直覺手術 (ISRG) 2007 Q3 法說會逐字稿

Good afternoon, and thank you for standing by.

(OPERATOR INSTRUCTIONS)

Today's conference is being recorded.

If you have any objections, you may disconnect at this time.

I would like to introduce your conference host for today's call, Ms.

Cindy Marple.

Ma'am, you may begin.

Good afternoon, and welcome to Intuitive Surgical's third quarter conference call.

With me today we have Lonnie Smith, our Chairman and CEO; Marshall Mohr, our Chief Financial Officer; Ben Gong, our Vice President of Finance; Aleks Cukic, our Vice President of Business Development and Strategic Planning; Gary Guthart, our President and Chief Operating Officer; and Jerry McNamara, our Executive Vice President of Worldwide Sales and Marketing.

Before we begin, I would like to inform you that comments mentioned on today's call may be deemed to contain forward-looking statements.

Actual results may differ materially from those expressed or implied as a result of certain risks and uncertainties.

These risks and uncertainties are described in detail in the Company's Securities and Exchange Commission filing.

Prospective investors are cautioned not to place undue reliance on such forward-looking statements.

Please note that this conference call will be available for audio replay on our website at IntuitiveSurgical.com on the audio archive section under our Investor Relations page.

In addition, today's press release has been posted to our website.

Today's format will consist of providing you with highlights of our third quarter as described in our press release which came out earlier today, followed by a question-and-answer session.

First, Lonnie will present the quarter's business highlights.

Marshall will follow with a review of our third quarter's financial results.

Next, Aleks will discuss sales and marketing highlights.

Then Ben will provided our updated financial forecast for 2007.

And finally we will host a question-and-answer session.

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

Thank you for joining us today.

As you can see from our press release, we continue to drive the adoption curve for robotically assisted surgery and continue to deliver significant top line and bottom line growth.

Operating highlights for the third quarter are as follows.

Total revenue grew to $157 million, up 64% from last year.

Instrument and accessory revenue increased to $49.5 million, up 70%.

Total reoccurring revenue, including service, grew to $71 million, up 64% from the prior year, comprising 45% of total revenue.

We sold 63 da Vinci Surgical Systems, up from 46 during the third quarter of last year.

A lot of the systems were second, third and fifth systems to existing customers.

Our international team had an excellent quarter, contributing 17 of the 63 systems sold.

We ended the third quarter with 719 systems installed worldwide.

We generated an operating profit of $63 million, 40% of revenue, before noncash 123R stock option expense, up 92% from the third quarter of last year.

GAAP net income before unusual operating income items grew to $37 million, 24% of revenue, up 116% from last year.

We ended the quarter with $533 million in cash investments, up $86 million from last quarter.

During the past nine months we have generated $203 million in cash, which, excluding $42 million in cash received from exercise of stock options, amounts to 169% of our reported GAAP net income.

This is a reflection of the significant noncash stock option and statutory tax expenses reflected in our GAAP net income and is the reason that we continue to believe that operating income before noncash 123R stock option expense remains the best measure of our true financial performance.

The da Vinci S continued to dominate our systems mix, accounting for 95% of the systems sold in the quarter.

High definition vision systems accounted for 68% of the systems.

We launched the Hem-o-lok Clip Applier, the G400-compatible Endo PK Dissecting Forceps and a new smoke-evacuating 8mm Cannula.

We grew our Intuitive team by 38 members this past quarter, to 697.

We continue to see solid procedure growth.

Year-over-year prior growth remains strong, while quarter-over-quarter sequential growth was impacted by summer vacations, particularly in Europe.

Procedure growth and adoption continues to be procedure-specific, patient-driven and the primary growth driver of our business.

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

Thank you, Lonnie.

Total third quarter revenue increased to $156.9 million, up 64% from $98.5 million for the third quarter of 2006, down 12% from $140.2 million for the second quarter of 2007.

Our revenue growth is driven by procedure adoption, which was consistent with our previous guidance.

Da Vinci hysterectomy and prostatectomy continue to be the primary drivers of our business.

Third quarter revenues by product category were as follows.

Instrument and accessory revenue increased to $49.5 million, up 70% compared with $29 million last year and 8% compared with $45.8 million last quarter.

The growth rate in instruments and accessories is comparable to and a direct result of our procedure growth rates.

The third quarter revenue growth rate of 8% reflects the expected impact of seasonality, particularly overseas.

The amount of instrument and accessory revenue we earn per procedure remained relatively unchanged, at between $1,500 and $2,000 per procedure for established da Vinci accounts.

Including the impact of initial orders completed with new system purchases, instrument and accessory revenue continued to be between $2,000 to $2,500 per procedure.

Systems revenue increased to $85.5 million, up 63% compared with $52.4 million last year and 18% compared with $74.1 million last quarter.

The increase in systems revenue reflects increased unit sales as well as an increase in the average revenue per system.

Third quarter da Vinci Surgical System revenue reflects the sale of 63 systems, compared with 46 systems during the last -- during the third quarter of last year and 56 systems sold in the second quarter.

Forty-three of the systems sold during the quarter were our latest S model, incorporating high definition vision capability; 13 were the four-arm S models, incorporating standard vision capabilities; (inaudible) were three-arm S models and three were standard systems.

Our third quarter average revenue per system, including all da Vinci models but excluding upgrades, was $1.33 million, which is $25,000 more than the average revenue per system in the second quarter of 2007.

The higher average revenue per system primarily reflects a favorable geographic mix, including direct sales to European customers, which are denominated in euros, which strengthened relative to the dollar this quarter.

