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Executives

Mark Klausner - IR

Maurice Ferré - President, CEO and Chairman of the Board of Directors

Fritz LaPorte - SVP of Finance and Administration, CFO and Treasurer

Analysts

Matt Miksic - Piper Jaffray

Kim Gailun - JPMorgan

Rick Wise - Leerink Swann

Patrick Clingan - Lazard Capital Markets

Michael Matson - Wells Fargo Securities

MAKO Surgical Corp. (MAKO) Q2 2010 Earnings Call August 3, 2010 4:30 PM ET

Operator

Good afternoon ladies and gentleman, and welcome to the MAKO Surgical Corporation’s 2010 second quarter results conference call. As a reminder, this conference is being recorded and will be available for replay on the company’s website www.makosurgical.com, under the Investor Relations section after the completion of this call. It is now my pleasure to introduce your host Mr. Mark Klausner of Westwicke Partners.

Mark Klausner

Thank you operator. Joining us on today's call are MAKO's President and CEO, Dr. Maurice Ferré, and the company's Senior VP and Chief Financial Officer, Fritz LaPorte. The company's press release of financial results has been released via Globe Newswire. Mr. LaPorte will detail the contents of this release following remarks by Dr. Ferré. If you have not received a copy of the press release, it is available in the Investor Relations section of MAKO's website www.makosurgical.com. I would also like to remind you that this call is being webcast live and recorded. A replay of the event will be available later today on our website and will be available for at least 30 days following the call.

Before we begin, I would like to caution listeners that certain information discussed by management during this conference call, including answers to your questions, will include forward-looking statements covered under the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Actual results could differ materially from those stated or implied by our forward-looking statements due to risks and uncertainties associated with the company's business. For discussion of risks and uncertainties associated with MAKO's business, I encourage you to review the company's periodic reports filed from time to time with the Securities and Exchange Commission, including the Form 10-K for the fiscal year ended December 31, 2009, the Form 10-Q for the quarter ended March 31, 2010, and the Form 8-K filed with our earnings release. MAKO disclaims any obligations to update any forward-looking statements made during the course of this call.

With that, it's my pleasure to turn the call over to MAKO's President and CEO, Maurice Ferré.

Maurice Ferré

Thank you Mark and good afternoon and thank you for joining us to discus MAKO’s second quarter results. On today’s call, I will provide you with an update on our business and Fritz will provide you with the details on our financial results.

I am pleased with the progress we made in the second quarter and particularly on the new system placements, increased procedure volumes and continued utilization we are experiencing in the market. Specifically, we sold seven RIO Systems in the quarter. Six of these were installed at new domestic commercial sites, increasing our installed base of domestic commercial systems for 46, up from 40 at the end of the first quarter of 2010.

Additionally, we sold our first international system to our exclusive South Korean distributor and placed a system in Scotland for credible research purposes. Worldwide, our customer performs 793 MAKOplasty procedures in the second quarter, representing an 8% increase over the prior quarter and a 122% over the second quarter of 2009. Average monthly utilization per domestic system was 6.3.

We continue to focus on the development of clinical data supporting our RIO System and MAKOplasty procedures. In partnership with Strathclyde University, Glasgow Royal Infirmary and the National Health Services in Glasgow, Scotland, we will be conducting our first randomized perspective clinical study. This study compares unique compartments on MAKOplasty to a conventional unique compartmental procedure.

We attended 14 medical meetings this quarter, including Current Concepts in Joint Replacement or CCJR in Las Vegas and the International Society for Computer Assisted Orthopedic Surgery or CAOS in Paris. We completed two BioSkill meetings, brining the total number to four in 2010. We continue to see strong interest from existing perspective surgeons in attending these meetings and we continue with the development of our anticipated future application that assist a surgeon in performing a total hip arthroplasty procedure using the RIO system. The preliminary results of an ongoing cadaver study on hip MAKOplastys were presented at CAOS during the quarter.

Overall, the second quarter was another positive one for MAKO. Our team continues to execute on our business plan as demonstrated by the expansion of our installed base, our first international sale and the increase in procedure volume.

Now I would like to turn the call over to Fritz to review our financial results for the second quarter. Fritz?

Fritz LaPorte

Thank you Maurice and good afternoon everyone. In the second quarter of 2010, we recognized procedure, system and other revenue of $10.3 million, compared to $14.9 million in the second quarter of 2009. It is important to note that total revenue in the second quarter of 2009 included the recognition of $8.8 million of differed revenue associated with upgrade of 13 Tactile Guidance Systems or TGS units to RIO systems and $2 million of deferred revenue associated with the sale of three RIO systems in the first quarter of 2009.

