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Intuitive Surgical Inc. (NASDAQ:ISRG)

Q2 2007 Earnings Call

July 19, 2007 4:30 pm ET

Executives

Sarah Norton - IR

Lonnie Smith - Chairman, CEO

Marshall Mohr - CFO

Ben Gong - VP of Finance

Aleks Cukic - VP of Business Development and Strategic Planning

Gary Guthart - President and COO

Jerry McNamara - EVP of Sales and Marketing

Analysts

Tao Levy - Deutsche Bank

Eli Kammerman - Cowen and Company

Tim Nelson - Piper Jaffray

Vincent Ritchie - Wachovia

Rick Wise - Bear Stearns

Mark Richter - Jefferies & Company

Presentation

Operator

Good afternoon and welcome to the Intuitive Surgical Second Quarter Earnings Call. Following today’s presentations, there will be a formal question-and-answer session. At that time instructions will be given. Until that time all the lines will remain in a listen-only fashion. At the request of the call leader, today's conference will be recorded, any objection you may disconnect at this time.

I'd now like to turn the call over to Ms. Sarah Norton. Ma'am, you may begin when you are ready.

Sarah Norton

Thank you. Good afternoon and welcome to Intuitive Surgical's Second Quarter Conference Call. With me today, we have Lonnie Smith, our Chairman and CEO; Marshall Mohr, our Chief Financial Officer; Ben Gong, our Vice President of Finance; and Aleks Cukic, our Vice President of Business Development and 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 website at intuitivesurgical.com on the audio archive section under our Investor Relations page. In addition, today's press release has been posted to our website.

Today's format will consist of providing you with highlights of our second quarter as described in our press release announced earlier today, followed by a question-and-answer session. First, Lonnie will present the quarter's business highlights, Marshall will follow with a review of our second quarter’s financial results, next Aleks will discuss sales and marketing highlights, then Ben will provide our updated financial forecast for 2007; and finally, we will host a question-and-answer session.

With that, I would like to introduce Lonnie Smith, our Chairman and CEO.

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Lonnie Smith

Thank you for joining us today. As you can see from our press release, we continue to drive adoption curve for robotically assisted surgery, delivering significant top-line and bottom-line growth.

Before we get into details of our operating and financial performance, I would like to acknowledge the presence of Gary Guthart, our President and Chief Operating Officer; and Jerry McNamara our Executive Vice President of Sales and Marketing.

Together Gary and Jerry manage all the core functions of our company, Gary inside and Jerry outside. Both have been instrumental in building Intuitive Surgical to the company it is today.

Gary is responsible for applied research, product and procedure development, engineering and design, quality, manufacturing, business development, continuous improvement, regulatory and legal.

Jerry is responsible for worldwide sales, service, customer and sales training, marketing and reimbursement. They are both exceptional leaders and have demonstrated the necessary foresight, capacity, energy, integrity and leadership to lead the company in the future. We are committed to maintaining our focus on the core activities that drive our success. Their recent promotions are part of our long-term succession planning. We believe that the best team wins and I believe that Gary and Jerry possess leadership qualities necessary to ensure the long-term performance and success of our company.

If anyone is wondering, I am not going anywhere. I plan to remain active and involved in the business as Chairman and Chief Executive Officer. However, I turn 63 next week, and I believe, and our Board agrees, that succession planning does not begin when you turn 65.

Gary and Jerry will be available to answer any of your questions. Any questions you might have during the Q&A portion of this call.

Now turning to highlights for the second quarter. Total revenue grew to $140 million, up 61% from last year. Instrument and accessory revenue increased to $46 million, up 76%. Total recurring revenue, including service, grew to $66 million, up 70% from the prior year, comprising 47% of total revenue. We sold 56 da Vinci Surgical Systems, up from 39 during the second quarter of last year. 13 of the 56 systems were sold outside the United States. 12 were second, third or fourth systems to existing customers driven by procedure growth in those accounts.

We ended the second quarter with 656 da Vinci systems installed worldwide. We generated an operating profit of $54 million, 39% of revenue before non-cash 123R stock option expense, up 76% from the second quarter of last year.

GAAP net income grew to $31 million, 22% of revenue, up 84% from last year. We ended the quarter with $448 million in cash and investments, up $63 million from last quarter. We generated $204 million in the last 12 months. Because of the significant non-cash stock option and statutory tax expenses reflected in our GAAP net income, we believe that operating profit before non-cash 123R stock option expense is the best measure of our actual financial performance.

While we reported $31 million in GAAP net income for the quarter, our cash and marketable securities grew by $63 million including $11 million receipts from stock option exercise during the quarter and $5 million invested during the quarter in fixed assets and working capital.

We continue to see solid sequential quarter-over-quarter procedure growth, led by gynecology and followed by urology. We believe the procedure growth continues to be the primary driver of our business. It indicates the rate of procedure adoption and drives systems sales to new and existing customers. The da Vinci S continued to dominate our systems mix, accounting for 55 of the 56 systems sold. High-definition Vision Systems dominated in the United States. 35, or over 80% of the 43 systems sold in the US, were High-definition. We launched the High-definition Vision System in our international markets at the end of the quarter. Two of the OUS Systems sold were HD.

We completed the move of our European headquarters from France to Switzerland, and grew our Intuitive team by 173 members in the last 12 months to 659 at the end of the second quarter.

