Overview
Open surgery remains the predominant form of surgery and is used in almost every area of the body. However, the large incisions required for open surgery create trauma to patients, typically resulting in longer hospitalization and recovery times, increased hospitalization costs, and additional pain and suffering relative to minimally invasive surgery ("MIS"), where MIS is available. For over three decades, MIS has reduced trauma to patients by allowing selected surgeries to be performed through small ports rather than large incisions. MIS has been widely adopted for certain surgical procedures. Da Vinci Surgical Systems enable surgeons to extend the benefits of 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. Ourda Vinci products fall into five broad categories: da Vinci Surgical Systems,da Vinci instruments and accessories, da Vinci Stapling,da Vinci Energy, and da Vinci Vision, including Firefly Fluorescence imaging systems ("Firefly") 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 approach offering 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, commercialized in the third quarter of 2018. We are early in the launch of our da Vinci SP Surgical System, and we have placed 29 da Vinci SP Surgical Systems in 2019 and have an installed base of 44 as ofDecember 31, 2019 . Our plans for the rollout of the da Vinci SP Surgical System include putting systems in the hands of experiencedda Vinci users first while we optimize training pathways and our supply chain. We received FDA clearances for the da Vinci SP Surgical System for urological and certain transoral procedures. We also received clearance inSouth Korea where the da Vinci SP Surgical System may be used for a broad set of procedures. We plan to seek FDA clearances for additional indications for da Vinci SP over time. The success of the da Vinci SP Surgical System 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. Allda 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-portda Vinci instruments to provide surgeons with 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 andda Vinci X platforms, including the da Vinci Vessel Sealer Extend andda Vinci Stapler products, to provide surgeons with sophisticated, computer-aided tools to precisely and efficiently interact with tissue.Da Vinci X andda 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 Intuitive Simulation products, our Intuitive Telepresence remote case observation and telementoring tools, and our dual console for use in surgeon proctoring and collaborative surgery. During the first quarter of 2019, the FDA cleared our Ion endoluminal system to enable minimally invasive biopsies in the lung. Our Ion system extends our commercial offering beyond surgery into diagnostic procedures with this first application. We are introducing the Ion system in theU.S. in a measured fashion while we optimize training pathways and our supply chain and collect additional clinical data. We are early in the launch and have placed 10 Ion systems for commercial use throughDecember 31, 2019 , which are not included in ourda Vinci Surgical System installed base. We have also placed 6 Ion systems with hospitals for gathering clinical data. 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. 46 -------------------------------------------------------------------------------- Table of Contents 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 and usage-based models 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$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 generally earn between$700 and$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 or leased at an annual fee between$80,000 and$190,000 , depending upon the 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. We generate revenue from the placements of the Ion endoluminal system in a business model consistent with the da Vinci Surgical System model described above. We generate revenue from the placement of Ion systems, and we earn recurring revenue from the sales of instruments and accessories used in biopsies and ongoing system service. We are introducing the Ion system in theU.S. in a measured fashion. For the year endedDecember 31, 2019 , the associated impact to revenue and gross margin was not significant. Recurring Revenue Recurring revenue consists of instrument and accessory revenue, service revenue, and operating lease revenue. Recurring revenue increased to$3.2 billion , or 72% of total revenue in 2019, compared with$2.6 billion , or 71% of total revenue in 2018, and$2.2 billion , or 71% of total revenue in 2017. Instrument and accessory revenue has grown at a faster rate than systems revenue over time. Instrument and accessory revenue increased to$2.4 billion in 2019, compared with$2.0 billion in 2018 and$1.6 billion in 2017. 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 12% to approximately 5,582 atDecember 31, 2019 ; 13% to approximately 4,986 atDecember 31, 2018 ; and 13% to approximately 4,409 atDecember 31, 2017 . Service revenue increased to$724 million in 2019, compared with$635 million in 2018 and$573 million in 2017.Intuitive 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 systems and expand their robotic-assisted 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 have also entered into usage-based arrangements with larger customers that have committedda Vinci programs where we charge for the system and service as the systems are utilized. We include operating and sales-type leases, and systems placed under usage-based arrangements, in our system shipment and installed base disclosures. We exclude operating lease-related revenue, usage-based revenue, and Ion system revenue from our da Vinci Surgical System average selling price ("ASP") computations. In the years endedDecember 31, 2019 , 2018, and 2017, we shipped 425, 272, and 139 systems, respectively, under lease and usage-based arrangements, of which 384, 229, and 108 systems, respectively, were operating lease and 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 into 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 at a faster rate than overall systems revenue and was$106.9 million ,$51.4 million , and$25.9 million for the years endedDecember 31, 2019 , 2018, and 2017, respectively. Generally, lease transactions generate similar gross margins as our sale transactions. As ofDecember 31, 2019 , a total of 658 da Vinci Surgical Systems were installed at customers under operating lease or usage-based arrangements. Our system leasing and usage-based models provide customers with flexibility regarding how they acquire or obtain access to our systems. We believe that these alternative financing structures 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 and usage-based 47 -------------------------------------------------------------------------------- Table of Contents systems is recognized over time, total systems revenue growth is reduced in a period when the number of operating lease and usage-based placements increases as a proportion of total system placements. Our exposure to the credit risks relating to our lease financing arrangements may increase if our customers are adversely affected by changes in healthcare laws, coverage and reimbursement, economic pressures or uncertainty, or other customer-specific factors. Also, usage-based leases generally contain no minimum payments; therefore, customers may exit such arrangements without paying a financial penalty to us. 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$92.8 million ,$48.8 million , and$39.5 million for the years endedDecember 31, 2019 , 2018, and 2017, 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 whereda 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. Systems revenue grew 19% to$1,346 million in 2019; 21% to$1,127 million in 2018; and 16% to$928 million in 2017. Systems revenue is also affected by the proportion of system placements under operating lease and usage-based arrangements, recurring operating lease and usage-based revenue, operating lease buyouts, product mix, ASPs, trade-in activities, and customer mix. 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 and EndoWrist Stapler products, and our Integrated Table Motion product targets the more complex procedure segment. Ourda Vinci X Surgical System is targeted towards price sensitive markets and procedures. Our da Vinci SP Surgical System complements the da Vinci Xi and X Surgical Systems by enabling surgeons to access narrow workspaces. Procedure Seasonality More than half ofda Vinci procedures performed are for benign conditions, most notably 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 theU.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 theU.S. varies and is more pronounced around local holidays and vacation periods. Distribution Channels We provide our products through direct sales organizations in theU.S. ,Europe (excludingSpain ,Portugal ,Italy ,Greece , and most Eastern European countries),China ,Japan ,South Korea ,India , andTaiwan . In May andDecember 2018 , we began direct operations inIndia andTaiwan , respectively. InJanuary 2019 , our Intuitive-Fosun joint venture began direct sales forda Vinci products and services inChina . In the remainder of our OUS markets, we provide our products through distributors. 