Ladies and gentlemen, thank you for standing by. Welcome to Intuitive Surgical Q2 2014 earnings release call. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session. Instructions will be given at that time. Should you require operator assistance during this call, you may press star and then zero. An operator will assist you offline. As a reminder, today's teleconference is being recorded. At this time, I will turn the conference call over to your host, Senior Director of Investor Relations, Mr. Calvin Darling. Please go ahead, sir.
Good afternoon. Welcome to Intuitive Surgical second quarter earnings conference call. With me today, we have Gary Guthart, our President and CEO, Marshall Mohr, our Chief Financial Officer, 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, 10-Q filed on April 25th, 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 intuitivesurgical.com on the audio archive section under our investor relations page. In addition, today's press release and supplementary financial data tables have been posted to our website. Today's format will consist of providing you with highlights of our second quarter results, as described in our press release announced earlier today, followed by a question and answer session. Gary will present the quarter's business and operational highlights. Marshall will provide a review of our second quarter financial results. Patrick will discuss 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. I'm encouraged by several trends relative to the first quarter of the year. First, global procedures grew 8% on a sequential basis 9% year-over-year. Our newest platform, the da Vinci Xi Surgical System, was launched in the quarter. Our customers' reception for it has been very positive. Also, during the quarter, we strengthened our direct presence in both Japan and Europe. Turning to the United States, procedure growth improved over the first quarter, led by growth in colorectal procedures, Single-S ite, Early growth in hernia repair. Hernia repair is a broad category consisting of several procedure types and techniques for multiple underlying conditions. For some of these repairs, da Vinci systems provide enhanced visualization and dexterity during the dissection and reconstruction phases of the procedure.
We are very encouraged by this early growth and will pursue this opportunity in coming quarters. Within our gynecology segment, negative trends in da Vinci use in U.S. hysterectomy in the first quarter moderated in the second. That said, the macro environment around U.S. hysterectomy appears unchanged, and overall performance in hysterectomy is likely better understood by viewing the first half of 2014 as a whole versus a quarterly breakout. Overall, general surgery interest and utilization in the United States is positive. Patrick will provide further procedure detail later in the call. Capital placements in the United States grew sequentially from 45 in the first quarter to 61 in the second, driven by the introduction of our da Vinci Xi system.
Surgeon and institutional interest in da Vinci Xi has been strong, with positive feedback from experienced users within many different specialties, as well as those new to da Vinci systems. The capital environment for robotic surgery remains constrained in the United States, with customers evaluating their capital priorities broadly. With regard to our Xi system specifically, we anticipate increasing interest as additional clearances are obtained and experience with the product grows. In Europe, procedure growth moderated relative to the first quarter. Growth rates in the quarter were balanced between urology, gynecology, and general surgery. Some of the slowing growth may be attributed to fewer working days in the quarter compared with prior year. As expected, capital sales in Europe have been impacted in the near term by the introduction of da Vinci Xi.
Capital sales cycles are typically longer in Europe, and the introduction of a new system creates some delay as customers evaluate our new offering. Longer term, we expect growing interest in our Xi system in Europe. We also expect continued interest in our Si system for price-sensitive customers. We continue to invest in our sales organization as well as scientific affairs to deepen our European capabilities. Turning to Asia, procedure trends have been healthy, with growth centered on cancer surgeries in urology and general surgery. We're pleased to have completed a transaction with our Japanese distribution partner to enable Intuitive to interact more closely with customers in Japan, and we welcome members of the Adachi team to Intuitive.
Direct interactions with customers, surgical societies, and government agencies in Japan are essential to the long-term growth of robotic surgery, and we look forward to serving the Japanese market meaningfully in coming years. As you know, we continue to work with multiple parties in pursuit of additional procedure reimbursement for da Vinci in Japan. Capital sales in Asia were lower than prior quarters, impacted by the introduction of da Vinci Xi in the U.S., as well as constrained procedure reimbursement in Japan. We have submitted applications for Xi clearance in Japan and Korea and will work with government bodies in subsequent quarters during their review process. As we have described in our earnings release, several non-cash charges make it valuable to understand our financial performance on a pro forma basis. Taken together, our operating performance in the quarter is as follows. Worldwide, procedures grew 9% over prior year.
We sold 96 systems in the quarter, down from 143 in Q2 of 2013 and up from 87 in Q1. Total non-GAAP revenue in the quarter was $507 million, down from $579 million in Q2 of 2013 and up from $490 million in Q1 of 2014. Non-GAAP operating profit in the quarter was $196 million, comprising 39% of non-GAAP revenue. Non-GAAP earnings per share were $3.70, compared with $4.60 in Q2 of 2013 and $3.50 in Q1. Speaking of product contribution margins, we expect capital pressures on hospitals in most regions to continue. Given our new product introduction cycle for systems and broader market conditions, we expect capital margins to remain below prior year levels. Over time, we expect recurring revenue margins to improve as new product volumes increase, and we benefit from efficiencies in our supply chain, services, and product architectures.