With that, I will pass the time over to Marshall Mohr, our Chief Financial Officer.

Marshall Mohr

Thank you, Lonnie. Total second-quarter revenue increased to $140.2 million, up 61% from $87 million for the second quarter of 2006 and up 23% from $114.2 million for the first quarter of 2007. Our revenue growth was driven by procedure adoption and we experienced growth in all of our targeted procedures during the second quarter. Da Vinci hysterectomy and prostatectomy continue to be our fastest-growing procedures.

Second-quarter revenues by product category were as follows. Instrument and accessory revenue increased to $45.8 million, up 76% compared with $26.1 million last year and 14% compared with $40.3 million last quarter. The growth rate in instruments and accessories is comparable to and a direct result of our procedure growth rates.

The amount of instrument and accessory revenue we earned per procedure remained relatively unchanged, between $1,500 and $2,000 per procedure for established da Vinci accounts. Including the impact of initial orders completed with new system purchases, instrument and accessory revenue continues to be between $2,000 and $2,500 per procedure.

Systems revenue increased to $74.1 million, up 54% compared with $48.1 million last year, and increased 32% compared with $56.1 million last quarter. The increase in systems revenue reflects increased unit sales as well as an increase in the average revenue per system. Second quarter da Vinci Surgical System revenue reflects the sale of 56 systems, two of which involved trade-ins, compared with 39 systems sold during the second quarter of last year and 44 systems sold in the first quarter. 37 of the systems sold during the quarter were our latest S model incorporating high definition vision capabilities. 18 were S models incorporating standard vision capabilities, one was a refurbished four-arm standard system. 12 of the systems represented repeat sales compared to 13 repeat sales in the previous quarter.

Our second quarter average revenue per system including all da Vinci models, but excluding upgrades, was $1.3 million, which is $50,000 more than the average revenue per system in the first quarter of 2007. The higher average revenue per system primarily reflects a higher proportion of our sales being comprised of our new HD model, which had a list price of $120,000 more than our da Vinci S standard vision model, as well as a lower proportion of our sales being comprised of da Vinci standard systems.

Upgrades including fourth arms and HD accounted for $1.1 million of the current quarter systems revenue, compared with $1 million last quarter. Service and training revenue increased to $20.3 million, up 59% compared with $12.8 million last year and up 15% compared with $17.8 million last quarter. The growth in service and training revenues is primarily driven by a larger system install base as well as higher annual contract prices associated with da Vinci S and HD models.

Total second-quarter recurring revenue comprised of instrument, accessory, service and training revenue increased to $66.1 million, up 70% compared with the second quarter of 2006 and up 14% compared with the first quarter of 2007. Recurring revenue represented 47% of second quarter revenue compared with 51% in the first quarter, reflecting the significant increase in system sales. Our second quarter 2007 gross margin of 67.1% was consistent with the 67% realized in the first quarter.

Total operating expenses for the second quarter of 2007 were $49.1 million compared with $42.2 million in the first quarter of 2007. Operating expenses include $7.8 million of non-cash stock option expense in the second quarter compared with $6.9 million of stock option expense in the first quarter. The sequential increase of stock option expense primarily reflects the annual grant to employees made in February. Excluding the effect of stock option expense, the sequential operating expense increase of $6.1 million reflects increased commissions associated with increased sales, increased spending on R&D- which included a minor amount of third-party development costs, increased headcount and increases in other costs associated with the growth in our top line.

Operating expenses for the second quarter also included $1.2 million of expense associated with the move of our international headquarters from France to Switzerland and the establishment of our new tax structure. Our new international headquarters is now fully operational in Aubonne, Switzerland. We added 44 employees during the second quarter ending the period with 659 regular employees. The majority of the additions were worldwide sales and support and manufacturing organizations.

Second quarter 2007 operating income was $45 million or 32.1% of sales, compared with $34.3 million or 30.1% of sales for the first quarter of 2007.

Our second quarter 2007 other income of $5.2 million increased, compared with $4.6 million in the first quarter of 2007. The increase is primarily the result of interest earned on greater cash and investment balances.

Our effective tax rate for the second quarter was 39%, which is consistent with the first quarter. We continue to utilize net loss carry-forwards in 2007 and expect our cash outlay as a percentage of pre-tax income for 2007 will be between 15% and 20% of pre-tax income. Our international tax structuring activities are proceeding on schedule but we will not generate a reduction in our global tax rate until after 2008.

Our net income increased to $30.7 million or $0.79 per share, up 84% compared with $16.7 million or $0.44 per share for the second quarter of 2006, and up 29% compared with $28.0 million or $0.62 per share for the first quarter of 2007.

Let me quickly summarize our results for the first six months of 2007. Total revenue for the first six months of 2007 was $254.5 million, up 55% compared with $164.3 million last year. Operating income for the first six months of 2007 was $79.4 million, up 72% compared with $46.2 million last year.

Operating income included $17.5 million of stock-based compensation charges in the first six months of 2007, compared with $11.6 million in 2006. Net income for the first six months of 2007 was $54.5 million or $1.41 a share, up 75% compared with $31.1 million or $0.82 per share.

