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

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
September 30, 2020, and results of operations for the three and nine months
ended September 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.
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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 58 da Vinci SP Surgical Systems as of September 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.
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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 32 Ion systems for
commercial use as of September 30, 2020. Ion systems are not included in our da
Vinci Surgical System installed base. We currently have 3 Ion systems placed
with hospitals for gathering clinical data in addition to the systems placed for
commercial use.
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 to
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% of 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 postponed elective procedures, and we 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 South Korea and Japan in the second quarter of
2020.
Third Quarter of 2020
In the U.S., procedures recovered slowly, leveling off near pre-COVID-19 levels
towards the end of the quarter. Outside of the U.S., da Vinci procedures varied
depending on the spread and/or resurgence of COVID-19. For example, COVID-19 had
a less significant impact in Germany where da Vinci procedures grew at mid
single digits relative to the third quarter of 2019, while it had a more
significant impact in the U.K. where da Vinci procedures declined year over
year. Procedures in China grew significantly year over year, while regional
COVID-19 outbreaks resulted in year-over-year procedure growth rates in Japan
slowing somewhat relative to the second quarter. The COVID-19 pandemic has also
affected the volumes of certain procedure types differently. For example,
patient concerns over exposure to COVID-19 and the fact that prostate cancer can
be slow growing, combined with lower prostate diagnoses and treatments, have
caused the number of dVP procedures to decline in the
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third quarter of 2020 relative to the third quarter of 2019. Da Vinci bariatric
procedures grew significantly year over year due to our optimized instrument set
and focus by our sales organization and may also have benefited from certain
patients prioritizing weight loss as obesity is a significant COVID-19 risk
factor. However, the diagnoses and treatment pathways for bariatric patients are
long, and many of the patients in the third quarter may have begun their
treatment pathway prior to the spread of COVID-19; therefore, we cannot assure
you that we will continue to see significant growth in bariatric procedures.
While total worldwide procedures per week have improved to near pre-COVID-19
procedure levels, procedure volumes vary by country, region, and type. It is
possible that a growth or resurgence in COVID-19 infections will negatively
impact da Vinci procedures. We continue to see that, when COVID-19 infections
rates spike in a particular region, procedure volumes are negatively impacted
and the diagnoses of new conditions are deferred. Furthermore, we do not expect
all markets to recover at the same pace. Due to the uncertainty of the recovery,
including the potential for COVID-19 infection rates to increase, coupled with
additional policy responses that may be outlined by governments and other
authorities, we cannot reliably estimate the impact that the COVID-19 pandemic
may have on procedure volume in the fourth quarter of 2020 and beyond.
System Demand
As the impact of the COVID-19 pandemic progressed through the first and second
quarters of 2020, customers in affected regions deferred decisions to purchase
or lease systems into future quarters and, in some cases, indefinitely. These
deferral decisions continued into the third quarter of 2020. In addition, the
year-to-date decline in procedures and, in turn, the reduced utilization of our
systems has resulted in unused capacity in the existing installed base. We
expect hospitals to first fill their unused 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 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 provided
credits against service fees otherwise due in the six-month period from April 1
through September 30, 2020, that generally reflects the under-utilization of the
system during that period. Those credits were offered to most customers
worldwide. The second element of the program deferred certain lease payments,
and the third extended certain payment terms. Service fee credits resulted in an
approximately $59 million and $23 million decrease in service revenue in the
second quarter of 2020 and third quarter of 2020, respectively. While the
short-term payment relief offered did not have a material impact to the results
of operations, we deferred $14 million of lease billings and extended payment
terms associated with $181 million of trade receivables since the start of the
program, of which $85 million remain outstanding at the end of the third quarter
of 2020. We may 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, including our
manufacturing operations, or the facilities of our suppliers and their contract
manufacturers, could further significantly impact our sales and our ability to
produce and 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
Our priorities and actions during the COVID-19 pandemic are as follows. First,
we are focused on the health and safety of all those we serve - patients,
customers, our communities, and our employees - implementing continuous updates
to our health and safety policies and processes. Second, we are supporting our
customers according to their priorities - clinical, operational, and economic -
and ensuring 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, we will continue to invest in our
priority development programs while eliminating avoidable spend.