Turning to new products, we've received FDA clearance for our Xi vessel sealer and are working through the clearance process with Xi stapler and Xi Firefly in the U.S. and other countries. These advanced technologies are an important step in filling in the Xi offering. Our Xi architecture simplifies implementation and improves performance for our advanced instruments. We look forward to their introduction around the world. We have submitted our 510(k) application for our single-site wristed needle driver and are working through the clearance process. Pilot product performance for the wristed needle driver for single site is compelling. We expect it will add significant capability and efficiencies for single-site surgeons. Lastly, we continue to make progress in refining our SP platform. I'm excited and encouraged by the progress the technical teams are making. This will be a multi-quarter development that will be paced by technical and regulatory milestones.
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 worldwide. Second, building da Vinci capability and supporting its use in general surgery. Third, 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'll be describing our results on a pro forma basis, which excludes the impact of our Xi trade-in program, legal claim accruals, stock-based compensation, intangible asset amortization, and investment impairments. We're 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 to our GAAP results on our website so that there is no confusion. Pro forma second quarter revenue was $507 million, down 12% compared with $579 million for the second quarter of 2013. Up 3% from last quarter. Procedures for the second quarter grew approximately 9% compared with the second quarter of 2013. Were up approximately 8% compared with 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 product for the newly introduced Xi product. At the time of announcing the da Vinci Xi Surgical System, we offered our first quarter customers in the U.S. the ability to trade their recently purchased da Vinci Si Surgical Systems for da Vinci Xi Surgical Systems. In the second quarter, we obtained CE mark in Europe and made similar trading offers to certain European customers that had recently purchased Si systems. These trade-in programs also provide our customers with the opportunity to exchange certain recently purchased 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 accept or decline their trade-in offers, we refine our estimate of the revenue reserves. In the second quarter, we reversed $10 million of the first quarter systems revenue reserve, partially reflecting four trade-outs completed and partially reflecting a refinement of the number of customers that we expect to accept our offer. As I stated, pro forma results exclude the impact of these revenue reserves. Revenue highlights were as follows. Pro forma instrument and accessory revenue of $262 million was down 1% compared with the second quarter of 2013 and was up 2% compared with the first quarter of 2014. The decrease relative to the second quarter of 2013 reflected lower stocking orders associated with fewer system sales.
The increase relative to the first quarter reflects increased procedures and number of stocking orders associated with higher systems placed, partially offset by customer buying patterns and fewer sales of energy generator units and single-site starter kits. Keep in mind that the Xi incorporates our energy generator units.
Instrument and accessory revenue realized per procedure, including initial stocking orders, was approximately $1,830 per procedure, compared with $2,020 in the second quarter of 2013 and $1,930 last quarter. The decrease relative to the prior year primarily reflects lower stocking order revenue. The decrease relative to the prior quarter reflects customer buying patterns and fewer energy unit and single-site starter kit sales. Pro forma systems revenue of $138 million decreased 36% compared with the second quarter of 2013 and increased 6% compared with the first quarter of 2014.
96 systems were placed in the second quarter, excluding the four Xi traded in for Si. We saw more hospitals finance their da Vinci systems in the second quarter, with 37% being financed compared to 11% in the first quarter and 20% for all of 2013. We are participating in that trend, financing 10 systems, of which three were structured as operating leases. Enabling system placements will drive greater procedures and recurring revenue. Globally, our system ASP for the second quarter was $1.5 million, roughly equal to last year and slightly higher than the $1.48 million last quarter. The increase compared to the last quarter was driven by product mix, partially offset by geographic mix. 50 of the 96 systems placed during the second quarter were da Vinci Xi models. We sold five Si-e in the quarter, compared with 13 last quarter.
In the U.S., we placed 61 systems in the first quarter, compared with 90 systems in the second quarter of 2013 and 45 systems in the first quarter of 2014. The decline in U.S. system placements relative to last year reflects the impact of lower procedure growth and ongoing macro factors that are impacting hospital capital decisions. The increase relative to the first quarter reflects seasonality and acceptance of our Xi system. Outside the U.S., we sold 35 systems in the second quarter, including 19 into Europe and five into Japan, compared with 53 in international markets in the second quarter of 2013, which included 21 into Europe and 20 into Japan, and 42 systems into international markets last quarter, which included 14 into Europe and 19 into Japan. Second quarter system sales also included five into France and three into Germany.
Lower second quarter 2014 system sales relative to last year and last quarter primarily reflect lower system unit sales in Japan, but also reflect delays in purchasing as customers await local market approval of Xi. The decrease in system sales in Japan reflect the high install base relative to only having one national reimbursement, prostatectomy, the Xi product not yet being available as we work through regulatory approval processes. In June, we entered into an agreement to transition direct sales and marketing responsibilities in Japan from our distributor to our wholly-owned subsidiary. The total transaction cost is expected to be approximately $70 million, of which $50 million is assigned to goodwill and the remainder is assigned to intangibles that will amortize over varying periods.
We expect that over time, the total costs associated with managing this direct channel and the costs of intangible amortization will be absorbed without a material impact to net income. As Gary indicated, the completion of the agreement enables direct interaction with our customers, surgical societies, and government agencies. Moving on to the remainder of the P&L. Pro forma gross margins were 69.2% in the second quarter of 2014, compared with 71.8% for the second quarter of 2013 and 70.2% for the first quarter of 2014. Our lower margin percentage reflects a higher mix of new product sales, including the da Vinci Xi system, and relative to last year, costs spread over lower production levels. Margins on newly launched products will typically be lower than our mature products, reflecting vendor pricing on low volumes, temporary tooling costs, and other startup costs.
