In this report, "Intuitive Surgical," "Intuitive," the "Company," "we," "us,"
and "our" refer to Intuitive Surgical, Inc. and its wholly and majority-owned
subsidiaries.
This management's discussion and analysis of financial condition as of June 30,
2020, and results of operations for the three and six months ended June 30,
2020, and 2019, should be read in conjunction with management's discussion and
analysis of financial condition and results of operations included in our Annual
Report on Form 10-K for the year ended December 31, 2019.
This report contains "forward-looking statements" within the meaning of Section
27A of the Securities Act of 1933, as amended, and Section 21E of the Securities
Exchange Act of 1934, as amended (the "Exchange Act"). Forward-looking
statements relate to expectations concerning matters that are not historical
facts. Words such as "estimates," "projects," "believes," "anticipates,"
"plans," "expects," "intends," "may," "will," "could," "should," "would,"
"targeted," and similar words and expressions are intended to identify
forward-looking statements. These forward-looking statements include, but are
not limited to, statements related to the expected impacts of the COVID-19
pandemic on our business, financial condition, and results of operations, the
strength of our long-term fundamentals, the potential decline of procedure
volume, our acquisitions, expected new product introductions, procedures and
procedure adoption, future results of operations, future financial position, our
ability to increase our revenues, the anticipated mix of our revenues between
product and service revenues, our financing plans and future capital
requirements, anticipated costs of revenue, anticipated expenses, our potential
tax assets or liabilities, the effect of recent accounting pronouncements, our
investments, anticipated cash flows, our ability to finance operations from cash
flows and similar matters, and statements based on current expectations,
estimates, forecasts, and projections about the economies and markets in which
we operate and our beliefs and assumptions regarding these economies and
markets. These forward-looking statements should, therefore, be considered in
light of various important factors, including, but not limited to, the
following: our ability to obtain accurate procedure volume in the midst of the
COVID-19 pandemic; the risk that the COVID-19 pandemic could lead to further
material delays and cancellations of, or reduced demand for, procedures;
curtailed or delayed capital spending by hospitals; disruption to our supply
chain; closures of our facilities; delays in surgeon training; delays in
gathering clinical evidence; the evaluation of the risks of robotic-assisted
surgery in the presence of infectious diseases; diversion of management and
other resources to respond to the COVID-19 outbreak; the impact of global and
regional economic and credit market conditions on healthcare spending; the risk
that the COVID-19 virus disrupts local economies and causes economies in our key
markets to enter prolonged recessions; healthcare reform legislation in the U.S.
and its impact on hospital spending, reimbursement, and fees levied on certain
medical device revenues; changes in hospital admissions and actions by payers to
limit or manage surgical procedures; the timing and success of product
development and market acceptance of developed products; the results of any
collaborations, in-licensing arrangements, joint ventures, strategic alliances,
or partnerships, including the joint venture with Shanghai Fosun Pharmaceutical
(Group) Co., Ltd.; our completion of and ability to successfully integrate
acquisitions, including Schölly Fiberoptic's robotic endoscope business and
Orpheus Medical; procedure counts; regulatory approvals, clearances, and
restrictions or any dispute that may occur with any regulatory body; guidelines
and recommendations in the healthcare and patient communities; intellectual
property positions and litigation; competition in the medical device industry
and in the specific markets of surgery in which we operate; risks associated
with our operations outside of the United States; unanticipated manufacturing
disruptions or the inability to meet demand for products; our reliance on sole
and single source suppliers; the results of legal proceedings to which we are or
may become a party; product liability and other litigation claims; adverse
publicity regarding us and the safety of our products and adequacy of training;
our ability to expand into foreign markets; the impact of changes to tax
legislation, guidance, and interpretations; changes in tariffs, trade barriers,
and regulatory requirements; and other risk factors. Readers are cautioned not
to place undue reliance on these forward-looking statements, which are based on
current expectations and are subject to risks, uncertainties, and assumptions
that are difficult to predict, including those risk factors described throughout
this filing and in the Annual Report on Form 10-K for the fiscal year ended
December 31, 2019, and other periodic filings with the Securities and Exchange
Commission. Our actual results may differ materially and adversely from those
expressed in any forward-looking statement. We undertake no obligation to
publicly update or release any revisions to these forward-looking statements,
except as required by law.
Intuitive®, Intuitive Surgical®, da Vinci®, da Vinci S®, da Vinci S HD Surgical
System®, da Vinci Si®, da Vinci Si HD Surgical System®, da Vinci Xi®, da Vinci
SP®, EndoWrist®, Firefly®, InSite®, da Vinci Connect®, Intuitive Surgical
EcoSystem®, da Vinci X®, SureFormTM, IonTM, IrisTM, and SynchroSealTM are
trademarks or registered trademarks of the Company.
                                       25
--------------------------------------------------------------------------------
  Table of Contents
Overview
Intuitive is committed to advancing patient care in surgery and other acute
medical interventions. We are focused on innovating to enable physicians and
healthcare providers to improve the quality of and access to minimally invasive
care. We believe that minimally invasive care is life-enhancing care. Intuitive
brings more than two decades of leadership in robotic-assisted surgical
technology and solutions to its offerings. While surgery and acute interventions
have improved significantly in the past decades, there remains a significant
need for better outcomes and decreased variability of these outcomes across care
teams. The current healthcare environment is exerting a large and increasing
burden on critical resources, including the professionals who staff care teams:
surgeons, anesthesiologists, nurses, and other staff. At the same time,
governments are straining to cover the healthcare needs of their populations and
are demanding lower total cost per patient to treat disease. In the face of
these challenges, we believe scientific, process, and technological advances in
biology, computing, imaging, algorithms, and robotics offer the promise of new
methods to solve old and difficult problems.
We address these needs by focusing on the quadruple aim. First, we focus on
products and services that can improve outcomes and decrease variability in the
hands of care teams. Second, we seek to improve the patient experience by
minimizing disruption to lives and creating greater predictability for the
treatment experience. Third, we seek to improve care team satisfaction by
creating products and services that are dependable, smart, and optimized for the
care environment in which they are used. Finally, we seek to lower the total
cost to treat per patient episode when compared with existing treatment
alternatives, providing a return on investment for hospitals and healthcare
systems and value for payers.
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.
Our da 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 an installed
base of 52 da Vinci SP Surgical Systems as of June 30, 2020. Our plans for the
rollout of the da Vinci SP Surgical System include putting systems in the hands
of experienced da Vinci users first while we optimize training pathways and our
supply chain. We received U.S. Food and Drug Administration ("FDA") clearances
for the da Vinci SP Surgical System for urological and certain transoral
procedures. We also received clearance in South Korea where the da Vinci SP
Surgical System may be used for a broad set of procedures. We plan to seek 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. All da Vinci systems include a
surgeon's console (or consoles), imaging electronics, a patient-side cart, and
computational hardware and software.
                                       26
--------------------------------------------------------------------------------
  Table of Contents
We offer approximately 70 different multi-port da 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 and da Vinci X platforms, including the da Vinci Vessel Sealer
Extend and da Vinci Stapler products, to provide surgeons with sophisticated,
computer-aided tools to precisely and efficiently interact with tissue. Da Vinci
X and da Vinci Xi Surgical Systems share the same instruments whereas the da
Vinci Si Surgical System uses instruments that are not compatible with X or Xi
systems. We currently offer nine core instruments on our da Vinci SP Surgical
System. We plan to expand the SP instrument offering over time.
Training technologies include our 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 the U.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 3 Ion systems for
commercial use as of June 30, 2020. Ion systems are not included in our da Vinci
Surgical System installed base. We continue to have 3 Ion systems placed 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.
COVID-19 Pandemic
First Quarter of 2020
Prior to the spread of COVID-19 in the first quarter of 2020, we experienced
procedure growth trends consistent with those experienced in the fourth quarter
of 2019, including strength in general surgery, growth in mature procedures in
the U.S., and growth in OUS urology. We also saw early strength in capital
placements, particularly in the U.S., with over half the systems placed in the
first quarter of 2020 related to arrangements where the sales cycle was mostly
completed in the fourth quarter of 2019. Beginning in January 2020, we saw a
substantial reduction in da Vinci procedures in China and, by early February
2020, procedures per week in China had declined by approximately 90% compared
with the weekly procedure rates experienced in early January 2020. As the
COVID-19 pandemic subsided in China in March 2020, da Vinci procedure volume
began to recover and, by the end of the first quarter of 2020, China procedures
per week were approximately 70% of the early January 2020 weekly procedure rate.
As the COVID-19 pandemic spread to Western Europe and the U.S., we experienced a
significant decline in da Vinci procedures in the last half of March 2020. As
the U.S. Surgeon General recommended that elective procedures be postponed and
hospitals pivoted to providing care to COVID-19 patients, procedures per week in
the U.S., which represented approximately 72% of our procedure volume in 2019,
declined to approximately 65% compared with the weekly procedure rate
experienced earlier in the first quarter of 2020.