Now turning our attention to the balance sheet. We ended the second quarter of 2007 with cash, cash equivalents and investments of $448 million, up $63 million from the previous quarter end. And $117 million from December 31, 2006. $11 million of the cash generated in the quarter and $20 million of the cash generated in this six-month period was associated with stock-purchase activities. The remaining cash generated is primarily related to operating activities.

Our accounts receivable balance increased to $105.6 million on June 30, 2007, from $90.5 million on March 31, 2007. The increase in accounts receivable is attributable to increased sales.

Our net inventory decreased to $24 million on June 30, 2007, from $26.3 million on March 31, 2007. Our inventory returns on June 30, 2007 of 7.4 times per year improved compared with 5.6 returns at the end of the previous quarter.

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 second quarter, we shipped 56 da Vinci systems. 44 systems in North America, 8 into Europe and 4 into rest-of-world markets. 55 of the 56 system shipments were da Vinci S Systems and one was the standard four-arm system. Of the 55 S Systems sold, 37 were High-definition or HD systems.

In addition, we sold eight HD upgrades to existing da Vinci S customers. The 56 systems sold during the quarter minus the 2 trade-ins brings to 656 the cumulative number of da Vinci systems worldwide—504 in North America, 108 in Europe and 44 in rest-of-world markets. 12 of the 56 systems sold during the quarter represented second, third or fourth system sales. Three hospitals Memorial Hermann at Houston, Clarian North in Indianapolis and Hartford Hospital in Hartford, Connecticut purchased third systems during the quarter. While Yonsei Medical Center in Seoul, Korea purchased their third and fourth systems.

Clinically we had another very good quarter, with strong sequential procedure growth across all major surgical specialties both US and internationally. Our gynecologic procedure business, paced by da Vinci hysterectomy, registered the largest sequential percentage growth for the quarter, followed by urology. Our cardiothoracic and general surgery procedure businesses, which are approximately the same size, showed strong steady sequential procedure growth. Ben will provide you with updated procedure guidance during his review.

During the quarter we had 42 da Vinci related clinical papers published within various peer-reviewed journals. And in June, we launched the da Vinci HD Vision system to international customers. We participated in 11 conferences within urology, gynecology, general surgery and cardiothoracic surgery, however I'll review highlights from only two, beginning with the American Urology Association or AUA.

Our AUA presence this year was exceptional. The program included 78 moderated da Vinci abstracts, 41 on DVP alone, along with three AUA sanctioned post-graduate robotic courses, five live da Vinci Telesurgery broadcasts and two AUA sanctioned robotic lunch programs. Our two da Vinci HD demo systems were running non-stop throughout the conference while our sales people were busy writing leads.

Also encouraging was the fact that there were 37 non-DVP moderated abstracts at this year's program which included da Vinci nephrectomy, radical prostatectomy, pyeloplasty, sacral colpopexy and various Pediatric Urology procedures.

The key observation from this year's AUA has to do with the procedure leverage DVP has established for us throughout the entire specialty of Urology and perhaps beyond. Five short years ago when DVP was in its infancy, there were a handful of urologists talking about it and almost no one presenting case data. At this year's AUA the Henry Ford Group, led by Dr. Manin Menon, presented their case data on a series of 2,632 patients. The series included patients with T2, T3 and T4 cancers with a reported overall positive margin rate of 13%. 13% compares very favorably to Henry Ford's 2003 British Journal of Urology Publication in which they reported a 23% overall positive margin rate in a series of 1,400 open prostatectomy patients.

The group also reported a postoperative inner course rate of 93% and men receiving The Veil of Aphrodite technique without any preoperative erectile dysfunction. On the same day the Ohio State Group led by Dr. V. Patel reported on their series of 1,300 consecutive DVPs and showed an average operating time of only 95 minutes. A one-day hospitalization with an overall margin rate of 11%, and only 4% in patients with organ-confined disease.

With large evidence-based patient series such as these becoming more common each quarter, it gives us as well as many of our customers the confidence to say that DVP is rapidly moving toward a standard of care for prostatectomy in the United States. However when you consider DVP adoption on a global scale, the penetration is significantly less.

We are also beginning to see our DVP momentum pull along a number of other urologic procedures. Examples, such as City of Hope Group presenting their initial 60 da Vinci radical prostatectomies, or a group out of Innsbruck, Austria reporting on their initial 26 da Vinci partial nephrectomies, or Tulane University Group presenting on their data of six sacral colpopexies, and so on. We've always believed that a heavy DVP focus with commensurate re-sourcing would ultimately be the most effective way for us to access the entire specialty of urology which now appears to be taking place.

This year was the first time we exhibited at the American College of Gynecology Conference or ACOG, which took place in San Diego. We were quite pleased with the level of da Vinci activity at this conference. On previous calls we highlighted our success at some of the specialty GYN conferences such as the Society of Gynecologic Oncology Conference or SGO, or the Association of Advance Gynecological Laparoscopy or AAGL, whereas ACOG is the predominant professional organization for the entire field of OBGYN.

In addition to the heavy test drive schedule for the HD system, our booth was filled with physicians listening to clinical lectures on da Vinci hysterectomy, myomectomy and sacral colpopexy. At the same ACOG was conducting da Vinci lectures and hands-on didactic sessions as part of their advance laparoscopic post-graduate course in which 120 surgeons participated. During the plenary session ACOG featured two live da Vinci hysterectomies, one for endometrial cancer broadcast from the University of North Carolina, and the second for benign pathology broadcast from the Mayo Clinic. The sessions were very well attended and enthusiasm was high.