Over time, as volumes increase and we refine the manufacturing process and the product, we would expect to see improvement in the margins of these newer products, although they may not ultimately reach the level of our mature products. In the first quarter, we recorded a pre-tax charge of $67 million to reflect the estimated cost 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. These claims relate to alleged complications from surgeries performed with certain versions of monopolar cautery scissor, or MCS instruments, that included an MCS tip cover accessory that was the subject of a market withdrawal in 2012, and surgeries that were performed with MCS instruments that were the subject of a recall in 2013.
Our estimate of the anticipated cost of settling these claims is based on negotiations with attorneys for patients who have participated in the mediation process that the company established in conjunction with the tolling agreement. Our estimates will be refined as we proceed through the negotiation process. Pro forma operating expenses, which exclude reserves for legal claims, stock compensation expense, and amortization of intangibles, were $155 million for the second quarter of 2014, compared with $152 million for the second quarter of 2013 and $155 million for the first quarter of 2014. The increase in pro forma operating expense in the second quarter relative to the first quarter reflects increased commissions associated with higher revenue and costs associated with new product launches.
We expect operating expenses to continue to ramp in the back half of the year, primarily associated with international expansion, particularly in Japan and Europe, and new product launches. In the quarter, we recorded a $4 million charge to other income to write down an investment in an early-stage company. The investment originally enabled a license for technology. Otherwise, other income reflects interest on our cash and investments. Our pro forma results exclude this charge. Our effective tax rate for the second quarter was 27.1%, compared with 28.6% for the second quarter of 2013 and 26.8% last quarter. Our pro forma net income was $140 million, or $3.73 per share, compared with $189 million or $4.63 per share for the second quarter of 2013, and $139 million or $3.54 per share for the first quarter of 2014.
As I indicated earlier, pro forma income provides an easy comparison of our financial results and business trends. I will now summarize our GAAP results. GAAP revenue was $512 million for the second quarter of 2014, compared with $579 million for the second quarter of 2013, and $465 million for the first quarter of 2014. GAAP net income was $104 million, or $2.77 per share, for the second quarter of 2014, compared with $159 million or $3.90 per share for the second quarter of 2013, and $44 million, or $1.13 per share for the first quarter of 2014. We ended the quarter with cash and investments of $2 billion, down from $3 billion as of March 31st, 2014.
The decrease was primarily driven by $1 billion used during the second quarter to repurchase company stock on an accelerated basis and our acquisition of distribution rights in Japan, partially offset by cash generated from operations. The majority of the shares repurchased under our ASR program, which amounts to approximately 2.5 million shares, have been received and retired. The remaining shares, if any, under the program will be received and retired in early November, although they could be received earlier if the ASR program is ended sooner. We do not plan to repurchase any additional shares until this ASR program is closed out. With that, I'd like to turn it over to Patrick, who will go over procedure and clinical highlights.
Thanks, Marshall. Q2 year-over-year procedure growth was approximately 9%, with U.S. procedures growing 7% and international procedures growing 17%. Stepping back and looking at the first half of 2014, U.S. procedures grew 5%. The softness in Q1 and the improvement in Q2 were impacted by a changing macro environment, including the implementation of the Affordable Care Act. We believe our U.S. procedure growth is best viewed by looking at the first half in aggregate. Q2 GYN procedure growth improved compared to Q1, though we believe the low single-digit decline in procedure growth we experienced during the first half is likely representative of an overall rate of decline in benign gynecologic surgical volumes. Since we do not sell power morcellators and they do not attach to our systems, we are unable to precisely measure the impact April's FDA advisory specific to power morcellators may have had on our Q2 procedures.
However, the advisory appears to be meaningfully impacting myomectomies, while the effect on hysterectomies appears to have been muted. We believe that for many patients, surgeons will not have to choose between minimally invasive surgery and morcellation. Alternatives for tissue extraction, including the use of da Vinci surgery, exist. Similar to last quarter, single-site hysterectomies continues to be a source of growth in U.S. GYN procedures, though off a small base. As we highlighted in a press release yesterday, a web-based patient satisfaction survey of over 6,000 hysterectomy patients sponsored by Intuitive and the HysterSisters patient support group, recently published in the Interactive Journal of Medical Research, found that robotic hysterectomy, when compared to abdominal, laparoscopic, and vaginal hysterectomies, was the only surgical modality that was an independent predictor of better patient experience, greater satisfaction, and willingness to recommend and have the same procedure again.
General surgery. Adoption continues to be strong across a broad number of procedures. Colorectal procedure adoption remains solid following the broad launch of our Si stapler earlier this year. In addition to driving procedure growth, with customers adopting stapler and vessel sealer, I&A per colorectal procedure has been increasing over the past few quarters. Single-site cholecystectomy continues to grow, with adoption being driven by cosmetically sensitive, commercially insured patients. A deeper look at INA per procedure among a large number of high-volume customers suggests that achieving little to no difference in material operating costs compared to laparoscopic instruments is reproducible and sustainable. Although there are additional general surgery procedures showing early signs of adoption, I want to take a moment to expand upon Gary's comments about what we are seeing in hernia repair. Hernias occur in the abdomen and pelvis, sometimes as a result of prior open surgical incisions.
