直覺手術 (ISRG) 2002 Q3 法說會逐字稿

Good afternoon participants.

Welcome to the third quarter earnings release conference call.

All lines are going to be on listen-only until the question and answer portion of today's program and at the request of our call leader, this conference is being recorded.

Any objections, you must disconnect at this time.

I would now like to turn the call over to our Vice President of Finance, Treasurer, and Corporate Controller of Intuitive Surgical Mr. Ben Gong.

Sir, you may begin when ready.

Good afternoon.

Welcome to Intuitive Surgical third quarter conference call.

With me today we have Lonnie M. Smith our President & CEO, Susan K. Barnes our Chief Financial Officer, Frederic H. Moll our Co-Founder and Medical Director, Aleks Cukic our Vice President of Business Development and Strategic Planning, and David M. Shah our Vice President of Legal Affairs and Corporate Counsel.

Before we begin, I would like to inform you that comments mentioned in 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.

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 www.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 the third quarter as described in our press release announced earlier today followed by a question and answer session.

First, Lonnie will present the business highlights of the third quarter;

Susan will follow with a review of our third quarter financial results and provide an outlook for the fourth quarter.

Next, Fred will describe our most recent clinical and regulatory progress, Aleks will discuss Sales & Marketing, and then Dave will update you regarding intellectual property issues.

Finally, we will host a question and answer session.

With that, I would like to introduce Lonnie Smith our President & CEO.

Thank you Ben.

I would like to thank each of you who have taken the time to join us for today's conference call.

I will begin with a review of the highlights of the third quarter.

Financially, we had a solid third quarter revenue and margin results.

We shipped 14 da Vinci surgical systems, ended the quarter with a 132 systems installed worldwide, achieved revenue of $17.1 million, up 57% from prior year, grew recurring revenue to $3.9 million, up 135% from prior year, grew gross margin to 51%, up from 47% in Q3 2001.

Regarding operating expenses net loss, we recorded total operating expenses of $15.6 million up 42% from prior year, had a net loss of $6.5 million or $0.18 a share and ended the quarter with $48.5 million in cash.

We are pleased with our revenue growth and improving gross margins in a seasonally slow third quarter.

We continue to see healthy growth in our recurring revenue stream, increased system usage.

We are however not happy with our third quarter operating expenses and net loss results.

We had higher-than-anticipated expenses this quarter due primarily to the impact of two non-recurring items - first, we made a significant investment during the quarter in our litigation against Computer Motion in Delaware, which included the trial in August.

While this is not our preferred type of investment, we believe that defending our intellectual property is very important to the long-term success of our company.

Second, during the quarter we incurred significant expenses associated with unauthorized purchases of administrative supplies for which we have no use.

A non-management employee circumvented company processes and purchased without proper authorization materials at a highly inflated price that neither fit our needs nor work with the products we are on.

We believe that this employee was improperly enticed to do so by an unscrupulous vendor.

Our financial review exposed this activity and we have tightened our processes to prevent any future recurrence of this kind of activity.

We are pursuing collection of monies from the vendor and from our insurance company to cover our losses from these illegal activities.

In the meantime, we have booked a loss in the quarter to cover the full $930,000 incurred.

Appropriate law enforcement agencies are investigating this issue and it would inappropriate to comment further at this time.

Our cash use was impacted by the timing of the bulk of our systems shipments in September and follows a seasonal pattern similar to that we had experienced in prior years.

Operationally, we had an excellent American College of Surgeons meeting in San Francisco.

We introduced an additional fourth arm for the da Vinci surgical system.

The fourth arm provides enhanced surgical capability, improves operating efficiency, and as a significant step towards solo-surgery for many procedures.

Dr. Aston Call of the West Chester Medical Center performed a live broadcast of a gastric bypass procedure to the J&J Ethicon Endo-Surgical booth during the conference as part of our core marketing partnership.

The surgery went beautifully with a 20-minute sutured double-layered anastomosis.

We won a $4.4 million jury verdict versus Computer Motion in the Delaware Patent Infringement trial.

The judge's decision regarding Computer Motion's latch's defense is still pending.

