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Intuitive Surgical, Inc. (NASDAQ:ISRG)

Q1 FY08 Earnings Call

April 17, 2008, 04:30 PM ET

Executives

Benjamin Gong - VP of Finance

Lonnie M. Smith - Chairman and CEO

Marshall L. Mohr - Sr. VP and CFO

Aleks Cukic - VP, Business Development and Strategic Planning

Gary Guthart - President and COO

Analysts

Eli Kammerman - Cowen and Company

Tao Levy - Deutsche Bank

David Louise - Morgan Stanley

Rick Wise - Bear Stearns

Vincent Ritchie - Wachovia

Operator

Thank you for holding and welcome to the Intuitive Surgical Inc. First Quarter 2008 Earnings Conference Call. All lines will be in a listen-only mode until the question and answer session. Today's call is being recorded. If any one has any objections, you may disconnect at this time.

I'd now like to turn the call over to Mr. Ben Gong, Vice President of Finance. Sir you may begin.

Benjamin Gong - Vice President of Finance

Good afternoon and welcome to Intuitive Surgical's first quarter conference call. With me today, we have Lonnie Smith, our Chairman and CEO; Gary Guthart, our President and Chief Operating Officer; Marshall Mohr, our Chief Financial Officer 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 Securities and Exchange Commission filings. Respective 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 Archives 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 first 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 first quarter's financial results. Next, Aleks will discuss sales and marketing highlights, and I'll provide an update of our financial forecast for 2008 and finally, we will host a question and answer session.

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

Lonnie M. Smith - Chairman and Chief Executive Officer

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

Operating highlights for the first quarter as follows. We sold 74 da Vinci surgical systems, up from 44 during the first quarter of last year. 27 of these systems were sold to existing customers. Our international team had another solid quarter contributing 20 of the 74 systems sold, up from 11 last year.

We ended the first quarter with 867 da Vinci systems installed worldwide. That solid quarter-over-quarter procedure growth in all significant specialties led by GYN with strong growth in Urology, particularly in Europe. Procedure adoption continues to be procedure specific, patient driven and the primary growth factor are driver of our business. Total revenue grew to a $188 million, up 65% from last year. Instrument and accessory revenue increased to $62 million, up 54%, total recurring revenue, including service grew to $89 million, up 53% from prior year, comprising 47% of total revenue.

We generated an operating profit of $79 million, 42% of our revenue before non-cash 123R stock option expenses, up 87% from the first quarter of last year. GAAP net income grew to $45 million, 24% of revenue, up 88% from last year. We ended the quarter with $700 million in cash and investments, up $64 million from last quarter and up $315 million from last year. After subtracting $15 million in cash received from exercise of stock options and adding back $30 million, invested in fixed assets and working capital during the quarter, our gross operating cash flow in the first quarter amounted to 167% of our reported GAAP net income. This is reflection of the significant non-cash stock option, and statutory tax expenses. Reflecting our GAAP net income and is reason that we continue to believe that operating profit before non-cash 123R stock option expense remains the best measure of our true financial performance. We launched several new instrument and accessory products. We received update clearance, with the da Vinci driven EndoWrist cardiac stabilizer and removal of the beating heart warning [ph] language and the FDA approved instructions were used, for both the da Vinci and da Vinci Systems. We grew our Intuitive team by 95 members to 859, 57 of those were in field sales and service.

With that I'll this time over to Marshall our Chief Financial Officer.

Marshall L. Mohr - Senior Vice President and Chief Financial Officer

Thank you Lonnie. Total first quarter revenue of $188.2 million increased 65%, compared with $114.2 million for the first quarter 2007 and decreased 1%, compared with $189.4 million for fourth quarter of 2007. First quarter revenues by product category were as follows. Instrument and accessory revenue increased $61.9 million, up 54%, compared with $40.3 million, last year and up 10% compared with $56.1 million last quarter.

The growth rate in instruments and accessories is comparable to in a direct result of our procedure growth rates. The amount of instrument and accessory revenue we earn per procedure has remained relatively unchanged between $1,500 and $2,000 per procedure for established da Vinci accounts. Our average revenue per procedure including initial stocking orders has been gradually decreasing as the ratio of new systems to our install base declined and it is between $2,000 and $2,300 per procedure. Systems revenue of $99.1 million increased 76%, compared with $56.1 million last year, and decreased 9%, compared with $108.6 million last quarter.

The increase in Systems revenue, compared with first quarter 2007, reflects increased unit sales, as well as an increase in the average revenue per system. The decrease in the Systems revenue, compared with the fourth quarter of 2007 reflects seasonality overseas, as well as a decrease in the average revenue per system.

First quarter da Vinci Surgical System revenue reflects the sale of 74 systems, compared 44 systems during first quarter of last year and 78 systems sold in the fourth quarter. Two of the systems sales in the quarter involved trade-institution, where two customers upgraded one of their existing da Vinci Standard Systems, while purchasing two da Vinci S Systems with HD. 60 of these systems sold during the quarter were latest S model, incorporating high definition vision capabilities.

10 were four-arm S models incorporating standard vision capabilities, three were three-arm S models and one was standard system. Our first quarter average revenue per system, including all da Vinci models, but excluding upgrades was approximately $1.32 million, which is 60,000 thousand less than the average revenue per system in the fourth quarter of 2007. The lower average revenue per system, primarily reflects a higher proportion of our fourth quarter sales, being direct sales to European customers which are denominated in euros and in otherwise favorable geographic mix in the fourth quarter.

Upgrades during the fourth quarter, including fourth arms and HD accounted for $1.6 million of the current quarter systems revenue, compared with $1 million, last quarter. Service revenue increased to $27.2 million, up 53% compared with $17.8 million last year and up 10%, compared with $24.7 million last quarter.

The growth and service revenue 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 first quarter recurring revenue comprise of instrument, accessory and service revenue increased to $89.1 million, up 53% compared with the first quarter of 2007 and up 10%, compared with the fourth quarter of 2007.

