Ladies and gentlemen, thank you for standing by, and welcome to the Intuitive Surgical Q3 earnings 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 should need assistance during the this conference is being recorded. I would now like to turn the conference over to our host, Mr.
Calvin Darling, Director of Financial Planning And Analysis for Intu to Surgical.
Call. With me today, we have Gary Guthardt, our president and CEO. Marshall Moore, our chief financial officer, and Alex Zukic, 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 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 forward looking statements. Please note that this conference call will be available for audio replay on our website at intuitive surgical.com on the audio archive section under our investor relations page. In addition, today's press release has been posted to our website. Today's format will consist of providing the highlights of our 3rd quarter results as described in our press release, followed by a question and answer session.
Gear will present the quarter's business and operational highlights. Marshall
will provide
a review of our 3rd and clinical highlights, then I will provide an update to our forecast for 2010. And finally, we will host a question and answer session. With that, I'll it over to Gary.
Good afternoon and thank you for joining us on the call today. In what is a historic historically, a seasonally challenging quarter, q32010 provided some added macroeconomic headwinds. In the face of these challenges, our procedures showed slight growth sequentially from Q2 and 33% growth over Q3 2009. In SIS we sold 105 Diminci systems in the quarter, up from 86 systems in Q3 2009, and acceptance of our SI system and dual consoles for strong. In absolute numbers, gynecology continued to show strength adding the most procedures in the quarter with contributions from both line and malignant conditions.
While Q3 is seasonally slow in Europe, prior year comparisons show relative strength in European procedures. Both procedures in gynecology and urology also sequential quarterly growth. Da Vinci lobectomy, da Vinci Low anterior resection, and da Vinci Transoral surgery are delivering strong patient and are being adopted well. On a relative basis, the procedure counts are still fairly small. However, their early growth rate remain encouraging.
Before summarizing Q3 highlights, I'd like to remind you that third quarter 2009 included a revenue deferral associated with an writing highlights for the third quarter were as follows. Proceeds grew 33% over the third quarter of 2009. We sold 100 5 DaVinci surgical systems, up from 86 during third quarter of last year. Total revenue was $344,000,000, up 26 percent over Q3 2009. Instrument and accessory revenue was $128,000,000, up 27 percent over the last year.
Total rep total recurring revenue grew to $185,000,000, up 20 percent from prior over last year. We generated an operating profit of $163,000,000 before non cash stock option expense, up 30 2% from the third quarter of last year. From last quarter and up 5 invested in intellectual property related technologies and fixed assets and 59,000,000 in stock repurchases. Excluding the impact of these outlays, as well as $17,000,000 from stock proceeds and $2,000,000 returned from working capital, we generated $126,000,000 in gross cash flow from operations, which is 145 percent of our reported GAAP net income in the third quarter. We have been making substantive investments in our clinical sales force and a new product and throughout the year.
We believe that close clinical sales support of emerging and high growth procedures is an important catalyst for achieving procedure adoption. However, reaching territory productivity for a new sales hire does not happen immediately. It is a multi month process so that made earlier in the year are just coming online in the field now. We will continue to measure the productivity of these investments and we will adjust spending is needed. This quarter, we added an additional ninety two people to our team, predominantly in sales, manufacturing, and R and D, but our total team to 1568 employees.
In product development and research, our teams are driving advancements in our focus areas. Our development teams are progressing and developing robotics stapling and energy instruments, as well as various specialty specific instruments. Are improving and expanding our imaging capability through investments in Image Acquisition Technologies And Fore Essence Imaging, are developing patient side technologies that allow for single port robotic surgery. And finally, we are making substantial progress in bringing to Mark surgical simulation and networking. Lastly, we have seen a shift in the approach to new product approvals by the FDA.
These changes appear to be extending timelines from past norms, and we cannot predict with certainty when a new product will receive approval. We are confident in the utility and the quality of our new products going through approval process and are focusing our regulatory teams on clean execution to meet the needs of FDA. We will announce availability of new products as they are ready to ship. In summary, developing and expanding procedures with strong patient the over to Marshall, our Chief Financial Officer.
Thank you, Gary. Prior to providing you with the details of our third quarter results, I would like to provide you with a quick review of the deferral accounting that took place during 2009, which sets into context the proper comparables. Last year, we for such of $20,000,000 of revenue in the first quarter of 2019 comprised of $18,000,000 of system revenue associated with system upgrade offers and $2,000,000 of revenue. We recognized $14,000,000 of the $20,000,000 deferral in our second quarter of 2009 and the remaining $6,000,000 in third quarter of 1009 as though the deferral had not occurred. Our third quarter 2010 revenue was $344,000,000, with 274,000,000 for the third quarter of 2009 and down 2% compared with 351,000,000 for the second quarter of 20 3rd quarter revenues by product category were as follows.
3rd quarter instrument and accessory revenue was $8,000,000, up 27% compared with quarter of 2010. The timing of customer stocking orders varies from customer to customer and are regularly placed after the da Vinci robot is ship to install. Fewer stocking orders were completed and a higher carryover of stocking orders existed in the 3rd quarter compared to the 2nd quarter. Tracking orders, growth in instrument and accessory revenue was slightly lower than the procedure growth as we would expect. Instrument and accessory revenue last per procedure, including initial stocking orders, was approximately $1840 per procedure, which is lower than the third quarter of 2009 by and approximately proprietary declined slowly 10 systems revenue of $160,000,000 increased 23% compared with $130,000,000 of systems revenue for the third quarter of 2009 in decreased with 86 systems last year and 108 systems last quarter.
Our 3rd quarter average sales price per system including all da Vinci models, but excluding upgrades and the deferral revenue was $1,430,000, an increase from the one point $39,000,000 realized in the third quarter of 2009 and a decrease from the $1,480,000 realized in the 2nd quarter. The increase compared to the prior year an increase in the proportion of SI and SI dual console systems, which carry a higher ASP. The decrease in average sales price per system compared with the prior in the value of our euro to dollar hedging position. As we indicated last quarter, the mix of systems and customers and therefore, ASPs in the first and second quarters of this year have been more favorable than we normally expect. We lock in hedges for most of our four to direct European system sales every 6 months.
The rates locked in for July to December are lower than the rates recognized in the 1st 6 months of 20 by approximately 15%. 3rd quarter systems revenue also included $10,000,000 of upgrade revenue to 10,000,000 in the third quarter of 2 1009 and 8,000,000 in the second quarter of 2010. Service revenue increased to 50 $7,000,000, up 31% compared with $44,000,000 last year and up 3% compared with $55,000,000 last quarter. The growth in the quarter recurring revenue comprised of instrument, accessory, and service revenue increased to $185,000,000, up quarter of 2009 and up 1% compared with the second quarter of 2010. Recurring revenue represented 4% of total 3rd quarter revenue compared with 53% in the third quarter last year and 52% last quarter.
Revenue geography was as follows. Non U. S. Revenue represented 17% of our total revenue in the quarter compared with 19% of total revenue in the quarter of 200918 percent of total revenue in the second quarter of 2010. The decline in the proportion of non US revenue relative to total revenue reflects growth in the US business.
Non US procedures grew faster at a faster days than US procedures on a year to year basis, although Q3 did reflect seasonality and a sequential decline. Sold 22 systems outside the U. S. Compared with 14 in third quarter of 2009 22 last quarter. 4 of the systems sold in the third quarter in one of the systems sold in the second quarter of 2010 were to Japanese customers.
We sold 16 systems in Europe this quarter or 2 more the past quarter and 8 more than last year. However, the capital sales market in Europe continues to be challenging, reflecting the macroeconomic environment. Moving on to the remainder of the P and L, let me remind you that there were no costs deferred in junction with the first quarter 2019 revenue deferral and therefore, the $20,000,000 deferral and subsequent reversals had an equal on the 2019 gross margin, excluding the impact of the deferral of 70% and compared with 2nd quarter 2010 gross margin of 73%. The increase in gross margin compared to the prior year reflects increased system ASPs, material cost reductions, and absorption of fixed costs over a larger revenue base compared to the prior quarter lower manufacturing costs were offset by lower system ASPs. 3rd quarter 2010 operating expenses of 119,000,000 were up 25% compared compared with the third quarter of 2009 and up 1% compared with the second quarter.
The quarter over quarter increase reflects loss associated with employees added during the quarter, partially offset by a decrease in r R and D spending. The decrease in R and D ending reflects lower prototype costs due to the lumpy nature of prototype purchasing, which will likely be incurred in fourth quarter. We added 92 employees in the quarter, including 77 employees in the sales and service organization as we continue to expand our clinical Salesforce and 10 employees in operation. 3rd quarter 2010 operating income was 130 $1,000,000 or 38 percent of sales compared with $98,000,000 or 36 percent of sales for the third quarter of 2009, excluding the impact of referral and $140,000,000 or 40 percent of sales for the second quarter of 2010. 3rd quarter 20 operating income reflected 30,000,000 $10,930,000,000 last quarter.
