Intuitive Surgical Inc (ISRG) — Q3 2015 Earnings Call Transcript

Thank you. Good afternoon and welcome to Intuitive Surgical's third quarter earnings conference call. With me today, we have Gary Guthart, our President and CEO; Marshall Mohr, our Chief Financial Officer, and Patrick Clingan, Senior Director of Finance and Sales Operations. Before we begin, I would like to inform you that comments mentioned on today's call may be deemed to contain forward-looking statements. Actual results may differ materially from those expressed or implied as a result of certain risks and uncertainties. These risks and uncertainties are described in detail in the company's Securities and Exchange Commission filings, including our most recent Form 10-K filed on February 5th, 2015, and 10-Q, filed on July 22nd, 2015. These filings can be found through our website or at the SEC's EDGAR database. Prospective investors are cautioned not to place undue reliance on such forward-looking statements. Please note that this conference call will be available for audio replay on our website at intuitivesurgical.com, on the audio archive section under our Investor Relations page. In addition, today's press release and supplementary financial data tables have been posted to our website. Today's format will consist of providing you with highlights of our 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; Patrick will discuss marketing and clinical highlights and I will provide our updated financial outlook for 2015. And finally, we will host a question-and-answer session. With that, I will turn it over to Gary.

Thank you for joining us on the call today. Overall, company performance in the quarter was solid with robust procedure growth, strong capital performance, and improved operating margins. Starting with procedures, year-over-year growth in the third quarter accelerated to 15% compared with Q3 2014. Procedure performance mirrored our experience in the first half of the year with strength in hernia repair, colon and rectal resections, solid growth in prostatectomy, and stable trends in hysterectomy. Internationally, growth trends in the first half of the year continued in the third quarter. Growth in Europe, China, and Korea was multi-disciplinary with particular strength in neurology. Patrick will review procedure trends in greater detail later in the call. Turning to capital sales, we placed 117 systems in the quarter compared to 111 in the third quarter of 2014. Capital placements in the United States accounted for most of the growth in system placements year-over-year. Customers are preferring our most capable products, and Xi systems and dual console configurations represented a larger proportion of placements in the quarter relative to a year ago. In Japan, procedure growth was solid and driven by neurology. As we've said on prior calls, the growth of the market in Japan will be paced by continued progress on reimbursement. Clinical investigators are submitting their partial nephrectomy data to MHLW for review, and ISI continues to work with key stakeholders on reimbursement for additional procedures. While we have no assurance of additional procedure reimbursement at this time, Japanese authorities will review reimbursement submission for partial nephrectomy for inclusion in 2016 national coverage. Conversations regarding reimbursement for other procedures are ongoing; however, inclusion of other procedures and full reimbursement guidelines in 2016 is unlikely. Turning to operating performance, our product operations teams have been focused on reducing costs for our new products, and we have been managing our fixed expenses carefully. This quarter was another step in the right direction on gross margin, helped by product mix and some costs coming in at the lower end of their expected ranges. We will continue to focus on improvements in direct product cost over the next several quarters. As we look at the long-term financial position of our products, we anticipate making targeted capital investments over the next few quarters and programs that we believe will facilitate better long-term product and operating margins. In summary, our operating performance for the third quarter is as follows: Procedures grew approximately 15% over the third quarter of last year. We placed 117 da Vinci Surgical Systems, up from 111 in the third quarter of 2014. Total pro forma revenue for the quarter was $590 million, up 10% from the prior year, and up 14% year-over-year on a constant currency basis. Total pro forma instrument and accessory revenue increased to $298 million, up 10% over the prior year. We generated pro forma operating profit of $240 million in the quarter compared with $197 million in the third quarter of last year, and pro forma net income was $199 million compared to $145 million in Q3 of 2014. We are deeply committed to advancing our technologies and offerings to benefit surgeons, their patients, and hospitals. We have launched integrated table motion for Xi in Europe this October and have submitted our U.S. 510(k) application. Table motion allows surgeons to interactively use gravity for retraction and eases patient management during da Vinci Xi surgical cases. As many of you saw at the American College of Surgeons meeting earlier this month, initial customer feedback has been strong. We also submitted our 510(k) for our single site instrument kit for Xi in the third quarter with the intent of bringing our single-incision tools to the Xi platform. In addition, we submitted a 510(k) application for a 30-millimeter stapler for Xi in the third quarter. This instrument has particular utility in thoracic surgery and includes multiple staple sizes, including green, blue, white, and grey reloads. Regarding our next-generation single-port technology, our technical teams continue to meet their development milestones for da Vinci Sp, having completed the build of our first 10 Xi compatible systems, five of which were slated for human clinical use. We anticipate increased clinical evaluations of da Vinci Sp in 2016, particularly in transoral and transabdominal applications. Lastly, da Vinci systems are sophisticated network computing systems. The availability of these computational resources allows for both real-time analytics that can provide surgeons relevant information, for example, the smart plant feature implemented in our stapler, as well as anonymized utilization data that administration can use to help optimize robotic surgery programs. We are developing increased computational capability in both real-time and program-level applications along with a field force of workflow experts; this analytic capability allows us to aid our customers both during surgery and in optimizing their robotic surgery programs.

