Ladies and gentlemen, thank you for standing by, and welcome to the Intuitive Surgical third quarter 2016 earnings release call. At this time, all lines are in a listen-only mode. Later, we will conduct a question-and-answer session. Instructions will be given at that time. Should you require assistance during the conference, please press star then zero. As a reminder, this conference is being recorded. I would now like to turn the conference over to Senior Director of Finance, Investor Relations, Calvin Darling. Please go ahead.
Thank you. Good afternoon, welcome to Intuitive Surgical's third quarter earnings conference call. With me today, we have Gary Guthart, our President and CEO, Marshall Mohr, our Chief Financial Officer, and Patrick Clingan, 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 2nd, 2016, and 10-Q, filed on July 20th, 2016. 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 Archives section under our Investor Relations page. Today's press release and supplementary financial data tables have been posted to our website. Today's format will consist of providing you with highlights of our third quarter results, as described in our press release announced earlier today, followed by a question-and-answer session. Gary will present the quarter's business and operational highlights. Marshall will provide a review of our third-quarter financial results. Patrick will discuss procedure and clinical highlights. I will provide our updated financial outlook for 2016. Finally, we will host a question-and-answer session. With that, I'll turn it over to Gary.
Good afternoon, thank you for joining us on the call today. Our company performance in the quarter was solid, with increasing customer adoption of procedures and growth in system placements. Global procedure growth was over 14% year-over-year in the quarter. Drivers of growth centered on U.S. general surgery and growth in the use of da Vinci surgical systems outside the United States. In the United States, year-over-year growth in ventral and inguinal hernia repair continues to be strong. U.S. colon resection and lung resection also contributed to solid growth. As we've stated in prior calls, we are expecting growth rates in mature procedures in the U.S. to moderate, and U.S. DVP is starting to follow this pattern, driven by the macroeconomic environment for prostate cancer diagnosis and treatment. In Europe, procedure growth tempered in the quarter, with some countries posting solid performance while growth softened in others.
We're pleased with growth in procedures in Asia, with Korea and China in particular demonstrating continued strength. Patrick will review procedure trends in greater detail later in the call. We placed 134 da Vinci systems in the quarter, up from 117 in Q3 of 2015. While we offer a range of models and price points, our most capable model, da Vinci Xi, again represented roughly three-quarters of new capital placements. As we've said on previous calls, capital placements are lumpy, and this quarter was no exception. Healthy placements stood out in the U.S., while placements in our European region softened relative to a year ago. Capital placements in Asia are particularly unpredictable given environmental constraints like reimbursements in Japan and quotas in China. Placements in Asia were in line with prior quarters.
Turning to revenue and gross margin dynamics, we experienced some one-time tailwinds in the quarter that contributed to higher-than-expected net income. Marshall will take you through these events and our general finances in greater detail later in the call. Turning to highlights of our third quarter operating results. Procedures grew approximately 14% over the third quarter of last year. We shipped 134 da Vinci surgical systems, up from 117 in the third quarter of 2015. Revenue for the quarter was $683 million, up 16% from the prior year. Pro forma gross profit margin was 73.1%, compared to 69.3% in the third quarter of last year. Instrument and accessory revenue increased to $348 million, up 17%. Total recurring revenue in the quarter was $478 million, representing 70% of total revenue.
We generated a pro forma operating profit of $308 million in the quarter, up 28% from the third quarter of last year, and pro forma net income was $246 million, up 23% from Q3 of 2015. As we discussed with you on our last call, as our business has strengthened, we have increased our mid and long-term investments in creating our next generation of products and services. We've been increasing these investments based on our belief that substantial opportunity exists to enable better outcomes and to expand access to our technologies globally. We continue to enhance features and expand access to our Xi suite of instruments, accessories, and imaging products. In the third quarter, we added the ability to ship Xi Single-Site, Xi 30-millimeter stapler, and Firefly to several countries. In addition, intraoperative table motion uptake and performance is meeting our expectations.
We are continuing to invest in expansion and refinement of our base instrument, stapling, and vessel-sealing products for our Xi platform. New system platforms continue to make good progress. Our da Vinci Single Port is progressing in its in-house clinical evaluations and preparations for human clinical trials expected later this quarter. As we've discussed on prior calls, we plan first markets to include head and neck surgery, urology, and colorectal surgery. SP is a platform technology that allows high dexterity access with great 3D vision to confine surgical spaces. Commentary by surgeons after in-house evaluations have indicated strong interest in the clinical potential of this platform. In the quarter, we also announced the creation of a joint venture with Fosun Pharma, owner of our current da Vinci partner in China.
The JV's first objectives are to work with ISI and Fosun to produce products that address an acute need in the diagnosis and cost-effective treatment of lung cancer, one of the most commonly diagnosed forms of cancer in the world, and for which early detection and treatment are important. The technology underpinning the system is based on computer-controlled catheters, advanced image processing, and sophisticated sensing. It incorporates a substantial set of proprietary intellectual property developed, owned, or licensed by Intuitive over the past several years. This system is in its early stages of our human clinical experience, and final clearance and launch targets are not yet set. That said, the raw capability of the technology is compelling, and it has the potential to perform as a broader diagnostic and treatment platform over time. Bringing new platforms to the market represents a significant investment.
