Ladies and gentlemen, thank you for standing by and welcome to the Intuitive Surgical First Quarter Earnings Release Call. At this time, all lines are in a listen only mode. Later, there'll be an opportunity for your questions and instructions will be given at that time. And as a reminder, this conference is being recorded. I'll now turn the conference over to a senior director of investor relations for intuitive surgical, Calvin Darling.
Please go ahead sir.
Thank you. Good afternoon, and welcome to Intuitive Surgical's 1st quarter earnings conference call. With me today, we have Gary Guthardt, our President and CEO Marshall Moore, our Chief Financial Officer and Patrick Clingan, Director of Finance. Before we begin, I would like to inform you that comments mentioned on today's call may be deemed to contain forward looking statements through filings, including our most recent Form 10 K filed on February 5 2015. These filings can be 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 first quarter results as described in our press release to now 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 first quarter financial results.
Patrick will discuss marketing and clinical highlights, then I'll provide our updated financial outlook for team. And finally, we will host a question and answer session. With that, I'll turn it over to Gary.
Thank you for joining us on the call today. In the first quarter, we experienced solid growth in procedures, modest system sales growth, and increased pressure on product margins. Starting with procedures, year over year growth in the first quarter was approximately 13%. Growth was led by General Surgery, particularly hernia repair and colon and rectal resections. Early response by surgeons to the use of da Vinci and early datasets in these procedures are very encouraging.
Eurology also continued to show growth maintaining growth rates seen in the fourth quarter. Year over year performance in gynecology grew modestly over Q1 of twenty 14. Procedure outperformance was broad based and included the U. S, Europe and key markets in Asia. Patrick will review procedure trends in greater detail later in the 2014.
Da Vinci XI continues to draw significant interest from our customers. Sales in Europe are historically lumpy and Q1 sales were lower than Q4 due primarily to seasonality. System placements in distributor markets were solid in the quarter. In Japan, da Vinci XI was cleared for sale at the end of Q1. We placed 1 SI system in Japan in Q1 as customers waited to evaluate XI.
We remain focused on supporting Japanese customers and pursuing reimbursement and continue to make progress in data collection and analysis. Turning to costs. Margins decreased relative to prior quarters as a result of 3 main drivers. First, manufacturing costs as a percentage of revenue for aggregated product margins have declined. 2nd, service costs for our XI imaging system have remained higher than we would like as we work new technologies into our supply We are addressing both manufacturing and service costs and will pursue the reduction diligently over the next several quarters.
Finally, the strength of the dollar was a negative in margins. In the first quarter, financial and operational hedges have offset some of the impact of exchange rate although we expect the impact of exchange rates to increase through the year. Marshall will take you through this and other financial performance in greater detail later in the call. In summary, our operating performance for We placed 99 Dementi surgical systems, up from 87 in the first quarter of 2014. Total pro form a revenue for the quarter was 532,000,000 up 9% from prior year and up 11% year over year on a constant currency basis.
Total pro form a instrument and accessory revenue increased $277,000,000, up 8% over prior year. We generated a pro form a operating profit of $185,000,000 in the compared to with $189,000,000 in the first quarter of 2014 and pro form a net income was $135,000,000 compared to $139,000,000 in in Q1 of 2014. In product development, we're rounding out our XI system offering by launching additional under risk instruments developing single site for our Xi system and integrating table motion onto the Xi platform. We expect to submit our 510 for software that enables table motion with our Xi System in the third quarter and the 5 10 K for XI single site instruments in the second half of the year. For da Vinci SP, our dedicated single point of entry architecture Development remains on track with system integration and laboratory testing and process.
I'll now turn the call over to Marshall, who will review our financial performance.
Thank you, Gary. I'll be describing our results on a non GAAP or pro form a basis, which excludes the impact of our exit trading program, legal claim accruals, stock based compensation, amortization of purchased IP and investment impairments. We are providing pro form a information because we believe Net business trends and operating results are easier to understand on a pro form a basis. I will also summarize our GAAP results later in my script. We have posted reconciliations of our pro form a results to our GAAP results on our website so that there is no confusion Pro form a 1st quarter revenue was $532,000,000, an increase of 9% compared with $490,000,000 for the first quarter of 2014 and down 11% from last quarter.
On a constant currency basis, pro form a 1st quarter revenue increased 11% definitely offered a trade out to trade out SI product or Xi product. These trade out offers were either fulfilled or lapsed in 2014. Revenue highlights are as follows. Pro form a instrument and accessory revenue grew 8% compared with the first quarter of 2014 in declined per procedure. The decrease from prior quarter primarily reflects procedure seasonality.
Instrument and accessory revenue realized per procedure in in the first quarter of $3,834 last quarter. The decrease prior relative to the prior year reflects the impact of foreign exchange, lower SI vessel sealer generators and firefly kits, lower instrument usage per case as surge become more efficient in their instrument usage, partially offset by increasing stocking orders. The increase relative to the previous quarter primarily reflects increased stocking orders and customer buying patterns, partially offset by the impact of foreign exchange. Pro form a system revenue of $141,000,000 increased 9% compared with the first quarter of 2014, and decreased 33 increased unit sales, lack seasonality of system sales and lower system sales in Japan as customers anticipated Xi approval. 99 systems replaced in the first quarter compared with 87 systems in the first quarter of 2017 and 137 systems last quarter.
