Intuitive Surgical - Earnings Call - Q3 2011
October 18, 2011
Transcript
Speaker 5
Ladies and gentlemen, thank you for standing by. Welcome to the Intuitive Surgical Q3 2011 earnings release conference call. At this time, all participants are in a listen-only mode. You will have an opportunity to ask questions after the presentation. If you have a question, press star, then one on your touch-tone phone at any time. You may remove yourself from the queue at any time by pressing the pound key. As a reminder, this call is being recorded. I would now like to turn the conference over to our host, Mr. Calvin Darling, Senior Director of Finance. Please go ahead.
Speaker 3
Thank you. Good afternoon and welcome to Intuitive Surgical's third quarter conference call. With me today, we have Gary Guthart, our President and CEO, Marshall Mohr, our Chief Financial Officer, and 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, in 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 results, as described in our press release announced earlier today, followed by a question and answer session. Gary will present the quarter's business and operational highlights. Marshall will provide a review of our third quarter financial results. Aleks will discuss marketing and clinical highlights. I'll provide you with an update to our financial guidance for 2011. Finally, we will host a question and answer session. With that, I'll turn it over to Gary.
Speaker 4
Thank you for joining us today. We are pleased with the growth in Da Vinci procedures and with the performance of our capital and clinical teams in the third quarter. Overall, the Intuitive team is executing well in our four 2011 focus areas, which are first, extending the benefits of minimally invasive surgery in gynecology and urology, second, expanding robotic surgery and deepening our organizational capability in Europe and Asia, third, crisp execution in our product development efforts, and finally, enabling emerging procedures in thoracic, transoral, colorectal, and general surgery. Total procedures grew approximately 30% over Q3 2010, with strong year-over-year growth in gynecology. Gynecology procedure performance was solid for all of our target procedures, including hysterectomy for malignant and benign conditions, sacrocolpopexy, and myomectomy. In urology, Da Vinci prostatectomy continued to grow year over year, driven by European uptake.
DVP was flat in the quarter on a sequential basis, expected given the summer seasonal slowdown in Europe. For follow-on procedures in urology, our penetration into treatment for kidney cancer continues to grow, as more total nephrectomies are converting to nephron-sparing partial nephrectomies, enabled by Da Vinci. Emerging procedures in thoracic surgery and colorectal surgery continue to show strength, both sequentially and year over year. Transoral robotic surgery grew nicely on a year-over-year basis. However, absolute volumes in TORs are relatively small, and quarter-to-quarter variation is significant. Aleks will provide additional procedure commentary later in the call. Operating highlights for the third quarter are as follows: procedures grew approximately 30% over the third quarter of 2010. We sold 133 Da Vinci Surgical Systems, up from 105 during the third quarter of last year, 99 of which were purchased by U.S. customers.
Total revenue was $447 million, up 30% over last year. Instrument and accessory revenue increased to $176 million, up 38% over Q3 of 2010. Total recurring revenue grew to $248 million, up 34% from prior year, and comprising 55% of total revenue. Net income was $122 million, up 41% over last year. We generated an operating profit of $214 million before non-cash stock option expense, up 32% from the third quarter of last year in Q3 revenue. We ended the quarter with $1.9 billion in cash and investments, up $65 million from last quarter. Significant cash outlays during the quarter included $15 million invested in intellectual property and fixed assets, and $181 million used in the repurchase of our stock.
Excluding the impact of these outlays, as well as $91 million from stock proceeds and $19 million provided by working capital, we generated $190 million in gross cash flow from operations, which is 155% of our reported GAAP net income in the third quarter. Turning to products, we received FDA approval for our suction irrigation instrument in the quarter, which, combined with a new thoracic grasper and new bipolar dissector, comprises an instrument kit designed to facilitate thoracic procedures. Early uptake of our thoracic instrument kit has been encouraging. As we mentioned on our last call, we continue to answer questions posed by the FDA on our single site and vessel sealing products. Our interactions with the FDA have been constructive, and our teams are working diligently to answer their questions. Our stapler continues to progress through its validation and testing processes, and progress there remains encouraging.
Given the current uncertainty of the U.S. regulatory process, we do not have additional information to share with you regarding timing for approval or launch of these products. With regard to recently launched products, our Firefly fluorescence imaging system is gaining acceptance with customers, primarily for visualizing vasculature and partial nephrectomy procedures. We are also pleased with the continued uptake of our Da Vinci simulators and feedback on their use. Simulators and dual consoles are providing our customers with targeted tools to improve the quality and accessibility of robotic surgery training, reflected in strong simulator purchases and steady demand for dual consoles. Lastly, we continue to invest in building our team, in expanding partnerships, and in acquiring those technologies that can make a difference to robotic surgery.
In the quarter, we moved our manufacturing operation to our new facility, built to allow for increased capacity and proximity to our R&D center. We added 76 people to our team, predominantly in manufacturing, sales, and R&D, bringing our total team to 1,845 employees. I'll now pass the time over to Marshall, our Chief Financial Officer.
Speaker 6
Thank you, Gary. Our third quarter revenue was $447 million, up 30% compared with $344 million for the third quarter of 2010, and up 5% compared with $426 million reported for the second quarter of 2011. Third quarter revenues by product category were as follows: third quarter instrument and accessory revenue was $176 million, up 38% compared with $128 million for the third quarter of 2010, and up 3% compared with $172 million in the second quarter of 2011. Year-over-year instrument and accessory revenue growth was driven by procedure growth of 30% and early adopter purchases of recently launched products, including our Firefly and thoracic instrument set. Quarter-over-quarter growth was primarily driven by procedure growth and sales for our recently launched products.