Open surgery remains the most common form of surgery for hernia repair. Looking specifically at ventral hernias that occur in the abdomen, high postoperative pain scores and difficulties associated with performing a laparoscopic repair has caused many surgeons to rely upon open surgery. To perform minimally invasive ventral hernia repair, instruments must reach back towards the abdominal wall to repair the defect, which can present a challenge even for proficient laparoscopists. Early surgeon feedback on the use of da Vinci for ventral hernia repair has been encouraging, as these surgeons find ease of suturing and enhanced vision enables a minimally invasive repair that is similar to open surgery. It is worth noting that some surgeons reduce or eliminate tack fixation instruments with robotic surgery, resulting in material operating costs that are similar between robotic and laparoscopic ventral hernia repair.
International procedure growth of 17% continues to be led by global adoption of dVP and other urologic procedures, with solid early contributions from GYN oncology and general surgery. Compared to Q1 procedure growth of 24%, a number of small factors impacted the growth rate during the quarter. Relative to Q1, Q2 international procedure growth compares to a more difficult prior year comparator, as international procedures grew 23% in Q2 2013 compared to 14% in Q1 2013. International procedure growth was also impacted by the mix of holidays in Europe. As we look forward, we expect that international procedure growth may be a bit lumpy quarter to quarter as adoption is not uniform across all procedures and geographies. We continue to expect international procedure adoption to be a driver of procedure growth as the opportunity for da Vinci surgery in cancer and complex open urologic, gynecologic, and colorectal procedures is substantial.
At the American Urological Association meeting in May, Dr. Murphy from Peter MacCallum Cancer Centre in Melbourne, Australia, presented the results of an economic evaluation of robotic surgery sponsored by the Victorian Government. His evaluation included more than 5,000 patients from a statewide database comparing outcomes and costs associated with open lap and robotic surgeries for prostate cancer. The analysis included direct costs associated with the surgery and postoperative care and concluded, quote, "Robotic assisted prostatectomy reduces hospital stay, blood transfusions, and positive surgical margin in a public health system in Australia. In a case mix activity-based funding model, the incremental cost of robotic-assisted prostatectomy may be offset by reduced length of stay and blood transfusions when greater than 140 cases per year are performed." End quote.
This finding is similar to the U.K. NICE recommendation to consider robotic surgery in the treatment of localized prostate cancer that found robotic prostatectomy cost-effective in centers performing at least 150 procedures per year. In the debate over health spending, analyses of economic impacts of new technologies on specific procedures are an important tool. However, meaningful analysis requires a detailed understanding of clinical outcomes, patient populations, surgeon experience and skill variation, and actual costs to care for a patient across several alternative treatments. Studies that satisfy these criteria, such as Dr. Murphy's, have been rare, and those that overlook one or more of these elements do a disservice to the healthcare community as a whole.
Recently, we have seen an increase in both careful economic studies by investigators who understand the need to take a population-based and direct cost approach to assessment, as well as those that inappropriately select subsets in analysis as the basis to draw broad conclusions. We encourage the healthcare community to demand rigor in these analyses. Those that do derive the clearest picture of how new technologies impact the lives and the economics of those who use them. This concludes my remarks, and I thank you for your time. I will now turn the call over to Calvin.
Thank you, Patrick. As Marshall described, we are focusing our commentary towards non-GAAP pro forma results, which exclude the impacts of significant non-cash expenses and certain non-recurring items. We believe that this enhances investors' ability to assess our financial results. In order to provide historical context, we have posted summary-level quarterly pro forma P&L metrics with GAAP reconciliations to the investor relations page of our website. I will be providing you with our updated financial outlook for 2014 in pro forma terms. Starting with procedures. On our last call, we estimated full-year 2014 procedure growth of between 2% and 8% above the approximately 523,000 procedures performed in 2013. Based upon trends described earlier on the call, we are adjusting our 2014 procedure growth guidance to the higher end of this range, between 5% and 8%. Moving to revenues.
Several factors continue to make it difficult in the near term for us to predict system sales volumes and, as a consequence, total revenue. Specifically, we are currently in the process of obtaining U.S. FDA and international regulatory clearances for the Xi versions of our Stapler and Firefly products, and the Xi system is not yet available in Japan, Korea, and other international markets. Customers' evaluation of the da Vinci Xi and the timing of their system purchasing decisions may be impacted as we work to expand the product and geographic clearances for the platform. Macro-environmental issues impacting hospital capital purchasing decisions. The breadth and evolving nature of our procedure growth.
Procedures are a primary driver of capital sales and the relationship between procedure growth rates and capital sales is highly sensitive and likely variability in the timing of Japan system sales, given the timeline for obtaining additional procedure reimbursement beyond EBP anticipated no sooner than 2016. Due to these factors affecting the capital side of our business, we will not be providing a revenue forecast at this time. Our Q2 2014 pro forma gross profit margin was roughly 69%, having declined about 100 basis points compared to last quarter, largely reflecting lower gross profit margins on the da Vinci Xi system launched in Q2. We move forward in 2014, we expect our gross profit margin to move differentially lower based upon the impact of new products, product mix, and market conditions.
