直覺手術 (ISRG) 2005 Q1 法說會逐字稿

I would like to welcome everyone to today's Intuitive Surgical first quarter 2005 earnings release conference call. Following today's presentation there will be a formal question-and-answer session. [OPERATOR INSTRUCTIONS] At the request of the Company this conference is being recorded. Any objections, you may disconnect at any time.

I'd like to introduce our host for today's conference call, Mr. Ben Gong, Vice President of Finance and Treasurer. Sir, you may begin when ready.

Hello and welcome to Intuitive Surgical's first quarter conference call. With me today we have Lonnie Smith, our President and CEO; Susan Barnes, 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 you comments mentioned on today's call may be deemed to contain forward-looking statements. Actual results may differ materially from those expressed or implied as a result of certain risks and uncertainties. These risks and uncertainties are described in detail in the Company's Securities and Exchange Commission filings. Prospective investors are cautioned not to place undue reliance on such forward-looking statements.

Please note that this conference call will be available for audio replay on our website at www.intuitivesurgical.com on the audio archive section under our Investor Relations page. In addition, today's press release has been posted to our website.

Today's format will consist of providing you with you 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. Susan will follow with a review of our first quarter's financial results, then I will review our financial forecast for the remainder of 2005. Next, Aleks will discuss sales and marketing highlights, and finally we will host a question-and-answer session.

And with that I would like to introduce Lonnie Smith, our President and CEO.

Thank you for joining us today. As you can see from our press release, we've started the year with a strong first quarter. Highlights for the first quarter are as follows: Total revenue grew to 41.6 million, up 54% from the prior year. Recurring revenue grew to 20.3 million, up 62% from the prior year, comprising 49% of total revenue.

We shipped 19 da Vinci Surgical Systems and 19 Fourth Arms. 18 of those systems were in the United States. We ended the first quarter with 305 cumulative da Vinci systems shipped. We estimate that 298 of those systems are currently installed worldwide. Approximately 280 are in operating rooms, with the remaining 18 installed in training or research labs. The seven-system difference between the number of systems installed and the cumulative number of systems shipped consists of: five systems repurchased from our former distributor in Japan and two systems that were destroyed, one in a fire and the other in a flood.

Our gross profit margin improved to 65.5%, up from 58.5% in the first quarter of 2004. We generated an operating profit of 8.9 million compared to 300,000 last year. Our net income for the quarter was 9.1 million or $0.25 per share compared to 900,000 or $0.02 per share last year.

EBITDA for the quarter grew to 10.6 million from 2.1 million in the first quarter of 2004. We ended the quarter with 149.5 million in cash and cash equivalents, up 17.4 million from last quarter. We continue to grow our top line, improve our margins, and effectively control our fixed cost growth.

In operations we had many successes and a couple of disappointments. I'll start with the disappointments.

First, we had no system shipments to Europe or Asia in the quarter. We believe this is a timing issue and not systemic. But we are watching it closely. Second, we had a voluntary recall of our new curved scissors. We caught the problem early and there were no patient incidents or issues. We have modified the design and are well into the performance and reliability testing process. We plan to relaunch the product in May and we will mark this up as an important learning experience from which we will hopefully benefit in the future. The net expense impact to our P&L for the quarter was less than $100,000.

On the positive side, procedure growth continued to be very strong and da Vinci prostatectomy continued to be a major growth driver. We have seen significant new interest in da Vinci prostatectomy in Europe and the rest of the world. We launched our new Harmonic curved shears. We continue to improve both quality and productivity in our manufacturing operations.

We began a 20,000 square foot expansion within our Sunnyvale facility. We are fully Sarbanes-Oxley compliant, and our business model is performing to our expectations. While funding over 50% revenue growth this past quarter and all of last year, we simultaneously generated very significant positive cash flow from operations.

With that I will pass the time over to Susan Barnes, our Chief Financial Officer.

As Lonnie has mentioned, we enjoyed strong first quarter results. Total first quarter revenue increased to $41.6 million, up 54% from 27.1 million for the first quarter of 2004. Higher first quarter sales were driven by higher da Vinci Surgical Systems and Fourth Arm unit sales as well as continued recurring revenue growth.

First quarter 2005 sales increased in all product categories. Compared to last year, system revenue increased to $21.3 million from 14.6, driven by both the increase in the number of systems sold and the high ratio of Fourth Arms to da Vinci system sales.

