Ladies and gentlemen, thank you for standing by and welcome to the Intuitive Surgical Q3 2014 earnings release. At this time, all lines are in a listen-only mode. Later, there will 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 will now turn the conference over to Calvin Darling, Senior Director of Finance for Intuitive Surgical. Please go ahead, sir.
Thank you. Good afternoon and welcome to Intuitive Surgical's third quarter earnings conference call. With me today, we have Gary Guthart, our President and CEO, Marshall Mohr, our Chief Financial Officer, and Patrick Clingan, 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. Actual results may differ materially from those expressed or implied as a result of certain risks and uncertainties. These risks and uncertainties are described in detail in the company's Securities and Exchange Commission filings, including our most recent Form 10-K filed on February 3rd, 2014, and 10-Q, filed on July 24th, 2014. 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 intuitive.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 third quarter results as described in our press release announced earlier today, followed by a question-and-answer session. Gary will present the quarter's business and operational highlights. Marshall will provide a review of our third quarter financial results. Patrick will discuss procedures and clinical highlights. I will provide our updated financial outlook for 2014. Finally, we will host a question-and-answer session. With that, I will turn it over to Gary.
Thank you for joining us on the call today. In this third quarter, our customers have continued to advance minimally invasive surgery through the use of their da Vinci surgical systems. Total da Vinci procedures grew nearly 10% over prior year, led by multifaceted growth in general surgery and growth in urology in Europe and Asia. Capital placements in the quarter were solid, totaling 111 systems, with strong performance outside of the United States. Our newest system, da Vinci Xi, is receiving favorable reviews and interest from our customers. Looking more closely at the United States, growth in general surgery led the way, with the procedure category our second largest behind gynecology. General surgery procedure growth was broad-based, including colon resection, rectal resection, and hernia repair.
Trends present in prior quarters in gynecology continued with stable trends in hysterectomy for malignant conditions, combined with a slight decline in benign hysterectomy versus prior year. Urology grew in the U.S. in the quarter with strength in prostatectomy and partial nephrectomy. Given the large proportion of da Vinci use in prostate cancer surgery, the increase in da Vinci prostatectomy likely reflects broader trends in patient care. Turning to systems in the United States, we placed 61 systems in the quarter. 80% of these systems were our newest product, the da Vinci Xi surgical system. In Europe, procedure growth returned to form. Growth in Germany improved materially. Likewise, I'm pleased with our performance in France, with multiple segments contributing. Growth in Italy, U.K., and the Nordic countries was also encouraging and broad-based. Capital sales in Europe were strong.
We continue to see capital segmentation with interest in both our most featured product, the da Vinci Xi system, as well as interest in refurbished systems acquired by price-sensitive customers. In Asia, the urology category continues to lead in volume, while procedure growth was driven by both urology and general surgery. As you know from last quarter, we are in the midst of a transition of our commercial business from our distribution partner in Japan to a direct team. We're building our direct sales organization as well as building deeper marketing, service, and support functions to better serve our Japanese customers. I am encouraged by their progress. We continue to pursue additional reimbursement in Japan, and surgeons have initiated prospective clinical trials to gather data for this purpose. The reimbursement process in Japan can be lengthy. We will report on our progress as we gain greater clarity.
Turning to capital sales in Asia, as we've said in the past, timing of placements can be lumpy, and Q3 is no exception. We placed 19 systems in the region, 10 of which were to customers in China. Given the role of governments in reimbursements and approvals, the timing of system placements remains hard to predict. Taken together, our non-GAAP pro forma operating performance for the third quarter is as follows. Procedures grew nearly 10% over the third quarter of 2013. We placed 111 da Vinci surgical systems, up from 101 during the third quarter of last year. Pro forma total revenue was $534 million, up 7% from last year. Pro forma instrument and accessory revenue was $272 million, up 14% over Q3 of 2013. Total pro forma recurring revenue grew to $380 million, up 12% from prior year and comprising 71% of total pro forma revenue.
We generated a pro forma operating profit of $197 million, down 14% from the third quarter of last year and representing 37% of Q3 revenue. Pro forma net income was $145 million, down 25% over last year, and cash and investments in the quarter grew by $219 million. Our new products continue to gain acceptance with customers. Starting with systems, da Vinci Xi has been well received. It is being used in a wide range of procedures, including urology, gynecology, general surgery, and thoracic surgery. Positive customer feedback highlights the flexibility and efficiency of setup, the ability of the system to work over a large workspace in the body, the ability of the endoscope to move to any port, and the integration and convenience of the imaging system, including Firefly. Urologists, colorectal surgeons, and general surgeons have been the main proponents for Xi system purchases to date.
Also, we received regulatory clearance for da Vinci Xi in Korea earlier this month. With regard to our dedicated single-port platform, da Vinci SP, we continue to make progress in design for manufacturability and compatibility with Xi. I believe SP will have strong applicability for procedures in which a single small entry point to the body and parallel delivery of instruments is important. A good example is head and neck surgery. We anticipate initiating clinical use of our Xi-compatible SP in the latter half of 2015, likely in support of regulatory submissions. We are planning a measured rollout of SP as we receive necessary clearances and optimize our supply chain and now do not expect 510 clearance for our Xi-compatible SP in 2015. Turning to instruments, we initiated a stop use of our da Vinci Si stapler in the quarter after three reports of malfunction.