Our actual gross profit margin will vary quarter to quarter, depending largely upon product mix and systems production volume. We believe deeply in our ability to fundamentally improve surgery and are continuing to pursue plans to increase the use of da Vinci-enabled MIS around the globe. As stated previously, 2014 will be a year of increased investment for Intuitive Surgical. Even during this period of capital sales uncertainty, we remain focused on building our international capabilities, investing in new product development, and pursuing growth in multiple areas of our procedure business. Last quarter, we forecast full-year operating expenses to grow between 12%-15% above 2013 levels. We now expect to grow our operating expenses roughly 10%-13% above the 2013 levels.
We expect the 2014 non-cash stock compensation to be between $170 million and $180 million as compared to the $180 million-$190 million range forecast on the previous call. We expect other income, excluding the impact of the Q2 impairment charge, to total between $13 million and $15 million. With regard to income tax, on our last call, we forecast our income tax rate to be between 25% and 28% pre-tax income, depending primarily on the mix of U.S. and international profits. We are now refining this forecast to a range of between 26% and 28% of pre-tax income. This forecast does not assume the reinstatement of the R&D tax credit in 2014. Our share count for calculating diluted EPS in Q2 2014 was approximately 37.6 million shares.
Going forward, based upon the full quarter impact of our Q2 buyback, we expect our Q3 share count to be between 36.7 million and 36.9 million shares. We do not plan to repurchase any of our common stock in Q3. That concludes our prepared comments. We will now open the call to your questions.
Thank you very much. Ladies and gentlemen, if you do wish to ask a question, please press star and then one on your touch-tone phone. You will hear a tone indicating that you've been placed in queue, and you may remove yourself from the queue at any time by pressing the pound key. Again, for your questions, you may press star one at this time. Our first question will come from Ben Andrew with William Blair. Please go ahead.
Gary, thank you for the comments, by the way. Given the view on sort of the international investments that you're making and the refinement of the expense structure this year, can you give us some sense of what else you have to do as you look into 2015 and what we might think about as a longer-term kind of margin trajectory for the company?
As we said in the opening remarks at the product side, I think we'll see capital margins come down a little bit relative to where we were in prior years, instruments and recurring revenue being strong. As we look at the spend profile, I think the next couple of years will be a set of investments, some of them around products, some of them around international expansion, as we've been detailing you as we go through. I think it'll take a couple of years for those investments to play out.
Okay. As we look at the kind of hernia opportunity that you're highlighting here, can you size that for us a bit relative to maybe the colorectal cholecystectomy opportunity or general surgery broadly? How big a contributor is that to the kind of the revision in the guidance on procedures that you gave today?
I think we're too soon yet to break out all the segments in hernia. I guess I'd start by saying the hernia does have a fair number of segments, both in terms of where they are in the body and techniques that people use to approach them. We're just working through now what that looks like in terms of the value we bring to each one. It's a broad category, not a single procedure. We're encouraged by it. I think that its growth rate has been real. It looks like there are real opportunities for us to bring value relative to alternative approaches, both clinical value and economic value, and that's a good and powerful combination. We're not ready yet to break out the segments and size them for you. It looks to be a real opportunity.
How big it ultimately will be, we're going to have to work through the next couple of quarters before we publish that.
Okay, I guess one other quick question for us. If you think about kind of the distribution of who was buying Xis versus Sis this quarter, particularly in the U.S., what might that help you understand in terms of people's willingness to buy in advance of the additional instrument sets that are being reviewed by FDA? Did that track with your expectations? Were people moving more quickly? Just maybe a little bit more flavor on what was going on in the quarter. Thank you.
Just in terms of basic response, we were pleased with the response to Xi. I think that surgeons in the markets that we had targeted for it I think really appreciated and understood the capabilities that were brought forward. Things like colorectal surgery and thoracic surgery. A lot of the kinds of features that we brought were things that they had been asking for or anticipating. I think I was positively surprised by some of the response in gynecologic oncology. Some features being brought forward in Xi that I think they'll appreciate, likewise in urology. I think there was a broader positive reception than we had anticipated at the surgical side.
In terms of the splits of who's interested and who is buying from a commercial point of view in the U.S., I'll turn that to Marshall and just give a little color on existing customers versus greenfields and so on.
Within the U.S., we sold 44 out of the 61 systems were Xi. I think there was a pretty good balance between second systems and trade-ins of assets and Xi products. I think greenfields has taken a little bit longer, but we sold some greenfields. It's a longer sales cycle.
Thank you.
Thank you very much. Our next question in queue will come from David Roman with Goldman Sachs. Please go ahead.
Thank you, good evening. I wanted maybe to start with a follow-up to, Gary, your answer to the prior question regarding the next couple of years being a period of investment. As you kind of look forward in the evolution here of robotic surgery globally, what do you want the business to look like when you come out the other end of that investment cycle? What would sort of be, in your mind, considered a successful trajectory for the company as we move beyond that investment period?
I think you're asking around what is the financial profile, or are you asking around what is ultimately the surgical vision?
Well, if you'd like it to put it into growth rate terms, I guess we'd certainly take that. Just what operationally is actually going on in the business, and maybe anything you can do to help frame it for us? Has this become standard of care across multiple categories? Do we see an inflection point in Europe? Do we see multiple categories in Japan? What would you operationally want to see come out of that?