Second Quarter of 2020
In April, procedures per week in the U.S. continued to decline, reaching
approximately 30% of pre-COVID-19 levels. In May and June, U.S. procedures began
a recovery phase, as COVID-19 cases dropped and elective procedures were
permitted, and, by the middle of June, had grown to nearly the same level as
that measured in the first two weeks of the first quarter of 2020. However, in
the last two weeks of June and into July, with the resurgence of COVID-19 cases,
some regions have postponed elective procedures again, and we have experienced a
corresponding decline in da Vinci procedures. The impact of COVID-19 in Europe
during the second quarter varied by country with procedures in Italy, France,
and the UK declining more steeply, while Germany experienced a year-over-year
increase in procedures. During the second quarter of 2020, China procedures per
week continued to increase to a level consistent with the early January 2020
weekly procedure rate. Consistent with the first quarter of 2020, we experienced
little impact on the procedure volume in Korea and Japan in the second quarter
of 2020. While procedures in certain markets have improved from levels
experienced early in the second quarter, it is possible that a recurrence of
COVID-19 similar to the one occurring in the U.S. will continue to negatively
impact da Vinci procedures through the remainder of 2020. Moreover, we do not
expect all markets to recover at the same pace, and some markets may experience
a resurgence in infection rates. Due to the uncertainty of the recovery,
including the significant increase in COVID-19 infections in the U.S. and the
potential for COVID-19 infections to increase in other markets coupled with
additional policy responses outlined by governments and other authorities, we
cannot reliably estimate the impact to procedure volume in the third quarter of
2020 and beyond.
                                       27
--------------------------------------------------------------------------------
  Table of Contents
System Demand
Most of the sales cycle for approximately half of the system placements in the
first quarter of 2020 were completed in the fourth quarter of 2019. As we
progressed through the first and second quarters of 2020 and the impact of the
COVID-19 pandemic progressed, customers deferred decisions to purchase or lease
systems into future quarters and, in some cases, indefinitely. In addition, the
decline in procedures and, in turn, the reduced utilization of our systems
resulted in unused capacity in the existing installed base. We expect hospitals
to first fill their capacity before purchasing additional systems. The depth and
extent to which the COVID-19 pandemic will impact individual markets will vary
based on the availability of testing capabilities, personal protective
equipment, intensive care units and operating rooms, and medical staff as well
as government interventions. As COVID-19 continues to disrupt healthcare
operations and patient flow, we would expect that system placements will lag
behind the recovery of da Vinci procedure volume. While we cannot reliably
estimate the extent or period of time over which the COVID-19 pandemic and the
resultant economic recession will impact hospital spending, we anticipate lower
year-over-year system placements for the remainder of 2020.
Customer Relief Program
In April, we announced a program to provide financial relief to our customers.
The program is comprised of three main elements. The first element provides
credits against service fees otherwise due in the six-month period from April 1
through September 30 that generally reflects the under-utilization of the system
during that period. Those credits were offered to most customers worldwide. The
second element deferred certain lease payments, and the third element extended
certain payment terms for accounts receivable. Service fee credits resulted in
an approximately $59 million decrease in service revenue in the second quarter
of 2020. The extent to which credits will be issued for the third quarter of
2020 is dependent on the spread and resurgence of COVID-19 and the impact that
it has on da Vinci surgeries. Given the second quarter da Vinci procedures rates
coupled with the U.S. resurgence, we estimate credits issued for the third
quarter of 2020 to be in the range of $20 to $50 million. While the short-term
payment relief offered did not have a material impact to the results of
operations, we deferred $10 million of lease billings and extended payment terms
associated with $65 million of trade receivables since the start of the program,
of which $37 million would otherwise have been due in the second quarter of
2020. Service revenue in the third quarter of 2020 could be reduced further if
COVID-19 infections increase and, correspondingly, da Vinci procedures decline.
We may also be subject to increased credit risks resulting in collection
delinquencies and defaults, which could materially impact our bad debt
write-offs and provisions for credit losses. Although we have programs in place
that are designed to monitor and mitigate the associated risks, there can be no
assurance that such programs will be effective in reducing credit risks relating
to these lease financing arrangements and extended payment terms.
General Increase in Risks
Capital markets and worldwide economies have been significantly impacted by the
COVID-19 pandemic, and it is possible that it could cause a prolonged recession
in local and/or global economies. Such economic recession could have a material
adverse effect on our long-term business as hospitals curtail and reduce capital
and overall spending. The COVID-19 pandemic and local actions, such as
"shelter-in-place" orders and restrictions on our ability to travel and access
our customers or temporary closures of our facilities or the facilities of our
suppliers and their contract manufacturers, could further significantly impact
our sales and our ability to ship our products and supply our customers. Any of
these events could negatively impact the number of da Vinci procedures performed
or the number of system placements and have a material adverse effect on our
business, financial condition, results of operations, or cash flows.
Our Response
We set our priorities and actions during the COVID-19 pandemic within the
context of the phased framework described in the American Enterprise Institute's
paper entitled "National coronavirus response - a road map to reopening." In
Phases 1 and 2, which are the 'Slow the Spread' and 'State-by-State Reopening'
phases of coronavirus response, our priorities are as follows. First, we are
focused on the health and safety of all those we serve - our customers, our
communities, our employees, and our suppliers - implementing early and
continuous updates to our health and safety policies and processes. Second, we
are supporting our customers according to their priorities - clinical,
operational, and economic. Third, we are focused on continuity of supply by
working with our suppliers and our distributors. Fourth, we are securing our
workforce economically. We have built a valuable team over the years, and we
believe they will be important in the recovery that follows the pandemic. Fifth,
in partnership with our Intuitive Foundation, we are contributing material,
product, and volunteers to the front lines of COVID-19 support - we have
designed, produced, and delivered personal protective equipment to local
hospitals, and our employees have volunteered in several communities. Finally,
we are eliminating avoidable spend during Phases 1 and 2 of the COVID-19
pandemic.
                                       28
--------------------------------------------------------------------------------
  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 instruments and accessories revenue
per surgical procedure performed, depending on the type and complexity of the
specific procedures performed and the number and type of instruments used.
Further, we plan to launch our Extended Use Program (refer to further discussion
immediately below), which will reduce the overall instruments and accessories
revenue per procedure. 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 placements of the Ion system, and we earn
recurring revenue from the sales of instruments and accessories used in biopsies
and ongoing system service. Ion systems are presented separately from our da
Vinci Surgical Systems installed base. We are introducing the Ion system in the
U.S. in a measured fashion. For the three and six months ended June 30, 2020,
Ion's contribution to revenue and gross margin was not significant.
Extended Use Program
In July 2020, we introduced our "Extended Use Program." Beginning in the fourth
quarter of 2020, we plan to introduce select Xi/X instruments possessing 12 to
18 uses compared to the current 10 use instruments. The Extended Use Program
instruments represent some of our higher volume instruments but exclude
stapling, monopolar, and advanced energy instruments. Instruments included in
the program are used across a number of da Vinci surgeries. Their increased uses
are the result of continuous, significant investments in the design and
production capabilities of our instruments, resulting in improved quality and
durability. In addition, in the fourth quarter of 2020, we will lower the price
of certain other instruments that are most commonly used in lower acuity
procedures. These actions will reduce the cost for customers to treat patients,
which in turn will reduce our revenue per procedure. Based on 2019 volume and
mix of procedures, our Extended Use Program and the reduced pricing on certain
other instruments would have reduced 2019 annual instruments and accessories
revenue by approximately $150 to $170 million. The impact of these actions on
future revenue will be dependent on the future volume and mix of procedures and
whether cost elasticity will enable greater penetration into available markets.
Recurring Revenue
Recurring revenue consists of instruments and accessories 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.
Instruments and accessories revenue has grown at a faster rate than systems
revenue over time. Instruments and accessories revenue increased to $2.4 billion
in 2019, compared with $2.0 billion in 2018 and $1.6 billion in 2017. The growth
of instruments and accessories revenue largely reflects continued procedure
adoption.
Service revenue increased to $724 million in 2019, compared with $635 million in
2018 and $573 million in 2017. Service revenue growth has been driven by the
growth of the installed base of da Vinci Surgical Systems. The installed base of
da Vinci Surgical Systems grew 12% to approximately 5,582 at December 31, 2019;
13% to approximately 4,986 at December 31, 2018; and 13% to approximately 4,409
at December 31, 2017.
