Intuitive Surgical
Annual Report 2014

Plain-text annual report

Table of Contents UNITED STATESSECURITIES AND EXCHANGE COMMISSIONWASHINGTON, D.C. 20549 FORM 10-K (MARK ONE)x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934FOR THE FISCAL YEAR ENDED DECEMBER 31, 2014OR¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF1934FOR THE TRANSITION PERIOD FROM TO COMMISSION FILE NUMBER 000-30713 Intuitive Surgical, Inc. (Exact name of Registrant as Specified in its Charter)DELAWARE 77-0416458(State or Other Jurisdiction of Incorporation or Organization) (I.R.S. Employer Identification Number)1020 KIFER RDSUNNYVALE, CA 94086(Address of Principal Executive Offices) (Zip Code)(408) 523-2100(Registrant’s Telephone Number, Including Area Code)Securities registered pursuant to Section 12(b) of the Act:Title of Each Class: Name of Each Exchange on which RegisteredCommon Stock, par value $0.001 per share The NASDAQ Global Select MarketSecurities registered pursuant to Section 12(g) of the Act: NoneIndicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes x No ¨Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No xIndicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filingrequirements for the past 90 days. Yes x No ¨Table of ContentsIndicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data Filerequired to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant wasrequired to submit and post such files). Yes x No ¨Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to thebest of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to thisForm 10-K. ¨Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. Seedefinition of “large accelerated filer, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.Large accelerated filerx Accelerated filer¨Non-accelerated filer¨(Do not check if a smaller reporting company)Smaller reporting company¨Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No xThe aggregate market value of the voting and non-voting common equity held by non-affiliates on June 30, 2014, based upon the closing price ofCommon Stock on such date as reported by NASDAQ Global Select Market, was approximately $14,639,055,551. Shares of voting stock held by each officerand director have been excluded in that such persons may be deemed to be affiliates. This assumption regarding affiliate status is not necessarily a conclusivedetermination for other purposes.The number of outstanding shares of the registrant’s common stock on January 16, 2015, was 36,599,799.DOCUMENTS INCORPORATED BY REFERENCEPart III incorporates information by reference to the definitive proxy statement for the Company’s Annual Meeting of Stockholders to be held on orabout April 23, 2015, to be filed within 120 days of the registrant’s fiscal year ended December 31, 2014. Table of ContentsINTUITIVE SURGICAL, INC.INDEX Page No. PART I Item 1.Business4 Item 1A.Risk Factors17 Item 1B.Unresolved Staff Comments31 Item 2.Properties32 Item 3.Legal Proceedings32 Item 4.Mine Safety Disclosures32 PART II Item 5.Market for the Registrant’s Common Equity, Related Stockholder Matters andIssuer Purchases of Equity Securities33 Item 6.Selected Financial Data35 Item 7.Management’s Discussion and Analysis of Financial Condition and Results of Operations36 Item 7A.Quantitative and Qualitative Disclosures About Market Risk54 Item 8.Financial Statements and Supplementary Data56 Item 9.Changes in and Disagreements with Accountants on Accounting and Financial Disclosure90 Item 9A.Controls and Procedures90 Item 9B.Other Information90 PART III Item 10.Directors, Executive Officers and Corporate Governance91 Item 11.Executive Compensation91 Item 12.Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters91 Item 13.Certain Relationships and Related Transactions and Director Independence91 Item 14.Principal Accountant Fees and Services91 PART IV Item 15.Exhibits and Financial Statement Schedules92 SIGNATURES943Table of ContentsFORWARD LOOKING STATEMENTSThis report contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the SecuritiesExchange Act of 1934 (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 andexpressions are intended to identify forward-looking statements. These forward-looking statements include, but are not limited to, statements related to ourexpected business, new product introductions, procedures and procedure adoption, future results of operations, future financial position, our ability toincrease 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 and our ability to finance operations from cash flows and similar matters and include 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 andmarkets. These forward-looking statements should be considered in light of various important factors, including the following: the impact of global andregional economic and credit market conditions on health care spending; health care reform legislation in the United States and its impact on hospitalspending, reimbursement, insurance deductibles, and fees which will be levied on certain medical device revenues; decreases in hospital admissions andactions by payers to limit or manage surgical procedures; timing and success of product development and market acceptance of developed products;procedure counts; regulatory approvals, clearances and restrictions, or any dispute that may occur with any regulatory body; guidelines andrecommendations in the health care and patient communities; intellectual property positions and litigation; competition in the medical device industry andin the specific markets of surgery in which we operate; unanticipated manufacturing disruptions; the inability to meet demand for products; the results oflegal proceedings to which we are or may become a party; product liability and other litigation claims; adverse publicity regarding our Company and safetyof our products and the adequacy of training; our ability to expand in foreign markets; and other risk factors. Readers are cautioned not to place unduereliance on these forward-looking statements, which are based on current expectations and are subject to risks, uncertainties, and assumptions that aredifficult to predict, including those risk factors described throughout this filing and particularly in Part I, “Item 1A. Risk Factors.” Our actual results maydiffer materially and adversely from those expressed in any forward-looking statements. We undertake no obligation to publicly update or release anyrevisions to these forward-looking statements, except as required by law.PART IITEM 1.BUSINESSIn this report, “Intuitive Surgical,” “Intuitive,” the “Company,” “we,” “us,” and “our” refer to Intuitive Surgical, Inc. and its wholly-owned subsidiaries.Intuitive®, Intuitive Surgical®, da Vinci®, da Vinci® S®, da Vinci® Si HD Surgical System™, da Vinci® S HD Surgical System®, da Vinci® Si™, da Vinci®Xi™, da Vinci® Si-e™, da Vinci® SP™, EndoWrist®, EndoWrist® One™, EndoWrist® Stapler 45, Single-Site®, Firefly™, InSite®, and da Vinci® Connect®are trademarks of Intuitive Surgical, Inc.Company BackgroundIntuitive designs, manufactures and markets da Vinci Surgical Systems and related instruments and accessories, which taken together, are advancedsurgical systems that we consider an advanced generation of surgery. This advanced generation of surgery, which we call da Vinci surgery, combines thebenefits of minimally invasive surgery (“MIS”) for patients with the ease of use, precision and dexterity of open surgery. A da Vinci Surgical System consistsof a surgeon’s console, a patient-side cart, and a high performance vision system. The da Vinci Surgical System translates a surgeon’s natural handmovements, which are performed on instrument controls at a console, into corresponding micro-movements of instruments positioned inside the patientthrough small incisions, or ports. The da Vinci Surgical System is designed to provide its operating surgeons with intuitive control, range of motion, finetissue manipulation capability and Three Dimensional (“3-D”), High-Definition (“HD”) vision while simultaneously allowing surgeons to work through thesmall ports enabled by MIS procedures.da Vinci Surgeryda Vinci Surgery utilizes computational, robotic and imaging technologies to enable improved patient outcomes compared to other surgical and non-surgical therapies. da Vinci Surgery is aimed towards advancing the critical surgical ideals of entering the body less invasively, seeing anatomy more clearly,interacting with tissue more precisely and building surgical skills. The da Vinci Surgical System enables surgeons to avail or improve the benefits of MIS tomany patients who would otherwise undergo a more invasive surgery. Surgeons using the da Vinci system operate while seated comfortably at a consoleviewing a 3-D, HD image of the surgical field. This immersive visualization connects surgeons to the surgical field and their instruments. While seated at theconsole, the surgeon manipulates instrument controls in a natural manner, similar to the more intuitive open surgery technique. Our multi-port technology isdesigned to provide surgeons with a range of motion in the surgical field analogous to the motions4Table of Contentsof 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 to use.Our systems provide the following features and benefits to surgeons:Immersive 3-D Visualization. Our vision system includes a 3-D endoscope with two independent vision channels linked to two separate color monitorsthrough sophisticated image processing electronics. The da Vinci Surgical System provides visualization of target anatomy with natural depth-of-field,enhanced contrast and magnification that is intended to facilitate accurate tissue identification and tissue layer differentiation. With our FireflyFluorescence Imaging upgrade, surgeons can use specialized imaging hardware in combination with an injectable fluorescent dye to visualizevasculature or biliary imaging in cholecystectomy beneath tissue surfaces in real-time.Precise and Tremor-Free Endoscope Control. Our imaging system also incorporates our proprietary Navigator camera control technology that allowsthe surgeon to easily change, move, zoom and rotate his or her field of vision. Surgeons can reposition the surgical camera quickly with foot controlsor zoom in, out, up, down, left and right by moving their hands while maintaining a stable image.Intuitive Instrument Movements. Our technology is designed to transform the surgeon’s natural hand movements outside the body into correspondingmicro-movements inside the patient’s body. For example, with the da Vinci Surgical System, a hand movement to the right outside the body causes theinstrument inside the patient to be moved to the right. In contrast, conventional MIS instruments are long rigid levers that rotate around a fulcrum, orpivot point, located at the port created in the body wall. In conventional MIS, the instrument tip moves in the opposite direction from the surgeon’shand and surgeons must adjust their hand-eye coordination to translate their hand movements in this “backward” environment.EndoWrist Instruments. Our technology is designed to provide surgeons with a range of motion in the surgical field analogous to the motions of ahuman hand and wrist. Most of our proprietary instruments, which we call EndoWrist instruments, incorporate “wrist” joints that enable surgeons toreach behind tissues and suture with precision, just as they can in open surgery.Scaled, Tremor Filtered Instrument Movement. With our technology, the surgeon can also use “motion scaling,” a feature that translates, for example, athree-millimeter hand movement outside the patient’s body into a one-millimeter instrument movement in the surgical field inside the patient’s body.Motion scaling is designed to allow precision and control for delicate tasks. In addition, our technology filters the tremor inherent in a surgeon’shands.Improved Surgeon Ergonomics. The da Vinci Surgical System is designed to allow surgeons to operate while seated, which may beclinically advantageous because of reduced surgeon fatigue. The da Vinci Surgical System’s design provides natural hand-eye alignment at thesurgeon’s console. Because the da Vinci Surgical System’s robotic arms hold the camera and instruments steady, there is less surgeon and assistantfatigue.Multi-Specialty Surgical Platform. The da Vinci Surgical System is designed to enable surgeons to perform a wide range of surgical procedures, withinour targeted gynecologic, urologic, general surgery, cardiothoracic and head and neck specialties. To date, surgeons have used the da Vinci SurgicalSystem to perform dozens of different types of surgical procedures. While we do not expect all of these different types of procedures to become widelyadopted, they demonstrate the flexibility of the da Vinci Surgical System in approaching anatomy.Advanced Training Tools. Surgeons can efficiently train and improve their da Vinci Surgery skills with a group of tools unique to robotic surgery,including our da Vinci Skills Simulator for software based skills practice and assessment, our da Vinci dual console for inter-operative collaboration,and our da Vinci Connect networking technology for on-line proctoring.Products:da Vinci Surgical SystemWe have commercialized four generations of da Vinci Surgical System— the da Vinci Xi Surgical System, the da Vinci Si Surgical System, the da Vinci SSurgical System and the standard da Vinci Surgical System. da Vinci Surgical Systems are comprised of the following components:Surgeon’s Console. The da Vinci Surgical System allows surgeons to operate while comfortably seated at an ergonomic console viewing a 3-D imageof the surgical field. The surgeon’s fingers grasp instrument controls below the display with the surgeon’s hands naturally positioned relative to his orher eyes. Using electronic hardware, software, algorithms and mechanics, our technology translates the surgeon’s hand movements into precise andcorresponding real-time micro movements of the EndoWrist instruments positioned inside the patient. On our most current systems, da Vinci Xi and daVinci Si, a second surgeon’s console may be used in two possible ways: to provide assistance to the primary surgeon during surgery or to act as anactive aid during surgeon-proctor training sessions. With the da Vinci Xi and da Vinci Si, a surgeon sitting at a second console can view the samesurgery as the primary surgeon and can be passed control of some or all of5Table of Contentsthe da Vinci instruments during the surgery. In addition, surgeons can control 3-D virtual pointers to augment the dual surgeon experience.Patient-Side Cart. The patient-side cart holds electromechanical arms that manipulate the instruments inside the patient. Up to four arms attached tothe cart can be positioned as appropriate, and then locked into place. At least two arms hold our EndoWrist instruments, one representing the surgeon’sleft hand and one representing the surgeon’s right hand. A third arm positions the endoscope, allowing the surgeon to easily move, zoom and rotate hisor her field of vision. An optional fourth instrument arm extends surgical capabilities by enabling the surgeon to add a third EndoWrist instrument toperform additional tasks. The fourth instrument arm is a standard integrated feature on the da Vinci Xi, Si, and S Surgical Systems and is available as anupgrade on three-arm da Vinci S Surgical Systems and da Vinci Si-e Surgical Systems.3-D Vision System. Our vision system includes our InSite 3-D endoscope with two separate vision channels linked to two separate color monitorsthrough high performance video cameras and specialized image processing hardware. The resulting 3-D image has high resolution, high contrast, lowflicker and low cross fading. A digital zoom feature in the 3-D, HD vision system allows surgeons to magnify the surgical field of view withoutadjusting the endoscope position and thereby reduces interference between the endoscope and instruments. The 3-D, HD vision is a standardintegrated feature on da Vinci Xi, Si, and S Surgical Systems.da Vinci Skills Simulator. The Skills Simulator is a practice tool that gives a user the opportunity to practice his or her facility with the surgeonconsole controls. The Skills Simulator incorporates 3-D, physics-based computer simulation technology to immerse the user within a virtualenvironment. The user navigates through the environment and completes exercises by controlling virtual instruments from the surgeon console. Uponcompletion of a skills exercise, the Skills Simulator provides a quantitative assessment of user performance based on a variety of task-specific metrics.The Skills Simulator is intended to augment, not replace, existing training programs for the da Vinci Xi and Si Surgical Systems. Most da Vinci SkillsSimulators have been sold in connection with new da Vinci Xi and Si Surgical Systems.Firefly Fluorescence Imaging. In the first quarter of 2011, we launched our Firefly product for use with the da Vinci Si Surgical System. Firefly is astandard feature of the da Vinci Xi Surgical System. This imaging capability combines a fluorescent dye with a specialized da Vinci camera head,endoscope and laser-based illuminator to allow surgeons to identify vasculature in three dimensions beneath tissue surfaces to visualize criticalanatomy. Adoption of Firefly is progressing with use across the categories of urology, gynecology and general surgery. In September 2013, wereceived U.S. Food and Drug Administration (“FDA”) 510(k) clearance to market our Firefly fluorescence imaging product for real-time imaging ofbile ducts (cystic duct, common bile duct and common hepatic duct).Standard da Vinci System. During 2014, we phased out the sale of all instrument, accessory and service contract offerings for the standard da VinciSurgical System.Instruments and AccessoriesEndoWrist Instruments. We manufacture a variety of instruments, most of which incorporate wrist joints for natural dexterity, with tips customized forvarious surgical procedures. EndoWrist instruments are offered in a variety of sizes, of which 5mm and 8mm diameter sizes are the most commonlysold. At their tips, the various EndoWrist instruments include forceps, scissors, electrocautery, scalpels, and other surgical tools that are familiar to thesurgeon from open surgery and conventional MIS. A variety of EndoWrist instruments are selected and used interchangeably during a surgery. OurEndoWrist instruments are sterilizable and most are reusable for a defined number of procedures. A programmed memory chip inside each instrumentperforms several functions that help determine how the system and instruments work together. In addition, the chip will not allow the instrument to beused for more than the prescribed number of procedures to help ensure that its performance meets specifications during each procedure. We typicallydevelop new types of EndoWrist instruments to support additional types of surgical procedures.da Vinci Single-Site. da Vinci Single-Site is a set of non-wristed instruments (except for wristed needle driver discussed below) and accessories thatallow Surgical Systems to work through a single incision, typically in the umbilicus, rather than multiple incisions. Single incision surgery is intendedto minimize trauma to patients by reducing the number of ports required to enter the body and is typically utilized for less complex surgery than multi-port surgery. Non-robotic single incision surgery today is typically performed with modified laparoscopic instruments. Early clinical adoption of thismanual technique has been mostly positive; however, physicians have reported that manual single incision surgery is technically and ergonomicallychallenging. da Vinci Single-Site instruments and accessories were designed to address these issues. In February 2011, we received the CE mark for ourda Vinci Single-Site instrument kit for da Vinci Si Surgical Systems and began selling these new products in Europe. The majority of da Vinci Single-Site procedures performed in Europe to date has been cholecystectomies. In December 2011, we received FDA regulatory clearance to market ourSingle-Site instrumentation in the U.S. for laparoscopic cholecystectomy procedures for da Vinci Si Surgical Systems. In February 2013, we receivedFDA clearance to market our da Vinci Single-Site instruments for benign hysterectomy and salpingo oophorectomy procedures. In September 2014, wereceived FDA clearance to market the wristed version of our da Vinci6Table of ContentsSingle-Site needle driver product for use on benign hysterectomy, cholecystectomy, and salpingo-oophorectomy procedures on da Vinci Si SurgicalSystems. We are encouraged by hospital, surgeon, and patient interest in da Vinci Single-Site, and believe this instrument may have particular utilityin benign hysterectomy procedures. However, these are our first products targeted towards procedures already highly penetrated by manual MIStechniques, and we are not able to predict the extent or pace that da Vinci Single-Site may be adopted.EndoWrist One Vessel Sealer. In December 2011, we received FDA clearance for our EndoWrist One Vessel Sealer for da Vinci Si Surgical Systems.The EndoWrist One Vessel Sealer is a wristed, single-use instrument intended for bipolar coagulation and mechanical transection of vessels up to 7mm in diameter and tissue bundles that fit in the jaws of the instrument. This instrument enables surgeons to fully control vessel sealing, whileproviding the benefits of da Vinci surgery. This instrument is designed to enhance surgical efficiency and autonomy in a variety of general surgery andgynecologic procedures. Clinical response to the EndoWrist One Vessel Sealer has been encouraging, with positive commentary on precision,articulation, vessel sealing quality and thermal spread, and we expect applications for the EndoWrist One Vessel Sealer to be centered on generalsurgery and gynecologic oncology procedures. EndoWrist One Vessel Sealer utilization rates have increased steadily in 2013 and 2014. In June 2014,we received FDA clearance for the da Vinci Xi version of the EndoWrist One Vessel Sealer.EndoWrist Stapler 45 Instrument. In October 2012, we received FDA clearance for our EndoWrist Stapler 45 Instrument with Blue and Green 45 mmreloads for da Vinci Si Surgical Systems. The EndoWrist Stapler 45 is a wristed, stapling instrument intended for resection, transection and/or creationof anastomoses in general, gynecologic and urologic surgery. This instrument enables surgeons to precisely position and fire the stapler. Its initialsurgical use has been directed towards colorectal procedures. During 2013, the EndoWrist Stapler was used by a limited and gradually increasingnumber of customers. In 2014, we expanded the availability of the EndoWrist Stapler to a broadening set of customers. In September 2014, we notifiedour customers to suspend the use of the EndoWrist Stapler 45 (see Recalls and Corrections section for additional discussion). Although our earlycustomer experiences have been positive, we are in the early stages of selling EndoWrist Stapler 45, and we are not able to predict the extent to whichthe instrument may be adopted.Accessory Products. We sell various accessory products which are used in conjunction with the da Vinci Surgical System as surgical procedures areperformed. Accessory products include sterile drapes used to ensure a sterile field during surgery, vision products such as replacement 3-D stereoendoscopes, camera heads, light guides, and other items that facilitate use of the system.Business StrategyOur objective is to bring the benefits of MIS to as many patients as possible through the use of computer aided robotic technologies. Our priorities toaccomplish this are as follows:1.Patient Value. We believe that the value of a surgical procedure to a patient can be defined as: Patient Value = Procedure Efficacy/Invasiveness.We define procedure efficacy as a measure of the success of the surgery in resolving the underlying disease and invasiveness as how disruptive andpainful the treatment is itself. When the patient value of a da Vinci procedure is deemed higher than alternate treatment options, patients may seekout surgeons and hospitals that offer that specific da Vinci procedure, potentially resulting in a local market share shift for the specific treatment.Adoption occurs procedure by procedure, and is driven by the relative patient value of da Vinci procedures compared to alternative treatmentoptions for the same disease state. We believe most patients will place higher value on procedures that are not only more efficacious, but also lessinvasive than alternative treatments. Our goal is to provide products to surgeons who in turn provide patients with procedure options that are bothhighly effective and less invasive than other surgical options.2.Surgeon Value. We train surgeons on the use of our da Vinci Surgical System and assist them in building their practices by their delivery of superiorpatient value. We provide an ergonomic platform for surgeons to perform their procedures. We seek to provide surgeons with reliable and easy to useproducts.3.Hospital Value. We assist hospitals in building value by offering patient value using da Vinci thereby increasing surgical revenue and reducingcosts through lower complication rates and reduced length of patient stay. da Vinci Surgery is a cost effective approach to many surgeries ascompared to alternative treatment options as demonstrated in many published studies.Given the priorities above, our strategy is to improve our target surgical procedures in one or more of the following ways:1.Convert Target Open Procedures to da Vinci Surgery. We believe that our technology has the potential to convert a significant percentage of ourtargeted open procedures to da Vinci Surgery.2.Facilitate Difficult MIS Operations. We believe that several surgical procedures that are seldom performed today using conventional MIStechniques can be performed more routinely using da Vinci Surgery. Some procedures have been adopted using MIS techniques but are extremelydifficult and are currently performed by a limited number of highly skilled surgeons. We believe our da Vinci Surgical System will enable moresurgeons at more institutions to perform such procedures.7Table of Contents3.Offer a Less Invasive Single Port Surgical Option. We believe that our da Vinci Single Site technology has the potential to convert targetprocedures typically performed via multiport laparoscopic technique to single port da Vinci Surgery, offering patients less invasive, improvedcosmetic outcomes.Clinical ApplicationsWe are the beneficiaries of productive collaborations with leading surgeons in exploring and developing new techniques and applications for da Vincisurgery—an important part of our creative process. We primarily focus our development efforts on those procedures in which we believe our products bringthe highest patient value, surgeon value, and hospital value. We currently focus on five surgical specialties: urologic surgery, gynecologic surgery, generalsurgery, cardiothoracic surgery, and head and neck surgery. Key procedures which we are focused on include da Vinci Prostatectomy (“dVP”), da VinciHysterectomy (“dVH”), da Vinci Cholecystectomy, da Vinci Colon and Rectal procedures, da Vinci Partial Nephrectomy, da Vinci Sacrocolpopexy, da VinciMitral Valve Repair, da Vinci Lobectomy, and da Vinci Transoral Robotic Surgery (for cancers of the throat). In 2014, total U.S. procedure volume wasapproximately 449,000, of which 20% was in urology, 52% was in gynecology, and 24% was in general surgery. International procedure volume wasapproximately 121,000 in 2014, of which most procedures were in urology. Representative surgical applications are described below.Urologic SurgeryProstatectomy. Radical prostatectomy is the removal of the prostate gland in patients diagnosed with clinically localized prostate cancer. The standardapproach to removal of the prostate has been via an open surgical procedure. The conventional laparoscopic approach is an option, but is difficult andposes challenges to even the most skilled urologist. The da Vinci Surgical System has enabled a large number of surgeons to convert from using anopen surgical technique to a minimally invasive technique.Partial Nephrectomy. Partial nephrectomy is the removal of a small portion of a kidney (typically, an area of the kidney containing a tumor). Partialnephrectomies are most commonly performed in patients diagnosed with clinically localized renal cancer. Excluding da Vinci surgery, there are threecommon surgical approaches to performing partial nephrectomies: open surgical technique, laparoscopy, and hand assisted laparoscopy, which is ahybrid of open and laparoscopic technique. Surgeons have reported that the da Vinci Surgical System’s capabilities may enable a large number ofthese procedures to be performed through a minimally invasive technique, conferring the benefits of MIS to a broader range of partial nephrectomypatients. Treatment guidelines for patients with localized renal cancer recommend partial nephrectomy due to the benefits nephron-sparing surgery hasin long-term patient outcomes. Published clinical literature has shown that the presence of a da Vinci Surgical System is associated with a higher-proportion of patients receiving guideline-recommended partial nephrectomy.Gynecologic SurgeryHysterectomy. Removal of the uterus is one of the most commonly performed surgeries in gynecology and is performed for a variety of underlyingbenign and malignant conditions. Hysterectomies can be performed using open surgery (laparotomy), or MIS techniques, which include vaginal,laparoscopic, and robotic approaches. Despite the availability of non-robotic MIS approaches to hysterectomy, most hysterectomies performed prior toda Vinci Surgery were open surgeries. da Vinci Surgery has enabled a large number of women to receive a minimally invasive treatment as analternative to an open hysterectomy. During the first quarter of 2013, Single-Site instruments were FDA cleared in the U.S. for use in benignhysterectomies and salpingo oophorectomies. In September 2014, we received FDA clearance to market the wristed version of our Single-Site needledriver product for use on benign hysterectomy, cholecystectomy, and salpingo-oophorectomy procedures. Single-Site instruments enable surgeons toperform surgery through a single port via the patient’s belly button, allowing for virtually scarless results.Sacrocolpopexy. The abdominal (open) sacrocolpopexy is one of the most successful operations for vaginal vault prolapse. Sacrocolpopexy involvessuturing a synthetic mesh that connects and supports the vagina to the sacrum (tailbone). A sacrocolpopexy can be performed using conventionallaparoscopic technique; however, it is generally described as difficult and cumbersome to perform. Surgeons have reported that the da Vinci SurgicalSystem’s capabilities may enable a large number of these procedures to be performed through a minimally invasive technique, conferring the benefitsof MIS to a broader range of sacrocolpopexy patients.Cardiothoracic SurgeryMitral Valve Repair. When patients are diagnosed with mitral valve disease, there are two surgical treatment options from which they can choose:mitral valve replacement or mitral valve repair. Mitral valve repairs are generally preferred over mitral valve replacement for a number of reasons,which include longevity and durability of the repaired valve over a replacement valve and the elimination or reduction of the patient’s post-surgicalpharmaceutical regimen. Because mitral valve repairs are considered to be more technically challenging than mitral valve replacements, they are onlyperformed8Table of Contentsapproximately 50% of the time. Several of our surgeon customers have reported an improvement in their mitral valve repair rates over mitral valvereplacements when using the da Vinci Surgical System.Thoracic Surgery. Conventional approaches to surgical procedures in the thorax include both open and video-assisted thoracoscopic approaches.Procedures performed via these methods include pulmonary wedge resection, pulmonary lobectomy, thymectomy, mediastinal mass excision, andesophagectomy. Many thoracic procedures remain open procedures. Surgeons have reported that the use of the da Vinci Surgery System in thoracicsurgery has enabled them to offer MIS approaches to a broader range of thoracic surgery patients.General SurgeryCholecystectomy. Cholecystectomy, or the surgical removal of the gall bladder, is a commonly performed general surgery procedure. Cholecystectomy is the primary method for the treatment of gallstones and other gall bladder diseases. Most cholecystectomies are performed usingmulti-port MIS techniques, although some surgeons choose to perform cholecystectomy using manual single-port instrumentation. With the 2011European introduction of da Vinci Single-Site instruments followed by the U.S. introduction in 2012, Single-Site robotic cholecystectomies are nowbeing performed. Using da Vinci Single-Site instruments, many of the technical challenges of manual single-port MIS are reduced as surgeons benefitfrom additional precision, control, and improved ergonomics. Multi-port robotic cholecystectomies are also being performed.Colorectal Surgery. These procedures typically involve benign or cancerous conditions of the lower digestive system, in particular the rectum orcolon. Common procedures in this area include hemicolectomy, sigmoidectomy, low anterior resection, and abdominoperineal resection.Conventional laparoscopy is not widely employed to treat these types of diseases, due to their high degree of difficulty. Surgeons have reported thatthe use of the da Vinci Surgery System in colorectal surgery has enabled them to offer MIS approaches to a broader range of colorectal surgery patients.Hernia Repair. A hernia occurs when an organ or fatty tissue squeezes through a weak spot in a surrounding muscle or connective fascia tissue. Duringa hernia repair surgery, the weakened abdominal wall tissue is secured and defects are repaired. Common types of hernia are ventral and inguinal. Ventral, or abdominal hernia, may occur through a scar after surgery in the abdomen. Inguinal hernia is a bulge in the groin and is more common inmen. Hernia repair can be performed using traditional open surgery or minimally invasive surgery. There is a wide-range of complexity in hernia repairsurgeries and the benefits of minimally invasive and robotic surgery varies by patient. da Vinci hernia repair is associated with low rates of recurrence,pain, and conversion to open surgery as well as shorter hospital stays.Gastric Bypass. A body of literature has emerged pointing to the benefit of surgery to treat patients for morbid obesity and its secondary effects, suchas diabetes. Laparoscopic roux-en-Y gastric bypass (“LRYGB”) is the most commonly performed surgical procedure for morbid obesity in the U.S. TheLRYGB can be a technically challenging procedure because of the suturing, stapling, and tissue (bowel) manipulation that is required. Surgeons usingthe da Vinci Surgical System have reported a reduction in a critical complication (anastomotic leaks) relative to LRYGB.Head and Neck SurgeryTransoral Surgery. Head and neck cancers are typically treated by either surgical resection or chemo-radiation, or a combination of both. Surgicalresection performed by an open approach may require a “jaw-splitting” mandibulotomy. This procedure, while effective in treating cancer, is traumaticand disfiguring to the patient. MIS approaches via the mouth (transoral surgery) are challenged by line-of-sight limitations dictated by conventionalendoscopic tools. Chemo-radiation as a primary therapy does allow patients to avoid traumatic surgical incisions; however, literature suggests that thismodality diminishes patients’ ability to speak and swallow normally. Surgeons have reported that da Vinci Transoral Surgery allows them to treatcancers occurring in the oropharynx (e.g., tonsil and base of tongue) and larynx via the mouth and to overcome some of the line-of-sight limitations ofconventional transoral surgery.Procedure MixOur procedure business is now splitting into two categories: (1) cancer and other highly complex procedures and (2) less complex benign procedures. Our strategy is to provide hospitals with attractive clinical and economic solutions in each of these categories. More fully featured products targetedtowards the more complex procedure segment include 4-arm, dual console, firefly enabled systems and advanced instruments including vessel sealingand stapler. Lower priced products targeted towards the less complex segment of procedures include the three-arm da Vinci Si-e System and lowerpriced Single-Site instruments. Clinical SummaryWe believe there are numerous additional applications that can be addressed with the da Vinci Surgical System and we work closely with our surgeoncustomers to refine and explore new techniques in which da Vinci may bring value. As of December 31, 2014, we had an installed base of 3,266 da VinciSurgical Systems, including 2,223 in the U.S., 549 in Europe, 193 in Japan, and9Table of Contents301 in the rest of the world. We estimate that surgeons using our technology completed approximately 570,000 surgical procedures of various types inhospitals throughout the world during the year ended December 31, 2014. Of those da Vinci procedures performed in 2014, we estimate that approximately203,000 were dVH procedures and approximately 125,000 were dVP procedures.Sales and Customer SupportSales ModelWe provide our products through a direct sales organization in the U.S.; most of Western Europe excluding Spain, Portugal, Italy and Greece; Japan andKorea. Beginning in 2013, we established a direct sales structure in the Czech Republic, Slovakia, and Hungary. Beginning in June 2014, we also establisheda direct sales structure in Japan. These markets were served by distributors prior to us establishing direct sales structures. In the remainder of our worldmarkets, we provide our products through distributors. No one customer accounted for more than 10% of revenue during the years ended December 31, 2014,2013, and 2012.Our direct sales organization is composed of a capital sales team, responsible for selling da Vinci Surgical Systems, and a clinical sales team, responsiblefor supporting da Vinci Surgical System use in surgical procedures performed at our hospital accounts. The initial da Vinci Surgical System sale into anaccount is viewed as a major capital equipment purchase by our customers and typically has a lengthy sales cycle that can be affected by macroeconomicfactors, capital spending prioritization, and the timing of budgeting cycles. Capital sales activities include educating surgeons and hospital staff acrossmultiple surgical specialties on the benefits of da Vinci Surgery and the clinical applications that our technology enables. We also train our salesorganization to educate hospital management on the potential benefits of adopting our technology, including clinical benefits of da Vinci Surgery,reductions in complications and length of stay, and the resulting potential for increased patient satisfaction, surgeon recruitment, and volume.Our clinical sales team works on site at the hospitals, interacting with surgeons, operating room staff, and hospital administrators to develop and sustainsuccessful robotics surgery programs. They assist the hospital in identifying surgeons who have an interest in robotic surgery delivering da Vinci’s benefits.Our clinical sales team provides the current clinical information on robotic surgery practices and new product applications to the hospital teams and hasgrown with the expanded installed base of da Vinci Surgical Systems and the total number of procedures performed. We expect this organization to continueto grow as our business expands.Our customers place orders to replenish their supplies of instruments and accessories on a regular basis. Orders received are typically shipped within onebusiness day. Direct customers who purchase a new da Vinci Surgical System typically place an initial stocking order of instruments and accessories withinone month of receiving their system.Our business is subject to seasonal fluctuations. Historically, our sales of da Vinci Surgical Systems have tended to be heaviest during the third month ofeach fiscal quarter, lighter in the first and third fiscal quarters and heavier in the fourth fiscal quarter. In addition, we have historically experienced lowerprocedure volume in the first and third fiscal quarters and higher procedure volume in the second and fourth fiscal quarter. Procedures treating benignconditions are typically higher in the fourth quarter and lower in the first quarter. Timing of procedures and changes in procedure growth impact the timing ofinstrument and accessory and capital purchases.Customer Support and Training ProgramsWe have a network of field service engineers across the U.S., Europe, and Asia and maintain relationships with various distributors around the globe.This infrastructure of service and support specialists offer a full complement of services, including 24/7 support, installation, repair, and maintenance for ourcustomers. We generate service revenue by providing these services to our customers through comprehensive service contracts and time and materialprograms.We provide basic system training that teaches the fundamental operating principles of the da Vinci Surgical System to surgeons, surgical assistants, andoperating room nurses. We have established training centers where initial system training and ongoing surgical procedural training are provided, the latterled by expert surgeons. Surgeons may also practice their robotic surgery technique using our da Vinci Skills Simulator. In addition, we help facilitate theproctoring of surgeons who are new to da Vinci Surgery by experienced da Vinci Surgical System users. Proctors provide training to other surgeons on how toperform certain surgical procedures with da Vinci Surgical Systems.Research and DevelopmentWe focus our research and development efforts on providing our customers with new products and product improvements that enable them to performMIS procedures with less difficulty. We employ research and development and engineering staff responsible for product design and engineering. We invested$178.0 million, $167.7 million, and $170.0 million of research and development expenses for the years ended December 31, 2014, 2013, and 2012,respectively.We establish strategic alliances with other medical device and technology based companies to complement our research and development effort. To date,these alliances have taken several forms, including cooperation in the areas of product development,10Table of Contentstraining, procedure development, and marketing activities. We have formed alliances with several companies, including, but not limited to, ErbeElektromedizin GMBH, Johnson & Johnson, Olympus/Gyrus, Novadaq Technologies, Inc., and Mimic Technologies, Inc.ManufacturingWe manufacture our da Vinci Surgical Systems at our facility in Sunnyvale, California. We manufacture our instruments at our Sunnyvale facility andMexicali, Mexico facility.We purchase both custom and off-the-shelf components from a large number of suppliers and subject them to stringent quality specifications andprocesses. Some of the