Recurring revenue represented 47% of total first quarter revenue, compared with 43% in the fourth quarter. Revenue outside the United States represented 23% of total first quarter revenue, compared to 26% in the fourth quarter, decrease reflects business seasonality as we placed 20 systems in the first quarter, compared with 26 systems in the fourth quarter. Our first quarter 2008 gross margin of 69% decreased compared with 71.4% realized in the fourth quarter. The decrease in gross margin reflects lower average system ASPs and higher operating cost over similar revenue levels. The increase in operating costs includes expansion of manufacturing operations in Sunnyvale, as well as initial start-up cost for Mexico.

Total operating expenses for the first quarter of 2008 were $64.9 million, compared with $61.8 million in the fourth quarter of 2007. The sequential operating expense increase of $3.1 million reflects increased non-cash 123R stock compensation expense costs of $3.8 million and costs associated with increased headcount, partially offset by lower cost associated with R&D activities that are expected to occur in the second quarter. We added 95 employees during the first quarter ending the period with 859 regular employees. The majority of the additions were to our worldwide sales and support and manufacturing organizations.

First quarter 2008 operating income was $64.9 million or 34.5% sales, compared with $73.4 million or 38.7% of sales for the fourth quarter 2007. I should point out that 123R stock compensation expense included in the operating income was $14.6 million for the first quarter, compared with $10.1 million in the fourth quarter. The increase of $4.5 million reflects the impact to our annual stock grant made on February 15th coupled with the increase in our stock price. Our first quarter 2008 other income was $8.5 million, which is approximately the same as we realized in the fourth quarter of 2007.

Our effective tax rate for first quarter was 39%, which is consistent with our rate for 2007. We continue to utilized carry forward tax benefits and employees stock related tax benefits in 2008 and expect that our cash outlaid for income taxes will be less than 25% of pre-tax income for 2008.

Our net income of $44.8 million, or $1.12 per share increased to 88%, compared with $23.8 million or $0.62 per share for the first quarter of 2007 and decreased 9%, compared with $49.2 million or $1.24 per share for the fourth quarter of 2007.

Now turning our attention to the balance sheet. We ended the first quarter of 2008 with cash, cash equivalents and investments of $700 million, up $64 million from December 31st 2007. $15 million of the cash generated in the quarter was associated with stock purchase activities. The remaining cash generated is primarily related to operating activities. Our accounts receivable balance increased to $135.7 million at March 31st from $130.4 million at December 31st. The change in receivables reflects the timing of customer purchases and payments relative to our quarter cut off.

Our net inventory increased to $38.8 million at March 31st from $32.4 million at December 31st. Our inventory returns at March 31st of 5.7 times per year were lower than the 6.5 turns at the end of the previous quarter, as we build in inventory for future growth.

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

Aleks Cukic - Vice President, Business Development and Strategic Planning

Thank you Marshall. During the first quarter, we shift 74 da Vinci Systems, which included two trade-ins. Geographically, 54 systems were sold in the United States, 12 in Europe and eight in rest of world markets. 73 of the 74 systems shipments were da Vinci S Systems and one was a Standard da Vinci system. Of the 73 S systems sold, 60 were high definition or HD systems. The net 72 systems sold during the quarter brings to 867, the cumulative number of da Vinci Systems worldwide, 647 in the U.S, 148 in Europe and 72 in rest of world markets.

27 of the 74 systems sold during the quarter represented VP systems sales to existing customers, which brings to 94, the number of hospitals which owned more than one da Vinci system. Within these 94 Hospitals, 69 owned two, 17 owned three, seven owned four and one owns five. I think it's relevant to know that we often experience da Vinci S is being purchased at a facility that already owns a standard system, or perhaps several standard systems, only the transfer the standard system to our sister facility that does not own one. We've excluded these transfer units from the multiple system calculation that I just referenced.

Outside the U.S, we had a strong quarter which included three more da Vinci systems into Korea, three into the Netherlands, three into Italy and our first three into Brazil. Basically, we had another good quarter, a quarter in which experienced solid sequential procedure growth within all four of our targeted surgical specialties.

Our gynecologic procedure business paced by da Vinci Hysterectomy and da Vinci Sacral Colpopexy registered the largest sequential percentage growth for the quarter, where as urology registered the largest absolute growth. Worth noting is the tremendous growth, we experienced within our Kidney and Bladder Cancer businesses, specifically the da Vinci Nephrectomy and Partial Nephrectomy and da vinci Cystectomy. Within our Cardiac business, da Vinci Mitral Valve Repair also showed strong sequential growth.

During Q1, we had 117 da Vinci related clinical papers published within the peer view Journals across multiple surgical specialties. We also launched four new products and received FDA 510(k) clearance for a fifth, the fourth arm upgrade for the three-arm da Vinci S System, the 8.5 millimeter stereo endoscope, balloon camera cannula and the da Vinci [indiscernible] were launched during the quarter. We also received 510(k) clearance for da Vinci Control Cardiac stabilizer product and had a beating heart warning language removed from the instructions for use for both da Vinci and da Vinci S Systems. Although, these products will assist our customers in optimizing targeted procedures. None of them is expected to immediately impact our top or bottom lines.

We participated in clinical conferences within urology, gynecology, general surgery, and cardiothoracic surgery during the quarter. However, I'll limit my review to only a few beginning with the Society of Gynecologic Oncology or SGO.

Is use SGO took place in Tampa, Florida and was attended by over a 1,000 GYN oncologists. As we've mentioned in the past, SGO members are key target customers for us. Since they are the group that perform hysterectomies for both malignancies and complex benign conditions. We have now presented da Vinci at three SGO conferences and this year's event clearly confirmed da Vinci's clinical role within the treatment path for complex Hysterectomy.

