Ladies and gentlemen, thank you for standing by. Welcome to the Intuitive Surgical second quarter 2017 earnings release call. At this time, all lines are in a listen-only mode. Later, there'll be an opportunity for your questions. Instructions will be given at that time. If you should require assistance during the call, please press star, then zero. As a reminder, this conference is being recorded. I'll now turn the conference over to Senior Director, Finance Investor Relations, Calvin Darling. Please go ahead, sir.
Thank you. Good afternoon. Welcome to Intuitive Surgical's second quarter earnings conference call. With me today, we have Gary Guthart, our President and CEO, Marshall Mohr, our Chief Financial Officer, Patrick Clingan, Vice President of Finance and Sales Operations. Before we begin, I would like to inform you that comments mentioned on today's call may be deemed to contain forward-looking statements. Actual results may differ materially from those expressed or implied as a result of certain risks and uncertainties. These risks and uncertainties are described in detail in the company's Securities and Exchange Commission filings, including our most recent Form 10-K filed on February 6th, 2017, and 10-Q filed on April 19th, 2017. These filings can be found through our website or at the SEC's EDGAR database. Prospective investors are cautioned not to place undue reliance on such forward-looking statements.
Please note that this conference call will be available for audio replay on our website at intuitivesurgical.com on the audio archive section under our investor relations page. In addition, today's press release and supplementary financial data tables have been posted to our website. Today's format will consist of providing you with highlights of our second quarter results as described in our press release announced earlier today, followed by a question-and-answer session. Gary will present the quarter's business and operational highlights. Marshall will provide a review of our second quarter financial results. Patrick will discuss procedure and clinical highlights. I will provide our updated financial outlook for 2017. Finally, we will host a question-and-answer session. With that, I will turn it over to Gary.
Good afternoon. Thank you for joining us on the call today. As you know, Intuitive is focused on significantly improving surgery and enabling access to our products and services in pursuit of this mission globally. The momentum built over the past several quarters continued into the second quarter of 2017 with solid performance and procedures and strong growth in system placements. Growth in procedures for the quarter was 16% over the second quarter of 2016. Overall trends in the first quarter remained stable into the second. Starting with the United States, both the emerging category of general surgery and more mature categories in urology and gynecology performed well. Hernia repair continues to stand out in the general surgery category, with additional contributions coming from colon procedures.
As we mentioned last quarter, European performance in Q1 of 2017 benefited from calendar tailwinds that we expected to balance out in the second quarter. Indeed, this occurred, with core growth staying roughly steady through the first half of 2017 and European second quarter growth moderating. Procedure performance in Asia was solid, with growth in China being a highlight from a constrained install base. Patrick will take you through these factors in more detail later in the call. Our capital placement performance in Q2 of 2017 strengthened, with a growth in total placements from 130 in Q2 of 2016 to 166 this quarter. As we mention on these calls, capital placements can be lumpy, as evidenced by our performance in the first half of the year. In the United States, placements rebounded from a softer Q1 to a strong Q2, anchored in repeat purchases by existing customers and multi-system placements.
System placements in Europe grew moderately, aided in part by the launch of da Vinci X. In Asia, the placements grew slightly over the prior year period and over last quarter, constrained for the time being by the lack of a new system quota in China and limited reimbursements in Japan. Marshall and Patrick will take you through system placement dynamics in greater detail. Turning to profitability for the quarter, strong system placements led to gross margins that are lower than last quarter. These margins are at the top of our expected range because of the strength in procedures and improvements in our operating efficiencies. Our fixed cost growth met our expectations, with increases in R&D expenses, growth in staff in European and Asian markets, investments in clinical trials, and growth in our corporate computational capabilities. Our second quarter pro forma operating results are as follows.
Procedures grew approximately 16% over the second quarter of last year. We shipped 166 da Vinci surgical systems, up from 130 in the second quarter of 2016. Revenue for the quarter was $756 million, up 13% from the prior year. Instrument and accessory revenue increased to $398 million, up 17%. Total recurring revenue in the quarter was $540 million, representing 71% of total revenue. Pro forma gross profit margin was 71.3% compared to 71.9% in the second quarter last year. We generated a pro forma operating profit of $313 million in the quarter, up 5% from the second quarter of last year, and pro forma net income was $228 million, up 4% from Q2 of 2016. Marshall will take you through our finances in greater detail shortly.
Turning to our product pipeline, as you know, in the back half of 2016 and the first half of 2017, we increased our midterm and long-term investments in creating our next generation of products and services. We're anchored on our belief that substantial opportunity exists to enable more minimally invasive surgery, better outcomes, and to expand access to our technologies globally. Starting with our multi-port portfolio We developed a system pathway that responds to our customer's desire for choice in clinical capability and choice in total economics. In the quarter, we received our CE mark and 510 clearance for da Vinci X, our system that brings core Xi technology into a highly capable, lower entry price surgical system.
We're pleased with the early reception of da Vinci X by our customers and the choice it brings to those around the world who seek to build robot-assisted surgery programs with logical upgrade pathways and affordable access to our leading robot-assisted surgery ecosystem. Our da Vinci SP program continues to progress in its human clinical trial work and pilot production capability. We now have 4 clinical trial sites active, 3 in the U.S. and 1 in Asia. Cases in Asia have included transoral, urologic, and colorectal surgery, while those in the U.S. are focused on transoral robotic-assisted surgery. As we mentioned on our call last quarter, we anticipate filing our 510(k) for da Vinci SP in urology in the back half of 2017. Surgeon feedback from our trial sites is very encouraging. Our teams continue to work on product validations and manufacturing capability to support submission and launch.
