Executives
Cindy Marple - IR
Lonnie Smith - Chairman and CEO
Marshall Mohr - CFO
Ben Gong - VP, Finance
Aleks Cukic - VP, Business Development and Strategic Planning
Jerry McNamara - EVP, Worldwide Sales and Marketing
Analysts
Tao Levy - Deutsche Bank Securities
Mimi Pham - HSBC
Tim Nelson - Piper Jaffray
Eli Kammerman - Cowen
Vincent Reece - Wachovia
Rick Wise - Bear Stearns
David Louis - Morgan Stanley
Intuitive Surgical Inc. (ISRG) Q3 2007 Conference Call October 18, 2007 6:00 PM ET
Operator
Good afternoon and thank you for standing by. At this time, all participants are in a listen-only mode. After the presentation, we will conduct a question-and-answer session. (Operator Instructions). I would like to introduce your conference host for today’s call Ms. Cindy Marple. Ma’am you may begin.
Cindy Marple
Good afternoon, and welcome to Intuitive Surgical's Third 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; Aleks Cukic, our Vice President of Business Development and Strategic Planning; Gary Guthart, our President and Chief Operating Officer; and Jerry McNamara, our Executive Vice President of Worldwide Sales and Marketing.
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 third 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 third quarters’ 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.
Lonnie Smith
Thank you for joining us today. As you can see from our press release, we continue to drive the adoption curve, robotically assisted surgery, and continue to deliver significant top-line and bottom-line growth.
Operating highlights for the third quarter are as follows. Total revenue grew to $157 million, up 64% from last year. Instrument and accessory revenue increased to $49.5 million, up 70%. Total recurring revenue including service grew to $71 million, up 64% from the prior year, comprising 45% of total revenue.
We sold 63 da Vinci surgical systems, up from 46 during the third quarter of last year. Positive systems were second, third, and fifth systems to existing customers.
Our international team had an excellent quarter contributing 17 of the 63 systems sold. We ended the third quarter with 719 systems installed worldwide.
We generated an operating profit of $63 million, 40% revenue before non-cash 123R stock option expense, up 92% in the third quarter of last year. GAAP net income before unusual operating income items grew to $37 million; 24% of revenue, up a 116% from last year.
We ended the quarter with $533 million in cash and investments, up $86 million from last quarter. During the past nine months we have generated $203 million in cash, which excluding $42 million cash received from exercise of stock options amounts to 169% of our reported GAAP net income.
This is reflection of the significant non-cash stock option and statutory tax expenses reflected in our GAAP net income. And as a reason of that we continue to believe that operating income before non-cash 123R stock option expense remains the best measure of our true financial performance.
The da Vinci S continued to dominate our systems mix, accounting for 95% of the systems sold in the quarter. High definition vision systems accounted for 68% of the systems. We launched the Hem-o-lock clip applier, the G 400 compatible, Endo PK a Dissecting Forceps and a new smoke evacuating 8 millimeter Cannula.
We grew our Intuitive team by 38 members this past quarter to 697. We continue to see solid procedure growth. Year-over-year prior growth remained strong, while quarter-over-quarter sequential growth was impacted by summer vacations, particularly in Europe. Procedure growth and adoption continues to be procedure specific, patient driven and the primary growth driver of our business.
With that I will pass the time over to Marshall Mohr our Chief Financial Officer.
Marshall Mohr
Thank you, Lonnie. Total third quarter revenue increased to $156.9 million, up 64% from $95.8 million for the third quarter of 2006, and up 12% from $140.2 million for the second quarter of 2007. Our revenue growth is driven by procedure adoption, which was consistent with our previous guidance. Da Vinci hysterectomy and prostatectomy continue to be the primary drivers of our business.
Third quarter revenues by product category were as follows; instrument and accessory revenue increased to $49.5 million, up 70% compared with $29 million last year and 8% compared with $45.8 million last quarter. The growth rate in instruments and accessories is comparable to and a direct result of our procedure growth rates. Third quarter revenue growth rate of 8% reflects the expected impact of seasonality, particularly overseas.
The amount of instrument and accessory revenue we earn per procedure remained relatively unchanged at between $1,500 and $2,000 per procedure per 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 to $2,500 per procedure.
Systems revenue increased to $85.5 million, up 63%, compared with $52.4 million last year and up 15% compared with $74.1 million last quarter. The increase in systems revenue reflects increased unit sales as well as an increase in the average revenue per system.
Third quarter da Vinci Surgical System revenue reflects the sale of 63 systems, compared with 46 systems during the third quarter of last year and 56 systems sold in the second quarter. 43 of the systems sold during the quarter were our latest S model incorporating high-definition vision capabilities; 13 with four-arm S models incorporating standard vision capabilities; four were three-arm S models, and three were standard systems.
Our third quarter average revenue per system including all da Vinci models, but excluding upgrades was $1.33 million, which is $25,000 more than the average revenue per system in the second quarter of 2007. The higher average revenue per system primarily reflects a favorable geographic mix, including direct sales to European customers, which are denominated in Euros, which strengthened relative to the dollar this quarter.
Upgrades including 4th arm in HD, accounted for $1.6 million of the current quarter systems revenue, compared with 1.1 million last quarter. Service and training revenue increased to $21.9 million, up 52% compared with $14.4 million last year, and up 7% compared with $20.3 million last quarter.
The growth in service and training revenue is primarily driven by a larger system installed base, as well as, higher annual contract prices associated with da Vinci S and HD models.