48 -------------------------------------------------------------------------------- Table of Contents 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 theInternational 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 the 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 generally obtained the clearances required to market our products associated with our da Vinci Surgical Multiport Systems (Standard, S, Si, Xi, and X systems) for our targeted surgical specialties within theU.S. ,South Korea ,Japan , and the European markets in which we operate. Between 2017 and 2019, we obtained regulatory clearances for the following products: •InNovember 2019 , we obtained FDA clearance for our SynchroSeal instrument and E-100 generator. •InJuly 2019 , we obtained FDA clearance for our SureForm 45 Curved-Tip stapler and SureForm 45 Gray reload, which round out our SureForm 45 portfolio. •InJune 2019 , we received CE mark clearance for our da Vinci Endoscope Plus for the da Vinci X/Xi Surgical Systems inEurope . Following the CE mark, inJuly 2019 , we obtained FDA clearance for our da Vinci Endoscope Plus. •InJune 2019 , we obtained FDA clearance for our da Vinci Handheld Camera. •InFebruary 2019 , we obtained 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. We are introducing the Ion endoluminal system in a measured fashion while we optimize training pathways and our supply chain and collect additional clinical data. We have placed 10 Ion systems for commercial use throughDecember 31, 2019 . •InFebruary 2019 , we obtained 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 pre- and intra-operative settings. We are in the early stages of an IRIS pilot study in the field at a small group ofU.S. hospitals to gain initial product experience and insights. •InDecember 2018 , we received regulatory clearance for our da Vinci Xi Surgical System inChina . The Xi clearance does not include advanced energy or stapling products that attach to the Xi system. Separate clearances are required for each of these products byChina National Medical Products Administration ("NMPA"). •InOctober 2018 , theChina National Health Commission published on its official website the quota for major medical equipment to be imported and sold inChina through 2020. The government will allow the sale of 154 new surgical robots intoChina , which could include da Vinci Surgical Systems as well as surgical systems introduced by others. As ofDecember 31, 2019 , we have sold 57 da Vinci Surgical Systems under this quota. Future 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. •InJuly 2018 , we obtained FDA clearance to market SureForm 60, ourda Vinci EndoWrist 60mm Stapler. InJanuary 2019 , we obtained FDA clearance to market SureForm 45. We have also received regulatory clearance inSouth Korea andJapan to market SureForm 60 and SureForm 45 and 60. •InMay 2018 , we obtained FDA clearance for the da Vinci SP Surgical System for urologic surgical procedures that are appropriate for a single port approach. InMarch 2019 , we obtained FDA clearance for the da Vinci SP Surgical System for certain transoral procedures. We also received regulatory clearance for the da Vinci SP Surgical System inSouth Korea inMay 2018 . We continue to introduce the da Vinci SP Surgical System in a measured fashion while we optimize training pathways and our supply chain. We have placed 29 da Vinci SP Surgical Systems in 2019 and have an installed base of 44 as ofDecember 31, 2019 . •InApril 2018 , we obtained FDA clearance for our da Vinci Vessel Sealer Extend. •InApril 2017 , we received CE mark clearance for our da Vinci X Surgical System inEurope . Following the CE mark, inMay 2017 , we obtained FDA clearance to market our da Vinci X Surgical System in theU.S. We received regulatory clearance for the da Vinci X Surgical System inSouth Korea andJapan inSeptember 2017 andApril 2018 , respectively. Regulatory clearances for the da Vinci X Surgical System may be received in other markets over time. 49 -------------------------------------------------------------------------------- Table of Contents Refer to the descriptions of our products that received regulatory clearances in 2019 and 2018 in the New Product Introductions section below.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. InApril 2012 andApril 2016 , the MHLW granted reimbursement status for da Vinci Prostatectomy ("dVP") and partial nephrectomy, respectively. Most prostatectomies and partial nephrectomies were open procedures prior toda 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 effectiveApril 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 otherda 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 inJapan 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 that 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 that 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 ada Vinci procedure is greater than that of alternative treatment 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 ofda Vinci procedures occurs procedure by procedure and market by market and is driven by the relative patient value and total treatment costs ofda Vinci procedures as compared to alternative treatment options for the same disease state or condition. Worldwide Procedures Ourda 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 forda Vinci products and is not intended to promote for sale or use anyIntuitive 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 whichda 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 includeda Vinci hysterectomy ("dVH"), for both cancer and benign conditions, and sacrocolpopexy. Target procedures in urology includeda Vinci prostatectomy ("dVP") andda Vinci partial nephrectomy. In cardiothoracic surgery, target procedures includeda Vinci lobectomy andda Vinci mitral valve repair. In head 50 -------------------------------------------------------------------------------- Table of Contents 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 2019, approximately 1,229,000 surgical procedures were performed with da Vinci Surgical Systems, compared with approximately 1,038,000 and 877,000 surgical procedures performed with da Vinci Surgical Systems in 2018 and 2017, respectively. The growth in our overall procedure volume in 2019 was driven by growth inU.S. general surgery procedures and worldwide urology procedures.U.S. Procedures OverallU.S. procedure volume with da Vinci Surgical Systems grew to approximately 883,000 in 2019, compared with approximately 753,000 in 2018 and approximately 644,000 in 2017. General surgery was our largest and fastest growingU.S. specialty in 2019 with procedure volume that grew to approximately 421,000 in 2019, compared with approximately 325,000 in 2018 and approximately 246,000 in 2017. Gynecology was our second largestU.S. surgical specialty in 2019 with procedure volume that grew to approximately 282,000 in 2019, compared with approximately 265,000 in 2018 and approximately 252,000 in 2017. Urology was our third largestU.S. surgical specialty in 2019 with procedure volume that grew to approximately 138,000 in 2019, compared with approximately 128,000 in 2018 and approximately 118,000 in 2017. Procedures Outside of theU.S. Overall OUS procedure volume with da Vinci Surgical Systems grew to approximately 346,000 in 2019, compared with approximately 285,000 in 2018 and approximately 233,000 in 2017. Procedure growth in most OUS markets was driven largely by urology procedure volume, which grew to approximately 206,000 in 2019, compared with approximately 175,000 in 2018 and approximately 149,000 in 2017. General surgery and gynecology procedures also contributed to OUS procedure growth. Recent Business Events and Trends Procedures Overall. Totalda Vinci procedures grew approximately 18% for the year endedDecember 31, 2019 , compared with approximately 18% for the year endedDecember 31, 2018 .U.S. procedure growth was approximately 17% for the year endedDecember 31, 2019 , compared with approximately 17% for the year endedDecember 31, 2018 . 2019 U.S. procedure growth was largely attributable to growth in general surgery procedures, most notably hernia repair, cholecystectomy, colorectal, and bariatric procedures.U.S. procedure growth was also driven by growth in thoracic procedures, as well as moderate growth in more mature urologic and gynecologic procedure categories. Procedure volume OUS grew approximately 21% for the year endedDecember 31, 2019 , compared with approximately 22% for the year endedDecember 31, 2018 . 2019 OUS procedure growth was driven by continued growth in urologic procedures, including prostatectomies and nephrectomies, and earlier stage growth in general surgery (particularly colorectal), gynecologic, and thoracic procedures. 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 ofda Vinci procedures.U.S. General Surgery. In 2019, general surgery was our largest and fastest growing specialty in theU.S. with procedure volume that grew to approximately 421,000 in 2019, compared with approximately 325,000 in 2018 and approximately 246,000 in 2017. Inguinal and ventral hernia repairs contributed the most incremental procedures in 2019, as they did in 2018 and 2017. We believe that growth inda 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 extentda 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 ofda 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 EndoWrist Staplers and energy devices and Integrated Table Motion. During 2019, we have seen increasing contributions to growth from otherU.S. general surgery procedures, including cholecystectomy and bariatric procedures. Given the already very high level of laparoscopic techniques used in cholecystectomy, it is unclear whether growth is sustainable and to what extentda Vinci cholecystectomy may be adopted. Our third quarter 2018 introduction of the SureForm 60mm stapler product provides surgeons a better optimized robotic tool set for bariatric procedures. 51 -------------------------------------------------------------------------------- Table of ContentsU.S. Gynecology. In 2019, growth in gynecology procedures in theU.S. increased modestly compared to 2018. Procedure volume was approximately 282,000 in 2019, compared with approximately 265,000 in 2018 and approximately 252,000 in 2017, driven by growth in benign hysterectomy procedures and, to a lesser extent, growth in hysterectomy for cancer. Combining robotic, laparoscopic, and vaginal approaches, MIS represents about 80% of theU.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. Along withU.S. general surgery, global urology procedures have also been a strong contributor to our overall procedure growth. In theU.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. 2019 growth inU.S. dVP procedures was consistent with growth in 2018. For OUS, dVP is at varying states of adoption in different areas of the world but is the largest overallda Vinci procedure. 2019 growth in OUS dVP procedures was consistent with growth in 2018. Kidney cancer procedures have also been a strong contributor to our recent global urology procedure growth. Clinical publications have demonstrated that the use of ada Vinci system increases the likelihood that a patient will receive nephron sparing surgery through a partial nephrectomy, which is typically the surgical society guideline recommended therapy. OUS Procedures. The 2019 OUS procedure growth rate reflects continuedda Vinci adoption in European and Asian markets. In 2018 and the first quarter of 2019, procedure growth inChina moderated, as the previous systems quota expired at the end of 2015 and the systems installed inChina are highly utilized. InOctober 2018 , theChina National Health Commission announced a new quota to allow the sale of 154 new surgical robots intoChina through 2020, which could include da Vinci Surgical Systems. This quota applies to the da Vinci Si and recently approved da Vinci 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 the last three quarters of 2019, procedure growth inChina accelerated, as initial systems placed during these quarters provided additional capacity in the field. InJapan , we experienced strong procedure growth after receiving the national reimbursements for dVP and partial nephrectomy in 2012 and 2016, respectively. 