直覺手術 (ISRG) 2013 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by.

Welcome to the Intuitive Surgical fourth-quarter earnings release.

(Operator Instructions).

As a reminder, this conference is being recorded.

I would now like to turn the conference over to our host, Senior Director of Finance, Mr. Calvin Darling.

Please go ahead.

Thank you.

Good afternoon and welcome to Intuitive Surgical's fourth-quarter earnings conference call.

With me today we have Gary Guthart, our President and CEO; Marshall Mohr, our Chief Financial Officer, and Patrick Clingan, Director of Finance.

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, including our most recent Form 10-K filed on February 4, 2013 and our Form 10-Q filed October 18, 2013.

These filings can be found through our website or at the SEC's EDGAR database.

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 and supplementary financial data tables have been posted to our website.

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

Gary will present the quarter's business and operational highlights, Marshall will provide a review of our fourth-quarter financial results, Patrick will discuss marketing and clinical highlights, and I will provide our financial outlook for 2014.

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

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

Thank you for joining us on the call today.

2013 was a challenging year for Intuitive.

Trends that emerged in the second quarter of 2013 continued through the balance of the year, including revenue uncertainties for United States customers due to pressure on gynecologic surgery broadly, the implementation of the Affordable Care Act, and confusion surrounding the public debate regarding some da Vinci procedures.

These factors resulted in the slowing of our growth in gynecology and a subsequent decline in the sale of systems in the United States.

The year also featured several strengths in our business.

Among them, the publication of several large studies supporting the clinical and economic value of da Vinci use.

We also experienced the acceleration of procedure growth in Europe and Japan, broad-based growth in general surgery procedures in the United States, and continued adoption of our new products worldwide.

I'll start with a review of procedures.

Year-over-year growth in procedures closed at 16%, led by growing use of da Vinci in general surgery in the United States, accelerating growth in the use of da Vinci outside the United States, and continued uptake in US gynecology.

General surgery growth in the United States was 93% in the year, including increased use of da Vinci in colorectal surgery and cholecystectomy using da Vinci Single-Site and Firefly, as well as growth in other general surgery procedures.

In the fourth quarter, general surgery overtook urology as the second largest category of da Vinci use in the United States.

Outside of the United States, procedure growth accelerated, rising 21% over procedures in 2012, based on strength in Europe and Japan.

We will review procedure trends in greater detail later in the call.

Looking at trends in capital sales for the year, procedure deceleration in the United States freed capacity on already installed systems.

Combined with a lack of visibility of revenue for our customers due to pressure on gynecologic surgery and the Affordable Care Act, US capital sales fell for the year.

Outside of the United States, our capital business in Europe and Asia performed very well with international systems revenue growing 59% over 2012.

Investments in Europe have yielded solid results, and we expect to continue to grow our European team given the large opportunity we see for da Vinci use in several procedures and countries.

As we have mentioned on prior calls, sustained growth in our business in Japan depends upon approval for reimbursement for additional procedures, which is targeted for the 2016 revision to national insurance coverage.

Until additional procedure reimbursement is received in Japan, capital sales are likely to be constrained and to varying timing.

The combination of gynecology trends and the ACA implementation in the United States and uncertainty of future capital purchases in Japan creates difficulty in revenue forecasting for at least the first half of 2014.

Calvin will take you through our view of 2014 later in the call.

Our product launches proceeded well in 2013 and reflect the growing segmentation of our business.

The combination of enabling technology, procedure opportunity, and aligned economics is important.

In the higher volume benign segment we serve, our Single-Site kit of instruments and accessories are being used increasingly for hysterectomy, as well as cholecystectomy.

We plan on rolling out our Single-Site kit for hysterectomy more broadly in 2014 and are working on a wristed Single-Site needle driver to augment our existing offering.

We anticipate submitting the wristed Single-Site needle driver 510K in the first half of 2014.

In 2013, we received a biliary visualization indication for our Firefly Fluorescence Imaging System in the third quarter, enabling enhanced visualization of anatomy during cholecystectomy.

Firefly use in biliary imaging grew nicely in the fourth quarter.

Turning to products used for procedures typically performed for an open incision, our focus has been on creating products that improve visualization, precision and control for surgeons performing these procedures.

Taking colorectal surgery as an example, open colorectal surgery is hard on patients with high complication, morbidity, and readmission rates compared with minimally invasive surgery.

We now offer colorectal surgeons the combination of wristed vessel sealing, wristed stapling, and Firefly perfusion imaging.

The combination of these technologies with the base capability of da Vinci is powerful and enabling minimally invasive colorectal surgery for a larger patient population.

Looking at each product individually, our Vessel Sealer was cleared for use in Korea in Q3 and Japan in Q4 of 2013, and feedback from general surgeons and gynecologists has been positive.

We are also pleased with the performance of our da Vinci Stapler in 2013 with outstanding feedback from customers on its clinical performance, easy-of-use, and smart plant feature.

We expect most use of our current stapler to be in colorectal procedures.

We are currently expanding our rollout of the stapler to general surgery customers in the United States.

A brief aside, you may have seen a press release yesterday by Luna Innovations announcing our acquisition of their shape-sensing business for medical use.

We have worked with Luna for several years and believe this sensing technology and the team that invented it represent a foundation for new types of flexible mechanisms that can augment or extend our products.

This is part of a long-term effort by Intuitive to innovate in reducing invasiveness in the access to the body, and we do not expect it to materially impact our business in 2014.

Looking back at the full-year 2013, our operating performance was as follows.

Worldwide procedures grew by approximately 16%.

We sold 546 da Vinci Surgical Systems in the year, down from 620.

Total revenue grew to $2.265 billion, up 4% over 2012.

Recurring revenue grew to $1.430 billion, up 15% and comprising 63% of total revenue.

