Ladies and gentlemen, thank you for standing by, and welcome to Intuitive Surgical Q2 2014 earnings release call. At this time, all participants are in a listen only mode. And also as a reminder, today's teleconference is being recorded. And 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, and welcome to Intuitive Surgical Second Quarter Earnings Conference Call. With me today, we have Gary Goodhart, our President and CEO. Marshall Moore, our Chief Financial Officer and Patrick Clingan, Director of Finance. Before we begin, I would like to inform you that comments meant on today's call may be deemed to contain forward looking statements. Actual results may differ materially from those arrest 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 3, 2014, 10 Q filed on April 25, 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. Have been posted to 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. And 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 X I Surgical System was launched in the quarter, and our customer's 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 site, and early growth in hernia repair. Hernia repair is a broad category consisting of several procedure types, and techniques for multiple underlying and dexterity during the dissection and reconstruction phases of the procedure. We are very encouraged by this early growth and we'll pursue this opportunity in coming quarters. Within our Gynecology segment, negative trends in da Vinci use and U.
S. Hysterectomy in the first quarter moderated in the second. That said, the macro environment around US hysterectomy appears unchanged and overall performance in hysterectomy is likely better understood by viewing the first half of twenty fourteen 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. Certain and institutional interest in davinci XI has been strong with positive feedback from experienced users within many different specialties as well as those new to davinci system. 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 experienced with the product 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 quarter compared with prior year.
As expected, capital sales in Europe have been impacted in the near term by the introduction of NGI. 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 SI 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 we'll work with government bodies in subsequent quarters during the 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 form a 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 twenty thirteen and up from 87 in Q1. Total non GAAP revenue in the quarter was 507,000,000 down from $579,000,000 in Q2 of 2013 and up from $490,000,000 in Q1 of 2014. Non GAAP operating profit in the quarter was $196,000,000, comprising 39% of non GAAP revenue. Non GAAP earnings per share were $3.70, compared with $4.60 in Q2 of twenty 13 $3.50 in Q1.
Speaking to product contribution margins, we expect 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. However, 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 received FDA clearance for our XI vessel sealer and are working through the clearance process with X I Stapler and X I Firefly in the United States and other countries. These advanced technologies are an important step and filling in the XI offering.
Our XI architecture simplifies implementation and improves performance for advanced instruments, and we look forward to their introduction around the world. We have submitted our FOX 10 K application for our single site listed needle driver and are working through the clearance process. Pilot product performance for the risk of 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 opportunity to fundamentally improve surgery and are focused on the following: 1st, extending the benefits of minimally invasive surgery using da Vinci worldwide. 2nd, building da Vinci capability and supporting its use in general surgery 3rd, discipline execution in our new product launches and 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 form a basis, which excludes the impact of our excise trade in program, legal claim accrual stock based compensation, intangible asset amortization and investment impairment. We're providing pro form a information as we believe these business trends and operating results are easier to understand on a pro form a basis. I will also summarize our GAAP results later in my script. We've posted reconciliations of our pro
form a
$1,000,000, down 12% compared with $579,000,000 for the second quarter of 2013 and up 3% from last quarter. Procedures for the second quarter grew approximately 9% compared with the second quarter of 2013 and were up approximately 8% compared with last quarter. Procedure highlights will be discussed by Patrick. Pro form a 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 S I surgical systems for da Vinci XI.
Surgical system. 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 trading 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 26,000,000 of U. S.
Revenue in the 1st quarter and reserved $6,000,000 of European revenue in the 2nd quarter. As these customers accept or decline training offers, we refine our estimate of the revenue reserves. In the 2nd quarter, we reversed 10,000,000
of the first quarter
systems revenue reserve, partially reflecting for trade out completed and partially reflecting a refinement of the number of customers that we expect to accept our offer. As I stated, pro form a results exclude the impact of these revenue reserves. Revenue highlights were followed. Pro form a, instrument and accessory revenue of $262,000,000 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 the 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 $18.30 per procedure compared with $20.20 in the second quarter of $3,943 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 form a results pro form a systems revenue of 138,000,000 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 2nd quarter, excluding the 4 excise traded in for SIs. We saw more hospitals financed 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 3 were structured as operating leases. Enabling system placements will drive greater procedures and recurring revenue. Globally, our system ASP for the second quarter was $1,500,000, roughly equal to last year and slightly higher than the $1,480,000 last quarter.