Our investigation has identified the underlying causes of the malfunctions, and our team has developed potential solutions. We're making good progress in validating these solutions, and we will update our customers and you once these validations are complete. Finally, we have received 510 regulatory clearance and initiated first cases for our Single-Site Wristed Needle Driver, an important addition to our product line for use in single-incision surgery with the Si platform. The Wristed Needle Driver is the first instrument of its kind, a fully articulating single-port surgery instrument that returns to the surgeon and a wrist capability in a single-incision format. Gynecologists performing single-incision hysterectomy are expressing a high level of interest and excitement about the Wristed Needle Driver. Surgeons performing initial cases with the Wristed Needle Driver have integrated it seamlessly into their cases.
Bringing a wrist to the single-site platform for da Vinci Si further enhances Si's capability and ease of use for surgeons pursuing single-incision technique and provides a capable and cost-effective platform for our customers. In summary, we are passionately pursuing the long-term opportunity to fundamentally improve surgery and are focused on the following. First, extending the benefits of minimally invasive surgery using da Vinci systems worldwide. Building da Vinci capability and supporting its use in general surgery. Disciplined execution in our new product launches. Finally, continuing to invest in our capabilities in key international markets. I'll now pass the time over to Marshall, our chief financial officer.
Thank you, Gary. I will be describing our results on a non-GAAP pro forma basis, which excludes the impact of our Xi trade-in programs, legal claim accruals, stock-based compensation, amortization of intangibles, and investment impairments. We're providing pro forma information in addition to GAAP information because we believe the business trends and operating results are easier to understand on a pro forma basis. I will also summarize our GAAP results later. We have posted reconciliations of our pro forma results to our GAAP results on our website so that there is no confusion. Pro forma third quarter revenue was $534 million, up 7% compared with $499 million for the third quarter of 2013 and up 5% from last quarter. Procedure growth for the third quarter rounded up to approximately 10% compared with the third quarter of 2013 and was seasonally slower by approximately 1% compared with the last quarter.
Procedure highlights will be discussed by Patrick. Pro forma revenue excludes the impact of offers made to customers to trade in their recently purchased Si for newly introduced Xi. As discussed last quarter, with the introduction of da Vinci Xi surgical system, we offered certain customers in the U.S. and Europe the ability to trade in their recently purchased da Vinci Si surgical systems for da Vinci Xi surgical systems. These trade-in offers also provided these customers the opportunity to exchange certain da Vinci Si instruments and accessories for da Vinci Xi instruments and accessories. As a result of these offers, we reserved $26 million of U.S. revenue in the first quarter and reserved $6 million of European revenue in the second quarter. As these customers accepted or declined their trade-in offers, we refined our estimates of the revenue reserves.
In the third quarter, we recognized $16 million of revenue, reflecting eight trade-outs completed and a refinement of the number of customers that we expect to accept our offer. Pro forma results exclude the impact of this program. As of September 30th, we had $4 million in reserves for three trade-ins that we expect to occur in the fourth quarter. Revenue highlights are as follows. Pro forma instrument and accessory revenue of $272 million was up 14% compared with the third quarter of 2013 and was up 4% compared with the second quarter of 2014. The increase relative to last year primarily reflects increased procedures, new product revenue, and increased stocking orders. The increase relative to last quarter primarily reflects customer buying patterns, new product revenue, and increased stocking orders.
Pro forma instrument and accessory revenue realized per procedure, including initial stocking orders, was approximately $1,930 per procedure, compared with $1,860 in the third quarter of 2013 and $1,830 last quarter. Pro forma systems revenue of $154 million decreased 3% compared with the third quarter of 2013 and increased 11% compared with last quarter. We placed 111 systems in the third quarter, excluding the eight Xis traded for Sis under our trade-in program, compared with 101 systems placed last year and 96 last quarter. Six of the system placements in the quarter and three of the placements in the second quarter of 2014 were structured as operating leases. The system average selling price for the third quarter was $1.45 million, which is lower than the $1.56 million recognized in the third quarter of last year and the $1.5 million recognized in the second quarter of this year.
The decreases compared to prior quarters reflect a greater number of trade-ins and products sold to cost-sensitive customers, particularly in Europe. 59, or a little more than half of the 111 systems placed in the third quarter, were da Vinci Xi models, 38 were Si models, seven were SIEs, and seven were S models. Hospitals financed approximately 27% of the systems placed in the third quarter, down from 37% last quarter. We directly financed 11, of which six were structured as operating leases and five as sales type leases. Through the third quarter of 2014, we've entered into nine operating leases. The amount of revenue that we recognize in any future quarter for these operating leases will be immaterial. In the U.S., we placed 61 systems in the third quarter, compared with 65 systems last year and 61 systems last quarter.
Outside the U.S., third quarter pro forma revenue was $153 million, up 15% compared with revenue of $133 million in the third quarter of last year and up 14% compared with revenue of $135 million last quarter. Our higher year-over-year OUS revenue was driven by increased procedures and higher system sales. Our higher sequential OUS revenue primarily reflects higher system sales, partially offset by a seasonal decline in procedures. Third quarter 2014 procedure volume outside the U.S. was approximately 20% higher than the third quarter of 2013 and 4% lower than the second quarter of this year. The growth over the prior year reflects DVP growth in Europe and Japan. The decrease compared to last quarter primarily reflects third quarter seasonality in Europe, partially offset by increased procedures in Asia.