Thank you, Gary. I will be describing our results on a non-GAAP or pro forma basis, which excludes the impact of our prior year Xi trade-in programs, legal claim accruals, stock-based compensation, amortization of purchased IP, and investment impairments. We provide pro forma information because we believe that business trends and operating results are easier to understand on a pro forma basis. I will also summarize our GAAP results later in my script. We've posted reconciliations of our pro forma results to our GAAP results on our website so that there's no confusion. Pro forma third-quarter revenue was $590 million, an increase of 10% compared with $534 million for the third quarter of 2014, and an increase of 1% compared with last quarter. Pro forma revenue for the third quarter of 2014 excludes net revenue associated with the offers made in 2014 to trade out Si product for Xi product. All trade-out offers were either fulfilled or lapsed in 2014. Third-quarter 2015 procedures of approximately 162,000 grew approximately 15% compared with the third quarter of 2014 and were approximately equal to the second quarter of 2015. Revenue highlights are as follows: Pro forma instrument and accessory revenue grew 10% compared with the third quarter of 2014 and was approximately equal to the second quarter of 2015. The increase relative to the prior year reflects procedure growth, partially offset by foreign exchange and customer buying patterns. Instrument and accessory revenue realized per procedure, including stocking orders, was approximately $1,840 per procedure. This metric has now been trending in a tight range between $1,830 and $1,840 per procedure over the past four quarters, with recent quarters reflecting higher sales of new instruments and the impact of foreign exchange. Pro forma system revenue of $174 million increased 13% compared with last year and decreased 1% compared with last quarter. The increase relative to the prior year reflects increased unit sales and higher average system selling prices. The decrease relative to the second quarter reflects a higher number of operating leases, partially offset by higher average system sales prices. 117 systems were placed in the third quarter compared with 111 systems in the third quarter of 2014 and 118 systems last quarter. 77% of the systems placed this quarter were Xis compared with 53% in the third quarter of 2014 and 64% in the second quarter of 2015. We expect the mix of Xi to Si product to fluctuate quarter to quarter. Globally, our average system price of $1.6 million increased compared with $1.45 million in the third quarter of 2014 and $1.5 million last quarter. Our third-quarter 2015 ASP was our highest to date, reflecting an unusually high mix of dual consoles, including a high number of shipments to academic centers. We shipped 29 dual console Xis in the third quarter of 2015 compared with 13 last year and 18 last quarter. We expect to return to our historical mix of dual consoles and therefore expect our future ASP to be lower than this quarter. ASPs fluctuate quarter to quarter based on geographic and product mix, trade-in volume, and changes in foreign exchange rates. Hospitals financed approximately 25% of the systems placed in the third quarter, up from 21% last quarter. We directly financed 20 systems, including placing the most operating leases, 13 since we began our direct leasing program in the second quarter of 2014. As of the end of the quarter, there were 36 systems out in the field under operating leases. Revenue from operating leases was less than 2 million in the third quarter. We expect the impacts of operating leases from our system if we exclude the impacts of operating leases from our system ASP calculations. The number of systems placed under operating leases will vary quarter to quarter. Service revenue of $170 million increased 8% year-over-year and increased approximately 4% compared with the second quarter of 2015. The year-over-year and quarter-over-quarter increases reflect the increase in our installed base of da Vinci systems. Outside of the U.S., results were as follows: third quarter pro forma revenue outside of the U.S. of $151 million decreased 1% compared with $153 million for the third quarter of 2014, and decreased 10% compared with $168 million last quarter. The decrease compared with the previous year reflects lower system sales into China and the impact of foreign exchange, partially offset by higher recurring revenue driven by approximately 28% higher procedure volume. The decrease compared with the last quarter was driven by lower system unit sales and the timing of customer instrument and accessory sales. Outside the U.S., we placed 37 systems in the third quarter compared with 50 in the third quarter of 2014 and 46 systems last quarter. Non-U.S. system placements included 9 systems in Japan compared with 7 last year and 13 last quarter; 19 systems in Europe compared with 25 last year and 22 last quarter, and no systems in China this quarter compared with 10 last year and none last quarter. System placements will continue to fluctuate quarter to quarter. Moving on to the remainder of the P&L, the pro forma gross margin for the third quarter of 2015 was 69.3% compared with 67.2% for the third quarter of 2014 and 68% for the second quarter of 2015. Compared with both the second quarter of 2015 and the third quarter of 2014, the higher third quarter of 2015 gross margin reflects higher system ASPs, improved efficiencies, lower inventory charges, among other factors. The increase in gross margins relative to the third quarter of 2014 also reflects charges to cost and sales related to the Si staple recall in 2014. In 2014, we recorded pre-tax charges of approximately $82 million, representing the estimated cost of settling a number of product liability legal claims under a tolling agreement. During 2015, we have refined our estimate of the overall cost of settling claims and recorded additional charges of approximately $14 million in the first half of the year. There were no charges in the third quarter of 2015. Charges made related to this agreement are excluded from our pro forma results and are included in our GAAP results. At the end of the third quarter, $30 million remained accrued on our balance sheet as a significant portion of the estimated cost has been paid. Pro forma operating costs, which excludes the reserves for legal claims, stock compensation expense, and the amortization of purchased IP, increased 4% compared with the third quarter of 2014 and were less than 1% less than last quarter. The year-over-year increase in pro forma operating expenses primarily reflects headcount additions and higher incentive compensation. Our pro forma effective tax rate for the third quarter was 18.4% compared with an effective tax rate of 27.2% for the third quarter of 2014 and 25.6% last quarter. The effective tax rate for the third quarter of 2015 included tax benefits of $29 million, or $0.77 per share related to a recent favorable tax court ruling involving an independent third party. Our tax rate will fluctuate with changes in the mix of non-U.S. and U.S. income, and will not reflect a federal research and development credit, unless such credit is reinstated. Our third quarter 2015 pro forma income was $199 million, or $5.24 per share compared with $145 million, or $3.92 per share for the third quarter of 2014 and $173 million, or $4.57 per share for the second quarter of 2015. Excluding the prior period tax benefits, our third quarter 2015 pro forma net income was $170 million, or $4.47 per share. As I indicated earlier, pro forma income provides an easier comparison of our financial results and business trends. I will now summarize our GAAP results. GAAP revenue was $590 million for the third quarter of 2015 compared with $550 million for the third quarter of 2014 and $586 million for the second quarter of 2015. GAAP net income was $167 million, or $4.40 per share for the third quarter of 2015, compared with $124 million, or $3.35 per share for the third quarter of 2014 and $135 million, or $3.56 per share for the second quarter of 2015. We ended the quarter with cash and investments of $3.1 billion, up from $2.9 billion as of June 30, 2015. The increase was primarily driven by cash generated from operations and proceeds from stock option exercises, partially offset by stock buybacks. During the quarter, we repurchased approximately 70,000 shares for $36 million at an average purchase price of $509 per share. This brings our total stock repurchases to approximately $100 million for the year. And with that, I would like to turn it over to Patrick who will go over our procedure and clinical highlights.