This year, the SGO offered a postgraduate course and robotic and Radical Hysterectomy for cervical cancer featured several oral presentations and robotic Hysterectomy for both cervical and endometrial cancers, and highlighted several clinical posters comparing da Vinci Hysterectomy to both open and Laparoscopic techniques.

During the SGO postgraduate course, Dr. John Boggess from the University of North Carolina shared his outcomes data for da Vinci Radical Hysterectomy, in which he compared 50 Radical dVH's [ph] for cervical cancer to 50 radical hysterectomies performed through traditional open incisions. His comparisons were pretty telling, beginning with over time, which was 210 minutes for its dVH's, compared to 247 minutes for his open hysterectomies. Blood loss for his dVH's was 95 milliliters and 416 milliliters for his open hysterectomies. dVH lymph nodes [ph] of 32... excuse me, 33.8, compared to 23.3 for his opens and hospitalization of one day for his dVH's versus 3.2 days for his opens, all while reducing complications by 50%. Dr. Lynn Kowalski, a surgeon from Nevada Surgery & Cancer Care in Las Vegas, presented a simple comparison and her radical hysterectomies with the addition of transfusion rates and published her results in excepted clinical poster. And Dr. Kowalski's series of 31 patients, she reported loss to be 182 milliliters with zero transfusions within a dVH co-work [ph], as compared to 415 and three transfusions for her open procedures.

dVH lymph node of 20.7, verses 16 for open and dVH hospitalizations of 1.4 days, versus 6.1 days for her open radical hysterectomies. All in all, we are pleased with the increase in the da Vinci Surgery awareness and clinical outcomes data presented at this year's SGO conference. At the world robotic urology symposium, which took place in Orlando the three day agenda was devoted exclusively to da Vinci and the presentations were non-stop.

The program was attended by over 600 urology professions. In addition to the oral presentations, panel discussions and poster reviews with channelized surgery broadcasts featuring dVP, da Vinci Nephrectomy and Partial Nephrectomy, da Vinci Cystectomy and thyroplasty [ph]. I selected one abstract which I believe capsulates da Vinci's value to not only the urologists, but the surgeons multiple across the multiple specialties. The team at University of California, Irvine, led by Dr. Lesley Dean [ph], presented their initial series on da Vinci Partial Nephrectomy comparing it to Laparoscopic Partial Nephrectomy performed by expert Laparoscopic surgeons within their facility.

Similar to Laparoscopic Radical Prostatectomy, Laparoscopic Partial/Wedge Nephrectomy is a technically challenging procedure that is performed by a limited number of expert Laparoscopic surgeons. This analysis compared the outcomes of an initial experience with robotic Partial/Wedge Nephrectomy performed by an experienced open surgeon to that our standard Laparoscopic Partial Nephrectomy being performed by two experienced Laparoscopic surgeons. Their initial clinical results were as follows: the mean tumor size was 3.1 centimeters for the da Vinci Partial Nephrectomy patients and 2.3 centimeters for their Laparoscopic patients. Mean total procedure time was reduced by an hour using da Vinci to 228 minutes versus 289 minutes during their Laparoscopic procedures. Estimated blood loss was 115 milliliters with da Vinci versus 198 millimeters during laparoscopy.

The mean warm ischemia time was 32.1 minutes in the da Vinci group and 35.3 minutes in the Laparoscopic group. The authors concluded, and I quote, introducing a robotic interface for Laparoscopic Partial/Wedge resection allows a fellowship trained urologic oncologist with limited reconstructive Laparoscopic experience to achieve comparable results for Laparoscopic Partial/Wedge resection performed by experienced Laparoscopic surgeons. In this regard the learning curve appears truncated, similar to that with robotic assisted Laparoscopic Prostatectomy.

It's important to mention that the field of nephron-sparing surgery is growing rapidly worldwide and for good reason. In the near past urologists have come to agree that preserving healthy kidney tissue contributes to improved kidney function for patients with renal tumors. The partial nephrectomies are difficult to perform. So the standard operation for patients with renal tumors has been the removal of the entire kidney.

Today the urology profession is rapidly moving towards sparing as much healthy tissue as possible. And da Vinci's role within these procedures is being recognized early. Some of the leading academic centers around the world have begun to make da Vinci standard within these procedures. And later this quarter the First Annual Worldwide Robotic Renal Symposium will be hosted by Washington University in St. Louis and chaired by one of the leaders in the field Dr. Sam Bhayani. And it will include an international faculty of prominent renal surgeons.

The European Association of Urology conference was held in Milan and attended by nearly 12,000 urologists. This year's program included multiple DDP presentations, abstracts, posters and live surgery, as well as presentations in da Vinci Nephrectomy, Partial Nephrectomy and Cystectomy. One of the most interesting initial series on Radical Cystectomy was given by the group out of [ph] guys in St. Thomas Hospital in London. Lead by Dr. Prakash S. [ph] Gupta.

The study compared their first ten da Vinci radical cystectomies to ten Laparoscopic and ten open radical cystectomies at various time intervals. Their first comparison performed intra... measured interoperatively reported that patients undergoing open radicals experienced 325 minute procedures with 1,300 milliliters of blood loss and 60% complication rates. Their Laparoscopic procedures averaged 345 minutes with 350 milliliters of blood loss and 50% complication rates. Whereas their da Vinci Cystectomy patients underwent 365 minute procedure with only 150 milliliters of blood loss with complication rates of only 20%. As these procedures are performed to eradicate cancer, the long-term disease free rates are primary concern. Their experiences for lap and robotic were not as seasoned as their experiences with open surgery. So they measured each patient at different intervals. They stated that 60% of the open radical patients were disease-free at five years. About 60% of the lap patients were disease-free at four years. Whereas da Vinci patients were 100% disease free at three years.

It's too early to declare a complete victory, but the significant reduction in blood loss and complication rates along with a three-year disease-free rates are very encouraging. In addition to some of the exciting presentations in Nephrectomy, Partial Nephrectomy, and Radical Cystectomy at this year's EAU were dozens of presentations and posters for da Vinci Prostatectomy. It's becoming pretty clear that dVP is rapidly expanding around the globe.

