Intuitive Surgical, Inc. (ISRG) Q1 2011 Earnings Report, Transcript and Summary

Ladies and gentlemen, good afternoon. Thank you for standing by, and welcome to the Intuitive Surgical Quarter One Earnings Conference Call. [Operator Instructions] And as a reminder, this conference is being recorded. I would now like to turn the conference over to our host, Director of Financial Planning for Intuitive Surgical, Mr. Calvin Darling. Please go ahead.

Thank you. Good afternoon, and welcome to Intuitive Surgical's First Quarter Conference Call. With me today, we have Gary Guthart, our President and CEO; Marshall Mohr, our Chief Financial Officer; and Aleks Cukic, our Vice President of Strategic Planning. Before we begin, I would like to inform you that comments mentioned on today's call may be deemed to contain forward-looking statements. Actual results may differ materially from those expressed or implied as a result of certain risks and uncertainties. These risks and uncertainties are described in detail in the company's Securities and Exchange Commission filings. Prospective investors are cautioned not to place undue reliance on such forward-looking statements. Please note that this conference call will be available for audio replay on our website at intuitivesurgical.com, on the Audio Archive section under our Investor Relations page. In addition, today's press release has been posted to our website. Today's format will consist of providing you with highlights of our first quarter's results as described in our press release announced earlier today, followed by a question-and-answer session. Gary will provide present the quarter's business and operational highlights, Marshall will review our first quarter financial results, Aleks will discuss marketing and clinical highlights, then I will provide you with an update to our financial forecast for 2011 and finally, we will host a question-and-answer session. With that, I will turn it over to Gary.

Thank you for joining us today. In this first quarter, our team has executed well, and we have had solid performance in procedures, system sales and the financial results that follow. For 2011, we are focused on the following: Extending the benefits of minimally invasive surgery in gynecology and neurology; expanding robotic surgery and deepening our organizational capability in Europe and Asia; crisp execution in our product development efforts; and enabling emerging procedures in thoracic, transoral and colorectal surgery. We grew in several specialties and geographies in the quarter. da Vinci Prostatectomy experienced strong growth in the quarter led by continued adoption of dVP in Europe. And gynecology malignant hysterectomy showed continued strength. Benign hysterectomy showed early year seasonality, particularly in January and February. Emerging procedures continue to experience growth in our early adopting centers, in TransOral Robotic Surgery, thoracic surgery and colorectal procedures. Aleks will provide additional procedure commentary later in the call. Turning to operating highlights for the first quarter. Procedures grew 30% over the first quarter of 2010. We sold 120 da Vinci Surgical Systems, up from 104 during the first quarter of last year. Total revenue was $388 million, up 18% over last year. Instrument and Accessory revenue increased to $157 million, up 28% over Q1 2010. Total recurring revenue grew to $221 million, up 28% from prior year and comprising 57% of total revenue. Net income was $104 million, up 22% over last year. We generated an operating profit of $180 million before noncash stock option expense, up 15% over the first quarter of last year and representing 46% of Q1 revenue. We ended the quarter with $1,757,000,000 in cash and investments, up $148 million from last quarter. Significant cash outlays during the quarter included $15 million invested in intellectual property and fixed assets and $12 million used in repurchasing stock. Excluding the impact of these outlays, as well as $60 million from stock proceeds and $53 million used from working capital, we generated $168 million in gross cash flow from operations, which is 162% of our reported GAAP net income for the first quarter. As we have mentioned on past calls, we are making significant investments in progress in product development. In Q1, we received the CE mark for our Single-Site da Vinci instruments and accessories. We have begun a stage rollout of Single-Site in Europe focused on Single-Site cholecystectomy. Our early clinical and product performance results there have been encouraging. In the U.S., the FDA has requested additional clinical data on our Single-Site products. We're in the process of collecting this data in part from our European experience and will provide it to FDA as needed. In the quarter, we received FDA clearance for our da Vinci Fluorescence Imaging System and have likewise begun a staged rollout in the U.S. Whether our initial launch of Single-Site in Europe and Fluorescence Imaging in the U.S., we are focused on an outstanding early customer experience in the development of clinical evidence supporting their use. We continue to make progress on both our da Vinci vessel sealing instrument and our da Vinci stapler. Our vessel sealer has been submitted to the FDA and we are working through production readiness for this product. Our stapler is undergoing validation work and engineering refinement. We have not yet submitted the stapler for clearance. Lastly, we introduced our da Vinci Surgical Simulator in Q4 of 2010 and shipped our first units and volume in the first quarter. We are working with leading centers on validating simulator tasks and on developing curricular for its use. As we enter new surgical markets and drive into new product arenas, we continue to invest in building our team and expanding partnerships and then acquiring those technologies that can make a difference through Robotic Surgery. This quarter, we added 69 people to our team predominantly in sales, manufacturing and R&D, bringing our total team to 1,729 employees. I'll now pass the time over to Marshall, our Chief Financial Officer.

