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MarketScreener Homepage  >  Equities  >  Nasdaq  >  Intuitive Surgical, Inc.    ISRG

INTUITIVE SURGICAL, INC.

(ISRG)
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INTUITIVE SURGICAL : MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (form 10-Q)

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07/22/2019 | 06:03am EDT
In this report, "Intuitive Surgical," "Intuitive," the "Company," "we," "us,"
and "our" refer to Intuitive Surgical, Inc. and its wholly- and majority-owned
subsidiaries.
This management's discussion and analysis of financial condition as of June 30,
2019, and results of operations for the three and six months ended June 30,
2019, and 2018, should be read in conjunction with management's discussion and
analysis of financial condition and results of operations included in our Annual
Report on Form 10-K for the year ended December 31, 2018.
This report contains "forward-looking statements" within the meaning of Section
27A of the Securities Act of 1933, as amended, and Section 21E of the Securities
Exchange Act of 1934, as amended (the "Exchange Act"). Forward-looking
statements relate to expectations concerning matters that are not historical
facts. Words such as "estimates," "projects," "believes," "anticipates,"
"plans," "expects," "intends," "may," "will," "could," "should," "would,"
"targeted" and similar words and expressions are intended to identify
forward-looking statements. These forward-looking statements include, but are
not limited to, statements related to our acquisitions, expected business, new
product introductions, procedures and procedure adoption, future results of
operations, future financial position, our ability to increase our revenues, the
anticipated mix of our revenues between product and service revenues, our
financing plans and future capital requirements, anticipated costs of revenue,
anticipated expenses, our potential tax assets or liabilities, the effect of
recent accounting pronouncements, our investments, anticipated cash flows, our
ability to finance operations from cash flows and similar matters, and
statements based on current expectations, estimates, forecasts and projections
about the economies and markets in which we operate and our beliefs and
assumptions regarding these economies and markets. These forward-looking
statements should, therefore, be considered in light of various important
factors, including, but not limited to, the following: the impact of global and
regional economic and credit market conditions on healthcare spending;
healthcare reform legislation in the U.S. and its impact on hospital spending,
reimbursement, and fees levied on certain medical device revenues; changes in
hospital admissions and actions by payers to limit or manage surgical
procedures; the timing and success of product development and market acceptance
of developed products; our ability to integrate acquisitions; the results of any
collaborations, in-licensing arrangements, joint ventures, strategic alliances
or partnerships; procedure counts; regulatory approvals, clearances and
restrictions, or any dispute that may occur with any regulatory body; guidelines
and recommendations in the healthcare and patient communities; intellectual
property positions and litigation; competition in the medical device industry
and in the specific markets of surgery in which we operate; unanticipated
manufacturing disruptions or the inability to meet demand for products; the
results of legal proceedings to which we are or may become a party; product
liability and other litigation claims; adverse publicity regarding us and the
safety of our products and adequacy of training; our ability to expand into
foreign markets; the impact of changes to tax legislation, guidance, and
interpretations; and other risk factors. Readers are cautioned not to place
undue reliance on these forward-looking statements, which are based on current
expectations and are subject to risks, uncertainties, and assumptions that are
difficult to predict, including those risk factors described throughout this
filing and in the Annual Report on Form 10-K for the fiscal year ended
December 31, 2018, and other periodic filings with the Securities and Exchange
Commission. Our actual results may differ materially and adversely from those
expressed in any forward-looking statement. We undertake no obligation to
publicly update or release any revisions to these forward-looking statements,
except as required by law.
Intuitive®, Intuitive Surgical®, da Vinci®, da Vinci S®, da Vinci S HD Surgical
System®, da Vinci Si®, da Vinci Si HD Surgical System®, da Vinci Xi®, da Vinci
SP®, EndoWrist®, Firefly®, InSite®, da Vinci Connect®, Intuitive Surgical
EcoSystem®, da Vinci X®, SureFormTM, Single-Site®, IonTM, and IRISTM are
trademarks or registered trademarks of the Company.
Overview
At Intuitive, we believe that minimally invasive care is life-enhancing care.
Intuitive brings more than two decades of leadership in robotic-assisted
surgical technology and solutions to its offerings, and develops, manufactures
and markets the da Vinci surgical system and the Ion endoluminal system. While
surgery and acute interventions have improved significantly in the past decades,
there remains a significant need for better outcomes and decreased variability
of these outcomes across care teams. The current health care environment is
exerting a large and increasing burden on critical resources, including the
professionals who staff care teams; surgeons, anesthesiologists, nurses, and
other staff. At the same time, governments are straining to cover the healthcare
needs of their populations and are demanding lower total cost per patient to
treat disease. In the face of these challenges, we believe scientific, process,
and technology advances in biology, computing, imaging, algorithms, and robotics
offer the promise of new methods to solve old and difficult problems.
At Intuitive, we address these needs by focusing on what hospitals have termed
the quadruple aim. First, we focus on products and services that can improve
outcomes and decrease variability in the hands of care teams. Second, we seek to
improve the patient experience by minimizing disruption to lives and creating
greater predictability for the treatment experience. Third, we seek to improve
care team satisfaction by creating products and services that are dependable,
smart, and optimized for the care environment in which they are used. Finally,
we seek to lower the total cost to treat per patient episode when compared with
existing treatment alternatives, providing a return on investment for hospitals
and healthcare systems and value for payers.

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Da Vinci Surgical Systems enable surgeons to extend the benefits of minimally
invasive surgery ("MIS") to many patients who would otherwise undergo a more
invasive surgery by using computational, robotic, and imaging technologies to
overcome many of the limitations of traditional open surgery or conventional
MIS. Surgeons using a da Vinci Surgical System operate while seated comfortably
at a console viewing a 3D high definition image of the surgical field. This
immersive console connects surgeons to the surgical field and their instruments.
While seated at the console, the surgeon manipulates instrument controls in a
natural manner, similar to open surgical technique. Our technology is designed
to provide surgeons with a range of articulation of the surgical instruments
used in the surgical field analogous to the motions of a human wrist, while
filtering out the tremor inherent in a surgeon's hand. In designing our
products, we focus on making our technology easy and safe to use.
Our da Vinci products fall into five broad categories: da Vinci Surgical
Systems; da Vinci instruments; da Vinci Stapling; da Vinci Energy; and da Vinci
Vision, including Firefly Fluorescence imaging systems and da Vinci Endoscopes.
We also provide a comprehensive suite of services, training, and education
programs. Within our integrated ecosystem, our products are designed to decrease
variability in surgery by offering dependable, consistent functionality and user
experiences for surgeons seeking better outcomes. We take a holistic 'systems'
approach, to offer intelligent technology and systems designed to work together
to make MIS intervention more available and applicable.
We have commercialized the following da Vinci Surgical Systems: the da Vinci
standard Surgical System in 1999, the da Vinci S Surgical System in 2006, the da
Vinci Si Surgical System in 2009, and the fourth generation da Vinci Xi Surgical
System in 2014. We have extended our fourth generation platform by adding the da
Vinci X Surgical System, commercialized in the second quarter of 2017 and the da
Vinci SP Surgical system in the third quarter of 2018. We are early in the
launch of our da Vinci SP Surgical System and have placed 34 da Vinci SP systems
through June 30, 2019. Our plans for the rollout of the da Vinci SP Surgical
System will include putting systems in the hands of experienced da Vinci users
first while we optimize training pathways and our supply chain. We received U.S.
FDA clearances for the da Vinci SP Surgical System for urological and certain
transoral procedures. We also received clearance in South Korea where the da
Vinci SP Surgical System may be used for a broad set of procedures. We plan to
seek U.S. FDA clearances for additional indications for da Vinci SP over time.
The success of the da Vinci SP product is dependent on positive experiences and
improved clinical outcomes for the procedures for which it has been cleared as
well as securing additional clinical clearances. All da Vinci systems include a
surgeon's console (or consoles), imaging electronics, a patient-side cart, and
computational hardware and software.
We offer over 80 different multi-port da Vinci instruments to provide surgeons
flexibility in choosing the types of tools needed to perform a particular
surgery. These multi-port instruments are generally robotically controlled and
provide end effectors (tips) that are similar to those used in either open or
laparoscopic surgery. We offer advanced instrumentation for the da Vinci Xi and
da Vinci X platforms, including the da Vinci Vessel Sealer Extend and da Vinci
Stapler products, to provide surgeons with sophisticated, computer-aided tools
to precisely and efficiently interact with tissue. Da Vinci X and da Vinci Xi
Surgical Systems share the same instruments whereas the da Vinci Si Surgical
System uses instruments that are not compatible with X or Xi systems. We
currently offer nine core instruments on our da Vinci SP Surgical System. We
plan to expand the SP instrument offering over time.
Training technologies include our da Vinci Skills Simulator, da Vinci Connect
remote case observation and mentoring tool, and our dual console for use in
surgeon proctoring and collaborative surgery.
During the first quarter 2019 the U.S. FDA cleared our Ion endoluminal system to
enable minimally invasive biopsy in the peripheral lung. Our Ion system will
extend our commercial offering beyond surgery into diagnostics with this first
application. We are introducing the Ion system in the U.S. in a measured fashion
while we optimize training pathways, our supply chain, and collect additional
clinical data. We anticipate commercial shipments to begin by the end of 2019.
The success of new product introductions depends on a number of factors
including, but not limited to, pricing, competition, market and consumer
acceptance, the effective forecasting and management of product demand,
inventory levels, the management of manufacturing and supply costs, and the risk
that new products may have quality or other defects in the early stages of
introduction.
Business Model
Overview
We generate revenue from the placements of da Vinci Surgical Systems, in sales
or sales-type lease arrangements where revenue is recognized up-front or in
operating lease transactions where revenue is recognized over time. We earn
recurring revenue from the sales of instruments, accessories, and services, as
well as the revenue from operating leases. The da Vinci Surgical System
generally sells for between approximately $0.5 million and $2.5 million,
depending upon the model, configuration and geography, and represents a
significant capital equipment investment for our customers when purchased. Our
instruments and accessories have limited lives and will either expire or wear
out as they are used in surgery, at which point they need to be replaced. We
earn between approximately $700 to $3,500 of instrument and accessory revenue
per surgical procedure performed, depending on the type and complexity of the
specific procedures performed and the number and type of instruments used. We
typically enter into service contracts at the time systems are sold at an annual
fee of approximately $80,000 to $190,000, depending upon the