As depicted in the non-GAAP reconciliation table in our Q2 earnings release, excluding the recognition of the deferred system revenue for comparative purposes, revenue generated in the second quarter of 2009 was $4.1 million. Accordingly, revenue generated in the second quarter of 2010, represents a 151% increase from the same period in 2009, excluding the recognition of deferred system revenue. Revenue in the second quarter of 2010 was primarily comprised of $4.2 million in procedure revenue and $5.7 million in RIO system revenue.

Procedure revenue was generated from 780 domestic MAKOplasty procedures performed in the quarter and average selling price or ASP of $5,058 per procedure, and a $295,000 stocking order from the Glasgow Royal Infirmary, which reported that 13 procedures were performed at its site during the quarter. System revenue was generated from the sale of seven RIO systems in the quarter, of which six systems were sold to domestic customers at an ASP of $852,000 per system. In addition, one RIO system was sold to an international distributor in South Korea which Maurice will detail shortly.

Total gross profit for the second quarter of 2010 was $6.6 million, compared to a gross profit of $4.47 million in the same period in 2009. Again for comparative purposes, excluding the $3.3 million impact on gross profit relating to the recognition of the systems, the gross profit generated in the second quarter of 2009 was $1.4 million. Total gross margin in the second quarter of 2010 was approximately 64%, comprised of a 74% gross margin on procedure revenue and a 58% gross margin on RIO system revenue.

Gross margin on procedure revenue remained consistent with the first quarter of 2010, excluding the inventory write-off for excess inventory in the first quarter driven by the favorable ASP per procedure combined with lower cost of goods as we transition from vendor development pricing to more favorable production pricing on our RESTORIS MCK implant system. The higher gross margin on the RIO system revenue was primarily driven by the higher ASP per system and higher production volume. Until we reach a steady state in production, gross margins on systems revenue will likely fluctuate from quarter-to-quarter.

Turning to expenses. Total operating expenses for the second quarter of 2010 were $15.2 million, an increase of $4 million from the $11.2 million for the second quarter of 2009. The increase in operating expenses for the quarter was primarily the result of an increase in selling, general and administrative costs and an increase in research and development costs.

Selling costs increased due to costs associated with the commercialization of our RESTORIS family of implants and our RIO system. General and administrative costs also increased as we continue to build infrastructure to support our growth. The increase in research and development costs was primarily associated with the continuous improvement of the RIO system platform and development of potential future products, including the RIO-enabled hip MAKOplasty application.

Our net loss for the second quarter was $8.5 million, including non-cash stock-based compensation expense of $1.6 million or $0.26 per basic and diluted common share based on average basic and diluted shares outstanding of $33.4 million. This compares to a net loss for the same period in 2009 of $6.4 million including non-cash stock-based compensation expense of $1 million or $0.26 per basic and diluted share, based on average, basic and diluted shares outstanding of $24.8 million.

Again, for comparative purposes, excluding the impact on gross profit of the recognition of deferred system revenue, net loss generated during the second quarter of 2009 was $9.7 million or $0.39 per basic and diluted share. As of June 30, 2010, we had $49.8 million in cash in investments and no debt. Our net cash used in the second quarter of 2010 was $10.9 million and was primarily used in operating and investing activities. With regard to guidance, we have narrowed the range of expected RIO systems to be sold in 2010 from our previously issued annual guidance of 30 to 37 RIO systems to 31 to 35 RIO systems, of which we have sold 11 RIO systems through the end of the second quarter.

We remain comfortable with our previously issued annual guidance of 3,400 to 3,700 expected MAKOplasty procedures to be performed in 2010, of which 1,524 procedures were performed through the end of the second quarter. Now I’d like to turn the call back over to Maurice.

Maurice Ferré

Thank you, Fritz. Before we open the call for question, I would like to spend a few minutes providing you with some additional details on our operational accomplishments during the second quarter.

In this second quarter, we sold seven RIO systems. Six of these systems were placed at US hospitals across multiple geographies, including three states which previously did not have systems. As of the end of the quarter, we now have RIO systems in 21 states, spread through out the United States. Of the hospitals that purchased a system, one was A. positions of those hospitals and the remaining were members of National or Regional hospital networks.

In the quarter, we also took steps towards developing an international presence. We sold one RIO system through our exclusive distributor in South Korea, which is our first international system sale. This system is intended to be used by our distributor for sale penetration purposes and to secure the regulatory approval necessary to fully market their RIO system and RESTORIS implant in South Korea. As you may know, South Korea represents one of the largest surgical robotic markets in Asia.

We currently anticipate that it will take at least 12 months for our distributor to secure regulator approval and begin marketing. Additionally, in the second quarter we secured the European Union CE marking which are required for the marketing and sale of our RIO system and our RESTORIS MCK implant system in Europe.

As I will discuss shortly, our first system in Europe was placed in Glasgow Royal Infirmary in Glasgow, Scotland. While this system is primarily being used for research purposes, despite it also represents an opportunity for MAKOplasty to gain more visibility in Europe. We continue to be pleased with the overall diverse composition of our domestic MAKOplasty sites and the developing international interest.