We've added approximately 400 employees year-to-date and expect increased fixed investments and some lumpiness in spending in future quarters as these platforms move through design, validation, data collection, and early launch. As we close 2016, we are focused on the following. First, expanding the use of da Vinci in general and thoracic surgery, particularly colorectal surgery and hernia repair. Second, advancing our ecosystem, including new clearances, additional clinical and economic validation, training centers, and the expansion of our product offerings. Third, driving our organizational capabilities and markets in Europe and Asia. Finally, assisting our customers in their efforts to maximize the comprehensive value of their programs. I'll now turn the call over to Marshall, who will review financial highlights.
Thank you, Gary. I'll be describing our results on a non-GAAP or pro forma basis, which excludes specified legal settlements and claim accruals, stock-based compensation, and amortization of purchased IP. We provide pro forma information because we believe that business trends and operating results are easier to understand on a pro forma basis. I will also summarize our GAAP results later in my script. We have posted reconciliations of our pro forma results to our GAAP results on our website so that there is no confusion. Third quarter 2016 revenue was $683 million, an increase of 16% compared with $590 million for the third quarter of 2015, and an increase of 2% compared with the second quarter revenue of $670 million. Third quarter 2016 procedures increased 14% compared with third quarter of 2015 and decreased 1% compared with last quarter.
Procedure growth relative to last year has been driven by general surgery in the U.S. and urology worldwide. The decrease relative to the prior quarter primarily reflects seasonality. Revenue highlights are as follows. Instrument and accessory revenue of $348 million increased 17% compared with last year and increased 3% compared with the second quarter of 2016. Growth in instruments and accessory revenue generally reflects procedure growth and increased sales of stapling and vessel sealing products. Instrument and accessory revenue realized per procedure, including initial stocking orders, was approximately $1,870 per procedure, compared with $1,840 last year and $1,810 last quarter. The increases relative to the third quarter of 2015 and last quarter reflect increased sales for stapling and vessel sealing products. The increase compared to the second quarter of 2016 also reflects the impact of customer buying patterns.
System revenue of $205 million increased 18% compared with the third quarter of 2015, increased 1% compared with last quarter. The year-over-year and quarter-over-quarter increases reflect higher system placements and higher revenue associated with lease buyouts, partially offset by lower average system selling prices. We generated approximately $13 million of revenue during the quarter from lease buyouts, compared with $3 million in the third quarter of 2015 and $13 million last quarter. While lease buyouts are difficult to predict, we expect the level of fourth quarter lease buyouts to be below those of the third quarter. 134 systems were placed in the third quarter of 2016, compared with 117 systems in the third quarter of 2015 and 130 systems last quarter. 15 systems were placed under operating lease transactions in the current quarter, compared with 15 last quarter and 13 systems in the third quarter of 2015.
As a reminder, revenue on operating lease transactions is recognized ratably over the life of the lease. As of the end of the third quarter, there were 74 systems out in the field under operating leases. We generated approximately $4 million of revenue associated with operating leases in the quarter, compared with $2 million in the third quarter of 2015 and approximately $4 million last quarter. We exclude the impact of operating leases and lease buyouts from our system ASP calculations. Globally, our average system price was $1.53 million, compared with $1.61 million last year and $1.56 million last quarter. The decreases compared with prior periods primarily reflect a lower mix of dual console systems, partially offset by a lower mix of trade-in systems in the third quarter of 2016. Service revenue of $130 million increased 10% year-over-year and increased approximately 1% compared with the second quarter of 2016.
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. Third quarter revenue outside of the U.S. of $189 million increased 25%, compared with $151 million for the third quarter of 2015, increased 2% compared with $185 million for the second quarter. The increase compared with the previous year is comprised of a 26% growth in recurring revenue, which is driven by procedure growth of 25% and increased systems revenue of 24%. The increase compared to the second quarter reflects systems revenue growth of 2% and recurring revenue growth of 2% in a seasonally slower quarter. Outside the U.S., we placed 49 systems in the third quarter, compared with 37 in the third quarter of 2015 and 51 systems last quarter.
Current quarter system sales included 18 into Europe, two into China, 11 into Japan, 18 into rest of world markets. System placements outside of the U.S. will continue to be lumpy as some of the OUS markets are in the early stages of adoption. Some markets are highly seasonal, reflecting budget cycles or vacation patterns. Sales into some markets are constrained by government regulation. Moving on to the remainder of the P&L. Pro forma gross margin for the third quarter of 2016 was 73.1%, compared with 69.3% for the third quarter of 2015 and 71.9% for the second quarter of 2016. The pro forma gross margin for the third quarter of 2016 included $7.1 million of medical device tax refunds. Without the medical device tax refunds, our pro forma gross margin would have been the same as the second quarter, or 72%.
Compared with the third quarter of 2015, the higher growth margin reflects reduced product costs, the medical device tax refunds, and manufacturing efficiencies. Future margins will fluctuate based on the mix of our newer products, the mix of system and instrument and accessory revenue, costs associated with our scope exchange program, 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 14% compared with the third quarter of 2015 and increased approximately $6 million compared with last quarter. The increases reflect increased headcount, increased product development activities, and investments in our OUS commercial organization. We added over 400 employees, primarily in the product operations area, over the past year. The increase compared with the prior quarter primarily reflects increased head count costs.