Upgrades, including fourth arms and HD, accounted for $1.6 million of the current quarter systems revenue, compared with $1.1 million last quarter.

Service and training revenue increased to $21.9 million, up 52% compared with $14.4 million last year and up 7% compared with $20.3 million last quarter.

The growth in service and training revenue is primarily driven by a larger install -- system install base, as well as higher annual contract prices associated with da Vinci S and HD models.

Total third quarter recurring revenue, comprised of instrument, accessory, service and training revenue, increased to $71.3 million, up 64% compared with the third quarter of 2006 and up 8% compared with the second quarter of 2007.

Recurring revenue represented 45% of the total third quarter revenue, compared with 47% in the second quarter, reflecting the significant increase in systems sales.

Revenue outside the United States represented 22% of total third quarter revenue, compared to 19% in the second quarter.

The growth in international revenue reflects 17 systems sales compared with 12 in the second quarter and lower instrument and accessory revenue growth, reflecting seasonality associated with summer vacations.

Our third quarter 2007 gross margin of 69.1% increased compared with 67.1% realized in the second quarter.

The increase in gross margin reflects higher system selling prices and favorable manufacturing absorption.

Total operating expenses for the third quarter of 2007 were $54.1 million, compared with $49.1 million in the second quarter of 2007.

The sequential operating expense increase of $5.4 million reflects increased spending in R&D, increased head count and increases in other costs associated with growth in our top line, partially offset by a reduction in noncash 123R stock compensation expenses.

We added 38 employees during the quarter, ending the period with 697 regular employees.

The majority of the additions were to our worldwide sales and support and manufacturing organizations.

Third quarter 2007 operating income was $54 million, or 34.4% of sales, compared with $45 million, or 32.1% of sales, for the second quarter of 2007.

Our third quarter 2007 other income of $12.2 million increased compared with $5.2 million in the second quarter of 2007.

Our third quarter 2007 other income included a $4.1 million gain on the sale of Hansen Medical (inaudible) shares and $1.8 million of foreign exchange gain associated with the increase in the euro relative to the U.S.

dollar.

Excluding these gains, the increase of $1.1 million is primarily the result of interest earned on greater cash and investment balances.

Our effective cash rate for the third quarter was 38.2%, which is slightly lower than the 39% we recorded in the second quarter.

The third quarter tax rate reflected certain one-time benefits, and we expect our ongoing tax rate to be around 39%.

We continue to utilize net loss carryforward and employee stock-related tax benefits in 2007.

The amount of employee stock-related tax benefits increased in the third quarter such that we now expect our cash outlay as a percentage of pretax will be less than 10% for 2007.

Our international tax structuring activities are proceeding on schedule but will not generate a reduction in our global tax rate until after 2008.

Our net income increased to $40.9 million, or $1.04 per share, up 137% compared with $17.3 million, or $0.45 per share, for the third quarter of 2006 and up 33% compared with $30.7 million, or $0.79 per share, for the second quarter of 2007.

Excluding the gain on the sale of Hansen shares and the foreign exchange gains, net income for the third quarter was $37.2 million, or $0.95 per share.

Let me quickly summarize our results for the first nine months of 2007.

Total revenue for the first nine months of 2007 was $411.4 million, up 58% compared with $260.1 million last year.

Operating income for the first nine months of 2007 was $133.4 million, up 85% compared with $71.9 million last year.

Operating income included $26.2 million of stock-based compensation charges in the first nine months of 2007, compared with $18.5 million in 2006.

Net income for the first nine months of 2007 was $95.4 million, or $2.46 per share, up 97% compared with $48.4 million, or $1.27 per share, last year.

Excluding a gain on the sale of Hansen shares and the foreign exchange gain, net income for the first nine months was $91.5 million, or $2.36 per share.

Now turning our attention to the balance sheet.

We ended the third quarter of 2007 with cash, cash equivalents and investments of $533 million, up $86 million from the previous quarter end and $203 million from December 31, 2006.

$21 million of the cash generated in the quarter and $42 million of the cash generated in the nine-month period was associated with stock purchase activities.

The remaining cash generated is primarily related to operating activities.

Our cash receivable balance increased to $120.5 million at September 30, from $105.6 million at (inaudible) 2007.

The increase in the cash receivable is attributed to increased sales.

Our net inventory increased to $26.8 million at September 30, 2007, from $24 million at June 30, 2007.

Our inventory turns at September 30, 2007 of seven times per year were slightly lower than the 7.4 turns at the end of the previous quarter.

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

Thank you, Marshall.

During the third quarter we shipped 63 da Vinci systems -- 46 systems in the United States, 11 into Europe and six into rest-of-world markets.

Sixty of the 63 system shipments were da Vinci S Systems, four of which were three-arm S systems, while the remaining three were standard da Vinci Systems.

Of the 60 S Systems sold, 43 were high definition, or HD systems.

We had no trade-ins during the quarter.

The 63 systems sold brings to 719 the cumulative number of da Vinci Systems worldwide -- 545 in the U.S., 119 in Europe and 55 in rest-of-world markets.

Five of the 63 systems sold during the quarter represented repeat system sales to existing customers.

Repeat system sales included the Cleveland Clinic, Northwestern University Hospital, the Leahy Clinic and Hackensack Medical Center.

The sale to Hackensack represented their fifth da Vinci System.

Internationally we had an excellent quarter, which included five additional da Vinci Systems into Belgium, three into Korea and our first system into Russia.

Clinically, we had another good quarter.

Through a seasonally slow quarter for elective surgeries, we experienced solid sequential procedure growth.