Total third quarter recurring revenue comprised of instrument, accessory, service and training revenue increased to $71.3 million, up 64% compared with the third quarter of 2006, and up 8% compared with the second quarter of 2007.
Recurring revenue represented 45% of the total third quarter revenue, compared with 47% in the second quarter, reflecting the significant increase in the system sales.
Revenue outside the United States represented 22% of total third quarter revenue, compared to 19% in the second quarter. The growth in international revenue reflects 17 system sales, compared with 12 in the second quarter; and lower instrument and accessory revenue growth, reflecting seasonality associated with summer vacations.
Our third quarter 2007 gross margin of 69.1% increased, compared with 67.1% realized in the second quarter. The increase in gross margin reflects higher system selling prices in favorable manufacturing absorption. Total operating expenses for the third quarter of 2007 were $54.1 million, compared with 49.1 million in the second quarter of 2007.
The sequential operating expense increase of 5.4 million reflects increased spending in R&D, increased headcount, and increases in other cost associated with growth in our top-line, partially offset by a reduction in non-cash 123R stock compensation expense.
We added 38 employees during the quarter, ending the period with 697 regular employees. Majority of the additions were to our world-wide sales and support and manufacturing organizations.
Third quarter 2007 operating income was $54 million or 34.4% of sales, compared with 45 million or 32.1% of sales for the second quarter of 2007. Our third quarter 2007 other income of $12.2 million increased as compared with $5.2 million in the second quarter of 2007.
Our third quarter 2007 other income included a $4.1 million gain on the sale of Hanson Medical [chairs] and $1.8 million of foreign exchange gain associated with the increase in Euro relative to the U.S. dollar. Excluding these gains, the increase of 1.1 million is primarily the result of interest earned on greater cash and investment balances.
Our effective tax rate for the third quarter was 38.2%, which is slightly lower than the 39% we recorded in the second quarter. Our third quarter tax rate reflected certain one-time benefits, and we expect our on-going tax rate to be around 39%.
We continue to utilize net loss carry forwards and employee stock-related tax benefits in 2007. The amount of employee stock-related tax benefits increased in the third quarter, such that we now expect our cash outlay as a percentage of pre-tax will be less than 10% for 2007.
Our international tax structuring activities are proceeding on schedule, but will not generate a reduction in our global tax rate until after 2008.
Our net income increased to $40.9 million, or $1.04 per share, up 137% compared with $17.3 million, or $0.45 per share for the third quarter of 2006, and up 33% compared with $30.7 million, or $0.79 per share for the second quarter of 2007.
Excluding the gain on the sale of Hansen shares and the foreign exchange gains, net income for the third quarter was $37.2 million or $0.95 per share.
Let me quickly summarize our results for the first nine months of 2007. Total revenue for the first nine months of 2007 was $411.4 million, up 58%, compared with $260.1 million last year.
Operating income for the first nine months of 2007 was $133.4 million, up 85%, compared with $71.9 million last year. Operating income included $26.2 million of stock-based compensation charges in the first nine months of 2007, compared with $18.5 million in 2006.
Net income for the first nine months of 2007 was $95.4 million or $2.46 per share, up 97% compared with $48.4 million or $1.27 per share last year. Excluding the gain on the sale of Hansen shares and the foreign exchange gain, net income for the first nine months was $91.5 million or $2.36 per share.
Now, turning our attention to the balance sheet. We ended the third quarter of 2007 with cash, cash equivalents, and investments of $533 million, up $86 from the previous quarter end, and $203 million from December 31, 2006. $21 million of the cash generated in the quarter and $42 million of the cash generated in the nine-period was associated with stock purchase activities. The remaining cash generated is primarily related to operating activities.
Our accounts receivable balance increased to $120.5 million at September 30th, from $105.6 million at June 30, 2007. The increase in accounts receivable is attributed to increased sales.
Our net inventory increased $26.8 million at September 30, 2007 from $24 million at June 30, 2007. Our inventory turns at September 30, 2007 of seven times per year were slightly lower then the 7.4 turns 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, Marshal. During the third quarter we shipped 63 da Vinci systems, 46 systems in the United States, 11 in to Europe and six in to rest of world markets. 60 of the 63 system shipments were da Vinci S systems, four of which were three-armed S systems, while the remaining three were standard da Vinci systems. Of the 60 S systems sold, 43 were high-definition or HD systems. We had no trade-ins during the quarter.
The 63 systems sold brings to 719 accumulative da Vinci systems worldwide; 545 in the U.S, 119 in Europe and 55 in rest of world markets. 5 of the 63 systems sold during the quarter represented repeat system sales to existing customers. Repeat systems sales included the Cleveland Clinic, NorthwesternUniversity Hospital, the Lahey Clinic and Hackensack Medical Center. The sale to Hackensack represented their fifth da Vinci system.
Internationally we had an excellent quarter, which included five additional da Vinci systems into Belgium, three into Korea and our first system into Russia. Clinically we had another good quarter. There was seasonally slow quarter for elective surgeries. We experienced solid sequential procedure growth. Our gynecologic procedure business paced by da Vinci Hysterectomy, registered the largest sequential percentage growth for the quarter, followed by Urology.
Ben will provide you with updated procedure guidance during his review. We had 57 da Vinci related clinical papers published within the various peer-reviewed journals. We also launched three new products the Hem-o-Lock clip applier, which was developed in collaboration with Teleflex Medical. The G 400 compatible and Endo PK Dissecting Forceps which was developed in collaboration with Gyrus ACMI and the 8 mm Cannula with a smoke evacuation outlet.
