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. If you should require assistance during the call, please press star then zero, and as a reminder, this conference is being recorded. I'll now turn the conference over to Senior Director of Investor Relations for Intuitive Surgical, Calvin Darling. Please go ahead, sir.
Thank you. Good afternoon, and welcome to Intuitive Surgical's first quarter earnings conference call. With me today, we have Gary Guthart, our President and CEO, Marshall Mohr, 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. Filings, including our most recent Form 10-K, filed on February 5, 2015. These filings can be found through our website or at the SEC's EDGAR database. Prospective investors are cautioned not to place undue reliance on such forward-looking statements. Please note that this conference call will be available for audio replay on our website at intuitivesurgical.com on the audio archive section under our investor relations page. In addition, today's press release and supplementary financial data tables have been posted to our website.
Today's format will consist of providing you with highlights of our first 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 first quarter financial results. Patrick will discuss marketing and clinical highlights. I'll provide our updated financial outlook for 2015. 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 data sets in these procedures are very encouraging. Urology also continued to show growth, maintaining growth rates seen in the fourth quarter. Year-over-year performance in gynecology grew modestly over Q1 of 2014. 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 call.
Looking at trends in capital sales for the year, we placed 99 systems in the quarter compared to 87 in the first quarter of 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 one 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 three main drivers.
First, manufacturing costs as a percentage of revenue for our new system and advanced instruments remain higher than our more mature products. As these new products make up a greater percentage of our sales, our aggregated product margins have declined. Second, service costs for our Xi imaging system have remained higher than we would like as we work new technologies into our supply chain. We are addressing both manufacturing and service costs and will pursue their 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 rates, 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 the first quarter is as follows. Procedures grew 13% over the first quarter of last year. We placed 99 da Vinci surgical systems, up from 87 in the first quarter of 2014. Total pro forma revenue for the quarter was $532 million, up 9% from prior year and up 11% year-over-year on a constant currency basis. Total pro forma instrument and accessory revenue increased to $277 million, up 8% over prior year. We generated a pro forma operating profit of $185 million in the quarter, compared with $189 million in the first quarter of 2014. Pro forma net income was $135 million, compared to $139 in Q1 of 2014.
In product development, we're rounding out our Xi system offering by launching additional EndoWrist instruments, developing Single-Site for our Xi system, and integrating table motion onto the Xi platform. We expect to submit our 510(k) for software that enables table motion with our Xi system in the third quarter and the 510(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 in process. I'll now turn the call over to Marshall, who will review our financial performance.
Thank you, Gary. I will be describing our results on a non-GAAP or pro forma basis, which excludes the impact of our Xi trade-in program, legal claim accruals, stock-based compensation, amortization of purchased IP, and investment impairment. We are providing 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. Pro forma first quarter revenue was $532 million, an increase of 9% compared with $490 million for the first quarter of 2014, and down 11% from last quarter. On a constant currency basis, pro forma first quarter revenue increased 11% over the prior year.
First quarter 2014 pro forma revenue includes revenue for systems where we subsequently offered a trade-out to trade-out Si product for Xi product. These trade-out offers were either fulfilled or lapsed in 2014. Revenue highlights are as follows. Pro forma instrument and accessory revenue grew 8% compared with the first quarter of 2014 and declined 1% compared with the fourth quarter of 2014. The increase relative to the prior year reflects procedure growth, partially offset by lower instrument and accessory revenue per procedure. The decrease from the prior quarter primarily reflects procedure seasonality. Instrument and accessory revenue realized per procedure, including initial stocking orders, was approximately $1,840 per procedure, compared with $1,930 in the first quarter of 2014 and $1,820 last quarter.
The decrease 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 surgeons 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 forma system revenue of $141 million increased 9% compared with the first quarter of 2014 and decreased 33% compared with the fourth quarter of 2014. The increase relative to the prior year reflects increased unit sales, partially offset by the impact of foreign exchange. The decrease in systems revenue compared with the fourth quarter primarily reflects seasonality of system sales and lower system sales in Japan as customers anticipated Xi approval.