Our pro forma effective tax rate for the third quarter was 22.7%, compared with an effective rate of 18.4% for the third quarter of 2015 and 27.8% last quarter. The pro forma third quarter of 2016 tax rate reflected $16 million of tax benefits, or $0.40 per share, realized as a result of the statute of limitation expirations in various jurisdictions. The third quarter of 2015 tax rate reflected $29 million, or $0.77 per share, related to a favorable tax court ruling involving an independent third party. Our tax rate will fluctuate with changes in the mix of OUS and U.S. income and with the impact of one-time items.
Our third quarter 2016 pro forma net income was $246 million, or $6.19 per share, compared with $199 million, or $5.24 per share for the third quarter of 2015 and $220 million or $5.62 per share for the second quarter of 2016. Excluding one-time income tax and medical device tax benefits, pro forma net income would have been $225 million or $5.65 per share. As I indicated earlier, pro forma income provides an easier comparison of our financial results and business trends. I will now summarize our GAAP results. GAAP net income was $211 million, or $5.31 per share for the third quarter of 2016, compared with $167 million, or $4.40 per share for the third quarter of 2015 and $185 million or $4.71 per share for the second quarter of 2016.
We ended the quarter with cash and investments of $4.6 billion, up from $4.2 billion as of June 30, 2016. The increase was primarily driven by 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 third quarter procedure growth of 14%, U.S. procedures grew approximately 11%, and outside of the U.S., procedures grew approximately 25%. During the first three quarters of 2016, global procedure growth was nearly 16%. In the U.S., taken together, growth in our mature procedures slowed in the third quarter compared to the first half of the year. General and thoracic procedure growth remained healthy. In U.S. urology, third quarter growth in da Vinci prostatectomy slowed to low single digit growth, a level that we believe to be similar to the overall rate of diagnosis of new prostate cancers. We believe that our U.S. prostatectomy volumes have been tracking to the broader prostate surgery market. In U.S. gynecology, third quarter procedures grew modestly year-over-year, with growth led by malignant and complex benign hysterectomy.
Continuing the recent trend, we estimate a larger proportion of da Vinci hysterectomy procedures were performed by gynecologic oncologists during the third quarter. Procedures for benign gynecologic conditions grew modestly during the third quarter, continuing a trend from the first half of the year. Third 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 general surgery, and existing surgeon retention and utilization remains encouraging. Cholecystectomy procedures declined in the quarter, with growth in multi-port procedures being offset by declines in single-site procedures. Early-stage adoption of lobectomies and other thoracic procedures is encouraging. Last month at the Global Symposium on Robotic-Assisted and Minimally Invasive Hernia Repair, several new data sets comparing da Vinci to open and laparoscopic hernia repair were presented.
Among the most notable presentations, Dr. Rosen from the Cleveland Clinic presented new data on retromuscular ventral hernia repair from the American Hernia Society's Quality Collaborative, or the AHSQC. In a prospective cohort of more than 400 patients, case-matched between da Vinci and open surgery, da Vinci surgery was shown to reduce the length of hospitalization by two and a half days compared to open surgery, with similar levels of wound outcomes, readmissions, and reoperations. Intuitive is a founding partner of AHSQC, and we are supporting its expansion to include data for inguinal hernia repair. Turning abroad, procedure growth outside of the U.S. was approximately 25% in the third quarter, led by the global adoption of da Vinci prostatectomy, with solid contributions from kidney procedures. Total procedure growth in Europe and Asia was similar to the first half of the year, though procedure performance varied by country.
Strong growth continued in China, South Korea, Japan, and Germany. While adoption of da Vinci in urology is the primary driver of procedure growth outside of the U.S., we are seeing multi-specialty adoption in certain countries. In China, roughly half of the year-to-date procedure growth has come from categories outside of urology. In South Korea, approximately 60% of the year-to-date procedure growth has come from categories outside of urology. We are investing in the development of clinical evidence to support the adoption of da Vinci surgery in markets around the world. Globally, we support several evidence initiatives and registries, including AHSQC, gynecologic oncology societal registries in the U.S. and Europe, and a colorectal registry in Europe. In the U.S., we are also supporting several comparative prospective and retrospective multi-center studies on hernia repair, colorectal surgery, and thoracic surgery.
Outside of the U.S., we are sponsoring clinical studies in Japan to support reimbursement submissions for malignant hysterectomy and gastrectomy. In Europe, we provide support for studies in colorectal, thoracic, and gynecologic oncology. We are committed to developing local evidence in key markets to support the adoption of da Vinci surgery, where our technology can bring value to hospitals, surgeons, and patients. Third quarter was another quarter with a large number of clinical publications evaluating da Vinci surgery. Of these, I have selected a few studies that you may find interesting. Dr. D'Alesio and colleagues from Indiana University published a study in Surgical Endoscopy comparing da Vinci to laparoscopic colorectal procedures captured in the American College of Surgeons' National Surgical Quality Improvement Project, or NSQIP database from 2011 through 2014.