Instrument and accessory revenue realized per procedure, including initial stocking orders of approximately $1,950 per procedure, was higher than the $1,830 realized in the third quarter of 2010 and slightly higher than the $1,940 achieved in the second quarter of 2011. Over time, we expect instruments and accessories per procedure to decline slowly, given that initial stocking orders have a lower impact on a larger install base. This natural decline has been more than offset in recent quarters by the positive impact of our new instrument and accessory products. Third quarter 2011 systems revenue of $199 million increased 25% compared with $160 million of systems revenue for the third quarter of 2010 and increased 7% compared with $187 million of systems revenue for the second quarter of 2011. Our higher third quarter 2011 systems revenue was driven by higher system unit sales and higher system ASPs.
We sold 133 systems in the third quarter of 2011, compared with 105 systems in the third quarter of 2010 and 129 systems in the second quarter of 2011. The third quarter of 2011 system count included 35 systems involving trade-ins of older units, comprised of 14 standard systems and 21 Da Vinci assets. During the second quarter of 2011, 36 systems involved trade-ins, comprised of 15 standard units and 21 Da Vinci assets. The third quarter 2010 system count included 15 standard system trade-ins, but excluded 10 SSI upgrades that were treated as upgrade revenue since the S units were upgraded in the field. Upgrade revenue for the third quarter of 2011 was approximately $5 million, compared with $10 million for the third quarter of 2010 and $1 million for the second quarter of 2011. Prior year upgrade revenue included the 10 SSI upgrades.
Our third quarter average sales price per system, including all Da Vinci models but excluding upgrades, was $1.46 million, an increase from the $1.43 million realized in the third quarter of 2010 and an increase compared with the $1.44 million realized in the second quarter. The increase in average sales price reflects a higher proportion of dual console systems in the product mix, as we sold 29 dual console systems in the third quarter of 2011, compared to 22 in the third quarter of 2010 and 21 in the second quarter of 2011. Also benefiting the year-over-year comparison is revenue associated with our simulator product. ASPs will fluctuate quarter to quarter based on product, customer, and trade-in mix. We sold 98 simulators in the third quarter of 2011, compared to 115 during the second quarter of 2011, which included 33 on backorder from the first quarter of 2011.
In total, we have sold 260 simulators in the first nine months since its introduction. A large majority of simulators are purchased in conjunction with new Da Vinci system sales and are included in our system ASP calculation. Service revenue increased to $72 million, up 25% compared with $57 million last year, and up 6% compared with $68 million last quarter. The growth in service revenue is primarily driven by a larger systems install base. Total third quarter recurring revenue, comprised of instrument, accessory, and service revenue, increased to $248 million, up 34% compared with the third quarter of 2010 and up 4% compared with the second quarter of 2011. Recurring revenue represented 55% of total third quarter revenue, compared with 54% in the third quarter last year and 56% last quarter. International results were as follows: procedures outside of the U.S.
grew 34% on a year-to-year basis, with Da Vinci prostatectomy in Europe being the greatest driver, although we also experienced growth in our other target procedures, including Da Vinci hysterectomy for malignant conditions in Europe. Third quarter revenue outside the U.S. was $94 million, up 59% compared with revenue of $59 million in the third quarter of 2010 and up 9% compared with revenue of $87 million in the second quarter of 2011. Instrument and accessory revenue outside the U.S. grew 51% year over year and decreased 7% sequentially, driven by summer seasonality. We sold 34 systems outside of the U.S., compared with 22 in the third quarter of 2010 and 30 last quarter. We sold 18 systems in Europe this quarter, compared with 16 in the third quarter of 2010 and 16 last quarter. Aleks will provide additional details of overseas system sales.
Moving on to the remainder of the P&L, gross margin in the third quarter was 73%, compared with 73% for the third quarter of 2010 and 72% for the second quarter of 2011. The increase compared with the second quarter of 2011 was driven by higher system ASPs and lower service parts consumption. Third quarter 2011 operating expenses of $147 million were up 24% compared with the third quarter of 2010 and up 6% compared with the second quarter of 2011. The quarter-over-quarter increase reflects costs associated with employees added during the quarter, higher engineering project costs, and variable costs associated with increased revenue. We added 76 employees in the quarter, including 47 employees in product operations and 25 employees in commercial operations.
Third quarter 2011 operating income was $179 million, or 40% of sales, compared with $132 million, or 38% of sales for the third quarter of 2010, and $168 million, or 39% of sales for the second quarter of 2011. Third quarter 2011 operating income reflected $35 million of non-cash stock compensation expense, compared with $30 million for the third quarter of 2010 and $35 million last quarter. Our effective tax rate for the third quarter of 32% is consistent with the rate for the first six months of 2011 and lower than the 37% reflected in the previous year. The year-over-year decrease reflects lower foreign and state taxes. Our net income was $122 million, or $3.05 per share, compared with $87 million, or $2.14 per share for the third quarter of 2010 and $117 million, or $2.91 per share for the second quarter of 2011.
Let me quickly summarize our results for the first nine months of 2011. Procedures grew by 30%. Total revenue for the first nine months of 2011 was $1.26 billion, up 23% compared with $1.02 billion last year. The revenue increase included recurring revenue growth of 31% and an increase in systems revenue of 15%. Operating income for the first nine months of 2011 was $495 million, up 23% compared with $402 million last year. Operating income included $102 million of stock-based compensation charges in 2011 compared with $88 million in 2010. Net income for the first nine months of 2011 was $344 million, or $8.55 per share, compared with $261 million, or $6.45 per share last year. Gross cash flows from operations for the first nine months of 2011 totaled $527 million, compared with $416 million last year.