Lastly, our flexible robotics program is meeting our expectations and making good progress in its product design phases and definition of regulatory pathways. In closing, the second quarter of 2017 has carried forward momentum built in prior quarters, and we remain focused on the following for the balance of the year. First, continued adoption of da Vinci in general surgery. Second, continued development of European markets and access to customers in Asia. Third, advancing our new platforms, imaging, advanced instruments, da Vinci SP, and flexible robotics progress. Finally, support for additional clinical and economic validation by region. I'll now turn the call over to Marshall, who will review financial highlights.
Thank you, Gary. I will describe our results on a non-GAAP or pro forma basis, which excludes specified legal settlements and claim accruals, excess tax benefits associated with employee stock awards, and charges associated with stock-based compensation and purchased IP. We provide pro forma information because we believe the business trends and operating results are easier to understand on a pro forma basis. I will also summarize our GAAP results later in my script. We've posted reconciliations of our pro forma results to our GAAP results on our website so that there is no confusion. Second quarter 2017 revenue was $756 million, an increase of 13% compared with $670 million for the second quarter of 2016, and an increase of 12% compared with first quarter revenue of $674 million. We launched the da Vinci X system during the second quarter in the U.S. and European countries covered by CE mark.
In conjunction with the launch, we offered certain customers who purchased systems in the first quarter the opportunity to upgrade or trade out their systems for the da Vinci X system. As a result, we deferred $23 million of first quarter revenue, which we recognize when customers either trade out their systems or when the offers expire, whichever comes first. None of the deferred revenue was recognized in the second quarter. We expect substantially all of the deferred revenue to be recognized by year-end. Second quarter 2017 procedures increased approximately 16% compared with the second quarter of 2016, and increased 5% compared with last quarter. Procedure growth relative to last year and the first quarter has been driven by general surgery in the U.S. and urology worldwide. Patrick will provide more detail concerning procedure adoption. Revenue highlights are as follows.
Instrument and accessory revenue of $398 million increased 17% compared with last year and increased 4% compared with the first quarter of 2017, which closely reflects procedure growth. Instrument and accessory revenue realized per procedure was approximately $1,830 per procedure, compared with $1,810 last year and $1,840 last quarter. The increase relative to the second quarter of 2016 primarily reflects increased sales of our stapling and vessel sealing products, partially offset by customer buying patterns. The decrease compared with the previous quarter primarily reflects customer buying patterns. System revenue of $216 million increased 7% compared with the second quarter of 2016, and increased 41% compared with last quarter. The year-over-year increase reflects higher system placements and operating lease revenue, partially offset by lower average selling prices and lower lease buyout revenue. System revenue for the first quarter of 2017 excluded the $23 million of deferred revenue.
Had the first quarter included that revenue, quarter-over-quarter increase would have been 23%, reflecting a higher number of system placements, partially offset by lower lease buyout revenue. 166 systems were placed in the second quarter of 2017, compared with 130 systems in the second quarter of 2016 and 133 systems last quarter. 27 systems were placed under operating lease transactions in the current quarter, compared with 15 systems in the second quarter of 2016 and 21 last quarter. As a reminder, revenue on operating lease transactions is recognized ratably over the life of the lease. Of the 166 second quarter systems, 11 were X systems. As of the end of the second quarter of 2017, there were 120 systems out in the field under operating leases.
We generated approximately $6 million of revenue associated with operating leases in the quarter, compared with $4 million in the second quarter of 2016 and approximately $5 million last quarter. We generated approximately $5 million of revenue during the quarter from lease buyouts, compared with $13 million in the second quarter of 2016 and $10 million last quarter. Globally, our average selling price, which excludes the impact of operating leases and lease buyouts and revenue deferrals, was $1.46 million, compared with $1.56 million last year and $1.46 million last quarter. The decrease in ASP compared to the second quarter of 2016 primarily reflects lower priced systems sold to cost-sensitive market segments and lower pricing offered to customers purchasing multiple systems. We believe that flexible financing programs like operating leases have positively impacted our ability to grow our installed base.
We expect the proportion of these types of arrangements will increase over time. Service revenue of $142 million increased 11% year-over-year and increased approximately 1% compared with the first quarter of 2017. The year-over-year and quarter-over-quarter increases reflect growth in our installed base of da Vinci systems. Outside of the U.S., results were as follows. Second quarter revenue outside of the U.S. of $205 million increased 11% compared with $185 million for the second quarter of 2016, and increased 12% compared with $183 million for the first quarter. The increase relative to the prior year primarily reflects increased system placements net of leases and increased instruments and accessories reflecting procedure growth, partially offset by lower system ASPs. Patrick will provide procedure growth information. The year-over-year decline in system ASPs reflects increased sales of lower cost systems to cost-sensitive markets.
The increase in revenue relative to the last quarter reflects increased system placements and increased instrument and accessory growth. Outside of the U.S., we placed 63 systems in the second quarter, compared with 51 in the second quarter of 2016 and 56 last quarter. Five of the system placements in the current quarter were operating leases, compared with two last year and six last quarter. Current quarter system placements, including 29 into Europe, 14 into Japan, five into India, five into Australia, and three into China. System placements outside of the U.S. will continue to be lumpy as some of the OUS markets are in early stages of adoption. Some markets are highly seasonal, reflecting budget cycles or vacation patterns, and sales into some markets are constrained by government regulations. Moving on to the remainder of the P&L.