Thank you, Gary. Our first quarter revenue was $388 million, up 18% compared with $329 million for the first quarter of 2010, and approximately the same as the $389 million reported for the fourth quarter of 2010. First quarter revenues by product category were as follows: First quarter Instrument and Accessory revenue was $157 million, up 28% compared with $123 million for the first quarter of 2010 and up 4% compared with $151 million in the fourth quarter of 2010. The increases in Instruments and Accessories are primarily driven by procedure growth. Instrument and Accessory revenue realized per procedure, including initial stocking orders, was approximately $1,940 per procedure, which is lower than the first quarter of 2010 by approximately $20 and approximately the same as the fourth quarter of 2010. Relative to the first quarter of 2010, the reduction reflects the lower impact of stocking orders over a larger base of revenue. Relative to the fourth quarter, we had lower stocking orders which were offset by increased orders associated with customer buying patterns. We expect Instruments and Accessories per procedure to decline slowly over time, given that initial stocking orders have a lower impact on a larger install base. First quarter 2011 Systems revenue of $167 million increased 8% compared with $155 million of Systems revenue for the first quarter of 2010, and decreased 6% compared with $178 million of Systems revenue for the fourth quarter of 2010. Beginning with the fourth quarter of 2010, we began delivering new Si Systems for customers S Systems versus converting S Systems into Si systems via field upgrade. The contract terms and economics for these Si for S trade-ins are now more closely reflective of Si sales as a result of the change. Accordingly, we began reporting S to Si trade-ins as system sales. Inclusive of 19 S to Si trade-ins, we sold 120 systems in the first quarter of 2011. This compares to 104 systems in the first quarter of 2010 and 124 systems in the fourth quarter of 2010. I would note that the first quarter of 2010 system count excluded 9 S to Si upgrade that were treated as upgrade revenue, and the fourth quarter of 2010 system count included 10 S to Si trade-ins. Upgrade revenue for the first quarter of 2011 was approximately $2 million compared to $5 million for the first quarter of 2010 and $3 million for the fourth quarter of 2010. Our first quarter average sales price per system, including all da Vinci models and S to Si trade-ins but excluding upgrades, was $1.38 million, a decrease from the $1.45 million realized in the first quarter of 2010 and a decrease from the $1.41 million realized in the fourth quarter. The decrease in average sales price compared to the fourth quarter of 2010 reflects in approximately $1.3 million of revenue associated with simulators that was deferred as the simulators were delivered after the end of the quarter, an increase in the number of S to Si trade-ins for which we offer customer discounts for the return to S product and discounts offered in multi-system purchases. The decrease in average sales price per system compared with the prior year reflects those factors outlined for the sequential-quarter comparison, combined with the positive product and geographical mix in the first quarter of 2010. Service revenue increased to $64 million, up 26% compared with $51 million last year and up 5% compared with $61 million last quarter. The growth in service revenue was primarily driven by a larger system install base. Total first quarter recurring revenue comprised of Instrument, Accessories and Service revenue, increased to $221 million, up 28% compared with the first quarter of 2010 and up 4% compared with the fourth quarter of 2010. Recurring revenue represented 57% of total first quarter revenue compared with 53% in the first quarter last year and 54% last quarter. International results were as follows: Outside the U.S., procedures grew 38% on a year-to-year basis, with dVP in Europe being the greatest driver, although we experienced growth in our other target procedures including dVH in Europe. First quarter revenue outside the U.S. was $91 million, up 32% compared with revenue of $69 million in the first quarter of 2010, and down 5% compared with revenue of $96 million in the fourth quarter of 2010. Instrument and accessory revenue grew 39% year-over-year and 31% sequentially. We sold 31 systems outside the U.S. compared with 24 in the first quarter of 2010 to 38 last quarter. We sold 15 systems in Europe this quarter compared with 11 in the first quarter of 2010 and 28 last quarter. The fourth quarter has historically been the seasonally strongest quarter for system sales in Europe. Five of the systems sold in the first quarter were to Japanese customers. However, the tsunami and follow-on issues are expected to curtail sales in Japan for the foreseeable future. Aleks will provide these additional details of overseas system sales. Moving on to the remainder of the P&L. Gross margin in the first quarter was 72% compared with the first quarter 2010 gross margin of 73% and compared with fourth quarter 2010 gross margin of 73%. The decreases compared to prior periods primarily reflects decreased system ASPs. First quarter 2011 operating expenses of $131 million were up 18% compared with the first quarter of 2010 and up 2% compared with the fourth quarter. The quarter-over-quarter increase reflects costs associated with employees added during the quarter. We added 69 employees during the quarter, including 48 employees in our commercial operations organization and 18 employees in product operation. First quarter 2011 operating income was $148 million or 38% of sales compared with $130 million or 39% of sales for the first quarter of 2010 and $154 million or 40% of sales for the fourth quarter of 2010. First quarter 2011 operating income reflected $32 million of noncash stock compensation expense compared with $27 million for the first quarter of 2010 and $30 million last quarter. The year-over-year growth to noncash compensation reflects our annual grant made February 15 of each year. Our effective tax rate for the first year -- for the first quarter of 32% was lower than our 2010 rate of 33%. The reduction in rates between years reflects lower state taxes and a greater portion of our income being generated outside the U.S. The first quarter rate was also favorably impacted by the benefit of stock option exercise. Our net income was $104 million or from $2.59 per share, compared with $85 million or $2.12 per share for the first quarter of 2011 and $121 million or $3.02 per share for the fourth quarter of 2010. Now moving to the balance sheet. We ended the first quarter with cash and investments of $1,757,000,000, up $148 million compared with December 31, 2010. The increase was driven by $100 million of cash flows from operations plus $60 million from the exercise of stock options, partially offset by $12 million of stock buyback and $15 million of capital and IP purchases. During the first quarter we bought back 36,000 shares at an average price of $323 per share. As of March 31, there were $389 million of the board authorized buybacks remaining. Our stock buyback program remains active, and we intend to utilize the authorization to offset dilution created by stock options. Our accounts receivable balance increased to $260 million at March 31 from $247 million at December 31, reflecting the timing of receivables and collections. There was no change in the quality of our receivables during the quarter. Our inventory increased to $93 million at March 31 from $87 million at December 31. The increase reflects steps taken to increase component inventory where supplies have tightened and have build up finished goods to reduce the risk of supply disruption as we move our manufacturing operations to our new building in Sunnyvale at the end of the second quarter. And with that, I'd like to turn it over to Aleks who will go over our sales, marketing and clinical highlights.