76% of the business placed in the 1st quarter were XIs compared with 71% in the 4th quarter. XI was launched in April of 2014. Globally, our system ASP of $1,480,000 was $1,550,000. Relative to the first quarter of 2014, system ASPs were higher due to the introduction of XI, which was offset by geographic mix a higher SI trade in credit mix in foreign exchange. The decrease in ASPs relative to last quarter reflects higher trading credits and foreign exchange, partially offset by an increased mix of XI product, including XI dual consoles.
Hospitals financed approximately 14% of the systems placed in the first quarter, down from 15% last quarter. 11 systems of which 9 were structured as operating leases. Through the first quarter of 2015, we've entered into 23 operating
In the U.
S, we placed 63 systems in the first quarter compared with 45 systems in the first quarter of 2014 and 71 systems in the fourth quarter of 2014. The increase compared with prior years reflects market acceptance of the II and procedure growth. The decrease compared with the 4th quarter reflects seasonality and system sales. Outside of the U. S, we placed 36 systems in the first quarter compared with 42 in the first quarter of 2014 and 66 systems last quarter.
The reduction in year over year system placements includes a reduction in Japan system placements. One system this quarter compared with 19 systems last quarter as customers anticipated the XI approval. We received XI approval in Japan in late March. Europe system placements grew from 14 systems in 2014 to 18 systems in the first quarter of 2015. We also placed 8 systems in China this year compared with 0 in the first quarter of 2014.
The reduction in system placements relative to the prior quarter reflects seasonality. International revenue results were as follows: 1st quarter pro form a revenue outside the U. S. Was $150,000,000 compared with $155,000,000 for the first quarter of 2014, $197,000,000 last quarter. The decrease compared with the previous year reflects lower Japan system revenue of over $30,000,000 and the impact of foreign exchange, partially offset by higher instrument accessory revenue, reflecting procedure growth and higher system placement into Europe and rest of world markets.
Our lower sequential international revenue primarily reflects seasonality first quarter 2015 OUS procedure volume was approximately 22% higher than the first quarter of 2014, and 12% higher than strong growth in gynecology and general surgery. Before moving on to the remainder of the P and L, I'd like to outline the impact that the strengthening of the dollar has had on our results. We generally hedge a portion of buyers and euros and pay our sales force in local currencies, providing for natural hedges. The pretax impact of currency movement net of hedges relative to impact of lowering our revenue to 9% versus 11% on a constant currency basis. Note that approximately 17% of first quarter 2015 revenue was transacted in other than the U.
S. Dollar, primarily in euro and yen. And natural hedges only partially offset the impact of currency movements on revenues. The impact of of the past year's currency changes will have a more pronounced impact going forward, particularly after our January hedges expire in July Moving to the remainder of the compared with 70.2% in the first quarter of 2014 and 67.1% for the fourth quarter of 2014. Lower margin percentage relative to prior quarters primarily reflect a high mix of XI systems, which have a lower margin than our mature SI products, as well as than our mature products.
We believe our efforts to reduce the cost of these products will begin to deliver limited improvement in our gross margins by the end of this year. And greater improvement in fiscal 2016. The costs associated with the Drape and scope product recalls are not expected to continue. In the first quarter of 2014, we recorded a pre tax charge of $67,000,000 to reflect the estimated costs of settling a number of product liability claims under a tolling agreement. In the 2nd and 4th quarters of 2014, we recorded another $15,000,000 of charges reflecting additional claims.
In the first quarter of 2015, we've refined our estimate of the overall cost of settling claims and recorded $7,000,000 of additional reserves. We will which exclude the reserves for legal claims, stock compensation expense, and amortization of purchased IP were up 6% compared with the first quarter of 2014 and were down 1% compared with last quarter. Our first quarter 20 15 pro form a operating expense compared to the first quarter of 2014 reflects headcount additions and higher incentive compensation. Our pro form a effective tax rate for the first quarter was 28.9 percent compared with an effective tax rate 27% for affected tax years where we have completed our IRS audit or jurisdictions where statute of limitations has now expired. In addition, the 20 of OUS and U.
S. Income and will not reflect a federal research and development credit unless such credit is reinstated. Our pro form a net income was $135,000,000 or $3.57 per share compared with 130 $9,000,000 or $3.54 per share for the first quarter of 2014 $184,000,000 or 4.9 $2 per share for the fourth quarter of 2014. As I indicated earlier, pro form a income provides an easier comparison of our financial results and $1,000,000 for the first quarter of 2015 compared with $465,000,000 for the first quarter of 2014 $605,000,000 for the fourth quarter of 20 14. GAAP net income was $97,000,000 15 compared with $44,000,000 or $1.13 per share for the first quarter of 2014 $147,000,000 or $3.94 per share for the fourth quarter of 2014.