components necessary for the assembly of our products are currently provided to us by sole-sourced suppliers (the only recognizedsupply source available to us) or single-sourced suppliers (the only approved supply source for us among other sources). We purchase the majority of ourcomponents and major assemblies through purchase orders rather than long-term supply agreements and generally do not maintain large volumes of finishedgoods.CompetitionWe consider our primary competition to be existing open surgery, conventional MIS, drug therapies, radiation treatment, and emerging interventionalsurgical approaches. Our success depends on continued clinical and technical innovation, quality and reliability as well as educating hospitals, surgeons andpatients on the demonstrated results associated with da Vinci Surgery and its value relative to other techniques. We also face competition from severalcompanies that are developing new approaches and products for the MIS market. We believe that many are focused on adding capability to manual MISsystems. Because many of these developments are aimed at MIS, we believe that our da Vinci Surgical System may prove complementary to some of thesenew technologies.Moreover, as we add new robotically controlled products (e.g., Single-Site, stapler, and vessel sealer) that compete with product offerings traditionallywithin the domains of open surgery and/or conventional MIS, we face greater competition from larger and well established companies such as Ethicon Endo-Surgery, Inc.Furthermore, as da Vinci use increases, a number of companies may be compelled to enter the field of robotic surgery. The following companies havemade explicit statements about their efforts to enter the field: Johnson & Johnson, MedRobotics Corp., meerecompany Inc., Medtronic PLC, Olympus Corp.,SOFAR S.p.A., IMRIS Inc., TransEnterix, Inc., and Titan Medical, Inc. Companies with substantial experience in industrial robotics could potentially expandinto the field of surgical robotics and become a competitor. In addition, research efforts utilizing computers and robotics in surgery are underway at variouscompanies and research institutions. Our revenues may be adversely impacted if our competitors develop and introduce products that compete in our markets.Intellectual PropertyWe place considerable importance on obtaining and maintaining patent, copyright and trade secret protection for significant new technologies, products,and processes.We generally rely upon a combination of intellectual property laws, as well as confidentiality procedures and contractual provisions, to protect ourproprietary technology. For example, we have trademarks, both registered and unregistered, that provide distinctive identification of our products in themarketplace. We also have exclusive and non-exclusive patent licenses with various third parties to supplement our own large and robust patent portfolio.As of December 31, 2014, we held ownership or exclusive field-of-use licenses for more than 1,700 U.S. and foreign patents and more than 1,500 U.S. andforeign patent applications. We intend to continue filing new patent applications in the U.S. and foreign jurisdictions to seek protection for our technology.Patents are granted for finite terms and eventually expire. Upon expiration, the inventions claimed in a patent enter the public domain. While our patentsare an important element of our success, our business as a whole is not significantly dependent on any one patent.Government RegulationOur products and operations are subject to extensive and rigorous regulation by the FDA, the State of California and countries or regions in which wemarket our products. In addition, our products must meet the requirements of a large and growing body of international standards which govern the design,manufacture, materials content and sourcing, testing, certification, packaging, installation, use and disposal of our products. We must continually keepabreast of these standards and requirements and integrate compliance to these with the development and regulatory documentation for our products. Failureto meet these standards could limit the ability to market our products in those regions which require compliance to such standards. Examples of groups ofsuch standards are electrical safety standards such as those of the International Electrotechnical Commission (e.g. IEC 60601-ss series of standards) andcomposition standards such as the Reduction of Hazardous Substances (“RoHS”) and Waste Electrical and Electronic Equipment (“WEEE”) Directives.11Table of ContentsUnited StatesThe FDA regulates the development, testing, manufacturing, labeling, storage, recordkeeping, promotion, marketing, distribution, and service of medicaldevices in the U.S. to ensure that medical products distributed domestically are safe and effective for their intended uses. In addition, the FDA regulates theexport of medical devices manufactured in the U.S. to international markets and the importation of medical devices manufactured abroad.Under the Federal Food, Drug, and Cosmetic Act (“FFDCA”), medical devices are classified into one of three classes—Class I, Class II or Class III—depending on the degree of risk associated with each medical device and the extent of control needed to ensure safety and effectiveness. Our current productsare Class II medical devices.Class II devices are those which are subject to general controls and most require premarket demonstration of adherence to certain performance standardsor other special controls, as specified by the FDA, and clearance by the FDA. Premarket review and clearance by the FDA for these devices is accomplishedthrough the 510(k) premarket notification process. Unless a Class II device is exempt from premarket review, the manufacturer must submit to the FDA apremarket notification submission demonstrating that the device is “substantially equivalent” in intended use and technology to a “predicate device” that iseither:1.a device that has grandfather marketing status because it was legally marketed prior to May 28, 1976, the date upon which the Medical DeviceAmendments of 1976 were enacted, or2.a device that has previously been cleared through the 510(k) process.If the FDA agrees that the device is substantially equivalent to a predicate device, it will grant clearance to commercially market the device in the U.S.The FDA has a statutory 90-day period to respond to a 510(k) submission, or a guidance-based 30-day period for “special” 510(k) submissions which have amore restrictive scope and generally involve more specific or very limited changes to a legally marketed device. As a practical matter, clearance often takeslonger. The FDA may require further information, including clinical data, to make a determination regarding substantial equivalence. If the FDA determinesthat the device, or its intended use, is not “substantially equivalent,” the FDA may deny the request for clearance. Although unlikely for the types of productsmarketed by us, the FDA may classify the device, or the particular use of the device, into Class III, and the device sponsor must then fulfill more rigorous pre-market approval (“PMA”) requirements. A PMA application, which is intended to demonstrate that a device is safe and effective, must be supported byextensive data, including data from preclinical studies and human clinical trials. The FDA, by statute and regulation, has 180 days to review a PMAapplication, though the review more often occurs over a significantly longer period of time, and can take up to several years. In approving a PMA applicationor clearing a 510(k) submission, the FDA may also require some form of post-market surveillance when necessary to protect the public health or to provideadditional safety and effectiveness data for the device. In such cases, the manufacturer might be required to follow certain patient groups for a number ofyears and makes periodic reports to the FDA on the clinical status of those patients.After a device receives FDA 510(k) clearance, any modification that could significantly affect its safety or effectiveness, or that would constitute a majorchange in its intended use, requires a new 510(k) clearance or could require a PMA application approval. The FDA requires each manufacturer to make thedetermination of whether a modification requires a new 510(k) notification or PMA application in the first instance, but the FDA can review any suchdecision. If the FDA disagrees with a manufacturer’s decision not to seek a new 510(k) clearance or PMA approval for a particular change, the FDA mayretroactively require the manufacturer to seek 510(k) clearance or PMA approval. The FDA also can require the manufacturer to cease U.S. marketing and/orrecall the modified device until 510(k) clearance or PMA approval is obtained.In addition, after a device is placed on the market, numerous FDA and other regulatory requirements continue to apply. These include establishmentregistration and device listing with the FDA; compliance with medical device reporting regulations, which require that manufacturers report to the FDA iftheir device may have caused or contributed to a death or serious injury or malfunctioned in a way that would likely cause or contribute to a death or seriousinjury if it were to recur; and compliance with corrections and removal reporting regulations, which require that manufacturers report to the FDA fieldcorrections and product recalls or removals if undertaken to reduce a risk to health posed by the device or to remedy a violation of the FFDCA that maypresent a risk to health. The FDA and the Federal Trade Commission (“FTC”) also regulate the advertising and promotion of our products to ensure that theclaims we make are consistent with our regulatory clearances, that there is scientific data to substantiate the claims and that our advertising is neither false normisleading. In general, we may not promote or advertise our products for uses not within the scope of our intended use statement in our clearances or makeunsupported safety and effectiveness claims. Many regulatory jurisdictions outside of the U.S. have similar regulations to which we are subject.Our manufacturing processes are required to comply with the FDA’s Good Manufacturing Practice (“GMP”) requirements contained in its Quality SystemRegulation (“QSR”) and associated regulations and guidance. The QSR covers, among other things, the methods used in, and the facilities and controls usedfor, the design, manufacture, packaging, labeling, storage, installation, and servicing of all medical devices intended for human use. The QSR also requiresmaintenance of extensive records which demonstrate compliance with FDA regulation, the manufacturer’s own procedures, specifications and testing as wellas distribution and postmarket experience. Compliance with the QSR is necessary to receive FDA clearance or approval to market12Table of Contentsnew products and is necessary for a manufacturer to be able to continue to market cleared or approved product offerings in the U.S. A company’s facilities,records, and manufacturing processes are subject to periodic scheduled or unscheduled inspections by the FDA, which may issue reports known as FormsFDA 483 or Notices of Inspectional Observations which list instances where the FDA inspector believes the manufacturer has failed to comply withapplicable regulations and/or procedures. If the observations are sufficiently serious or the manufacturer fails to respond appropriately, the FDA may issueWarning Letters, or Untitled Letters, which are notices of intended enforcement actions against the manufacturer. If a Warning Letter or Untitled Letter is notaddressed to the satisfaction of the FDA, or if the FDA becomes aware of any other serious issue with a manufacturer’s products or facilities, it could result infines, injunctions, civil penalties, delays, suspension or withdrawal of clearances, seizures or recalls of products, operating restrictions, total shutdown ofproduction facilities, prohibition on export or import and criminal prosecution. Such actions may have further indirect consequences for the manufactureroutside of the U.S., and may adversely affect the reputation of the manufacturer and the product. In the U.S., routine FDA inspections usually occur every twoyears, and may occur more often for cause.An FDA inspection of our facilities occurred in April-May 2013 and the FDA issued a Form FDA 483 listing four observations relating to the reporting offield corrections, information which is to be included on reports of field corrections, written procedures for changes to certain product labeling, and designinput documentation. We responded to each observation with corrective actions during the course of the inspection and provided additional evidence ofcorrective actions to the FDA in response to the Form FDA 483. The FDA issued a Warning Letter on July 16, 2013 related to two of the four Form FDA 483observations asking for additional corrective actions, and its intent to perform a follow-up inspection. In addition, the FDA collected electronic samples of allour advertising and promotional material for review, and to date has taken no action in connection therewith. We responded to the Warning Letter,communicating corrective actions taken. The FDA re-inspected our facilities during February-March of 2014 to complete a general quality system audit aswell as a review of the status of the Warning Letter and 483 remediation activities. At the end of the inspection, the FDA issued a Form FDA 483 listing fiveobservations related to quality management system improvement opportunities. We responded to the FDA with a corrective action plan for thoseobservations. On April 25, 2014, we received a closure letter from the FDA stating that the observations in the July 16, 2013 Warning Letter had beenaddressed, and on April 25, 2014, we also received an Establishment Inspection Report (EIR) confirming close-out of the FDA inspection. Although the FDAdid not indicate whether it reviewed the promotional materials previously collected, we believe that the FDA’s review of these materials and all other 2013findings are now closed based on receipt of both the Warning Letter close-out and the EIR.To a greater or lesser extent, most other countries require some form of quality system and regulatory compliance, which may include periodicinspections, inspections by third party auditors, and specialized documentation. Failure to meet all the requirements of these countries could jeopardize ourability to import, market, support and receive reimbursement for the use of our products in these countries.In addition to the above, we may seek to conduct clinical research on products that have not yet been cleared or approved for particular indications inclinical studies or trials in the U.S. or other countries. Additional regulations govern the approval, initiation, conduct, documentation and reporting ofclinical studies to regulatory agencies in the countries or regions in which they are conducted. Such investigational use is generally also regulated by localand institutional requirements and policies which usually include review by an ethics committee or institutional review board (“IRB”). Failure to complywith all regulations governing such studies could subject the company to significant enforcement actions and sanctions, including halting of the study,seizure of investigational devices or data, sanctions against investigators, civil or criminal penalties, and other actions. Without the data from one or moreclinical studies, it may not be possible for us to secure the data necessary to support certain regulatory submissions, to secure reimbursement or demonstrateother requirements. We cannot assure that access to clinical investigators, sites and subjects, documentation and data will be available on the terms andtimeframes necessary.Products manufactured outside the U.S. by or for us are subject to U.S. Customs and FDA inspection upon entry into the U.S. We must demonstratecompliance of such products to U.S. regulations and carefully document the eventual distribution or re-exportation of such products. Failure to comply withall applicable regulations could prevent us from having access to products or components critical to the manufacture of finished products and lead toshortages and delays.California RegulationThe State of California requires that we obtain a license to manufacture medical devices and until 2012 conducted periodic inspections of medicaldevice manufacturers. Our facilities and manufacturing processes were last inspected in July 2011 and were found to be in compliance. In accordance with theState of California regulations, the license to manufacture is renewed annually with any updated manufacturing information. Although the State of Californiahas announced suspension of routine periodic inspections, there can be no assurance the State of California will not resume such inspections or conduct suchinspections under specific circumstances which are not yet known.13Table of ContentsForeign RegulationIn order for us to market our products in other countries, we must obtain regulatory approvals and comply with extensive product and quality systemregulations in other countries. These regulations, including the requirements for approvals or clearance and the time required for regulatory review, vary fromcountry to country. Some countries have regulatory review processes which are substantially longer than U.S. processes. Failure to obtain regulatory approvalin a timely manner and to meet all local requirements including language and specific safety standards in any foreign country in which we plan to market ourproducts could prevent us from marketing products in such countries or subject us to sanctions and fines.To be sold in Japan, most medical devices must undergo thorough safety examinations and demonstrate medical efficacy before they receive regulatory(“Shonin”) approval. In October 2012, we obtained from the Japanese Ministry of Health, Labor, and Welfare ("MHLW") approval for our da Vinci Si SurgicalSystems. Effective April 2012, we obtained national reimbursement for dVP procedures, our only reimbursed procedure in Japan to date. We are currentlyseeking reimbursement for additional procedures through the MHLW's Senshin Iryo process as well as other alternative reimbursement processes. Suchapprovals require in-country clinical data and are considered for reimbursed status in April of even numbered years. No additional procedures were granted inthe April 2014 cycle. We are currently working with the Japanese surgical societies to gather the necessary data on additional procedures for MHLWconsideration in the April 2016 cycle. If we are not successful in obtaining additional regulatory clearances, importation licenses, and adequate procedurereimbursements for future products and procedures, then the demand for our products in Japan could be limited.Commercialization of medical devices in Europe is regulated by the European Union (“EU”). The EU presently requires that all medical products bearthe Conformité Européenne (“CE”) mark, for compliance with the Medical Device Directive (93/42/EEC) as amended. The CE mark is an internationalsymbol of adherence to certain essential principles of safety and performance mandated in applicable European medical device directives, which onceaffixed, enables a product to be sold in member countries of the EU and those affiliated which accept the CE mark. The CE mark is also recognized in manycountries outside of the EU, such as Australia, and can assist in the clearance process. In order to affix the CE mark on products, a recognized EuropeanNotified Body must certify a manufacturer’s quality system and design dossier for compliance with international and European requirements. We havereceived authorization from DGM Denmark A/S, a recognized European Notified Body and part of Nemko Presafe A/S, to affix the CE mark to our da VinciSurgical System and EndoWrist instruments and accessories. To maintain authorization to apply the CE mark, we are subject to annual surveillance auditsand periodic re-certification audits. As of 2014, Notified Bodies, including DGM, are also required to conduct periodic unannounced inspections.If we modify our existing products or develop new products in the future, we may need to apply for authorization to affix the CE mark to such products.We do not know whether we will be able to obtain authorization to affix the CE mark for new or modified products or whether we will continue to meet thesafety and performance standards required to maintain the authorizations we have already received. If we are unable to maintain authorizations to affix theCE mark to our products, we will no longer be able to sell our products in member countries of the EU or those whose marketing authorizations are based onthe CE Mark.Regulations in other countries, including the requirements for approvals or clearance and the time required for regulatory review, vary from country tocountry. Certain countries have their own regulatory agencies, such as China and Korea. These regulations typically require regulatory approvals andcompliance with extensive safety and quality system regulations. Failure to obtain regulatory approval in any foreign country in which we plan to market ourproducts, or failure to comply with any regulation in any foreign country in which we market our products, may negatively impact our ability to generaterevenue and harm our business. In addition, local regulations may apply which govern the use of our products and which could have an adverse effect on ourproduct utilization if they are unfavorable. All such regulations are revised from time to time and in general are increasing in complexity, and in the scopeand degree of documentation and testing required. There can be no assurance the outcomes from such documentation and testing will be acceptable to anyparticular regulatory agency or will continue to be acceptable over time. There are further regulations governing the importation, marketing, sale,distribution, use and service as well as the removal and disposal of medical devices. Failure to comply with any of these regulations could result in sanctions,fines and prevent us from marketing our products in these regions.Other Healthcare LawsWe are also subject to federal and state healthcare laws and regulations pertaining to fraud and abuse, physician payment transparency and privacy andsecurity laws and regulations. These laws include:•the federal Anti-Kickback Statute, which prohibits, among other things, persons from knowingly and willfully soliciting, receiving, offering orpaying remuneration, directly or indirectly, in exchange for or to induce either the referral of an individual for, or the purchase, order orrecommendation of, any good or service for which payment may be made under federal healthcare programs, such as the Medicare and Medicaidprograms. A person or entity does not need to have actual knowledge of the federal Anti-Kickback Statute or specific intent to violate it to havecommitted a violation. In addition, the government may assert that a claim including items or services resulting14Table of Contentsfrom a violation of the federal Anti-Kickback Statute constitutes a false or fraudulent claim for purposes of the False Claims Act;•federal false claims laws which prohibit, among other things, individuals or entities from knowingly presenting, or causing to be presented,claims for payment from Medicare, Medicaid or other federal third-party payors that are false or fraudulent;•the federal Civil Monetary Penalties Law, which prohibits, among other things, offering or transferring remuneration to a federal healthcarebeneficiary that a person knows or should know is likely to influence the beneficiary’s decision to order or receive items or servicesreimbursable by the government from a particular provider or supplier;•federal criminal laws that prohibit executing a scheme to defraud any federal healthcare benefit program or making false statements relating tohealthcare matters;•the federal Health Insurance Portability and Accountability Act of 1996, as amended by the Health Information Technology for Economic andClinical Health Act, which governs the conduct of certain electronic healthcare transactions and protects the security and privacy of protectedhealth information;•the federal Physician Payment Sunshine Act, which requires manufacturers of drugs, devices, biologics and medical supplies for which paymentis available under Medicare, Medicaid or the Children’s Health Insurance Program (with certain exceptions) to report annually to CMSinformation related to payments or other “transfers of value” made to physicians (defined to include doctors, dentists, optometrists, podiatristsand chiropractors) and teaching hospitals, and requires applicable manufacturers and group purchasing organizations to report annually to CMSownership and investment interests held by the physicians described above and their immediate family members and payments or other“transfers of value” to such physician owners. Manufacturers are required to submit reports to CMS by the 90th day of each calendar year; and•analogous state and foreign law equivalents of each of the above federal laws, such as anti-kickback and false claims laws which may apply toitems or services reimbursed by any third-party payor, including commercial insurers; state laws that require device companies to comply withthe industry’s voluntary compliance guidelines and the applicable compliance guidance promulgated by the federal government or otherwiserestrict payments that may be made to healthcare providers and other potential referral sources; state laws that require device manufacturers toreport information related to payments and other transfers of value to physicians and other healthcare providers or marketing expenditures; andstate laws governing the privacy and security of health information in certain circumstances, many of which differ from each other in significantways and may not have the same effect, thus complicating compliance efforts.If our operations are found to violate any of the laws described above or any other laws and regulations that apply to us, we may be subject to penalties,including civil and criminal penalties, damages, fines, the curtailment or restructuring of our operations, the exclusion from participation in federal and statehealthcare programs and imprisonment, any of which could adversely affect our ability to market our products and materially adversely affect our business,results of operations and financial condition. Any action against us for violation of these laws, even if we successfully defend against it, could cause us toincur significant legal expenses and divert our management’s attention from the operation of our business.Third-Party Coverage and ReimbursementIn the U.S. and most international markets where we sell our products, the government and health insurance companies together are responsible forhospital and surgeon reimbursement for virtually all covered surgical procedures. Governments and insurance companies generally reimburse hospitals andphysicians for surgery when the procedure is considered medically necessary. In the U.S., the Centers for Medicare & Medicaid Services (“CMS”) administersthe Medicare and Medicaid programs (the latter, along with applicable State governments). Many other third-party payors model their reimbursementmethodologies after the Medicare program. As the single largest payor, this program has a significant impact on other payors’ payment systems.Generally, reimbursement for professional services performed at a facility by physicians is reported under billing codes issued by the American MedicalAssociation (“AMA”), known as Current Procedural Terminology (“CPT”) codes. Physician reimbursement under Medicare generally is based on a feeschedule and determined by the relative values of the professional service rendered. In addition, CMS and the National Center for Health Statistics (“NCHS”)are jointly responsible for overseeing changes and modifications to billing codes known as ICD-9-CM procedural codes used by hospitals to report inpatientprocedures. For Medicare, CMS generally reimburses hospitals for services provided during an inpatient stay based on a prospective payment system that isdetermined by a classification system known as Medicare-Severity Diagnostic Related Groupings (“MS-DRGs”). MS-DRGs are assigned using a number offactors including the principal diagnosis, major procedures, discharged status, patient age and complicating secondary diagnoses among other things.Hospital outpatient services, reported by CPT codes, are assigned to clinically relevant Ambulatory Payment Classifications (“APCs”) used to determine thepayment amount for services provided.On October 1, 2008, CMS and NCHS issued a new family of ICD-9-CM procedure codes for “Robotically Assisted Procedures.” For laparoscopicprocedures completed with the da Vinci Surgical System, U.S. hospitals are expected to report the15Table of Contentsprimary surgical procedure code, along with ICD-9-CM 17.42, to describe a laparoscopic robotic assisted procedure. The purpose of the ICD-9-CM family ofprocedure codes, 17.4X, is to gather data on robotic assisted surgical procedures. At this time, it does not appear that these codes will be available afterOctober 1, 2015, when the ICD-10 code sets are implemented. A surgical procedure, completed with or without robotic assistance, continues to be assigned tothe clinically relevant MS-DRG.Governments and insurance companies carefully review and increasingly challenge the prices charged for medical products and surgical services.Reimbursement rates from private companies vary depending on the procedure performed, the third-party payor, contract terms, and other factors. Becauseboth hospitals and physicians may receive the same reimbursement for their respective services, with or without robotics, regardless of actual costs incurredby the hospital or physician in furnishing the care, including for the specific products used in that procedure, hospitals and physicians may decide not to useour products if reimbursement amounts are insufficient to cover any additional costs incurred when purchasing our products.Domestic institutions typically bill for the primary surgical procedure that includes our products to various third-party payors, such as Medicare,Medicaid and other government programs and private insurance plans. Because our da Vinci Surgical System has been cleared for commercial distribution inthe U.S. by the FDA, coverage and reimbursement by payors are generally determined by the medical necessity of the primary surgical procedure. We believethat the additional procedures we intend to pursue are established surgical procedures that are generally already reimbursable by government agencies andinsurance companies for appropriately selected patients. If hospitals do not obtain sufficient reimbursement from third-party payors for procedures performedwith our products, or if governmental and private payors’ policies do not cover surgical procedures performed using our products, we may not be able togenerate the revenues necessary to support our business.In countries outside the U.S., reimbursement is obtained from various sources, including governmental authorities, private health insurance plans, andlabor unions. In most foreign countries, private insurance systems may also offer payments for some therapies. In addition, health maintenance organizationsare emerging in certain European countries. To effectively conduct our business, we may need to seek international reimbursement approvals, and we do notknow if these required approvals will be obtained in a timely manner or at all. In some countries, patients may be permitted to pay directly for surgicalservices; however, such “co-pay” practices are not common in most countries.In March 2010, the U.S. President signed the Patient Protection and Affordable Care Act, as amended by the Health Care and Education ReconciliationAct (collectively, “the PPACA”), which makes changes that significantly impact healthcare providers, insurers, pharmaceutical and medical devicemanufacturers. One of the principal aims of the PPACA is to expand health insurance coverage to Americans who are currently uninsured. The consequencesof these significant coverage expansions on the sales of our products are currently unknown. The PPACA contains a number of provisions designed togenerate the revenues necessary to fund this coverage expansion, including, but not limited to new fees or taxes on certain health-related industries,including medical device manufacturers. Since 2013, medical device manufacturers have been required to pay an excise tax (or sales tax) of 2.3% on certainU.S. medical device revenues. Under this provision, the Company has incurred an excise tax of approximately $16 million in 2014. The tax is included as acost of revenue and a reduction of product gross profit margin.The PPACA also has provisions to study the comparative effectiveness of health care treatments and strategies. It remains unclear how this research willinfluence future Medicare coverage and reimbursement decisions, as well as influence other third-party payor coverage and reimbursement policies. AsCongress and state governments determine how to implement the PPACA, the full impact of the PPACA on the medical device industry and the sale of ourproducts is currently unknown. The PPACA, as well as other federal or state health care reform measures that may be adopted in the future, could have amaterial adverse effect on our business. The taxes imposed by PPACA and the expansion in the government’s role in the U.S. healthcare industry may resultin decreased profits, lower reimbursement from payors for procedures that use our products and/or reduced procedural volumes, all of which may adverselyaffect our business, financial condition and results of operations.In addition, other legislative changes have been proposed and adopted since the PPACA was enacted. More recently, on August 2, 2011, the U.S.President signed into law the Budget Control Act of 2011, which, among other things, creates the Joint Select Committee on Deficit Reduction to recommendproposals in spending reductions to Congress. The Joint Select Committee did not achieve a targeted deficit reduction of at least $1.2 trillion for the years2013 through 2021, triggering the legislation’s automatic reduction to several government programs. This included aggregate reductions of 2% per fiscalyear of Medicare payments to providers, which went into effect on April 1, 2013 and, due to subsequent legislative amendments to the statute, will remain ineffect through 2024 unless additional Congressional action is taken. On January 2, 2013, the American Taxpayer Relief Act of 2012 was signed into law,which, among other things, further reduced Medicare payments to several providers, including hospitals, imaging centers and cancer treatment centers.Any regulatory or legislative developments in domestic or foreign markets that eliminate or reduce reimbursement rates for procedures performed withour products could harm our ability to sell our products or cause downward pressure on the prices of our products, either of which would affect our ability togenerate the revenues necessary to support our business.16Table of ContentsEmployeesAs of December 31, 2014, we had 2,978 employees, 342 of whom were engaged directly in research and development, 1,106 in manufacturing andservice and 1,530 in marketing, sales, and administrative activities. None of our employees are covered by a collective bargaining agreement, and weconsider our relationship with our employees to be good.GeneralWe make our periodic and current reports, including our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K,our Code of Business Conduct and Ethics Policy and any amendments to those reports, available free of charge, on our website as soon as practicable aftersuch material is electronically filed or furnished with the Securities and Exchange Commission (the "SEC"). Our website address iswww.intuitivesurgical.com and the reports are filed under “SEC Filings,” on the Company—Investor Relations portion of our website. Periodically, wewebcast Company announcements, product launch events and executive presentations which can be viewed via our Investor Relations pages on our website.In addition, we provide notifications of our material news including SEC filings, investor events, and press releases as part of our Investor Relations website.The contents of these websites are not intended to be incorporated by reference into this report or in any other report or document we file and any referencesto these websites are intended to be inactive textual references only. The public may read and copy any materials filed by the Company with the SEC at theSEC’s Public Reference Room at 100 F Street, NE, Room 1580, Washington, DC 20549. The public may obtain information on the operation of the PublicReference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet site that contains reports, proxy and information statements andother information regarding issuers that file electronically with the SEC at www.sec.gov. The contents of these websites are not incorporated into this filing.Further, references to the URLs for these websites are intended to be inactive textual references only.We operate our business as one segment as defined by U.S. generally accepted accounting principles. Our financial results for the year endedDecember 31, 2014, 2013, and 2012 are discussed in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” and“Item 8. Financial Statements and Supplementary Data” of this Annual Report.Intuitive Surgical, Inc. was founded in 1995. We are a Delaware corporation with our corporate headquarters located at 1020 Kifer Road, Sunnyvale,California 94086. Our telephone number is (408) 523-2100, and our website address is www.intuitivesurgical.com.ITEM 1A.RISK FACTORSRISKS RELATING TO OUR BUSINESSIF OUR PRODUCTS DO NOT ACHIEVE MARKET ACCEPTANCE, WE WILL NOT BE ABLE TO GENERATE THE REVENUE NECESSARY TOSUPPORT OUR BUSINESS.The da Vinci Surgical System and our other products represent a fundamentally new way of performing surgery. Achieving physician, patient and third-party payor acceptance of da Vinci Surgery as a preferred method of performing surgery will be crucial to our success. If our products fail to achieve marketacceptance, customers will not purchase our products and we will not be able to generate the revenue necessary to support our business. We believe thatphysicians and third-party payors’ acceptance of the benefits of procedures performed using our products will be essential for acceptance of our products bypatients. Physicians will not recommend the use of our products unless we can demonstrate that they produce results comparable or superior to existingsurgical techniques. Even if we can prove the effectiveness of our products through clinical trials, surgeons may elect not to use our products for any numberof other reasons. For example, cardiologists may continue to recommend conventional heart surgery simply because such surgery is already widely accepted.In addition, surgeons may be slow to adopt our products because of the perceived liability risks arising from the use of new products and the uncertainty ofreimbursement from third-party payors, particularly in light of ongoing health care reform initiatives.We expect that there will be a learning process involved for surgical teams to become proficient in the use of our products. Broad use of our products willrequire training of surgical teams. Market acceptance could be delayed by the time required to complete this training. We may not be able to rapidly trainsurgical teams in numbers sufficient to generate adequate demand for our products.ECONOMIC CONDITIONS COULD MATERIALLY ADVERSELY AFFECT OUR COMPANY.During 2008 and 2009, the global economy experienced a severe downturn due to the sequential effects of the subprime lending crisis, the credit marketcrisis, collateral effects on the finance and banking industries, volatile currency exchange rates and energy costs, concerns about inflation, slower economicactivity, decreased consumer confidence, reduced corporate profits and capital spending, adverse business conditions and liquidity concerns. More recently,credit and sovereign debt issues destabilized certain European economies and thereby contributed to global macroeconomic uncertainties. Uncertainty aboutcurrent global economic conditions continue to pose a risk as customers may postpone or reduce spending in response to restraints17Table of Contentson credit. There could be additional effects from adverse conditions in the credit markets on our business, including the insolvency of key suppliers or theirinability to obtain credit to finance the development and/or manufacture of our products resulting in product delays, and the inability of our customers anddistributors to obtain credit to finance purchases of our products. If economic conditions worsen or if the improved economic conditions are slower thananticipated, our forecasted demand may not materialize to the levels we require to achieve our anticipated financial results, which could in turn have amaterial adverse effect on our revenue, profitability, and the market price of our stock.BECAUSE OUR MARKETS ARE HIGHLY COMPETITIVE, CUSTOMERS MAY CHOOSE TO PURCHASE OUR COMPETITORS’ PRODUCTS ORMAY NOT ACCEPT DA VINCI SURGERY, WHICH WOULD RESULT IN REDUCED REVENUE AND LOSS OF MARKET SHARE.da Vinci Surgery is a relatively new technology that competes with established and emerging treatment options in both disease management andreconstructive medical procedures. These competitive treatment options include conventional MIS, open surgery, interventional approaches, orpharmacological regimens. Some of these procedures are widely accepted in the medical community and in many cases have a long history of use.Technological advances could make such treatments more effective or less expensive than using our products, which could render our products obsolete orunmarketable. Studies could be published that show that other treatment options are more beneficial and/or cost-effective than da Vinci Surgery. We cannotbe certain that physicians will use our products to replace or supplement established treatments or that our products will continue to be competitive withcurrent or future technologies.In addition, we may face competition from companies that develop wristed, robotic or computer-assisted surgical systems and products in the future. Forexample, SOFAR S.p.A, an Italian medical device company, supported by the European Commission’s Joint Research Centre, has developed a telesurgicalrobot system. Other competitors have made explicit statements about their efforts to enter the field. Our revenues may be reduced or eliminated if ourcompetitors develop and market products that are more effective or less expensive than our products. If we are unable to compete successfully, our revenueswill suffer. We may not be able to maintain or improve our competitive position against current or potential competitors, especially those with greaterresources.NEW PRODUCT INTRODUCTIONS MAY ADVERSELY IMPACT OUR FINANCIAL RESULTS.We