Thank you, Marshall. During the first quarter, we sold 120 da Vinci Systems, 89 in the United States, 15 in Europe and 16 in rest of the world markets. As part of the 120 system sales, 13 standard da Vinci Systems were traded in for credit against sales for new da Vinci Si Systems and 19 S systems were traded in for Si Systems. We had a net 88 system additions to the installed base during the quarter, which brings to 1,840, the cumulative number of da Vinci Systems worldwide, 1,344 in the U.S., 330 in Europe and 166 in rest of world markets. 51 of the 120 systems installed represented repeat system sales to existing customers. In total, 110 of the 120 systems sold during the quarter represented da Vinci Si Systems, which included 15 dual console systems. The 31 system sales internationally included five da Vinci systems into Japan, four into Australia and three into the countries of Germany, France and Turkey. Clinically, we had a solid quarter, achieving overall year-over-year procedure growth of approximately 30%. Neurology and thoracic showed particularly solid sequential strength. On a year-over-year basis, the categories of thoracic, head and neck, GYN, colorectal and general surgery displayed the strongest growth. As we previously discussed, Q1 is a seasonally challenged quarter for surgeries that could be classified as discretionary, which causes some early year lumpiness within benign gynecologic procedures. Consistent with Q1 2010 procedure trends, malignant dVH showed greater sequential strength than benign dVH during the quarter. However, on a year-over-year basis, benign dVH is growing at a faster rate than malignant dVH. The overall category of da Vinci GYN surgery grew approximately 40% on a year-over-year basis. We would expect to see normal dVH cycles resume for the remainder of the year. Within urology, our dVP business remains strong and particularly so outside the United States, specifically within Europe. France and Germany are coming up the curb nicely, and Italy remains strong. We described our U.S. dVP business as relatively flat over the past several quarters. However, on a sequential basis, it can fluctuate a bit, and in Q1, it showed sequential strength. Having said that, we believe the greatest opportunity for growth will continue to be fueled from the OUS markets. At last year's European Association of Urology Conference, da Vinci related presentations, abstracts and postgraduate courses dominated the agenda, and the live surgery presentations were projected into standing-room only audiences. And at next month's AUA Conference, over 200 da Vinci-related abstracts have already been accepted. In addition, 16 AUA postgraduate courses will include da Vinci. dVP growth and urology in general remains strong and is certainly a catalyst for many of our OUS system placements. Regarding Japan, as you can imagine, the catastrophic earthquake and subsequent tsunami have caused significant disruptions to the healthcare system and has placed a tremendous burden on all Japanese government resources. The five da Vinci sales in Japan had occurred prior to these tragic events. We would expect uncertainty within Japan to prevail for some time to come and we will share more as it becomes known. During the quarter, over 200 clinical papers were presented at various conferences and/or within peer review journals. But I'll take a moment to highlight just a few. In the recent edition of the journal Gynecologic Oncology, Doctors Lim and Kang et al, published a paper entitled a Comparative Detailed Analysis of the Learning Curve and Surgical Outcome for Robotic Hysterectomy with Lymphadenectomy versus Laparoscopic Hysterectomy with Lymphadenectomy in Treatment of Endometrial Cancer: A Case-Matched Controlled Study of the first 122 Patients. The goal was to determine the learning curve and surgical outcome for the first 122 robotic hysterectomy with lymphadenectomy patients in comparison to the first 122 patients who underwent the same procedure laparoscopically. The learning curve of the surgical procedure was determined by measuring operative time with respect to chronological order of each patient who had undergone their respective procedure. Number of lymph nodes, estimated blood loss, days of hospitalization and complications of all patients were also analyzed and compared. Data were analyzed by mean age, body mass index, operative time, estimated blood loss, lymph node retrieval and complications for both surgical procedures. In their results, they reported the mean operated time was approximately 40 minutes shorter for the dVH cohort as compared to the traditional laparoscopic cohort. The mean estimated blood loss was statistically significant at 81 milliliters for da Vinci hysterectomy compared to 207 milliliters for the laparoscopic approach. The days of hospitalization for the dVH patients was 1.5 days compared to 3.2 days for the laparoscopic group. The number of intraoperative complications in the dVH group was one as compared to seven within the lap group. The authors concluded by saying, and I quote, "Robotic hysterectomy with lymphadenectomy has a faster learning curve in comparison to laparoscopic hysterectomy with lymphadenectomy. The adequacy of the surgical staging was comparable between the two surgical methods. Robotic hysterectomy is associated with shorter hospitalization, less blood loss and less intraoperative and major complications, and lower rate of conversion to open procedure." The interest in da Vinci from the thoracic community is increasing rapidly. In addition to lobectomies, we're seeing interest in thoracic pull-through procedures such as mediastinal mass resections. While the procedure numbers may be relatively small, the patient value is potentially very high. In a recent edition of the European Journal of Cardio-thoracic Surgery, a paper out of the University of Antwerp in Belgium authored by Doctors Balduyck and Hendriks et al entitled, Quality of Life After Anterior Mediastinal Mass Resection: A Prospective Study Comparing Open with Robotic-Assisted Thoracoscopic Resection, was published. The objective was to prospectively evaluate quality of life evolution after robotic-assisted thoracoscopic resection as compared to open anterior mediastinal tumor resection. The authors used a validated European quality of life questionnaire. Quality of life was prospect of all patients undergoing surgery for mediastinal tumors. A total of 36 patients underwent thoracoscopic resection using either the da Vinci robotic system or a sternotomy-based open resection. Questionnaires were administered before surgery and at one, three, six and 12 months, postoperatively, with response rates of 100%, 86%, 94% and 75% respectively. The results were as follows: Both approaches had comparable preoperative patient characteristics and quality of life subscales. Open resection by sternotomy was characterized by a significant decrease in general functioning one month after surgery, both physical and social. Patients also complained of increased thoracic pain in the first three months post-surgery. Following a da Vinci robotic resection, quality of life scores approximated the baseline preoperative scores one month after surgery. In other words, there were no reduction in patient function scores at the first postoperative quality of life measurement. The authors' conclusion, and I quote, "Numerous techniques have been published with different degrees of invasiveness, generating the existing controversy as to which is the best surgical approach for anterior mediastinal tumors. The high burden of decreased physical functioning reported after sternotomy is not seen after the da Vinci robotic-assisted thoracoscopic resection. The initial experience and postoperative quality of life data are excellent and, therefore, the da Vinci robot will stay our future technique of choice for the treatment of resectable mediastinal tumors measuring less than 4 centimeters." The patient value of replacing large thoracotomies and/or sternotomies with a small, minimally invasive incision is significant, which is one of the reasons why thoracic surgery has become one of our fastest-growing specialties. In closing, I'll remind you that the second quarter marks the peak of our busy global conference season, with the AUA, ACOG, AATS and the American Society of Colorectal Surgery Conference is taking place, to name a few. We will provide you with the clinical highlights from some of these conferences during next quarter's call. That concludes my remarks, so I'll turn the time over the Calvin.