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 additionalda Vinci procedures were granted national reimbursement status effectiveApril 1, 2018 , including gastrectomy, low anterior resection, lobectomy, and hysterectomy, for both malignant and benign conditions. Procedure growth inJapan 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 otherda Vinci procedures. 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 inJapan could be limited. System Demand Future demand for da Vinci Surgical Systems will be impacted by factors including hospital response to the evolving healthcare environment under the currentU.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, includingJapan , the timing around governmental tenders and authorizations, includingChina , 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 including, but not limited to, the following companies:Avatera Medical GmbH ;CMR Surgical Limited ; Johnson & Johnson (including their wholly-owned subsidiariesAuris Health, Inc. andVerb Surgical Inc. );Medicaroid Inc. ;MedRobotics Corp. ; Medtronic plc; meerecompany Inc.; Olympus Corp.;Samsung Corporation ;Smart Robot Technology Group Co. Ltd. ; Titan Medical, Inc.; TransEnterix, Inc.; andWego 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, including, 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 SynchroSeal and E-100 Generator. InNovember 2019 , we obtained FDA clearance for our SynchroSeal instrument and E-100 generator. SynchroSeal is a single-use, bipolar, electrosurgical instrument intended for grasping, dissection, sealing, and transection of tissue. With its wristed articulation, rapid sealing cycle, and refined curved jaw, SynchroSeal offers enhanced 52 -------------------------------------------------------------------------------- Table of Contents versatility to the da Vinci Energy portfolio. The E-100 generator is an electrosurgical generator developed to power two key instruments - Vessel Sealer Extend and SynchroSeal - on the da Vinci X and Xi Surgical Systems. The generator delivers high frequency energy for cutting, coagulation, and vessel sealing of tissues. SureForm 45 Curved-Tip and Gray Reload. InJuly 2019 , we obtained FDA clearance for the SureForm 45 Curved-Tip stapler and SureForm 45 Gray reload. SureForm 45 Curved-Tip is a single-use, fully wristed stapling instrument with a curved tip intended for resection, transection, and/or creation of anastomoses. SureForm 45 Gray reload is a new, single-use cartridge that contains multiple staggered rows of implantable staples and a stainless steel knife. The SureForm 45 Curved-Tip stapler and Gray reload have particular utility in thoracic procedures and round out our SureForm 45 portfolio. Not all reloads or staplers are available for use on all systems or in all countries. Da Vinci Endoscope Plus. InJune 2019 , we received CE mark clearance inEurope for our da Vinci Endoscope Plus, an enhanced 3D endoscope for use with ourda Vinci X and Xi Surgical Systems. Following the CE mark, inJuly 2019 , we obtained FDA clearance for our da Vinci Endoscope Plus. The da Vinci Endoscope Plus leverages new sensor technology to allow for increased sharpness and color accuracy. The da Vinci Endoscope Plus is currently available inEurope and is expected to launch in theU.S. later in 2019. Da Vinci Handheld Camera. InJune 2019 , we obtained FDA clearance for our da Vinci Handheld Camera, 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 ofda Vinci procedures that may require use of a laparoscope, thus eliminating the need for redundant equipment in the operating room and increasing procedure efficiency. We are introducing the da Vinci Handheld Camera in a measured fashion in 2019 with a broad launch expected in early 2020. Ion endoluminal system. InFebruary 2019 , we obtained 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 allows physicians to navigate through small and tortuous airways to reach nodules in most airway segments 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 and our supply chain and collect additional clinical data. We have placed 10 Ion systems for commercial use as ofDecember 31, 2019 . IRIS. InFebruary 2019 , we obtained 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 ofU.S. hospitals to gain initial product experience and insights. SureForm 60 and SureForm 45 Staplers. InJuly 2018 , we obtained FDA clearance for the SureForm 60 instrument with White, Blue, Green, and Black 60mm reloads. InJanuary 2019 , we obtained FDA clearance for the SureForm 45 instrument with White, Blue, Green, and Black 45mm reloads. Additionally, we received regulatory clearance inSouth Korea for the SureForm 60 instrument and 60mm reloads inJune 2018 andJuly 2018 , respectively, and for the SureForm 45 instrument and 45mm reloads inJune 2019 andSeptember 2019 , respectively. Also, we received regulatory clearance inJapan for the SureForm 60 instrument and 60mm reloads inJune 2018 andNovember 2018 , respectively, and for the SureForm 45 instrument and 45mm reloads inSeptember 2019 . The SureForm 60 and SureForm 45 Staplers are single-use, fully wristed stapling instruments intended for resection, transection, and/or creation of anastomoses. The SureForm 60 instrument has particular utility in bariatric procedures, while the SureForm 45 instrument has particular utility in colorectal procedures. SureForm 60 and SureForm 45 Staplers broaden our existing stapler product line, which also includes EndoWrist Stapler 45 with White, Blue, and Green 45mm reloads and EndoWrist Stapler 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 SP Surgical System. InMay 2018 , we obtained FDA clearance for the da Vinci SP Surgical System for urologic surgical procedures that are appropriate for a single port approach. InMarch 2019 , we obtained FDA clearance for the da Vinci SP Surgical System for certain transoral procedures. The da Vinci SP Surgical System includes three, multi-jointed, wristed instruments and the firstda 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 Surgical System, which uses the same fourth generation surgeon console as the da Vinci X and Xi Surgical Systems. The da Vinci SP Surgical 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 Surgical System, including colorectal applications, broadening the applicability of the SP platform over time. We continue to introduce the da Vinci SP 53 -------------------------------------------------------------------------------- Table of Contents Surgical System in a measured fashion while we optimize training pathways and our supply chain. We have placed 29 da Vinci SP Surgical Systems in 2019 and have an installed base of 44 as ofDecember 31, 2019 . Da Vinci Vessel Sealer Extend. InApril 2018 , we obtained 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. Da Vinci X Surgical System. InMay 2017 , we launched a newda Vinci model, the da Vinci X, in theU.S. The da Vinci X system provides surgeons and hospitals with access to some of the most advanced fourth generationda Vinci surgery technology at a lower cost. The da Vinci X system 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 olderda Vinci systems in order to standardize their robotics programs onto the fourth generation platform, choosing which system model by considering clinical and economic factors. The da Vinci X system 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 system 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. Acquisition of Certain Assets from Schölly Fiberoptic InJuly 2019 , we entered into an agreement to acquire certain assets and operations from SchöllyFiberoptic GmbH ("Schölly"), a supplier of endoscopes and other visualization equipment (the "Schölly Acquisition"). OnAugust 31, 2019 , upon the satisfaction of closing conditions, we acquired control of these assets and operations, which collectively met the definition of a business. Total purchase consideration of$101.4 million , as of the acquisition date, consisted of an initial cash payment of$34.4 million and deferred cash payments totaling approximately$67.0 million , of which$37.3 million continues to be deferred as ofDecember 31, 2019 . The timing of the future payments is based upon achieving certain integration steps, which are expected to be completed around the end of 2020. The process to manufacture endoscopes is complex, and there can be no assurance that we can successfully integrate or operate the endoscope manufacturing operations of the acquired business. 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. 