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Intuitive Surgical, Inc. (NASDAQ:ISRG)

Q1 2010 Earnings Call Transcript

April 15, 2010 4:30 pm ET

Executives

Ben Gong – VP, Finance

Gary Guthart – President & CEO

Marshall Mohr – SVP & CFO

Aleks Cukic – VP, Strategic

Analysts

Tao Levy – Deutsche Bank

Ben Andrew – William Blair

James [ph] – Morgan Stanley

Tycho Peterson – JP Morgan

Vincent Ricci – Wells Fargo

Miroslava Minkova – Leerink Swann

Sameer Harish – Needham & Co.

Operator

Welcome, everyone. Thank you for standing by. All lines are in listen-only mode until the question and answer session of today’s call. (Operator instructions) Today’s call is being recorded. If you have any objections, you may disconnect at this time.

I would now like to turn the call over to Ben Gong, Vice President of Finance.

Ben Gong

Good afternoon and welcome to Intuitive Surgical’s first quarter 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. 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 Web site, at intuitivesurgical.com, on the Audio Archives section under our Investor Relations page. In addition, today’s press release has been posted to our Web site.

Today’s format will consist of providing you with highlights of our first quarter results as described in our press release announced earlier today, followed by a question-and-answer session. Gary will present the quarter’s business and operational highlights. Marshall will provide a review of our first quarter financial results. Aleks will discuss marketing and clinical highlights, and I will provide an update to our financial forecast for 2010, and finally, we will host a question-and-answer session.

With that, I will turn it over to Gary.

Gary Guthart

Thank you for joining us today. In this first quarter, our team has executed well. We continue to see broad interest in da Vinci surgery by our customers across a variety of procedures, which is reflected in our strong financial results for the quarter.

With regard to procedures, we experienced continued growth in numerous specialties. Urologic and gynecologic procedures continue to lead the way and we see early signs of growth in both general and colorectal surgery and thoracic procedures.

We are also pleased that European procedure growth was strong in the quarter. While the diversity of procedures is encouraging, it presents both opportunities and sales management challenges. The breadth of procedures is commanding increased investments in our sales force and is reflected in our recent hiring.

Turning to systems, U.S. sales were robust. We did, however, see an increasing pressure on hospital capital budgets in Europe where capital sales conversations mirrored those in the U.S. during the first half of last year. Lastly, we sold our first systems in Japan this quarter post our Shonin approval. We’ll discuss Japan in greater detail later in the call.

As we move to highlights for the first quarter, recall that Q1 2009 financials included a revenue deferral associated with the introduction of the da Vinci Si System. In my year-over-year comparisons, I will compare financial performance excluding the deferral to give a more accurate picture of relative performance.

With that as a background, operating highlights for the first quarter are as follows. Procedures grew 37% over the first quarter of 2009. We sold 104 da Vinci Surgical Systems, up 38 from 66 during the first quarter of last year. Total revenue was $329 million, up 58% over the last year.

Instrument and accessory revenue increased to $123 million, up 50% over the year. Total recurring revenue grew to $173 million, up 43% from prior year and comprising 53% of total revenue.

Net income was $85 million, up 112% over last year. We generated an operating profit of $157 million before non-cash stock option expenses, up 78% from the first quarter of last year and representing 48% of Q1 revenue. With operating profit percentage at this level, we do not expect to pursue further margin expansion.

We will continue to share productivity gains with our customers and we will continue to invest in R&D and long-term growth opportunities for the business. We ended the quarter with $1.396 billion in cash and investments, up $224 million from last quarter and up $574 million from last year.

Significant cash outlays during the quarter included $16 million invested in intellectual property and fixed assets. Excluding the impact of these outlays as well as $93 million from stock proceeds and $6 million used for working capital, we generated $153 million in gross cash flow from operations, which is 180% of our reported GAAP net income in the first quarter. I share this number with you because we believe that it is the best measure of the economic horsepower of our company.

As you know, we continue to make significant investments in research, development and manufacturing. Our largest investments focus on four areas. First, we are extending our instrument offering through major additions, like multifunction energy devices and robotic stapling. Second, we are improving and expanding our imaging capabilities. Third, we’re developing new patient side mechanisms. And finally, we are creating surgical networking and training technologies.

Overall, we’re pleased with the progress of our product development teams and our technology partners both in the depth of their achievements and in the speed with which they are accomplishing them.

Lastly, as we enter new surgical markets and drive them to new product arenas, we will invest in building our team and expanding partnerships and in acquiring those technologies that could make a difference to robotic surgery. This quarter we added 94 people to our team predominantly in sales, manufacturing and R&D, bringing our total team to 1,357 employees.

And with that, I’ll pass the time over to Marshall, our Chief Financial Officer.

Marshall Mohr

Thank you, Gary. Prior to providing you with the details of our first quarter results, I would like to provide you with a quick review of the deferral accounting that took place during 2009, which sets into context the proper comparables.

Last year we offered certain first quarter 2009 customers the opportunity to upgrade their da Vinci S Systems to da Vinci Si Systems at a discount to the otherwise list price for such an upgrade. We also offered those customers the opportunity to return da Vinci S accessories in exchange for da Vinci Si accessories.

As a result, we deferred a total of $20 million of revenue in the first quarter of 2009, comprised of $18 million of system revenue associated with system upgrade offers and $2 million of accessory revenue. We recognized $14 million of the total $20 million deferral in our second quarter of 2009 and the remaining $6 million in the third quarter of 2009.

I will now walk you through our revenue results with comparisons to the first quarter of 2009 as though the deferral had not occurred. Our first quarter revenue was $329 million, up 58% compared with $209 million for the first quarter of 2009 and up 2% compared with $323 million for the fourth quarter of 2009.