introduce new products with enhanced features and extended capabilities from time to time. Our products are subject to various regulatory processes,and we must obtain and maintain regulatory approvals in order to sell our new products. If a potential purchaser believes that we plan to introduce a newproduct in the near future or if a potential purchaser is located in a country where a new product that we have introduced has not yet received regulatoryapproval, planned purchases may be deferred or delayed. As a result, new product introductions may adversely impact our financial results.WE EXPECT GROSS PROFIT MARGINS TO VARY OVER TIME, AND CHANGES IN OUR GROSS PROFIT MARGINS COULD ADVERSELYAFFECT OUR FINANCIAL CONDITION OR RESULTS OF OPERATIONS.Our gross profit margins have fluctuated from period to period, and we expect that they will continue to fluctuate in the future. Our gross profit marginsmay be adversely affected by numerous factors, including: •changes in customer, geographic, or product mix, including mix of da Vinci Surgical System models sold;•changes in the portion of sales involving a trade-in of another system and the amount of trade-in credits given;•introduction of new products, which may have lower margins than our existing products;•our ability to maintain or reduce production costs;•changes to our pricing strategy;•changes in competition;•changes in production volume driven by demand for our products;•changes in material, labor or other manufacturing-related costs;•inventory obsolescence and product recall charges; and•market conditions.If we are unable to offset the unfavorable impact of the factors noted above by increasing the volume of products shipped, reducing productmanufacturing costs or otherwise, our financial condition and results of operations may be materially adversely affected.WE EXPERIENCE LONG AND VARIABLE CAPITAL SALES CYCLES AND SEASONALITY IN OUR BUSINESS, WHICH MAY CAUSEFLUCTUATIONS IN OUR FINANCIAL RESULTS.Our da Vinci Surgical System has a lengthy sales and purchase order cycle because it is a major capital item and its purchase generally requires theapproval of senior management of hospitals, their parent organizations, purchasing groups, and government18Table of Contentsbodies, as applicable. This approval process can be lengthy. In addition, hospitals may delay or accelerate system purchases in conjunction with timing oftheir capital budget timelines. Further, the introduction of new products could adversely impact our sales cycle as customers take additional time to assessthe benefits and costs of such products. As a result, it is difficult for us to predict the length of capital sales cycles and, therefore, the exact timing of capitalsales. Historically, our sales of da Vinci Surgical Systems have tended to be heaviest during the third month of each fiscal quarter, lighter in the first and thirdfiscal quarters and heavier in the fourth fiscal quarter.Recently, we have experienced procedure growth for a number of benign conditions, including hysterectomies for benign conditions, sacrocolpopexies,hernia repair, and certain other surgeries. Many of these types of surgeries may be postponed in the short term by patients to avoid vacation periods and forother personal scheduling reasons. Patients may also accelerate procedures to take advantage of insurance funding cut-off dates. Historically, we haveexperienced lower procedure counts in the first and third fiscal quarters and higher procedure counts in the second and fourth fiscal quarters. Timing ofprocedures and changes in procedure growth directly affect the timing of instrument and accessory purchases and capital purchases by customers.The above factors may contribute to substantial fluctuations in our quarterly operating results. Because of these fluctuations, it is possible that in somefuture quarters our operating results will fall below the expectations of securities analysts or investors. If that happens, the market price of our stock wouldlikely decrease. These fluctuations, among other factors, also mean that you will not be able to rely upon our operating results in any particular period as anindication of future performance.INTERNATIONAL SALES ACCOUNT FOR A SIGNIFICANT PORTION OF OUR REVENUES, WHICH EXPOSES US TO RISKS INHERENT ININTERNATIONAL OPERATIONS. OUR GROWTH MAY BE LIMITED IF WE ARE UNABLE TO SUCCESSFULLY MANAGE OURINTERNATIONAL ACTIVITIES.Our business currently depends in part on our activities in international markets. Revenue from markets outside of the United States accounted forapproximately 30%, 28%, and 21% of our revenue for the years ended December 31, 2014, 2013, and 2012, respectively. We are subject to a number ofchallenges that specifically relate to our international business activities. These challenges include:•failure to obtain the same degree of protection against infringement of our intellectual property rights as we have in the United States;•protectionist laws and business practices that favor local competitors, which could slow our growth in international markets;•local or national regulations that make it difficult or impractical to market or use our products;•inability or regulatory limitations on our ability to move goods across borders;•the risks associated with foreign currency exchange rate fluctuations;•difficulty in establishing, staffing and managing non-U.S. operations;•the expense of establishing facilities and operations in new foreign markets; and•building and maintaining an organization capable of supporting geographically dispersed operations.A large portion of our international sales are denominated in U.S. dollars. As a result, an increase in the value of the U.S. dollar relative to foreigncurrencies could make our products less competitive and/or less affordable in international markets. If we are unable to meet and overcome these challengesour international operations may not be successful, which would limit the growth of our business.WE UTILIZE DISTRIBUTORS FOR A PORTION OF OUR SALES, WHICH SUBJECTS US TO A NUMBER OF RISKS THAT COULD HARM OURBUSINESS.We have strategic relationships with a number of key distributors for sales and service of our products in certain foreign countries. If these strategicrelationships are terminated and not replaced, our revenues and/or ability to service our products in the territories serviced by these distributors could beadversely affected. In addition, we may be named as a defendant in lawsuits against our distributors related to sales or service of our products performed bythem. Please see our risk factor below titled “Unfavorable Results of Legal Proceedings Could Materially Adversely Affect Our Financial Condition.” Theactions of our distributors may affect our ability to effectively market our products in certain foreign countries or regulatory jurisdictions if the distributorholds the regulatory authorization in such countries or within such regions and causes, by action or inaction, the suspension of such marketing authorizationor sanctions for non-compliance. It may be difficult, expensive and time consuming for us to re-establish market access or regulatory compliance in such case.WE ARE EXPOSED TO THE CREDIT RISK OF SOME OF OUR CUSTOMERS, WHICH COULD RESULT IN MATERIAL LOSSES.We believe customer financing through leasing is an important consideration for some of our customers and have experienced an increase in demand forcustomer financing. We may experience loss from a customer’s failure to make payments according to19Table of Contentsthe contract terms. Our exposure to the credit risks relating to our lease financing arrangements may increase if our customers are adversely affected bychanges in healthcare laws, coverage and reimbursement, economic pressures or uncertainty, or other customer-specific factors.Although we have programs in place that are designed to monitor and mitigate the associated risk, there can be no assurance that such programs will beeffective in reducing credit risks relating to these lease financing arrangements. Although we have not experienced significant credit losses to date, shouldthe level of credit losses we experience in the future exceed our expectations, they could have a material adverse effect on our financial condition or results ofoperations.WE MAY INCUR LOSSES ASSOCIATED WITH CURRENCY FLUCTUATIONS AND MAY NOT BE ABLE TO EFFECTIVELY HEDGE OUREXPOSURE.Our operating results are subject to fluctuations in foreign currency exchange rates. We attempt to mitigate a portion of these risks through foreigncurrency hedging, based on our judgment of the appropriate trade-offs among risk, opportunity and expense. We have established a hedging program topartially hedge our exposure to foreign currency exchange rate fluctuations primarily for the Euro, Japanese Yen, Korean Won, and the British Pound. Weregularly review our hedging program and make adjustments as necessary based on our assessment of the relevant risks, opportunities and expenses. Ourhedging activities may not offset more than a portion of the adverse financial impact resulting from unfavorable movement in foreign currency exchangerates, which could adversely affect our financial condition or results of operations.IF DEFECTS ARE DISCOVERED IN OUR PRODUCTS, WE MAY INCUR ADDITIONAL UNFORESEEN COSTS, HOSPITALS MAY NOTPURCHASE OUR PRODUCTS AND OUR REPUTATION MAY SUFFER.Our products incorporate mechanical parts, electrical components, optical components, and computer software, any of which may contain errors orfailures, especially when first introduced. In addition, new products or enhancements may contain undetected errors or performance problems that, despitetesting, are discovered only after commercial shipment. Because our products are designed to be used to perform complex surgical procedures, we expect thatour customers will have an increased sensitivity to such defects. In the past, we have voluntarily recalled certain products as a result of performance problems.We cannot assure that our products will not experience component aging, errors, or performance problems in the future. If we experience flaws or performanceproblems, any of the following could occur:•delays in product shipments;•loss of revenue;•delay in market acceptance;•diversion of our resources;•damage to our reputation;•product recalls;•regulatory actions;•increased service or warranty costs; or•product liability claims.WE ARE SUBJECT TO PRODUCT LIABILITY AND NEGLIGENCE CLAIMS RELATING TO THE USE OF OUR PRODUCTS THAT COULD BEEXPENSIVE, DIVERT MANAGEMENT’S ATTENTION AND HARM OUR BUSINESS.Our business exposes us to significant risks of product liability claims, which are inherent to the medical device industry. Product liability claims may bebrought by individuals or by groups seeking to represent a class. We currently are subject to product liability claims, which are described in more detail inNote 7 to the Consolidated Financial Statements included in Part II, Item 8, and which have been brought by individuals alleging that they have sustainedpersonal injuries and/or death as a result of purported product defects, the alleged failure to warn, and/or the alleged inadequate training by us of physiciansregarding the use of the da Vinci Surgical System. The individuals who have brought the product liability claims seek recovery for the alleged personalinjuries and in many cases, punitive damages. Current product liability claims have resulted in negative publicity regarding our Company, and these and anyother product liability or negligence claims or product recalls also could harm our reputation. Please see our risk factor below titled “Negative Publicity,Whether Accurate or Inaccurate, Concerning Our Products or Our Company Could Reduce Market Acceptance of Our Products and Could Result inDecreased Product Demand and a Decline in Revenues” for additional risks related to the potential effects of negative publicity on our business.The outcome of product liability litigation is inherently uncertain and difficult to quantify, and the magnitude of potential damages, if any, may not beknown for a substantial period of time. Although we maintain product liability insurance, the coverage limits of these policies may not be adequate to covercurrent or future claims. Particularly as sales of our products increase, we may be unable to maintain product liability insurance in the future at satisfactoryrates or in adequate amounts. In addition, current20Table of Contentsor future product liability claims, regardless of their merit or eventual outcome, could result in significant legal costs (including settlements, judgments, legalfees, and other related defense costs). It is possible that future legal costs could have a material adverse effect on our business, financial condition, results ofoperations, or cash flows.NEGATIVE PUBLICITY, WHETHER ACCURATE OR INACCURATE, CONCERNING OUR PRODUCTS OR OUR COMPANY COULD REDUCEMARKET ACCEPTANCE OF OUR PRODUCTS AND COULD RESULT IN DECREASED PRODUCT DEMAND AND A DECLINE IN REVENUES.There have been articles published and papers written questioning patient safety and efficacy associated with da Vinci Surgery, the cost of da VinciSurgery relative to other disease management methods, and the adequacy of surgeon training. Negative publicity, whether accurate or inaccurate, concerningour products or our Company could reduce market acceptance of our products and could result in decreased product demand and a decline in revenues. Inaddition, significant negative publicity could result in an increased number of product liability claims, regardless of whether these claims are meritorious.The number of claims could be further increased by plaintiffs’ law firms that use a wide variety of media to advertise their services and solicit clients forproduct liability cases against us.UNFAVORABLE RESULTS OF LEGAL PROCEEDINGS COULD MATERIALLY ADVERSELY AFFECT OUR FINANCIAL CONDITION.We are and may become subject to various legal proceedings and claims that arise in or outside the ordinary course of business. Certain current lawsuitsand pending proceedings, including purported class action and derivative lawsuits and product liability litigation, are described in Note 7 to theConsolidated Financial Statements included in Part II, Item 8.The results of these lawsuits and other legal proceedings cannot be predicted with certainty. Accordingly, we cannot determine whether our insurancecoverage would be sufficient to cover the costs or potential losses related to these lawsuits and proceedings. In addition, as described in more detail in Note 7to the Consolidated Financial Statements included in Part II, Item 8, certain product liability insurers have instituted legal proceedings to rescind theCompany’s products liability insurance. Regardless of merit, litigation may be both time-consuming and disruptive to our operations and cause significantexpense and diversion of management attention. If we do not prevail in the purported class action and derivative lawsuit, product liability litigation, or otherlegal proceedings, we may be faced with significant monetary damages or injunctive relief against us that could have a material adverse effect on ourbusiness, financial condition, results of operations, or cash flows.WE ARE SUBJECT TO SIGNIFICANT, UNINSURED LIABILITIES.For certain risks, we do not maintain insurance coverage because of cost and/or availability. For example, we indemnify our directors and officers forthird-party claims and do not insure for the underlying losses, and we do not carry earthquake insurance, among other types of coverage that we do notmaintain. In addition, in the future, we may not continue to maintain certain existing insurance coverage or adequate levels of coverage. Premiums for manytypes of insurance have increased significantly in recent years, and depending on market conditions and our circumstances, in the future, certain types ofinsurance such as directors’ and officers’ insurance or products liability insurance may not be available on acceptable terms or at all. Because we retain someportion of our insurable risks, and in some cases self-insure completely, unforeseen or catastrophic losses in excess of insurance coverage could require us topay substantial amounts, which would materially adversely affect our financial condition and operating results.WE MAY ENCOUNTER MANUFACTURING PROBLEMS OR DELAYS THAT COULD RESULT IN LOST REVENUE.Manufacturing our products is a complex process. We (or our critical suppliers) may encounter difficulties in scaling up or maintaining production of ourproducts, including:•problems involving production yields;•quality control and assurance;•component supply shortages;•import or export restrictions on components, materials or technology;•shortages of qualified personnel; and•compliance with state, federal and foreign regulations.If demand for our products exceeds our manufacturing capacity, we could develop a substantial backlog of customer orders. If we are unable to maintainlarger-scale manufacturing capabilities, our ability to generate revenues will be limited and our reputation in the marketplace could be damaged.21Table of ContentsOUR RELIANCE ON SOLE AND SINGLE SOURCE SUPPLIERS COULD HARM OUR ABILITY TO MEET DEMAND FOR OUR PRODUCTS IN ATIMELY MANNER OR WITHIN BUDGET.Some of the components necessary for the assembly of our products are currently provided to us by sole-sourced suppliers or single-sourced suppliers.We generally purchase components through purchase orders rather than long-term supply agreements and generally do not maintain large volumes ofinventory. While alternative suppliers exist and could be identified for sole-sourced components, the disruption or termination of the supply of componentscould cause a significant increase in the costs of these components, which could affect our operating results. A disruption or termination in the supply ofcomponents could also result in our inability to meet demand for our products, which could harm our ability to generate revenues, lead to customerdissatisfaction and damage our reputation. Furthermore, if we are required to change the manufacturer of a key component of our products, we may berequired to verify that the new manufacturer maintains facilities and procedures that comply with quality standards and with all applicable regulations andguidelines. The delays associated with the verification of a new manufacturer could delay our ability to manufacture our products in a timely manner orwithin budget.IF INSTITUTIONS OR SURGEONS ARE UNABLE TO OBTAIN COVERAGE AND REIMBURSEMENT FROM THIRD-PARTY PAYORS FORPROCEDURES USING OUR PRODUCTS, OR IF REIMBURSEMENT IS INSUFFICIENT TO COVER THE COSTS OF PURCHASING OURPRODUCTS, WE MAY BE UNABLE TO GENERATE SUFFICIENT SALES TO SUPPORT OUR BUSINESS.In the United States, hospitals generally bill for the services performed with our products to various third-party payors, such as Medicare, Medicaid andother government programs and private insurance plans. If hospitals do not obtain sufficient reimbursement from third-party payors for procedures performedwith our products, or if government and private payors’ policies do not cover surgical procedures performed using our products, we may not be able togenerate the revenues necessary to support our business. Our success in international markets also depends upon the eligibility of our products for coverageand reimbursement through government-sponsored health care payment systems and third-party payors. Reimbursement practices vary significantly bycountry. Many international markets have government-managed healthcare systems that control reimbursement for new products and procedures. Otherforeign markets have both private insurance systems and government-managed systems that control reimbursement for new products and procedures. Marketacceptance of our products may depend on the availability and level of coverage and reimbursement in any country within a particular time. In addition,health care cost containment efforts similar to those in the United States are prevalent in many of the other countries in which we intend to sell our productsand these efforts are expected to continue. Please see our risk factor below titled “Recently Enacted Healthcare Legislation Reforming the U.S. HealthcareSystem, as well as Future Reforms, May Have a Material Adverse Effect on Our Financial Condition and Results of Operations” for additional risks related tothe ability of institutions or surgeons to obtain reimbursements.IF WE LOSE OUR KEY PERSONNEL OR ARE UNABLE TO ATTRACT AND RETAIN ADDITIONAL PERSONNEL, OUR ABILITY TOCOMPETE WILL BE HARMED.We are highly dependent on the principal members of our management and scientific staff. Our product development plans depend, in part, on our abilityto attract and retain engineers with experience in mechanics, electronics, software and optics. Attracting and retaining qualified personnel will be critical toour success, and competition for qualified personnel is intense. We may not be able to attract and retain personnel on acceptable terms given the competitionfor such personnel among technology and healthcare companies and universities. The loss of any of these persons or our inability to attract and retainqualified personnel could harm our business and our ability to compete.NATURAL OR OTHER DISASTERS COULD DISRUPT OUR BUSINESS AND RESULT IN LOSS OF REVENUE OR IN HIGHER EXPENSES.Natural disasters, terrorist activities and other business disruptions could seriously harm our revenue and financial condition and increase our costs andexpenses. For example, the March 2011 earthquake and tsunami in Japan and their aftermath created economic uncertainty and disrupted economic activitiesin Japan, including a reduction in hospital spending.Our corporate headquarters and many of our operations, including certain of our manufacturing facilities, are located in California, a seismically activeregion. We do not have multiple-site capacity for all of the operations in the event of a business disruption. A natural disaster in any of our major marketscould have a material adverse impact on our operations, operating results and financial condition. Further, any unanticipated business disruption caused byInternet security threats, damage to global communication networks or similar events could have a material adverse impact on our operating results.EPIDEMIC DISEASES OR THE PERCEPTION OF THEIR EFFECT COULD HAVE A MATERIAL ADVERSE EFFECT ON OUR BUSINESS,FINANCIAL CONDITION, RESULTS OF OPERATIONS, OR CASH FLOWS.Outbreaks of pandemic or contagious diseases, such as the Ebola virus could divert medical resources and priorities towards the treatment of that disease.An outbreak of a contagious disease could also negatively affect hospital admission rates. This could negatively impact the number of da Vinci proceduresperformed and have a material adverse effect on our business, financial condition, results of operations or cash flow.22Table of ContentsIF WE FAIL TO SUCCESSFULLY ACQUIRE OR INTEGRATE NEW BUSINESSES, PRODUCTS AND TECHNOLOGY, WE MAY NOT REALIZEEXPECTED BENEFITS OR OUR BUSINESS MAY BE HARMED.We need to grow our businesses in response to changing technologies, customer demands and competitive pressures. In some circumstances, we maydecide to grow our business through the acquisition of complementary businesses, products or technologies rather than through internal development. Forexample, we acquired certain intellectual property, know-how, and employees from Luna Innovations, Inc. in January 2014 and reacquired the Japandistribution rights from our Japanese distributor in June 2014. If we are unable to effectively transition the sales, marketing, regulatory and other operationalfunctions in Japan, our Japanese business could be disrupted.Identifying suitable acquisition candidates can be difficult, time-consuming and costly, and we may not be able to identify suitable candidates orsuccessfully complete identified acquisitions. In addition, completing an acquisition can divert our management and key personnel from our businessoperations, which could harm our business and affect our financial results. Even if we complete an acquisition, we may not be able to successfully integratenewly acquired organizations, products, technologies or employees into our operations, or may not fully realize some of the expected synergies. An acquiredcompany may have deficiencies in product quality or regulatory marketing authorizations which are not detected during due diligence activities or which areunasserted at the time of acquisition. It may be difficult, expensive and time consuming for us to re-establish market access, regulatory compliance or curesuch deficiencies in product quality in such cases.Integrating an acquisition can also be expensive and time-consuming, and may strain our resources. In many instances, integrating a new business willalso involve implementing or improving internal controls appropriate for a public company at a business that lacks them. In addition, we may be unable toretain the employees of acquired companies, or the acquired company’s customers, suppliers, distributors or other partners for a variety of reasons, includingthat these entities may be our competitors or may have close relationships with our competitors.CHANGES TO FINANCIAL ACCOUNTING STANDARDS MAY AFFECT OUR REPORTED RESULTS OF OPERATIONS.A change in accounting standards or practices can have a significant effect on our reported results and may even affect our reporting of transactionscompleted before the change is effective. New accounting pronouncements and varying interpretations of accounting pronouncements have occurred andmay occur in the future. Changes to existing standards or the reevaluation of current practices may adversely affect our reported financial results or the waywe conduct our business.WE USE ESTIMATES, MAKE JUDGMENTS AND APPLY CERTAIN METHODS IN MEASURING THE PROGRESS OF OUR BUSINESS INDETERMINING OUR FINANCIAL RESULTS AND IN APPLYING OUR ACCOUNTING POLICIES. AS THESE ESTIMATES, JUDGMENTS, ANDMETHODS CHANGE, OUR ASSESSMENT OF THE PROGRESS OF OUR BUSINESS AND OUR RESULTS OF OPERATIONS COULD VARY.The methods, estimates, and judgments we use in applying our accounting policies have a significant impact on our results of operations. Such methods,estimates, and judgments are, by their nature, subject to substantial risks, uncertainties and assumptions, and factors may arise over time may lead us tochange our methods, estimates, and judgments. Changes in any of our assumptions may adversely affect our reported financial results.In addition, we utilize methods for determining surgical market sizes and number of da Vinci procedures completed that involve estimates andjudgments, which are, by their nature, subject to substantial risks, uncertainties, and assumptions. Our estimates of surgical market sizes or number of daVinci procedures performed do not have an impact on our results of operations but are used to estimate the progress of our business. Estimates and judgmentsfor determining surgical market sizes and number of da Vinci procedures may vary over time with changes in treatment modalities, hospital reportingbehavior, increases in procedures per field employee and other factors. In addition, from time to time, we may change the method for determining marketsizes and number of da Vinci procedures, causing variation in our reporting.CHANGES IN OUR EFFECTIVE TAX RATE MAY IMPACT OUR RESULTS OF OPERATIONSA number of factors may impact our future effective tax rate including:•the jurisdictions in which profits are determined to be earned and taxed;•the resolution of issues arising from tax audits with various tax authorities;•changes in valuation of our deferred tax assets and liabilities;•increases in expenses not deductible for tax purposes, including write-offs of acquired intangibles and impairment of goodwill in connectionwith acquisitions;•changes in available tax credits and deductions;•changes in share-based compensation;23Table of Contents•changes in tax laws or the interpretation of such tax laws and changes in generally accepted accounting principles; and•the repatriation of non-U.S. earnings for which we have not previously provided for U.S. taxes.Any significant increase in our future effective tax rate could harm net income for future periods.DISRUPTION OF CRITICAL INFORMATION SYSTEMS OR MATERIAL BREACHES IN THE SECURITY OF OUR SYSTEMS COULD HARMOUR BUSINESS, CUSTOMER RELATIONS AND FINANCIAL CONDITION.Information technology helps us operate efficiently, interface with customers, maintain financial accuracy and efficiency and accurately produce ourfinancial statements. If we do not allocate and effectively manage the resources necessary to build and sustain the proper technology infrastructure, we couldbe subject to transaction errors, processing inefficiencies, the loss of customers, business disruptions or the loss of or damage to intellectual property throughsecurity breach. If our data management systems do not effectively collect, store, process and report relevant data for the operation of our business, whetherdue to equipment malfunction or constraints, software deficiencies or human error, our ability to effectively plan, forecast and execute our business plan andcomply with applicable laws and regulations will be impaired, perhaps materially. Any such impairment could materially and adversely affect our financialcondition, results of operations, cash flows and the timeliness with which we report our internal and external operating results.Our business requires us to use and store customer, employee and business partner personally identifiable information (“PII”). This may include names,addresses, phone numbers, email addresses, contact preferences, tax identification numbers and payment account information. We require user names andpasswords in order to access our information technology systems. We also use encryption and authentication technologies to secure the transmission andstorage of data. These security measures may be compromised as a result of third-party security breaches, employee error, malfeasance, faulty passwordmanagement or other irregularity, and result in persons obtaining unauthorized access to our data or accounts. Third parties may attempt to fraudulentlyinduce employees or customers into disclosing user names, passwords or other sensitive information, which may in turn be used to access our informationtechnology systems.While we devote significant resources to network security, data encryption and other security measures to protect our systems and data, these securitymeasures cannot provide absolute security. We may experience a breach of our systems and may be unable to protect sensitive data. The costs to us toeliminate or alleviate network security problems, bugs, viruses, worms, malicious software programs and security vulnerabilities could be significant, and ourefforts to address these problems may not be successful and could result in unexpected interruptions, delays, cessation of service and may harm our businessoperations. Moreover, if a computer security breach affects our systems or results in the unauthorized release of PII, our reputation and brand could bematerially damaged and use of our products and services could decrease. We would also be exposed to a risk of loss or litigation and potential liability,which could result in a material adverse effect on our business, results of operations and financial condition.RISKS RELATING TO OUR REGULATORY ENVIRONMENTRECENTLY ENACTED HEALTHCARE LEGISLATION REFORMING THE U.S. HEALTHCARE SYSTEM, AS WELL AS FUTURE REFORMS,MAY HAVE A MATERIAL ADVERSE EFFECT ON OUR FINANCIAL CONDITION AND RESULTS OF OPERATIONS.In March 2010, the U.S. President signed the Patient Protection and Affordable Care Act, as amended by the Health Care and Education ReconciliationAct (collectively, the "PPACA"), which makes changes that are expected to significantly impact the pharmaceutical and medical device industries. One of theprincipal aims of the PPACA as currently enacted is to expand health insurance coverage to approximately 32 million Americans who are currentlyuninsured. The consequences of these significant coverage expansions on the sales of our products are unknown and speculative at this point.The PPACA contains a number of provisions designed to generate the revenues necessary to fund the coverage expansions among other things. Thisincludes new fees or taxes on certain health-related industries, including medical device manufacturers. Beginning in 2013, medical device manufacturerswere required to pay an excise tax (or sales tax) of 2.3% of certain U.S. medical device revenues. Though there are some exceptions to the excise tax, thisexcise tax does apply to all or most of our products sold within the United States. The PPACA also establishes a new Patient-Centered Outcomes ResearchInstitute to oversee and identify priorities in comparative clinical effectiveness research in an effort to coordinate and develop such research; implementspayment system reforms including a national pilot program on payment bundling to encourage hospitals, physicians, and other providers to improve thecoordination, quality, and efficiency of certain healthcare services through bundled payment models; and creates an independent payment advisory boardthat will submit recommendations to reduce Medicare spending if projected Medicare spending exceeds a specified growth rate.The PPACA provisions on comparative clinical effectiveness research also extend the initiatives of the American Recovery and Reinvestment Act of2009, known as the stimulus package, which included $1.1 billion in funding to study the comparative effectiveness of health care treatments and strategies.This stimulus funding was designated for, among other things, conducting, supporting or reviewing research that compares and evaluates the risks andbenefits, clinical outcomes, effectiveness and appropriateness of products. The PPACA appropriates additional funding to comparative clinical effectivenessresearch. Although Congress has indicated that this funding is intended to improve the quality of health care, it remains unclear how the research will impactcurrent Medicare coverage and reimbursement or how new information will influence other third-party payor policies. The taxes imposed by the PPACA andthe expansion in the government’s role in the U.S. healthcare industry may result in decreased24Table of Contentsprofits to us, lower reimbursement by payors for our products, and/or reduced medical procedure volumes, all of which may adversely affect our business,financial condition and results of operations.In addition, other legislative changes have been proposed and adopted since the PPACA was enacted. More recently, on August 2, 2011, the U.S.President signed into law the Budget Control Act of 2011, which, among other things, creates the Joint Select Committee on Deficit Reduction to recommendproposals in spending reductions to Congress. The Joint Select Committee did not achieve a targeted deficit reduction of at least $1.2 trillion for the years2013 through 2021, triggering the legislation’s automatic reduction to several government programs. This included aggregate reductions to Medicarepayments to providers of 2% per fiscal year, which went into effect on April 1, 2013, and will remain in effect through 2024 unless additional Congressionalaction is taken. On January 2, 2013, the American Taxpayer Relief Act of 2012 was signed into law, which, among other things, further reduced Medicarepayments to several providers, including hospitals, imaging centers and cancer treatment centers, and increased the statute of limitations period for thegovernment to recover overpayments to providers from three to five years.We expect that additional state and federal health care reform measures may be adopted in the future, any of which could have a material adverse effecton our industry generally and our ability to successfully commercialize our products or could limit or eliminate our spending on certain developmentprojects.The U.S. government has in the past considered, is currently considering and may in the future consider healthcare policies and proposals intended tocurb rising healthcare costs, including those that could significantly affect both private and public reimbursement for healthcare services. State and localgovernments, as well as a number of foreign governments, are also considering or have adopted similar types of policies. Future significant changes in thehealthcare systems in the United States or elsewhere, and current uncertainty about whether and how changes may be implemented, could have a negativeimpact on the demand for our products. We are unable to predict whether other healthcare policies, including policies stemming from legislation orregulations affecting our business may be proposed or enacted in the future; what effect such policies would have on our business; or the effect ongoinguncertainty about these matters will have on the purchasing decisions of our customers.WE ARE SUBJECT TO FEDERAL, STATE AND FOREIGN LAWS GOVERNING OUR BUSINESS PRACTICES WHICH, IF VIOLATED, COULDRESULT IN SUBSTANTIAL PENALTIES. ADDITIONALLY, CHALLENGES TO OR INVESTIGATION INTO OUR PRACTICES COULD CAUSEADVERSE PUBLICITY AND BE COSTLY TO RESPOND TO AND THUS COULD HARM OUR BUSINESS.The Dodd-Frank Wall Street Reform and Consumer Protection Act requires us to track and disclose the source of any tantalum, tin, gold, and tungstenused in manufacturing which may originate in the Democratic Republic of the Congo or adjoining regions (so called “conflict minerals”). These metals arecentral to the technology industry and are present in some of our products as component parts. In most cases no acceptable alternative material exists whichhas the necessary properties. Because it is not possible to determine the source of the metals by analysis, we must obtain a good faith description of the sourceof the intermediate components and raw materials from parties in our supply chain. The components that incorporate those metals may originate from manysources and we purchase fabricated products from manufacturers who may have a long and difficult-to-trace supply chain. As the spot price of these materialsvaries, producers of the metal intermediates can be expected to change the mix of sources used. Accordingly, components and assemblies we buy may have amix of sources as their origin. We are required to carry out a diligent effort to determine and disclose the source of these materials. There can be no assurancewe can obtain this information accurately or reliably, or at all, from intermediate producers who may be unwilling or unable to provide this information orfurther identify their sources of supply or to notify us if these sources change. In addition, these metals are subject to price fluctuations and shortages whichcan affect our ability to obtain the manufactured materials we rely on at favorable terms or from consistent sources. These changes could have an adverseimpact on our ability to manufacture and market our devices and products.The Medicare and Medicaid anti-kickback laws, and several similar state laws that may apply to items or services reimbursed by any third-party payor,including commercial insurers, prohibit payments or other remuneration that could be considered to induce hospitals, physicians or other potentialpurchasers of our products either to refer patients or to purchase, lease or order, or arrange for or recommend the purchase, lease or order, of healthcareproducts or services for which payment may be made under federal and state healthcare programs, such as Medicare and Medicaid. Further, the PPACA,among other things, amends the intent requirement of the federal anti-kickback and criminal health care fraud statutes. A person or entity no longer needs tohave actual knowledge of this statute or specific intent to violate it. In addition, the PPACA provides that the government may assert that a claim includingitems or services resulting from a violation of the federal anti-kickback statute constitutes a false or fraudulent claim for purposes of the false claims statutes.These laws may affect our sales, marketing and other promotional activities by limiting the kinds of financial arrangements we may have with hospitals,physicians or other potential purchasers of our products. They particularly impact how we structure our sales offerings, including discount practices, customersupport, education and training programs, physician consulting and other service arrangements. These laws are broadly written, and it is often difficult todetermine precisely how these laws will be applied to specific circumstances. Violating anti-kickback laws can result in civil and criminal penalties, whichcan be substantial and include exclusion from government healthcare programs for noncompliance. Even an unsuccessful challenge or investigation into ourpractices could cause adverse publicity, and be costly to defend, and thus could harm our business and results of operations.25Table of ContentsThe PPACA also imposes new reporting and disclosure requirements on device manufacturers for any “transfer of value” made or distributed toprescribers and other healthcare providers. Such information must be made publicly available in a searchable format. In addition, device manufacturers willalso be required to report and disclose any ownership or investment interests held by physicians and their immediate family members, as well as any transfersof value made to such physician owners and investors, during the preceding calendar year. Failure to submit required information may result in civilmonetary penalties of up to an aggregate of $150,000 per year (and up to an aggregate of $1 million per year for “knowing failures”), for all payments,transfers of value or ownership or investment interests not reported in an annual submission. Device manufacturers will be required to submit reports to CMSby the 90th day of each calendar year.In addition, there has been a recent trend of increased federal and state regulation of payments made to physicians, including the tracking and reportingof gifts, compensation and other remuneration to physicians. Certain states mandate implementation of commercial compliance programs to ensurecompliance with these laws, impose restrictions on device manufacturer marketing practices and/or require the tracking and reporting of gifts, compensationand other remuneration to physicians. The shifting commercial compliance environment and the need to build and maintain robust and expandable systemsto comply with multiple jurisdictions with different compliance and/or reporting requirements increases the possibility that a healthcare company may befound out of compliance of one or more of the requirements, subjecting us to significant civil monetary penalties.Compliance with complex foreign and U.S. laws and regulations that apply to our international operations increases our cost of doing business ininternational jurisdictions and could expose us or our employees to fines and penalties in the United States and/or abroad. These numerous and sometimesconflicting laws and regulations include U.S. laws such as the Foreign Corrupt Practices Act, and similar laws in foreign countries, such as the U.K. BriberyAct of 2010, which became effective on July 1, 2011. Violations of