Thank you, Aleks. I will be providing you with an update to our financial forecast for 2011, including procedures, revenues and other elements of the income statement on a GAAP basis. I will also provide estimates for significant noncash expenses to provide you with visibility of our expected future cash flows. Starting with procedures. Our first quarter 2011 procedures grew approximately 30% compared to the first quarter of last year. Based upon our latest projections and consistent with our previous forecast, we continue to expect our total procedures for 2011 to grow approximately 25% to 28% for the year from approximately 278,000 procedures performed in 2010. Moving on to revenues. Our 2011 total revenue forecast also remains unchanged compared to our previous quarter's estimates. Our Q1 2011 revenues increased 18% compared to Q1 of last year. We continue to expect our full year 2011 revenue to grow approximately 16% to 20% for the year. With regard to gross margin. On our last call, we estimated our 2011 gross margin percentage to fall between 72% and 73% of revenue. Our first quarter 2011 gross profit margin of 71.8% was just below this range as system ASPs and product margins were impacted by higher da Vinci S trade-in volume, a factor that we expect to continue going forward. We now anticipate our full year 2011 gross margin percentage to come in at the lower end of the 72% to 73% range forecast on our last call. Moving to operating expense. We continue to invest across multiple areas of our business, particularly our sales force, manufacturing and R&D. Consistent with our last call, we anticipate growing operating expenses between 16% and 20% in 2011 in line with our top line growth. In terms of noncash expenses, we continue to expect 2011 noncash stock compensation to total between $140 million and $145 million, up from $118 million reported in 2010. And we continue to expect 2011 amortization of purchased intellectual property to total between $17 million and $20 million. Other income, which is mainly comprised of interest income, is expected to come in at the higher end of the $17 million to $18 million range forecast on our last call. With regard to income tax driven primarily by lower state income tax estimates, we are now reducing our tax rate forecast to 33% of pretax income from 34% forecast on our last call. We estimate that our diluted share counts for calculating Q2 2011 earnings per share will be approximately 40.3 million shares. We aim to keep the share count around this level throughout the balance of 2011 which is equal to our 2010 average. Finally, regarding our cash flows. Since we're forecasting to report over $157 million in noncash stock compensation and amortization expenses for the year, our full year cash flows will continue to be significantly higher than our reported net income. We believe cash flows generated from operation is a better measure of our actual financial performance than net income. During Q1, we repurchased and retired $12 million of our common stock. Entering Q2, we have $389 million remaining authorized by the board to purchase additional shares. Our repurchase program is active, and we expect to increase our level of repurchases going forward. That concludes our prepared remarks. We will now open the call to your questions.