First quarter revenues by product category were as follows. First quarter instrument and accessory revenue was $123 million, up 50% compared with $82 million for the first quarter of 2009 and up 8% compared with $113 million in the fourth quarter of 2009. The increase compared with prior quarters reflects procedure growth and higher initial stocking orders.

The amount of instrument and accessory revenue we realized per procedure, including initial stocking orders, was approximately $1,970 per procedure, which is approximately $170 higher than the first quarter of 2009 and approximately the same as the fourth quarter.

The year-to-year increase primarily reflects higher stocking orders in the current quarter in customer buying patterns as we believe that customers reduced inventory levels in the first quarter of 2009 in the face of a deteriorating economic environment. We expect instruments and accessories per procedure to decline over time given that initial stocking orders have a lower impact on a larger installed base.

First quarter 2010 systems revenue of $155 million increased 77% compared with $88 million of systems revenue for the first quarter of 2009 and decreased 4% compared with $162 million of systems revenue for the fourth quarter.

We sold 104 systems in the first quarter of 2010 compared with 66 systems last year and 110 systems last quarter. 80 of the 104 or 77% of the units sold in the quarter were da Vinci Si systems. There were 17 da Vinci Standard systems traded in this quarter compared to six in the first quarter of 2009 and 23 last quarters.

First quarter system revenue also included $5 million of upgrade revenue compared to none in the first quarter of 2009 and $7 million in the fourth quarter of 2009.

Our first quarter average sales price per system, including all da Vinci models, but excluding upgrades in the revenue deferral, was $1.45 million, an increase from $1.33 million realized in the first quarter of 2009 and an increase from the $1.41 million realized in the fourth quarter.

The increase compared to the prior year reflects the introduction of the Si product, which has a higher price point than the S. The increase compared to the fourth quarter reflects favorable customer and product mix. We expect ASPs over the next several quarters to return to historical levels.

Service revenue increased to $51 million, up 29% compared with $39 million last year and up 6% compared with $48 million last quarter. The growth in service revenue was driven by a larger system installed base.

Total first quarter recurring revenue comprised of instrument, accessory and service revenue increased to $173 million, up 43% compared with the first quarter of 2009 and up 8% compared with the fourth quarter of 2009. Recurring revenue represented 53% of total first quarter revenue compared with 58% in the first quarter last year and 50% last quarter.

Revenue by geography was as follows. Non-U.S. revenue represented 21% of our total revenue in the quarter compared with 25% of total revenue in the first quarter of 2009 and 22% of total revenue in the fourth quarter of 2009. Overall, procedures grew faster outside of the U.S.

We sold 24 systems outside the U.S. compared with 22 in the first quarter of 2009 and 30 last quarters. Seven of the systems sold in the first quarter were to early thought leaders in Japan.

We would remind you, however, that adoption in Japan is expected to proceed slowly, and therefore we expect system volume to decline in Japan quarter-to-quarter. Excluding Japan, non-U.S. system sales decreased attributable to reduced capital spending in a challenging European economic environment.

Moving on to the remainder of the P&L, let me remind you that there were no costs deferred in conjunction with the first quarter 2009 revenue deferral, and therefore, the $20 deferral had an equal impact on revenue, gross profit and operating income.

Gross margin in the first quarter was 73% compared with the first quarter 2009 gross margin, excluding the impact of the deferral of 71%, and compared with fourth quarter 2009 gross margin of 72%. The increase in gross margin reflects increased system ASPs, material cost reductions and absorption of fixed costs over a larger revenue base.

First quarter 2010 operating expenses of $111 million were up 32% compared with the first quarter of 2009 and up 6% compared with the fourth quarter. The quarter-over-quarter increase reflects costs associated with employees added during the quarter and increased investment in research and development.

We added 94 employees during the quarter, including 49 employees in the sales service organization as we continue to expand our clinical sales force and 39 employees in operations as we continue to grow manufacturing capacity and invest in research and development.

First quarter 2010 operating income was $130 million or 40% of sales compared with $65 million or 31% of sales for the first quarter of 2009, excluding the impact of the deferral, and $128 million or 40% of sales for the fourth quarter of 2009.

First quarter 2010 operating income reflected $27 million of non-cash stock compensation expense compared with $23 million for the first quarter of 2009 and $25 million last quarter. The growth in non-cash compensation reflects our annual grant made February 15 of each year.

Our effective tax rate for the first quarter of 36% was lower than our 2009 rate of 41%, reflecting the implementation of our international tax structure. Our net income was $85 million or $2.12 per share compared with $40 million or $1.02 per share for the first quarter of 2009, excluding the impact of the deferral, and $78 million or $1.95 per share for the fourth quarter of 2009.

Now, moving to the balance sheet, we ended the first quarter of 2010 with cash and investments of $1.396 billion, up $224 million compared with December 31, 2009. The increase during the quarter reflects $153 million of cash flows from operations and $93 million from the exercise of stock options, partially offset by $16 million of capital expenditures. $3 million of our capital expenditures relate to the construction of our new manufacturing facility next to our corporate headquarters in Sunnyvale. We anticipate that building to be completed in early 2011.

Our accounts receivable balance decreased to $180 million at March 31 from $205 million at December 31. The decrease in accounts receivable reflects the timing of system shipments.

Our net inventory increased to $69 million at March 31 from $58 million at December 31. We increased inventory during the quarter since we believe that inventory at December 31 was below optimal level. We will likely continue to increase inventory levels in future quarters.

And with that, I would like to turn it over to Aleks who will go over our sales, marketing and clinical highlights.