Turning to utilization. The average monthly utilization per commercial system was 6.3 procedures during the first quarter, a slight decrease from 6.6 in the first quarter of 2010, and an increase from 5.5 in the second quarter of 2009. As we have stated previously, we expect the utilization will fluctuate on a quarter-to-quarter basis due primarily to the number of new systems sold in the prior quarter, the speed at which these systems move up the utilization curve and new product introductions. Additionally, in this quarter we saw an impact on utilization due to some regional, seasonal trends.

As we continue to expand our customer base, we believe that the fluctuations in utilization will become normalized overtime. We continue to see an increase in our lateral, unique compartmental and isolated patellofemoral procedures. In the second quarter, 131 lateral and isolated patellofemoral MAKOplasty procedures were performed, representing approximately 17% of the total MAKOplasty procedure volumes in the quarter up from 12% in the first quarter.

Additionally in the second quarter, 64 bicompartmental procedures were performed. Consistent with prior quarters, this represents approximately 8% of the total MAKOplasty procedures performed. Our early MAKOplasty surgeon feedback has been positive on bicompartmental procedures. We would not expect a material increase in adoptions until data is published supporting the clinical benefit of the MAKOplasty bicompartmental procedure.

In conjunction with our surgeon users and academic collaborators, we remained focused on continuing to broaden and deepen the body of clinical evidence supporting MAKOplasty. Towards this goal, in the second quarter we placed a real system at the Glasgow Royal Infirmary in Glasgow, Scotland. This system is being used in the first randomized perspective study, conducted on MAKOplasty, a three year study at the Glasgow Royal Infirmary in conjunction with Strathclyde University and the National Health Services.

The study will consist of a 150 cases, 75 unique compartmental MAKOplasty procedures, compared to 75 conventional unique compartmental procedures. The intent of the study is to evaluate the clinical, functional and ultimately economic benefit of MAKOplasty. The study will compare accuracy, pain reduction, functional outcomes, biomechanical gate assessment, hospital stay, rehabilitation and recovery between MAKOplasty and conventional surgery.

Additionally, in the United States, we continue to build upon our strong base of clinical evidence with our quarterly clinical studies currently in process. These studies include basic clinical outcome studies to all of our implant systems, basic science studies on the progression of our share price in both knee and the hip, as well as a number of studies comparing the kinematic and functional outcomes of bicompartmental arthroplasty through traditional total knee arthroplasty. Based on these studies, seven abstracts were accepted at the international society for technology in arthroplasty meeting being held in Dubai in October 2010 and eight abstracts and one surgical technique video our lateral unicompartmentals procedures were submitted to the 2011 CAOS meeting.

Turning to our clinical marketing effort in the quarter, MAKO attended five conferences where surgeons engaged in RIO interactive hands-on demonstrations. In addition, a live surgical case was performed at the CCJRs spring meeting and podium presentation at three other meetings offered peer-to-peer experience and discussion.

MAKO exhibited and engaged surgeons at another eight meetings across the United States for a total of 14 professional meetings. Our particular interest, we participated in the CAOS meeting in June. At this conference, there four presentations discussing MAKO implant and applications. Two featuring medial unicompartmental results, one featuring bicompartmental results and discussed below, one on the accuracy of robotic total hip arthroplasty.

Also, as we have highlighted previously, we continue to conduct BioSkill courses that are designed to allow new and current MAKOplasty surgeons to obtain advanced training on the RIO system and the RESTORIS MCK implant system, and for prospective surgeons to obtain hand-drawn experience with the RIO and MAKOplasty procedures. We held two BioSkill meetings in the second quarter with approximately 40 surgeons and attendants, and we intend to hold approximately four additional meetings in geographically diverse locations in the remainder of 2010. These meetings are one of our key tools to introduce, educate and cultivate MAKOplasty surgeon champions as who are instrumental in supporting our RIO systems sales process.

On the patient education front, our 37 person MAKOplasty implant sales force continues key efforts in the second quarter to educate our customers on the value of MAKOplasty. We supported our hospital customers in conducting 52 consumer seminars and attracting over 1,600 potential MAKOplasty patients. In the quarter, there were also 10 local new stories that featured MAKOplasty. We continue to believe that increased patient awareness from the benefits of MAKOplasty will be a contributing factor to driving our continued adoption.

Regarding the expansion of application for our RIO platform, our hip product development is continuing and we remain on plan to begin clinical procedures through our surgeon preference evaluation or SPE process by the end of 2010 as part of our ongoing developmental process. A presentation was made at CAOS that discussed preliminary results from an ongoing cadaveric study from Dr. Dorr from Good Samaritan Hospital, Dr. Pagnano and Trousdale from Mayo Clinic and Dr. Padgett from Hospital for Special Surgery, comparing the accuracy of robotic versus manual total hip arthroplasty. It was reported that manual instrument procedures had on average an air ratio for 4.8 times higher in anti-version and 4.2 times higher in inclination than robotic procedures, we are optimistic that this early data will be supported by MAKO’s further development efforts.