[Operator Instructions] Our first question today comes from the line of Bill Andrew (sic) [Ben Andrew], representing William Blair. Ben Andrew - William Blair & Company L.L.C.: Thank you for taking the question. I wanted to ask here, if I might, plans for continued hiring. You've been growing the organization very rapidly, trying to scale into some new significant opportunities. How far have you come in that process? And can you give us a thought on maybe how many more quarters we would see this above trend hiring or is this now the new trend?

Yes. I think it'll start to temper as a percentage of the base and it already has actually in Q1 from Q4. So we'll continue to hire but not quite at the same percent growth rate. The two barbells that have been commanding most of the hiring has been the clinical side in the field as we try to get territory's balance for the right procedure for rep coverage. And I think our coverage is getting pretty close to where we want it. It's really now just filling open territories as needed, and then a little bit on the R&D and operations side to support programs as we're growing. So I think you'll see a temper. We'll continue to hire but it will start to temper. Ben Andrew - William Blair & Company L.L.C.: And then maybe a question for Aleks. If my math is right, did you add 59 de novo systems in the U.S. this quarter?

Give me a second on that.

It should be close to that...

I believe it's 59.

That is correct. It is 59. Ben Andrew - William Blair & Company L.L.C.: So my question is, as you look at that rate, it has come down a little bit from, say, the Q4 and Q1 were a bit below the trend you had seen in the previous three or four quarters for de novo U.S. placements. How do you think about the pipeline of potential new hospital is flowing in? And you did mention kind of multi-system orders, but just talk a little bit about the flow of potential customers for de novo systems in the U.S. if you would.

So I believe 89 systems in the U.S. represents a new high watermark for us. So the flow of systems into the United States remains very strong. What we probably have a more difficult time assessing on a go-forward basis is at what rate existing customers want to upgrade, either their Standard system or their S System to the Si System. I know it's a little different than the question you asked about the de novo system, but as you look at the activity that the sales organization has to go through to trade out a system and trade up or cultivate a new de novo system, it isn't that there is an enormous difference in the time required to get one done versus the other. So as we look at the overall system placement in the United States, it remains important for us to continue to either get our customers into the Si Systems or cultivate new green field. I don't know that there's a trend that we can point out that says this is going to continue. I think it'll probably oscillate up and down a bit as we go forward, and that's probably the most -- the best visibility we have. Ben Andrew - William Blair & Company L.L.C.: Okay. And then as you think about satisfying the needs of the customer across multiple specialties, it sounds like you're seeing some pickup in the number of multi-system orders or hospitals with obviously recurring orders. So is that more important to you, if you will, as developing maybe [indiscernible] -- is that obviously a point of focus for the company, trying to grow that installed base of existing and strong customers, maybe even more important than driving new customer installations?

It's hard to say again and I think you caught yourself in the question, and I think that's probably the way we'd answer it. It's hard to say what is the most important. I would say this, that when you have customers who are coming back and buying second, third, fourth or fifth system, I believe we now have five hospitals that have six systems, and they build very comprehensive programs. That's very valuable for us, both regionally and nationally. And so, I don't want to diminish from that, but at the same time, opening up a new store, if you will, the analogy being same-store sales versus new stores, is also important. The most important element is driving into those stores and keeping the shelves full with procedures. And so that happens both ways. So we're really not going to pick and choose as to which one is a little more valuable or a little less valuable. They're very valuable to us and we'll continue to operate that way.

Mr. Peterson, your line is open. [JPMorgan Chase] Tycho Peterson - JP Morgan Chase & Co: Thanks for taking the question. Maybe just starting out with ASPs. A little bit obviously some give and takes with mix here. Can you just talk about where you see ASPs maybe on da Vinci progressing for the rest of the year, and maybe talk about -- you talked about the Simulator impacting this quarter. Does that carry over as we go forward?

The Simulator impact for the quarter was we had greater demand than we had anticipated going into the quarter, and so there were 32 systems that we did not deliver in the quarter and we've delivered those early in the second quarter. It's about $1.3 million worth of revenue. So that has a $10,000 impact on ASPs for the quarter. And to your question, that does carry over into Q2. But I wouldn't expect ASPs to vary greatly from where we are today. Tycho Peterson - JP Morgan Chase & Co: Okay. And was there any contribution from the Si-e?

Si-e, very little. We had three Si-e units in the quarter. Tycho Peterson - JP Morgan Chase & Co: And then on sales, can you just talk about the market opportunity within Europe, what with yearly traction is like? And then any additional color you can provide on what the FDA is asking for here in the U.S.?

I'll start with kind of the initial experience, Aleks can talk a little bit about the broader activity. So far, we're starting in cholecystectomy. The first experiences have been great. We've seen good procedure outcomes, low complication rates all been cholecystectomy, good learning curves. So our early opening experience in Europe has been really strong. And the conversation with FDA is really centered around indications per use and the clinical data to support that, so we're collecting additional data and we'll provide it to them per their request, and off we go. Cholecystectomy is clearly the place we're going to start and where it takes us from there will require some procedural development and additional medical research, but I'll let Aleks take...