We ended the quarter with cash and investments of $2,700,000,000, up from $2,500,000,000 as of December 31, 2014. The increase primarily driven by cash generated from operations and proceeds from During the quarter, we repurchased 30,000 shares for 15,000,000 at an average price of $4.95 per share. And with that, I'd like turn it over to Patrick Hoog over our sales, marketing, clinical highlights. Thanks, Marshall.
As mentioned earlier, total first quarter year over year procedures grew approximately 13% U. S. Procedures growing approximately 11% and international procedures growing approximately 22%. The meaningful uptick in U. S.
Procedure growth rates during the first quarter was largely due to a return to a more normal Q4 to Q1 transition relative to what we experienced during the first quarter of 2014 U. S. Da Vinci prostatectomy procedure growth experienced in the second half of twenty fourteen continued through the first half of twenty fifteen. Given our high rate of penetration in the U. S.
Prostatectomy market, our DBP volumes are likely to attract overall U. S. Prostatectomy volumes which have improved over the past 3 quarters. Kidney cancer procedures continued to be a solid contributor to our U. S.
Urology procedure growth during the first quarter. In U. S. Gynecology, modest growth returned in Q1 led by benign and malignant hysterectomy. We believe that the modest increase in da Vinci benign hysterectomy volume during the first quarter has more to do with the return to normal seasonality than a change in the trajectory of the total market for benign hysterectomies.
Continue to believe that our high levels of da Vinci penetration for malignant hysterectomy, growth remained consistent in cancer procedures. Moving on to U. S. General surgery, adoption continues to be solid across a broad number of procedures. Colorectal and hernia adoption remains sources strength, while cholecystectomy has continued to decline in the quarter.
During the quarter, there were positive developments supporting the adoption of da Vinci surgery and colorectal resections in her repair. For colorectal resections,
the return of our SI Stapler and launch of
our SI Stapler were positively received by surgeons, with our stapler surgeons are reporting that the improved articulation and stability of the platform enables use deepened the pelvis for rectal resection while improved dexterity is so supporting and evolving technique of intra corporeal enastrophes and right chemical activities. For hernia, the momentum adoption of da Vinci surgery and ventral and inguinal hernia repair continues to build. At the Society of American Gastrointestinal And Endoscopic Surgeons annual meeting, and the global symposium on robotic assisted and minimally invasive hernia repair, surgeons shared case series that showed VINCI surgery contributed to improved and may serve as a tool to expand minimally invasive surgery to a larger population of patients. A number of surgeons have reported that the material operating costs associated with their da Vinci procedures is similar to the costs of laparoscopic procedures, the da Vinci technique can enable substitution of high cost instruments such as tax and balloons. Looking abroad for quarter international procedure growth of approximately 22 percent continued to be led by global adoption of DBP and other urologic procedures, with solid early contributions from psychology and general surgery.
In Asia, DVP adoption in Japan remained a source of strength in the first quarter. The clinical trial to a reimbursement submission for partial nephrectomy completed enrollment and we continue to explore reimbursement pathways for additional procedures. And China's strong initial utilization of the system sold in the second half of twenty fourteen contributed to international procedure growth. In Europe, DBP adoption continued to be the primary driver of procedure growth in the first quarter, with solid contributions from gynecologic oncology and cholera procedures. During the quarter, Doctor.
Inns and colleagues from the Royal Morrison Hospital within the United Kingdom's National Health Service, helped us on the impact Da Vinci Surgery has had on a Gynecologic Oncology service in the Journal of Medical Robotics And Computers in surgery. In a study of 196 radical hysterectomies, the rate of laparotomy decreased from 60% pre dementia to 26% following the adoption of dementia surgery. Clinical outcomes improved as complications in blood loss were reduced and length of stay decreased by 2 days, and average cost per patient decreased by about £1400 or about £1200 when system depreciation was modeled though the author noted that the hospital's existing system had capacity not being consumed by their urologists. In a detailed cost analysis, da Vinci surgery was found to be the least expensive method reported at £7900 versus £12,500 for open surgery and 10,000 pounds for laparoscopic surgery, with the da Vinci surgery costs remaining lowest at £8500 when modeled depreciation was included. These results are similar to papers from the U.
S, Canada and Sweden that report clinical advantages and cost effectiveness of da Vinci surgery for gynecologic oncology. During the quarter, there were several large scale database studies published supporting the role of DaVinci Surgery. 2 studies of interest pertains benign hysterectomy and partial nephrectomy. The first study used the premier database of nearly 300,000 benign hysterectomies from 156 hospitals that adopted da Vinci following FDA clearance for Gynecologic surgery in 2005, published by Doctor. Luciano and colleagues from the hospital of Central Connecticut with support from Intuitive.