99 systems were placed in the first quarter compared with 87 systems in the first quarter of 2014 and 137 systems last quarter. 76% of systems placed in the first quarter were Xis, compared with 71% in the fourth quarter. Xi was launched in April of 2014. Globally, our system ASP of $1,480,000 was approximately the same as the first quarter of last year and decreased relative to last quarter ASP of $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, and foreign exchange. The decrease in ASPs relative to last quarter reflects higher trade-in 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. We directly financed 11 systems, of which nine were structured as operating leases. Through the first quarter of 2015, we've entered into 23 operating leases. 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 Xi and procedure growth. The decrease compared with the fourth quarter reflects seasonality in 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 eight systems in China this year, compared with zero in the first quarter of 2014. The reduction in system placements relative to the prior quarter reflects seasonality. International revenue results were as follows. First quarter pro forma revenue outside the U.S. was $150 million, compared with $155 million for the first quarter of 2014 and $197 million last quarter. The decrease compared with the previous year reflects lower Japan system revenue of over $30 million and the impact of foreign exchange, partially offset by higher instrument and accessory revenue reflecting procedure growth and higher system placements in the 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 the fourth quarter of 2014. Procedure growth was led by DVP, but also reflected strong growth in gynecology and general surgery. Before moving on to the remainder of the P&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 our expected revenue for six-month periods at the beginning of January and July. In addition, we purchase system components from suppliers in euros and pay our sales force in local currencies, providing for natural hedges. The pre-tax impact of currency movement, net of hedges, relative to the fourth quarter, was less than $1 million.
Relative to the first quarter of 2014, currency movements had the impact of lowering our revenue to 9% versus 11% on a constant currency basis. Note that approximately 17% of our first quarter 2015 revenue was transacted in other than U.S. dollar, primarily in euro and yen, and natural hedges only partially offset the impact of currency movements on revenues. The impact 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 P&L. Pro forma gross margin for the first quarter of 2015 was 65.6%, compared with 70.2% in the first quarter of 2014, and 67.1% for the fourth quarter of 2014.
Our 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 costs associated with our drape and scope recalls. New products like Xi and stapling have lower gross margins early in their life cycle 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 million to reflect the estimated costs of settling a number of product liability claims under a tolling agreement.
In the second and fourth quarters of 2014, we recorded another $15 million of charges reflecting additional claims. In the first quarter of 2015, we refined our estimate of the overall cost of settling claims and recorded $7 million of additional reserves. We will continue to refine our estimates as we proceed through the negotiation process. Pro forma operating expenses, 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 2015 pro forma operating expense compared to the first quarter of 2014 reflects headcount additions and higher incentive compensation. Our pro forma effective tax rate for the first quarter was 28.9%, compared with an effective tax rate of 27% for all of 2014.
The pro forma effective tax rate for 2014 benefited from the release of reserves specific to tax years where we have completed our IRS audit or jurisdictions where statute of limitations has now expired. In addition, the 2014 rate benefited from the reinstatement of the federal research and development credit. Our tax rate will fluctuate with changes in the mix of OUS and U.S. income and will not reflect a federal research and development credit unless such credit is reinstated. Our pro forma net income was $135 million, or $3.57 per share, compared with $139 million, or $3.54 per share for the first quarter of 2014, and $184 million or $4.92 per share for the fourth quarter of 2014. 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 revenue was $532 million for the first quarter of 2015, compared with $465 million for the first quarter of 2014 and $605 million for the fourth quarter of 2014. GAAP net income was $97 million, or $2.57 per share for the first quarter of 2015, compared with $44 million, or $1.13 per share for the first quarter of 2014, and $147 million, or $3.94 per share for the fourth quarter of 2014. We ended the quarter with cash and investments of $2.7 billion, up from $2.5 billion as of December 31st, 2014. The increase was primarily driven by cash generated from operations and proceeds from stock option exercises, partially offset by stock buybacks. During the quarter, we repurchased 30,000 shares for $15 million at an average price of $495 per share.