In fact in the feature presentation to the joint session of the EAU and the Chinese Urology Association entitled is robotic Radical Prostatectomy the future? Dr. Richard Gaston of the Clinique St Augustin in Bordeaux, France, the chairperson and the surgeon often credited with performing the first Laparoscopic Prostatectomy in Europe, concluded, and I quote. The overall data indicates that robotic Prostatectomy is the future, and the future is now.

This concludes my overview, and I'll now turn the time over to Benj.

Benjamin Gong - Vice President of Finance

Thank you, Aleks. I will be providing our updated 2008 financial forecast on a GAAP reporting basis including non-cash FAS 123R stock compensation expenses and on a pro forma basis which excludes the stock compensation expenses.

Based on our first quarter results we are increasing our previous guidance for revenue and pro forma profits for 2008. On a GAAP reporting basis we are not increasing our forecasts for profits because stock compensation expenses are greater due largely to our higher stock price.

I will provide details of our stock compensation expense later in the call.

Now starting with procedures, we continue to expect dVP and dVH adoption to drive the growth in our 2008 recurring revenues. For 2008 we continue to expect dVP procedures to grow approximately 40% from a base of about 55,000 procedures performed in 2007. And we expect dVH procedures to grow approximately 150% from a base of about 13,000 procedures performed in 2007.

As regard to revenue, we expect our total 2008 to grow approximately 42% over 2007, which is up from our previous estimate of 40%. Instrument and accessory revenue which is specifically driven by procedures performed is on track to grow 55% this year. During Q1 procedures grew in line with our previous estimates and therefore we are maintaining our forecast for 55% growth in instrument and accessory revenues for the year. System revenues were modestly stronger than we expected in Q1 and we are increasing our forecast for the year. We are forecasting system revenue to grow 33% to 35% over 2007, which is up from our previous forecast of 30% growth. We expect this growth to come from an increase in unit shipments.

Our system ASP was $1.32 million in Q1 which is similar to our average for all of 2007. As we mentioned in our last call we expect our average system ASP for the year to be about the same. However, our system ASP may fluctuate quarter-to-quarter as a result of geographic and product mix.

We expect service revenues to grow approximately 45% above 2007 levels which is slightly higher than our previous estimate of 44%. Our average annual service revenue per installed system is approximately $135,000 per year. With regard to gross profit margin our Q1 results were inline with our expectations and we're continuing to forecast gross margins to be between 69% and 70% for the year.

Moving to operating expense and operating income, I will start with our forecast on a pro forma basis excluding the impact of non-cash stock compensation expense. Excluding stock compensation charges we expect R&D expense to grow approximately 40% over last year. SG&A expense to grow approximately 37%. And total operating expense to grow approximately 40%. We expect pro forma operating income to grow approximately 47% for the year. Last quarter we were forecasting pro forma operating income to grow 43%.

Improvement in our pro forma operating income is being driven by our higher revenue forecast coupled with only a modest increase in pro forma SG&A expense.

Now on a GAAP basis, the largest change to our forecast related to our estimate of non-cash stock compensation expense. During our last earnings call we have forecasted these charges based on a stock price of $250 which was approximately where the stock was trading at the time. As you know our stock price depreciated significantly over the past three months and as a result we expect the charges to income for stock compensation expense to be significantly higher. Based on the current stock price we are now estimating a total of $75 million in stock compensation charges for the year which is up from our previous forecast of 60 million.

Our new estimate of 75 million is distributed as follows: 12 million in cost of good sold which compares with 10 million previously forecast. 17 million in R&D which compares with 13 million previously forecast. And 47 million in SG&A which compares with 37 million previously forecast. This would represent an over 100% increase in the stock compensation expense for the year compared with the 36 million total stock compensation expense recorded in 2007.

Therefore on a GAAP basis our total operating expenses are expected to be higher than we previously forecast. In the R&D expense category, our spending in Q1 was lower than expected due to timing of some planned expenditures. We expect to incur those expenses during the second quarter. For the year we expect R&D expense to grow approximately 59%, this is up from our previous forecast of 52% growth due to the increase in stock compensation expense.

In the SG&A expense category, we made progress expanding our field sales and service organization by adding 57 people, bringing our total field organization to approximately 320 people. We are continuing to hire field personnel at a rapid pace.

For the year we expect our SG&A expenses to grow approximately 47%. This is up from our previous forecast of 40% growth, primarily due to the increase in stock compensation expense and to a smaller extent due to the growth in our revenue forecast. We expect total operating expense, including FAS 123R stock compensation expense, to grow approximately 15% for the year. We expect operating income to grow approximately 37% for the year. For the second quarter 2008 we expect our stock compensation expense to grow approximately $5 million from Q1. Other income expense for 2008 is expected to come in between $33 million and $35 million for the year. This is down from our previous estimates of $36 million to $40 million due to lower interest rates on our cash investments.

With regard to income tax, as mentioned in the past, we expect to report a GAAP tax rate of approximately 39% for the year. However, we expect our effective cash-tax expense to be less than 25% for 2008. We expect to start reporting the benefits of our international tax strategy in the form of a lower GAAP tax rate in 2009. Regarding shares outstanding, we currently have 38.7 million common shares outstanding. We also have approximately 3.9 million option shares outstanding.

Depending upon our average stock price during the year, a portion of the 3.9 million option shares will be added to the fully diluted shares calculation. Calculating EPS, in 2008, we expect the share count to be approximately 40.2 million shares in Q2 and growing to approximately 40.8 million shares by the end of the year.

That concludes our prepared remarks; we will now open the call to your question.

Question And Answer

Operator

Thank you. At this time we will begin the question-and-answer session. [Operator Instructions] Our first question from Eli Kammerman with Cowen. Sir your line is open.

