直覺手術 (ISRG) 2010 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the Intuitive Surgical Q3 earnings conference call.

At this time all participants are in a listen only mode.

You will have an opportunity to ask questions after the presentation.

(Operator Instructions) As a reminder, this conference is being recorded.

I would now like to turn the conference over to our host, Mr.

Calvin Darling, Director of Financial Planning and Analysis for Intuitive Surgical.

Please go ahead.

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

With me today we have Gary Guthart, our President and CEO, Marshall Mohr, our Chief Financial Officer and Alex Cukic, our Vice President of Strategic Planning.

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

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

These risks and uncertainties are described in detail in the Company'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 archives section under our investor relations page.

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

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

Gary will present the quarter's business and operational highlights.

Marshall will provide a review of our third quarter financial results, Alex will discuss marketing and clinical highlights and I will provide an update to our forecast for 2010.

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

With that, I'll turn it over to Gary.

Good afternoon, and thank you for joining us on the call today.

In what is historically a seasonally challenging quarter, Q3 2010 provided some added macroeconomic headwinds.

In the face of these challenges, our procedure showed slight growth sequentially from Q2 and 33% growth over Q3 2009.

In systems, we sold 105 da Vinci systems in the quarter, up from 86 systems in Q3 2009 and acceptance of our SI system and dual console was strong.

In absolute numbers gynecology continued to show strength, adding the most procedure in the quarter with contributions for both benign and malignant conditions.

While Q3 is seasonality slow in Europe, prior year comparisons show relative strength in European procedures.

Pull through surgery gynecology and urology also reflect positive trends.

Emerging procedures continue to expand, exhibiting strong sequential quarterly growth.

Da Vinci lobectomy, da Vinci low anterior resection and da Vinci trans oral surgery are delivering strong patient value and are being adopted well.

On a relative basis, the procedure counts are still fairly small.

However, their early growth rates remain encouraging.

Before summarizing Q3 highlights, I'd like to remind you that third quarter 2009 included a revenue deferral associated with an upgrade offer related to the introduction of our SI system.

Comparisons that follow exclude the deferral.

Operating highlights for the third quarter were as follows.

Procedures grew 33% over the third quarter of 2009.

We sold 105 da Vinci surgical systems, up from 86 during the third quarter of last year.

Total revenue was $344 million, up 26% over Q3 2009.

Instrument and accessory revenue was $128 million, up 27% over last year.

Total recurring revenue grew to $185 million, up 28% from prior year and comprising 54% of total revenue.

Net income was $87 million, up 43% over last year.

We generated an operating profit of $163 million before non-cash stock option expense, up 32% from the third quarter of last year.

We ended the quarter with $1.621 billion in cash and investments, up $33 million from last quarter and up $597 million from third quarter 2009.

Significant cash outlays during the quarter included $50 million invested in intellectual property, related technologies and fixed assets and $59 million in stock repurchases.

Excluding the impact of these outlays, as well as $17 million from stock proceeds and $2 million returned from working capital, we generated $126 million from gross cash flow from operations, which is 145% of our reported GAAP net income in the third quarter.

We have been making substantive investments in our clinical sales force and in new product development throughout the year.

We believe that close clinical sales support of emerging and high growth procedures is an important catalyst for achieving procedure adoption.

However, reaching territory productivity for a new sales hire does not happen immediately.

It is a multi month process so that hires made earlier in the year are just coming online in the field now.

We will continue to measure the productivity of these investments and we'll adjust our spending as needed.

This quarter, we added an additional 92 people in our team, predominantly in sales, manufacturing and R&D, bringing our total team to 1,568 employees.

In product development and research, our teams are driving advancements in our focus areas.

Our instrument development teams are progressing in developing robotic stapling and energy instruments, as well as various specialty specific instruments.

We are improving and expanding our imaging capabilities through investments, in image acquisition technologies and fluorescents imaging.

We are developing patient side technologies that allow for single port robotic surgery.

And finally, we're making substantial progress in bringing to market surgical simulation and networking.

Lastly, we have seen a shift in the approach to new product approvals by the FDA.

These changed appear to be extending timelines from past norms, and we cannot predict with certainty when a new product will receive approval.

We are confident in the utility and the quality of our new products going through the approval process and are focusing our regulatory teams on clean execution to meet the needs of FDA.

We'll announce the availability of new products as they are ready to ship.

In summary, developing and expanding procedures with strong patient value and outstanding organizational execution remain our focus, with particular emphasis in execution in our clinical sales force and in our product development and regulatory teams.

I'll now pass the time over to Marshall, our Chief Financial Officer.

Thank you, Gary.

Prior to providing you with the details of our third quarter results, I would like to provide you with a quick review of the deferral accounting that took place during 2009, which sets into context the proper comparables.

Last year, we offered certain first quarter 2009 customers with the opportunity to upgrade their da Vinci S system to da Vinci SI system at a discount to the otherwise list price for such an upgrade.

We also offered those customers the opportunity to return da Vinci S accessories in exchange for da Vinci SI accessories.

As a result, we deferred a total of $20 million of revenue in the first quarter of 2009, comprised of $18 million of system revenue associated with system upgrade offers and $2 million of accessory revenue.