As we look forward to the balance of 2010, I remain encouraged with the trends I am seeing in our business, both our MAKOplasty sales force and our RIO capital sales force are pooling gates in their territories and we believe that our pipeline remains strong. I continue to believe that our procedure growth and system utilization demonstrates economic value propositions and the increased volume of significant clinical evidence along with our anticipated hip application will continue to support our sales process as we grow our business.

With that, I would like to open up the call to take your questions.

Question-and-Answer

Operator

Thank you. (Operators Instructions) And our first question comes from Matt Miksic with Piper Jaffray.

Matt Miksic - Piper Jaffray

So, on the capital side, just one question on the tone out there. It seems like based on what some of the other companies in the space have delivered and commented on, the climate may be starting to stabilize or improve a little bit on the margin. I just wanted to get your sense of whether that’s what you are seeing. And then looking forward, how should we think about that? Are you thinking or concerned about any kind of variability there. Are you planning for some variability or a lumpiness here in the backend of the year?

Maurice Ferré

Thank you for that question and I think first thing I would add is that I think our sample in terms of where we are in our universe, I think it’s too small a sample to really reflect what's going on in the broader macroeconomic environment. However, based on what we hear in the market, it seems like capital spending market is continuing to recover, but much of the near-term spending seems focused on replacement capital equipment. And as hospitals compress healthcare reform, we are hearing from our customers that they need to invest in products that can differentiate their hospital in the market and become more profitable. So we think the trend is positive, I think this is positive thing for MAKO and our job is to demonstrate to the hospital how the implementation of the MAKOplasty center of excellence can help them develop a market leading orthopedic program.

I mean those are kind of the key messaging and I think that hospitals are moving in a positive trend, we are seeing it. But they are looking from our perspective, of ways of how to differentiate themselves and become key in increasing profitability and I think the MAKO story really feeds into that.

I was going to say that with that we're encouraged with what we're seeing, and what we said in the past with regards to placement of systems in order from Fritz's comments in terms of, we feel in terms of our guidance is appropriate time to tighten it up or narrow it and kind of going in at the mid range of about 33 based on what we're seeing, what we're seeing on a forward looking basis and also what we’ve seen in the past. I think we're very comfortable with similar to what we ended up with last quarter or last year with one third, two third type of situation. So I think we're well on our way of getting there and I think our pipeline is strong and I think we are seeing ways of differentiating our products and our offerings in this environment.

Matt Miksic - Piper Jaffray

And just a follow-up, looking into the back half, I know you don’t get into sort of backlog or pipeline commentary specifically. But in terms of activity of RSPs or evaluations or new interest coming into the pipeline are you seeing that? Is that changing or picking up or the same as you've seen in the last couple of quarters.

Maurice Ferré

I think we are seeing a stronger pipeline on our front, remember we talked about having a stronger sales force, the sales force has now being out there longer in terms of the adding of the seven plus sales people in the end of Q3. So we're seeing visibility, we are starting to see those guys performed. We had four new guys actually do sales this quarter. So I think that those are very encouraging trends that allow us to feel comfortable with how these members are starting to roll up. And I think that the awareness side of things, we are getting a lot of traction with a lot of these presentations. In this quarter particularly as you noticed, we talked a lot about a lot of these big presentations that are being made at these conferences, these seminars being held, a lot of hospitals are now coming to us and asking about the MAKO program.

I think it could be because of the Obama chair, but we are seeing our hospitals trying to differentiate themselves in their marketplace and we’ve heard even commentary about that they are focused on 2014 and they want to be able to gain market share quickly so they are taking more risk and I think that’s very favorable to the MAKO story. MAKO and it’s systems and placements is not just the robot, its actually building programs around it and we're seeing a huge impact on the halo effect where doctors and hospitals are gaining market share in their regions by having the robot system there and it also feeds into this whole idea of building more applications on our system.

Matt Miksic - Piper Jaffray

The follow-up on just the kinds of surgeons and I guess now hospitals as you talk about it that are interested in getting into the pipeline or deciding to go ahead with the robot. How is that changing from what you have seen I guess in the last year and looking forward, how much of a roll is things like the hip or your clinical data that you have in development to get a play in this next tranche or even entering in the next tranche doctors?