Thanks, Marshall. As mentioned earlier, total third quarter year-over-year procedures grew approximately 15% with U.S. procedures growing approximately 12% and international procedures growing approximately 28%. In the U.S., third quarter procedure growth was approximately 12%, accelerating modestly from first half growth of approximately 10%, driven by an uptick in the growth of general surgery procedures with solid contribution coming from mature procedures. It remains uncertain how sustainable the year-to-date growth in these mature procedures will be in future periods. In urology, trends observed during the first half of the year continued through the third quarter. Growth in da Vinci prostatectomy and kidney cancer procedures continued at a similar rate as the first half of 2015, with da Vinci prostatectomy again exceeding our expectations. We continue to believe that our U.S. prostatectomy volumes have been tracking to the broader prostate surgery market. In gynecology, third quarter procedures grew modestly year-over-year, with growth in malignant and complex hysterectomy partially offset by declines in benign procedures. Similar to the first half of the year, an increased proportion of total hysterectomy procedures have been performed by gynecologic oncologists. Third quarter growth in general surgery increased compared to the first half of the year, with robust growth in hernia repair and an uptick in colorectal procedures, being partially offset by continued declines in cholecystectomies. Hernia repair continued to drive the majority of growth in general surgery procedures during the quarter. Earlier this month at the American College of Surgeons meeting, several presentations highlighted the emerging role of da Vinci surgery in ventral and inguinal hernia repair. Surgeons commented on the advantages of da Vinci surgery including precise dissection, improved visualization, secure closure of the primary defect, application casing of the abdominal wall, suture fixation of mesh, and a reduction in postoperative pain for patients. Specifically, for ventral hernia repair, Dr. Ballacer from the Banner Health Network compared 180 da Vinci hernia repairs to over 60,000 lap and open hernia repairs from the ACS National Surgery Quality Improvement Program database and found that reduction in hospital length of stay and complications saved approximately $550 per case compared to laparoscopy and over $700 per case compared to open surgery. We are encouraged by these early clinical and economic validations around the use of da Vinci surgery in hernia repair. Regarding our Single-Site cholecystectomy business, as we've stated over the past four quarters, our total cholecystectomy procedures declined, though the rate of decline moderated in the third quarter. Growth in multiport cholecystectomies offset much of the decline in Single-Site cholecystectomy, as our belief is that customers are finding added value in a more complex patient population and therefore gravitating to the traditional da Vinci multiport approach. Firefly technology was used in approximately 40% of da Vinci cholecystectomies in the quarter. Looking abroad during the third quarter, the approximate 28% international procedure growth was led by global adoption of da Vinci prostatectomy, with solid contributions from kidney procedures, malignant hysterectomies, and colorectal resections. Procedure growth in Europe remains steady through the first nine months of the year, while the acceleration in procedure growth in Asia that began during the first half of the year continued into the third quarter. During the quarter, the global evidence supporting the cost-effectiveness of da Vinci prostatectomy in international markets continued to build. Our recent economic analysis from the Peter MacCallum Cancer Centre in Australia published in BJU International reviewed nearly 6,000 prostatectomies from the Victorian Admitted Episode Dataset. Their analysis found da Vinci prostatectomy to be cost-equivalent to open prostatectomy where 140 da Vinci procedures per year were performed on the system, well below the global third quarter annualized average of approximately 190 procedures per system. During the study period from 2010 to 2013, the rate of open prostatectomies declined from approximately 73% to 47% among public hospitals in Victoria due to an increase in the adoption of da Vinci prostatectomy. This concludes my remarks, and I thank you for your time. I will now turn the call over to Calvin.