The study determined that the rate of minimally invasive surgery increased from 40% to 67% from 2005 to 2010. The increase of minimally invasive surgery came from both the adoption of da Vinci surgery and the expansion of laparoscopy. The profile of the da Vinci cohort was similar to the open cohort with higher comorbidities, larger uterine and a greater rate of morbid obesity than the laparoscopic and vaginal cohort. Despite this more complex patient mix, da Vinci surgery experienced a lower complication rate than open, flat, or vaginal procedures, This lower complication rate was also true during the initial 25 case series of the newly adopting surgeon compared to mature rates of lapar open surgery. Conversion rates were also lower in the da Vinci surgery arm compared to microscopic arm.
While da Vinci procedures took longer than other the other 3 modalities, experienced surgeons were able to similar operative times to laparoscopy. There have been earlier studies published from the premier database that compared to VINCI surgery to laparoscopic procedures within the narrower patient population that is amenable to laparoscopy, but this study showed that da Vinci patient populations were closer and profiled open surgery patients and that da Vinci surgery improved clinical outcomes. The 2nd study analyzed kidney cancer from within the Medicare surveillance, epidemiology and end results database to assess whether access to da Vinci systems enabled greater adherence to surgical society guidelines for partial nephrectomy and the clinical and economic impact of itchy surgery has had on kidney cancer populations. The team of health economist led by Doctor. Chandra from Harvard studied over 27,000 kidney cancer patients treated with a partial with total nephrectamies from 1995 to 2010 and published the results in health affairs.
The authors found that communities that had access to a da Vinci system were consistently more likely to have a higher rate of partial nephrectomies compared to total nephrectomies and then those communities that did not have a da Vinci system. With an average 52% increase in the rate of partial nephrectomy penetration. Patients in these communities experienced lower rates of mortality and renal failure. These improved outcomes led to a 5 year net benefit and quality adjusted life years of about $100,000 for patients. The authors concluded that the benefits of DaVinci Surgery outweighed the costs by a ratio of 5 to 1 from a payer and patient perspective.
Intuitive provided financial support for this study. This concludes my remarks and I thank
you for
your time. I will now turn the
call over to Calvin.
Thank you, Patrick. I will be providing you with 15 procedure growth of 7% to 10% above the approximately 570,000 procedures performed in 2014. Now based upon continued strength full year 2015 procedure growth with an Our full year 2014 pro form a gross profit margin was 68.4 percent of revenue During 2015, at today's exchange rate, we expect the stronger U. S. Dollar will reduce gross profit by about 200 basis points for the year.
Excluding this exchange impact we anticipate our full year 2015 gross profit margin will be roughly flat with 2014 15 as the positive impacts of our product cost reductions take effect. Our actual gross profit margin will vary to quarter depending largely upon product mix, systems production volume, and foreign exchange rates. Turning to operating expenses. On our last call, we forecasted to grow pro form a 2015 operating expenses between 7% 10% above 2014 levels. We now expect to grow operating expenses towards the lower end of this range.
We now dollars in 2015 compared to $180,000,000 to $185,000,000 forecast on our last call and $169,000,000 in 2014. We continue to expect other income, which is comprised mostly of interest income to total between $14,000,000 $16,000,000 in 2015. With regard to income tax, we continue to expect our 2015 pro form a income tax rate to be between 28% 30% of pretax income, depending primarily upon the mix of U. S. And international profits.
This comments.
Star then one on your telephone keypad. Your hear tone indicating you've been placed in queue, and you may remove yourself And our first question will come from Tycho Peterson with JP Morgan. Go ahead, please. Thanks guys.
I just want to start with your view on sustainability of some of the trends you're seeing in hernia. How much do you think is traveling right now, if you kind of go back and compare contrast to your early experience with COLI. How do you think about the trajectory going forward on hernia please?
Yes. Thanks for the question. As I look at, ventral hernia, I think that, you're seeing pretty nice response. The early response from surgeons and the and the data looks looks quite good. I think long term there that that's moving in a positive direction for us.
How big that total market market is still a little bit hard to estimate, but the early returns there look like surgeons are finding value pretty quickly. When you look at inguinal hernia, there are some sub sub segments in that. And so that one that picture is a little more, complicated or a little more nuanced. There are clearly some cases, that are are more complex either because the disease is more advanced or because the patient has comorbidities in which, da Vinci really is delivering value. We're getting a lot of great feedback.
And there are some other procedures that are a little simpler and a little different, where its use may be a little bit, more optional. I think we're gonna have to let that play out. So I think on the inguinal side, there's clearly a segment that matters, and there are some other segments that, maybe less. So and we won't know that for sure until we see a few quarters pass.
Okay. And then as a follow-up, call since we saw the United Policy. Can you maybe just talk around pre authorization and what your discussions with docs are like and how you see that playing out both with United and other private payers?
Yeah. Really speaking to the too soon to make any commentary really in the second quarters. Speaking to the first quarter, it really that set of pre authorizations and conversations is the continuation of a trend. We didn't feel the nature of those conversations really change with our customers. We're tracking it in Q2, and that's something that we can give you more detail on on our next call.
Okay. And then just one last one on DBP. Are you seeing any kind of bounce back around watchful waiting as some of the the patients wrap up?