We generated $1.021 billion in operating profit before non-cash stock compensation expense, down 1% from last year.

GAAP net income grew to $671 million, up 2% year over year, and we reduced our shares outstanding by repurchasing 2.6 million shares during 2013.

Finally, we generated $880 million in cash flows from operations, ending the year with $2.8 billion in cash and investments.

Turning to our operating performance for the fourth quarter.

Procedures grew approximately 12% over the fourth quarter of last year.

We sold 138 da Vinci Surgical Systems, down from 175 in the fourth quarter of 2012.

Total revenue for the quarter was $576 million, down 5% from the prior year.

Instrument and accessory revenue increased to $268 million, up 6%.

We generated an operating profit of $250 million in the quarter before non-cash stock option expense, down 13% from the fourth quarter of last year, and GAAP net income decreased to $166 million, down 5%.

In 2013, we opened two new technology training centers in the United States, one at our headquarters in Sunnyvale and the other in Atlanta.

We ended the year with 2792 members on our team and anticipate growing our organization in specific areas through 2014, with a particular emphasis on Asia and Europe.

Before reviewing our priorities for 2014, I'll take a moment to touch on our mission.

In the face of near-term pressure and scrutiny, our commitment to our mission to fundamentally improve surgery remains unshaken.

Around the globe, surgery for many complex conditions is still conducted through an open incision, with serious risks of complications, morbidity, mortality, readmission, and prolonged recovery.

Despite their long availability, conventional MIS technologies are difficult to apply to some patient populations, and the advanced skills required to use them for complex procedures are hard to master.

da Vinci has overcome these limitations for our targeted procedures with proven results.

Furthermore, today's minimally invasive surgery still leaves room for improvement in outcomes, predictability, recovery, and economics.

Taken together, these opportunities are the focus of our current and future product development efforts.

Our team has weathered 2013 well and is fully engaged in the challenge of providing tools that improve the experience of surgery for those who need it.

Looking to 2014, our priorities are as follows.

First, we will focus on the expanded use of da Vinci in general surgery, particularly colorectal surgery and single incision surgery.

Second, we will support growth of da Vinci use in gynecology and neurology worldwide.

Third, we will broaden our stapling and Single-Site lodges, including the planned introduction of the wristed Single-Site instrument, and finally, we will continue to strengthen our capabilities in international markets, particularly Europe and Japan.

Before passing the time over to Marshall, I would like to take a moment to thank Aleks Cukic for his outstanding service to this group.

Aleks will continue to work with the Company in an advisory capacity, but will no longer join us on these calls.

We welcome Patrick Clingan to this role.

Many of you know Patrick already, and he has ably represented us.

With that, I turn the call over to Marshall who will review financial highlights.

Thank you, Gary.

Our fourth-quarter 2013 revenue and procedures were consistent with the press release issued on January 14.

Fourth-quarter revenues were $576 million, down 5% compared with $609 million for the fourth quarter of 2012 and up 15% from last quarter.

Procedures for the fourth quarter grew approximately 12% compared with the fourth quarter of 2012 and approximately 8% compared with last quarter.

Procedure highlights will be covered by Patrick.

Revenue highlights are as follows.

Instrument and accessory revenue grew 6% compared to the fourth quarter of 2012 and 12% compared to the third quarter of 2013.

The increase relative to the prior year reflects procedure growth in sales of new products, including Single-Site, Vessel Sealer, and Firefly, partially offset by lower instrument and accessory stocking orders associated with fewer system sales.

The change from the prior quarter reflects procedure growth in the sales of new products.

Instrument and accessory revenue realized for procedure, including initial stocking orders, was approximately $1930 per procedure compared with $2050 in the fourth quarter of 2012 and [$1060 -- $860] last quarter.

The decrease from the prior year reflects fewer stocking orders associated with fewer system sales, partially offset by new product sales.

The increase from the prior quarter primarily reflects new product sales and the timing of customer orders.

Systems revenue of $205 million decreased 23% compared with the fourth quarter of 2012 and increased 29% compared with the third quarter of 2013.

The decline in systems revenue primarily reflects fewer system sales in the US, partially offset by higher system sales outside of the US.

In the US, we sold 72 systems in the fourth quarter compared with 133 systems in the fourth quarter of 2012 and 66 systems in the third quarter of 2013.

The decline in US system sales relative to the fourth quarter of 2012 reflects the impact of lower procedure growth, spending uncertainties associated with the Affordable Care Act, and confusion surrounding the public debate regarding some da Vinci procedures.

The increase relative to the third quarter of 2013 reflects seasonality and increased sales of our SIE product.

As benign procedures are becoming a larger portion of our procedure mix in the US, we are experiencing demand for lower-cost systems for use in reimbursement-sensitive benign conditions in patient settings.

As a result, we sold 20 SIEs with prices between $1 million to $1.2 million, depending on their configuration.

Globally, our system ASP of $1.455 million declined relative to the third quarter system ASP of $1.556 million.

The decline reflects a higher proportion of SIE systems in the US, partially offset by geographic mix and a higher mix of dual console systems.

In the fourth quarter, we sold 38 dual console systems compared with 32 systems in the third quarter.

Outside the US, we sold 66 systems in the fourth quarter, including 28 into Europe and 21 into Japan, compared with 42 into international markets in the fourth quarter of 2012, which included 24 into Europe and 10 in Japan and 36 systems in the international markets in the third quarter of 2013, which includes 17 into Europe and 13 into Japan.

Fourth-quarter system sales also included eight into Korea, seven into Italy, five into France, and seven into the Nordic countries.

Moving on to the remainder of the P&L, gross margin in the fourth quarter of 2013 was 69.1% compared with 71.9% for the fourth quarter of 2012 and 71.5% for the third quarter of 2013.

Our lower margin percentage reflects expensing certain system production costs in light of lower system unit production.