Now moving to the balance sheet, we ended the third quarter with cash and investments of $1.89 billion, up $65 million compared with June 30, 2011. The increase was driven by $190 million of gross cash flows from operations, plus $91 million from the exercise of stock options, partially offset by $181 million of stock buybacks and $15 million of capital and IP purchases. During the third quarter, we bought back 526,000 shares at an average price of $344 per share. As of September 30, there was $68 million of the board authorized buybacks remaining. Our accounts receivable balance increased to $265 million at September 30, from $250 million at June 30, primarily reflecting the impact of higher third quarter revenues. There was no change in the quality of our receivables during the quarter. Our net inventory increased to $109 million at September 30, from $100 million at June 30.
Our higher inventory reflects our business growth, expanded product offerings, and safety stocks acquired for key components. With that, I'd like to turn it over to Aleks, who will go over our sales, marketing, and clinical highlights. Thank you, Marshall. During the third quarter, we sold 133 Da Vinci systems, 99 in the U.S., 18 into Europe, and 16 into the rest of the world markets. As part of the 133 system sales, 14 standard Da Vinci systems and 21 Da Vinci S systems were traded in for credit against sales for new Da Vinci SI systems. We had a net 98 system additions to the install base during the quarter, which brings to 2,031 the cumulative number of Da Vinci systems worldwide: 1,478 in the U.S., 357 in Europe, and 196 in the rest of the world markets.
60 of the 133 systems installed during the quarter represented repeat system sales to existing customers. In total, 117 of the 133 systems sold represented Da Vinci SI systems, which included 29 dual console systems. The 34 system sales internationally included six Da Vinci systems into Japan, six into Germany, four into India, and three into Spain. Clinically, we had a strong quarter, achieving overall year-over-year procedure growth of approximately 30%. Colorectal and thoracic surgery growth was particularly strong, while gynecology displayed solid sequential growth, specifically benign hysterectomy and myomectomy. As mentioned in the past, Q3 represents certain seasonal challenges, specifically in Europe. The months of July and August are particularly slow. Our European system sales growth for the quarter was less affected than our EU procedure business during these months. Our system sales performance in Europe continues to be fueled by urology.
Q3 represents a quieter quarter for clinical trade shows and surgical conferences. However, it represented a very productive quarter for clinical publications within the medical journal. This quarter alone, nearly 400 papers and abstracts appeared within various peer-reviewed journals. Gynecology, urology, general and colorectal, head and neck, cardiac, and thoracic surgery were well represented. The British Journal of Urology, which is considered to be among the more conservative and most respected peer-reviewed urology journals in circulation, dedicated their entire September edition to papers reporting on Da Vinci's role within their field. The edition contained 15 papers covering a wide range of Da Vinci studies, including Da Vinci prostatectomy, Da Vinci nephrectomy, Da Vinci cystectomy, and Da Vinci pyeloplasty. In addition to the various clinical reports and comparisons, there were also procedure technique and economic cost reviews.
A few reports offered neutral or even critical analysis of robotic surgery, but the majority were positive. Rather than taking time to review each of these papers in detail, I'll take a moment to highlight some of the written observations and conclusions. With regard to Da Vinci cystectomy, Dr. Lee and his team from Cornell concluded that despite an increased materials cost, robotic radical cystectomy can be more cost-efficient than open radical cystectomy as a treatment for bladder cancer when the impact of complications is considered. With respect to Da Vinci partial nephrectomy, Dr. Abreu and Gill from USC reported that within their study, zero ischemia robotic partial nephrectomy was successful in all cases without any hilar clamping, and the warm ischemia time was zero in all cases. They also stated that the elimination of warm ischemia may optimally preserve renal function. Dr.
Cha and Lee wrote, "Robotic partial nephrectomy appears to be a viable minimally invasive option for nephron-sparing surgery." Robotic partial nephrectomy may reduce some of the technical challenges associated with lap partial nephrectomy and thus extend the potential benefits of minimally invasive nephron-sparing surgery to a larger population. Simply that Da Vinci has become an integral tool in urologic cancer surgery, and its presence in the global urologic community has become widespread. The dedication of an entire British Journal of Urology edition to robotic surgery is just further evidence of this phenomenon. A very large observational study comprised of over 19,000 prostate cancer surgery patients appeared in the British Journal of Urology a month earlier. The study analyzed the substitution that took place between open prostatectomy and minimally invasive prostatectomy over a four-year period beginning in 2003. These patients had their prostatectomy between 2003 and 2006.
However, the reported trends should certainly apply to subsequent years. The study emanated out of Brigham and Women's Hospital in Boston, and it was a collaboration between the Division of Urology and the Center for Surgery at Public Health. The aim of the study was to determine differences in surgical outcomes by surgical approach during a period of rapid adoption for the minimally invasive surgical approach to radical prostatectomy. The study noted that minimally invasive radical prostatectomy had grown from 5.7% of the US prostatectomies in 2003 to approximately 39.2% in 2006. At the same time, open prostatectomy decreased by approximately 33.5%. During this study period, the length of hospital stay for minimally invasive radical prostatectomy decreased from two days to one day, and the length of stay from 3.2 days to 2.9 days.