One of the underlying drivers we think for, return of some strength in DBP in the U. S. Is that that we're seeing some patients come back into surgical options. As falling out of watchful waiting. And you see some patients being diagnosed later as a result of less PSA screening.
So it's a little bit of both of those things I think are contributing to growth. We've seen that stability now for a few quarters in a row and seems to be, seems to be evident.
Okay. Thank you.
Thank you. We'll go next to Bob Hopkins with Bank of America. Go ahead, please.
Hi, thanks and thanks for taking the question. Just wanted to ask a financial question of Marshall on the gross margin side. Because that was the one of the things that stuck out to me in the quarter. I think on the last quarterly call, you suggested that the gross margin for 2015 excluding stock option would be kind of similar to the low 67 levels that you saw exiting 2014. And I know you gave some updated guidance here, but I was just curious if you could, talk about for 2015, what your new guidance implies relative to the old guidance of the low 67s for the full year?
So to be clear, going from, last quarter, you're right. It was at 67.1%. And this quarter, we undershot that. A couple of factors there. One is foreign exchange changed since the time that we gave our original estimates back in January and that has a negative impact on us.
Second thing is as we had some in the quarter, we had some a higher mix of XI systems and XI systems as we've said before have lower margins than our SI systems. And then finally, we had some product call costs that we don't expect to continue, but they they reduced our margin this quarter. As we go forward into the year, what our guidance is really predicting is that we are working hard towards reduction of costs associated with our newer products and it will start to see some benefit from that. Having said that, it takes time and the majority of the benefit from those will really be realized in 2016.
And just to kind of run you through the guidance one more time, Bob. So we kind of took a look at the full year 2014 gross profit margin on a pro form a basis, it was 68.4%. You know, now when you kind of look at the exchange impact of today's exchange rate we think, the impact is roughly 200 basis points to get you back to a constant currency scenario So excluding that, you get to something like 66.4 as the full year rate, as Marshall mentioned, making improvements by quarter as the year goes on as we are implementing some of these cost reduction improvements.
Okay. All right. So for the full year, you think you'll be somewhere around that 664 roughly on the manufacturing costs for XI, originally when you launched it, told us it was a lower margin product, but then you said over time, you thought that the margin on XI could get up and approach some of the, some of the SI levels. I'm just wondering if you can update us on how long you think that will take? And then lastly for me, is, I was just wondering, Gary, if you could comment on a different subject, which is just your confidence in, reimbursement for Japan in 2016.
Any updates there would be appreciated. Thank you.
Going back to the comments on XI. What we've said in the past is that our margins on our newer products and we typically talked about XI stapling feeling. We're lower in the we'll be lower in the early stages of introduction and it will work to reduce those costs of time. We've always provided the caveat that it doesn't necessarily mean you'll get to the same level as our mature products. There highly complex products.
And so it and they add they have added features to them. And so it we never committed that we would get back to that. Having said that, I
think there's room to improve from where we are and we're working hard on those improvements. That's right. On on just turning to hand. We continue to be in full conversation with multiple parties in Japan and supporting them as they pursue reimbursement. Where I'm generally pleased with the direction that the conversations are taking.
We have not received assurance from the surgical societies or from the government that those methods will produce reimbursements in the 2016 timeframe. So remains uncertain. Having said that, I think the work that's being done and the pace of work being done is is appropriate. And, we're, we're, feel like we're doing the right thing.
Great. Thank you very much.
Thank you. Our next question comes from Ben Andrew with William Blair. Please go ahead.
Good afternoon guys. Thanks for taking the questions. A few things. First off, Gary, talk a little bit about your confidence in the procedure growth and what dynamic push it towards the higher end of the newly raised range?
So you're asking kind of hypothetically what would we see happen that would move it toward the top end?
Yes.
Yes. So, I think we're seeing strength in in U. S. General Surgery. So we would expect that to continue.
The strength there is centered on, hernia and, colon rectal. Colon rectal resection the data looks really good. There's a lot of data that's starting to come out. We expect that that will be a vigorous conversation, but the early results seeing, particularly as a result as it relates to the large population of patients who are getting open surgeries looks great. I think that hernia would continue on its growth rate.
It's on a fast growth rate. I think as surgeons find value as those publications come out, I think that would support the higher end. Urology has had some macro environment positives. We would have to see those continue to be at the high end. And then gynecology has stabilized in this quarter, although we think as, as Patrick has described in his prepared remarks, that his direct to me, the fundamentals around his direct to me are are likely staying about same environmentally.
We think that we're really just looking at Q1 over Q1 changes here. So to be on the high end, I think you have to see positive support there. And stabilization of the COLI business.
And then just to kind
of add sorry, Ben, to add the other end of it, what would be the assumptions to get to the low end, probably it would be an assuming a higher degree of payer pushback on some of the benign necologic procedures.
Okay. And then Gary, just one other thing extending off that. What do you think the bottleneck is in general surgery penetration right now that XI availability? Is it surgeon kind of training? And obviously you're working hard on both of those, but where do you think the bottleneck is?