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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 nine months ended September 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," which consists of select
Xi/X instruments possessing 12 to 18 uses ("Extended Use Instruments") compared
to the current 10 use instruments. These Extended Use 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. Extended Use
Instruments have been introduced in the U.S. in October 2020. They will be
introduced later in the fourth quarter in Europe and at various times throughout
2021 and 2022 in other geographies, depending on regulatory processes. In
addition, simultaneous with the regional launches of Extended Use Instruments,
we will lower the price of certain instruments that are most commonly used in
lower acuity procedures and/or lower reimbursed procedures within the region.
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 to $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 to $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 to $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, number of shipments, and utilization 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, number of shipments, and utilization of da Vinci Surgical
Systems provide meaningful supplemental information regarding our performance,
as management believes that the installed base, number of shipments, and
utilization 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, number of shipments, and
utilization of da Vinci Surgical Systems in assessing our performance and when
planning,
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forecasting, and analyzing future periods. The installed base, number of
shipments, and utilization of da Vinci Surgical Systems also facilitate
management's internal comparisons of our historical performance. We believe that
the installed base, number of shipments, and utilization 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 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, number of shipments, and utilization 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, number of shipments, and utilization of da Vinci Surgical
Systems and our revenues may fluctuate from period to period, and growth in the
installed base, number of shipments, and utilization of da Vinci Surgical
Systems may not correspond to an increase in revenue. The installed base, number
of shipments, and utilization 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 third 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 to 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,
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2018, and 2017, respectively. We expect that revenue recognized from customer
exercises of the buyout options will fluctuate based on the timing of when, and
if, customers choose to exercise their buyout options.
Systems Revenue
System placements are driven by procedure growth in most markets. In geographies
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 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.
Clearances and Approvals
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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. Following the FDA clearance, in February 2020, we received CE
mark clearance for both products. 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 South 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 and,
in February 2020, we received CE mark clearance.
•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 32 Ion systems for commercial use as of September 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 currently conducting a pilot study of our Iris product and
service in the field at a small group of U.S. hospitals to gain initial product
experience and insights.
•In December 2018, we received product registration approval for our da Vinci Xi
Surgical System in China. The Xi registration approval does not include advanced
energy or stapling products that attach to the Xi system. Separate product
registrations are required for each of these products with the 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. After an adjustment notice published in the third quarter of 2020,
the government will now allow for the total sale of 225 new surgical robots into
China, which could include da Vinci Surgical Systems as well as surgical systems
introduced by others. As of September 30, 2020, we have sold 100 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 May 2018 and July 2018, we received CE mark clearance and FDA clearance,
respectively, to market SureForm 60, our da Vinci EndoWrist 60mm Stapler. In
January 2019 and February 2019, we obtained FDA clearance and CE mark clearance,
respectively, 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 58 da Vinci SP
Surgical Systems as of September 30, 2020.
•In September 2017 and April 2018, we obtained CE mark clearance and FDA
clearance, respectively, 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.
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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
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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 three 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 to approximately 1,038,000 and 877,000 surgical
procedures performed with da Vinci Surgical Systems in 2018 and 2017,
respectively. The growth in our overall procedure volume in 2019 was driven by
growth 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 to 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 to 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
to 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 to 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 to 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 to approximately 175,000 in 2018 and approximately 149,000 in
2017. General surgery and gynecology procedures also contributed to OUS
procedure growth.
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Recent Business Events and Trends
Procedures
Overall. Total da Vinci procedures performed by our customers grew approximately
7% for the three months ended September 30, 2020, compared to approximately 20%
for the three months ended September 30, 2019. Total da Vinci procedures
performed declined approximately 1% for the nine months ended September 30,
2020, as compared to the same period in the prior year. Total da Vinci
procedures grew approximately 18% for the nine months ended September 30, 2019.
The third quarter and year-to-date 2020 procedure results reflect significant
disruption caused by the COVID-19 pandemic, as noted in the COVID-19 Pandemic
section above. We saw continued recovery and growth in most of the major
procedure categories during the third quarter of 2020, most notably in general
surgery procedures (particularly bariatrics) and, to a lesser extent, gynecology
and urology procedures. The rates of recovery in urology procedures appear to
have been particularly impacted by the COVID-19 pandemic due to delays in both
the diagnosis of and procedures in patient populations that are considered to be
at higher risk from COVID-19 infections as well as for conditions that may
progress more slowly.