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configuration of the underlying system and composition of the services offered
under the contract. These service contracts have generally been renewed at the
end of the initial contractual service periods.
The Ion endoluminal system program will have a business model consistent with
the da Vinci Surgical System model described above. Consistent with da Vinci
Surgical Systems, we plan to initially place the Ion system as a piece of
capital equipment. Once the system is installed, we plan to earn recurring
revenue from sales of consumables used in biopsies and ongoing services. For
2019, we are introducing the Ion system in the U.S. in a measured fashion. The
associated impact to revenue and gross margin is not expected to be significant.
Recurring Revenue
Recurring revenue consists of instrument and accessory revenue, service revenue,
and operating lease revenue. Recurring revenue increased to $2.6 billion, or 71%
of total revenue in 2018, compared with $2.2 billion, or 71% of total revenue in
2017, and $1.9 billion, or 71% of total revenue in 2016.
Instrument and accessory revenue has grown at a faster rate than system revenue
over time. Instrument and accessory revenue increased to $2.0 billion in 2018,
compared with $1.6 billion in 2017 and $1.4 billion in 2016. The growth of
instrument and accessory revenue largely reflects continued procedure adoption.
Service revenue growth has been driven by the growth of the base of installed da
Vinci Surgical Systems. The installed base of da Vinci Surgical Systems grew 13%
to approximately 4,986 at December 31, 2018; 13% to approximately 4,409 at
December 31, 2017; and 9% to approximately 3,919 at December 31, 2016. Service
revenue grew 11% to $635.1 million in 2018; 12% to $572.9 million in 2017; and
10% to $510.7 million in 2016.
Intuitive Surgical da Vinci System Leasing
Since 2013, we have entered into sales-type and operating lease arrangements
directly with certain qualified customers as a way to offer customers
flexibility in how they acquire da Vinci Surgical Systems and expand their
robotic-assisted surgery programs while leveraging our balance sheet. These
leases generally have commercially competitive terms as compared with other
third-party entities that offer equipment leasing. We include both operating and
sales-type leases in our system shipment and installed base disclosures. We
exclude operating leases from our average selling price ("ASP") computations.
In the years ended December 31, 2018, 2017, and 2016, we shipped 272, 139, and
95 systems, respectively, under lease arrangements, of which 229, 108, and 62,
respectively, were operating leases or usage-based arrangements. Revenue from
operating lease arrangements is generally recognized on a straight-line basis
over the lease term. More recently, we have entered usage-based arrangements
with certain large customers whereby system and service revenue is recognized as
the systems are used. We set operating lease and usage-based pricing at a modest
premium relative to purchased systems reflecting the time value of money and, in
the case of usage-based arrangements, the risk that system utilization may fall
short of anticipated levels. The proportion of revenue recognized from
usage-based arrangements has not been significant and has been included in our
operating lease metrics herein. Operating lease revenue has grown faster than
overall system revenue and was $51.4 million, $25.9 million, and $16.6 million
for the years ended December 31, 2018, 2017, and 2016, respectively. Generally,
lease transactions generate similar gross margins as our sale transactions. As
of June 30, 2019, a total of 486 da Vinci Surgical Systems were installed at
customers under operating lease arrangements.
Our da Vinci system leasing provides customers with flexibility regarding how
they acquire or obtain access to da Vinci Surgical Systems. We believe leasing
and alternative financing structures, such as usage-based payment models have
been effective and well-received, and we are willing to expand the proportion of
these structures based on customer demand. As revenue for operating leases is
recognized over the lease terms, total system revenue growth is reduced in a
period when the number of operating lease placements increase as a proportion of
total system placements.
For some operating lease arrangements, our customers are provided with the right
to purchase the leased system at certain points during and/or at the end of the
lease term. Revenue generated from customer purchases of systems under operating
lease arrangements ("Lease Buyouts") was $48.8 million, $39.5 million, and $38.2
million for the years ended December 31, 2018, 2017, and 2016, respectively. We
expect that revenue recognized from customer exercises of the buyout options
will fluctuate based on the timing of when, and if, customers choose to exercise
their buyout options.
Systems Revenue
System placements are driven by procedure growth in most markets. In geographies
where da Vinci procedure adoption is in an early stage, system sales will
precede procedure growth. System placements also vary due to seasonality largely
aligned with hospital budgeting cycles. We typically place a higher proportion
of annual system placements in the fourth quarter and a lower proportion in the
first quarter as customer budgets are reset. System revenue grew 21% to $1,127.1
million in 2018; 16% to $928.4 million in 2017; and 11% to $800.0 million in
2016. System revenue is also affected by the proportion of systems placed that
are under operating lease arrangements, recurring operating lease revenue,
operating lease buyouts, product mix, ASPs, trade-in activities, and customer
mix.

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Procedure Mix / Products
Our da Vinci Surgical Systems are generally used for soft tissue surgery for
areas of the body between the pelvis and the neck, primarily in general surgery,
gynecologic surgery, urologic surgery, cardiothoracic surgery, and head and neck
surgery. Within these categories, procedures range in complexity from cancer and
other highly complex procedures to less complex procedures for benign
conditions. Cancer and other highly complex procedures tend to be reimbursed at
higher rates than less complex procedures for benign conditions. Thus, hospitals
are more sensitive to the costs associated with treating less complex benign
conditions. Our strategy is to provide hospitals with attractive clinical and
economic solutions across the spectrum of procedure complexity. Our fully
featured da Vinci Xi Surgical System with advanced instruments, including
the EndoWrist Vessel Sealer, EndoWrist Stapler products, and our Integrated
Table Motion product target the more complex procedure segment. Our da Vinci X
Surgical System and Single-Site instruments are targeted towards price sensitive
markets and procedures.
Procedure Seasonality
More than half of da Vinci procedures performed are for benign conditions, most
notably benign hernia repairs, hysterectomies, and cholecystectomies. These
benign procedures and other short-term elective procedures tend to be more
seasonal than cancer operations and surgeries for other life threatening
conditions. Seasonality in the U.S. for these procedures for benign conditions
typically results in higher fourth quarter procedure volume when more patients
have met annual deductibles and lower first quarter procedure volume when
deductibles are reset. Seasonality outside the U.S. varies and is more
pronounced around local holidays and vacation periods.
Distribution Channels
We provide our products through direct sales organizations in the U.S., Europe
(excluding Spain, Portugal, Italy, Greece, and most Eastern European countries),
Japan, South Korea, India, Taiwan, and China. In May and December 2018, we began
direct operations in India and Taiwan, respectively. In January 2019, our
Intuitive-Fosun joint venture began direct operations for da Vinci products and
services in China. In the remainder of our OUS markets, we provide our products
through distributors.
Regulatory Activities
Overview
Our products must meet the requirements of a large and growing body of
international standards that govern the product safety, efficacy, advertising,
labeling, safety reporting design, manufacture, materials content and sourcing,
testing, certification, packaging, installation, use, and disposal of our
products. Examples of such standards include electrical safety standards such as
those of the International Electrotechnical Commission, and composition
standards such as the Reduction of Hazardous Substances and the Waste Electrical
and Electronic Equipment Directives. Failure to meet these standards could limit
our ability to market our products in those regions that require compliance to
such standards.
Our products and operations are also subject to increasingly stringent medical
device, privacy, and other regulations by regional, federal, state, and local
authorities. We anticipate that timelines for introduction of new products
and/or indications may be extended relative to past experience as a result of
these regulations.
Clearances and Approvals
We have obtained the clearances required to market our multi-port products
associated with all of our da Vinci Surgical Systems (Standard, S, Si, Xi, and X
systems) for our targeted surgical specialties within the U.S., South Korea,
Japan, and the European markets in which we operate.
In June 2019, we obtained U.S. FDA clearance for our da Vinci Handheld Camera
(see the description of the da Vinci Handheld Camera in the New Product
Introductions section below).
In February 2019, we obtained U.S. FDA clearance for our Ion endoluminal system,
our new flexible robotic-assisted catheter-based platform, designed to navigate
through very small lung airways to reach peripheral nodules for biopsies (see
the description of the Ion endoluminal system in the New Product Introductions
section below). We are introducing the Ion endoluminal system in a measured
fashion while we optimize training pathways, our supply chain, and collect
additional clinical data. We anticipate commercial shipments to begin by the end
of 2019.
In February 2019, we obtained U.S. FDA clearance for our IRISTM augmented
reality product (see the description of IRIS in the New Product Introductions
section below). IRIS is a service that delivers a 3D image of the patient
anatomy (initially targeting kidneys) to aid surgeons in both pre- and
intra-operative settings. We are in the early stages of an IRIS pilot study in
the field at a small group of U.S. hospitals to gain initial product experience
and insights.
In December 2018, we received clearance for our da Vinci Xi Surgical System in
China. The Xi clearance does not include advanced energy, stapling, or wireless
table motion products which attach to the Xi system. Separate clearances are
required for each of these products by China National Medical Products
Administration ("NMPA").