We use the installed base and number of shipments of da Vinci Surgical Systems
as metrics for financial and operational decision-making and as a means to
evaluate period-to-period comparisons. Management believes that the installed
base and number of shipments of da Vinci Surgical Systems provide meaningful
supplemental information regarding our performance, as management believes that
the installed base and number of shipments of da Vinci Surgical Systems are an
indicator of the rate of adoption of robotic-assisted surgery as well as an
indicator of future recurring revenue (particularly service revenue). Management
believes that both it and investors benefit from referring to the installed base
and number of shipments of da Vinci Surgical Systems in assessing our
performance and when planning, forecasting, and analyzing future periods. The
installed base and number of shipments of da Vinci Surgical Systems also
facilitate management's internal comparisons of our historical performance. We
believe that the installed base and number of shipments of da Vinci Surgical
Systems are useful to investors as metrics, because (1) they allow for greater
transparency with respect to key metrics used by management in its financial and
operational decision-making, and (2) they are used by institutional investors
and the analyst community to help them analyze
                                       29
--------------------------------------------------------------------------------
  Table of Contents
the performance of our business. The vast majority of da Vinci Surgical Systems
installed are connected via the internet. System logs can also be accessed by
field engineers for systems that are not connected to the internet. We utilize
this information as well as other information from agreements and discussions
with our customers that involve estimates and judgments, which are, by their
nature, subject to substantial uncertainties and assumptions. Estimates and
judgments for determining the installed base and number of shipments of da Vinci
Surgical Systems may be impacted over time by various factors, including system
internet connectivity, hospital and distributor reporting behavior, and inherent
complexities in new agreements. Such estimates and judgments are also
susceptible to technical errors. In addition, the relationship between the
installed base and number of shipments of da Vinci Surgical Systems and our
revenues may fluctuate from period to period, and growth in the installed base
and in the number of shipments of da Vinci Surgical Systems may not correspond
to an increase in revenue. The installed base and number of shipments of da
Vinci Surgical Systems are not intended to be considered in isolation or as a
substitute for, or superior to, revenue or other financial information prepared
and presented in accordance with GAAP.
The COVID-19 pandemic reduced the number of shipments of da Vinci Surgical
Systems in the second quarter of 2020 as compared to the prior year. Based on
the factors outlined in the COVID-19 Pandemic section above, historical system
shipment trends may not be a good indicator of future system shipments.
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
surgery programs while leveraging our balance sheet. These leases generally have
commercially competitive terms as compared with other third-party entities that
offer equipment leasing. We have also entered into usage-based arrangements with
larger customers that have committed da 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 ended December 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. For usage-based arrangements,
systems revenue and service revenue are 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 is 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, $25.9 million for the
years ended December 31, 2019, 2018, and 2017, respectively. Generally, lease
transactions generate similar gross margins as our sale transactions.
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 arrangements 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, including
disruption associated with the current COVID-19 pandemic, or other
customer-specific factors. In addition, as customers divert significant
resources to the treatment of or the preparation to treat patients with the
COVID-19 virus, we may be exposed to defaults under our lease financing
arrangements. Moreover, usage-based arrangements generally contain no minimum
payments; therefore, customers may exit such arrangements without paying a
financial penalty to us. As a result of the COVID-19 pandemic, we anticipate
that some customers will exit such arrangements or seek to amend the terms of
our operating lease and usage-based arrangements with them.
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 ended December 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.
                                       30
--------------------------------------------------------------------------------
  Table of Contents
Systems Revenue
System placements are driven by procedure growth in most markets. In geographies
where da Vinci procedure adoption is in an early stage, system sales will
precede procedure growth. System placements also vary due to seasonality largely
aligned with hospital budgeting cycles. We typically place a higher proportion
of annual system placements in the fourth quarter and a lower proportion in the
first quarter as customer budgets are reset. 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. System
revenue grew 19% to $1,346 million in 2019; 21% to $1,127 million in 2018; and
16% to $928 million in 2017. Based on the factors outlined in the COVID-19
Pandemic section above, the ability to forecast future system shipments has been
significantly disrupted and, therefore, we believe that historical system
shipment trends may not be a good indicator of future system shipments.
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. Our da 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 of da 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 the U.S. for these procedures for benign conditions typically
results in higher fourth quarter procedure volume when more patients have met
annual deductibles and lower first quarter procedure volume when deductibles are
reset. Seasonality outside the U.S. varies and is more pronounced around local
holidays and vacation periods. As a result of the factors outlined in the
COVID-19 Pandemic section above, including the recommendations of authorities to
defer elective procedures, historical procedure patterns may be disrupted.
Distribution Channels
We provide our products through direct sales organizations in the U.S., Europe
(excluding Spain, Portugal, Italy, Greece, and most Eastern European countries),
China, Japan, South Korea, India, and Taiwan. In 2018, we began direct
operations in India and Taiwan. In January 2019, our Intuitive-Fosun joint
venture began direct sales for da Vinci products and services in China. In the
remainder of our OUS markets, we provide our products through distributors.
Regulatory Activities
Overview
Our products must meet the requirements of a large and growing body of
international standards that govern the product safety, efficacy, advertising,
labeling, safety reporting design, manufacture, materials content and sourcing,
testing, certification, packaging, installation, use, and disposal of our
products. Examples of such standards include electrical safety standards, such
as those of the International Electrotechnical Commission, and composition
standards, such as the Reduction of Hazardous Substances and the Waste
Electrical and Electronic Equipment Directives. Failure to meet these standards
could limit our ability to market our products in those regions that require
compliance to such standards.
Our products and operations are also subject to increasingly stringent medical
device, privacy, and other regulations by regional, federal, state, and local
authorities. We anticipate that timelines for the introduction of new products
and/or indications may be extended relative to past experience as a result of
these regulations.
                                       31
--------------------------------------------------------------------------------
  Table of Contents
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 the U.S., South
Korea, Japan, and the European markets in which we operate. Since 2018, we
obtained regulatory clearances for the following products:
•In November 2019, we obtained FDA clearance for our SynchroSeal instrument and
E-100 generator. In March 2020, we received regulatory clearance in Japan to
market both our SynchroSeal instrument and E-100 generator.
•In July 2019, we obtained FDA clearance for our SureForm 45 Curved-Tip stapler
and SureForm 45 Gray reload, which round out our SureForm 45 portfolio. We have
also received CE mark clearance for our SureForm 45 Curved-Tip stapler and
SureForm 45 Gray reload.
•In June 2019, we received CE mark clearance for our da Vinci Endoscope Plus for
the da Vinci X/Xi Surgical Systems in Europe. Following the CE mark, in July
2019, we obtained FDA clearance for our da Vinci Endoscope Plus. We have also
received regulatory clearances in Korea and Japan to market our da Vinci
Endoscope Plus in December 2019 and May 2020, respectively.
•In June 2019, we obtained FDA clearance for our da Vinci Handheld Camera.
•In February 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 21 Ion systems for commercial use as of June 30, 2020.
•In February 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 of U.S. hospitals to gain initial product experience and insights.
•In December 2018, we received regulatory clearance for our da Vinci Xi Surgical
System in China. 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 by China National Medical Products Administration ("NMPA").
•In October 2018, the China National Health Commission published on its official
website the quota for major medical equipment to be imported and sold in China
through 2020. The government will allow the sale of 154 new surgical robots into
China, which could include da Vinci Surgical Systems as well as surgical systems
introduced by others. As of June 30, 2020, we have sold 83 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.
•In July 2018, we obtained FDA clearance to market SureForm 60, our da Vinci
EndoWrist 60mm Stapler. In January 2019, we obtained FDA clearance to market
SureForm 45. We have also received regulatory clearance in Taiwan, South Korea,
and Japan to market both SureForm 60 and SureForm 45.
•In May 2018, we obtained FDA clearance for the da Vinci SP Surgical System for
urologic surgical procedures that are appropriate for a single port approach. In
March 2019, we 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 in South Korea in May 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 an installed base of 52 da Vinci SP
Surgical Systems as of June 30, 2020.
•In April 2018, we obtained FDA clearance for our da Vinci Vessel Sealer Extend.
Refer to the descriptions of our products that received regulatory clearances in
2020, 2019, and 2018 in the New Product Introductions section below.
                                       32
--------------------------------------------------------------------------------
  Table of Contents
The Japanese Ministry of Health, Labor, and Welfare ("MHLW") considers
reimbursement for procedures in April of even-numbered years. The process for
obtaining reimbursement requires Japanese university hospitals and surgical
societies, with our support, to seek reimbursement. There are multiple pathways
to obtain reimbursement for procedures, including those that require in-country
clinical data/economic data. In April 2012 and April 2016, the MHLW granted
reimbursement status for da Vinci Prostatectomy ("dVP") and partial nephrectomy,
respectively. Most prostatectomies and partial nephrectomies were open
procedures prior to da Vinci reimbursement. Da Vinci procedure reimbursement for
dVP and partial nephrectomy procedures are higher than open and conventional
laparoscopic procedure reimbursements. An additional 12 da Vinci procedures were
granted reimbursement effective April 1, 2018, including gastrectomy, low
anterior resection, lobectomy, and hysterectomy, for both malignant and benign
conditions. An additional 7 da Vinci procedures were granted reimbursement
effective April 1, 2020. These additional 19 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 19 procedures, there can be no assurance
that the adoption pace for these procedures will be similar to dVP or partial
nephrectomy, given their higher reimbursement, or any other da Vinci procedure.