Product mix, partially offset by geographic mix. 50 of the 96 systems placed during the second quarter were da Vinci XI models. We sold 5 SIEs in the quarter compared with 13 last quarter. In the U. S, we placed 61 so in the first quarter compared with 90 systems in the second quarter of 2013 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 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 compared with 53 international markets in the second quarter of 2013, which included Japan and 42 systems in international markets last quarter, which included 14 into Europe and 19 into Japan. 2nd quarter system sales also included 5 into France and 3 into Germany. Lower second quarter 2014 system sales relative to last year 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 a high end the high installed base relative to only having 1 national reimbursement prostatectomy. The XII product not yet being available as we work through regulatory approval processes.
In June, we entered into marketing responsibilities in Japan from our distributor to our wholly owned subsidiary. The total transaction cost is expected to be approximately $70,000,000. Of of which $50,000,000 is assigned to goodwill and 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 14 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 divinity XI system and relative to last year cost 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. However, over time as volumes increase when we refine the manufacturing process in the product, we would expect to see improvement in the margins of these newer products although they may not charge of $67,000,000 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 $10,000,000 charge reflecting additional claims.
These claims relate to alleged complications from surgeries performed with certain versions of monopolarcautery scissor or MCS instruments that included an MCS tip cover excess that was the subject of a market withdrawal in 2012 in surgeries that were performed with MCS instruments that were the subject of a recall in 2013. Estimate of the anticipated cost of settling this 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 form a operating expenses, which exclude reserves for legal claims, stock compensation expense and amortization of equals were $155,000,000 for the second quarter of 2014 compared with $152,000,000 for the second quarter of 2013 $155,000,000 for the first quarter of 2014. The increase in pro form a 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 $4,000,000 charge to other income to write down an investment in an early stage company. The investment originally enabled a life for technology. Otherwise, other income reflects interest on our cash and investments. Our pro form a results exclude discharge Our effective tax rate for dollars last quarter.
Our pro form a net income was $140,000,000 or 3.73 per share compared with $189,000,000 or 4.6 $3 per share for the second quarter of 2013 $139,000,000 or $3.54 per share for the first quarter of 2014. As I indicated earlier, pro form a income provides an easy comparison of our financial results and business trends. I will now summarize our GAAP results. GAAP revenue was $512,000,000 for the second quarter of 2014 compared with 579,000,000 for the second quarter of 2013 $465,000,000 for the first quarter of 2014. GAAP net income was $104,000,000 or $2.77 per share for the second quarter of 2014 compared with $159,000,000 or $3.90 per share for the second quarter of $13,20134,000,000 or $1.13 per share for the first quarter of 2014.
31, 2014. The decrease was primarily driven by $1,000,000,000 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 share repurchase under our ASR program, which amounts to approximately 2,500,000 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.
And with that, I'd like to turn it over to Patrick who'll 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 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. Q2GYN procedure growth improved compared to Q1. That 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 surge volumes. Since we do not sell power morselators and they do not attach to our systems, we are unable to precisely measure the impact April's FDA advisory specific to power morseulators 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 morsely alternatives for tissue extraction, including the use of DaVinci Surgery exists. Similar to last quarter, single site hysterect continues to be a source of growth in USGYN procedures, though off a small base. As we highlighted in a press release yesterday, a web based patient satisfaction survey of over 6000 hysterectomy patients sponsored by intuitive and the hipster sister's 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 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, INA per colorectal procedure has been increasing over the past few quarters. Single cyclolycystectomy continues to grow with adoption being driven by cosmetically sensitive, commercially insured patients. A deeper look at I and A per procedure among a large number of high volume customers suggested achieving little to no difference in material operating costs compared to optic instruments is reproducible and sustainable. Although there are additional general surgery procedures showing early signs of adoption, I want to take a moment expand upon Gary's comments about what we are seeing 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 post operative pain scores and difficulties associated with performing laparoscopic repair has caused many surgeons to rely upon and surgery. To perform minimally invasive ventral hernia repair, instruments must reach back towards the abdominal wall to repair the defect can present a challenge even for a proficient laparoscopic. Early surgeon feedback on the use of DaVinci 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 TAC 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 DBP and other urologic procedures with 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 'thirteen compared to 14% in Q1 'thirteen. 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 be 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 for da Vinci surgery in cancer and complex open urologic, gynecologic and colorectal procedures is substantial.