Instruments and Accessories increased to 12.9 million from 7.9 million and service and training increased to $7.4 million from 4.6 million. We shipped 19 da Vinci Surgical Systems during the quarter, up 5 compared to 14 shipped during the first quarter last year. First quarter demand for Fourth Arms was again strong, as we shipped 19 da Vinci Fourth Arms during the quarter compared to 11 during the first quarter last year. We shipped five Aesop systems during the quarter compared to seven during first quarter last year.

We continue to drive recurring revenue growth, surpassing $20 million of recurring revenue for the quarter. Recurring revenue, comprised of Instrument, Accessory, Service and Training revenue, grew to 20.3 million, up 62% from the 12.5 million during the first quarter of 2004. Recurring revenue comprised 49% of total first quarter 2005 sales, up from 46% during the first quarter of 2004.

Our first quarter 2005 gross margin percentage increased to 65.5% compared to 58.5 for the first quarter of 2004. Our higher first quarter 2005 gross margin was driven partly by leveraging manufacturing and service overhead costs across higher first quarter 2005 revenue and partly by stronger ASPs. da Vinci average selling prices were higher due mainly to channel mix. Only one of our first -- our 19 first quarter 2005 system sales was a distributor sale, compared to three of 14 during the first quarter last year.

Q1 last year's ASP was also impacted negatively by a discounted system sold through the Zeus [ph] trade-in program. Total operating expenses for the first quarter 2005 increased 18% to $18.3 million compared to 15.6 million during the first quarter 2004. First quarter 2005 operating expenses were 44% of sales compared to 57% last year.

SG&A expenses for the first quarter 2005 were $14.2 million, compared to 10.2 million for first quarter last year. The increase was driven by headcount growth in the sales organization to support higher sales and higher variable compensation associated with achieving higher revenues and profitability.

Research and development expenses for the first quarter 2005 were $4.1 million compared to 15.3 million for the first quarter last year. The decrease was driven by the elimination of Computer Motion R&D operating costs and a restructuring charge of $700,000 incurred during the first quarter of 2004. Operating income for the first quarter 2005 was $8.9 million, compared to $300,000 for the first quarter of 2004. This growth reflects significant operating leverage realized during the last 12 months.

Compared to the first quarter of 2004, our sales increased by 54%, we improved our gross margin percentage by 7% and grew operating expenses by just 18%. Because of this operating leverage, the $14.6 million increase in sales Q1 2005 over Q1 2004 resulted in an $8.6 million increase in first quarter 2005 operating income, a 59% fall-through.

Other income of $700,000 was comprised of $1 million of interest income netted against $300,000 of foreign exchange losses resulting from euro-based transactions. First quarter 2005 Other income increased by $100,000 compared to the first quarter 2004, primarily due to higher interest earned on $300,000 offset by higher foreign exchange losses of $200,000.

Our first quarter 2005 income tax expense was $500,000, or 5.5% of pretax income compared to a 4% provision taken during the first quarter of 2004. Ben will provide more detail regarding our tax status later in the call.

Our first quarter 2005 net income was $9.1 million, or $0.25 per diluted share, compared to $900,000 or $0.02 per diluted share in the first quarter of 2004.

Now in regards to our balance sheet. We again strengthened our balance sheet metrics during the quarter. We were $17.4 million cash flow positive during the quarter, ending the period with $149.5 million in cash and investments. In addition to our $9.1 million in net income, we had $1.7 million of noncash operating expenses and generated 1.6 million from working capital decreases.

We invested $1 million in property and equipment and we received $7 million of proceeds from stock option and warrant exercises and our employee stock purchase plan. Our accounts receivable balance decreased to $31.4 million from 35.4 million ending 2004. The decrease was primarily due to the lower first quarter 2005 sales compared to the first -- fourth quarter of 2004.

We improved our average day sales outstanding to 70 days compared to 71 ending the prior quarter. Our net inventory increased to $7.6 million from 6 million ending the previous quarter. This increase was anticipated as last quarter's ending balance was depleted due to high 2004 year-end sales. Inventory turns stand at 7.6 compared to 10.3 ending last year.

Finally, we ended the first quarter with $17.3 million of total deferred revenue compared to 15.9 million ending the previous quarter. This buildup is an indication of the growth in our service contract business and continued expansion of our installed base.

And with that, I'd like to turn it over to Ben who will provide an update of our business forecast for 2005.

Thank you, Susan. We are encouraged by our strong first quarter financial results and we expect to see continued growth for the balance of the year. Regarding revenue, on our last call we indicated that we expected 2005 annual sales to grow between 20 and 30% over 2004. Based upon our first quarter revenue results, we are now targeting our 2005 revenues toward the higher end this range.