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 a da 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 of da Vinci procedures occurs procedure by procedure and market by
market and is driven by the relative patient value and total treatment costs of
da Vinci procedures as compared to alternative treatment options for the same
disease state or condition.
We use the number and type of da Vinci procedures as metrics for financial and
operational decision-making and as a means to evaluate period-to-period
comparisons. Management believes that the number and type of da Vinci procedures
provide meaningful supplemental information regarding our performance, as
management believes procedure volume is an indicator of the rate of adoption of
robotic-assisted surgery as well as an indicator of future revenue (including
revenue from usage-based arrangements). Management believes that both it and
investors benefit from referring to the number and type of da Vinci procedures
in assessing our performance and when planning, forecasting, and analyzing
future periods. The number and type of da Vinci procedures also facilitate
management's internal comparisons of our historical performance. We believe that
the number and type of da Vinci procedures are useful to investors as metrics,
because (1) they allow for greater transparency with respect to key metrics used
by management in its financial and operational decision-making, and (2) they are
used by institutional investors and the analyst community to help them analyze
the performance of our business. The vast majority of da Vinci Surgical Systems
installed are connected via the internet. System logs can also be accessed by
field engineers for systems that are not connected to the internet. We utilize
certain methods that rely on information collected from the systems installed
for determining the number and type of da Vinci procedures performed that
involve estimates and judgments, which are, by their nature, subject to
substantial uncertainties and assumptions. Estimates and judgments for
determining the number and type of da Vinci procedures may be impacted over time
by various factors, including changes in treatment modalities, hospital and
distributor reporting behavior, and system internet connectivity. Such estimates
and judgments are also susceptible to algorithmic or other technical errors. In
addition, the relationship between number and type of da Vinci procedures and
our revenues may fluctuate from period to period, and da Vinci procedure volume
growth may not correspond to an increase in
                                       33
--------------------------------------------------------------------------------
  Table of Contents
revenue. The number and type of da Vinci procedures are not intended to be
considered in isolation or as a substitute for, or superior to, revenue or other
financial information prepared and presented in accordance with GAAP.
The COVID-19 pandemic reduced the number of da Vinci procedures performed by our
customers in the first and second quarters of 2020 as compared to our
expectations. Based on the factors outlined in the COVID-19 Pandemic section
above, the ability to forecast future procedures based on historical procedure
patterns has been disrupted. Therefore, we believe that historical procedure
trends may not be a good indicator of future procedure volumes.
Worldwide Procedures
Our da Vinci systems and instruments are regulated independently in various
countries and regions of the world. The discussion of indications for use and
representative or target procedures is intended solely to provide an
understanding of the market for da Vinci products and is not intended to promote
the sale or use of any Intuitive 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 as
compared to non-da Vinci alternatives and to provide 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. Target procedures in general surgery include hernia
repair (both ventral and inguinal) and colorectal procedures. Target procedures
in gynecology include da Vinci hysterectomy ("dVH"), for both cancer and benign
conditions, and sacrocolpopexy. Target procedures in urology include dVP and
partial nephrectomy. In cardiothoracic surgery, target procedures include da
Vinci lobectomy and da Vinci mitral valve repair. In head and neck surgery,
target procedures include certain procedures resecting benign and malignant
tumors classified as T1 and T2. Not all of 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 2018 was driven by
growth in U.S. general surgery procedures and worldwide urology procedures.
U.S. Procedures
Overall U.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
growing U.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 largest U.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 largest U.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 the U.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. Total da Vinci procedures performed by our customers declined
approximately 19% for the three months ended June 30, 2020, as compared with the
same period in the prior year. Total da Vinci procedures grew approximately 17%
for the three months ended June 30, 2019. Total da Vinci procedures performed by
our customers declined approximately 5% for the six months ended June 30, 2020,
as compared with the same period in the prior year. Total da Vinci procedures
grew approximately 17% for the six months ended June 30, 2019. The second
quarter and year-to-date 2020 procedure decline reflects significant disruption
caused by the COVID-19 pandemic, as noted in the COVID-19 Pandemic section
above. While we saw procedure declines in all categories during the second
quarter of 2020, urology and thoracic procedures were impacted to a lesser
degree, while gynecology experienced the greatest decline. The rates of recovery
from their lows by procedure type were more uniform.
                                       34
--------------------------------------------------------------------------------
  Table of Contents
U.S. Procedures. U.S. da Vinci procedures declined approximately 24% for the
three months ended June 30, 2020, as compared with the same period in the prior
year. U.S. da Vinci procedures grew approximately 16% for the three months ended
June 30, 2019. U.S. da Vinci procedures declined approximately 8% for the six
months ended June 30, 2020, as compared with the same period in the prior year.
U.S. da Vinci procedures grew approximately 16% for the six months ended
June 30, 2019. The second quarter and year-to-date 2020 U.S. procedure decline
reflects significant disruption caused by the COVID-19 pandemic, as noted in the
COVID-19 Pandemic section above. While cancer procedures saw a more modest
decline and recovery, benign procedures saw a more pronounced decline but have
since recovered consistent with cancer procedures. We expect that benign
procedures will continue to be more volatile, particularly if elective
procedures continue to be deferred in certain states.
OUS Procedures. OUS da Vinci procedures declined approximately 7% for the three
months ended June 30, 2020, as compared with the same period in the prior year.
OUS da Vinci procedures grew approximately 20% for the three months ended
June 30, 2019. OUS da Vinci procedures grew approximately 2% for the six months
ended June 30, 2020, compared with approximately 21% for the six months ended
June 30, 2019. The second quarter and year-to-date 2020 OUS procedure growth
reflects significant procedure disruption caused by the COVID-19 pandemic, as
noted in the COVID-19 Pandemic section above. The disruption was most pronounced
in the UK, Italy, and France. Due to the COVID-19 outbreak in China during the
first quarter of 2020, as noted in the COVID-19 Pandemic section above, the
procedure volume decreased by 23% as compared to the first quarter of 2019.
However, during the second quarter of 2020, the procedure volume increased by
21% as compared to the second quarter of 2019. During the first and second
quarters of 2020, the impact of the COVID-19 pandemic on procedure volume in
Japan was limited. In Germany, Italy, and France, we have seen a similar decline
and recovery as has been experienced in the U.S. Overall, we have not seen a
significant change in the mix of da Vinci procedures performed during the three
and six months ended June 30, 2020 as compared with the same period in the prior
year.
System Demand
Future demand for da Vinci Surgical Systems will be impacted by a number of
factors: economic and geopolitical factors; the impact of the current COVID-19
pandemic, as noted in the COVID-19 Pandemic section above; hospital response to
the evolving healthcare environment under the current U.S. administration;
procedure growth rates; hospital consolidation trends; evolving system
utilization and point of care dynamics; capital replacement trends; additional
reimbursements in various global markets, including Japan: the timing around
governmental tenders and authorizations, including China; the timing of when we
receive regulatory clearance in our other OUS markets for our da Vinci Xi
Surgical System, da Vinci X Surgical System, and da Vinci SP Surgical System,
and related instruments; and market response.
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-assisted surgery competition, including
from companies that have introduced products in the field of robotic-assisted
surgery or have made explicit statements about their efforts to enter the field
including, but not limited to, Avatera Medical GmbH; CMR Surgical Limited;
Johnson & Johnson (including their wholly owned subsidiaries Auris Health, Inc.
and Verb 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.; and Wego Holding Co.,
Ltd.
Many of the above factors will also impact future demand for our recently
cleared Ion system, as we extend our commercial offering into diagnostics, along
with additional factors associated with a new product introduction, 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. In November 2019, we obtained FDA clearance for
our SynchroSeal instrument and E-100 generator. In March 2020, we received
regulatory clearance in Japan to market both 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 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. In July 2019, we obtained FDA clearance
for the SureForm 45 Curved-Tip stapler and SureForm 45 Gray reload. We have also
received CE mark clearance for our 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
                                       35
--------------------------------------------------------------------------------
  Table of Contents
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. In June 2019, we received CE mark clearance in Europe
for our da Vinci Endoscope Plus, an enhanced 3D endoscope for use with our da
Vinci X and Xi Surgical Systems. Following the CE mark, in July 2019, we
obtained FDA clearance for our da Vinci Endoscope Plus. We have also received
regulatory clearances in Korea and Japan to market our da Vinci Endoscope Plus
in December 2019 and May 2020, respectively. The da Vinci Endoscope Plus
leverages new sensor technology to allow for increased sharpness and color
accuracy.
Da Vinci Handheld Camera. In June 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 of da 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 broadly launched
the da Vinci Handheld Camera in our European direct markets as well as in the
U.S. in May 2020 and June 2020, respectively.