2019 Operational and Financial Highlights •Total revenue increased by 20% to$4.5 billion for the year endedDecember 31, 2019 , compared with$3.7 billion for the year endedDecember 31, 2018 . •Approximately 1,229,000da Vinci procedures were performed during the year endedDecember 31, 2019 , an increase of 18% compared with approximately 1,038,000da Vinci procedures for the year endedDecember 31, 2018 . •Instruments and accessories revenue increased by 23% to$2.4 billion for the year endedDecember 31, 2019 , compared with$2.0 billion for the year endedDecember 31, 2018 . •Systems revenue increased by 19% to$1.3 billion for the year endedDecember 31, 2019 , compared with$1.1 billion for the year endedDecember 31, 2018 . •A total of 1,119 da Vinci Surgical Systems were shipped during the year endedDecember 31, 2019 , an increase of 21% compared with 926 systems during the year endedDecember 31, 2018 . •As ofDecember 31, 2019 , we had a da Vinci Surgical System installed base of approximately 5,582 systems, an increase of 12% compared with the installed base of approximately 4,986 systems as ofDecember 31, 2018 . •During the year endedDecember 31, 2019 , we began commercial sales of the Ion system and shipped the first 10 commercial systems. •Gross profit as a percentage of revenue was 69.4% for the year endedDecember 31, 2019 , compared with 69.9% for the year endedDecember 31, 2018 . •Operating income increased by 15% to$1.4 billion for the year endedDecember 31, 2019 , compared with$1.2 billion for the year endedDecember 31, 2018 . Operating income included$338 million and$263 million of share-based 54 -------------------------------------------------------------------------------- Table of Contents compensation expense related to employee stock plans and$67.2 million and$31.6 million of intangible asset charges for the years endedDecember 31, 2019 , and 2018, respectively. •As ofDecember 31, 2019 , we had$5.8 billion in cash, cash equivalents, and investments. Cash, cash equivalents, and investments increased by$1.0 billion compared withDecember 31, 2018 . Results of Operations This section of the Form 10-K generally discusses 2019 and 2018 items and year-to-year comparisons between 2019 and 2018. Discussions of 2017 items and year-to-year comparisons between 2018 and 2017 that are not included in this Form 10-K can be found in "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Part II, Item 7 of the Company's Annual Report on Form 10-K for the fiscal year endedDecember 31, 2018 . The following table sets forth, for the years indicated, certain Consolidated Statements of Income information (in millions, except percentages): Years Ended December 31, % of % of % of total total total 2019 revenue 2018 revenue 2017 revenue Revenue: Product$ 3,754.3 84 %$ 3,089.1 83 %$ 2,565.3 82 % Service 724.2 16 % 635.1 17 % 572.9 18 % Total revenue 4,478.5 100 % 3,724.2 100 % 3,138.2 100 % Cost of revenue: Product 1,119.1 25 % 906.2 24 % 756.3 24 % Service 249.2 6 % 213.9 6 % 179.9 6 % Total cost of revenue 1,368.3 31 % 1,120.1 30 % 936.2 30 % Product gross profit 2,635.2 59 % 2,182.9 59 % 1,809.0 58 % Service gross profit 475.0 10 % 421.2 11 % 393.0 12 % Gross profit 3,110.2 69 % 2,604.1 70 % 2,202.0 70 % Operating expenses: Selling, general and administrative 1,178.4 26 % 986.6 27 % 810.5 26 % Research and development 557.3 12 % 418.1 11 % 328.6 10 % Total operating expenses 1,735.7 38 % 1,404.7 38 % 1,139.1 36 % Income from operations 1,374.5 31 % 1,199.4 32 % 1,062.9 34 % Interest and other income, net 127.7 3 % 80.1 2 % 41.9 1 % Income before taxes 1,502.2 34 % 1,279.5 34 % 1,104.8 35 % Income tax expense 120.4 3 % 154.5 4 % 433.9 14 % Net income 1,381.8 31 % 1,125.0 30 % 670.9 21 % Less: net income (loss) attributable to noncontrolling interest in joint venture 2.5 - % (2.9) - % - - % Net income attributable to Intuitive Surgical, Inc.$ 1,379.3 31 %$ 1,127.9 30 %$ 670.9 21 % Total Revenue Total revenue increased by 20% to$4.5 billion for the year endedDecember 31, 2019 , compared with$3.7 billion for the year endedDecember 31, 2018 . Total revenue for the year endedDecember 31, 2018 , increased by 19% compared with$3.1 billion for the year endedDecember 31, 2017 . The increase in total revenue for the year endedDecember 31, 2019 , resulted from 23% higher instruments and accessories revenue, driven by approximately 18% higher procedure volume, 19% higher systems revenue, and 14% higher service revenue. Revenue denominated in foreign currencies as a percentage of total revenue was approximately 20%, 20%, and 17% for the years endedDecember 31, 2019 , 2018, and 2017, respectively. We generally sell our products and services in local currencies where we have direct distribution channels. Foreign currency rate fluctuations did not have a material impact on total revenue for the year endedDecember 31, 2019 , as compared with 2018, or for the year endedDecember 31, 2018 , as compared with 2017. 55 -------------------------------------------------------------------------------- Table of Contents Revenue generated in theU.S. accounted for 70%, 71%, and 73% of total revenue for the years endedDecember 31, 2019 , 2018, and 2017, respectively. We believe thatU.S. revenue has accounted for the large majority of total revenue due toU.S. patients' ability to choose their provider and method of treatment, reimbursement structures supportive of innovation and minimally invasive surgery, and our initial investments focused onU.S. infrastructure. We have been investing in our business in the OUS markets, and our OUS procedures have grown faster in proportion toU.S. procedures. We expect that our OUS procedures and revenue will make up a greater portion of our business in the long term. The following table summarizes our revenue and system unit shipments for the years endedDecember 31, 2019 , 2018, and 2017, respectively (in millions, except percentages and unit shipments):
Years Ended
2019 2018 2017
Revenue
Instruments and accessories$ 2,408.2 $ 1,962.0 $ 1,636.9 Systems 1,346.1 1,127.1 928.4 Total product revenue 3,754.3 3,089.1 2,565.3 Services 724.2 635.1 572.9 Total revenue$ 4,478.5 $ 3,724.2 $ 3,138.2 United States$ 3,129.5 $ 2,633.5 $ 2,285.8 OUS 1,349.0 1,090.7 852.4 Total revenue$ 4,478.5 $ 3,724.2 $ 3,138.2 % of Revenue - U.S. 70 % 71 % 73 % % of Revenue - OUS 30 % 29 % 27 % Instruments and accessories$ 2,408.2 $ 1,962.0 $ 1,636.9 Services 724.2 635.1 572.9 Operating lease 106.9 51.4 25.9 Total recurring revenue$ 3,239.3 $ 2,648.5 $ 2,235.7 % of Total revenue 72 % 71 % 71 % Da Vinci Surgical System Shipments by Region: U.S. unit shipments 728 581 417 OUS unit shipments 391 345 267 Total unit shipments* 1,119 926 684 *Systems shipped under operating leases (included in total unit shipments) 384 229 108 Ion System Shipments 10 - -
Da Vinci Surgical System Shipments involving System Trade-ins:
Unit shipments involving trade-ins 442 277 163 Unit shipments not involving trade-ins 677 649 521 Product Revenue Product revenue increased by 22% to$3.8 billion for the year endedDecember 31, 2019 , compared with$3.1 billion for the year endedDecember 31, 2018 . Product revenue increased by 20% to$3.1 billion for the year endedDecember 31, 2018 , compared with$2.6 billion for the year endedDecember 31, 2017 . Instruments and accessories revenue increased by 23% to$2.4 billion for the year endedDecember 31, 2019 , compared with$2.0 billion for the year endedDecember 31, 2018 . The increase in instruments and accessories revenue was driven primarily by procedure growth of 18%, incremental sales of our advanced instruments, and customer buying patterns.U.S. procedure growth in 2019 of 17%, compared with 17% in 2018, was driven by strong growth in general surgery procedures, most notably hernia repair, cholecystectomy, colorectal, and bariatric procedures, and thoracic procedures as well as moderate growth in the more mature gynecologic and urologic procedures categories. OUS procedure growth in 2019 was 21% compared with 22% in 2018. Key drivers for OUS procedure growth in both years was driven by continued growth in urologic procedures 56 -------------------------------------------------------------------------------- Table of Contents and earlier stage growth in general surgery and gynecology procedures. Geographically, OUS procedure growth was driven by procedure expansion inJapan ,Germany ,Korea , andChina with varying results in other countries. Systems revenue increased by 19% to$1.3 billion for the year endedDecember 31, 2019 , compared with$1.1 billion for the year endedDecember 31, 2018 . Higher systems revenue was primarily driven by higher system shipments, higher 2019 ASPs, higher operating lease revenue, and higher lease buyouts, partially offset by a higher proportion of system shipments under operating lease or usage-based arrangements. During 2019, a total of 1,119 da Vinci Surgical Systems were shipped compared with 926 systems during 2018. By geography, 728 systems were shipped into theU.S. , 169 intoEurope , 182 intoAsia , and 40 into other markets during 2019, compared with 581 systems shipped into theU.S. , 169 intoEurope , 116 intoAsia , and 60 into other markets during 2018. During 2019, 384 of the 1,119 systems were shipped under operating lease arrangements, compared with 229 of the 926 systems shipped during 2018. The increase in system shipments was primarily driven by procedure growth, the need for hospitals to expand or establish capacity, and more customers trading in olderda Vinci models for fourth generationda Vinci Xi andda Vinci X systems. We shipped 425 and 272 da Vinci Surgical Systems under lease or usage-based arrangements, of which 384 and 229 systems were classified as operating leases for the years endedDecember 31, 2019 , and 2018, respectively. Operating lease revenue was$106.9 million for the year endedDecember 31, 2019 , compared with$51.4 million for the year endedDecember 31, 2018 . Systems placed as operating leases represented 34% of total shipments during 2019, compared with 25% during 2018. A total of 658 da Vinci Surgical Systems were installed at customers under operating lease or usage-based arrangements as ofDecember 31, 2019 , compared with 350 as ofDecember 31, 2018 . Revenue from Lease Buyouts was$92.8 million for the year endedDecember 31, 2019 , compared with$48.8 million for the year endedDecember 31, 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 and Ion systems, was approximately$1.52 million for the year endedDecember 31, 2019 , compared with approximately$1.45 million for the year endedDecember 31, 2018 . The higher 2019 ASP was largely driven by favorable geographic and product 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. Service Revenue Service revenue increased by 14% to$724 million for the year endedDecember 31, 2019 , compared with$635 million for the year endedDecember 31, 2018 . Service revenue increased by 11% to$635 million for the year endedDecember 31, 2018 , compared with$573 million for the year endedDecember 31, 2017 . Higher service revenue in 2019 was primarily driven by a larger installed base ofda Vinci Surgical Systems producing service revenue. Gross Profit Product gross profit for the year endedDecember 31, 2019 , increased 21% to$2.6 billion , representing 70.2% of product revenue, compared with$2.2 billion , representing 70.7% of product revenue, for the year endedDecember 31, 2018 . The higher 2019 product gross profit was primarily driven by higher product revenue, partially offset by lower product gross profit margin. The lower product gross profit margin for the year endedDecember 31, 2019 , was primarily driven by higher intangible assets amortization expense. The MDET initially became effective onJanuary 1, 2013 , and we treated MDET as a reduction in gross profit. InDecember 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 throughDecember 31, 2019 , by the Extension of Continuing Appropriations Act of 2018, signed into law onJanuary 22, 2018 . The MDET was repealed inDecember 2019 . Product gross profit for the years endedDecember 31, 2019 and 2018, included share-based compensation expense of$46.6 million and$36.4 million , respectively, and intangible assets amortization expense of$31.5 million and$5.3 million , respectively. Service gross profit for the year endedDecember 31, 2019 , increased 13% to$475 million , representing 65.6% of service revenue, compared with$421 million , representing 66.3% of service revenue, for the year endedDecember 31, 2018 . The higher 2019 service gross profit was driven by higher service revenue, reflecting a larger installed base of da Vinci Surgical Systems, partially offset by lower service gross profit margin. The lower service gross profit margin for the year endedDecember 31, 2019 , was primarily driven by higher share-based compensation expense and intangible assets amortization. 