Aleks Cukic

Thank you, Marshall. During the first quarter, we sold 104 da Vinci Systems, 80 in the United States, 11 in Europe and 13 in the rest of world markets. As part of the 104 system sales, 17 standard da Vinci Systems were traded in for credit against sales for new da Vinci Si Systems.

We had a net 87 system additions to the installed base during the quarter, which brings to 1,482 the cumulative number of da Vinci Systems worldwide; 1091 in the U.S., 264 in Europe and 127 in rest of world markets. 44 of the 104 systems installed represented repeat system sales to existing customers. Also during the quarter, nine customers purchased upgrades to convert their da Vinci S Systems into da Vinci Si Systems.

The outlier this quarter was Japan with 7 da Vinci placements. As was stated earlier, several of these placements were sold to early Japanese thought leaders who were anxiously awaiting Shonin clearance and importation rights. Although we’re pleased with these sales, we don’t expect this rate of Japanese purchases to continue for the near future.

Clinically, we had another nice quarter with good sequential procedure growth within our targeted procedures. da Vinci Hysterectomy and Prostatectomy showed solid growth, whereas partial nephrectomy, sacrocolpopexy, ENT and colon and rectal procedures showed large percentage of sequential growth.

Within our hysterectomy business for the first time in several quarters, dVH for malignant conditions showed larger sequential growth than dVH for benign conditions.

It’s difficult to say for certain why that was, but it’s our belief that three factors probably played a role; one, the Q1 reset of co-payment minimum spending; two, high unemployment rates; and three, the difficult sales force task of simultaneously managing multiple high growth procedure businesses. The latter we can do something about. In fact, we’ve recently made some adjustments to our sales structure to better support the large benign hysterectomy market.

During the quarter, nearly 300 da Vinci related clinical publications and abstracts appeared within various peer reviewed journals. With the current trend in health care policy moving directionally toward comparative effectiveness research, it’s our belief that we’ll be well positioned in the evidence-based environment.

With volumes of peer reviewed da Vinci publications already in print, as well as more due to be published, clinicians, policymakers and patients are in position to make informed health care decisions. As we’ve said before, comparative effectiveness research done well is something we very much support.

As it pertains to dVP versus open prostatectomy, an excellent comparative study out of Vanderbilt University was recently published in The Journal of Urology. The paper emanated out of the University’s Department of Urology and Biostatistics and is entitled “Robotic-assisted laparoscopic prostatectomy versus radical retropubic prostatectomy for clinically localized prostate cancer; comparison of short-term biochemical recurrence free survival.”

1,904 men represented the cohort study between June of 2003 and January of 2008 where 491 received an open retropubic prostatectomy and 1,413 received a dVP. As you might suspect, the study is filled with detailed analysis from which I’ll spare you today, but I’d encourage those of you interested to pick up a copy and read through it yourselves.

To summarize, the three-year biochemical recurrence free survival rate was statistically similar between the da Vinci Prostatectomy and the radical retropubic prostatectomy groups on the whole, as well as, when stratified by pathological stage, grade and margins status on a multivariate analysis, extracapsular extension, pathological grade 7 or greater and positive surgical margin were independent predictors of biochemical recurrence, while surgical approach was not.

The authors concluded by saying, “The likelihood of biochemical recurrence was similar between groups when stratified by known risk factors of recurrence. Surgical approach was not a significant predictor of biochemical recurrence in the multivariate model. Our analysis is suggestive of comparative effectiveness for robotic-assisted prostatectomy.”

Of all the desired endpoints associated with prostatectomy, none is more important than cancer control. One of the fastest growing procedures that you haven’t heard a great deal about is da Vinci Sacrocolpopexy. Sacrocolpopexy is performed for the condition of vaginal vault prolapse and has an estimated annual U.S. market opportunity of between 60,000 and 70,000 patients.

The gold standard surgical approach for this debilitating condition is an open sacrocolpopexy. But since this approach requires a laparotomy, which is associated with longer hospitalization and increased blood loss, the postoperative road to recovery is often slow and painful as compared with less invasive approaches.

Traditional laparoscopic approaches were introduced nearly 15 years ago, and in the hands of skilled laparoscopists can be an alternative to the open approach. However, laparoscopic sacrocolpopexy is considered technically challenging due to its limitations, such as lack of depth perception and surgical access required for difficult suture placements.

da Vinci is rapidly proving capable in overcoming these clinical and technical challenges. A paper out of the Department of Obstetrics and Gynecology at the University of Rochester Medical Center entitled “Recovery after robotic-assisted laparoscopic sacrocolpopexy; the patients’ perspective,” authored by McNanley, Buchsbaum, et al, look closely at the patients perioperative experience.

In their analysis, patients were queried about resumption of activities, such as work, driving, bowel function, whether recovery went as expected and whether they would recommend this surgery to others.

Use of pain medication, pain scores and perioperative data were collected. N was 21 patients, which is admittedly small, but smaller than desired sample sizes is the reality of evaluating procedures that are still in the early part of the adoption curve.

Be that as it may, I think it’s pretty significant when 100% of the respondents stated that they would recommend a da Vinci sacrocolpopexy to a friend, 72% indicated that their recover went better than expected, 28% felt that the recovery went as expected and zero felt that the recovery went worse than expected.

Patient advocates had been a powerful component to the success of several da Vinci procedures. So we’re encouraged when we hear the early reports on an emerging procedure support this trend.

Over the past few quarters you’ve heard us describe substantive product development projects aimed toward the general and colorectal surgery markets. We’ve also highlighted that colorectal, and specifically, low rectal cancer resections are among our fastest growing procedures. The number of peer-reviewed publications in these specialties has grown rapidly and this past quarter was no exception.