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In May 2018, we obtained U.S. FDA clearance for the da Vinci SP Surgical System
for urologic surgical procedures that are appropriate for a single port
approach. In March 2019, we received U.S. FDA clearance for the da Vinci SP for
certain transoral procedures. We also received regulatory clearance for the da
Vinci SP Surgical System in South Korea in May 2018. We are introducing the da
Vinci SP Surgical System in a measured fashion while we optimize training
pathways and our supply chain. We have placed 34 da Vinci SP systems with
customers through June 30, 2019.
In October 2018, the China National Health Commission published on its official
website the quota for major medical equipment to be imported and sold in China
through 2020. The government will allow the sale of 154 new surgical robots into
China, which could include da Vinci Surgical Systems as well as surgical systems
introduced by others. Sales of da Vinci Surgical Systems under the quota are
uncertain, as they are dependent on hospitals completing a tender process and
receiving associated approvals.
In July 2018, we received U.S. FDA clearance to market SureForm 60, our da Vinci
EndoWrist 60mm Stapler. In January 2019, we received U.S. FDA clearance to
market SureForm 45 (see the description of the SureForm 45 and 60 Staplers in
the New Product Introductions section below).
In April 2018, we received U.S. FDA clearance for our Vessel Sealer Extend (see
the description of the da Vinci Vessel Sealer Extend in the New Product
Introductions section below).
In April 2017, we received CE mark clearance for our da Vinci X Surgical System
in Europe. Following the CE mark, in May 2017, we received U.S. FDA clearance to
market our da Vinci X Surgical System in the U.S. We received regulatory
clearance for the da Vinci X Surgical System in South Korea and Japan in
September 2017 and April 2018, respectively (see the description of the da Vinci
X Surgical System in the New Product Introductions section below). Regulatory
clearances for the da Vinci X Surgical System may be received in other markets
over time.
The Japanese Ministry of Health, Labor, and Welfare ("MHLW") considers
reimbursement for procedures in April of even numbered years. The process for
obtaining reimbursement requires Japanese university hospitals and surgical
societies, with our support, to seek reimbursement. There are multiple pathways
to obtain reimbursement for procedures including those that require in-country
clinical data/economic data. In April 2012 and April 2016, the MHLW granted
reimbursement status for da Vinci Prostatectomy ("dVP") and partial nephrectomy,
respectively. Most prostatectomies and partial nephrectomies were open
procedures prior to da Vinci reimbursement. Da Vinci procedure reimbursement for
dVP and partial nephrectomy procedures are higher than open procedure
reimbursements. An additional 12 da Vinci procedures were granted reimbursement
effective April 1, 2018, including gastrectomy, low anterior resection,
lobectomy and hysterectomy, for both malignant and benign conditions. These
additional 12 reimbursed procedures have varying levels of conventional,
laparoscopic penetration and will be reimbursed at rates equal to the
conventional laparoscopic procedures. Given the reimbursement level and
laparoscopic penetration for these 12 procedures, there can be no assurance that
adoption will occur or that the adoption pace for these procedures will be
similar to any other da Vinci procedures. If these procedures are not adopted
and we are not successful in obtaining adequate procedure reimbursements for
additional procedures, then the demand for our products in Japan could be
limited.
Recalls and Corrections
Medical device companies have regulatory obligations to correct or remove
medical devices in the field that could pose a risk to health. The definition of
"recalls and corrections" is expansive and includes repair, replacement,
inspections, relabeling, and issuance of new or additional instructions for use
or reinforcement of existing instructions for use and training when such actions
are taken for specific reasons of safety or compliance. These field actions
require stringent documentation, reporting, and monitoring worldwide. There are
other actions a medical device manufacturer may take in the field without
reporting including, but not limited to, routine servicing and stock rotations.
As we determine whether a field action is reportable in any regulatory
jurisdiction, we prepare and submit notifications to the appropriate regulatory
agency for the particular jurisdiction. Regulators can require the expansion,
reclassification, or change in scope and language of the field action. In
general, upon submitting required notifications to regulators regarding a field
action which is a recall or correction, we will notify customers regarding the
field action, provide any additional documentation required in their national
language, and arrange, as required, return or replacement of the affected
product or a field service visit to perform the correction.
Field actions as well as certain outcomes from regulatory activities can result
in adverse effects on our business, including damage to our reputation, delays
by customers of purchase decisions, reduction or stoppage of the use of
installed systems, and reduced revenue as well as increased expenses.
Procedures
We model patient value as equal to procedure efficacy / invasiveness. In this
equation, procedure efficacy is defined as a measure of the success of the
surgery in resolving the underlying disease and invasiveness is defined as a
measure of patient pain and disruption of regular activities. When the patient
value of a da Vinci procedure is greater than that of alternative treatment

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options, patients may benefit from seeking out surgeons and hospitals that offer
da Vinci Surgery, which could potentially result in a local market share shift.
Adoption of da Vinci procedures occurs procedure by procedure, market by market,
and is driven by the relative patient value and total treatment costs of da
Vinci procedures as compared to alternative treatment options for the same
disease state or condition.
Worldwide Procedures
Our da Vinci systems and instruments are regulated independently in various
countries and regions of the world. The discussion of indications for use and
representative or target procedures is intended solely to provide an
understanding of the market for da Vinci products and is not intended to promote
for sale or use any Intuitive Surgical product outside of its licensed or
cleared labeling and indications for use.
The adoption of robotic-assisted surgery using the da Vinci Surgical System has
the potential to grow for those procedures that offer greater patient value than
non-da Vinci alternatives and competitive total economics for healthcare
providers. Our da Vinci Surgical Systems are used primarily in general surgery,
gynecologic surgery, urologic surgery, cardiothoracic surgery, and head and neck
surgery. We focus our organization and investments on developing, marketing, and
training products and services for procedures in which da Vinci can bring
patient value relative to alternative treatment options and/or economic benefit
to healthcare providers. Target procedures in general surgery include hernia
repair (both ventral and inguinal) and colorectal procedures. Target procedures
in gynecology include da Vinci hysterectomy ("dVH"), for both cancer and benign
conditions, and sacrocolpopexy. Target procedures in urology include dVP and
partial nephrectomy. In cardiothoracic surgery, target procedures include da
Vinci lobectomy and da Vinci mitral valve repair. In head and neck surgery,
target procedures include certain procedures resecting benign and malignant
tumors classified as T1 and T2. Not all the indications, procedures, or products
described may be available in a given country or region or on all generations of
da Vinci Surgical Systems. Surgeons and their patients need to consult the
product labeling in their specific country and for each product in order to
determine the cleared uses, as well as important limitations, restrictions, or
contraindications.
In 2018, approximately 1,037,000 surgical procedures were performed with the da
Vinci Surgical Systems, compared with approximately 877,000 and 753,000
procedures performed in 2017 and 2016, respectively. The growth in our overall
procedure volume in 2018 was driven by growth in U.S. general surgery procedures
and worldwide urologic procedures.
U.S. Procedures
Overall U.S. procedure volume grew to approximately 753,000 in 2018, compared
with approximately 644,000 in 2017, and approximately 563,000 in 2016. General
surgery was our largest and fastest growing U.S. specialty in 2018 with
procedure volume that grew to approximately 325,000 in 2018, compared with
approximately 246,000 in 2017 and 186,000 in 2016. Gynecology was our second
largest U.S. surgical specialty in 2018 with procedure volume of approximately
265,000 in 2018, compared with 252,000 in 2017 and 246,000 in 2016. U.S. urology
procedure volume was approximately 128,000 in 2018, compared with approximately
118,000 in 2017 and 109,000 in 2016.
Procedures Outside of the U.S.
Overall OUS procedures grew to approximately 284,000 in 2018, compared with
approximately 233,000 in 2017 and approximately 190,000 in 2016. Procedure
growth in most OUS markets was driven largely by urology procedure volume, which
grew to approximately 175,000 in 2018, compared with approximately 149,000 in
2017 and approximately 124,000 in 2016. General surgery and gynecologic oncology
procedures also contributed to OUS procedure growth.
Recent Business Events and Trends
Procedures
Overall. Total da Vinci procedures grew approximately 17% for the six months
ended June 30, 2019, compared with 17% for the six months ended June 30, 2018.
U.S. procedure growth was approximately 16% for the six months ended June 30,
2019, compared with 16% for the six months ended June 30, 2018. Year-to-date
2019 U.S. procedure growth was largely attributable to growth in general surgery
procedures, most notably hernia repair, cholecystectomy, colorectal, and
bariatric procedures. Year-to-date procedures growth was also driven by growth
in thoracic procedures, as well as moderate growth in more mature gynecologic
and urologic procedure categories.
Procedure volume OUS grew approximately 21% for the six months ended June 30,
2019, compared with 20% for the six months ended June 30, 2018. Year-to-date
2019 OUS procedure growth was driven by continued growth in dVP procedures and
earlier stage growth in general surgery, gynecology, and kidney cancer
procedures. Slightly higher year-to-date 2019 procedure growth was driven by
higher procedure growth in Japan attributable to additional procedures granted
reimbursement status in April 2018, partially offset by lower procedure growth
in China. We believe growth in these global markets is being driven by increased
acceptance among surgeons and health systems, supported by expanded global
evidence validating the clinical and economic value of da Vinci procedures.