I'd like to turn it over to Patrick, who will go over our sales, marketing, and clinical highlights.
Thanks, Marshall. As mentioned earlier, total first quarter year-over-year procedures grew approximately 13%, with 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 2014 continued through the first half of 2015. Given our high rate of penetration in the U.S. prostatectomy market, our DVP volumes are likely to track to overall U.S. prostatectomy volumes, which have improved over the past three 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 hysterectomies.
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. We continue to believe that our procedure volumes are likely to track to the overall benign hysterectomy market, estimated to be declining at a low single-digit rate. Despite the 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 a source of strength, while cholecystectomies continued to decline in the quarter. During the quarter, there were positive developments supporting the adoption of da Vinci surgery in colorectal resections and hernia repair.
For colorectal resections, the return of our Si stapler and launch of our Xi stapler were positively received by surgeons. With our stapler, surgeons are reporting that the improved articulation and stability of the platform enables use deep in the pelvis for rectal resections, while improved dexterity is supporting an evolving technique of intracorporeal anastomoses in right hemicolectomies. For hernia, the momentum behind adoption of da Vinci surgery in 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 show da Vinci surgery contributed to improved clinical outcomes within their practice 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, as da Vinci technique can enable substitution of high-cost instruments such as tacks and balloons. Looking abroad, first quarter international procedure growth of approximately 22% continued to be led by global adoption of DVP and other urologic procedures, with solid early contributions from gynecology and general surgery. In Asia, DVP adoption in Japan remained a source of strength in the first quarter. The clinical trial to support a reimbursement submission for partial nephrectomy completed enrollment, and we continue to explore reimbursement pathways for additional procedures. In China, strong initial utilization of the system sold in the second half of 2014 contributed to international procedure growth.
In Europe, DVP adoption continued to be the primary driver of procedure growth in the first quarter, with solid contributions from gynecologic oncology and colorectal procedures. During the quarter, Dr. Ind and colleagues from the Royal Marsden Hospital within the United Kingdom's National Health Service published on the impact da Vinci surgery has had on a gynecologic oncology service in the Journal of Medical Robotics and Computer Assisted Surgery. In a study of 196 radical hysterectomies, the rate of laparotomy decreased from 60% pre-da Vinci to 26% following the adoption of da Vinci surgery. Clinical outcomes improved as complications and blood loss were reduced and length of stay decreased by two days. An average cost per patient decreased by about GBP 1,400 or about GBP 1,200 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 GBP 7,900 versus GBP 12,500 for open surgery and GBP 10,000 for laparoscopic surgery, with the da Vinci surgery cost remaining lowest at GBP 8,500 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 da Vinci surgery. Two studies of interest pertain to 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 Dr. 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 patient cohort was similar to the open cohort, with higher comorbidities, larger uteri, and a greater rate of morbid obesity than the laparoscopic and vaginal cohorts. Despite this more complex patient mix, da Vinci surgery experienced a lower complication rate than open, lap, 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 lap or open surgery. Conversion rates were also lower in the da Vinci surgery arm compared to the laparoscopic arm.
While da Vinci procedures took longer than the other three modalities, experienced surgeons were able to achieve similar operative times to laparoscopy. There have been earlier studies published from the Premier database that compare da Vinci surgery to laparoscopic procedures within the narrower patient population that is amenable to laparoscopy. This study showed that da Vinci patient populations were closer in profile to open surgery patients and that da Vinci surgery improved clinical outcomes. The second 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 da Vinci surgery has had on kidney cancer populations.