these laws and regulations could result in fines, criminal sanctions against us, our officersor our employees, prohibitions on the conduct of our business and damage to our reputation. Although we have implemented policies and proceduresdesigned to ensure compliance with these laws, there can be no assurance that our employees, contractors or agents will not violate our policies.OUR PRODUCTS ARE SUBJECT TO A LENGTHY AND UNCERTAIN DOMESTIC REGULATORY REVIEW PROCESS. IF WE DO NOT OBTAINAND MAINTAIN THE NECESSARY DOMESTIC REGULATORY AUTHORIZATIONS, WE WILL NOT BE ABLE TO PROVIDE OUR PRODUCTSIN THE UNITED STATES.Our products and operations are subject to extensive regulation in the United States by the U.S. Food and Drug Administration (“FDA”). The FDAregulates the development, bench and clinical testing, manufacturing, labeling, storage, record keeping, promotion, sales, distribution and postmarketsupport and reporting of medical devices in the United States to ensure that medical products distributed domestically are safe and effective for their intendeduses. In order for us to market certain products for use in the United States, we generally must first obtain clearance from the FDA pursuant to Section 510(k)of the Federal Food Drug and Cosmetic Act (“FFDCA”). Clearance under Section 510(k) requires demonstration that a new device is substantially equivalentto another device with 510(k) clearance or grandfathered (“pre-amendment”) status. If we significantly modify our products after they receive FDA clearance,the FDA may require us to submit a separate 510(k) or premarket approval application (“PMA”) for the modified product before we are permitted to marketthe products in the United States. In addition, if we develop products in the future that are not considered to be substantially equivalent to a device with510(k) clearance or grandfathered status, we will be required to obtain FDA approval by submitting a PMA. The FDA may not act favorably or quickly in itsreview of our 510(k) or PMA submissions, or we may encounter significant difficulties and costs in our efforts to obtain FDA clearance or approval, all ofwhich could delay or preclude sale of new products in the United States. Furthermore, the FDA may request additional data or require us to conduct furthertesting, or compile more data, including clinical data and clinical studies, in support of a 510(k) submission. Regulatory policy affecting our products canchange at any time. The changes and their impact on our business cannot be accurately predicted. For example, in 2011, the FDA announced a Plan of Actionto modernize and improve the FDA’s premarket review of medical devices, and has implemented, and continues to implement, reforms intended to streamlinethe premarket review process. In addition, as part of the Food and Drug Administration Safety and Innovation Act of 2012 ("FDASIA"), Congress enactedseveral reforms entitled the Medical Device Regulatory Improvements and additional miscellaneous provisions which will further affect medical deviceregulation both pre- and post-approval. Changes in the FDA 510(k) process could make approval more difficult to obtain, increase delay, add uncertainty andhave other significant adverse effects on our ability to obtain and maintain approval for our products. The FDA may also, instead of accepting a 510(k)submission, require us to submit a PMA, which is typically a much more complex, lengthy and burdensome application than a 510(k). To support a PMA, theFDA would likely require that we conduct one or more clinical studies to demonstrate that the device is safe and effective. In some cases such studies may berequested for a 510(k) as well. We may not be able to meet the requirements to obtain 510(k) clearance or PMA approval, in which case the FDA may notgrant any necessary clearances or approvals. In addition, the FDA may place significant limitations upon the intended use of our products as a condition to a510(k) clearance or PMA approval. Product applications can also be denied or withdrawn due to failure to comply with regulatory requirements or theoccurrence of unforeseen problems following clearance or approval. Any delays or failure to obtain FDA clearance or approvals of new products we develop,any limitations imposed by the FDA on new product use, or the costs of obtaining FDA clearance or approvals could have a material adverse effect on ourbusiness, financial condition and results of operations.26Table of ContentsIn order to conduct a clinical investigation involving human subjects for the purpose of demonstrating the safety and effectiveness of a medical device, acompany must, among other things, apply for and obtain Institutional Review Board (“IRB”) approval of the proposed investigation. In addition, if theclinical study involves a “significant risk” (as defined by the FDA) to human health, the sponsor of the investigation must also submit and obtain FDAapproval of an Investigational Device Exemption (“IDE”) application. Many of our products to date have been or would be considered significant riskdevices requiring IDE approval prior to investigational use. We may not be able to obtain FDA and/or IRB approval to undertake clinical trials in the UnitedStates for any new devices we intend to market in the United States in the future. If we obtain such approvals, we may not be able to conduct studies whichcomply with the IDE and other regulations governing clinical investigations or the data from any such trials may not support clearance or approval of theinvestigational device. Failure to obtain such approvals or to comply with such regulations could have a material adverse effect on our business, financialcondition and results of operations. Certainty that clinical trials will meet desired endpoints, produce meaningful or useful data and be free of unexpectedadverse effects, or that the FDA will accept the validity of foreign clinical study data cannot be assured, and such uncertainty could preclude or delay marketclearance or authorizations resulting in significant financial costs and reduced revenue.In addition, some products may be regulated by the FDA as drugs, biologics or combination devices which carry still greater requirements for clinicaltrials, regulatory submissions and approvals.COMPLYING WITH FDA REGULATIONS IS A COMPLEX PROCESS, AND OUR FAILURE TO COMPLY FULLY COULD SUBJECT US TOSIGNIFICANT ENFORCEMENT ACTIONS.Because our products, including the da Vinci Surgical System, are commercially distributed, numerous quality and postmarket regulatory requirementsapply, including the following:•continued compliance to the QSR, which requires manufacturers to follow elaborate design, testing, control, documentation and other qualityassurance procedures during the development and manufacturing process;•labeling regulations;•the FDA’s general prohibition against false or misleading statements in the labeling or promotion of products for unapproved or “off-label”uses;•stringent complaint reporting and Medical Device Reporting regulations, which requires that manufacturers keep detailed records ofinvestigations or complaints against their devices and to report to the FDA if their device may have caused or contributed to a death or seriousinjury or malfunctioned in a way that would likely cause or contribute to a death or serious injury if it were to recur;•adequate use of the Corrective and Preventive Actions process to identify and correct or prevent significant systemic failures of products orprocesses or in trends which suggest same; and•the reporting of Corrections and Removals, which requires that manufacturers report to the FDA recalls and field corrective actions taken toreduce a risk to health or to remedy a violation of the FFDCA that may pose a risk to health.We are subject to inspection and marketing surveillance by the FDA to determine our compliance with regulatory requirements. If the FDA finds that wehave failed to comply, it can institute a wide variety of enforcement actions, ranging from inspectional observations (Form FDA 483) to a public WarningLetter to more severe civil and criminal sanctions including the seizure of our products and equipment or ban on the import or export of our products. Ourfailure to comply with applicable requirements could lead to an enforcement action that may have an adverse effect on our financial condition and results ofoperations.Any modification or change of medical devices cleared for market requires the manufacturer to make a determination whether the change is significantenough to require new 510(k) clearance. We have created labeling, advertising and user training for the da Vinci Surgical System to describe specific surgicalprocedures that we believe are fully within the scope of our existing 510(k) indications for use stated in our 510(k) clearances. Although we have relied onexpert in-house and external staff, consultants and advisors, many of whom were formerly employed by FDA and familiar with FDA requirements, we cannotassure that the FDA would agree that all such specific procedures are within the scope of the existing general clearance or that we have compiled adequateinformation to support the safety and efficacy of using the da Vinci Surgical System for all such specific procedures. We also have modified the hardware andsoftware in the da Vinci Surgical System since obtaining 510(k) clearance in ways that we do not believe require new 510(k) clearance. We cannot assure thatthe FDA would agree in all cases with our determinations not to seek new 510(k) clearance for any of these changes. Computer Motion, which we acquired in2003, also modified the hardware and software in its products subsequent to 510(k) clearance without seeking new clearance. The FDA could imposeenforcement sanctions and/or require us to obtain 510(k) clearance for any modification to our products or Computer Motion’s products. We may beprohibited from marketing the modified device until such 510(k) clearance is granted.An FDA inspection of our facilities occurred in April-May 2013, and the FDA issued a Form FDA 483 listing four observations relating to the reportingof field corrections, information which is to be included on reports of field corrections, written procedures for changes to certain product labeling, and designinput documentation. We responded to each observation with corrective actions27Table of Contentsduring the course of the inspection and provided additional evidence of corrective actions to the FDA in response to the Form FDA 483. The FDA issued aWarning Letter, dated July 16, 2013, related to two of the four Form FDA 483 observations asking for additional corrective actions and indicated their intentto perform a follow-up inspection. In addition, the FDA collected electronic samples of all our advertising and promotional material for review, and to datehave taken no action in connection therewith. We responded to the Warning Letter, communicating corrective actions taken. The FDA re-inspected ourfacilities during February-March of 2014 to complete a general quality system audit as well as a review of the status of the Warning Letter and 483remediation activities. At the end of the inspection, the FDA issued a Form FDA 483 listing five observations related to quality management systemimprovement opportunities. We responded to the FDA with a corrective action plan for those observations. On April 25, 2014, we received a closure letterfrom the FDA stating that the observations in the July 16, 2013 Warning Letter have been addressed. However, we cannot assure that the FDA will not findother observations in future inspections. The FDA previously inspected our Sunnyvale, California facilities in January 2012 and did not issue a Form FDA483 as a result of this inspection.The receipt of a Warning Letter places certain limits on the ability to obtain FDA issued Certificates to Foreign Government (“CFGs”) used for new andre-registration of products in certain foreign countries.We have a wholly owned manufacturing facility located in Mexicali, Mexico which manufactures reusable and disposable surgical instruments. Thisfacility is registered with the FDA as well as Mexican authorities. The facility is operated under U.S. and international quality system regulations includingthose applicable to Canada, the European Union and Japan among others. Our wholly owned manufacturing facility in Mexicali, Mexico has an FDAEstablishment Registration but has not been FDA inspected to date. If the FDA were to determine non-conformances in our product documentation or qualitysystem compliance, they could hold indefinitely the importation of instruments at the border which would deprive us of the ability to sell and supply themajority of our customers until the FDA requirements have been satisfied. Similar supply disruptions could occur if key suppliers outside of U.S. were toencounter non-conformances with their documentation or quality system compliance. Please see our risk factor below titled “If Our Manufacturing Facilitiesdo not Continue to Meet Federal, State or Other Manufacturing Standards, We May Be Required to Temporarily Cease All or Part of Our ManufacturingOperations, Import/Export of Our Products and/or Recall Some Products Which Would Result in Significant Product Delivery Delays and Lost Revenue” foradditional risks related to the potential effects of our expansion of our manufacturing space in Mexicali, Mexico.OUR PRODUCTS ARE SUBJECT TO VARIOUS INTERNATIONAL REGULATORY PROCESSES AND APPROVAL REQUIREMENTS. IF WE DONOT OBTAIN AND MAINTAIN THE NECESSARY INTERNATIONAL REGULATORY APPROVALS, WE WILL NOT BE ABLE TO PROVIDEOUR PRODUCTS IN FOREIGN COUNTRIES.To be able to provide our products in other countries, we must obtain regulatory approvals and comply with the regulations of those countries whichmay differ substantially from those of the United States. These regulations, including the requirements for approvals and the time required for regulatoryreview, vary from country to country. Obtaining and maintaining foreign regulatory approvals is complex, and we cannot be certain that we will receiveregulatory approvals in any foreign country in which we plan to market our products, or to obtain such approvals on a favorable schedule. If we fail to obtainor maintain regulatory approval in any foreign country in which we plan to market our products, our ability to generate revenue will be harmed. In particular,if the FDA refuses to provide CFGs our ability to register products or renew such registrations may be delayed or denied.The EU requires that manufacturers of medical products obtain the right to affix the CE mark to their products before selling them in member countries ofthe EU. The CE mark is an international symbol of adherence to quality assurance standards and compliance with applicable European medical devicedirectives. In order to obtain the authorization to affix the CE mark to products, a manufacturer must obtain certification that its processes meet certainEuropean quality standards. In January 1999, we received permission to affix the CE mark to our da Vinci Surgical System and EndoWrist instruments andhave maintained this authorization continuously since that time. From time to time we seek the authorization to affix the CE mark to new or modifiedproducts. Subsequent products and accessories have received marketing authorization by our Notified Body, DGM. In September 2013, we received noticethat DGM has changed their name to PreSafe following acquisition by a larger Notified Body. The change did not have a significant impact on our operationsother than replacement of various quality system certificates with the new name.As we modify existing products or develop new products in the future, including new instruments, we currently plan to apply for authorization to affixthe CE mark to such products. In addition, we will be subject to annual regulatory audits in order to maintain the CE mark authorizations we have alreadyobtained including inspection of our compliance to required standards and directives to enable this path to CE marking. We cannot be certain we will be ableto affix the CE mark for new or modified products or that we will continue to meet the quality and performance standards required to maintain theauthorizations we have already received. If we are unable to maintain permission to affix the CE mark to our products, we will no longer be able to sell ourproducts in member countries of the EU and many affiliated countries that accept the CE mark, which would have a material adverse effect on our results ofoperations. Some member states of the European Union have additional requirements for registration and notification which may add to the time and effort toobtain market access. In addition, the regulations applied to end users28Table of Contentsof our products may increase over time, forcing us to provide additional solutions to regulations which do not apply directly to us, but which apply indirectlyas they may limit our customers’ ability to use our products.In November 2009, we received Shonin approval from the Japanese Ministry of Health, Labor and Welfare (“MHLW”) for our da Vinci S Surgical Systemand in October 2012, we received approval for our da Vinci Si system and various associated instruments and accessories for use in certain da Vinciprocedures. We may seek additional approvals for other products and/or procedures, however, there can be no assurance that such approvals will be granted.In addition, because only a subset of our instruments has received Shonin approval, and reimbursement is an additional process to generate marketacceptance, it is possible that approved procedures will be adopted slowly or not at all. Sales of our products depend, in part, on the extent to which the costsof our products are reimbursed by governmental health administration authorities. To date, we have received reimbursement approval for prostatectomy inJapan. There are multiple pathways to obtain reimbursement for procedures including those require in-country clinical data and which are considered forreimbursed status in April of even numbered years. If we are not successful in obtaining the necessary reimbursement approvals or obtaining approvals forfuture products and procedures, then the demand for our products could be limited. These limitations could eliminate a significant market opportunity for ourproducts in Japan. In addition, in January 2012 we acquired certain assets of our distributor in Korea, Bio-Robotics. Our products are highly regulated inKorea and we face many of the same risks and limitations on the commercialization of our products as in Japan and the United States.IF OUR MANUFACTURING FACILITIES DO NOT CONTINUE TO MEET FEDERAL, STATE OR OTHER MANUFACTURING STANDARDS, WEMAY BE REQUIRED TO TEMPORARILY CEASE ALL OR PART OF OUR MANUFACTURING OPERATIONS, IMPORT/EXPORT OF OURPRODUCTS AND/OR RECALL SOME PRODUCTS WHICH WOULD RESULT IN SIGNIFICANT PRODUCT DELIVERY DELAYS AND LOSTREVENUE.Our manufacturing facilities are subject to periodic inspection by regulatory authorities and our operations will continue to be regulated and inspectedby the FDA and other regulatory agencies for compliance with Good Manufacturing Practice requirements contained in the QSR and other regulatoryrequirements. We are also required to comply with International Organization for Standardization (“ISO”) quality system standards as well as EuropeanDirectives and norms in order to produce products for sale in the European Union. In addition, many countries such as Canada and Japan have very specificadditional regulatory requirements for quality assurance and manufacturing. If we fail to continue to comply with Good Manufacturing Practice requirements,as well as ISO or other regulatory standards, we may be required to cease all or part of our operations until we comply with these regulations.We continue to be subject to FDA and certain other inspections at any time. Maintaining such compliance is difficult and costly. We cannot be certainthat our facilities will be found to comply with Good Manufacturing Practice requirements or ISO standards and other regulatory requirements in futureinspections and audits by regulatory authorities.Our Sunnyvale, California facility is licensed by the State of California to manufacture medical devices. We have been subject to periodic inspections bythe California Department of Health Services Food and Drug Branch and, if we are unable to maintain this license following any future inspections, we willbe unable to manufacture or ship some products, which would have a material adverse effect on our results of operations. In 2012 the State of Californiaannounced suspension of routine inspections but this policy could be modified or inspections could be resumed for specific circumstances. In addition, bothour Sunnyvale, California and Mexicali, Mexico facilities are subject to periodic inspections by other regulatory bodies, including third party auditors onbehalf of national regulatory authorities. Compliance with multiple regulatory standards is complex, difficult and costly to maintain, and materialdeficiencies could result in significant limitations on our ability to manufacture, transport and sell our products in one or more countries.IF HOSPITALS AND OTHER SURGERY FACILITIES DO NOT CONTINUE TO MEET FEDERAL, STATE OR OTHER REGULATORYSTANDARDS, THEY MAY BE REQUIRED TO TEMPORARILY CEASE ALL OR PART OF THEIR DA VINCI UTILIZATION.Our global customers are subject to periodic inspection by regulatory authorities. Our customers are required to comply with applicable local andinternational regulations, including with respect to the reprocessing of da Vinci instruments and accessories. Hospitals may not follow cleaning andsterilization instructions properly. Equipment used for cleaning and sterilization may malfunction or be used improperly. If our customers deviate fromcleaning and sterilization instructions, regulatory authorities may require them to suspend use of da Vinci Surgical Systems.RISKS RELATING TO OUR INTELLECTUAL PROPERTYIF WE ARE UNABLE TO REPLACE OUR PATENTS BY THE TIME THEY EXPIRE OR TO FULLY PROTECT OUR INTELLECTUALPROPERTY FROM USE BY THIRD PARTIES, OUR ABILITY TO COMPETE IN THE MARKET WILL BE HARMED.We believe new competitors will emerge in medical robotics. We also do not know whether we will be able to develop additional patentable proprietarytechnologies as older patents expire. Our commercial success will depend in part on obtaining29Table of Contentspatent and other intellectual property protection for the technologies contained in our products, and on successfully defending our patents and otherintellectual property against third-party challenges. We will incur substantial costs in obtaining patents and, if necessary, defending our proprietary rights.The patent positions of medical device companies, including ours, can be highly uncertain and involve complex and evolving legal and factual questions.We do not know whether we will obtain the patent protection we seek, or that the protection we do obtain will be found valid and enforceable if challenged.We also do not know whether we will be able to develop additional patentable proprietary technologies. We may also determine that it is in our best intereststo voluntarily challenge a third party’s products or patents in litigation or administrative proceedings, including patent interferences or reexaminations.Furthermore, the laws of certain foreign countries do not protect intellectual property rights to the same extent as do the laws of the United States.In addition to patents, we typically rely on a combination of trade secret, copyright and trademark laws, nondisclosure agreements and other contractualprovisions and technical security measures to protect our intellectual property rights. Nevertheless, these measures may not be adequate to safeguard thetechnology underlying our products. If these measures do not protect our rights adequately, third parties could use our technology, and our ability tocompete in the market would be reduced. In addition, employees, consultants and others who participate in developing our products may breach theiragreements with us regarding our intellectual property, and we may not have adequate remedies for the breach. We also may not be able to effectively protectour intellectual property rights in some foreign countries. For a variety of reasons, we may decide not to file for patent, copyright or trademark protectionoutside the United States. We also realize that our trade secrets may become known through other means not currently foreseen by us. Notwithstanding ourefforts to protect our intellectual property, our competitors may independently develop similar or alternative technologies or products that are equal orsuperior to our technology and products without infringing any of our intellectual property rights, or may design around our proprietary technologies, whichwould harm our ability to compete in the market.OTHERS MAY ASSERT THAT OUR PRODUCTS INFRINGE THEIR INTELLECTUAL PROPERTY RIGHTS, WHICH MAY CAUSE US TOENGAGE IN COSTLY DISPUTES AND, IF WE ARE NOT SUCCESSFUL IN DEFENDING OURSELVES, COULD ALSO CAUSE US TO PAYSUBSTANTIAL DAMAGES AND PROHIBIT US FROM SELLING OUR PRODUCTS.There may be U.S. and foreign patents issued to third parties that relate to our products. Some of these patents may be broad enough to cover one or moreaspects of our present or future technology. We do not know whether any of these patents, if challenged, would be held valid, enforceable and infringed.From time to time, we receive, and likely will continue to receive, letters from third parties accusing us of infringing and/or inviting us to license theirpatents. We may be sued by, or become involved in an administrative proceeding with, one or more of these third parties.We cannot assure that a court or administrative body would agree with any arguments or defenses we may have concerning invalidity, unenforceabilityor non-infringement of any third-party patent. In addition to the issued patents of which we are aware, other parties may have filed, and in the future are likelyto file, patent applications covering products that are similar or identical to ours. We cannot assure that any patents issuing from applications filed by a thirdparty will not cover our products or will not have priority over our patent applications.The medical device industry has been characterized by extensive litigation and administrative proceedings regarding patents and other intellectualproperty rights, and companies have employed such actions to gain a competitive advantage. If third parties assert infringement or other intellectual propertyclaims against us, our technical and management personnel will experience a significant diversion of time and effort and we will incur large expensesdefending our Company. If third parties in any patent action are successful, our patent portfolio may be damaged, we may have to pay substantial damages,including treble damages, and we may be required to stop selling our products or obtain a license which, if available at all, may require us to pay substantialroyalties. We cannot be certain that we will have the financial resources or the substantive arguments to defend our patents from infringement or claims ofinvalidity or unenforceability, or to defend against allegations of infringement of third-party patents. In addition, any public announcements related tolitigation or administrative proceedings initiated by us, or initiated or threatened against us, could cause our stock price to decline.OUR PRODUCTS RELY ON LICENSES FROM THIRD PARTIES, AND IF WE LOSE ACCESS TO THESE TECHNOLOGIES, OUR REVENUESCOULD DECLINE.We rely on technology that we license from others, including technology that is integral to our products. We have entered into license agreements withseveral industry partners. Any of these agreements may be terminated for breach. If any of these agreements are terminated, we may be unable to reacquire thenecessary license on satisfactory terms, or at all. The loss or failure to maintain these licenses could prevent or delay further development orcommercialization of our products, which would have a material adverse effect on our results of operations.30Table of ContentsRISKS RELATING TO OUR TRADING MARKETSOUR FUTURE OPERATING RESULTS MAY BE BELOW SECURITIES ANALYSTS’ OR INVESTORS’ EXPECTATIONS, WHICH COULD CAUSEOUR STOCK PRICE TO DECLINE.Due to the nascent nature of our industry, we have limited insight into trends that may emerge in our market and affect our business. The revenue andincome potential of our market are unproven, and we may be unable to continue to generate significant revenues. Our products typically have a lengthy salescycle. In addition, our costs may be higher than we anticipated. If we fail to generate sufficient revenues or our costs are higher than we expect, our results ofoperations will suffer. Further, future revenue from sales of our products is difficult to forecast because the market for new surgical technologies is stillevolving. Our results of operations will depend upon numerous factors, including:•the extent to which our products achieve and maintain market acceptance;•actions relating to regulatory matters;•our timing and ability to develop our manufacturing and sales and marketing capabilities;•demand for our products;•the size and timing of particular sales and any collection delays related to those sales;•product quality and supply problems;•the progress of surgical training in the use of our products;•our ability to develop, introduce and market new or enhanced versions of our products on a timely basis;•third-party payor reimbursement policies;•our ability to protect our proprietary rights and defend against third party challenges;•our ability to license additional intellectual property rights; and•the progress and results of clinical trials.Our operating results in any particular period will not be a reliable indication of our future performance. It is likely that in some future quarters, ouroperating results will be below the expectations of securities analysts or investors. If this occurs, the price of our common stock, and the value of yourinvestment, will likely decline.OUR STOCK PRICE HAS BEEN, AND WILL LIKELY CONTINUE TO BE, VOLATILE.The market price of our common stock has experienced fluctuations and is likely to fluctuate significantly in the future. For example, during fiscal 2011,the NASDAQ closing price of one share of our common stock reached a high of $466.30 and a low of $267.40, during fiscal 2012, it reached a high of$588.28 and a low of $440.00, during fiscal 2013, it reached a high of $583.67 and a low of $355.93, and during fiscal 2014, it reached a high of $540.63and a low of $352.35. Our stock price can fluctuate for a number of reasons, including:•announcements about us or our competitors;•quarterly variations in operating results;•introduction or abandonment of new technologies or products;•regulatory approvals and enforcement actions;•changes in product pricing policies;•changes in earnings estimates by analysts or changes in accounting policies;•economic changes and overall market volatility; and•political uncertainties.In addition, stock markets have experienced significant price and volume volatility in the past, especially recently. This volatility has had a substantialeffect on the market prices of securities of many public companies for reasons frequently unrelated or disproportionate to the operating performance of thespecific companies. In addition, the securities of many medical device companies, including us, have historically been subject to extensive price and volumefluctuations that may affect the market price of their common stock. If these broad market fluctuations continue, they may adversely affect the market price ofour common stock.ITEM 1B.UNRESOLVED STAFF COMMENTSNone.31Table of ContentsITEM 2.PROPERTIESAs of December 31, 2014, we owned approximately 918,000 square feet of space on 70 acres of land in Sunnyvale, California, where we house ourheadquarters, research and development, service and support functions, and certain of our manufacturing operations. In Norcross, Georgia, we ownedapproximately 92,000 square feet of space on ten acres, of which 50,000 square feet of space serves as our East Coast sales and training headquarters and41,000 square feet of space was leased to third parties that will be used for future expansion of our East Coast sales and training campus. In Aubonne,Switzerland, we owned 35,000 square feet of space on 1.6 acres, which is used for our international headquarters and 5,000 square feet of space was leased toa third party. We leased 76,000 square feet in Mexicali, Mexico where we manufacture most of our EndoWrist instruments. We also leased facilities inMilford, Connecticut, and Blackburg, Virgina for research and development and other operations. We also leased facilities for sales and operations in Tokyo,Japan; Shanghai, China; Brazil; and Seoul, Korea.ITEM 3.LEGAL PROCEEDINGSThe information included in Note 7 to the Consolidated Financial Statements included in Part II, Item 8 of this report is incorporated herein by reference.ITEM 4.MINE SAFETY DISCLOSURESNot applicable.32Table of ContentsPART IIITEM 5.MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OFEQUITY SECURITIESPRICE RANGE OF COMMON STOCKOur common stock is being traded on The NASDAQ Global Select Market under the symbol “ISRG.” The following table sets forth the high and lowclosing prices of our common stock for each period indicated and are as reported by NASDAQ. 2014 2013FiscalHigh Low High LowFirst Quarter$453.84 $370.94 $583.67 $459.44Second Quarter$540.63 $352.35 $513.49 $470.30Third Quarter$480.73 $380.26 $504.01 $363.89Fourth Quarter$533.84 $456.51 $401.68 $355.93As of January 16, 2015, there were 215 stockholders of record of our common stock, although we believe that there are a significantly larger number ofbeneficial owners of our common stock.DIVIDENDSWe have never declared or paid any cash dividends on our common stock. We intend to retain earnings for use in the operation and expansion of ourbusiness.SECURITIES AUTHORIZED FOR ISSUANCE UNDER EQUITY COMPENSATION PLANSThe following table contains information as of December 31, 2014 for two categories of equity compensation plans.Plan CategoryNumber ofsecurities to beissued uponexercise ofoutstandingoptions,warrants andrights (a) Weighted-averageexercise priceof outstandingoptions Number of securitiesremaining available forfuture issuance underequity compensationplans (excludingsecurities reflected incolumn (a))Equity compensation plans approved by security holders4,458,082 $387.52 1,337,919Equity compensation plans not approved by security holders736,558 $446.83 107,255Total5,194,640 $395.85 1,445,174RECENT SALES OF UNREGISTERED SECURITIESNone.ISSUER PURCHASES OF EQUITY SECURITIESSince March 2009, we have had an active stock repurchase program. The most recent authorizations occurred in March 2013 and July 2013 when theBoard of Directors increased the authorization for stock repurchases by $1.0 billion and $0.8 billion, respectively. During the period from March 2009 toDecember 2014, we repurchased a total of 8.7 million shares of our common stock at a total of $3.0 billion. As of December 31, 2014, we had used allamounts authorized for stock repurchases under the stock repurchase program. We did not purchase any of our securities in the open market during thequarter ended December 31, 2014.On January 29, 2015, our Board of Directors authorized the Company to repurchase up to $1.0 billion of our outstanding common stock.STOCK PERFORMANCE GRAPHThe graph set forth below compares the cumulative total stockholder return on our common stock between December 31, 2009 and December 31, 2014,with the cumulative total return of (i) the S&P Healthcare Index, (ii) the NASDAQ Composite Index and (iii) the S&P 500 Index, over the same period. Thisgraph assumes the investment of $100.00 on December 31, 2009 in our common stock, the S&P Healthcare Index, the NASDAQ Composite Index, and theS&P 500 Index and assumes the reinvestment of dividends, if any.33Table of ContentsThe comparisons shown in the graph below are based upon historical data. We caution that the stock price performance shown in the graph below is notnecessarily indicative of, nor is it intended to forecast, the potential future performance of our common stock.COMPARISON OF CUMULATIVE TOTAL RETURN AMONG INTUITIVE SURGICAL, NASDAQCOMPOSITE, S&P HEALTH CARE INDEX, AND S&P 500 INDEX December 31, 2009 2010 2011 2012 2013 2014Intuitive Surgical, Inc.$100.00 $84.95 $152.59 $161.61 $126.58 $174.32NASDAQ Composite$100.00 $118.02 $117.04 $137.47 $192.62 $221.02S&P 500 Healthcare Index$100.00 $102.81 $115.76 $136.26 $192.18 $240.44S&P 500 Index$100.00 $115.06 $117.49 $136.30 $180.44 $205.1434Table of ContentsITEM 6.SELECTED FINANCIAL DATAThe following selected consolidated financial data should be read in conjunction with our Consolidated Financial Statements and the accompanyingNotes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this report. The selected data inthis section is not intended to replace the Consolidated Financial Statements. Fiscal Year 2014 2013 2012 2011 2010 (In millions, except per share amounts and headcount)Revenue$2,131.7 $2,265.1 $2,178.8 $1,757.3 $1,413.0Gross profit$1,413.8 $1,594.2 $1,570.3 $1,273.8 $1,030.0Net income$418.8 $671.0 $656.6 $495.1 $381.8Net income per common share: Basic$11.35 $17.12 $16.50 $12.63 $9.74Diluted$11.11 $16.73 $15.98 $12.32 $9.47Shares used in computing basic and diluted netincome per share: Basic36.9 39.2 39.8 39.2 39.2Diluted37.7 40.1 41.1 40.2 40.3Cash, cash equivalents and investments$2,497.0 $2,753.9 $2,920.5 $2,171.8 $1,608.9Total assets$3,959.4 $3,950.3 $4,059.2 $3,063.1 $2,390.4Other long-term liabilities$78.8 $68.0 $77.5 $96.9 $79.2Stockholders’ equity$3,379.4 $3,501.4 $3,580.1 $2,645.6 $2,037.4Total headcount2,978 2,792 2,362 1,924 1,66035Table of ContentsITEM 7.MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONSOverviewOpen surgery remains the predominant form of surgery and is used in almost every area of the body. However, the large incisions required for opensurgery create trauma to the patient, typically resulting in longer hospitalization and recovery times, increased hospitalization costs, and additional pain andsuffering relative to minimally invasive surgery (“MIS”), where MIS is available. For over two decades, MIS has reduced trauma to the patient by allowingselected surgeries to be performed through small ports rather than large incisions. MIS has been widely adopted for certain surgical procedures, but has notyet been widely adopted for reconstructive surgeries.da Vinci Surgical Systems enable surgeons to extend the benefits of MIS to many patients who would otherwise undergo a more invasive surgery byusing computational, robotic and imaging technologies to overcome many of the limitations of conventional MIS. Surgeons using a da Vinci SurgicalSystem operate while seated comfortably at a console viewing a Three Dimensional (“3-D”) representation of a High Definition (“HD”) image of the surgicalfield. This immersive visualization connects surgeons to the surgical field and their instruments. While seated at the console, the surgeon manipulatesinstrument controls in a natural manner, similar to the open surgery technique. Our multi-port technology is designed to provide surgeons with a range ofmotion of MIS instruments in the surgical field analogous to the motions of a human wrist, while filtering out the tremor inherent in a surgeon’s hand. Indesigning our products, we focus on making our technology easy and safe to use.Our products fall into four broad categories - the da Vinci Surgical Systems, InSite and Firefly Fluorescence imaging systems (“Firefly”), instruments andaccessories (e.g., EndoWrist, EndoWrist One Vessel Sealer, da Vinci Single-Site and EndoWrist Stapler 45) and training technologies. We havecommercialized four generations of da Vinci Surgical Systems: the first is our da Vinci standard Surgical System, commercialized in 1999, the second is ourda Vinci S Surgical System, commercialized in 2006, the third is our da Vinci Si Surgical System, commercialized in 2009, and the fourth is our da Vinci XiSurgical System, launched in the second quarter of 2014 (see further description in New Product Introductions section below). Systems include a surgeon’sconsole (or consoles), imaging electronics, a patient-side cart, and computational hardware and software.We offer over 65 different da Vinci instruments enabling surgeons flexibility in choosing the types of tools needed in a particular surgery. In the fourthquarter of 2011, we introduced our Single-Site instruments in the U.S. for use with the da Vinci Si Surgical System and for use in cholecystectomy procedures.During the first quarter of 2013, Single-Site instruments were cleared by the U.S. Food and Drug Administration (the “FDA”) in the U.S. for use in benignhysterectomies and salpingo-oophorectomies. Single-Site instruments enable surgeons to also perform surgery through a single port via the patient’s bellybutton, resulting in the potential for virtually scarless results. The initial instrumentation set for single site surgery was not wristed. However, in September2014, the FDA cleared our wristed needle driver, designed for Single-Site surgeries. We believe that the wristed needle driver will better enable single sitesurgeries requiring significant reconstruction, like hysterectomies.Training technologies include our recently developed da Vinci Connect remote case observation and mentoring tool, our da Vinci Skills Simulator, andour dual console for use in surgeon proctoring and collaborative surgery.ProceduresWe model patient value as equal to procedure efficacy / invasiveness. In this equation procedure efficacy is defined as a measure of the success of thesurgery in resolving the underlying disease and invasiveness is defined as a measure of patient pain and disruption of regular activities. When the patientvalue of a da Vinci procedure is greater than that of alternative treatment options, patients may benefit from seeking out surgeons and hospitals that offer daVinci Surgery, which potentially could result in a local market share shift. Adoption occurs procedure by procedure, and is driven by the relative patientvalue of da Vinci procedures compared to alternative treatment options for the same disease state or condition.Worldwide Proceduresda Vinci systems and instruments are regulated independently in various countries and regions of the world. The discussion of indications for use andrepresentative or target procedures is intended solely to provide an understanding of the market for da Vinci products but is not intended to promote for saleor use any Intuitive Surgical product outside of its licensed or cleared labeling and indications for use.The adoption of da Vinci surgery has the potential to grow for those procedures that offer greater patient value than non da Vinci alternatives, whileproviding economic return to health care providers. We focus our organization and investments on developing, marketing and training for those products andprocedures where da Vinci can bring significant patient value relative to alternative treatment options. da Vinci Surgical Systems are used primarily ingynecologic