Fourth-quarter 2013 operating expenses of $189 million were approximately the same as the fourth quarter of 2012 and were up 4% compared with last quarter.

Our fourth-quarter 2013 operating expense compared to 2012 operating expense reflects headcount additions offset by lower incentive compensation and lower R&D prototype expenses.

Our increase compared the last quarter was driven by higher R&D prototype costs, severance costs, and increased headcount, partially offset by lower stock compensations cost.

Our effective tax rate for the fourth quarter was 22.5% compared with 30.5% for the fourth quarter of 2012 and 12% last quarter.

The third quarter of 2012 tax rate benefited from the release of reserves specific to tax years where the statute of limitations have now expired.

The fourth quarter of 2013 rate benefited from a greater proportion of our pretax income coming from outside the US where our tax rates are lower.

Our net income was $166 million or $4.28 per share compared with $175 million or $4.25 per share for the fourth quarter of 2012 and $157 million or $3.99 per share for the third quarter of 2013.

Excluding one-time tax benefits, our third-quarter 2013 net income would have been $131 million or $3.32 per share.

An important measure of our performance is cash flow from operations.

We define cash flow from operations as net income excluding after-tax non-cash compensation and amortization of intangible assets.

We will refer to this as non-GAAP net income.

For the fourth quarter of 2013, we generated $193 million in non-GAAP net income or $4.98 per share compared with $205 million or $4.99 per share for the fourth quarter of 2012.

For the year ended December 31, 2013, we generated $795 million in non-GAAP net income or $19.83 per share compared with $777 million or $18.91 per share last year.

We will be providing the statistic to you going forward.

We ended the year with cash and investments of $2.8 billion, up $222 million compared with September 30, 2013.

This increase was primarily driven by net cash provided by operating activities.

During the year, we repurchased 2.6 million shares for $1.1 billion at an average stock price of $429 per share.

As of December 31, we still have $1 billion of share buybacks authorized.

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

Thanks, Marshall.

Q4 year-over-year procedure growth was approximately 12%, which was led by US general surgery and international procedures.

In the US, general surgery was paced by cholecystectomy, colorectal resections, and a wide variety of emerging procedures, reflecting the broad-based interest in da Vinci surgery among different subspecialties within general surgery.

US urology continues to show signs of stabilization as modest declines in DBP were nearly offset by growth in treatments for kidney cancer.

As expected, the growth rate for US benign GYN procedures was down from Q3, which continued to place pressure on US system sales.

Q4 international procedure growth of 23% was led by urology with contributions from GYN and general surgery.

DBP uptake in Europe and Japan was robust, accelerating in the back half of 2013.

During the fourth quarter, international DBP volumes surpassed US DBP volumes, despite representing approximately 30% penetration in key developed markets.

Earlier this month, the UK National Institute for Health and Care Excellence published an update to its 2008 clinical guidelines on prostate cancer, which recommends consideration of robotic surgery in the treatment of prostate cancer.

The recommendation also states that surgical treatments of localized prostate cancer are cost effective by basing them in centers that are expected to perform at least 150 procedures per year.

As Gary mentioned, our US customers are increasingly segmenting our business between less complex benign and complex for cancer procedures, and we are pursuing strategies to realize the opportunities for the new segments.

The adoption of da Vinci surgery in less complex benign procedures has changed our procedure mix, growing from approximately 40% to approximately 60% of our US procedures over the past three years.

In order to provide solutions for customers to address lower reimbursements and alternate sites of care, we have launched products such as Single-Site and SAE.

Single-Site instruments are lower cost, enabling us to offer the advantages of robotic surgery at a lower instrument price.

The addition of a wristed needle driver to the Single-Site product family will optimize this technology for additional procedures, beginning with benign hysterectomy.

Single-Site surgery provides an alternative to traditional approaches for procedures that are largely being performed in a minimally invasive manner.

However, the push by robotic surgeons into less complex benign procedures is not simply about patient choice, but the potential for safer outcomes.

Following our September 510-K approval of Firefly for biliary imaging, we have witnessed acceleration in the adoption of fluorescence imaging during da Vinci cholecystectomies as Firefly enables visualization of the biliary anatomy that cannot be seen under white light.

During the fourth quarter, Firefly was included on 80% of the US SIE systems licenses.

While the available capacity on our existing installed base has served as a headwind to 2013 system sales, not all capacity is in the right location.

This industry-wide shift in surgery from inpatient to outpatient settings has led some hospitals to pursue robotic surgery in an outpatient setting.

We believe our SIE platform is suited to meet the needs of these hospitals.

At the other end of the spectrum, we believe the value proposition and evidence-based supporting conversion of complex and cancer surgeries from open to MIS is growing increasingly clear.

Traditional minimally invasive tools have attempted to make inroads into these procedures for decades, but the technical complexity and challenging patient anatomies has limited adoption.

We believe da Vinci surgery represents an evolution in minimally invasive technology that can expand MIS more deeply into a number of traditionally open procedures.

Given the high value we bring to converting complex open surgery to MIS, we are seeing increased global interest in our fully featured systems and advanced instrumentation.

Vessel sealing and stapling technologies are important tools for colorectal surgeons, and with our stapler entering full launch mode in the US, we believe we are well suited to drive adoption in colorectal resections.

Globally, there are more open colorectal resections than prostatectomies and malignant hysterectomies combined, and we believe our vessel sealing, stapling, and Firefly technologies bring a powerful tools to enable deeper penetration of MIS into colorectal surgery.

During the quarter, we continue to see growth in peer-reviewed publications, highlighting robotic surgery in a number of journals.

I'll take a moment to highlight just a few.

Dr. Davids from M.D. Anderson offered a multi-institution database study in the December issue of Journal of Endourology that evaluated over 71,000 prostatectomy patients from 2004 to 2010.