A team of health economists led by Dr. Chandra from Harvard studied over 27,000 kidney cancer patients treated with partial and total nephrectomies 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 than 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 five-year net benefit in quality adjusted life years of about $100,000 per patient. The authors concluded that the benefits of da Vinci 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 our updated financial outlook for 2015. Starting with procedures. On our last call, we estimated full-year 2015 procedure growth of 7%-10% above the approximately 570,000 procedures performed in 2014. Now, based upon continued strength in U.S. general surgery procedures, particularly hernia repair, favorable DVP macro trends, and solid international procedure growth, we are increasing our estimate for 2015. We now anticipate full-year 2015 procedure growth within a range of 8%-11%. Turning to gross profit. Our full-year 2014 pro forma gross profit margin was 68.4% 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 on a constant currency basis.
We expect gross margin to increase by quarter in 2015 as the positive impacts of our product cost reductions take effect. Our actual gross profit margin will vary quarter 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 forma 2015 operating expenses between 7% and 10% above 2014 levels. We now expect to grow operating expenses towards the lower end of this range. We now expect our non-cash stock compensation expense to range between $170 million and $180 million in 2015, compared to $180 million-$185 million forecast on our last call and $169 million in 2014. We continue to expect other income, which is comprised mostly of interest income, to total between $14 million and $16 million in 2015.
With regard to income tax, we continue to expect our 2015 pro forma income tax rate to be between 28% and 30% of pre-tax income, depending primarily upon the mix of U.S. and international profits. This forecast does not assume the reinstatement of the R&D tax credit in 2015. That concludes our prepared comments. We will now open the call to your questions. Operator?
Ladies and gentlemen, if you'd like to ask a question, please press star then one on your telephone keypad. You'll hear a tone indicating you've been placed in queue, and you may remove yourself from the queue at any time by pressing the pound key. Once again, press star one if you have a question. Our first question will come from Tycho Peterson with J.P. Morgan. Go ahead, please.
Thanks, guys. I just want to start with your view on the sustainability of some of the trends you're seeing in hernia. How much do you think is trialing right now? If you go back and compare and contrast to your early experience with chole, how do you think about the trajectory going forward on hernia specifically?
Yeah, thanks for the question. As I look at ventral hernia, I think that you're seeing a pretty nice response. The early response from surgeons and the data looks quite good. I think long term there, that's moving in a positive direction for us. How big that total 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-segments in that. That picture is a little more complicated, a little more nuanced. There are clearly some cases that are more complex, either because the disease is more advanced or because the patient has comorbidities in which da Vinci really is delivering value, and we're getting a lot of great feedback.
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 going to have to let that play out. I think on the inguinal side, there's clearly a segment that matters, and there are some other segments that may be less so, and we won't know that for sure until we see a few quarters pass.
Okay. As a follow-up, since this is the first call since we saw the UnitedHealthcare 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 UnitedHealthcare and other private payers?
Yeah, it's too soon to make any commentary really in the second quarters. Speaking to the first quarter, 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, that's something that we can give you more detail on our next call.
Okay. Just one last one on DVP. Are you seeing any kind of bounce back around watchful waiting as some of the older patients drop out?
One of the underlying drivers we think for a return of some strength in DVP in the U.S. is 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. 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 evident.
Okay. Thank you.
Thank you. We'll go next to Bob Hopkins with Bank of America. Go ahead, please.
Hi, thanks for taking the question. Just wanted to ask a financial question of Marshall on the gross margin side, because that was 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. 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.
To be clear, going from last quarter, you're right, it was at 67.1, and this quarter, we undershot that. 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. The second thing is, we had some, in the quarter, we had a higher mix of Xi systems, and Xi systems, as we've said before, have lower margins than our Si systems. Finally, we had some product recall costs that we don't expect to continue, but 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. We'll start to see some benefit from that.
Having said that, it takes time, and the majority of the benefit from those efforts will really be realized in 2016.