Maurice Ferré

I think that we're heading towards a new level of doctors and I think it’s the all the above I think it's the awareness. I mean if you asked me a year ago, how many people knew about MAKO, I think there'd be a lot less and I think that we're really most big programs we’ve reached up to them, they know about it and a lot of the people that were skeptical are at least more interested in calling meetings, are more intrigued, do I learn more about it, they want to understand what the additional product offerings are, they want to understand the bicompartmentals the patellofemoral, the lateral, they want to understand what we are trying with hip and we're not actively and aggressively pitching the hip but we know that that's something that is very encouraging. It expands as you know. It’s a much larger market in terms of mainstream, in terms of what we're trying to address.

So I think that in combination with successful sites that have really made an impact in their community on the MAKO program and I think that is attributed by the volumes that they are generating, their business models that they have leased with their hospital administration. I mean these are the types of key things that are critical in today’s hospital environment. I was just talking today to a CEO one of the chains, and his commentary to me was very positive in saying the MAKO program has built their orthopedic practice. And now they have other hospitals in that system that are trying to replicate it, so the CEOs are coming to visit them, the hospital administrators, the doctors, they are sending people to these multiple sites around our country. And I think we are still early in the process, but clearly it’s sending a ripple effect a message and I think it has allowed us to continue to perform to plan.

Matt Miksic - Piper Jaffray

And then just one last on the pricing, it seems like that continues to, on a contrary, to much of the rest of the world of mid-tech, you are seeing kind of better than expected pricing. Should we use what we’re seeing here as a good model for the rest of the year or is there anything that you can see that should causes to moderate?

Maurice Ferré

I’m going to let Fritz answer that.

Fritz LaPorte

So, Matt, I think overall we are obviously pleased to see the same old trends in pricing in ASP to-date. However, we remain a little cautious and take a little bit of a cautious stance with regard to pricing in the future. Just as you hear about pricing pressures, we’re experiencing them in the market place as well. And so looking forward, again positive trend, but I think more of an average of maybe last couple two to four quarters is probably more reasonable than bringing it up to what we experience in this quarter. There’s really no guarantee that, that will continue to be as strong as it was in Q2.

Operator

Our next question comes from Kim Gailun from JPMorgan.

Kim Gailun - JPMorgan

I guess my first is just, because we are talking about price, I’d love to follow-up on the comment there, Fritz. So, you know we have talked for a couple of quarters about pricing probably not staying at the levels it’s been at, but it continues to increase. Have you seen anything so far this quarter that makes you think that you won’t be on pricing on par with what we saw in the second quarter?

Fritz LaPorte

Well, we totally are dancing. We don’t really give much insight to the current quarter that we are in. But I think one thing I would say is that our guidance clearly implies an increase in volume in the second half, both from a systems placement as well as procedures, and we a couple good price systems with a lower volume. It obviously has a greater impact on the ASPs. So it will be a little more of a dilutive effect on that pricing. So, nothing in particular in this quarter, again just optimistic because all of the mac kind of the environment that we are in and anything to hear about is downward pressure, and although we have been able to have favorable pricing, it’s still something that we have to be cautious of going forward.

Kim Gailun - JPMorgan

And then I wanted to ask a little bit on the utilization side. The utilization was solid in the quarter, and I’m wondering if you guys saw any impact from the procedural slowdown, that kind of a broader orthopedic market farther in the quarter.

Maurice Ferré

I am not sure we saw a decrease in the utilization, but I am not sure how much of it is attributed to the macro, but may be it is. I think one of the highlights on our thing that we commented on was the fact that we saw a, I would say, kind of a winter month snowbird effect on some of our seasonal accounts. And I think part of that could be attributed to the fact that we held, mentioned in our last call, about 20 different seminars in these accounts that we saw a decrease. And they had snowbird effect of where that benefited and impacted about 500 patients in terms of we were able to seminars where we had over 500 patients that participated.

I think that some of these patients went back to the primary residence, and I think had an impact. And I think on forward-looking basis, I think as we continue to add more successful MAKOplasty accounts, I think our trends in utilization will start normalizing. And it’s fair to say that we think that over the next few quarters that our utilization rates are going to be between 6 and 6.6. And I think that really supports what puts it that I already alluded to where our procedure guidance hasn’t changed and we think that is going to be 3,400 and 3,700.

Kim Gailun - JPMorgan

Did you see between 6 and 6.6?

Maurice Ferré

Correct.

Kim Gailun - JPMorgan

And then my last question and then I will drop this. Just looking at the systems guidance now, 31 to 35 for the year, within that do you expect there to be any other international system sales or do you think the bulk. Do you that will be all US with the exception of the one we saw this quarter?

Maurice Ferré

I think that international now is becoming the beginnings of international spread to be created, and we have a lot of work. We are in early stages of development of our international business and we are very encouraged by the systems that we sold obviously in South Korea and also placing the CE margin. We believe that the study that's being conducted in Glasgow will increase the visibility in Europe. But this is a long-term process, but we're pleased with the initial traction that we're getting. So I think, the impacts are going to be, we are going to see them, but I think it’s more kind of a growth part of our business in terms of opportunities in future years.