Although none of these products is expected to significantly boost our top-line, each will offer our surging customers added utility, leading to a more optimized surgical procedure. We are building this procedure business one procedure at a time and therefore optimizing each of our target procedures through the development of new products and product enhancements remains an important priority.
Of the peer-reviewed literature I mentioned there is one particular study I'll bring to your attention. In the October 8th edition of the Archives of Internal Medicine, a study entitled short and long term mortality of localized prostate cancer set out to compare survival rates for prostate cancer patients undergoing primary radiation therapy, radical prostatectomy, as well as other treatment options. The consortium of authors represented surgical departments, radio-oncology divisions and cancer registries from Geneva University in Geneva, Switzerland, the National University of Singapore, and the University of Turin in Turin, Italy.
The population cohort included 844 men that have been diagnosed with localized prostate cancer. 158 of these mentioned underwent a prostatectomy. 205 were treated with radiotherapy, 378 selected a watchful waiting regiment, 72 received hormone therapy and 31 were treated with other therapies
The result, at five years, the survival rates were fairly consistent between cohorts, except for the hormone therapy cohort, which was statistically inferior to the other treatments. However, at 10 years, the survival results changed materially. The prostatectomy cohort showed an 83% survival rate, radiotherapy 75%, watchful waiting 72%, but when you look a little closer at the data, specifically within the larger segment, men under 70 years of age, the survival rate gap between prostatectomy and radiotherapy widened to 92% compared with 78% respectively.
Said another way, the study reported that for man under the age of 70 with localized prostate cancer, the risk of dying from the disease within 10 years, following prostatectomy was 8%, as compared with 22% following radiotherapy. The author's conclusion and I quote "our study results suggest that surgery offers the best chance of long-term prostate cancer specific survival, in particular for younger patients with poorly differentiated tumor"
Many of our customers have reported shifts in their hospital's treatment mix away from primary radio therapy toward dVP. With the increased awareness for earlier PSA testing leading to earlier stage disease detection in younger patients, we would expect this mix shift to continue.
We participated in multiple conferences within urology, gynecology, general surgery, and cardiothoracic surgery during the quarter. However, I’ll limit my review to only two. This year was the first time we attended the American Urogynecology Society Conference or the AUGS, which took place in Florida and was attended by approximately 900 urogynecologists.
Urogynecologist are the specialists, which among other things, focus on the condition of vaginal vault and uterine prolapse, which lead to pelvic floor and vaginal vault reconstructed procedures.
The society put da Vinci front and center at the conference. The post graduate course entitled, The Surgical Management of Pelvic Organ Prolapse focused on da Vinci’s roll within these prolapsed procedures, and was one of the most popular courses offered.
The satellite symposium entitled, Robotic Applications to Surgically Repair Vaginal Vault and Uterine Prolapse was in fact the most popular symposium at this year’s conference. It was so well attended that the organizers had to move it to a larger venue to accommodate the standing [remaining] crowd.
Dr. Tony Visco from Duke University presented his experience, rationale, and surgical technique for da Vinci sacrocolpopexy. Followed by Dr. Arleen Song from the University of Michigan, who covered da Vinci Hysterectomy for those patients that required removal of the uterus prior to sacrocolpopexy.
The rationale for da Vinci's use within these complex operations is very consistent with our Patient Value equation, which translates into efficacy over invasiveness, which in this case means eliminating a large open incision to create what is considered a durable gold standard repair procedure.
Overlapping the AUGS Conference was the Mayo Clinic's Advance Techniques in Endoscopic and Robotic Gynecologic Surgery Symposium, which took place in Maui. Perhaps the most notable at this year's program was da Vinci's role within all sub-specialty categories of gynecology, which include GYN Oncology, Laparoscopic GYN, Urogynecology, and Reproductive surgery.
Presentations were made by Mayo Clinic staff surgeons and guest faculty on da Vinci Hysterectomy for endometrial and cervical cancer, da Vinci Hysterectomy for Benign Disease, da Vinci Sacrocolpopexy, Myomectomy and for Excision of Invasive Endometriosis.
As we are experiencing in urology, establishing a strong clinical story around a common, but complex procedure provides us with the opportunity to expand da Vinci's utility within an entire specialty. And in the case of the GYN specialty, that procedure is da Vinci Hysterectomy; and it's brought a new awareness to minimizing the invasiveness of other complex GYN procedures.
In the fourth quarter we will be participating in several key GYN conferences, including the European Society of GYN Oncology Conference, which takes place in Berlin; The AAGL Conference in Washington DC; and the First Annual International Robotic GYN Oncology Symposium, which is said to take place at the University of North Carolina in Chapel Hill.
That concludes my overview, and I will now pass the time over to Ben.
Ben Gong
Thank you, Aleks. As in previous earnings calls, I will be providing our updated forecast on a GAAP reporting basis, including stock compensation expenses. I will also provide an estimate of the stock compensation expenses separately, so you can calculate meaningful comparisons that exclude these non-cash expenses.
As previously mentioned, we had better than anticipated growth in revenue and profit in the third quarter, and we expect this momentum to continue through the remainder of the year. Therefore we are increasing our previous guidance for revenue and profit for 2007.
Starting with procedure growth, we continue to expect dVP and dVH adoption to drive the growth in our recurring revenues. Our procedures performed in Q3 were inline with our expectation for these areas, and we continue to expect dVP growth for the year to be at least 65%. We also continue to expect dVH growth for the year to exceed 175%.
Instrument and accessory revenues are expected to grow between 70% and 75% over 2006. This is consistent with our forecast from our last earnings call, and it reflects our overall procedure growth from last year.