57 -------------------------------------------------------------------------------- Table of Contents Service gross profit for the years endedDecember 31, 2019 and 2018, included share-based compensation expense of$20.4 million and$16.8 million , respectively, and intangible assets amortization expense of$3.7 million and$0.8 million , 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 year endedDecember 31, 2019 , increased by 19% to$1,178 million , compared with$987 million for the year endedDecember 31, 2018 . The higher selling, general and administrative expenses in 2019 were primarily associated with our expanded Asian and European teams, including establishing our direct organizations inChina ,India , andTaiwan , increased infrastructure to support our growth, and higher headcount. Also, in the fourth quarters of 2019 and 2018, we made charitable contributions of$5.0 million and$25.2 million , respectively, to theIntuitive Foundation , a not-for-profit entity whose mission is to reduce the global burden of disease and suffering through research, education, and philanthropy aimed at better outcomes for patients around the globe. Selling, general and administrative expenses included net pre-tax litigation charges of$0.8 million and$45.2 million for the years endedDecember 31, 2019 , and 2018, respectively. The litigation charges for the year endedDecember 31, 2018 , were primarily related to the settlement of the Abrams class action lawsuit further described in Note 8 to the Consolidated Financial Statements included in Part II, Item 8. Selling, general and administrative expenses for the years endedDecember 31, 2019 , and 2018, included share-based compensation expense of$170 million and$133 million , respectively, and intangible assets amortization expense of$5.7 million and$2.2 million , 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 year endedDecember 31, 2019 , increased by 33% to$557 million , compared with$418 million for the year endedDecember 31, 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. Research and development expenses for the years endedDecember 31, 2019 , and 2018, included share-based compensation expense of$101.4 million and$76.2 million , respectively, and intangible asset charges of$26.3 million and$23.3 million , 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, was$127.7 million for the year endedDecember 31, 2019 , compared with$80.1 million for the year endedDecember 31, 2018 , and$41.9 million for the year endedDecember 31, 2017 . The increase in interest and other income, net, for the year endedDecember 31, 2019 , was primarily driven by higher interest earned due to higher interest rates and higher cash and investment balances. Income Tax Expense Our income tax expense was$120 million ,$155 million , and$434 million for the years endedDecember 31, 2019 , 2018, and 2017, respectively. Our effective tax rate for 2019 was approximately 8.0% compared with 12.1% for 2018 and 39.3% for 2017. Our effective tax rate for 2019 and 2018 differs from theU.S. federal statutory rate of 21% primarily due to the excess tax benefits recognized for employee share-based compensation, the effect of income earned by certain overseas entities being taxed at rates lower than the federal statutory rate, the federal research and development credit benefit, and the release of unrecognized tax benefits from the expiration of statutes of limitations, partially offset byU.S. tax on foreign earnings and state income taxes (net of federal benefit). In addition, our 2019 tax rate reflected a$51.3 million benefit associated with re-measurement of our Swiss deferred tax assets due to a Swiss statutory tax rate increase enacted as part of Swiss tax reform inAugust 2019 . Our tax rate for 2017 reflected the effect of a one-time discrete item in the amount of$317.8 million associated with the enactment of the 2017 Tax Act. Besides the impact of the 2017 Tax Act, our tax rate for 2017 differs from theU.S. federal statutory rate of 35% due to the effect of income earned by certain overseas entities being taxed at rates lower than the federal statutory rate, excess tax benefits recognized for employee share-based compensation, and the reversal of certain unrecognized tax benefits, partially offset by state income taxes (net of federal benefit). 58 -------------------------------------------------------------------------------- Table of Contents OnDecember 22, 2017 , theU.S. federal government enacted the 2017 Tax Act. The 2017 Tax Act includes a number of changes in existing tax law impacting businesses, including a one-time deemed repatriation of cumulative undistributed foreign earnings and a permanent reduction in theU.S. federal statutory rate from 35% to 21%, effective onJanuary 1, 2018 . UnderU.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. InDecember 2017 , we estimated an income tax expense of$317.8 million related to the 2017 Tax Act,$270.2 million of which related to the one-time deemed repatriation toll charge ("Toll Tax") and$47.6 million of which related to the re-measurement of our net deferred tax assets at the reducedU.S. federal statutory rate of 21%. InDecember 2018 , we completed our accounting for the effect of the 2017 Tax Act within the measurement period and reflected a$0.5 million net increase in the 2018 income tax expense. InJune 2018 , we repatriated$1.6 billion of our cumulative undistributed foreign earnings back to theU.S. without any significantU.S. income tax consequences. We intend to repatriate earnings from our Swiss subsidiary as needed, since theU.S. and foreign tax implications of such repatriations are not expected to be significant. We will continue to indefinitely reinvest earnings from the rest of our foreign subsidiaries, which are not significant. Our 2019, 2018, and 2017 provisions for income taxes included excess tax benefits associated with employee equity plans of$147 million ,$116 million , and$103 million , respectively, which reduced our effective tax rate by 9.8, 9.1, and 9.3 percentage points, respectively. The amount of excess tax benefits or deficiencies will fluctuate 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 underU.S. GAAP, which results in increased income tax expense volatility. Our 2019, 2018, and 2017 tax provision reflected tax benefits of$8.4 million ,$5.2 million , and$62.4 million , respectively, associated with the reversal of unrecognized tax benefits and interest resulting from the expiration of statutes of limitations in multiple jurisdictions and certain audit conclusions. We file federal, state, and foreign income tax returns in many jurisdictions in theU.S. and abroad. Years prior to 2016 are considered closed for most significant jurisdictions. Certain of our unrecognized tax benefits could reverse based on the normal expiration of various statutes of limitations, which could affect our effective tax rate in the period in which they reverse. 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. InJuly 2015 , aU.S. Tax Court opinion (the "2015 Opinion") was issued involving an independent third party related to intercompany charges for share-based compensation. Based on the findings of theU.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 in 2015, direct share-based compensation has been excluded from intercompany charges. InJune 2019 , theNinth Circuit Court of Appeals (the "Ninth Circuit") reversed the 2015 Opinion (the "Ninth Circuit Opinion"). Subsequently, a re-hearing of the case was requested, but the rehearing request was denied by the Ninth Circuit onNovember 12, 2019 . However, a petition for appeal to theU.S. Supreme Court can be filed within 90 days of the denial. 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 that reverses the 2015 Opinion, there may be an adverse impact to our income tax expense and effective tax rate. Net Income (Loss) Attributable to Noncontrolling Interest in Joint VentureThe 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 and is located inChina . 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 inChina will be conducted by the joint venture, while distribution outside ofChina will be conducted by us. InJanuary 2019 , the Joint Venture acquired certain assets, including distribution rights, customer relationships, and certain personnel, fromChindex and its affiliates, a subsidiary of Fosun Pharma, and began direct operations forda Vinci products and services inChina . As ofDecember 31, 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 2020 related to the sale of robotic-assisted, catheter-based medical devices. There can be no assurance 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 59 -------------------------------------------------------------------------------- Table of Contents Venture will continue to be profitable, or that the acquiredChindex assets will be successfully integrated and the expected benefits will be realized. Net income (loss) attributable to noncontrolling interest in Joint Venture for the year endedDecember 31, 2019 , was$2.5 million , compared with$(2.9) million for the year endedDecember 31, 2018 . The increase in net income attributable to noncontrolling interest in Joint Venture was primarily due to the increase in sales inChina , partially offset by intangible assets amortization expense and higher costs to ramp up operations inChina . Liquidity and Capital Resources Sources and Uses of Cash Our principal source of liquidity is cash provided by operations and by the issuance of common stock through the exercise of stock options and our employee stock purchase program. Cash and cash equivalents plus short- and long-term investments increased by$1.0 billion to$5.8 billion as ofDecember 31, 2019 , from$4.8 billion as ofDecember 31, 2018 , primarily from cash provided by our operations, partially offset by capital expenditures and share repurchases. Cash and cash equivalents plus short- and long-term investments increased by$1.0 billion to$4.8 billion as ofDecember 31, 2018 , from$3.8 billion as ofDecember 31, 2017 , primarily from cash provided by our operations and employee stock option exercises. As ofDecember 31, 2019 ,$362 million of our cash, cash equivalents, and investments were held by foreign subsidiaries. We intend to repatriate earnings from our Swiss subsidiary as needed, since theU.S. and foreign tax implications of such repatriations are not expected to be significant. We will continue to indefinitely reinvest earnings from the rest of our foreign subsidiaries, which are not significant. We believe the cash provided by our operations will meet our liquidity needs for the foreseeable future. See "Item 7A. Quantitative and Qualitative Disclosures About Market Risk" for discussion on the impact of interest rate risk and market risk on our investment portfolio. Consolidated Cash Flow Data Years Ended December 31, 2019 2018 2017 (in millions) Net cash provided by (used in) Operating activities$ 1,598.2 $ 1,169.6 $ 1,143.9 Investing activities (1,154.4) (1,049.6) 378.7 Financing activities (168.4) 126.3 (1,913.1)