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U.S. General Surgery. Growth in general surgery procedures continued to drive
the majority of incremental procedures during the six months ended June 30,
2019. Ventral and inguinal hernia repairs contributed the most incremental cases
during the six months ended June 30, 2019, as they did in 2018 and 2017. We
believe that growth in da Vinci hernia repair reflects improved clinical
outcomes within certain patient populations, as well as potential cost benefits
relative to certain alternative treatments. We believe hernia repair procedures
represent a significant opportunity with the potential to drive growth in future
periods. However, given the differences in surgical complexity associated with
treatment of various hernia patient populations and varying surgeon opinion
regarding optimal surgical technique, it is difficult to estimate the timing of
and to what extent da Vinci hernia repair procedure volume will grow in the
future. We expect a large portion of hernia repairs will continue to be
performed via different modalities of surgery.
Adoption of da Vinci for colorectal procedures, which includes several
underlying procedures including low anterior resections for rectal cancers and
certain colon procedures for benign and cancerous conditions, has been ongoing
for several years, and is supported by our recently launched technologies such
as the da Vinci Xi Surgical System, EndoWrist Stapler, EndoWrist Vessel Sealer,
and Integrated Table Motion.
In recent quarters, we have seen increasing contributions to growth from other
U.S. general surgery procedures, including cholecystectomy and bariatric
procedures. Our third quarter 2018 introduction of the SureForm 60mm stapler
product provides surgeons a better optimized robotic tool set for bariatric
procedures.
U.S. Gynecology. Growth in gynecology procedures during the six months ended
June 30, 2019, increased modestly compared to 2018 driven by higher growth in
benign hysterectomy procedures, partially offset by moderating growth in
hysterectomy for cancer. Combining robotic, laparoscopic, and vaginal
approaches, MIS represents about 80% of the U.S. hysterectomy market for benign
conditions. We believe that our growth in gynecologic procedures over the past
several years has primarily been driven by consolidation of gynecologic
procedures into higher volume surgeons that focus on cancer and complex
surgeries.
Global Urology. Global urology procedures have also been a strong contributor to
our overall procedure growth. In the U.S., dVP is the standard of care for the
surgical treatment of prostate cancer and we believe growth is largely aligned
with surgical volumes of prostate cancer. For OUS, dVP is at various stages of
adoption in different areas of the world but is the largest overall da Vinci
procedure. Year-to-date 2019 growth in OUS dVP was consistent with growth in
2018.
Kidney cancer procedures have also been a strong contributor to our recent
global urology growth. Clinical publications have demonstrated that the use of a
da Vinci system increases the likelihood that a patient will receive nephron
sparing surgery through a partial nephrectomy, which is typically surgical
society guideline-recommended therapy.
OUS Procedures. Year-to-date 2019 OUS procedure growth rate reflects continued
da Vinci adoption in European and Asian markets. In 2018 and year-to-date 2019,
procedure growth in China moderated as the previous systems quota expired at the
end of 2015 and systems installed in China are highly utilized. In October 2018,
the China National Health Commission announced a new quota to allow the sale of
154 new surgical robots into China through 2020, which could include da Vinci
Surgical Systems. This quota applies to the da Vinci Si and recently approved Xi
Surgical Systems (refer to the previous discussion in the "Clearances and
Approvals" section), as well as competitors' products when and if cleared by
NMPA. Sales of da Vinci Surgical Systems under the quota are uncertain, as they
are dependent on provincial allocation processes and hospitals completing a
tender process and receiving associated approvals. In Japan, we have experienced
strong procedure growth since receiving the national reimbursements for dVP and
partial nephrectomy. However, as adoption for these procedures has progressed
towards higher levels of penetration, growth in these two urologic procedures
has moderated. A total of 12 additional da Vinci procedures were granted
national reimbursement status effective April 1, 2018, including gastrectomy,
anterior resection, lobectomy, and hysterectomy, for both malignant and benign
conditions. Procedure growth in Japan has accelerated since the new procedures
were granted reimbursement status. However, these additional 12 reimbursed
procedures have varying levels of conventional laparoscopic penetration and are
reimbursed at rates equal to the conventional laparoscopic procedures. Given the
reimbursement level and laparoscopic penetration for these procedures, there can
be no assurance that adoption will occur or that the adoption pace for these
procedures will be similar to any other da Vinci procedure. If these procedures
are not adopted and we are not successful in obtaining adequate procedure
reimbursement for additional procedures, then the demand for our products in
Japan could be limited.
System Demand
Future demand for da Vinci Surgical Systems will be impacted by factors
including hospital response to the evolving health care environment under the
current U.S. administration, procedure growth rates, hospital consolidation
trends, evolving system utilization and point of care dynamics, capital
replacement trends, additional reimbursements in various global markets,
including Japan, the timing around governmental tenders and authorizations,
including China, the timing of when we receive regulatory clearance in our other
OUS markets for our da Vinci Xi Surgical System, da Vinci X Surgical System, and
da Vinci SP Surgical System, and related instruments, market response as well as
other economic and geopolitical factors. Market acceptance of our recently
launched da Vinci SP Surgical System and the nature and timing of additional da
Vinci SP regulatory indications may also impact future system placements. Demand
may also be impacted by robotic surgery competition, including from companies
that have introduced products in the field of robotic surgery or have made
explicit statements about their efforts to enter the field