The growth, the non cash compensation, reflects our annual grant made February 15th each year and the increase in the number of employees. Our effective tax rate for the third quarter of 37 percent lower than our 2009 rate of 41 percent, reflecting the implementation of our international tax structure. Our third quarter rate was lower than the second than the rate for the 2nd quarter of 39%. Our net income was 87,000,000 or $2.14 per share compared compared with 61,000,000 or $1.55 per share for the third quarter of 2009, excluding the impact this deferral and $89,000,000 or $2.19 per share for the second quarter of 2010. Let me quickly summarize our results for the 1st 9 months of 2010.
The first quarter of 2009 deferral did not have an impact on the 9 months of 2009 information. Procedures grew by 35% for the 1st 9 months of 2010. Total revenue for the 1st 9 months of 2010 up 40% compared with $729,000,000 last year. This included recurring revenue growth of 35 spend and an increase in systems revenue of 47 percent. Operating income for the 1st 9 months of 2010 61% compared with 249,000,000 last year.
Operating income included 88,000,000 of stock based compensation charges in the first months of 2010 compared with 72,000,000 in 2009. Net income for the 1st 9 months of 2010 was 261,000,000 or $6.45 per share compared with 155,000,000 or $3.97 per share last year. Now moving to the balance 32,010. The increase during the quarter reflects $126,000,000 of cash flows from operations 17,000,000 from the exercise of stock option, partially offset by 59,000,000 of stock buybacks and 50,000,000 of capital and IP purchases In July, our board authorized 150,000,000 to buyback shares. Considering the previous authorization and buyback we currently have 241,000,000 authorized to buy back shares.
Our accounts receivable balance increased to 208,000,000 at September 30th from 195,000,000 at June 30th, selecting the timing of revenue. Our net inventory increased to 85,000,000 at September 30th from 74,000,000 at June 30th. The increase reflects safety stock to ensure adequate supply of certain components in inventory associated with yet to be released products. And with I'd like to turn it over to Alex, who will go over our sales, marketing, and clinical highlights.
Thank you, Marshall. During the third quarter, we sold 105 da Vinci systems. 83 in the United States, 16 system sales, 15 standard da Vinci systems were traded in for credit against sales for new da Vinci Si systems. We had a net 90 system additions to Vinci systems worldwide, 1228 in the U. S, 292 in Europe, and 141 in rest of markets.
45 customers. Also during the quarter, 10 customers purchased upgrades to convert their da Vinci S system into da Vinci systems. Internationally, we sold 5 da Vinci systems in Spain, 4 into the countries of Germany and Japan and 3 into France. Clinically, we had a cell the quarter with GYN and more specifically benign DDH Contributing the greatest absolute growth. While DDH malignant conditions showed very good sequential percentage growth.
Additional categories of growth included ENT, colorectal, and thoracic surgery. As one would expect, with DBP flatening in the US and seasonality in OUS markets, our urology growth was tempered. On a year over year comparison, overall 3rd quarter procedures grew by approximately 33%. Also during the quarter, over 250 Avinci related clinical publications and abstracts, representing multiple surgical specialties appeared within the various peer reviewed journals. DVH for benign conditions has become a significant driver of our overall business.
And within this target, comparisons between DVH and traditional labH and lap supraservical hysterectomies or LSH are beginning to emerge. For background in LSH is a less complete resection than a total hysterectomy, but an appropriate option for some pay In LSH the cervix is left in place and only the uterus is extracted. In some ways it can be thought of as a partial hysterectomy. A recent study comparing the 3 techniques was published in the journal of robotic surgery. The study was entitled comparison of minimally invasive surgical approaches for hysterectomy at a community hospital and eliminated out of the Department of Obstetrics And Gynecology in Spartenberg Regional Medical Center in Spartanburg, South Carolina.
The study included patient cohorts comprised of the first 230 7 patients undergoing a DVH, the last 265 patients undergoing in LADH and 87 patients
undergoing
included a higher prevalence of prior abdominal pelvic surgery than found among the LABH patients, as well as Despite added case complexity, operative time was significantly lower in DVH than 90 minutes compared to 125 minutes and similar to that of LSH. Blood loss was also less in DVH patients as compared to LAVH, 59 milliliters compared to 168 milliliters. Similar to LSH. And hospitalization was shorter for DVH than LAVH and LSH 1.0 day compared to 1.2 days for the others. In their summary, the author stated the following, and I quote, our analysis learning curve suggest that operative time for robotic assisted laparoscopic hysterectomy may continue to improve beyond the initial patient series despite the increased complexity of cases undergoing this procedure.
The results of this study lends support to the small but growing body of liver describing the benefits of robotic assisted laparoscopic hysterectomy over conventional laparoscopic assisted vaginal erectomy. With DBP growth in the United States flattening, we look to your and other OUS markets as fertile growth opportunities. In addition, clinical data comparing long term outcomes going prostatectomy versus alternative treatments for organ confined disease is demonstrating the advantages prostatectomy in long term survival. In a recent publication of the journal cancer, surgeons and researchers from the University of California at San Francisco And Memorial Sloan Kettering, working from the nation's largest prostate cancer registry, CAPTURE, for paired cancer specific mortality outcomes among men who underwent radical prostatectomy, men who received external beam radiation and 8 men with localized disease were analyzed. Prostate cancer risk was assessed using 2 well validated instruments that were calculated from clinical data at the time the results.
In total, 266 men died of prostate cancer during the follow-up. Adjust think for risk and age, the hazard ratio for cancer specific mortality relative to prostatectomy was point 21. For radiation
Ladies and gentlemen, thank you for standing by, and welcome to the Intuitive Surgical Q3 earnings 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 should need assistance during the call or if you would like to ask a question, please press star then 1. And you will be assisted offline by an operator. As a reminder, this conference is recorded.
I would now like to turn the conference over to our host, Mr. Calvin Darling, Director of Financial Planning And Analysis for Intuitive Surgical. Please go ahead.
Good afternoon, and welcome to Intuitive Surgical's 3rd quarter conference call. With me today, we have Gary Guthart, our president and CEO. Marshall Moore, our chief financial officer, and Alex 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 may differ materially from those expressed or implied as a result of certain risks and uncertainties.
These risks and uncertainties 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 surgical.com on the audio archive section under our investor relations page. In addition, today's press release been posted to our website. Today's format will consist of providing you with the highlights of our 3rd quarter results as described in our press release followed by a question and answer session.
Gary will present the quarter's business and operational highlights. Marsh
will provide
a review of our 3rd quarter financial results. Alex will discuss marketing and clinical highlights, then I will provide an update to our forecast for 2010. And finally, we will host a question and answer session. With that, I'll turn it over to
Gary. Good afternoon, and thank you for joining us on the call today. In what is a historic historically a seasonally challenging quarter, q32010 provided some added macroeconomic headwinds. In the face of these challenges, our procedures showed slight growth sequentially from Q2 and 33% growth over Q3 to 1009. In systems, we sold 105 Diminci systems in the quarter, up from 86 systems in Q3 2009 and of our SI system and dual consoles was strong.
In absolute numbers, gynecology continued to show strength, adding the most procedures in the quarter with contributions from both benign and malignant conditions. While Q3 is seasonally slow in Europe, prior year comparisons show relative in European procedures. Pull through procedures in gynecology and urology also reflect positive trends. Emerging seizures continued to expand exhibiting strong sequential quarterly growth. Da Vinci lobectomy, da Vinci low anterior resection, and Tranz oral surgery are delivering strong patient value and are being adopted well.
On a relative basis, the procedure counts are still fairly all. However, their early growth rates remain encouraging. Before summarizing Q3 highlights, I'd like to remind you third quarter 2009 included a revenue deferral associated with an upgrade offer related to
the introduction of our SI system. Compared and 3.22 for androgen deprivation. Said another way, the analyst reports the analysis reports that the risk of a man dying from prostate cancer after primary radiation therapy was prostatectomy and the mortality risk for primary androgen deprivation therapy was reported to be 3 times as great. The authors concluded their report by stating, I quote, prostatectomy for localized prostate cancer relative to radiation therapy and androgen deprivation monotherapy. Although this is not a randomized study, the multiple adjustments and sensitivity analysis it is unlikely that the unmeasured confounding would account for the large observed differences in survival.
The successful adoption of any new of the associated with training significant endeavor. It has been our belief that in time, initial da Vinci procedure experience will find its way into the formal processes of academic medicine through residency and fellowship programs. As several da Vinci procedures have take place. Researchers from the University of Alabama, Birmingham, set out to define as developing trend within grams around the country. UAB conducted a survey of GYN Oncology fellows and fellowship directors and summarized findings in last month's edition of the International Journal of Medical Robotics And Computer Assistant Surgery.
The survey was designed to determine the prevalence, application and acceptance of robotics into 41 approved U. S. Programs. Approximately half of the fellow collections, have 2 or more gynecologic oncology faculty members who perform robotic surgery. 78 percent of the responding institutions due more than 5 robotic procedures per month and 22% reported that A perform more than 12 procedures per month.
All responding institutions have utilized the robotic system in the management of end metrial cancer and all respondents reported using the system for lymph node dissections. 89% reported utilization in tree cervical of the Davinci System Council. Although it's the first time we've seen an analysis of this form published in the peer of journal, we are aware of parallel activity taking place within the American Urology Association and the Association of Advanced in residency and fellowship training speaks well to Uh-huh.