We released 2 new energy-based surgical instruments, the Prim Electrocuatery and Bipolar Forceps.

These new tools continue to improve the clinical capability of our system.

We submitted our Mital Valve 510k with the FDA, summarizing the excellent results of our trial, and expect to obtain clearance for this cardiac indication in the fourth quarter.

We reorganized our European operations and named Esco Viscari as a Director of the European Sales & Marketing.

Esco brings to us 13 years of proven sales & marketing experience with Guidance and Ventrica and we look forward to the leadership that Esco brings to the European team.

Finally, we enjoyed a quarter of continued clinical progress and success.

Ultimately, the success of our business is a direct result of the surgical capability and clinical benefits that the da Vinci surgical system delivers to surgeons and to their patients.

Fred will give a detailed clinical review later in this call.

With that, I will pass the time over to Susan who will discuss our third quarter financial results.

Thank you Lonnie.

As Lonnie highlighted, we ended the quarter with strong operating results.

We realized $17.1 million of revenue, 57% above last year.

We sustained gross margin at 51% exceeding 50% for 2 quarters in a row.

We grew recurring revenue to $3.9 million up 135% over the previous year.

Operating expenses grew to $15.6 million up 42% from Q3 2001 and we recorded a net loss of $0.18 per share and used $6.9 million in cash.

Going into more detail, our third quarter 2002 revenue was $17.1 million up 57% from third quarter 2001 revenue of $10.9 million.

We shipped 14 da Vinci surgical systems during the quarter; 13 in the United States and 1 in Europe.

The 14 total units shipped were up 4 compared to 10 units shipped during the third quarter of 2001.

We now have cumulative placements of 132 systems - 88 in the US, 39 in Europe, and 5 in the rest of the world.

Total Q3 2002 revenue by product group was as follow: Systems $13.2 million, Instruments & Accessories $2.5 million, and Service $1.4 million.

Recurring revenue was up 135% compared to Q3 2001.

Recurring revenue grew to $3.9 million or 23% of total revenue compared to $1.7 million or 15% of revenue in the third quarter of 2001.

Our recurring revenue continues to climb each quarter as we place more systems, as our customers perform more robotic procedures.

Year-to-date sales totaled $58.9 million up $15.2 million or 43% compared to the first nine months of 2001.

Third quarter 2002 gross margins rose to 51% compared to the 47% in the same quarter last year.

The improvement in gross margin over the prior year is due to higher sales volume and higher da Vinci surgical systems selling prices.

Total operating expenses for the third quarter 2002 was $15.6 million, up $4.6 million or 42% compared to the third quarter of 2001.

SG&A expenses were $11.4 million in the third quarter of 2002, up approximately $4.2 million from $7.5 million in the third quarter of 2001.

SG&A for he quarter was higher than we had anticipated due to the impact of higher litigation expenses and the write-off of unauthorized purchases that Lonnie described earlier.

As previously announced, the Delaware jury did in fact award us $4.4 million in damages.

Because post-trial proceedings have not concluded we have not received or accrued any of these funds.

We will only record the judgment awarded when and if actual cash is received.

And in addition to the non-routine items, SG&A expenses grew over previous periods due to headcount growth in our field sales and support organizations.

R&D expense was $3.9 million in the third quarter 2002, up approximately $400,000 from the $3.5 million incurred in the third quarter of last year.

The increase versus prior year resulted primarily from headcount growth.

We ended the quarter with 278 regular employees, up 6 from the previous quarter end.

Total worldwide field employees accounted for 5 of the adds, increasing from 69 to 74 during the quarter.

Non-cash deferred compensation and patent amortization expenses represented $300,000 of total operating expenses in Q3 2002 compared to $500,000 in Q3 2001.

The balance of unamortized deferred compensation is now down to $300,000 and should be completely amortized early next year.

Our balance of unamortized patents is now $2.7 million, which we will amortize at a straight line rate of $200,000 per quarter until it is fully expensed.

Intuitive Surgical had $400,000 of other incomes for Q3 2002, compared to $1 million in the third quarter of 2001.

The decrease is due to lower cash balances and lower rates of return earned on cash investments.