The pro forma gross margin for the second quarter of 2017 was 71.3%, compared with 71.9% for the second quarter of 2016 and 72% for the first quarter of 2017. The decrease compared with the second quarter of 2016 primarily reflects decreased service margins associated with higher scope repair costs. The decrease compared with the first quarter reflects a higher proportion of system revenue relative to total revenue. Since we defer costs associated with the $23 million revenue deferral, the trade-up program had little impact on our margins. Future margins will fluctuate based on the mix of our newer products, the mix of systems and instrument and accessory revenue, our ability to further reduce product costs and improve manufacturing efficiency, and in the long term, the potential reinstatement of the medical device tax.
Pro forma operating expenses increased 23% compared with the second quarter of 2016, increased 2% compared with last quarter. The increases are consistent with our planned investments in product development, specifically da Vinci SP, flexible robotics, imaging, and advanced instrumentation, and the expansion of our OUS markets. The year-over-year growth rates will subside over the remainder of the year, with total year growth still expected to be around 18%. Our pro forma effective tax rate for the second quarter was 29.2%, compared with an effective tax rate of 27.8% for the second quarter of 2016 and 28.1% last quarter. The increase in our tax rate reflects an increased proportion of U.S. income relative to total income. Our tax rate will fluctuate with changes in the mix of U.S. and OUS income and with the impact of one-time items.
Our second quarter 2017 pro forma net income was $228 million, or $5.95 per share, compared with $220 million, or $5.62 per share for the second quarter of 2016 and $196 million or $5.09 per share for the first quarter of 2017. The $23 million revenue deferral, including the associated deferral of cost of sales and the income tax effects, reduced GAAP and pro forma net income per share in the first quarter of 2017 by approximately $0.28 per share. Earnings per share benefited from the full impact of our $2 billion stock buyback as we retired approximately 2.4 million shares on January 27, 2017. At this point, given the increase in the share price since the start of the ASR, the ultimate number of shares delivered under the ASR may not change materially from the initial delivery.
As I indicated earlier, pro forma income provides an easier comparison of our financial results and business trends. I will now summarize our GAAP results. GAAP net income was $222 million, or $5.77 per share for the second quarter of 2017, compared with $185 million or $4.71 per share for the second quarter of 2016 and $180 million or $4.67 per share for the first quarter of 2017. GAAP net income for the second quarter included a net benefit of $5 million associated with litigation settlements, net of charges, compared with $4 million of charges in the second quarter of 2016 and $21 million of charges last quarter. GAAP net income for the second quarter of 2017 also included a charge of approximately $6 million associated with purchased IP.
Beginning in 2017, we are required under GAAP to report the excess tax benefits or deficiencies associated with employee stock awards in our tax provision, rather than as an adjustment to paid in capital as in prior periods. The excess tax benefit included in our GAAP results for the second quarter was $31 million, contributing $0.80 per share, compared with $33 million, contributing $0.85 per share in the first quarter of 2017. We have excluded these benefits from our pro forma results. This amount will fluctuate quarter to quarter based on the volume of employee stock option exercises and the number of RSUs vesting and the value of our stock. We ended the quarter with cash and investments of $3.4 billion, up from $3.1 billion as of March 31st, 2017. The increase reflects cash generated from operations and proceeds from stock option exercises.
With that, I'd like to turn it over to Patrick, who will go over our procedure and clinical highlights.
Thanks, Marshall. Of our second quarter procedure growth of 16%, U.S. procedures grew approximately 14%, and outside of the United States, procedures grew approximately 22%. Procedure trends were consistent with the first quarter, with growth led by U.S. general surgery and global urology. In the United States, both mature and growth procedures, such as general and thoracic surgery, outperformed our plan. The majority of the outperformance was driven by continued growth in our mature procedures. In U.S. urology, the second quarter growth rate for da Vinci Prostatectomy was modestly higher than the first quarter. We believe that our U.S. prostatectomy volumes have been tracking to the broader prostate surgery market. In U.S. gynecology, second quarter procedure growth sustained trends observed during the first quarter.
Procedure growth in U.S. GYN appears to be driven by consolidation of surgeries towards physicians that specialize in complex and cancer surgery, who tend to be users of the da Vinci system. First quarter U.S. general and thoracic surgery procedure adoption remained strong, led by solid growth in hernia repair and continued adoption of colorectal procedures. Hernia repair continues to contribute the largest volume of new procedures in the United States. Existing surgeon retention and utilization remains strong. Growth trends in lobectomies and other thoracic procedures continue to show strength off of a small base. Second quarter was another quarter with a large number of clinical publications evaluating da Vinci surgery.
One that we'd like to highlight is from Dr. Rashidi from the University of Texas and colleagues from Providence Health & Services, who published a study of more than 3,500 colorectal patients treated by 58 high-volume surgeons within the Providence Health & Services network in The American Journal of Surgery. The authors found that in exchange for a longer operative time, patients treated on a da Vinci system experienced a threefold reduction in conversion rate and nearly a day shorter length of hospital stay compared to laparoscopy. In addition, the authors found that there was no difference in total direct costs between the two cohorts. Turning abroad, procedure growth outside of the United States was approximately 22% in the second quarter, led by the global adoption of da Vinci Prostatectomy, with solid contributions from kidney procedures, general surgery and gynecology.