In the Annals of Surgical Oncology, a study entitled “Multicentric Study on Robotic Tumor-Specific Mesorectal Excision for the Treatment of Rectal Cancer” was published. It was a prospective three center study on 143 consecutive patients, which, for the record, was analyzed by an independent researcher.

The three centers included City of Hope National Cancer Center in California, the European Institute of Oncology in Milan and Hospital San Matteo in Spoleto, Italy.

In their commentary, the author stated that to the best of their knowledge the present study evaluating robotic-assisted tumor-specific rectal surgery represents the largest series ever published with the longest follow-up period. The majority of the patient cohort had either mid or low rectal tumor and 65% received neoadjuvant chemoradiation.

Even though both conditions are known to render surgical dissection demanding successful excisions were successfully completed in over 95% of the patients and successful restoration of bowel continuity was achieved in 78.3% of them.

Margin clearance was obtained in all, but one patient, with a number of harvested nodes that compares favorably with that of open and laparoscopic series. Survival curve analysis revealed a three-year overall survival rate of 97% and local recurrence were not found during mean follow-up of 17.4 months.

When discussing the technical differences between laparoscopy and robotic approaches, the author stated, and I quote, “Laparoscopy offers an optimal tumor specific mesorectal excision or TME with intact pelvic fascia and even greater accuracy than the open technique, but use of non-articulated forceps, camera tremor and surgeon fatigue make this procedure demanding and restricted to a few centers.

Robotic TME seems to enhance microdissection accuracy, leading to a better and more comfortable mesorectal dissection with a lower risk of circumferential resection margin.” Later, the authors went on to say, and again I quote, “We feel that robotic surgery could dramatically change the standard approach to rectal cancer employed to-date.”

This week the 12th World Congress of The Society of American Gastrointestinal and Endoscopic Surgeons or SAGES convenes in Landover, Maryland. This year Intuitive will have a bigger presence than in the years past. Clinical prototypes of our single-site product for single incision da Vinci surgery will be on display at our booth.

But to be clear, these products are early within the FDA clearance process and should not be viewed as commercially available products at this stage. However, da Vinci multiport, general and colorectal surgery products and procedures, which are commercially available, will be discussed and featured within various conference sessions.

Our product development and marketing groups have been very active in the area of general and colorectal surgery, and the reason is simple. It’s our belief and the belief of many of our customers that the benefits of da Vinci surgery can positively affect a number of patients being treated within these specialties. Though we are in the early phases of procedure adoption within these specialties, the early indicators appear positive.

That concludes my remarks, and I’ll now turn the time over to Ben.

Ben Gong

Thank you, Aleks. I will be providing an update to our financial forecast for 2010, including procedures, revenues and the other elements of the income statement on a GAAP basis. I will also provide estimates on significant non-cash expenses to provide you with visibility of our expected future cash flows.

Starting with procedures, as Gary mentioned, our procedures this past quarter grew 37% over the year ago first quarter. We continue to expect our total procedures to grow approximately 35% for the year from the approximately 205,000 procedures performed in 2009.

Moving on to revenues, based on the upside we recorded in the first quarter, we are increasing our forecast for annual revenue growth to 27% to 30%, which is up from our previous estimate of 25%. As a reminder, our revenues can fluctuate quarter-to-quarter as system placements may vary.

With regard to our Japan revenues, as previously mentioned, while we sold seven systems in Q1, we do not expect to maintain this level of quarterly system sales in Japan for the balance of 2010.

With regard to gross margin, the 73% margin we achieved in Q1 was higher than in previous quarters due to higher ASPs on systems and manufacturing efficiencies. We expect ASPs to return to historical levels. As Gary indicated, we will continue to share productivity gains with our customers, and as a result, we expect gross margins to be approximately 72% for the year.

Moving to operating expense, we are making significant investments across multiple areas of our business, particularly our sales force, manufacturing and R&D. We now expect our total GAAP operating expense to grow by 27% to 29% in 2010 compared with our previous forecast of 25% growth.

In terms of non-cash expenses, we expect to report stock compensation charges of approximately $122 million in 2010, which is a little lower than our previous forecast of $127 million. In addition, previous purchases of intellectual property are scheduled to amortize in our R&D line at approximately $15 million for the year.

Other income, which is mainly comprised of interest income, is expected to come in between $16 million and $18 million for the year.

With regard to income tax, as Marshall mentioned earlier, we have begun taking advantage of the international tax structure we created to report a lower tax rate this year. We recorded a 36.2% tax rate for Q1 and we expect to record the same rate for the full year. This is a significant improvement over the 41% tax rate we reported for 2009.

For calculating earnings per share, we ended the first quarter with 39.2 million common shares outstanding and approximately 5.1 million options shares outstanding. Depending on our average stock price this year, a portion of the 5.1 million option shares will be added to the fully diluted shares calculation.

Assuming our stock price remains where it is today, we estimate that our share count for calculating EPS in Q2 will be approximately 40.6 million shares and for calculating EPS for the year, we estimate it will be approximately 40.8 million shares.

Finally, regarding our cash flows, since we are forecasting to report over $137 million in non-cash stock compensation and amortization expenses for the year, our cash flows will continue to be significantly higher than our reported net income.

We believe cash flows generated from operations is a better measure of our actual performance than net income. Once again, cash flows from operations in Q1 were $153 million compared with our net income of $85 million.

And with that, we’d like to open the call to your questions.

Question-and-Answer Session

Operator

(Operator instructions).

Ben Gong

Operator, can you check to see that the callers can actually dial in for questions?

Operator

I will double check. (Operator instructions).

Ben Gong

Operator, I just received a message that it’s not working on their end.

Gary Guthart

Looks like it’s just come up.