Our net loss for the third quarter 2002 was $6.5 million or $0.18 per share compared to $4.8 million or $0.13 per share in the third quarter of 2001.

Basic and diluted shares outstanding for EPS calculations were 36 million shares for the third quarter 2002 compared to 36.1 million for the same period last year.

Moving to our balance sheet, we ended the quarter with $48.5 million in cash, down $6.9 million from the previous quarter end.

The reduction reflected the company's net loss of $6.3 million and increases in accounts receivable and inventory offset by non-cash expenses and higher current liabilities' balances.

Our current day sales outstanding was 100 days up from 71 at the end of Q2.

Ending fourth quarter net inventory was $9.9 million up about $2.6 million from previous quarter end, reflecting a buildup to support higher fourth quarter revenue plans.

Our outlook for the fourth quarter, we expect fourth quarter revenues to come in between $21 and 25 million on system unit shipments of between 18 and 22 systems.

We anticipate Q4 growth margins to increase slightly due to higher sales.

Taking into account the non-recurring items that impacted Q3, we expect operating expenses to be down slightly from Q3 levels.

We expect the average number of shares outstanding during the fourth quarter 2002 for EPS calculations to be approximately 36.6 million shares.

With that, I would like to turn it over to Fred who will provide a summary of our latest clinical progress.

Thanks Susan.

I am pleased to report that during the quarter we have made significant clinical progress in each of our primary surgical markets- urology, general surgery, and cardio thoracic surgery.

Regarding the urology market, the da Vinci prostatectomy procedure or DVP as we refer to it had another outstanding quarter with continued growth in a number of procedures being performed as well as the number of institutions performing the surgery.

As case numbers grow, there is mounting clinical evidence, which documents the clear benefits of DVP.

In the September edition of the Journal of Urology an article was published comparing the clinical results of the DVP versus laparoscopic prostatectomy.

While the benefits as compared to traditional open techniques are obvious, this study compared the first 40 cases, learning curve included, performed by Dr. Mani Menon at Henryford Hospital to the combined results of over 600 cases performed by the world's most experienced laparoscopic prostate surgeons Dr. Givelensian and Dr. Bertrand Genive.

Average operating times were 274 minutes with the da Vinci compared to 258 for a laparoscopic procedure.

However, note that Dr. Menon now further along in his learning curve routinely performs cases in a 120 minutes or 2 hours faster than the most experienced laparoscopists.

The patient benefits were also addressed in this study.

Average blood loss was only 256 cc with DVP compared to 391 cc with LRP.

Also, cancer removal was more complete with DVP, orbit of surgical margins were 17.5% as compared to 25% with LRP.

Finally, 80% da Vinci patients went home within 24 hours of surgery compared to 65% using laparoscopic technique.

Patient's discharge at 24 hours represents a 2.5- to 3-day reduction in hospital recovery compared to open surgical techniques.

In addition to providing an excellent procedure base for the da Vinci system, DVP has opened the door to many other urologic procedures that can improve with the use of robotics.

We are experiencing growth in a variety of urologic surgeries such as pyeloplasty and partial nephrectomy.

In an article published in the September edition of Urology, the Male Clinic Rochester reported the mean operative times at their institution had been reduced in the procedure of pyeloplasty by the use of da Vinci from 214 minutes to 139 minutes when compared to conventional laparoscopic technique.

Additionally, a team of plastic and urologic surgeons from the Cleveland Clinic performed the world's first DVP with bilateral sural nerve grafting.

This procedure involves harvesting a cutaneous nerve from the leg and using it to restore the continuity of the nerve bundle that was excised during the prostatectomy.

The expectation is that the use of nerve graft may improve potency after prostate removal.

Finally, in New York University Medical Center, surgeons have gained experience with the da Vinci in the procedure of partial nephrectomy.

A partial nephrectomy is performed when removing a renal tumor that is less than 4 cm in size.

This procedure is reconstructive in nature and can be used in lieu of kidney transplantation.

With increasing organ shortages, the capability to repair rather than replace diseased kidneys will be extremely valuable.

In the cardiac area, we have gained momentum in minimally invasive cavage surgery.