Eli Kammerman - Cowen and Company

Yes, thank you. Couple of questions here, first question I had is with the very small sequential decline in systems that you had for the quarter. What do you think this says for the pattern of seasonality that you expect to see this year? Are you expecting to see relatively level system sales through the year or do you think we will see the same kind of thing as we saw in 07 where the fourth quarter was significantly higher than the first?

Benjamin Gong - Vice President of Finance

This is Ben. Eli I think the seasonality is going to be similar as far as we know. It was sequentially down in Q1 this year as it has been in previous years. We will expect Q4 to be our highest quarter, but that said we think the total number is going to increase year-over-year by between 33% and 35%.

Eli Kammerman - Cowen and Company

Okay, and my next question is can you make some comment about the expected launch date for the new visualization technology that's going to integrate anatomical radiology images into the viewer.

Aleks Cukic - Vice President, Business Development and Strategic Planning

I'm not sure what you're referencing there.

Eli Kammerman - Cowen and Company

Okay, I thought I read that you are developing some type of integration function where you can put volumetric imagery into the view screen, so that a physician can see, for instance, MRI images at the same time that they are performing the surgery.

Unidentified Company Representative

That capability exists today in the S System... the S System part of the... the system allows you to bring other information sources into a picture within a picture on the screen, and so we... that is not... that capability was launched when we launched the S; the da Vinci S.

Eli Kammerman - Cowen and Company

Do you plan to upgrade that functionality to allow for image guided surgery where certain parts of the anatomy will be structured as off limits to dissection for safety purposes.

Unidentified Company Representative

No fly zone.

Gary Guthart - President and Chief Operating Officer

Yeah, so this is Gary, we have some research programs ongoing internally and with external partners exploring how those types of things can be done. I guess I would not characterize them as product development at this time. So there are some significant hurdles in base technology that will have to be overcome to make that kind of no fly zone repeatable in soft tissue areas as we go.

Eli Kammerman - Cowen and Company

Okay. Thanks very much.

Operator

And our next comes from Tao Levy with Deutsche Bank. Your line is open.

Tao Levy - Deutsche Bank

Good afternoon.

Unidentified Company Representative

Hi, Tao.

Tao Levy - Deutsche Bank

So, I was just wondering, just following on Eli's comment. This is the first time I think in the last few years that sequentially in the U.S. you had more systems placed in Q1 then in Q4. Does that say anything about the capital spending environment and any issues there? Obviously we get that question all the time and you read about in the papers everyday.

Benjamin Gong - Vice President of Finance

Tao, this is Ben. It was slightly higher in Q1 versus Q4, but I think we feel that is within the realm of the normal, let's say fluctuation you might have quarter-to-quarter. System sales are strong, that's true, and that's why we took up our guidance for the year, but I think our forecast captures what we are currently seeing.

Tao Levy - Deutsche Bank

And anything on capital equipment spend that you are hearing from your sales reps?

Benjamin Gong - Vice President of Finance

No, we are not hearing anything there. I know over the quarter we've had various questions as to whether or not there has been impact due to credit issues, and as far as we can tell we haven't had any impact to our system sales.

Tao Levy - Deutsche Bank

Okay, and I think during the prepared remarks someone commented that urology in Europe was strong. I was just wondering if you could further elaborate on that point. Is that why you are seeing... you feel like in at least in the Netherlands every quarter they're buying three or four systems, is that... what they are using it primarily for, for example there?

Aleks Cukic - Vice President, Business Development and Strategic Planning

Well, I think it's safe to say that da Vinci Prostatectomy is being adopted outside of the United States and at different rates in different countries. Urology specifically including... excuse me Nephrectomy, Cystectomy and the like were strong both U.S. and o-U.S., but particularly strong in the o-U.S. market. So, I think as we've always said that outside of the United States, Europe and rest of world markets tends to trial the United States. And so the growth that we have seen over the last several years in da Vinci Prostatectomy within the U.S. is now starting to really play out in Middle East, Asia, and so on.

Tao Levy - Deutsche Bank

Okay, great. Thanks a lot.

Unidentified Company Representative

Thank you.

Operator

And your next question comes from David Louise with Morgan Stanley. Your line is open.

David Louise - Morgan Stanley

Hello, good afternoon Thanks for taking the question. I guess open-ended question here just on new customer growth in the U.S. marketplace. I think this is the second quarter in a row where we've seen it decline on a box basis. Is there any chance that new [indiscernible] customers in the U.S. would reaccelerate in 2008. And sort of the second part of that question would be. Is the focus in the U.S. market specifically some comments on ads [ph] is it really shifting from driving aggressive utilization and less about version customer or new customer placement.

Aleks Cukic - Vice President, Business Development and Strategic Planning

David I think there is a... and we've commented at different times over the let's say the last seven or eight quarters. There have been some quarters where the percentage of repeat purchases was high followed by quarters where it was low. I don't know that we can say that it's going to follow this trend or that trend and quite honestly we are pleased to see recurring customers coming back and buying more systems.

Now one of the things that is, is something that perhaps you don't have great disability into it are, for example, customer like St. Joes in Atlanta. This quarter they brought another system, that was a repeat customer, in fact they would have bought their fifth system, but they moved one of their earlier systems to a customer, that did... a sister hospital that did not have a da Vinci. So there is a lot of things that are going on, and we think all positive. So, is it possible that in some quarters it will reaccelerate, yeah it is possible.

Lonnie M. Smith - Chairman and Chief Executive Officer

But, I think, this is Lonnie. I think the confirmation of the value-add of the system is really reflected in repeat purchases. And those that have bought and had found success and then buy a second system that's a confirmation of their satisfaction with their purchase and willingness to do it again.