Our gynecologic procedure business, paced by da Vinci hysterectomy, registered the largest sequential percentage growth for the quarter, followed by urology.

Ben will provided you with updated procedure guidance during his review.

We had 57 da Vinci-related clinical papers published within various peer review journals.

We also launched three new products -- the Hem-o-Lok Clip Applier, which was developed in collaboration with Teleflex Medical; the G400-compatible Endo PK Dissecting Forceps, which was developed in collaboration with Gyrus ACMI; and the 8mm Cannula with a smoke evacuation outlet.

Although none of these products is expected to significantly boost our top line, each will offer our surgeon customers added utility, leading to a more optimized surgical procedure.

We're building this procedure business one procedure at a time, and therefore optimizing each of our target procedures through the development of new products and product enhancements remains an important priority.

Of the peer review literature I mentioned, there is one particular study I'll bring to your attention.

In the October 8 edition of the Archives in Internal Medicine, a study entitled "Short and Long-Term Mortality of Localized Prostate Cancer" set out to compare survival rates for prostate cancer patients undergoing primary radiation therapy, radical prostatectomy, as well as other treatment options.

The consortium of authors represented surgical departments, radiooncology divisions and cancer registries from Geneva University, in Geneva, Switzerland; the National University of Singapore; and the University of Turin, in Turin, Italy.

The population cohort included 844 men that had been diagnosed with localized prostate cancer.

One hundred (inaudible) of these men underwent a prostatectomy, 205 were treated with radiotherapy, 378 selected a watchful waiting regimen, 72 received hormone therapy and 31 were treated with other therapies.

The results -- at five years the survival rates were fairly consistent between cohorts except for the hormone therapy cohort, which was statistically inferior to the other treatments.

However, at 10 years, the survival results changed materially.

The prostatectomy cohort showed an 83% survival rate; radiotherapy, 75%; watchful waiting, 72%.

But when you looked a little closer at the data, specifically within the largest segment -- men under 70 years of age -- the survival rate gap between prostatectomy and radiotherapy widened to 92% compared with 78%, respectfully.

Said another way, the study reported that for a man under the age of 70 with localized prostate cancer, the risk of dying from the disease within 10 years following prostatectomy was 8%, as compared with 22% following radiotherapy.

The authors' conclusion, and I quote, "Our study results suggest that surgery offers the best change of long-term prostate cancer-specific survival, in particular, for younger patients with poorly differentiated tumor," close quote.

Many of our customers have reported shifts in their hospital's treatment mix away from primary radiotherapy toward dVP.

With the increased awareness for earlier PSA testing leading to earlier stage disease detection in younger patients, we would expect this mix shift to continue.

We participated in multiple conferences within urology, gynecology, general surgery and cardiothoracic surgery during the quarter.

However, I'll limit my review to only two.

This year was the first time we attended the American Urogynecology Society Conference, or the AUGS, which took place in Florida and was attended by approximately 900 urogynecologists.

Urogynecologists are the specialists which, among other things, focus on the condition of vaginal vault and uterine prolapse, which lead to pelvic floor and vaginal vault reconstructive procedures.

The Society put da Vinci front and center at the conference.

The postgraduate course entitled "The Surgical Management of Pelvic Organ Prolapse" focused on da Vinci's role within these prolapse procedures and was one of the most popular courses offered.

The satellite symposium entitled "Robotic Applications to Surgically Repair Vaginal Vault and Uterine Prolapse" was in fact the most popular symposium at this year's conference.

It was so well attended that the organizers had to move it to a larger venue to accommodate the standing room only crowd.

Dr.

Tony Visco, from Duke University, presented his experience, rationale and surgical technique for da Vinci sacrocolpopexy, followed by Dr.

Arlene [Song], from the University of Michigan, who covered da Vinci hysterectomy for those patients that required removal of the uterus prior to sacrocolpopexy.

The rationale for da Vinci's use within these complex operations is very consistent with our patient value equation, which translates into efficacy over invasiveness, which in this case means eliminating a large open incision to create what is considered a durable gold standard repair procedure.

Overlapping the AUGS conference was the Mayo Clinic's Advanced Techniques in Endoscopic and Robotic Gynecologic Surgery Symposium, which took place in Maui.

Perhaps the most notable at this year's program was da Vinci's role within all subspecialty categories of gynecology, which include GYN oncology, laparoscopic GYN, urogynecology and reproductive surgery.

Presentations were made by Mayo Clinic staff surgeons and guest faculty on da Vinci hysterectomy for endometrial and cervical cancer, da Vinci hysterectomy for benign disease, da Vinci sacrocolpopexy, myomectomy and for excision of invasive endometriosis.

As we are experiencing in urology, establishing a strong clinical story around a common but complex procedure provides us with the opportunity to expand da Vinci's utility within an entire specialty.

And in the case of the GYN specialty, that procedure is da Vinci hysterectomy, and it's brought a new awareness to minimizing the invasiveness of other complex GYN procedures.

In the fourth quarter, we will be participating in several key GYN conferences, including the European Society of GYN Oncology Conference, which takes place in Berlin; the AAGL Conference in Washington, D.C.; and the first annual International Robotic GYN Oncology Symposium, which is set to take place at the University of North Carolina in Chapel Hill.

That concludes my overview, and I will now pass the time over to Ben.

Thank you, Aleks.

As in previous earnings calls, I will be providing our updated forecast on a GAAP reporting basis, including stock compensation expenses.

I will also provide an estimate for the stock compensation expenses separately, so you can calculate meaningful comparisons that exclude these noncash expenses.