U.S. Procedures. U.S. da Vinci procedures grew approximately 7% for the three
months ended September 30, 2020, compared to approximately 18% for the three
months ended September 30, 2019. U.S. da Vinci procedures declined approximately
3% for the nine months ended September 30, 2020, as compared to the same period
in the prior year. U.S. da Vinci procedures grew approximately 17% for the nine
months ended September 30, 2019. The third quarter and year-to-date 2020 U.S.
procedure results reflect significant disruption caused by the COVID-19
pandemic, as noted in the COVID-19 Pandemic section above. We saw varied
performance in each of the procedure categories during the third quarter of
2020, with growth in general surgery and gynecology procedures offset by
declines in urology procedures. We are seeing patients delay non-urgent
procedures to a greater extent, particularly when patients are at higher risk of
COVID-19.
OUS Procedures. OUS da Vinci procedures grew approximately 9% for the three
months ended September 30, 2020, compared to approximately 23% for the three
months ended September 30, 2019. OUS da Vinci procedures grew approximately 5%
for the nine months ended September 30, 2020, compared to approximately 21% for
the nine months ended September 30, 2019. The third 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 more pronounced in the UK and India. Due to the COVID-19 outbreak
in China during the first quarter of 2020, as noted in the COVID-19 Pandemic
section above, China's procedure volume decreased as compared to the first
quarter of 2019. However, during the second and third quarters of 2020, the
procedure volume in China recovered and increased as compared to the second and
third quarters of 2019. During the third quarter of 2020, the impact of the
COVID-19 pandemic on procedure volume in Japan was higher than in previous
quarters.
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; 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, avateramedical GmbH; CMR Surgical Ltd.; Johnson &
Johnson (including their wholly owned subsidiaries Auris Health, Inc. and Verb
Surgical Inc.); Medicaroid, Inc.; Medrobotics Corporation; Medtronic plc;
meerecompany Inc.; Olympus Corporation; Samsung Group; 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.
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New Product Introductions
SynchroSeal and E-100 Generator. In November 2019, we obtained FDA clearance for
our SynchroSeal instrument and E-100 generator. Following the FDA clearance, in
February 2020, we received CE mark clearance for both products. 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 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 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 South 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. In February 2020, we
received CE mark clearance for our da Vinci Handheld Camera. 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 32 Ion systems for commercial use as of
September 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 May 2018 and July 2018, we received CE
mark clearance and FDA clearance, respectively for the SureForm 60 instrument
with White, Blue, Green, and Black 60mm reloads. In January 2019 and February
2019, we obtained FDA clearance and CE mark clearance, respectively, 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.
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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 58 da Vinci SP Surgical Systems as of
September 30, 2020.
Da Vinci Vessel Sealer Extend. In September 2017 and April 2018, we received CE
mark clearance and FDA clearance, respectively, for da Vinci Vessel Sealer
Extend, our newest instrument in the Vessel Sealing family of products. Da Vinci
Vessel Sealer Extend is a single-use, fully wristed bipolar electrosurgical
instrument compatible with our fourth generation multiport systems. It is
intended for grasping and blunt dissection of tissue and for bipolar coagulation
and mechanical transection of vessels up to 7mm in diameter and tissue bundles
that fit in the jaws of the instrument.
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.
Intuitive Ventures
We launched Intuitive Ventures, an inaugural $100 million fund focused on
investment opportunities in companies that share Intuitive's commitment to
advancing positive outcomes in healthcare.
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Third Quarter 2020 Operational and Financial Highlights
•Total revenue decreased by 4% to $1,078 million for the three months ended
September 30, 2020, compared to $1,128 million for the three months ended
September 30, 2019.
•The service fee credits within the Customer Relief Program resulted in a
$23 million decrease in service revenue for the three months ended September 30,
2020.
•Approximately 329,000 da Vinci procedures were performed during the three
months ended September 30, 2020, an increase of 7% compared to approximately
307,000 for the three months ended September 30, 2019.
•Instruments and accessories revenue increased by 4% to $631 million for the
three months ended September 30, 2020, compared to $606 million for the three
months ended September 30, 2019.
•Systems revenue decreased by 21% to $268 million for the three months ended
September 30, 2020, compared to $339 million during the three months ended
September 30, 2019.
•A total of 195 da Vinci Surgical Systems were shipped during the three months
ended September 30, 2020, a decrease of 29% compared to 275 systems during the
three months ended September 30, 2019.
•As of September 30, 2020, we had a da Vinci Surgical System installed base of
approximately 5,865 systems, an increase of approximately 8% compared to the
installed base of approximately 5,406 systems as of September 30, 2019.