We placed 50 systems outside of the U.S. in the third quarter, including 25 into Europe and seven into Japan, compared with 36 outside the U.S. in the third quarter of 2013, which included 17 into Europe and 13 into Japan, and 35 systems outside the U.S. last quarter, which included 19 into Europe and five into Japan. Third quarter system sales included 10 into China and nine into Germany. The sales into China were completed under tender offers following the Ministry of Health's announcement in 2013 that 38 hospitals were eligible to import da Vinci systems through 2015. The Ministry of Health's announcement does not represent a commitment to purchase. We do not expect additional systems to be sold under the tender in the fourth quarter. There is no assurance that the remaining 28 hospitals will purchase systems.
Sales in new markets and markets where we have limited reimbursements, like Japan, will be lumpy. Moving on to the remainder of the P&L. Pro forma gross margins were 67.2% in the third quarter of 2014 compared with 73.8% for the third quarter of 2013 and 69.2% for the second quarter of 2014. Our lower margin percentage reflects a higher mix of new product sales, including the da Vinci Xi system, costs associated with our stapler stop use and scope recall, costs related to purchase accounting for the buyout of our Japanese distributor's market rights, and service costs associated with product recalls and the Xi rollout. In the first quarter, we recorded a pre-tax charge of $67 million to reflect the estimated costs of settling a number of product liability legal claims against the company. During the second quarter, we recorded an additional $10 million charge reflecting additional claims.
Our estimates remained unchanged in the third quarter. We paid out approximately $16 million associated with previously accrued amounts. Pro forma operating expenses, which exclude reserves for legal claims, stock compensation expense, and amortization of intangibles, were $162 million for the third quarter of 2014, compared with $138 million for the third quarter of 2013 and $155 million for the second quarter of 2014. The increase in pro forma operating expense in the third quarter relative to the second quarter reflects costs associated with new product launches, costs of expanding our operations in Japan and Europe, and increased incentive compensation. We expect operating expenses to ramp in the fourth quarter, primarily associated with international expansion, particularly in Japan and Europe, and new product launches. Our pro forma effective tax rate for the third quarter was 27.2%, compared with 17% for the third quarter of 2013 and 29.8% last quarter.
The tax rate for the third quarter of 2013 included the reversal of reserves where statutes of limitations had expired. The reduction in rate from the second quarter of 2014 reflects an increase of non-U.S. taxable income relative to U.S. taxable income. Our pro forma net income was $145 million, or $3.92 per share, compared with $194 million, or $4.94 per share for the third quarter of 2013, and $140 million or $3.73 per share for the second quarter of 2014. I will now summarize our GAAP results. GAAP revenue was $550 million for the third quarter of 2014, compared with $499 million for the third quarter of 2013, and $512 million for the second quarter of 2014.
GAAP net income was $124 million, or $3.35 per share for the third quarter of 2014, compared with $157 million or $3.99 per share for the third quarter of 2013, and $104 million or $2.77 per share for the second quarter of 2014. We ended the quarter with cash and investments of $2.3 billion, up from $2 billion as of June 30, 2014. The increase was primarily driven by cash generated from operations. We have completed the repurchase of stock under our $1 billion accelerated stock repurchase program. Under the program, we purchased a total of 2.5 million shares at an average purchase price of $397.52 per share. With that, I'd like to turn it over to Patrick, who'll go over procedure and clinical highlights.
Thanks, Marshall. As mentioned earlier, total Q3 year-over-year procedures grew nearly 10%, with U.S. procedures growing 8% and international procedures growing 20%. U.S. procedure results were broadly similar to our commentary after Q2, with the exception of DVP, which was better than expected. 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. In U.S. gynecology, Q3 results were similar to the first half of 2014, with low single-digit procedure declines. DVHB volume appears consistent with expected total market benign hysterectomy procedure declines, while the myomectomy negative year-over-year trend continued from the second quarter. Single-site hysterectomy grew quickly off a small base, and we will monitor the adoption of our wristed Single-Site Needle Drivers' impact on this procedure. Moving on to U.S. general surgery, adoption continues to be solid across a broad number of procedures.
Colorectal procedure adoption remains a source of strength. It is too early to precisely estimate the impact the stapler stop ship action may have on our procedure growth, though initial inspections suggest it may weigh on colorectal procedure growth. Single-site cholecystectomy continued to grow in Q3, though at a more modest rate relative to the first half of 2014. Hernia growth remains encouraging in this early phase of adoption. In addition to robust procedure growth for hernia repair, we are hearing positive feedback from surgeons about the clinical outcomes being generated with their da Vinci surgical systems. During the quarter, one of the first studies comparing robotic to laparoscopic ventral hernia was published, supporting the feedback we have been receiving.
These results, when combined with some of the early cost analyses that suggest robotics has a similar level of material operating cost as laparoscopic ventral hernia repair, gives us belief that the current adoption is sustainable. Looking abroad, international procedure growth of 20% continues to be led by global adoption of DVP and other urologic procedures, with solid early contributions from gynecology and general surgery. Procedure growth rebounded in Europe after holidays weighed on the Q2 growth rate. In Japan, we have observed a slight disruption to procedure growth in Q3 as we transition sales and service to our direct organization. We believe that this is temporary in nature and expect it to stabilize as we move towards a direct selling model.