Customer request for GYN case observation, training, case proctoring- which are all early indicators to the strength of the business- remains high. In summary we remain very bullish on our GYN opportunity.

That concludes my update and I’ll turn the time over to Ben.

Ben Gong

Thank you, Aleks. As in previous earnings calls I’ll be providing our update or forecast on a GAAP reporting basis, including stock compensation expenses. I’ll also provide an estimate of the stock compensation expenses separately so that you can calculate meaningful comparisons that exclude these non-cash expenses.

We reported better than anticipated growth in revenue and profits in the second quarter and we expect to continue this momentum in the second half of the year, therefore we are increasing our previous guidance for revenue and profits for 2007. We have mentioned in the past that the primary driver for the company’s growth is the growth in procedures performed with da Vinci System. Today, our top two procedures are da Vinci Prostatectomy or DVP and da Vinci Hysterectomy or DVH.

At the beginning of the year we had given guidance that we expected the DVP growth this year to exceed 50%. Based on what we have experienced in the first half of the year, we now expect DVP growth for the year to exceed 65%. With regard to DVH, we have previously given guidance that we expected DVH growth this year to exceed 150%. We now expect DVH growth for the year to exceed 175%.

Now with regard to revenue, in our previous call we estimated our instrument and accessory revenues to grow between 65% and 70% over 2006. Based upon stronger procedure growth led by DVP and DVH, we now expect 2007 instrument and accessory revenue to grow between 70% and 75% over 2006.

Our systems sales were particularly strong in the second quarter, across new and existing customers and across domestic and international customers. We expect to have continued year-over-year growth in system unit placements this year.

We are forecasting systems revenue to grow between 30% and 35% over 2006, which is up from our previous forecast of 20% to 25%. The majority of this growth is resulting from an increase in system units, while part of this growth is also driven by higher average selling prices for systems.

Our system ASP was approximately $1.3 million for the second quarter and $1.25 million in the first quarter. For the balance of the year, we expect our system ASP to remain between $1.25 and $1.3 million. This is approximately $100,000 higher than our average ASP in 2006.

We expect service revenues to grow approximately 50% above 2006 levels, up from our previous forecast of 45%.

Overall, we now expect our total 2007 revenues to grow approximately 45% to 50% over 2006, compared to 40% previously forecast.

Please note that we typically have a seasonally softer third quarter as elective surgeries are often postponed during the summer months, and summer vacations often disrupt our customers’ buying patterns. Therefore, we expect total revenue in the third quarter to be about the same as our revenue in the second quarter; we should then see sequential revenue growth in the fourth quarter, which is seasonally our strongest quarter of the year. With regard to gross profit margin, we have consistently maintained gross margins at around 67% over the past few quarters and we expect our gross margins to remain at approximately this rate for the remainder of the year.

Moving to operating expenses, there are number of factors which are driving our operating expenses higher than we previously forecast. First, higher revenues are driving higher sales commissions which are reflected in SG&A expense. We expect our SG&A expense to grow between 40% and 44% for the year.

In the R&D expense category, we'd stepped up our investment in internal projects as well as co-development projects with third-party corporate partners. Our co-development projects with third-parties are expected to increase our quarterly R&D expense by approximately $1.5 million per quarter starting in the third quarter.

In total, we expect our R&D expense for 2007 to be 48% to 52% higher than our total R&D expense for 2006. We expect our total operating expense for 2007 to be 41% to 45% higher than our total operating expense in 2006. These forecasts for gross margin and operating expense include the impact of FAS123R stock compensation expense.

Our second quarter operating income included $9.4 million of non-cash stock compensation expenses, allocated as follows: $1.5 million in cost of sales, $5.8 million in SG&A and $2 million in R&D. For the year, we expect the impact of FAS123R to be between $36 and $37 million with a percentage of allocation to P&L lines consistent with Q2.

Other income expense, which is mainly comprised of interest income is expected to be approximately $21 to $22 million for the year, compared with the $20 million estimate we had previously forecast due to higher cash balances.

With regard to income tax, we continue to expect GAAP tax rates of 39% for the remainder of the year. However, we expect our effective cash tax expense to be 15% to 20% for 2007. Regarding shares outstanding, we currently have 37.7 common shares outstanding. We also have approximately 33.7 million option shares outstanding. Depending upon our average stock price during the third quarter, a portion of the 3.7 million option shares will be added to the fully diluted shares calculation. For calculating EPS in Q3, we expect the share count to be between 38.7 million and 39 million shares.

That concludes our prepared remarks and we will now open the call to your questions.

Question-and-Answer Session

Operator

Thank you. At this time we will begin the question-and-answer portion of today's program. (Operator Instructions). Thank you. And our first question comes from Tao Levy or Levy I'm sorry go ahead with your question.

Tao Levy - Deutsche Bank

Close enough, it's Tao Levy. Hi guys.

Gary Guthart

Hi Tao.

Jerry McNamara

Hi Tao.

Tao Levy - Deutsche Bank

Congratulations, great numbers here. Just wanted to flush a couple of things out the very impressive system number. Anyway, you know, last quarter was a little bit different where versus our numbers, the system was a little bit softer yet utilization was really strong and then now you had a little bit of the reverse versus our numbers here in this quarter. Is that, like you've seen in years before where you have greater utilization drive system placement? Is that what we’ve seen this quarter versus the first quarter again?