Our systems sales were strong in the third quarter across both domestic and international markets, and we expect to have continued growth in system unit placements in the fourth quarter. We are now forecasting system revenue to grow between 48% and 52% over 2006, which is up from our pervious forecast of 30% to 35%.
A majority of this growth is resulting from an increase in unit shipments, while part of this growth is also driven by higher average selling prices for systems compared with the prior year. Our system ASP was approximately $1.33 million for the third quarter, and $1.3 million even year-to-date. For the fourth quarter we expect our system ASP to be approximately $1.3 million.
We expect service revenues to grow approximately 52% above 2006 levels, up from our previous forecast of 50% growth. This increase is driven our higher system placement this year.
Overall, we now expect our total 2007 revenues to grow approximately 55% to 58% over 2006, compared to 45% to 50% previously forecast.
With regard to gross profit margin, we had an up tick in the third quarter, driven primarily by higher average selling prices from favorable geography mix and by manufacturing productivity improvements. We expect to maintain the benefit from productivity improvement through Q4. However, we would be cautious about predicting the same favorable geographic mix we had in Q3. Therefore, we are forecasting gross margins to be approximately 68% for both the fourth quarter and the year-end.
Moving to operating expense, we are also expecting to spend more on both R&D and SG&A expenses then 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 41% and 45% for the year, which is up about 1 percentage point from our previous forecast.
In the R&D expense category, we've mentioned in our last earnings call, we have stepped up our investment in internal projects, as well as co-development projects with third-party corporate partners. We are continuing to increase our activities in these areas. In total, we expect our R&D expense for 2007 to be 55% to 60% higher than our R&D expense for 2006, which is up from our previous forecast of 48% to 52%.
We expect our total operating expense for 2007 to be 45% to 47% higher than our total operating expense in 2006. These forecast for gross margin and operating expense, include the impact of FAS 123R stock compensation expense. Our third quarter operating income included $8.7 million of non-cash stock compensation expenses allocated as follows; $1.4 million in cost of sales, $5.2 million in SG&A and $2.1 million in R&D. For the year, we expect the impact of FAS 123R to be between $35 million and $36 million with the percentage allocation to P&L lines consistent with Q3.
Other income expense for the third quarter included $6 million of income, which we did not expect to repeat in the fourth quarter, specifically, gains on sale of equity investment and foreign exchange gains. Interest income for the fourth quarter is expected to be between $6.5 million and $7 million. For the year, we expect total other income and expense to be between $28 million and $29 million.
With regard to income tax, we expect to report a GAAP tax rate of 39% for the fourth quarter, which will result in an annual GAAP tax rate of between 38.5% and 39%. However, we expect our effective cash tax expense to be less than 10% for 2007.
Regarding shares outstanding, we currently have 38.2 million common shares outstanding, and we also have approximately $3.3 million option shares outstanding. Depending upon our average stock price during the fourth quarter, a portion of the 3.3 million option shares will be added to the fully diluted shares calculations. Calculating EPS in Q4, we expect the share count to be approximately 39.5 million shares.
By concluding our prepared remarks, we will now open the call to your questions.
Question-and-Answer Session
Operator
Thank you. (Operator Instructions). Mr. Tao Levy, you may ask your question.
Tao Levy - Deutsche Bank Securities
Good afternoon everyone.
Jerry Mcnamara
Hi Tao.
Tao Levy - Deutsche Bank Securities
Hi. I guess my first question, on the strength in the international market, it seems like Belgium, the folks over there get real excited about robotic surgery. Maybe you could talk about how that development happened. Was it the government that ended up purchasing the five systems or is it a group of hospitals?
Jerry Mcnamara
Tao, this is Jerry. We have been growing our procedures in Belgium overtime and we have had installations in Belgium since early 2000s. And at the beginning of Q3 we had 10 sites up and running and we have been extremely well staffed and this really set the table to be able to sell five additional new systems during the quarter. So, now that to answer your last question and I have nothing to do with the government.
Tao Levy - Deutsche Bank
Is it something that you think international will continue to see, not necessarily in Belgium, but across other areas?
Jerry Mcnamara
Well, business is generally strong internationally. That being said, procedures were seasonally softer in the third quarter as we experienced long vacation times for both patients and physicians. Overall, we expect to see a lot of continued growth in the US and for the rest of the year we are not expecting or forecasting a higher percentage of business international sales than what we have seen earlier this year.
Tao Levy - Deutsche Bank
Alright, and if I look at the full year guidance, I guess effectively the fourth quarter, Ben, the right way to think about system placements in terms of total number is this somewhat slightly higher than the third quarter. Is that the, if I do the math quickly?
Ben Gong
Yeah, we are expecting some sequential unit growth in fourth quarter over the third quarter and that's incorporated in that new system revenue guidance of 48% to 52%.
Tao Levy - Deutsche Bank
Perfect. And then just lastly, what's the capital spending environment like in the hospitals these days just given some of the credit concerns. Obviously, given the third quarter didn't seem like there was any impact. But as you go ahead and start to talk to at the hospitals or administrators, any changes there that we should be looking at?
Jerry McNamara
Tao, this is Jerry. No negative changes, actually we see our pipeline for Greenfield and repeat system sales to be stronger than ever.
Tao Levy - Deutsche Bank Securities
Great, thanks a lot.
Operator
Mimi Pham of HSBC, you may ask your question.
Mimi Pham - HSBC
Hi good afternoon. For international geographies, do you plan on expanding into any new geographies next year that aren't earlier and selling in now?