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including, but not limited to: Avatera Medical GmbH; CMR Surgical Limited;
Johnson & Johnson (including their recent acquisition of Auris Health, Inc.);
Medicaroid Inc.; MedRobotics Corp.; Medtronic PLC.; meerecompany Inc.; Olympus
Corp.; Samsung Corporation; Smart Robot Technology Group Co. Ltd.; Titan
Medical, Inc.; TransEnterix, Inc.; Verb Surgical Inc. (a joint venture between
Johnson & Johnson and Google Inc.); and Wego Holding Co., Ltd.
Many of the above factors will also impact future demand for our recently
cleared Ion system, as we extend our commercial offering into diagnostics, along
with additional factors associated with a new product introduction, such as, but
not limited to, our ability to optimize manufacturing and our supply chain,
competition, clinical data to demonstrate value, and market acceptance.
New Product Introductions
Ion endoluminal system. In February 2019, we obtained U.S. FDA clearance for the
Ion endoluminal system, our new flexible robotic-assisted catheter-based
platform, designed to navigate through very small lung airways to reach
peripheral nodules for biopsies. The Ion system uses an ultra-thin articulating
robotic catheter that can move 180 degrees in all directions. The outer diameter
of the catheter is 3.5mm, which physicians can navigate through small and
tortuous airways to reach nodules in any airway segment within the lung. The Ion
system's flexible biopsy needle can also pass through very tight bends via Ion's
catheter to collect tissue in the peripheral lung. The catheter's 2mm working
channel can also accommodate other biopsy tools, such as biopsy forceps or
cytology brushes, if necessary. We are introducing Ion in a measured fashion
while we optimize training pathways, our supply chain, and collect additional
clinical data. We anticipate commercial shipments to begin by the end of 2019.
Da Vinci SP Surgical System. In May 2018, we obtained U.S. FDA clearance for the
da Vinci SP Surgical System for urologic surgical procedures that are
appropriate for a single port approach. In March 2019, we received U.S. FDA
clearance for the da Vinci SP for certain transoral procedures. The da Vinci SP
system includes three, multi-jointed, wristed instruments and the first da Vinci
fully wristed 3DHD camera. The instruments and the camera all emerge through a
single cannula and are triangulated around the target anatomy to avoid external
instrument collisions that can occur in narrow surgical workspaces. The system
enables flexible port placement and broad internal and external range of motion
(e.g. 360-degrees of anatomical access) through the single SP arm. Surgeons
control the fully articulating instruments and the camera on the da Vinci SP
system, which uses the same fourth generation surgeon console as the da Vinci X
and Xi systems. The da Vinci SP system provides surgeons with robotic-assisted
technology designed for deep and narrow access to tissue in the body. We
anticipate pursuing further regulatory clearances for the da Vinci SP, including
colorectal applications, broadening the applicability of the SP platform over
time. We are introducing the da Vinci SP Surgical System in a measured fashion
while we optimize training pathways and our supply chain. We have placed 34 SP
Surgical Systems with customers through June 30, 2019.
Da Vinci X Surgical System. In May 2017, we launched a new da Vinci model, the
da Vinci X, in the U.S. The da Vinci X system provides surgeons and hospitals
with access to some of the most advanced fourth generation da Vinci surgery
technology at a lower cost. The da Vinci X uses the same vision cart and surgeon
console that are found on our flagship product, the da Vinci Xi system. For new
customers, the da Vinci X System provides a cost effective capital entry point
while providing a pathway for upgrading to other fourth generation systems.
Existing customers may negotiate to trade in their older da Vinci systems in
order to standardize their robotics programs onto the fourth generation
platform, and choosing which system model by considering clinical and economic
factors.
The da Vinci X enables optimized, focused-quadrant surgery including procedures
like prostatectomy, hernia repair, and benign hysterectomy, among others. The
system features flexible port placement and 3D digital optics, while
incorporating the same advanced instruments and accessories as the da Vinci Xi.
The da Vinci X drives operational efficiencies through set-up technology that
uses voice and laser guidance, drape design that simplifies surgery
preparations, and a lightweight, fully integrated endoscope.
SureForm 60 and SureForm 45 Staplers. In July 2018, we received U.S. FDA
clearance in the U.S. for SureForm 60 instrument with White, Blue, Green, and
Black 60mm reloads. In January 2019, we received U.S. FDA clearance for SureForm
45 instrument with White, Blue, Green, and Black 45mm reloads. The SureForm 60
and SureForm 45 are single-use, fully wristed, stapling instruments intended for
resection, transection, and/or creation of anastomoses. The SureForm 60 has
particular utility in bariatric procedures, while the SureForm 45 has particular
utility in colorectal procedures. SureForm 60 and SureForm 45 broaden our
existing stapler product line, which also includes EndoWrist Stapler 45 with
White, Blue, and Green, 45mm reloads and EndoWrist 30 with White, Blue, Green,
and Gray 30mm reloads. Not all reloads or staplers are available for use on all
systems or in all countries.
Da Vinci Vessel Sealer Extend. In April 2018, we received U.S. FDA clearance for
da Vinci Vessel Sealer Extend, our newest instrument in the Vessel Sealing
family of products. Da Vinci Vessel Sealer Extend is a single-use, fully wristed
bipolar electrosurgical instrument compatible with our fourth generation
multiport systems. It is intended for grasping and blunt dissection of tissue
and for bipolar coagulation and mechanical transection of vessels up to 7mm in
diameter and tissue bundles that fit in the jaws of the instrument.

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IRIS. In February 2019, we obtained U.S. FDA clearance for our IRIS augmented
reality product. IRIS is a service that delivers a 3D image of the patient
anatomy (initially targeting kidneys) to aid surgeons in both the pre- and
intra-operative settings. We are now in the early stages of an IRIS pilot study
in the field at a small group of U.S. hospitals to gain initial product
experience and insights.
Da Vinci Handheld Camera. In June 2019, we obtained U.S. FDA clearance for our
da Vinci Handheld Camera. The da Vinci Handheld Camera is a lightweight 2D
camera head which can be connected to third-party laparoscopes. This allows the
laparoscopic image to be displayed on the da Vinci X/Xi vision cart to address
aspects of da Vinci procedures that may require use of a laparoscope. We plan to
launch and begin commercial activities for the da Vinci Handheld Camera by the
end of 2019.
Acquisition of Certain Assets from Schölly Fiberoptic
In July 2019, we entered into an agreement to acquire certain assets and
operations from Schölly Fiberoptic GmbH ("Schölly"), a supplier of endoscopes
and other visualization equipment, for cash consideration of approximately $100
million (the "Schölly Acquisition"). The exact amount of the purchase
consideration and timing of the closing of the Schölly Acquisition is subject to
certain substantive closing conditions.
The process to manufacture endoscopes is complex, and it cannot be assured that
we can successfully integrate the endoscope manufacturing operations subsequent
to the closing of the Schölly Acquisition. For example, we may be unable to
retain the employees of Schölly or its current suppliers. The integration
process will be complex and involves the integration of manufacturing operations
across multiple sites globally. The integration may require expenses and time in
excess of expectations. Integrating the Schölly Acquisition will also involve
getting certain regulatory approvals and re-certification of manufacturing
sites. If we cannot successfully integrate or manufacture endoscopes subsequent
to the Schölly Acquisition, it may have an adverse impact on our business,
financial condition, results of operations, or cash flows.
Second Quarter 2019 Financial Highlights
•      Total revenue increased by 21% to $1,098.9 million during the three months

ended June 30, 2019, compared with $909.3 million during the three months

ended June 30, 2018.

• Approximately 301,000 da Vinci procedures were performed during the three

months ended June 30, 2019, an increase of approximately 17% compared with

approximately 257,000 for the three months ended June 30, 2018.

• Instrument and accessory revenue increased by 22% to $578.5 million during

the three months ended June 30, 2019, compared with $476.1 million during

the three months ended June 30, 2018.

• Systems revenue increased by 24% to $343.8 million during the three months

ended June 30, 2019, compared with $277.4 million during the three months

ended June 30, 2018.

• A total of 273 da Vinci Surgical Systems were shipped during the three

months ended June 30, 2019, an increase of 24% compared with 220 during

       the three months ended June 30, 2018. As of June 30, 2019, we had a da
       Vinci Surgical System installed base of approximately 5,270 systems, an
       increase of approximately 13% compared with the installed base as of
       June 30, 2018.

• Gross profit as a percentage of revenue was 69.1% for the three months

       ended June 30, 2019, compared with 69.5% for the three months ended
       June 30, 2018.

• Operating income increased by 29% to $359.0 million during the three

months ended June 30, 2019, compared with $277.4 million during the three

months ended June 30, 2018. Operating income for the three months ended

June 30, 2018, included pre-tax litigation related charges of $42.5

million. Operating income included $82.0 million and $63.6 million of

share-based compensation expense related to employee stock plans during

the three months ended June 30, 2019, and 2018, respectively. Operating

income included intangible asset charges of $10.6 million and $5.6 million

for the three months ended June 30, 2019 and 2018, respectively.

• As of June 30, 2019, we had $5.1 billion in cash, cash equivalents, and

investments. Cash, cash equivalents, and investments increased by $313.8

million, compared with December 31, 2018, primarily as a result of cash

generated from operating activities, partially offset by share repurchases

       and capital expenditures.



