Intuitive Surgical, Inc. (ISRG) Q3 2008 Earnings Report, Transcript and Summary

Welcome and thank you for standing by. At this time all participants are on a listen-only mode. After the presentation, we will conduct a question-and-answer session. [Operator Instructions]. Today's conference is being recorded. If you have any objection, please disconnect at this time. And now I would like to introduce your host for today's call Mr. Ben Gong, Vice President of Finance. Sir, you may begin.

Good afternoon and welcome to Intuitive Surgical's third quarter conference call. With me today, we have Lonnie Smith, our Chairman and CEO; Gary Guthart, our President and Chief Operating Officer; Marshall Mohr, our Chief Financial Officer; Aleks Cukic, our Vice President of Strategic Planning and Jerry McNamara, our Executive Vice President, Sales and Marketing. Before we begin, I would like to inform you that comments mentioned on today's call may be deemed to contain forward-looking statements. Actual results may differ materially from those expressed or implied as a result of certain risks and uncertainties. These risks and uncertainties are described in detail in the company's Securities and Exchange Commission 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 of providing you with highlights of our third quarter, as described in our press release announced earlier today, followed by a question-and-answer session. First, Lonnie will present the quarter's business highlights. Marshall will follow with a review of our third quarter's financial results. Next, Aleks will discuss sales and marketing highlights, then I'll provide an update to our financial forecast for 2008 and finally, we will host a question-and-answer session. With that, I'd like to introduce Lonnie Smith, our Chairman and CEO.

Thank you for joining us today. This past quarter, we continued to drive and broaden the adoption of robotically-assisted surgery, resulting in significant top and bottom-line growth. Operating highlights for the third quarter are as follows. We sold 91 da Vinci Surgical Systems, up from 63 system sold during the third quarter of last year. 20 of the systems were sold through existing customers. Our international team contributed 20 of the 91 systems sold, up from 17 last year. We passed through two significant milestones during the third quarter. We exceeded 1000 da Vinci systems installed worldwide. And we installed systems in Mesilla, Montana, Casper, Wyoming and Albuquerque, New Mexico and now have at least one system in each of the United States. Procedure adoption continues to be procedure specific, patient driven and the primary growth driver of our business. In what has historically been a seasonally slow quarter, we had solid quarter-over-quarter procedure growth led by GYN with strong growth in the United States and a pronounced seasonal drop in Europe. Among our fastest growing procedures in terms of percent of sequential quarter-to-quarter growth were nephrectomy and partial nephrectomy for kidney cancer, radical cystectomy for bladder cancer, hysterectomy, sacral colpopexy and colon resection. Total revenue grew to $236 million, up 50% from last year. Instrument and accessory revenue increased to $76 million, up 53%. Total recurring revenue, including service, grew to $110 million, up 54% from the prior year comprising 46% of total revenue. We generated an operating profit of $106 million, 45% of revenue, before non-cash 123R stock option expense, up 69% from the third quarter of last year. GAAP net income grew to $58 million, 24% of revenue, up 41% from last year. We ended the quarter with $821 million in cash and investments, up $82 million from last quarter and up $288 million in the last 12 months. After subtracting $19 million in cash receipts from exercise of stock options and added back $28 million invested in fixed assets, purchase of intellectual property and working capital during the quarter. Our gross operating cash flow in the third quarter amounted to 158% of our reported GAAP net income. We ramped up production in our new instrument plant in Mexicali Mexico, and we are pleased with operating performance of this new production facility. And finally, we grew our Intuitive team by 78 members to 1,013. With that, I'll pass the time over to Marshall Mohr, our Chief Financial Officer.