Yeah. I don't think it's, so much a product availability problem. I think that, you can do a lot of, certainly the introductory work on SI systems, for sure, Xi makes a difference in the multi quadrant. And so that's something we're working on. Part of it is, access to training, although I think honestly more of it is going to be surgeon education, surgeons interacting with their peers and looking at the data and the potential benefits.
So some of it is just pure adoption dynamics, peer to peer interaction.
Okay, great. And then maybe a quick one for Marshall. You gave us some good insights in the gross margin trajectory. Where do you think you exit 15 on a gross margin standpoint excluding currency impacts? Thank you.
So I think Calvin's giving you sort of the expectation for the year And of course, given the commentary around that we believe that we'll be able to reduce costs, I would expect that the latter part of the year will be better the earlier part of the year.
Thank you. We now have a question from David Roman with Goldman Sachs. Please go ahead.
Hey there guys. It's actually Chris Hammond in for, for David here. Thank you for taking the questions. So my for my first question, I wanted to circle back to the gross margin conversation. And I understand that there are a number of puts and takes a step back and talk about what your assessment is of the long term trajectory for the gross margin of the businesses.
And primarily I think the, at least it might be the biggest letter was probably around the ASP, both on instruments and for the systems. If I look at this over several years, they tend to be declining and the argument that XI is a greater percentage of that seems to be the way of the future, I guess, and where systems are going. So I just don't understand how we can get back to where that old run rate was? And is there any more color there would be very helpful?
So when you talk about the old run rate, I'm not sure whose period you're speaking about. I think that as we go forward, again, not sound like a broken record, but we'll continue to work down costs associated with the newer products. I think that there are numerous dynamics on a long term basis. So we haven't put out any guidance beyond this year. And the numerous dynamics include over time, we'll see some pressure on capital.
We'll defend what we have in terms of instrument and accessory and recurring revenue margins. We will end And we'll as we expand into, products like stapling and vessel sealing, we'll be taking a greater share of the overall wallet, but likely at a lower margin. So there's things going for us and then there are things that will push back on
Okay. That's helpful. And then just on the OUS side, I know there you talked about the customers waiting in Japan ahead of the X side approval, but now that we're moving past that, is there any incremental color that you could talk about and what the customer reaction has been so far? Is there a more trialing period that has go on or demo period that would make a more meaningful uptick in Japan be pushed out till later in the year? Or is that something that, that we might get expect in the second quarter?
2 dynamics going on with regard to the capital side in Japan. One of them is, feel free to come in and evaluate XI. The evaluation and that's not in hospital that's looking at the product and understanding its differences vis a vis si. Now that's happening now. The interest in it is quite high.
What that looks like in terms of translating that interest into sales. We'll see in future quarters, longer term in terms of building new programs, that really is going to be dependent on the reimbursement conversations that we've been having in this call and prior calls.
Our next question comes from David Lewis with Morgan Stanley. Go ahead please.
Good afternoon. Good afternoon. Gary, just a couple of questions here. I guess, first off, on the hiring, looks like the hiring particular quarter was the strongest we've seen or the highest we've seen in 2 years. I wonder if you could just add, hey, that's accurate, accurate.
Obviously, let me know that would be an embarrassing question. But just in terms of where the hiring is happening, is this U. S. Hiring? Is this OUS hiring?
And specifically, if it's U. S. Which particular procedures is this hiring going to support?
Yes. Just functionally, where the ads remain. You're right. It was 100 and 40 new employees added. We added the quarter with 3118 employees.
I think the majority of the ad, this quarter, we're in the year in the product operations area, specifically in manufacturing, product development and quality groups. Then, some primarily continuing to invest in our international organizations, including Japan and to a much lesser extent, the U. S. Commercial side.
Okay. Very helpful. And then another question I think I asked a couple of quarters ago was about the broader capital environment. I think the question then was based on what we're seeing, you S. Versus OUS, have we reached a point where it's more obvious that future capital growth or net placement growth is going to come outside the U.
S. Versus U S. I think at the time, I think Gary mentioned it wasn't clear where we see. As we take this forward two quarters and a couple of things this quarter, I mean, is it now beginning to become clear that net placement growth is really going to be materially driven outside the U. S.
Versus the U. S. And this particular quarter, that placement growth was a little lighter. And was that just simply driven by Japan and China specifically? Was there any particular region you could call out that would explain the net placement differential.
So those two pieces would be great if you get some color on. Thank you.
Side, I think there were a couple of things in the quarter that were a little more specific to us. On the U. S. Side, we see hospital systems, particularly corporate ownership, optimizing their capital portfolio. It actually makes perfect sense.
And so what they're doing is looking at where they want their systems both within a hospital and between hospitals that they own. We support them in doing that. And that, I think, will drive capacity consumption. And so on those bigger customers, they're doing that and we see that. That's not new for the quarter.