Ben Gong
Mimi, this is Ben. We mentioned that we just sold our first system into Russia.
Mimi Pham - HSBC
Yes.
Ben Gong
And one thing that we see is, you first place something into a new geography and it takes a little bit of time for that geography to develop. So you're seeing that with places like Korea. And so we expect that, now that we got our first one into Russia, maybe there will be some activities there not right away, but maybe a couple of years down the road.
Mimi Pham - HSBC
And in these international markets, are they being driven mainly by da Vinci Prostatectomy and Hysterectomy like in the US.
Ben Gong
Primarily urology is strongest outside the United States. Many of those territories lag the US by about two years, and so right now one of our biggest growth drivers in Europe is dVP, and likewise in Asia some of the activities we're seeing there are primarily urology at this point.
Aleks Cukic
But within, for example, Korea which was also a strong market for us specifically this quarter, you see multiple specialty focused robotics programs that include general surgery that include cardiac surgery. It's fair to say prostate is a big driver, but its not limited to Prostatectomy.
Mimi Pham - HSBC
Thanks. And on the margin side, can you break up the product margins for the disposables in the system, and what would consider the ceiling?
Ben Gong
We did tick the gross margin guidance by about 1 point, and you saw that we got two points better this quarter than last quarter. So, the big drivers for that were some manufacturing improvements as well as ASP improvements, but some of that was from foreign gains.
It's not materially different than what we had before, so you have product gross margins somewhere on the order of 17%, and that's roughly the amount for systems and for instruments and accessories alike, and you still have the gross margins for a service lower than that, due to the way we account for the training expenses.
Mimi Pham - HSBC
But in terms of a ceiling is there?
Lonnie Smith
Let me comment on that. We've got strong margins, we'll continue to drive efficiency. But I am not sure, we're going to try to drive that in to margins, and maybe more deliver it back to our customer. And so I wouldn't plan on expanding margins dramatically, even though we may drive cost down pretty dramatically or we will continue to do it.
I think we are not -- there comes the point where we want a balance this in fairness to our customers as well, and so we will share some of the benefits with them.
Operator
Mr. Tim Nelson of Piper Jaffray, you may ask your question.
Tim Nelson - Piper Jaffray
Hi, you talked a little bit about seasonal slow down in procedure growth rates, was that any different between OUS and US geographies? We expect that sort of thing in and outside we've heard you pronounced it.
Lonnie Smith
Clearly more pronounced in the overseas markets.
Jerry McNamara
And it was similar to our experience in the last few years Tim.
Tim Nelson - Piper Jaffray
Could you comment on what the differential utilization rate are between your installed base outside the United States and in US.
Ben Gong
Just repeating some of the stuff we said in the past. The overall utilization rate internationally is a little bit lower than in United States, but there are certainly pockets, lets say in Scandinavia or let's say in Belgium where you have utilization rates that are actually pretty similar.
But since there are typically newer users out there internationally, you don't have the same sort of overall productivity on those sides as a whole.
Tim Nelson - Piper Jaffray
Okay. And you also mentioned strong pipeline on systems. Can you again give us some feel for the geographic split for that? Is the strength of the pipeline for here in the United States and outside the United States equally or is there some differential?
Lonnie Smith
I think it's pretty consistent globally.
Tim Nelson - Piper Jaffray
Okay. And then you did have -- I am curious on your expected growth for dVP and dVH for the year, because you commented on what it was in the quarter?
Ben Gong
No I guess that what's indicative is we have the same forecast for the year as we did last quarter. So, our growth in the quarter was in line with what we are expecting and therefore for the year it's about the same.
And then the [repeat], the overall procedure growth like the instrument and accessory growth for the year is expected to be 70% to 75% and the biggest drivers continue to be dVP at least 65% and dVH at least a 175%.
Tim Nelson - Piper Jaffray
Okay. And we are really starting to get some good traction in dVH outside of the oncology's segment, are you seeing an acceleration there?
Aleks Cukic
I don't know Tim that I would use terms like acceleration. We are getting I think very strong representation both within the oncology as well as the complex benign cohort. And I will tell you that we are picking up some momentum in things like sacrocolpopexy and Myomectomy. So I would say it's sort of a global statement that the category of GYN is coming along quite nicely, similar to how we had talked about in the past it seems to be unfolding that way.
Tim Nelson - Piper Jaffray
Great.
Lonnie Smith
And just a comment on dVH and what's driving the underlying growth, and I think this is more than just dVH, but it's the patient behavior in terms of speaking, what I'd say our higher value-added treatments.
I recently spoke with a Senior Executive of a large public company. And I was surprised that he was familiar with our company. And I asked him about it and he said, well, his wife was diagnosed with endometriosis and required a hysterectomy. And she then went to a GYN of 17 years who has delivered two of their children and told him that she was interested in having it done robotically as she was been on the internet. And his response was first, I would never heard of hysterectomy performed by a robot. His second response was, wouldn't it be nice if a robot could do everything that I do. And last he said, I think it's ridiculous. So, what do you think she did?
Tim Nelson - Piper Jaffray
She went to find somebody who could do it robotically?
Lonnie Smith
Find the right oncologist, that's right, who did her procedural robotically. I tell that story only because I think it's fundamentally, it is what is underlying the growth of our company. It's that more and more patients are proactive in seeking treatments that provide superior outcomes to them in terms of effectiveness and impact on their daily lives and it's certainly true, GYN with hysterectomies, sacrocolpopexies, myomectomies, as Aleks has mentioned.