In the first quarter, we experienced strong Procedure growth, which likewise resulted in strong Instrument and Accessory sales. In our last earnings call we had forecasted this revenue segment to grow between 40 and 50% above our 2004 total. We have since increased our estimate for Instrument and Accessory revenue to grow between 50 and 55% above 2004.

As we have mentioned before, our Service revenues are highly predictable because they are primarily driven by annual contracts. However, there are two factors that have increased our run rate. We have had a higher mix of Fourth Arm systems, which generate higher service contracts, and we have been generating additional non-contract service billings. As a result, we are now forecasting the Service and Training revenue segment to grow between 40 and 45% over 2004, up from the 35 to 40% range indicated on our previous call.

Our System revenues, which include da Vinci systems, Fourth Arms, and Aesop systems, may fluctuate quarterly, as it is more difficult for us to predict how many units we will ship each quarter. Nevertheless, we are pleased with the number of units we shipped during the first quarter and we continue to expect our System revenues for the year to grow 10 to 15% above our annual total for 2004.

With regard to gross profit margin, we have indicated in the past that we expect 2005 margins to average approximately 65% for the year. Our first quarter gross profit margin came in slightly higher, at 65.5%. While this can fluctuate, based on our revenue mix, we continue to target gross margin at about the same level of 65% for the balance of the year.

Moving to operating expense, on our last call we forecasted 2005 operating expenses to grow between 15 and 25% above 2004 levels. Due to our higher revenue forecast, we believe total operating expense growth will be at the higher end this range, namely, between 20 and 25%. We continue to target total operating expenses to be approximately 45% of sales for the year.

Based upon our revised 2005 sales and operating margin forecast, we expect our 2005 net operating income to grow in excess of 60% compared to 2004. This is an increase from our previous estimate of 50% or more indicated on our previous call.

As you may be aware, last week the SEC postponed the implementation date for Statement of Financial Accounting Standards 123R, which requires companies to recognize stock option expense on their income statements. As a result, we do not anticipate adding stock option expense to our income statement until the first quarter of 2006.

With regard to income tax, previously we had estimated that we would record a tax rate of approximately 3% this year, until we converted to reporting fully taxed earnings toward the end of the year. As you may have noted we recorded a 5.5% tax rate in Q1 due to our requirement to record taxes in additional states where we do not have NOL benefits. We are still predicting that toward the end of this year we will recognize a large portion of our deferred tax asset as a negative tax in our income statement. When that occurs, the tax rate for that particular quarter will likely be a large negative number or a benefit to the P&L, and in quarters thereafter we anticipate reporting a tax rate between 35 and 40%.

There is one additional tax event that we are currently working on that will likely impact our reported tax rate for at least the next two quarters. In order for to us take full advantage of the NOLs that we acquired from Computer Motion, we will need to record additional tax expense starting in the second quarter. By doing so, we will be able to shelter these amounts from actual cash tax payments in the future. This will likely increase our reported tax rate to between 10 and 25% for the next two quarters.

Regarding shares outstanding, we currently have approximately 34.7 million shares outstanding and 4.7 million shares that could be added to the diluted share formula, depending on our average stock price. To provide you with a range on what the diluted share count for EPS calculations may be in Q2, a 25% change in our current stock price would result in a diluted share count as low as 37 million shares or as high as 38 million shares.

And with that, I would like to turn it over to Aleks, who will provide a summary of our latest sales and marking highlights.

Thank you Ben. As mentioned earlier, during the first quarter we shipped 19 da Vinci systems: 18 in the United States and one to Canada. This brings to 298 the cumulative number of da Vinci systems worldwide: 222 in North America, 55 in Europe, and 21 to rest-of-world markets.

All of our sales are important. However, there were several in Q1 that were notable. The system sale to the Mayo Clinic in Jacksonville, Florida, represents the first da Vinci placement into the Jacksonville market as well as the third placement into the Mayo Clinic system, with the others being Mayo-Rochester and Mayo-Scottsdale.

We also sold a da Vinci to both the University of North Carolina in Chapel Hill and the University of Kansas. We sold our first da Vinci into the state of Alaska, to Alaska Regional Medical Center in Anchorage, and we had a second system sale to Sutter Medical Center in Sacramento, California. This brings to 25 the number of hospitals with two or more da Vinci systems.