Forecast for 2010, including procedures, revenues, and the other elements of the income statement on a GAAP basis. I will also provide estimates on non cash expenses to provide you with visibility of our expected future cash to in 2009. Moving on to revenues. Based on our results through 3 quarters and our view into our 4th quarter sales pipeline, we can you to expect revenue results to grow within the 30 to 33% range forecast last quarter. For the instrument and accessory portion of revenue, we would expect full year revenue growth in this category to come in slightly below the 35% forecasted procedure growth due to the diminishing impact of stocking orders on instrument and accessory revenue per procedure.
As a reminder, our revenues can fluctuate quarter to quarter as the timing of placements system the 73 point in Q3, primarily reflecting the impact of lower Q3 system ASPs. Going forward, we our Q4 margins to 73% range projected on our last call. Moving to operating expense, we have made and will continue to make significant investments across multiple areas of our business, particularly in our clinical sales force. We added 92 employees during the third quarter 305 so far this year compared to a 139 added through 3 quarters last year. While we continue to invest in our business, the timing of some our expenses can be lumpy.
We now expect our total GAAP operating expense to grow by 27 to 29% in 2010 compared with our previous forecast of 29 to 31 percent growth. In terms of non cash expenses, we continue to to record stock compensation charges of approximately $120,000,000 in 2010. Our guidance for intellectual property amortization is now 17,000,000 compared to 15,000,000 last quarter. This increase reflects additional amortization related to comprised of interest income is expected to come in around 18a half 1000000 for the year, just above the 18,000,000 forecasted last quarter. With our income tax, our year to date tax rate now stands at 37.2 percent of pretax income.
We now expect to record income tax at approximately that 37.2% rate for the rest of 2010. For Cal related earnings per share, we ended the 3rd quarter with 39,300,000 common shares outstanding and approximately 4 point 9,000,000 option shares outstanding. Depending on our average stock price in Q4, a portion of the 4,900,000 option shares will be added to the fully diluted shares calculation. At present, we estimated that our diluted share count for calculating EPS in Q4 will be approximate 40,300,000 shares. Our estimate for the full year is 40,400,000 shares.
Finally, we regarding our cash flows since we are forecasting to report over $135,000,000 in non cash stock compensation and amortization expenses for the year, our cash flows will continue to be significantly higher than our reported net income. Better measure of our actual performance and net income. And with that, we would like to open the call to your questions. You.
First question comes from the line of Ben Andrew with William Blair. Please go ahead.
Maybe talk a little bit Gary about same store procedure growth and you know maybe if you can isolate the of the unemployment situation, from your efforts to penetrate new procedures and give us a sense of kind of what you're making with the the additions to the Salesforce?
Sure. As as you know, we we track and and plot our procedure trends pretty close what we saw in the beginning of the summer was, an unusual pressure on, on existing procedure And then we've seen a little bit of return to strength, at the end of the summer, the beginning of September, on the sales force side. So we think there's some environmental pressure out there. It's hard to quantify exactly the number. On the, clinical sales reps and the hiring there, As you know, it's a multi month process.
So, the hires we made in Q1 and Q2 are just becoming active in the field that, you end of Q3. And so our expectation is they'll become productive as we go into Q4. And that's something we're measuring pretty carefully and making sure we understand and what the optimal loading looks like. There's a little bit of titration there. We'll have to watch it as it grows, but that's kind of our thinking on it now.
On Gary to to keep adding aggressively to the sales force for 2, 3 more quarters, to again try to get maximal penetration on the new procedures as well as keep driving the ones so that maybe we could see op margins stay under a bit of pressure here before it returns to, you know, closer to the 40% level?
We will, for the for the next couple of quarters, we'll be continuing to invest in the sales force as as we watch, the productivity of the first in. We think that the demand out there for da Vinci procedures is real and present and that the investment in the sales force will bring those into, into our into our house our hospitals, our customers.
You. And our next question comes from the line of Tycho Peterson with JPMorgan. Please go ahead.
Maybe just to the first question, Ben, head on kind of the underlying economic factors and taking it a step further, you talked about benign and malignant, you know, flip flopping this quarter with benign picking up a little bit. Can you just talk about how sustainable you think that trend is, or it just, you know, I mean, how much of that was driven by new reps being added, versus kind of, you know, a slight uptake in kind of a patient, you know, volumes or something else?
Well, if you look at, again, the overall hysterectomy target, for us, break it up as you know and then lignite and into the benign. But what we have found to be the case, not just in GYN, but in other procedures is the greater patient value seems to take place in the more complex procedures. And with in the benign category recognize that there is an underlying condition or several underlying conditions that range from let's say very complex to very complex. The way we've been tracking the hysterect me growth. It leads us to believe that we're making good penetration into the complex and probably picking up some of the less complex along the way.
But when we look at where we are in our growth trajectories and what the opportunity is, we are in a pretty steep part of our growth curve. So, is it sustainable in our view? Absolutely, in the procedures that we're and I don't think there was anything from a, let's say, a favorable tailwind through Q3 between seasonality and high employment rates that gave us any stimulus for the quarter. And if you recall, we returned to sort of the norm of benign growth happening at a faster or a larger percentage than malignant growth last quarter as well as this quarter. So this isn't the first time we've restored that.
And just to color that up a little bit. Willing to distract me is further up on the adoption curve. And so we'd expect that M benign is lower. We'd expect that the growth rate of 9 should be higher than the growth rate of Milligan given where they are relative to to what we think the total market is.
Okay. That that's And then I think you talked about 45 year placements were repeat customers. Any color you can give us on just kind of hospital size in terms of placement between larger, medium, and and smaller hospitals?
You know, there really isn't, anything that is remarkable or different that to mind in this particular quarter. I think you'll find that all sizes and shapes of hospitals remain our customers in this quarter really nothing different. So we don't really track that as we once did in the past for a number of reasons, but bottom line is that that that large and small hospitals, remain remain targets for us.
And then on the sales front, have you looked to redeploy reps away from prostate into gynecology or are you solely thinking about addition at this point. I guess, you know, how do we think about that dynamic?
Yeah. We we don't have prostate specific reps, so there are reps that that will cover both prostate and kinda We do have a secondary force of gynecology to reinforce the gynecologic procedures in certain regions of the country. So at top much a redeployment. We do think that reps are most effective. They have their greatest leverage, when procedures are lower occur where they're helping, surgeons and they're helping hospitals build their programs around a new and emerging procedure.
So a percentage of their time they spend is is probably highlighted on the the emerging procedures versus the more mature ones. Having that we have pull through procedures in urology that are growing parts and nephrectomy. And, even a mature procedure requires some, some attention from the reps. So kind of what the ideal mix of a rep's time is depends a lot on what their local, area looks like in terms of procedure mix.
And then just lastly, Gary, you touched on the FDA. I mean, are you doing anything different from a regulatory standpoint on your end?
In terms of the process we're using and the conversations we're having, there's not a big difference. Nothing that I'd really point out. I think that just of questions and the turnaround times and and the type of engagement has just been extended a little bit. And we've seen that here and as well as other parts industry. I think it's it's something we're we're hearing about as well.
From the line of David Lewis with Morgan Stanley. Please go ahead.
Good afternoon. This is actually Jameson for David. So maybe give us a little bit of color on how you're seeing the economic environment shape up in the EU and OUS generally? Kind of where do some of those geographies stand in the economic versus the U. S.
And then also more broadly, you've mentioned that at least in prostate, EU and other ROW markets are going to be offering greater reasons for growth in the U. S. So how should we think about the ability of those procedures to ramp, especially to the extent the capital spending overseas remains pretty constrained?
It's an excellent question. I think there's actually some connectivity between Part A of your question and Part B and it's really the following in that and we've said this over and over and it just becomes even more apparent every quarter that it's a really a country by country market dynamic that's taking place within the EU and markets and other parts of Asia. You know, an example of that is we know what the macroeconomic headwinds were in pigs countries over the last few quarters, but we sold 5 systems into Spain. Because there is a number of underlying variables that really drive those sales and that is how many what the demand is for the procedures, what is the installed base within that particular country and what are the underlying economic conditions. And if you kind of go through that, a case by case basis or a country by country basis, you're just going to find, different parts of those ingredients that will drive to in any given quarter or not.
So I would say as a general statement, as far as Europe is concerned, it is still become, it still remains less predictable and probably more challenge than we have seen in some years past and how that projects on a go forward basis is really not something we're going to really try to assess in terms of being macro economists here. In terms of the OUS procedure growth, again, you're the same variables unfold on a country by country basis. In some countries, it is absolutely on a very steep part of the curve, while in others, it's an earlier part, less steep. It is not going to be as predictable or a much this is, if you will, of the U. S.
Market and we'll try to color it up as best we can, but it's difficult to try to lump it into one and make a general comment about its growth rates.
Thanks. That's very helpful. Then maybe could you give us any more granularity on the impact of FX in the quarter. Clearly, that was a headwind, but from a financial perspective, any way to break that out?