Recently, clinical trials to support our reimbursement submissions for partial nephrectomy and gastrectomy have begun enrollment, though it is uncertain how quickly these trials will enroll and whether they'll achieve the outcomes needed to support reimbursement. We continue to expect international procedure adoption to be a driver of procedure growth, as the opportunity for da Vinci surgery is substantial. As we've said in the past, quarterly procedure growth rates may be lumpy as adoption is not uniform across countries and procedures. One of the challenges of evaluating clinical and economic advances in surgery is the diversity in patient and surgeon populations. As da Vinci is used in more and different types of procedures, well-done studies evaluating the clinical and economic efficacy consider the impact of new technology and techniques on different segments of the patient population and surgeon populations.
They evaluate important preexisting conditions in the patient population, such as disease state, obesity, prior surgery, and other comorbidities, as well as appropriate near-term and long-term clinical outcomes. They also consider diversity in surgeon experience and practice patterns. As da Vinci is adopted in gynecology and general surgery, where a range of surgical approaches exists from open surgery to other forms of minimally invasive surgery, careful segmentation of patient and surgeon populations is important. A couple of colorectal studies published this quarter are good examples of using an appropriate set of patients and procedures. Unlike rectal resection, where open surgery remains the most common procedure, right colectomies are often performed laparoscopically. Studies of various types of right colectomy in broad patient populations have noted high rates of complications. We believe there is an opportunity for robotics to improve upon these outcomes.
One study is a meta-analysis by Dr. Xu and colleagues from the Shandong Cancer Hospital, published in the "World Journal of Surgical Oncology," which concludes, "Compared to laparoscopic right colectomy, robotic right colectomy was associated with reduced estimated blood loss, reduced postoperative complications, longer operative times, and a significantly faster recovery of bowel function." The second study, published in Surgical Endoscopy by Dr. Trastulli and colleagues, noted that intracorporeal anastomosis in right colectomy is associated with improved clinical outcomes, yet remains uncommon in laparoscopic procedures due to its technical difficulty. The study showed that a cohort of patients undergoing robotic right colectomies with intracorporeal anastomosis recovered more quickly compared to laparoscopic cohorts with both intracorporeal and extracorporeal anastomoses.
While there are over 8,000 peer-reviewed clinical studies on robotic surgery, many of which support the value of our technology, we wanted to take a moment to highlight future clinical initiatives in which we are participating. We are working with surgical societies, including support of the Society of Gynecologic Oncology's Clinical Outcomes Registry for cancer procedures, as well as a national registry for ventral hernia repair. In addition to supporting research, during the quarter, we also expanded our support of society fellowship trainings with both the American Society of Colon and Rectal Surgeons and the American Association for Thoracic Surgery. Turning back to research, we are supporting a number of multi-center clinical studies, including studies on rectal resection, single-site cholecystectomy, thoracic resections, and benign hysterectomies. We are also supporting national database reviews looking at outcomes from a population health perspective for rectal resection, thoracic resection, and benign hysterectomy.
This concludes my remarks. 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 2014 in pro forma terms. As Marshall mentioned, our GAAP financial results and pro forma reconciliations are available on our website. Starting with procedures. On our last call, we estimated full-year 2014 procedure growth of between 5% and 8% above the approximately 523,000 procedures performed in 2013. Based upon trends described earlier on the call, we are increasing our 2014 procedure growth guidance to a range of between 8% and 9%. Consistent with our recent calls, we will not be providing revenue guidance. Moving on to gross profit margin. Our Q3 2014 gross profit margin was 200 basis points lower than Q2. Certain charges to Q3 2014 cost of sales that Marshall described earlier on the call were non-recurring in nature. We estimate that these non-recurring items accounted for about three-quarters of the sequential decline.
Our actual gross profit margin will vary quarter to quarter, depending largely upon product mix and systems production volume. Operating expenses. Last quarter, we forecast full-year operating expenses to grow between 10% and 13% above 2013 levels. Based upon the timing of certain expenses, we expect to grow our operating expenses between 9% and 11% above 2013 levels. We expect 2014 non-cash stock compensation to be towards the lower end of the $170 million-$180 million range forecast on our previous call. We expect other income, excluding the impact of the Q2 impairment charge, to total between $12 million-$13 million. With regard to income tax, we expect our pro forma base tax rate for the balance of 2014 to fall within a range of between 27.5% and 29% of pre-tax income.
Our current estimate is directionally lower than our expectations earlier in the year, driven by the geographic mix of our pre-tax income. Note that the pro forma tax rate tends to run above the GAAP tax rate, driven by the geographic mix of the pro forma items. Our Q3 2014 diluted share count decreased to 36.9 million shares, reflecting the full quarter impact of our accelerated share buyback completed in Q2. We estimate our Q4 diluted share count to range between 36.9 and 37.1 million shares. That concludes our prepared comments. We will now open the call to your questions.
Thank you. Ladies and gentlemen, if you'd like to ask a question, please press star one on your telephone keypad. You'll hear a tone indicating you've been placed in queue, and you may remove yourself from the queue at any time by pressing the pound key. Our first question will come from David Roman with Goldman Sachs. Go ahead, please.