Jerry McNamara

Hey Tao, this is Jerry. Yeah, I just wanted to point out as you have suspected, we have experienced that increase in utilization within our installed base across all areas of the world and it’s being led primarily by the increase in GYN procedures and DVP procedures and as hospitals reach capacity with their da Vinci Systems, in many cases they evaluate the need for additional systems and that launches second or third systems sales as Aleks mentioned. But overall what we have seen is an expansion of robotics surgery programs in hospitals and it’s taking place at a very consistent and solid rate, so we are pretty pleased with that.

Tao Levy - Deutsche Bank

Great and maybe, could you flush out the whole sort of, any way to flush out sort of the number of systems or the percentage of systems that were purchased due to sort of our interesting gynecology versus urology?

Jerry McNamara

That’s always a hard thing for us to do Tao, because as we’ve always said our focus is multiple specialty, and so to kind of draw a line to say this one was GYN or that one was urology is an imperfect science. What we can say is that since the approval of GYN, back in the May timeframe of 2005, we’ve seen a preponderance of second system placements and one can conclude that there is just not enough capacity in the hospitals that have multiple specialties seeking to use the system. So it continues to happen, but it would be hard for us to tell you exactly what percentage is due to this, but it's something we see continuing.

Tao Levy - Deutsche Bank

Okay, and then the last question, maybe for Gary and Jerry, maybe given your new roles at the company, maybe you could sort of talk about sort of the challenges and opportunities that you see for robotic surgery over the next several years, you know worldwide? I know it's quite a tough question, but any insight there would obviously be helpful for us as we try to see where this is going and again over the next several years?

Jerry McNamara

Tao we’ve got a couple of hours.

Tao Levy - Deutsche Bank

Yeah.

Jerry McNamara

Okay, Tao we are -- our challenges just to continue to drive the key procedure adoption, and I think Aleks did a really great job of pointing out that with our success in driving DVP and growing that procedure we gained tremendous leverage if you will for additional procedures in the same specialty, so we are not just moving a procedure but we are moving the specialty of urology. This is also what we are challenged with in gynecology, so simply put we are driving a procedure business and our customers are investing in robotics programs that are multi-specialty.

Gary Guthart

I'll add something on the development side. I think the common theme for us on development is that we want to both enable new procedure as well as refine and improve the products for existing procedures and so we are all restructuring ourselves to do that.

Tao Levy - Deutsche Bank

Okay, thanks.

Operator

Thank you and our next question comes from Eli Kammerman.

Eli Kammerman - Cowen and Company

Thanks very much. First question is it looks like your average utilization is still solidly below three procedures per week per system over your installed base, so how do you reconcile that with the hospitals' need for a second system because they are bumping up against capacity ceilings?

Ben Gong

Eli this is Ben. We definitely experienced growth in utilization during the second quarter over the first quarter; we've continued to see increased utilization on a quarterly basis barely steadily over the last year, say 10 quarters. Now, keep in mind that our metric of an average of between two and three procedures per week and it still is in that range, is an average and so we've mentioned we have a number of people that are over five procedures a week, which tends to be a bit of a point where they have trouble scheduling cases and then needing to buy additional systems and at the same time you might have newer users that are less than two procedures a week. So, the key here is that the utilization continues to grow on average and that means everyone's using their systems more.

Gary Guthart

The other point is we are constantly bringing in new customers right? We've got 56 new systems, of those 44 were new customers and those ramp up. They take some time to ramp up, so we are always constant alluding on the low-end and growing on the top end.

Jerry McNamara

And I think one more piece of information that is also helpful is that we have 504 systems in the United -- in North America and we have 63 customers or roughly 63 customers in North America that have more than one system. So we have a total of 420 different centers of which 63 have more than one system. In other words, 15% of the U.S. base of hospitals has more than one system and so when you add a second system to let’s say a hospital that's doing 300 or 400 procedures per year, their average gets cut in half and even despite that we are continuing to grow the overall metric and so I think it’s important to recognize it’s not exactly a linear algorithm because there are a lot of moving parts here. The bottom line is that we have a lot of people that are requiring second systems and we are pleased to sell them.

Eli Kammerman - Cowen and Company

Okay, that's very helpful. Thank you. And my next question is in the area of OB/GYN could you give us some rough idea of what fraction of procedures are for oncology-related surgeries and what fraction are for other?

Jerry McNamara

You know, what we are able to track pretty clearly is the type of surgeon that's actually performing the operation- in other words, the GYN oncologist or a non-oncologist. What is less of a perfect science is exactly the pathology, but it's pretty clear that the GYN oncology practice is primarily gynecologic procedures. But I can say at this point again without having an exact breakdown that we are tracking both sides and both sides are tracking very nicely, both complex, benign as well as oncologic, and we see that obviously based on our up guidance continuing to grow very strongly.

Eli Kammerman - Cowen and Company

Alright. Thanks very much.

Operator

Thank you. And our next question or comment comes from Tim Nelson, Piper Jaffray.