Ben Gong

Okay.

Operator

I have a question from Tao Levy.

Tao Levy – Deutsche Bank

Hey, good afternoon, guys. It’s Tao Levy from Deutsche Bank.

Gary Guthart

Good afternoon.

Tao Levy – Deutsche Bank

So, first question, you mentioned on the call a comment about sharing productivity gains with customers and I’m just wondering if you could go into that a little bit more. You’re talking about sort of discounts providing for your equipment, I just wasn’t sure about that. Thanks.

Gary Guthart

It’s Gary. Just a combination of things. I think one thing is that as we move into more price sensitive procedure markets, we expect that margin levels may fluctuate. The other thing is as we bring online technologies for training and networking and things like simulation, those were opportunities to help our customer and may have really a different margin profile.

Tao Levy – Deutsche Bank

Tao Levy

Thanks, that’s helpful. And you also talked about the sales force adds. So I was wondering if you could go into are you adding them by indication, are you adding them internationally? And then also just lastly on the international front in Europe, with sort of the headwinds that you were seeing, was that new from the beginning of the year, did they start at the end of last year because Q4 was pretty robust, Q1, obviously, a little bit choppier? And is that kind of what you are seeing going forward kind of continued choppiness until that macro environment improves? Thanks.

Gary Guthart

I’ll let Ben to take up.

Ben Gong

Thanks. I think the first part was sales force. As I mentioned, we added 49 people to our sales and marketing group and about 40 of those were in the field this past quarter. So, part of that comment is we’re still adding quite a few people to the sales force and we continue to hire a lot of folks.

With regard to the last part of the question, European demand, one thing I would say is that, just want to point out; procedures in Europe grew very well in the quarter which makes us feel good about the overall health of that business. Now, system sales were down in the quarter, and you’re right, it did fluctuate a little bit from Q4 to Q1. But generally speaking, we think that there is a challenging economic environment in Europe and that’s making system sales in Europe under some pressure.

Gary Guthart

How long that’s going to last we don’t know.

Tao Levy – Deutsche Bank

I don’t know that it’s anything different than you’re seeing in the general descriptions in the broader economic markets. Thanks.

Operator

Our next question is from Ben Andrew.

Ben Andrew – William Blair

Just wanted to follow-up on something, Aleks, that you mentioned, the notion of changing the sales structure to better support benign hysterectomy. Can you talk about that a little bit more?

Aleks Cukic

Yes, and again, I think I would ask you to not overstate that. In other words, we’ve added some GYN specialists in the area. And the focus again if you look at with respect to the GYN community and specifically the benign GYN segment, it’s really spread out. That’s a procedure that’s done in a lot of different places and there are a lot of people that own large practices.

So we’re really trying to focus some specialists, if you will, in that area, so they don’t have to make the decision on should they go and support a prostatectomy case or a partial nephrectomy case. Believe me, there is a lot of integration that is going to be natural in the sales organization, but we’re really looking to bolster that side of it a little bit more.

Ben Andrew – William Blair

And do you see a similar dynamic as you move into some of these other procedures because you’re obviously talking about some good growth in a pretty wide variety of procedure codes. You’ve obviously done this in cardio; you’re doing it a bit now in GYN, and do you see that as something maybe you end up with more frequently?

Aleks Cukic

I don’t think we’re in any position to say that this is any sort of a long-term strategy. I think we’re really looking at it from the perspective of where is the opportunity and what are the vital few things we can do to really attack that opportunity right now? Longer term, based on once a product is put out, once there is a clear understanding of the choreography of the sales person’s territory, those things will get visited. But it’s way too early to say that it should be something you should expect in future.

Ben Andrew – William Blair

And then just briefly on Japan, the seven systems that went out, do you have a sense of what those thought leaders will be doing with the product before you get to Shonin and really are able to move forward and promote the product?

Gary Guthart

We do have the Shonin, so they can go ahead and use it. We have basically all indications that we have in the U.S. except for pediatric, cardiac, although we do have thoracic and ENT. So they can use it. It’s reimbursement that we don’t have yet. And we’ll see a mix of those different procedures across that set of customers.

Ben Andrew – William Blair

So in terms of not having the reimbursement though, how does that constrain you in the near-term with the product?

Gary Guthart

I think until we have reimbursement, the broad adoption will be constrained, and that’s because of the way they have to go through their mix billing process. In other words, there is not really a mechanism for them to do private pay.

Ben Andrew – William Blair

Okay, thanks.

Operator

David Lewis has a question.

James – Morgan Stanley

Hi, guys, this is actually James [ph] in for David. I had a question about the EU market. Obviously, very strong procedure results over there, but how is the procedure mix and adoption curve OUS developing compared to the U.S.? And is prostatectomy still the driving force on the OUS growth or are you seeing a little bit of a different development there?

Aleks Cukic

I think generally speaking there has been a lag between outside the U.S. markets and the U.S. So the answer to the second part of that question, yes, prostatectomy is a big driver outside the United States. It’s still a driver within the United States, but it’s a bigger driver outside the United States, as it pertains to the percentage of their overall procedures. So, if you look at the GYN side, there is a lag there which you would expect.

The numbers in terms of a percentage sequentially or for the past few quarters has been strong, but it’s out of a much lower base. So, I think, in general, it’s our expectation that there will be a lag. The OUS markets will lag the broader U.S. market. Now, there may be exceptions on a country-by-country basis, but generally speaking, that’s the case.

James – Morgan Stanley

Right. And as you try to make a bigger push into general and colorectal surgery, what gives you the confidence there that you could be as successful, general surgery both from a share and margin perspective, where there is much more focus and pressure on procedural cost in those areas?