Our Fourth Arm sales continue to be strong. During the quarter we shipped 19 Fourth Arms: 16 as initial four-arm da Vinci systems and three as upgrades to existing da Vinci customers. This brings to 121 the overall number of Fourth Arm systems within our installed base.

Clinically, we had another robust quarter. We experienced excellent growth within our Clinical specialties of focus, with urology, specifically dVP, leading the way. We also participated in a number of trade shows and medical conferences within urology, cardiac, and gynecologic surgery.

This quarter we had several dVP papers published within the urology journals. We also launched a new instrument, the Harmonic Curved Shears, a product we developed in collaboration with Ethicon Endo-Surgery.

In addition we filed our 5-10K submission with the FDA for gynecology clearance.

We continue to drive clinical adoption of dVP, again showing excellent quarter-over-quarter growth. As we've said before, one of the key drivers for dVP momentum is greater surgeon and patient awareness of dVP clinical outcomes.

In the February issue of Urology Times, two articles, one focusing on positive margin rates, and the other on preservation of sexual function following prostatectomy, featured the results of three groups performing dVP. Regarding positive margin rates: the groups from the University of California-Irvine, Beth Israel Medical Center in New York, and Henry Ford Medical Center in Detroit all reported improved positive margin rates with dVP over traditional open prostatectomy. The Henry Ford team reported that their positive margins rates went from 21% for open surgery to 9% for their last 530 dVP patients.

With respect to improved sexual function Dr. Sanjiv Kaul, call from Henry Ford Hospital, reported at one-year follow-up, that 80% of their patients who underwent their "Veil of Aphrodite" technique, incorporating da Vinci, reported erection quality similar to that of their pre-operative experience. This is notable when compared to the reported 13% for their patients who underwent a standard open nerve-sparing procedure. As data like this makes its way into the public domain, patients will undoubtedly seek out those centers that can deliver these favorable results.

During the quarter we participated in two urology events: The New Frontiers in Endourology course, held at the University of California-Irvine, and the first annual European Robotic Urology Symposium, or ERUS, which took place in Geneva, Switzerland. The New Frontiers program, chaired by Dr. Ralph Clayman, was sold to capacity several months in advance. The program provided the 52 surgeon participants an opportunity to not only hear and see dVP presentations and technique video, but also to experience a live dVP operation as well as to participate in a hands-on animate da Vinci lab.

Dr. Tom Ahlering, Chief of Urologic Oncology at UCI, performed a state-of-the-art dVP operation incorporating several of the latest techniques designed to enhance cancer control. The operation was flawless and received high praise from the viewing audience.

On the last day of the three-day program the surgeons took part in a da Vinci demonstration as well as animate lab. This was a very productive program for Intuitive, both from a lead generation standpoint as well as providing advanced training to existing da Vinci owners.

At the ERUS meeting in Geneva, attended by 85 surgeons representing 16 countries, the content was exclusively da Vinci-based procedures. There were multiple presentations on technique, indications, and outcomes related to dVP and other urologic procedures, including cystectomy and pyeloplasty. Participants also had the opportunity to observe four live dVP operations and one pyeloplasty.

The ERUS organizers as well as the participants considered this inaugural meeting to be a success and we would expect to see it expand in the coming years.

Historically the European community has lagged behind the U.S. in widespread adoption of new medical technology and procedures. Programs such as ERUS will help to drive awareness for dVP throughout the European urologic community.

As an aside, from May 21st to the 26th the AUA will hold their 100th annual meeting in San Antonio, Texas. Professional attendance is expected to exceed 11,000. In addition to the 36 different abstracts, videos, and podium presentations on da Vinci procedures, the AUA will also be conducting four da Vinci-related courses, two AUA instructional courses, and two postgraduate courses. We will provide you with an AUA overview during our Q2 earnings call.

Within cardiac surgery, we continue to make progress with our target procedures, most notably, da Vinci mitral valve repair.

Earlier this month, we participated in the American Association of Thoracic Surgery, or AATS, conference, which was held in San Francisco. There were approximately 3,000 surgeons at this year's meeting. Our booth was very busy over the three-day meeting, with several presentations on da Vinci mitral valve repair, da Vinci revascularization, and da Vinci cardiac oblation.

We also cosponsored a surgeon dinner symposium, with J&J's Cardiovations division, in which Dr. Doug Murphy, Chief of Cardiovascular Surgery at St. Joseph's Hospital in Atlanta, gave a presentation on da Vinci mitral valve repair and da Vinci ASD repair to over 50 surgeon participants.