Sell product in euro and British pounds, where we sell direct in Europe and think of it as the core of Western Europe, we sell direct, we sell through distributors to Spain, Italy, Greece, and rest of world. And, so in customers that we sell direct to as I said earlier, we take out hedges for the majority of our estimated future sales. It's any of every 6 month period and those hedges that we took out for the second half of twenty ten were at a lower rate by about 15% in the earlier part. Now, mind you that, you know, about 10% or around that is the amount of our revenue that is designated in those currencies. We also have, obviously, costs that are, that are incurred in those foreign currencies and then we also have I and A revenue and service revenue that's designated in those currencies and those pretty much offset.
So, we think we're hedging the majority of the exposure and therefore the currencies don't have a lot of impact other than when we lock in the hedges.
Okay. Great, pretty
helpful. Thank you. And our next question comes from the line of Sameer Harish with Needham And Company. Please go ahead.
Hi, guys. Thanks for taking the question. Just to follow-up on the FX question there. Was the FX impact also translating onto procedures as well, or is it mostly on the system side?
Really doesn't have any any, when you say procedures, you mean, instruments and accessories?
Yeah. The the instruments. It
does have some impact on, instruments and accessories because we don't hedge instruments and accessories. But again, when you to the bottom line of our financial statements that's pretty much offset by the costs that are designated in those currencies.
Okay. Got it. I think last quarter you mentioned the pipeline for the SIs was notably lower than you'd seen in the first half of the year and it seems like you didn't have the tail off, this quarter. Can you talk about sort of what you're seeing in the pipeline for SI going forward and what that means in terms of, sales cycle, if if it's changing within the quarters, then then you're what you're seeing at the in the onset.
You you know, honestly, I'm I'm not sure of the commentary that led you to think that we have, we have a slowdown in SI's last quarter. SIs have actually been showing, you know, growth quarter over quarter over quarter and it was again pretty substantive in the most recent quarter. And so, when we, when you look at the pipeline, you look at the deals that we've done or we work on, I think the trends show pretty clearly that are really looking at the SI system as the predominant purchase the predominant system to purchase and I don't see anything that's changed in that, or even on a go forward basis.
Okay. And just last question. In terms of sort of the long term trajectory on R And D, just in terms of both where the dollars are being spent in leverage, you talk about, you know, how you think about, you know, over the next 2, 3 years, do you have specific R and D targets based on, development programs, or are you thinking about in terms of percentage of revenues and seeing what you're able to do. And maybe talk about, you know, the R and D mix, you know, as you go forward, do you expect that to change in terms of investment in systems, instruments and perhaps clinical data going forward?
Just from the point of view of kind of how much money we think we have for R and D, just kind of starting on that on that front. The usually what we do is make sure that that, we're we're matching. We're not our R and D growth is not exceeding that, which we can bring in with regard to revenue growth. So we're we're not looking to deleverage, with regard to R and D. Having said that, once once we say, okay, we know what we can fund, and we believe we're still, in the early phases of of robotics surgeries, and we wanna fund R And D.
Then we look out and we're really asking what going to drive patient value and what's going to drive the adoption of procedures. And in that bucket, there are always a of instruments and accessories that as you look out and think about how to make, new procedures happen on systems, instruments and accessories in. It's a pretty, it's it's a given. But the next step is really, imaging visualization. You know, what what can you provide to the surgeon to have a better understanding of what's happening in the tissue.
So that bucket is usually filled as well. From there, we look at the the next bucket has really been technologies, those things that ease training and ease of use. And so that's kinda how we think about it. And and I think for the next of years, that that's the way it's, it will play out. Thank you.
Thank you. And our next question comes from the line of Roman with Goldman Sachs. Please go ahead.
Volume side. Obviously, this quarter came in somewhat below where the consensus expectation was in terms of growth, but you sort of reiterated your guidance for the full year. Can you maybe just talk about what the conversations, or feedback you're getting from your sales force are like with respect to timing of procedures, deferrals that etcetera that that would support a strong 4th quarter to get to the full year numbers?
Well, you know, again, David, when we look at the guidance in any given quarter or we are in our planning horizon, the taking a look at what we want to drive or pace the budget off of, you know, we'll track and plot the procedure trends pretty closely, both on a tops down and from a bottoms up from a sales manager's perspective that rolls up the individual sales territory and we will sort of triangulate around what we believe are the best mids for that particular period in which we are projecting. And so when we go through that process, again, not getting into the granularity of each individual discussion, but when we go through that process, we have a level of comfort with the 35% that we reiterated. And so, be, again, the difference in some of the I and A expectations versus the procedure expectation and so on and so forth with the 33% growth in the procedures, looking at what we believe, we saw in later August September plus the addition of the sales force expansion of some of those people coming on and the tops down bottoms up build up 35% is the number that we were comfortable with.
I'll just call that up a little bit. You know, I think one easy way to look at it is, as we look our adoption curves. For us, that's an an estimation of what we think the demand is out there for the procedures. And then you look rep productivity and that's what we can do about it. And and so as Alex said, those are the two things that we're trying to match up.
On the one hand, look out and we think the demand for procedures is there. The macroeconomic pressures about whether there's some influence of unemployment or headwinds against that demand and then our product rep productivity is is the bottoms upside. And so we look at those two things and that's we build our estimates, but they're estimates.
Okay. That's that's helpful. And maybe you talked to us on the call, but could you maybe just elaborate a little bit on the 85,000,000 increase in in the inventory balance in in in the quarter and, how we should say is anything specific in there with product launches, etcetera, and how we should how that number should track going forward?
So what we said is that we've we've built inventory a good part of that build has to do with components that earlier in in some semiconductor components, the semiconductor supplies became tight in the industry. And so we actually have built, our inventory to some of those components so we don't run into shortages as we go forward. Those components, by the way, are used in da Vinci systems. And then the harder part is
they're also used in helpfuls. Yeah.
That's right. That's the thing. Our volumes are much smaller than a lot of others. And then the, the second element is that I made comment to is that we do have some inventory associated with new product introductions. And as Gary alluded to, some of the introductions through the FDA are a little slower than, we had anticipated and therefore, we're we're still carrying that inventory.
But that, that, that, there's no signaling in that inventory number that there is a pending product launch on the horizon that, that either your that the FDA have improved and that there's something more significant coming. It's more of the result of a delay in product approvals?
So it's a commercial now. I think just to be clear on one thing, the inventory level has risen to not not at we didn't rise by 85 right now.
No. No. It grew to 80.
Right.
Right. And the the mix largely, safety stock on electronic components in which we're a small player in the global market. And then there's some in there for products that we're building up in patient of FDA approval. And when we get that approval, that will release that that inventory. And that happens, by the way, all the time.
The the bill ahead of an approval and then the approval timing is uncertain. Time for 2 more questions.
Thank you. Next question comes from the line of Rick Wise with Leerink Swan. Please go ahead.
Good afternoon. Gary, Marshall, Alex. A couple of questions. First, can you give us any update on the timing or any perspective on when you'll have full ability to launch in Japan?
So we are we are, approved for the system and what we're really what we're really working on now are, the first one through that's being negotiated it is prostatectomy. There are some others behind it. And right now, they're they're basically in in the customers, hospitals, and the government are are, are in a negotiation of kind of what the boundaries are for approvals. And then the first reimbursements that have gone through have been on a hospital by hospital basis, which is a reasonable way to start. And then over time, we'll see how that how that generalizes.
I think give you a specific time frame in which a broad blanket of reimbursement approval will be ran.
The uncertainties and it's, I appreciate it's unknowable, but I mean, should we think about it that as you say, the blanket approval coming in the next 12 months, in the next three 5 years? I mean, how should we think about it just broadly or directionally?
I don't think you're gonna the broad reimbursements in the next 6 to 12 months. I think that's unlikely.
A lot of way to ways to calculate utilization and a lot of numbers to go into, but just my rough back of the envelope, utilization per instrument line sequentially in my calculation to 3.6 per system versus 3.8 in the second quarter. But whatever the right number are is this all seasonality? Was it the procedure slowdown or how do we think about that?
Yes, I'll take a shot at that, Rick. This is Calvin. Yes, I think this reflects, the seasonality that we see typically every year around the summer months. We have we continue to see increases in utilization when making the year over year comparisons to 3rd quarter last year.
Okay. And two last questions that sort of follow-up some the topics we've discussed earlier, the FDA, the comment on the FDA is slower to approve. I just wanted to make sure I understood, did you expect some approval for some instruments that didn't happen in the third quarter. Was that the message or was it just a more general message. And last, just a little more color if you would be so kind of understand the stocking order issue,
I think, but the carryover from the second quarter. Did that imply that people sort of overbought disposables didn't use them and that was a factor related
to the slowing procedures, just to make sure I understand that point? Thanks.
I'll answer the second one first and then I'll
when someone buys a da Vinci system, they typically buy a bolus of instruments and accessories. And, there were a number of those, I think that, fall over from quarter to quarter in any quarter. And it happened to be a little higher amount in Q3. But it's not as though, they've built up a bunch of inventory in 1 quarter and now they're bleeding that out of the next order. It's just strictly the magnitude of the number of stocking orders to get done in any one quarter.
Okay. And the question?