Thank you, everybody, for taking the questions. I wanted to start on procedure volumes, given Calvin's outlook that you provided for the balance of the year. I'm just hoping you could help us understand the balance of the year in the context of what you've done year to date. Specifically, this guidance now implies 6%-10% growth for the fourth quarter. Maybe you could just sort of frame for us what's happening in the assumptions at the bottom end, and what's happening in the assumptions at the high end, and why we wouldn't see a continued trajectory from what we've seen year to date.
Yeah, I can help you a little there. As you mentioned, we're three-quarters of the way through the year. Q3 rounded up to 10%, as we described. On a year to date basis, we're also rounding up to 9%. It has a lot to do with numbers. You're three-quarters of the way through the year. The fact is, in order to get a 10% procedure range, let's say, you'd have to do in excess of 12% in the fourth quarter. Based upon the trajectories and the procedures that we've seen and our projections, it's just not what we're expecting at this time.
Okay. Maybe on the topic of total revenue, maybe Gary, you could just sort of comment on the overall operating environment. I mean, the data points thus far around the hospital CapEx continuum look to be coming together a little bit more favorably than where we were starting the year. I think some of the concerns out of Europe don't look to necessarily have played themselves out as expected. Maybe you should help us understand what's happening in the broader operating environment and what it'll take for you to get more confident in the forward view.
Yeah. As we look at the system sales side, as we've described before, really, we can describe our environment, that is really driven by three things. One is an interest in acquiring technologies for existing customers, Xi is being well-received, so we're seeing some interest in trade-ins. The second piece has been adding capacity if they're a existing hospital or existing customer, that will have to do with what their procedure mix and procedure growth looks like. The last one is starting new programs. In terms of looking at global capital equipment environments, you're probably in a better position to comment on that than we. In general, where hospital finances look stronger, that gives them more flexibility. Turning to Europe, what we've talked about before is really true. It's not a smooth distribution of customers.
There are those who are interested in the most highly featured products, there are those who are interested in real price-sensitive offerings. So we see a little bit of both in that marketplace, so one size doesn't fit all.
Maybe very specifically to your business, we started the year, I think, in what some might call a very turbulent set of events, you're talking about, I think your language was the unintended consequences around the Affordable Care Act and some of the gyrations in procedure volumes and what was happening at the hospital, particularly the evolution of your technology. That followed last year, which was an adjustment period around utilization rates. Where are we, more broadly speaking, just in the adoption of your technology, are we close to the point where you think we're back on a positive trajectory, a positive, sustainable trajectory?
Speaking first to procedures, I think the procedure performance speaks for itself. We're seeing early adoption in several general surgery procedure categories. I think that's a positive. As that grows and matures, I think we'll see whether it continues and how fast it accelerates. In general, reports on things like ventral hernia and colorectal surgery have been really strong and leave us encouraged. I think with regard to the early impact of Affordable Care Act, we saw some uncertainty with regard to hospital finances as to how that would impact them, and that uncertainty put them into a pause mode as it related to us. As I think they get better clarity, that allows them to plan a little bit, and looking forward, should smooth things out. What we'll actually be like as time plays out, we'll have to see.
Thank you very much.
Thank you. Our next question will come from Tycho Peterson with JP Morgan. Go ahead, please.
Thanks. Gary, I'm just wondering if you can elaborate on the SP delay. Is this a function of you guys doing more trial work? I'm just kind of wondering what the rationale there was.
Yeah. The biggest reason for us to move it out a little bit was actually some of the positive things we've learned from our Xi launch. We are seeing customer feedback on Xi that is really strong, and some things that they particularly appreciate. As we do our customer evaluations on SP and look to integrate those things, there's a few things that we'd like to bring over from one to the other, and we made a decision to do so.
Okay. Marshall, can you comment a little bit more on some of the drivers of the gross margin softness? I know you talked about the stapler stop use and some of these other dynamics. Is there any way you can kind of quantify the various costs? I guess the underlying question is, where do we reach a low water mark on margins?
Yeah. What we commented on was there was about a 200 basis point decline in gross margins. I would attribute three quarters of that to unusual items in the quarter. You mentioned the stapler stop use. We also had a scope recall, and then we had some costs associated with our acquisition of Japan, the Japanese distribution business, and the accounting around that. I guess I would say that there's a portion of it, though, that is just part of the normal margin and reflects new product. New product has lower margins to start, and we'll continue to try to drive those down over time. As far as where we're going in the future, I think Calvin gave you the projection for Q4. We're not going to give you 2015, but you get a sense as to where we were this quarter.
Okay, last one. China, nice number there. Can you maybe just talk about the sustainability of the trend there? Are we at kind of an inflection point? I think up till now you'd had only 26 systems or so in China. Just maybe talk about some of the drivers.
I think we're in the phase 1. Long term, we think there's real opportunity in China, but in the near term, I think there are a lot of steps to building a sustainable business there. In terms of feel and approach, we'll feel a little bit like our conversations around Japan. I think there's an element of having a deeper presence in China, both direct and potentially with others, and requiring a build-out to have sustained growth. I think it's a good first step, certainly a positive, but I don't think it is signaling a strong inflection point. I would not assume that.
That brought our total systems in China ending the quarter up to 36 systems.
Great. Thank you.
Thank you. Our next question is from Rick Wise with Stifel . Go ahead, please.
Good afternoon, everybody. Starting with Xi, Gary, last quarter, it felt like you all were pleased and maybe a bit surprised by the strong system placement trends. Is Xi now, this quarter, the same kind of surprise? Is the rollout where you expected at this point? Again, is it a little better than you might have thought?