Yes. I'll just say, Tycho, you've been following us for a while and I think when we go into a procedure category, we tend to be very diligent, very careful as to how we roll out the launch. And so as you can imagine, to Gary's comments, we had a few centers that were up and running. We're really trying to validate the procedure, we're trying to understand sort of the nuances of the procedure and the choreography of the procedure, and then in a very step-wise and thoughtful manner, expanding it a little bit at a time. And so that's really the approach that we have, whether it's Europe or anywhere else. In terms of the overall market, it's way too early for us to really claim what that size might be. I think there's probably an update out there that suggest what the laparoscopic cholecystectomy market is, but that's not what we're saying our opportunity is. We'll figure it out and we'll do it thoughtfully and we'll share more information as it becomes available. Tycho Peterson - JP Morgan Chase & Co: I guess as we think about colorectal, can you talk to some of the momentum coming out of SAGES from the physician community and any additional commentary you can provide coming out of the conference?

Yes, I think colorectal in general, if you look at -- again, it's been a very rapid ascent into that market. Now we're dealing off a small base just to level set. But what is very interesting is that each quarter that goes by, we tend to have a greater awareness in the community. And when I say the community, we're talking about the board-certified colon and rectal surgeons, independent of the interest that general surgeons might have with some of them do colorectal procedures. But when you really look at the colorectal specialty, you have to look at the board-certified colorectal surgeons. And the data that was disseminated and the discussions at stages and the general awareness of it in that community is growing pretty rapidly. We've said all along that we think that there are some products that will be required to fully optimize the opportunity, be it stapling, be it a vessel sealing platform and suction/irrigation and so on, but we're very pleased at the rate of growth despite having the perfectly optimized system. Tycho Peterson - JP Morgan Chase & Co: And then just last one on TransOral. Can you just talk as to how interesting that market's becoming? I guess we get a few more questions on the margin on that opportunity lately and if you could just talk to whether it's sleep apnea or other areas that are expanding pretty quickly, that'd be helpful.

Where we've set our initial targets is really where we remain today, and that's in the base of tongue in some of the malignant cancers, tonsil cancers -- I should say the base of tongue cancers and some of the benign conditions there resections as well as the tonsil cancers, et cetera. As far as sleep apnea, there's really not a lot that we can share there. I know there have been people that have talked about it, but we're aware of the interest people have there. But our focus is really into the high-value procedures today that we've identified with our customers and we'll continue to drive there.

And next, we will go to the line of David Lewis with Morgan Stanley.

This is actually Jon Demchick in for David. First off, on the trade-ins of Si, the former upgrades, I believe there were 19 of them. What was the breakdown between U.S. and EU? And how many S Systems are still out there?

I think it was two international trade-ins of which one was a Standard and one was an S. The rest would have been U.S.

On procedure adoption with Single-Site in Europe and soon to be in the U.S. and then also the stapling and sealing tools in development, can you give us any more clarity on the launch times of these as well as the main procedures that you're targeting with these devices, and how you guys are looking at the adoption curves?

I think there's really not a lot of more detail we can provide on prospective launch dates. I think we, again, I think, label them as either in with the FDA or soon-to-be and/or will at some point be in with the FDA. Beyond that, once it gets into that position, it's difficult to really say. In terms of the opportunities or the market, I think again with the Single-Site System, the initial target is going to be cholecystectomy with respect to the stapler. Staplers are used in a variety of applications ranging from general surgery to colorectal, to lung, to GYN oncology and so on and so forth. So I would envision that following along in parallel to where our procedure efforts are going that require a stapler and I think the same thing could be settled with vessel sealing.

And lastly, last quarter we saw international placements up around 40, and this year they were, I guess, a little bit above 30. Is the system placements a reflection of the strength in the same countries like Germany, Italy and France, or is it more a result of just broad adoption? Also with the European box trend, is that more of a result of just increased traction or is it easing in austerity?

Yes. I think if you look at the comparison you made, and you can back test this for years, Q4 is the strongest market, assuming the strongest period for system sales outside the United States, and Q1 is traditionally, along with Q3, among the slowest. And so, there's really no surprise to us in terms of 31 systems as opposed to 38, I believe, we did last year -- excuse me, last quarter. So I think we're actually pleased with 31. The market, again, the breakouts, we introduced, I think, for the first time, talking about Australia. We haven't talked about Australia in a while, we haven't talked about Turkey in a while. Those are markets that again are coming on and certainly come on this quarter. And then Germany, and France and Italy remain very important markets to the EU. In terms of austerity measures, there really isn't, I think, a lot more for us to share there. We've seen it oscillate up and down over the past year or perhaps six quarters, and there's really nothing new for us to add there.

Our next question is from the line of Rick Wise representing Leerink Swann.

It's Miroslava for Rick tonight. Can we talk a little bit about Japan. I appreciate the commentary that with the tragic situation that we have over there, there's probably going to be little update. But just prior to that, you had a pretty strong quarter. Is there something new that you can share with us on the reimbursement front?

Not really anything new we can tell you. We continue to work down the process there, which is a combination of working with our partners and collecting data and working with surgical societies likewise. But I can't give you any update on the time line.

Okay, no updates. And secondly maybe on the increase in da Vinci S upgrades. It seems to me, if I'm looking at my model at least correctly, it seems like it's a pretty significant step up from what you've done from the nine to 10 upgrades you've done historically to something like 19 this quarter. Is there a reason why -- and you anticipate this continuing. What are the drivers there that you suddenly see this -- we see a bit of a step up there and you expect to see it continuing?