Just to kind of run you through the guidance one more time, Bob. We kind of took a look at the full year 2014 gross profit margin on a pro forma basis, it was 68.4%. When you kind of look at the exchange impact at today's exchange rates, we think the impact is roughly 200 basis points to get you back to a constant currency scenario. 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. For the full year, you think you'll be somewhere around that 66.4 roughly. On the manufacturing costs for Xi, originally when you launched it, you 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 Si levels. I'm just wondering if you can update us on how long you think that will take. 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 and vessel sealing, will be lower in the early stages of introduction, and it will work to reduce those costs over time. We've always provided the caveat that it doesn't necessarily mean they'll get to the same level as our mature products. They're highly complex products, and they have added features to them. We never committed that we would get back to that. Having said that, I think that there's room to improve from where we are, and we're working hard on those improvements.
That's right. On just turning to Japan, we continue to be in full conversation with multiple parties in Japan and supporting them as they pursue reimbursement. 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. That remains uncertain. Having said that, I think the work that's being done and the pace of work being done is appropriate, and we feel like we're doing the right thing.
Great. Thank you very much.
Thank you. Our next question comes from Benjamin Andrew with William Blair. Please go ahead.
Good afternoon, guys. Thanks for taking the questions. Few things. First off, Gary, talk a little bit about your confidence in the procedure growth and what dynamics push you towards the higher end of the newly raised range.
You're asking kind of hypothetically, what would we see happen that would move it toward the top end?
Yes.
I think we're seeing strength in U.S. general surgery, so we would expect that to continue. The strength there is centered on hernia and colon and rectal. Colon rectal resections, 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 we're seeing, particularly 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. Gynecology has stabilized in this quarter.
Although we think, as Patrick has described in his prepared remarks, that the fundamentals around hysterectomy are likely staying about the same environmentally. We think that we're really just looking at Q1-over-Q1 changes here. To be on the high end, I think you have to see positive support there and a stabilization of the chole business.
Just to 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 assuming a higher degree of payer pushback on some of the benign gynecologic procedures.
Okay. Gary, just one other thing extending off that, what do you think the bottleneck is in general surgery penetration right now? Is it Xi availability? Is it surgeon training? Obviously, you're working hard on both of those, where do you think the bottleneck is?
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, 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. Some of it is just pure adoption dynamics, peer-to-peer interaction.
Okay, great. Maybe a quick one for Marshall. You gave us some good insights on the gross margin trajectory. Where do you think you exit 2015 on a gross margin standpoint excluding currency impacts? Thank you.
I think Calvin's given you sort of the expectation for the year, and of course, given the commentary around it, we'll be able to reduce costs. I would expect that the latter part of the year will be better than the earlier part of the year.
Great. Thanks, guys.
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 David here. Thank you for taking the questions. For my first question, I wanted to circle back to the gross margin conversation. I understand that there are a number of puts and takes in the quarter, whether that's FX or recall costs, et cetera. I was hoping that we could just kind of take a step back and talk about what your assessment is of the long-term trajectory for the gross margin of the businesses. Primarily, I think the, at least in my view, the biggest lever 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. The argument that Xi is a greater percentage of mix, that seems to be the way of the future, I guess, in where systems are going. I just don't understand how we can get back to where that old run rate was. Any more color there would be very helpful.
When you talk about the old run rate, I'm not sure which period you're speaking about. I think that as we go forward, again, not to sound like a broken record, we'll continue to work on costs associated with the newer products. I think that there are numerous dynamics on a long-term basis. We haven't put out any guidance beyond this year. 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. As we expand into products like stapling and Vessel Sealer, we'll be taking a greater share of the overall wallet, but likely at a lower margin. There's things going for us, then there are things that will push back on us.
Okay, that's helpful. Then just on the OUS side, I know there you talked about the customers waiting in Japan ahead of the Xi approval. 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 to go on or demo period that would make a more meaningful uptick in Japan be pushed out till later in the year? Is that something that we might could expect in the second quarter?