Tim Nelson - Piper Jaffray

Hi guys, wonderful quarter. The most common question I get from my clients and (inaudible) is how much longer can a radical prostatectomy DVP procedure grow? Can you tell on your penetration rate and where you think it tops out and maybe some time as to where you think the market strategy is now, I know it's growing relative at expense of some other procedures?

Gary Guthart

Well, Tim you just hit two pieces- that again our role is very difficult for us to quantify, I mean, I am going to add a third- US versus all US. So, when you look at all three of those pieces it's hard for us to kind of answer it in the way that you formed it, where it's going to tap out. I think if you look at the way we reported it we'd given a fixed approximation of 90,000 procedures in United States and we'd sort of based everything off of that, but when you look at it on a global basis, it’s a significantly larger number.

When you look at the moving parts which you accurately called out between brachytherapy, external beam radiation, watchful waiting, etcetera. Unfortunately, that’s lagging numbers, so we really don’t know what that translates into now. So, as a result, we feel very strongly that we can give with confidence an up guidance of a 65% annual growth rate, taking it up from 50% and that’s about as clear as we can go.

Lonnie Smith

I guess the other comment, longer term I'd make is that, we do track procedures against a new diagnosis and that continues to grow and if you look at it by state there are some states that are highly penetrated and some of that are not yet. And we are seeing growth in all of them, even the most highly penetrated states. And so that’s encouraging, I think also is that, if you look at, if you’re talking about the prostatectomy, but there are multiple other procedures where we are now deserving a clear adoption curve. It's a very high correlation factor. So, I think we don’t plan to stop with prostatectomy, we are following with gynecology and as Jerry pointed out, I think it’s important that we started with one re-procedure within a group and pretty soon it expands in that specialty to other procedures. And so, where we bring value and as Jerry pointed out, we continue to try to drive the value add that we bring to existing procedures, as well as the value add we bring to new procedures.

Tim Nelson - Piper Jaffray

Great. On the R&D front, you talked about some co-development agreements. Can you comment on any new products that can add over the balance of the year that you are excited about on the instrumentation side, and if any losing products may help increase that ASP per procedure?

Lonnie Smith

Well, we don't announce products before the ratio, so we'll announce those as they come ready. I will say that we are accelerating our R&D activities in several areas including investments in imaging technologies of robotics, software instruments and applied research. In addition, we've stepped up our technical partnerships with outside third parties. I'll tell you also we are pleased with the progress and the pace of our R&D teams to-date, and as new products come out we'll share that with you at that time.

Jerry McNamara

And to the other side, you asked about ASPs and regarding that ASPs will stay around the same range that we've see them in the first half of the year. This is for system sales obviously and it's going to be driven by things like product mix and geographic mix as it has in the past.

Tim Nelson - Piper Jaffray

Okay. I was thinking more about the instrumentation, the revenue per procedure on instrumentation side, it has been flat for a long, long time. I was just wondering if you ever can break out of that range?

Gary Guthart

And if you are driving the adoption, we are not necessarily driving to increase or striving to increase the cost for procedure to our customers. So that is not part of our strategy, our strategy is penetration, system placement and procedure adoption.

Jerry McNamara

And I think just on top of that, we are conscious of the way our customers evaluate their cost and as they are reimbursed on a per case basis it's important for us to really recognize the way their business is structured, so I wouldn't think of that as just one that we could just continue to grow and grow through technology

Tim Nelson - Piper Jaffray

Okay, and then a final question is back on the installed base, it's sort of about utilization rate. Do you have anything [right on] the numbers of system out there that are actually idle that don’t get used much and do you see any trends as procedures grow, utilization grows, that those older systems that maybe still out of use or getting reused or getting refurbished to get more active?

Jerry McNamara

Tim that's exactly what happens, as the success of robotic surgery and the increased adoption of prostatectomy and da Vinci Hysterectomy grows, systems that were not optimized become busier and also our field sales teams are not selling robots at this point in time. They are selling robotic surgery programs that bring the benefits of the technology to patients in multi-specialty. So, this enables us to take systems that might have been laggards or stalled systems and move them to the active state and we do that very proactively.

Tim Nelson - Piper Jaffray

Is that part of the trade-in program that sort of (inaudible) that going?

Jerry McNamara

No, Tim that's not part of the training program.

Tim Nelson - Piper Jaffray

Okay, all right thanks.

Jerry McNamara

Thank you.

Operator

Thank you. And our next question comes from Vincent Ritchie, Wachovia.

Vincent Ritchie - Wachovia

Hi, thanks for taking my question. I got a couple of quick questions for you. The first one is do you have a split on the international and OUS revenues?

Gary Guthart

Yeah, it's been tracking pretty consistently in the 80% to 85% domestic, and that means 15% to 20% international, and it didn’t change significantly this quarter versus previous quarters.

Vincent Ritchie - Wachovia

Okay, that's great. More on the procedural side, have you guys been tracking residency programs that are training their residence on the system and exposing it to them?

Gary Guthart

I don’t think that is an absolute metric we track. I can say anecdotally that the awareness of robotic surgery in, starting if you were a little above up the food chain in other words fellowship programs down into residency programs starting with senior residence fourth year, third year, second year, etcetera. Anecdotally I can tell you that there is more exposure there, but in terms of a number or some form of a metric I can't give you one.

Vincent Ritchie - Wachovia

Okay. I think that was just something that we noticed the SGO that there were a couple of posters about that, I was just curious if that was, when is it happening?