Tim Nelson - Piper Jaffray
That's very interesting, because you generally think of women having much great loyalty to their OB/GYN and men to their urologist, so I am glad to hear that. Okay, thank you.
Operator
Eli Kammerman of Cowen, you may ask your question.
Eli Kammerman - Cowen
Thanks very much. My first question is about two years ago in the third quarter of '05, you had margins that were pretty similar to the margins you just reported and I am wondering if the reasons were similar then or something else happened two years ago to make the gross margin and the operating margin tick up so much for that period?
Ben Gong
Two years ago we did not have SFAS 123R and when we started reporting stock compensation expenses, remember it hits the gross margin line, as well as the operating expense line. When you saw a down tick, I am thinking this is what you are asking, when you saw a decrease in the gross margin line, part of it was that stock compensation expense and then now that we've gotten some of these productive gains that we talked about, now we are back at the level that perhaps we were at before SFAS 123R.
Eli Kammerman - Cowen
Okay. All right, all right. The other question I have is, are you actively encouraging or promoting new uses in surgical oncology, specifically for rectal cancer? And can you just describe what's going on in that particular surgery it does seem to bear some physical resemblance to lot of the other types of lower pelvic surgeries?
Aleks Cukic
Yeah, that's a good observation and obviously you are dealing in a narrow male pelvic region, which is very similar to prostatectomy and the vascularity associated with that region is pretty high and the area or the work area is very tight. So, it does set up pretty well for the things that we have seen da Vinci do well at.
We just came off the ACS Meeting literally last week and there seems to be a, I don't want to say renewed interest, because there is always been interest, but more interest than in the past and continuing to move minimally invasive surgery through colon and rectal surgery. There have been a lot of attempts at it. There is hand assist approaches and what not. But, it is something that we are looking at. I think we have a fair amount of interest out there. As far as promoting, I wouldn't use that term because we are exploring, I think it's probably a better term, but there is a lot of interest that's out there right now.
Eli Kammerman - Cowen
Alright, thanks very much for those answers.
Operator
Our next question comes from Vincent [Reece] from Wachovia. Your line is open.
Vincent Reece - Wachovia
Hi guys. Can you talk just a little bit about the venture you guys did with Cardica with the C-Port Flex A. I think you guys have performed the surgery with them and just how that effects what you are looking at in cardiothoracic?
Aleks Cukic
I think, there is no venture with Cardica. I think you are probably referring to a couple of press releases around one of our customers that incorporated one of their products with the da Vinci operation. And so, there is really not a lot to comment on there. I mean, we've worked with a lot of companies and we've worked with a lot of companies in that particular space over the years, Cardica being one of them. But, there certainly isn't any venture there and how it effects what we are doing, it’s speculative certainly at best at this point. So, we'll let the customers decide where and how they can use our system and where and how they can use their system. And if there is a natural intersection point that will be great.
Lonnie Smith
The time will tell. I mean, they've got some interesting technology, they are working on it, they have done and we support everyone who helps us to drive cardiac to a more minimal invasive procedure.
Vincent Reece - Wachovia
Okay, great. And in urology, are you still seeing erosion of some of these other competing paradigms, and more specifically with radiation therapy is it a brachytherapy, first is directed beam radiation or both of them being impacted or is it more of a watchful waiting?
Aleks Cukic
It's really hard for us to tell you, it's such a dynamic situation, and all we really have to go on what our customers are telling us. We've had situations where large brachytherapy based programs have moved a lot of those patients to da Vinci Prostatectomy. We have examples of primary radiation treatments; again that were fairly large in numbers that have reduced.
But at the same time, there is always and we shouldn't say always, but there is a combination of both of them in many operations, where there is some cancer that's remaining and they will use external beam and clean up procedures. There is just a lot of movement that's going on, so I think it would be difficult for us to tell you exactly what that looks like.
But it is something that we are hearing is continuing, and as patients and younger patients are getting diagnosed, the data I think supports now, again there is another piece of data that's out there, that supports long-term survival and prostatectomy. And so, that I think as the patient becomes more informed becomes a bigger consideration.
Vincent Reece - Wachovia
Okay, great. And then finally with that international it seems that there was a little bit more acceleration rest of world than Europe. Is that more of a artifact of a lot of large numbers or you guys think some traction there that you hadn't seen before?
Jerry McNamara
Overall our international pipeline's billing very well and timing is always difficult to predict, and so we expect overall the international system sales to grow, rest of world versus Europe it's hard to forecast them separately.
Lonnie Smith
But we started out in Europe and so we have -- we are more established there. We are building also expanding our distributors in the smaller, rest of world markets, and as that happens as Jerry says the dynamic is going to be -- [most] its body as some of these guys come up. But everyone's in a while they really start to gain some traction and the early that [stay up] it's just the way the markets develop. It's usually Europe, then comes United States, then its back to Europe and then it's the rest of the world and so we are just in that cycle.
Vincent Reece - Wachovia
Okay great thanks for taking my questions.
Operator
The next question comes from Rick Wise from Bear Stearns your line is open.
Rick Wise - Bear Stearns
Good afternoon everybody.
Lonnie Smith
Rick.
Rick Wise - Bear Stearns
Let me pick up on the couple of comments that were discussed before. The pipeline is strong you made it very clear, US and OUS. Is it equally strong by procedural dVH and dVP or is dVH carrying more of the backlogs team, as it were at this point?
Aleks Cukic
Again Rick I think what we have talked about in the past and it remains true, is that, that a program that we are trying to establish be it US or OUS has a number of specialties in mind.