We recognized $14 million of the $20 million deferrals in our second quarter of 2009 and the remaining $6 million in the third quarter of 2009.

I will now walk you through our revenue results with comparisons to the third quarter of 2009 as though the deferral had not occurred.

ur third quarter 2010 revenue was $344 million, up 26%, compared with $274 million for the third quarter of 2009 and down 2% compared with $351 million for the second quarter of 2010.

Third quarter revenues by product category were as follows.

Third quarter instrument and accessory revenue was $128 million, up 27% compared with $100 million for the third quarter of 2009 and approximately equal to the $128 million in the second quarter of 2010.

The timing of customer stocking orders varies from customer to customer and are regularly placed after the da Vinci robot is shipped or installed.

Fewer stocking orders were completed and a higher carryover of stocking orders existed in the third quarter compared to the second quarter.

Excluding stocking orders, growth in instrument and accessory revenue was slightly lower than the procedure growth, as we would expect.

Instrument and accessory revenue realized per procedure including initial stocking orders was approximately $1,840 per procedure, which was lower than the third quarter of 2009 by approximately $80 and approximately $30 lower than the second quarter in 2010.

The changes in instrument and accessory revenue per procedure primarily reflect changes in the impact of stocking orders.

We expect instruments and accessories per procedure to decline slowly over time, given that initial stocking orders have a lower impact on a larger install base.

Third quarter 2010 systems revenue of one $160 million increased 23% compared to $130 million of systems revenue for the third quarter of 2009 and decreased 5% compared with $168 million of systems revenue for the second quarter.

We sold 105 systems in the third quarter of 2010 compared with 86 systems last year and 108 systems last quarter.

Our third quarter average sales price per system, including all da Vinci models, but excluding upgrades and the deferral revenue, was $1.43 million, an increase from the $1.39 million realized in the third quarter of 2009 and a decrease from $1.48 million realized in the second quarter.

The increase compared to the prior year reflects an increase in the proportion of SI and SI dual console system which carry a higher ASP.

The decrease in average sales price per system compared with the prior quarter is primarily the result of the mix of customers and the reduction in the value of our euro to dollar hedging position.

As we indicated last quarter, the mix of systems and customers and therefore ASPs in the first and second quarters this year had been more favorable than we normally expect.

We lock in hedges for most of our forecasted direct European system sales every six months.

The rates locked in for July to December are lower than the rates recognized in the first six months of 2010 by approximately 15%.

Third quarter systems revenue also included $10 million of upgrade revenue compared to $10 million in the third quarter of 2009 and $8 million in the second quarter 2010.

Service revenue increased to $57 million, up 31% compared with $44 million last year and up 3% compared with $55 million last quarter.

The growth in service revenue was primarily driven by a larger system install base and an increase in the mix of SIs which carry a higher annual service fee.

Total third quarter recurring revenue comprised of instrument, accessory and service revenue increased to $185 million, up 28% compared with the third quarter of 2009 and up 1% compared with the second quarter of 2010.

Recurring revenue represented 54% of total third quarter revenue compared with 53% in the third quarter last year and 52% last quarter.

Revenue by geography was as follows.

Non-US revenue represented 17% of total revenue in the quarter compared with 19% of total revenue in the third quarter 2009 and 18% of total revenue in the second quarter of 2010.

The decline in the proportion of non-US revenue relative to total revenue reflects growth in the US business.

Non-US procedures grew faster at a faster pace than US procedure on a year-to-year basis, although Q3 did reflect seasonality and a sequential decline.

We sold 22 systems outside the US compared with 14 in the third quarter of 2009 and 22 last quarter.

Four of the systems sold in the third quarter and one of the systems sold in the second quarter of 2010 were to Japanese customers.

We sold 16 systems in Europe this quarter, or two more than the past quarter and eight more than the last -- than last year.

However, the capital sales market in Europe continues to be challenging, reflecting the macroeconomic environment.

Moving on to the remainder of the P&L, let me remind you that there were no cost deferred in conjunction with the first quarter 2009 revenue deferral and therefore, the $20 million deferral and subsequent reversals had an equal impact on revenues, gross profit and operating income.

Gross margin in the third quarter was 73% compared with third quarter 2009 gross margin, excluding the impact of the deferral of 70% and compared with second quarter 2010 gross margin of 73%.

The increase in gross margin compared to the prior year, reflects increased system ASPs, material cost reductions and absorptions of fixed costs over a larger revenue base.

Compared to the prior quarter, lower manufacturing costs were offset by lowering system ASPs.

Third quarter 2010 operating expenses of $119 million were up 25%, compared with the third quarter of 2009 and up 1% compared with the second quarter.

The quarter-over-quarter increase reflects costs associated with employees added during the quarter, partially offset by a decrease in our R&D spending.

The decrease in R&D spending reflects lower prototype costs due to the lumpy nature of prototype purchasing which will likely be incurred in the fourth quarter.

We added 92 employees in the quarter, including 77 employees in the sales and service organization as we continue to expand our clinical sales force and ten employees in operations.

Third quarter 2010 operating income was $132 million, or 38% of sales compared with $98 million or 36% of sales for the third quarter of 2009, excluding the impact of the deferrals and $140 million, or 40% of sales for the second quarter of 2010.