surgery, urologic surgery, general surgery, cardiothoracic surgery, and head and neck surgery. Principal target procedures in gynecology includeda Vinci Hysterectomy (“dVH”) and sacrocolpopexy. Target procedures in urology include da Vinci Prostatectomy (“dVP”) and partial nephrectomy. Targetprocedures in general surgery include colorectal procedures, hernia repair, Single-Site Cholecystectomy, and a broad base36Table of Contentsof other general surgery procedures. In cardiothoracic surgery, target procedures include da Vinci Lobectomy and da Vinci Mitral Valve Repair. In head andneck surgery, target procedures include certain procedures resecting benign and malignant tumors classified as T1 and T2. Not all the indications, proceduresor products described may be available in a given country or region or on all generations of da Vinci Surgical Systems. Please consult the product labeling ina specific country and for each product in order to determine the actual authorized uses, as well as important limitations, restrictions or contraindications.In 2014, approximately 570,000 surgical procedures were performed with the da Vinci Surgical System, compared to approximately 523,000 and450,000 procedures performed in 2013 and 2012, respectively. The growth in our overall procedure volume in 2014 was driven by the growth in U.S. generalsurgery procedures and worldwide urologic procedures.U.S. ProceduresOverall U.S. procedure volume grew to approximately 449,000 in 2014, compared to approximately 422,000 in 2013, and 367,000 in 2012.Gynecology is our largest U.S. surgical specialty. Overall U.S. gynecology procedure volume was approximately 235,000 2014 compared to 240,000 in2013 and 222,000 in 2012. Our growth through 2013 was driven by adoption of dVH, our highest volume procedure, and other gynecologic procedures,including sacrocolpopexy and myomectomy largely resulting from capturing market share from open surgery techniques for these procedures. In 2014, our2% U.S. gynecology procedure decline was driven primarily by fewer benign dVH procedures. As of 2014, we estimate that approximately 80% of totalbenign hysterectomies were performed via minimally invasive approaches, including robotic, endoscopic, and vaginal techniques. Given this high level ofMIS penetration, we believe our benign hysterectomy volume largely declined with the overall market, which reflected payor trends encouraging moreconservative non-surgical disease management approaches for certain uterine conditions. Our benign dVH procedure volumes were approximately 148,000,150,000, and 138,000 in 2014, 2013, and 2012, respectively. We now consider robotic surgery to be the standard of care for hysterectomies for cancer. dVHfor cancer procedure volumes were approximately 43,000, 41,000, and 38,000 in 2014, 2013, and 2012, respectively.General surgery is our second largest and fastest growing specialty in the U.S. Overall U.S. general surgery procedure volume grew from approximately42,000 cases in 2012 to approximately 81,000 in 2013 and to approximately 107,000 in 2014. Growth through 2013 was driven by rapid adoption of daVinci Cholecystectomies, the first procedure to be FDA-cleared for Single-Site Surgery, and earlier stage growth in colorectal and several other generalsurgery procedures. In 2014, cholecystectomy growth moderated, and general surgery growth was driven by growth across a broad set of procedures,including ventral and inguinal hernia repair, colorectal, bariatric, cholecystectomy, foregut, and other procedures.U.S. urology procedure volume was approximately 91,000 in 2014, compared to approximately 85,000 in 2013, and 88,000 in 2012. We consider dVP tobe the standard of care for the surgical treatment of prostate cancer in the U.S. About 60,000 dVPs were performed in 2014, compared to 58,000 in 2013, and62,000 in 2012.International ProceduresOverall international procedure volume grew to approximately 121,000 in 2014, compared to approximately 101,000 in 2013 and 83,000 in 2012.International procedure growth was driven largely by dVP volume, which grew from approximately 47,000 in 2012, to 56,000 in 2013, to 65,000 in 2014.Partial nephrectomy, general surgery, and gynecologic oncology procedures also contributed to international procedure growth.Business ModelWe generate revenue from both the initial capital sales of da Vinci Surgical Systems as well as recurring revenue, derived from sales of instruments,accessories and service. The da Vinci Surgical System generally sells for approximately between $0.6 million and $2.5 million, depending uponconfiguration and geography, and represents a significant capital equipment investment for our customers. We generate recurring revenue as our customersconsume our EndoWrist and Single-Site instrument and accessory products used in performing procedures with the da Vinci Surgical System. Our instrumentsand accessories have a limited life and will either expire or wear out as they are used in surgery, at which point they are replaced. Also, we generate recurringrevenue from ongoing system service. We typically enter into service contracts at the time systems are sold at an annual rate of approximately $100,000 to$170,000 per year, depending upon the configuration of the underlying system. These service contracts have generally been renewed at the end of the initialcontractual service periods.Recurring revenue has generally grown at a faster rate than system revenue in the last few fiscal years. Recurring revenue increased from $1.2 billion, or57% of total revenue in 2012 to $1.4 billion, or 63% of total revenue in 2013 to $1.5 billion, or 70% of total revenue in 2014. The increase in recurringrevenue relative to system revenue reflects lower 2014 system sales and continuing adoption of procedures on a growing base of installed da Vinci SurgicalSystems. The installed base of da Vinci Surgical Systems has grown to 3,266 at December 31, 2014, compared with 2,966 at December 31, 2013, and 2,585 atDecember 31, 2012.We provide our products through direct sales organizations in the U.S., Japan, Korea, and Europe, excluding Spain, Portugal, Italy, Greece and EasternEuropean countries. In June 2014, we terminated our distribution relationship with Adachi Co., Ltd.37Table of Contents("Adachi"), a Japanese distributor and now market, sell, and service our products directly in Japan. In the remainder of our world markets, we provide ourproducts through distributors.Regulatory ActivitiesClearances and ApprovalsWe have obtained the clearances required to market our multiport products associated with the first three generations of our da Vinci Surgical Systems(Standard, S, and Si systems) for our targeted surgical specialties within the U.S. and most of Europe. As we expand indications and introduce new products,we will continue to seek necessary clearances. In February 2013, we received FDA clearance to market our Single-Site instruments for benign hysterectomyand salpingo-oophorectomy procedures. In September 2014, we received FDA clearance to market the wristed version of our Single-Site needle driverproduct for use in benign hysterectomy, cholecystectomy, and salpingo-oophorectomy procedures.In March 2014, we received FDA clearance to market our da Vinci Xi System in the U.S. This is our fourth generation da Vinci Surgical System and isnow available to U.S. customers (see the complete description of the da Vinci Xi Surgical System in the New Product Introductions Section). In June 2014, wereceived CE mark clearance for our da Vinci Xi Surgical System in Europe. In October 2014, we received regulatory clearance for our da Vinci Xi SurgicalSystem in Korea. Regulatory submissions have been made for the da Vinci Xi Surgical System in Japan with the status currently pending. The regulatorystatus of the da Vinci Xi Surgical System in other international markets varies by country.In April 2014, we received FDA clearance to market our da Vinci Single Port Surgical System in the U.S. for single-port urologic surgeries. However, wedo not plan to commercialize the da Vinci Single Port Surgical System until it is further developed and cleared as an extension of the da Vinci Xi SurgicalSystem dedicated to single port surgeries. We will seek additional FDA clearance(s) for the da Vinci Single Port Surgical System for procedure(s) in which asingle small entry point to the body and parallel delivery of instruments is important. Such surgeries could include those performed through a natural orificelike the mouth for head and neck procedures or those performed through a single incision like prostate removal. We are in the process of modifying the daVinci Single Port Surgical System to be compatible with the da Vinci Xi Surgical system and ready for commercialization.In September 2013, we received FDA clearance to expand the indication for use of Firefly to include visual assessment of at least one of the major extra-hepatic bile ducts (cystic duct, common bile duct and common hepatic duct), using near infrared imaging. Fluorescence imaging of biliary ducts with Fireflyis intended for use with standard of care white light and, when indicated, intraoperative cholangiography. The device is not intended for standalone use forbiliary duct visualization. We believe that the use of Firefly during cholecystectomy procedures will enhance the ability of surgeons to identify keyanatomical structures during the surgery. In October 2012, we obtained from the Japanese Ministry of Health, Labor, and Welfare ("MHLW") approval in Japan for our da Vinci Si SurgicalSystems. Effective April 2012, we obtained national reimbursement for dVP procedures in Japan, our only broadly reimbursed procedure to date. We arecurrently seeking reimbursement for additional procedures through the MHLW's Senshin Iryo process as well as other alternative reimbursement processes.Such approvals require in-country clinical data and are considered for reimbursed status in April of even numbered years. No additional procedures weregranted in the April 2014 cycle. Japanese surgeons have begun registering patients to gather clinical data for partial nephrectomy and gastrectomy surgeries.We also are continuing our discussions with the MHLW and surgical societies concerning the pathway to obtain reimbursement for several other procedures.The next cycle for MHLW reimbursement consideration is April 2016 and there can be no assurance that we will gain additional reimbursements at that time.If we are not successful in obtaining additional regulatory clearances, importation licenses, and adequate procedure reimbursements for future products andprocedures, then the demand for our products in Japan could be limited. In June 2014 we terminated the distribution relationship with our Japanesedistributor, Adachi, and now market, sell, and service our products directly in Japan. Prior to the acquisition, these functions were performed through Adachi.If we are unable to effectively transition the sales, marketing, regulatory and other operational functions from Adachi, our Japanese business could bedisrupted.FDA InspectionAn FDA inspection of our facilities occurred in April-May 2013 and the FDA issued a Form FDA 483 listing four observations relating to the reporting offield corrections, information which is to be included on reports of field corrections, written procedures for changes to certain product labeling, and designinput documentation. We responded to each observation with corrective actions during the course of the inspection and provided additional evidence ofcorrective actions to the FDA in response to the Form FDA 483. The FDA issued a Warning Letter, dated July 16, 2013, related to two of the four Form FDA483 observations asking for additional corrective actions and indicated its intent to perform a follow-up inspection. In addition, the FDA collected electronicsamples of all our advertising and promotional material for review, and to date has taken no action in connection therewith. We responded to the WarningLetter, communicating corrective actions taken. The FDA re-inspected our facilities during February-March of 2014 to complete a general quality systemaudit as well as a review of the status of the Warning Letter and 483 remediation activities. At the end of the inspection, the FDA issued a Form FDA 483listing five observations related to quality management38Table of Contentssystem improvement opportunities. We responded to the FDA with a corrective action plan for those observations. On April 25, 2014, the Company receiveda closure letter from the FDA stating that the observations in the July 16, 2013 Warning Letter have been addressed.Medical Device ReportingIn September of 2012 we contacted the Office of Surveillance and Biometrics (“OSB”) in the FDA Center for Devices and Radiological Health (“CDRH”)regarding proposed changes to our reporting practices for non-injury malfunction Medical Device Reports (“MDRs”). In addition we discussed summaryreporting for well characterized events. As a result of the proposed changes, we have increased our reports of device malfunction MDRs, the vast majority ofwhich are related to instruments and not to systems. By definition, none of these device malfunction MDRs involve reportable injuries or deaths. TheseMDRs are posted on the FDA Manufacturer and User Facility Device Experience (“MAUDE”) database.In addition, claims brought to our attention by plaintiffs’ attorneys that contain allegations of patient injury are required to be investigated ascomplaints. In those cases in which da Vinci was used and the system cannot yet be ruled out as a cause or contributor of the alleged injury, these cases arereported to the FDA as MDRs. This has led to increases in MDRs. During the first quarter 2014, as agreed to by the FDA, MDR Policy Branch, we reported asummary level MDR for 1,406 events related to these claims. 1,387 of these events relate to allegations of injuries that had not previously been reported to usand, subsequently, we had not reported them to the FDA; the remaining 19 events are supplemental reports to events previously reported to the FDA. In thesecond quarter of 2014, we filed a second summary level MDR for 455 events related to legal claims. 219 of these events related to allegations of injuries thathad not previously been reported to us and, subsequently, we had not reported them to the FDA; the remaining 236 events are supplemental reports to eventspreviously reported to the FDA.Recalls and CorrectionsMedical device companies have regulatory obligations to correct or remove medical devices in the field that could pose a risk to health. The definitionof "recalls and corrections" is expansive and includes repair, replacement, inspections, re-labeling and issuance of new, added or reinforcement of instructionsfor use and training when such actions are taken for specific reasons of safety or compliance. These field actions require stringent documentation, reportingand monitoring worldwide. There are other actions which a medical device manufacturer may take in the field without reporting, including routine servicing,the introduction of new products, and new indications for use and stock rotations.As we determine whether a field action is reportable in any regulatory jurisdiction, we prepare and submit notifications to the appropriate regulatoryagency for the particular jurisdiction. In general, upon submitting required notifications to regulators regarding a field action which is a recall or correction,we will notify customers regarding the field action, provide any additional documentation required in their national language, and arrange, as required, returnor replacement of the affected product or a field service visit to perform the correction. In addition, regulators can require the expansion, reclassification, orchange in scope and language of the field action. Field actions can result in adverse effects on our business, including damage to reputation, delays bycustomers of purchase decisions, reduction or stoppage of use of installed systems, and reduced revenue as well as increased expenses to complete fieldactions.In September 2014, we stopped shipping the EndoWrist Stapler 45 for the da Vinci Si Surgical System and advised our customers to suspend use. Whilethe observed failure rate in the field was low at 0.023%, based on the total number of staple fires, we believe that immediately suspending use was the bestcourse of action in the interest of patients. Our investigation of the three failed EndoWrist Staplers uncovered two separate failure modes in the clampmechanism: 1) a component failure in two instruments and 2) an assembly error in one instrument. Based on these findings, in December 2014, we voluntarilyinitiated a field recall related to the EndoWrist Stapler 45 instrument for the da Vinci Si Surgical System. We have refined the relevant design elements andmanufacturing processes to address these failure modes and have begun shipping replacement instruments in early 2015. Certain outcomes from any of the above regulatory activities may result in material adverse effects on the business, including damage to reputation,delays by customers of purchase decisions, reduction or stoppage of use of installed systems, and reduced revenue as well as increased expenses.39Table of Contents2014 Business Events and TrendsProceduresOverall. During the year ended December 31, 2014, total da Vinci procedures grew approximately 9% compared with 16% for the year ended December31, 2013. Procedure growth during the year ended December 31, 2014 was driven by growth in general surgery in the U.S. and worldwide urologicprocedures. The lower 2014 procedure growth rate was driven by continued pressure on U.S. benign gynecologic procedures and slowing growth in U.S.cholecystectomy procedures partially offset by growth in several multi-port general surgery procedures, including hernia repair, colorectal, and bariatricprocedures and worldwide growth in urologic procedures.dVP. We believe the U.S. Preventive Services Task Force recommendation against PSA screening, as well as changes in treatment patterns for low riskprostate cancer away from definitive treatment, contributed to a 15% decline in our dVP business in 2012 and a 6% decline in 2013. U.S. dVP proceduresgrew 2% for the full year 2014. Treatment patterns impacting the U.S. dVP market have likely also impacted our European dVP procedure volumes. As dVP isat earlier market penetration stages in the European markets, we are unable to precisely estimate the extent to which these recommendations and treatmentpattern changes may have been adopted by governments or clinicians within non-U.S. jurisdictions.Benign Gynecology Procedure Adoption Trends. During the year ended December 31, 2014, we experienced continued pressure on the category of U.S.benign gynecologic procedures. For the year ended 2014, U.S. benign gynecologic procedures reflected an approximately 3% decline compared to 2013. Thepressure on U.S. benign gynecologic procedures reflected a macro trend of fewer benign gynecologic procedures caused by a number of factors including, butnot limited to, apparent pressure on benign gynecology hospital admissions, larger patient deductibles and co-pays associated with the Affordable Care Act,a trend by payers toward encouraging conservative disease management, and FDA actions regarding the use of power morcellation in uterine surgeries whichmostly impacted da Vinci myomectomy procedures (see more detailed description of the FDA Actions Concerning Morcellation below). Minimally invasivesurgery is presently approaching 80% penetration of the U.S. benign hysterectomy market, causing the rate of migration from open surgeries to minimallyinvasive surgeries to slow. Combined with the dispersion of the remaining open procedures among hospitals and surgeons, we believe the number of da Vincihysterectomies performed for benign conditions has moved roughly in-line with the gradually decreasing surgical market in 2014.Cholecystectomy. In December 2011, we received FDA clearance for Single-Site Cholecystectomy, our first procedure cleared for Single-Siteinstruments. Since then, da Vinci Cholecystectomy has grown into our third largest procedure, after hysterectomy and prostatectomy. da VinciCholecystectomies are performed with either Single-Site instruments or multiport instruments. In many cases, surgeons performing multiportcholecystectomies are using that approach as a training pathway towards Single-Site Cholecystectomy or other more complex procedures. Cholecystectomyis a lower complexity procedure which can generally be executed in a minimally invasive manner via multiport laparoscopy and has lower reimbursementrates than more complex procedures. For these reasons, it is difficult to estimate to what degree we may capture these procedures. During 2014, total U.S.cholecystectomies grew at a lower percentage than in previous periods.Procedure Seasonality. More than half of da Vinci procedures performed are for benign conditions, most notably benign hysterectomies andcholecystectomies. The proportion of these benign procedures has grown over time in relation to the total number of procedures performed. Hysterectomiesfor benign conditions, cholecystectomies, hernia repairs, and other short-term elective procedures tend to be more seasonal than cancer operations andsurgeries for other life threatening conditions. Seasonality for these benign procedures results in higher fourth quarter procedure volume when more patientshave met annual deductibles and lower first quarter procedure volume when deductibles are reset. We experienced lower seasonality in 2014 which could bereflective of higher deductible insurance plans required by PPACA. It is possible that in the first quarter 2015, benign procedures will decline at a similar orgreater rate than first quarter 2014 procedures declined from the fourth quarter of 2013 procedures. Third quarter activity has historically been seasonallylower due to summer vacations, particularly in Europe.Procedure Mix. Our procedure business is now comprised of: (1) cancer and other highly complex procedures and (2) less complex benign procedures.Cancer and other highly complex procedures tend to be reimbursed at higher rates than less complex benign procedures. Thus, hospitals are more sensitive tothe costs associated with treating less complex benign conditions. Our strategy is to provide hospitals with attractive clinical and economic solutions in eachof these procedure categories. More fully featured products, including 4-arm, dual console, Firefly enabled systems, and advanced instruments includingvessel sealing and stapler are targeted towards more complex procedures. Lower priced products, including the three-arm da Vinci Si-e System and lowerpriced Single-Site instruments are targeted towards less complex procedures.40Table of ContentsFDA Actions Concerning Morcellation. In April 2014, the FDA announced that it discourages the use of power morcellators in the surgical removal ofassumed benign fibroids. This statement was followed in July 2014 by an FDA panel discussion on the topic. In November 2014, the FDA issued specificcontraindications for the use of laparoscopic power morcellation and required specific patient warning prior to its use in surgery. We do not manufacture orsell power morcellation products and power morcellators do not attach to da Vinci Surgical Systems. Minimally invasive da Vinci gynecologic surgeries areroutinely performed without the use of power morcellators. However, we believe that these FDA actions likely created some uncertainty for surgeons andpatients when choosing among minimally invasive surgical methods for removing fibroids that may have adversely impacted the number of da Vinciprocedures performed. During the second, third, and fourth quarters of 2014 we experienced a decline in myomectomies that likely reflected the impact of theFDA actions. Myomectomies are not a significant portion of our business. It is difficult to gauge what impact the FDA actions may have had on benign dVHprocedures.System DemandFuture demand for da Vinci Surgical Systems will be impacted by factors including procedure growth rates, market response to our recently launched daVinci Xi Surgical System, economic pressure and uncertainty at hospitals associated with the Affordable Care Act, evolving system utilization and point ofcare dynamics, likely variability in the timing of Japanese systems sales given that additional da Vinci procedures are considered for reimbursement only ineven numbered years and the possible approval of the Xi System, the timing of when we receive regulatory clearance in our other international markets forour Xi System and related instruments, as well as other economic and geopolitical factors.Recent Media and LawsuitsPrior to and during the twelve months ended December 31, 2014, various print, television, and internet media have released pieces questioning thepatient safety and efficacy associated with da Vinci Surgery, the cost of da Vinci Surgery relative to other disease management methods, and the adequacy ofsurgeon training and our sales and marketing practices. In addition, as further described in Note 7 to the Consolidated Financial Statements included in PartII, Item 8, we are currently named as a defendant in approximately 102 individual product liability lawsuits and a multi-plaintiff product liability lawsuitfiled on behalf of 20 patients who underwent da Vinci Surgery. Plaintiffs’ attorneys have been engaged in well-funded national advertising campaignssoliciting clients who have undergone da Vinci Surgery and claim to have suffered an injury, and we have seen a substantial increase in these claims. Webelieve that da Vinci Surgery continues to be a safe and effective surgical method, as supported by a substantial and growing number of scientific studies andpeer reviewed papers. We also believe that we provide appropriate training on the use of the da Vinci Surgical System, consistent with our role as devicemanufacturer. However, the recent negative media publicity likely has and may continue to delay or adversely impact procedure adoption, system sales, andour revenue growth in future periods.The increase in product liability claims coincided with national attorney advertising efforts seeking patients dissatisfied with da Vinci surgery. In aneffort to avoid the expense and distraction of defending multiple lawsuits, we entered into tolling agreements to pause the applicable statutes of limitationsfor the claims, and engaged in mediation efforts. The attorneys for the patients agreed to collect and supply medical records, operative notes and othernecessary information from these patients to us. Each claim was individually investigated. The collection and evaluation of the patients’ medical informationwas laborious. For hundreds of the asserted claims, we have never received medical records. As patient records related to these claims were received, we andour legal counsel, assisted by independent medical consultants, reviewed and analyzed the large volumes of medical information that began to arrive in thefall of 2013. The completion of the evaluation of a significant number of these claims occurred during the first quarter of 2014 and continued throughout2014.During the year ended December 31, 2014, we recorded pre-tax charges of $82.4 million, of which $67.4 million, $9.6 million, and $5.4 million wasrecorded in the first, second, and fourth quarters of 2014, respectively, to reflect the estimated cost of settling a number of the product liability claims coveredby the tolling agreements described below. The claims relate to alleged complications from surgeries performed with certain versions of Monopolar CurvedScissor (MCS) instruments that included an MCS tip cover accessory that was the subject of a market withdrawal in 2012 and MCS instruments that were thesubject of a recall in 2013.Our estimate of the anticipated cost of settling these claims is based on negotiations with attorneys for patients who have participated in a mediationprocess. To date, approximately 4,800 claims have been reviewed as part of that mediation process. Of those, however, a substantial number have alreadybeen removed from the tolling agreement that covers the claims in the mediation process and plaintiffs’ counsels have indicated to us that they no longerintend to pursue these claims. Nonetheless, the claimants that have been removed from the tolling agreement remain free to pursue lawsuits against us and itis also possible that more claims will be made by other individuals who have undergone da Vinci surgery and allege that they suffered injuries. It is furtherpossible that the claimants who participate in the mediations, as well as those claimants who have not participated in negotiations, will pursue greateramounts in mediation or in a court of law. Consequently, the final outcome of these claims is dependent on many variables that are difficult to predict and theultimate cost associated with these product liability claims may be materially different than the amount of the current estimate and accruals and could have amaterial adverse effect on our business,41Table of Contentsfinancial condition, and results of operations or cash flows. Although there is a reasonable possibility that a loss in excess of the amount recognized exists,we are unable to estimate the possible loss or range of loss in excess of the amount recognized at this time. See Note 7 to the Consolidated FinancialStatements included in Part II, Item 8 for further details.We submit reports to the FDA for these claims as part of our post-market surveillance process. The FDA publicly reports these claims on its MAUDEdatabase. On February 27, 2014, we submitted an Alternative Summary Report (ASR) to consolidate 1,406 of the product liability claims for surgeriesspanning the period 2004 through the third quarter of 2013. On May 29, 2014, we submitted a second ASR to consolidate 219 initial claims and amend 236previous claims for surgeries spanning the period 2005 through the fourth quarter of 2013. On August 27, 2014, we submitted a third ASR that included 441initial claims and amended 204 previous claims for surgeries spanning from September 2005 through January 2014. During the time period of 2004 throughDecember 2014, approximately 2.2 million surgeries were performed with the da Vinci Surgical System in the U.S.MDR reporting criteria are described in FDA regulations at 21 CFR Part 806. An MDR report or any other information submitted by us to the FDA is notnecessarily an admission that the device caused or contributed to the reportable event. The February 27, 2014 ASR contains information from attorneys whosubmitted claims of injury involving da Vinci use in surgery. The vast majority of the alleged injuries in the ASR are common complications associated withsurgery, including minimally invasive and open surgical procedures. In the rare instances in which our records were able to confirm claims of a malfunctionof the da Vinci Surgical System during a surgery, we filed a separate MDR. Where a claim indicated a patient death, we filed a separate MDR. The ASRexcludes these individually reported death and malfunction events.New Product Introductionsda Vinci Xi Surgical System. During April 2014, we launched our newest da Vinci model, the da Vinci Xi, in the U.S. The da Vinci Xi can be used acrossa wide spectrum of minimally invasive surgical procedures, and has been optimized for multi-quadrant surgeries. The da Vinci Xi expands upon core da Vincifeatures including wristed instruments, 3D-HD visualization, intuitive motion, and ergonomic design, while improving ease, and delivering several newfeatures, including:•A new overhead instrument arm architecture designed to facilitate anatomical access from virtually any position.•A new endoscope digital architecture that creates a simpler, more compact design with improved vision definition and clarity.•An ability to attach the endoscope to any arm, providing flexibility for visualizing the surgical site.•Smaller, thinner arms with newly designed joints that offer a greater range of motion than ever before.•Longer instrument shafts designed to give surgeons greater operative reach.With the da Vinci Xi, we now offer hospitals a broader line of da Vinci Surgical Systems to match their surgical profile and patient care requirements.These include the da Vinci Si-e, a lower price system suited for surgeries requiring two instrument arms; the da Vinci Si, which has the capability ofcontrolling three instrument arms; and the da Vinci Xi, which has four universal instrument arms that attach to a rotating overhead platform. We separatelyapplied for FDA clearance for the da Vinci Xi Firefly, Vessel Sealer, and Stapler products and have received clearance for these products between June andAugust of 2014. Our Single Site line of instruments is only available for our da Vinci Si and da Vinci Si-e systems.We CE marked the da Vinci Xi system in June 2014 and have begun sales and marketing activities in certain countries recognizing the CE mark. We arein various stages of applying for CE mark on other da Vinci Xi products, including Firefly, Vessel Sealer, and Stapler. We plan to bring these products tomarket upon receiving CE marks. In October 2014, we received regulatory clearance for our da Vinci Xi Surgical System in Korea. Regulatory submissionshave been made for the da Vinci Xi Surgical System in Japan with the status currently pending. The regulatory status of the da Vinci Xi Surgical System inother international markets varies by country.da Vinci Single-Site Instruments. da Vinci Single-Site consists of a set of non-wristed instruments (except for wristed needle driver discussed below) andaccessories that allow the da Vinci Si systems to work through a single incision, typically in the umbilicus, rather than multiple incisions. Single incisionsurgery is intended to minimize invasiveness to patients by reducing the number of ports required to enter the body and is typically utilized for less complexsurgery than multi-port surgery. Non-robotic single incision surgery today is typically performed with modified laparoscopic instruments. Early clinicaladoption of this manual technique has been mostly positive, although physicians have reported that manual single incision surgery is technically andergonomically challenging. da Vinci Single-Site instruments and accessories were designed to address these issues. In February 2011, we received the CEmark for our da Vinci Single-Site instrument kit and began selling these new products in Europe. The majority of da Vinci Single-Site procedures performedin Europe to date have been cholecystectomies. In December 2011, we received FDA regulatory clearance to market our Single-Site instrumentation in theU.S. for laparoscopic cholecystectomy procedures. In February 2013, we received FDA clearance to market our Single-Site instruments for benignhysterectomy and salpingo-oophorectomy procedures. In September 2014, we received FDA clearance to market the wristed version of our Single-Site needledriver product for use on benign hysterectomy, cholecystectomy, and salpingo-oophorectomy procedures. We believe42Table of Contentsthis instrument may have particular utility in benign hysterectomy procedures. However, as these are our initial products targeted towards procedures alreadyhighly penetrated by manual MIS techniques, we are not able to predict the extent or pace that da Vinci Single-Site may be adopted.da Vinci Firefly Fluorescence Imaging. In the first quarter of 2011, we launched our Firefly product for use with the da Vinci Si Surgical System. Fireflyis a standard feature of the da Vinci Xi Surgical System. This imaging capability combines a fluorescent dye with a specialized da Vinci camera head,endoscope and laser-based illuminator to allow surgeons to identify vasculature in three dimensions beneath tissue surfaces to visualize critical anatomy.Adoption of Firefly is progressing with use across the categories of urology, gynecology and general surgery. In September 2013, we received FDA 510(k)clearance to market our Firefly fluorescence imaging product for real-time imaging of bile ducts (cystic duct, common bile duct, and common hepatic duct).We believe that the use of Firefly during cholecystectomy procedures will enhance the ability of surgeons to identify key anatomical structures during thesurgery.EndoWrist One Vessel Sealer. In December 2011, we received FDA clearance for the EndoWrist One Vessel Sealer. The EndoWrist One Vessel Sealer is awristed, single-use instrument intended for bipolar coagulation and mechanical transection of vessels up to 7 mm in diameter and tissue bundles that fit in thejaws of the instrument. This instrument enables da Vinci Si surgeons to fully control vessel sealing, while providing the benefits of da Vinci Surgery. Thisinstrument is designed to enhance surgical efficiency and autonomy in a variety of general surgery and gynecologic procedures. Clinical response to theEndoWrist One Vessel Sealer has been encouraging, with positive commentary on precision, articulation, vessel sealing quality and thermal spread, and weexpect applications for the EndoWrist One Vessel Sealer to be centered on general surgery and gynecologic oncology procedures. EndoWrist One VesselSealer utilization rates have increased steadily in 2013 and 2014. In June 2014, we received FDA clearance for the da Vinci Xi version of the EndoWrist OneVessel Sealer.EndoWrist Stapler 45. In October 2012, we received FDA clearance for the EndoWrist Stapler 45 instrument with Blue and Green 45 mm reloads. TheEndoWrist Stapler 45 is a wristed, stapling instrument intended for resection, transection and/or creation of anastomoses in general, gynecologic and urologicsurgery. This instrument enables operators of the da Vinci Si to precisely position and fire the stapler. Its initial surgical use was directed towards colorectalprocedures. During 2013, the EndoWrist Stapler was used by a limited and gradually increasing number of customers. In 2014, we expanded the availabilityof the EndoWrist Stapler to a broadening set of customers. In September 2014, we notified our customers to suspend the use of the EndoWrist Stapler 45 (seeRecalls and Corrections section for additional discussion). In January 2015, we began to ship the replacement product. Although our early customerexperiences have been positive, we are in the early stages of selling EndoWrist Stapler 45, and we are not able to predict the extent to which the instrumentmay be adopted.2014 Financial Highlights•Total revenue was $2.1 billion during the year ended December 31, 2014, compared to $2.3 billion during the year ended December 31, 2013.•Approximately 570,000 da Vinci procedures were performed during the year ended December 31, 2014, up approximately 9% from the year endedDecember 31, 2013.•Instruments and accessories revenue increased 4% to $1.1 billion during the year ended December 31, 2014, from $1.0 billion during the year endedDecember 31, 2013.•Recurring revenue increased 5% to $1.5 billion during the year ended December 31, 2014, representing 70% of total revenue, from $1.4 billionduring the year ended December 31, 2013, representing 63% of total revenue.•We shipped 431 da Vinci Surgical Systems during the year ended December 31, 2014, compared with 546 for the year ended December 31, 2013.•System revenue decreased 24% to $632.5 million during the year ended December 31, 2014, from $834.9 million during the year endedDecember 31, 2013.•As of December 31, 2014, we had a da Vinci Surgical System installed base of 3,266 systems - 2,223 in the U.S., 549 in Europe, 193 in Japan and301 in the rest of the world.•Operating income decreased 36% to $544.8 million during the year ended December 31, 2014, compared with $852.5 million during the year endedDecember 31, 2013. Operating income included $169.1 million and $168.9 million during the years ended December 31, 2014, and 2013,respectively, of share-based compensation expense related to employee stock plans. Operating income for the year ended December 31, 2014, alsoincluded a pre-tax charge of $82.4 million to reflect the estimated cost of settling a number of the product liability claims covered by the tollingagreements.