The perioperative complication rate for minimally invasive radical prostatectomy had decreased from 13.8% to 10.7%, while the perioperative complication rate for open prostatectomy had decreased from 18.1% to 14.6%. Said another way, the perioperative complication rate for minimally invasive radical prostatectomy at the end of 2006 was 27% less than it was for open prostatectomy. When comparing the data over the entire four-year study period, the results were fairly striking. Perioperative complications were 27% less for the minimally invasive group. Blood transfusions were fewer by 83%. Anastomotic strictures were fewer by 51%, and length of stay was shorter by 42%. In their conclusions, the authors stated, and I quote, "The increased use of minimally invasive radical prostatectomy corresponds with a decreasing trend for complications, blood transfusions, length of stay, and need for reoperation.
Additionally, minimally invasive radical prostatectomy was found to have fewer associated complications compared with men undergoing the open procedure." As we've mentioned in previous calls, Da Vinci's role within the specialty of thoracic surgery is on the rise. The desire to reduce or eliminate large, painful intercostal incisions is shared mutually by patients and surgeons. Traditional video-assisted thoracoscopy has provided some relief for patients. However, its adoption has been somewhat limited to smaller, less complex procedures. While Da Vinci lobectomy, wedge, and segmental procedures are relatively new, with instrument sets that have yet to be optimized, its early adoption has been strong. In a recent edition of the Journal of Thoracic and Cardiovascular Surgery, Dr. Robert Saffolio and his team from the University of Alabama, Birmingham, published a study on their initial 168 consecutive completely portal robotic pulmonary resections.
The study took place over a 14-month period and included lobectomies, wedge, and segmental resections. The majority, 106 patients, had Da Vinci lobectomies. The results of the Da Vinci patients were compared to 318 propensity-matched patients who underwent a rib and nerve-sparing thoracotomy. The metrics that made up the comparison were morbidity, mortality, quality of life, hospitalization, and operative time. Dr. Saffolio reported that the Da Vinci group had a morbidity rate of 27% compared to a 38% morbidity rate for the thoracotomy group. Associated mortality was zero for the Da Vinci group and 3.1% for the thoracotomy group. Quality of life metrics were defined as a subject's functioning and well-being in the physical, psychological, and social domains in relation to their disease and treatment. In this comparison, the Da Vinci group scored 53 compared to 40 with the thoracotomy group.
Hospitalization was reduced in half, four days to two, when performing these procedures robotically. Following technical procedure improvements in their final 106 patients, which included four-thumb retraction and some minor instrument modification, only one was converted to an open thoracotomy. All patients underwent a lymph node dissection, which yielded an average of 17 lymph nodes. As is usually the case with initial series comparisons, the procedure time for the robotics patient was shown to be a bit longer than with the open thoracotomy group. In conclusion, the author states, and I quote, "The newly refined four-arm robotic lobectomy is safe and yields an R0 resection with complete lymph node removal. It has a lower morbidity, mortality, shorter hospital stay, and better quality of life than rib and nerve-sparing thoracotomy. Technical advances are possible to shorten and improve the operation." As many of you have recently read, the U.S.
Preventive Services Task Force has published its recommendations against PSA screening for prostate cancer. Their recommendation applies to U.S. men that do not have symptoms that are considered highly suspicious for prostate cancer, regardless of age, race, or family history. You may also be aware that the American Urology Association disagrees with the panel's recommendation. Our position on this topic is consistent with the 18,000 physicians that comprise the AUA. It is our belief that the physician members of the AUA are in the best position to appropriately assess the tools and techniques for screening their patients for this serious disease. This concludes my remarks, and I'll turn the time over to Calvin.
Speaker 3
Thank you, Aleks. I will be providing an update to our financial guidance for 2011, including procedures, revenues, and other elements of the income statement on a GAAP basis. I will also provide estimates of significant non-cash expenses to provide you with visibility of our expected future cash flows. Starting with procedures, based upon our year-to-date procedure results, we are increasing our guidance for 2011. Our prior forecast was for total 2011 procedures to grow approximately 27% to 29% for the year. We now project procedures to grow approximately 29% to 30% from an estimated 278,000 procedures performed in 2010. Moving on to revenues, we are also raising our 2011 total revenue guidance. On our last call, we had estimated 2011 revenue to grow approximately 19% to 21% above 2010 results.
Based upon higher capital and recurring revenue projections, we are now forecasting total 2011 revenue to increase between 22% and 23% for the year. We are also slightly increasing our guidance for 2011 gross margin percentage. Our previous guidance was for full-year 2011 gross margin to come in at roughly 72% of revenue. Our year-to-date gross margin percentage now stands at 72.3%. We now forecast our full-year 2011 gross profit percentage to be consistent with these year-to-date results, within a range of between 72% and 72.5%. Moving to operating expense, we continue to invest across multiple areas of our business, particularly our sales force, manufacturing, and R&D. Driven primarily by higher variable expenses associated with our higher revenue forecast, we now anticipate full-year 2011 operating expenses to grow between 19.5% and 20.5% above 2010 levels, compared to 18% to 20% growth previously forecast.
Our guidance for significant non-cash expenses remains unchanged. We continue to expect 2011 non-cash stock compensation to total between $135 million and $140 million and amortization of purchases of intellectual property to total between $17 million and $20 million. We are slightly reducing our guidance for other income, which is mainly comprised of interest income. We now expect 2011 other income to total around $15 million, down from the $17 million to $18 million previously forecast. With regard to income tax, we continue to expect our 2011 income tax rate to fall within a range of between 32% and 33% of pre-tax income, consistent with the guidance provided on our previous call. We estimate that our diluted share count for calculated Q4 2011 earnings per share will be approximately 40.2 million shares.