Gary Guthart

Yeah it's happening but it's just a hard one to -- kind of to keep real time.

Vincent Ritchie - Wachovia

Okay. The five procedures through weak metric you kind of mentioned- when you are talking about that, are you talking about a multi-specialty hospital or is it that the hospital that's using it for one specialty, because that seems kind of low for a hospital that would be a straight urology hospital?

Gary Guthart

Yeah. That's a good point and I will take the opportunity to repeat some of the concepts from before. When a system is being shared among multiple specialties we find that the capacity of the system is lower than when it is fully dedicated to one specialty because it's just harder to schedule across different specialties. And so we've said that when there is sharing among different specialties, we've seen people buy second systems when they would hit somewhere in the order of 250 procedures a year, whereas we would see people who are exclusively in urology get up to 400 procedures per year on the system before they would buy their next system.

Vincent Ritchie - Wachovia

Okay. And how many of the hospitals are presently multi-system hospitals?

Gary Guthart

We have 71 worldwide with 63 in North America and the breakdown to just give you the specifics on how many have per, I should say we have six hospitals that have four da Vinci's. We have 15 hospitals that have three and we have approximately 50 that have two.

Vincent Ritchie - Wachovia

Okay, great and then my last question is in terms of the partnerships that you’re looking at, are these for specific specialties such as general cardio OBGYN or is it more just towards specific type of technologies?

Jerry McNamara

It tends to be more broad than single and -- I guess I have to say it really depends on the partnership as well. If there is one and it is a particularly good fit then we will pursue it for a single specialty, but most of them are broader than a single.

Vincent Ritchie - Wachovia

Okay, great, thanks for taking my questions.

Operator

Thank you, and our next question comes from Rick Wise, Bear Stearns.

Rick Wise - Bear Stearns

Good afternoon everybody and truly congratulations on a terrific quarter. A couple of things, clearly we saw a lot of operating leverage this quarter with operating expenses growing well below the sales rate and Ben, you’ve given us some very clear-cut and excellent guidance going forward, but just in general as we think about whether it’s a second half or the next two years, should we expect to see this kind of significant operating leverage too just in a general way as we look out to the future?

Lonnie Smith

Rick, let me make sure of that, I think that's a -- we do manage the business on a fixed and variable basis and so we do understand operating leverage well. Our longer term goal is to bring those more in line, not -- because we are investing in R&D and a lot of other areas.

Rick Wise - Bear Stearns

I’m sorry, Lonnie more in line meaning --

Lonnie Smith

It is more in line with sales growth.

Rick Wise - Bear Stearns

So that -- it would be equivalent?

Lonnie Smith

Yeah, so that would be more equivalent, I think that when we have -- literally when we have this kind of growth, we -- it outpaces our ability to build the infrastructure. Now, we are all just trying to get (inaudible) -- we are not going to have a culture here where we build infrastructure faster and we built sales that just won't happen, so there is probably some leverage but I would not factor into a model a lot of operating leverage going forward we'll be investing infrastructure because we are investing in the future, I mean, we are still in the very, very early stages of this market and this technology and where it can go and we want to remain the leader, so we will continue to invest heavily to do so.

Rick Wise - Bear Stearns

Okay, I sort of cut-off from mid -- so I apologize if I am asking a question that’s been asked just tell me if it has. First quarter units were less than we expected, second quarter a little more and I know Lonnie how finer you are of focusing on quarters, it's not so much that question as is this the kind of variation we should expect to see on sort of randomly much stronger randomly a little less, with continued strong procedure growth, again just in a directional kind of way?

Lonnie Smith

I suspect there will be a variability in that and part of it is self-induced to be fair, in terms of our ability to hire in from our clinical sales organization as well as our various sales managers who sell the systems, but I think that we will have variability and we know that there is seasonality to the capital purchase cycle. We'd mentioned that before we always see that usually on a capital side, the second and fourth quarters are the strongest or we see a stronger ever since I suppose that sometimes because of different budgetary cycles there are and procedures follow more of a different cycle based upon patients and timing and vacations and lot of other things. So, I think that there's variability there that is driven by just the structure of our healthcare system and individual's personal priorities.

Rick Wise - Bear Stearns

Okay, and let me ask a really dumb question related to that. Are we now in a sort of 50 to 60 kind of unit range now, or is that just where we are given the opportunities, new procedures? I am not looking for specific forecast but more, have we kicked up to a new high level for going forward?

Lonnie Smith

Yeah, Rick for this yeah you are probably in the right range. The guidance that we'd given for system revenue growth probably hovers in that range.

Rick Wise - Bear Stearns

And, last maybe a question to ask, when we went into the SGO meeting docs were -- I have asked you this before, I ask for just an update on this, docs were hollering the adoption hurdle (inaudible) were staff training issues. Maybe you could give us a little more color on what's going on and has that changed and evolved and maybe our docs perception is changing about the amount of time it might take to get your staffs up and running? Thanks.

Aleks Cukic

When you were referring to staff, I'll maybe just answer in two ways. One, is if you mean the hospital staff, nursing, assistance and so on and so forth, we take a great deal of responsibility for that training and our ability to deliver high quality training on a scalable level has been pretty strong to this point but I don’t think in my mind at least that, that is going to be a limiting element to the growth of the business. Now, if you are talking about staff in terms of other surgeons on the hospital staff, that takes on a little different complexion and that one certainly requires the help of different physician peers and different training centers and so on and so forth. While it is true that that could be a limiting factor, I think we are managing it very well and are not expecting it to slow it down.