Yeah. As we think about the opportunity looking forward, I think there are a couple of big buckets. One of them is in areas of treating cancer and complex disease, which are largely open surgical procedures, we see opportunity globally. In the U.S., we're early in our experience in colorectal and thoracic. In Europe, we see opportunity in urology and in gynecology for malignant conditions in colorectal and thoracic as well, likewise in Asia. That set of opportunities is one that we have been investing in both on the product side, as you know, things like Xi and stapling and expanding and filling out the stapling line, as well as increasing our capabilities in terms of direct markets. I think that opportunity is substantial.
I think we're still in the early innings of exploring that opportunity and delivering those products and the consequences of those to those markets. That's one set that continues. A large part of our business is for benign surgery as well, and you see things like the hernia opportunity we just discussed evolving pretty nicely. As that happens, we'll also look for products that optimize that opportunity, both clinically and economically. I think those things also translate across borders. We're really working on both sets. We're further ahead in adoption on the complex and cancer side, and so that's where we're starting in OUS markets for the most part, and that really informs the product pipeline and the go-to-market strategies that you've heard us talk about.
Maybe just my follow-up on Japan, if you could go into perhaps a little bit more detail on the acquisition. I know in your prepared remarks, you referenced the potentially closer to some of the medical societies, my understanding in Japan is that the approval of new indications does stem more from the medical societies, which is a little bit different from what we see in the rest of the world. Do you anticipate that this closer relationship will provide you with access to helping influence the adoption of procedure rates, provide more clinical data? How can we see that play out in terms of gaining new applications in that country?
I think in general, being closer to the user groups in the country helps us a lot in a bunch of different directions. One of them is making sure we understand their needs and understand it in a very deep way, in a broad setting so that we are speaking to multiple specialties. That helps a lot. Number 2 is, as you say, in Japan, the government interacts very closely with surgical societies, to set guidance, to understand data requirements, to help review issues and activities. Having closer relationships with surgical societies, with key opinion leaders, and with our customers directly, those who already own our products, helps speed up the communication. It gets us a more careful and deeper look into opportunities and issues to be resolved, we were pleased to do it.
I think it's absolutely in line with what we want to get done.
Okay. Thank you very much.
Thank you. Our next question in queue, that will come from Bob Hopkins with Bank of America. Please go ahead.
Thank you, good afternoon.
Hey, Bob.
Just the first question is on the procedure volume growth guidance that you provided. You grew 8% in the first half. You got easier comparisons in the back half, I just wanted to understand the 5%-8%. Is there something specific that you guys are anticipating that would cause a little bit of weakness despite the softer comps in the back half, maybe specifically referring to hysterectomy there? Is it just, it's been kind of an interesting last year, you want to remain conservative in your projections?
Looking at it, there's not a specific thing that we think is looming. As we said in the prepared remarks, I think there was some choppiness between Q1 and Q2 that had to do with quarter boundaries and some other things that may have been unique to Q1. If you look at the first half together rather than separating it on quarter boundaries, I think it gives a better picture of where we are. Going forward, I think the determining factors will be continued strength in general surgery, which we've been pleased with in the first half of the year, offset by what happens next in gynecology in terms of stabilization. Those are really the underlying dynamics in the back half, and that's what Calvin has used to think through the back half range.
Yeah, the other thing I'd point out, Bob, is when you talked about comparisons, when you get into the fourth quarter and seasonality of procedures, complex benign procedures or simpler benign procedures, less complex, are more seasonal where you'd expect higher fourth quarter volumes. Now, in the affordable care environment, you just don't have a precedent for this with more people on high deductible plans, and I think we're learning as we go on that front and could some of these be deferred beyond the year? We're just not sure. It's just another factor that we've considered.
Gary, specifically on U.S. GYN, I just wanted to kind of gauge your confidence that the trends you're seeing in Q2 can remain kind of at this type of level instead of getting worse. I noticed another article in JAMA talking about morcellation. I just wanted to kind of, again, gauge your confidence specifically in U.S. GYN and the stability of that kind of growth rate you're experiencing today for the rest of the year.
Yeah, I think that it's really interesting. On the clinical side and what da Vinci surgeons have been telling us, I think how the system works, what it can do for gynecology is pretty stable and really well-known. What's hard to predict are any of the consequences of FDA guidance on tissue extraction and things like that. Part of that consequence is the breadth of the range that Calvin has described to you. I think as we look at kind of the underlying dynamics of how our products are used, we feel like those are stable. I think as you look out what the environmental factors might do, that's harder to predict, and that accounts for the width of the range.
Great. Just real quickly, I was curious as to why the expense guidance changed this quarter relative to what you gave at the beginning of the year.
Front half of the year, we've obviously spent less than what we had originally provided guidance for at the beginning of the year, which was 12%-15%. Some of that has to do with, I don't think it's a big difference, but it has to do with the hiring patterns and ability to hire people quickly in Japan and places like that. We're a little bit to the favorable side. Again, as I said earlier, we expect to ramp expenses as we do continue our international expansion and product development.
Yeah, there's not a change there in what we believe is fundamentally important from an investment point of view. There are some things in the front half that are, in a sense, volume related, that are costs that we didn't have to incur, and there are some things that are timing issues.
Great, congrats on the progress.
Thank you.
Thank you.
Thank you. Our next question in queue will come from David Lewis with Morgan Stanley. Please go ahead.