Dr. Murphy reported on a new technique for da Vinci mitral valve repair that is gaining popularity within the da Vinci cardiac surgery community. With this new technique, surgeons are entering the right chest from a more lateral angle than before, which provides them a more native angle in which to operate on the mitral valve, resulting in less atrial retraction and manipulation, as well as an improved view inside the heart. Dr. Murphy went on to say that he is able to repair even the most diseased valves, using this new technique. His repair-versus-replacement mix with da Vinci is 96% repair and 4% replacement, which is a significant improvement over his 50/50 mix through an open sternotomy approach. As a result, the number of new patients within his referral network continues to grow.

When asked about the economics associated with the da Vinci system, Dr. Murphy described how his hospital administration, which was initially skeptical with the ROI for their da Vinci purchase, has seen tremendous economic value in their robotics program, both from a per procedure cost savings, as well as from an incremental patient standpoint. And as a result they have gone on to purchase a second da Vinci system.

During the quarter we bolstered our da Vinci mitral valve training efforts to include a new surgeon-led training program for da Vinci mitral valve repair. We conducted our first da Vinci mitral valve repair masters' course, here at our training labs in Sunnyvale, California. The masters' course is a 2-day program and is led by Dr. Lee Siwek, an experienced da Vinci mitral valve repair surgeon from Sacred Heart Medical Center in Spokane, Washington. This program is scheduled to run monthly and is designed to meet the increasing demand for da Vinci mitral valve training while at the same time being geographically desirable for our customers in the western United States.

Our customers can now choose among four locations that focus on da Vinci mitral valve training: East Carolina University; St. Joe's in Atlanta; Good Samaritan in Cincinnati; or the masters' program here in Sunnyvale.

This quarter for the first time we attended the annual meeting of the SGO, or Society of Gynecologic Oncology, in Miami. Although we don't have 510K clearance for gynecology, there are some centers that are performing gynecologic procedures. At the SGO, Dr. Javier Magrina, Chairman of ObGyn and Chief of Gyn Oncology at the Mayo clinic in Scottsdale, gave a lecture entitled, "Robotics in Gynecology," in which he reported that the da Vinci system provided benefit to him in applications such as hysterectomy, pelvic, and para-aortic lymph node dissection, miomectomy, and sacral colpopexy. Dr. Magrina and his team at the Mayo-Scottsdale are among the most experienced da Vinci users in the field of gynecologic oncology.

Lastly, we launched a new energy-based da Vinci instrument this past quarter, the Harmonic Curved Shears. This is a product we co- developed with Ethicon Endo-Surgery. It is being sold by Intuitive and is powered by Ethicon's Standard Harmonic Scalpel Generator, which is sold by Ethicon EndoSurgery. The product will be focused toward general surgery and gynecologic surgery.

That concludes my summary and I'll now pass the time back to Lonnie.

That concludes our presentation. We'd be happy to take your questions at this time.

Thank you. [OPERATOR INSTRUCTIONS] Our first question comes from Rick Wise with Bear Stearns.

Good morning -- or, good afternoon, everybody. Couple questions. First, can you elaborate a little more on the no shipments to Europe or other international markets, and that that's a timing issue. Timing, in the sense that you had the orders, they could have been in the quarter, and maybe if you could quantify that? Or should we expect a sort of a bolus of international shipments in the second quarter? How do we think about all that?

If I could tell you that precisely, I probably wouldn't be doing what I'm doing today.

Clearly, there were many projects we were working on. And in these countries where there's tenders and there's a lot of -- the process is often cumbersome and slow, none of them popped. And so, you know, do we anticipate -- we think that's a kind of a systemic issue? We do not. We think it's a timing issue and that most of those will come to fruition. But the exact timing of any one of them I would not care to predict. So I -- I think we will do well. I'm not terribly concerned about it. But I am, as an organization, want to make sure that we drive hard and that this doesn't -- isn't the persistent thing.

So again, I assume when you're doing your budgets though, you still assume that there will be, I don't know, one or two or three in a given quarter, so, if those are -- I appreciate exactly what you're saying about the unpredictability, but --

I know you'd like to have the answer and if I had it I would be delighted to give it to you. I will tell you that we don't -- I don't anticipate a huge bolus but these things do come lumpy. And we may have -- last quarter we had a great quarter --

Right.

-- with systems, from both Europe and the rest of the world, and we will have some great quarters in the future and probably some lean ones, and as Ben said in his, this is a little more difficult for us to predict. We still anticipate good growth in Systems this year.