As we discussed last quarter, the timing of the Easter holidays from Q1 into Q2, which provided a tailwind to our first quarter result, served as a headwind in the quarter, likely reducing our outside of the United States procedure growth by an estimated 3%. Taken together, first half procedure growth of 25% provides a better representation of procedure performance outside of the United States than either quarter's result. Procedure growth was led by China, Germany, and Japan. Procedure growth in China was driven by a strong expansion in system utilization as system placements remained constrained pending the issuance of a new quota for civilian hospitals. Procedure growth in China is broad-based, with a number of specialties contributing to the strong performance. In Germany, procedure growth is supported by installed base expansion that is driving strong adoption in urology with contributions from general surgeries.
In Japan, DVP and DVPN continue to grow, though year-to-year comparators have begun to slow as DVP adoption has crossed 80%. During the quarter, the first clinical experience on da Vinci X occurred in Germany. Initial procedures include urology and gynecology with strong early utilization. Commenting on the experience, Dr. Witt from St. Antonius-Hospital Gronau stated da Vinci X is, quote, "Ideal add-on to our existing da Vinci Xis. Same feeling on the console," close quote. Globally, evidence continues to build in support of the clinical and economic validation of da Vinci surgery. During the quarter, an economic analysis studying the impact of da Vinci partial nephrectomy in England was published in European Urology. The work was completed by HCD Economics, an affiliate of the University of Chester.
Comparing more than 4,200 partial nephrectomy patients between open and da Vinci surgery, the authors found that da Vinci surgery lowered the total cost to treat during the first year after the procedure by an average of GBP 900, primarily by reducing postoperative inpatient utilization from length of stay, cancer and other readmissions, and 90-day complications. This concludes my remarks. I'll now turn the call over to Calvin.
Thank you, Patrick.
I will be providing you with our updated financial outlook for 2017. Starting with procedures. On our last call, we estimated full-year 2017 procedure growth of 12%-14% above the approximately 752,000 procedures performed in 2016. Based largely upon continued strong results in U.S. growth and mature procedure categories in China, we are increasing our estimate for 2017. We now anticipate full-year 2017 procedure growth within a range of 14%-15%. During the second half of the year, we expect our procedure growth rate to moderate, in part due to one fewer operating day during the third quarter. As we move into the second half of the year, we also expect contributions from China and Japan to temper until we obtain a new quota and place additional systems in China and obtain additional procedural reimbursements in Japan.
With regards to system placements, a record high of 27 of the 166 second quarter system placements were structured as operating leases. In the second half of 2017, we expect the proportion of systems placed under operating leases will continue to increase. The average selling price per system sold outright will vary quarter to quarter based upon factors including product, regional, and trade and mix. With increasing placements into cost-sensitive markets, we expect that our average system selling price will continue to trend gradually lower in the back half of 2017. As Marshall mentioned, no amounts were either deferred or released in Q2 related to our da Vinci X trade-in program. Going forward, we expect to defer no further revenue related to this program and expect to release and recognize substantially all of the $23 million accrued during the first quarter by the end of this year.
Turning to gross profit. On our last call, we forecast 2017 pro forma gross profit margin to be within a range of between 70% and 71% of net revenue. We are now modestly raising the top end of the range and expect pro forma gross profit margin to be between 70% and 71.5% of net revenue. Turning to operating expenses. As we have described previously, we have accelerated our investments in several strategic areas that will benefit the company over the long term. Accordingly, we have ramped our operating expenses as we focus on execution. On our last call, we forecast pro forma 2017 operating expenses to grow at the higher end of a range between 15% and 18% above 2016 levels. We continue to expect results at the high end of the range, between 17% and 18% for the year.
On our last call, we forecast our non-cash stock compensation expense to range between $190 million and $200 million in 2017. Based upon updated Black-Scholes valuation estimates, we expect our non-cash stock compensation expense to range between $200 million and $210 million. We expect 2017 other income to be between $35 million and $40 million, compared to the $30 million to $35 million range forecast on our last call. With regard to income tax, we now expect our 2017 pro forma income tax rate to be between 28% and 29.5% of pre-tax income, higher than our previous guidance of 26.5% to 28.5%, based upon a higher anticipated mix of U.S. pre-tax profits.
During Q2, we had 38.4 million diluted shares outstanding for EPS calculations, roughly equal to the first quarter, as the share reduction related to the full quarter impact of the Q1 accelerated share buyback was mostly offset by the dilutive effects of our higher stock price. As a result of our higher stock price, we don't expect the ultimate number of shares received and retired when the ASR closes later this year to vary significantly versus the 2.4 million shares already retired in January. That concludes our prepared comments. We will now open the call to your questions.
Thank you. Ladies and gentlemen, if you'd like to ask a question, please press star then one on your telephone keypad. You'll hear a tone indicating you've been placed in queue, and you may remove yourself from the queue at any time by pressing the pound key. Our first question will come from Tycho Peterson with J.P. Morgan. Go ahead, please.
Hey, thanks. First on da Vinci X, I know it's early days, obviously, but any color you can provide on the funnel in terms of new versus existing customers and maybe the types of customers that are emerging?