Third quarter 2010 operating income reflected $30 million of non-cash stock compensation expense compared with $25 million for the third quarter 2009, and $30 million last quarter.

The growth in non-cash compensation reflects our annual grant made February 15 of each year and the increase in the number of employees.

Our effective tax rate for the third quarter of 37% was lower than our 2009 rate of 41%, reflecting the implementation of our international tax structure.

Our third quarter rate was lower than the second -- than the rate for the second quarter of 39%.

Our net income was $87 million, or $2.14 per share compared with $61 million or $1.55 per share for the third quarter of 2009, excluding the impact of the deferral, and $89 million, or $2.19 per share for the second quarter of 2010.

Let me quickly summarize our results for the first nine months of 2010.

The first quarter of 2009 deferral did not have an impact on the nine months of 2009 information.

Procedures grew by 35% for the first 9 months of 2010.

Total revenue for the first nine months of 2010 was $1.024 billion, up 40% compared with $729 million last year.

This included recurring revenue growth of 35% and an increase in systems revenue of 47%.

Operating income for the first nine months of 2010 was $402 million, up 61% compared with $249 million last year.

Operating income included $88 million of stock based compensation charges in the first nine months of 2010 compared with $72 million in 2009.

Net income for the first nine months of 2010 was $261 million, or $6.45 per share compared with $155 million, or $3.97 per share last year.

Now moving to the balance sheet.

We ended the third quarter of 2010 with cash and investments of $1.621 billion, up $33 million compared with June 30, 2010.

The increase during the quarter reflects $126 million of cash flows from operation and $17 million from the exercise of stock option, partially offset by $59 million of stock buybacks and $50 million of capital and IT purchases.

In July, our board authorized $150 million to buy back shares.

Considering the previous authorization and buy back activity, we currently have $241 million authorized to buy back shares.

Our accounts receivable balance increased to $208 million at September 30 from $195 million on June 30, reflecting the timing of revenue.

Our net inventory increased to $85 million at September 30 from $74 million at June 30.

The increase reflects safety stock to insure adequate supply of certain components and inventory associated with yet to be released products.

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 sold 105 da Vinci system.

83 in the United States, 16 in Europe and six in the rest of world markets.

As part of the 105 systems sales, 15 standard da Vinci systems were traded in for credit against sales for new da Vinci SI systems.

We had a net 90 system editions to the install base during the quarter, which brings to 1,661 the cumulative number of da Vinci system worldwide.

1,228 in the US, 292 in Europe and 141 in rest of world markets.

45 of the 105 systems installed represented repeat systems sales to existing customers.

Also during the quarter, ten customers purchased upgrades to convert their da Vinci S systems into da Vinci SI systems.

Internationally, we sold five da Vinci systems in Spain, four into the countries of Germany and Japan and three into France.

Clinically, we had a solid quarter, with GYN and more specifically, benign DDH contributing the greatest absolute growth.

While DDH for malignant conditions showed very good sequential growth, benign DDH growth was stronger, both in actual procedure growth and in percentage growth.

Additional categories of growth included ENT, colorectal and thoracic surgery.

As one would expect, with DBP flattening in the US and seasonality in OUS markets, our urology growth was tempered.

On a year-over-year comparison, overall third quarter procedures grew by approximately 33%.

Also during the quarter, over 250 da Vinci related clinical publications and abstracts representing multiple surgical specialties appeared within the various peer review journals.

DVH for benign conditions has become a significant driver of our overall business.

And within this target, comparisons between DVH and traditional LAVH and lap super cervical hysterectomies, or LSH are beginning to emerge.

For background, an LSH is a less complete resection than a total hysterectomy but an appropriate option for some patients.

In LSH, the cervix is left in place and only the uterus is extracted.

In some way it can be thought of as a partial hysterectomy.

A recent study comparing the three techniques was published in The Journal of Robotic Surgery.

The study was entitled Comparison of Minimally Invasive Surgical Approaches for Hysterectomy at a Community Hospital and emanated out the Department of Obstetrics and gynecology at Spartanburg Regional Medical Center in Spartanburg, South Carolina.

The study included patient cohorts comprised of the first 237 patients undergoing a DVH, the last 265 patients undergoing an LAVH and 87 patients undergoing an LSH.

Among the DVH patients were cases of greater complexity that included a higher prevalence of prior abdominal pelvic surgery than found among the LAVH patients as well as an increased procedure for endometriosis and pelvic reconstruction.

And finally, patients which had greater uterine weights greater by an average of 35%.

Despite added case complexity, operative time was significantly lower in DVH that LADH, 90 minutes compared to 125 minutes.

And similar to that of LSH, blood loss was also less in the DVH patients as compared to LAVH, 59 milliliters compared to 168 milliliters, and similar to LSH.

And operational was shorter for DVH than LAVH and LSH, 1.0 days compared to 1.2 days for the others.

In their summary, the author stated the following, and I quote, "Our analysis of the learning curve suggest that operative time for robotic assisted laproscopic hysterectomy may continue to improve beyond the initial patient series, despite the increased complexity of cases undergoing this procedure.

The results of this study lends support to the small but growing body of literature describing the benefits of robotic assisted laproscopic hysterectomy over conventional laproscopic assisted vaginal hysterectomy." With DDP growth in the United States flattening, we look to Europe and other OUS markets as fertile growth opportunities.