As previously mentioned, we had better-than-anticipated growth in revenue and profits in the third quarter and we expect this momentum to continue through the remainder of the year.

Therefore we are increasing our previous guidance for revenue and profits for 2007.

Starting with procedure growth, we continue to expect dVP and dVH adoption to drive the growth in our recurring revenues.

Our procedures performed in Q3 were in line with our expectations for these areas, and we continue to expect dVP growth for the year to be at least 65%.

We also continue to expect dVH growth for the year to exceed 175%.

Instrument and accessory revenues are expected to grow between 70 and 75% over 2006.

This is consistent with our forecast from our last earnings call, and it reflects our overall procedure growth from last year.

Our system sales were strong in the third quarter across both domestic and international markets, and we expect to have continued growth in system unit placements in the fourth quarter.

We are now forecasting system revenue to grow between 48 and 52% over 2006, which is up from our previous forecast of 30 to 35%.

The majority of this growth is resulting from an increase in unit shipments, while part of this growth is also driven by higher average selling prices for systems compared with the prior year.

Our system ASP was approximately $1.33 million for the third quarter and $1.3 million even year to date.

For the fourth quarter we expect our system ASP to be approximately $1.3 million.

We expect service revenues to grow approximately 52% above 2006 levels, up from our previous forecast of 50% growth.

This increase is driven by our higher system placement this year.

Overall, we now expect our total 2007 revenues to grow approximately 55 to 58% over 2006, compared to 45 to 50% previously forecast.

With regard to gross profit margin, we had an uptick in the third quarter, driven primarily by higher average selling prices from favorable geography mix and by manufacturing productivity improvements.

We expect to maintain the benefit from productivity improvement through Q4.

However, we would be cautious about predicting the same favorable geographic mix we had in Q3.

Therefore, we are forecasting gross margins to be approximately 68% for both the fourth quarter and the year.

Moving to operating expense, we are also expecting to spend more in both R&D and SG&A expenses than we previously forecast.

First, higher revenues are driving higher sales commissions, which are reflected in SG&A expense.

We expect our SG&A expense to grow between 41 and 45% for the year, which is up about 1 percentage point from our previous forecast.

In the R&D expense category, we mentioned in our last earnings call we have stepped up our investment in internal projects as well as co-development projects with third party corporate partners.

We are continuing to increase our activities in these areas.

In total, we expect our R&D expense for 2007 to be 55 to 60% higher than our R&D expense for 2006, which is up from our previous forecast of 48 to 52%.

We expect our total operating expense for 2007 to be 45 to 47% higher than our total operating expense in 2006.

These forecasts for gross margin and operating expense include the impact of FAS 123R stock compensation expense.

Our third quarter operating income included $8.7 million of noncash stock compensation expenses, allocated as follows -- $1.4 million in cost of sales, $5.2 million in SG&A and $2.1 million in R&D.

For the year, we expect the impact of FAS 123R to be between $35 million and $36 million, with a percentage allocation to P&L lines consistent with Q3.

Other income expense for the third quarter included $6 million of income which we do not expect to repeat in the fourth quarter, specifically gains on sale of equity investments and foreign exchange gains.

Interest income for the fourth quarter is expected to be between $6.5 million and $7 million.

For the year, we expect total other income and expense to be between $28 million and $29 million.

With regard to income tax, we expect to report a GAAP tax rate of 39% for the fourth quarter, which will result in an annual GAAP tax rate of between 38.5 and 39%.

However, we expect our effective cash tax expense to be less than 10% for 2007.

Regarding shares outstanding, we currently have 38.2 million common shares outstanding, and we also have approximately 3.3 million option shares outstanding.

Depending upon our average stock price during the fourth quarter, a portion of the 3.3 million option shares will be added to the fully diluted shares calculation.

Calculating EPS in Q4, we expect the share count to be approximately 39.5 million shares.

That concludes our prepared remarks.

We will now open the call to your questions.

Thank you.

(OPERATOR INSTRUCTIONS)

Mr.

Tao Levy, you may ask your question.

Good afternoon, everyone.

Hi, Tao.

Hey.

So I guess my first question, on the strength in the international market, you know, it seems like Belgium, you know, the folks over there got real excited about robotic surgery.

Maybe you could talk about how that development happened.

Was it -- was it the government that ended up purchasing the five systems, or was it a group of hospitals?

Tao, this is Jerry.

We've been growing our procedures in Belgium over time, and we've had installations in Belgium since early 2000.

And at the beginning of Q3 we had 10 sites up and running, and we've been extremely well staffed.

And this really set the table to be able to sell five additional new systems during the quarter.

So, no, to answer your last question, it had nothing to do with the government.

Is this something that you think internationally we'll continue to see?

You know, not necessarily in Belgium but across other areas.

Well, business is generally strong internationally.

That being said, procedures were seasonally softer in the third quarter, as we experienced long vacation times for both patients and physicians.

Overall we expect to see a lot of continued growth in the U.S., and for the rest of the year we are not expecting or forecasting a higher percentage of business in international sales than what we've seen earlier this year.

Right.

And on the -- if I look at the four -- I guess the full-year guidance, I guess effectively the fourth quarter, then the right way to think about the system placements in terms of total numbers is just somewhat slightly higher than the third quarter, is that the -- if I do the math quickly?

We're expecting some sequential unit growth in the fourth quarter over the third quarter, and that's incorporated in that new system revenue guidance of 48 to 52%.

Perfect.

And then just lastly, any -- you know, could you maybe go through the -- what's the capital spending environment like inside the hospitals these days, you know, just given some of the credit concerns?