Long-term, in terms of adoption of the technology that's a good sign, that's a positive. The worst case for us is everybody buys one and they don't buy another one, because they weren't satisfied with their investment. And that is not the case. We are seeing people who buy these systems and develop excellent programs, come back and buy a second, third or fourth system, as Aleks has pointed out. And we expect that to continue. The volatility, the change in that dynamic from quarter-to-quarter... I think Aleks is right on the money.

David Louise - Morgan Stanley

Okay, that's very helpful. It's hard to be naked about box placements, it is just interesting that in two more quarters it looks like Europe could even eclipse new placement growth or new box growth in the U.S., which obviously isn't a bad thing, but I appreciate the color. The second thing is just on surgical volumes, I may have missed in the commentary, it was flying fast and furious. But there was little mention of Myomectomy or Sacral Colpopexy, but there was some mention obviously of Nephrectomy, Cystectomy as well as the Mitral Valve is that simply just giving us a flavor for new procedures that are out there or did you see trends in Myomectomy and Sacral Colpopexy that flat than they [ph] did in the first quarter?

Lonnie M. Smith - Chairman and Chief Executive Officer

Both have grown.

Aleks Cukic - Vice President, Business Development and Strategic Planning

Yeah, and actually I did mention Sacral Colpopexy with Hysterectomy. So those were the two leaders within gynecology which the category being the fastest growing as a percentage were lead by Hysterectomy and Sacral Colpopexy. And I think the added color on some of the other procedures were really in line with the color that those procedures are getting at the various conferences that we've attended during the quarter and they're coming on pretty strongly. So I think it was a way to call out some endpoints that people are looking at and really let you know that these things are arriving within the clinical community and at the clinical conferences.

David Louise - Morgan Stanley

Great, and I'll jump back in queue, but it was [ph] last question, could you provide us an update on any discussions you've had or any progress with Japan or to a lesser extent China?

Unidentified Company Representative

Yeah, on the Japan front we continue to make progress with the government. We are going back and forth on the form of our submission it's not, we're not in the window where we're predicting the end date, but I'm happy with our progress to-date? I [indiscernible]... and I'll turn that back over to Lonnie.

Lonnie M. Smith - Chairman and Chief Executive Officer

China, there really is no new... really nothing new to mention there with regard to China. And for the quarter

Marshall L. Mohr - Senior Vice President and Chief Financial Officer

We didn't have any placements this past quarter in China.

David Louise - Morgan Stanley

Great. Well, thank you very much.

Unidentified Company Representative

Thanks David.

Operator

And our next question comes from Rick Wise with Bear Stearns. Your line is open.

Rick Wise - Bear Stearns

Good afternoon everybody.

Unidentified Company Representative

Hi Rick.

Rick Wise - Bear Stearns

Gross margins. Again you talked about the pressure or drag on gross margins from... and the Sunnyvale expansion and the Mexico startup. Can you just remind us, either... I'd be happy to hear you quantify the amount of that drag and just remind us again when that goes away?

Benjamin Gong - Vice President of Finance

Yeah, Rick, this is Ben. Actually the biggest impact on gross margins was probably the product and geographic mix which made the ASPs lower by $60,000 quarter-over-quarter on the system sales. So there were some modest things. Revenue was relatively flat quarter-over-quarter, but we continue to build our team, and so you have a higher fixed cost there over... about similar number of revenues. And but the point here is not that there is a big drag there. And the 69% to 70% forecast that we have for the rest of the year is right in line with where we thought we hit the Q1.

Rick Wise - Bear Stearns

Yeah, well, as always, Ben, you anticipate where I am going. I mean it came out slightly higher revenue, roughly, revenue volumes... so you are saying most of that sequential shift was that geographic mix element.

Benjamin Gong - Vice President of Finance

Absolutely the 71% that you saw in Q4, if anything, was standing out a little bit among all the quarters around it. And that was a quarter where we had a pretty high mix of direct sales into Europe and a low mix of... lower mix in distribution sales.

Rick Wise - Bear Stearns

And I apologize for asking this question again, it was already well asked by Tao and well answered. But let me ask it somewhat differently. The anxiety over cap spending and hospital credit. I don't know if it's a question for Lonnie or Marshall, but just... when you look at the environment or your conversations with hospitals or the decision makers. Is there anything in the external environment that makes you External environment that mix you incrementally more concerned that you look out over the next 12 months in you know in the U.S. versus where you might itself six months ago just in that external environment that makes you incrementally more concerned as you look out over the next 12 months in the U.S. versus what you might have felt six months ago just in that external environment.

Lonnie M. Smith - Chairman and Chief Executive Officer

On the external side... I'll try to answer it. I don't get any. I've still not get any feedback from the sales organization that there is pressuring out, some hospitals are in better shape than others. And... but there is always the decision within a hospital, how do they prioritize their capital investment. And I think we came up typically fairly high on that priority list. As you know in the financial markets whenever you keep stipulating for the next shoot or drop and you are familiar with it more than probably anyone, we don't... but we don't hear anything that causes us any significant concern. I've got lots of concerns about other things we have to be running or working very hard, but not... that one has not yet look like it's real issues. So, I don't have any different news than we had. No change from last quarter, I guess, is the simple way to state it.

Aleks Cukic - Vice President, Business Development and Strategic Planning

I would just add one thing Rick, is... to underscore Lonnie's point on the priorities that hospitals, the way they will prioritize. If you compare the purchase of a da Vinci to some other piece of technology, let's say in the 7 figure range. Number one, our system does not require any sort of a room fit. So, it doesn't have to be staged with new operating rooms or a series of new operating rooms, which tend to be very, very expense. Our systems are installed by one person, in a morning. So they are delivered uncrated and installed.

So, as compared to some of the other things that are out there that require room, refits and bricks and mortar, that may end up being part of major OR refits that may be supported by a bond or some form of debt vehicles. So, we are not really in the same category with a lot of those decisions. So thus far we haven't seen it, but we are certainly not going to predict the velocity of the broader credit markets.