At the American Urological Association meeting in May, Doctor. Murphy from Peter McCollum Cancer Center in Melbourne Australia presented the results of an economic evaluation of robotic surgery sponsored by the Victorian government. His evaluation included more than from a statewide database comparing outcomes and costs associated with open lab and robotic surgeries for prostate cancer. The analysis this included detectomy reduces hospital stay, blood transfusions, and positive surgical margin in a public health system in Australia. 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.
This finding is similar to the U. K. Nice recommendation consider robotic surgery and the treatment of localized prostate cancer had 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 Doctor.
Murphy's have been rare and those that overlook 1 or more of these elements do a disservice to the healthcare community as a whole. Recently, we have seen an increase both careful economic studies by investigators who understand subsets in analysis as the basis to draw broad conclusions. We encourage the health care 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 you for your time. I'll now turn the call over to Calvin.
Thank you, Patrick.
As Marshall described, we are focusing our commentary towards non GAAP pro form a results which exclude the impacts this enhances investors' ability to assess our financial results. In order to provide historical context, we have posted summary level quarterly pro form a P and L metrics with gap reconciliations to the Investor Relations page of our website. I will be providing you with our updated financial look for 2014 14 procedure growth of between 2 8% above the approximately 523,000 procedures performed in 2013. Now based upon trends described earlier on the call, we are adjusting 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 Fireflies products and the XI system is not yet available in Japan, Korea and other international markets. Customer's 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 sale highly sensitive and likely variability in the timing of Japan system sales given the timeline for obtaining additional procedure reimbursement beyond DBP anticipated no sooner than 2016. Due to these factors affecting the capital side of our business, we will not be providing revenue forecast at this time. Our Q2 2014 pro form a gross profit margin was roughly 69% having declined about 100 basis points compared to last quarter largely reflecting lower gross profit 14, we expect our gross profit margin to be 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 the period of capital sales uncertainty. We remain focused on building our international capabilities, investing in new product development pursuing growth in multiple areas of our procedure business. Last quarter, we forecast full year operating expenses to grow between 12% 15% above 20 13 levels. We now expect to grow our operating expenses roughly 10% to 13% above the 2013 levels.
We expect the 2014 non cash stock compensation to be range forecast on the previous call. We expect other income, excluding total between $13,000,000 $15,000,000. With regard to income tax, on our last call, We forecast our income tax rate to be between 25 percent 28 percent pretax income, depending primarily on the mix of U. S. And international profits.
We are now refining this forecast This forecast does not assume the reinstatement of the R and D tax credit in 2014. Our share count for calculating diluted EPS in Q2, twenty four 18 was approximately 37,600,000 shares. Going forward, based upon the full quarter impact of our Q2 buyback we expect our Q3 share count to be between 36,700,000,000 shares. We do not plan to repurchase any of our common stock in Q3.
And our first question will come from Ben Andrew with William Blair. Please go ahead.
Gary, given the thank you for the comments, by the way. Given the view on sort of the international investments that you're making in the refinement of the expense this year. Can you give us some sense of what else you have to do as you look into 'fifteen and what we might think about as a longer term kind of margin to for the company?
As we said in the, 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. But, but instruments and recurring revenue being strong has 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. And I think it'll take a couple of years for those investments to play out.
Okay. And then as we look at the kind of hernia that you're highlighting here. Can you size that for us a bit relative to maybe the cold cystectomy opportunity or general surgery broadly? And, how big a contributor is that to the kind of the revision in the guidance on procedures that you gave today?
You know, 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. And we're just working through now what that looks like in terms of the value we bring to each one. So 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. So we're not ready yet to break out the segments and size them for you. It looks to be a real opportunity big it ultimately will be.