Thank you, Lonnie. Total third quarter revenue of $236 million, increased 50% compared with $156.9 million for the third quarter 2007, and increased 8% compared with $219.2 million for the second quarter of 2008. Third quarter revenues by product category were as follows: instrument and accessory revenue increased $76 million, up 53% compared to $49.5 million last year and up 3% compared with $73.6 million last quarter. The growth rate in instruments and accessories is a direct result of our procedure growth rates. Procedure growth rates increased slightly more than instrument and accessory revenue, reflecting procedure mix and hospital efficiency. Overall as expected, procedure and instrument accessory growth rates reflect seasonality particularly in our European business. The amount of instrument and accessory revenue we earned per procedure declined slightly but remains in a range of between $1500 and $2000 per procedure for established da Vinci accounts and up between $2000 and $2300 per procedure including initial stocking orders. Systems revenue of $126.3 million increased 48% compared with the $85.6 million last year and increased 9% compared with $116.2 million last quarter. The increase in systems revenue compared with the second quarter of 2008 reflects increased unit sales, as well as an increase in the average revenue per system. Third quarter da Vinci Surgical Systems revenue reflects the sale of 91 systems compared with 63 systems sold in during the third quarter of last year, and 85 systems sold in the second quarter of this year. 76 of the systems sold during the quarter were our latest S model incorporating high definition vision capabilities. 11 were four-arm S models incorporating standard vision capabilities. Two were three-arm S models, and two were refurbished standard systems. 20 of the systems... system sales were outside of the U.S. compared with 19 in the second quarter of 2008 and 17 in the third quarter of 2007. Five of the system sales in the quarter involved trade-ins. Our third quarter average revenue per system, including all da Vinci models but excluding upgrades, was $1.37 million which is 20,000 more than the average revenue per system in the second quarter of 2008. The higher average revenue per system primarily reflects favorable product mix. Service and training revenue increased to $33.7 million, up 54% compared with $21.9 million last year and up 15% compared with $29.4 million last quarter. The growth in service and training revenue is primarily driven by a larger system installed base and non-contract revenue. Total third quarter recurring revenue comprised of instrument, accessory and service revenue, increased to $109.7 million, up 54% compared with the third quarter of 2007 and up 6% compared with the second quarter of 2008. Recurring revenue reflects or represented 46% of total revenue in the third quarter compared with 47% in the second quarter of 2008. Revenue outside the United States represented 19% of total third quarter revenue compared with 20% last quarter, reflecting the strength in our U.S. business coupled with a seasonal slowdown overseas. Our third quarter 2008 gross margin of 71.9% was higher than the 71.2% realized in the second quarter, primarily reflecting lower cost of service. Total operating expenses for the third quarter of 2008 were $84.5 million compared with $77.9 million in the second quarter of 2008. This sequential operating expense increase of $6.9 million reflects increased surgeon training activities, increased R&D activities, increased non-cash flow 123R stock compensation expense, commissions on increased revenue and costs associated with increased headcount. We added 78 employees during the third quarter ending the period with 1,013 regular employees. The majority of the additions were to our worldwide sales and support and manufacturing organizations. Third quarter 2008 operating income was $85 million or 36% of sales, compared with $78.2 million or 35.7% of sales for the second quarter of 2008. Third quarter operating income included $21 million of 123R stock compensation expenses compared with $19.7 million in the second quarter. The increase of $1.3 million reflects options granted to new hire. Our third quarter 2008 other income was $4.6 million, which is lower than the $5.7 million realized in the second quarter, reflecting exchange losses on euro accounts, as the euro weakened against the dollar during the quarter and lower interest rates on our investment portfolio. Our effective tax rate for the third quarter was 35.7% which is lower than the rate of 39% recorded for the first six months of the year. The decrease in our rate reflects $3.1 million of 2007 R&D credits recorded in association with our 2007 tax return which was filed in September. I should note that in October, Congress renewed the federal R&D credit for 2008. We will quantify and record the benefit of this new law change in the fourth quarter. We continue to utilize carry-forward tax benefits in stock... and employee stock related tax benefits in 2008 and expect that our cash outlays with income taxes will be approximately 20% of pre-tax income for 2008. Our net income at $57.6 million or $1.44 per share increased 41% compared with $40.9 million or $1.04 per share for the third quarter of 2007 and increased 13% compared with $51.2 million or $1.28 per share for the second quarter of 2008. Let me quickly summarize our results for the first nine months of 2008. Total revenue for the first nine months of 2008 was $643.4 million, up 56% compared with $411.4 million last year. Operating income for the first nine months of 2008 was $228.1 million, up 71% compared with $133.4 million last year. Operating income included $55.2 million of stock-based compensation charges in the first nine months of 2008, compared with $26.2 million in 2007. Net income for the first nine months of 2008 was $153.6 million or $3.84 per share, up 61% compared with $95.4 million or $2.46 per share last year. Now turning our attention to the balance sheet. We ended the second quarter of 2008 with cash, cash equivalents and investments of $821 million, up $82 million from June 30, 2008. $18.7 million of the cash generated in quarter was associated with stock purchase activities. The remaining cash generated is primarily related to operating activities. Capital expenditures for the third quarter included $13.5 million payment associated with the purchase of intellectual property from Power Medical Interventions Inc. and $7.5 million of expenditures associated with facilities and information technology infrastructure to support our growth. The total costs of the Power Medical Interventions purchased of $20 million will be amortized over a five-year period. At September 30, we held $87 million of student loan backed auction rate securities. Earlier this week, UBS offered to purchase the auction rate securities held by them at their par value of approximately $71 million, any time during a two-year period beginning at June 30, 2010. If we accept their offer, we will likely have to take a charge to other income in the fourth quarter for the difference in value of the auction and the unrealized loss on these securities, which was approximately $6 million at September 30, 2008. Our accounts receivable balance increased to $173.7 million at September 30, compared $162.1 million at June 30, 2008. The change in receivables reflects higher revenue in the third quarter. Our net inventory increased to $52.5 million at September 30, compared with $42.6 million at June 30. Our inventory turns at September 30 decreased to 4.8 times compared with 5.7 turns at the end of the previous quarter. The increase in inventory reflects a planned increase for future growth. And with that, I would 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 91 da Vinci systems, 71 in the United States, 12 in Europe and eight into rest of world markets. A total of five system sales were part of trade-off transactions. The net 86 new installations brings to 1032, the cumulative number of da Vinci systems worldwide, 776 in the United States, 171 in Europe and 85 in rest of world markets. 15 of the 86 net systems installed during the quarter represented repeats system sales to existing customers, which brings to 122, the total number of customers which own two or more da Vinci systems. Also, as of Q3, we have placed at least one da Vinci into all 50 states. International sales included two more than da Vinci placements into the countries of Korea, China, The Czech Republic and Greece. Clinically, we had another good quarter. In what is a seasonally slow quarter, we delivered solid procedure growth within several of our targeted surgical specialties. Procedure growth was led by da Vinci Hysterectomy both for benign and malignant conditions but most notably within dVH for benign conditions. Sacral colpopexy and myomectomy also showed excellent growth. Within our urology business, notably our kidney and bladder business, da Vinci Nephrectomy, and partial nephrectomy and da Vinci Cystectomy, showed excellent growth. Our U.S. dVP growth was steady, while our international dVP business was seasonally slower and lagged behind. Our cardiothoracic business remains steady. In Q3, there were over 180 da Vinci related clinical papers published within various peer-reviewed journals throughout several surgical specialties. And within limited Q3 medical conferences that took place during the quarter, several scientific abstracts, clinical posters and podium presentations highlighted da Vinci's clinical benefit. There were a number of favorable highlights from these various sources but I'll limit my review to a few. In the September edition of the Journal of Clinical Oncology, Dr. Ash Towori, Professor of Urology of Kernel University Medical Center provided a rebuttal to a comparative analysis of various surgical approaches to radical prostatectomy that was published in an earlier edition. Dr. Towori took issue with previous studies design and lack of clarity between traditional laparoscopic prostatectomy and dVP results, which for this particular study, were blended into a single minimally invasive radical prostatectomy category. To address this misleading results, Dr. Towori published his data on 1,170 dVP patients collected between 2005 and 2008. The results provided absolute transparency between the previously reported results for open prostatectomy minimally invasive radical prostatectomy and dVP. The comparison was striking. Comparing perioperative complications between the three cohorts showed open prostatectomy with a rate of 36.4% minimally invasive radical prostatectomy, 29.8% and dVP 1.64%. Hospital length of stay was 4.35 days for open, 1.42 days for minimally invasive radical prostatectomy compared to 1. 3 days for dVP. And finally, for asthmatic scriptures where the open prostatectomy rate was 12%, minimally invasive radical prostatectomy 15.2% compared to 0.54% with dVP, the significant of which has direct implications to desired urinary function. The two takeaways for me, from this study are as follows. First, the addition of the recently issued robotic specific DRG code will help to erase the misleading element of blending and reporting laparoscopic and robotic outcomes as similar. And second, the clinical outcomes between open prostatectomy and dVP are perhaps greater than we previously thought. The second study appeared in the August edition of Gynecologic Oncology and was offered... authored by Doctors Gary and Vagus, University of North Carolina, Chapel Hill. The authors' aim was to assess the most effective minimally invasive surgical treatment for endometrial cancer operations for obese and morbidly obese patients. Within this cohort, they compared traditional laparoscopic outcomes performed by laparoscopically skilled surgeons to their da Vinci outcomes. Obese and morbidly obese women are at a much higher risk of developing endometrial cancer and, according to this study, represents 33% of all U.S. women. The results of the study were as follows. For both the obese and morbidly obese patient, robotic surgery was associated with shorter operative times, 189 versus 215 minutes, less blood loss, 50 versus 150 milliliters, increased lymph node retrieval 31.4 versus 24 and shorter hospitalization. The authors' conclusion and I quote, Robotic surgery is a useful tool for comprehensive surgical staging for obese and morbidly obese women with endometrial cancer. As this patient population is at increased risk of death from all causes, including post-operative complications, all efforts should be made to improve their outcomes. The same University of North Carolina Group also published a comparative 322 patients study on endometrial cancer treatments which appeared in the October edition of the American Journal of Obstetrics and Gynecology. The purpose of this study was to compare total abdominal hysterectomy or TAH, total laparoscopic hysterectomy or TLH and da Vinci Hysterectomy or dVH within all clinical areas. When comparing para-aortic node retrieval between the three groups, they reported an average yield of three nodes within their TAH as their total abdominal hysterectomies. 6.3 nodes within their TLHs compared to 12 para-aortic lymph nodes within their da Vinci patients. When they compare total lymph node retrievals, they reported 14.9 within their TAHs, 23.1 within their TLHs and 32.9 within their da Vinci hysterectomies. Estimated blood loss between the three groups was as follows. 266 milliliters for their TAH patients, 145 for their TLH patients compared to 74 milliliters for their da Vinci hysterectomy patients. Length of hospitalization was reduced from an average of 4.4 days for their TAH patients to 1.2 days for their TLH patients to 1.0 days for the da Vinci hysterectomy patients, which led to the authors' conclusion, and I quote Total robotic hysterectomy with staging is feasible and preferable over total abdominal hysterectomy and may be preferable over total laparoscopic hysterectomy. This is a very strong endorsement especially so when you consider that the overwhelming majority of these procedures are performed through open incisions. My final reference is also specific to da Vinci's value within GYN Oncology and was authored by Dr. Limbandu and Harvingale [ph] from the Institute of Peritectomy [ph] in Marcey, France. And it appeared in the August edition of Surgical Endoscopy. The aim of this prospective study was to evaluate the feasibility and outcomes of GYN cancer surgery with the da Vinci S System. The patients underwent procedures consisting of total hysterectomy, bilateral inpherectomy [ph] and/or lumbo-aortic lymphadenectomy for endometrial, cervical or ovary cancer. Following the analysis of their data, the authors concluded by saying in a quote as suggested in the literature, the use of robotic laparoscopy leads to less blood loss, less post-operative pain and shorter hospitalizations days compared with those treated by more traditional surgical approaches. Despite the need for extensive studies robotic-assisted surgery seems to represent a similar technological evolution as the laparoscopic approach 50 years ago. All of these studies discussed da Vinci hysterectomy cancer outcomes. And I think it's important to reiterate that our fastest growing GYN procedure both in terms of absolute growth as well as percentage growth is dVH for benign conditions. That concludes my update and I'll now turn the time over to Ben.