I'd say we're pleased with where we are on the Xi rollout. I think that we're getting feedback that I think is what we expected in some parts of the market, in terms of multi-port access and multi-quadrant access. We're surprised and pleased by, I think, the broad-based nature of commentary in terms of urologists and GYN oncologists who are finding value in it perhaps more than we had anticipated. I think we're continuing the feeling and the trend that we saw in the second quarter.
Okay. Back to the stapler. It just maybe went by too quickly. Do you hope to resolve the stapler issues this year? I think you said you weren't going to be specific, but is it in 2014? When we reflect on fourth quarter procedure trends, does the recall have any impact on those procedures, or a meaningful impact? How do we think about that?
We haven't given you a date that we'll put it back on the market. We think we have root cause well identified and are in the midst of validating solutions. When those are validated, when we have them in our hands and they're done, the validation is done, we'll report to our customers and to you. I don't have a timeframe for you yet. Having said that, I think that the teams are making good progress, both understanding where we are and what the possible solutions are. In terms of modeling procedure impact, a little bit hard to say. I think that it's certainly some drag. Very hard to know how big the drag is.
Okay, just last from me. On the da Vinci prostatectomy side, it sounds like things are stabilizing. Can you just give us a little more color there, Gary? Just, what's happening? Do you think the market is set to remain stable or actually grow? How are you thinking about it? How would you have us think about it? Thank you.
It's a little bit hard to know based on one quarter of return to growth here. What happens in the next quarter and the next one after that, hard to predict. We have seen in past quarters that when there's an increase in things like watchful waiting, at some period of time after that, you see a bolus of patients come out of watchful waiting and into definitive treatment of one type or another, as some subset of that watchful waiting cohort has their cancer progress. It may be that. We'll have to wait a couple of quarters to see if that indeed is the case.
Thank you.
Thank you. We'll go next to Ben Andrew with William Blair. Please go ahead.
Good afternoon. Can you talk a little bit about what you're seeing in terms of the expenses? You talked about trimming that back a little bit based on timing. Are those things likely to drop in 2015 so we could actually see operating margin go down a bit? I think most of us have modeled it flat kind of through the end of 2015.
Yeah. We've been talking about investments we're making this year. Clearly, we believe strongly in our opportunities and have been investing. We did take the guidance range down a bit on expenses this year. It has mostly to do with the timing of some of the hiring activities. As we move forward into next year, obviously, we will be providing that guidance commentary on the next call. That being said, in the longer term, we really wouldn't expect to make the types of operating expense investments in future years that we made in 2014 relative to revenue growth trends.
Okay, great. That's helpful. Thank you. Gary, is there any comments relative to the approval we saw a few weeks ago for base of tongue resections? Is that for combination use with UPPP for a sleep apnea case, or is that sort of an entrée to the ENT space broadly?
It's a next step in clearances for ENT surgeons. It is not a sleep apnea claim. The company does not take that position. It really is as it has been published, which is a clearance to allow surgeons to do resection of benign tongue-based tissue as they deem appropriate. Where they take it from there, I think we'll have to see in future quarters.
Okay. Can you characterize, as best you can given the confounding nature of the stapler pullback, how the general surgery procedure growth trajectory has compared to prior procedure growth trajectories? They've tended to parallel each other, except some of the more recent ones were faster. Are those more encouraging than you would have expected?
Stepping back, I think as you look at the segments of growth in general surgery, the hernia growth is still early in its life cycle. It's been on the faster side in terms of hernia growth. If you look at separate rectal and colon, rectal, so deep in the pelvis, has been the one that is most utilizing the stapler and is the one for which I think the surgeons are most wanting it back quickly. That has been growth that's been consistent with what we've seen in past adoptions, and that's one we'll watch pretty closely for any changes with regard to the stapler. The solution to the stapler problem is really straightforward, which is identify the issues, get the solutions validated, and bring it back to the market. We will do that scientifically and carefully, but that's the path forward.
As you look at colon resection, that growth has been positive for us also. It's a multifaceted procedure. It's not just one thing. We do see stapler use in colon resection, but not in all segments, so it's kind of a mixed story in that one.
Okay, finally from me, when may we see the first of some of the clinical work being done in Japan for expanded indications?
The beginnings in terms of reimbursement, those trials have initiated already. I think first enrollments have already occurred this month.
When might we see results of those? Is that in 2015?
That'll play out over multiple quarters. In terms of when they start to publish, we'll have to talk about that as we get greater clarity on their timelines.
Thank you.
Thank you. Our next question comes from Tao Levy with Wedbush Securities. Go ahead, please.
Hi, good afternoon.
Hi, Tao.
A couple quick questions. On the Single-Site , the wristed device that you recently got approval, the uptake in that market, is it possible that you could start to see benign hysterectomy sort of go flat to positive as a result of that technology? Basically what I'm getting at is that going to go after the laparoscopic patient population or still the open patient population that you normally talk about?
Hey, Tao, it's Patrick. First off, we're excited about the level of enthusiasm and interest that gynecologists broadly have shown towards adopting single-incision surgery. The initial case series that have been done since the product was approved have been seamlessly integrated, and the surgeons have reported positive feedback to us about what they're able to achieve with the device. Relative to what happens in the overall market, this has been a market that has been in decline for a while now, as payers have looked to alternative treatments rather than surgery, putting pressure on the overall number of benign hysterectomies performed. We'll see where we go from here, but we'll definitely try to use the device to restore our rate of growth. It's just too early to comment on the trajectory at this stage.