Several European institutions are routinely performing beating heart bypass procedures with da Vinci as the primary surgical tool.

Recently, Dr. Gearhart van Engraniger performed a live broadcast of a closed-chest endoscopic beating heart bypass procedure in less than 2 hours at a European meeting of Cardiac Surgeons.

Domestically, momentum is building in the cardiac arena in anticipation of upcoming cardiac clearances.

As Lonnie mentioned, we submitted a 510k to the FDA after the completion of our Mtral Valve study.

The results were excellent and the company expects to obtain clearance for this cardiac procedure before the end of this year.

Cases for our AST repair trail are progressing well and nearing completion.

We expect to receive FDA clearance for this indication early next year.

Cases are also ongoing for our cavage trial and we target cavage clearance by the end of 2003.

As these clearances approach, we see more cardiac centers initiating the formation of minimally invasive cardiac programs at their institutions.

That completes my summary and I will pass the time over to Aleks Cukic.

Thank you Fred.

As was previously mentioned, we shipped 14 da Vinci surgical systems during the third quarter.

We had another strong quarter in the US with 13 of the 14 units going to US customers.

The other system was sold in Europe.

We continue to see higher percentages of systems shipped to community hospitals versus academic institutions.

This quarter 12 of the 14 systems shipped went to community hospitals.

This is our highest quarterly concentration into this segment and helps confirm the value that da Vinci surgical system provides to mainstream hospitals.

During the quarter, we made 2 additional sales of second systems into existing accounts.

We sold a second system into Memorial Herman Hospital in Houston, Texas as well as a second system to Santonio Medical Center in Nashville, Tennessee.

That now makes a total of 9 sites with 2 da Vinci surgical systems.

The second system at Santonio Medical Center is significant in that HCA has established Santonio as a da Vinci training center for all HCA hospitals.

This investment demonstrates HCA's commitment to robotics and to Intuitive Surgical.

Intuitive Surgical recently took part in a number of key trade show events.

The European Association of Cardio thoracic Surgery held in Monaco, the Society of Laparo-Endoscopic Surgeons' Conference in New Orleans, and American College of Surgeons held in San Francisco.

The highlight of each of these meetings was a live surgery broadcast.

At EX, we presented a live telecast of a totally endoscopic beating heart bypass procedure using the da Vinci.

At SLS, it was a gastric banding procedure and at ACS, we broadcast a gastric bypass surgery procedure into the Ethicon Endo-Surgery tool.

As we had 10 more of these shows we are finding that participants placed more and more focus on surgical and clinical capability of the da Vinci to perform specific procedures.

Now that surgeons have gotten past the technology "wow" phase, they become very interested in observing other surgeons performing da Vinci procedures as well as understanding the steps required to build a multidisciplinary robotics program within their own facilities.

With a 132 da Vincis placed throughout the world, numerous preceptors and proctors are in place along with Intuitive Surgical's established clinical training pathways, we find ourselves uniquely positioned to meet all of the market's clinical needs.

As minimally invasive robotic surgery climbs the adoption curve, we find customers less focused on technical theories and more focused on evidence-based medicine.

We not only encourage this shift but also embrace it.

At this time, I will pass the time over to David Shaw who will discuss the legal developments of the quarter.

Thanks Alecks.

This past quarter we continued to invest in our joint Delaware litigation with IBM against Computer Motion on our patent covering voice-controlled surgical robots.

As was previously announced by Press Release], the jury faced with the Delaware trial came to a favorable conclusion in August.

After 6 days of evidence and a day of deliberations, the Delaware jury concluded that Computer Motion failed to invalidate any claim of our patent.

Since Computer Motion had already admitted its AESOP and ZEUS products infringe our patent, the jury awarded $4.4 million in damages.

Needless to say that we are pleased with how this is case is progressing.

The case is now on the post trial phase.

Both sides have agreed Computer Motion's equitable defensive prosecution latches and await the court's decision, which may not issue for several more months.

More arguement the issue will occur next week.

In the ongoing litigation against Computer Motion in California, there is really not much to add to what we have preciously said.

Our first four motions for summary judgment of non-infringement remain pending and briefing is now concluded on 2004.