•We ended fiscal 2014 with $2.5 billion in cash, cash equivalents and investments. Cash, cash equivalents and investments decreased by $256.9million compared to December 31, 2013, primarily due to $1.0 billion of cash used in share repurchases, partially offset by cash provided byoperating activities.43Table of ContentsTechnology and Other AcquisitionsWe continue to make strategic acquisitions of intellectual property and related technologies. On January 17, 2014, we completed the acquisition ofcertain intellectual property, know-how, and retained employees from Luna Innovations, Inc. ("Luna"). On June 25, 2014, we terminated our distributionrelationship with our Japanese distributor, Adachi, and now market, sell, and service our products directly in Japan. Both transactions, from an accountingperspective, met the definition of a business and were accounted for using the acquisition method of accounting. The purchase considerations were $19.9million and $73.6 million for Luna and Adachi, respectively. Pro-forma results of operations related to the acquisitions have not been presented because theoperating results of the acquired businesses are not material to the Company's consolidated financial statements.Total investments in intellectual property and related technologies during the year ended December 31, 2013 were $2.0 million. Other than Luna andAdachi, there were no other intellectual property and related technologies acquired during the year ended December 31, 2014. Amortization expense relatedto purchased intellectual property for the years ended December 31, 2014, and 2013 were $22.4 million and $21.3 million, respectively.Results of OperationsThe following table sets forth, for the years indicated, certain Consolidated Statements of Income information (in millions, except percentages): Years Ended December 31, 2014 % oftotalrevenue 2013 % oftotalrevenue 2012 % oftotalrevenueRevenue: Product$1,702.7 80% $1,867.8 82% $1,836.2 84%Service429.0 20% 397.3 18% 342.6 16%Total revenue2,131.7 100% 2,265.1 100% 2,178.8 100%Cost of revenue: Product569.9 27% 543.4 24% 495.3 23%Service148.0 7% 127.5 6% 113.2 5%Total cost of revenue717.9 34% 670.9 30% 608.5 28%Product gross profit1,132.8 53% 1,324.4 58% 1,340.9 61%Service gross profit281.0 13% 269.8 12% 229.4 11%Gross profit1,413.8 66% 1,594.2 70% 1,570.3 72%Operating expenses: Selling, general and administrative691.0 32% 574.0 25% 522.2 24%Research and development178.0 8% 167.7 7% 170.0 8%Total operating expenses869.0 40% 741.7 32% 692.2 32%Income from operations544.8 26% 852.5 38% 878.1 40%Interest and other income, net4.2 —% 18.4 1% 15.8 1%Income before taxes549.0 26% 870.9 39% 893.9 41%Income tax expense130.2 6% 199.9 9% 237.3 11%Net income$418.8 20% $671.0 30% $656.6 30%Total RevenueTotal revenue decreased by 6% during the year ended December 31, 2014 from the year ended December 31, 2013, and increased by 4% during the yearended December 31, 2013, from the year ended December 31, 2012. Total revenue was $2.1 billion during the year ended December 31, 2014, compared to$2.3 billion during the year ended December 31, 2013, and $2.2 billion during the year ended December 31, 2012. The decline in total revenue for the yearended December 31, 2014, was driven by 24% lower sales of da Vinci Systems, largely reflecting lower system sales in the U.S. and Japan, partially offset by5% higher recurring instruments, accessories, and services revenue, resulting primarily from an approximately 9% higher procedure volume. The increase intotal revenue for the year ended December 31, 2013, was driven by 15% higher recurring instruments, accessories, and services revenue, resulting primarilyfrom approximately 16% higher procedure volume. The increase in recurring revenue during the year ended December 31, 2013 was partially offset by 11%lower sales of da Vinci Systems, largely reflecting lower da Vinci System sales in the U.S.Revenue generated in the U.S. accounted for 70%, 72%, and 79% of total revenue during the years ended December 31, 2014, 2013, and 2012,respectively. We believe that domestic revenue has accounted for the large majority of total revenue due to patients44Table of Contentsability to choose their provider and method of treatment in the U.S., reimbursement structures supportive of innovation and minimally invasive surgery, andinitial investments focused on domestic infrastructure. Our international revenue has grown faster in proportion to U.S. revenue primarily due to higherprocedure growth rates in international markets and lower U.S. system sales.The following table summarizes our revenue and da Vinci Surgical System unit shipment information for the years ended December 31, 2014, 2013, and2012, respectively (in millions, except unit sales and percentages): Years Ended December 31, 2014 2013 2012Revenue Instruments and accessories$1,070.2 $1,032.9 $903.3Systems632.5 834.9 932.9Total product revenue1,702.7 1,867.8 1,836.2Services429.0 397.3 342.6Total revenue$2,131.7 $2,265.1 $2,178.8Recurring revenue$1,499.2 $1,430.2 $1,245.9% of total revenue70% 63% 57%Domestic$1,490.9 $1,625.9 $1,726.9International640.8 639.2 451.9Total revenue$2,131.7 $2,265.1 $2,178.8% of Revenue—Domestic70% 72% 79%% of Revenue—International30% 28% 21%Unit Shipments by Region: Domestic unit shipments238 342 476International unit shipments193 204 144Total unit shipments*431 546 620*Systems shipped on operating leases (included in total unit shipments)14 — — Unit Shipments by Model: da Vinci S unit shipments10 6 40da Vinci Si-e - Single console unit shipments (3 arm)29 30 26da Vinci Si - Single console unit shipments (4 arm)143 365 449da Vinci Si - Dual console unit shipments43 145 105da Vinci Xi - Single console unit shipments157 — —da Vinci Xi - Dual console unit shipments49 — —Total unit shipments*431 546 620*Systems shipped on operating leases (included in total unit shipments)14 — — Unit Shipments involving System Trade-ins: Unit shipments involving trade-ins of da Vinci standard Surgical Systems18 28 51Unit shipments involving trade-ins of da Vinci S Surgical Systems82 126 116Unit shipments involving trade-ins of da Vinci Si Surgical Systems31 — —Total unit shipments involving trade-ins131 154 167Unit shipments not involving trade-ins300 392 453Total unit shipments431 546 620Product RevenueProduct revenue decreased to $1.7 billion during the year ended December 31, 2014, from $1.9 billion during the year ended December 31, 2013.Instruments and accessories revenue increased to $1.1 billion for the year ended December 31, 2014, up 4% compared with $1.0 billion for the yearended December 31, 2013. The increase in revenue was driven by an approximate 9% increase in procedure volume, partially offset by lower initialinstrument and accessory stocking orders associated with lower 2014 system unit sales.45Table of ContentsThe growth in our overall procedure volume was driven by approximately 32% growth in U.S. general surgery procedures and approximately 12%growth in worldwide urologic procedures, partially offset by approximately 2% lower U.S. gynecologic procedures. Higher U.S. general surgery proceduresreflected growth in hernia repair, colorectal, cholecystectomy, and several other procedures.Systems revenue decreased to $632.5 million during the year ended December 31, 2014, down 24% from $834.9 million during the year endedDecember 31, 2013, primarily due to lower U.S. and Japanese da Vinci Surgical System unit shipments, partially offset by higher da Vinci Surgical Systemunit shipments into Europe and other international markets. During 2014, 238 systems were shipped into the U.S., 97 into Europe, 37 into Japan, and 59 intoother markets, compared with 342 systems shipped into the U.S., 82 into Europe, 79 into Japan, and 43 into other markets in 2013. The demand for systems isultimately driven by da Vinci surgical procedure volume and is highly sensitive to changes in procedure growth rates. The decline in U.S. system sales in2014 was largely driven by moderating procedure growth (as described in the Procedures section) resulting in lower need for customers to expand capacity,economic pressure and uncertainty at hospitals associated with the Affordable Care Act, and evolving system utilization and point of care dynamics. Thedecrease in system sales in Japan likely reflect the fact that only prostatectomies are broadly reimbursed and the effect of a possible approval of the XiSystem. The increase in system sales in Europe reflects continued procedure growth and investments we have made in our European sales and marketingorganizations.The da Vinci Surgical System average selling price ("ASP"), excluding the impact of units shipped under operating leases, was fairly consistent at $1.5million for 2014 and 2013.Product revenue increased to $1.9 billion during the year ended December 31, 2013, from $1.8 billion during the year ended December 31, 2012.Instruments and accessories revenue increased to $1,032.9 million for the year ended December 31, 2013, up 14% compared with $903.3 million for theyear ended December 31, 2012. The increase in revenue was driven by an approximate 16% increase in procedure volume and, to a lesser extent, higherinitial instrument and accessory orders associated with recently released products, including da Vinci Single-Site, the EndoWrist One Vessel Sealer, andFirefly Fluorescence Imaging products, partially offset by lower initial instrument and accessory stocking orders associated with lower 2013 system unitssales and procedure mix.The growth in our 2013 overall procedure volume was driven by growth in U.S. general surgery procedures, U.S. gynecologic procedures andinternational urology procedures, partially offset by a decline of approximately 6% in U.S. dVP procedures.Systems revenue decreased to $834.9 million during the year ended December 31, 2013, down 11% from $932.9 million during the year endedDecember 31, 2012, primarily due to lower U.S. da Vinci Surgical System unit sales, partially offset by higher international system unit sales. During 2013,342 systems were sold into the U.S., 82 into Europe, 79 into Japan, and 43 into other markets, compared with 476 systems sold into the U.S., 64 into Europe,40 into Japan, and 40 into other markets in 2012. The demand for systems is ultimately driven by da Vinci surgical procedure volume and is highly sensitiveto changes in procedure growth rates. The decline in U.S. system sales in 2013 was largely driven by moderating growth in the category benign gynecologicprocedures resulting in fewer systems sales required to be sold into the installed base to expand capacity. In addition, hospital capital spending appears tohave been impacted by strategic uncertainties surrounding the Affordable Care Act, economic pressures, and negative media reports.The da Vinci Surgical System ASP was fairly consistent at $1.5 million for 2013 and 2012.Service RevenueService revenue, comprised primarily of system service and customer training, increased 8% to $429.0 million for the year ended December 31, 2014,from $397.3 million for the year ended December 31, 2013. Service revenue increased 16% to $397.3 million for the year ended December 31, 2013, from$342.6 million for the year ended December 31, 2012. We typically enter into multi-year service fixed annual rate contracts at the time systems are sold.These service contracts have been generally renewed at the end of the service periods. Higher service revenue in 2014 and 2013 was driven by a largerinstalled base of da Vinci Surgical Systems producing service contract revenue.Gross ProfitProduct gross profit during the year ended December 31, 2014, decreased 14% to $1.1 billion, or 66.5% of product revenue, compared with $1.3 billion,or 70.9% of product revenue, during the year ended December 31, 2013. The lower 2014 gross profit was driven by lower 2014 product revenue as describedabove and a lower 2014 gross product profit margin. The lower 2014 gross profit margin was driven by a higher proportion of 2014 sales of recentlyintroduced products that yield lower gross margin percentages, including the da Vinci Xi Surgical System, as well as the EndoWrist One Vessel Sealer and theEndoWrist Stapler. Margins on newly launched products will typically be lower than our mature products reflecting vendor pricing on low volumes,temporary tooling costs and other start-up costs. Over time, as volumes increase, and we refine the manufacturing processes and products, we expect to seeimprovement in the margins of these newer products. However, gross margins may ultimately differ for these newer products relative to our previous productsbased on market conditions, volume, and complexity of the product.46Table of ContentsOther factors contributing to the lower 2014 product gross profit margin were a higher proportion of sales involving trade-in’s and higher credits given forthose trade-ins, higher 2014 incentive compensation, and higher product recall costs.Product gross profit for the year ended December 31, 2014, and 2013 reflected share-based compensation expense of $19.1 million and $17.6 million,respectively. Product gross profit for the years ended December 31, 2014, and 2013 included $15.7 million and $21.0 million, respectively, related to the U.S.medical device excise tax, which became effective January 1, 2013.Service gross profit during the year ended December 31, 2014, increased to $281.0 million, or 65.5% of service revenue, compared with $269.8 million,or 67.9% of service revenue during the year ended December 31, 2013. The higher 2014 service gross profit was driven by higher service revenue. The lower2014 gross service profit margin was primarily driven by costs added to support the newly introduced da Vinci Xi system and higher incentive compensation.Service gross profit during the years ended December 31, 2014, and 2013, reflected share-based compensation expense of $13.5 million and $12.7 million,respectively.Product gross profit during the year ended December 31, 2013, decreased 1% to $1.3 billion, or 70.9% of product revenue, compared with $1.3 billion, or73.0% of product revenue, during the year ended December 31, 2012. The lower 2013 product gross margin largely reflected the impact of the new U.S.medical device excise tax and lower gross margins earned on recently released instrument and accessory products. 2013 product revenue included a higherproportion of recently introduced instrument and accessory products which yield lower gross margin percentages, particularly Single-Site Instruments and theEndoWrist One Vessel Sealer. Margins on newly launched products will typically be lower than our mature products reflecting vendor pricing on lowvolumes, temporary tooling costs and other start-up costs. Over time, as volumes increase, and we refine the manufacturing processes and products, we expectto see improvement in the margins of these newer products. However, gross margins may ultimately differ for these newer products relative to our previousproducts based market conditions, volume, and complexity of the product. Product gross profit for the year ended December 31, 2013 and 2012, reflectedshare-based compensation expense of $17.6 million and $14.1 million, respectively.Service gross profit during the year ended December 31, 2013, increased to $269.8 million, or 67.9% of service revenue, compared with $229.4 million,or 67.0% of service revenue during the year ended December 31, 2012. The higher 2013 service gross profit was driven by higher service revenue asdescribed above. The higher 2013 gross service profit margin was primarily driven by lower service parts consumption rates. Service gross profit during theyears ended December 31, 2013 and 2012, reflected share-based compensation expense of $12.7 million and $12.9 million, respectively.Selling, General and Administrative ExpensesSelling, general and administrative expenses include costs for sales, marketing and administrative personnel, sales and marketing activities, tradeshowexpenses, legal expenses, regulatory fees and general corporate expenses.Selling, general and administrative expenses for the year ended December 31, 2014 increased 20% to $691.0 million compared to $574.0 million for theyear ended December 31, 2013. The increase was primarily due to a pre-tax charge of $82.4 million of which $67.4 million, $9.6 million, and $5.4 millionwas recorded in the first, second, and fourth quarters of 2014, respectively, to reflect the estimated cost of settling a number of the product liability claimscovered by tolling agreements outlined above. In addition, selling, general and administrative expenses for the year ended December 31, 2014, also increaseddue to higher legal costs related to the pending or threatened litigation, expansion of our Japanese and other international organizations, higher regulatorycompliance costs, and higher incentive compensation. Share-based compensation expense charged to selling, general and administrative expenses during theyears ended December 31, 2014, and 2013, were $99.0 million and $101.4 million, respectively.Selling, general and administrative expenses for the year ended December 31, 2013, increased 10% to $574.0 million compared to $522.2 million for theyear ended December 31, 2012. The increase was primarily due to organizational growth to support our expanding business, particularly in the clinical fieldsales function, regulatory activity, and higher legal costs related to pending or threatened litigation, and higher share-based compensation expenses, partiallyoffset by lower employee incentive costs. Share-based compensation expense charged to selling, general and administrative expenses during the years endedDecember 31, 2013 and 2012 were $101.4 million and $93.1 million, respectively.Research and Development ExpensesResearch 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. These enhancements represent significant improvements to our products.Research and development expenses during the year ended December 31, 2014, increased 6% to $178.0 million compared to $167.7 million during theyear ended December 31, 2013. The increase was driven by higher headcount and incentive compensation expenses. Share-based compensation expensecharged to research and development expense during the years ended December 31, 2014, and 2013, were $37.5 million and $37.2 million, respectively.Amortization expense related to purchased intellectual property during the years ended December 31, 2014, and 2013, were $11.6 million and $10.8 million,respectively. We expect to continue47Table of Contentsto make substantial investments in research and development and anticipate that research and development expenses, including co-developmentarrangements with industry partners, will increase in the future.Research and development expenses during the year ended December 31, 2013, decreased 1% to $167.7 million compared to $170.0 million during theyear ended December 31, 2012. The decrease was due to lower 2013 incentive compensation, amortization of intangible assets, and prototype expenses,partly offset by higher share-based compensation. Share-based compensation expense charged to research and development expense during the years endedDecember 31, 2013 and 2012, was $37.2 million and $33.2 million, respectively. Amortization expense related to purchased intellectual property during theyears ended December 31, 2013, and 2012, were $10.8 million and $13.8 million, respectively.Interest and Other Income, NetInterest and other income, net, was $4.2 million during the year ended December 31, 2014, compared to $18.4 million for the year ended December 31,2013. Lower interest and other income, net for the year ended December 31, 2014, was driven by lower 2014 interest income on lower investment balancesand $8.5 million in charges recorded related to the impairment of two equity investments.Interest and other income, net, was $18.4 million during the year ended December 31, 2013, compared to $15.8 million for the year ended December 31,2012. Higher interest and other income, net for the year ended December 31, 2013, was driven by higher 2013 interest income earned.Income Tax ExpenseOur income tax expense was $130.2 million, $199.9 million, and $237.3 million during the years ended December 31, 2014, 2013, and 2012,respectively. The effective tax rate for 2014 was approximately 23.7% compared with 23.0% for 2013, and 26.5% for 2012. Our tax rates for all these periodsdiffered from the U.S. federal statutory rate of 35% due primarily to income earned by certain of our overseas entities being taxed at rates lower than thefederal statutory rate and the reversal of unrecognized tax benefits, partially offset by state income taxes net of federal benefit. We intend to indefinitelyreinvest all of our undistributed foreign earnings that were not previously subject to U.S. tax in activities outside the U.S. Our 2014, 2013, and 2012 taxprovision reflected net tax benefits of $20.3 million, $26.7 million, and $38.0 million, respectively, associated with the reversal of unrecognized tax benefitsand interests resulting from expiration of statutes of limitations in multiple jurisdictions and certain audit settlements. Our 2014 tax provision included a nettax benefit of $5.0 million related to the federal research and development (“R&D”) credit which was reinstated in December 2014. Our 2013 tax provisionincluded a net tax benefit of $4.7 million for the 2013 federal R&D credit and a net tax benefit of $8.2 million related to 2012 federal R&D credit as thefederal R&D credit was retroactively reinstated during the first quarter of 2013. Our 2012 tax provision did not reflect any benefit from federal R&D creditbut reflected $8.5 million in benefits related to certain previously unrecognized tax benefits and associated interest as a result of new IRS guidance issued inthe first quarter of 2012.A valuation allowance has been recorded against our California deferred tax assets because it is more likely than not these deferred tax assets will not berealized as a result of the computation of California taxes under the single sales factor. We will continue to monitor and reassess the need for further increasesor decreases to the valuation allowance. As of December 31, 2014, and 2013, we had valuation allowances of $9.5 million and $7.2 million, respectively,primarily on California deferred tax assets.The U.S. Internal Revenue Service (“IRS”) completed its audit of our 2010 and 2011 federal income tax returns in December 2014. At the conclusion ofthe audit, the IRS provided its Revenue Agent’s Report to the Joint Committee of Taxation, which agreed with the IRS examiner’s Report with no exceptions.As a result, we released reserves in connection with years 2010 and 2011 in the fourth quarter of 2014, which were included in the $20.3 million reversal ofunrecognized tax benefits and interests described above. In addition, we anticipate receiving a refund of $4.5 million in 2015 in connection with theconclusion of the audit.We file federal, state and foreign income tax returns in many jurisdictions in the U.S. and abroad. Generally, years before 2010 are closed for mostsignificant jurisdictions except for California, for which years before 2008 are considered closed. We are subject to the examination of our income tax returnsby various tax authorities and the outcome of these audits cannot be predicted with certainty.Certain of our unrecognized tax benefits could reverse based on the normal expiration of various statutes of limitations, which could affect our effectivetax rate in the period in which they reverse. Management regularly assesses the likelihood of adverse outcomes resulting from these examinations todetermine the adequacy of our provision for income taxes. If any issues addressed in our tax audits are resolved in a manner not consistent withmanagement’s expectations, we could be required to adjust our provision for income taxes in the period such resolution occurs.48Table of ContentsLiquidity and Capital ResourcesSources and Uses of CashOur principal source of liquidity is cash provided by operations and issuance of common stock through exercise of stock options and our employee stockpurchase program. Cash and cash equivalents plus short and long-term investments decreased from $2.9 billion at December 31, 2012, to $2.8 billion atDecember 31, 2013, and to $2.5 billion at December 31, 2014. Cash generation is one of our fundamental strengths and provides us with substantial financialflexibility in meeting our operating, investing, and financing needs. The decreases in cash and investments generally reflect cash used for stock repurchasesand capital expenditures partially offset by cash flow from operations.As of December 31, 2014, $766.7 million of our cash, cash equivalents and investments were held by foreign subsidiaries. Amounts held by foreignsubsidiaries are generally subject to U.S. income taxation on repatriation to the U.S. We currently have no plans to repatriate any foreign earnings back to theU.S. as we believe our cash flows provided by our U.S. operations will meet our U.S. liquidity needs.See “Item 7A. Quantitative and Qualitative Disclosures About Market Risk” for discussion on the impact of interest rate risk and market risk on ourinvestment portfolio.Consolidated Cash Flow Data Years Ended December 31, 2014 2013 2012 (in millions)Net cash provided by (used in) Operating activities$665.1 $880.0 $814.2Investing activities(153.9) 259.0 (845.7)Financing activities(692.4) (910.6) 119.2Effect of exchange rates on cash and cash equivalents(0.6) — 0.2Net increase (decrease) in cash and cash equivalents$(181.8) $228.4 $87.9Operating ActivitiesDuring the year ended December 31, 2014, cash flow from operations of $665.1 million exceeded our net income of $418.8 million for two primaryreasons:1.Our net income included substantial non-cash charges primarily in the form of share-based compensation, amortization of intangible assets, taxes,and depreciation. These non-cash charges totaled $232.1 million during the year ended December 31, 2014.2.Changes in operating assets and liabilities resulted in approximately $14.2 million in cash provided by operating activities during the year endedDecember 31, 2014.Operating assets and liabilities are comprised primarily of accounts receivable, inventory, deferred revenue, other accrued liabilities, and prepaidexpenses. Accrued liabilities increased by $63.4 million, mainly driven by an increase in product liability accruals. Deferred revenue, which includesdeferred service revenue that is being recognized as revenue over the service contract period, increased by $19.8 million in 2014 primarily due to the increasein the number of installed systems for which service contracts existed. Also, accrued compensation and accounts payable increased by $39.1 million. Thefavorable impact of these items on cash provided by operating activities was partly offset by an increase in accounts receivable of $13.7 million in 2014reflecting timing of our system sales and related collections, a net increase in inventory of $26.8 million primarily due to expanded product offerings, and anincrease in prepaids and other assets of $67.6 million, primarily driven by timing of tax payments and an increase in lease receivables relating to sales-typelease arrangements entered into during fiscal 2014.During the year ended December 31, 2013, cash flow from operations of $880.0 million exceeded our net income of $671.0 million for two primaryreasons:1.Our net income included substantial non-cash charges in the form of share-based compensation, amortization of intangible assets, taxes, anddepreciation. These non-cash charges totaled $231.0 million during the year ended December 31, 2013.2.Changes in operating assets and liabilities resulting in cash used in operating activities during the year ended December 31, 2013 wasapproximately $22.0 million.49Table of ContentsOperating assets and liabilities are comprised primarily of accounts receivable, inventory, deferred revenue and other liabilities. Accounts receivabledecreased by $68.9 million, or 19%, in 2013 reflecting timing of our system sales. Inventory increased by $58.1 million, or 48%, in 2013 due to expandedproduct offerings and safety stocks acquired for key components. Deferred revenue, which includes deferred service revenue that is being recognized asrevenue over the service contract period, increased $15.3 million, or 8%, in 2013 primarily due to the increase in the number of installed systems for whichservice contracts exist. Other liabilities including accounts payable, accrued compensation and employee benefits, and accrued liabilities decreased by $35.1million in 2013 primarily due to timing of vendor, tax and employee compensation payments during 2013.During the year ended December 31, 2012, cash flow from operations of $814.2 million exceeded our net income of $656.6 million for two primaryreasons:1.Our net income included substantial non-cash charges in the form of share-based compensation, amortization of intangible assets, taxes anddepreciation. These non-cash charges totaled $223.1 million during the year ended December 31, 2012.2.Changes in operating assets and liabilities resulting in cash used in operating activities during the year ended December 31, 2012 wasapproximately $65.5 million.Operating assets and liabilities are comprised primarily of accounts receivable, inventory, deferred revenue and other liabilities. Accounts receivableincreased by $68.9 million, or 24%, in 2012 reflecting timing of our system sales. Inventory increased by $7.1 million, or 8%, in 2012 due to our businessgrowth, expanded product offerings, and safety stocks acquired for key components. Deferred revenue, which includes deferred service contract revenue thatis being amortized over the service contract period, increased $30.5 million, or 20%, in 2012 primarily due to the increase in the number of installed systemsfor which service contracts exist. Other liabilities including accounts payable, accrued compensation and employee benefits, and accrued liabilities increasedby $17.1 million in 2012 primarily due to timing of vendor, tax and employee compensation payments during 2012.Investing ActivitiesNet cash used in investing activities during the year ended December 31, 2014, consisted primarily of cash used for purchases of property and equipmentof $105.6 million and purchases of businesses of $84.3 million, partially offset by the proceeds from the sales and maturities of investments (net of purchasesof investments) of $36.0 million. Purchases of property included the acquisition of approximately 15 acres of land in Sunnyvale, California for futureexpansion. During the year ended December 31, 2014, we acquired certain intellectual property, know-how, fixed assets, and employees from Luna and wereacquired the Japan distribution rights from Adachi.Net cash provided by investing activities during the year ended December 31, 2013, consisted primarily of proceeds from the sales and maturities ofinvestments (net of purchases of investments) of $363.6 million, less purchases of property and equipment and licensing of intellectual property of $104.6million.Net cash used in investing activities during the year ended December 31, 2012, consisted primarily of purchases of investments (net of proceeds fromsales and maturities of investments) of $703.9 million less purchases of property and equipment and licensing of intellectual property of $114.2 million. Weinvest 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/or tax exempt municipal notes, corporate notes and bonds, commercial paper, cash deposits and money marketfunds.Financing ActivitiesNet cash used in financing activities in 2014 consisted primarily of $1.0 billion used for the repurchase of 2.5 million shares of our common stockthrough an accelerated share repurchase program, offset by proceeds from stock option exercises and employee stock purchases of $283.6 million and excesstax benefits of $24.0 million. Net cash used in financing activities in 2013 consisted primarily of $1.1 billion used for the repurchase of 2.6 million shares ofour common stock, offset by proceeds from stock option exercises and employee stock purchases of $160.6 million and excess tax benefits of $38.0 million.Net cash proceeds provided by financing activities in 2012 consisted primarily of stock option exercises and employee stock purchases of $263.3 millionand excess tax benefits of $94.2 million, offset by $238.3 million used for the repurchase of 0.4 million shares of our common stock through open markettransactions.Our cash requirements depend on numerous factors, including market acceptance of our products, the resources we devote to developing and supportingour products and other factors. We expect to continue to devote substantial resources to expand procedure adoption and acceptance of our products. We havemade substantial investments in our commercial operations, product development activities, facilities and intellectual property. Based upon our businessmodel, we anticipate that we will continue to be able to fund future growth through cash provided from operations. We believe that our current cash, cashequivalents and investment balances, together with income to be derived from the sale of our products, will be sufficient to meet our liquidity requirementsbeyond one year and for the foreseeable future.50Table of ContentsContractual Obligations and Commercial CommitmentsThe following table summarizes our contractual obligations as of December 31, 2014 (in millions): Payments due by period Total Less than1 year 1 to 3 years 3 to 5 yearsOperating leases$10.8 $5.1 $5.1 $0.6Purchase commitments and obligations251.5 250.0 1.5 —Total contractual obligations$262.3 $255.1 $6.6 $0.6Operating leases. We lease office spaces in the U.S., Switzerland, Mexico, Japan, Brazil, China, and Korea. We also lease automobiles for certain salesand field service employees. Operating lease amounts include future minimum lease payments under all our non-cancellable operating leases with an initialterm in excess of one year.Purchase commitments and obligations. These amounts include an estimate of all open purchase orders and contractual obligations in the ordinarycourse of business, including commitments with contract manufacturers and suppliers, for which we have not received the goods or services and acquisitionand licensing of intellectual property. A majority of these purchase obligations are due within a year. Although open purchase orders are consideredenforceable and legally binding, the terms generally allow us the option to cancel, reschedule, and adjust our requirements based on our business needs priorto the delivery of goods or performance of services. In addition to the above, we have committed to make potential future milestone payments to third partiesas part of licensing, collaboration and development arrangements. Payments under these agreements generally become due and payable only uponachievement of certain developmental, regulatory and/or commercial milestones. Because the achievement of these milestones is neither probable norreasonably estimable, such contingencies have not been recorded on our Consolidated Balance Sheets and have not been included in the table above.Other commitments. We are unable to make a reasonably reliable estimate as to when payments may occur for our unrecognized tax benefits. Therefore,our liability for unrecognized tax benefits is not included in the table above.Off-Balance Sheet ArrangementsAs of December 31, 2014, we did not have any significant off-balance sheet arrangements, as defined in Item 303(a)(4)(ii) of SEC Regulation S-Kpromulgated under the Exchange Act.Critical Accounting EstimatesOur Consolidated Financial Statements are prepared in conformity with U.S. generally accepted accounting principles (“U.S. GAAP”), which requires usto make judgments, estimates and assumptions. See “Note 2. Summary of Significant Accounting Policies,” in Notes to the Consolidated FinancialStatements, which is included in “Item 8. Financial Statements and Supplementary Data,” which describes our significant accounting policies and methodsused in the preparation of our Consolidated Financial Statements. The methods, estimates and judgments that we use in applying our accounting policiesrequire us to make difficult and subjective judgments, often as a result of the need to make estimates regarding matters that are inherently uncertain. Our mostcritical accounting estimates include:•the valuation and recognition of investments, which impacts our investment portfolio balance when we assess fair value, and interest and otherincome, net, when we record impairments;•the valuation of revenue and allowance for sales returns and doubtful accounts, which impacts revenue;•the estimation of transactions to hedge, which impacts revenue and other expense;•the valuation of inventory, which impacts gross profit margins;•the assessment of recoverability of intangible assets and their estimated useful lives, which primarily impacts gross profit margin or operatingexpenses when we record asset impairments or accelerate their amortization;•the valuation and recognition of share-based compensation, which impacts gross profit margin and operating expenses;•the recognition and measurement of current and deferred income taxes (including the measurement of uncertain tax positions), which impact ourprovision for taxes; and•the estimate of probable loss associated with product liability claims, which impacts accrued liabilities and operating expenses.51Table of ContentsInvestments ValuationFair ValueOur investment portfolio may at any time contain investments in U.S. Treasury and U.S. government agency securities, taxable and/or tax exemptmunicipal notes (some of which may have an auction reset feature), corporate notes and bonds, commercial paper, cash deposits and money market funds. Inthe current market environment, the assessment of the fair value of investments can be difficult and subjective. U.S. GAAP establishes three levels of inputsthat may be used to measure fair value. Each level of input has different levels of subjectivity and difficulty involved in determining fair value. Valuation ofLevel 1 and 2 instruments generally do not require significant management judgment and the estimation is not difficult. Level 3 instruments includeunobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. The determination offair value for Level 3 instruments requires the most management judgment and subjectivity. During the year ended December 31, 2014, the Level 3 securitieswere redeemed. There were no other Level 3 securities as of December 31, 2014.Other-than-temporary impairmentAfter determining the fair value of our available-for-sales instruments, gains or losses on these securities are recorded to other comprehensive income,until either the security is sold or we determine that the decline in value is other-than-temporary. The primary differentiating factors we considered inclassifying impairments as either temporary or other-than-temporary impairments are our intent and ability to retain our investment in the issuer for a periodof time sufficient to allow for any anticipated recovery in market value, the length of the time and the extent to which the market value of the investment hasbeen less than cost, the financial condition and near-term prospects of the issuer. Given the current market conditions, these judgments could prove to bewrong, and companies with relatively high credit ratings and solid financial conditions may not be able to fulfill their obligations.During the year ended December 31, 2014, we recorded pre-tax losses of $8.5 million related to a decline in the value of two equity investments that weconcluded were other-than-temporary. No significant impairment charges were recorded during the years ended December 31, 2013, and 2012. As ofDecember 31, 2014, and 2013, net unrealized losses on investments of $0.2 million, net of tax and net unrealized gains on investments of $1.7 million, net oftax, respectively, were included in accumulated other comprehensive income (loss).Allowance for sales returns and doubtful accounts. We record estimated reductions in revenue for potential returns of products by customers and otherallowances. As a result, management must make estimates of potential future product returns and other allowances related to current period product revenue.In making such estimates, management analyzes historical returns, current economic trends and changes in customer demand and acceptance of our products.If management were to make different judgments or utilize different estimates, material differences in the amount of reported revenue could result.Similarly, we make estimates of the collectibility of accounts receivable, especially analyzing the aging and nature of accounts receivable and historicalbad debts, customer concentrations, customer credit-worthiness, current economic trends, and changes in customer payment terms when evaluating theadequacy of the allowance for doubtful accounts. Credit evaluations are undertaken for all major sale transactions before shipment is authorized. On aquarterly basis, we evaluate aged items in the accounts receivable aging report and provide an allowance in an amount we deem adequate for doubtfulaccounts. If management were to make different judgments or utilize different estimates, material differences in the amount of our reported operatingexpenses could result.Hedge Accounting for Derivatives. We utilize foreign currency forward exchange contracts to hedge certain anticipated foreign currency sales transactions.When specific criteria required by relevant accounting standards have been met, changes in fair values of hedge contracts relating to anticipated transactionsare recorded in other comprehensive income (“OCI”) rather than net income until the underlying hedged transaction affects net income. By their nature, ourestimates of anticipated transactions may fluctuate over time and may ultimately vary from actual transactions. When we determine that the transactions areno longer probable within a certain time-frame, we are required to reclassify the cumulative changes in the fair values of the related hedge contracts from OCIto net income.Inventory valuation. Inventory is stated at the lower of cost or market, with cost determined on a first-in, first-out basis. The cost basis of our inventory isreduced for any products that are considered excessive or obsolete based upon assumptions about future demand and market conditions. If actual futuredemand or market conditions are less favorable than those projected by management, additional inventory write-downs may be required, which could have amaterial adverse effect on the results of our operations.Intangible Assets. Our intangible assets include identifiable intangibles and goodwill. Identifiable intangibles include developed technology, patents,distribution rights, customer relationships, and licenses. All of our identifiable intangibles have finite lives. Goodwill and intangible assets with indefinitelives are subject to an annual impairment review (or more frequent if impairment indicators arise) by applying a fair-value based test. There have been noimpairments from the analysis required by U.S. GAAP.52Table of ContentsIdentifiable intangible assets with finite lives are subject to impairment testing and are reviewed for impairment when events or circumstances indicatethat the carrying value of an asset is not recoverable and its carrying amount exceeds its fair value. We evaluate the recoverability of the carrying value ofthese identifiable intangible assets based on estimated undiscounted cash flows to be generated from such assets. If the cash flow estimates or the significantoperating assumptions upon which they are based change in the future, we may be required to record additional impairment charges.The valuation and classification of intangible assets and goodwill and the assignment of useful lives for purposes of amortization involves judgmentsand the use of estimates. The evaluation of these intangibles and goodwill for impairment under established accounting guidelines is required on a recurringbasis. Changes in business conditions could potentially require future adjustments to the assumptions made. When we determine that the useful lives ofassets are shorter than we had originally estimated, we accelerate the rate of amortization over the assets’ new, shorter useful lives. No impairment charge oraccelerated amortization was recorded for the years ended December 31, 2014, 2013, and 2012. A considerable amount of judgment is required in assessingimpairment, which includes financial forecasts. Should conditions be different from management’s current estimates, material write-downs of long-livedassets may be required, which would adversely affect our operating results.Revenue recognition. Our system sale arrangements contain multiple elements, including system(s), system accessories, instruments, accessories, andsystem service. We generally deliver all of the elements, other than service, within days of entering into the system sale arrangement. Each of these elementsis a separate unit of accounting. System accessories, instruments, accessories, and service are also sold on a stand-alone basis.For multiple-element arrangements, revenue is allocated to each unit of accounting based on their relative selling prices. Relative selling prices are basedfirst on vendor specific objective evidence of fair value (“VSOE”), then on third-party evidence of selling price (“TPE”) when VSOE does not exist, and thenon management's best estimate of the selling price (“ESP”) when VSOE and TPE do not exist.Our system sale arrangements generally include a one-year period of free service, and the right for the customer to purchase service annually after that forup to four years at a stated service price. The revenue allocated to the free service period is deferred and recognized ratably over the free service period.Because we have neither VSOE nor TPE for our systems, the allocation of revenue is based on ESP for the systems sold. The objective of ESP is todetermine the price at which we would transact a sale, had the product been sold on a stand-alone basis. We determine ESP for our systems by consideringmultiple factors, including, but not limited to, features and functionality of the system, geographies, type of customer, and market conditions. We regularlyreview ESP and maintain internal controls over establishing and updating these estimates.Accounting