Ion endoluminal system. In February 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 articulate 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 21 Ion systems for commercial use as of June 30,
2020.
Iris. In February 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 of U.S. hospitals to gain initial product
experience and insights.
SureForm 60 and SureForm 45 Staplers. In July 2018, we obtained FDA clearance
for the SureForm 60 instrument with White, Blue, Green, and Black 60mm reloads.
In January 2019, we obtained FDA clearance for the SureForm 45 instrument with
White, Blue, Green, and Black 45mm reloads. Additionally, we received regulatory
clearance in South Korea for the SureForm 60 instrument and 60mm reloads in June
2018 and July 2018, respectively, and for the SureForm 45 instrument and 45mm
reloads in June 2019 and September 2019, respectively. Also, we received
regulatory clearance in Japan for the SureForm 60 instrument and 60mm reloads in
June 2018 and November 2018, respectively, and for the SureForm 45 instrument
and 45mm reloads in September 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. The 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. In May 2018, we obtained FDA clearance for the da
Vinci SP Surgical System for urologic surgical procedures that are appropriate
for a single port approach. In March 2019, we 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 first
da Vinci fully wristed, 3DHD camera. The instruments and the camera all emerge
through a single cannula and are triangulated around the target anatomy to avoid
external instrument collisions that can occur in narrow surgical workspaces. The
system enables flexible port placement and broad internal and external range of
motion (e.g., 360 degrees of anatomical access) through the single SP arm.
Surgeons control the fully articulating instruments and the camera on the da
Vinci SP system, which uses the same fourth generation surgeon console as the da
Vinci X and Xi systems. The da Vinci SP 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 Surgical
System in a measured fashion while we optimize training pathways and our supply
chain. We have an installed base of 52 da Vinci SP Surgical Systems as of
June 30, 2020.
Da Vinci Vessel Sealer Extend. In April 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
                                       36
--------------------------------------------------------------------------------
  Table of Contents
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.
Acquisition of Orpheus Medical
In February 2020, we acquired Orpheus Medical Ltd. and its wholly owned
subsidiaries to deepen and expand our integrated informatics platform. Orpheus
Medical provides hospitals with information technology connectivity, as well as
expertise in processing and archiving surgical videos. Orpheus Medical will be a
wholly owned subsidiary of Intuitive.
Second Quarter 2020 Operational and Financial Highlights
•Total revenue decreased by 22% to $852 million for the three months ended
June 30, 2020, compared with $1,099 million for the three months ended June 30,
2019.
•The service fee credits within the Customer Relief Program resulted in a
$59 million decrease in service revenue for the three months ended June 30,
2020.
•Approximately 243,000 da Vinci procedures were performed during the three
months ended June 30, 2020, a decrease of 19% compared with approximately
301,000 for the three months ended June 30, 2019.
•We continued to experience a decline in da Vinci procedures in April 2020 due
to the COVID-19 pandemic, reaching approximately 30% of pre-COVID-19 levels in
the U.S. In May and June, U.S. procedures began a recovery phase and, by the
middle of June, grew to nearly the same level as that measured in the first two
weeks of the first quarter of 2020. However, in the last two weeks of June and
into July, we have experienced another decline in da Vinci procedures. The
impact of COVID-19 in Europe during the second quarter varied by country with
procedures in Italy, France, and the UK declining more steeply. Procedure volume
in Japan, China, Korea, and Germany grew as compared to the second quarter of
2019.
•Instruments and accessories revenue decreased by 20% to $461 million for the
three months ended June 30, 2020, compared with $579 million for the three
months ended June 30, 2019.
•Systems revenue decreased by 24% to $261 million for the three months ended
June 30, 2020, compared with $344 million during the three months ended June 30,
2019.
•A total of 178 da Vinci Surgical Systems were shipped during the three months
ended June 30, 2020, a decrease of 35% compared with 273 systems during the
three months ended June 30, 2019.
•As of June 30, 2020, we had a da Vinci Surgical System installed base of
approximately 5,764 systems, an increase of approximately 9% compared with the
installed base of approximately 5,270 systems as of June 30, 2019.
•During the three months ended June 30, 2020, we placed 3 Ion systems for
commercial use.
•Gross profit as a percentage of revenue was 59.0% for the three months ended
June 30, 2020, compared with 69.1% for the three months ended June 30, 2019.
•Operating income decreased by 78% to $80.6 million for the three months ended
June 30, 2020, compared with $359.0 million during the three months ended
June 30, 2019. Operating income included $96.4 million and $82.0 million of
share-based compensation expense related to employee stock plans and $14.6
million and $10.6 million of intangible asset-related charges for the three
months ended June 30, 2020, and 2019, respectively.
•Income tax expense decreased by 51% to $37.0 million for the three months ended
June 30, 2020, compared with $75.4 million during the three months ended
June 30, 2019. Income tax expense included $36.8 million of discrete charges
arising from the conclusion of a tax case between an independent third party and
the IRS related to charging foreign subsidiaries for share-based compensation.
•As of June 30, 2020, we had $6.1 billion in cash, cash equivalents, and
investments. Cash, cash equivalents, and investments increased by $220 million,
compared with December 31, 2019, primarily as a result of cash generated from
operating activities, partially offset by capital expenditures.
                                       37
--------------------------------------------------------------------------------
  Table of Contents
Results of Operations
The following table sets forth, for the periods indicated, certain unaudited
Condensed Consolidated Statements of Income information (in millions, except
percentages):
                                                                 Three Months Ended June 30,                                                                                                  Six Months Ended June 30,
                                                                % of total                               % of total                                % of total                                % of total
                                            2020                 revenue               2019               revenue                2020               revenue                2019               revenue
Revenue:
Product                                $     721.8                      85  %       $  922.3                     84  %       $ 1,622.6                     83  %       $ 1,722.1                     83  %
Service                                      130.3                      15  %          176.6                     16  %           329.0                     17  %           350.5                     17  %
Total revenue                                852.1                     100  %        1,098.9                    100  %         1,951.6                    100  %         2,072.6                    100  %
Cost of revenue:
Product                                      283.8                      33  %          283.4                     26  %           580.5                     30  %           529.8                     25  %
Service                                       65.4                       8  %           56.5                      5  %           130.0                      7  %           114.2                      6  %
Total cost of revenue                        349.2                      41  %          339.9                     31  %           710.5                     37  %           644.0                     31  %
Product gross profit                         438.0                      52  %          638.9                     58  %         1,042.1                     53  %         1,192.3                     58  %
Service gross profit                          64.9                       7  %          120.1                     11  %           199.0                     10  %           236.3                     11  %
Gross profit                                 502.9                      59  %          759.0                     69  %         1,241.1                     63  %         1,428.6                     69  %
Operating expenses:
Selling, general and administrative          279.1                      33  %          279.2                     25  %           587.2                     30  %           552.6                     27  %
Research and development                     143.2                      17  %          120.8                     11  %           290.3                     15  %           264.8                     13  %
Total operating expenses                     422.3                      50  %          400.0                     36  %           877.5                     45  %           817.4                     40  %
Income from operations                        80.6                       9  %          359.0                     33  %           363.6                     18  %           611.2                     29  %
Interest and other income, net                26.6                       3  %           32.8                      3  %            51.7                      3  %            60.3                      3  %
Income before taxes                          107.2                      12  %          391.8                     36  %           415.3                     21  %           671.5                     32  %
Income tax expense                            37.0                       4  %           75.4                      7  %            28.9                      1  %            51.1                      2  %
Net income                                    70.2                       8  %          316.4                     29  %           386.4                     20  %           620.4                     30  %
Less: net income (loss) attributable
to noncontrolling interest in joint
venture                                        2.2                       -  %           (1.9)                     -  %             4.9                      -  %            (4.4)                     -  %
Net income attributable to Intuitive
Surgical, Inc.                         $      68.0                       8  %       $  318.3                     29  %       $   381.5                     20  %       $   624.8                     30  %



Total Revenue
Total revenue decreased by 22% to $852 million for the three months ended
June 30, 2020, compared with $1,099 million for the three months ended June 30,
2019, resulting from 20% lower instruments and accessories revenue, driven by
approximately 19% lower procedure volume, 24% lower systems revenue, and 26%
lower service revenue. Total revenue decreased by 6% to $2.0 billion for the six
months ended June 30, 2020, compared with $2.1 billion for the six months ended
June 30, 2019, resulting from 5% lower instruments and accessories revenue,
driven by approximately 5% lower procedure volume, 8% lower systems revenue, and
6% lower service revenue. The service fee credits provided to customers as part
of our Customer Relief Program resulted in a $59 million decrease in service
revenue for the three months ended June 30, 2020.