In other words, when we are selling a system we are trying to incorporate Urology and Gynecology and Cardiac and general surgery. That's no different from OUS and US. So I would say that as we made clear Prostatectomy and Hysterectomy are the fastest growing procedures.
But I would be careful to think of these as specific to one procedure. In other words, they are buying it only for Urology or they're buying it only for Gynecology. When they come in, they tend to have support from multiple specialties.
Now what happens after it's installed, and what that mix looks like is different. But you could suspect that Urology is going to get on quickly, it's going to grow faster. Gynecology and Cardiac in general are going to get on etcetera, etcetera.
So, I would say that that hasn't changed, but urology on a global basis is definitely proliferating Gynecology slower than it is in the United States, but it is spreading around the world, and then General Surgery and Cardiac are slow-steady areas.
Rick Wise - Bear Stearns
Lonnie was kind enough to remind us how critical the consumer or the patient is to driving a robotic choice in surgery. Is that prompting you maybe particularly in the dVH areas, any unique marketing initiatives Aleks?
Aleks Cukic
Again, I think when you are using terms like marketing initiatives, I think if you look at what has happened and continues to happen in Urology, and I would say it's actually happening in Gynecology, is that, hospitals recognize the value and the power of a women's health initiatives, and so you will see da Vinci fit in very nicely to minimally invasive reproductive procedures for Myomectamy or pelvic floor reconstructions or benign or malignancies. And that is taking place.
And certainly where you reside on the east coast, I'm getting close all the time of people that are hearing radio ads, television ads, billboards etcetera. You know we are doing things like, putting together dVH.com. We have a number of marketing support in internet-focused areas, but the patient awareness is something that hospitals do, and some of them do it really very well, and I think are the recipients of those patients.
Rick Wise - Bear Stearns
Let me focus on two questions that both have implications of looking ahead. As we wrestle with our models, I realize it's early to think about '08 and you are not ready to give '08 guidance today.
But just directionally so we can think about it, is it - two questions essentially. Is it reasonable to think about sequential unit growth of some magnitude for the next three to five quarters as far as the eye could see? How do we just conceptually think about that?
And second, I have to note that one of my favorite hobby horse is the possibility of positive operating leverage is quite evident this quarter with EBIT income up, I think 110% of my eyes are working here, well above the [64%] you grew revenue.
Is it reasonable to think that that kind of leverage conceptually continues into the next year?
Ben Gong
Rick this is Ben. So we will definitely give you some guidance next year in our next conference call. I don't think we are prepared to give you guidance on 2008 today.
We are certainly continuing to see momentum from the third quarter to the fourth quarter. So generally speaking, things are going very well, definitely driven by dVP going at 65% year-over-year and dVH at 175%.
So there's likely to be growth next year absolutely. But we will get more specific about that next quarter. And then getting to your point on leverage, I think Lonnie, expressed some of this earlier, is that. It's not our intent to continue to lets say drive our margins higher.
As an example, when we launch new products we said in the past that our new products were at lower gross margin when we launch them, because our costs on delivering new products is a little bit higher.
So, in our efforts to continue to drive procedure growth, use the existing procedures or new procedures, we are going to make sure that we put our products out there that can drive that growth and we are not so intent on driving that leverage if you will higher.
Lonnie Smith
Well, and as Ben pointed in the numbers this quarter, our R&D effort is up, our development efforts are up, and we will continue to invest there as fast as we can find the talent that really drives it.
So, we are in this, as I pointed out to you couple of times, we are in this for the long-term and trying to build a business that last. And we will continue to invest in the business, but we will invest where we think we have the most leverage.
And so I wouldn't count on a whole lot of -- we may get some because it's growing faster than we can invest, but we are not trying to get a lot of operating leverage at this point of time.
Rick Wise - Bear Stearns
Got you. Just one last quick one or not, in recent weeks there was some anxiety about possible emerging competitive products in Korea, and there is on going discussions about other modalities presenting incremental competition for da Vinci. Aleks, Lonnie, how should we think about some of these issues, and maybe just update us with your thoughts and just?
Lonnie Smith
Let me ask, let Gary answer that question.
Rick Wise - Bear Stearns
Okay.
Gary Guthart
Anyway, as we look at it, there are competitive groups that we know of working in Asia, Europe, and North America. The recent announcement from Korea and other places has not been a surprise, nor do they represent an eminent threat.
We think our barriers to entry are significant from products that produce outstanding clinical results, are easy to operate, reliable and cost effective. There are broad and growing range of instrument and imaging options through our pipeline of significant new products that will both increase efficacy and easy of use for our products and new procedures and in existing procedures, a strong relationship with our customers through our field and marketing organizations, a deep patent portfolio and a strong set of regulatory approvals. That said, we believe that computer aided surgery is in its infancy and we cultivate relationship with research centers and third-party groups worldwide to help us develop ideas and monitor trends. We believe we are taking the necessary steps to remain leader here and we will keep watching and developing.
Rick Wise - Bear Stearns
Thank you so much.
Lonnie Smith
Thank you. We have time for one more question.
Operator
And our next question comes from [David Louis] for Morgan Stanley. Your line is open.
David Louis - Morgan Stanley
Good afternoon. Running tight on task, I'll be brief here. I don't want to beat the dead horse, but I want to come back to margins and that has been and obviously senior management less bullish on margin increases. But, just on gross and SG&A, if you think about gross margins, there seem to be four factors inputting to margins this quarter which would be geography mix, price increases, currency and absorption and we've got good numbers I think in two or three of them. It appears that absorption was over a 150 bps and I appreciate Lonnie's comments on passing the stock off to customers. But, absorption doesn't appear to be something that would go away. So, I guess I am having a hard time seeing how gross margins only go up a 100 bps in this quarter. Is it something that, go ahead.
