep in some areas for gynecology that resource is to pursue general surgery and other things, so that's really how we are directing on our sales force.
John Demchak - Morgan Stanley
Yes. Then just one quick follow-up on the buyback authorization for March, I was wondering if you could give any additional color on your thoughts towards the capital deployment and maybe timing?
It will be consistent with what we said in the past and we will look for the right opportunities to buy back shares, so looking this continuities and expect stock price from the market and we have authorized and we intend to use it appropriately.
Our next question is from the line of Tycho Peterson with JPMorgan. Please go ahead.
Tycho Peterson - JPMorgan
Thanks for taking the question. I guess first one just on kind of a general roadmap here for general surgery. Can you talk a little bit about how sustainable do you think the demand you are seeing in chole is right now? Are you seeing centers trial and then other ramp up or what's the dynamic right there and then can you also talk on bariatric and maybe some of these other opportunities in general surgery beyond chole and LAR?
Okay. On single site cholecystectomy, we have seen a good stick rate and in some ways better stick rate than past procedures in terms of early experiences and we have seen great growth out of some centers. One of the exciting things about single site cholecystectomy is that, number one, it's a procedure where surgeons can see high volume. And so when they move, they get a lot of experience quickly. So, the early part of that experience has been good.
Having said that, there were absolutely some surgeons and there were absolutely some institutions who will not participate. There are some folks who believe in the value proposition and see the benefits it's bringing and bringing to them and it’s patients. Some centers have great growth in their admissions, but there are some who are on the sidelines and may stay on the side line, so I think it's going to split the field for some time.
How far it penetrates and how long, I think that remains to be seen. I think, there is a segment of patients that value it. I think there is a segment of surgeons who value it and who are gaining experience rapidly, but trying to call where the end is something we can do.
With respect to the broader category that you outlined, I think there's really two things to think about or two ways to think about it. One is the absolute contribution of the individual procedure. So, for example, on a distal pancreatectomy or on a liver procedures, or spleen procedure esophageal. They are going to contribute the form of I&A, but really the hidden power there is the combination of strength from the surgeons that are performing a lot of the benign operations coupled with the strength of the surgeons who are seeing demand in things like colorectal distal pancreatectomy, collectively getting together into the system purchasing suite or decision. It is also pretty powerful. So we don’t really, per se, value them as one-for-one. I think the broader you go between malignant and cancer, I should say, malignant and benign, the more strength you see in terms of placing systems out of that particular vertical which we saw in gynecology and we saw in urology as well.
Okay, Tycho, I will give you one last follow-up here.
Tycho Peterson - JPMorgan
Just on Japan, can you talk about how the growth trajectory is going to change in the absence of the new procedures. And you alluded to the fact that you are looking for Japan specific data. So you probably won't get the reimbursement code but is that a definitive decision at this point that you won't get it?
It is not definitive but the conversation is ongoing and per our statements we think that broad approvals across multiple procedures are unlikely. I can describe the process what the growth rate looks like, I think, is hard to predict. Process wise, we will submit data before the surgical societies. They will in turn work with MHLW. MHLW may require them to solicit and collect data in Japan. That may involve a partial reimbursement for certain number of centers. If so, then that will start the process of data collection for a group of hospitals in Japan. How many and how many procedures concurrently, we don’t have a resolution on yet, but as I said before, as we get closer to it we will share it with you.
Tycho Peterson - JPMorgan
Okay, thank you.
Okay, that was our last question. I would like to close with a letter we received this week from a surgeon and medical director at one of the U.S. academic centers. We talked about our finances and cash flow and so on but this sort of takes it back to what the value of our products is and so this came from a surgeon and medical director.
"What you are doing is touching patients' lives. It’s healing them and getting them better. You cannot put a price on curing some of their cancer and doing it with minimal change to their life. It is priceless. Let them inspire you to go ahead and continue the innovation to lead surgery in to the future. Patients are your partners in this endeavor. Sure everything can be refined and everything can be improved but you only get one chance sometimes to cure someone of their cancer. Your technology has given me a step up in that pursuit. Companies that help us change patients' lives will survive and prosper."
This concludes today's call. We thank you for your participation and support on this extraordinary journey to improve surgery and we look forward to talking with 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.
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