Revenue denominated in foreign currencies as a percentage of total revenue was
approximately 26% and 23% for the three and six months ended June 30, 2020,
respectively, and 17% and 18% for the three and six months ended June 30, 2019,
respectively. We generally sell our products and services in local currencies
where we have direct distribution channels. Foreign currency rate fluctuations
did not have a material impact on total revenue for the three and six months
ended June 30, 2020, as compared with the three and six months ended June 30,
2019.
                                       38
--------------------------------------------------------------------------------
  Table of Contents
Revenue generated in the U.S. accounted for 63% and 67% of total revenue for the
three and six months ended June 30, 2020, respectively, and 71% for both the
three and six months ended June 30, 2019. We believe that U.S. revenue has
accounted for the large majority of total revenue due to U.S. patients' ability
to choose their provider and method of treatment, reimbursement structures
supportive of innovation and MIS, and our initial investments focused on U.S.
infrastructure. We have been investing in our business in the OUS markets, and
our OUS procedures have grown faster in proportion to U.S. procedures. We expect
that our OUS procedures and revenue will make up a greater portion of our
business in the long term. However, the current increase in OUS revenue as a
percentage of total revenue is a result of the COVID-19 pandemic and is
reflective that U.S. procedures and revenue were more impacted than OUS
procedures and revenue.
As the COVID-19 pandemic is expected to continue to cause a strain on hospital
resources, as outlined in the COVID-19 Pandemic section above, including
recommended deferrals of elective procedures by various authorities and policy
makers, we cannot reliably estimate the extent procedures and system placements
will be impacted in the third quarter of 2020 and beyond.
The following table summarizes our revenue and system unit shipments for the
three and six months ended June 30, 2020, and 2019, respectively (in millions,
except percentages and unit shipments):
                                                   Three Months Ended June 30,                              Six Months Ended June
                                                                                                                     30,
                                                     2020                 2019               2020                 2019
Revenue
Instruments and accessories                     $     460.8           $   578.5          $ 1,078.3          $   1,130.8
Systems                                               261.0               343.8              544.3                591.3
Total product revenue                                 721.8               922.3            1,622.6              1,722.1
Services                                              130.3               176.6              329.0                350.5
Total revenue                                   $     852.1           $ 1,098.9          $ 1,951.6          $   2,072.6
United States                                   $     535.4           $   785.3          $ 1,317.0          $   1,476.9
OUS                                                   316.7               313.6              634.6                595.7
Total revenue                                   $     852.1           $ 1,098.9          $ 1,951.6          $   2,072.6
% of Revenue - U.S.                                      63   %              71  %              67  %                71    %
% of Revenue - OUS                                       37   %              29  %              33  %                29    %

Instruments and accessories                     $     460.8           $   578.5          $ 1,078.3          $   1,130.8
Services                                              130.3               176.6              329.0                350.5
Operating lease revenue                                42.2                25.1               81.3                 45.5
Total recurring revenue                         $     633.3           $   780.2          $ 1,488.6          $   1,526.8
% of Total revenue                                       74   %              71  %              76  %                74    %

Da Vinci Surgical Systems Shipments by Region:
U.S. unit shipments                                     106                 193                288                  347
OUS unit shipments                                       72                  80                127                  161
Total unit shipments*                                   178                 273                415                  508
*Systems shipped under operating leases
(included in total unit shipments)                       52                  88                129                  166

Ion Systems Shipments                                     3                   -                 11                    -

Da Vinci Surgical Systems Shipments involving
System Trade-ins:
Unit shipments involving trade-ins                       72                 103                208                  188
Unit shipments not involving trade-ins                  106                 170                207                  320



                                       39

--------------------------------------------------------------------------------
  Table of Contents
Product Revenue
Three months ended June 30, 2020
Product revenue decreased by 22% to $722 million for the three months ended
June 30, 2020, compared with $922 million for the three months ended June 30,
2019.
Instruments and accessories revenue decreased by 20% to $461 million for the
three months ended June 30, 2020, compared with $579 million for the three
months ended June 30, 2019. The decrease in instruments and accessories revenue
was driven primarily by a decline in procedures of approximately 19%. The second
quarter 2020 U.S. procedure volumes declined by approximately 24% primarily as a
result of the significant disruption caused by the COVID-19 pandemic, as noted
in the COVID-19 Pandemic section above. The second quarter 2020 OUS procedure
volumes declined by approximately 7%, also driven by the significant disruption
caused by the COVID-19 pandemic, as noted in the COVID-19 Pandemic section
above. Geographically, the second quarter 2020 OUS procedure decline was driven
by the UK, France, and Italy as well as various other smaller countries, while
we saw procedure expansion in Japan, China, Korea, and Germany.
Systems revenue decreased by 24% to $261 million for the three months ended
June 30, 2020, compared with $344 million for the three months ended June 30,
2019. The lower second quarter 2020 systems revenue was primarily driven by
fewer system shipments and lower lease buyouts, partially offset by higher
second quarter 2020 ASPs and higher operating lease revenue.
During the second quarter of 2020, a total of 178 da Vinci Surgical Systems were
shipped compared with 273 systems during the second quarter of 2019. By
geography, 106 systems were shipped into the U.S., 18 into Europe, 48 into Asia,
and 6 into other markets during the second quarter of 2020, compared with 193
systems shipped into the U.S., 30 into Europe, 40 into Asia, and 10 into other
markets during the second quarter of 2019. The decrease in systems shipments was
primarily driven by decisions by customers to defer purchases or leases of
systems into future quarters and, in some cases, indefinitely as a result of the
COVID-19 pandemic as well as the decline in procedures, which lead to excess
capacity at certain hospitals.
We shipped 61 and 99 da Vinci Surgical Systems under lease arrangements, of
which 52 and 88 systems were classified as operating leases for the three months
ended June 30, 2020, and 2019, respectively. Operating lease revenue was $42.2
million for the three months ended June 30, 2020, compared with $25.1 million
for the three months ended June 30, 2019. Systems placed as operating leases
represented 29% of total shipments during the second quarter of 2020, compared
with 32% during the second quarter of 2019. A total of 758 da Vinci Surgical
Systems were installed at customers under operating lease or usage-based
arrangements as of June 30, 2020, compared with 486 as of June 30, 2019. Revenue
from Lease Buyouts was $9.4 million for the three months ended June 30, 2020,
compared with $27.2 million for the three months ended June 30, 2019. We expect
revenue from Lease Buyouts to fluctuate period to period depending 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 lease or usage-based arrangements and Ion systems, was approximately
$1.65 million for the three months ended June 30, 2020, compared with
approximately $1.54 million for the three months ended June 30, 2019. The higher
second quarter 2020 ASP was largely driven by favorable geographic and product
mix, partially offset by higher relative trade-in volume. ASP fluctuates from
period to period based on geographic and product mix, product pricing, systems
shipped involving trade-ins, and changes in foreign exchange rates.
Six months ended June 30, 2020
Product revenue decreased by 6% to $1.6 billion for the six months ended
June 30, 2020, compared with $1.7 billion for the six months ended June 30,
2019.
Instruments and accessories revenue decreased by 5% to $1.08 billion for the six
months ended June 30, 2020, compared with $1.13 billion for the six months ended
June 30, 2019. The decrease in instruments and accessories revenue was driven
primarily by a decline in procedures of approximately 5%. The year-to-date 2020
U.S. procedure volumes declined by approximately 8% primarily as a result of the
significant disruption caused by the COVID-19 pandemic, as noted in the COVID-19
Pandemic section above. The year-to-date 2020 OUS procedure volumes increased by
approximately 2%, also driven by the significant disruption caused by the
COVID-19 pandemic, as noted in the COVID-19 Pandemic section above.
Geographically, the year-to-date 2020 OUS procedure growth was driven by
procedure expansion in Japan, Korea, Germany, and China offset by declines in
the UK, France, and Italy as well as various other smaller countries.
Systems revenue decreased by 8% to $544 million for the six months ended
June 30, 2020, compared with $591 million for the six months ended June 30,
2019. The lower year-to-date 2020 systems revenue was primarily driven by fewer
system shipments and lower lease buyouts, partially offset by higher 2020 ASPs
and higher operating lease revenue.
                                       40
--------------------------------------------------------------------------------
  Table of Contents
During the six months ended June 30, 2020, a total of 415 da Vinci Surgical
Systems were shipped compared with 508 systems during the six months ended
June 30, 2019. By geography, 288 systems were shipped into the U.S., 43 into
Europe, 75 into Asia, and 9 into other markets during the six months ended
June 30, 2020, compared with 347 systems shipped into the U.S., 79 into Europe,
61 into Asia, and 21 into other markets during the six months ended June 30,
2019. The decrease in systems shipments was primarily driven by decisions by
customers to defer purchases or leases of systems into future quarters and, in
some cases, indefinitely as a result of the COVID-19 pandemic as well as the
decline in procedures, which lead to excess capacity at certain hospitals,
partially offset by more customers trading in older da Vinci models for fourth
generation da Vinci Xi and da Vinci X systems and the need for certain hospitals
to expand or establish capacity.