Going forward, we plan to continue to repurchase shares of our common stock to reduce the dilutive effect of stock option grants. Finally, regarding our cash flows, since our guidance calls for over $150 million in non-cash 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 operations is a better measure of our financial performance than net income. We would like to open the call to your questions.
Speaker 5
Thank you, ladies and gentlemen. If you wish to ask a question, please press the star, then one on your touch-tone phone. You will hear a tone indicating you've been placed in queue. You may remove yourself from the queue at any time by pressing the pound key. If you are using a speakerphone, please pick up the handset before pressing the numbers. Once again, if you have a question, please press star one at this time. Our first question comes from the line of Mr. Ben Andrew with William Blair. Please go ahead.
Speaker 0
Good afternoon, Gary.
Speaker 3
Good afternoon.
Speaker 0
Just a couple of questions for you. I guess first, if you think about the investments that you've been making over the last couple of years, they appear to be paying off in the form of increased productivity and strong sequential growth despite the challenges around seasonality. I know you've talked before about holding the operating margin down to about 40% for a variety of reasons, primarily to drive long-term penetration, but also for other obvious reasons. If you think about where you go from here, coming out of the third quarter with a 40% operating margin and a lot of the opportunities you have, what are the key priorities over the next maybe four or five quarters for additional investment above and beyond what you might have been looking at before?
Speaker 3
Yeah, I think the biggest investment you've been talking about, at least in that question, is around sales force in the commercial operation. We've continued to do that. We're investing, and we've moderated our investments in the U.S. sales force, although in Europe and in Asia, we have been investing on the commercial side of the business and will continue to do so. We think that those are good investments. This has been a period of substantial product development investment, and we are continuing to do that as well. I think it's nothing big and surprising. I think it's a little bit more of the same.
Speaker 0
OK. Two quick follow-ups, if I may. Can you update us on the Japanese organization, what you have on the ground there, where you're making investments today, and if there's any update on regulatory timing, or excuse me, reimbursement timing? Second, is it fair to say that Da Vinci hysterectomy is still north of 60% of your sequential procedure growth, even in the seasonally weak quarter? Thank you.
Speaker 3
To the first question on Japan, the first sets of investments have really been kind of back office investments. We're building an organization that's capable of handling regulatory and logistics kinds of functions and supporting our reimbursement efforts with the Japanese government. We're engaged. We think we're engaged with the right elements of NHLW in Japan. I don't have any additional color for you on timing of those efforts. That continues. On the procedure side, I don't have the exact splits in front of me. I think I'll look to Aleks to cover that question.
Speaker 0
Ben, could you repeat the way you phrased that question? It was with hysterectomy, I understand, and you're talking about growth on a sequential basis. I kind of lost it after that.
Speaker 2
Sure. If you look at the growth both this quarter, I think, and then over the next couple of years, the key determinant for that sequential procedure growth is likely to be DVH, and we calculated it at about 60% or more. I'm curious if that was what you saw in the quarter, if that's still sort of a reasonable assumption for the next couple of years.
Speaker 0
Not commenting on the % and certainly over the time frame of a couple of years, I will say that the sequential hysterectomy, specifically in the benign side, was very strong in Q3.
Speaker 2
OK, thank you.
Speaker 5
Thank you. Our next question comes from the line of David Lewis with Morgan Stanley. Please go ahead.
Speaker 1
Hello. This is John Demcheck in for David.
Speaker 2
Hi, John.
Speaker 1
Hi. We saw strong system placements this quarter in an environment where many have been a little concerned about capital equipment. Last quarter, you mentioned that there was an increase in customers financing systems, and I was curious if that was still the case. Also, if there were any macro changes to the environment that you could point out, either in Europe or in the U.S.
Speaker 3
Yeah, this is Calvin. I'll comment on the leasing side. You brought up last quarter we saw kind of a spike in the % of systems financed up to around the 30% range. What we saw here in the third quarter was a return to the normal rate, I guess, that we've seen over the past few years, which is within a range between 15% and 20% of the systems going through financing. Just to remind everyone, we don't hold any of the paper for those loans. Those are all with third-party vendors. I'll leave it to Marshall to comment on the environment.
Speaker 1
I think you were pointing specifically at Europe, and I'd say that we did have a successful capital sales quarter in Europe despite seasonality. Having said that, it's driven by DVP, DVP growth in the major countries of Germany, France, and Italy. Going forward, it's hard to predict what will happen in those specific economies. Again, I think we had a successful quarter.
Speaker 0
Yeah, I would only add that if you looked at the second quarter, Germany wasn't particularly strong in Q2, but here you are in Q3, and six systems were placed. You had Spain, which again has been in the headlines for its own challenges during the past several quarters, which has also participated with three systems. I think it's important to recognize that the underlying stimulus on systems getting placed is the strength of the procedures, and that continues to be the case.
Speaker 1
Gotcha. OK, very helpful. Another question I wanted to follow up on was prostatectomy procedures, given the, I guess, increased focus with pivot and watchful waiting, and then also the recommendation against PSA. I was wondering if you've seen physicians changing their behavior at all and how you kind of expect these procedures to trend in 2012. Lastly, if you've heard any insurers talking about altering coverage at all.
Speaker 0
A couple of things. One is with respect to, you said a few things there. You said pivot, watchful waiting, the recommendation against PSA, just to separate all of those. The latest news is from the panel, the preventive panel, which is different from what you had described earlier. In general, I think our view on DVP, and it has been this way for some time, is that we consider it fairly flat in the U.S., and it's been that way for a few quarters. The majority of the growth in DVP should happen outside the U.S. In the short period we've had following the pivotation and the discussions we've had with physicians, a lot of physicians believe that they will follow the guidelines of the AUA. How that unfolds over time is really anyone's guess at this point, and we're not going to speculate what that might mean.