•Utilization of da Vinci systems, measured in terms of procedures per system per
year, declined 2% relative to the third quarter of 2019.
•During the three months ended September 30, 2020, we placed 11 Ion systems for
commercial use.
•Gross profit as a percentage of revenue was 67.2% for the three months ended
September 30, 2020, compared to 69.6% for the three months ended September 30,
2019.
•Operating income decreased by 26% to $270 million for the three months ended
September 30, 2020, compared to $366 million during the three months ended
September 30, 2019. Operating income included $107.0 million and $89.3 million
of share-based compensation expense related to employee stock plans and $21.7
million and $10.7 million of intangible asset-related charges for the three
months ended September 30, 2020, and 2019, respectively.
•As of September 30, 2020, we had $6.4 billion in cash, cash equivalents, and
investments. Cash, cash equivalents, and investments increased by $506 million,
compared to December 31, 2019, primarily as a result of cash generated from
operating activities, partially offset by capital expenditures.
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Results of Operations
The following table sets forth, for the periods indicated, certain unaudited
Condensed Consolidated Statements of Income information (in millions, except
percentages):
                                                           Three Months Ended September 30,                                                                                              Nine Months Ended September 30,
                                                          % of total                                % of total                                 % of total                                 % of total
                                        2020                revenue               2019                revenue                2020                revenue                2019                revenue
Revenue:
Product                              $  898.4                      83  %       $  944.8                      84  %       $ 2,521.0                      83  %       $ 2,666.9                      83  %
Service                                 179.3                      17  %          183.4                      16  %           508.3                      17  %           533.9                      17  %
Total revenue                         1,077.7                     100  %        1,128.2                     100  %         3,029.3                     100  %         3,200.8                     100  %
Cost of revenue:
Product                                 287.7                      27  %          277.3                      25  %           868.2                      29  %           807.1                      25  %
Service                                  65.7                       6  %           65.3                       6  %           195.7                       6  %           179.5                       6  %
Total cost of revenue                   353.4                      33  %          342.6                      31  %         1,063.9                      35  %           986.6                      31  %
Product gross profit                    610.7                      56  %          667.5                      59  %         1,652.8                      54  %         1,859.8                      58  %
Service gross profit                    113.6                      11  %          118.1                      10  %           312.6                      11  %           354.4                      11  %
Gross profit                            724.3                      67  %          785.6                      69  %         1,965.4                      65  %         2,214.2                      69  %
Operating expenses:
Selling, general and administrative     298.9                      28  %          284.0                      25  %           886.1                      29  %           836.6                      26  %
Research and development                155.0                      14  %          135.9                      12  %           445.3                      15  %           400.7                      13  %
Total operating expenses                453.9                      42  %          419.9                      37  %         1,331.4                      44  %         1,237.3                      39  %
Income from operations                  270.4                      25  %          365.7                      32  %           634.0                      21  %           976.9                      30  %
Interest and other income, net           84.8                       8  %           33.3                       3  %           136.5                       5  %            93.6                       3  %
Income before taxes                     355.2                      33  %          399.0                      35  %           770.5                      26  %         1,070.5                      33  %
Income tax expense                       38.4                       4  %            0.3                       -  %            67.3                       2  %            51.4                       1  %
Net income                              316.8                      29  %          398.7                      35  %           703.2                      24  %         1,019.1                      32  %
Less: net income (loss) attributable
to noncontrolling interest in joint
venture                                   2.9                       -  %            1.9                       -  %             7.8                       -  %            (2.5)                      -  %
Net income attributable to Intuitive
Surgical, Inc.                       $  313.9                      29  %       $  396.8                      35  %       $   695.4                      24  %       $ 1,021.6                      32  %



Total Revenue
Total revenue decreased by 4% to $1,078 million for the three months ended
September 30, 2020, compared to $1,128 million for the three months ended
September 30, 2019, resulting from 21% lower systems revenue, driven by 29%
lower system placements, and 2% lower service revenue, partially offset by 4%
higher instruments and accessories revenue, driven by approximately 7% higher
procedure volume partially offset by customer buying patterns. Total revenue
decreased by 5% to $3.0 billion for the nine months ended September 30, 2020,
compared to $3.2 billion for the nine months ended September 30, 2019, resulting
from 13% lower systems revenue, driven by 22% lower system placements, 2% lower
instruments and accessories revenue, driven by approximately 1% lower procedure
volume, and 5% lower service revenue. The service fee credits provided to
customers as part of our Customer Relief Program resulted in a $23 million and
$82 million decrease in service revenue for the three and nine months ended
September 30, 2020, respectively.