Thank you Aleks. I will be providing our updated 2008 financial forecast on a GAAP reporting basis, including non-cash FAS 123R stock compensation expenses. I will also provide an estimate of our stock compensation charges separately, so you can calculate meaningful comparisons that exclude these non-cash expenses. Based on our third quarter results we're increasing our previous guidance for revenue and profits for 2008. Starting with procedures, our dVH procedures are the greatest contributor to our overall procedure growth. We continue to expect our dVH procedures to grow approximately 150% in 2008 over 2007. With regard to dVP procedures, as Aleks mentioned, our growth in dVP lagged behind our expectations particularly in Europe. We continue to see dVP growth but lower than our previous forecast. We expect our worldwide dVP growth for 2008 to be greater than 30% over 2007. Other procedures, such as nephrectomies, partial nephrectomies, cystectomies and sacral colpopexies are growing much faster. And as a result, our Q3 procedures in total were in line with our expectations, and we continue to expect our total procedures to grow 57% to 58% this year from a base of approximately 85,000 total procedures performed in 2007. This is a reiteration of our forecast from the previous earnings call. Our instrument and accessory revenues are driven by procedures performed and typically grow in unison with procedures. As Marshall mentioned earlier, our revenues per procedure have come down slightly. This was caused by two factors: first, initial stocking orders continuing to comprise a lower proportion of total instrument and accessory revenues as our installed base continues to grow. Secondly, as customers increase their utilization rates, they've become more efficient in their use of consumable supplies. As a result, all procedures are expected to grow 57% to 58% this year. We are forecasting our instrument and accessory revenues to grow 55% to 56% which is down slightly from our previous forecast of 57% to 58%. System revenues in Q3 were stronger than we previously expected. We are now forecasting our system revenues to grow 45% to 46% over 2007, which is up from our previous forecast of 38% to40% growth. Our system ASP was approximately $1.37 million in Q3 compared to $1.35 million in Q2 and $1.32 million in Q1. As we have mentioned in previous calls, our system ASP fluctuates quarter-to-quarter as a result of geographic and product mix. On a year-to-date basis, our system ASP has averaged $1.35 million, and we expect it to remain at approximately at this level for the reminder of the year. Service revenues in Q3 were higher than we expected due to service and training fees generated outside of annual contracts. We expect total service revenues to grow 49% to 50%, above 2007 levels. Our previous estimate was 45% to 46%. Our average annual service revenue per installed system, including fees outside of annual contracts is approximately $140,000 per year. In summary, we are increasing our top-line revenue forecast for 2008. We now expect revenues to grow 49% to 50% over 2007, which is up from our previous estimate of 45% to 47%. With regard to gross profit margin, our Q3 margins were sequentially higher than Q2 due to better gross margins on service revenue. We expect our total gross margin to be approximately 71% for the year. This is up from our previous forecast of 70%. Moving to operating expense and starting with R&D, we expect total R&D expense to come in at approximately $82 million for the year, up approximately 68% from $49 million spent in R&D expense last year. With regard to SG&A expense, we expect total SG&A expense to grow 49% to 50%, which is up from our previous forecast of 48% to 49% growth, due to higher variable costs associated with higher revenue forecast. We expect total operating expense to grow 53% to 54%. We expect operating income to grow 53% to 54% for the year. Last quarter, we were forecasting operating income to grow 42% to 44% for the year. The improvement in our operating income is being driven by higher revenue forecast and higher gross margins coupled with only a modest increase in SG&A expense. These forecasts include the impact of FAS 123R stock compensation expense. We expect to require approximately $76 million as stock compensation charges for the year, broken down as follows: $11 million in cost of goods sold, $17 million in R&D expense and $48 million in SG&A expense. We are forecasting other income to come in between $24 million and $25 million. This is down slightly from our previous estimate of approximately $26 million due to foreign exchange losses we recorded in the third quarter. This forecast does not assume any foreign exchange gains or losses in the fourth quarter nor does it include any potential charges associated with the UBS auction rate securities offer that Marshall mentioned earlier. With regard to income tax, we reported a GAAP tax rate of approximately 36% for the third quarter, down from previous quarters of 39% due to R&D tax credits realized on our 2007 tax return. Earlier this month, the U.S. government approved an extension on R&D tax credits for 2008. As Marshall mentioned, we expect to record a benefit in Q4 associated with this tax credit. So, we do not have a specific estimate of the amount at this time. Excluding this benefit, we expect to record a tax rate of approximately 39% in Q4. And once again, we expect our effective cash tax expense to be approximately 20% for 2008. And finally, regarding shares outstanding for calculating EPS for Q4, we expect the share count to be between 40 million and 40.5 million shares. That concludes our prepared remakes and we will now open the call to your questions. Question And Answer