Thank you, Patrick. I will be providing you with our updated financial outlook for 2015. Starting with procedures, on our last call we estimated full year 2015 procedure growth between 11% and 13% above the approximately 570,000 procedures performed in 2014. We are now increasing our procedure estimate for 2015. We now anticipate full year 2015 procedure growth of between 13% and 14%. Turning to gross profit, our outlook for gross profit margin has again modestly improved compared to last quarter. We expect our fourth quarter 2015 pro forma gross profit margin to be within a range of 67.5% to 68.5% of revenue. Note that this range is a bit lower than our third quarter gross margin as Q3 benefited from favorable product mix and other factors which we expect to return to more typical patterns in Q4. Our actual gross profit margin will vary quarter-to-quarter depending largely on product and regional mix, system production volume, and foreign exchange rates. Turning to operating expenses, consistent with our last call, we continue to expect to grow pro forma 2015 operating expenses towards the lower end of a range of between 7% and 10% above 2014 levels. Also consistent with our last call, we expect our 2015 non-cash stock compensation expense to come in towards the lower end of the $170 million to $180 million range, roughly flat compared to $169 million in 2014. We continue to expect other income, which consists mostly of interest income, to total between $16 million and $18 million in 2015. With regard to income tax, for Q4 we expect our pro forma income tax rate to be between 28% and 30% of pre-tax income consistent with our previous estimate. This forecast does not assume the reinstatement of the R&D tax credit in 2015. That concludes our prepared comments. We will now open the call to your questions.

Good afternoon, guys. Thank you for taking the questions. I guess two things for us. If you look at the legacy U.S. procedures, Gary, we talked in August about some of the hospital systems looking more carefully at cost-benefit analysis. Do you think that's supporting the complex dVH and dVP, and are you getting more evidence that that's the case?