Revenue denominated in foreign currencies as a percentage of total revenue was
approximately 22% and 23% for the three and nine months ended September 30,
2020, respectively, and 20% and 19% for the three and nine months ended
September 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 both the
three and nine months ended September 30, 2020, and the three and nine months
ended September 30, 2019.
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Revenue generated in the U.S. accounted for 69% and 68% of total revenue for the
three and nine months ended September 30, 2020, respectively, and 71% for both
the three and nine months ended September 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 fourth quarter of 2020 and beyond.
The following table summarizes our revenue and system unit shipments for the
three and nine months ended September 30, 2020, and 2019, respectively (in
millions, except percentages and unit shipments):
                                                  Three Months Ended September 30,                                Nine Months Ended
                                                                                                                    September 30,
                                                      2020                   2019               2020                  2019
Revenue
Instruments and accessories                    $         630.6           $   606.2          $ 1,708.9          $    1,737.0
Systems                                                  267.8               338.6              812.1                 929.9
Total product revenue                                    898.4               944.8            2,521.0               2,666.9
Services                                                 179.3               183.4              508.3                 533.9
Total revenue                                  $       1,077.7           $ 1,128.2          $ 3,029.3          $    3,200.8
United States                                  $         743.8           $   796.4          $ 2,060.8          $    2,273.3
OUS                                                      333.9               331.8              968.5                 927.5
Total revenue                                  $       1,077.7           $ 1,128.2          $ 3,029.3          $    3,200.8
% of Revenue - U.S.                                         69   %              71  %              68  %                 71     %
% of Revenue - OUS                                          31   %              29  %              32  %                 29     %

Instruments and accessories                    $         630.6           $   606.2          $ 1,708.9          $      1,737
Services                                                 179.3               183.4              508.3                 533.9
Operating lease revenue                                   45.7                27.4              127.0                  72.9
Total recurring revenue                        $         855.6           $   817.0          $ 2,344.2          $    2,343.8
% of Total revenue                                          79   %              72  %              77  %                 73     %

Da Vinci Surgical Systems Shipments by Region:
U.S. unit shipments                                        116                 185                404                   532
OUS unit shipments                                          79                  90                206                   251
Total unit shipments*                                      195                 275                610                   783
*Systems shipped under operating leases
(included in total unit shipments)                          68                  92                197                   258

Ion Systems Shipments                                       11                   3                 22                     3

Da Vinci Surgical Systems Shipments involving
System Trade-ins:
Unit shipments involving trade-ins                          78                 116                286                   304
Unit shipments not involving trade-ins                     117                 159                324                   479



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Product Revenue
Three months ended September 30, 2020
Product revenue decreased by 5% to $898 million for the three months ended
September 30, 2020, compared to $945 million for the three months ended
September 30, 2019.
Instruments and accessories revenue increased by 4% to $631 million for the
three months ended September 30, 2020, compared to $606 million for the three
months ended September 30, 2019. The increase in instruments and accessories
revenue was driven primarily by procedure growth of approximately 7%, partially
offset by customer buying patterns. The third quarter 2020 U.S. procedure growth
was approximately 7%. The third quarter 2020 OUS procedure growth was
approximately 9%. Both growth rates were significantly impacted by the
disruption caused by the COVID-19 pandemic, as noted in the COVID-19 Pandemic
section above. Geographically, the third quarter 2020 OUS procedure growth was
driven by China, Japan, South Korea, and Italy, while procedures declines were
noted in the UK as well as various other smaller countries.
Systems revenue decreased by 21% to $268 million for the three months ended
September 30, 2020, compared to $339 million for the three months ended
September 30, 2019. The lower third quarter 2020 systems revenue was primarily
driven by fewer system shipments, lower lease buyouts, and lower third quarter
2020 ASPs, partially offset by higher operating lease revenue.
During the third quarter of 2020, a total of 195 da Vinci Surgical Systems were
shipped compared to 275 systems during the third quarter of 2019. By geography,
116 systems were shipped into the U.S., 39 into Europe, 34 into Asia, and 6 into
other markets during the third quarter of 2020, compared to 185 systems shipped
into the U.S., 36 into Europe, 43 into Asia, and 11 into other markets during
the third quarter of 2019. The decrease in systems shipments was primarily
driven by a decline in year-to-date procedures, which has led to customers
utilizing existing system capacity as well as 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.