for stock options. We account for share-based compensation in accordance with the fair value recognition provisions of U.S. GAAP. We usethe Black-Scholes-Merton option-pricing model which requires the input of highly subjective assumptions. These assumptions include estimating the lengthof time employees will retain their vested stock options before exercising them, the estimated volatility of our common stock price over the expected term,and the number of options that will ultimately not complete their vesting requirements. The assumptions for expected volatility and expected term are thetwo assumptions that most significantly affect the grant date fair value of stock options. Changes in expected risk-free rate of return do not significantlyimpact the calculation of fair value, and determining this input is not highly subjective.We use implied volatility based on freely traded options in the open market, as we believe implied volatility is more reflective of market conditions anda better indicator of expected volatility than historical volatility. In determining the appropriateness of relying on implied volatility, we considered thefollowing:•the sufficiency of the trading volume of freely traded options;•the ability to reasonably match the terms, such as the date of the grant and the exercise price of the freely traded options to options granted; and•the length of the term of the freely traded options used to derive implied volatility.The expected term represents the weighted-average period that our stock options are expected to be outstanding. The expected term is based on theobserved and expected time to exercise. We determine expected term based on historical exercise patterns and our expectation of the time it will take foremployees to exercise options still outstanding.U.S. GAAP requires us to develop an estimate of the number of share-based awards that will be forfeited due to employee turnover. Adjustments in theestimated forfeiture rates can have a significant effect on our reported share-based compensation, as we recognize the cumulative effect of the rateadjustments for all expense amortization in the period the estimated forfeiture rates were adjusted. We estimate and adjust forfeiture rates based on a periodicreview of recent forfeiture activity and expected future employee turnover. If a revised forfeiture rate is higher than previously estimated forfeiture rate, wemay make an adjustment that will result in a decrease to the expense recognized in the financial statements during the period when the rate was changed.Adjustments in the estimated forfeiture rates could also cause changes in the amount of expense that we recognize in future periods.53Table of ContentsChanges in these subjective assumptions can materially affect the estimate of fair value of stock options and, consequently, the related amount of share-based compensation expense recognized on the Consolidated Statements of Income.Accounting for income taxes. Significant management judgment is required in determining our provision for income taxes, deferred tax assets andliabilities and any valuation allowance recorded against net deferred tax assets in accordance with U.S. GAAP. These estimates and judgments occur in thecalculation of tax credits, benefits, and deductions, and in the calculation of certain tax assets and liabilities, which arise from differences in the timing ofrecognition of revenue and expense for tax and financial statement purposes, as well as the interest and penalties related to uncertain tax positions.Significant changes to these estimates may result in an increase or decrease to our tax provision in the current or subsequent period.We must assess the likelihood that we will be able to recover our deferred tax assets. If recovery is less than a 50% likelihood, we must increase ourprovision for taxes by recording a valuation allowance to reduce our deferred tax assets to the amount that is more likely than not to be recoverable. As ofDecember 31, 2014, we believe it is more likely than not that our deferred tax assets ultimately will be recovered with the exception of our California deferredtax assets. We believe that due to the computation of California taxes under the single sale factor, it is more likely than not that our California deferred taxassets will not be realized. Should there be a change in our ability to recover our deferred tax assets, our tax provision would be affected in the period inwhich such change takes place.The calculation of our tax liabilities involves dealing with uncertainties in the application of complex tax regulations. We recognize liabilities foruncertain tax positions based on a two-step process. The first step is to evaluate the tax position for recognition by determining if the weight of availableevidence indicates that it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, ifany. If we determine that a tax position will more likely than not be sustained on audit, then the second step requires us to estimate and measure the taxbenefit as the largest amount that is more than 50% likely to be realized upon ultimate settlement. It is inherently difficult and subjective to estimate suchamounts, as we have to determine the probability of various possible outcomes. We re-evaluate these uncertain tax positions on a quarterly basis. Thisevaluation is based on factors including, but not limited to, changes in facts or circumstances, changes in tax law, effective settlement of audit issues, andnew audit activity. Such a change in recognition or measurement would result in the recognition of a tax benefit or an additional charge to the tax provision.Accounting for legal contingencies. We are involved in a number of legal proceedings involving product liability, intellectual property, shareholderderivative actions, securities class actions, and other matters. We record a liability and related charge to earnings in our consolidated financial statements forlegal contingencies when the loss is considered probable and the amount can be reasonably estimated. Our assessment is reevaluated each accounting periodand is based on all available information, including discussion with any outside legal counsel that represents us. If a reasonable estimate of a known orprobable loss cannot be made, but a range of probable losses can be estimated, the low-end of the range of losses is recognized if no amount within the rangeis a better estimate than any other. If a loss is reasonably possible, but not probable and can be reasonably estimated, the estimated loss or range of loss isdisclosed in the notes to the consolidated financial statements.When determining the estimated probable loss or range of losses, significant judgment is required to be exercised in order to estimate the amount andtiming of the loss to be recorded. Estimates of probable losses resulting from litigation are inherently difficult to make, particularly when the matters are inearly procedural stages with incomplete facts and information. The final outcome of legal proceedings is dependent on many variables difficult to predict,and therefore, the ultimate cost to entirely resolve such matters may be materially different than the amount of current estimates. Consequently, newinformation or changes in judgments and estimates could have a material adverse effect on our business, financial condition, and results of operations or cashflows. See Note 7 Commitments and Contingencies for discussion of the charges recorded during fiscal 2014 related to our best estimate of probable lossassociated with product liability claims.RECENT ACCOUNTING PRONOUNCEMENTSSee “Note 2. Summary of Significant Accounting Policies” of the Notes to Consolidated Financial Statements in “Item 8. Financial Statements andSupplementary Data” for a full description of recent accounting pronouncements including the respective expected dates of adoption and estimated effects, ifany on our consolidated financial statements.ITEM 7A.QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKInterest Rate and Market RiskThe primary objective of our investment activities is to preserve principal while at the same time maximizing the income we receive from ourinvestments without significantly increasing risk. To achieve this objective, we maintain our portfolio of cash equivalents and short-term and long-terminvestments in a variety of high quality securities, including U.S. treasuries and government agencies, corporate debt, money market funds, commercialpaper, and taxable or tax exempt municipal bonds. The securities are classified as available-for-sale and consequently are recorded at fair value withunrealized gains or losses reported as a separate component of accumulated other comprehensive income (loss). The weighted-average maturity of ourinvestments as of December 31, 2014 was approximately 1.4 years. If interest rates rise, the market value of our investments may decline,54Table of Contentswhich could result in a realized loss if we are forced to sell an investment before its scheduled maturity. A hypothetical increase in interest rate by 25 basispoints would have resulted in a decrease in the fair value of our net investment position of approximately $7.5 million as of December 31, 2014. We do notutilize derivative financial instruments to manage our interest rate risks.The uncertain financial markets have resulted in a tightening in the credit markets, a reduced level of liquidity in many financial markets, and extremevolatility in fixed income and credit markets. The credit ratings of the securities we have invested in could further deteriorate and may have an adverseimpact on the carrying value of these investments.Foreign Exchange RiskThe majority of our revenue, expense, and capital purchasing activities are transacted in U.S. dollars. However, we sell in local currency in most of theEuropean markets where we sell direct, as well as in Japan, and in Korea. We operate in a number of markets on a direct sales basis and incur operatingexpenses in local currencies in Europe, Japan, and Korea. We also purchase certain product components from non-U.S. suppliers in local currency. As a result,because a portion of our operations consist of sales activities outside of the U.S., we have foreign exchange exposures to non-U.S. dollar revenues, operatingexpenses, accounts receivable, accounts payable, and foreign currency bank balances.For the year ended December 31, 2014, sales denominated in foreign currencies (Euro, British Pound, Japanese Yen, and Korean Won) wereapproximately 16% of total revenue. The objective of our hedging program is to mitigate the impact of changes in currency exchange rates on our net cashflow from foreign currency denominated sales. For the year ended December 31, 2014, our revenue would have decreased by approximately $3.6 million ifthe U.S. dollar exchange rate would have strengthened by 10%. We also hedge the net recognized non-functional currency balance sheet exposures withforeign exchange forward contracts to reduce the risk that our earnings and cash flows will be adversely affected by changes in exchange rates. A 10%strengthening of the U.S. dollar exchange rate against all currencies to which we have exposure, after taking into account hedges and offsetting positions asof December 31, 2014, would have resulted in a $7.2 million decrease in the carrying amounts of those net assets. Actual gains and losses in the future maydiffer materially from the hypothetical gains and losses discussed above based on changes in the timing and amount of foreign currency exchange ratemovements and our actual exposure and hedging transactions. Bank counterparties to foreign exchange forward contracts expose us to credit-related losses inthe event of their nonperformance. To mitigate that risk, we only contract with counterparties that meet certain minimum requirements under our counterpartyrisk assessment process. We monitor ratings and potential downgrades on at least a quarterly basis. Based on our ongoing assessment of counterparty risk, wewill adjust our exposure to various counterparties.Although we sell to distributors outside the U.S. in U.S. dollars, strengthening of the dollar can impact our distributors’ margins and could impact the endcustomers’ ability to purchase our product if our distributors seek to recover the impact of the change in the dollar by increasing product and service prices.Less than 10% of our revenue is conducted through distributors outside the U.S. Strengthening of the dollar relative to non-U.S. currencies could have anadverse impact on our business.Our international operations are subject to risks typical of international operations, including, but not limited to, differing economic conditions, changesin political climate, differing tax structures, other regulations and restrictions, and foreign exchange rate volatility.55Table of ContentsITEM 8.FINANCIAL STATEMENTS AND SUPPLEMENTARY DATAIndex To Consolidated Financial Statements Page No. Report of Independent Registered Public Accounting Firm57 Report of Ernst & Young - Independent Registered Public Accounting Firm58 Consolidated Balance Sheets at December 31, 2014 and 201359 Consolidated Statements of Income for the years ended December 31, 2014, 2013, and 201260 Consolidated Statements of Comprehensive Income for the years ended December 31, 2014, 2013, and 201261 Consolidated Statements of Stockholders’ Equity for the years ended December 31, 2014, 2013, and 201262 Consolidated Statements of Cash Flows for the years ended December 31, 2014, 2013, and 201263 Notes to the Consolidated Financial Statements64 Schedule II—Valuation and Qualifying Accounts89All other schedules have been omitted because they are not applicable or the required information is shown in the Consolidated Financial Statements orthe Notes thereto.56REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRMTo the Board of Directors and Shareholders of Intuitive Surgical, Inc.In our opinion, the accompanying consolidated balance sheet of Intuitive Surgical, Inc. as of December 31, 2014 and the related consolidated statements ofincome, comprehensive income, stockholders’ equity and cash flows for the year then ended present fairly, in all material respects, the financial position ofIntuitive Surgical, Inc. and its subsidiaries at December 31, 2014, and the results of their operations and their cash flows for the year then ended in conformitywith accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule for the yearended December 31, 2014 listed in the accompanying index presents fairly, in all material respects, the information set forth therein when read in conjunctionwith the related consolidated financial statements. Also in our opinion, the Company maintained, in all material respects, effective internal control overfinancial reporting as of December 31, 2014, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee ofSponsoring Organizations of the Treadway Commission (COSO). The Company's management is responsible for these financial statements and financialstatement schedule, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control overfinancial reporting, included in Management's Report on Internal Control Over Financial Reporting appearing under Item 9A. Our responsibility is to expressopinions on these financial statements, on the financial statement schedule and on the Company's internal control over financial reporting based on ourintegrated audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Thosestandards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatementand whether effective internal control over financial reporting was maintained in all material respects. Our audit of the financial statements includedexamining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used andsignificant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reportingincluded obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluatingthe design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as weconsidered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reportingand the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal controlover financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairlyreflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permitpreparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are beingmade only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention ortimely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation ofeffectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliancewith the policies or procedures may deteriorate./s/ PricewaterhouseCoopers LLPSan Jose, CaliforniaFebruary 5, 201557Table of ContentsREPORT OF ERNST & YOUNG - INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRMThe Board of Directors and Stockholders of Intuitive Surgical, Inc.We have audited the accompanying consolidated balance sheet of Intuitive Surgical, Inc. as of December 31, 2013, and the related consolidated statements ofincome, comprehensive income, stockholders’ equity, and cash flows for the two years ended December 31, 2013. Our audits also included the financialstatement schedule listed in the index at Item 15(a). These financial statements and schedule are the responsibility of the Company’s management. Ourresponsibility is to express an opinion on these financial statements and schedule based on our audits.We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require thatwe plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includesexamining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accountingprinciples used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our auditsprovide a reasonable basis for our opinion.In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Intuitive Surgical, Inc.at December 31, 2013, and the consolidated results of its operations and its cash flows for the two years ended December 31, 2013, in conformity with U.S.generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financialstatements taken as a whole, presents fairly in all material respects, the information set forth therein./s/ ERNST & YOUNG LLPSan Francisco, CaliforniaFebruary 5, 201558Table of ContentsINTUITIVE SURGICAL, INC.CONSOLIDATED BALANCE SHEETS(IN MILLIONS, EXCEPT PAR VALUE AMOUNTS) December 31, 2014 2013ASSETS Current assets: Cash and cash equivalents$600.3 $782.1Short-term investments632.2 621.4Accounts receivable, net of allowances of $0.3 and $0.5 at December 31, 2014 and 2013, respectively315.1 301.4Inventories181.7 179.6Prepaids and other current assets82.6 38.3Deferred tax assets35.1 9.6Total current assets1,847.0 1,932.4Property, plant and equipment, net387.4 309.9Long-term investments1,264.5 1,350.4Long-term deferred tax asset136.2 126.1Intangible and other assets, net126.3 94.1Goodwill198.0 137.4Total assets$3,959.4 $3,950.3LIABILITIES AND STOCKHOLDERS’ EQUITY Current liabilities: Accounts payable$61.6 $46.2Accrued compensation and employee benefits96.2 70.7Deferred revenue216.6 200.1Other accrued liabilities126.8 63.9Total current liabilities501.2 380.9Other long-term liabilities78.8 68.0Total liabilities580.0 448.9Commitments and contingencies (Note 7) Stockholders’ equity: Preferred stock, 2.5 shares authorized, $0.001 par value, issuable in series; no shares issued and outstandingas of December 31, 2014 and December 31, 2013, respectively— —Common stock, 100.0 shares authorized, $0.001 par value, 36.6 shares and 38.2 shares issued andoutstanding as of December 31, 2014 and December 31, 2013, respectively— —Additional paid-in capital2,896.8 2,519.9Retained earnings487.7 979.4Accumulated other comprehensive income (loss)(5.1) 2.1Total stockholders’ equity3,379.4 3,501.4Total liabilities and stockholders’ equity$3,959.4 $3,950.3See accompanying Notes to Consolidated Financial Statements.59Table of ContentsINTUITIVE SURGICAL, INC.CONSOLIDATED STATEMENTS OF INCOME(IN MILLIONS, EXCEPT PER SHARE AMOUNTS) Years Ended December 31, 2014 2013 2012Revenue: Product$1,702.7 $1,867.8 $1,836.2Service429.0 397.3 342.6Total revenue2,131.7 2,265.1 2,178.8Cost of revenue: Product569.9 543.4 495.3Service148.0 127.5 113.2Total cost of revenue717.9 670.9 608.5Gross profit1,413.8 1,594.2 1,570.3Operating expenses: Selling, general and administrative691.0 574.0 522.2Research and development178.0 167.7 170.0Total operating expenses869.0 741.7 692.2Income from operations544.8 852.5 878.1Interest and other income, net4.2 18.4 15.8Income before taxes549.0 870.9 893.9Income tax expense130.2 199.9 237.3Net income$418.8 $671.0 $656.6Net income per share: Basic$11.35 $17.12 $16.50Diluted$11.11 $16.73 $15.98Shares used in computing net income per share: Basic36.9 39.2 39.8Diluted37.7 40.1 41.1See accompanying Notes to Consolidated Financial Statements.60Table of ContentsINTUITIVE SURGICAL, INC.CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME(IN MILLIONS) Years Ended December 31, 2014 2013 2012Net income$418.8 $671.0 $656.6Other comprehensive income (loss): Change in foreign currency translation gains (losses)(2.5) — 0.6Available-for-sale investments: Change in unrealized gains (losses), net of tax(3.9) (3.9) 5.0Less: Reclassification adjustment for net gains (losses) on investments recognizedduring the year, net of tax2.0 (0.6) 0.1Net change, net of tax effect(1.9) (4.5) 5.1Derivative instruments: Change in unrealized gains (losses)8.6 (1.8) (1.1)Less: Reclassification adjustment for gains (losses) on derivative instrumentsrecognized during the year, net of tax(7.5) 1.8 1.1Net change, net of tax effect1.1 — —Employee benefit plans: Change in unrealized losses(4.2) — —Less: Reclassification adjustment for gains (losses) on employee benefit plansrecognized during the year, net of tax0.3 — —Net change, net of tax effect(3.9) — —Other comprehensive income (loss)(7.2) (4.5) 5.7Total comprehensive income$411.6 $666.5 $662.3See accompanying Notes to Consolidated Financial Statements.61Table of ContentsINTUITIVE SURGICAL, INC.CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY(IN MILLIONS) Common Stock AdditionalPaid-InCapital RetainedEarnings AccumulatedOtherComprehensiveIncome (loss) Total Shares Amount Balances at December 31, 201139.3 $— $1,742.8 $901.9 $0.9 $2,645.6Issuance of common stock uponexercise of options and under stockpurchase plan1.3 263.3 263.3Income tax benefit from employee stockplans 93.9 93.9Share-based compensation expenserelated to employee stock plans 153.3 153.3Repurchase and retirement of commonstock(0.4) (13.2) (225.1) (238.3)Net income 656.6 656.6Other comprehensive income 5.7 5.7Balances at December 31, 201240.2 $— $2,240.1 $1,333.4 $6.6 $3,580.1Issuance of common stock uponexercise of options and under stockpurchase plan0.6 160.6 160.6Income tax benefit from employee stockplans 34.5 34.5Share-based compensation expenserelated to employee stock plans 168.9 168.9Repurchase and retirement of commonstock(2.6) (84.2) (1,025.0) (1,109.2)Net income 671.0 671.0Other comprehensive loss (4.5) (4.5)Balances at December 31, 201338.2 $— $2,519.9 $979.4 $2.1 $3,501.4Issuance of common stock uponexercise of options and under stockpurchase plan0.9 283.6 283.6Income tax benefit from employee stockplans 13.9 13.9Share-based compensation expenserelated to employee stock plans 168.9 168.9Repurchase and retirement of commonstock(2.5) (89.5) (910.5) (1,000.0)Net income 418.8 418.8Other comprehensive loss (7.2) (7.2)Balances at December 31, 201436.6 $— $2,896.8 $487.7 $(5.1) $3,379.4See accompanying Notes to Consolidated Financial Statements.62Table of ContentsINTUITIVE SURGICAL, INC.CONSOLIDATED STATEMENTS OF CASH FLOWS(IN MILLIONS) Years Ended December 31, 2014 2013 2012Operating activities: Net income$418.8 $671.0 $656.6Adjustments to reconcile net income to net cash provided by operating activities: Depreciation52.0 46.0 34.7Amortization of intangible assets22.4 21.3 23.1Loss of investment, accretion of discounts and amortization of premiums on investments,net33.9 36.8 33.1Deferred income taxes(35.0) (38.5) (20.8)Income tax benefits from employee stock plans13.9 34.5 93.9Excess tax benefit from employee stock plans(24.0) (38.0) (94.2)Share-based compensation expense168.9 168.9 153.3Changes in operating assets and liabilities, net of effects of acquisition: Accounts receivable(13.7) 68.9 (68.9)Inventories(26.8) (70.0) (7.1)Prepaids and other assets(67.6) (5.0) (37.1)Accounts payable17.7 (8.9) 8.4Accrued compensation and employee benefits21.4 (33.3) 21.0Deferred revenue19.8 15.2 30.5Other liabilities63.4 11.1 (12.3)Net cash provided by operating activities665.1 880.0 814.2Investing activities: Purchase of investments(1,344.6) (1,443.7) (1,833.9)Proceeds from sales of investments665.9 984.9 329.8Proceeds from maturities of investments714.7 822.4 800.2Purchase of property, plant and equipment, intellectual property(105.6) (104.6) (114.2)Acquisition of business, net of cash acquired(84.3) — (27.6)Net cash provided by (used in) investing activities(153.9) 259.0 (845.7)Financing activities: Proceeds from issuance of common stock283.6 160.6 263.3Excess tax benefit from employee stock plans24.0 38.0 94.2Repurchase and retirement of common stock(1,000.0) (1,109.2) (238.3)Net cash (used in) provided by financing activities(692.4) (910.6) 119.2Effect of exchange rate changes on cash and cash equivalents(0.6) — 0.2Net increase (decrease) in cash and cash equivalents(181.8) 228.4 87.9Cash and cash equivalents, beginning of year782.1 553.7 465.8Cash and cash equivalents, end of year$600.3 $782.1 $553.7 See accompanying Notes to Consolidated Financial Statements.63Table of ContentsINTUITIVE SURGICAL, INC.NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTSNOTE 1. DESCRIPTION OF THE BUSINESSIntuitive Surgical, Inc. designs, manufactures, and markets da Vinci® Surgical Systems and related instruments and accessories, which taken together, areadvanced surgical systems, The Company believes these surgical systems enable a new generation of surgery. This advanced generation of surgery, which theCompany calls da Vinci Surgery, combines the benefits of minimally invasive surgery (“MIS”) for patients with the ease of use, precision and dexterity ofopen surgery. A da Vinci Surgical System consists of a surgeon’s console, a patient-side cart and a high performance vision system. The da Vinci SurgicalSystem translates a surgeon’s natural hand movements, which are performed on instrument controls at a console, into corresponding micro-movements ofinstruments positioned inside the patient through small incisions, or ports. The da Vinci Surgical System is designed to provide its operating surgeons withintuitive control, range of motion, fine tissue manipulation capability and Three Dimensional (“3-D”), High-Definition (“HD”) vision while simultaneouslyallowing surgeons to work through the small ports enabled by MIS procedures.NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIESBasis of PresentationThe accompanying Consolidated Financial Statements have been prepared in accordance with U.S. generally accepted accounting principles (“U.S.GAAP”) and include the accounts of the Company and its wholly-owned subsidiaries. All significant inter-company balances and transactions have beeneliminated in consolidation.Use of EstimatesThe preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amountsreported in the Consolidated Financial Statements and accompanying Notes to the Consolidated Financial Statements. The accounting estimates that requiremanagement’s most significant, difficult and subjective judgments include the valuation and recognition of investments, the valuation of the revenue andallowance for sales returns and doubtful accounts, the estimation of hedging transactions, the valuation of inventory, the assessment of recoverability ofintangible assets and their estimated useful lives, revenue recognition, the valuation and recognition of share-based compensation, the recognition andmeasurement of current and deferred income tax assets and liabilities, and the legal contingencies estimate. Actual results could differ materially from theseestimates.Concentrations of Credit Risk and Other Risks and UncertaintiesThe carrying amounts for financial instruments consisting of cash and cash equivalents, accounts receivable, accounts payable and accrued liabilitiesapproximate fair value due to their short maturities. Marketable securities and derivative instruments are stated at their estimated fair values, based on quotedmarket prices for the same or similar instruments. The counterparties to the agreements relating to the Company’s investment securities and derivativeinstruments consist of various major corporations, financial institutions, municipalities and government agencies of high credit standing.The Company’s accounts receivable are derived from net revenue to customers and distributors located throughout the world. The Company performscredit evaluations of its customers’ financial condition and, generally, requires no collateral from its customers. The Company provides reserves for potentialcredit losses but has not experienced significant losses to date. As of December 31, 2014, and 2013, 64% and 66%, respectively, of accounts receivable werefrom domestic customers. No single customer represented more than 10% of net accounts receivable as of December 31, 2014, and 2013.During the years ended December 31, 2014, 2013, and 2012, domestic revenue accounted for 70%, 72%, and 79%, respectively, of total revenue, whileinternational revenue accounted for 30%, 28%, and 21%, respectively, of total revenue for each of the years then ended. No single customer represented morethan 10% of total revenue for the years ended December 31, 2014, 2013, and 2012.Cash and Cash EquivalentsThe Company considers all highly liquid investments with an original maturity from date of purchase of 90 days or less to be cash equivalents.InvestmentsAvailable-for-sale investments. The Company’s investments consist of U.S. treasury and U.S. government agency securities, taxable and tax exemptmunicipal notes, corporate notes and bonds, commercial paper, cash deposits, and money market funds. The Company has designated all investments asavailable-for-sale and therefore, such investments are reported at fair value, with unrealized gains and losses recorded in accumulated other comprehensiveincome. For securities sold prior to maturity, the cost of securities sold is based on the specific identification method. Realized gains and losses on the sale ofinvestments are recorded64Table of Contentsin interest and other income, net. Investments with original maturities greater than approximately three months and remaining maturities less than one yearare classified as short-term investments. Investments with remaining maturities greater than one year are classified as long-term investments.Other-than-temporary impairment. All of the Company’s investments are subject to a periodic impairment review. The Company recognizes animpairment charge when a decline in the fair value of its investments below the cost basis is judged to be other-than-temporary. Factors considered indetermining whether a loss is temporary included the extent and length of time the investment's fair value has been lower than its cost basis, the financialcondition and near-term prospects of the investee, extent of the loss related to credit of the issuer, the expected cash flows from the security, the Company’sintent to sell the security, and whether or not the Company will be required to sell the security prior the expected recovery of the investment's amortized costbasis. During the year ended December 31, 2014, the Company recorded pre-tax other-than-temporary losses of $8.5 million related to equity investments,while there were no such charges during the years ended December 31, 2013, and 2012.Fair Value MeasurementsThe Company measures the fair value of money market funds, corporate equity securities and certain debt securities based on quoted prices in activemarkets for identical assets as Level 1 securities. Marketable securities, measured at fair value using Level 2 inputs, are primarily comprised of U.S.government agencies and FDIC guaranteed securities and corporate debt securities. The Company reviews trading activity and pricing for these investmentsas of the measurement date. When sufficient quoted pricing for identical securities is not available, the Company uses market pricing and other observablemarket inputs for similar securities obtained from various third party data providers. These inputs either represent quoted prices for similar assets in activemarkets or have been derived from observable market data. This approach results in the Level 2 classification of these securities within the fair valuehierarchy.Where Level 1 and Level 2 inputs are not available, the Company used a discounted cash flow model based on data available, including interest rates,timing and amount of cash flows, credit and liquidity premiums, and expected holding period for Level 3 securities. The only Level 3 securities consist ofmunicipal bonds with auction rate securities ("ARS") whose underlying assets are student loans which are substantially backed by the federal government.Because the auctions for these securities have continued to fail since February 2008, these investments were not actively traded and therefore did not have areadily determinable market value. During the year ended December 31, 2014, the ARS were redeemed at par value.InventoriesInventory is stated at the lower of cost or market on a first-in, first-out basis. Inventory costs include direct materials, direct labor, and normalmanufacturing overhead. The cost basis of the Company’s inventory is reduced for any products that are considered excessive or obsolete based uponassumptions about future demand and market conditions.Property, Plant and EquipmentProperty, plant and equipment are stated at cost, net of accumulated depreciation. Depreciation is computed on a straight-line basis over the estimateduseful lives of the assets generally as follows: Useful LivesBuildingUp to 30 yearsBuilding improvementsUp to 15 yearsLeasehold improvementsLesser of useful life or term of leaseEquipment and furniture5 yearsComputer equipment3 yearsEnterprise-wide software5 yearsPurchased softwareLesser of 3 years or life of licenseDepreciation expense for years ended December 31, 2014, 2013, and 2012 was $52.0 million, $46.0 million, and $34.7 million, respectively.Capitalized Software Costs for Internal UseInternally developed software primarily includes enterprise-level business software that the Company customizes to meet its specific operational needs.The Company capitalized costs for enhancement of the enterprise resource planning software system and other internal use software of $12.0 million and $6.6million during the years ended December 31, 2014 and 2013, respectively. Upon being placed in service, these costs are depreciated over an estimated usefullife of up to 5 years.65Table of ContentsGoodwill and Intangible AssetsGoodwill and intangible assets with indefinite useful lives are not amortized, but are tested for impairment at least annually during the fourth fiscalquarter, or as circumstances indicate their value may no longer be recoverable. Goodwill represents the excess of the purchase price over the fair value of nettangible and identifiable intangible assets. The Company continues to operate in one segment, which is considered to be the sole reporting unit andtherefore, goodwill was tested for impairment at the enterprise level. As of December 31, 2014, there has been no impairment of goodwill.The Company does not have intangible assets with indefinite useful lives other than goodwill. The Company’s intangible assets are comprised ofpurchased intellectual property. These intangible assets are carried at cost, net of accumulated amortization. Amortization is recorded on a straight-line basisover the intangible assets' useful lives, which range from approximately 1 to 9 years.Impairment of Long-lived assetsThe Company evaluates long-lived assets, which include amortizable intangible and tangible assets, for impairment whenever events or changes incircumstances indicate that the carrying value of long-lived assets may not be recoverable. The Company recognizes such impairment in the event the netbook value of such assets exceeds the future undiscounted cash flows attributable to such assets. No material impairment losses were incurred in the periodspresented.Revenue RecognitionThe Company’s revenue consists of product revenue resulting from the sales of systems, instruments and accessories, and service revenue. The Companyrecognizes revenue when persuasive evidence of an arrangement exists, delivery has occurred or service has been rendered, the price is fixed or determinable,and collectability is reasonably assured. Revenue is presented net of taxes collected from customers that are remitted to government authorities. TheCompany generally recognizes revenue at the following points in time:•System sales. For systems sold directly to end customers, revenue is recognized when acceptance occurs, which is deemed to have occurred uponcustomer acknowledgment of delivery or installation, depending on the terms of the arrangement. For systems sold through distributors, revenue isrecognized when title and risk of loss has transferred, which generally occurs at the time of shipment. Distributors do not have price protection rights and theCompany’s system arrangements generally do not provide a right of return. The da Vinci Surgical Systems are delivered with a software component. However,because the software and non-software elements function together to deliver the system’s essential functionality, the Company's arrangements are excludedfrom being accounted for under software revenue recognition guidance.•Instruments and accessories. Revenue from sales of instruments and accessories is generally recognized at the time of shipment. The Companyallows its customers in the normal course of business to return unused products for a limited period of time subsequent to initial purchase and records anallowance against revenue recognized based on historical experience.