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Results of Operations
The following table sets forth, for the periods indicated, certain unaudited
Condensed Consolidated Statements of Income information (in millions, except
percentages):
                                          Three Months Ended June 30,                               Six Months Ended June 30,
                                            % of total                 % of total                   % of total                   % of total
                                2019         revenue        2018        revenue         2019         revenue         2018         revenue
Revenue:
Product                      $   922.3           84 %     $ 753.5           83 %     $ 1,722.1           83 %     $ 1,448.3           82 %
Service                          176.6           16 %       155.8           17 %         350.5           17 %         308.5           18 %
Total revenue                  1,098.9          100 %       909.3          

100 % 2,072.6 100 % 1,756.8 100 % Cost of revenue: Product

                          283.4           26 %       228.1           25 %         529.8           25 %         429.6           24 %
Service                           56.5            5 %        48.9            5 %         114.2            6 %         101.1            6 %
Total cost of revenue            339.9           31 %       277.0           30 %         644.0           31 %         530.7           30 %
Product gross profit             638.9           58 %       525.4           58 %       1,192.3           58 %       1,018.7           58 %
Service gross profit             120.1           11 %       106.9           12 %         236.3           11 %         207.4           12 %
Gross profit                     759.0           69 %       632.3           70 %       1,428.6           69 %       1,226.1           70 %
Operating expenses:
Selling, general and
administrative                   279.2           25 %       259.8           29 %         552.6           27 %         481.4           27 %
Research and development         120.8           11 %        95.1           10 %         264.8           13 %         190.6           11 %
Total operating expenses         400.0           36 %       354.9           39 %         817.4           40 %         672.0           38 %
Income from operations           359.0           33 %       277.4           31 %         611.2           29 %         554.1           32 %
Interest and other income,
net                               32.8            3 %        18.2            2 %          60.3            3 %          31.4            1 %
Income before taxes              391.8           36 %       295.6           33 %         671.5           32 %         585.5           33 %
Income tax expense                75.4            7 %        41.0            5 %          51.1            2 %          43.6            2 %
Net income                       316.4           29 %       254.6           28 %         620.4           30 %         541.9           31 %
Less: net loss attributable
to noncontrolling interest
in joint venture                  (1.9 )          - %        (0.7 )          - %           (4.4)          - %          (1.0 )          - %
Net income attributable to
Intuitive Surgical, Inc.     $   318.3           29 %     $ 255.3           28 %     $   624.8           30 %     $   542.9           31 %


Total Revenue
Total revenue was $1,098.9 million for the three months ended June 30, 2019,
compared with $909.3 million for the three months ended June 30, 2018, resulting
from 22% higher instrument and accessory revenue driven by approximately 17%
higher procedure volume, 24% higher systems revenue, and 13% higher service
revenue.
Revenue denominated in foreign currencies as a percentage of total revenue was
approximately 17% and 18% for the three and six months ended June 30, 2019,
respectively, and 19% and 20% for the three and six months ended June 30, 2018,
respectively. We generally sell our products and services in local currencies
where we have direct distribution channels. Foreign currency rate fluctuations
did not have a material impact on total revenue for the three months ended June
30, 2019, as compared with the three months ended June 30, 2018.
Revenue generated in the U.S. accounted for 71% of total revenue for both three
and six months ended June 30, 2019, respectively, and 71% and 69% for the three
and six months ended June 30, 2018, respectively. We believe that U.S. revenue
has accounted for the large majority of total revenue due to U.S. patients'
ability to choose their provider and method of treatment, reimbursement
structures supportive of innovation and minimally invasive surgery, and initial
investments focused on U.S. infrastructure. We have been investing in our
business in the OUS markets and our OUS procedures have grown faster in
proportion to U.S. procedures. We expect that our OUS procedures and revenue
will make up a greater portion of our business in the long term.

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The following table summarizes our revenue and da Vinci Surgical System unit shipments for the three and six months ended June 30, 2019, and 2018, respectively (in millions, except percentages and unit shipments):

                                         Three Months Ended June 30,          Six Months Ended June 30,
                                            2019               2018              2019              2018
Revenue

Instruments and accessories $ 578.5 $ 476.1$ 1,130.8$ 936.4 Systems

                                        343.8             277.4             591.3            511.9
Total product revenue                          922.3             753.5           1,722.1          1,448.3
Services                                       176.6             155.8             350.5            308.5
Total revenue                        $       1,098.9$     909.3$     2,072.6$  1,756.8
United States                        $         785.3       $     644.7$     1,476.9$  1,217.1
OUS                                            313.6             264.6             595.7            539.7
Total revenue                        $       1,098.9$     909.3$     2,072.6$  1,756.8
% of Revenue - U.S.                               71 %              71 %              71 %             69 %
% of Revenue - OUS                                29 %              29 %              29 %             31 %

Instruments and accessories $ 578.5 $ 476.1$ 1,130.8$ 936.4 Services

                                       176.6             155.8             350.5            308.5
Operating lease revenue                         25.1              11.5              45.5             21.0
Total recurring revenue              $         780.2       $     643.4$     1,526.8$  1,265.9
% of Total revenue                                71 %              71 %              74 %             72 %

Unit Shipments by Region:
U.S. unit shipments                              193               138               347              250
OUS unit shipments                                80                82               161              155
Total unit shipments*                            273               220               508              405
*Systems shipped under operating
leases (included in total unit
shipments)                                        88                44               166               87

Unit Shipments involving System
Trade-ins:
Unit shipments involving trade-ins               103                74               188              131
Unit shipments not involving
trade-ins                                        170               146               320              274



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Product Revenue
Three months ended June 30, 2019
Product revenue increased by 22% to $922.3 million for the three months ended
June 30, 2019, compared with $753.5 million for the three months ended June 30,
2018.
Instrument and accessory revenue increased by 22% to $578.5 million for the
three months ended June 30, 2019, compared with $476.1 million for the three
months ended June 30, 2018. The increase in instrument and accessory revenue was
driven by procedure growth of approximately 17% and higher sales of our advanced
instruments. Second quarter 2019 U.S. procedure growth of approximately 16% was
driven by growth in general surgery procedures, most notably hernia repair,
colorectal, cholecystectomy, and bariatric procedures, thoracic procedures, and
a moderate growth in the more mature gynecologic and urologic procedures
categories. OUS procedure growth was approximately 20% for the second quarter of
2019, and was driven by continued growth in dVP procedures, earlier stage growth
in general surgery, gynecology, and kidney cancer procedures. Geographically,
second quarter 2019 OUS procedure growth was driven by procedure expansion in
Germany, France, and Japan.
Systems revenue increased by 24% to $343.8 million for the three months ended
June 30, 2019, compared with $277.4 million for the three months ended June 30,
2018. Higher second quarter 2019 systems revenue was primarily driven by higher
system shipments, higher lease buyouts, higher second quarter 2019 ASPs, and
higher leasing related revenue, partly offset by a higher proportion of system
shipments under operating leases.
During the second quarter of 2019, a total of 273 systems were shipped compared
with 220 during the second quarter of 2018. By geography, 193 systems were
shipped into the U.S., 30 into Europe, 40 into Asia, and 10 into other markets
during the second quarter of 2019, compared with 138 systems shipped into the
U.S., 39 into Europe, 23 into Asia, and 20 into other markets during the second
quarter of 2018. The increase in systems shipments was primarily driven by
procedure growth, the need for hospitals to expand or establish capacity and
more customers trading in older da Vinci models for fourth generation da Vinci
Xi and da Vinci X systems.
We shipped 99 and 52 systems under lease arrangements, of which 88 and 44 were
classified as operating leases, in the three months ended June 30, 2019, and
2018, respectively. Operating lease revenue was $25.1 million for the three
months ended June 30, 2019, compared with $11.5 million for the three months
ended June 30, 2018. Systems placed as operating leases represented 32% of total
shipments during the second quarter of 2019, compared with 20% during the second
quarter of 2018. A total 486 of da Vinci Surgical Systems were installed at
customers under operating lease arrangements as of June 30, 2019. Revenue from
Lease Buyouts was $26.5 million for the three months ended June 30, 2019,
compared with $12.5 million for the three months ended June 30, 2018. We expect
revenue from Lease Buyouts to fluctuate period to period based on the timing of
when, and if, customers choose to exercise the buyout options embedded in their
leases.
The da Vinci Surgical System ASP, excluding the impact of systems shipped under
operating leases, was approximately $1.54 million for the three months ended
June 30, 2019, compared with $1.42 million for the three months ended June 30,
2018. The higher second quarter 2019 ASP was largely driven by favorable product
and geographic mix. ASP fluctuates from period to period based on geographic and
product mix, product pricing, systems shipped involving trade-ins, and changes
in foreign exchange rates.
Six months ended June 30, 2019
Product revenue increased by 19% to $1.7 billion for the six months
ended June 30, 2019, compared with $1.4 billion for the six months ended June
30, 2018.
Instrument and accessory revenue increased by 21% to $1,130.8 million for
the six months ended June 30, 2019, compared with $936.4 million for the six
months ended June 30, 2018. The increase in instrument and accessory revenue was
driven by procedure growth of approximately 17% and higher sales of our advanced
instruments. Year-to-date 2019 U.S. procedure growth of approximately 16% was
driven by growth in general surgery procedures, most notably hernia repair,
colorectal procedures, cholecystectomy, bariatric, and thoracic procedures, as
well as moderate growth in more mature gynecologic and urologic procedure
categories. OUS procedure growth was approximately 21% for the six months
ended June 30, 2019, driven by continued growth in dVP procedures and earlier
stage growth in general surgery, gynecology, and kidney cancer procedures.
Systems revenue increased by 16% to $591.3 million for the six months ended June
30, 2019, compared with $511.9 million for the six months ended June 30, 2018.
Higher year-to-date 2019 systems revenue was primarily driven by higher system
shipments and higher lease related revenue, partly offset by a higher number of
system placements under operating lease arrangements and lower ASPs.
During the six months ended June 30, 2019, a total of 508 systems were shipped
compared with 405 during the six months ended June 30, 2018. By
geography, 347 systems were shipped into the U.S., 79 into Europe, 61 into Asia,
and 21 into other markets during the six months ended June 30, 2019, compared
with 250 systems shipped into the U.S., 84 into Europe, 39 into Asia,
and 32 into other markets during the six months ended June 30, 2018.