[Operator Instructions]. Today's first question comes from Sean Levin. Sir, your line is open.

Thank you. Congratulations on another strong quarter.

Thanks Sean.

Sure. My first question has to do with hysterectomy. We have done a lot of survey work here, and it seems that the simple procedures, as you said, seem to picking up quite a bit of steam here. In the past, you have mainly talked about looking malignant or complex procedures. We are wondering if you could you could give a little bit more detail on what you are seeing on the benign or simple arena.

I think I would even make a different distinction. I don't think benign by definition means simple. There are complex benign and we are seeing a lot of traction within both complex benign and I think by definition all malignant which is also complex. That remains our initial target. There is no question about it. We have the highest value to add within those complex surgeries. We have, however, seen centers that flipped the majority and in some cases all of their hysterectomies to da Vinci. But in terms of where we are targeting, where we believe the highest value is, it really boils down to our patient value equation and that really is in the complex hysterectomy, which by our definition, is probably over around the 0.24 million of procedures U.S.

Okay. And then just one other question on the Power Medical deal that you announced during the quarter. Could you give us some timeline on products on this and what procedures might benefit?

I'll take the second part and then I'll turn the first part over to Gary Guthart. The second part in terms of the procedures that might benefit from it. If look at the tools that are used throughout surgery as surgical stapling is found in many surgical specialties and you will find general surgery, thoracic surgery, GYN, GYN/oncology, urology and so and so forth. So many of those procedures in many of those specialties have da Vinci within them. However it is just not a perfect choreography between the stapling application and the general dissection and reconstruction and visualization. So the answer is, we think it will potentially have a place in multiple specialties. Colorectal is an area where there is a lot of stapling, lung resections, a lot of stapling. And we will see ultimately when you get it. But there are plenty of targets we believe. Now as far as the actual development I'll let Gary comment on that.

On the development side it's not a simple integration, it's a fairly complex product. And so we're... we don't have a shift date to share with you but don't anticipate in the next call to 18 months.

All right, thank you very much.

Our next question comes from Tao Levy. Your line is open.

Good afternoon. And so I guess obviously the pre-requisite question, obviously great quarter here but what's the economic crisis, credit environment, how do we factor or how do you guys factor that into your fourth quarter and 2008 thinking, you're seeing much or any impact? Thanks.

Well Tao, I wish I had a crystal ball, I am sure you do too.

Me too yes exactly.