We shipped 83 and 102 da Vinci Surgical Systems under lease arrangements, of
which 68 and 92 systems were classified as operating leases for the three months
ended September 30, 2020, and 2019, respectively. Operating lease revenue was
$45.7 million for the three months ended September 30, 2020, compared to $27.4
million for the three months ended September 30, 2019. Systems placed as
operating leases represented 35% of total shipments during the third quarter of
2020, compared to 33% during the third quarter of 2019. A total of 806 da Vinci
Surgical Systems were installed at customers under operating lease or
usage-based arrangements as of September 30, 2020, compared to 560 as of
September 30, 2019. Revenue from Lease Buyouts was $16.9 million for the three
months ended September 30, 2020, compared to $19.8 million for the three months
ended September 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
$1.55 million for the three months ended September 30, 2020, compared to
approximately $1.57 million for the three months ended September 30, 2019. 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.
Nine months ended September 30, 2020
Product revenue decreased by 5% to $2.5 billion for the nine months ended
September 30, 2020, compared to $2.7 billion for the nine months ended
September 30, 2019.
Instruments and accessories revenue decreased by 2% to $1.71 billion for the
nine months ended September 30, 2020, compared to $1.74 billion for the nine
months ended September 30, 2019. The decrease in instruments and accessories
revenue was driven primarily by a decline in procedures of approximately 1%. The
year-to-date 2020 U.S. procedure volumes declined by approximately 3% 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 5%, 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, China, South Korea, and Germany,
partially offset by declines in the UK, France, Italy, and other countries with
lower procedure volume.
Systems revenue decreased by 13% to $812 million for the nine months ended
September 30, 2020, compared to $930 million for the nine months ended
September 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.
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During the nine months ended September 30, 2020, a total of 610 da Vinci
Surgical Systems were shipped compared to 783 systems during the nine months
ended September 30, 2019. By geography, 404 systems were shipped into the U.S.,
82 into Europe, 109 into Asia, and 15 into other markets during the nine months
ended September 30, 2020, compared to 532 systems shipped into the U.S., 115
into Europe, 104 into Asia, and 32 into other markets during the nine months
ended September 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 year-to-date procedures, which has led 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 265 and 282 da Vinci Surgical Systems under lease arrangements, of
which 197 and 258 systems were classified as operating leases for the nine
months ended September 30, 2020, and 2019, respectively. Operating lease revenue
was $127.0 million for the nine months ended September 30, 2020, compared to
$72.9 million for the nine months ended September 30, 2019. Systems placed as
operating leases represented 32% of total shipments during the nine months ended
September 30, 2020, compared to 33% during the nine months ended September 30,
2019. Revenue from Lease Buyouts was $38.5 million for the nine months ended
September 30, 2020, compared to $59.0 million for the nine months ended
September 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
$1.54 million for the nine months ended September 30, 2020, compared to
approximately $1.48 million for the nine months ended September 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 2% to $179 million for the three months ended
September 30, 2020, compared to $183 million for the three months ended
September 30, 2019. The decrease in service revenue was primarily driven by the
effects of the Customer Relief Program, which resulted in a $23 million
decrease, partially offset by a larger installed base of da Vinci Surgical
Systems producing service revenue.
Service revenue decreased by 5% to $508 million for the nine months ended
September 30, 2020, compared to $534 million for the nine months ended
September 30, 2019. The decrease in service revenue was primarily driven by the
effects of the Customer Relief Program, which resulted in an $82 million
decrease, 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 September 30, 2020, decreased 9%
to $611 million, representing 68.0% of product revenue, compared to $668
million, representing 70.6% of product revenue, for the three months ended
September 30, 2019. The lower product gross profit for the three months ended
September 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 September 30, 2020, was primarily driven by period costs in the
third quarter of 2020 associated with abnormally low production as a result of
the COVID-19 pandemic.
Product gross profit for the nine months ended September 30, 2020, decreased 11%
to $1.7 billion, representing 65.6% of product revenue, compared to
$1.9 billion, representing 69.7% of product revenue, for the nine months ended
September 30, 2019. The lower product gross profit for the nine months ended
September 30, 2020, was primarily driven by lower product revenue and lower
product gross profit margin. The lower product gross profit margin for the nine
months ended September 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
and third quarters 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 nine months ended September 30, 2020,
included share-based compensation expense of $16.2 million and $43.2 million,
respectively, compared to $12.4 million and $34.8 million, for the three and
nine months ended September 30, 2019, respectively. Product gross profit for the
three and nine months ended September 30, 2020, included intangible assets
amortization expense of $9.0 million and $26.7 million, respectively, compared
to $7.9 million and $22.9 million, for the three and nine months ended
September 30, 2019, respectively.