Obviously, given the third quarter, it didn't seem like there was any impact.

But as you go ahead and start to talk to, at the hospital, those administrators, any changes there that we should be looking at?

Tao, this is Jerry.

No negative changes.

Actually, we see our pipeline for greenfield and repeat system sales to be stronger than ever.

Great.

Thanks a lot.

Mimi Pham, of HSBC, you may ask your question.

Hi, good afternoon.

Hi.

For international geographies, do you plan on expanding into any new geographies next year that you aren't already in now, selling in now?

Mimi, this is Ben.

We mentioned that we just sold our first system into Russia.

Yes.

And, you know, one thing that we see is you first place something into a new geography and it takes a little bit of time for that geography to develop, so we're seeing that with places like Korea and -- so we expect that now that we've got our first one into Russia, maybe there'll be some activities there, not right away but maybe a couple years down the road.

And in these international markets, are they being driven mainly by da Vinci prostatectomy and hysterectomy like in the U.S.?

Primarily urology is strongest outside the United States.

Many of those territories lag the U.S.

by about two years, and so right now one of our biggest growth drivers in Europe is dVP, and likewise in Asia, some of the activities we're seeing there are primarily urology at this point.

But within, for example, Korea, which was also a strong market for us, specifically this quarter, you see multiple specialty focused robotics programs that include general surgery, that include cardiac surgery.

So I would say it's fair to say prostate is a big driver, but it's not limited to prostatectomy.

Thanks.

And on the margin side, can you break out the product margins for the disposables in the systems and what would you consider the ceiling (inaudible)?

Well, we did uptick the gross margin guidance by about a point, and you saw that we got two points better this quarter than last quarter.

So the big drivers for that were some manufacturing improvements as well as some ASP improvements.

But some of that was from foreign exchange gains.

It's not materially different than what we had before, so you have product gross margins somewhere on the order of 70%, and that's roughly the amount for systems and for instruments and accessories and the like.

And you still have the gross margins for service lower than that due to the way we account for the training expenses.

But in terms of a ceiling, is there --

Well, you know, let me comment on that.

Yes.

We've got strong margins.

We'll continue to drive efficiency.

But I'm not sure we're going to try to drive that into margins and maybe more deliver it back to our customer.

And so, you know, I wouldn't plan on us expanding margins dramatically.

That's -- even though we may drive costs down pretty dramatically, or we will continue to do it, I think we're not -- you know, it comes to a point where we want to balance this in fairness to our customers as well.

And so we'll share some of the benefits with them.

Mr.

Tim Nelson of Piper Jaffray, you may ask your question.

Hi.

You talked a little bit about seasonal slowdown in procedure growth rates.

Was that any different between OUS and U.S.

geographies.

Is it -- do we expect that sort of thing in outside the United States to be pretty pronounced?

Well, it's really more pronounced in overseas markets.

And it was similar to our experience in the last few years, Tim.

Could you comment on what the differential utilization rates are between your install base outside of the United States and in the U.S.?

Just repeating some of the stuff we said in the past, the overall utilization rate internationally is a little bit lower than in the United States.

But there are certainly pockets, let's say, in Scandinavia, or let's say in Belgium, where you have utilization rates that are actually pretty similar.

But since they're typically newer users out there internationally, you don't have the same sort of overall productivity in those sites as a whole.

Okay.

You also mentioned strong pipeline on systems.

Can you, again, give us some feel for maybe a geographic split for that?

Is it -- is the strength of the pipeline full here in the United States and outside the United States equally, or is there some differential?

I think it's pretty consistent globally.

Okay.

And then you did (inaudible) on your expected growth for dVP and dVH for the year, but could you comment on what it was in the quarter?

So I guess that what's indicative is we have the same forecast for the year as we did last quarter, so our growth in the quarter was in line with what we were expecting, and therefore for the year it's about the same.

And the repeat, the overall procedure growth, like the instrument and accessory growth for the year, is expected to be 70 to 75%.

And the biggest drivers continue to be dVP, at least 65%, and dVH, at at least 175%.

Oh, okay.

And are we really starting to get some traction on dVH outside of the oncologic segment?

Are you seeing an acceleration there?

You know, I don't know, Tim, that I would use terms like "acceleration." We're getting, I think, very strong representation both within the oncologic as well as the complex benign cohort.

And I will tell you that we're picking up some momentum in things like sacrocolpopexy and myomectomy.

So I would say as sort of a global statement that the category of GYN is coming along quite nicely, similar to how we have talked about it in the past.

It seems to be unfolding that way.

Great.

Just a comment on dVH and what's driving the underlying growth -- and I think this is more than just dVH -- but is patient behavior in terms of seeking what I'd say are higher value-added treatments.

I recently spoke with a senior executive of a large public company, and I was surprised that he was familiar with our company.

And I asked him about it, and he said, well, his wife was diagnosed with endometriosis and required a hysterectomy.

And she then went to her GYN of 17 years, who had delivered two of their children, and told him that she was interested in having it done robotically.

She had been on the Internet.

And his response was, first, "I've never heard of a hysterectomy performed by a robot." His second response was, "Wouldn't it be nice if a robot could do everything that I do?" And last he said, "I think it's ridiculous." And what do you think she did?

She went to find somebody who could do it --

Another gynecologist -- that's right -- who did (inaudible) her procedure robotically.

And, you know, I think that this is -- this is -- I tell that story only because I think it's fundamentally -- it is what is underlying the growth of our company.