In addition, clinical data comparing long-term outcomes in patients undergoing prostatectomy versus alternative treatments for organ confined disease is demonstrating the advantages of prostatectomy in long-term survival.

In a recent publication of the journal Cancer, surgeons and researchers from the University of California at San Francisco and Memorial Sloan Kettering, working from the nations largest prostate cancer registry, CaPSURE , compared cancer specific mortality outcomes among men who under went radical prostatectomy, men who received external beam radiation therapy and men who received primary androgen deprivation therapy.

In the current study, the 7,538 men with localized disease were analyzed.

Prostate cancer risk was assessed using two well validated instruments that were calculated from clinical data at the time of diagnoses.

Then, a parametric survival model was constructed to compare outcomes across treatments, adjusted for risk and age.

The results.

In total, 266 men died of prostate cancer during the follow-up.

Adjusting for risk and age, the hazard ratio for cancer specific mortality relative to prostatectomy was 2.21 for radiation therapy and 3.22 for androgen deprivation.

Said another way, the analyst reports -- the analysis reports that the risk of a man dying from prostate cancer after primary radiation therapy was more than twice as great when compared to radical prostatectomy, and the mortality risk for primary androgen deprivation therapy was reported to be three times as great.

The authors concluded their report by stating, and I quote, "Prostatectomy for localized prostate cancer was associated with a significant and substantial reduction in mortality relative to radiation therapy and androgen deprivation mono therapy.

Although this is not a randomized study, given the multiple adjustments and sensitivity analysis, it is unlikely that the unmeasured confounding would account for the large observed differences in survival."

The successful adoption of any new procedure or technology is directly tied to the efficacy of the training pathway.

We've done a pretty good job thus far of assisting our customer base with their initial da Vinci training experience.

When you consider the scale associated with training surgeons across multiple surgical specialties, on a global basis, you'll quickly see that it's a significant endeavor.

It has been our belief that in time, initial da Vinci procedure experience will find its way into the formal processes of academic medicine through residency and fellowship programs.

As several da Vinci procedures have gone mainstream, we have begun to see this transition take place.

Researchers from the University of Alabama Birmingham set out to define this developing trend with the GYN oncology fellowship programs around the country.

UAB conducted a survey of GYN oncology fellows and fellowship directors and summarized their findings in last month's edition of the International Journal of Medical Robotics and Computer Assisted Surgery.

The survey was designed to determine the prevalence, application and acceptance of robotics in the 41 approved US programs.

Approximately half of the fellowship directors responded to the survey with the following results.

95% of the respondents have a robotic system at their institution, and 94% have two or more gynecologic oncology faculty members who perform robotic surgery.

78% of the responding institutions do more than five robotic procedures per month, and 22% reported that they performed more than 12 procedure per month.

All responding institutions have utilized the robotic system in the management of endometrial cancer and all respondents reported using the system from lymph node dissections.

89% reported utilization in treating cervical cancer and 83% reported robotic usage in benign hysterectomy.

Furthermore, 89% of the fellows responding to the survey have been involved in cases that utilize robotic systems and 77% have worked from the da Vinci system console.

Although it's the first time we've seen an analysis of this form published in a peer review journal, we are aware of parallel activity taking place within the American Urology Association and the Association of Advanced Gynecologic laparoscopy as well as in various international medical societies.

The introduction of da Vinci surgery intra-residency and fellowship training speaks well to our product adoption thus far.

But more importantly, it speaks volumes to what we can expect with future robotics raining.

That concludes my summary, and I'll now turn the time over

Thank you, Aleks.

I will be providing an update to our financial forecast for 2010 including procedures, revenues and the other elements of the income statement on a GAAP basis.

I will also provide estimates on significant non-cash expenses to provide you with visibility of our expected future cash flows.

Starting with procedures, we continue to project our 2010 procedures to grow approximately 35% for the year from the base of approximately 205,000 procedures performed in 2009.

Moving onto revenues, based on our results through three quarters and our view into our fourth quarter sales pipeline, we continue to expect revenue results to grow within the 30% to 33% range forecast last quarter.

Regarding the instrument and accessory portion of our revenue, we would expect full year revenue growth in this category to come in slightly below the 35% forecasted procedure growth due to the diminishing impact of stocking orders on instrument and accessory revenue per procedure.

As a reminder, our revenues can fluctuate quarter to quarter as the timing of placements -- system placements and instrument and accessory stocking orders may vary.

With regard to gross margin, we reported a 73.2% margin in both Q1 and Q2 of this year and a slightly lower rate of 72.8% in Q3, primarily reflecting the impact of lower Q3 system ASPs.

Going forward, we expect our Q4 margins to be near our Q3 level, resulting in a full year 2010 gross margin percentage near the higher end of the 72% to 73% range projected on our last call.

Moving to operating expense, we have made, and will continue to make significant investments across multiple areas of our business, particularly in our clinical sales force.

We added 92 employees during the third quarter and 305 so far this year compared to 139 added through three quarters last year.

While we continue to invest in our business, the timing of some of our expenses can be lumpy.

We now expect our total GAAP operating expense to grow by 27% to 29% in 2010 compared with our previous forecast of 29% to 31% growth.