Operator

Our next question comes from the line of Rick Wise of Leerink Swann.

Rick Wise - Leerink Swann

Back to start of the bigger picture question again, obviously the larger ortho players had a tough quarter on the procedure front. Particularly on the knee side it seemed and maybe it’s all of them in my experience singled out, (inaudible). You touched on seasonal trends and yet that don’t usually think of the second quarter as having seasonal trends, I think usually think that’s a third quarter. I know it’s small, it’s early, you are different, but what are you seeing on the actual procedure front, would you have thought they would have been better or all things equal or?

Maurice Ferré

I think it’s apples and oranges and I don’t know if the big company has experienced a significant decrease in unit. I mean I think if anything, more people are opting to do a less invasive procedure for economic purposes, in terms of getting the work faster and quicker in recoveries, so I don’t see that trend. I mean I see very positive trends in our growth accounts and I think that we’re going to continue to see that as we continue to add and introduce in new products, new doctors into our existing account and looking at the pipeline and looking at the types of accounts that are asking for MAKOplasty procedures, I see that kind of trailing what we’re anticipating in our guidance. So I don’t see it going in a negative direction or sawed in a negative direction other than I would say some seasonality with some of our accounts. I mean just to kind of give you a sense, something that we just got to be aware of, the impact of I think it was one case per account contributed 37, it would first go from 6.3 to 6.6 its just 37 procedures.

So less than one per site, so I think that this is a situation where I don’t think you can really say anything about it, that is something material, its not part of the big picture. The bigger picture for me is seeing how our customers are starting to build their MAKOplasty center of excellence program and what the implications of that are going to be and how they are taking market share from their existing sites. I mean that to me is the more exciting thing. I mean think about it. If our utilizations are in the sixes, we're talking about 60-70 procedures and most of these procedures are incremental. So there are actually going right to the bottom line in these hospitals and that’s what I think these hospitals are getting excited about.

Rick Wise - Leerink Swann

Thank you, the next question. If I take the mid point of your new 31 to 35 system placement range, you settled out in another first half, so that’s 21 plus minus in the second half. And just the fact that you've narrowed the range so meticulously at the low end specially, (inaudible) that you must have a lot of confidence or visibility in the pipeline. Is that the right way to think about it and maybe just what gives you so much confidence in the second half ramp?

Maurice Ferré

This is an art as much as a science. We know how this works, but I think that we look at our business and we base it first on our pipeline, we look forward and ask ourselves what's out there, what are we trending towards, how good are those accounts in our pipeline and then we also look backwards in terms of what we’ve done in the past and what we expect to do and we look at certain trends and some of the things that we look at is like the sales force starting to mature and we're beginning to see some of the new sales higher last year been productive. Those are really important steps. We’re seeing the markets and hospitals starting to talk a lot more about MAKOplasty programs. The healthcare environment where hospitals are seeking programs to differentiate and I mentioned that earlier. I think where that comes in the contributing factors, we look at our guidance and also as important, the increased body clinical evidence that we're really meticulously paying attention to, in the trade shows and the interest shown by patients, we have a 800 number call where patients are calling in. We are seeing an increase in that.

We are seeing an increase in the number of hits on our internet sites. All these, all contribute to how we look at guidance and visibility, okay. But that being said the narrowing of the guidance, and I just want to note that we went up, we took that the 30 and moved it to 31, and we took 37, we were just 35, because we felt comfortable with this one-third, two-third which seemed to fall into 33 and then if we are honest with ourselves and what we have said in the past, with the one-third, two-thirds in knowing what we know about the visibility, it goes, we said let’s distribute it equally. Now, at the end of the day is that were the chips fall? Well, I mean I think at this point the arched side of it, so I think we’ve got it, we have got the visibility, and I think we have tried to be intellectually honest with ourselves and with the people out there of where we think we are going to fumble. We'll see where it goes.

Rick Wise - Leerink Swann

And Maurice or Fritz, maybe you can help us a little bit with the seasonal flow. We had you increasing each quarter in the revenue, total revenues increasing each quarter, but you have come in nicely ahead here in the second quarter. Can the third quarter is it going to look a lot like the second quarter? Can you make sequential progress? Is it for some reason do you feel, Maurice any clarity about it or are we even more backend-loaded this year or less than usual? Any help there would be great.

Fritz LaPorte

Yes, Rick. This is Fritz. So, obviously we’ve got to carry on. Well, we don’t give the quarterly guidance, but I think as our annual guidance implies, we were to see a incremental step-up on the third quarter and then the fourth quarter as well. Just from system placement as well as procedures growing. Maurice indicated earlier, utilization should stay in relatively consistent range and based on new system placements, the ones we placed in the first half, overall procedural volume will grow accordingly in the third and fourth quarter as well. So I think we will see a reasonable incremental step-up in the third and then again in the fourth quarter.