We've seen that for the last few, but I expect that trend to continue. For sure you saw a difference in Japan. I think a year ago in Japan, Marshall, the number was 19, down to 1. So that, that had to do with the things we had talked about prior about Japan, both, reimbursement and timing of XI. I think that, the real question becomes the answer to your question is going to come down to, available capacity on systems and existing customers.
How hard can they push capacity utilization before they need additional systems? We have a pretty good read on that for single hospitals. What changes the dynamic is, corporate owned hospital groups. Where they're willing to either move doctors, move patients or move systems to get higher utilization. And that part is not yet clear where that will settle.
Thank you. Our next question is from Tayo Levy with Wedbush. Go ahead please.
Great. Thanks. So a quick question on the gross margin side. So you've I understand you brought in house some manufacturing that you were outsourcing before. Does that have an pack sort of a negative near term impact on X-five manufacturing costs and we expect that to improve you get better experience at some of that?
A couple of things there. One is we've, periodically both in source and outsource. I wouldn't I wouldn't tag one particular thing as the general trend here. In terms of excise cost reductions, the, the, the work that we're doing tends the, a fair number of little things. It's it's not one big activity that that does the trick.
It's really, optimizing both, component manufacturing, looking at manufacturing yields in various parts of the of the line and working with suppliers who have better processes. So it's it's a lot of little work and I wouldn't tag it to one thing in particular. On the service side, some of it is really getting to utilization of our products and what service costs are both in terms of building out the field replace able units in the field. So there's some investments to make that happen as well as optimizing kind of the ruggedness of some products in some environments. And so we're those that's the main focus on on that product side.
As Marshall said, we expect the instruments and accessories side, to reach to recover our margin quickly. We think the system side will be a little slower.
Okay. And sort of on the hysterectomy front, any update on the uptake of single site hysterectomy with the wristed articulation and also to tag on to that. And you said year over year, the comps were easy in his direct. What about quarter over quarter? Anything there that might give you some comfort that misdirecting might, might be a little bit better than you're alluding to.
Yeah. Thanks for the question, Tayo. When you look at the single site, it's been the wrist and needle driver has been well received by the Gynecologic surgery community. Reinstalling a risk on the single side platform enables them to do more of the reconstruction that they're used to when they do a whole pipe for da Vinci hysterected me. So it's been well received.
It's still very early days and we'll see where it goes from here. Specific to sorry, what was your other question?
It's looking at hysterectomy quarter over quarter instead of year over year with the com.
Yes, I think when you look at the GYN space and some of the other benign procedures, this quarter looked a lot more like traditional Q4 to Q1 transitions. Relative to what we experienced in 2014.
Okay,
great. And then just lastly, any reason why, you're seeing lower vessel sealer usage? I would assume that would have
gone up. Just a point of clarity. Calvin, go ahead.
No, I think in general, we are seeing increased vessel sealer utilization in the field for what you're seeing less of are those initial orders of the vessel sealers and the generator products that are part of that initial sale. A bolus of hospitals have now made those investments, and that happened to run through our accessory line. Also, the
That's right.
The generator is integrated into the exercise. They don't have to do a separate purchase.
Okay. Perfect. Great.
Thank you.
Thank you. Our next question is from Larry Cooch with Raymond James. Please go ahead.
Good afternoon. Thanks. Gary or any of the team. I'm wondering if you could speak a little bit to Coley's. You did indicate that that again you saw those procedures decline.
I think in the past, you sort of talked about, surgeons making decisions on what procedures should be done and perhaps coldly falls to the bottom when you're looking at other general surgical procedures. So just wanted to see if you've gotten any further insights to why that procedure set appears to be declining?
I think our commentary is similar to what we had talked about last quarter. Given the choice for competitive, block time on on one of our systems. If they can trade it off between hernia procedure or colorectal procedure or Techme. COLI tends to be a lower priority. We, we see, surgeons and patients who are delighted with the results, and who are committed to it.
And we see some folks who, they have a barrier we'll switch to a different approach. And if there's a barrier having to do with machine access or there's a barrier with or times or other approaches. So how big that market ultimately is and what it does as capacity settles out remains to be seen.
Okay. But you're not seeing any specific issues with the procedure itself, I take it.
No, we haven't seen anything that would indicate that clinically there's something going on that that's changing folks' view.
Okay. And then I'm wondering, Gary, if you could talk a little bit about China, which is just a market that you started to speak to in the last couple of quarters. Maybe help us understand sort of where we are within that market, what needs to happen to further develop it and, maybe how we should think about the potential adoption of this technology over there?
Sure. Clearly, We were in early innings here in China. The the response we're seeing both in terms of capital and then the utilization really has to do with release of our government quota a few quarters ago. And now the placement of those systems is there, is that meeting that quota capital sales are still, paced in terms of the civilian market through a quota system. And so that'll be a limiting, a limiting step on growth over time.
Having said that, once they're placed, the utilization is coming up and the level of excitement and interest, on the part of surgeons is high. We're currently, partnered with a distributor in China. I think that as we look out long term in years and our quarters, clearly there opportunity there. And, there'll be some build out of organizational strength required on both sides for for that market to really reach its full potential. And it's something of course that we're taking about.