In terms of non-cash expenses, we continue to expect to record stock compensation charges of approximately $120 million in 2010.

Our guidance for intellectual property amortization is now $17 million compared to $15 million last quarter.

This increase reflects additional amortization related to our Q3 IP investments.

Other income, which is mainly comprised of interest income, is expected to come in around $18.5 million for the year, just above the $18 million forecasted last quarter.

With regard to income tax, our year to date tax rate now stands at 37.2% of pre-tax income.

We now expect to record income taxes at approximately that 37.2% rate for the rest of 2010.

For calculating earnings per share, we ended the third quarter with 39.3 million common shares outstanding and approximately 4.9 million option shares outstanding.

Depending on our average stock price in Q4, a portion of the 4.9 million option shares will be added to the fully diluted shares calculation.

At present, we estimated that our diluted share count for calculating EPS in Q4 will be approximately 40.3 million shares.

Our estimate for the full year is 40.4 million shares.

Finally, regarding our cash flows.

Since we are forecasting to report over $135 million in non-cash stock compensation and amortization expenses for the year, our cash flows will continue to be significantly q-and-a

(Operator Instructions) And our first question comes from the line of Ben Andrew with William Blair, please go ahead.

Good afternoon, guys.

Hi, Ben.

Hi.

Maybe talk a little bit, Gary, about same-store procedure growth, and maybe if you can isolate the effect of the unemployment situation from your efforts to penetrate new procedures and give us a sense of the kind of headway you're making with the additions to the sales force?

Sure.

As you know, we track and plot our procedure trends pretty closely.

What we saw in the beginning of the summer was an unusual pressure on existing procedures.

And then we've seen a little bit of return to strength at the end of the summer, the beginning of September on the sales force side, so we think there's some environmental pressure out there.

It's hard to quantify exactly the number.

On the clinical sales reps and the hiring there, as you know, it's a multi-month process, so the hires we made in Q1 and Q2 are just becoming active in the field at the end of the Q3.

And so our expectation is they'll become productive as we go into Q4, and that's something we're measuring pretty carefully and making sure we understand what the optimal loading looks like.

There's a little bit of titration there, we'll have to watch it as it grows, but that's our thinking on it now.

Is your thought, Gary, to keep adding aggressively to the sales force for two or three more quarters to again, try to get maximum penetration on the new procedures as well as keep trying existing ones so that maybe we can see op margin stand a bit of pressure here before returns to closer to the 40% level?

We will, for the next couple of quarters, we'll be continuing to invest in the sales force as we watch the productivity of the first set go in.

We think that the demand out there for da Vinci procedures is real and present and that the investment in the sales force will help bring those into our hospitals, our customers.

Okay, great.

Thank you.

Thank you.

And our next question comes from the line of Tycho Peterson with JPMorgan.

Please go ahead.

Hi, thanks for taking the question.

Maybe just, to the first question Ben hit on, the underlying economic factors and taking it a step further, you talked about benign and malignant flip flopping this quarter with benign picking up a little bit.

Can you talk how sustainable you think that trend is, or is it just -- how much of that was driven by new reps being added versus a slight uptick in patient volumes or something else?

Well, it you look at, again, the overall his hysterectomy target for us, we break it up, as you know, in the malignant and into the benign.

But what we have found to be the case, not just in GYN but in other procedures, is the greater patient value seems to take place in the more complex procedures.

And within the benign category, recognize that there is an underlying condition or several underlying conditions that range from, let's say, not very complex to very complex.

The way we've been tracking the hysterectomy growth leads us to believe that we're making good penetration into the complex and probably picking up some of the less complex along the way.

But when we look at where we are in our growth trajectories and what the opportunity is, we are in a pretty steep part of our growth curve, so is it sustainable in our view?

Absolutely.

In the procedures that we're targeting, and I don't think there was anything from a, let's say a favorable tail wind through Q3 between seasonality and high unemployment rates that gave us any stimulus for the quarter.

And if you recall, we returned to sort of the norm of benign growth happening at a faster or a larger percentage than malignant growth last quarter as well as this quarter, so this isn't the first time we've restored that .

Just to color that up a little bit, malignant hysterectomy is further up on the adoption curve, so we'd expect that -- and benign is lower, we'd expect that the growth rate of benign should be higher than the growth rate of malignant, given where they are relative to what we think the total market is.

Okay.

That's helpful.

Then I think you talked about 45 year placements for repeat customers.

Any color you can give us in just hospital size in terms of placement in your mix between larger, medium and smaller hospitals?

There really isn't anything that is remarkable or different that comes to mind in this particular quarter.

I think you'll find that all size and shapes of hospitals remain our customers, and this quarter was really nothing different.

So, we don't really track that as we once did in the past for a number of reasons.

But the bottom line is that large and small hospitals remain targets for us.

Okay.

And then on the sales front, have you looked to redeploy reps away from prostate into gynecology, or are you solely thinking about additions at this point?

I guess, how do we think about that dynamic?

Yes, we don't have prostate specific reps.

So, there are reps that will cover both prostate and gynecology.

We do have a secondary force of gynecology to reinforce the gynecologic procedures in certain regions of the country, so it's not so much a redeployment.