Including over 27,000 procedures across a range of colon and rectal resections, in exchange for an approximate 45-minute longer operative time, da Vinci low anterior resections and right colectomies showed a reduction in conversion rates. Left colectomies trended towards a reduction in conversion rates without statistical significance. Low anterior resections also showed a lower rate of sepsis with a higher rate of diverting ostomy. Across all cohorts, da Vinci surgery generated a reduction in length of hospital stay. The next study was published by Dr. Ozben and colleagues from Acıbadem University in Istanbul, Turkey in the Journal of Surgical Laparoscopy, Endoscopy & Percutaneous Techniques. In a small case series, the authors compared their experience in performing rectal resections on da Vinci Xi to da Vinci Si. They found that da Vinci Xi was associated with an approximate 40 minutes of reduced operative time.
The reduction in operative time was attributable to an elimination of double docking and hybrid surgeries in the da Vinci Xi cohort. The surgeons also found the da Vinci Xi patient population experienced an increase in lymph nodes harvested and quicker return of bowel function with a one-day longer length of hospital stay. The authors concluded, quote, "The Xi generation appeared to allow shorter console times, and its broader capabilities promise to make it a lot easier for surgeons to perform this complex robotic procedure." Close quote. While this study highlights the enhanced workflow capabilities of da Vinci Xi for multi-quadrant surgeries such as rectal resection, our da Vinci Si installed base has remained stable in 2016 as customers continue to find value in its utilization. Taken together, procedures performed on da Vinci Si and Xi platforms represented over 95% of our third quarter procedures. This concludes my remarks.
Will now turn the call over to Calvin.
Thank you, Patrick. I will be providing you with our updated financial outlook for 2016. Starting with procedures, on our last call, we estimated full year 2016 procedure growth of 14%-15% above the approximately 652,000 procedures performed in 2015. As we enter the fourth quarter, we continue to forecast full year procedure growth of 14%-15%, likely towards the higher end of the range. With regard to Q4 2016 system placements, we directionally expect system placements for the quarter to follow recent seasonal trends. However, we anticipate system placements outside of the U.S. will continue to be lumpy as some of our OUS markets are in early stages of adoption and sales in the sub-markets are constrained by government regulations. Recall, we placed 13 systems into China and seven systems into Brazil in the fourth quarter of 2015.
As the quota in China expired in 2015 and a new quota has not yet been issued. As we are in the very early stages of adoption in Brazil, we do not expect comparables and placements into these markets in the fourth quarter of 2016. Also, we believe that the flexibility we've offered customers in the form of operating leases has been well-received. As a result, as compared to prior periods, we expect a higher proportion of Q4 2016 placements to be under operating leases, with revenue recognized in future periods. Finally, we expect to see a lower number of lease buyouts in the fourth quarter compared to the previous two quarters, given the lower number of short-term leases that are outstanding at this time. Turning to gross profit.
On our last call, we forecast 2016 pro forma gross profit margin to be within a range of between 70% and 71% of net revenue. We now expect our full year 2016 pro forma gross profit margin to be approximately 71.5% of net revenue. As Marshall indicated, the third quarter benefited from a $7.1 million medical device tax refund. Excluding that benefit, our gross profit margin would've been 72%. We expect our fourth quarter margin to be directionally lower than the third quarter, primarily due to product mix. Turning to operating expenses. Based upon investments we are making in key areas of the business, we expect expense growth will continue to accelerate. On our last call, we forecast pro forma 2016 operating expenses to grow between 12% and 15% above 2015 levels. We are now refining this range to 13%-14%.
Consistent with our last call, we expect our non-cash stock compensation expense to range between $170 million and $180 million in 2016, compared to $168 million in 2015. We expect other income to total approximately $33 million in 2016, higher than the $30 million forecast on our last call, due primarily to higher interest income. With regard to income tax, consistent with previous guidance, we expect our Q4 2016 pro forma income tax rate to be between 26.5% and 28.5% of pre-tax income, depending primarily on the mix of U.S. and international profits. That concludes our prepared comments. We will now open the call to your questions.
Ladies and gentlemen, if you wish to ask a question, please press star then one on your touch tone phone. You will hear a tone indicating you've been placed in queue. You may remove yourself from queue at any time by pressing the pound key. Once again, if you have a question, please press star one at this time. One moment before our first question. That will come from the line of Bob Hopkins from Bank of America. Please go ahead.
Hi, thanks. Good afternoon. Can you hear me okay?
We can.
I have two questions. First, for Marshall, just to clarify a couple of things that were mentioned relating to the fourth quarter, and then a question for Gary on the Fosun agreement. Marshall, I'll start with you. Just two quick clarifications. One, on the medical device tax that's in the $7 million, could you explain why that is one time? And then on the system sales guidance that you're providing, is that essentially suggesting that systems will be globally roughly flat in Q4? Thank you.
Yeah, sure. The medical device tax refund is the result of when you originally compute the tax, there's some subjective areas, and we modified what we had previously filed, so we get a one-time refund, and it's over. We've received the money, and there's been an audit, so we're all done with that. Second question had to do with the level of systems. No, I think that what Calvin said was that the systems are seasonally stronger in Q4. What he was trying to set up, however, was that, relative to the prior year, there's some hard comparables given that we had some markets that are rather lumpy, like China and Brazil.
All right, next-
He had a second question on Fosun.
Our next question comes from the line of David-
I think Bob had a question on Fosun before he got to it, if you still have him. If not, we'll come back around in queue.
I'm here. Can you hear me?
I can. Go.