Rick Wise - Leerink Swann

And finally any comment about seasonal, is there any…

Maurice Ferré

Look, I think Rick I mean I think we are a high growth company, alright. And if you look at how we’ve grown over the last year, we continue to do it and we are committed to that and I think we feel comfortable with how we are guiding the street, and last year as you recall, when we were on this second quarter call. We did three and three and we’ve said we are sticking with our guidance on the back end of 18 to 22, and then we narrowed it down in the third quarter to hit between 18 and 20. We landed up right on the middle of the 19. So, this is feeling the same way and that’s how we see our business.

Operator

Our next question comes from the line of Patrick Clingan with Lazard Capital Markets.

Patrick Clingan - Lazard Capital Markets

I just wanted to follow-up Maurice on your comment around the snowbird effect that you fell like you saw in the quarter. I know you’ve got a several really high volume physicians in some of the snowbird-oriented states. I mean did you have any disruption in your turnover in perhaps some of your very high volume docs?

Maurice Ferré

On the quarter, no, we did not.

Patrick Clingan - Lazard Capital Markets

If I kind of kind of strip out some of the, I guess the 195 or so and bicompartmental, laterals and PPS. It looks like your needs perhaps on a year-over-year basis didn’t really grow that much in terms of utilization on the base platform. Is that the right way to think about it, at sort of 5.5 unis per system at this stage or am I reading too much into that?

Maurice Ferré

Well, I think you are reading too much into it, because I mean laterals are also unis and patellofemorals.

Patrick Clingan - Lazard Capital Markets

Let me just get back to your product launches, I mean really laterals and PPS and bicompartmentals are relatively new over the course of the last year. So I guess I’m just trying to get a read on the media or what you guys started with. Has that sort of flattened out in terms of a percent of the mix at each system or is there something else going on?

Maurice Ferré

I don’t think we are seeing it flattening out. I think there is bits and pieces of this. I think clearly that there has been a lot of success, and from our perspective rapid growth at our accounts of introducing lateral patellofemoral. And I think that there are sites out there that are going to do a certain number of medial unis and they are probably not going to grow. That’s not where their growth is going to take place. And there are other accounts out there that have an indication and a belief that there are more patients out there. So, I wouldn’t describe it as kind of going, I think the growth is still there in all of this.

Patrick Clingan - Lazard Capital Markets

And in terms of the commercial opportunity in Europe, congrats on the CE Marked, wanted to just add, I mean given the length of times it's going to take to enroll the Glasgow study, do you think you will leave that in order to generate reimbursement for the procedure in certain markets in Europe?

Maurice Ferré

I think that, what I am excited about is that we've got the NH involved and as you know in Europe and in the UK in particular, that’s a ruling body that creates reimbursement strategies. And I think one of the things that I am very excited about is the fact that we can address through a minimalist approach of lesser space at hospitals compared to traditional and that I think it has an impact on the waiting list. One of the big things that they are concerned about is that waiting list in the UK and I think that’s one of the key things that’s going to help create the reimbursement in the pricing strategy in Europe.

Patrick Clingan - Lazard Capital Markets

Right, then for Fritz on gross margins, I appreciate that you said that the systems can be a bit lumpy. Is there any reason for us to expect that the gross margins on the system side or even on the procedure side at this stage could potentially go down in back half of the year?

Fritz LaPorte

So I'll start with the systems, it could fluctuate, one of my commentaries about production, so its linked to the actual production, is you know pretty much spreading a fixed overhead cost across the production for the quarter and we produce systems for various reasons in addition to sales. So yes, that could fluctuate with the quantity we're talking about that go through revenue and cost through revenue there we could see that balance between the 10% range that we saw from last quarter to this quarter, from high 40’s mid to high 50’s . And that will continue until we do get couple of years out some more steady state production.

From a procedural standpoint, I think that we're around the 74 this quarter on procedures. That should stay fairly constant until we have a new product introduction on the implant side. As you may recall with a procedural margin when we launched CMCK, we started out with lower margin due to the initial production volumes where we have a lot more of a quality check on the first couple of production runs until we get to pass the initial production runs and then the margin kind of stabilizes. So we should stay stable again on the procedure side until we have another implant product launch.

Patrick Clingan - Lazard Capital Markets

Then on the installed base that have kind of moved around a little bit the unit being placed in Glasgow and then the one in Korea and really not being commercial units and the way you guys historically quoted utilization, can you just maybe touch on where we are in terms of units in the filed in the US that you guys use when you calculate your, and how we should think about how you're going to calculate your utilization metrics going forward.