We do think that reps are most effective, they have their greatest leverage when procedures are a lower part of the curve, where they're helping surgeons and they're helping hospitals build their programs around a new and emerging procedure.

So, that the percentage of their time they spend is probably highlighted on the emerging procedures versus the more mature ones.

Having said that, we have pull through procedure in urology that are growing, partial nephrectomy , and even a mature procedure requires some attention from the reps.

So, what the idea mix of a rep's time is -- depends a lot on what their local area looks like in terms of

Okay.

And then just lastly, Gary, you touched on the FDA.

Are you doing anything different from a regulatory standpoint on your end?

In terms of the process we're using and the kinds of conversations we're having, there's not a big difference.

Nothing that I'd really point out.

I think that just the frequency of questions and the turnaround times and the type of engagement has been extended a little bit.

We've seen that here as well as other parts of the industry, I think it's something we're hearing about as well.

Okay.

Thank you.

And our next question comes from the line of David Lewis with Morgan Stanley please go ahead.

Good afternoon, this is actually James in for David.

James.

Maybe you can give us a little bit of color how you're seeing the economic environment shape up in the EU and OUS generally.

Where do some of those geographies stand in the economic cycle versus the US?

And then also, more broadly, you mentioned that at least in prostate, that the EU and other ROW markets are going to be offering greater opportunities for growth in the US.

So, how should with think about the ability of those procedure to ramp, especially to the extent that capital spending overseas remains pretty constrained?

Again, it's an excellent question.

I think there's actually some connectivity between part A of your question and part B, and it's really the following.

In that, and we've said this over and over, and it just becomes even more apparent every quarter, that it's a really a country by country market dynamic that's taking place within the EU and other markets and other parts of Asia.

An example of that is, we know what the macroeconomic headwinds were in the PIGS country over the last few quarters, but we sold five systems into Spain.

Because there's a number of underlying variables that really drive those sales, and that is how many -- what the demand is for the procedures, what is the install base within that particular country, and what are the underlying economic conditions?

And if you kind of go through that on a case by case basis or a country by country basis, you're just going to find different parts of those ingredients that will drive to success in any given quarter or not.

So, I would say as a general statement, as far as Europe is concerned, it is still become -- it's still -- it still remains less predictable and probably more challenging than we have seen in some years past.

And how that projects on a go forward basis is really not something we're going to really try to assess in terms of being macroeconomists here.

In terms of the OUS procedure growth, again, you're seeing the same variables unfold on a country by country basis and some countries it is absolutely on a very steep part of the curve while in others, it's on an earlier part, less steep.

It is not going to be as predictable or homogenous, if you will, of the US market.

And we'll try to color it up as best we can, but it's difficult to try to lump it into one bucket and make a general comment about its growth rates.

Thanks, that's very helpful.

Then maybe could you give us any more granularity on the impact of FX in the quarter?

Clearly, that was a headwind, but from a financial perspective, any way to break that out?

So, we sell product in euro and British pounds where we sell direct in Europe and think of it as the core of western Europe, we sell direct.

We sell through distributors to Spain, Italy, Greece and the rest of the world.

So, and in those customers that we sell direct to, as I said earlier, we take out hedges for the majority of our estimated future sales at the beginning of every six-month period.

And those hedges that we took out for the second half of 2010, were at a lower rate by about 15% than the earlier part.

Now, mind you that about 10% or around that is the amount of our revenue that is designated in those currencies.

We also have, obviously, costs that are incurred in those foreign currencies, and then we also have I&A revenue and service revenue that's designated in those currencies, and those pretty much offset.

So, we think we're hedging the majority of the exposure and therefore, the currencies don't have a lot of impact other than when we lock in the hedges.

Okay, great.

Very helpful

Thank you, and our next question comes from the line of Sameer Harish with Needham & Company.

Please go ahead.

Hi guys, thanks for the question.

Just to follow up on the FX question there.

Was the FX impact also translating onto procedures as well, or was it mostly on the systems side?

Really doesn't have any -- when you say procedures, you mean the instruments and accessories?

Yes, the instruments.

Is it does have some impact on instruments and accessories because we don't hedge instruments and accessories.

But again, when you get down the bottom line of our financial statements, that's pretty much offset by the costs that are designated into those currencies.

Okay, got it.

And I think last quarter you mentioned the pipeline for -- the SIs was notably lower than you'd seen in the first half of the year, and it seemed like you didn't have the tail off this quarter.

Can you talk about what you're seeing in the pipeline for SI going forward?

And what that means in terms of sales cycle, if it's changing within the quarters than what you're seeing at the onset?

Honestly, I'm not sure of the commentary that led you to think that we had a slowdown in SIs last quarter.

SIs have actually been showing growth quarter over quarter over quarter, and it was, again, pretty substantive in the most recent quarter.

And so when we -- when you look at the pipeline and you look at the deals that we've done or we work on, I think the trends show pretty clearly that customers are really looking at the SI system as the predominant purchase -- the predominant system to purchase, and I don't see anything that's changed in that, or even on a go forward basis.

Okay.

And just last question, in terms of the long-term trajectory on R&D, just in terms of both where the dollars are being spent and leverage, can you talk about how you think about over the next two or three years, do you have specific R&D targets based on development programs, or are you thinking about it in terms of percentage of revenues and seeing what you're able to do?