Yes. On the FDA, we're working with them now on single site. I don't know that I'd say that we had an expectation prior, but the general comment is that we're seeing as a whole, a greater number of questions and kind of a slower turnaround time. And that in that point of view has been shared around the industry. So thank you.
That that was our last question.
Thank you.
While we focus financial metrics during these conference calls, our organizational focus remains on increasing patient value by improving surgical outcomes using surgical trauma. I hope the following da Vinci surgery experience gives you some sense of what this means in the lives of our patients. Me from California rights, I I silently suffered from excessive menstrual bleeding and cramping for years, which seemed only to get worse as each month passed. At one of my quarterly repeat response office because I felt my parents were running my life and I couldn't handle it anymore. I have 2 teenagers and 2 toddlers and couldn't limited to the bathroom for days out of the month.
The nurse practitioner gave me some literature to read about my different options and suggested that I make an appointment with Doctor. Swanson, who has been my doctor for over 13 years, to discuss my concerns. I read all the literature and did much research on my own. I then saw doctor swanson 3 weeks later and describe my issues. He basically said my options were to do nothing, which had been working out well for me, hormone pills, a blade or hysterectomy.
I had been on several different birth control peers pills in the past, and they all made me no nauseated. In informing that I would need a pretty strong dose, so that was not an option for me either. As for an ablation, I read many complaints about women that had had the procedure done and that the cramping was now worse. I already had bad cramps in spotting, so I didn't wanna risk that. Doctor Swanson agreed that it was a possibility that cramping could worsen and suggested that as a perfect candidate for his direct knee.
Not only would it relieve me of my excessive bleeding and cramps, it would also free me from my abnormal apps every 3 months. Doctor Swanson explained the procedure to me and thoroughly answered all my questions. Finally, I felt some was coming. In the weeks prior to my scheduled surgery, I did much research online and actually found many videos of hysterectomy done Davinci Robot on YouTube. I felt very prepared when my surgery day rolled around.
And on August 3 2010, at St. Agnes Medical center in Fresno, Doctor. Swanson and the staff were fantastic. Everyone may be feel relaxed and cared for. This surgery went very well.
I had very little blood loss. I was able to get up and walk around to the bathroom and around the hospital room within hours after the surgery. My pain was minimal, and the and really no more than some discomfort rather than real pain. As David only 1 night in the hospital and was discharged the next morning, we recovery at home was very quick. I was back to my normal self within the same week as my surgery.
No pain, no cramps, no bleeding. My only regret is not speaking to my doctor and having is directly done soon done sooner. Patients like Stephanie are the strongest advocates for dementia surgery and form the very found of our committed to driving the vital few things that truly makes a difference. This concludes today's call. We thank you for your participation and support on this forward in our journey to improve surgery, and we look forward to talking with you again in 3 months.
Ladies and gentlemen, that does conclude our conference for today. Thank you for your participation and for using AT and T Executive Teleconference Service. You may now disconnect.
Does that follow exclude the deferral? Operating highlights for the third quarter were as follows. Proceedors grew 33 33% over the third quarter of 2009. We sold 105 da Vinci surgical systems, up from 86 during third quarter of last year. Total revenue was $344,000,000, up 26% over Q3 2009.
Instrument and accessory revenue was 128,000,000, up 27% over the last year. Total rev total recurring revenue to $185,000,000, up 28% from prior year and comprising 54% of total revenue. Net income was $87,000,000, up 43 percent over last year. We generated an operating profit of $163,000,000 before non cash stock option expense, up 22% from the third quarter of last year. We ended the quarter with 1,621,000,000 in cash and investments, up 33,000,000 from last quarter and up $597,000,000 from 3rd quarter 20 quarter included $50,000,000 invested in intellectual property related technologies and fixed assets and $59,000,000 in stock purchases.
Excluding the impact of these outlays, as well as $17,000,000 from stock proceeds and $2,000,000 returned from working capital, we turn 1,000,000 in the third quarter. We have been making substantive investments in support of emerging and high growth procedures as an important catalyst for achieving procedure adoption. However, reaching the year are just coming online in the field now. We will continue to measure the productivity of these investments and we will adjust our expanding is needed. This quarter, we added an additional ninety two people to our team, predominantly in sales, manufacturing, and R and D, bringing our total team to 1 1568 employees.
And product development and research, our teams are driving advancements in our focus areas. Our development teams are progressing and developing robotics stapling and energy instruments, as well as various specialty specific instruments. Are improving and expanding our imaging capability through investments in Image Acquisition Technologies And Fore Essence Imaging, are developing patient side technologies that allow for single port robotic surgery. And finally, we are making substantial progress in bringing to Mark surgical simulation and networking. Lastly, we have seen a shift in the approach to new product approvals by the FDA.
These change appear to be extending and the quality of our new products going through the approval process and are focusing our regulatory teams on clean execution to meet the needs of FDA We will announce the availability of new products that they are ready to ship. In summary, developing and expanding procedures with strong value and outstanding organizational execution remain our focus with particular emphasis and execution in clinical sales force and in our product development and regulatory teams. I'll now pass the time over to Marshall, our Chief Financial Officer.
Thank you, Gary. Prior to providing you with the details of our 3rd quarter results, I would like to provide you with a quick review of the deferral county VIXI systems to da Vinci systems at a discount to the otherwise list price for such an upgrade. We also offered those customers the opportunity to return Da Vinci S accessory in exchange for Da Vinci S I accessory. As a result, we deferred a total of $20,000,000 of revenue in the first quarter of 2019 comprised of 18,000,000 of system revenue associated with system upgrade offers and 2,000,000 of industry revenue. We recognized 14,000,000 quarter of 2009.
I will now walk you through our not occurred. Our third quarter 2010 revenue was $344,000,000, up 26% compared with 74,000,000 for the third quarter of 2009 and down 2% compared with 351,000,000 for the second quarter of 2010. Quarter revenues by product category were as follows. 3rd quarter instrument and accessory revenue was $128,000,000, up 27% compared was 100,000,000 quarter of 2010. The to the second procedure growth as we would expect.
Instrument and accessory revenue realized for procedure, including initial stocking orders, was approximately $1840 procedure, which is lower than the third quarter of 2019 by approximately $80 and approximately $30 lower than the in quarter of 2010. The changes in instrument and accessory revenue per procedure primarily reflect changes in the impact stocky orders. We expect instruments and accessories per procedure to decline slowly over time given that initial stocking orders have a lower impact on a larger installed base. 3rd quarter 2010 systems revenue of 160,000,000 increased 23 dollars compared with $130,000,000 of systems revenue for the third quarter of 2019 and decreased 5% compared with 160 $1,000,000 of systems revenue for the 2nd quarter. We sold 105 systems in the third quarter of 2010 compared with 6 systems last year and 108 systems last quarter.
Our 3rd quarter average sales price per system in including all da Vinci models, but excluding upgrades and the deferral revenue was $1,430,000, an increase from the one point $39,000,000 realized in the third quarter of 2009 and a decrease from the $1,480,000 realized in the 2nd quarter. The increase compared to prior year reflects an increase The decrease in average sales price per system compared with the prior quarter is primarily the result of the mix of customers and the reduction in the value of our euro to dollar hedging position. As we indicated last quarter, the mix of systems and customers and therefore ASP ease in the First And Second quarters of this year had been more favorable than we normally expect. We lock in hedges for most of our four after direct European system sales every 6 months. The rates locked in for July to December are lower than the rates recognized in the 1st 6 months of 20 by approximately 15%.
3rd quarter systems revenue also included 10,000,000 of upgrade revenue compared to
10,000,000
to 57,000,000, up 31% compared with 44,000,000 last year and up 3% compared with 55,000,000 last quarter. The growth in the quarter recurring revenue comprised of instrument, accessory, and service revenue increased to 185,000,000 3rd quarter of 2000 represented 54% of total 3rd quarter revenue compared with 53% in the 3rd quarter last year and 52% last quarter Revenue by geography was as follows. Non U. S. Revenue represented 17% of our total revenue in the quarter compared with 19% of total revenue in the third quarter of 2019 18% of total revenue in the second quarter of 20 10.
The decline in the proportion of non US revenue relative to total revenue reflects growth in the US business. Non S. Procedures grew faster at a faster pace than US procedures on a year to time. We sold 22 systems outside the U. S.
Compared with 14 in third quarter of 2009 22 last quarter. 4 of the systems Japanese customers. We sold 16 systems in Europe this quarter or 2 more than the past quarter and 8 more than the last year. However, the capital sales market in Europe continues to be challenging, reflecting the macroeconomic environment. Moving on to the remainder of the P and L, let me remind you that there were no loss deferred in conjunction with the first quarter 2019 revenue deferral, and therefore, the $20,000,000 deferral and subsequent reversals an equal impact on revenue, gross profit, and operating income.