Good afternoon. Marshall, just a quick question on stock comp. It appears you want the street to value the company now, excluding stock compensation. I just have a couple questions on that. I appreciate their non-cash charges, but options are dilution for shareholders. How does excluding that instill discipline in how the company is going to issue equity awards? Given it's a form of compensation, why is it appropriate for us to evaluate Intuitive relative to peer set who none of which back out stock comp?
Sure. This isn't a new thing. We've always wanted you to look at it without stock comp. We've previously provided you with cash flow information that does exclude the impact of stock comp. In our particular second, we're pretty disciplined about how we issue equity. We maintain specific guidelines that are well within the industry parameters of 3% dilution on an annual basis. What's different about us is the valuation. The Black-Scholes valuation has issues with it, and one of those would be that it's heavily reliant on volatility and other factors that go into the computation. With our stock being a higher beta and a little bit more volatile, we compare unfavorably compared to some of the peers like Johnson & Johnson and Covidien. We think that it's better to look at us without it.
David, if you look broadly across larger cap med tech stocks, you'll see that we range in stock-based comp as a percent of revenue around 7% to 8%, whereas most of the other companies range around 1%.
That's just my point. It's a form of compensation. You need to be compared against your peer group who are expensing that compensation. You're trying not to. What I'm asking is relative to your peer group, how that's defensible?
Short answer is we value equity. We understand completely dilution, and we respect shareholders' view of dilution. In terms of how our comp plans are absolutely built, we are building them so that we compete effectively for the talent that's required to build this company, and that's relative to sometimes med tech, but often our peer group is, in terms of talent, is tech companies that share our location here in headquarters. We're careful about dilution. We don't give it away without deep thought. In terms of what the expenses are, they're not in any way hidden. They're absolutely available. When Marshall talks about pro forma, he's really pointing at the economic engine of the company. We understand and appreciate your remarks. We absolutely understand and respect the need to treat equity carefully. Brad, the next one.
Okay. Maybe just Gary, a quick follow-up there. Maybe shift onto procedures because we're probably going to agree to disagree on the prior topic. As we move over to main procedures, you gave us a nice color, or Patrick did, on dVH. Just as you think relatively, can you give us any sense sequentially? It sounds like hernia did obviously much better, but specifically as it relates to cholecystectomy, whether cholecystectomy progressed sequentially, whether that was faster growth, slower growth, or relatively the same quarter-on-quarter. Thank you.
Just generally, the dynamics we described last quarter in cholecystectomy really stayed about the same in terms of it continues to grow. We see a segment of the market that values it, both in terms of patients and in terms of the surgeons and institutions that are providing it. Directionally, I think it, in terms of rates, was more or less in line with where we were before, perhaps a slight slowing as volume has grown.
We'll take our next question in queue. That will come from Tycho Peterson with JPMorgan. Please go ahead.
Thanks. Given the strong placement number this quarter, just wondering if you could talk a little bit about how it flows through to revenues, in particular around the trade-ins. I've had a number of people ask why you didn't show more revenue upside given both strong procedures and the trade-ins. Maybe talk a little bit about that and how you think about trade-ins flowing through in the back half of the year. Then as a follow-on, can you talk about the leasing option? You talked about the current %, but what % of potential systems are-?
potentially open to operating leases.
In regards to the systems, Tycho, the ASPs we report, the $1.5 million, they do reflect the contractual revenue related to the sales agreement. This quarter, we did happen to have three systems that were shipped under operating lease arrangements, where the system revenues will be recognized over future periods. There were also other sales involving financing terms where revenue will be deferred over future periods, which again, is offset by the upgrade portion within the system category. I think with this additional complexity, it's not as simple as it was, just multiply the ASP times the number of units and get the systems revenue. We are absolutely focused on finding the customer solutions and adding to the installed base.
On the clinical data side, it seems like the bar for clinical data might be a little bit higher in Europe. Can you talk about whether you have the appropriate data set today as you go out and try to further penetrate that market? Is there any data on clinical efficacy or cost support for hernia at this point?
On the first question of what are the data requirements in Europe, in general, I think that they tend to ask for data in local countries and particularly around local economics and so on. A lot of what the emphasis has been there has been making sure the data sets make sense in country. We have good indications and good feasibility studies and a lot of work from around the world, so that can help guide us. Ultimately, it requires engaging those markets directly and the surgical societies directly. That's kind of what the European picture looks like. On hernia, it's early in the experience. Hernia data will start to be collected and analyzed more broadly. As usual, in these kind of procedures, the early upticks precede the large studies.
Lastly, on SP, can you just give us a sense as to whether you've finalized plans to sell standalone versus the card onto Xi and any chance that the port size may come down from 25 millimeters initially?
Let's see. On the first one, we are designing the product such that it can link up with an existing Xi, or you can configure it as a standalone. It will be able to be sold either as a standalone or as an option up into an Xi. That's our product plan. There's nothing fundamental in the SP long term that keeps us from changing port size. The initial design and the initial instrumentations are a particular size, but the architecture is actually quite flexible.
Okay. Thank you.
Your next question in queue will come from Tao Levy with Wedbush. Please go ahead.
Hey, good afternoon.
Good afternoon.
I wanted to ask about the U.S. procedure growth, which you touched on. As I try to figure what were the areas that kind of improved in the quarter, I was surprised to hear you answer to one of the prior questions that COE rates maybe were a little bit lower than in the Q1. I was just wondering where did the incremental improvement in the rates specifically come from?