Two dynamics going on with regard to the capital side in Japan. One of them is folks are going to come in and evaluate Xi. That's not in-hospital. That's looking at the product and understanding its differences vis-à-vis Si. 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.
Okay, great. Thanks, guys.
Thank you. Our next question comes from David Lewis with Morgan Stanley. Go ahead, please.
Good afternoon.
Good afternoon.
Gary, just a couple questions here. I guess, first off on hiring. Looks like the hiring this particular quarter was the strongest we've seen or the highest we've seen in two years. I wonder if you just could, A, if that's accurate, but if it's not accurate, obviously let me know, that would be an embarrassing question. Just in terms of where the hiring is happening, is this U.S. hiring? Is this OUS hiring? Specifically, if it's U.S., which particular procedures is this hiring going to support?
Just functionally, where the adds remain, you're right, it was 140 new employees added. We added the quarter with 3,118 employees. I think a majority of the adds this quarter were in the product operations area, specifically in manufacturing, product development, and quality groups. Secondarily, continuing to invest in our international organizations, including Japan, and to a much lesser extent, the U.S. commercial side.
Okay. Very helpful. Another question I think I asked a couple of quarter ago was about the broader capital environment. I think the question then was based on what we're seeing U.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 you take this forward two quarters and a couple things this quarter, 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.? In this particular quarter, net placement growth was a little lighter. 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? Those two pieces would be great if we get some color on. Thank you.
Yeah. On the capital side, I think there were a couple 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, 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. That, I think, will drive capacity consumption. 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 one.
That has to do with the things we had talked about prior about Japan, both reimbursement and timing of Xi. I think that 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. That part is not yet clear where that will settle.
Okay. Thank you so much.
Thank you. Our next question is from Tao Levy with Wedbush. Go ahead, please.
Great. Thanks. A quick question on the gross margin side. My understanding is you brought in-house some manufacturing that you were outsourcing before. Did that have an impact, sort of a negative near term impact on Xi manufacturing costs? You expect that to improve as you get better experience at some of that?
A couple of things there. One is we periodically both insource and outsource. I wouldn't tag one particular thing as the general trend here. In terms of Xi cost reductions, the work that we're doing tends to be a fair number of little things. It's not one big activity that does the trick. It's really optimizing both component manufacturing, looking at manufacturing yields in various parts of the line, and working with suppliers who have better processes. 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 replaceable 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.
That's the main focus on that product side. As Marshall said, we expect the instruments and accessories side to recover margin quickly. We think the systems side will be a little slower.
Okay. Sort of on the hysterectomy front, any update on the uptake of Single-Site hysterectomy with the wristed articulation? Also just to tag onto that, you said, year-over-year, the comps were easy in hysterectomy. What about quarter-over-quarter? Anything there that might give you some comfort that hysterectomy might be a little bit better than you're alluding to?
Yeah. Thanks for the question, Tao. When you look at the Single-Site, the wristed needle driver has been well received by the gynecologic surgery community. Reinstalling a wrist on the Single-Site platform enables them to do more of the reconstruction that they're used to when they do a multi-port da Vinci hysterectomy. 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 easy comps.
Yeah. 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. Then just lastly, any reason why you're seeing lower Vessel Sealer usage? I would've assumed that would've 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. 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 happens right through our accessory line.
Also the-
Yeah.
That's right.
The generator is integrated into the Xi. You don't have to do a separate purchase.
Okay, perfect. Great. Thank you.
Okay.
Thank you. Our next question is from Larry Keusch 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 chole. You did indicate 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 chole falls to the bottom when you're looking at other general surgical procedures. Just wanted to see if you got any further insights into 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 one of our systems, if they can trade it off between a hernia procedure or a colorectal procedure or a prostatectomy, chole tends to be a lower priority. We see surgeons and patients who are delighted with the results, and who are committed to it, and we see some folks who, if they have a barrier, will 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. How big that market ultimately is and what it does as capacity settles out remains to be seen.
Okay. 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's changing folks' view.