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Service gross profit for the three months ended September 30, 2020, decreased 4%
to $114 million, representing 63.4% of service revenue, compared to $118
million, representing 64.4% of service revenue, for the three months ended
September 30, 2019. The lower service gross profit for the three months ended
September 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 September 30, 2020, was primarily driven by the decrease in service
revenue as a result of the Customer Relief Program.
Service gross profit for the nine months ended September 30, 2020, decreased 12%
to $313 million, representing 61.5% of service revenue, compared to
$354 million, representing 66.4% of service revenue, for the nine months ended
September 30, 2019. The lower service gross profit for the nine months ended
September 30, 2020, was primarily driven by lower service revenue and lower
service gross profit margin. The lower service gross profit margin for the nine
months ended September 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 nine months ended September 30, 2020,
included share-based compensation expense of $7.1 million and $17.8 million,
respectively, compared to $5.6 million and $14.9 million, for the three and nine
months ended September 30, 2019, respectively. Service gross profit for the
three and nine months ended September 30, 2020, included intangible assets
amortization expense of $0.9 million and $2.7 million, respectively, compared to
$0.9 million and $2.8 million, for the three and nine and months ended
September 30, 2019, respectively.
As a result of the continued impacts from the COVID-19 pandemic, our production
facilities may run at less than normal capacity in the fourth 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
fourth 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
September 30, 2020, increased by 5% to $299 million, compared to $284 million
for the three months ended September 30, 2019. Selling, general and
administrative expenses for the nine months ended September 30, 2020, increased
by 6% to $886 million, compared to $837 million for the nine months ended
September 30, 2019. The changes in selling, general and administrative expenses
for the three and nine months ended September 30, 2020, were primarily driven by
higher headcount, resulting in increased share-based compensation expense, and
increased infrastructure to support our growth, partially offset by lower
marketing, travel, and training expenses as well as lower variable compensation,
particularly in the second and third quarters of 2020.
Selling, general and administrative expenses for the three and nine months ended
September 30, 2020, included share-based compensation expense of $54.2 million
and $149.5 million, respectively, compared to $44.7 million and $124.0 million,
for the three and nine months ended September 30, 2019, respectively. Selling,
general and administrative expenses for the three and nine months ended
September 30, 2020, included intangible assets amortization expense of $1.8
million and $5.2 million, respectively, compared to $1.4 million and $4.0
million, for the three and nine months ended September 30, 2019, respectively.
Our spending in the second and third quarters of 2020 reflected a curtailment of
certain costs as a result of the COVID-19 pandemic, including travel, marketing
events, surgeon training, clinical trials, and other related expenses. We expect
that these costs will increase to the extent that the impact of COVID-19
decreases and decline to the extent that the impact of COVID-19 increases.
However, 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. We will continue to manage the hiring of
volume-related roles, such as sales representatives and manufacturing employees,
to meet the needs of the business.
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 September 30, 2020,
increased by 14% to $155 million, compared to $136 million for the three months
ended September 30, 2019. Research and development expenses for the nine months
ended September 30, 2020, increased by 11% to $445 million, compared to
$401 million for the nine months ended September 30, 2019. The increases in
research and development expenses for the three and nine months ended
September 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.
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Research and development expenses for the three and nine months ended
September 30, 2020, included share-based compensation expense of $29.5 million
and $84.1 million, respectively, compared to $26.6 million and $74.5 million,
for the three and nine ended September 30, 2019, respectively. Research and
development expenses for the three and nine months ended September 30, 2020,
included intangible asset charges of $10.0 million and $15.0 million,
respectively, compared to $0.5 million and $21.8 million, for the three and nine
months ended September 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 nine months ended
September 30, 2020, was $84.8 million, and $136.5 million, respectively,
compared to $33.3 million and $93.6 million for the three and nine months ended
September 30, 2019, respectively. The increases in interest and other income,
net, for the three and nine months ended September 30, 2020, were primarily
driven by unrealized gains on strategic investments and realized gains on the
sale of certain securities, partially offset by lower interest income earned,
despite higher cash and investment balances, due to the decline in average
interest rates, and realized foreign exchange losses.