It's that more and more patients are proactive in seeking treatments that provide superior outcomes to them in terms of effectiveness and impact on their daily lives, and it's certainly true in GYN, with hysterectomies, sacrocolpopexies, myomectomies, as Aleks has mentioned.

That's very interesting, because you generally think of women as having much greater loyalty to their OB/GYN than men do to their urologists, so I'm glad to hear that.

Okay, thank you.

Eli Kammerman, of Cowen, you may ask your question.

Thanks very much.

My first question is, about two years ago, in the third quarter of '05, you had margins that were pretty similar to the margins you just reported, and I'm wondering if the reasons were similar then or if something else happened two years ago to make the gross margin and the operating margin tick up so much for that period.

So, you know, two years ago we did not have FAS 123R, and when we started reporting stock compensation expenses -- remember, it hits the gross margin line as well as the operating expense line.

And when you saw a downtick -- I'm thinking this is what you're asking -- when you saw a decrease in the gross margin line, part of it was that stock compensation expense.

And then now that we've gotten some of these productivity gains that we've talked about, now we're back at the level that perhaps we were at before FAS 123R

Okay.

The other question I have is are you actively encouraging or promoting new uses in surgical oncology specifically for rectal cancer?

And can you just describe what's going on in that particular surgery?

It does seem to bear some physical resemblance to a lot of the other types of lower pelvic surgeries.

Yes, that's a good observation, and obviously you're dealing in a narrow male pelvic region, which is very similar to prostatectomy.

And the vascularity associated with that region is pretty high, and the area, or the work area, is very tight.

So it does set up pretty well for the things that we have seen da Vinci do well at.

We just came off of the ACS meeting literally last week.

And there seems to be a -- I don't want to say renewed interest, because there's always been interest, but more interest than in the past on continuing to move minimally invasive surgery through colon and rectal surgery.

There have been a lot of attempts at it.

There have been -- there's hand assist approaches and whatnot.

But it is something that we are looking at.

I think we have a fair amount of interest out there.

As far as promoting, I don't -- I wouldn't use that term, because we're exploring, I think is probably a better term.

But there's a lot of interest that's out there right now.

All right.

Thanks very much for those answers.

Our next question comes from Vincent Ricci, from Wachovia.

Your line is open.

Hi, guys.

Can you talk to us a little bit about the venture you guys did with Cardica, with the (inaudible).

I think you guys performed a surgery with them.

And just how did that affect what you're looking at in cardiothoracic?

Yes, I think you're -- there is no venture with Cardica.

I think you're probably referring to a couple of press releases around one of our customers that incorporated one of their products with a da Vinci operation.

And so there's really not a lot to comment on there.

I mean, we work with a lot of companies, and we've worked with a lot of companies in that particular space over the years, Cardica being one of them.

But there certainly isn't any venture there.

And how it affects what we're doing, it's speculative certainly at best at this point.

So we'll let the customers decide where and how they're going to use our system and where and how they're going to use their system and if there's a natural intersection point, that'll be great.

(Inaudible) I mean, they've got some interesting technology and they're working on it, and we support everyone who (inaudible) help us to drive cardiac to a more minimally invasive procedure.

Okay, great.

And in urology, are you still seeing erosion of some of these other competing paradigms, and more specifically with radiation therapy, is it a brachiatherapy versus a directed beam radiation?

Are both of them being impacted?

Or is it more of watchful waiting?

You know, it's really hard for us to tell you what -- it's such a dynamic situation, and all we really have to go on are what our customers are telling us.

We've had situations where large brachiatherapy-based programs have moved a lot of those patients to da Vinci prostatectomy.

We have examples of primary radiation treatments, again, that were fairly large in numbers that have reduced.

But at the same time there is always -- I shouldn't say always, but there's a combination of both of them in many operations, where there's some cancer that's remaining and they'll use external beam and cleanup procedures.

There's just a lot of movement that's going on.

So I think it would be difficult for us to tell you exactly what that looks like.

But it is something that we are hearing is continuing, and as patients and younger patients are getting diagnosed, the data, I think, supports -- now, again, there's another piece of data that's out there that supports long-term survival and prostatectomy.

And so that, I think, as the patient becomes more informed, becomes a bigger consideration.

Okay, great.

And then, finally, with international, it seems that there is a little bit more acceleration rest of the world than Europe.

Is that more of an artifact of law of large numbers, or are you guys seeing some traction there that you hadn't seen before?

Overall our international pipeline's building very well, and timing is always difficult to predict, and so we expect overall the international system sales to grow.

The rest of the world versus Europe, it's hard to forecast them separately.

But we started out in Europe, so we have -- we are more established there.

We're building our -- we're also [expanding] our distributors in the smaller rest-of-world markets, and as that happens, as Jerry says, the dynamic's going to be (inaudible) some of these guys come up and -- but every once in a while they're really starting to gain some traction, so (inaudible).

It's just the way the market's developed.

It's usually Europe, then it comes to the United States, then it's back to Europe and then it's the rest of the world.

And so we're just in that cycle.

Okay, great.

Thanks for taking my questions.

The next question comes from Rick Wise, from Bear Stearns.

Your line is open.

Good afternoon, everybody.

Hi, Rick.

Let me pick up on the -- a couple of comments that were discussed before.

The pipeline is strong, you made it very clear, U.S.

and OUS.

Is it equally strong by procedure at dVH and dVP or is dVH carrying more of the backlog steam, as it were, at this point?

You know, again, Rick, I think what we have talked about in the past, and it remains true, is that a program that we're trying to establish, be it U.S.

or OUS, has a number of specialties in mind.