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During the six months ended June 30, 2019, 166 of the 508 systems were shipped
under operating lease arrangements compared with 87 of 405 systems shipped
during the six months ended June 30, 2018.
Operating lease revenue was $45.5 million for the six months ended June 30,
2019, compared with $21.0 million for the six months ended June 30, 2018. The
increase in systems shipments was primarily driven by procedure growth, the need
for hospitals to expand or establish capacity and more customers trading in
older da Vinci models for fourth generation da Vinci Xi and da Vinci X systems.
The da Vinci Surgical System ASP, excluding the impact of systems shipped under
operating leases, was approximately $1.43 million for the six months
ended June 30, 2019, compared with $1.45 million for six months ended June 30,
2018. ASP fluctuates period to period based on geographic and product mix,
product pricing, systems shipped involving trade-ins, and changes in foreign
exchange rates.
Service Revenue
Service revenue increased by 13% to $176.6 million for the three months ended
June 30, 2019, compared with $155.8 million for the three months ended June 30,
2018. Service revenue increased by 14% to $350.5 million for the six months
ended June 30, 2019, compared with $308.5 million for the six months
ended June 30, 2018. Higher service revenue for the three and six months ended
June 30, 2019, was primarily driven by a larger installed base of da Vinci
Surgical Systems producing service revenue.
Gross Profit
Product gross profit for the three months ended June 30, 2019, increased 22% to
$638.9 million, representing 69.3% of product revenue, compared with $525.4
million, representing 69.7% of product revenue, for the three months ended
June 30, 2018. Product gross profit for the six months ended June 30, 2019,
increased 17% to $1.2 billion, representing 69.2% of product revenue, compared
with $1.0 billion, representing 70.3% of product revenue, for the six months
ended June 30, 2018. The higher product gross profit for the three and six
months ended June 30, 2019, was primarily driven by higher product revenue.
Lower gross profit margin for the three months ended June 30, 2019 was driven by
higher intangible assets amortization expense partially offset by higher da
Vinci system ASPs and improved manufacturing efficiencies. Lower product gross
profit margin for the six months ended June 30, 2019 was primarily driven by
higher intangible assets amortization expense, lower system ASPs, partially
offset by improved manufacturing efficiencies. Product gross profit for the
three and six months ended June 30, 2019 reflected share-based compensation
expense of $11.4 million and $22.4 million, respectively, compared with $8.9
million and $17.1 million for the three and six months ended June 30, 2018,
respectively. Product gross profit for the three and six months ended June 30,
2019 included intangible assets amortization expense of $7.7 million and $15.0
million, respectively, compared with $1.1 million and $2.0 million for the three
and six months ended June 30, 2018, respectively.
In prior periods, we were subject to the Medical Device Excise Tax ("MDET") in
the United States. MDET initially became effective on January 1, 2013 and we
treated MDET as a reduction in gross profit. In December 2015, the Consolidated
Appropriations Act, 2016 (the "Appropriations Act") was signed into law. The
Appropriations Act included a two-year moratorium on MDET such that medical
device sales in 2016 and 2017 were exempt from the excise tax. This moratorium
was extended through December 31, 2019 by the Extension of Continuing
Appropriations Act of 2018, signed into law on January 22, 2018. MDET is
scheduled to be reinstated on January 1, 2020.
Service gross profit for the three months ended June 30, 2019, was $120.1
million, or 68.0% of service revenue, compared with $106.9 million, or 68.6% of
service revenue for the three months ended June 30, 2018. Service gross profit
for the six months ended June 30, 2019, was $236.3 million, or 67.4% of service
revenue, compared with $207.4 million, or 67.2% of service revenue, for
the six months ended June 30, 2018.
The higher service gross profit for the three and six months ended June 30,
2019, was driven by higher service revenue, reflecting a larger installed base
of da Vinci Surgical Systems.
Service gross profit for the three and six months ended June 30, 2019 reflected
share-based compensation expense of $4.8 million and $9.3 million, respectively,
compared with $4.1 million and $8.0 million for the three and six months ended
June 30, 2018, respectively. Service gross profit for the three and six months
ended June 30, 2019 included intangible assets amortization expense of $1.0
million and $1.9 million, respectively, compared with $0.2 million and $0.3
million for the three and six months ended June 30, 2018, respectively.
Selling, General and Administrative Expenses
Selling, general and administrative expenses include costs for sales, marketing
and administrative personnel, sales and marketing activities, tradeshow
expenses, legal expenses, regulatory fees, and general corporate expenses.
Selling, general and administrative expenses for the three months ended June 30,
2019, increased by 7% to $279.2 million, compared with $259.8 million for the
three months ended June 30, 2018. Selling, general and administrative expenses
for the six months ended June 30, 2019, increased by 15% to $552.6 million,
compared with $481.4 million for the six months

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ended June 30, 2018. The higher selling, general and administrative expenses for
the three and six months ended June 30, 2019, were primarily associated with our
expanded Asian and European teams, including establishing our direct
organizations in China, India, and Taiwan, and infrastructure to support our
growth.
Selling, general and administrative expenses for the three and six months ended
June 30, 2019 included net pre-tax litigation charges of zero, compared with
$42.5 million and $47.7 million for the three and six months ended June 30,
2018, respectively.
Selling, general and administrative expenses for the three and six months ended
June 30, 2019 reflected share-based compensation expense of $40.7 million and
$79.3 million, respectively, as compared with $32.7 million and $62.2 million
for the three and six months ended June 30, 2018, respectively.
Research and Development Expenses
Research and development costs are expensed as incurred. Research and
development expenses include costs associated with the design, development,
testing, and significant enhancement of our products.
Research and development expenses for the three months ended June 30, 2019,
increased by 27% to $120.8 million, compared with $95.1 million for the three
months ended June 30, 2018. Research and development expenses for the six months
ended June 30, 2019, increased by 39% to $264.8 million, compared with $190.6
million for the six months ended June 30, 2018. The increase was primarily due
to higher personnel related expenses, intangible asset charges, and other
project costs incurred to support a broader set of product development
initiatives, including Ion and SP platform investments; informatics; advanced
instrumentation; advanced imaging; and future generations of robotics.
Share-based compensation expense charged to research and development expense was
$25.1 million and $47.9 million for the three and six months ended June 30,
2019, respectively, compared with $17.9 million and $34.2 million for the three
and six months ended June 30, 2018. For the three and six months ended June 30,
2019, intangible asset charges were $0.5 million and $21.3 million,
respectively, as compared with $4.1 million and $10.7 million for the three and
six months ended June 30, 2018, respectively.
Research and development expenses fluctuate with project timing. Based upon our
broader set of product development initiatives and the stage of the underlying
projects, we expect to continue to make substantial investments in research and
development and anticipate that research and development expenses will continue
to increase in the future.
Interest and Other Income, Net
Interest and other income, net, for the three and six months ended June 30, 2019
was $32.8 million and $60.3 million, respectively, compared with $18.2 million
and $31.4 million for the three and six months ended June 30, 2018,
respectively. The increase was primarily driven by higher interest earned during
the three and six months ended June 30, 2019 due to higher interest rates and
higher cash and investment balances.
Income Tax Expense
Income tax expense for the three months ended June 30, 2019, was $75.4 million,
or 19.2% of income before taxes, compared with $41.0 million, or 13.9% of income
before taxes, for the three months ended June 30, 2018. Income tax expense for
the six months ended June 30, 2019, was $51.1 million, or 7.6% of income before
taxes, compared with $43.6 million, or 7.4% of income before taxes, for
the six months ended June 30, 2018.
Our effective tax rate for the three and six months ended June 30, 2019, and
2018, differs from the U.S. federal statutory rate of 21% primarily due to
excess tax benefits associated with employee equity plans, the effect of income
earned by certain overseas entities being taxed at rates lower than the federal
statutory rate, and federal R&D credit benefit, partially offset by state income
taxes (net of federal benefit) and U.S. tax on foreign earnings. The higher
effective tax rate for the three months ended June 30, 2019, compared with the
same period of 2018, was primarily due to lower excess tax benefits from
employee equity plans realized in the current quarter.
Our provision for income taxes included excess tax benefits associated with
employee equity plans of $11.3 million and $84.0 million, which reduced our
effective tax rate by 2.9 percentage points and 12.5 percentage points, for the
three and six months ended June 30, 2019, respectively. Our income tax provision
is subject to volatility as the amount of excess tax benefits or deficiencies
fluctuates from period to period based on the price of our stock, the volume of
share-based instruments settled or vested, and the value assigned to employee
equity awards under U.S. GAAP.
We are subject to the examination of our income tax returns by the Internal
Revenue Service and other tax authorities. The outcome of these audits cannot be
predicted with certainty. Management regularly assesses the likelihood of
adverse outcomes resulting from these examinations to determine the adequacy of
our provision for income taxes. If any issues addressed in our tax audits are
resolved in a manner not consistent with management's expectations, we could be
required to adjust our provision for income taxes in the period such resolution
occurs.