And maybe talk about the R&D mix as you go forward, do you expect that to change in terms of investments in systems instruments and perhaps clinical data going forward?

Just from a point of view of how much money we think we have for R&D just starting on that front, usually what we do is make sure that we're matching -- we're not -- our R&D growth is not exceeding that which we can bring in with regard to our revenue growth.

So, we're not looking to deleverage with regard to R&D.

Having said that, once we say okay, we know what we can fund and we believe we're still in the early phases of robotic surgeries, and we want to fund R&D, then we look at and we're really asking, what's going to drive patient value and what's going to drive the adoption of procedures?

And in that bucket, there are always a set of instruments and accessories that as you look out and think about how to make new procedures happen on systems, instruments and accessories come in, it's a pretty -- it's a given.

The next step is really imaging visualization, what can you provide to the surgeon to have a better understanding of what's happening in the tissue.

So that bucket is usually filled as well.

From there we look at the patient side robotics, what can be doing in the robotic space that makes for a better customer experience.

And then of late, the next bucket has really been training technologies, those things that he's training and ease of use.

And so that's how we think about it, and I think for the next couple of years, that's the way it will play out.

Thank you

Thank you.

And our next question comes from the line of David Roman with Goldman Sachs.

Please go ahead.

Good evening, everyone.

Thank you for taking my question.

I just wanted start on the procedure volume side.

Obviously, this quarter came in somewhat below where the consensus expectations was in terms of growth.

You reiterated your guidance for the full year.

Can you maybe just talk about what the conversation or feedback you're getting from your sales force are like with respect to timing of procedures, deferrals, et cetera, that would support strong fourth quarter to get to the full year numbers?

Well again, David, when we look at the, the guidance in any given quarter where we're in our planning horizon and we're taking a look at what we want to drive or base the budget off of, we'll track and plot the procedure trends pretty closely, both on a tops down and from a bottoms up, from a sales manager's perspective that rolls up the individual sales territories, and we'll sort of triangulate around what we believe are the best estimates for that particular period in which we're projecting.

And so when we go through that process, again, not getting into the granularity of each individual discussion, but when we go through that process, we have a level of comfort with the 35% that we reiterated.

And so the, again, the difference in some of the I&A expectations versus the procedure expectations and so on and so forth, with the 33% growth in the procedures, looking at what we believe we saw in later August and September, plus the addition of the sales force expansion in some of those people coming on and the tops down and the bottoms up build up, 35% is the number that we were comfortable with.

I'll just color that up a little bit.

I think one easy way to look at it is as we look out at our adoption curves, for us that's up an estimation of what we think the demand is out there for the procedures, and then you look at rep productivity, and that's what we can do about it.

And so as Aleks said, those are the two things that we're trying to match up.

On the one hand, we look out, we think demand for the procedures is there.

The macroeconomic pressure's about whether there's some influence of unemployment or headwinds against that demand.

And then our rep productivity is the bottoms up side.

And so we look at those two things and that's how we build our estimates, but they're estimates.

Okay.

That's helpful.

And then maybe you talked about this on the call, but could you maybe just elaborate a little on the $85 million increase in the inventory balance in the quarter and how we should -- is there anything specific in there with pending product launches, et cetera, and how that number should track going forward?

What we said is that we built inventory a good part of that build has to do with components that earlier in the year we started to experience some shortages, specifically in some semiconductor components.

The semiconductor supplies came tight in the industry, so we actually have built our inventory to contain some of those components so we don't run into shortages as we go forward.

Those components, by the way, are used in da Vinci systems.

Okay.

The harder part is they're also used in cel phones.

Yes (laughter).

Hence the safety -- Our volumes are much smaller than a lot of others.

And then the second element is -- that I made comment to is that we do have some inventory associated with new product introduction.

And as Gary eluded to, some of the introductions through the FDA are a little slower than we had anticipated and therefore, we're still carrying that inventory.

Okay.

But that -- there's no signalling in that inventory number that there's a pending product launch on the horizon that either your conversations with the FDA have improved in that there's something more significant coming, it's more the result of a delay in product approvals?

So to Marshall point, now I think just to be clear on one thing, the inventory level has risen to, not -- we didn't rise by 85, right?

No, no.

Grew to 85.

Right, right.

And the mix is largely safety stock on electronic components in which we're a small player in the global market, and then there's some in there for products that we're building up in anticipation of FDA approval.

And when we get that approval, we'll release that inventory.

And that happens, by the way, all the time.

The build a little bit ahead of an approval, and then the approval timing is uncertain.

Okay.

Time for two more questions.

Thank you.

Our next question comes from the line of Rick Wise with Leerink Swann.

Please go ahead.

Good afternoon Gary, Marshall, Aleks.

A couple questions.

First, can you give us any update on the timing or any perspective on when you'll have full ability to launch in Japan?

So we are approved for the system.

Right.

And what we're really working on now are reimbursements.

It looks like reimbursements are going to be procedure -- by procedure.

The first one through that's being negotiated is prostatectomy.

There's some others behind it and right now, they're basically in -- the customers, hospitals and the government are in a negotiation of what the boundaries are for approvals.

The first reimbursements that have gone through have been on a hospital by hospital basis.