Rick Wise - Bear Stearns

Okay. And did I miss, did you give a service revenue, did I miss that number when we cut our again our phones cut up here?

Gary Guthart

Yeah. The growth in service revenue for the year is going to be 50% year-over-year.

Rick Wise - Bear Stearns

Okay. Thanks a lot.

Gary Guthart

Thank you. We have time for one more question.

Operator

Thank you. And that final question will come from Mark Richter, Jefferies & Company.

Mark Richter - Jefferies & Company

Thanks guys and good quarter. First question as most of them might have been answered, I've got a couple of quick ones. First one, how was the procedure of volume growth in the quarter for general surgical procedures? Can you comment specifically on bariatric surgery? And then maybe cardiothoracic market and how that's evolving?

Gary Guthart

Yeah. I think if you look at cardiothoracic and general surgery the growth rates were roughly the same for the quarter, both had nice strong growth specifically within cardiac. As we've talked about in the past our target areas are mitral valve repair and revascularization. During the quarter, we did very well with those procedures and probably most notable in there were some of the new centers that are beginning to perform mitral valve repair, namely the Cleveland Clinic, which as probably most of you know is the preeminent cardiac center, one of the preeminent cardiac centers anywhere in the world with enormous valve practice. So, they are up and running and doing very well.

Within bariatric again, as we've sort of said in the past, we see that being a nice steady growth driver, but there isn’t anything unusual about it to really report on, so I think I would classify both of those as good, solid, steady growth.

Mark Richter - Jefferies & Company

Okay, perfect and then I don’t and I apologize if I missed this, I did walk out of my office for a quick second, but did you comment on DVP penetration for the quarter and where you stand now?

Jerry McNamara

Well, what we’ve said earlier was that we’ve grown the guidance for the remainder of the year to be taking it up from 50% growth to 65% growth, but we did not give a percentage or a penetration number, but rather a growth target for the year.

Mark Richter - Jefferies & Company

And just curious why you are not giving penetration numbers now whereas you have in the past?

Jerry McNamara

Well, we actually got away from that at the end of the fourth quarter of 2006, so we have not given it in 2007, and the reason is that there are just too many moving targets and what we’ve heard from a number of people is that global growth rate is probably of more value to modeling, etcetera than is some type of penetration, especially with the market changing within radiation therapy, prostatectomy, watchful waiting and so on. So we made that change earlier this year and I think it’s one that we will continue with.

Mark Richter - Jefferies & Company

Okay, perfect and the last question is as obviously your cash balance continues to build, what do you plan on doing with your cash? Thanks.

Lonnie Smith

Well, that’s one of my favorite questions. The fact is that we are in, this is a quickly evolving market there, so a lot of technology that’s being developed and procedures that we think are opportunities and the opportunities and the generation of cash do not always perfectly match in terms of timing and so what we -- we are essentially building our cash and we will invest it as we find opportunities for technology and things that support robotic surgery, I mean we are not going to go off and buy another company because we think that's interesting; we are going to be focused on those investments that will drive the penetration of robotic surgery and the adoption course for the procedures we are focused on. So we think cash is good and we will spend it appropriately, we've -- where we find opportunities we won't get cash happy, not burning a hole in our pocket at this point of time.

Mark Richter - Jefferies & Company

Great thanks.

Lonnie Smith

That was our last question, as I said last quarter while we focused on the financial metrics such as revenues and profits, cash flow during these conference calls our organizational focus is on increasing patient value by improving surgical outcomes and reducing surgical trauma, we believe that adoption is procedure-specific and patient-driven. It is our goal to help the surgeon deliver a significant shift and value to the patient and we define patient value as efficacy of the procedure divided by its invasiveness. Dr. Lee [Sevak] who is the Chief of Cardiac Surgery at Sacred Heart in Spokane, Washington told us last week that the da Vinci system had enabled him to repair the mitral valves of two patients who could not tolerate a sternonomy or minotarconmy due to severe bone disease.

One of these was a 49-year-old with osteogenesis so severe that he cracked his ribs by merely coughing. Dr. Sevak repaired the man's mitral valve with the da Vinci without complications and he was released from the hospital two days post-surgery. The other patient was a 63-year-old with severe mitral valve disease, osteoporosis and scoliosis and he was released three days post-surgery. Both men are doing well and have been given a reprieve from the long-term sentence of congestive heart failure. But Dr. Sevak also said that he was no longer a customer only. His wife recently had a hysterectomy performed with the da Vinci system. She went kayaking four days after surgery and played nine holes of golf six days post-surgery. You see that was in sharp contrast to a woman who was supposed to play in a golf tournament with one of his partners and cancelled because she had a cyst hysterectomy six weeks prior to the tournament and still did not fell well enough to play. Patients like Dr. Sevak's wife become our strongest advocates for surgery with the da Vinci system. So, that is the key to our success.

In closing, I assure you we remain committed to focusing on the vital few things that would really make a difference and we strive to take surgery beyond the limits of human hands. That concludes today's call, we thank you for your participation and support in this extraordinary journey. We look forward to talking to you again in three months.

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