Rick Wise - Bear Stearns

Okay, just one last quick one. Given the strength in complex hysterectomies and nephrectomies, partial nephrectomies. Can you just remind us the opportunity. And given the up-tick, is this where is... as you know, I am always looking for upside... is this where upside could come in the next 6, 12, 18 months. We are hearing a lot of great things about use in these areas as well. Thanks.

Aleks Cukic - Vice President, Business Development and Strategic Planning

You know I would just caution on a timeline for the following reason. What we have learned thus far, let's start with da Vinci Prostatectomy. It was cleared by the U.S. FDA in 2001. And it took pretty significant commitment for the first two years to really get that to what at the time was a material number. And so it's not going to be... I doubt we stumble across a procedure that is like throwing a light switch, that everybody just comes running to it immediately. It's going to take a lot of work. So when you define upside... not having benefit of what you are calling upside... we are very bullish on it, we will grow it over the next 18- to 24 months. But whether it meets the quote upside definition, I am just not sure what that is, but we are very bullish on it.

Rick Wise - Bear Stearns

Thank you.

Unidentified Company Representative

Thank you, Rick.

Operator

And our next question comes from Vincent Ritchie with Wachovia. Your line is open.

Vincent Ritchie - Wachovia

Hi guys. Thanks for taking my questions. My first question is going to be on option rate securities [Audio Gap]...

Marshall L. Mohr - Senior Vice President and Chief Financial Officer

... that we did evaluate those, and given the liquidity issue to exists today we did record a $4.4 million reserve that only runs through the balance sheet, because we believe this is a temporary impairment, if you will.

Vincent Ritchie - Wachovia

Okay great. And then switching over to more of a therapeutic view. Can you kind of give us a perspective on your maybe compare and contrast for us ASCO with SGO?

Unidentified Company Representative

I'm sorry could you repeat that question.

Vincent Ritchie - Wachovia

Just kind of qualitatively characteristics about ASCO with SGO, in terms of, kind of a concentrated group of surgeons having a very focused kind of perspective on the different factors?

Unidentified Company Representative

I'm still not following you

Unidentified Company Representative

What's ASCO.

Vincent Ritchie - Wachovia

The colorectal American side ?

Unidentified Company Representative

Okay, the compare and contrast for this, alright.

Vincent Ritchie - Wachovia

Yeah.

Unidentified Company Representative

Well, I would say that there are... I mean in raw numbers they are very, very similar. I believe there are 1,100 registered GYN oncologists in the United States and there are roughly 1,500 board certified colorectal surgeon. And they both are subspecialties within a very large group as SGO is to gynecology, colorectal is to general surgery. So I think there is definitely some easy things to compare and contrast there. I would say that in terms of the development within or I should say the early adoption thus far within gynecology as compare to colorectal surgery. It hasn't quite been on that level and nor at this stage are we saying that it is going to be. But there are a lot of things within that society and within that disease state that we believe set up well with da Vinci. It just hasn't materialized yet, but it's a procedure we're focusing on and time will tell.

Vincent Ritchie - Wachovia

Okay, great. And then my last question is on notes. You know this is a topic of conversation among surgeons. About a year ago you guys had expressed some modest but conservative interest there and then one of the sessions of SGO also discussed possibly some robotic applications. Do you think this is an area of interest or what's your guys' perspective on it because this is a very controversial topic.

Gary Guthart - President and Chief Operating Officer

This is Gary. You know as we look out at it, we look at both single port surgery and notes. And we're exploring those fields. I think they are a little bit different and single port maybe a little sooner than notes. I think it will be a little while for real patient value to be understood in those two. And I guess our strongest statement is that if there is patient value to be had there, we think robotics will play a significant role in pursuing that value. So we're in the exploration phase, we take it seriously, and we will see where it takes us.

Vincent Ritchie - Wachovia

Okay, great. Thanks for taking my questions.

Unidentified Company Representative

We have time for two more questions.

Operator

And our next question comes from Amit Hazan with Oppenheimer & Co. Your line is open.

Unidentified Analyst

Hi this is Michael Chu [ph] calling in for Amit. Thank you for taking my questions. My first question is related to, both, how you said guidance and visibility on hospital spending trends? Can you just remind us of how long it typically takes from initially lead to become a system sale. And we know it's a general question but any color you can give us would be helpful.

Unidentified Company Representative

Yeah this has been... for the sale cycle on systems. We said in the past that the full cycles averages maybe three to six months in the United States, and that's probably still the case. We will occasionally get some that sell pretty quickly in less than three months. So, we also have some that will take longer than six, but on average it's still looking the same. Internationally, is definitely longer, you can have some territories that are currently over a year, but there is actually some signs in Europe with some of our direct sales that that's definitely shorter. So you know maybe somewhere closer to six months in some of those territories. And we take that all into account when we give our forecast.

Unidentified Analyst

Okay, thank you and the next question is related to the macroeconomic issues. Wanted to know, currently what is the percentage of U.S. system sales are financed?

Unidentified Company Representative

Roughly speaking about 15% of our system sales are financed.

Unidentified Analyst

And how about in Europe or rest of the world.

Unidentified Company Representative

There is actually maybe a similar percentage in Europe that are financed. The rest of the world ones, they vary quite a bit actually. So, it can be very different let's say in Brazil as you might see, in say Korea.

Unidentified Analyst

Okay.

Unidentified Analyst

My last question is, what is the average utilization on the system, before you are seeing a second and third system purchase from the same customer and how should we think about the second and third system purchases as they relate to hospital spending if there is really a contraction in terms of capital expenditures?

Unidentified Company Representative

Couple of things there. I don't know that there is a perfect algorithm for when a second or third of fourth system is purchased. What we have seen that I think is pretty unanimous is that the larger the... of specialties in other words, if urology and gynecology and cardiac surgery and general surgery are all engaged in robotic surgery that the capacity of that system is reached much sooner and the requirement for a second system happens much sooner than let's say a system that has a really strong urology focus and they are the dominant specialty. So what we have seen in the past is that in multiple specialty purchases we tend to sometime see those around 250 to 300 procedures per year when they are trending at that rate. And you'll probably see, again in some situations where it's actually higher than that where they aren't as many specialties.