Yeah. Tao, I think if you look through the comments we've made, the stabilization in GYN and the improvement in Q2 is the largest factor between Q1 and Q2. We think you should increasingly look at, particularly with all that's been going on and the volatility around elective benign procedures, look at the first half of the year in aggregate when you think about those procedures, given everything that's been going on around the macro landscape.
Okay, great. The deferred revenue for the systems in the quarter, I think Marshall had talked about how you were going to make some changes to that. Maybe I missed it, but what are some of the changes that you expect on that, and why weren't sort of more systems that were deferred turned into revenue in the quarter?
Yeah. Effectively, we deferred revenue associated with the number of systems we expected that would be traded back in. There's an estimate involved there. When I say that we would modify, all I said was that we would modify that estimate as we go through time. In fact, at the end of Q1, we did. There are certain customers that we understand will not trade in. We reversed the accrual for that. As far as why didn't more take us up on our offer, remember, right now the Xi isn't fully featured, and there are other products that will go with it that we're still working on getting regulatory approval for. We think that some customers may have hesitated for that reason, but we've extended these offers until September 30th. They have till September 30th to decide.
Okay. That's helpful. Thanks. Just lastly, any progress or any update on the single-site, the articulated needle driver, is that still kind of year-end potential approval?
A couple of things. I think from a product design and usability point of view in terms of internal testing, looks very, very good. I'm quite encouraged there. We're in the process with FDA. I think the process is following a routine kind of exchange, it's always hard to predict what the final endpoint will be there, I don't see big barriers to completing that work.
Okay, great. Thanks a lot.
Thank you.
Our next question will come from Richard Newitter with Leerink. Please go ahead.
Hi. Thanks for taking the questions, guys. I wanted to ask a question. Thanks for the color on some of the clinical advancements that you guys saw either published or talked about this quarter. I just was hoping to get a better idea of what and when we can expect perhaps a more definitive, either company-sponsored or surgeon multi-center kind of definitive study analyzing things like colorectal experience using the robot versus traditional laparoscopic surgery. I know there's a study ongoing called ROLARR. Is this something that should be viewed as a proxy and something that could be more kind of catalytic for your adoption rates in colorectal? If not, is there something else? Is there anything that Intuitive can do to help create or generate this type of data?
A couple of things. I think it's really important to start with understanding the concept that both clinical efficacy and economic value have to be evaluated procedure by procedure across both the population of patients and a population of surgeons. What that means is that looking for the one definitive study on da Vinci is unlikely. It's just not possible. You're going to have to take it case by case. As you look at case by case, there's actually quite a bit that has been done already and quite a bit that is in process, both company-sponsored and sponsored by others. We pay attention to it. It's important. Really, the strong elements that must be present for us to tell anything. Take colorectal as an example. The majority of colorectal surgeries done are open. Some are done lap, and now robotics is coming in.
A good study, one that's going to look at that, looks at both the patient population that's being done open, the patient population that's minimal lap, patient population that can be done robotically, as well as the variance in surgeon skill from those who are skilled laparoscopically and those who are not. Those are broad sweeps. Some of the studies going on approach that, but a lot of them look at subsets. The kinds of things that we're interested in making sure happen and support are ones that look broadly enough. I think it's a huge mistake, as Patrick said in his remarks, to go look at a subpopulation of patients that's da Vinci and then ignore the majority population, which is open. The short answer to your question is, those things will develop in time. They go procedure by procedure.
We ask folks who are investigating to look broadly and compare against the majority modalities, some of which are sponsored by us, some of which are sponsored by government sponsorship or other approaches. They'll develop in time, and we'll share them with you as they come out.
Great. Thanks. Then maybe if I could just ask one other one on-- You called out hernia this quarter, obviously, as a general surgery procedure category that's maybe gaining accelerated attention and adoption. Can you give a little color on the types of hernia surgeons that are performing these procedures, mostly around the experience level and the, are you getting the thought leaders in the space who are taking this on? And we should potentially see more talk at the podium from high-level thought leaders about this procedure? Or is this more, I don't know the right terminology, but everyday surgeons, so to speak, in the hernia category?
Rich, I think it's early, and we're encouraged by what we're seeing. You're seeing both a mixed bag of procedures that are being done, as well as the types of surgeons and who is adopting. It's early for us to try to pigeon it into any given subsegment yet, but we plan to look closely at it and continue to report on it moving forward. Thanks.
Thanks.
Thank you very much. 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. The following are two responses to our new Xi Surgical System from experienced customers. From one of the most experienced robotic urologists, quote, "This is the best robot to date. Vision is nicer and clearer. I can see structures very, very nicely." End quote. From a patient-side surgical assistant, quote, "Docking process is easier and more efficient. Our second case was docked faster than our typical Si dockings, and we have done hundreds of those. We did not have a single external collision, and there were almost no intraoperative adjustments necessary.
Usually, on a bariatric procedure, I'm adjusting the camera and instruments arms frequently, but with the Xi, it was not necessary." End quote. We believe we have a unique opportunity to improve surgery. The quotes above speak to the care and diligence of our design, operations, training, and field teams in meeting our customers' needs. 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 very much. Ladies and gentlemen, that does conclude your conference call for today. We do thank you for your participation. For using AT&T's Executive Teleconference. You may now disconnect.