Analyst Conference Summary

conference date: October 21, 2014 @ 1:30 PM Pacific Time
for quarter ending: September 30, 2014 (third quarter, Q3 2014)

Forward-looking statements

Overview: Continuing to recover from its slump with a nice sequential increase in systems shipped.

Basic data (GAAP):

Revenue was $550.1 million, 7% sequentially from $512.2 million and up 10 % from $499.0 million in the year-earlier quarter.

Net income was $123.7 million, up 19% sequentially from $104.0 million, but down 21% from $156.8 million year-earlier.

EPS (earnings per share, diluted) were $3.35, up 21% sequentially from $2.77 and down 16% from $3.99 year-earlier.

Guidance:

For the full year 2014, procedure growth now estimated increased to between 8% and 9% over 2013. Operating expenses are now expected just 9% to 11% y/y. 2014 non-cash stock based compensation near $170 million. Income tax (non-GAAP) 27.5% to 29%. Share count 36.9 to 37.1 million at end of year.

Conference Highlights:

Intuitive Surgical shipped 111 da Vinci Surgical Systems, up sequentially from 96, and also up from 101 in the year-earlier quarter. Da Vinci Xi system sales were 59. 6 system places were structured as operating leases. 61 systems were placed in the U.S.

Firefly was cleared for Xi system imaging by the FDA. The Single-Site needle driver was also approved.

The stapler system shop was stopped in the quarter, while issues are investigated.

Growth in general surgery led the way and was broad-based.

Procedure volume grew 10% y/y, but was seasonally slower by 1% sequentially. International (ex-US) procedure volume increased 20% y/y, led by urological procedures. Single-site hysterectomy grew quickly off a small base.

Revenue from Da Vinci system sales was $169 million, up 4% sequentially from $144 million and up 6% from $159 million in the year-earlier quarter.

Revenue from instruments and accessories was $273 million, up 4% sequentially from $262 million and 14% from $239 million year-earlier. $1930 per procedure average.

Revenue from services was $109 million, up 2% sequentially from $107 million and 8% from $101 million year-earlier.

Non-GAAP numbers: revenue was $534 million (due to exclusion of trade-outs). Net income was $145 million, up 4% sequentially from $140 million but down 8% from $157 million year-earlier. Non-GAAP EPS was $3.92, up 5% sequentially from $3.73, and down 21% from $4.94 year-earlier. 67.2% gross margin, down sequentially due to higher mix of new products and costs related to stapler stock use and product recalls.

The cash and equivalents balance ended at $2.3 billion, up $19 million in the quarter. Cash flow from operations was not stated. Stock repurchase program was completed before the quarter ended.

Cost of revenue was $189.5 million. Operating expenses of $201.5 million included: $154.0 million for selling, general, and administrative; $47.5 million for research and development. Leaving income from operations of $159.1 million. Other net was $2.0 million. Income tax expense $37.4 million.

Believes there are still many opportunities to develop and sell robotic surgery systems and instruments. Intuitive Surgical continues to invest in selling into international markets.

Q&A:

Procedure volumes for rest of year? We are expecting Q4 to not reach the 12% necessary to reach 10% for the year, at this point.

System sales environment is driven by interest in acquiring technologies for existing customers and starting new programs. Europe does not have a smooth distribution of customers, some a very price sensitive.

Are we on a positive, sustainable trajectory for adopting your technology? We are seeing good early adoption for certain new procedures, which is encouraging. The ACA did have an impact on hospital finances.

SP delay, rational? Some of the positive things we learned from Xi launch, we decided to add to SP.

Gross margin softness? It declined about 200 basis points. 3/4 of that was due to unusual items in the quarter, including stapler, scope recall, and change in distribution in Japan. But some reflects new product introductions, with have lower margins, but should improve over time.

China, sustainability? We are in the first phase. It is a long-term opportunity, with a lot of steps to get set up there for a build out. Total systems in China ended at 36 at the end of the quarter.

Where is Xi in rollout versus your expectations? We are pleased with where we are. Feedback is that urologists and others are finding more value in it than we anticipated.

Reduced expense guidance is partly due to delaying some hiring. We are not likely to invest as much in operating expenses in future years as we did in 2014, relative to revenue.

Hernia growth is still early in its life cycle, but is going well. Rectal is where the stapler is most used, and where surgeons want it back quickly. We need to carefully identify the issues, fix them, and get it back to the market. We do also see stapler use in colon resection.

Change in head of sales in U.S.? The company's needs change as the market changes. We believe we have a really good team.

Revenue per procedure varies greatly on the specific type of surgery. The average changes based mostly on the mix. We are comfortable with our present pricing and margins for accessories and instruments.

Stapler stop use issue? We have asked customers to stop using it. We have taken a reserve with regard to inventory depending on conclusions. Customer sentiment is they understand our request as conservative, just 3 malfunctions among thousands of uses. We have many requests to bring it back quickly.

We don't know when we will get reimbursement approval in Japan, but we are working towards 2016.

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