This paper shows da Vinci surgery has a shorter hospital stay and lower rate of complications compared to open surgery, even for surgeons in their initial 25 procedures.

We believe these outcomes reflect the value created by the totality of resources available for safely training sessions on da Vinci.

Turning to GYN and specifically benign hysterectomy, while near-term ACA implementation creates some uncertainty among our customers, this study supports how da Vinci surgery aligns with the underlying principles of healthcare reform published in the October version of the Journal of Minimally Invasive Gynecology.

Dr. Martino and colleagues from the Lehigh Valley Health Network presented results covering more than 2500 benign hysterectomies because all four surgical modalities -- robotic, laparoscopic, vaginal, and abdominal.

The authors concluded that da Vinci benign hysterectomy had a statistically significantly lower rate of 30-day readmissions, as well as reduced blood loss and length of stay compared to the other three modalities of care.

Moving back to urology, a national database study of approximately 5500 prostatectomy patients was published by [Dr.

Pileggi] from Northwestern in the November Journal of Endourology.

This study reported statistically significant results that favored robotic surgery, including a total complication rate of 6% for da Vinci versus 23% for open surgery, a surgical complication rate of 1% for da Vinci versus 3% for open surgery, and a readmission rate of 3.5% for da Vinci versus 5.5% for open surgery.

These results came at the cost of an additional 38 minutes of operative time for da Vinci.

Finally, we will conclude with a large national database study on colon resection.

Originating from [Dr.

Juo] and colleagues at Johns Hopkins who studied 244,000 US surgeries from 2008 to 2010, this paper published in the December edition of JAMA showed that minimally invasive colon resections offered lower mortality rates, lower complication rates, shorter length of stay, and reduced costs compared to open surgery.

Robotic surgery represents less than 1% of the colectomies performed in this data set.

When comparing this small cohort to laparoscopy, there were two statistically significant outcomes in favor of robotics -- reduced hospital stay and lower conversion rate -- while costs statistically significantly favored laparoscopy.

The authors concluded that robotic surgery was similar to laparoscopy with a higher cost, but noted that less than 50% of colon resections within this study were performed laparoscopically in 2010.

The authors could not include rectal resections in the study, which are notably absent given a higher proportion of open surgery.

We encourage you to look closely at the underlying data and consider the opportunity for da Vinci surgery to expand MIS for colon resections as adoption grows among colorectal surgeons.

Please visit the Clinical Evidence section of our website to learn more about these and other publications regarding da Vinci surgery.

Thank you for your time, and I will now turn the call over to Calvin.

Thank you, Patrick.

I will be providing you with our financial outlook for 2014.

Starting with procedures.

In 2013, total da Vinci procedures grew approximately 16% to roughly 523,000 procedures performed worldwide.

We exited 2013 with fourth-quarter procedures up approximately 12% versus the prior year.

During 2014, we anticipate a stabilization of the procedure growth rate with the full-year procedures growing within a range of approximately 9% to 12%.

Based on an increasing proportion of benign procedures in our procedure mix, we anticipate a more pronounced quarterly seasonality impact in the upcoming first quarter of 2014.

Moving to revenues, as has been discussed earlier, several factors are pressuring our business, making it difficult in the near-term for us to predict system sales volumes and, as a consequence, total revenue.

As we enter 2014, our visibility into system sales is challenged by the breath of the range of our procedure growth forecast.

As a reminder, procedures drive capital sales and the relationship between procedure growth rates and capital sales is highly sensitive.

Economic pressure and uncertainty at hospitals associated with the implementation of the Affordable Care Act, evolving utilization patterns, and point of care dynamics as described by Patrick early in the call, and likely variability in the timing of Japan's system sales given the time until additional procedure reimbursement anticipated in 2016.

Given our capital sales performance in the back half of 2013 and the persistence of some of the issues described above, it is likely that we will sell fewer systems in 2014 than the 546 systems sold in 2013.

Due to limited visibility regarding the capital side of our business, we will not be providing revenue forecasts at this time.

As we gain greater visibility, it is our intention to reinstate revenue guidance.

We believe deeply in our ability to fundamentally improve surgery and are pursuing plans to increase the use of da Vinci enabled MIS around the globe.

As a result, 2014 will be a year of increased investment for Intuitive Surgical, even during this upcoming period of capital sales uncertainty.

We will be building our international capabilities, investing in new product development, and pursuing growth in both of our procedures businesses segments.

In 2014, we plan to grow our operating expenses roughly 12% to 15% above 2013 levels.

We expect our non-cash stock compensation to range between $180 million and $190 million in 2014 compared to $169 million in 2013.

We expect other income, which is comprised mostly of interest income, to total between $15 million and $20 million in 2014.

With regard to income tax, we expect our 2014 income tax rate to be between 25% and 28% of pretax income, depending primarily on the mix of US and international profits.

This forecast does not assume the reinstatement of the R&D tax credit in 2014.

Our share count for calculating diluted EPS in Q4 2013 was approximately 38.8 million shares, declining 500,000 shares in the quarter, primarily due to the full quarter impact of Q3 buybacks.

Our actual Q1 and fiscal year 2014 share count will depend on several factors, including the magnitude and timing of any additional share buybacks.

That concludes our prepared comments.

We will now open the call to your questions.

Thank you.

(Operator Instructions).

Tao Levy, Wedbush.

Yes, hello.

Good afternoon.

So a couple questions on my end.

Obviously, the decision not to provide full-year guidance leaves us a little bit, not necessarily confused, but struggling to figure out where our numbers should end up this year, especially given all the volatility.

Would you maybe comment on the comfort that you feel around where consensus is at this moment in terms of your topline, or do you want to stay away from that type of guidance?

It is not clear where consensus will wind up, so I think trying to project where that will go I think is probably not worth speculating on the call.