Okay, great. Thank you. Thank you very much for that. I was wondering if you could give us some perspective on the biopsy platform and the joint venture, because it seems to me like this is an entirely new platform that you're announcing here. I was wondering if you could just give us a little more color on what this is. Is this a totally new system, or just an add-on to Xi? Should we think about it as being a couple of years away from commercialization, or is it really a longer-term project? I was just sort of wondering if you could provide some perspective.
Yeah. I'll give you a little bit of an overview. We'll, of course, give you additional detail in coming quarters. It is not currently designed as an add-on. The technology is based, as I said in the prepared remarks, on computer-controlled catheters, along with some special sensing technologies and some image analysis. The current configuration it's in, it's a standalone. Those types of technologies in the future could be integrated into other things, and we won't preclude ourselves from doing that. We do conceive of it as a way to access the body through natural orifices and other means where you want to follow a prescribed pathway to get to some deep place in the body and do something. Our first clinical interest is
In biopsying lung cancers or biopsying suspicious lesions in the lung. We think that is important globally and particularly important in China. As a result, the partnership with those who we've known through their Tyndall company for many years, made a lot of sense to us, and we're excited about it. We're not ready to give you commercial timelines yet. The technology is mature enough that we're in our initial human clinical experience. That's really the very beginnings for us, and as we get greater clarity on our launch timelines and thoughts, we'll share them with you.
Thank you.
Now we'll go to the line of David Lewis with Morgan Stanley.
Good afternoon. Gary, I want to start with a strategic question, then maybe have two follow-up boring questions. It was occurring to me on this call that I feel like the Intuitive story is sort of poised for a pretty significant change. I really think Intuitive has always really been about one system. I know you have multiple configurations, but in this quarter alone, Xi was still 75% of new placements. If I think about the next two years, you're still going to have Xi and all those multitude of prior systems. You'll have SP, and you're also now going to have this catheter-based sensing system.
I wonder if you could help us understand, are we right to think about this company as morphing these next two years, and how does supporting sort of multiple platforms now impact the addressable markets you can serve, your ability to accelerate growth, and obviously, just flat out R&D spending across these platforms? I know it's a big question, but I think it's an important one.
Yep. Fair enough. I think as you think about SP shares a lot in architecture and in kind of underlying technology with the Xi platform. We do think it branches us into places that are hard to reach otherwise, literally hard to reach with conventional technologies, open surgery, conventional laparoscopy, or with Xi. We think SP can broaden clinically what surgeons can do. I think that will start in niches, and then we'll move out into broader applications as we gain clinical experience. It does increase our support load a little bit in terms of complexity with regard to the SP, just because it's a new set of instruments and add-on accessories. It's not an entirely new set of computational platform and things like that. As you start thinking about the catheter-based technologies, again, that's a new set of technologies.
You had kind of framed it in a two-year horizon. I would stretch that horizon out a little bit. I wouldn't anchor us there. I do think that takes us to different places. I think it allows access to parts of the body that you may not think of surgically. It may be more around diagnostics, and I think it will open up to practitioners ways of approaching tissue that they just haven't thought about before. That's why we're doing it. You've seen us increase our R&D spend, and we've been both talking about it and doing it, and part of it has been investing in these technologies. I think it matters.
I think as we look from the bottom of your feet to the top of your head and look for opportunities to get better outcomes, we think there are a variety of technologies, from access technologies to imaging technologies to computational technologies that can really make a difference, and that's where putting our money where our mouth is.
Okay, thanks, Gary. Marshall, the company's always been hesitant to talk about margins on a go-forward basis. Obviously, margins this year is a huge part of the story, and they've been, frankly, kind of extraordinary. As you head into 2017, just in light of the spending comments you've made, I don't think it's realistic for investors to expect 200 basis points of margin expansion in 2017. Based on your comments on spending and what you're going to have to do to support these platforms, how should we sort of calibrate our thinking next year between sort of an extraordinary 2016 expansion and a more moderate 2015 margin expansion? Should we be thinking about something between those two poles as more appropriate than what we're seeing this year, which seems very outsized?
David Lewis, we'll give you guidance in January on what 2017 is going to look like. Some of the variables that can occur obviously have to do with product mix. As you introduce new products, new products have, by their nature, lower margins than existing products. As we introduced stapling, for example, we saw a decline in margin initially. As we improved the manufacturability and efficiency of the manufacturing processes, we see improvements in margins. I'm not going to predict what we're going to do next year. I would just say that there are a lot of moving parts. Mix geographically also has an impact. Mix between systems and instruments and accessories has an impact. There's just a lot of variables that go into it.
I think what you've seen this last year, though, is outstanding performance by our manufacturing group to reduce the cost of newer products that were lower margin a year ago.
Okay. Gary, just really quickly, lastly, on the ex-U.S. business on systems, I think the commentary on Brazil and China, those seem kind of very short-term in nature. Eventually, those tenders will get raised. In terms of the European business, did you see any impact from Brexit, or do you just think this is lumpiness that always occurs generally in your business? Thank you.
I think the dynamics in the U.K. in particular, it's hard for us to segregate what's Brexit and what isn't. The capital acquisition pipelines are pretty long relative to these things, and it's been clear that in the U.K., that their NHS anyway, that NHS England has been looking at how to spend their money and trying to cover budget shortfalls, so there's been pressure there for some time. Brexit likely doesn't help.