Okay. And then then lastly, there for Marshall Calvin. Calvin, in your guidance, you indicated on operating expense if I got this correctly, that you now anticipate those expenses to grow at the lower end of the 7% to 10% range It wasn't clear to me why those expenses now are anticipated to go slow than they had been a quarter ago? Yes.
I mean, there's a certain element of timing in terms of new hires and programs, but I think really the exchange impact that we've been talking about terms of its impact on revenue and margin has an effect of reducing the expenses in U. S. Dollar terms and it's largely down you're seeing?
No holding back on the programs. No. Okay. Thank you.
Thank you. We now have a question from Imran Zafar with Jefferies. Go ahead please.
Hi, good afternoon. Thank you for taking my question. I wanted to ask you about where penetration stands in some of the developed markets like Western Europe and maybe Korea. In DVP and I guess also DVAs just in terms of where penetration is and what the how much runway lies ahead in terms of, growth opportunity going forward?
As you look out at Europe, take it country by country, generally, we're at healthy, penetration, but below half in most of the big markets in Europe. So, Germany, Italy, France, probably highest in the Nordics. And then in UK. So we think there's there's a significant room both in DBP and partial nephrectomy. Hysterectomy will really be anchored on his direct me from malignant conditions.
I think we're just in the beginnings of his direct me from malignant conditions in we're seeing some nice early uptake and some nice early work, but but you're probably still in single digits for the most part.
Burn like the Nordic Countries and growing quickly in the U. K.
Korea is a similar I think a similar picture, DVP again in double digits, probably not quite half. And likewise, early days in DvH4 malignant conditions of partial nephrectomy in between those two.
Yeah. One thing that's interesting, Imran, last year, for 2014, we did about 60,000 prostasies in the United States. If you look at the international market all in, it was 65,000 with a lot of room to grow as was described.
And then lastly, I was wondering if you had any more updates on the SP in terms of timing, where you are vis a vis instrumentation and things like that.
Yep. So we were re recall we were working through 2 things. 1 is making the computational platform and the software compatible with XI and, we're on track doing that. And the second thing has been getting the supply chain and costs, in line for the instrumentation on the technical side, and that's also on track. As those things come together, then we start doing laboratory testing, some in house customer evaluation and the beginnings of regulatory testing and the building of those dossiers, which is really what's set for the back half of the year.
So, so far, we're pleased with where we are.
Okay. And not to beat the gross margin dead horse even more, but the SP launch plan that is all into your commentary about, potentially improving gross margin next year?
Well, we haven't tagged a launch date on SP nora. We tag pricing yet. So we're really the commentary is really ex SP without it. Yes.
Okay, great. Thank you very much.
Thank you. We now have a question from Richard Noitter with Leerink Swan. I'm go ahead, please.
Hi. Thanks. For squeezing me in. Just to follow-up on that last question on the gross margin and SP. When SP does actually come to market.
Is that something where we should maybe expect for kind of an incremental gross margin drag until you get up to kind of economies of scale on that?
Yeah. Generally speaking, just sort of some context system gross margins. These systems when they come out relative to industrial products are very low volume compared to anything you're used to in your day to day life compared to cars or cell phones or anything like that, these are really low volume. So, part of the reason that go through a process of optimization over a couple of years is that it takes that long to get through the volume changes that you need to make, and also to do some of the manufacturing optimizations. Just can't not possible to do it on very low volumes ahead of time.
So it is generally, expect that you'll have a margin hit when one of the new pieces of capital come in. And so we would expect some. Now we'll manage that both the work pre work we do and how we price when SP comes out, but we're premature for that in the forecast.
Okay. And then just one more on gross margin. You're saying all else equal improvement in 2016. Is that the improvement off of the 2015 level that you kind of alluded to in that 66.4% range. Is that the right kind of benchmark to think of improvement off of?
Yes. That's exactly what the guidance was.
Okay. Thank you. And then Gary, just one last one. Now that we're a few quarters into the XI launch, just wondering where you're seeing XI being used in the field. Are you surprised by kind of the types of procedures that's being used in?
Are there is there anything worth calling out or telling us with respect to kind of where it's being used that maybe you wouldn't expect it to be used in or certain types of physicians gravitating towards it for certain types of procedures?
You know, in the places that we designed it for, I think we're really feeling like it's meeting our expectations that it looks really good. I you know, multi quadrant surgery, colorectal surgery, we expected it to set up really well thoracic surgery and it is. If we've been surprised, it's been positive surprises. We've seen, urologists, appreciate what it can do. Folks doing ventral hernia find the flexibility of it set up is helpful for them.
And, do you want oncologist find the range of motion helpful. So that has been a pleasant surprise, is there interest in using it and the benefit that it brings them. Well, thank you. 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 patient value by improving surgical outcomes, and reducing surgical trauma through products that our surgeons use.
We have built our company to take surgery beyond the limits of the human hand, and I assure you that we remain committed to driving the 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
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