Hi, Tycho. I don't think we'd call out anything surprising here. We had indicated to you in prior quarters that we think cost-sensitive customers, particularly in Europe, are going to be interested, and that remains so. It may have broader remit than that over time.
Okay. Urology continues to do well here. It hasn't reverted to the lower growth rates I think you'd previously expected, and you talked about that sequential pickup. Can you maybe just talk to the sustainability of those trends in the U.S. urology dVP market?
Hey, Tycho. I think we continue to believe that our prostatectomy volumes are following broader prostate surgery trends. As you know, prostate surgery really only represents about a third of all men diagnosed in the U.S. with prostate cancer. From time to time, you'll see movements between watchful waiting, radiation, and surgery. We think mostly you've seen the procedures recover from the prior USPSTF decision in 2012, where we worked through patients who had the disease progress. We think at this stage, you're just seeing general small movements between populations period to period.
Okay. I'll leave it at that. Thanks.
Thanks, Tycho.
Thank you. Our next question is from Bob Hopkins with Bank of America. Go ahead, please.
Hi. Thanks. Good afternoon. Can you hear me okay?
Hi, Bob. Yes.
Hey, great. Good afternoon. The first thing I want to touch on, just kind of looking through the results, which were obviously strong pretty much across the board, but the U.S. capital number really stuck out as a strong number. You mentioned more kind of multi-system sales and repeat customers. Is this really a function of the increase in procedure volume growth and higher utilization? Or was there something else going on this quarter?
I think it's the former. We're seeing, first of all, I think the consolidation of U.S. customers into IDNs means that the negotiations are often happening one layer up, and I think they're looking across their portfolio of MIS opportunities and making decisions in broader settings. I think it's a continuation of a trend we've been seeing for the past several quarters.
Great. The other thing I just wanted to follow up was a couple of quick checks on the pipeline timelines. You mentioned China and Japan as constraining you in the back half. Is there any update at all on the China quota from a timing perspective or even, your sense as to whether or not it could happen this year? Also wanted to just get a quick update on the timelines for SP beyond urology and the filings we could expect, either later this year or into 2018. Thank you.
Sure. Marshall, I'll let you take the China quota, and I'll take the SP.
Okay. China quota, there is no new news here. It is, as we've stated before, the quota system involves first, the government is tied up in the government's overall planning process. They did approve their budget in December. After that, it then rolls through a series of decisions about province spending as well as hospital spending, eventually we'll hear something about a quota. We don't know when that will be. What we would caution is that you put anything in the models for this year, frankly, because last time when the quota was approved, it took some time before the tender offers that the hospitals have to go through to get them done.
On the SP regulatory question, we are targeting 510 for urology in the back half of the year. There's data collection going on at the IDE sites for transoral robotic surgery and some lab-based clinical development for other procedures as well as the trial site in Asia. We haven't yet publicly projected our timelines for submissions after the urology 510. There will be a set that come. It'll be months, not years, after the 510 submission. What that looks like will depend on the speed of closure of the clinical trial data and some of the conversations with FDA about what kind of submissions they'd like, and we're not ready yet to anchor down those dates.
Great. That's helpful. Thank you.
Thank you. We'll go next to David Lewis with Morgan Stanley. Go ahead, please.
Good afternoon. Just maybe a few quick questions here. Gary, just for you, just SP timing I know came up in the pipeline, on [FC], and I know it's pretty early, can you give us any sense of the major markets, U.S., China, Europe, which one? Our sense is U.S. and China are kind of ahead of Europe, that's not based on a whole bunch. Which region you think precedes the other, and is 2019 a reasonable estimate for a launch in some geographic locale?
First to the question of which regions matter. We think it will have a global appeal, I think you're right that United States and China and then Europe will be interesting. In terms of timing, a lot of it will be predicated on regulatory pathways and what kind of data requirements there are. We think there are real opportunities in China. We're going to make sure that we do that right with our joint venture partner. We likewise think there is in the U.S. I'm not ready yet to call when the launch dates are for both sets because of negotiations with clinical trial results.
Europe, likewise, I think there's a little bit of uncertainty right now as to what kind of submission package will be required, that's one of the things we're in the midst of working out, both internally and with conversations with regulatory authorities over time. We will do a controlled launch when we're ready, we've told you don't model any revenue into 2018. We have not yet published and are not ready to publish when the final launch will be. We'll let you know as we get closer to some of the certainty on regulatory timelines.
Okay. Very helpful. Marshall, just two quick kind of margin-related questions for you. The first is on gross margin. Given the greater systems mix, I guess I was surprised to see gross margins as strong as they were, I wonder, we would have thought that X, which wasn't very material in the quarter, would have also pressured margins. What's driving the margin strength, as it relates to X, is that just because a lot of the components of X frankly are already at scale in other places of the business? The second question related is, you're looking at hiring. We typically don't ask about hiring, but I think your hiring level this quarter is 25% above the next highest level. That's pretty remarkable. I wonder if you could share with us where you're hiring and where those people are being deployed. Thank you.
Sure. On the X margins, we had communicated before. Typically, when we introduce a new product, you see a little bit of a decrease in the margin, and then we work to improve it over time. We did not expect as much of a decrease in margins due to X. X, as you said, really is the result of putting together parts that are already manufactured for other systems. We have worked out most of the cost effectiveness of that. As far as total margins, the total margin came down a little bit due to the mix of systems. I think it exceeded our expectations just because of the overall strength of procedures and it driving instrument and accessory revenue above our original expectations.