Effect of exchange rates on cash, cash equivalents, and restricted cash
(2.2) (0.1) 2.1 Net increase (decrease) in cash, cash equivalents, and restricted cash$ 273.2 $ 246.2 $ (388.4) Operating Activities For the year endedDecember 31, 2019 , net cash provided by operating activities of$1,598 million exceeded our net income of$1,382 million , primarily due to the following reasons: 1.Our net income included non-cash charges of$537.9 million , consisting primarily of the following significant items: share-based compensation of$335.8 million ; depreciation expense and losses on the disposal of property, plant, and equipment of$160.0 million ; and amortization of intangible assets of$43.0 million . 2.The non-cash charges outlined above were partially offset by changes in operating assets and liabilities that resulted in$321.5 million of cash used by operating activities during the year endedDecember 31, 2019 . Inventory, including the transfer of equipment from inventory to property, plant, and equipment, increased by$360.5 million , primarily due to the increased number of systems under operating lease and usage-based arrangements and build-up to address the growth in the business as well as to mitigate risks of disruption that could arise from trade, supply, or other matters. Prepaid expenses and other assets increased by$116.9 million , primarily due to an increase in leasing, an increase in deferred commissions, and an increase in prepaid taxes, driven by the timing of tax payments. The unfavorable impact of these items on cash provided by operating activities was partially offset by a$57.4 million increase in accrued compensation and employee benefits, primarily due to higher headcount, a$38.8 million decrease in accounts receivable, primarily due to the timing of collections, and a$35.5 million increase in deferred revenue, primarily due to the increased volume of sales contracts. 60 -------------------------------------------------------------------------------- Table of Contents For the year endedDecember 31, 2018 , net cash provided by operating activities of$1,170 million exceeded our net income of$1,125 million , primarily due to the following reasons: 1.Our net income included non-cash charges of$428.3 million , consisting primarily of the following significant items: share-based compensation of$261.2 million ; depreciation expense and losses on the disposal of property, plant, and equipment of$108.6 million ; deferred income taxes of$31.9 million ; amortization of intangible assets of$14.2 million ; and amortization of contract acquisitions assets of$10.6 million . 2.The non-cash charges outlined above were partially offset by changes in operating assets and liabilities that resulted in$383.7 million of cash used in operating activities during the year endedDecember 31, 2018 . Inventory, including the transfer of equipment from inventory to property, plant, and equipment, increased by$279.0 million , primarily due to the increased number of systems under operating lease arrangements and build-up to address the growth in the business as well as to mitigate risks of disruption that could arise from trade, supply, or other matters. Accounts receivable increased by$161.3 million , primarily due to higher customer billings and timing of billings and collections. Prepaid expenses and other assets increased by$77.7 million . The unfavorable impact of these items on cash provided by operating activities was partially offset by a$54.3 million increase in deferred revenue, a$37.1 million increase in other accrued liabilities, and a$26.2 million increase in accrued compensation and employee benefits. Investing Activities Net cash used in investing activities for the year endedDecember 31, 2019 , consisted of purchases of investments (net of proceeds from sales and maturities of investments) of$669.1 million , the acquisition of property and equipment of$425.6 million , and the acquisition of businesses, net of cash acquired, of$59.7 million . Net cash used in investing activities for the year endedDecember 31, 2018 , consisted of purchases of investments (net of proceeds from sales and maturities of investments) of$774.3 million , the acquisition of property and equipment of$187.4 million , and the acquisition of businesses of$87.9 million . Net cash provided by investing activities for the year endedDecember 31, 2017 , consisted of proceeds from sales and maturities of investments (net of purchases of investments) of$569.4 million , partially offset by the acquisition of property and equipment of$190.7 million . We invest predominantly in high quality, fixed income securities. Our investment portfolio may, at any time, contain investments inU.S. treasury andU.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 for the year endedDecember 31, 2019 , consisted primarily of cash used in the repurchase of approximately 0.6 million shares of our common stock in the open market for$269.5 million and taxes paid on behalf of employees related to net share settlements of vested employee equity awards of$159.1 million , partially offset by proceeds from stock option exercises and employee stock purchases of$272.8 million . Net cash provided by financing activities for the year endedDecember 31, 2018 , consisted primarily of proceeds from stock option exercises and employee stock purchases of$236.6 million , partially offset by taxes paid on behalf of employees related to net share settlements of vested employee equity awards of$120.0 million . Net cash used in financing activities for the year endedDecember 31, 2017 , consisted primarily of$2.3 billion related to an accelerated share buyback program executed and settled during 2017 and taxes paid on behalf of employees related to net share settlements of vested employee equity awards of$56.6 million , partially offset by proceeds from stock option exercises and employee stock purchases of$415.5 million . 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$400 million in each of the next two years. We intend to fund these needs with cash generated from operations. Our cash requirements depend on numerous factors, including market acceptance of our products, the resources we devote to developing and supporting our products, and other factors. We expect to continue to devote substantial resources to expand procedure adoption and acceptance of our products. We have made substantial investments in our commercial operations, product development activities, facilities, and intellectual property. Based upon our business model, we anticipate that we will continue to be able to fund future growth through cash provided from operations. We believe that our current cash, cash equivalents, and investment balances, together with income to be derived from the sale of our products, will be sufficient to meet our liquidity requirements for the foreseeable future. 61
--------------------------------------------------------------------------------
Table of Contents
Contractual Obligations and Commercial Commitments
The following table summarizes our contractual obligations and commercial
commitments as of
Payments due by period
Less than More than 5 Total 1 year 1 to 3 years 3 to 5 years years Operating leases (Note 6)$ 87.7 $ 9.6
805.6 37.7 1.4 - Tax Cuts and Jobs Act Toll Tax (Note 11) 225.2 21.4 42.9 93.9 67.0 Total$ 1,157.6 $ 836.6 $ 115.1 $ 116.5 $ 89.4 Operating leases. We lease spaces for operations in theU.S. as well as inJapan ,Mexico ,China ,South Korea , and other foreign countries. We also lease automobiles for certain sales and field service employees. These leases have varying terms up to 15 years. Operating lease amounts include future minimum lease payments under all of our non-cancellable operating leases with an initial term in excess of one year. Refer to Note 6 for further details. Purchase commitments and obligations. These amounts include an estimate of all open purchase orders and contractual obligations in the ordinary course of business, including commitments with contract manufacturers and suppliers for which we have not received the goods or services, commitments for capital expenditures and construction-related activities for which we have not received the services, and acquisition and licensing of intellectual property. A majority of these purchase obligations are due within a year. Although open purchase orders are considered enforceable and legally binding, the terms generally allow us the option to cancel, reschedule, and adjust our requirements based on our business needs prior to the delivery of goods or performance of services. In addition to the above, we have committed to make potential future milestone payments to third parties as part of licensing, collaboration, and development arrangements. Payments under these agreements generally become due and payable only upon achievement of certain developmental, regulatory, and/or commercial milestones. For instances in which the achievement of these milestones is