We're going to have to work through the next couple of quarters before we publish that.
Okay. And I guess one more quick question for us. If you think about kind of the distribution of who was buying excise 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? And 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 XII. 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 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 things that some features being brought forward in XI that I think appreciate, likewise in urology.
So 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 and just give a little color on, existing customers versus Greenfields and so on.
So within the U. S, we sold 4461 where XIs, I think there was a pretty balance between the, between 2nd systems and trading of acidism and SI products. I think taking a little bit longer, but we'll we sold some greenfields. It's just it takes it's a longer sell 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. And good evening. I wanted to maybe just start with a follow-up to Gary, your answer to the prior question regarding the next couple of years a period of investment. As you kind of look forward in the evolution of robotic surgery globally, what 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 directory 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 what is the ultimately the surgical vision?
Well, if you'd like it to put it into growth rate terms, I guess we'd certainly take that, but just what, what operational is actually going on in the business? And maybe anything you can do to help frame it for us, is this become standard of care across multiple categories? Do we see an inflection point in Europe? Do we see multiple categories in Japan? Like what would you operationally want to see come out of that?
Yes. So as we think about the opportunity looking forward, I think there are a couple of big buckets. One of them is in in areas, treating cancer and complex disease, which are largely open surgical procedures. We see opportunity Wobally. In the U.
S, we're early in our experience in colorectal and thoracic. In Europe, we see opportunity in urology and in psychology for malignant conditions in colorectal and thoracic as well, likewise in Asia. So that that set of opportunities is one that we have been investing in both on the product side. As you know, things like XI and Safeling and expanding and filling out the stabling line as well as increasing our capabilities in terms of direct markets. And so I think that opportunity is substantial.
I think we're still in the early innings of that of exploring that opportunity and delivering those products and the of those to those markets. So 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. And as that happens, we'll also look for products that optimize that opportunity both clinically and economically.
And I think those things also translate across borders. So we're really working 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 most part. And that really informs the product pipeline and the go to market strategies that you've heard us talk about.
And then 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, reference the potential to get closer to some of the medical societies. And my understanding in Japan is that the approval of new indications does stem more from the medical size, 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 application in that country?
I think in general being closer to the user groups, in the in the country helps us a lot in directions. One of them is making sure we understand their needs and understand it in a very deep way, and in a broad setting. 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 and to help review issues and activities.
And so, having close relationships with surgical societies, with key opinion leaders and with our customers directly, those who already own our products, help speed up the communication it gets us a more careful and deeper look into opportunities and issues to be resolved. And so, we were pleased to do it. I think it's absolutely in line with what we want to get done.
Our next question in queue that will come from Bob Hopkins with Bank of America.
So just the first question is on the procedure volume growth guidance that you provided. You grew 8% in the first half. You've got easier comparisons in the back half. And I just wanted to understand the 5% to 8%. Is there something specific that you guys are anticipating that would cause little bit of weakness despite the softer comps in the back half and maybe specifically referring to hysterectomy there?
Or is it just it's been kind of an interesting last year and you want to remain conservative in your projections?
Looking at it, there's not a specific thing that we think is looming. And as we said in the prepared remarks, I think there were some choppiness between Q1 and Q2 that that had to do with quarter boundaries and some other things that may have been unique to Q1. And so if you look at the first half together rather than separating it border boundaries. I think it gives us 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 now in gynecology in terms of stabilization.
But 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 and 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 4th quarter volumes now in the affordable care environment, you know, 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. So it's just another factor that we've considered.
And then, Gary, specifically on U. S. Guine, 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 today talking about more solution And I just wanted to kind of, again, gauge your confidence specifically in U. S.
Guide 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 I think, how the system works, what it can do for gynecology is pretty stable and and really well known. But what's what's hard to predict are are any of the consequences of FDA guidance that on tissue extraction and things like that. And part of that points is the breadth of the range that Kevin has described to you.
So I think as we look at the at kind of the underlying dynamics of how our products are used, we feel like 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?
From half of the year, we've obviously spent less than, what we originally provided guidance for at the beginning of the year, which was 12% to 15% And, so some of that has to do with, you know, 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. And so we're a little bit of 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 our 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 timing issues.