I can hit that. As far as the headcount goes, David, we ended the quarter with 4,108 employees. That was up a little over 100 from the last quarter end, it was 19% year-over-year, it really does marry up with the strategic investments that we're making in the business on that side. The majority of the investments were in our product operations group in the quarter.
Thank you very much.
Thank you. Our next question comes from Tao Levy with Wedbush. Go ahead, please.
Great. Thanks. Good afternoon. Marshall, I wanted to ask on the SP platform. The pathway forward will be filing later on towards the end of this year and then assuming approval sometime next year. How is the launch going to proceed? Is an experienced da Vinci surgeon going to be able to sit in front of a console and use the SP right off the bat, or are they going to have to go through a proctoring of different types of cases? Just any color there would be great.
Just in broad brushes, it's a family member in the da Vinci family. We believe a lot of the learning and skills will be portable from one of the family members to the other. They're not identical, there'll be some learning that goes through that transition. We think experienced da Vinci surgeons will find that transition to be pretty manageable. What that looks like and how it's finally framed will evolve as we finish our clinical trials and our validations. I'd expect a lot of that to be portable. I think in terms of rollout, we'll be at a controlled rollout when we come out. In part, that controlled rollout will be for data generation at the first sites, also we'll have some constraints due to what our labeling will be at the first launch, given the regulatory sequence and pathway.
Feedback from the clinical trial sites has been really good about usability of the system and it meeting the expectations they had for what they believe they could do with it clinically. So far, so good there. We also get pretty good insight into the characteristics of the system vis-a-vis what they're used to on SI and Xi and kind of in response to your initial question.
Got you. Perfect. Then just lastly, what's anything special going on in Japan? They've got way more systems than they need at this point, and they keep on buying more. I don't know if there is a government incentive or any credit there that they're using. Thanks.
Hey, Tycho. Sorry, Tao.
That's close. Don't worry.
Japan has a very diffuse healthcare system and hospital network system, they're not very concentrated in terms of where the patients are. While we are at a high level of penetration in dVP, you still have a lot of pockets of patients who are treated in fairly remote areas in local hospitals. They've continued to buy systems even to be able to access some of the remaining urology patients that are out there.
We've also been in Japan for some number of years here, I think there's a little bit of building capacity in hopes of broader reimbursements over time.
Perfect. Thanks, guys.
Thank you. We'll go next to Amit Hazan with Citi. Go ahead, please.
Thanks. Good afternoon, guys. Just one on the quarter and then a couple longer term ones. On the quarter, obviously just going back to the U.S. system number, a really strong number. I wanted to ask about trade-ins, though. They were weak again in the U.S. It's the second quarter in a row. I'm trying to kind of better understand why. On one hand, you've got this obvious growing pool of systems that need to be replaced, so you should in theory be replacing more systems every year. On the other hand, there seems to be a relationship between quarters where you had really strong de novo units like this year so far, both quarters, then trade-ins kind of tend to be inversely weaker in those quarters. What's kind of the correct way to be thinking about modeling trade-ins in the U.S.?
Let me speak to our intent a little bit, then I'll ask Calvin to jump in on the modeling side. For us, our thought process really has been to enable accounts with technologies and support that help them get to their clinical goals and in support of their MIS program goals. If they can do that effectively with an SI, we're happy to support them in that regard. If they want to add capacity or grow their system capability in some way that is benefited by our advanced technologies, that helps us and drives a new system placement or new system sale. Our incentives aren't strongly built on trade-outs. We're much more interested in aligning with how they want to build their programs and giving them access to technologies that make a difference in their procedures. That leads to lumpiness in trade-outs, and that's okay with us.
Calvin, to the modeling, I just gave you a little time to think about it. Go ahead.
What I'd say, Amit, is that you have such strong procedure growth and such demand for access to systems among the surgeon population that in a lot of cases, when hospitals are seeking to acquire new systems, they look at the procedures and the surgeons that they want to be able to do within their robotics program. The SI can still serve a broad range of patients and can help them facilitate that, so they tend to be buying more incremental systems than trading in.
As X matures in the market, X may be an opportunity for some folks who are happy with their capacity but want to upgrade up to additional capabilities, that may provide an opportunity for us in future quarters.
Just quickly, from the modeling perspective that you asked, beware of using our past experience with our XI and previous system launches as the model for what's going to happen now. It's a different world where you have, again, consolidated hospital networks that can align certain procedure characteristics with sets of procedures with a lot more ability to do so now than in the past. It could very well follow a different pattern this go around than it has in the past.
Okay. That maybe possibly leads me into the next question, which is on reimbursement. It looks like prostate is getting a new Medicare outpatient reimbursement code for the first time, I believe. I realize most of these dVP procedures can't really be done in one day just yet, but, it just got me thinking about the question of what the trigger might be for hospitals to start equipping their outpatient settings with da Vincis. I have to imagine that between hysterectomies moving that way and things like hernia now, there's already enough volume to justify it nowadays. Is something like prostate reimbursement any kind of an anchor that can maybe drive boxes into outpatient setting? If not, then what could be the trigger to do that?