You guys probably more than we do. Clearly, it's not a positive for anyone. We haven't seen a significant impact yet, and that's all I can say is yet. We are... in some ways, we are in an excellent position in that our procedures are not procedures that you just casually do. These are procedures that people need to have. I think we offer a compelling value to the patients and therefore they will seek this especially in anytime. And I guess, the other point I think is that, this is the time when I'm delighted that we're not a levered company. We don't have a bunch of debt. We have a lot of cash, and I think that gives us flexibility. I think that in this... in ugly times and this is certainly one of them, there are also opportunities. And so and those will... I can't get specific. And I am not sure that we have seen them yet. But we are certainly... we will be thoughtful to the things that will help us to build the our franchise in robotically assisted surgery. So the answer is I don't know any better than you do. I mean, I look at the volatility of the markets, incredible highs and incredible lows. Clearly the market isn't valuing fundamentals much anymore, but running on a motion. And so, until that settles down, until... and the market settles down, we will see. But I think that we are... most of our hospitals, we haven't seen a ton of them and Ben and Aleks can deal with this better than I can in terms of doing leases. But I suspect that may increase. Our leasing companies still have an appetite for these devices and so we'll see how it plays out. In the meantime, we will manage the business in as prudent and thoughtful way as we can and be in a position to do as well as we can during these times and hopefully very well. And be in position long-term to continually to build this franchise in the marketplace.

Yes, Tao,just to comment on last part of your question, from what we see today, we expect Q4 to be again a sequentially higher quarter than we had in Q3. Again, Q4 tends to be our strongest quarter of the year. And that is reflected in our guidance.

And in terms of feedback from the sales force, in terms of like sort of cancellations or delays in orders, anything that's a different than what you may have seen you call it three months ago or it's always challenging?

I'll ask Jerry to give you his thoughts on that. Jerry McNamara - Executive Vice President, Worldwide Sales & Marketing: Well we're reservedly optimistic, we came off a good quarter of pipeline, closing and pipeline development. And reports backed from the field suggest that, that's continuing. We're in a dynamic time. We're just going to work through it.

Great and just I have one question also... my final question on procedures. Now that you're adding more systems and it seems like did the procedure number came in line with expectations maybe little bit slower internationally. It seemed like maybe that seasonally adjusted. As you place more systems in this quarter obviously exceeded expectations there. Is the idea that you'll see, obviously as these hospitals have more systems, more cases being done robotically. Is that kind of the right way to think about that you'll see automatic growth from on the procedure front because there are more systems out there? Jerry McNamara - Executive Vice President, Worldwide Sales & Marketing: What I would say there is generally speaking, yes but in terms of following some linearity, I think that's where it becomes difficult. To say that a system is placed here therefore, procedure should grow by some fixed percentage, is just an algorithm that doesn't work out. There is a lot of... as you know in our key procedures, the patients are very important in terms of determining where they're going to have their surgery done. So how things happen in a particular market, it's just not a perfect science yet.

One other thing I'd just point out to and I think I mentioned this to couple people before. You got to remember we have over thousand systems out there, 1030 or so. And if we place two or three more than what somebody thought I mean that mathematically does not turn into a significantly different metric that you're going to calculate in terms of procedures.

Okay. Great. Thanks a lot guys.

Thanks Tao.

Our next question comes from Mr. David Lewis. Sir, your line is open.

Good afternoon. One question here, I just... strategically if we think about the last couple of question quarters, I don't know if you've broken out specifically but this quarter was around 50 greenfield aversion systems, is that about right out?

Actually it'll be higher than that. 15 out of 86 went to individual customer. So, it was probably closer to 70.

Yes. So, there is a lot... for whatever reason globally speaking.

I was saying just U.S. but the point is straight quarters in U.S. market received 40 to 50 new systems. I'm trying to understand this reacceleration which is exciting and positive. Can you give me a sense of the size of these hospitals, these last sorts of 90 U.S. boxes versus had the repeat customers. Just give me a flavor for what transition is happening in your business. Is this a proxy for the sales force additions you made back half '07. Our new business strategy are just simply doing down market or they were just sort of a lot of under penetrated customers that are roughly the same size as your old customers.

Well it's interesting, we do as you know look at those statistics. And I can say within the United States market, we had 71 placements. So if you backed out the 15... and I believe all of the repeats were U.S. denominated. So that would give you 56 greenfields now. 51, I am sorry. And so when you look at the makeup of those hospitals, we had 33 of them that were over 325 beds. We had 28 of them which were in what we've called a middle tier which is 200 to 325 beds and we had 10 that were in hospitals below 200 beds. So again I think it falls in line with our thinking that... as da Vinci will find the procedures and as you expand GYN, you tend to see procedures, those procedures that are done in smaller hospitals. So it might surprise some people that 10 of those placements went to hospitals less than 200 beds. I know it's a dynamic situation but I think across the board that spread is pretty good, and I think it speaks to its value, da Vinci's value in hospitals regardless of size.

Okay. So clearly, the technology is broadening maybe to second inflection point. In terms of downstream implications here, I mean number one, should we expect that utilization for this new system to slightly lower than old systems, just by sheer hospital size and do we think these new hospital customers are more or less insulated from any type credit cycle crunch if it would have materialized?

I will take a solid utilization, and so far we haven't seen any difference in utilization. On average worldwide it's about 150 procedures per system. And everyone is buying a system, has a clinical plan for utilization of that system. So it's not looking as far as we can tell so far that the new buyers are using it any less than let's say the average buyers from before.

And I would also just remind you of the fact that the hospital size does not directly correlate to our utilization numbers. I can think of two hospitals, one being City of Hope Cancer Center which is one of the busiest and the handful of hospitals, we have as one of the busiest we have anywhere in the world as is the hospitals in Celebration, Florida, which is also about 130 beds. So it doesn't directly relate but it is something we again continually go through the data.

Okay. That's very helpful and just one last question and I'll hop. At the risk of being sort of globally insensitive here, I wonder the European slowdown, the European traction that looks like a little less active than we'd have expected. Is this a simply a European thing where we're seeing classic medical device lagged effect overseas or is there something that you didn't not anticipate that pass to overseas [ph]?

Do youwant to answer to it? Jerry McNamara - Executive Vice President, Worldwide Sales & Marketing: Yes. We manage the pipeline and we have variability quarter-to-quarter. We have a very strong pipeline in Europe and our quarter was what it was and we still have strong expectations going forward.