Aleks Cukic

I think you started the question correctly with the separation of general and colorectal, and I think you could continue to sub-segmentize it even further. So, I think what we have always believed is where there is great patient value; we stand a very good chance to be rapidly adopted. Now, I’d just say within some of those procedures in the broader category you find that laparoscopy has been introduced or had been introduced 15 years ago or as many as 20 years ago in some of those areas, but the penetration is very low. Why? Because it’s technically demanding.

And so, what we have found in the past is where those procedures have been technically demanding laparoscopically, where we can prove capable, we tend to have rapid adoption. We are not saying anything about margins in those areas or really giving anything beyond that other than if we can find procedures with high patient value, which we believe there are several, then we believe we’ll be successful.

James – Morgan Stanley

Okay. Could you give us some detail on what the two or three most attractive general or colorectal procedures might be for you?

Aleks Cukic

I think if you looked at it by some of the peer reviewed literature that’s out there or the anticipation from the surgeon categories, low rectal cancer really sticks out. If you look at low rectal cancers, there is laparoscopic colorectal surgery being done all over the United States and all over the world. But when you get to the low rectal cancers, those tend to be restricted to a few centers, high volume centers.

There seems to be a lot of consistency between that anatomy, obviously, and the male pelvic anatomy in working in prostatectomy. The same challenges that existed in laparoscopic prostatectomy exist in laparoscopic low rectal cancers. So, there are some indicators there that I think are favorable.

When you’re moving up into general thoracic sort of non-cardiac thoracic operations, that could be a large area, and again, I think the same thing can be said there. And then within general surgery, we will see. It’s too early. There are different platforms, as I mentioned, that we’re showing. And we’ll just see where some of those products land.

James – Morgan Stanley

Great, thanks, guys. I will jump back in queue.

Operator

Our next question comes from Tycho Peterson.

Tycho Peterson – JP Morgan

Hey, good afternoon. Maybe just coming out of the conference in Orlando this week, can you talk a little bit more about your thoughts on single port and maybe talk a little bit about the market opportunity, how attractive is the market beyond gallbladder for that initial product? And any color you can give us around how you are thinking about pricing or consumable use would be helpful? I know it’s early but –

Aleks Cukic

It is early, and therefore, there is really not a lot of depth that I’m going to or any of us really will go through at this point. As a reminder, we’re not through the FDA. And so, we are certainly going to be very cautious and careful recognizing that we’re not even approved yet, so we’re not going to make any claims. I think, generally, from a sort of 5,000-foot level, when we look at some of those procedures, if we look at where the multipuncture or the multiport da Vinci procedures have not been able to penetrate, they tend to be in some of the “simpler procedures” within general surgery. So, anything we’re able to really pick up in that area we look at as accretive.

And beyond that, it’s really hard for me to go into great detail whether it would be laparoscopic Collis or some of the other high volume, low technical challenging procedures, it’s hard to say. We will wait until it comes out, until we start doing some procedures in abundance, and we can start looking at the data and really determining what the value is going to be.

Tycho Peterson – JP Morgan

Okay. Can you talk a little bit about how the transoral is doing? You talked about, I think last quarter about some of the initial ENT procedures. How is that ramping?

Aleks Cukic

I think if you look at it, again, as a reminder, coming off of a small base. When we look at the procedures, there was very strong growth on a sequential basis, but it’s off a small base. If you look at the interest within the community, I think you said you were at the World Congress on Robotic Surgery, the expectations I think were exceeded in terms of the number of ENT surgeons that attended that conference and that attended the various sessions. If you look at the request for training and some of the other sort of early indicators, they all appear positive. So, we’re pleased with the early progress. We know in our minds and in the minds of a lot of our customers that there is high patient value there and we get excited about procedures where we can do that.

Tycho Peterson – JP Morgan

Could you maybe also comment just briefly on how you view the competitive dynamic with external beam radiation therapy? There was a new LINAC introduced yesterday from Varian, and clearly, they talked more about trying to go after prostate a little bit more aggressively. Can you just comment on whether you feel a need to fund clinical studies or how you view the competitive dynamic there?

Gary Guthart

There are several studies ongoing now that look at prostate cancer treatment first between open surgery, robotic surgery and different forms of radiation therapy. I think the way we look at it is the patient population is segmented. So, for the younger patients, surgery makes a lot of sense. There is a lot of data that indicates that surgical resections result in better long-term cancer outcomes than radiation. And where other discussion comes in is kind of is the patient’s age. And I think we’ll have to see. We’re certainly not ready to make any claims about what their new products can or cannot do, and we have several studies I think in the works that we’ll publish over the next few years.

Tycho Peterson – JP Morgan

And then just one last one, maybe for Ben, any updated thoughts on capital deployment priorities? This year you obviously talked about the cash you built up.

Gary Guthart

Why don’t I take that one? As we look at the cash, we really look at it in four buckets. The first bucket is really where in organic need do we have a requirement for cash infusion and we’ve been doing that quarter-over-quarter and we’ll continue to do so. We also look out at technology partnerships that we can initiate or accelerate, and then, acquisitions of technologies that fit well with us.

Again, we’ve done that as we’ve gone and the cash gives us the flexibility to do that as we need it. We’ll look at returning cash to shareholders as kind of an anti-dilution measure when the time is right and where it makes sense. And of course, we’ll like to keep some for flexibility. So, it really is that same set of priorities and it really is looking at it quarter-after-quarter and doing what makes sense as we see it.

Tycho Peterson – JP Morgan

Okay, thank you very much.

Operator

Our next question comes from Vincent Ricci.

Vincent Ricci – Wells Fargo

Hey, guys. Can you hear me, okay?

Gary Guthart

Yes.