Gross margin in the third quarter was 73% compared with 3rd quarter 1009 gross margin, excluding the impact of the deferral of 70% and compared with 2nd quarter 2010 gross margin of 73%. The increase in gross margin compared to the prior year reflects increased system ASPs, material cost reductions and absorption of fixed costs over a larger revenue base compared to the prior quarter, lower manufacturing costs were offset by lower system ASPs. 3rd quarter 2 2010 operating expenses of $119,000,000 were up 25% compared with the third quarter of 2009 and up 1% with the second quarter. The quarter over quarter increase reflects costs associated with employees added during the quarter, partially offset by a decrease in r R and D spending. The decrease in R and D spending reflects lower prototype costs due to the lumpy nature of prototype prototype purchasing, which will likely be incurred in the 4th quarter.
We added 92 employees in the quarter, including 70 7 employees in the sales and service organization as we continue to expand our clinical sales force and 10 employees in operation. 3rd quarter 20 operating income was $132,000,000 or 38 percent of sales compared with 98,000,000 or 36 percent of sales for the third quarter of 1009, excluding the impact of the deferral, and 140,000,000 or 40 percent of sales for the second quarter of 2010. 3rd quarter 2010 operating income reflected $30,000,000 of non cash stock compensation expense compared with $25,000,000 for the third quarter 20 9,030,000,000 last quarter. The growth in non cash compensation reflects our annual grant made February 15th each year and the in the number of employees. Our effective tax rate for the third quarter of 37 percent was lower than our 2009 rate of 41%, reflecting the implementation of our international tax structure.
Our 3rd quarter rate was lower than the second than the rate for the second of 39%. Our net income was 87,000,000 or $2.14 per share compared with 61,000,000 or $1.55 per share for the third quarter of 2009, excluding the impact of and $89,000,000 or $2.19 per share for the second quarter of 2010. Let me quickly summarize our results for the 1st 9 months of 2010. The first quarter of 2009 deferral did not have an impact on the 9 months of 2009 information. Procedures grew by 35% for the 1st 9 months of 2010.
Total revenue for the 1st 9 months of 2010 up 40% compared with $729,000,000 last year. This included recurring revenue growth of 35 in systems revenue of 47%. Operating income for the 1st 9 months of 61% compared with 249,000,000 last year. Operating income included 88,000,000 of stock based compensation charges in the first months of 2010 compared with 72,000,000 in 2009. Net income for the 1st 9 months of 2010 was 261,000,000 or 6 dollars 45¢ per share compared with 155,000,000 or $3.97 per share last year.
Moving to the balance sheet, we ended
32,010.
17,000,000 from the exercise of stock option, partially offset by 59,000,000 of stock buybacks and 50,000,000 of capital and IP purchases In July, our board authorized 150,000,000 to buyback shares. Considering the previous authorization and buyback activity, we currently have 241,000,000 authorized to buy back shares. Our accounts receivable balance increased to 208 at September 30th from 195,000,000 at June 30th, reflecting the timing of revenue. Our net inventory increased $85,000,000 at September 30th from $74,000,000 at June 30th. The increase reflects safety stock to ensure adequate supply of certain components associated with yet to be released products.
And with that, I'd like to turn it over to Alex who will go over our sales, marketing, and clinical highlights.
Thank you, Marshall. During third quarter, we sold 105 Da Vinci systems, 83 in the United States, 16 in Europe, and 6 in the rest of the world markets. As part of the and 5 system sales, 15 standard da Vinci systems were traded in for credit against sales for new da Vinci system additions to the installed base during the quarter, which brings to 1661 the cumulative number of da Vinci systems worldwide. We 1228 in the U. S, 292 in Europe and 141 in rest of world markets.
45 of the 105 systems installed represented repeat system sales to existing customers. Also during the quarter, 10 customers purchased upgrades to convert their da Vinci S systems into da Vinci S I systems. Internationally, we sold 5 da Vinci systems in Spain, 4 into the countries of Germany and Japan and 3 into France. We had a solid malignant conditions showed very good sequential percentage growth. Additional categories of growth included ENT, colorectal, and thoracic surgery.
As one would expect with EVP flattening in the efforts. On a year over year comparison, overall third quarter procedures grew by approximately 30 3%. Also during the quarter, over 250 Da Vinci related clinical publications and abstracts representing multiple driver of and lap supraservical hysterectomies or LSH are beginning to emerge. For background in LSH is a less complete resection than a total hysterectomy, but an appropriate option for some pay In LSH, the cervix is left in place and only the uterus is extracted. In some ways it can be thought of as a par hysterectomy.
A recent study comparing the 3 techniques was published in the journal of robotic surgery. The study was entitled comparison of minimally invasive surgical approaches for hysterectomy at a community hospital and eliminated out of the Department of Obstetrics And Gynecology as Spartenberg Regional Medical Center in Spartanburg, South Carolina. The study included patient cohorts comprised of the first two 37 patients undergoing a DVH, the last 265 patients undergoing in LADH and 87 patients undergoing in LSH. Among the number of of 35%. Despite added case complexity, operative time was significantly lower in DVH than L ADH, 90 minutes compared to 125 minutes and similar to that of LSH.
Blood loss was also less in the CVH patients as compared to LAVH, 59 milliliters compared to 168 milliliters. Similar to LSH. And hospitalization was shorter for DVH than LAVH and LSH 1.0 day compared to 1.2 days for the others. In their summary, the author stated the following, and I Our analysis of the learning curve suggest that operative time for robotic assisted laparoscopic directly may continue to improve beyond the initial patient series despite the increased complexity of cases undergoing this procedure. There is of this study lends support to the small but growing body of literature describing the benefits of robotic assisted laparoscopic hysterectomy over conventional laparoscopic assisted vaginal hysterectomy.
With EVP growth in the United States flattening, we look Europe and other OUS markets as fertile growth opportunities. In addition, clinical data comparing long term outcomes in patients going prostatectomy versus alternative treatments for organ confined disease is demonstrating the advantages prostatectomy in long term survival. In a recent publication of the Journal Cancer, surgeons and researchers from the University of in San Francisco and Memorial Sloan Kettering, working from the nation's largest prostate cancer registry, CAPTURE, compared to cancer specific mortality outcomes among men who underwent radical prostatectomy, men who received external beam radiation therapy and men who received primary androgen deprivation therapy. In the current study, 7538 with localized disease were analyzed. Prostate cancer risk was assessed using 2 well validated instruments that were calculated from clinical data the and age.
The results in total, 266 adjusting for risk and age to hazard ratio for cancer specific mortality relative to prostatectomy was 2.21 for radiation therapy and 3.22 for androgen deprivation. Another way, the analyst reports, the the analysis reports that the risk of a man dying from prostate cancer after primary radiation therapy was more than twice as great when compared to radical prostatectomy and mortality affirmation therapy was reported to be 3 times as great. The authors concluded their report by stating, and I quote, prostatectomy for localized, 8 cancer was associated with a significant and substantial reduction in mortality relative to radiation therapy and androgen deprivation monotherapy. Although this is measured confounding would account for the large observed differences in survival. The successful adoption of customer base with their initial da Vinci training experience.
When you consider the scale associated with training surgeon across multiple surgical specialties on a global basis, you will quickly see that it's a significant endeavor. It has been our belief in time, initial da Vinci procedure experience will find its way into the formal processes of academic medicine through residency in fellowship programs. As several da Vinci procedures have gone mainstream, we have begun to see this transition take place. Researchers from the University of BAMA Birmingham set out to define as developing trend within the GYN Oncology fellowship programs around the country. UAB conducted a survey of GYN Oncology fellows and fellowship directors and summarize their findings in last month's edition of the International of medical robotics and computer assisted surgery.
Products in the 41 approved U. S. Programs. Approximately half of the fellowship directors responded to the survey with the following have 2 or more gynecologic oncology faculty members who perform robotic surgery. 78% of responding institutions do more than 5 robotic procedures per month and 22% reported that they perform more than 12 procedures per month.
All responding institutions have utilized the robotic system in the management of endometrial cancer and all respondents reported using the system for lymph node dissections. 89% reported utilization in tree in of the fellows responding Davinci System Council. Although it's the first time we've seen an analysis of this form published in the peer review journal, we are aware of parallel activity taking place within the American Urology Association and the Association of Advanced Gynecological laparoscopy, as well as in various international medical 90s. The introduction of da Vinci Surgery into residency and fellowship training speaks well to our product adoption thus far, but more importantly, it speaks volumes as to what we can expect with future robotics and I'll now turn the time over to Kelk.
Thank you, Alex. I will be providing an update to our financial forecast for 2010, including procedure revenues and the other elements of the income statement on a GAAP basis. I will also provide estimates on significant non cash expenses for provide you with visibility of our expected future cash flows. Starting with procedures, we continue to project our 20 10 procedures to grow approximately 35% for the year from the base of approximately 205,000 procedures performed in 2009. Moving on to revenues.
Based on our results through 3 quarters and our view into our 4th that range forecast last quarter. Regarding the instrument and accessory portion of revenue, we would expect full year revenue growth in this category to in slightly below the 35 percent forecasted procedure growth due to the diminishing impact of stocking and accessory placements and instrument and accessory stocking orders may vary. With regard to gross margin, we reported a 73.2 percent in Q3, primarily reflecting the impact of lower Q3 system ASPs. Going forward, we expect our Q4 margins to 73% range projected on our last call. Moving to operating expense, we have made and will continue to make significant investments across multiple areas of our business, particularly in our clinical sales force.