Great. And congrats on the progress.
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 the street to value the company now excluding stock compensation. I just have a couple of questions on that. I mean, I appreciate their non cash charges, but options are dilution for shareholders.
So does excluding that instill discipline and
how the company is going
to issue equity awards? And even it's a form of compensation, why is it appropriate for us to evaluate intuitive relative peer said who none of which backouts.com?
Sure. So this isn't a new thing. We've always wanted you to look at it. Without stock comp. We've previously provided you with a cash flow information that, does exclude the impact access.com.
I think in our particular segment, we're pretty disciplined about how we issue equity. We maintain specific guidelines that I think are well within the industry parameters of 3% dilution on an annual basis. What it's different about us is the valuation. I think the Black Scholes valuation has has issues with it. And one of those would be that it's real 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 our our some of the peers like Jonathan and Johnson and Covidien. And so we think it's better to look at us without it.
David, I think if you look broadly across larger cap medtech stocks, you'll see that we range in stock based comp as a percent of revenue around 7% to 8% as most of the other companies range around 1%.
But that's just my point. It's a form of compensation. So you need to be compared against your peer group who are expensing that compensation, you're trying not to. That's what I'm asking is relative to your peer group, Kyle's defense all?
Yeah. 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 actually absolutely built, we are building them so that we compete 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 that share our our location here in headquarters.
And so, we're careful about dilution. We don't give it away, without deep thought. It's not in terms of what the expenses are, they're not in any way hidden. They're absolutely available. And, when Marshall talks about pro form a, he's really pointing at the economic engine the company.
And so we understand and appreciate your remarks. We absolutely understand and respect the need to treat equity carefully.
Maybe just Gary, a quick follow-up there, maybe shift on the procedures because we're probably going to agree to disagree on the prior topic. But, as we move over to May seizures. 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 relates to COLI, whether COLI progressed sequentially, whether that was faster growth, slower growth or relatively the same quarter on quarter?
Thank you.
Just generally the dynamics, the dynamics we described last quarter in COLI 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 they're providing it. Directionally, I think it, it, in terms of rates, was more or less in line with where we were before, perhaps a slight slowing as volume has grown. And
we'll take
a question in queue that will come from Tycho Peterson with JP Morgan. Please go ahead.
Thanks. Given the strong place number this quarter. Just wondering if you can 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. So maybe talk a little bit about that and how you think about trade ins flowing through in the back half of the year.
And then as a follow on, can you talk about leasing option. You talked about the current percentage, but what percentage of potential systems are potentially open to operating leases?
Sure. In regards to the systems, Tycho, the ASPs we report, the 1,500,000, they do reflect contractual revenue related to sales agreement. This quarter, we did happen to have 3 systems that were shipped under operating lease arrangements. Where the system revenues will be recognized over future periods. And 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. So I think it's probably with this additional complexity, it's not as simple as it was multiply the ASP times the number of units and get the, get the systems revenue. But we are absolutely focused on finding the customer solutions and adding to the installed base.
And then on the clinical data side, can you talk it seems like the BARPA clinical data might be a little bit higher on your you talk about whether you have the appropriate data set today as you go out and try to further penetrate that market? And then is there any data on clinical efficacy or cost support for Honey 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. And so a lot what the emphasis has been there, has been making sure the datasets 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. But, ultimately, it requires engaging those markets directly and the surgical societies directly.
So 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 analyze more broadly. But as usual in these kind of procedures, the early upticks, proceed the large studies.
And then lastly on SP, can you just give us a sense as to whether you finalize plan 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 products such that it can link up with an existing XI or you can configure it as a standalone. So 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 the initial design and the initial instrumentations are particular size, but the architecture is actually quite flexible.
Okay. Thank you.
Your next question in queue will come from Tal Levy with Wedbush. Please go ahead.
I wanted to ask about the U. S. Procedure growth, which you touched on. And as I try to figure out what were the areas that kind of improved in the quarter? I was surprised to hear you answered one of the prior questions that Coley rates maybe were a little bit lower than than in in the q 1.