Fritz LaPorte

Sure we’ve tried to remain consistent with our utilization calc since the beginning and just to remind everyone what’s included in that so it has been our commercial site which as of the end of the second quarter, we have 46 commercial site. So going forward we are not going to include international. Part of reason there is they are getting the stalking purchase orders, they are reporting to us the procedures obviously with the clinical study program in Glasgow. We will have a pretty solid tracking.

But we're going to be relying on their reporting and as you indicated, it will be a while to the for example on the Korean systems placed in service. So, until our international business gets some more of a steady state, where we'll report just the full numbers as apposed to measuring the metrics that our core visits has measured on domestically.

So, its 46 and we have one which technically classifies as non-commercial site which is (inaudible) but as you know, that’s been part of our installed based for quite a long time and is at a consistent level and they are included as well in out utilization calc. So, its 47 sites for example as would be in the calculation going forward in the third quarter and what I mean by that is one other important note on the calculation is that we do not include sites added during the quarter.

So the sixth domestic systems we added this quarter are not included in our utilization calc and the reason being is that in the capital sales process the majority of these are placed near the end the quarter and really don’t contribute to procedural volumes in the quarter. So they are mot included for the following quarter. So our utilization, the denominator of utilization calc for this quarter would have been the 40 commercial sites plus the one site I mentioned (inaudible) in the denominator.

Operator

A final question comes from of Michael Matson with Wells Fargo Securities.

Michael Matson - Wells Fargo Securities

Just want a little clarification on the system placements in the quarter. So, I think I understand it, but I just want to make sure, so there were six systems placed in the US. And those were all installed and accepted. There was the one that was sold to a South Korean distributor, and I assume that’s the one that was not installed and accepted. But it was considered sold from a revenue recognition standpoint. And then the system in Scotland I assume was not sold. Is that correct?

Fritz LaPorte

Yeah, it’s correct. There is one correction. The South Korean distributor system was accepted. It wasn’t installed, that was accepted and in revenue recognized by the Korean distributor, but it is not installed, they are using it for the demonstration and Korean FDA clearance.

Michael Matson - Wells Fargo Securities

And then the 852,000 ASP number, I assume that it excludes the South Korean unit.

Fritz LaPorte

That’s correct.

Michael Matson - Wells Fargo Securities

And then the 5,058 I think was the number for the implant ASPs, does that include the stocking order or not?

Maurice Ferré

No it doesn’t. That’s the 780 domestic procedures performed.

Michael Matson - Wells Fargo Securities

And then, with regard to Scottish trial, is there any plans to do something like that in the US and if is not, why did you kind of elect to do that in Europe and in the UK versus doing it in the US.

Maurice Ferré

We attempted to do it here in the US, very difficult to do a randomized clinical trial. The problem is most consecutive, that hear about the robotic MAKOplasty opt to do it. They do want to be part of the study. In the UK, they are able to address it because of healthcare system that they have.

Michael Matson - Wells Fargo Securities

That’s interesting. And then, is MAKO working on a total needs to kind of complement the partial implants that they have?

Maurice Ferré

We haven’t spoken about products beyond the hip and we get a lot of enquiries about being able to do a total knee and we continue to be in the process with our R&D team and our marketing team to identify those opportunities. One of the things that we spent a lot of time on is coming up with a real, definitive and clarity of what the value proposition is to the surgeon and to the patient and to the hospitals and now to the insurance companies. Those are our key drivers and if we introduce products, we will always build around those models and that’s why what we talk about is creating these programs, MAKO is about creating programs for these constituents and creating value creation.

Michael Matson - Wells Fargo Securities

All right and then my follow-up question just, given that you did have, I understand this South Korea situation, I mean the parts are not really approved there yet, so I wouldn’t really expect in the near term any additional sales but given the CE mark, is there a potential for additional sales this year, outside of the US and in any of the European Union countries and do you have any distribution arrangement set up in any of those countries at this point?

Maurice Ferré

We continue to build on our business plans. We look at this as a big picture story, right. We're in it to do it right. And we want to be able to kind of dot the ‘Is’ and cross the ‘Ts’ and there are certain things that we have throughout our business like getting our regulatory pieces put together and plan I mean we're looking at this thing three to five years out and where we want to be. Is international going to become a bigger part of the MAKO story? Absolutely, but we're not right now in a position to really start talking about where we're going next and for a lot of reasons one of them is competitive. But what we will say is that we are encouraged and we are excited to introduce and bring out that we are taking steps on what we believe is other side of what MAKI is going to be all about going forward.

Operator

And at this time I'd like to turn the call over to Maurice for a wrap up.

Maurice Ferré

Let me close by thanking all of you for taking the time to join us on our call today. We sincerely appreciate your interest in MAKO and look forward to updating you on our continuing progress. Thank you.

Operator

Ladies and gentlemen thank you for your participation in today’s conference. This concludes the program. You may all disconnect. Everyone have a great day.

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Source: MAKO Surgical Corp. Q2 2010 Earnings Call Transcript
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