I guess my comment is that the Europe is impacted both in procedures and just getting deals done during the summer because they take so much time off during the summer. I think we saw most... more of that directly in Europe not the rest of the world. And so I really look into the pipeline as Jerry says and we'll see, we also find that we are little less capable of predicting the exact time of close in Europe than we are here at. It tends to be a little more bureaucratic in the process, and I don't want to be insensitive here either. But it does tend to be little more bureaucratic in the process. And so you can get snag and move it over to next quarter pretty easily. And so that's kind of the nature of the beast.

and I will say from a procedure adoption standpoint what we have experienced in some of our procedures and this continues also within GYN is that it does trail the United States in terms of its uptick of steepness on adoption curves. We saw it in dVP. We saw it in some of the other procedures. We're seeing it in GYN. The US uptick of GYN is significantly steeper than the European. Now, that isn't alarming and probably for someone like yourself who has followed these things over the years, that's almost to be expected. So I think the combination of all of that in a pretty slow summer in Europe led to a little lagging behind.

Great. Well thanks for the color.

Thank you.

Our Next question comes from Rick Wise. Your line is open sir.

Hi Rick?

Hi, how you doing?

Good.

Just wanted to touch on utilization. Do you mean if you expand little more on the dVP weakness in Europe and just beyond seasonality and I'm not sure I remember seasonality in the past, can you help --

We always have seasonality in the past.

Okay. So that's not unusual but utilization for instrument still seeing a little tad liner. Any other color or anything else we should understand?

I think if you take a look back at third quarter of last year you would probably calculate that the utilization per system also was flattish, if not slightly down. So what we saw on third quarter of this year is actually pretty similar to what we saw on third quarter of last year. That said, we are watching it, and particularly in Europe and as Lonnie mentioned not in other parts of the world. We saw somewhat pronounced seasonality.

Yes. Although not in terms of placements fairly.

But yes. In fact I'd say that the seasonality in the United States was less this year than was last year.

Yes.

But, strong, but clearly stronger. Jerry McNamara - Executive Vice President, Worldwide Sales & Marketing: It always becomes harder for us to use international as a single body of land. So I mean it was in countries we saw it more pronounced and then other we saw less pronounced. So and we saw some pretty good strength in non-European, specifically some of the Asian markets. So it's hard to lump into one, into sort of one stereotype.

Okay. And again maybe just reflect a little more, Lonnie or Aleks, the whole capital spending trends just... where you think we're over the next six to 12 months. And we keep... I keep reading the times and we're doing surveys and we're really getting a lot of conflicting messages, just again your larger picture.

As I said, as I started out and when I talked to Tao, I wished we had a crystal ball, we don't. I think this thing is from day to today whether it will... I mean, the one thing we have is we have a very... the governments throughout world are taking very aggressive interventional action as you saw today in Switzerland. And trying to learn from what went wrong in prior situations like this. And I think that the exact timing of how this will play out over the next few months. I guess, Rick, you got to ask me and you came here and said what's the next quarter look like? And you remember my response? If you're buying the stock for the next quarter, and my point is, I understand. I don't know if this is a one quarter deal or it's a two quarter deal or it's a year or two, but we will come out stronger and here we'll deal with the performance near term as best we can and in the long-term we will come out stronger that's... but I just don't have... I wish I knew, I just don't know. I mean I think it's just situation specific. Jerry McNamara - Executive Vice President, Worldwide Sales & Marketing: Rick, specific to the hospitals rather than sort of the macro space.

Sure. Jerry McNamara - Executive Vice President, Worldwide Sales & Marketing: I mean, even listening to the debates last night and listening to two candidates that were talking about healthcare and healthcare spending and reducing system wide costs. When you look at our value preposition which is in directed capital expenditures, I think from a hospital standpoint in macroeconomics, we're setting a pretty good position in that the procedures that we are focused on are necessary. They are not elective procedures. And for the most part very complex and a lot of our business is cancer specific. The value proposition for the hospital I think is pretty well documented on being able to increase flow in and in many in many instances, a decrease cost of the procedure and overall cost in their expenses. So, when it comes to how they are going to allocate their capital dollars, I think we're pretty good positioned but as far as really taking the guess at what the macro economics looks like it, your economists and your resources are going to be better at that for the year.

Hey Rick, it's one other thing I'd mention. I'm putting this in because you and others have asked me this and Lonnie touched on it. This is question about leasing and because and it's connected with the availability of capital device systems, and there is something that we can probably shed some light on is historically we said about 15% of our systems have been leased. That's how it's actually increased a little bit over the past couple of quarters to closer to 20%. And according to our leasing partners it appears that the credit crunch is causing an increase in financed system purchases, because hospitals are turning to these leasing companies more since their other sources of funding have gotten a little bit tighter. Those leasing companies they tell us have plenty of capacity and we get calls from them all the time. So, just to address a series of questions we've had about financing and availability of capital, just want to say that there are certainly from our perspective availability from a leasing standpoint.

Ben, thank you for that, for your thorough response. I appreciate it.

Our next question comes from MimiPham. Your line is open.

Hi, good afternoon. I guess you sort of touch on this already but would you say that 100% or what percent of your total procedures done, year-to-date, would you consider as elective procedures? Jerry McNamara - Executive Vice President, Worldwide Sales & Marketing: I wouldn't say that this is a 100%, I think the way I would think about it is... let's take a non-cancer procedure like hysterectomy, benign hysterectomy. So, if a woman is suffering from multiple fibroids, endometriosis, some combination there, and she is going through some very severe pain, theoretically could she put up with pain longer? Probably, I mean she is making some election that she could push it out a little bit but it isn't as let's say on the other side of the coin elective in the context of cosmetic procedures. So there is some variability to when it absolutely has to begin but by and large most of them are of that serious condition. And the cancer operations I think speak for themselves. So, it I wouldn't say that it's a 100% but it's the lion share of our business plan.