Vincent Ricci – Wells Fargo

First question for you is with regard to a product you have showcasing at SAGES, the simulator product that’s presently on display, what is your strategy and what do you think the market opportunity would be?

Gary Guthart

We really look at that as something that can supplement training, and the goal really simply is to get more comfortable surgeons faster. We don’t look at that as a big revenue opportunity as a direct product line. So we’re not looking out and saying, boy, this is a huge revenue opportunity in and of itself. We really see it as a way to have good outcomes sooner with our existing products. So, you should not be looking at that and modeling with the big revenue stream of trend that simulation is. I think there is a lot of interest in it and a lot of interest that makes sense, but I would view it that way.

Vincent Ricci – Wells Fargo

And where exactly would you record revenues from that in your P&L?

Marshall Mohr

It’s a physical product, but I think what Gary is mentioning is that the intent of that product is not to be a significant revenue generator, but to be helpful in all the training that we do with surgeons.

Gary Guthart

As we get closer there, we could answer that question.

Vincent Ricci – Wells Fargo

And since you called it as part of the R&D, you’ve been talking a little bit more about colorectal, could you update us on the progress you’ve made with getting a surgical stapler on the market?

Aleks Cukic

The product, again, this is a reminder, we did a licensing deal a while back and we told you at that time and in subsequent quarters that the project is moving forward. We haven’t put any timelines in place as to when it’s going to be launched. I would just say that the teams are very well resourced, they are very energized and we’re pleased with the progress they’re making.

Vincent Ricci – Wells Fargo

Okay, great. And then lastly, you touched on this a little bit, you talked about adoption curves for procedures in the past, can you talk just a little bit about the adoption curve internationally for gynecology and specifically dVH?

Aleks Cukic

You broke up little there. Was it gynecology and specifically dVH?

Vincent Ricci – Wells Fargo

Yes, that’s correct.

Aleks Cukic

Again, I would say that, as a reminder, when we look back retrospectively at the dVP adoption curve between U.S. and OUS, we found it was lagging by a couple of years, if you looked at the overall numbers and you looked at the adoption rate and so on. Having said that, there were countries within Europe that look very similar to the United States. I would say with dVH it is lagging. However, the number is small, but on a sequential basis, it grew very well this quarter. It’s too early to say which countries are going to lead in that, but I think it’s fair to say that the dVH for malignancies is being adopted, let’s say, more rapidly or more uniformly outside the United States than dVH for benign.

Gary Guthart

We have time for two more questions.

Vincent Ricci – Wells Fargo

All right, thanks, guys.

Operator

I am sorry, is Mr. Ricci done with his question?

Aleks Cukic

Yes.

Vincent Ricci – Wells Fargo

I just assumed that we were done. Thanks guys for taking the questions.

Gary Guthart

Yes.

Operator

I am sorry; I am having a hard time understanding. Should I move on to the next question?

Ben Gong

Yes, please, operator.

Operator

Rick Wise will have the question.

Miroslava Minkova – Leerink Swann

Hi, guys, it’s actually Miroslava for Rick Wise. Congratulations on another very, very strong quarter. Let me start with asking a capital spending question. I know you discussed Europe in quite a lot of details, but turning to the U.S., the placement here seemed very strong. In fact, if I have this correctly, they didn’t even decline sequentially in what is supposed to be a seasonally weaker first quarter. Now, as the economy rebounds, do you think we can see an acceleration in U.S. da Vinci Si placement given that you do have a new product cycle as well? Any thoughts that you might relate on the capital spending environment here would be appreciated.

Ben Gong

Miroslava, this is Ben. You’re right. We had a pretty strong quarter in the U.S. Again, from a broad standpoint, we take a look at the procedure growth, and in the long-term, system placements are going to be a factor of the need for those systems based off of the procedure growth. And procedures are growing pretty well. As we mentioned that we’re still forecasting 35% procedure growth worldwide and that will lead to system sales. But we’re not speculating too much because these things do tend to vary quarter-to-quarter. They were really strong quarters in both Q4 and Q1, and I don’t know that it would be a fair thing for you to start modeling off of that and then expecting acceleration off of those numbers. We’re not being really specific about it, but we are giving you some top-line guidance on revenues.

Miroslava Minkova – Leerink Swann

Okay. I do appreciate that. Secondly, not to peek on you again, but gross margin you’ve given a guidance of 72%, but again in the last few quarters it has been above that already. Why should gross margins go down so significantly in the next couple of quarters span?

Ben Gong

Actually, this is the only quarter I can recall that it was 73%. In Q4, it was 72% and in the previous quarters it was lower than that. Pricing has been very consistent. So since we launched the Si in Q2 of 2009, all of our pricing for our products has been exactly the same. And you see a little bit of fluctuation due to product mix and customer mix. I think that’s probably just going to be the normal fluctuation you’re going to be seeing. If you just take a look at our historical average on the mixes that we’ve seen, we expect it to come in at 72%.

Miroslava Minkova – Leerink Swann

Okay. And maybe one more, can you update us where you stand with reimbursement in Japan? Is there any time line here that can be forecast? Are we several months away from getting any reimbursement in Japan, are we years away, how do we think about that?

Gary Guthart

Right now, it’s too soon to call. And so, we’re working through with our partners and with the government on how to approach it, and as we get to know more, we’ll let you know.

Miroslava Minkova – Leerink Swann

And let me throw one last one. We are at SAGES as well and I appreciate the comments on colorectal procedures, but there is quite a bit of talk about everything else here like bariatrics, cholecystectomy, including robotics. And I’m just wondering, traditionally, this has not been in your sweet spot so to say, because these have been the easy laparoscopic procedures. How close are you to this opportunity now and is there any instruments that you need to develop, is there any studies that you need to do, are you making any sort of a push into these type of procedures and how big is colorectal in the U.S. in terms of cases?