I think we laid out the underlying dynamics that had reduced near-term visibility through the script pretty well, and if we had greater visibility on that, we would share it with you.

I think that looking out at what the inpatient admissions will be for the benign procedures we serve and what those dynamics will be has been moving around, looking at how hospitals model their revenues in the face of ACA and that benign segment that we operate in and then trying to predict what Japan will do.

We have an operating plan.

We understand what we are going.

We are disciplined about what we expect to do in terms of activity, but there's a wide range.

And so rather than speculate, I think this is where we are.

Okay.

And I think at the beginning of the script, you'd mentioned that there was more concern around the first half of the year, specifically on capital system placements.

Is there something that happens in the middle of the year, back half of the year, that, you know, again, would get you more comfortable?

I don't think it's an event.

I think more around, as we see how patient flows are going to our customers, they'll have a better view, and as their view improves, our view improves.

I think it's really as simple as that.

Okay.

And just lastly, maybe you can talk a little bit about the profitability of the SIE system versus the SIE, just given that that's becoming a bigger part of your mix?

Thanks.

Here, I'll ask Marshall to take you through a little bit of what that framing looks like, and my only comment before he jumps in is beware of averaging.

There's now multiple products in the line, and the average is not necessarily predictive of what's going on underneath.

So, as I said in the call, the average pricing that we received for SIEs was between about $1 million and $1.2 million depending on the configuration.

That's obviously lower than a SI with four arms.

The SIE, though, is -- does only have three arms, and so it does not cost the same amount of money to produce.

The gross margins are several points below -- 6 to 7 points below what they are for SIE systems.

But if it's able to open up benign procedures for us, particularly in outpatient settings, we are all for it.

Thank you.

Tycho Peterson, JPMorgan.

Hey.

Thanks for taking my question.

Maybe just following up on the last one, what should we thinking about in terms of our run rate for SIE placements, and maybe could you also just touch on your pricing assumptions that you're thinking about for 2014 overall?

So we really have -- if you go back, we sold three in the first quarter, two in the second quarter, two in the third quarter, and then we sold 21 total.

There were 20 in the US.

21 total.

That's an -- to me, that's one quarter of success in selling it at a -- to customers that are looking for a lower cost system for benign conditions.

I think -- I don't have enough data to really predict exactly how many I'm going to be selling every quarter, so I'm not going to go there.

And then can you comment on your pricing assumptions for 2014?

Yes, I assume you mean the system pricing assumptions, and like Gary said, here it's really important to be aware of the averages.

If you look at it overall, our ASP was about $1.5 million in both the full year of 2012 and 2013, and in Q4, our ASP declined to $1.455 million as we saw this significant increase in the lower-priced three-arm SIEs.

As you know, these SIEs are targeted towards a growing procedure segment of Single-Site and less complex procedures, and in 2014, we will remain focused on growing this procedure category with more SIE system sales.

But also as was mentioned, at the same time, the proportion of the higher featured dual console and Firefly systems also increased in 2013, and furthermore, the systems that went in Japan in strong numbers were higher.

So I guess the point of it is, going forward, the ASPs will potentially vary more significantly quarter to quarter based upon this broader pricing mix.

And I'll just pull short of trying to guess which way it's going to go.

One comment I guess I'd add and a little clarity there is I don't think within each subsegment, the ASPs are going to fluctuate that much.

It's the mix of those subsegments that makes the prediction hard.

Okay.

That's helpful.

And then on Japan, it sounds like we should assume that you had a bullish placement here, and then that's going to slow a little bit.

Is that the right way to be thinking about it for 2014?

The timing of it is very hard to predict, but we have 2014 and 2015 before the next round of broad national reimbursements.

There may be hospitals that get individual exemptions to collect data, but broadly, there will be some time.

And so figuring out how much absorption there will be in Japan over that two-year period is just very hard to model.

And so what the timing looks like is hard to predict.

But over time, I think it's going to be constrained until -- directionally, I don't think you'll keep selling systems at a very high rate until that constraint is broken with reimbursement.

And then last one, you talked about we're having to reinvest a bit this year.

You had a small headcount reduction at the end of last year.

Maybe just should we be thinking about headcount being up and talk maybe a little bit more specifically if you can on where those investments are being made?

Do you need to build the channel to the ambulatory market, for example?

Yes, good question.

So we had a small reduction in our US sales force at the end of the year.

It was about 50 people.

Just for those who may be listening that haven't heard this conversation, we had a team that had grown that was layered on top of our main force that was designed to pursue gynecology.

As gynecology has matured in US, they were, in a sense, double serving those accounts, and so we folded them back into the main force.

So that was 50 out of a commercial force of about 800.

We anticipate growing forward in the year in a few places.

Europe, we continue to see investment in our organizations there.

In Asia, more broadly, we will invest in that opportunity in our channel there.

In the US, in product development, we will continue investments and in -- other parts of our operations.

So I think headcount growth will continue through the year.

It won't be a sharp increase, but I think it will be targeted where we need it.

With regard to how we discuss opportunities with hospital customers in terms of site of care, we think our capital sales team is well-positioned to start the year here to have those conversations.

Thank you.

David Roman, Goldman Sachs.

Thank you and good afternoon.

I also wanted to point out that it's very helpful -- all the additional disclosure you're giving on the website.

I know it takes time to add that altogether, so thank you for that.

So I guess on my question -- I wanted just to take a step back for a second.

As you look at the overall US market and what's transpired this year, I guess in some ways when I look at the trends in capital, that this could have happened at any point in time as procedure volumes slowed because what I'm trying to reconcile is that you had a modest slowing in procedure volumes but a very significant drop-off in capital.

So I am just wondering if you can talk about why we shouldn't think that there's overcapacity in this system and that you penetrated just a large segment of the addressable market here and that there's going to be sort of a normalization period until procedure volume picks back up?