Is there anything different between the gallbladder sort of approach or experience, obviously different type of surgeon, and what you could see in gynecology?
I think the way that we would envision segments here are a little bit different than in the past, where the segments have typically been open versus MIS. I think this one may draw a little bit from both. The segmentation is more likely around patient interest and needs with regard to single-incision surgery and a little less about open versus lap versus robotics. We'll see as it develops how that actual segment develops.
Great. Just lastly, the approval in Korea, that's one of your larger markets, and you're now direct there since I think maybe a year or two ago. Any expectations of how quickly that market could start to purchase Xi systems?
I believe, given the clearance, that they can start to purchase product as soon as we start shipping it, and I think we have intentions to ship it before the end of the quarter.
Okay. The interest is there, I guess that's kind of what I was-
Yes. We have customers who have an interest. Yes.
Okay. Great. Thank you a lot.
Thank you. Next we have Bob Hopkins with Bank of America. Go ahead, please.
Thanks. Can you hear me okay?
We can.
Great. Good afternoon. Just a couple quick things. First off, I noticed since your quarter, I think you guys have confirmed that there's been a change in your head of sales in the U.S., I was just wondering if there's any color you're willing to provide on that change. I'm sure folks on this call would be interested to hear if there's any commentary from you guys.
Yeah, we've had a couple of changes in our leadership team over the last couple of quarters. I think just standing back as the marketplace changes out in the U.S. as well as the company needs to change, I think for both the company and for individuals, people look at what they want to do, what their skills are, and what's a match. We have been the beneficiaries of a really strong team, and we also have a strong bench. For those who've moved on, we wish them well and expect them to do great things in their next engagement. Having said that, I think we also have a really good team here, it's natural in the evolution of any company.
You look out at what the needs of the organization are and what people's long-term needs are, both they do and we do, these transitions occur. I think we have a great team. We're confident in our opportunity, and we're confident in their ability.
Great. The other two things I wanted to ask about really quickly is one for you, Gary, and one on the finance side. Gary, for you, I was wondering if you could just give us your thoughts on SP have changed since you first announced the technology. I'm not asking about timing because you've already addressed that. I'm just asking about your thoughts on the kind of long-term market opportunity for that technology. Things like, could this system ultimately be competitive with traditional laparoscopic surgery in addition to some of the other things that you've talked about? That's my question for you. On the finance side, just to get it out of the way, I just wanted to be clear on the comments on OpEx growth as we look forward.
Were you suggesting that, relative to the double-digit growth in OpEx that we might see this year, that you wouldn't expect double-digit growth going forward? Was that the message? I just wanted to be clear.
Okay. Well, let me take them in order, and I think I got them both. With regard to SP, I think there's a. Just standing back on the introduction of new technology, there tends to be a trend for folks to overestimate what they do in the near term and underestimate what they do in the long term. I look at SP, and I think it has a lot of long-term potential. It is fundamentally a technology that enters the body through a small entry point, brings in instruments in a parallel way, and works with high precision in tight spots. As you sit down and talk to surgeons, and I've spoken with many, I have personally, as well as our team, I think there are a lot of possibilities as to where they could go and take it.
What that looks like and whether it displaces one alternative or another depends entirely on what part of the body it's applied to. There are some places that are really straightforward areas to explore that just set up well for this type of technology. Things like transoral surgery or transrectal or transvaginal, these are areas that hold a lot of promise. Having said that, bringing a new technology to market, you want to make sure you do it in a way that brings value early and establishes value for your customer, gives high-value patient outcomes, and value to the surgeons and hospitals who adopt it. How we evolve that is something that we work through in the next several quarters. As we get closer, we'll describe it to you.
With regard to OpEx growth, speaking not to 2015, we'll give you our thoughts on 2015 in the next call, but longer term, we don't expect that we'll ramp expenses highly out of sync with the growth in revenue. We think longer term, looking out a few years, that we have an opportunity for both stabilization and then later leverage. That's how we're thinking about it.
Great. Very helpful. Thanks.
Thank you. Our next question will come from Ross Muken with ISI Group. Go ahead, please.
Hey, guys. Thanks for taking my question. This is Vijay. I had a question on, I guess, last quarter, Gary, a lot of questions from Instruments and accessories. I guess you guys were pretty sort of, I guess, had this view that procedures were up, and you expected that number to come back up, right? I guess going forward, when you look at that, you had this dynamic about general surgery, which has higher also, but then you also have hernia and chole sort of growing. How should we think about the normalized, I guess, longer-term INA revenues per procedure?
Let me give you a kind of a directional pointer, then I think Calvin maybe a little help on the modeling side. I think directionally, remember that general surgery is a cluster of different procedures and does not model as one thing. Just the few that you mentioned have really strong differences in INA per procedure. If you think about a rectal case, a cancer case uses staplers will be on the high end of INA per procedure. Hernia is somewhere in the middle. Hernia is also in itself a cluster of procedures. It's not one thing. Ventral hernia is different than inguinal hernia, and there are different techniques in each of those so that the cost basis for each one of those subsets may be a little bit different. Then Single-Site cholecystectomy is at the low end of our revenue per procedure.