With regard to Europe more broadly, it really is varying country by country. Some places we see reasonable growth and support. Other countries have been a little bit more of a struggle, the response to that really has been to increase local presence, increase local data generation, and be in close contact with government payers and private payers.
Okay. Thank you very much.
We'll go to the line of Tycho Peterson from JPMorgan.
Hey, thanks. Actually, I want to follow up on David's question earlier on margins. If we think about the Xi experience and the impact that had on gross margins, as we think forward to SP, is that a fair proxy in terms of the magnitude of the impact on the gross margins when that does roll out?
We're not at the stage where we've introduced the product and we're manufacturing them in bulk. I think it's fair to say that SP's margins will be lower than our existing product portfolio, and we will work on it over time to try to reduce those costs.
In terms of magnitude, Tycho, you look at the Xi, that was our next-generation multi-port system. It quickly took off to a very high proportion of the sales. What we're talking about with SP is a more controlled type of launch, lower overall quantity. Just based on magnitude, it's probably not going to have as big an impact on the overall margin there.
Understood. Can you comment on trade-ins? I know you called it out in the footnotes. You had 58 in the U.S., highest number ever. Was this kind of a one-time thing where you kind of went back and scrubbed systems in the field?
Yeah. There was a footnote in our data tables that we referenced in the beginning. During the third quarter, we actually implemented a new system and some processes for tracking our da Vinci systems out in the field. As part of the transition process, we performed a verification audit of our installed base records, which identified 43 systems, mostly older standard and S models, which had been retired. We went and removed those retired systems from our installed base during the quarter. I think the trade-out number was 33. Most of the rest here was just kind of this adjustment we made to the base. The trade-ins were pretty, I think, in line with previous periods.
Okay. Last one, I'll just ask the obligatory capital deployment question because you're over $4.5 billion now. Obviously, you're stepping up your own spending, can you maybe just talk a little bit about capital deployment at this point?
Yeah, sure. We think about capital deployment consistent with how we've talked about it before. We're in a period where we're facing future competition, we want to have the ability to expand and to deal with competition. We're also going to see additional opportunities as companies get into this game for acquisition of technologies that may expand our marketplace and enhance our products. Those technologies, it's nice to do tuck-ins and small licensing arrangements that we've done in the past, and we'll try to do those, it may be that we have to pay a greater dollar to get some of that technology in the future. We want to have money for those things.
Beyond that, to the extent that we have the right opportunity to buy back stock and return money to shareholders, we'll take that opportunity, but we'll do that opportunistically as we have in the past.
Okay, thank you.
Next, we'll go to the line of Ben Andrew with William Blair.
Good afternoon, guys. Thanks for taking the questions. Gary, looking at the Fosun relationship, does this give you a demonstrably closer relationship over in China that may influence the tender process? Kind of as a second piece to that, from a regulatory perspective, what sort of time frames would you be looking at to get something through once you've finished development and you've done some human testing to approval? Is it quicker there, or is it similar to the U.S.?
On the first question, I think in the long term, I think it deepens our relationships with customers and regulators in China. I wouldn't assume that it's a magic switch in the near term. With regard to regulatory approvals for various products in China, typically in our past, it's been a little bit longer process than it has in the U.S. What that looks like going forward, in particular for the new products we're talking about, I can't speak to at this time. We just don't have enough information on it.
Okay. You talked about international procedures being up about 25%, which is a strong number, but I thought I heard you say that parts of Europe were weaker than a year ago. Was there a particular geographic pattern there? Was China demonstrably, or that plus the ROW placements sort of got my attention relative to some emerging opportunities overseas?
Hey, Ben, this is Patrick. In certain international markets, we're pretty deeply penetrated in urology and where you have seen those penetration rates increase over time, the rate of growth has decelerated. Emerging procedures, things like colorectal and gynecologic oncology are still fairly small. Countries like the Nordic countries, places like the U.K., where we're pretty deep, you see those growth rates slow.
Okay. This may be for Patrick as well, a competitor this morning talked about seeing some of their general surgery cases and calling out hernia being down something like 10%. Kind of give us your state of the state in terms of where you are in hernia and kind of the trajectory of adoption relative to some of the historical fast-adopting procedures, if you would.
Yeah. Hernia continues to be encouraging. The rates of both procedure adoption, surgeon retention, and utilization within the existing surgeon population as they continue to do more procedures has been a strong point in the way in which the technology has been adopted. Hernia repair, though, is not one thing. There's a variety of patient subsets within, and variety of different physician perspectives around the value that our technology can bring in the procedure. It's probably not quite like DVP in terms of the way you would think of it as being adopted. Maybe a little more like benign hysterectomy, given the alternative therapies and the heterogeneous landscape out there in terms of how they address these patients.
Okay. Last question from me, I guess, is the question is around the INA. The revenue beat there with the procedures being roughly in line with our target was quite noticeable. Marshall, you did go through some of the math there, but other than stapling and vessel sealing, was there anything in particular in there that caught your attention relative to mix?
Yeah, just kind of giving a little historical perspective. If you look at prior to Q2 of 2016, our INA revenue per procedure has been running within a really tight, narrow range, $1,830-$1,840 per procedure. You probably recall last quarter it actually dropped down to $1,810. We talked about timing of orders being the main factor here. As expected here in Q3, we saw an orders rebound to offset Q2. If you take the average of Q2 and Q3, you're right back at the $1,840, kind of in line with those trends over the past two years. As we said, though, we continue to see increasing utilization of the advanced instruments, including the stapler and vessel sealer.