Oral argument is concluded on two of them.

Oral argument on the other two will occur in November.

We continue to expect decisions on these four motions to start issuing sometime in the next several months and we also continue to anticipate filing further motions for summary judgment after the court has decided those already are on file.

Other than that, discovery continues.

Finally, we continue to add to our own portfolio of patents.

This past month, for example, we closed another exclusive license in computerized surgery through a third-party patent on a variety of articulating surgical instruments.

We believe that patent will be useful in the future to protect our inventive strides.

And that completes the legal summary.

Now I will pass the time back to Lonnie.

That concludes our presentation.

We will now open the floor to any questions you might have.

Thank you participants.

If you would like to ask a question, please signal by pressing *1 on your phone keypads.

If your question has been answered and you wish to withdraw, then you would press *2.

Once again, that is *1 to ask a question and *2 to cancel.

In some cases you may have to lift your hand receiver prior to pressing *1 if you are using a speaker equipment.

One moment while question register please.

And our first question comes from Ms. Sitar Mato with Bear Sterns.

Good afternoon.

I guess, although, from the sound of my voice I am a female.

Couple of questions.

First on this non-recurring items, the unauthorized purchase of these administrative supplies.

Can you give any further clarity as to what happened and I understand that you probably do not feel compelled to say a lot, but can you discuss may be when you expect to get a refund or when we could see that money back from the losses?

That is my first question.

This is Susan.

One thing that we want to make clear is that we are clear that the $936,000 is a complete amount, we have reconciled our accounts to make sure that and our auditors have reviewed our reconciliation processes.

The details on any further on who, what, when, and how we are really investigating using the law enforcement to investigate and get us the details on that.

Part of that is negotiation with the vendors as well as claims on our insurance.

We do not feel that those are coming anytime soon and that is just as far as we can go on where we see this coming.

Okay.

But we do have...we have clearly identified the person and exactly what happened.

But obviously with the kind of process of law moves slower than we would like.

But you do not expect any material change from this $930,000 number?

That is the complete amount.

It has all been booked.

And we have as we said tightened our procedures, so this kind of event cannot happen again.

Okay.

And that values all the material at 0.

Okay.

Second question is regarding litigation but also have you had any ongoing discussions with Computer Motion with regard to settling the Delaware suit or the California suit for this matter?

Have there been any conversations between you guys and Computer Motion that you can update us on?

We have nothing new to share with you at this time.

Okay.

And then may last question is regarding international - this year you placed 5 systems in Europe.

Is there something, I know it is a very price-sensitive barrier, but is there something else going on there it seems surprisingly low relative to what you guys did last year in Europe?

Well, while we are very pleased with the sales growth and the momentum in the US, we have not met our internal sales goals in Europe and we are not comfortable with the current visibility we have on the timing of several significant projects in Europe.

So, therefore we have become a little more conservative in our projections, but as I mentioned earlier we have brought on board Esco Viscari as head of our European sales and marketing effort and he will bring some significant leadership to unremarkable sales and marketing organization over there.

It is more price-sensitive but we also believe that we have not executed as well as we should have.

Okay, great.

Thank you very much.

Thank you.

Thank you.

My apologies Ms. Mato.

And our next question comes from Mr. Kevin Dede of Wells Fargo Securities.

Hi, Dede.

Good afternoon.

How are you doing?

Great.

Glad to see you are getting this call done before the Giants came tonight.

I got a couple of questions if I may.

Could you comment a bit more specifically on, given the strength in the US business, what you anticipate going forward as relates to academic placements versus community centers we have normally discussed this on the calls before and I know there are some comments as to why should that going forward clearly had a significant community hospital interest in recent quarters accounting for the majority of US placements.

What do you expect looking ahead in the next couple of quarters in that regard?

This is Alecks Cukic.

With respect to community versus academic-based facilities, I think an important note to keep in mind is there are only approximately 150 academic based medical schools with hospitals in the US and with 88 of our systems already placed within the US, we have a very good penetration.

Certainly in the top tier hospitals, the medical universities, as well as many of the mid-level medical schools.

We have a very high penetration there.