It's not a perfect algorithm and depending on the commitment that the hospital is making to its overall MIS program which is starting to become very apparent, they will often get systems dedicated to each specialty to avoid that lockjam.

Unidentified Analyst

And just one quick follow-up as well to you, sales for the quarter. Want to know what was the overall FX impact?

Unidentified Company Representative

FX impact? On a year-over-year basis we had $1.1 million of FX gain greater than last year. And what we haven't yet done is how much impact was there on the overall business, 23% of our sales were international for the quarter. But you are right there was only six systems that were sold directly into Europe this past quarter.

Unidentified Analyst

Okay, alright, thank you very much.

Unidentified Company Representative

One more question.

Operator

And our last question come from Steve Algovi [ph] with ThinkEquity. Your line is open.

Unidentified Analyst

Hey guys, thanks for taking the question. Wanted to dive in a little deeper on the SG&A spend, specifically the 57 new hires. If you could maybe give us some color on where that is Europe versus U.S? And then as a follow-up to that talking about concentration of procedures, and does it make more sense from your perspective to invest in the recurring revenue type of sells reps because you're getting these areas where all the robotic procedures are going to one area versus hiring somebody who is going to sell capital equipment and drive that into a new hospital where they need to see their patients leaving? Thanks.

Unidentified Company Representative

So, we... last quarter we mentioned investing a lot more on the procedure-driven sales force, and this we strongly believe that we can drive more procedures by having people focused on fewer sites, but going deeper. And so it's our goal to get to a metric where one sales person covers, let's say, four systems instead of five, and we're well on our way to doing that and that's where some large portion of those 57 new hires went. As far as the mix between domestic and international. We did have adds in both territories, I don't have the split out exactly...

Unidentified Company Representative

But it's also important to note that we have even in international there is a mix between direct and indirect employees, so the distributors are also committing resources and people to sell. So the international number is not going to necessarily parallel the U.S. numbers growth, because we do have that secondary sales org there too.

Unidentified Company Representative

But we will continue to invest in both capital sales people who sell the system as well as the sales force that supports the ongoing procedure development and procedure use of the system.

Unidentified Company Representative

Yeah, I think the way to think about it also is that, a few years ago when a -- really predominantly in urology and some cardiac and... a little bit general surgery, with a handful of procedures that really were being focused on. Now today we are talking about a host of new procedures that we weren't talking about a couple of years ago. As that list grows and we hope it to grow and continue to grow for a long time, the dependency of the person in the operating room goes up, because there are new procedures that require their attention, there are more and more surgeons that they are trying to get trained. And as that wheel turns that is really accretive to the business. So I would expect that number to continue to be... that role to be a really important role in the overall strength of the business.

Lonnie M. Smith - Chairman and Chief Executive Officer

That was our last question for today. As I have said on prior calls, we believe the adoption is driven by significant shift in patient value. And we are focused on increasing that patient value by improving surgical outcomes, and reducing surgical trauma. While the FDA clearance of the da Vinci-driven endorisk [ph] stabilize during the removable of the beating heart, warning language may not have a significant near-term impact. We do believe that it will have a significant long-term positive impact in the adoption of Robotic coronary artery surgery.

Professor [indiscernible] who is the Chief of cardiac surgery at Arasma Academic Hospital and Trivole University Hospital [ph] in Belgium uses the da Vinci S endo [indiscernible] stabilizer for coronary artery bypass surgery. And he says that it provides, and this is a quote, rock solid stabilization for coronary vessel on the beating heart, enabling the avoidance of not only of the thrasic [ph] incision but also of the cardiopulmonary bypass system. The advantage for the patients, he says, are obvious, avoiding cracking the chest is not only a matter of cozmesis [ph], it corresponds to a much lower injury to the patient, much less inflammatory reaction, much less blood air interface, leading to a significant decrease in complications such as infections and stroke, which means shorter length of stay and a faster return to normal life and work.

One of his patients, a forty-year old man wrote some letters, and he... I am going to kind of summarize that, they said, ladies and gentlemen, good day. What a wonderful world, I have endured my first hospitalization. And it was not a little intervention but a bypass operation. This meant at least three months out of my job, surely one year of unpleasant and tormenting physical shortcomings what a [indiscernible] thanks to Arasma Hospital [ph] professor [indiscernible] and Dr. Yansun [ph], and the entire team of the cardio unit as well as the robot da Vinci. My opinion has changed into wallah what a wonderful world. Some days later I walked three hours with the in-laws across Brussels Christmas market and on January 4, 2008, back to full time work. This being topped off by a eight day ski holiday in the alps. Without the invention of the robot da Vinci this would have never been in my dreams, less even a reality. Thanks to the combination of technical progress and human dedication. I am grateful with all my heart. Jean Paul [ph].

Patients like these are the strongest advocates, strongest advocates for surgery with a da Vinci system and are the very foundation of our operating performance. In terms of our expectation of ourselves to continue to deliver exceptional operating performance, I like the story of the lion and the gazelle.

Every morning in Africa, a gazelle wakes up, it knows it must run faster than the fastest lion or will be eaten. Every morning the lion wakes up and knows it must outrun the slowest gazelle or will starve to death.

The moral, it doesn't matter whether you are a lion or gazelle, when the sun comes up, you better be running.

In closing I assure you that we remain committed to focusing on vital few things that truly make a difference as we strive to take surgery beyond the limits of the human hand. And you can count on the fact that when the Sun comes up we will be running.

That concludes today's call, we thank you for your participation and support of this extraordinary journey. We look forward to talking to you again in three months.

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Source: Intuitive Surgical, Inc. Q1 2008 Earnings Call Transcript
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