Moving forward, as we anticipate continued growth in the procedure volumes in colorectal and thoracic surgery, areas where these products are more widely used, we would anticipate a slightly higher contribution to revenue per procedure on an organic consumption model, if you will. It's important to remember that a variety of factors impact revenue per procedure, including the type of procedure performed, the efficiency of use and optimization, use of advanced instruments, stocking orders, timing, and distributors. There's a lot of factors here. As a result, INA can be lumpy, and future trends can be difficult to forecast in the end.
Thank you very much.
Over to the line of Amit Hazan, with Citi.
Thanks. Good afternoon, guys. Let me maybe start with prostate. Just kind of thinking through the trend this year, just going from low double-digit growth in the first quarter for DVP, all the way down to low single digits, it sounds like, for this quarter. It seems like a pretty fast change in what otherwise would seem to me to be something that would be a slower trend line. Any more color you can add as to what's happening now, why it's happening, and maybe more importantly, just the confidence you guys have that this quarter kind of marks that bottom and that incidence rate growth is kind of your right rate of growth for prostate?
Yeah. Hey, Amit. As you know, predicting how the patient treatment trends across prostate cancer in a mature procedure like DVP is difficult. We've highlighted for a period of time the rates of growth that we've seen were not rates of growth that we thought were consistent with the rate of diagnoses. It's hard to say in the quarter or the rate at which we've seen growth change over the course of this year. The specifics behind it, that data typically comes to us years down the road. We feel that what we saw in the quarter is probably more consistent with the rate of diagnoses than perhaps what we've seen over the past handful of quarters.
Okay. Let me move to gynecology. It sounds like there things are still kind of like you described in the first half of the year, maybe slightly better than what we've seen in the past. I don't think we've asked this in a while, so just to throw this question out, just as one possible avenue. Just thinking about outpatient centers, ambulatory surgery centers, to what extent or is there kind of any increase in the success that you're having in being able to place da Vincis in outpatient centers? Is that becoming more of a focus for you at all? Is that at all a part of maybe the slightly better rates of growth we're seeing in gynecology in the U.S.?
Yeah. I think you're connecting two things I'm not quite sure I'd connect. The relative health of the gynecology business seems to me to be driven by a few factors, among them concentration of patients into higher volume surgeons and higher volume centers. Separately, there is a trend toward more outpatient work. We do see utilization of our systems in outpatient environments that tends to be more in existing integrated delivery networks, hospital-owned outpatient departments as part of an integrated plan. It's not something I'd call out as a major trend at this point. I'm not sure that I would quite link it to GYN. It's possible, I think there are a lot of factors there that sorting them is not possible yet.
If you look at GYN overall and you look at the history of benign hysterectomy adoption, the entrance of da Vinci surgery into benign hysterectomy has enabled the majority of patients to now be treated on an outpatient basis. When minimally invasive surgery is adopted with the technology, it will enable hospitals to manage these patients in a more outpatient-oriented way.
Just one last question from me on the systems side. Just thinking through not just the fourth quarter, but just a little bit longer term, maybe call it 2017 if you want. Thinking about the install base, it's been really consistently growing now 10% a year. Almost every quarter it seems like it grows on that 10% rate on an annual basis. Can you maybe just talk through the key drivers and maybe pressure points as we think about that number and the sustainability of that 10% growth in the installed base growth figure as we think through the next year or two?
A couple of the way I think about it, kind of puts and takes. The major factor is anticipated procedure growth by the customer. Customers are making capital placements based on what they think will happen in future procedure trends. That is the biggest driver and where they see growth, I think that they move forward. The places where that can be a little bit different or disconnected is in a very early market where you're just getting started. A new reimbursement clearance or a new quota or a new procedure clearance doesn't follow the more mature trend. Those are the two things that are rolling around. I think the biggest one for us is customer belief in utilization for future procedures is the best predictor of capital.
Thanks, Gary.
Next, we'll go to the line of Rick Wise from Stifel Nicolaus.
Afternoon, everybody. Hi, Gary. Just maybe just coming back to Fosun briefly. Obviously, you have alluded several times to this notion of building out the ecosystem and how important and valuable it is to Intuitive. Are there other similar opportunities to Fosun, whether it be geographic or technology, or is this a direction we should expect Intuitive to push, looking for other technologies to bring into the ecosystem? Is that the right way to think about it?
I think the idea that if there are technologies or other assets that we can bring that we think will increase the value of a robotic surgery program or a minimally invasive surgery program based on computation to one of our customers, is that an opportunity for us? Yes. They tend to develop in time. The underlying catheter-based technologies that we're talking about now, as you know, having followed us for some time, were really first acquired by us years ago. The answer to that is yes, we're out looking. Fosun has been a good partner. They have both a relationship with us through Tyndall, but they also understand the healthcare space extremely well in multiple dimensions. Short answer to that is we've been doing it and expect to continue to do it.
Thanks. A couple more. Just a general question about the general surgery adoption, particularly in the U.S. Maybe just can you talk a little bit more about where we are just in terms of that adoption process? Are these still earnings or early innings rather? Particularly on colorectal, how do you accelerate colorectal adoption? Do we need more clinical data? Can you talk through some of those issues?