We believe that the men and women that comprise the AUA are, as I said earlier, in the best position to determine that care and that testing for their patients, and that's what we support. We will see what that leads to in time.
Speaker 1
OK, thank you very much.
Speaker 5
Thank you. Our next question comes from the line of Tayo Levy with Cowen and Company. Please go ahead.
Speaker 1
Hey, good afternoon, guys.
Speaker 3
Hi.
Speaker 1
Can you maybe provide the number of Firefly systems you sold in the quarter?
Speaker 3
Yeah, in Marshall's commentary, when we're talking about instrument and accessory revenue per procedure, we've seen that at a level around the $1,940 to $1,950 level all in, including stocking orders. That metric was helped these last few quarters by the new products that we've launched in instruments and accessories, including the thoracic kit, some new vision instruments, the 8.5 millimeter scope, and now this fluorescence imaging product, which is included in accessories. The combination of those products has moved that overall metric, and we're encouraged with what we've seen on the fluorescence side in terms of our initial sites. I don't think we're in a position to say exactly how many are sold, but we think it's positive movement on the new products.
Speaker 0
OK. There's also a few components of that, which makes it a little difficult to sort of tease it out and give you a clean number. In other words, there's scopes, there's dye, there's a few sources of revenues, if you will, SKUs that make up that system.
Speaker 1
Gotcha. Is it possible to maybe comment on how many Firefly fluorescence imaging systems are out in the field, just in general, being used, tested?
Speaker 0
I don't have that number. I don't know if Marshall has it.
Speaker 3
We're not ready to report.
Speaker 1
On the gross margin side, the service part of that came in higher than expected and probably better than it's been for a while, actually forever. How much of that is due to the SI potentially being less of a service-intensive system?
Speaker 3
I think you've seen that we've built into the systems better quality over time, and that has served to reduce the costs associated with service. I think, though, on the other hand, the service margins can be a little bumpy because it depends on service part consumption. In this quarter, we had a little lower service part consumption. I don't know that the 65% is necessarily sustainable over a period of time. I think that the rates that you saw over the last few quarters are probably more indicative.
Speaker 1
Gotcha. OK, thanks, love.
Speaker 3
Thank you.
Speaker 5
Thank you. Our next question comes from the line of Tycho Peterson with JPMorgan. Please go ahead.
Speaker 1
Hey, good afternoon.
Speaker 3
Hey, Tom.
Speaker 1
I'm just wondering if you can talk a little bit about system mix. I know you don't provide data anymore by kind of hospital size, but to what extent are you seeing uptake by the community hospitals and second and third-tier hospitals? The repeat systems, are they largely being driven by hospitals wanting to get into new procedures or just pulling a higher volume of patients around Da Vinci prostatectomy or Da Vinci hysterectomy? That'd be helpful.
Speaker 0
Yeah, just as a reminder, we had 60 of the 133 systems went to existing customers, which means that there were 73 customers that bought for the first time. Within both cohorts, both the existing customers as well as the new first-time buyers, we've seen, I'd say, a pretty good mix across various size hospitals, from fairly what you might consider smaller hospitals to large hospitals. I think that continues. I don't know that there's anything remarkably different from one quarter to the next because it ultimately follows the path to the patient. In other words, if the procedures are being performed, procedures like GYN, benign hysterectomy, myomectomies, if they're being performed in smaller hospitals, then it stands to reason that the physicians that are looking to participate in those procedures are going to look toward Da Vinci.
It can certainly move into smaller hospitals, and it continues to do that. I don't think there's any new trends to really report on there. As far as the overall number of hospitals that own more than one now, I believe following Q3, there are almost 300 hospitals that have, in fact, 299 hospitals that own more than one system. You have five hospitals that own six systems. You have three hospitals that own five. You've got 15 that own four, and you've got 45 that own three and 231 that own two. I don't know, again, that's been fairly consistent. We keep adding to each of those cohorts. I guess I'll summarize this long answer. There really isn't anything remarkable that I think we could point to over the past few quarters in terms of demographics.
Speaker 1
Going back to the question on DVP, we understand the shortcomings of the task force. The other side of it has been, there was a JAMA article and The New York Times article questioning kind of the outcomes. I understand the JAMA article was kind of old data, but to what extent do you see any impact from either of those publications?
Speaker 0
Like I said earlier, it's very difficult to say. As long as I've been aware and been in this business, there has been very little consensus around this very topic on PSA screening, watchful waiting. It is constantly being evaluated and constantly being studied by different groups. I don't think there's anything that we believe has come out that's been conclusive in terms of the negative here. I think it's going to be something personally that's going to be debated for some time to come. I'll be careful not to project expectations based on any of this because it's really anyone's guess at this point.
Speaker 1
On single port, can you just talk a little bit about use in Europe? You talked last quarter, I think, about general surgery, seeing some signs of adoption, and I think you've got 10 sites or so using SPs over there. Also, as we think about getting data back to the FDA here, can you use data from those European sites?
Speaker 3
Yeah, so the answer on the first side, most of our single-site experience in Europe remains focused on cholecystectomy. As you know, Q3 is a slow quarter for European procedures as a whole. We're seeing continued use and uptake of the single-site product there. We have collected data from Europe and other sources, and we have provided that to the FDA and are continuing to answer any questions that they have on that data. We have supplied that.
Speaker 1
OK, thank you.
Speaker 5
Thank you. Our next question comes from the line of David Roman with Goldman Sachs. Please go ahead.