So I was just wondering, you know, where did where did the incremental improvement in the rates, specifically come from?
Yes, Tayo, 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. But we think you should increasingly look at, particularly with all that's been going on in 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. And also, so the deferred revenue, for the systems in the quarter, I think Marshall had talked about how they were you're going to make some changes to that. Maybe I had missed it, but what are some of the changes that you expect on that? And And why weren't sort of more systems from, you know, that were deferred, turned into revenue in the quarter?
Yeah. So effectively, we deferred revenue associated with the number of systems we expected that would be traded back in. And so there's an estimate involved there. So when I say that we would modify all I said was that we would modify that estimate as we go through time. And in fact, at the end of Q1, we did.
There are certain customers that we understand will not trade in. And so we reversed that 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 ready for approval for.
And, we think that some customer may have hesitated for that reason, but we've extended these offers until September 30. So they have till September 30 to decide.
Okay. That's helpful. Thanks. Then just lastly, any progress on already update on the single site, the articulated needle driver? And is that still a kind of year end potential approval?
So a couple of things. I think from product design and usability point of view in terms of internal testing looks very, very good. So I'm quite encouraged there. We're in the process with FDA. I think the process is following a routine kind of exchange.
And so it's always hard to predict what the final endpoint will be there, but I don't see a big, big barriers to completing that work.
Okay, great. Thanks a lot.
Thank you.
And our next question will come from Richard Newitter with Leerink. Please go ahead.
Hi, thanks for taking the questions guys. I just 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, but I just was hoping to get a better idea of what and when we can expect perhaps a more definitive either company sponsored or industry, not industry, but surgeon multicenter kind of definitive study analyzing things like colorectal experience using the robot versus the traditional laparoscopic surgery. I know there's a study ongoing called ROLAR, is this something that should be viewed as a proxy as I think that could be more kind of catalytic for your adoption rates in colorectal? And and if not, is there something else?
And and is there anything that intuitive can do to help kind of create or or generate this type of data?
Yeah. So a couple of things. I think it's really important to start with, understanding the concept that that, both clinical efficacy and and value, economic value have to be evaluated procedure by procedure across both the population of patients and a population of surgeons. And so what that means is that looking for the 1 definitive study on, on da Vinci is, is unlikely you're going to have to take it at 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 the colorectal exam as an example.
The majority of colorectal surgeries done are open. Some are done lap. And and now robotics is coming in. And so a good study, one that's going to look at that looks at both the patient population that's that's being done open, the patient population that's a minimal lab patient population that can be done robotically, as well as the variance in surgeon's skill from those who are skilled laparoscopically and those who are not. So those are broad sweeps.
Some of the studies going on approach that, but a lot of them look at subsets. And so 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 that is lap a subpopulate of patients, a subpopulation of patients at DaVinci and then ignore the majority population, which is So, 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 and they'll develop in time and we'll share them with you as they come out.
Great, great. Thanks. And 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 getting accelerated attention and adoption. Can you give a little color on the types of her surgeons that are performing these procedures for mostly around the experience level? And are you getting kind of the thought leaders in the space who are kind of taking this on and and we should potentially see kind of more talk at the podium, from from high level thought leaders about this procedure?
Or is this kind of more, kind of, I don't know the right but everyday surgeons, so to speak, in the hernia category?
Yeah. Rich, I think it's early and we're encouraged by what we're seeing. You're seeing both a mixed bag of seizures that are being done as well as the types of surgeons and who is adopting. So it's early for us to try to digit into any given sub segment yet, but we plan to look closely at it and continue to report on it moving forward. Thanks.
Just, 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 flow during these conference calls, our organizational focus remains on increasing patient value by improving surgical outcomes and reducing surgical trauma. The following are 2 responses to us, quote, this is the best robot to date. Vision is nicer and clearer.
I can see structures very, very nicely, end quote, and from a patient side surgical assistant, Docking process is easier and more efficient. Our second case was doc faster than our typical SI dockings, and we have done hundreds of those. We did not have a single 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. 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 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 3 months.
Thank you very much. And ladies and gentlemen, that does conclude your conference call for today. We do thank you for your participation and President AT And T Executive Teleconference. You may now disconnect.