neither probable nor reasonably estimable, such contingencies have not been recorded on our Consolidated Balance Sheets and have not been included in the table above. Tax Cuts and Jobs Act Toll Tax. As ofDecember 31, 2019 , our obligation associated with the deemed repatriation toll charge is$225.2 million , which is expected to be paid in installments. Refer to Note 11 for further details. We are unable to make a reasonably reliable estimate as to when payments may occur for our unrecognized tax benefits. Therefore, our liability for unrecognized tax benefits is not included in the table above. Off-Balance Sheet Arrangements As ofDecember 31, 2019 , we did not have any significant off-balance sheet arrangements, as defined in Item 303(a)(4)(ii) of SEC Regulation S-K promulgated under the Exchange Act. 62 -------------------------------------------------------------------------------- Table of Contents Critical Accounting Estimates Our Consolidated Financial Statements are prepared in conformity withU.S. generally accepted accounting principles ("U.S. GAAP"), which requires us to make judgments, estimates, and assumptions. See "Note 2. Summary of Significant Accounting Policies," in Notes to the Consolidated Financial Statements, which is included in "Item 8. Financial Statements and Supplementary Data," which describes our significant accounting policies and methods used in the preparation of our Consolidated Financial Statements. The methods, estimates, and judgments that we use in applying our accounting policies require us to make difficult and subjective judgments, often as a result of the need to make estimates regarding matters that are inherently uncertain. Our most critical accounting estimates include: •the valuation and recognition of investments, which impacts our investment portfolio balance when we assess fair value and interest and other income, net, when we record impairments; •the standalone selling prices used to allocate the contract consideration to the individual performance obligations, which impacts revenue recognition; •the allowance for sales returns and doubtful accounts, which impacts revenue; •the estimation of transactions to hedge, which impacts revenue and expense; •the valuation of inventory, which impacts gross profit margins; •the valuation of and assessment of recoverability of intangible assets and their estimated useful lives, which primarily impacts gross profit margin or operating expenses when we record asset impairments or accelerate their amortization; •the valuation and recognition of share-based compensation, which impacts gross profit margin and operating expenses; •the recognition and measurement of current and deferred income taxes (including the measurement of uncertain tax positions), which impact our provision for taxes; and •the estimate of probable loss associated with legal contingencies, which impacts accrued liabilities and operating expenses. Investments Valuation Fair Value. Our investment portfolio may, at any time, contain investments inU.S. treasuries andU.S. government agency securities, non-U.S. government securities, taxable and/or tax-exempt municipal notes, corporate notes and bonds, commercial paper, cash deposits, and money market funds. The assessment of the fair value of investments can be difficult and subjective.U.S. GAAP establishes three levels of inputs that may be used to measure fair value. Each level of input has different levels of subjectivity and difficulty involved in determining fair value. Valuation of Level 1 and 2 instruments generally do not require significant management judgment and the estimation is not difficult. Level 3 instruments include unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. The determination of fair value for Level 3 instruments requires the most management judgment and subjectivity. There were no Level 3 securities for the periods presented. Other-than-temporary impairment. After determining the fair value of our available-for-sale instruments, gains or losses on these securities are recorded to other comprehensive income ("OCI") until either the security is sold or we determine that the decline in value is other-than-temporary. Factors considered in determining whether a loss is temporary include the extent and length of time that the investment's fair value has been lower than its cost basis, the financial condition and near-term prospects of the investee, the extent of the loss related to credit of the issuer, the expected cash flows from the security, the Company's intent to sell the security, and whether or not the Company will be required to sell the security prior to the expected recovery of the investment's amortized cost basis. These judgments could prove to be wrong, and companies with relatively high credit ratings and solid financial conditions may not be able to fulfill their obligations. No significant impairment charges were recorded during the years endedDecember 31, 2019 , 2018, and 2017. As ofDecember 31, 2019 , and 2018, net unrealized losses on investments of$20.4 million and$9.8 million , net of tax, respectively, were included in accumulated other comprehensive income/(loss). Revenue recognition. Our system sale arrangements contain multiple products and services, including system(s), system components, system accessories, instruments, accessories, and service. Other than service, we generally deliver all of the products upfront. Each of these products and services is a distinct performance obligation. System accessories, instruments, accessories, and service are also sold on a standalone basis. For multiple-element arrangements, revenue is allocated to each performance obligation based on its relative standalone selling price. Standalone selling prices are based on observable prices at which we separately sell the products or services. If a standalone selling price is not directly observable, then we estimate the standalone selling prices considering market conditions and entity-specific factors including, but not limited to, features and functionality of the products and services, geographies, 63 -------------------------------------------------------------------------------- Table of Contents type of customer, and market conditions. We regularly review standalone selling prices and maintain internal controls over establishing and updating these estimates. Our system sales arrangements generally include a five-year period of service. The first year of service is generally free and included in the system sale arrangement and the remaining four years are billed at a stated service price. Revenue that is allocated to the service obligation is deferred and recognized ratably over the service period. Allowance for sales returns and doubtful accounts. We record estimated reductions in revenue for potential returns of certain products by customers and other allowances. As a result, management must make estimates of potential future product returns and other allowances related to current period product revenue. In making such estimates, management analyzes historical returns, current economic trends and changes in customer demand and acceptance of our products. If management were to make different judgments or utilize different estimates, material differences in the amount of reported revenue could result. Similarly, we make estimates of the collectability of accounts receivable, especially analyzing the aging and nature of accounts receivable and historical bad debts, customer concentrations, customer credit-worthiness, current economic trends, and changes in customer payment terms when evaluating the adequacy of the allowance for doubtful accounts. Credit evaluations are undertaken for all major sales transactions before shipment is authorized. On a quarterly basis, we evaluate aged items in the accounts receivable aging report and provide an allowance in an amount that we deem adequate for doubtful accounts. If management were to make different judgments or utilize different estimates, material differences in the amount of our reported operating expenses could result. Hedge Accounting for Derivatives. We utilize foreign currency forward exchange contracts to hedge certain anticipated foreign currency-denominated sales transactions and expenses. When specific criteria required by relevant accounting standards have been met, changes in fair values of hedge contracts relating to anticipated transactions are recorded in OCI rather than net income until the underlying hedged transaction affects net income. By their nature, our estimates of anticipated transactions may fluctuate over time and may ultimately vary from actual transactions. When we determine that the transactions are no longer probable within a certain time frame, we are required to reclassify the cumulative changes in the fair values of the related hedge contracts from OCI to net income. Inventory valuation. Inventory is stated at the lower of cost or net realizable value on a first-in, first-out basis. The cost basis of our inventory is reduced for any products that are considered excessive or obsolete based upon assumptions about future demand and market conditions. If actual future demand or market conditions are less favorable than those projected by management, additional inventory write-downs may be required, which could have a material adverse effect on the results of our operations. Intangible assets. Our intangible assets include identifiable intangible assets and goodwill. Identifiable intangible assets include developed technology, patents, distribution rights, customer relationships, licenses, and non-competition arrangements. All of our identifiable intangible assets have finite lives.Goodwill and intangible assets with indefinite lives are subject to an annual impairment review (or more frequent if impairment indicators arise) by applying a fair value-based test. There have been no such impairments. Identifiable intangible assets with finite lives are subject to impairment testing and are reviewed for impairment when events or circumstances indicate that the carrying value of an asset is not recoverable and its carrying amount exceeds its fair value. We evaluate the recoverability of the carrying value of these identifiable intangible assets based on estimated undiscounted cash flows to be generated from such assets. If the cash flow estimates or the significant operating assumptions upon which they are based change in the future, we may be required to record additional