And one other thing to add on that, Rick, is that we continue to see growth in procedures performed internationally, quarter over quarter, so we think this should lead to some more system placements going forward.

Can you break down at all the US/OUS Systems -- rather, Procedure growth?

We typically don't break it out but we definitely saw growth in all geographies and in all of the Procedure segments.

Okay. Two other questions. One, Ben, you often give -- or Aleks -- often give the penetration of procedures for the market for the prostate -- prostatectomy, if you could give us that. And second, back to you Lonnie, you talked about the Curved Scissor recall or issue, rather. And you mentioned there have been lessons learned and you said it very strongly. What are those lessons and what are the implications going forward? Thanks.

Rick, as far as the percentage of prostatectomy penetration, it is not a number that we have guided toward this year, and it's a difficult number for us to guide to because there's movement between segments within prostate cancer, be it radiation treatment, seeds, prostatectomy, et cetera. So it not a number that -- at this point that we have given any guidance on for 2005.

Rick on the Curved Scissors, I'm not going to -- I'm not going to get into details but the -- there were some subtle material characteristics and we've learned some things from it. I'm not willing -- necessarily anxious to share them because I think that now is part of our cumulative knowledge base, and in the long term, it helps build our competitive advantage.

Is it fully resolved, Lonnie?

What?

Is it fully resolved at this point?

Oh, yes. We've fully resolved it. As I said, the products are well into the reliability and performance testing. The results have been excellent, and we plan to relaunch in May.

We have -- we actually literally had to have them pulled away from certain surgeons, but we've retrieved them all, we just felt it was the best, most appropriate thing to do. We will always act on the conservative side when it comes to anything like this and that's what we've done. But it's been a good learning experience with the new material for us.

Thank you.

It's been a learning -- I won't say it's a good learning expense. It's been a learning experience.

Thank you.

And your next question comes from Tom Gunderson of Piper Jaffray.

Hi. Good afternoon. Just a couple of numbers I think you usually give. Can you -- any change in the ASPs on the Systems or the Fourth Arms? The disposables, per case?

Yes. Tom this is Ben. Actually, the ASPs were slightly higher this quarter because of the mix that we only had one system that was -- that went to distributors out of the total 19.

Can you put a number on that, Ben?

Yes. The ASP was about 920,000 and about 175,000 for the Fourth Arms.

Very consistent.

And was there any change in the average disposables per case?

No, it still continues to be where we've seen it in the past.

Okay. And then, help me out with the math here. You're guiding to the higher end of revenue of 20 to 30% now, because of a good first quarter, but first quarter was supposed to be maybe a little lighter, based on fourth quarter strength and it came in very nicely. Even if we just flat-lined here, you're almost to 30% for the rest of the year and at the same time you're increasing Procedure growth, Instrument and Accessories, you're increasing Service, what are we giving up here that we still stay within the 20 to 30%?

I think if we just flat-lined we would not get to the upper end of the range. You definitely need to have --

A little. But --

-- growth. Well, actually, I think you do need to have sequential growth as well as significant year-over-year growth. So I think the models that I had seen out there, probably some of you guys already had us at the upper end of that range.

Right.

In the 20 to 30. And, you know, how we came in with the first quarter, might have been a little bit higher than what you had in the first quarter, but again, the toughest part for us to predict is the timing of the system revenues.

Okay.

And Tom -- it's Susan -- you're right in one sense, that we could have flat first quarter to second quarter systems, and grow in the other areas and do nicely, but we do see, again, an annual increase where the fourth is our strongest quarter.

Great. I'm just looking at -- maybe my bad math aside, -- everything is going up, and yet the overall stays within the range. And so I'm just wondering, is there some negative that I'm missing here? Or is this just a little bit of first quarter conservatism?

Well, actually, if I just do the ranges of the three components, the 10 to 15% on Systems, the 50 to 55% on Instruments and Accessories, and the 40 to 45% on Service and Training, I certainly come in in that high end of the range of 20 to 30.

Tom, this is Lonnie. There's nothing you're missing. We have no negatives that we're worried about, but we would rather be conservative than over-optimistic and disappoint the market.

Worked so far, hasn't it, Lonnie?

Yes, it has.

The -- and then, so, I'll ask you, Lonnie. The cash is growing. The R&D seems to me to be moderate. What's next? Where do you invest to keep things going into the long term?

Well, we will continue to obviously invest in improving both the Instruments, the Accessories and the System features. And beyond that, you'll know when we announce whatever we're doing.