Mimi, just one comment. You know, this is an observation not a statement. But in prior lives, I can remember that we went through a significant recessions and people have potentially laid off their jobs, we actually saw an acceleration, where people were moving things forward while they were still insured and I don't know that will be case this time. But we did in terms of hospital stays and specific treatment. So you're just going to have to see how this plays out.

Okay, and then in terms of CapEx spending potentially being just a tougher for the hospitals are you expecting longer lead times and generally more people administration be involved in the purchase decision going forward?

At the present time we don't have any indicators that tell us that's the case if anything has changed but we're early into this.

And then lastly I guess I know we have to wait till next quarter to get 2009 guidance but just looking at higher portion do you think you'll be using sort of when you look at your systems pipeline, will you be using little more conservative conversion rate than you've got in past years, just given the economy?

Don't know.

There is too much uncertainties this point for us predict that.

I think the base of our business, the core of our business is procedures and that's very healthy as Aleks was coloring out what's going on dVH, it's pretty clear that we're on a growth path on dVH.

Okay. Thank you very much.

Our next question comes from Ben Andrew. Your line is open, sir.

Good afternoon, it's actual Matt in for Ben. All I have just two real quick ones. The services gross margin in the quarter was obviously very good and on an absolute basis in terms of the costs over the last two quarters, it's been coming down. Should we expect a big catch up in Q4 or can you just give us little color on what's going on there?

Yes, you're right, you noticed in the past two quarters we've had better leverage if you will on our service. So couple things are going on there, we got higher service revenues. And we've been keeping our fixed costs pretty stable there. So, we've had better leverage on our fixed costs. And the other thing is, we're seeing the benefits of reliability improvements that we've been working on pretty much continuously. So what reliability improvement translates into is a reduced number of spare parts we need for repairs, reduced number of service calls we have to make and that's all being reflected in that better gross margin line.

Okay. And then on your sales force expansion can you just real quick housekeeping, tell me the number again, I missed that when you gave in terms of the field sales force increases in the quarter?

So, roughly speaking, I think we added about 20 people to the field and there is a few metrics that I think we report on for you guys. And it is about a total of 340 people now on the field and roughly speaking about 60 of those folks are focusing on selling systems. We got over 210 people that are focusing in on procedure growth. You got about, I think 65 people that service engineers and about 15 people that are in field training.

Okay, would you say that the allocation between the two in terms of pricing systems and driving utilization has been changing recently or is that pretty much steady state? Jerry McNamara - Executive Vice President, Worldwide Sales & Marketing: No we run that by set of metrics that's pretty much steady state.

Okay. And then just lastly given the scare that was on the stock with Mero [ph] recently, is there any update on the competitive front?

Really, I'll let Gary answer the question on many changes in the competitive front.

Nothing really big on that front. We continue to watch companies in Asia and in Europe. But I think nothing that really looks imminent.

Okay. Thank you.

Our next question comes from Ed Shenkan. Your line is open. Ed Shenkan - Needham & Co: Thanks. We recently surveyed 60 CEOs and CFOs of hospitals about the da Vinci and one thing they were anxious for is incremental reimbursement when they use da Vinci. Just wondering where we stand with insurers and CMS to get incremental reimbursement?

Yes. As a reminder I think we might have mentioned this before. So CMS starting October 1, so literally about 15 days ago, they've implemented these new ICD9 codes and what that does is now allow hospitals to now record, specifically when robotic procedure has been performed because remember before the DRG codes were pretty much the same for whether it was done open or da Vinci or laparoscopic or laparoscopic da Vinci we would be using the same code. So the idea here is for them to capture that data on robotic surgery. And what we expect going to happen is over the next two years they're going to collect data and then after that we will see what they do with that data.

That now I think those administrators that you're referring to, I suspect and in fact we've already seen some signs of this where in... aside from Medicare patients they will use that risk data to try to seek high reimbursement from some of other third-party payers and now they have a vehicle to do that. Whether and how successful they are going to be is going to depend on the various plans, but at least we are in the point now where they can literally give pure transparent data and make a case for why they may deserve higher reimbursement, so that's the first step. Ed Shenkan - Needham & Co: And with regard to mitral valve repair, da Vinci is getting used more here and makes as we're talking to docs repairs easier, and when will we get closer to an inflection point when we will start to see even more utilization in mitral valve?

That's a little harder to predict and specifically I think if you would ask me about, if you ask that same question within any cardiac procedure, I think it is just difficult for us to say. I think you're right on in that there are lot of doctors who are now aware of the patient value and the physician sort of friendliness of da Vinci within those complex operations. Mitro valve is not just that they're becoming easier, they'll be able to do more complex repairs and are seeing fewer replacements required. So that word is really starting get out, it's been a slow steady growth for us. And there are some really key centers and we've talked about them in the past, places like the Mayo Clinic and the Cleveland Clinic, very generally speaking conservative places that have really adopted this. And we will expect that to continue. But to predict what the inflection point looks like is really hard for us to do.

But this again viral and as we -- as awareness builds, and as Aleks says places like the Cleveland Clinic and others are doing to really do help that. And what constantly find situations where patients... there's a fellow who just wrote a book. I picked it up on Internet that was on his mitral valve is asymptomatic runner real athletic guy. And we've connected with him and already patients, have come to them that they go to their first cardiologist, they don't know anything about it. Their first response is kind of well, you're out of Canada for this rather than saying I don't know much about it. But as that awareness grows, I think we will see it. And then I think it will be true also with revask as especially with some of the data that's coming out and both for stents and the data coming out for revask. We have time for one more question?

Yes sir. Our last question today comes from Amit Hazan. Your line is open sir.

Thanks very much. I just have a couple if you'll bear with me. First of all, on prostate, just, it's on prostate, full questions, and I will ask my first one. I think you were talking if I recall in the 2nd quarter, 35% growth during the first half of the year for prostate procedures. And so, now, if we look at the 30% that implies of course the much bigger slowdown than we anticipated. In fact, if we run the numbers that's about 3 to 5000 procedures decline versus the last time that you gave guidance. And so, I am wondering if you can focus on the U.S. in particular because I'm guessing that has to come at least a little bit from the U.S. And let us know what is going there that's coming below your expectation.