impairment charges. The valuation and classification of intangible assets and goodwill and the assignment of useful lives for purposes of amortization involves judgments and the use of estimates. The evaluation of these intangible assets and goodwill for impairment under established accounting guidelines is required on a recurring basis. Changes in business conditions could potentially require future adjustments to the assumptions made. When we determine that the useful lives of assets are shorter than we had originally estimated, we accelerate the rate of amortization over the assets' new, shorter useful lives. No impairment charge or accelerated amortization was recorded for the years endedDecember 31, 2019 , 2018, and 2017. A considerable amount of judgment is required in assessing impairment, which includes financial forecasts. If conditions are different from management's current estimates, material write-downs of long-lived assets may be required, which would adversely affect our operating results. Business combinations. We allocate the fair value of the purchase consideration to the assets acquired and liabilities assumed based on their estimated fair values at the acquisition date. The excess of the fair value of the purchase consideration over the fair value of assets acquired and liabilities assumed is recorded as goodwill. When determining the fair value of assets acquired and liabilities assumed, management is required to make certain estimates and assumptions, especially with respect to intangible assets. The estimates and assumptions used in valuing intangible assets include, but are not limited to, the amount 64 -------------------------------------------------------------------------------- Table of Contents and timing of projected future cash flows, the discount rate used to determine the present value of these cash flows, and the determination of the assets' life cycle. These estimates are inherently uncertain and, therefore, actual results may differ from the estimates made. Accounting for stock options. We account for share-based compensation in accordance with the fair value recognition provisions ofU.S. GAAP. We use the Black-Scholes-Merton option-pricing model, which requires the input of highly subjective assumptions. These assumptions include estimating the length of time employees will retain their vested stock options before exercising them, the estimated volatility of our common stock price over the expected term, and the number of options that will ultimately not complete their vesting requirements. The assumptions for expected volatility and expected term are the two assumptions that most significantly affect the grant date fair value of stock options. Changes in expected risk-free rate of return do not significantly impact the calculation of fair value and determining this input is not highly subjective. We use implied volatility based on freely traded options in the open market, as we believe implied volatility is more reflective of market conditions and a better indicator of expected volatility than historical volatility. In determining the appropriateness of relying on implied volatility, we considered the following: •the sufficiency of the trading volume of freely traded options; •the ability to reasonably match the terms, such as the date of the grant and the exercise price of the freely traded options to options granted; and •the length of the term of the freely traded options used to derive implied volatility. The expected term represents the weighted-average period that our stock options are expected to be outstanding. The expected term is based on the observed and expected time to exercise. We determine expected term based on historical exercise patterns and our expectation of the time it will take for employees to exercise options still outstanding. We develop an estimate of the number of share-based awards that will be forfeited due to employee turnover. Adjustments in the estimated forfeiture rates can have a significant effect on our reported share-based compensation, as we recognize the cumulative effect of the forfeiture rate adjustments for all expense amortization in the period that the estimated forfeiture rates are adjusted. We estimate and adjust forfeiture rates based on a periodic review of recent forfeiture activity and expected future employee turnover. If a revised forfeiture rate is higher than the previously estimated forfeiture rate, we may make an adjustment that will result in a decrease to the expense recognized in the financial statements during the period when the rate was changed. Adjustments in the estimated forfeiture rates could also cause changes in the amount of expense that we recognize in future periods. Changes in these subjective assumptions can materially affect the estimate of the fair value of stock options and, consequently, the related amount of share-based compensation expense recognized in the Consolidated Statements of Income. Accounting for income taxes. Significant management judgment is required in determining our provision for income taxes, deferred tax assets and liabilities, and any valuation allowance recorded against net deferred tax assets in accordance withU.S. GAAP. These estimates and judgments occur in the calculation of tax credits, benefits, and deductions and in the calculation of certain tax assets and liabilities, which arise from differences in the timing of recognition of revenue and expense for tax and financial statement purposes, as well as the interest and penalties related to uncertain tax positions. Significant changes to these estimates may result in an increase or decrease to our tax provision in the current or subsequent period. We must assess the likelihood that we will be able to recover our deferred tax assets. In the event that all or part of our deferred tax assets are not recoverable in the future, we must increase our provision for taxes by recording a valuation allowance to reduce our deferred tax assets to the amount that is more likely than not to be recoverable. In order for our deferred tax assets to be recoverable, we must be able to generate sufficient taxable income in those jurisdictions where the deferred tax assets are located. We consider forecasted income, including income that may be generated as a result of certain tax planning strategies, together with future reversals of existing taxable temporary differences, in determining the need for a valuation allowance. As ofDecember 31, 2019 , we believe it is more likely than not that our deferred tax assets ultimately will be recovered with the exception of ourCalifornia deferred tax assets. We believe that, due to the computation ofCalifornia taxes under the single sales factor, it is more likely than not that ourCalifornia deferred tax assets will not be realized. Should there be a change in our ability to recover our deferred tax assets, our tax provision would be affected in the period in which such change takes place. The calculation of our tax liabilities involves dealing with uncertainties in the application of complex tax regulations. We recognize liabilities for uncertain tax positions based on a two-step process. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates that it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. If we determine that a tax position will more likely than not be sustained on audit, then the second step requires us to estimate and measure the tax benefit as the largest amount that is more than 50% likely to be realized upon ultimate settlement. It is inherently difficult and subjective to estimate such amounts, as we have to determine the probability of various possible outcomes. We re-evaluate these uncertain tax 65 -------------------------------------------------------------------------------- Table of Contents positions on a quarterly basis. This evaluation is based on factors including, but not limited to, changes in facts or circumstances, changes in tax law, effective settlement of audit issues, and new audit activity. Such a change in recognition or measurement would result in the recognition of a tax benefit or an additional charge to the tax provision. Accounting for legal contingencies. From time to time, we are involved in a number of legal proceedings involving product liability, intellectual property, shareholder derivative actions, securities class actions, insurance, employee-related, and other matters. We record a liability and related charge to earnings in our Consolidated Financial Statements for legal contingencies when the loss is considered probable and the amount can be reasonably estimated. Our assessment is re-evaluated each accounting period and is based on all available information, including discussion with any outside legal counsel that represents us. If a reasonable estimate of a known or probable loss cannot be made, but a range of probable losses can be estimated, the low-end of the range of losses is recognized if no amount within the range is a better estimate than any other. If a loss is reasonably possible, but not probable, and can be reasonably estimated, the estimated loss or range of loss is disclosed in the Notes to the Consolidated Financial Statements. When determining the estimated probable loss or range of losses, significant judgment is required to be exercised in order to estimate the amount and timing of the loss to be recorded. Estimates of probable losses resulting from litigation are inherently difficult to make, particularly when the matters are in early procedural stages with incomplete facts and information. The final outcome of legal proceedings is dependent on many variables difficult to predict and, therefore, the ultimate cost to entirely resolve such matters may be materially different than the amount of current estimates. Consequently, new information or changes in judgments and estimates could have a material adverse effect on our business, financial condition, and results of operations or cash flows. RECENT ACCOUNTING PRONOUNCEMENTS See "Note 2. Summary of Significant Accounting Policies" of the Notes to Consolidated Financial Statements in "Item 8. Financial Statements and Supplementary Data" for a full description of recent accounting pronouncements including the respective expected dates of adoption and estimated effects, if any, on our Consolidated Financial Statements. 66
--------------------------------------------------------------------------------
Table of Contents
© Edgar Online, source