But, -- we're going to stick to our knitting here. We think that there's enormous growth opportunity here. We do have a model that generates significant cash, but that gives us lots of flexibility. And we will preserve that flexibility until we find an opportunity that really warrants using it. I don't -- I don't mind having -- having run a start-up, where you're living on other people's money, it's very nice to be generating our own. And so -- we'll continue to invest in the business. That's in the field organization, our organization, facilities, equipment, and R&D.

Okay. Thanks.

Thank you.

Thank you. Next question comes from Teo Levy of Deutsche Bank.

Good afternoon, everyone. Just a couple quick questions here. You know, the utilization trend was very strong. Very nice to see that in the quarter. Was there anything different in the types of procedures that were being done? Is there a certain type of procedure that maybe wasn't done as frequently a quarter or two ago that's really gaining some traction now? Or is it still really driven by prostatectomy?

I would say that the business is being led by da Vinci prostatectomy, without question, but we had nice up-ticks in things like mitral valve repair and the procedures that we've talked about. All in all, the fastest growing procedure is dVP, urology being the fastest growing segment, and everything else growing nicely.

Okay. And can you comment on the impact that some of the new products have had in the quarter and what you expect the impact to be going forward, especially -- obviously, on the disposable side of things?

I think, as Lonnie mentioned, we had the voluntary pull back of the Curved Shears, which were recently launched. And we were pleased with the -- some of the clinical features and benefits of that product but we won't know specifically until that's relaunched. The Harmonic Scalpel is something that -- or the Harmonic -- Curved Harmonic Shears is something that we just recently launched, and are pleased with very early results, but those data points are few at this point.

But Teo, to your point, something we talked about last quarter, we launched a Maryland bipolar and a micro-bipolar instrument and the demand for both of those instruments is very robust.

Okay. And Susan, the higher gross margin this quarter: is that because of the higher ASPs and that's why we should expect that to go back down to the 65% range, going forward?

Well, the part that we talked about where it's tough for to us call the mix of the systems between the direct sale and the distributor ones, that could make the --

Yes, Teo, you're right. It is that a higher ASP, shifting that half percent out there.

Okay, great. And just on the European sales. Obviously, a little disappointed not to see any placements there. There was nothing going on with the sales force, maybe new hires that needed to get trained or some other experienced guys maybe moving to other opportunities?

No. In fact, as I mentioned before, in the total global number we're continuing to invest in the field and we just have field growth out there.

And just -- if I can -- just one last question. On the tax rate, last quarter you'd mentioned that we should expect normalized taxes, in the 35 to 40, by the end of this year. Now is it more 2006? Is that early 2006? End of 2006?

One of the things is, it's hard for to us call the exact quarter. And we're giving the best information that we have. So we definitely think that toward the end of the year we would have that one-time event of the pull-in of the deferred tax assets. And then in quarters following that, we would go toward that 35 to 40% range.

Okay. Perfect. Thanks a lot.

[OPERATOR INSTRUCTIONS] The next question comes from Mike Davidoff with Sidoti & Company.

Hi, guys. Good afternoon.

Good afternoon.

Just -- I was wondering if you've seen anything new in terms of competition, just in terms of anyone else trying to come out with robotic surgery instruments or devices or if you are seeing any new minimally invasive procedures that would compete with your types of procedures?

Well, in terms of robotic competition, most of what we see is occurring in labs, university labs, not anything near a commercial product, and of course if it gets to commercial stage, they'll have -- we've got -- we continue to build a very strong intellectual property barrier that -- we are willing and ready to defend.

In terms of other minimally invasive procedures, obviously there's lots of things going on, from -- but we don't see anything that immediately concerns us. Only time will tell with these new -- anything that's new, as to how effective it is and what the longer term consequences are. So, you know, we remain alert and observant but -- I don't have any significant concern about something that's really going to shift a major procedure that we're aiming at.

Okay. And can you just give us the size of your direct sales force at this point, both U.S. and OUS?

We can give you some rough numbers on that, Mike. Just a second. We have about 120 people total in the field. Roughly speaking. And the vast majority of those are domestic. In Europe we have probably about 15 to 20 and in the rest of the world locations we use distributors.

So we don't count those.

And so those are not employees.

Okay. Great. Thanks a lot, guys.

I think we have time for one last question.

Thank you. Our final question comes from Tom Gunderson of Piper Jaffray.

Sorry to make the last one such a tiny one but I was just curious on how you run the business and partner. Do you record 100% of the revenues on the Harmonic Scissors and do you pay any royalty?