Let me start, and Calvin, you can jump in.

I think a couple of things.

Underlying capital sales are really three factors, and you've hit on a couple.

Well, one of them is procedure capacity, and that's a highly sensitive element.

So that just a percent change in procedure growth rate can free about 20 systems worth of capacity give or take, not an exact number.

So there is a high sensitivity there since capacity is highly sensitive to pursuit of growth rate.

That's one element.

The second element is, do hospital customers feel they have the right technologies to pursue the opportunity that's in front of them?

So if they have an S system and they want to pursue colorectal or Single-Site, then there is an upgrade opportunity for them to move up into SI.

And then Patrick pointed out in his section that not always -- the systems are not always in the same operating rooms.

So that if hospitals are doing benign procedures in a different point and ambulatory surgery environment costs alone, it's not the same set of oars.

So while they have capacity in one place, it's not necessarily in the right place.

And so those three things are underlying what happens, and one of them, highly sensitive procedure volume, the other two, one is sensitive to technology, one is point of care.

Calvin?

Yes, I mean I don't have much to add to that other than just to acknowledge that prior to 2013, we had really a long standing history of gradually increasing utilization per system.

And it is true that, based upon the issues that we described, we had a modest decrease in utilization -- average utilization and again, beware of averages, in 2013.

But, again, capacity is really just one of the factors involved in system acquisitions by hospitals.

But then, and to finish the thought, to acknowledge your question, I think our procedures are the number one.

Of the three things, procedures are very important, and procedure growth rate is important, and it's something we're focused on.

Okay.

That's helpful.

Then maybe just a follow-up, as you sort of think about the operating profile of the business from a profitability standpoint, I know you've talked a lot about being focused on topline growth, and while your margins have come down, they are still very high, particularly on a cash basis.

Can you maybe just talk about how you're thinking about P&L leverage versus efforts you are undertaking to restimulate topline growth?

And I would assume that at this point resumption of topline growth is a priority and that you have financial levers to help protect earnings, or am I not thinking about that the right way?

I'll start and Marshall can chime in.

I think the first thing is we will manage the business for the long-term.

And we will look around and say, our mission, our mission of the Company, and the way we ought to be evaluated is are we satisfying the mission of improving surgery in the areas and markets that we can do that, and I think there's a lot of opportunity for us, and we will pursue that.

Fiscal discipline is important, and I think it's important in two ways.

One is spending discipline is important, so make sure that we're careful about where we spend.

And investment discipline is important.

In this period of time, we will invest.

We'll invest in a disciplined way, but we think that the opportunity ahead of the Company to make surgery better is substantial, and we are in a great position to do it.

And I think pulling back that set of investments in the face of some near-term uncertainty would not be in the long-term interests of the Company.

So that's how we look at it.

In terms of operating levers, there is sort of near-term and long-term, and I'll let Marshall talk to that.

Some operating levers are already certain.

They operate on their own.

What I mean by that is a large portion of our cost base is variable.

It varies with revenue.

So even in the SG&A category, a large portion is commission based.

And so as revenue fluctuates, so does the amount of costs that we have and -- but otherwise, I think Gary sort of outlined some of the other things.

I think that we have some levers, but we're going to continue to invest in our future.

I got it.

Thank you.

Ben Andrew, William Blair.

Good afternoon guys.

It's actually Margaret this time.

Thanks for taking the questions.

Gary, if we look at the opportunity in colorectal in 2014 and as you kind of look at the current system and the current toolset, do you think that can get you to the procedure growth so at least you are modeling internally.

It's not getting to us.

And then how do you view the rate of penetration in general surgery over the next several years and 2014?

Is it going to be similar to DVP, DVH, or slower?

Any clarity would be helpful.

Well, I'll speak to the first one.

The second question has several moving parts.

On the first one, we think that the set of Vessel Sealer, stapler -- as you know, stapler as a whole marketplace is quite broad in terms of the number of sub products you need in a stapling family.

Our first offering is targeted at colorectal, and feedback on that has been great, and then perfusion imaging with Firefly, those three things together combined with da Vinci is really powerful and a great starting point.

It will not be the last set of things we do in general surgery, but we think it's powerful, and I think that it is in a good position to power the early growth that we are seeing in colorectal surgery here and later in markets outside the United States.

In terms of what that looks like for total colorectal as a whole, I think we're early in the adoption, but I think we'll have a real opportunity for growth there.

You had said how do we think about general surgery growth rates as a whole, and I'll give you one framework that I think is important is we have gynecology and urology as precedents.

In urology, prostatectomy was really the lead procedure, and there are just a few procedures that followed it, like kidney cancer treatment and partial nephrectomy bladder cancer treatment and cystectomy.

So it was not a huge broad set.

Gynecology is little bit broader, but hysterectomy was really the leading growth engine and then some other procedures behind it, myomectomy and sacrocolpopexy, pelvic floor reconstruction.

General surgery does not quite have that same structure.

There are some specialties that are quite broad.

So you have colorectal subspecialty.

You have [forga] procedures.

You have bariatric surgery.

What the folks do in academic centers is quite different than what they do in community centers.

So the category as a whole is going to be the sum of adoptions in different places.

The sum of adoption in Single-Site, the sum of adoption in colorectal, and those are really different.

Single-Site is largely done in community settings.

Cholecystectomies are.

Colorectal procedures are largely concentrated in cancer hospitals.

And so those different growth rates, they differ.

How they add up I think is a little bit harder to predict.

Patrick or Calvin, anything you'd like to add?

Is there something on the learning curves that can maybe speed that up as you come out with kind of new add-ons, toolsets, and so on to help drive general surgery?

I think that the new instruments that we are bringing in, I think the broadening of the launch of stapling and use of Firefly, those are enabling technologies.

