Analyst Conference Summary

conference date: October 17, 2013 @ 1:30 PM Pacific Time
for quarter ending: September 30, 2013 (third quarter 2013)

Forward-looking statements

Overview: Pretty bad quarter for a company that has a long history of growth. Lowered guidance.

Basic data (GAAP):

Revenue was $499 million, down 14% sequentially from $578.5 million, and down 7% from $538 million in the year-earlier quarter.

Net income was $156.8 million, down 1% sequentially from $159.1 million, and down 14% from $183.3 million year-earlier.

EPS (earnings per share) were $3.99, up 2% sequentially from $3.90, and down 11% from $4.46 year-earlier.

Guidance:

Updated for full 2013. Procedure growth between 16% and 17%. Revenue growth lowered to flat to up 3.5%. Operating income 37 to 38% of revenue. Non-cash stock-based compensation $169 to $172 million. Other income (mostly interest) $16 to $17 million. Income tax for Q4 28% of pre-tax income. Share count for Q4 down about 600,000 shares from Q3.

Conference Highlights:

System sales were down mainly as a result of "moderating growth in benign gynecology, combined with changing hospital capital spending priorities associated with the implementation of the Affordable Care Act."

Revenue from Da Vinci system sales was $158.5 million, down 27% sequentially $215.9 million, and down 32% from $232.0 million year-earlier. 101 Da Vinci systems were sold in the quarter, down from 155 year-earlier. 36 systems were sold internationally, mostly in Europe (17 systems) and Japan (13). $1.56 million average price per system. 2871 systems were installed at the end of the quarter.

Revenue from instruments and accessories was $239.1 million, down 10% sequentially from $264.5 million, but up 10% from $218.0 million year-earlier. Lower stocking was main reason for sequential downtrend. $1880 revenue per procedure, down due to lower stocking orders due to fewer new systems sold.

Revenue from services was $101.4 million, up 3% sequentially from $98.1 million and up 15% from $87.8 million year-earlier.

Surgical procedures using da Vinci robots grew 16% y/y, which is slowly due to benign gynecology slowdown and concerns over robotic surgery in general [due to lawsuits and publicity about adverse events]. Utilization grew in major categories excepting benign gynecology. Hysterectomy remained the largest single type of operation performed. Statistics from studies showing benefits of da Vinci surgeries were recited at length.

Made good progress in responding to FDA warning letter.

Gross margin was 71.5%, up sequentially from 70.0% on higher ASPs, but down y/y due to medical device excise tax.

The cash and equivalents balance ended at $2.5 billion, down $495 million in the quarter. $694 million was used to repurchase shares. $204 million cash flow from operations. $34 million was used for capital expense and IP acquisitions. Future share buyback authorization is approximately $1 billion.

Cost of revenue was $142.3 million. Operating expenses of $182.5 million included: $139.3 million for selling, general, and administrative; $43.2 million for research and development. Leaving income from operations of $174.2 million. Interest income was $3.9 million. Income tax expense $21.3 million.

There was $50 million non-cash stock compensation expense in the quarter. There was a $26 million tax benefit in the quarter.

Intuitive Surgical CEO Dr. Gary Guthart remains confident in the long-term opportunity for surgical robots. Stapling launch will be expanded in Q4. Remains confident in the safety and efficacy of products, which are being born out with studies.

Q&A:

Will there be U.S. placements only if utilization continues to increase sequentially? In near term systems sales will depend on procedure growth. People will be looking to increase utilization over time. If they have an S platform and want access to stapling, they need to upgrade to SI.

Japan trends? Reimbursement approval process involves clinical data collection, which means hospitals will buy some systems for that. We expect buying to be lumpy, but interest in Japan is strong.

Inventory is mostly SIs, so we see no exposure from it.

Spending plans? Some spending will scale with volume, but we can save by prioritizing spending on prototypes and expansion plans. We will see the smaller Firefly cohorts start.

We did see some potential sales not come in by the end of the quarter, same as last quarter. We got an approval, then were stopped by the CEO or CFO due to their uncertainties around spending. The ACA requires certain IT spending that is cutting into capital budgets.

Are you doing anything different to deal with the situation? We are making sure people have clinical data showing the benefits of da Vinci systems. In Japan and Europe we are working on the economic analysis needed for government reimbursement approval.

We have options to address more cost-sensitive procedures, as well as for more complex, more expensive procedures.

Procedure trends within the quarter? September is typically seasonally stronger due to the end of vacations. The mix is also increasingly seasonal.

There is a lot of uncertainty for Q4 on system purchasing. Our visibility is better for procedures than for how hospitals will do their capital spending. There is revenue uncertainty due to the ACA.

Benign gynecology trend? It was seasonally stable, not much of a change between Q2 and Q3.

For urology, for the cancers, you are more immune to the media allegations than for a benign procedure. So urology has seen little impact for misleading media articles.

Stapler expansion, more sizes? The first expansion will be with the current offering going to more sites. It is optimized for colorectal. Longer term we are working on prototypes for other types of procedures; that is not near-term.

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