I think it is also important to note that there are approximately 1500 cardiac programs within the US and over 4000 hospitals within US.

So, the percentage of academic versus community is certainly going to weigh toward the community side which is by far the bigger of the 2 markets and the one that we think is the one we have to penetrate deeper.

Following up on your comment on the cardiac placement opportunities in various centers, obviously you got the key for expectation on mitral valve.

Looking ahead however, the broader cardiac approval will likely drive utilization significantly higher for the systems, so I realize there remains an uncertain timeline here on that, but can you describe the dynamics as well as it relates to the purchase of the system ahead of that broad approval and my impression has been that you have had some major cardiac figures driving to some degree system purchases already ahead of the cardiovascular approvals.

Can you just comment on that side of things please?

Sure, I will be glad to.

With respect to the growth of procedures that may fall under cardiac in many of our minds but are certainly thoracic procedures like IMA takedown which we have been able to perform for several years now under our thoracic approval.

Those are going to be steps that are going to be absolutely imperative to ultimate cavage procedures which we hope to receive approval in 2003.

So, many of the hospitals and many of the placements are already getting inline with that part of the procedure in addition to the mitral valve, which will be approved this quarter.

One thing to keep in mind aside from cardiac is we are approaching our sales with a multidisciplinary approach.

In other words, urologic, general, and cardiac.

Although cardiac is a key driver, our most successful hospitals are the one that are taking full advantage of our approvals and taking it across all surgical disciplines that are approved, therefore lowering the cost per department of the investment.

So, we see that continuing and only picking up in the future.

Okay.

And just one last question briefly.

Can you comment as relates to the visibility you continue to get by having a da Vinci in J&J's training facility?

What specifically are you getting out of that in terms of leads?

Is it possible to track looking ahead and any other benefits from your relationship from J&J and for that matter do you anticipate a broader relationship with J&J looking ahead?

First part of that question - if you look back to the original press release and the original comments that we have made on the relationship with J&J specifically at the Carnendo relationship.

It was really framed up on three legs.

The first leg was professional education and co-training, the second was with respect to co-marketing, and the third is co-product development.

So, if you take a look at where we are with respect to the professional training and education, I speak for Ethicon for this as well, are very satisfied with the number of people that have passed through the Ethicon Surgical Institute as well as the people that have passed out that have actually taken da Vinci for test drive and done clinical lab work with da Vinci as well as the co-marketing that Lonnie had mentioned earlier that we are doing and things like ACS with live procedures being broadcast into the boot and those things are going very well.

We are taking a look at a number of different co-development opportunities as we speak so as it sits now I would say that we are very happy with that relationship and look to prolong our relationship with them in the future.

Thanks very much.

Thank you.

Our next question comes from Mr. Neil Gagnan of Gagnan Securities.

Hi, Neil.

Hi, folks.

Can you give us some background on what is going on with usage per machine?

The usage is building.

I think we have not given specific numbers by system and we are still not willing to do that but we feel very good about the way it significant progressing.

We had a record quarter in terms of number of procedures and it continues to ramp on the number of procedures per system and we feel like we are making excellent progress there.

It continues to be one of our major areas of emphasis in terms of driving this as Alecks mentioned across multiple procedures and multiple disciplines.

Okay.

Let me ask a couple of financial type questions.

The SG&A you built in the third quarter and you had talked about that but it was built in the second quarter and as I remember that was legal also.

And there has not been that much headcount growth this year.

So I am guessing that your total SG&A is something like $2.5 to 3 million over what it should be leaving your current operations this quarter.

We do not disclose that.

Wait a minute.

Susan, lets back it up here.

Your headcount went up next to nothing in the quarter?

It went up 2 million.

Okay.

So, you cannot spend it otherwise.

That is fair.

That is fair.

And your SG&A also went up a million dollars in Q2 without much headcount growth.

I think there is a little bit of delay effect on the expenses versus the headcount growth.

A lot of times you can add people in prior quarter and then you get the full impact of the expenses in the following quarter.

What is important for us though, folks, is to have an idea of what your true operating costs are.

And I would like to add some may be in this way.