Speaker 1
Good afternoon, everyone. I was hoping you could provide a little bit more detail on some of the new procedures, Gary, and some of your remarks. You did touch briefly on some of the specific procedures where you were seeing some uptake outside of DVH and DVP. Could you give us maybe some sense to what % of the U.S. mix those procedures represent this quarter and maybe how that compares to last year and the prior quarter sequentially?
Speaker 3
Yeah, I don't have the specific breakdowns for you. If you look at what we think of as follow-on procedures in the U.S., in urology, it's really going from prostate cancer to kidney cancer, so partial nephrectomies. That's been growing nicely for us in the U.S., and behind that, bladder cancer and cystectomies. Partial nephrectomies are becoming a material part of the business. Cystectomy is a little bit smaller disease state, but continues to rise. On the GYN side, the follow-on procedures then are myomectomy. That has been growing nicely for sacral colpopexies, pelvic floor reconstruction, and endometriosis resection. Those have also started to grow. Taken as categories, the follow-ons have been growing nicely. In the case of urology, they're growing faster, of course, than da Vinci prostatectomy in the U.S.
Speaker 0
I'll just add to that. Outside of the categories of GYN and urology, we've talked a little bit about thoracic surgery. We've talked a little bit about colon surgery. I would say that specifically within colon and rectal surgery, earlier our focus had really been on the low rectal cancers, the low anterior resections, and the AP resections. We've talked about this in the past, where if successful in these very difficult anatomies, low in the rectum, the likelihood of surgeons looking at it in the right colon, the left colon, the sigmoid colon, the likelihood of them starting to really evaluate Da Vinci's role in there is probably pretty high. I would say on a sequential basis, if you looked at some of the growth in those areas, it was very strong. The same, I think, could be said about thoracic surgery.
When you look at the lobectomies, wedge, and segmental resections, and recognize that neither of these areas is fully optimized yet with the instrument set, there's a very good core of instruments that procedure, which they are doing. I would just say qualitatively, those areas, and through a seasonally challenged quarter like Q3, were showing very, very promising growth.
Speaker 1
OK, maybe just a follow-up on Japan. I think you said you placed six systems in the quarter, sold six systems in the quarter in Japan. Can you maybe just kind of update us on what the sort of install base looks like in Japan right now and how we can sort of think about the addressable market, both with and without reimbursement?
Speaker 0
The install base specifically, I can give you.
Speaker 3
We expand at 35, ending this quarter.
Speaker 0
Yeah, I think that the challenge on trying to project what the market looks like in advance of knowing what the reimbursement climate looks like is kind of a dangerous exercise. In other words, we know it is not optimized for mass market distribution. We also know that hospitals that are purchasing it now are purchasing it with the full understanding that they're going to have to go through a manual process to get reimbursement. Some of them have been very successful in getting that reimbursement initially for Da Vinci prostatectomy. You are still sort of handcuffed in terms of trying to address the broader market. Until you get the reimbursement and understand what you're being reimbursed for, it's difficult for us to say.
We're encouraged by the fact that there are 35 systems that are in Japan already, and the sort of demand that is built in Japan for robotic surgery, we believe, is strong.
Speaker 1
Lastly, on the P&L, the 40% operating margin that at least over the past couple of years, that's pretty much a high watermark. Maybe close to sort of not a peak point for you, but sort of the highest we've seen in some time. Can we maybe sort of talk about investment priorities on a go-forward basis? It sounds as though a lot of the investments in the U.S., there was a big step up in sales force, I think, in the end of last year on the hysterectomy side, and that seems to be paying some rewards. As you look at some of the other markets outside the United States, obviously the sales base is somewhat small relative to total. How can we sort of think about a trajectory with respect to investment spending? You're still generating quite a bit of operating leverage, even at margins at this level.
Speaker 3
Yeah, our goal is not to drive operating returns higher than that profile. Investment-wise, as we said earlier, we're really looking at, in the commercial organization, keeping pace in the U.S., investing in Japan and Europe and other countries. On the product side, we continue to invest in the products we tell you about and in acquiring and developing technologies we think are going to have an impact in the long run. We really believe we're in the early phases of adoption of robotic surgery. As a result, we're willing to make those investments both in the commercial organization and in the product development side.
Speaker 1
OK, thank you very much.
Speaker 5
Thank you. Our next question comes from Rick Wise with Stifel. Please go ahead.
Speaker 1
Good afternoon, everybody. If we could talk a little bit more about some of the general surgery arena. Aleks, I think you said colorectal is doing well. Can you give us any more color on the growth there or the growth relative to the rest of the business? Just related to that, to wherever it is, I know we're not going to hear precisely, but are the new instrument approvals required to see that next steep acceleration of the growth curve here?
Speaker 0
You said it correctly. We're not going to break out the numbers in detail for you. I think you've heard us over the years, and certainly you have in following us for as long as you have, in that we look at early adopters and recognize that early adopters will put up with what we term as fiddle factor, something that is less than optimized. We saw it with prostatectomy. We saw it with hysterectomy. We've seen it with just about everything we've done. When we look at general surgery, specifically colon and rectal surgery, there is a very good set of instrumentation. There are ways to manage the vessels, either by suturing, by using our PK device or our harmonic device, and/or stapling through an ancillary port.
It's just not optimized in the sense that the surgeon has to break the choreography, have someone else do tasks that they would like to do or should do or believe is in their best interest to do, or break scrub, and so on and so forth. Now, despite all of that, we're seeing very nice trajectories in the growth in both low anterior resection, in sigmoid resection, in right colon resections, and thoracic surgery. As you said, we're not going to break those out in detail. I would say that it is very encouraging at an early stage, but it's difficult to tell you much more without really going into. Is it necessary to have those other instruments? We believe to get to full optimization, you have to optimize the procedure. You have to optimize the instrument set. You'll grow until you get there.