Let me make a comment on that. I mean and you are right. As we plot the adoption curve we clearly are now on the upper quadrant of the adoption curve. If you assume kind of the open procedures that we're taking all open procedures. So, with that growth was slow. I mean it's just the nature of an adoption curve. As it slows as you reach up into that. Now as we penetrate or the next phase of dVP will largely depend on how successful we are at penetrating alternative treatment modalities. And those will be tougher. The adoption will be slower because you have in French competitors, they are going to fight hard, to resist that. You don't have an organized competitor in open to resist. So, I think that will slow a bit. But I think that it is a function and I just recently updated all of our adoption curves and we are not that we always have a seasonal drop in the third quarter. We will see what the fourth quarter looks like but it comes back under the line it will be on, which I'm suspect it will because every third quarter it's off the line. It comes right back, we've got a very, I mean a very consistent adoption curve going. Now that said that is... I believe is primarily for the open procedures and the next segment we'll penetrating I think will be slower and high resistance but time will tell.

The other thing I would fill in there is we've always talked about international, and we quite fall into this ourselves is that we tend to characterize international as one big group. It's really not it, it's a lot of different places. And so it's kind of hard to predict what that growth rate is country-to-country. It's still definitely growing. So we are again forecasting over 30% growth year-over-year on the 55,000 procedures we did last year. So it's still a significant growth.

Well, I'll tell you another thing, another place we've got such growth in GYN that the field resources are being sucked right into GYN. And quite frankly it's part of our strategy. As we look at adoption curve and the lower portion of the adoption curve, the lower half that is primarily push, I mean it's sales driven. I mean sales, we got to get the systems placed, we've got to get surgeons trained. We got to build the infrastructure that can support the procedure. In the later part of the adoption curve we believe that it's marketing driven because if we are now... we now have hospital with the system, we have surgeons who're trained and now we need to help continue to build awareness and to help them to draw patients into to be... for the surgeons to perform surgery on. So, I think that it's also a shift, and dVP is our maiden voyage in many ways in terms of the first major procedure to drive to standard of care.

Thanks to that. And if I can ask actually the question in a different, from a different angle, just to kind of get your thoughts on it. With regard to your clinical sales force and if you can remind us how much you've in fact increased them by this year. But if you are not hitting the procedure number and you've increased them by as much as you have, and the dVH guidance that you've given for procedures hasn't really increased this year. How do we think about of the clinical sales force and the sales, the procedure per sales force or how you think about that and is there something there that you're thinking about doing differently or just color around that would be great?

Couple of clarifications for you Amit. So one is actually from a total procedures standpoint from the beginning of the year, we have increased our guidance. So in fact, when we started off the year we thought we might be going somewhere around 50 or so percent on total procedures, we now think we're growing 57% to 58%. And that clinical sales force that you are talking about and Lonnie was talking about, they go after all procedures not just dVPs, so anyway where we have been adding people in the field and in terms of the metrics that Jerry was talking about before. And what we're pleased with the productivity of those clinical sales people

Okay, thanks very much.

Thank you. That's our last question for today. As I have said in our prior calls that we believe the adoption is driven by a significant shift in patient value, which is a function of improved surgical outcomes with new surgical trauma. It is our goal to deliver value in the following order, first to the patients, as we discussed, second, to the surgeons, third to the hospitals, fourth to our employees. And if we do these four things we believe will bring value to our shareholders. And by the every one of our employees is a shareholder. Two weeks ago, I met with surgeons in several large East coast university medical centers. On doing this trip, I spoke with two chiefs of gynecology that have become major da Vinci users. I mentioned these two because of their contrasting perspective, one is in his mid 40s and a highly skilled laparoscopic surgeon. He said that he had converted to da Vinci surgery for two reasons; first he is seeing... he said that he had a seen a dramatic reduction in pain and improvement in the speed of recovery of his patients, even patients he operated on a very end of the day and early evening, he said were ready to go home at 11 o'clock the next morning. The second reason he said is he experienced major reduction in his own muscular and skeletal pain associated with performing surgery day after day with conventional laparoscopic instruments. The second surgeon is in his mid to late 50s probably closer to his late 50s. He describes himself as a very fast and effective large incision surgeon, with no interest in laparoscopic. And he established a case until it was diagnosed with prostate cancer, which he had removed with the da Vinci system. He was so amazed with the speed of his recovery that he became to reconsider the benefits the da Vinci might bring to his own patients. And he says he is now a very fast and effective small incision robotic surgeon. The last story, kind of relates to the question that was raised about cardiac and mitral valve adoption, last story is sister of one of our engineers was diagnosed with Endoscopic Mitral Valve disease. She is physical runner living in Southern California, she asked her cardiologist about the possibility for robotic repair and was told that she was not a candidate and center surgeon re-planned to perform the surgery to a large incision, that's true anatomy. Her brother suggested that she get a second opinion, so she spoke with Alfredo Franto [ph] who is the director of the cardiovascular surgery at Cedars-Sinai Medical Center in Los Angeles. He repaired a mitral valve with the da Vinci system. Shared a great outcome and return to our cardiologist a few weeks later. He was surprised that I have learned a lot of surgery. He was so impressed with the results but he said he would refer all future patients to Dr. Franto [ph] at Cedar-Sinai. It is always great to hear these patient stories but even better when someone close to member of our Intuitive family. In closing, we remain committed to delivering exceptional value in terms of improve surgical outcomes, reduce surgical trauma for our patients and exceptional operating performance for our shareholders. We're committed to focusing on the vital few things that truly make a difference as we strive to take surgery as the human have. That concludes today's call. We thank you for your participation and sport in this extraordinary journey. We look forward to talk with you again in three months.

This concludes today's conference. You may disconnect at this time.