Okay. 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're in early innings here in China. The response we're seeing both in terms of capital and then the utilization really has to do with the release of a government quota a few quarters ago. Now the placement of those systems is they're meeting that quota. Capital sales are still paced in terms of the civilian market through a quota system. That'll be 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, not quarters, clearly there's an opportunity there. There'll be some build-out of organizational strength required on both sides for that market to really reach its full potential. It's something, of course, that we're thinking about.
Okay, lastly there for Marshall or Calvin. Calvin, in your guidance, you indicated on operating expenses, if I got this correctly, that you now anticipate those expenses to grow at the lower end of the 7%-10% range. It wasn't clear to me why those expenses now are anticipated to go slower than they had been a quarter ago.
Yeah, there's a certain element of timing in terms of new hires and programs, I think, really the exchange impact that we've been talking about in terms of its impact on revenue and margin has an effect of reducing the expenses in U.S. dollar terms. It's largely that which we're seeing.
No holding back on programs.
No.
No. Okay. Thank you.
Thank you. We now have a question from Imron Zafar with Jefferies. Go ahead, please.
Hi, good afternoon. Thanks 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 DVA, just in terms of where penetration is and how much runway lies ahead in terms of growth opportunity going forward.
Think about 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.
UK
UK. We think there's a significant room both in DVP and partial nephrectomy. Hysterectomy will really be anchored on hysterectomy for malignant conditions. I think we're just in the beginnings of hysterectomy for malignant conditions in Europe. We're seeing some nice early uptake and some nice early work, but you're probably still in single digits for the most part.
That were in the Nordic countries and growing quickly in the U.K.
Korea is a similar picture. DVP again in double digits, probably not quite half, and likewise, early days in DVH for malignant conditions, partial nephrectomy in between those two.
Yeah. One thing that's interesting, Imron, last year, for 2014, we did about 60,000 prostatectomies 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.
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. Recall we were working through two things. One is making the computational platform and the software compatible with Xi, We're on track doing that. The second thing has been getting the supply chain and costs in line for the instrumentation on the technical side, That's also on track. As those things come together, 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 far we're pleased with where we are.
Okay. Not to beat the gross margin dead horse even more, The SP launch plan, that is all factored into your commentary about potentially improving gross margin next year?
Well, we haven't tagged a launch date on SP, nor have we tagged pricing yet. The commentary is really ex SP without it. Yep.
Okay, great. Thank you very much.
Thank you. We now have a question from Rick Newitter with Leerink Swann. Go ahead, please.
Hi. Thanks for squeezing me in. Just to follow up on that last question on the gross margin in 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 on 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. Part of the reason that you 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 not possible to do it on very low volumes ahead of time. It is generally expected that you'll have a margin hit when one of the new pieces of capital come in. We would expect some.
Now we'll manage that both with the pre-work we do and how we price when SP comes out. A little premature for that in the forecast.
Okay. Just one more on gross margin. You're saying, all else equal, improvement in 2016. Is that 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. Gary, just one last one. Now that we're a few quarters into the Xi launch, I was just wondering where you're seeing Xi being used in the field. Are you surprised by kind of the types of procedures it's being used in? Is there anything worth calling out or telling us with respect to kind of where it's being used that maybe you weren't expect it to be used in, or certain types of physicians gravitating towards it for certain types of procedures?
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. Multiquadrant surgery, colorectal surgery, we expected it to set up really well for 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 its set up is helpful for them. GYN oncologists find the range of motion helpful. That has been a pleasant surprise, is their 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've built our company to take surgery beyond the limits of the human hand, and I assure you that we remain committed to driving the vital few things that truly make a difference. This concludes today's call. We thank you for your participation and support on this extraordinary journey to improve surgery, and we look forward to talking with you again in three months.
Thank you. Ladies and gentlemen, that does conclude our conference for today. Thank you for your participation and for using AT&T Executive Teleconference. You may now disconnect.