Two important thoughts there, Amit. One is, in order to be able to do a surgery like a dVP in an outpatient setting, first off, it has to be done in a minimally invasive fashion so that you can have the patient be able to recover quick enough to get out of that setting. The second thing is, outpatient is really a billing setting, not necessarily a site of care differentiator. What we see over time is that as programs mature in their robotics capacity, they have an array of systems that can both serve really complex inpatient surgeries like thoracic or colorectal, they have a sufficient volume of outpatient procedures like the ones you mentioned in hernia and benign gynecology, even potentially dVP, where you have a technique and a surgeon capable of getting a result that can get the patient out the same day.
You'll see them actually put systems into multiple different types of setting. Typically, still under the hospital's umbrella, they're the ones who have the capability of treating the range of patients who come in with different complexities that might be either inpatient or outpatient. It's usually a byproduct of maturity of a program as opposed to a specific reimbursable event.
Okay. Thanks very much, guys.
Thanks, Amit.
Thank you. Our next question comes from Isaac Ro with Goldman Sachs. Please go ahead.
Thanks very much. Good afternoon. Question for you on the X. Just trying to think through the gross margin implications of that product cycle as it plays out. Realize it's a little early, but just trying to think through some of the comments you made earlier around how purchasing is evolving for hospitals and so forth. As that product cycle plays out, if you could give us some sense of what it means for your gross margin profile based on what you know now, that'd be helpful.
Initially, the gross margin profile is not substantially different than our other products. It kind of fits in nicely. I think what you're asking is, over time, could we see that there's pressure on the ultimate price that we charge for our X. I think we'll see. We don't know. It's only been out in the market for a quarter. What we've said in the past is that we're about market expansion, and if there's the opportunity to expand the market at the expense of a little bit of price, we'd do that.
That's helpful. Just to follow up on the expense side, as you move towards expanding the market, interested in sort of allocation of resources in the sales force. If you could talk a little bit about just qualitatively how you're moving some of your top performers to help drive X conversion, and then at the same time, maybe thinking about adding new heads. Just interested in the interplay on investment in sales force. Thank you.
How we think about sales force investments really varies by region and maturity of the market. How we're building the sales team in Germany, for example, will look kind of qualitatively different than what's happening in the United States. In general, in the United States, we've had a stable structure of growth in our key accounts teams, no surprise. A little bit better stratification of levels in the force itself that gives us the opportunity to promote and engage high-level salespeople, at the same time, bring in people who can support high volume accounts that are premature. The U.S. is a well-stratified sales force. In Germany and places like Japan, we're really at the basic building stages, the investments there are a little more filling empty slots and making sure territory coverage is right.
Thank you.
Thank you. We now have a question from Rick Wise with Leerink Partners. Please go ahead.
Hi. Thanks for taking the questions. It seems like for the third quarter in a row, China, on the procedure growth side, is exceeding your expectations. Seemingly you were at capacity, or you thought you were at capacity in the fourth quarter, and yet this is still kind of your capacity utilization seems to be creeping higher. Anything to explain that? Are there certain types of procedures that are maybe just quicker and that as a percentage of the mix in China is different than the U.S. or can you explain what might be driving this?
I think at the top line, what's going on here is a high belief in value of the procedures and the technology and a willingness to
Expand the number of hours that people are able to get procedures. I think the biggest effect is that, which is a willingness to work on weekends and for them to expand the after-hours use of devices. That will dwarf the underlying which procedures are in the mix. Marshall, you can clean up that answer if you like.
It's absolutely right. It's a theoretical capacity that you're quoting, and that theoretical capacity is based on just averages that we see around the world. Be careful of averages. In China, they are operating on Saturdays, Sundays, and late at night, in order to get things done. I think Gary's answer is right.
I think there's also an opportunity for us to learn from their experiences, which is under capital constraint, what kinds of barriers can they remove to get both good outcomes and high volumes? I think that's exciting for us, and we have an open mind toward how they're approaching it.
Great. Maybe just one follow-up on Japan. That's the other area where you're kind of saying capacity constrained until you get additional, on the procedure side at least, until you get additional approvals. Can you maybe just remind us the key procedures that you're hoping are up for consideration next year? Maybe which ones represent the biggest market opportunities, and do you feel like there's any that might be further along with the approval agencies over there?
In terms of maturity, there are some that have been going through clinical trials and have a lot of data behind them, and others that are using existing data sources. The one that has the most structured data so far is gastrectomy, and that is going to be exciting for us over time. It's a real market in Japan. The prevalence is quite high, we have good hopes and optimism that that will go through the process. Other categories are things like GI and oncology that is of interest. Esophagectomy. Calvin.
Yeah. Lobectomy procedures and some of the lower colon LAR procedures are potential.
I think the interest in broad use of da Vinci in Japan is very high. We do not have assurance that MHLW will accept it in the next insurance cycle, although so far so good. We don't have assurance that the reimbursement levels will be any particular level. Again, so far the indicators are pretty good for us, but that's still a work in process from the government's evaluation point of view, and we stand by to support the surgical societies and answer questions for them as they need it.
Thank you.
Thank you. Our next question is from Larry Biegelsen with Wells Fargo. Please go ahead.
Hey, guys. Thanks for taking the question. Let me just start with hernia. You received recently a specific inguinal hernia indication, which includes positive data in the label. Could you talk about the implications of that label and data? Are you pursuing other specific indications for other procedures? I have one follow-up.
Sure. On the first one, this really is something around what gives us a little more freedom about what we can claim in our materials. It allows us to be a little bit more specific versus the general. For us, we think that that just clarifies what our teams can speak about. We think it's an incremental positive. It's a small positive. I think the data underlying it is supportive, and the interactions with FDA, I think, are ultimately helpful for the whole process. This is one of a set of specific indications that we have pursued over the last couple of years, and we do have a pipeline of the next set of things we want to do and align.