Yes. We've seen, I can speak to anecdotes. Anecdotally, the dVPs and some of the more complex procedures we've seen have been well supported by analysis done at the IDN level. They are getting more sophisticated in those analyses and I think they are getting more confident in them.

Okay. And then, as far as the kind of international procedure growth, that was an exceptional acceleration. How durable is that as we look at 2016 with Europe kind of steady growth, U.S. obviously a little bit above plan, but that Asian piece, it really sort of sticks out?

Yes. It depends on the country. So, if you go country by country in Asia, I think Korea has been building nicely. I don't see radical changes one way or the other. Japan, we've talked about, I think that there's a lot of interest and a lot of organic activity, but major penetration is going to require reimbursement. China, we saw a lot of acceleration. And the pacing there will be in part driven by capital placements, and as you know well, there's a quota system in China, so there are some systems remaining on the quota that can be placed. There's a point at which you need a new quota to keep going. So we can get some growth in the existing installed base, although to really accelerate quickly you need additional systems, and that's something that Calvin can take you through a little later in the Q&A.

Sure. And just last thing is the China zero last quarter, zero this quarter, anything to read there as it kind of a bolus effect in the year end? And obviously the quota being the quota, but how do we think about that from a consistency perspective over time? Thanks.

Yes. This is Marshall. There's a process behind it. The quota was provided year and a half ago, two years ago. There are 18 systems that remained on the quota, but there's a tender process that each of the hospitals have to undertake, and the tender process is unpredictable in terms of when it will complete. It turns out that they've been completing in boluses, as you suggested. But the fact that none were completed in the last – no systems were shipped in the last two quarters, I don't necessarily believe is indicative of whether we'll ship more or less in the next couple of quarters. So, we'll see how the tenders play out and we'll see what we wind up with.

Great. Thank you very much.

Thank you and good afternoon everybody. I wanted just to start with the overall procedure volume environment, and understandably some of your comments, Patrick regarding the sustainability of some of the mature procedures may make sense. But if I look at the overall procedure volumes in the quarter, they were flat sequentially. I can't remember when in the third quarter you did not see a sequential decline, whether that was related to seasonality or some of the other factors that were influencing your business. So could you maybe just talk about what's going on in the overall environment and whether what we are seeing now is the impact of sun-setting some of the concerns that surfaced a couple of years ago, and maybe what materialized in the third quarter that might have made for the outsized performance?

I'll speak to a couple of things, and Patrick, you can jump in. At the dVP level in the U.S., we really think that's the flow back into treatment of some folks who had set out in watchful waiting and then had disease progression. How long that persists is a little bit hard to predict based on some of the changes in PSA diagnostics. On the hysterectomy market, we're seeing a rotation of patients away from some of the lower volume surgeons in general and into higher volume and dedicated surgeons, so, GYN oncologists. That appears to be particularly durable. I think that that trend makes sense, and I think the activity is likely to continue. We're a large part of the dVH market, and so I think the macro trend will go as the macro dVH market grows in the United States.

The one thing to bear in mind is that for the past handful of years, the number of benign hysterectomies in total has been declining, and so that will continue to counterbalance the hysterectomy market.

On the upside, I think we're in the beginnings of our experience in a lot of our markets. In Europe, we're still in the meaty part of adoption in many of the countries that we're in. We're really excited about what can happen in Asia and the various markets that we talked about. In general surgery, I think we're more at the beginning of some of the adoption that we see in colon, rectal, and hernia. So I think as you think about the future, it’s a little bit of the puts and takes there of how fast do mature markets moderate and how quickly do our emerging markets grow.

Okay. That's helpful. And then I just want to make sure I understand what you're saying explicitly about Japan for next year. Obviously, you have the dVP reimbursing. You talked about the society submitting on partial nephrectomy. What are the next steps in gaining additional reimbursement in Japan and how will that be disseminated?