In other words, when we're selling a system, we are trying to incorporate urology and gynecology and cardiac and general surgery.

That's no different OUS and U.S.

So I would say that, as we made clear, prostatectomy and hysterectomy are the fastest-growing procedures.

But I would be careful to think of these as specific to one procedure.

In other words, they're buying it only for urology, or they're buying it only for gynecology.

When they come in, they tend to have support for multiple specialties.

Now, what happens after it's installed, and what that mix looks like, is different, but you could suspect that urology is going to get on quickly.

It's going to grow faster.

Gynecology and cardiac and general are going to get on, etc., etc.

So I would say that that hasn't changed.

But urology on a global basis is definitely proliferating.

Gynecology, slower than it is in the United States, but it is spreading around the world.

And then general surgery and cardiac are slow, steady areas.

Lon was kind enough to remind us how critical the consumer or the patient is to driving a robotic choice in surgery.

Is that prompting you maybe particularly in the dVH area in a unique marketing initiative, Aleks?

You know, again, I think when you're using terms like "marketing initiatives," I think if you look at what has happened and continues to happen in urology, and I would say it's actually happening in gynecology, is that hospitals recognize the value and the power of a woman's health initiative.

And so you will see da Vinci fit in very nicely to minimally invasive reproductive procedures for myomectomy or pelvic floor reconstructions or benign or malignancies.

And that is taking place.

And certainly where you reside on the East Coast, I'm getting calls all the time of people that have -- that are hearing radio ads, television ads, billboards, etc.

You know, we are doing things like putting together -- at dVH.com we have a number of marketing supports in Internet-focused areas.

But the patient awareness is something that hospitals do, and some of them do it really, really well and I think are the recipients of those patients.

Let me focus on two questions that both have implications sort of looking ahead as we wrestle with our models.

I realize it's early to think about '08, and you're not ready to give '08 guidance today, but just directionally, so we can think about it -- is it -- two questions, essentially.

Is it reasonable to think about sequential unit growth of some magnitude for the next three to five quarters, or as far as the eye can see?

How do we just conceptually think about that?

And, second, I have to note that one of my favorite hobby horses, you know, the possibility of positive operating leverage is quite evident this quarter, with EBIT income up, I think, 110%, if my eyes are working here, well above the 63, 64% you grew revenues.

Is it reasonable to think that that kind of leverage conceptually continues into the next year?

Rick, this is Ben.

So we will definitely give you some guidance next year in our next conference call.

I don't think we're prepared to give you guidance for 2008 today.

We are certainly continuing to see momentum from the third quarter to the fourth quarter, and so generally speaking things are going very well, definitely driven by dVP growing at 65% year over year and dVH at 175%.

So is there likely to be growth next year?

Absolutely.

But we'll get more specific about that next quarter.

And then getting to your point on leverage, I think Lonnie expressed some of this earlier, is that it's not our intent to continue to, let's say, grab our margins higher.

You know, as an example, when we launch new products, we've said in the past that we -- our new products are at lower gross margin when we launch them, because our costs on (inaudible) new products is a little bit higher.

So in our efforts to continue to drive procedure growth, either the existing procedures or new procedures, we're going to make sure that we put out products out there that can drive that growth, and we're not so intent on driving that leverage, if you will, higher.

And, as Ben pointed out in the numbers this quarter, our R&D effort is up, our development efforts are up, and we will continue to invest there as fast as we can find the talent that really drives itself.

So, you know, we're in this, as I've pointed out to you multiple times, we're in this for the long term, and trying to build a business that lasts, and we will continue to invest in the business, but we will invest where we get a -- where we think we have the most leverage.

And so, now, I wouldn't count on a whole lot of -- we may get some, because it's growing faster than we can invest, but we are not trying to get a lot of operating leverage at this point in time.

Got you.

Just one last quick one, or not, in recent weeks there was some anxiety about possible emerging competitive products in Korea, and there's ongoing discussions about other modalities presenting incremental competition for da Vinci.

I don't know, Aleks, Lonnie, how should we think about some of these issues?

And maybe just update us with your thoughts, and just --

Well, let me let Jerry answer that question.

Okay.

Sure.

Anyway, as we look at this there are competitive groups that we know of working in Asia, Europe and North America.

The recent announcements from Korea and other places have not been a surprise, nor do they represent an imminent threat.

We think our barriers to entry are significant from products that have produced outstanding clinical results, are easy to operate, reliable and cost effective, to a broad and long range of instrument and imaging options, to a pipeline of significant new products that will both increase efficacy and ease of use for our products in new procedures and in existing procedures; our strong relationships with our customers through our field and marketing organizations; a deep patent portfolio; and a strong set of regulatory approvals.

That said, we believe that computer-aided surgery is in its infancy, and we cultivate relationships with research centers and [third-party] groups (inaudible) to help us develop ideas and monitor trends.

We believe we're taking the necessary steps to remain a leader here, and we'll keep watching and developing.

Thank you so much.

Thank you.

That's -- we have time for one more question.

And our next question comes from David Lewis, from Morgan Stanley.

Your line is open.

Good afternoon.

Hi, David.

We're running tight on time, so I'll be brief here.

I don't want to beat a dead horse, but I want to come back to margins and (inaudible).

Obviously (inaudible) management has been less bullish on margin increases, but just on gross and SG&A, if you think about gross margins, there seem to be four factors inputting to margin this quarter, which would be geography mix, price increases, currency and absorption.

And we've got good numbers, I think, on two or three of them.

It appears that absorption was over 150 [bits].