They speed the efficiency of the procedure, and they allow a better workflow, and so I think that's helpful.

The investments we have made in our training centers are really to make for easy access for learning surgeons that have access to resources.

And I think that's been a good investment for us, and that can help the investments we've made in simulation and access to simulation are other things that I think help.

And, you know, we're really happy and feel that the Davis study is important in showing that the totality of learning resources for surgeons, not just what Intuitive does, what proctors do, what advanced coursework does, has resulted in great and safe adoption of new technology, and I think that's a powerful message and likely to be repeated in other disciplines beyond just prostatectomy.

Okay.

And then on the gynecology side, you guys are clearly fairly well penetrated in hysterectomy and kind of some of the other ancillary procedures, [miles] and the sacros.

But how should we think about that as a category now that it's over 50% penetrated?

Should it materially slow in 2014, gradual changes?

And then could Single-Site actually become quickly material?

Thanks.

A fair question.

I think -- and you know this well, I know your team knows this well, but once you are on these adoption curves, the year-over-year growth rate falls.

That's just the nature of those adoption curves.

So on the multi-forward side, I would expect that it continues in the US, that there is a continued deceleration, the pace of which will be hard to predict and we'll see.

Hysterectomy -- Single-Site hysterectomy is an opportunity.

We're early in that opportunity.

We've been in limited launch.

The limited launch has gone very well clinically, and it's gone really well from uptake in the way surgeons who are being trained have adopted it.

We are adding some instruments into that kit, bringing back some wristed instruments that will, we think, optimize the procedure and give surgeons a little more flexibility in approaching tissue, and we are working through those things.

I think that's a well-known pathway for us, and we think that will help.

That's still early.

We're not into a full very broad launch there, although we have broadened the launch from its earlier days really starting in the fourth quarter and continuing through here.

So I think that launch will open up through to Single-Site hysterectomy, and we'll continue to report on it to you as to how we progress.

And I would just add, we still feel we have a significant opportunity here in women's health, specifically hysterectomy on the more complex multi-forward side.

There are over 100,000 women now who are still having open hysterectomies in the United States where we think our technology can improve their outcomes.

And then we're very early on the less complex side on our Single-Site offering where there's something like 200,000 laparoscopic and vaginal procedures that perhaps we would have a place there.

Great.

Thank you.

Bob Hopkins, Bank of America.

Hello, thanks.

Good afternoon.

Can you hear me okay?

Great.

So just a couple on the guidance.

I heard your comments about operating expenses for the year, but I was wondering if you had any comments on gross margins, both as it relates to 2014, and then given some of the changes in the customer mix longer-term, just any longer-term thoughts on gross margin as well?

So, again, for 2014, and then longer-term, any thoughts on gross margin?

Yes, I think you saw in the fourth quarter, there were some points that were mentioned.

First off, the margin -- the gross margin was impacted by lower production volumes, which when you divide some of the manufacturing costs by fewer units of production, that has a negative impact on margin, and so you saw that.

Could that be a continuing headwind to some extent?

I would say yes.

Then, beyond that, you come down to some of the product mix discussions on gross margin that I think we're not predicting how much it's going to be, SIE versus a forearm SI, geographic.

I think it's too many moving parts to make a prediction there on that.

You know, I think you had asked kind of a longer-term question -- directionally how do we think about it?

And I think as we look at the opportunities and we talk about segmentation of the business, we want to match the clinical and technical capability of the products we bring.

The procedure opportunity and underlying economics of those procedures together.

And we think we have opportunities to do that, and we think it's really in the best interest of the Company to do it.

I think we can get to an attractive margin profile in both segments.

Some of that is near term, and some of that is long term in terms of investments and product, and so we will do that.

And then on the decision on the revenue guidance or lack thereof for 2014, I just want to ask a little bit about that.

Because you guys have always been so adamant about saying that system sales are driven by procedure volume, and you're willing to give procedure volume numbers, but not some thoughts on system sales.

And so I was wondering if there's anything sort of different in that relationship going forward?

In other words, we have historically assumed that utilization just has to go up, and that's the way we've tried to predict your system sales.

Is there something unique about 2014 that would cause that relationship to bifurcate further?

Do we need to assume much greater utilization than we've been seeing in the past in terms of increases, and again, just want to ask about that because you guys have been so adamant about the correlation.

I just -- maybe start -- two ways to think about it.

I think the first one is the range and procedure guidance is pretty broad relative to the base, and because system placements are sensitive to that range, that's a multiplier on the uncertainty.

That's one.

The second one is that it may be that utilization trends differ over time just because of point of care, as Patrick had mentioned pretty clearly, and because hospitals may look out and say I want clear capital utilization of what I've got.

And I'm willing to make some compromises in convenience to get that.

We may see those two different things that work against each other and so how that plays out.

What I'd say on that second half is that those changes are unlikely to switch on a dime because they're operational in nature.

You have to move.

You have to adjust hospital operations to make it happen.

So that may happen, but I don't think that happens the day after tomorrow.

I think that's something that would play out in time.

(multiple speakers) To add to what Gary said, you're right.

We do believe that procedures will drive systems in the long-term, so there's going to be short-term fluctuations in capital sales.

But overall, long-term, particularly in mature markets, you're going to see capital sales catch up or fall behind -- will catch up over time.

Having said that, in nascent markets like Japan, which also causes our overall utilization statistic to fluctuate, we're selling systems ahead of procedures, and so that one is more difficult to predict.

And then lastly, you guys have again talked about the opportunity for outpatient and more benign type procedures.

Can you help us think about how big of an opportunity that might be for the Company?

I assume today sales into outpatient surgery centers and centers like that are pretty minimal.

So have you guys given much thought to how big an opportunity that might be?

You know, as always, we start with procedures and work our way back rather than thinking about outpatient operating rooms and working our way forward.