Sure. As we've said in the past, adoption is really per procedure, per procedure is really segmented. For example, colorectal is probably really four or five underlying procedures that are a little bit different. Adoption goes quickly when there's a large value, distinct value for the procedure relative to alternatives, and when the procedure is pretty well concentrated in the hands of well-trained surgeons. Take colorectal and separate it a little bit. In the case of rectal cancer, that's a complex set of procedures. Oncologic, of course, in nature has been growing steadily, not a super rapid rise relative to some prior adoptions, but a steady adoption for us. Data collection has been occurring, data publication has been occurring, and we're doing okay there. I think in other parts of colon, sometimes it's for benign, sometimes it's oncology.
Those are typically done by different surgeons, they adopt at a little bit different rates. You look at hernia again, it's sub-segmented. Ventral hernia versus inguinal and sub-segments within inguinal. We look at it, ventral hernia and inguinal hernia as we define the available markets for procedures for which we bring value, have adopted pretty nicely relative to past trends. Rectal has been on a slower adoption, but a steady one, and colon is in the middle.
Just last from me on the procedure side, obviously a lot of moving pieces here. Urology maybe now a little more slow growth now that it's rebounded. Gynecology recovering. General surgery continuing to grow dramatically. When we roll up that math with what we're seeing internationally, should we feel reasonably optimistic that something like mid-teens procedure growth, again, with some variation, is that the right sustainable growth rate from here given the growing installed base, given the geographic penetration, and given the continuing evolution of Intuitive technology? Thanks, Gary.
Yep. We're not ready to give our 2017 forecast yet. We'll see how we close here in the fourth quarter and roll up our estimates and answer that very question in our next call in January.
Thank you.
We'll go to the line of Larry Biegelsen with Wells Fargo.
Good afternoon. Thanks for taking the question. I'm new to these calls, just maybe a couple of basic ones here. SG&A as a percent of sales was relatively low. I apologize if I missed it. Any reason for SG&A to be relatively low this quarter? The R&D spending of about 7% of sales, is that a good rate to use going forward? I had a couple of follow-ups.
There's going to be variability quarter to quarter, lumpiness, if you will, between SG&A and R&D. We've talked a lot about our R&D investments. Gary went through them on the SG&A side. I think we're investing a little heavier disproportionately for international to support the earlier phase growth there. You look at it overall, we're within our guidance range. We refined our full year guidance to that 13%-14%. Again, there'll be some quarter variability, but I think we're tracking to the overall plan.
Larry, given the lumpiness in some of our capital revenue from period to period, we typically talk about operating expenses in terms of growth rates, which Calvin will walk you through.
Got it. Thanks. When we think about the pipeline and potential launches of new products and functionality, should we be expecting any meaningful product introductions either later this year or in 2017, excluding SP?
Well, we've been launching a fair number of instruments and accessories, various things in various markets. We tend to tell you when they come out. We have not tagged a launch date either for SP or other kind of major systems at this time.
All right. Lastly from me, Gary, you talked about the growth you've seen in Hernia, and you talked about ventral and inguinal. Are you seeing anything different in terms of the penetration or ramp in ventral versus inguinal, or are both of them equally strong? Thanks for taking the questions.
It's a good question. I think the dynamics are a little bit different in them, both in terms of procedure complexity and a little bit of practice patterns, so they don't track exactly the same. Having said that, I don't think there's anything about adoption that I'd call out strongly at this time. I think both of them are moving through that first set of adopters, generating additional data. We're seeing more data now generally supportive. It looks pretty good. I think that technique refinement and data generation is what the next round of surgeons rely upon to evaluate, and so we're seeing that kind of transition right now, really in both those Hernia domains. We'll just take one more question for one more caller, please.
Our final question will come from Brandon Henry with RBC Capital Markets.
Thanks for taking my question. Intuitive again posted strong growth in operating margins this quarter. Can you discuss some of the product and cost initiatives that are driving these better margins, and in what inning you're in with some of these cost initiatives? Separately, the company's headcount has increased meaningfully over the last couple of quarters. Can you discuss where you're making the investments in headcount and how much of that increase in headcount can be attributed to the Fosun JV versus some other initiatives? I have a follow-up.
That was two questions already, and I gave you one. I think I'll choose one. We'll go fast. On the first one, in terms of cost reductions, it's a careful and long list of activity that goes on. You shouldn't so much think of it as one thing as it is a routine discipline of scanning through both operating processes and manufacturing processes and parts costs and working them down as they come. You do get the greatest help on those things in the first few years of a platform release, after that, it starts getting increasingly hard. That's not to say that it isn't possible to do it.
In terms of headcount growth, it's a mixture of commercial growth, a little bit more weighted outside the U.S. than U.S., some manufacturing growth to cover volumes of things like instruments and accessories and other things that have been increasing, as well as some design help. The headcount growth as it relates to Fosun, we're not really ready to break out at this time. We have certainly made headcount investments over the last few years into the technologies that have underpinned that relationship. I wouldn't call it out as Fosun just yet. With that, I'll go ahead and close the call, Brandon, we'll catch your next question on the next conference call. 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 organizational 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, 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, we look forward to talking with you again in three months.