Aleks Cukic

I think the answer to most of those questions is yes. We will need instrumentation, we will need training pathways, we will need to push for peer reviewed data and so on and so forth. And the answer to that as always is most often going to be yes anytime we move into new areas. And so as far as predictions of where the adoption might be and to which of those sub-segments you said, it’s difficult to say and we won’t speculate.

But in terms of overall size of markets, if you look at the GI opportunity and you look at the colorectal opportunity, I believe estimates in the United States are that could approach 200,000. So, I am pleased to hear that there is a lot of excitement around all of those areas. That’s really motivating certainly for us, and that’s why we’re there. I think we have time for one more question, operator. Thank you.

Operator

Our final question comes from Sameer Harish.

Sameer Harish – Needham & Co.

Hi, guys, thanks for taking the question. I thought I would start off, you talked on the call about focusing on sales in GYN market, and does this open the door for more interaction at the patient level, possibly direct-to-consumer type marketing?

Aleks Cukic

I wouldn’t read that into the comments. I think, again, what we really strive for is providing patient value and we understand the chain of events there. There is a hospital customer, there is a physician customer and they are the people that own the patient. What we certainly do is provide a lot of information that patients can access to help them, sort of narrow their search as to the various opportunities that are out there. We will always do our best to provide as much information as we can.

Sameer Harish – Needham & Co.

Okay. In terms of the interaction that you are seeing from a customer level at the Web site or through the phone, has there been any change in the way that customers are approaching the company in terms of the procedures that they are asking about or does it mimic the current mix of prostate versus hysterectomy, can you talk about that?

Aleks Cukic

I can’t think of any per se outliers in there. I can say that there is nothing remarkable that stands out in that that is different from what our expectations would be.

Sameer Harish – Needham & Co.

And lastly, I know you don’t typically talk about pipeline products, but can you give us a little bit more detail on the pathway to getting ourselves approved in the U.S.?

Aleks Cukic

Again, we’re in discussions with the FDA, let’s put it that way. But in terms of the process or the timeline, there is really not a lot more we can comment on at that point.

Gary Guthart

That was our last question. As we have said previously, while we focus on financial metrics, such as revenues, profits and cash flow during these conference calls, our organizational focus remains on increasing patient value by improving surgical outcomes and reducing surgical trauma. I hope the following experiences give you some sense of what this means in the lives of our patients.

One patient is Rhonda of Florida. Rhonda describes her experience as follows, “Although I have had a uterine fibroid for years, I have successfully been able to avoid surgery. I had no symptoms and the fibroid was causing no problems, so I couldn’t bring myself to go through my pre-conceived notion of a hysterectomy when it wasn’t absolutely necessary.

After my recent ultrasound and subsequent CT scan revealed that it was now impacting my ureter and kidney, I could no longer avoid action. Thankfully, my new OB/GYN, Dr. Carol McKenzie, recommended that I contact Dr. Sam about a da Vinci robotic procedure. I was concerned that the fibroid was too big to even consider a robotic procedure, so I called to check before even making an appointment.

I felt very confident that I wanted her to do the surgery, but had previously scheduled a second appointment with a prominent surgeon who had performed this surgery on my friend just a few weeks earlier. At my consultation with him, he was adamant that the fibroid was simply too large to consider anything other than an abdominal hysterectomy.

I called Dr. Sam’s office to discuss it, and while she couldn’t guarantee that it could be done robotically, she was 80% to 85% sure that she could do it that way. For me, those were good enough odds and I truly believed that if anyone could do it, she was the one.

I went home the day after my surgery, and was able to get up and down the stairs without significant pain, though I moved slowly. 72 hours after my surgery, I felt well enough to go to my daughter’s soccer game and accompany my husband to his holiday party later that evening. Although I was still feeling a little bloated and swollen, for the most part I felt amazing.

For me, this experience has underscored how important it is for people to find out the latest treatments available, yet how important it is for people to also realize how critical it is to select the most competent and experienced technician. After years of avoiding this surgery, it’s so nice to finally have it behind me.”

Second patient is Doug, a marketing director at a hospital in West Virginia, who describes his experience as follows. “I had been diagnosed with mitral valve prolapse as a child, but it had never progressed to anything remarkable until September of 2009, when I began experiencing shortness of breath, chest and back tightness and uncomfortable palpitations. After numerous tests, it was determined that my mitral valve prolapse had progressed to severe mitral regurgitation and that I would need to either have my valve repaired or replaced.

After considerable research, I was committed to finding a physician and a facility that could, most importantly, repair my mitral valve. And secondarily, repair it with robotic assistance from the da Vinci Surgical System. My research led me to Dr. Marc Gillinov at The Cleveland Clinic Foundation, who did a fantastic job repairing both the anterior and posterior leaflets of my mitral valve robotically.

My recovery has been remarkably fast and easy. I feel great. And there are no signs of regurgitation or a heart murmur any more. I’m completely fixed. I can’t tell you what a relief it is to know that my health problems are now solved, that my sternum didn’t have to be sawed and spread apart, and that I can look forward to living a long, healthy life with my wonderful family. I truly feel blessed.”

Patients like these are the strongest advocates for da Vinci Surgery and form the very foundation of our operating performance. We have built our company to take surgery beyond the limits of the human hand, and I assure you that we remain committed to driving the vital few things that really make a difference.

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.

Operator

That concludes today’s conference. Thank you for participating. You may disconnect at any time.

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Source: Intuitive Surgical, Inc. Q1 2010 Earnings Call Transcript
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