Yes. There are multiple conversations from multiple stakeholders in Japan. Surgical societies play a role as well as government societies, in deciding what data is required and kind of in what sequence they want to address those different procedures, so from thoracic surgery to general surgery, things in the colon and others are of interest to Japanese surgeons and are in active discussion. To get into the national reimbursement, there are a couple of different pathways, wherein one of them called Senshin Iryo B for the process that we're in for partial nephrectomy. The government has asked to see that data and is going to review it. So we're not guaranteed what and when, but it’s part of the formal process. Other ones are not yet in that formal process. The government can choose to send it down a different reimbursement process. If that happens and we have some assurance that that is likely, then we'll report that out to you. So in terms of the near term and national coverage, partial nephrectomy is the one to keep your eye on. I am not generally upset about progress. I think there is a fair amount of interest. I think the conversations are active and it's just continuing to push forward.

And then maybe lastly Gary, as you kind of reflect on the business and look at the progress that you've made over the past call it, 18 months, you kind of put all the moving parts together with macro and one thing you designated as the 'unintended consequence' of the Affordable Care Act or economic pressures in Europe or the state of your business. How would you just compare your view of the forward outlook today versus how you might have felt a year ago and your level of confidence?

I believe we are receiving significant validation for our products from our customers. I am encouraged by the feedback from general surgeons, their engagement with our company, and their interest and satisfaction with our products, as well as their demand for new offerings that we can provide. In Europe, we are investing in enhancing our organization's capabilities and getting closer to our customers. Overall, customer demand is very strong, which is a positive indicator for us. We have room for improvement within our team and processes, and we are actively addressing that. The company is growing and is committed to these initiatives, and I anticipate we will see improved capabilities in the coming quarters.

Okay. Thank you for all the detail.

Hi. Thanks for taking the question and congrats on a really good quarter. Two things, first I just wanted to start out for Marshall on the OpEx growth in the quarter. It was one thing that kind of surprised us. It looks like the operating expense growth in Q3 was a lot lower than we would have thought. So I was just wondering if you could kind of highlight that, and it sounds like things will kind of pick back up in Q4. But is 7% to 8% still the right way to think about OpEx growth longer term and just again what happened in Q3 with the lower growth in OpEx?

Well, certainly for the rest of this year, Calvin has given you guidance on the lower end of the 7% to 10% range, and more like to 7%, but I think we're focused on controlling cost and watching it carefully. There are some costs that kind of happen – when they happen, and that includes prototypes in the engineering group and some of those didn't happen this quarter and will happen next quarter, and so that's why you get some of the fluctuation between quarters, but overall I think we're managing to the bottom line.

Okay. And then just back on, Gary, back on Japan. I just want to be clear on the message there, because on the Q2 call you talked about partial nephrectomy but then also four additional procedures. And it sounds like you're not as optimistic on those four additional procedures. So, I was wondering if you could give some color on what's happened there and how do we look to Japan as a source of real incremental procedure volume growth in 2016 or is that not the case given what you're articulating here?

Yes. I think in terms of partial nephrectomy, that's moving forward with a formal process into review for the national coverage. The conversations and the work being done on other procedures are ongoing, but it's not yet at that level of rigor for the 2016 review and as a result, I don't think it's likely that they will be included in the 2016 book. We're not ready yet to give you the 2016 procedure guidance, and we're working through that and rolling that up and that's something we'll talk about in general in the next call. You can anticipate that additional reimbursements accelerating in Japan and lack of it will put more pressure on procedures and they'll be part of the conversation as we go through our forecasting.

And then any quick update on Sp in terms of timing, I heard the comments you may have a call here, but just what is the year where you think you could start to generate revenues from Sp?

Yes. We're making good progress in terms of our technology and customer valuations of the product in lab are encouraging and quite exciting. In terms of when we expect real revenue? We're not ready to tell you exactly where the revenue launch will be. We're definitely looking forward to human clinical interactions in 2016 and we'll color that up more as we go forward in future calls.

Thank you. Good afternoon everybody. Let me start with hernia. Gary, anecdotally talking to general surgeons about Xi adoption, it sounds like a lot of the folks we have talked to start with a ventral procedure because of the suturing benefits and then seem to move quickly to inguinal as they get comfortable. Are you seeing that kind of progression, maybe to what extent, and is this process what's driving the solid hernia adoption?

We see different pathways actually, as you know as you talk to different general surgeons, I wouldn't characterize the one that you've described as the most common or the only path that folks take. It's certainly a path. No doubt that's ventral hernia is something that benefits from precise control, great visualization, suturing, the ability to close the primary defect directly with suture, as well as supporting infrastructure. So there are some advantages there. As general surgeons get comfortable, then they start to explore other things that they can do with the tool and sometimes it goes ventral, then inguinal, sometimes the reverse, and from there it can take them into more complex cases or cases where there is an acute called cholecystectomy that they might want to try. So there are different pathways that can happen. I wouldn't characterize one as the only.