And so Calvin or Patrick can speak to it.

Yes, so if you look at where most of the outpatient surgeries are performed, it's in a hospital outpatient setting.

So either within the four walls of the hospital or in an adjacent ambulatory care facility, but the predominance of them are, in, fact channels as opposed to the physician-owned freestanding facilities.

Thank you.

We have time for one more question.

David Lewis, Morgan Stanley.

Good afternoon.

Thanks for fitting me in.

Gary, I wonder if you could just talk qualitatively about procedures in 2014.

I'm assuming the two biggest dynamics driving procedure deceleration is one, obviously still very rapid growth in general surgery, but maybe slowing up a larger base, and then hysterectomy, either that's deceleration or stabilization.

I wonder if just very broadly, you could help us understand those two buckets?

Can general surgery hold its growth rate trend line based on a further or broader launch in the minimally invasive in colorectal, and do you expect DVH to hold its trendline, slightly decelerate, or potentially even improve in 2014?

Yes, I'll start with hysterectomy.

I think that the underlying disease state is not changing in the US.

I don't see any rapid change there.

I think the set of treatments that are being offered are also not changing very much.

What we seem to be seeing change is payer behavior and kind of patient decision-making with that payer behavior.

And so it's a little bit harder to predict what that would look like over time, and I think any of the three possibilities you outlined is possible, I think.

I look out and -- Calvin mentioned it really well, there are 100,000 or so open procedures being done for women in the United States for hysterectomy, many of whom are great candidates for a proven, safer minimally invasive procedure, and yet they're getting open procedures, and that's an opportunity.

And so if that patient population comes in and has an opportunity, then that would be a positive and an upside.

The other possible upside is, of course, single incision, Single-Site hysterectomy if that kit pulls out further and we augment it.

So those are possible upsides.

How payer behavior changes through the year, what some of the patient decision-making looks like, that's a little bit harder to predict.

On the general surgery side, as you know, adoption rates are always -- year-over-year growth rates and adoption curve are always highest at the beginning, and then they decline over time as the base grows.

It's absolutely a natural progression.

The speed of that, I think, is going to depend on procedure by procedure.

What is the total available market for single incision cholecystectomy?

That's an estimate.

Everybody would look at that and try to figure it out.

It's not a clear substitution against another one that's just sitting there, and so we'll see what that looks like.

Colorectal, I think, we feel really good about.

You look out at colorectal, and we bring a huge amount of value there.

Cholecystectomy, patient enthusiasm, surgeon commitment, training, and growth in those procedures has been really encouraging.

And the last thing is that general surgery has been growing beyond those two into some other things, and we will let them evolve for a couple of quarters.

But I think that will be interesting to see where else general surgeons take the opportunity and the technology, and it looks to be broader than just those two.

And so overall, I think our feeling we can bring a lot of value to general surgery is high.

Okay, Gary.

Just one quick one on -- just so I understand SIE, I think that's --

The quick one.

This is going to be very quick and I promise, even for me.

On the SIE, it's been available for a while, but it sounds like there is sort of growing enthusiasm.

So I'm trying to understand that trendlines are relatively stable, which is hard to understand just obviously because this year the larger capital is under pressure.

So is the situation with SIE, you now see better positioning in the ambulatory care market, and have there been upgrades to that system, or is this simply going to be a corporate focus on the SA heading into 2014?

I'm just trying to figure out what is changing relatively given the systems that are available.

Thank you.

Yes, the question.

So short answer, a combination of a couple things.

The Single-Site instrument kit is both procedurally adopted to a three-arm system.

It's also priced right for that set of procedures, and then Firefly adding into that is a nice mix together that gives kind of a fully capable system to do those things in an adulatory setting.

So I think those combinations brought together help and I think with an organizational alignment around describing the value of that also helps, and so that's how we've gotten where we are.

Thank you for the question.

That was our last question.

As we said previously, while we focus on financial metrics such as revenues, profits, and cash flow during these conference calls, our organizational focus remains on increasing patient value by improving surgical outcomes and reducing surgical trauma.

I hope the following segment of an editorial by Dr. Tim Wilson, Chief of the Division of Urology and Neurologic Oncology at the City of Hope Cancer Center, gives you some sense of what this means to da Vinci surgeons and their patients.

Quote-unquote, in this era of healthcare reform, policymakers, hospitals, and providers are all evaluating ways to reduce the overall cost burden to society while improving the quality of outcomes for patients.

Often lost in the debate is the need for investment in technology that can help mitigate the significant cost drivers of healthcare.

Robotic-assisted surgery is a gamechanging technology in medicine, yet it is deeply misunderstood and often dismissed as just another expensive tool for driving costs up.

This cannot be further from the truth.

The cost of our technology has to be compared with the alternative cost of treatment.

Displacing large abdominal decisions that have complications, high rates of death, blood loss, and high risk of infection, and higher length of hospital stay is a good investment, and aligns with the goals of healthcare reform.

Medicine needs innovation, but is usually slow to change.

Decades ago, the same criticisms of robotic surgery plague laparoscopy.

It was expensive, unproven, and unsafe.

To date, more than 2.1 million da Vinci surgeries have been performed worldwide with an extremely low death rate, a declining rate of adverse events, and a growing body of clinical evidence that demonstrates safety, effectiveness, and an ability to reduce both costs and complications about surgery.

As a surgeon who has performed thousands of procedures, including open, manual laparoscopic, and robotic-assisted urologic cancer surgeries, I believe robotic assisted surgery is the kind of technological disruption they truly will reform healthcare.

The improvements in surgery described by Dr. Wilson drive our team to form the foundation of our operating performance.

We have built our Company to take surgery beyond the limits of the human hand, and I assure you that we remain committed to driving the vital few things that truly make 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.