Again, I think in terms of the expectations, we don't really go into a particular quarter or particular time period and say we would expect this many customers to participate in an upgrade program. We try that through the communication with our sales organization, understand what the range might be, if you will. But what the customer ultimately decides to do is really up to the customer, and we will help facilitate whichever transaction they wanted, if they own a Standard and they want to get into an Si, we've got a program to help facilitate that. The same is true with the S. I can't out point at one event-driven activity that has caused an uptick from 10 to 19. But again, we've got a few quarters of this now under our belt and I think you can start to plot it and develop -- some trends are developing there and we just have no reason to think that it's either going to grow materially or decrease materially.

Okay, thank you. And lastly, there is a study coming up at AUA that some physicians have pointed to us maybe interesting in terms of evaluating watchful waiting versus radical prostatectomy. Do you anticipate any sort of impact from this study? And what could this mean for your prostatectomy rates in the U.S.?

It's really hard to say. If I'm not mistaken, that study has been -- patients have been enrolled in that study from the '90s and there's a long-term follow-up on it, and that's great. I mean, I think you get long-term results. Unfortunately, you have to go through long periods of time. And I would suspect that there are only a few, if any, da Vinci Prostatectomies that are part of that cohort. And so, I think the watchful waiting versus surgery versus radiation debate will be with us for a long time. I don't know that there is anything that we would expect one direction or the other based on that particular study. I'm glad it's being done. I think good science needs to be done in a lot of different areas within prostate cancer, and we'll see what the results say.

The next question is from David Roman with Goldman Sachs.

Thank you for taking the question. I was hoping to come back to gross margins. I know you talked a little bit about ASPs negatively impacting numbers, but if I look at the product gross margin, it looks like that was down from 75.5% in the prior year quarter down to sort of 73.9%. Maybe you could help us sort of understand a little bit more the dynamics on the gross margin anything beyond ASPs. And then maybe a follow-on on the ASPs. As you’re selling repeat systems, are you seeing the ASPs on those systems the same as when you're selling systems to de novo accounts?

Yes. So the product gross profit that you mentioned, yes, 74.5% in Q4 down to 73.9%, so we're talking about 0.6 point here. And I think we tried to highlight the biggest factor out there which would be the ASPs for the decline of product margins, specifically the higher volume of S trade-ins which are going to carry a higher customer credit which helps to inform the sales discount. So that's the biggest factor, I think. We talked a little bit about the Simulator, too. And the Simulator, it's being bundled in with a lot of these sales in the quarter, and there's some cost that goes at the Simulator and at the same time, the ASP was steady to down. So the scenario we've set all along that we're going to be investing in our business in areas where we think we can grow procedures and drive adoption of robotic surgery, and I think the Simulator is one of those areas of investment that they kind of see on the gross margin line.

And then just on the ASPs, if you look at the centers to which you were selling second, third or fourth systems, et cetera, when you're making a repeat systems sales to any of those hospitals are the -- for the ASP there, are you recognizing something that's close to what you're recognizing on when you're making a new sale to a new hospital?

There's not a significant difference between the ASPs and follow-on systems versus initial system sales.

And then lastly, on the procedure volume side, I think in several examples you've talked about prostatectomy sort of flattish and then some seasonal gyrations on the benign hysterectomy side of the business. Would you say that -- does that mean that the vast majority of the sequential growth in procedures really came from outside of your 2 core procedures just on a sequential basis that the incremental procedures are becoming increasingly comprised of head and neck, for example, and some of the non-GYN, non-urological procedures?

I would say that the urologic procedures grew, and this is one of the quarters that we talked about. And I mentioned in my commentary from time to time in the United States. And we've talked about dVP being flattish for several quarters, but there are quarters where you will see some pretty -- some nice sequential strength and Q1 was one of them. So we -- in addition to seeing the OUS growth and specific to Europe, we saw U.S. growth. So there was -- the category of neurology was a decent contributor to the incremental sequential growth. This growing category of Other, I think you're right. I think when you look at the category of Other, it tends to grow at a faster rate, then the blend of the two main line procedures. And so nothing really different there. And I think you highlighted the sequential, or I should say, the seasonal challenge with some of the benign procedures, specifically dVH that you start to see in the early part of the year that tends to sort of correct itself as we get out beyond the first few months.

The next question is from the line of Tao Levy with Collins Stewart.

So Aleks, maybe you could mention you could talk a little bit about the benefits of the vessel sealing device that they sent to the FDA, and not only on sort of the types of procedures versus kind of the other vessel sealing products that are readily available to da Vinci users, and also the benefit to the P&L, if any, or the impact?

Well, yes, as far as benefits, I'm going to be very careful. As you know, without having FDA clearance, you're not to be making claims on a particular product, so I'm going to be careful not to make any claims. I think in the category of vessel sealing, what tends to be the target is moving into a larger -- moving into a larger vessel and some of them, again, you're taking significantly larger vessels than you would with traditional bipolar or other forms of elective surgery. That's the target. As you know with the da Vinci instrument, you get articulation and get control, so we look to bring all of those things to the product. But in terms of making benefit claims, I’ll wait and preserve that until we get the product through the FDA and out the market, we can actually make those claims. And as far as the P&L, there's really not much we can comment on there because the product isn't priced and it's not in the market yet. So we do believe that a vessel sealer in some of the complex procedures, which we've become accustomed to operating in will add value. But that's about as far as I think we can really talk about it.