And I appreciate Lonnie's comments about passing this back off to customers, but absorption doesn't appear to be something that would go away.

So I guess I'm having a hard time seeing how gross margins only go up 100 [bits] in this quarter.

Go ahead.

I'll let Ben answer the numbers.

You know, you talk about absorption.

Internally we don't run the Company on fully absorbed accounting.

We don't.

We run it by fixed and variable costs.

You know, we have to report (inaudible) GAAP.

I understand that.

But internally we manage our fixed costs and we manage our variable costs.

And so, you know, there's leverage, and depending upon how quickly you invest and how hard you invest in fixed costs as you grow revenue.

And so, you know, that's what happens, and -- but it's always a tradeoff.

We tend to try to be thoughtful and conservative in our investment for fixed costs, but we try not to be foolish, either, because, as Jerry pointed out, we're at the very beginning of what we think's going to become a large and dynamic market.

And we intend to be the leaders here.

And -- we are the leaders.

We intend to remain the leaders.

And so we'll be investing in fixed costs, which will reduce some of that "absorption" in the process.

So (inaudible).

It's not going to be [fully] predictable.

When we're wrapping up on prototypes that raises fixed costs.

When we're investing in a new area with some engineering [staff], that raises fixed costs.

So I'll just tell you that I'm not saying we won't have some market improvement at times.

We'll also have times when they'll drop a bit because we've invested more heavily in fixed cost, anticipating the future.

I think that was extremely well said.

The only thing I would just point out with you -- and you're on the right track -- is there were some productivity gains that we had.

I like to call them productivity gains.

And that's why we're giving the guidance of 68% gross margin, which is higher than the 67%, let say, that we were driving to or at the beginning part of the year.

And it's harder for us to estimate what's going to go on with the geography mix.

But, you know, back on Lonnie's point, while we might be enjoying some of these productivity gains right now, we're certainly not afraid to invest in certain things that are going to be beneficial to our future products.

Okay, and then just two more quick ones.

On the utilization, Ben, you mentioned that obviously there could be two things that impacted utilization this quarter, one being, obviously, seasonality, and the other one was geographic mix.

Historically, you've been up on utilization sequentially, even in sort of a slowish third quarter.

So is the bigger driver this quarter international versus utilization, or are they about even?

Well, the procedure growth in Q3 in the past has always been much lower than in previous quarters, and the seasonality this quarter was there.

Seasonality was also there in the last third quarter.

So what we experienced this quarter is not necessarily that different than what we had in the third quarter of last year.

So we know that the numbers, and being off by a percentage or something like that, but when we step back and take a look at what happened, the same sort of seasonality hit us in the third quarter this year as last year.

And, David, just as a reminder, in the practical side of it, as GYN becomes a larger percentage of our business, aside from the GYN oncology procedures, most of those procedures have some elective nature to them, so they can be postponed -- for example, benign conditions and pelvic floor or pelvic pain issues and myomectomies, etc.

So as you look out over the -- the core of this is patients pushing off elective surgery.

So that's just sort of a subtle footnote there.

Okay, just lastly, and I'll end here, can you just rank in order of procedure number -- because I don't think you're going to give us any relative metrics, myomectomy, prolapsed hysterectomy, in order of procedure volume?

Well, hysterectomy is certainly our largest procedure in gynecology.

And we've been at the myomectomy for a little while longer than sacrocolpopexy, so we actually have some momentum going on there.

Sacrocolpopexy is a very fast grower, so even ranking those two against each other is going to be kind of tough.

They're both very strong procedures for us, and they're both growing very fast.

Okay.

Thank you very much.

Thank you.

That was our last question for the day.

And, as I said previously, in these calls we focus on the financial metrics, such as revenues, profits, cash flow, procedures.

But our organizational focus remains on increasing patient value by improving surgical outcomes and reducing surgical trauma.

We believe that the adoption is procedure-specific, as has been mentioned, and patient driven.

And it's our goal to help the surgeon deliver a significantly improvement -- significant improvement in the value to the patient.

And we define patient value as efficacy of the procedure divided by how invasive it is.

And we hear stories daily of patients returning to their jobs, their normal lives, literally days after surgery, such as a young woman who was a key aide in a congressional campaign and was diagnosed with endometriosis and two large myomas, which gets to your point.

She was in significant pain and required a myomectomy.

She had two close relatives in the community she lives, both who were gynecologists.

But in the end she chose to go to a gynecologist who could perform the procedure with the da Vinci System.

And she was back on the campaign trail in three days.

Another patient of Dr.

Mihaljevic, a cardiac surgeon at Cleveland Clinic, wrote to Dr.

Mihaljevic saying, "Dear Dr.

Mihaljevic, thank you for bringing robotic mitral valve repair to the Cleveland Clinic.

Although my mitral valve was diagnosed by another Cleveland hospital, with due diligence I found that the Clinic alone offered robotic surgery, with the potential of speedy return to normal activities, a normal life.

Indeed, as I write this letter, I've been out of surgery fewer than six days, yet I can walk miles every day, drive and do almost everything.

My recovery does not include narcotics, and I've never experienced pain above a level 2.

My confidence was well placed, and I thank you."

My point is that patients like this are the strongest advocates of surgery with the da Vinci System and are the underlying strength of our business.

In closing, I assure you that we remain committed to focusing on a vital few things that truly make a difference as we strive to take surgery beyond the limits of the human hand.

That concludes today's call.

We thank you for your participation and support in this extraordinary journey.

We look forward to talking with you again in three months.

Thank you for participating in today's conference call.

You may disconnect at this time.