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In May 2019, a Swiss tax reform package was approved by Swiss voters in a
referendum. The enactment of the tax reform is pending the completion of certain
legislative procedures. If enacted, our Swiss entity will have a higher
effective tax rate for years after 2019. Under U.S. GAAP, changes in tax rates
and tax law are accounted for in the period of enactment, and deferred tax
assets and liabilities are measured at the enacted tax rate. The impact of the
re-measurement of our Swiss deferred tax asset is expected to be a benefit of
approximately $51 million, which will be reflected in the period of the
enactment of the Swiss tax reform.
In the third quarter of 2015, we recorded a $29.3 million tax benefit due to a
U.S. Tax Court opinion (the "2015 Opinion") issued in July 2015 involving an
independent third party related to intercompany charges for share-based
compensation. Based on the findings of the U.S. Tax Court, we were required to,
and did, refund to our foreign subsidiaries the share-based compensation element
of certain intercompany charges made in prior periods. Starting from 2015,
share-based compensation has been excluded from intercompany charges. In June
2019, the Ninth Circuit Court of Appeals reversed the 2015 Opinion (the "Ninth
Circuit Opinion"). Since the Ninth Circuit Opinion potentially is subject to
further judicial review, we continue to treat our share-based compensation
expense in accordance with the 2015 Opinion and continue to recognize the
related tax benefits in our financial statements based upon our evaluation of
the position in light of the present facts. In the event of a final opinion
which reverses the 2015 Opinion, there may be an adverse impact to our income
tax expense and effective tax rate.
Net Loss Attributable to Noncontrolling Interest in Joint Venture
The Company's majority-owned joint venture (the "Joint Venture") with Shanghai
Fosun Pharmaceutical (Group) Co., Ltd. ("Fosun Pharma"), a subsidiary of Fosun
International Limited, was established to research, develop, manufacture, and
sell robotic-assisted catheter-based medical devices. The Joint Venture is owned
60% by us and 40% by Fosun Pharma. The catheter-based technology will initially
target early diagnosis and cost-effective treatment of lung cancer, one of the
most commonly diagnosed forms of cancer in the world. Distribution of
catheter-based medical devices in China will be conducted by the joint venture,
while distribution outside of China will be conducted by us. The Joint Venture
is located in China. In January 2019, the Joint Venture acquired certain assets,
including distribution rights, customer relationships, and certain personnel,
from Chindex and its affiliates, a subsidiary of Fosun Pharma, and began direct
operations for da Vinci products and services in China. As of June 30, 2019, the
companies have contributed $55 million of up to $100 million required by the
joint venture agreement.
We do not expect the Joint Venture to generate revenue in 2019 related to the
sale of robotic-assisted catheter-based medical devices. There can be no
assurance that we and the Joint Venture can successfully complete the
development of the robotic-assisted catheter-based medical devices; or that we
and the Joint Venture will successfully commercialize such products. There can
also be no assurance that the joint venture will not require additional
contributions to fund its business; that the Joint Venture will become
profitable; or that the acquired Chindex assets will be successfully integrated
and the expected benefits realized.
Net loss attributable to noncontrolling interest in Joint Venture for the three
and six months ended June 30, 2019 was $1.9 million and $4.4 million,
respectively, compared with $0.7 million and $1.0 million for the three and six
months ended June 30, 2018, respectively. The increase was primarily due to the
intangible assets amortization expense and higher costs to ramp up operations in
China during the six months ended June 30, 2019.
Liquidity and Capital Resources
Sources and Uses of Cash
Our principal source of liquidity is cash provided by operations and issuance of
common stock through exercise of stock options and our employee stock purchase
program. Cash and cash equivalents plus short- and long-term investments
increased from $4.8 billion as of December 31, 2018, to $5.1 billion as of
June 30, 2019, primarily from cash provided by our operations. Cash generation
is one of our fundamental strengths and provides us with substantial financial
flexibility in meeting our operating, investing, and financing needs.
See "Item 7A. Quantitative and Qualitative Disclosures About Market Risk" on our
Form 10-K for the fiscal year ended December 31, 2018 for discussion on the
impact of interest rate risk and market risk on our investment portfolio.

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Condensed Consolidated Cash Flow Data (Unaudited)
The following table summarizes our cash flows for the six months ended June 30,
2019, and 2018 (in millions):
                                                                Six Months Ended
                                                                     June 30,
                                                               2019            2018
Net cash provided by (used in)
Operating activities                                       $     649.2$    511.7
Investing activities                                            (531.6 )          9.3
Financing activities                                            (220.4 )         34.9

Effect of exchange rates on cash, cash equivalents, and restricted cash

                                                   (1.3 )         (0.6 )
Net increase (decrease) in cash, cash equivalents, and
restricted cash                                            $    (104.1 )$    555.3


Operating Activities
For the six months ended June 30, 2019, net cash provided by operating
activities of $649.2 million exceeded our net income of $620.4 million primarily
for the following reasons:
1.     Our net income included non-cash charges: share-based compensation of

$157.7 million; depreciation expense of $67.8 million; deferred income

taxes of $52.7 million; amortization of intangible assets of $20.5

million; and amortization of contract acquisition asset of $5.9 million.


2.     The non-cash charges outlined above were partially offset by changes in
       operating assets and liabilities that resulted in $274.2 million of cash
       used by operating activities. Operating assets and liabilities are

primarily comprised of accounts receivable, inventory, prepaid expenses

and other assets, deferred revenue, and other accrued liabilities.

Inventory, including the transfer of equipment from inventory to property,

       plant and equipment, increased by $178.0 million primarily due to more
       systems under operating lease arrangements and safety stock build up to

meet increased sales volume. Prepaid expenses and other assets increased

by $89.2 million primarily due to an increase in prepaid taxes driven by

the timing of tax payments. Other accrued liabilities decreased by $53.0

million primarily due to the settlement of a legal matter. Accrued

compensation and employee benefits decreased by $33.3 million primarily

due to the payments of 2018 incentive compensation. The unfavorable impact

of these items on cash used by operating activities was partly offset by a

$48.9 million decrease in accounts receivable primarily due to timing of

billings and collections and a $21.7 million increase in accounts payable.



Investing Activities
Net cash used in investing activities during the six months ended June 30, 2019,
consisted primarily of purchases of investments (net of proceeds from sales and
maturities of investments) of $335.9 million and the acquisition of property and
equipment of $196.9 million. We invest predominantly in high quality, fixed
income securities. Our investment portfolio may at any time contain investments
in U.S. treasury and U.S. government agency securities, taxable and tax exempt
municipal notes, corporate notes and bonds, commercial paper, non-U.S.
government agency securities, cash deposits, and money market funds.
Financing Activities
Net cash used in financing activities during the six months ended June 30, 2019,
consisted primarily of cash used in the repurchase of approximately 0.4 million
shares of our common stock in the open market for $200.0 million and $145.0
million in taxes paid on behalf of employees related to net share settlements of
vested employee equity awards partly offset by $119.6 million of proceeds from
stock option exercises and employee stock purchases.
Capital Expenditures
Our business is not capital equipment intensive. However, with the growth of our
business and our investments in property and facilities and in manufacturing
automation, capital investments in these areas have increased. We expect these
capital investments to exceed $250 million in both 2019 and 2020. We intend to
fund these needs with cash generated from operations.
Our cash requirements depend on numerous factors, including market acceptance of
our products, the resources we devote to developing and supporting our products,
and other factors. We expect to continue to devote substantial resources to
expand procedure adoption and acceptance of our products. We have made
substantial investments in our commercial operations, product development
activities, facilities, and intellectual property. Based upon our business
model, we anticipate that we will continue to be able to fund future growth
through cash provided from operations. We believe that our current cash, cash
equivalents, and investment balances, together with income to be derived from
the sale of our products, will be sufficient to meet our liquidity requirements
for the foreseeable future.

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Critical Accounting Estimates
The discussion and analysis of our financial condition and results of operations
are based upon our Financial Statements, which have been prepared in accordance
with U.S. GAAP. The preparation of these Financial Statements requires us to
make estimates and judgments that affect the reported amounts of assets,
liabilities, revenues, and expenses. On an ongoing basis, we evaluate our
critical accounting estimates. We base our estimates on historical experience
and on various other assumptions that we believe to be reasonable under the
circumstances, the results of which form the basis for making judgments about
the carrying values of assets and liabilities that are not readily apparent from
other sources. Actual results may differ from these estimates under different
assumptions or conditions. There have been no new or material changes to the
critical accounting estimates discussed in our Annual Report on Form 10-K for
the fiscal year ended December 31, 2018, that are of significance, or potential
significance to the Company.

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