We added 92 employees during the third quarter 305 so far this year compared to a 139 added through 3 quarters last year. While we to invest in our business the timing of some of our expenses can be lumpy. We now expect our total gas operating expense to grew by 27 to 29% in 2010 compared with our previous forecast of 29 to 31% growth. In terms of non cash expenses, we continue to expect to record stock compensation charges of approximately $120,000,000 in 2010. Guidance for intellectual property amortization is now 17,000,000 compared to 15,000,000 last quarter.
Increase reflects additional amortization related price of interest income is expected to come in around 18,500,000 for the year. Just above the 18,000,000 forecast dollars. Record income taxes at approximately that 37.2 percent rate for the rest of 2010. For calculating earnings per share, we ended the 3rd quarter with 39,300,000 common shares outstanding and approximately 4 point 9,000,000 option shares outstanding. Depending on our average stock price in Q4, a portion of the 4,900,000 option shares be added to the fully diluted shares calculation.
At present, we estimated that our diluted share count for calculating EPS in Q4 will be approximately 40.3000000 shares. Our estimate for the full year is 40,400,000 shares. Finally, regarding our cash flows, since we are forecasting to report over 135,000,000 in non cash stock compensation and amortization expenses for the year, cash flows will continue to be significantly higher than our reported net income. Or measure of our actual performance than net income. And with that, we would like to open the call to your questions.
You.
And our first question comes from the line of Ben Andrew with William Blair. Please go ahead.
Maybe talk a little bit Gary about same store procedure growth and maybe if you can't isolate the effects of the unemployment situation from your efforts to penetrate new and give us a sense of kind of the headway you're making with the additions to the Salesforce?
Sure. As you know, we we track and and plot our procedure trends pretty closely. What we saw in the beginning of the summer was an unusual pressure on, on existing procedure And then we've seen a little bit of return to strength, at the end of the summer, the beginning of September, on the force side. So we think there's some environmental pressure out there. It's hard to quantify exactly the number.
On the the in the field at the end of Q3. And so our expectation is they'll become productive as we go into Q4. And that's something we're measuring pretty carefully and making sure we understand what the optimal loading looks like. There's a little bit of titration there. We'll have to watch as it grows, but that's kind of our thinking on it now.
Is your is your thought Gary to keep adding aggressively to the sales force for 2, 3 more quarters to again try to get maximal penetration on the new procedures as well as keep driving the existing ones so that maybe we could see op margins stay under a bit of pressure here before it returns closer to the 40% level?
We will for the next couple of quarters, we'll be continuing to invest in the sales force as we watch the activity of the first set go in. We think that the demand out there for da Vinci procedures is real and present and that, the investment in the sales force will help bring those into, into our into our house our hospitals, our customers.
Okay. Great. Thank you.
Thank you. And our next question comes from the line of Michael Peterson with JP Morgan. Please go ahead.
Hey, thanks for taking the question. Maybe just to the first question Ben had on kind of the underlying economic factors. And taking it a step further, you talked about benign and malignant, you know, flip flopping this quarter with benign picking up a little bit. Can you just about how sustainable you think that trend is, or is it just, you know, I mean, how much of that was driven by new reps being added, versus kind of, you know, a slight taken kind of a patient volumes or something else?
Well, if you look at, again, the overall hysterectomy target us. We break it up as you know and then malignant and into the benign. But what we have found to be the case, not just in GYN in other procedures is the greater patient value seems to take place in the more complex procedures. And within the benign category, recognize that there is an underlying condition or several underlying conditions that range from, let's say, not very complex to very complex. The way we've been tracking, the history to me growth.
It leads us to believe that we're making good penetration into the complex and probably pick of some of the less complex along the way. But when we look at where we are in our growth trajectories and what the opportunity We are in a pretty steep part of our growth curve. So, is it sustainable in our view? Absolutely, in in the procedures that we're targeting. And I don't think there was anything from a, let's say, a favorable tailwind through Q3 between seasonality and high unemployment rates that gave us any stimulus we returned to sort of the the malignant growth last quarter as well as this quarter.
So this isn't the first time we've restored that.
And just to color that up a little bit. Willingness to distract me is further up on the adoption curve. And so we'd expect that, M benign is lower. We'd expect that the growth rate of of 9 should be higher than the growth rate of Milligan given where they are relative to to what we think the total market is.
Okay. That that's And then I
think you talked about 45 year placements for repeat customers. Any color you can give us on just kind of hospital size in terms of placement mix between larger, medium, and smaller hospitals? You know, there really isn't, anything that is remarkable or different that to mind in this particular quarter. I think you'll find that all sizes and shapes of hospitals remain our customers this quarter was really nothing different. So, we don't really track that as we once did in the past for a of reasons, but the bottom line is that that that large and small hospitals remain remain targets for us.
Okay. And then on the sales front, have you looked to redeploy reps away from prostate into gynecology or are you solely thinking about addition at this point. I guess, you know, how do we think about that dynamic?
Yeah. We we don't have prostate specific reps, so there are reps that that will cover both prostate and and oncology, we do have a secondary force of gynecology to reinforce the gynecologic procedures in certain regions of the country. So it's up much, redeployment. We do think that reps are most effective. They have their greatest leverage, when procedures are part of the curve where they're helping, surgeons and they're helping hospitals build their programs around a new and emerging procedure.
So that the percentage of their time, they end is is probably highlighted on the the emerging procedures versus the more mature ones. Having said that, we pull through procedures in urology that are growing, partial nephrectomy, and, even a mature procedure requires some, some attention from the reps. So kind of what the ideal mix a rep's time is depends a lot on what their local, area looks like in terms of procedure mix.
And then just lastly, Gary, you touched on the FDA. I mean, are you doing anything different from a regulatory standpoint on your end?
Terms of the process we're using and the conversations we're having, there's not a big difference. Nothing that I'd really point out. I think that just the consecutive questions and the turnaround times and the type of engagement has just been extended a little bit. And we've seen that here and as well as other parts of the industry. I think it's, it's something we're we're hearing about as well.
And our next question comes from the line of David Lewis with Morgan Stanley.
This is actually James in for David.
So maybe you could give us
a little bit of color on how you're seeing the economic environment shape up in the EU and OUS generally, kind of where do some of those geographies stand in the economic cycle versus the US? And then also more broadly, you've mentioned that at least in prostate, EU and other ROW markets are going to be offering greater opportunities for growth in the U. S. So how should think about the ability of those procedures to ramp, especially to the extent that capital spending overseas remains pretty constrained?
It's an excellent question. I think there's actually some connectivity between Part A of your question and Part B and it's really the following in that and we've said this over and over and it just becomes even more apparent every quarter that it's really a country by country market dynamic that's taking place within the EU and other markets in other parts of Asia. You know, an example of that is we know what the macroeconomic headwinds were in the pigs countries over the last few orders, but we sold 5 systems into Spain. Because there's a number of underlying variables that really drive those conditions. And if you kind of go through that on a case by case basis or a country by country basis, just going to find different parts of those ingredients that will drive to success in any given quarter or not.
So, I would say as a general statement, as far as Europe is concerned, it it still remains less predictable and probably more challenging than we have seen in some years past, and how that projects on a go forward basis is really not something we're going to really try to assess in terms of being macro economists here. In terms of the OUS procedure growth, again, you are seeing the same variables unfold on a by country basis. In some countries, it is absolutely on a very steep part of the curve. While in others, it's on an earlier part, less steep. It is not going to be as predictable or, homogeneous, if you will, of the U.
S. Market and, and we'll try to color it up as best we can, but it's difficult to try to lump it into one bucket and make a a general comment about its growth rates.
Thanks. That's very helpful. Then maybe could you give us any more granularity on the impact of FX in the quarter? Clearly, that was a headwind, but from a financial of any way to break that out?
So, we sell product in Euro and British pounds. We we sell direct in Europe and think of it as the core of Western Europe, we sell direct, we sell through distributors to Italy, Greece and rest of world. And so in those customers that we sell direct to, as I say, earlier, we take out hedges for the majority of our estimated future sales at the beginning of every 6 month period and those edges that we took out for the second half of twenty ten were at a lower rate by about 15% than the earlier part. Remind you that about 10% or around that is the amount of our revenue that is designated in those currencies. We also have obviously costs that are, that are incurred in, in those foreign currencies and then we also have and A revenue and service revenue that's designated in those currencies and those pretty much offset.
So we we're hedging the majority of the exposure. And therefore, the currencies don't have a lot of impact other than when we lock in the hedges.
Okay. Great. Very helpful.
Thank you. And our next question comes from the line of Sameer Harish with Needham And Company. Please go ahead.
Guys. Thanks for taking the question. Just to follow-up on the FX question there. Was the FX impact also translating onto procedures as well, or was it mostly on the system side?
Really doesn't have any any, when you say procedures, you mean, the instruments and rate.
Yeah. The the instruments.
Does have some impact on, instruments and accessories because we don't hedge instruments and accessories. But again, when you to the bottom line of our financial statements that's pretty much offset by the costs that are designated in those currencies.