Okay. I have to ask once more about procedures. If I’m interpreting the numbers correctly, you've had a strong year with procedure growth up 14% over the nine months and up 15% in the third quarter. However, Marshall, it seems you are forecasting a growth of 13% to 14% for the year, which indicates a potential slowdown in the fourth quarter compared to a similar comparison to the third quarter. Last year, you grew about 10% in both the third and fourth quarters. Can you clarify your reasoning? Given that mature procedures appear to be stable or improving and the growing segments are still experiencing growth, what should we understand regarding the fourth quarter?

Yes, Rick. This is Calvin. And absolutely overall we're pleased with our procedure growth trends, and this is actually the third quarter in a row that we've increased our guidance for procedures and the revised procedure growth assumptions generally reflect the continuation of the trends that we've seen through three quarters with growth coming from U.S. general surgery and international procedures as I described. In our updated view, 13% to 14%, it's lower than 15% in Q3, we're certainly at 14% on a year-to-date basis. And the fact is in Q4, the comps get more difficult for those mature categories, the dVPs in the United States and other mature categories where, as Patrick described, I think maintaining the rate that you saw in the first nine months will become more challenging in the fourth quarter.

Thanks. First one, maybe a bit of a subtlety, but Gary, in your comments you talked more about the network effect and then in the press you commented on the technology ecosystem, can you maybe just elaborate on that a little bit? Are you directing additional resources to software and informatics, you need a customer is asking for more?

We have over the last few years increased our capabilities in real-time software and kind of guidance tools for the surgeon, as well as kind of offline informatics. So, that's not an immediate thing, it's actually been a rising trend. When you think about the ecosystems, sort of stepping back as a whole, one of these products is the robot itself, the imaging system, sometimes with molecules like Firefly, instrumentation, everything from needle drivers to staplers and vessel sealers, training technologies like stimulators and dual console. And then there is another piece, which is informatics. Informatics has been power force. At the surgeon level, what data can you give me in real-time that helps surgeons make a decision, at the institutional level it comes down to what kind of instruments you're using, how long are you on the system, what does that look like relative to national norms. And they've been interested in that data and we've been supplying that data now for over a year and those conversations have been really healthy and I think it will only grow.

And then I guess that's helping them to figure out the cost side of the equation as well?

It lets them understand a couple of things. It lets them model their cost really carefully and really get the value right. The big thing in any of these conversations is total cost to treat, not price, and so that helps them really understand total cost to treat. And we've found it to be an extremely productive and rich conversation with our customer base. So, they like that. And it also gives them some sense of variation amongst different procedures and different surgeons, so they get a sense of how much variability they see within their institutions. Yes, we’ve talked about the facts, that when we introduced new products the margins are lower than mature products and lower than they'll be ultimately once that product has been around for a while, both because we are able to drag down the cost of vendors through volume, as well as be able to redesign the products, and we've undertaken some redesigns as well as increasing volume. I think what we've said before is that those efforts are well underway. We're happy with where they are going. They won't drive a lot of benefit this quarter, more of the benefit will be in 2016 and even more in 2017.

Hey guys, thanks for squeezing me in and congrats on a nice quarter. Maybe one on the margins here. I know that you sort of mentioned mix, right? When you think about mix, you had a higher proportion of Xi, and if I remember correctly on the last call you said Xi you are still scaling up margins was lower, but then offsetting that you had a higher proportion of system sales coming in from the U.S. I’m just trying to think how those two trade off and how they benefit your gross margins?

Yes, this quarter we benefited from the product mix. There was a significant proportion of the dual console Xi, and regarding product costs, the extra surgeon console is mature technology with lower costs, which contributes positively to our margins. As Marshall mentioned, there were minimal inventory charges this quarter, and other cost of sales charges were relatively minor. Several factors aligned in our favor during the third quarter; we expect the fourth quarter to reflect a more typical pattern concerning product mix and costs along with a seasonally stronger capital quarter. We experienced more system sales that generally have higher margins compared to the recurring revenue side, and we will provide more detailed comments about 2016 in the next call. Thank you. I will now turn it over to Calvin.

Thank you, everyone, for your participation in today's call. We appreciate your continued interest in Intuitive Surgical and we look forward to speaking with you again in three months.