Tom, we do record 100% of what we are selling and in terms of our agreement with Ethicon, I don't think we're at liberty to give you the details on that.

Okay.

Okay.

Thanks.

That was our last question for today. And before I summarize our performance for the quarter, I'd like to take a moment to share some personal thoughts on a topic that I have very strong opinions.

Our success to date is a result of the dedication and hard work of an extraordinary team of highly talented, motivated, and principled individuals. Every employee is a shareholder of our Company. Our incentive programs, both cash and stock options, are directly tied to our three-year, one-year, and quarterly performance goals, based upon the vital few things we believe are essential to our future success and subsequent growth in shareholder value. We believe that stock options are a fundamental element of our compensation program for all employees and are essential to attracting and retaining the talent necessary to continue to build a truly exceptional company. We also believe that stock options directly align the interest of every member of our team with the interests of our shareholders.

Therefore, we have no plans to modify our stock option grants or to change our stock option practices. We will continue to target our annual stock option grants in the range of 3% of our total shares outstanding each year. We believe that the ownership of our Company is most precious. We value it highly and manage it carefully.

This coming year companies in the United States will be required by the Financial Accounting Standards Board, FASB, to begin expensing stock options. This new FASB requirement is well-intended. However, it presents some very significant challenges for investors, as well as management.

Before stock options can be expensed, they must be valued. The value assigned to the options will be highly dependent upon assumptions selected by management to be used in the theoretical formulas they success -- they choose to estimate future value. These assumptions will require management to predict future stock performance and volatility. Since most mere mortals have been unsuccessful at doing this in the past it's hard to understand or believe that they will be successful at doing so in the future. If the estimated value of the grant options -- of the granted options is wrong, as it almost certainly will be, then expensed elements of that value, which must be allocated to various line items in the income statement, will also be wrong.

The end result will be a theoretically interesting, or maybe theoretically interesting, but it will make the income statement inaccurate and misleading as a tool to measure actual financial performance. This will create a significant challenge for investors. SFAS 123R requires management to select one of two different valuation methodologies and allows significant latitude in determining the assumptions appropriate for valuing their company's stock options. This combination of different methodologies and valuation assumptions will make relative performance comparisons between companies nearly impossible.

Without additional information, this introduction of a large and highly judgmental noncash cost element into each line item of the income statement will require investors to focus on cash flow and balance sheet statements as they attempt to understand true financial performance. Consistent with our commitment to full financial disclosure, we intend to break out, within our GAAP income statement, estimated stock option expenses by line items. We also will provide the information required to reconcile our GAAP income statement with one that excludes these noncash stock option expenses.

Of course we will continue to reflect the ownership impact of in-the-money stock options in our diluted earnings per share calculations. We believe that this additional information, in combination with the balance sheet and cash flow statements, will provide the information necessary for investors to better assess true financial performance and economic value.

Finally, I assure you that this management team will continue to focus on those financial and operating metrics that reflect true financial performance and drive share holder value, such as system placements, procedure growth, market share by surgical procedure, top line and bottom line growth, and certainly, cash flow.

With that said, we had a great quarter. Total revenue grew to 41.6 million, up 54% from the prior year. Recurring revenue grew to 20.3 million, up 62% from prior year, comprising 49% of total revenue.

We shipped 19 da Vinci Surgical Systems and 19 Fourth Arms. Our gross margin improved to 65.5%. Our net income for the quarter was 9.1 million or $0.25 per share. EBITDA for the quarter grew to 10.6 million or 25% of revenue. We ended the quarter with just under 150 million in cash.

And as I have previously stated, we believe adoption of our technology will be driven surgical procedure by surgical procedure, starting with those procedures where it currently provides compelling surgical capability and patient value. We continue to work with our surgeons to identify and drive those procedures while expanding the surgical capability of our products so their use is compelling for the patient, the surgeon, and the hospital in an ever-increasing number of surgical procedures.

We are dedicated -- and I do mean dedicated -- to taking surgery beyond the limits of the human hand. We remain committed to managing within realistic financial constraints, focusing on the vital few things that will truly make a difference, and driving future investment priorities based upon clinical need and economic return.

Our Company priorities are, first, superior products, customer service, and patient outcomes. Second, consistent revenue and operating income growth. And third, a results-driven company culture in which we measure ourselves by our accomplishments.

That concludes today's call. We thank you for your participation and we'll talk with you again in three months. Thank so you much.

Thank you. That concludes today's conference call. At this time all sites may disconnect.