Okay. Got it. And, last quarter, you mentioned the pipeline for the, the SIs was notably lower than you'd seen in the first half of the year. And it seems like you didn't have the tail off, this quarter, Can you talk about sort of what you're seeing in the pipeline for SI going forward and what that means in terms of, sales cycle if it's changing within the quarters than than your what you're seeing at the in the onset?
You you know, honestly, I'm I'm not sure of commentary that led you to think that we have, we have a slowdown in SIs last quarter. SIs have actually been showing a growth over quarter over quarter and it was again pretty substantive in the, in the most recent quarter. And so, when you look at the pipeline and you look at the deals that we've on or we work on, I think the trends show pretty clearly that customers are really looking at the SI system as the predominant purchase, the predominant system to purchase and I don't see anything that's changed in that or or even on a go forward basis.
Okay. And just last question, in terms of sort of the long term trajectory on R and D, just, you know, in terms of, you know, both where the dollars are being spent in leverage. Can you talk about, you know, how you think about, you know, over the next 2, 3 years? Do you have R and D targets based on, development programs or are you thinking about it in terms of percentage of revenues and seeing what you're able to do? Maybe talk about the R and D mix, as you go forward, do you expect that to change in terms of investment in systems, instruments, and perhaps clinical data going forward?
Yes, just from the point of view of kind of how much money we think we have for R and D, just kind of starting on on that front. Usually what we do is make sure that that, we're we're matching. We're not our R and D growth is not exceeding that, which we can bring with regard to our revenue growth. So we're we're not looking to deleverage, with regard to R and D. Having said that, once once we say, okay, we know we can fund.
And we believe we're still, in the early phases of robotics surgeries, and we wanna fund R and D. Then we look out and we're really asking what's going to drive patient value and what's going to drive the adoption of procedures and and and bucket, there are always a set of instruments and accessories that as you look out and think about how to make, new procedures happen on systems, instruments and accessories come in. It's a pretty, it's it's a given. The next step is really, imaging visualization. You know, what what can you provide the surgeon to have a better understanding of what's happening in the tissue.
So that bucket is usually filled as well. From there, we look at the the patient side robotics, what can we be doing in the robotics space that makes for a better customer experience? And then of late, the next bucket has really been technologies, those things that ease training and ease of use. And so that's kinda how we think about it. And and I think for the next, of years that that's the way it's, it will play out.
Thank you.
Thank you. And our next question comes from the line of Roman with Goldman Sachs. Please go ahead.
Good evening, everyone. Thank you for taking my question. Just wanted to start on the procedure volume side. Obviously, this quarter came in or below where the consensus expectation was in terms of growth, but you sort of reiterated your guidance for the full year. Can you just talk about what the conversations or feedback you're getting from your sales force are like with respect to timing of procedures, deferrals that say etcetera that would support a strong 4th quarter to get to the full year numbers?
Well, David, when we look at the, the guidance in any given quarter where we are in our planning horizon taking a look at what we want to drive or base the budget off of, you know, we'll track and plot the procedure trends pretty closely, both on a tops down and from a bottoms up from a sales manager's perspective that rolls up the individual sales territory base and we will sort of triangulate around what we believe are the best estimates for that particular area in which we are projecting. And so when we go through that process, again, not getting into the granularity of each individual discussion but when we go through that process, we have a level of comfort with the 35% that we reiterated. And so the, again, the difference in some of the I and A expectations versus the procedure expectation and so on and so forth with the 33% growth in the procedures looking at what we believe, we saw in later August September plus the addition of the sales force expansion of some of those people coming on and the tops down and bottoms up build up 35% is the number that we were comfortable with.
And I'll just call that up a little bit. You know, I think one easy way to look at it is, as we look out at our occurs. For us, that's an estimation of what we think the demand is out there for the procedures. And then you look at productivity, and that's and that's what we can do about it. And and so as Alex said, those are the two things that we're trying to match up.
On the one hand, so we look out and we think the demand for procedures is there. The macroeconomic pressures about whether there's some influence of unemployment or headwinds against that demand and then our rep productivity is is the bottoms upside. And so we look at those 2 things and that and that's how we build our estimates, but they're estimates.
Okay. That's that's And maybe you talked to us on the call, but could you maybe just elaborate a little bit on the $85,000,000 increase in in the inventory balance in in in the quarter and, how we should is anything specific in there with the pending product launches, etcetera, and how we should how that number should track going forward?
So we is that we've built inventory a good part of that build has to do with components that earlier in the year reached to experience some shortages specifically in some semiconductor components as semiconductor supplies became tight in the industry. And so we we actually have by the way, are used in da Vinci systems.
Okay.
And then the harder part
is they're also used in cell
phones. Yeah.
That's right. Volumes are much smaller than a lot of us. And then the, the second element is, that I made comment to was, is that we do have some, some inventory associated with new product introductions. And as Gary alluded to, you know, some of the introductions through the FDA are a little slower than we had anticipated, and therefore, we're we're still hearing that inventory.
Okay. But that that that that there's no signaling signaling in in that Tory number that there is a pending product launch on the horizon that either your conversations with the FDA have improved and that there's something more significant coming. It's more the result of lay in product approvals?
So to to Marshall's point, now I think just to be clear on one thing, the inventory level has risen to not not at we didn't write by 85, right now?
No. No. It grew to
80. Right.
Right.
And the the mix is largely, safety stock on product components in which we're a small player in the global market. And then there's some in there for products that we're building up in anticipation of FDA approval. And when we get that approval, will release that that inventory. And that happens, by the way, all the time. In the the bill a little bit ahead of an approval and then timing is uncertain.
Time for 2 more questions.
Thank you. Our next question from the line of Rick Wise with Leerink Swan. Please go ahead.
Questions. First, can you give us any update on the timing or any perspective on when you'll have full ability to, launch in Japan?
So we are we are, approved for the system and Right. Really what really working on now are, reimbursements. It looks like reimbursements are going to be procedure by procedure. The first one through that's that's negotiated as prostatectomy. There are some others behind it.
And right now, they're they're basically in in the customers, hospitals, and the government are are, are in a negotiation of kind of what the boundaries are
for approvals.
And the the first reimbursements that have gone through have been on a hospital by hospital basis, which is a reasonable way to start. And then over time, we'll see how that how that generalizes. I I can give you a specific time frame at which a broad blanket of reimbursement approval will be ran.
The uncertainties and it's, I appreciate it's unknowable, but I mean, should we think about it that, as you said, the blanket approval coming in the next 12 months in the next 3 to 5 years? I mean, how should we think about it just for layered directionally?
I don't think you're going to see a broad reimbursements, in the next 6 to 12 months. I think that's unlikely.
I appreciate that there's a
lot of ways to calculate utilization and a lot of numbers to go into, but just rough back of the envelope utilization per instrument declined sequentially in my calculation to 3.6 per system versus 3 late in the second quarter. But whatever the right numbers are, is this all seasonality? Was it the procedure slowdown or how we think about that?
Yes, I'll take a shot at that, Rick. This is Calvin. Yes, I think this really reflects the seasonality that we see typically every year around the summer months, we have we continue to see increases in utilization when making the over year comparisons to third quarter last year.
Okay. And two last questions, there are sort of follow ups that some of the topics you've discussed earlier, the FDA, the comment on the FDA is slower to approve. I just wanted to make sure I understood, did you expect some approval for some instruments that didn't happen in the third quarter? I mean, was that the message or was it just a more general message. And last, just a little more color if you would be so kind.
I understand the stocking order issue,
I think, but the carryover from the second quarter, did that imply that people sort of overbought disposables didn't use them? And that was a factor related to
the slowing procedures, just to make sure I understand that point.
Thanks.
When someone buys a da Vinci system, they typically buy a bolus of instruments and accessories. And, there were a number of those, I think that, fall over from quarter to quarter in any quarter. And it happened to be a little higher amount in Q3. But it's not as though, they've built up a bunch of inventory in 1 quarter and now they're bleeding that out into next quarter. Strictly the the magnitude of the number of stocking orders to get done in any one quarter.
K. And the FDA
Yes, on the FDA, we're working with them now on single site. I don't know that I'd say that we had an expectation prior, but the general comment is that we're seeing as a whole, a greater number of questions and kind of a slower turnaround time. And that, in that point of view has been shared around the industry. So thank you. That was our last question.
Thank you.
While we focus on financial metrics during these conference calls, our organizational focus remains on increasing patient value by improving surgical outcomes and reducing surgical trauma. Vinci surgery experience gives you some sense of what this means in the lives of our patients. Stephanie from California writes, I silent I silently suffer from excessive menstrual bleeding and cramping for years, which seemed only to get worse as each month passed. At one of my quarterly repeat apps, I finally decided to speak up to the nurse practitioner in Doctor. Swanson's office because I felt my periods were running my life and I couldn't handle it anymore.
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I was back to my normal self within the same week as my surgery. No pain, no cramps, no bleeding, minor Gret is not speaking to my doctor and having the dementia hysterectomy done soon done sooner. Patients like Stephanie are the strongest advocates for and formed the very foundation of our operating performance. We have built our company to take surgery beyond the limits of the human hand, and I assure you that we remain committed to driving the bottle few things that truly makes 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 with you again in
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