We have not publicly disclosed what those are or what the order is, but I guess what I'd tell you is I'd expect more to come. Again, I think it's a healthy process between us and the agency to supply data as we get it, and that allows us a little more specific capability in terms of what we talk about.
Thanks. I think you're planning to file and launch a 45 millimeter stapler, which should help with bariatric procedures. Is there any update on the timing there? Thanks for taking the questions.
Sure. We are working on additional staplers besides the ones that are in the market. We have a 30 and a 45. Remember, staplers are characterized by not only their length, but also the length of the staples that go in the jaw. There are a set of things that we're working on beyond that. We do think that there are opportunities to build staplers that can have broader use in general surgery. We have not yet predicted or publicly disclosed what the expected timelines are. We do have technology in development. As those things approach maturity, we'll share with you where we are.
Thanks for taking the questions.
Thank you. We'll go next to Brandon Henry with RBC Capital Markets. Please go ahead.
Thanks for taking my question. Can you provide an update on the Australian clinical trial for the flexible catheter platform, and any lessons you've learned from that trial? When and where do you think we can see the data from that trial being published or presented? A couple follow-ups.
Thanks, Brandon. I think the short answer is no, I can't provide an update. The data's being analyzed. The clinical teams that are there are preparing their abstracts, they'll decide in which meeting they want to show it. Once they've made that decision, then we're happy to share it with you. As we said last time, the results were very positive for us. We were really happy with what we saw. I think the scientific principal investigators need the chance to write their manuscripts and analyze the data and present it in a way that makes sense to them. We'll wait for that, and as we get clarity there, we're sure to share it with you.
Okay. Just more broadly, can you help me understand some of the differences or the benefits for Intuitive's flexible catheter platform relative to some of the other platforms on the market, like Medtronic with its superDimension platform?
Sure. I think what we can bring in our concepts and our technology here is a couple of things. One is we have novel sensing technologies that allow us to sense all the way along the catheter length with a high degree of certainty. That helps us in terms of understanding and navigating tortuous pathways. That's one. The second thing is the use of robotic assistance gives you stability and navigation capabilities that are very hard to do manually. Those are technical benefits. What could they result in terms of clinical benefits? The hope there is that you can get to more distal locations that are otherwise hard to get to in tortuous pathways, and that you're more accurate in terms of tissue sampling because you have high degree of stability and better imaging and targeting.
Now, those claims have to be backed up, that's the hypothesis, that's the set of trials and data and analysis that we're going after. I think people are excited about flexible technologies in general by some of the technologies that our competitors and other med companies have put out there. I think the excitement is there, the question is, can you go a little further and get a little more predictability? We think we have technologies and capabilities that can do that.
Okay. Thank you.
Thank you. Our next question is from Travis Steed with Cantor Fitzgerald. Please go ahead.
Thanks for taking the questions.
Travis, you'll be the last questioner, so make it a good one.
Okay. You placed a decent amount of SI systems in the quarter. Did those customers have an option to purchase X? Just any color on how customers are deciding between the two systems, recognizing we're still very early on.
I think the question was there was a fair number of SIs in the system in the quarter, despite the availability of X.
Yes.
Right.
Yes.
I think first, while we were pleased with the approval timelines of X in the U.S. and Europe, there are still many markets that X is not yet approved in. Some of the SIs are just purchases by folks whose choices were SI or Xi. In the case of China, their choice is SI right now, not Xi. Some of it is just that. In other cases, some of the negotiations are multi-quarter negotiations and are right at the endpoint, they will finish the transaction based on where they started. Those are opportunities for us to go back to those customers over time. That's one of the reasons that we had the revenue deferral and the offers for people to evaluate whether they wanted to make a change. That's mostly what the dynamics are.
Travis, the other part to think about is just the approvals came mid-quarter. I think Europe was in the beginning of April, and the U.S. was in the beginning of May. You didn't really have a full quarter to get out with the team and communicate to all your customers what X is relative to other products that may have already been in a long sales cycle.
Okay.
Just a little color commentary on X. I think the customer base and our field understood well what X is, what its benefits are. I think the logic of X is well understood, and where it fits in the line is well understood, and we're pleased with that.
Okay. Just one quick follow-up. I think I know the answer to this, but is it still your view we should be modeling in 2018 expense growth below your revenue growth?
Actually, what we've said is that operating expense growth will grow 18% for the year.
I'm sorry, in 2018, kind of longer term.
Do we expect to dial back to that?
Sorry. In 2018, what we've said is we expect to dial it back so that we are adding leverage.
Okay. All right. Thanks for taking the questions.
Thanks, Travis. Well, that was our last question. As we've said previously, while we focus on financial metrics such as revenues, profits, and cash flow during these conference calls, our organization's focus remains on increasing value by enabling surgeons to improve surgical outcomes and reduce surgical trauma. We've built our company to take surgery beyond the limits of the human hand, and I assure you that we remain committed to driving the vital few things that truly make a difference. This concludes today's call. We thank you for your participation and support on this extraordinary journey to improve surgery, and we look forward to talking with you again in three months.
Thank you. Ladies and gentlemen, that does conclude our conference for today. Thank you for your participation and choosing AT&T Teleconference Services. You may now disconnect.