Which a reasonable way to start, and then over time, we'll see how that generalizes.

I can't give you a specific time frame in which a broad blanket reimbursement approval will be made.

But just, again, I appreciate the uncertainties and I appreciate it's unknowable.

But should we think about, as you say, the blanket approval coming in the next 12 months?

In the next three to five years?

How should we think about it just, broadly or directionally?

I don't think you're going to see broad reimbursements in the next six to 12 months.

I think that's unlikely.

Okay.

I appreciate there's a lot of ways to calculate utilization and a lot of numbers that go into it.

But just my rough back of the envelope, utilization per instrument declined sequentially in my calculations to 3.6 per system versus 3.8 in the second quarter.

But whatever the right numbers are, is this all seasonality?

Was it the procedure slowdown, or how do we think about that?

Yes, I'll take a shot at that, Rick.

This is Calvin.

Yes I think this really reflects the seasonality that we see typically every year around the summer months.

We have -- we continue to see increases in utilization when making the year -over-year comparisons to third quarter last year.

Okay.

And two last questions that are sort of follow-ups to some of the topics you discussed earlier.

The FD -- the comment on the FDA slower to approve, I just wanted to make sure I understood.

Did you expect some kind of approval for some instruments that didn't happen in the third quarter?

Was that the message, or was it just a more general message?

And last, just a little more color if you would be so kind.

I understand the stocking order issue I think, but the carryover from the second quarter, did that imply that people over bought disposables and didn't use them, and that was a factor related to the slowing procedures?

Just make sure I understand that point.

Thanks.

Marshall will answer the second one first and then I'll --

Stocking orders, no.

When someone buys a da Vinci system, they typically buy a bolus of instruments and accessories, and there were a number of those I think that fall over from quarter-to-quarter in any quarter, and it happened to be a little higher amount in Q3.

But it's not as though they built up a bunch of inventory in one quarter and now they're bleeding that into the next quarter.

It's just strictly the magnitude of the number of stocking orders that get done in any one quarter.

Okay, and the FDA question?

Yes, on the FDA, we're working with them now on single site.

I don't know that I'd say that we have an expectation prior, but the general comment is that we're seeing as a whole a greater number of questions and a slower turnaround time.

And that point of view has been shared around the industry.

So, thank you, that was our last question

Thank you.

While we focus on financial metrics during these conference calls, our organizational focus remains on increasing patient value by improving surgical outcomes and reducing surgical trauma.

I hope the following da Vinci surgery experience gives you some sense what this means in the lives of our patient.

Stephanie from California writes, "I silently suffered from excessive menstrual bleeding and cramping for years, which seemed only to get worse as each month passed.

At one of my quarterly repeat paps, I finally decided to speak up to the nurse practitioner in Dr.

Swanson's office because I felt like my periods were running my life and I couldn't handle it my more.

I have two teenagers and two toddlers and couldn't be limited to the bathroom for days out of the month.

The nurse practitioner gave me some literature to read about my different option and suggested that I make an appointment with Dr.

Swanson who has been my doctor over 13 degrees to discuss my concerns.

I read all the literature and did much research on my own and then saw Dr.

Swanson three weeks later and described my issues.

He basically said my options were to do nothing, which hadn't been working out well for me, hormone pills, ablation or hysterectomy.

"I had been on several different birth control pills in the past and they all made me nauseated.

Dr.

Swanson informed me that I would need a pretty strong dose, so that was not an option for me either.

As for an ablation, I read many complaints about women that had had the procedure done and stated that their cramping was now worse.

I already had bad cramps an spotting, so I didn't want to risk that.

Dr.

Swanson agreed that it was a possibility that cramping could worsen and suggested that I was a perfect candidate for a hysterectomy.

Not only would it relieve me of my excessive bleeding and cramps, it would also free me from my abnormal paps every three months.

Dr.

Swanson explained the procedure to me and thoroughly answered all my questions.

Finally, I felt some resolution was coming.

"In the weeks prior to my scheduled surgery, I did much research online and actually found many videos of hysterectomies done by da Vinci robot on You Tube.

I felt very prepared when my surgery day rolled around and on August 3, 2010 at St.

Agnes Medical Center in Fresno, Dr.

Swanson and the staff were fantastic.

Everyone made me feel relaxed and cared for.

The surgery went very well.

I had very little blood loss.

I was able to get up and walk around to the bathroom and around the hospital room within hours after the surgery.

My pain was minimal and really no more than some discomfort rather than real pain.

I stayed only one night in the hospital and was discharged the next morning.

My recovery at home was very quick.

I was back to my normal self within the same week as my surgery.

No pain, no cramps, no bleeding.

My only regret is not speaking to my doctor and having the da Vinci hysterectomy done sooner."

Patients like Stephanie are the strongest advocates for da Vinci surgery and form the very foundation of our operating performance.

We have built our Company to take surgery behind the limits of human hand, and I assure you that remain committed to driving the vital few things that truly makes a difference.

This concludes today's call.

We thank you for your participation and support on this extraordinary journey to improve surgery, and we look forward to talking with you again in three months

Ladies and gentlemen, that does conclude our conference for today.

Thank you for your participation and for using AT&T Executive Teleconference Service.

You may now disconnect.