We shipped 182 and 180 da Vinci Surgical Systems under lease arrangements, of
which 129 and 166 systems were classified as operating leases for the six months
ended June 30, 2020, and 2019, respectively. Operating lease revenue was $81.3
million for the six months ended June 30, 2020, compared with $45.5 million for
the six months ended June 30, 2019. Systems placed as operating leases
represented 31% of total shipments during the six months ended June 30, 2020,
compared with 33% during the six months ended June 30, 2019. Revenue from Lease
Buyouts was $21.6 million for the six months ended June 30, 2020, compared with
$39.2 million for the six months ended June 30, 2019. We expect revenue from
Lease Buyouts to fluctuate period to period depending 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 lease or usage-based arrangements and Ion systems, was approximately
$1.53 million for the six months ended June 30, 2020, compared with
approximately $1.43 million for the six months ended June 30, 2019. The higher
year-to-date 2020 ASP was largely driven by favorable geographic and product
mix, partially offset by higher trade-in volume. 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 decreased by 26% to $130 million for the three months ended
June 30, 2020, compared with $177 million for the three months ended June 30,
2019. The decrease in service revenue was primarily driven by the effects of the
Customer Relief Program, which resulted in a $59 million decrease, partially
offset by a larger installed base of da Vinci Surgical Systems producing service
revenue.
Service revenue decreased by 6% to $329 million for the six months ended
June 30, 2020, compared with $351 million for the six months ended June 30,
2019. The decrease in service revenue was primarily driven by the effects of the
Customer Relief Program, partially offset by a larger installed base of da Vinci
Surgical Systems producing service revenue.
Gross Profit
Product gross profit for the three months ended June 30, 2020, decreased 31% to
$438 million, representing 60.7% of product revenue, compared with $639 million,
representing 69.3% of product revenue, for the three months ended June 30, 2019.
The lower product gross profit for the three months ended June 30, 2020, was
primarily driven by lower product revenue and lower product gross profit margin.
The lower product gross profit margin for the three months ended June 30, 2020,
was primarily driven by higher excess and obsolete inventory costs related to
transitioning to new technologies coupled with the decrease in demand for older
technologies, period costs in the second quarter of 2020 associated with
abnormally low production, and higher freight costs. These higher charges were
primarily a result of the COVID-19 pandemic.
Product gross profit for the six months ended June 30, 2020, decreased 13% to
$1.0 billion, representing 64.2% of product revenue, compared with $1.2 billion,
representing 69.2% of product revenue, for the six months ended June 30, 2019.
The lower product gross profit for the six months ended June 30, 2020, was
primarily driven by lower product revenue and lower product gross profit margin.
The lower product gross profit margin for the six months ended June 30, 2020,
was primarily driven by higher excess and obsolete inventory costs related to
transitioning to new technologies coupled with the decrease in demand for older
technologies, period costs in the second quarter of 2020 associated with
abnormally low production, and higher freight costs. These higher charges were
primarily a result of the COVID-19 pandemic. There were also increased costs
associated with da Vinci Si product transitions and higher intangible assets
amortization expense and share-based compensation expense.
Product gross profit for the three and six months ended June 30, 2020, included
share-based compensation expense of $14.2 million and $27.0 million,
respectively, compared with $11.4 million and $22.4 million, for the three and
six months ended June 30, 2019, respectively. Product gross profit for the three
and six months ended June 30, 2020, included intangible assets amortization
expense of $8.9 million and $17.7 million, respectively, compared with $7.7
million and $15.0 million, for the three and six months ended June 30, 2019,
respectively.
                                       41
--------------------------------------------------------------------------------
  Table of Contents
Service gross profit for the three months ended June 30, 2020, decreased 46% to
$64.9 million, representing 49.8% of service revenue, compared with $120.1
million, representing 68.0% of service revenue, for the three months ended
June 30, 2019. The lower service gross profit for the three months ended
June 30, 2020, was primarily driven by lower service revenue and lower service
gross profit margin. The lower service gross profit margin for the three months
ended June 30, 2020, was primarily driven by the decrease in service revenue as
a result of the Customer Relief Program.
Service gross profit for the six months ended June 30, 2020, decreased 16% to
$199 million, representing 60.5% of service revenue, compared with $236 million,
representing 67.4% of service revenue, for the six months ended June 30, 2019.
The lower service gross profit for the six months ended June 30, 2020, was
primarily driven by lower service revenue and lower service gross profit margin.
The lower service gross profit margin for the six months ended June 30, 2020,
was primarily driven by the decrease in service revenue as a result of the
Customer Relief Program.
Service gross profit for the three and six months ended June 30, 2020, included
share-based compensation expense of $5.2 million and $10.7 million,
respectively, compared with $4.8 million and $9.3 million, for the three and six
months ended June 30, 2019, respectively. Service gross profit for the three and
six months ended June 30, 2020, included intangible assets amortization expense
of $0.9 million and $1.8 million, respectively, compared with $1.0 million and
$1.9 million, for the three and six and months ended June 30, 2019,
respectively.
As a result of the continued impacts from the COVID-19 pandemic, we expect that
our production facilities may run at less than normal capacity in the third
quarter of 2020. Accordingly, certain fixed production overhead costs may be
expensed as incurred, reducing our gross profit margin. We cannot reliably
estimate the extent to which the COVID-19 pandemic will impact our overall
demand in the third quarter and beyond.
Selling, General and Administrative Expenses
Selling, general and administrative expenses include costs for sales, marketing,
and administrative personnel, sales and marketing activities, tradeshow
expenses, legal expenses, regulatory fees, and general corporate expenses.
Selling, general and administrative expenses for the three months ended June 30,
2020, was $279 million, compared with $279 million for the three months ended
June 30, 2019. Selling, general and administrative expenses for the six months
ended June 30, 2020, increased by 6% to $587 million, compared with $553 million
for the six months ended June 30, 2019. The changes in selling, general and
administrative expenses for the three and six months ended June 30, 2020, were
primarily driven by higher headcount, including expansion of our Asian and
European teams, and increased infrastructure to support our growth, partially
offset by lower marketing, travel, and training expenses, particularly in the
second quarter of 2020.
Selling, general and administrative expenses for the three and six months ended
June 30, 2020, included share-based compensation expense of $49.6 million and
$95.3 million, respectively, compared with $40.7 million and $79.3 million, for
the three and six months ended June 30, 2019, respectively. Selling, general and
administrative expenses for the three and six months ended June 30, 2020,
included intangible assets amortization expense of $1.7 million and $3.4
million, respectively, compared with $1.4 million and $2.6 million, for the
three and six months ended June 30, 2019, respectively.
Our spending in the second quarter of 2020 reflected a curtailment of certain
costs associated with the impact of the COVID-19 pandemic. While certain
spending will continue to decrease in the third quarter of 2020 as a result of
activities limited by the COVID-19 pandemic, much of our spending will continue.
We will continue to support our customers, invest in innovation focused on the
quadruple aim, and invest in manufacturing and our supply chain to ensure supply
for our customers. Certain costs will decline as the underlying activities are
restricted by the COVID-19 pandemic, including travel and related expenses,
clinical trials, surgeon training, and customer data collection. We will
eliminate spending that is ineffective due to the COVID-19 pandemic, such as
surgeon and hospital events, and we are pausing the hiring of volume-related
roles, such as sales representatives and manufacturing employees.
Research and Development Expenses
Research and development costs are expensed as incurred. Research and
development expenses include costs associated with the design, development,
testing, and significant enhancement of our products.
Research and development expenses for the three months ended June 30, 2020,
increased by 19% to $143 million, compared with $121 million for the three
months ended June 30, 2019. Research and development expenses for the six months
ended June 30, 2020, increased by 10% to $290 million, compared with
$265 million for the six months ended June 30, 2019. The increases in research
and development expenses for the three and six months ended June 30, 2020, were
primarily driven by higher personnel-related expenses 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, partially offset by lower
intangible asset-related charges in the first quarter of 2020.
                                       42
--------------------------------------------------------------------------------
  Table of Contents
Research and development expenses for the three and six months ended June 30,
2020, included share-based compensation expense of $27.4 million and $54.6
million, respectively, compared with $25.1 million and $47.9 million, for the
three and six ended June 30, 2019, respectively. Research and development
expenses for the three and six months ended June 30, 2020, included intangible
asset charges of $3.1 million and $5.0 million, respectively, compared with $0.5
million and $21.3 million, for the three and six months ended June 30, 2019,
respectively.
Research and development expenses fluctuate with project timing. Based upon our
broader set of product development initiatives and the stage of the underlying
projects, we expect to continue to make substantial investments in research and
development and anticipate that research and development expenses will continue
to increase in the future.