Then you start modeling this out. It all has to do with mix and growth rate, and that's when it gets turned over to Calvin.
I think you laid it out pretty well. This is an average, right? The average INA revenue per procedure. Our message is really just be aware of the average. You've got a widening and widening gap in the actual per procedure on the complex side and the less complex side. I don't think we have any specific commentary whether it should be increasing or decreasing. It really depends on really which factors win the day on this thing, and you can be successful in any scenario as far as that goes.
I'd make a last comment on that point. We feel comfortable with pricing in those procedures. We think it's appropriate for us and for the customer, and we think the margin structure is right in those things. It's really looking out at what the mix is going to be rather than whether the company has to make a good change.
Great. I guess I had one follow-up on procedures, right? I think you guys have been pretty consistent when you were talking about this changing healthcare dynamic and increased seasonality and back half pickup. When you look at the guidance of eight to nine, I guess at the high end, you're sort of getting in a flattish Q on Q. Is that a reasonable assumption or is there a belief that given this exaggerated seasonality, Q4 should be better than Q3?
Well, the simple way I think to answer that is we're all together experiencing what seasonality is going to be like after the implementation of the Affordable Care Act. I think nobody has been through it yet. We have our estimates. We've given the guidance based on those estimates, but I think we're all just going to have to see and gain some experience together.
Thanks, guys. I'll step back in the queue. Congrats on the Q.
Thank you.
Okay. Thank you. Our next question is from Richard Newitter with Leerink Partners. Go ahead, please.
Hi, thank you for taking the questions. I just wanted to turn back to the stapler stop use for a moment. Can you just characterize whether or not, or the feedback that you've gotten in the field, is it a matter of an issue of for the moment not using the stapler? Obviously, it's not available, but the second it comes back it gets reused. Or is there an actual hesitation in your customer base amongst rectal resection users that they're concerned about the safety issues from an ongoing basis, or is this just a very transient issue?
First, to characterize where we are, we have asked customers to stop using it until we have identified and given them further instruction about what and how to handle it. We've taken a reserve with regard to inventory, should we want to send them replacements, depending on what the conclusions of root cause and validations are. I think that the customer sentiment around it has been they understand our request. It is quite a conservative request, three malfunctions over greater than 10,000 fires. They have viewed this as understandable. I think that I have not seen any deep confidence being shaken. We have many requests to hurry up and bring it back. I think they want to use it. I think it's differentiated relative to other products that they use. That's what we're working on.
Okay. Can you maybe just describe what they're doing in the meantime? Does it actually decrease the utilization? It sounds like you're more hesitant there. How are they managing through not having access to the stapler?
Yeah, it depends on what the case is. If it's a low rectal case and they can do it with a manual stapler, they'll try that. If it's very deep, they may have to use a laparotomy rather than doing it minimally invasively. There's a real variety depending on what the patient characteristics are.
Great. If I could just ask one more on just as we look out to your new product initiatives, obviously SP is getting delayed. I didn't catch whether you provided a timeline for when that might be delayed until. Also, are there other new products that we can potentially expect to hear about making progress on? I'm thinking about things in that brochure that we saw at SAGES, like the rotating bed. Where are you on some of those additional features? Thank you.
With regard to commercialization timing with SP, we're not giving you updated timing. We do expect clinical use of XI compatible SP in 2015. With regard to other things that we've been working on, there is another set of XI instrumentation, phase II instrumentation that we'll describe as it goes through the process. We are making progress on an XI integrated bed. I don't have the timeline to describe to you at this time, but in future quarters, we will. The pipeline is quite robust, and we continue to walk down it.
Thank you.
Thank you. We have a question now from David Lewis with Morgan Stanley. Go ahead, please.
Well, thank you. Thanks for squeezing me in. Gary, just two quick ones here. On Japan, you talked about the clinical development program. Is it still the company's thinking that 2016 is a good estimate for reimbursement in Japan?
We are working towards 2016 on a couple of fronts. It is as yet uncertain. We don't have, of course, final approval from anybody on that timeline, but we are working toward that end.
Okay, nothing's changed on that front. It sounds like the clinical development program is on track.
Well, it's a dynamic conversation, so I wouldn't characterize it as everything is solid and locked in stone. I think that's a set of conversations that has been going on and will continue to do so. That's the nature of these kind of conversations in Japan.
Gary, just if you think about the last several quarters adjusting for the second quarter, where obviously Xi was going to be stronger in the U.S., it does look like OUS net system placements are stronger than U.S. Do you think these kind of three quarters justifies a trend and on a go-forward basis, it's likely that OUS net placements are higher than the U.S. placements?
Hard to say. I think a couple of things. I'd say that on the one hand, we are earlier in total market adoption in some of our OUS countries, and we think that those are real markets and worthy of pursuit. If they go where we hope they go, we'll see increased spending there. In the U.S., of course, we have a bigger install base, so the conversation tends to be somewhat around new technologies and other things they want to do. I think as you look over years, not quarters, I'd expect that the OUS represents a strong growth path for us.
Great. Thank you very much.
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 benefit by providing surgical outcomes, by improving surgical outcomes, and reducing surgical trauma. 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' time.
Thank you. Ladies and gentlemen, that does conclude our conference for today. Thank you for your participation and for using AT&T Executive Teleconference.