Other than the two sort of non-recurring items that happened in the third quarter, our expenses would've been inline in the SG&A area from where we had planned and also where I believe our analysts had it planned, which is probably closer to an order of $14 million in total operating expenses versus the $15.6 million that we reported.

The other thing that I want you to understand is that the legal and litigation expenses are not something that we see as a one-time quarter head for, but these are built into the practice of our business and are defense of our intellectual property and that is why we do not want to leave you too far straight on one-time quarterly hits.

On the other hand, they are higher than we would certainly expect on an ongoing run rate because of the litigation and that is absolutely true.

Neil, one of the things that we are doing here is investment right now, we are fully invested and fully staffed pretty much at our offices here in Sunnyvale and our factory and in our Engineering and R&D and all sort of things.

So, that is going to stay pretty flat.

What we are going to is we will continue to build.

Our investment will be in the field both in field sales, clinical support and service because that is where the growth is going to be and of course the goal here is to hold the fixed costs constant except for those costs in the field and build sales and crossover into profitability and clearly this misallocation of funds, do not know how to describe it, I would probably describe it more strong.

Your revenues were not too bad, so that is not a big deal.

Yeah, anyway.

That was disappointing, very disappointing.

Lets talk about gross margins.

As you ramp up form here and look at your product mix and revenue mix and as you add another dollar of revenue, what should be the gross margin effect or what is the incremental margin?

A dollar of revenue?

Yep.

It is almost 60%, 50 some percent, high 50s.

That is fine.

Thank you.

Thank you once again participant.

If you would like to ask a question, please signal by pressing *1 on you phone keypads.

And our next question comes from Mr. Mark Smiley of Cydler & Co.

Can you guys hear me okay?

Yes.

The question I had was what kind of incremental revenue can expect from introducing a fourth arm back to the existing placed units?

I am not sure we are ready to forecast that at this point in time.

We have introduced that.

We have not launched it yet.

We will launch it early next year and it is still in clinicals right now.

So, we are not ready to incorporate that into our business projections.

Okay, thanks.

Thank you.

And once again participants, if you would like to ask a question please signal by pressing *1 on your phone keypads.

And our next question comes from Mr. John Massey of Bear Sterns.

Hi, John.

Before I ask a question, obviously we have strip out the unauthorized purchase of supplies and we come to 14.7 in operating expenses.

Should we expect from that number fourth quarter to be down?

I think what we said John was that again we are continuing to invest the fields that you have to take the number down from the total number of the 15.6.

Okay.

Can you tell us though what we should expect from litigation costs going forward in the fourth quarter?

We believe that exposing litigation cost is still proprietary and that while they will be there, they will not be as heavy as the third quarter with the trial.

Okay.

That is what I wanted.

Thanks.

We will take one more question and then close.

Thank you.

Our next question comes from Raymond Myers of Boston Partners.

Yes thank you.

If I could may be just two quick ones.

One is how is pricing holding up?

And the other one is your guidance for the full year with 18-22 systems in the fourth quarter is the guidance for the full year coming down a little bit from what you gave in the second quarter?

Pricing has come up every year since we introduced the da Vinci in the US market and we continue to see that pattern going forward.

And as I mentioned earlier, while we are very comfortable with the sales growth momentum in the US, because Europe has not met its sales goals and we do not feel real comfortable with the current visibility on the timing of some of several European projects, we have become a little more conservative in our projections for the fourth quarter.

Ray, in response to your question on the full year, our previous guidance had been 40-50% revenue growth over the prior year and that is still inline with what our guidance is now.

Okay, good luck.

That concludes our presentation and the Q&A.

What I would like to do is summarize the highlights for the third quarter the third quarter once more.

We shipped 14 da Vinci surgical systems, we achieved $17.1 million in revenue, up 57% from prior year, we grew recurring revenue to a record $3.9 million, up 135% from prior year, and we ended the quarter with $45.8 million in cash.

We won a $4.4 million jury verdict versus Computer Motion, but as David said the latches' decision is still pending.

We released two new energy-based products and we submitted our mitral valve repair 510k to the FDA and expect clearance in the fourth quarter.

That concludes today's call and we thank you all for your participation.