Interest and Other Income, Net
Interest and other income, net, for the three and six months ended June 30,
2020, was $26.6 million, and $51.7 million, respectively, compared with $32.8
million and $60.3 million for the three and six months ended June 30, 2019,
respectively. The decreases in interest and other income, net, for the three and
six months ended June 30, 2020, were primarily driven by lower interest income
earned, despite higher cash and investment balances, due to the decline in
average interest rates and realized foreign exchange losses, partially offset by
gains on the sale of certain securities.
Income Tax Expense
Income tax expense for the three months ended June 30, 2020, was $37.0 million,
or 34.5% of income before taxes, compared with $75.4 million, or 19.2% of income
before taxes, for the three months ended June 30, 2019. Income tax expense for
the six months ended June 30, 2020, was $28.9 million, or 7.0% of income before
taxes, compared with $51.1 million, or 7.6% of income before taxes, for the six
months ended June 30, 2019.
Our effective tax rate for the three and six ended June 30, 2020, and 2019,
differs from the U.S. federal statutory rate of 21% primarily due to excess tax
benefits associated with employee equity plans, the effect of income earned by
certain overseas entities being taxed at rates lower than the federal statutory
rate, and federal R&D credit benefit, partially offset by state income taxes
(net of federal benefit) and U.S. tax on foreign earnings. Our effective tax
rate for the three and six months ended June 30, 2020, reflected a $36.8 million
increase in income tax expense discussed below.
In July 2015, a U.S. Tax Court opinion (the "2015 Opinion") was issued involving
an independent third party related to charging foreign subsidiaries for
share-based compensation. Based on the findings of the U.S. Tax Court, direct
share-based compensation has been excluded from our intercompany charges
starting in 2015. In June 2019, the Ninth 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 was denied in November 2019. In
February 2020, a petition was filed to appeal the Ninth Circuit Opinion to the
U.S. Supreme Court. The petition was denied by the U.S. Supreme Court on June
22, 2020, which makes the Ninth Circuit Opinion binding precedent in the Ninth
Circuit. As a result, we increased our unrecognized tax benefits by
$36.8 million with a corresponding increase in income tax expense for the three
and six months ended June 30, 2020, related to the intercompany charges for
share-based compensation for relevant periods before 2020. We will continue to
monitor future IRS actions or other developments regarding this matter and will
assess the impact of any such developments to our income tax provision in the
quarter that they occur. We are treating share-based compensation expense in
accordance with the Ninth Circuit Opinion for 2020 and going forward.
Our provision for income taxes for the three and six months ended June 30, 2020,
included excess tax benefits associated with employee equity plans of
$31.6 million and $97.0 million, which reduced our effective tax rate by 29.4
and 23.3 percentage points, respectively. Our provision for income taxes for the
three and six months ended June 30, 2019, included excess tax benefits
associated with employee equity plans of $11.3 million and $84.0 million, which
reduced our effective tax rate by 2.9 and 12.5 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 under U.S.
GAAP, which results in increased income tax expense volatility.
We file federal, state, and foreign income tax returns in many U.S. and OUS
jurisdictions. Years before 2016 are closed for the significant jurisdictions.
Certain of our unrecognized tax benefits could change due to activities of
various tax authorities, including evolving interpretations of existing tax laws
in the jurisdictions we operate, potential assessment of additional tax,
possible settlement of audits, or through normal expiration of various statutes
of limitations, which could affect our effective tax rate in the period in which
they change. Due to the uncertainty related to the timing and potential outcome
of audits, we cannot estimate the range of reasonably possible change in
unrecognized tax benefits that may occur in the next 12 months.
                                       43
--------------------------------------------------------------------------------
  Table of Contents
We are subject to the examination of our income tax returns by the IRS 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.
Net Income (Loss) Attributable to Noncontrolling Interest in Joint Venture
Net income (loss) attributable to noncontrolling interest in Joint Venture for
the three months ended June 30, 2020, was $2.2 million, compared with $(1.9)
million for the three months ended June 30, 2019. Net income (loss) attributable
to noncontrolling interest in Joint Venture for the six months ended June 30,
2020, was $4.9 million, compared with $(4.4) million for the six months ended
June 30, 2019. The increases in net income attributable to noncontrolling
interest in Joint Venture were primarily due to increased revenue, partially
offset by a re-measurement loss related to the contingent consideration during
the three and six months ended June 30, 2020.
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 $0.22 billion to $6.07 billion as of June 30, 2020,
from $5.85 billion as of December 31, 2019, primarily from cash provided by our
operations and proceeds from stock option exercises and employee stock
purchases, partially offset by capital expenditures, taxes paid related to net
share settlements of equity awards, and common stock repurchases.
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 by our 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.
However, as a result of the COVID-19 pandemic, we expect to experience reduced
cash flow from operations as a result of decreased revenues and extending
payment terms on sales and operating lease and usage-based arrangements.
Moreover, we are focused on ensuring that we have adequate supplies on hand
given the potential disruption of the COVID-19 pandemic to our suppliers and
their supply chain and, accordingly, we expect to continue to increase inventory
during the third quarter of 2020 and beyond.
See "Item 7A. Quantitative and Qualitative Disclosures About Market Risk" in our
Form 10-K for the fiscal year ended December 31, 2019, for discussion on the
impact of interest rate risk and market risk on our investment portfolio.
Condensed Consolidated Cash Flow Data
The following table summarizes our cash flows for the six months ended June 30,
2020, and 2019 (in millions):
                                                                             Six Months Ended
                                                                                  June 30,
                                                                         2020                 2019
Net cash provided by (used in)
Operating activities                                                $     582.7          $     649.2
Investing activities                                                      419.6               (531.6)
Financing activities                                                     (131.1)              (220.4)

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

                                                                       (1.6)                (1.3)
Net increase (decrease) in cash, cash equivalents, and restricted
cash                                                                $     869.6          $    (104.1)



                                       44

--------------------------------------------------------------------------------
  Table of Contents
Operating Activities
For the six months ended June 30, 2020, net cash provided by operating
activities of $583 million exceeded our net income of $386 million, primarily
due to the following reasons:
1.Our net income included non-cash charges of $372 million, consisting primarily
of the following significant items: share-based compensation of $187 million;
deferred income taxes of $53 million; depreciation expense and losses on the
disposal of property, plant, and equipment of $103 million; and amortization of
intangible assets of $25 million.
2.The non-cash charges outlined above were partially offset by changes in
operating assets and liabilities that resulted in $176 million of cash used by
operating activities during the six months ended June 30, 2020. Prepaid expenses
and other assets increased by $96 million, primarily due to an increase in
prepaid taxes, driven by the timing of tax payments, and an increase in leasing.
Accrued compensation and employee benefits decreased by $83 million, primarily
due to the payments of 2019 incentive compensation. Inventory, including the
transfer of equipment from inventory to property, plant, and equipment,
increased by $120 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, such as the COVID-19 pandemic. The
unfavorable impact of these items on cash provided by operating activities was
partially offset by a $137 million decrease in accounts receivable, primarily
due to the timing of collections.
Investing Activities
Net cash provided by investing activities for the six months ended June 30,
2020, consisted primarily of proceeds from sales and maturities of investments
(net of purchases of investments) of $673 million, the acquisition of property
and equipment of $215 million, and the Orpheus Medical Acquisition, net of cash
acquired, of $38 million. We invest predominantly in high quality, fixed income
securities. Our investment portfolio may, at any time, contain investments in
U.S. treasury and U.S. government agency securities, taxable and tax-exempt
municipal notes, corporate notes and bonds, commercial paper, non-U.S.
government agency securities, cash deposits, and money market funds.
Financing Activities
Net cash used in financing activities during the six months ended June 30, 2020,
consisted primarily of taxes paid on behalf of employees related to net share
settlements of vested employee stock purchases of $155 million and cash used in
the repurchase of approximately 0.2 million shares of our common stock in the
open market for $100 million, partially offset by proceeds from stock option
exercises and employee stock purchases of $154 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 both 2020 and 2021. We intend to
fund these needs with cash generated from operations.
Critical Accounting Estimates
The discussion and analysis of our financial condition and results of operations
are based upon our Financial Statements, which have been prepared in accordance
with U.S. GAAP. The preparation of these Financial Statements requires us to
make estimates and judgments that affect the reported amounts of assets,
liabilities, revenues, and expenses. On an ongoing basis, we evaluate our
critical accounting estimates. We base our estimates on historical experience
and on various other assumptions that we believe to be reasonable under the
circumstances, the results of which form the basis for making judgments about
the carrying values of assets and liabilities that are not readily apparent from
other sources. Actual results may differ from these estimates under different
assumptions or conditions. There have been no new or material changes to the
critical accounting estimates discussed in our Annual Report on Form 10-K for
the fiscal year ended December 31, 2019, that are of significance, or potential
significance, to the Company.
                                       45

--------------------------------------------------------------------------------

Table of Contents

© Edgar Online, source Glimpses