The Company held an equity investment in preferred shares of InTouch, which was
reflected in the Company's financial statements on a cost basis. On July 1,
2020, Teladoc completed its acquisition of InTouch. Based on the terms of the
agreement, the Company has received Teladoc shares on the date of closing and
recognized a gain on its investment of approximately $45 million. The Company is
restricted from selling these shares for a period of six months. Additionally,
during the third quarter, the Company recorded unrealized gains on other
strategic investments of approximately $17 million.
Income Tax Expense
Income tax expense for the three months ended September 30, 2020, was $38.4
million, or 10.8% of income before taxes, compared to $0.3 million, or 0.1% of
income before taxes, for the three months ended September 30, 2019. Income tax
expense for the nine months ended September 30, 2020, was $67.3 million, or 8.7%
of income before taxes, compared to $51.4 million, or 4.8% of income before
taxes, for the nine months ended September 30, 2019.
Our effective tax rate for the three and nine ended September 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 nine months ended September 30, 2020 is higher,
mainly because the three and nine months ended September 30, 2019 reflected a
$51.3 million decrease in income tax expense as a result of the re-measurement
of our Swiss deferred tax assets. In addition, the effective tax rate for the
nine months ended September 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
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 nine months ended September 30,
2020, included excess tax benefits associated with employee equity plans of
$47.9 million and $144.8 million, which reduced our effective tax rate by 13.5
and 18.8 percentage points, respectively. Our provision for income taxes for the
three and nine months ended September 30, 2019, included excess tax benefits
associated with employee equity plans of $28.8 million and $112.8 million, which
reduced our effective tax rate by 7.2 and 10.5 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.
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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.
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 September 30, 2020, was $2.9 million, compared to $1.9
million for the three months ended September 30, 2019. Net income (loss)
attributable to noncontrolling interest in Joint Venture for the nine months
ended September 30, 2020, was $7.8 million, compared to $(2.5) million for the
nine months ended September 30, 2019. The increases in net income attributable
to noncontrolling interest in Joint Venture were primarily due to increased
revenue, partially offset by re-measurement losses related to the contingent
consideration during the three and nine months ended September 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 $0.51 billion to $6.36 billion as of September 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.
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 nine months ended
September 30, 2020, and 2019 (in millions):
                                                                             Nine Months Ended
                                                                                September 30,
                                                                         2020                  2019
Net cash provided by (used in)
Operating activities                                                $      857.3          $   1,045.5
Investing activities                                                      (606.3)              (748.2)
Financing activities                                                       (45.9)              (219.2)

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

                                                                        (2.0)                (2.9)
Net increase (decrease) in cash, cash equivalents, and restricted
cash                                                                $      203.1          $      75.2



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Operating Activities
For the nine months ended September 30, 2020, net cash provided by operating
activities of $857 million exceeded our net income of $703 million, primarily
due to the following reasons:
1.Our net income included non-cash charges of $509 million, consisting primarily
of the following significant items: share-based compensation of $292 million;
depreciation expense and losses on the disposal of property, plant, and
equipment of $159 million; deferred income taxes of $72 million; gain on
investments, accretion, and amortization, net, of $64 million; and amortization
of intangible assets of $37 million.
2.The non-cash charges outlined above were partially offset by changes in
operating assets and liabilities that resulted in $355 million of cash used by
operating activities during the nine months ended September 30, 2020. Inventory,
including the transfer of equipment from inventory to property, plant, and
equipment, increased by $177 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. Prepaid expenses and other assets increased by $119 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
$76 million, primarily due to the payments of 2019 and certain 2020 incentive
compensation. The unfavorable impact of these items on cash provided by
operating activities was partially offset by a $57 million decrease in accounts
receivable, primarily due to the timing of collections.
Investing Activities
Net cash provided by investing activities for the nine months ended
September 30, 2020, consisted primarily of proceeds from sales and maturities of
investments (net of purchases of investments) of $289 million, the acquisition
of property and equipment of $280 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 nine months ended September 30,
2020, consisted primarily of taxes paid on behalf of employees related to net
share settlements of vested employee stock purchases of $165 million, cash used
in the repurchase of approximately 0.2 million shares of our common stock in the
open market for $100 million, and the payment of deferred purchase consideration
from prior acquisitions of $49 million, partially offset by proceeds from stock
option exercises and employee stock purchases of $268 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 $300 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.
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