Hopefully, if you spec the instruments right, it should be a nice addition to the armamentarium.
Speaker 3
Gotcha. To follow up on that, Gary, I know that, or Marshall, I know that the FDA is particularly opaque now, and there's not much to be gained by making public forecasts. Should we assume that the chances are low that these new products are approved this year? Does it feel now, just given the pace of things and just the pace of what's going on with everybody at the FDA, that it's more likely to fall into 2012? I can't handicap it for you. I'll tell you that we're engaged in constructive discussion. I think that the questions and answers are pretty reasonable, and we're working through them. How long that will go on for, I cannot predict.
Speaker 0
Yeah, I think it's also just to level set, Rick. If you replayed the tape over the last few quarters, you'd see that we are further along in the single site submission than we are in the vessel sealing and that we are in the stapling. Stapling, we haven't submitted yet. Recognizing that the calendar gets converted to 2012 relatively soon, you should be able to perhaps answer your own question there.
Speaker 3
OK. And just last, if I could, the European outlook is incredibly confusing on multiple fronts. Are you more concerned now about the next few quarters in Europe, given the political and economic disruption than you had been in the past? I'd be curious to just get your sense of just the general environment. Obviously, you did a great job this quarter. For us, there's uncertainty for us as well. We don't have a crystal ball into what the economic winds will bring there. We do feel that the interest and the procedure adoption has been high, particularly in the countries that have most of the population and are really adopting nicely now. We think if that's true, ultimately system sales should follow. It may be lumpy, depending on local market conditions. We'll see. We had a good quarter this quarter, and we'll see where it carries us next.
We have time for just one more question.
Speaker 5
Thank you. Our last question comes from the line of Lennox Ketner with Bank of America. Please go ahead.
Speaker 1
Hi, guys. Thank you so much for fitting me in and congrats on a great quarter. Just a few quick ones. First, on your guidance for procedure growth, it has gone from, I think, about 25% to 28% initially to 29% to 30%, when a lot of companies are talking about seeing pressure on procedure volumes. I'm just wondering if it's possible to characterize where the upside has come from in that. Is it relative to your initial thoughts? Is the upside coming from one or two specific procedures?
Speaker 0
I don't know that it is one procedure. I think if you look at it in terms of GYN, GYN is a large bucket and really drives a lot of that growth. In 2009, on a year-over-year basis, GYN has been very strong in not just hysterectomy, but myomectomy and sacral colpopexy, endometrial resections. I would say some of the general surgery procedures, i.e., the colon and rectal procedures, even into the thoracic procedures, although they're not as large as some of the other categories we talk about at this stage, growth from a number of procedures adds up pretty well. The pull-through procedures on urology, as well as some of the OUS DVP business, has been strong. It's really come from a number of places, and I think pretty good performance on our downstream commercial team.
Speaker 1
OK, more across the board. On the Cooley, the single site product in Europe, you mentioned you're still seeing good uptake there. I think last quarter you said you were at 10 sites. Are you able to give the number of sites that you're at now? Is it still close to 10, or have you rolled it out more broadly?
Speaker 3
We're adding sites, but we're adding them slowly. I don't have the specific number of sites in front of me right now. In general, the first part of our experience in Europe has been to optimize the product and to get feedback on how customers are using it. We're working on getting its approval in the U.S.
Speaker 1
OK, that's all I have. Thanks so much, and congrats again.
Speaker 3
Thanks so much. 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. Lori of Pennsylvania shares the following experience. Quote, "I have been suffering with painful periods for almost two years. I had already had one endoscopic surgery, and I got very little relief from the pain. After suffering for several more months and having to spend two to three days in bed each month and everyone telling me I needed to have a hysterectomy, I decided I needed to try something else. A friend and coworker recommended Dr. Kosselit to me.
I met with him and started to feel that maybe there was help for me that didn't require a hysterectomy. Dr. Kosselit explained the procedure that he would perform and the risks. He said there would be only an 8% chance of the endometriosis recurring. He explained that he would be performing the procedure with the help of a robotic arm. I agreed to the procedure, and I am thrilled that I did. The procedure took one and a half hours. Dr. Kosselit removed all of the endometriosis and an endometrioma. I have had two periods since the surgery, and I am amazed at the results. I'm leading a normal life again. I do still have the normal cramping that accompanies most women's periods, but I no longer need to spend several days in bed and take prescription pain relievers.
There was very little scarring because the procedure only required four small incisions, and the pain I experienced was less than what I would experience when I get my period. My only regret is that I didn't find Dr. Kosselit sooner. When I compare this procedure to my other endoscopic procedure, the Da Vinci procedure was far better. There was less scarring, and I experienced less pain with the Da Vinci procedure. I only took two pain pills after the procedure and was back to my normal routine in less than a week. I would definitely recommend the Da Vinci." Patients like these 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.
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.
Speaker 5
Ladies and gentlemen, this conference will be available for replay today after 3:30 P.M. Pacific Time through October 18, 2012, at midnight. You may access the AT&T teleconference replay system at any time by dialing 1-800-475-6701 and entering the access code 219051. International participants dial 320-365-3844. Those numbers again are 1-800-475-6701 and 320-365-3844. The access code is 219051. That concludes our conference for today. Thank you for your participation and for using AT&T executive teleconference. You may now disconnect.