Lonnie Smith
I will let Ben answer those numbers. You are talking about absorption, internally we don't run the company on fully absorbed accounting, we don't. We run it by fixed and variable cost. We have to report on GAAP, understand that, but internally we manage our fixed cost and we manage our variable cost. And so, there is leverage and is depending upon how quickly you invest, how hard you invest in fixed cost as you grow revenue. And so, that's what happens. But, it's always a trade off. We tend to try to be thoughtful and conservative in our investment for fixed costs, but we try not to be foolish either, because as Gary pointed out with the very beginning of what we think is going to become a large and dynamic market. And we are the leaders here and I mean we are the leaders who tend to remain the leaders. And so, we'll be investing in fixed costs, which will reduce some of that "absorption" in the process and it could be lumpy. So, I cannot be totally predictable. When we are ramping up on prototypes that raises fixed costs, when we are investing in a new area with some engineering staff that raises fixed costs, so I'll just tell you that I am not saying we won't have some margin improvement at times. We also have times when we [went up with it] because we've invested more heavily in fixed cost anticipating the future.
Ben Gong
All right. That was extremely well said the only thing I would just point with you and you are on the right track is, there were some productivity gains that we had, I would like to call them productivity gains. And that's why we are giving the guidance of 68% gross margins, which is higher than the 67%. Let's say that we are driving towards at the beginning part of the year, and it's hard for us to estimate what's going to go on with the geography mix. But, back to Lonnie's point, while we might be enjoying some of these productivity gains right now that we are certainly not afraid to invest in certain things that are going to be beneficial for our future products.
David Louis - Morgan Stanley
Okay. And then just two more quick ones; On utilization, Ben you mentioned that obviously, there could be two things that impacted utilization this quarter, one being obviously seasonality and another one is geographic mix. Historically, you've been up on utilization sequentially even in sort of a slowest third quarter. So, is that bigger driver this quarter international versus utilization or they are about even?
Ben Gong
Well, the procedural growth in Q3 in the past has always been much lower than in the previous quarters and the seasonality this quarter was there, seasonality was also there in the last third quarter. So, what we experienced this quarter is not necessary that's different than what we had in the third quarter of last year. So, we know that the number is in beyond five percent or something like. But, when we step back and take a look at what happened, the same sort of seasonality hit us in the third quarter this year as last year.
Aleks Cukic
And David just as a reminder, and that the practical side of it, as GYN becomes a larger percentage of our business, aside from the GYN oncology procedures, most of those procedures have some elective nature to them. So, they can be postponed. For example, benign conditions and pelvic floor, pelvic team issues and myomectomies, etcetera. So, as you look out over the -- I mean, the core of this is patients pushing off elective surgery. So, it's just a, but sort of a subtle footnote there.
David Louis - Morgan Stanley
Okay. Just lastly and I'll end here. Can you just rank in order of procedure number; because I don't think you're going to give us any related metrics, myomectomy, prolapsed hysterectomy in order of procedure volume?
Ben Gong
Well, hysterectomy is certainly our largest procedure in gynecology. And we've been at the myomectomy for a little while longer than sacrocolpopexy. So, we actually have some momentum going on there. Sacrocolpopexy is a very fast grower, so even ranking those two against each other is going to kind of tough. They are both very strong procedures for us and they are both growing very fast.
David Louis - Morgan Stanley
Okay. Thank you very much.
Lonnie Smith
Thank you. That was our last question for today. And as I said previously in these calls we focus on the financial metrics such as revenues, profits, cash flow, and procedures. But, our organizational focus remains on increasing patient value by improving surgical outcomes and reducing surgical trauma.
We believe that adoption is procedure specific, as it's been mentioned and patient driven. And it's our goal to help the surgeon deliver a significant improvement in the value to the patient and we developed a fine patient value as efficacy of the procedure divided by how invasive it is.
And we hear stories daily of patients returning to their jobs and their normal lives literally days after surgery. Such as a young women who is a key aid in the congressional campaign and was diagnosed with endometriosis and two large myomas, just gets to your point. She was in significant pain and required a myomectomy. She had two close relatives in the community she lives, both who were gynecologist. But, in the end, she chose to go to a gynecologist who could perform the procedure with the da Vinci System and she was back on the campaign trial in three days.
Another patient of Dr. Mihaljevic, a cardiac surgeon at Cleveland Clinic wrote to Dr. Mihaljevic saying, dear Dr. Mihaljevic thank you for bringing robotic mitral valve repair to the Cleveland Clinic. Although, my mitral valve was diagnosed by another Cleveland hospital, with due diligences I found that the clinic alone offered robotic surgery with a potential of a speedy return to normal activity, a more normal life. Indeed, as I write this letter I've been out of surgery fewer than six days and I can walk miles everyday, drive and do almost everything. My recovery does not include narcotics, and I had never experienced pain above the Level II. My confidence was well placed and I thank you. My point is that the patients like this are the strongest advocates of surgery with the da Vinci System and are the underlying strength of our business.
In closing, I assure you that we remain committed to focusing on the quite a few things that truly make a difference, as we strive to take surgery beyond the limits of the human hand.
That concludes today's call. We thank you for your participation and support in this extraordinary journey. We look forward to talking to you with again in three months.
Operator
Thank you for participating in today's conference call. You may disconnect at this time.
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