Okay. And a couple other pipeline products, is the Single-Site experience in Europe, maybe you can comment on the price point of that technology at this point?

Right now, it's priced at a slight premium to the manual products in the market and a little bit lower than typical da Vinci instrument kit just directionally.

Okay, perfect. And then lastly, what are your early thoughts on the Fluorescence Imaging? You're starting to see some press releases out of some of the hospitals with some initial procedures on that technology. Where do you think it potentially could add the most value in that area?

Good question. For us, it's a little bit of a platform technology and this is really the first indication for it. So the current clearance is for vascular imaging. So it's being used in partial nephrectomy and some colorectal and allows surgeons to understand profusion. There are other potentials for Fluorescence Imaging that we're working on that will have subsequent follow-on clearances that will have subsequent follow-on clearances that will allow us to take in other directions. So I think generally speaking, directionally, what it does is allow surgeons to see some structures beyond the tissue surface and do more precise dissection than they would otherwise be able to do. I think it'll be a slow build for us as we gain experience, as the publications come out. So far, the early use of it is encouraging, but I think it will take some time to get that built into our procedure packages and into our clinical publications, and we have some follow-on indications we'd like to pursue.

Our final question today comes from the line of Mimi Pham with Weeden & Co. Mimi Pham - Weeden & Co., LP: Do you have any target in terms of Single-Site in Europe? Do you have a target of how many sites you want to be at by the end of the year?

We don't, and I would just say that if the first quarter where we really started to commercialize it and it'd be difficult for us to assess what that number is going to be at the end of the year. Mimi Pham - Weeden & Co., LP: Okay. And then in terms of the U.S. mission for Single-Site, I mean, I know you're saying you're -- do you have everything you need to resubmit in the current quarter? Is that something that might take you through year end to get all the FDA -- all the data to the FDA?

Some of that data, we're currently collecting now, so I don't know exactly when we'll have it all in our hands but it's not all sitting right now on the dockets. We'll have to do some of the work to get it done. Mimi Pham - Weeden & Co., LP: And when you say work, you mean additional clinical work?

Yes, there's clinical work to be done. Mimi Pham - Weeden & Co., LP: Okay. And then in terms of your procedure growth of being 30% this quarter but you still kept your guidance for the year 25% to 28%, can you just talk about -- do you expect that year-over-year growth through the year to decline throughout the quarters or in terms...

Well, I guess that's implied in the guidance. I mean, mathematically, that has to be the case. If you look at Q4 last year, it was 35%. Now we're in Q1, it was down to 30%, so we know this was seasonally a lighter quarter in some of our benign procedures. But I think still the math is as you described it, I think the year-over-year growth in the outer quarters would be slightly down from here. Mimi Pham - Weeden & Co., LP: Okay. So I guess just implied by that, you're not expecting sort of an uptick in the back half of the year from Single-Site to keep that level [indiscernible]?

Nothing like that will be built in to the numbers here. As Aleks said, it's just too early to forecast what that maybe. Mimi Pham - Weeden & Co., LP: Okay. Thank you for the clarification.

Thank you. That was our last question. As we have 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 experience gives you some sense of what this means in the lives of our patients. One experience comes from Jenn in Ohio who had a da Vinci surgery for endometriosis. After several laparoscopies that removed some but not all of the endometriosis, she writes, "In the meantime, I had lost my job. I had to take pain medications throughout each day and it just barely touched my pain. I couldn't drive, cook or clean. Some days I couldn't even drag myself out of bed. I had to rely on my family for everything. I felt absent from my son, my husband and my entire life. Finally, a friend contacted me and told me about Dr. Ross Marchetta and how he helped her after years of being misdiagnosed by several doctors. Thank God she did. He informed me of the da Vinci robotic-assisted surgery and explained that I was a perfect candidate. He was the first doctor who was confident he could help me. In June of 2010, I had my da Vinci robotic-assisted laparoscopy. Using the robot, Dr. Marchetta was able to remove all of my endo lesions, both fibroids and my fallopian tube and cystic ovary. My ovary was growing into my kidney, and if it would've remained untreated much longer, it could have caused serious damage. Dr. Marchetta called my case one of the worst he had ever treated and said he would call it Stage V, if there was such a stage. He was thrilled with the work he was able to accomplish and explained that he never could have achieved this amazing result without the robot. He called my surgery a miracle. It was miraculous. He gave me back my life. I weaned off my pain medication. On the 4th of July, my family and I attended a friend's party, the first fun I had, had all year. I felt like myself again. My pain was completely gone. I returned to my normal everyday life as a mom, wife and writer. On my birthday, I celebrated my health by parasailing, an activity on my bucket list. If people had told me this was possible during those previous dark months, I never would've believed them. Dr. Marchetta and the da Vinci robot saved my life. My family and I will be forever grateful." Patients like Jenn are the strongest advocates for da Vinci surgery and form the very foundation of our operating performance. We have built our company to take surgery 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.

Ladies and gentlemen, that does conclude our conference for today. Thank you for your participation and for using AT&T Executive Teleconference. You may now disconnect.