•Service. Service revenue is recognized ratably over the term of the service period. Revenue related to services performed on a time-and-materialsbasis is recognized when it is earned and billable.The Company offers its customers the opportunity to trade in their older systems for credit towards the purchase of a newer generation system. TheCompany generally does not provide specified price trade-in rights or upgrade rights at the time of system purchase. Such trade-in or upgrade transactions areseparately negotiated based on the circumstances at the time of the trade-in or upgrade, based on the then fair value of the system, and are generally not basedon any pre-existing rights granted by the Company. Accordingly, such trade-ins and upgrades are not considered as separate deliverables in the arrangementfor a system sale.As part of a trade-in transaction, the customer receives a new generation system in exchange for its pre-owned system. The trade-in credit is negotiated atthe time of the trade-in and is applied towards the purchase price of the new generation unit. Traded-in systems can be reconditioned and resold. TheCompany accounts for trade-ins consistent with the guidance in AICPA Technical Practice Aid 5100.01, Equipment Sales Net of Trade-Ins (“TPA 5100.01”).The Company applies the accounting guidance by crediting system revenue for the negotiated price of the new generation system, while the differencebetween (a) the trade-in allowance and (b) the net realizable value of the traded-in system less a normal profit margin is treated as a sales allowance. The valueof the traded-in system is determined as the amount, after reconditioning costs are added, that will allow a normal profit margin on the sale of thereconditioned unit to be generated. When there is no market for the traded-in units, no value is assigned. Traded-in units are reported as a component ofinventory until reconditioned and resold, or otherwise disposed.In addition, customers may also have the opportunity to upgrade their systems, for example, by adding a fourth arm to a three-arm system, adding asecond surgeon console for use with the da Vinci SiTM and XiTM Surgical System or adding new vision systems to the standard da Vinci and da Vinci STMSurgical Systems. Such upgrades are performed by completing component level upgrades at the customer’s site. Upgrade revenue is recognized when thecomponent level upgrades are complete and all revenue recognition criteria are met.66Table of ContentsThe Company's system sale arrangements contain multiple elements including a system(s), system accessories, instruments, accessories, and systemservice. The Company generally delivers all of the elements, other than service, within days of entering into the system sale arrangement. Each of theseelements is a separate unit of accounting. System accessories, instruments, accessories and service are also sold on a stand-alone basis.For multiple-element arrangements, revenue is allocated to each unit of accounting based on their relative selling prices. Relative selling prices are basedfirst on vendor specific objective evidence of fair value (“VSOE”), then on third-party evidence of selling price (“TPE”) when VSOE does not exist, and thenon management's best estimate of the selling price (“ESP”) when VSOE and TPE do not exist.The Company’s system sale arrangements generally include a one-year period of free service, and the right for the customer to purchase service annuallyafter that for up to four years at a stated service price. The revenue allocated to the free service period is deferred and recognized ratably over the free serviceperiod.Because the Company has neither VSOE nor TPE for its systems, the allocation of revenue is based on ESP for the systems sold. The objective of ESP isto determine the price at which the Company would transact a sale, had the product been sold on a stand-alone basis. The Company determines ESP for itssystems by considering multiple factors, including, but not limited to, features and functionality of the system, geographies, type of customer, and marketconditions. The Company regularly reviews ESP and maintains internal controls over establishing and updating these estimates.LeasesThe Company enters into sales-type lease and operating lease arrangements with certain qualified customers to purchase or rent its systems. Sales-typeleases have on average a 5-year term and are usually collateralized by a security interest in the underlying assets. Revenue related to multiple-elementarrangements are allocated to lease and non-lease elements based on their relative selling prices as prescribed by the Company's revenue recognition policy.Lease elements generally include a da Vinci Surgical System, while non-lease elements generally include service, instruments and accessories. Indetermining whether a transaction should be classified as a sales-type or operating lease, the Company considers the following terms: (1) whether title of thesystem transfers automatically or for a nominal fee at the end of the term of the lease, (2) whether the present value of the minimum lease payments are equalto or greater than 90% of the fair market value of the system at the inception of the lease, (3) whether the life of the lease exceeds 75% of the life of the asset,and (4) whether there is an option to purchase the asset at a "bargain price" at the end of the lease term.The Company generally recognizes revenue from sales-type lease arrangements at the time the system is accepted by the customer, assuming all otherrevenue recognition criteria have been met. Revenue from sales-type leases is presented as product revenue. Revenue from operating lease arrangements isrecognized as earned over the lease term, which is generally on a straight-line basis and is presented as product revenue. Revenue from operating leasearrangements was not material in any of the periods presented.Allowance for Sales Returns and Doubtful AccountsThe allowance for sales returns is based on the Company’s estimates of potential future product returns and other allowances related to current periodproduct revenue. The Company analyzes historical returns, current economic trends, and changes in customer demand and acceptance of the Company'sproducts. The allowance for doubtful accounts is based on the Company’s assessment of the collectability of customer accounts. The Company regularlyreviews the allowance by considering factors such as historical experience, credit quality, the age of the accounts receivable balances, and current economicconditions that may affect a customer’s ability to pay.Share-Based CompensationThe Company accounts for share-based employee compensation plans using the fair value recognition and measurement provisions under U.S. GAAP.The Company’s share-based compensation cost is measured at the grant date, based on the fair value of the award, and is recognized as expense over therequisite service period.Expected Term: The expected term represents the weighted-average period that the stock options are expected to be outstanding prior to beingexercised. The Company determines expected term based on historical exercise patterns and its expectation of the time it will take for employees to exerciseoptions still outstanding.Expected Volatility: The Company uses market-based implied volatility for purposes of valuing options granted. Market-based implied volatility isderived based on at least one-year traded options on the Company’s common stock. The extent to which the Company relies on market-based volatility whenvaluing options, depend among other things, on the availability of traded options on the Company’s stock and the term of such options. Due to sufficientvolume of the traded options, the Company used 100% market-based implied volatility to value options granted, which the Company believes is morerepresentative of future stock price trends than historical volatility.67Table of ContentsRisk-Free Interest Rate: The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of grant for the expected term of theoption.The fair value of restricted stock units is determined based on the closing quoted price of the Company's common stock on the day of the grant. See“Note 9. Share-Based Compensation,” for a detailed discussion of the Company's share-based employee compensation plans and share-based compensationexpense.Computation of Net Income per ShareBasic net income per share is computed using the weighted-average number of shares outstanding during the period. Diluted net income per share iscomputed using the weighted-average number of shares and dilutive potential shares outstanding during the period. Dilutive potential shares primarilyconsist of employee stock options and restricted stock units.U.S. GAAP requires that employee equity share options, non-vested shares and similar equity instruments granted by the Company be treated as potentialcommon shares outstanding in computing diluted earnings per share. Diluted shares outstanding include the dilutive effect of in-the-money options, which iscalculated based on the average share price for each fiscal period using the treasury stock method. Under the treasury stock method, the amount the employeemust pay for exercising stock options, the amount of compensation cost for future service that the Company has not yet recognized, and the amount of taxbenefits that would be recorded in additional-paid-in-capital (“APIC”) when the award becomes deductible are all assumed to be used to repurchase shares.Research and Development ExpensesResearch and development expenses include amortization of purchased intellectual property, costs associated with co-development R&D licensingarrangements, costs of prototypes, salaries, benefits and other headcount related costs, contract and other outside service fees, and facilities and overheadcosts.Foreign Currency and Other Hedging InstrumentsFor subsidiaries whose local currency is their functional currency, their assets and liabilities are translated into U.S. dollars at exchange rates at thebalance sheet date and revenues and expenses are translated using average exchange rates in effect during the period. Gains and losses from foreign currencytranslation are included in accumulated other comprehensive income (loss) within stockholders’ equity in the Consolidated Balance Sheets. For all non-functional currency account balances, the re-measurement of such balances to the functional currency will result in either a foreign exchange gain or loss,which is recorded to interest and other income, net in the same accounting period that the re-measurement occurred.The Company uses derivatives to partially offset its business exposure to foreign currency exchange risk. The Company enters into foreign currencyforward contracts with one to seven-month terms. The Company typically hedges portions of its forecasted foreign currency exposure associated withrevenue. The Company may also enter into foreign currency forward contracts to offset the foreign currency exchange gains and losses generated by re-measurement of certain assets and liabilities denominated in non-functional currencies. The hedging program is not designated for trading or speculativepurposes.The Company’s accounting policies for these instruments are based on whether the instruments are designated as hedge or non-hedge instruments. TheCompany records all derivatives on the Consolidated Balance Sheets at fair value. The effective portions of cash flow hedges are recorded in othercomprehensive income (loss) (“OCI”) until the hedged item is recognized in earnings. Derivative instruments designated as cash flow hedges are de-designated as hedges when it is probable the forecasted hedged transaction will not occur in the initially identified time period or within a subsequent twomonth time period. Deferred gains and losses in OCI associated with such derivative instruments are reclassified immediately into earnings through interestand other income, net. Any subsequent changes in fair value of such derivative instruments also are reflected in current earnings.Derivatives that are not designated as hedging instruments and the ineffective portions of cash flow hedges are adjusted to fair value through earnings ininterest and other income, net.Income TaxesDeferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carryingamounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected toapply to taxable income in the year in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets andliabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Valuation allowances are established whennecessary to reduce deferred tax assets to the amounts that are expected more likely than not to be realized in the future.The Company recognizes tax benefits from uncertain tax positions only if it is more likely than not that the tax position will be sustained onexamination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from suchpositions are then measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement.68Table of ContentsSegmentsThe Company operates in one segment. Management uses one measurement of profitability and does not segregate its business for internal reporting. Asof December 31, 2014 and 2013, 93% and 94% of all long-lived assets were in the United States. For the years ended December 31, 2014, 2013, and 2012,70%, 72%, and 79%, respectively, of net revenue were generated in the United States.Legal ContingenciesThe Company is involved in a number of legal proceedings involving product liability, intellectual property, shareholder derivative actions, securitiesclass actions, and other matters. A liability and related charge are recorded to earnings in the Company's consolidated financial statements for legalcontingencies when the loss is considered probable and the amount can be reasonably estimated. The assessment is reevaluated each accounting period andis based on all available information, including discussion with outside legal counsel. If a reasonable estimate of a known or probable loss cannot be made,but a range of probable losses can be estimated, the low-end of the range of losses is recognized if no amount within the range is a better estimate than anyother. If a loss is reasonably possible, but not probable and can be reasonably estimated, the estimated loss or range of loss is disclosed in the notes to theconsolidated financial statements. The Company expenses legal fees as incurred.When determining the estimated probable loss or range of losses, significant judgment is required to be exercised in order to estimate the amount andtiming of the loss to be recorded. Estimates of probable losses resulting from litigation are inherently difficult to make, particularly when the matters are inearly procedural stages with incomplete facts and information. The final outcome of legal proceedings is dependent on many variables difficult to predict,and therefore, the ultimate cost to entirely resolve such matters may be materially different than the amount of current estimates. Consequently, newinformation or changes in judgments and estimates could have a material adverse effect on the Company's business, financial condition, and results ofoperations or cash flows.Recent Accounting PronouncementsIn May 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Updates No. 2014-09, Revenue from Contracts withCustomers, requiring an entity to recognize the amount of revenue to which it expects to be entitled to for the transfer of promised goods or services tocustomers. The updated standard will replace most existing revenue recognition guidance in U.S. GAAP when it becomes effective and permits the use ofeither the retrospective or cumulative effect transition method. Early adoption is not permitted. The updated standard becomes effective for the Company inthe first quarter of fiscal year 2017. The Company has not yet selected a transition method and is currently evaluating the effect that the updated standard willhave on the Consolidated Financial Statements and related disclosures.69Table of ContentsNOTE 3. FINANCIAL INSTRUMENTSCash, Cash Equivalents and InvestmentsThe following tables summarize the Company’s cash and available-for-sale securities’ amortized cost, gross unrealized gains, gross unrealized losses, andfair value by significant investment category recorded as cash and cash equivalents or short-term or long-term investments as of December 31, 2014, and2013 (in millions): AmortizedCost GrossUnrealizedGains GrossUnrealizedLosses FairValue Cash andCashEquivalents Short-termInvestments Long-termInvestmentsDecember 31, 2014 Cash$227.7 $— $— $227.7 $227.7 $— $—Level 1: Money market funds324.4 — — 324.4 324.4 — —U.S. treasuries & corporateequity securities46.1 — (0.1) 46.0 — 19.3 26.7Subtotal370.5 — (0.1) 370.4 324.4 19.3 26.7Level 2: Commercial paper120.5 — — 120.5 48.2 72.3 —Corporate securities904.8 1.3 (1.6) 904.5 — 241.7 662.8U.S. government agencies446.0 0.3 (0.4) 445.9 — 105.6 340.3Non-U.S. governmentsecurities42.2 — (0.1) 42.1 — 26.1 16.0Municipal securities385.4 0.7 (0.2) 385.9 — 167.2 218.7Subtotal1,898.9 2.3 (2.3) 1,898.9 48.2 612.9 1,237.8Total assets measured at fairvalue$2,497.1 $2.3 $(2.4) $2,497.0 $600.3 $632.2 $1,264.5 AmortizedCost GrossUnrealizedGains GrossUnrealizedLosses FairValue Cash andCashEquivalents Short-termInvestments Long-termInvestmentsDecember 31, 2013 Cash$247.8 $— $— $247.8 $247.8 $— $—Level 1: Money market funds516.2 — — 516.2 516.2 — —U.S. treasuries & corporateequity securities65.4 — (0.3) 65.1 — 25.5 39.6Subtotal581.6 — (0.3) 581.3 516.2 25.5 39.6Level 2: Commercial paper100.2 — — 100.2 18.1 82.1 —Corporate securities844.7 2.9 (1.9) 845.7 — 227.7 618.0U.S. government agencies352.2 0.7 (0.7) 352.2 — 84.7 267.5Non-U.S. governmentsecurities67.7 0.2 (0.1) 67.8 — 41.2 26.6Municipal securities550.1 1.5 (0.1) 551.5 — 160.2 391.3Subtotal1,914.9 5.3 (2.8) 1,917.4 18.1 595.9 1,303.4Level 3: Auction rate securities8.0 — (0.6) 7.4 — — 7.4Subtotal8.0 — (0.6) 7.4 — — 7.4Total assets measured at fairvalue$2,752.3 $5.3 $(3.7) $2,753.9 $782.1 $621.4 $1,350.470Table of ContentsThe following table summarizes the contractual maturities of the Company’s cash equivalents and available-for-sale investments (excluding cash andmoney market funds), at December 31, 2014 (in millions): AmortizedCost FairValueMature in less than one year$676.7 $677.4Mature in one to five years1,265.4 1,264.5Mature in after five years— —Total$1,942.1 $1,941.9Realized gains and losses, net of tax, were not material for any of the periods presented.As of December 31, 2014, and 2013, net unrealized loss on investments of $0.2 million, net of tax, and net unrealized gains on investments of $1.7million, net of tax, were included in accumulated other comprehensive income (loss) in the accompanying Consolidated Balance Sheets.The following tables present the breakdown of the available-for-sale investments with unrealized losses at December 31, 2014, and 2013 (in millions): Unrealized losses lessthan 12 months Unrealized losses 12months or greater TotalDecember 31, 2014FairValue UnrealizedLosses FairValue UnrealizedLosses FairValue UnrealizedLossesCorporate securities$456.7 $(1.3) $16.9 $(0.2) $473.6 $(1.5)U.S. government and agency securities239.1 (0.4) 31.8 (0.2) 270.9 (0.6)Municipal securities91.3 (0.2) — — 91.3 (0.2)Non-U.S. government securities20.9 (0.1) 20.9 (0.1) $808.0 $(2.0) $48.7 $(0.4) $856.7 $(2.4)December 31, 2013 Corporate securities$245.3 $(1.9) $9.5 $— $254.8 $(1.9)U.S. government and agency securities142.8 (1.0) — — 142.8 (1.0)Municipal securities37.6 (0.1) — — 37.6 (0.1)Non-U.S. government securities18.7 (0.1) — — 18.7 (0.1)Auction rate securities— — 7.4 (0.6) 7.4 (0.6) $444.4 $(3.1) $16.9 $(0.6) $461.3 $(3.7)The unrealized losses on the available-for-sale investments are related to corporate securities and government securities. The Company determined theseunrealized losses to be temporary. Factors considered in determining whether a loss is temporary included the length of time and extent to which theinvestment's fair value has been less than the cost basis; the financial condition and near-term prospects of the investee; extent of the loss related to credit ofthe issuer; the expected cash flows from the security; the Company’s intent to sell the security and whether or not the Company will be required to sell thesecurity before the recovery of its amortized cost.71Table of ContentsThe following table provides reconciliation for all assets measured at fair value using significant unobservable Level 3 inputs for the years endedDecember 31, 2014, 2013, and 2012 (in millions): Fair Value Measurements atReporting Date UsingSignificant UnobservableInputs (Level 3) Auction rate securitiesBalance at January 1, 2012$16.4Sales(12.0)Total gains: Included in other comprehensive income3.0Included in earnings—Balance at December 31, 2012$7.4Sales—Total gains: Included in other comprehensive income—Included in earnings—Balance at December 31, 2013$7.4Sales(8.0)Total gains: Included in other comprehensive income0.6Included in earnings—Balance at December 31, 2014$—There were no transfers between Level 1 and Level 2 measurements during the year ended December 31, 2014, and there were no changes in thevaluation techniques used. The Level 3 assets consisted of municipal bonds with auction rate securities ("ARS") that were sold at par value of $8.0 million inApril 2014.Foreign currency derivativeThe objective of the Company’s hedging program is to mitigate the impact of changes in currency exchange rates on net cash flow from foreign currencydenominated sales and intercompany balances and other monetary assets or liabilities denominated in currencies other than the U.S. dollar ("USD"). Thederivative assets and liabilities are measured using Level 2 fair value inputs.Cash Flow HedgesThe Company enters into currency forward contracts as cash flow hedges to hedge certain forecasted revenue transactions denominated in currenciesother than the USD, primarily the European Euro (“EUR”), the British Pound (“GBP”), the Japanese Yen (“JPY”), and the Korean Won (“KRW”).For these derivatives, the Company reports the after-tax gain or loss from the hedge as a component of accumulated other comprehensive income (loss) instockholders' equity and reclassifies into earnings in the same period in which the hedge transaction affects earnings. The Company reclassified net gains of$7.5 million to revenue related to the hedged revenue transactions for the years ended December 31, 2014, while the net gains/losses reclassified for the yearended December 31 2013, and 2012 were not significant.Other Derivatives Not Designated as Hedging InstrumentsOther derivatives not designated as hedging instruments consist primarily of forward contracts that the Company uses to hedge intercompany balancesand other monetary assets or liabilities denominated in currencies other than the USD, primarily the EUR, GBP, JPY, KRW, and the Swiss Franc (“CHF”).72Table of ContentsDerivative instruments used to hedge against balance sheet foreign currency exposures at the end of each period were as follows (in millions): Years Ended December 31, 2014 2013 2012Recognized gains (losses) in interest and other income, net$5.7 $(3.4) $(0.3)Foreign exchange gains (losses) related to re-measurement$(6.9) $3.1 $0.7The notional amounts for derivative instruments provide one measure of the transaction volume. Total gross notional amounts (in USD) for derivativesand aggregate gross fair value outstanding at the end of each period were as follows (in millions): Derivatives Designated as HedgingInstruments Derivatives Not Designated as HedgingInstruments December 31, 2014 December 31, 2013 December 31, 2014 December 31, 2013Notional amounts: Forward contracts$7.9 $85.6 $102.1 $119.6Gross fair value recorded in: Prepaid and other current assets1.1 — 7.9 — Other accrued liabilities$— $— $0.1 $3.8NOTE 4. BALANCE SHEET DETAILS AND OTHER FINANCIAL INFORMATIONThe following table provides details of the inventories (in millions): December 31, 20142013Inventories: Raw materials$60.0 $67.2Work-in-process8.7 12.6Finished goods113.0 99.8Total inventories$181.7 $179.6The following table provides details of the property, plant and equipment, net (in millions): December 31, 2014 2013Property, plant and equipment, net: Land$131.7 $84.7Building and building/leasehold improvements159.0 151.9Machinery and equipment181.6 137.2Computer and office equipment31.3 27.1Capitalized software77.9 66.9Construction-in-process28.8 16.4Gross property, plant and equipment610.3 484.2Less: Accumulated depreciation(222.9) (174.3)Total property, plant and equipment, net$387.4 $309.973Table of ContentsThe following table provides details of the other accrued liabilities—short term (in millions): December 31, 2014 2013Other accrued liabilities—short term: Taxes payable$7.4 $5.1Tolled product liability claims accrued49.5 —Other accrued liabilities69.9 58.8Total other accrued liabilities—short-term$126.8 $63.9The following table provides details of the other long-term liabilities balance sheet item (in millions): December 31, 2014 2013Other long-term liabilities: Income taxes—long term$61.8 $64.5Other long-term liabilities17.0 3.5Total other long-term liabilities$78.8 $68.0Supplemental Cash flow InformationThe following table provides supplemental cash flow information (in millions): Years Ended December 31, 2014 2013 2012Income taxes paid$176.8 $194.1 $226.1Supplemental non-cash investing activities: Equipment transfers from inventories to property, plant and equipment$27.2 $13.1 $22.3NOTE 5. LEASE RECEIVABLESLease receivables relating to sales-type lease arrangements are presented on the Consolidated Balance Sheets as follows (in millions): December 31, 2014 2013Gross lease receivables$40.4 $10.1Unearned income(2.2) (0.6)Allowance for credit loss— —Net investment in sales-type leases38.2 9.5Reported as: Prepaids and other current assets5.8 1.9 Intangible and other assets, net32.4 7.6 Total, net$38.2 $9.5Contractual maturities of gross lease receivables at December 31, 2014, are as follows (in millions):74Table of Contents Amount20157.4201610.4201710.320189.120193.2Thereafter—Total$40.4NOTE 6. GOODWILL AND INTANGIBLE ASSETSOn January 17, 2014, the Company acquired certain intellectual property, know-how, fixed assets, intangible assets, and employees from LunaInnovations, Inc. (“Luna”). On June 25, 2014, the Company reacquired the Japan distribution rights and intangible assets from Adachi Co., Ltd. (“Adachi”).The acquisition of Japan distribution rights enhances the Company's ability to directly interact with customers, surgical societies, and government agenciesin Japan. In both transactions, the assets acquired met the definition of a business and were accounted for using the acquisition method of accounting forfinancial reporting purposes.In connection with the Luna acquisition, the Company recognized goodwill of $10.1 million and intangible assets of $9.5 million, which are beingamortized over nine years.In connection with the acquisition of Japan distribution rights, the Company recognized goodwill of $50.5 million, intangible assets related toreacquired distribution rights of $5.5 million, and customer relationships of $17.2 million, which are being amortized over a weighted average period of 1.1years and 7.0 years, respectively. The purchase consideration consisted of cash of $71.8 million and contingent payments of $1.8 million. Goodwill related tothe acquisitions in 2014 is deductible for tax purposes.Pro forma results of operations related to the acquisitions have not been presented because the operating results of the acquired businesses are notmaterial to the Company's consolidated financial statements.GoodwillThe Company’s gross carrying amount of goodwill was $198.0 million and $137.4 million as of December 31, 2014, and 2013, respectively.IntangiblesThe following table summarizes the components of gross intangible asset, accumulated amortization, and net intangible asset balances as of December31, 2014, and 2013 (in millions): December 31, 2014 December 31, 2013 Gross CarryingAmount AccumulatedAmortization Net CarryingAmount Gross CarryingAmount AccumulatedAmortization Net CarryingAmountPatents and developed technology $162.1 $(116.8) $45.3 $155.7 $(104.5) $51.2Distribution rights and others 12.7 (6.5) 6.2 11.2 (6.4) 4.8Customer relationships 30.0 (7.4) 22.6 12.8 (4.5) 8.3Total intangible assets $204.8 $(130.7) $74.1 $179.7 $(115.4) $64.3Amortization expense related to intangible assets was $22.4 million, $21.3 million, and $23.1 million for the years ended December 31, 2014, 2013, and2012, respectively.75Table of ContentsThe estimated future amortization expense of intangible assets as of December 31, 2014 is as follows (in millions):Fiscal YearAmount2015$24.4201618.2201712.420188.620193.62020 and thereafter6.9Total$74.1NOTE 7. COMMITMENTS AND CONTINGENCIESOPERATING LEASESThe Company leases office space in Brazil, China, Japan, Korea, Mexico, Switzerland, and United States. The Company leases automobiles for certainsales and field service employees. These leases have varying terms, predominantly no longer than three years.Future minimum lease commitments under the Company’s operating leases as of December 31, 2014, are as follows (in millions):YearsAmount2015$5.120163.520171.620180.62019—2020 and thereafter—Total$10.8Other commitments include an estimated amount of approximately $251.5 million of all open cancellable purchase orders and contractual obligationsthat occur in the ordinary course of business, including commitments with suppliers, for which we have not received the goods or services.CONTINGENCIESThe Company is involved in a variety of claims, lawsuits, investigations and proceedings relating to securities laws, product liability, false claims,insurance, and contract disputes. Certain of these lawsuits and claims are described in further detail below. It is not possible to predict what the outcome ofthese matters will be and the Company cannot guarantee that any resolution will be reached on commercially reasonable terms, if at all. With the exception ofthe charges recorded related to the Company’s estimate of the probable loss associated with the tolled product liability claims described below, the Companyhas determined that an estimate of probable loss or range of loss related to material pending or threatened litigation matters cannot be determined as ofDecember 31, 2014. Nevertheless, it is possible that future legal costs (including settlements, judgments, legal fees and other related defense costs) couldhave a material adverse effect on the Company's business, financial position, or future results of operations.The Company is also a party to various other legal actions that arise in the ordinary course of business and does not believe that any of these other legalactions will have a material adverse impact on the Company's business, financial position, or future results of operations.In accordance with U.S. GAAP, the Company records a liability when it is both probable that a liability has been incurred and the amount of the loss canbe reasonably estimated. These provisions are reviewed at least quarterly and adjusted to reflect the impact of negotiations, settlements, rulings, advice oflegal counsel, and other information and events pertaining to a particular case.Purported Shareholder Class Action Lawsuit filed August 6, 2010On August 6, 2010, a purported class action lawsuit entitled Perlmutter v. Intuitive Surgical et al., No. CV10-3451, was filed against 7 of the Company'scurrent and former officers and directors in the United States District Court for the Northern District of California. The lawsuit sought unspecified damages onbehalf of a putative class of persons who purchased or otherwise acquired the Company's common stock between February 1, 2008, and January 7, 2009. Thecomplaint alleged that the defendants76Table of Contentsviolated federal securities laws by making allegedly false and misleading statements and omitting certain material facts in filings with the SEC. OnFebruary 15, 2011, the Police Retirement System of St. Louis was appointed lead plaintiff in the case pursuant to the Private Securities Litigation Reform Actof 1995. An amended complaint was filed on April 15, 2011, making allegations substantially similar to the allegations described above. On May 23, 2011,a motion was filed to dismiss the amended complaint. On August 10, 2011, that motion was granted and the action was dismissed; the plaintiffs were given30 days to file an amended complaint. On September 12, 2011, plaintiffs filed their amended complaint. The allegations contained therein weresubstantially similar to the allegations in the prior complaint. The Company filed a motion to dismiss the amended complaint on October 13, 2011. Ahearing occurred on February 16, 2012, and on May 22, 2012, the court granted the Company's motion. The complaint was dismissed with prejudice and afinal judgment was entered in the Company's favor on June 1, 2012. On June 20, 2012, plaintiffs filed a notice of appeal with the United States Court ofAppeals for the Ninth Circuit. The appeal was styled Police Retirement System of St. Louis v. Intuitive Surgical, Inc. et al., No. 12-16430. Plaintiffs filedtheir opening brief on September 28, 2012. The Company filed an answering brief on November 13, 2012, and plaintiffs filed a reply brief on December 17,2012. Oral argument was held on March 14, 2014, and the matter was taken under submission. On July 16, 2014, the Ninth Circuit published an opinionaffirming the district court’s order dismissing the amended complaint with prejudice. Plaintiffs declined to seek any further review of the decision and thematter is now at an end.Purported Derivative Actions filed August 19, 2010On August 19, 2010, an alleged stockholder caused a purported stockholder’s derivative lawsuit entitled Himmel v. Smith et al., No. 1-10-CV-180416, tobe filed in the Superior Court of California for the County of Santa Clara naming the Company as a nominal defendant and naming 14 of the Company'scurrent and former officers and directors as defendants. The lawsuit seeks to recover, for the Company's benefit, unspecified damages purportedly sustained inconnection with allegedly misleading statements and/or omissions made in connection with the Company's financial reporting for the period betweenFebruary 1, 2008, and January 7, 2009. It also seeks a series of changes to the Company's corporate governance policies and an award of attorneys’ fees. OnSeptember 15, 2010, another purported stockholder filed a substantially identical lawsuit entitled Applebaum v. Guthart et al., No. 1-10-CV-182645, in thesame court against 15 of the Company's current and former officers and directors. On October 5, 2010, the court ordered that the two cases be consolidated forall purposes. By agreement with plaintiffs, all activity in the case was stayed pending final resolution of the appeal in the purported shareholder class actionlawsuit discussed above. On October 23, 2014, the plaintiffs voluntarily dismissed the consolidated cases. The matter is now at an end.Purported Shareholder Class Action Lawsuits filed April 26, 2013 and May 24, 2013On April 26, 2013, a purported class action lawsuit entitled Abrams v. Intuitive Surgical, et al., No. 5-13-cv-1920, was filed against several of theCompany's current and former officers and directors in the United States District Court for the Northern District of California. A substantially identicalcomplaint, entitled Adel v. Intuitive Surgical, et al., No. 5:13-cv-02365, was filed in the same court against the same defendants on May 24, 2013. The Adelcase was voluntarily dismissed without prejudice on August 20, 2013. The matter is now at an end.On October 15, 2013, plaintiffs in the Abrams matter filed an amended complaint. The case has since been re-titled In re Intuitive Surgical SecuritiesLitigation, No. 5:13-cv-1920. The plaintiffs seek unspecified damages on behalf of a putative class of persons who purchased or otherwise acquired theCompany's common stock between February 6, 2012, and July 18, 2013. The amended complaint alleges that the defendants violated federal securities lawsby making allegedly false and misleading statements and omitting certain material facts in certain public statements and in the Company's filings with theSEC. On November 18, 2013, the Court appointed Employees’ Retirement System of the State of Hawaii as lead plaintiff and appointed lead counsel. TheCompany filed a motion to dismiss the amended complaint on December 16, 2013, which was granted in part and denied in part on August 21, 2014. Theplaintiffs have elected not to further amend their complaint. On October 22, 2014, the court granted the Company’s motion for leave to file a motion forreconsideration of the court’s August 21, 2014, order. The Company filed its motion for reconsideration on November 5, 2014, the plaintiffs filed theiropposition on November 19, 2014, and the Company filed its reply on November 26, 2014. The court denied the motion for reconsideration on December 15,2014. The case will move forward on the claims that remain. No trial date has been set. Based on currently available information, the Company does notbelieve the resolution of this matter will have a material adverse effect on the Company's business, financial position or future results of operations.77Table of ContentsPurported Derivative Actions filed on February 3, 2014, February 21, 2014, March 21, 2014, and June 3, 2014On February 3, 2014, an alleged stockholder caused a purported stockholder’s derivative lawsuit entitled Berg v. Guthart et al., No. 4:14-CV-00515, tobe filed in the United States District Court for the Northern District of California. It names the Company as a nominal defendant and names 16 of theCompany’s current and former officers and directors as defendants. The lawsuit seeks to recover, for the Company’s benefit, unspecified damages purportedlysustained by the Company in connection with allegedly misleading statements and/or omissions made in connection with the Company’s financial reportingfor the period between 2012 and the present. It also seeks a series of changes to the Company’s corporate governance policies and an award of attorneys’fees. On April 3, 2014, it was related to In re Intuitive Surgical Securities Litigation. On July 30, 2014 the court granted Robert Berg’s motion to beappointed lead plaintiff, denied the City of Birmingham’s motion seeking such appointment (see below for additional description), and re-titled the matter Inre Intuitive Surgical, Inc. Shareholder Derivative Litigation, No. 4:14-CV-00515. On August 13, 2014, Berg filed a consolidated complaint, makingallegations substantially similar to the allegations in his original complaint. On September 12, 2014, the Company filed a motion to dismiss the consolidatedcomplaint. Berg filed his opposition on October 9, 2014, and the Company filed its reply on October 30, 2014. The motion remains pending. Based oncurrently available information, the Company does not believe the resolution of this matter will have a material adverse effect on the Company's business,financial position or future results of operations.On February 21, 2014, a second alleged stockholder caused a substantially similar purported stockholder’s derivative lawsuit entitled Public SchoolTeachers’ Pension and Retirement Fund of Chicago v. Guthart et al., No. CIV 526930, to be filed in the Superior Court of the State of California, County ofSan Mateo, against the same parties and seeking the same relief. On March 26, 2014, the case was removed to the United States District Court for theNorthern District of California, where it was related to In re Intuitive Surgical Securities Litigation and Berg v. Guthart on April 30, 2014. The district courtremanded the case back to San Mateo County Superior Court on June 30, 2014, where it remains pending. On August 28, 2014 the Company filed a motionseeking to stay the case in favor of the federal action and asking that the plaintiff be required to post a bond because the action was duplicative and was notin the Company’s best interests. On November 13, 2014, the superior court entered an order denying the Company’s bond request and denying in part theCompany’s motion to stay. On November 18, 2014, the Company petitioned the First Appellate District of the California Court of Appeal for a writ ofmandate directing the superior court to stay the case in its entirety. At the same time, the Company requested an immediate stay of proceedings pendingresolution of the petition. On November 19, 2014, the Court of Appeal granted the Company’s request for an immediate stay and set a briefing schedule forthe petition. The plaintiff filed its opposition to the petition on December 8, 2014, and the Company filed its reply on December 22, 2014. The petition wasdenied on January 8, 2015. On January 20, 2015, the Company demurred (moved to dismiss) the complaint. A hearing is set for February 11, 2015. Based oncurrently available information, the Company does not believe the resolution of this matter will have a material adverse effect on the Company's business,financial position or future results of operations.On March 21, 2014, a third alleged stockholder caused a substantially similar purported stockholder’s derivative lawsuit entitled City of BirminghamRelief and Retirement System v. Guthart et al., No. 5-14-CV-01307, to be filed in the United States District Court for the Northern District of Californiaagainst the same parties and seeking the same relief. On April 8, 2014, it was related to In re Intuitive Surgical Securities Litigation and Berg v. Guthart. OnJuly 30, 2014, the court consolidated the case with Berg v. Guthart and, as noted above, granted Berg’s motion to be appointed lead plaintiff and denied theCity of Birmingham’s motion seeking such appointment. This effectively ends the City of Birmingham’s involvement in this matter. Based on currentlyavailable information, the Company does not believe the resolution of this matter will have a material adverse effect on the Company's business, financialposition or future results of operations.On June 3, 2014, a fourth alleged stockholder caused a substantially similar purported stockholder’s derivative lawsuit entitled City of Plantation PoliceOfficers’ Employees’ Retirement System v. Guthart et al., C.A. No. 9726-CB, to be filed in the Court of Chancery of the State of Delaware. The Company fileda Motion to Stay Proceedings in favor of the earlier-filed stockholder derivative lawsuits pending in federal and state courts in California. In light of theCompany’s motion, the plaintiff agreed to a stay of all proceedings in the case in favor of the earlier-filed actions. Based on currently available information,the Company does not believe the resolution of this matter will have a material adverse effect on the Company's business, financial position or future resultsof operations.Product Liability LitigationThe Company is currently named as a defendant in approximately 102 individual product liability lawsuits filed in various state and federal courts byplaintiffs who allege that they or a family member underwent surgical procedures that utilized the da Vinci Surgical System and sustained a variety ofpersonal injuries and, in some cases, death as a result of such surgery. The Company has also received a large number of product liability claims fromplaintiffs' attorneys that are part of certain tolling agreements further discussed below. The Company has also been named as a defendant in a multi-plaintifflawsuit filed in Missouri state court. On November 26, 2014, plaintiffs amended their complaint to add three additional plaintiffs. In total, plaintiffs seekdamages on behalf of 20 patients who had da Vinci Surgeries in 13 different states. The cases raise a variety of allegations including, to varying degrees, thatplaintiffs’ injuries resulted from purported defects in the da Vinci Surgical System and/or failure on the Company's part to provide adequate trainingresources to the healthcare professionals who performed plaintiffs’ surgeries. The78Table of Contentscases further allege that the Company failed to adequately disclose and/or misrepresented the potential risks and/or benefits of the da Vinci Surgical System.Plaintiffs also assert a variety of causes of action, including for example, strict liability based on purported design defects, negligence, fraud, breach ofexpress and implied warranties, unjust enrichment, and loss of consortium. Plaintiffs seek recovery for alleged personal injuries and, in many cases, punitivedamages. The Company has reached confidential settlements in many of the filed cases. With certain exceptions, including the Taylor case described below,the remaining filed cases generally are in the early stages of pretrial activity.The Company previously reported that it was named as a defendant in a purported class action filed in Louisiana state court, and removed to federalcourt, seeking damages on behalf of all patients who were allegedly injured by the da Vinci Surgical System at a single hospital in Louisiana. The Companysettled this case and it was dismissed with prejudice on October 20, 2014. The settlement did not have a material adverse effect on the Company’s business,financial position or results of operations.Plaintiffs’ attorneys have engaged in well-funded national advertising efforts seeking patients dissatisfied with da Vinci surgery. Among the allegations,a substantial number of claims relate to alleged complications from surgeries performed with certain versions of Monopolar Curved Scissor (“MCS”)instruments that included an MCS tip cover accessory that was the subject of a market withdrawal in 2012 and MCS instruments that were the subject of arecall in 2013. The Company has received a significant number of claims from plaintiffs’ attorneys that it believes are as a result of these advertising efforts.In an effort to avoid the expense and distraction of defending multiple lawsuits, the Company entered into tolling agreements to pause the applicable statutesof limitations for these claims and engaged in confidential mediation efforts. The attorneys for the patients agreed to collect and supply medical records,operative notes and other necessary information from these patients to the Company. Each claim was individually investigated. The collection andevaluation of the patients’ medical information was laborious. For hundreds of the asserted claims, the Company has never received medical records. Aspatient records related to these claims were received, the Company, assisted by independent medical consultants, reviewed and analyzed the large volumes ofmedical information that began to arrive in the fall of 2013. The completion of the legal and medical evaluation of a significant number of these claimsoccurred during the first quarter of 2014 and continued throughout the remainder of 2014.After an extended confidential mediation process with legal counsel for many of the claimants covered by the tolling agreements, the Companydetermined during the first quarter of 2014 that, while it denies any and all liability, in light of the costs and risks of litigation, settlement of certain claimsmay be appropriate. During the year ended December 31, 2014, the Company recorded pre-tax charges of $82.4 million to reflect the estimated cost ofsettling a number of the product liability claims covered by the tolling agreements. The Company’s estimate of the anticipated cost of resolving these claimsis based on negotiations with attorneys for patients who have participated in the mediation process. To date, approximately 4,800 claims have been added tothe tolling agreements and/or submitted into the mediation program. Of those, however, over 3,100 claims have voluntarily been removed from the tollingagreements and/or mediation program and plaintiffs’ counsels have indicated to the Company that they no longer intend to pursue these claims. Nonetheless,the claimants that have been removed from the tolling agreement remain free to pursue lawsuits against the Company and it is also possible that more claimswill be made by additional individuals who have undergone da Vinci surgery and allege that they suffered injuries. It is further possible that the claimantswho participate in the mediations, as well as those claimants who have not participated in negotiations, will choose to pursue greater amounts in a court oflaw. Consequently, the final outcome of these claims is dependent on many variables that are difficult to predict and the ultimate cost associated with theseproduct liability claims may be materially different than the amount of the current estimate and accruals and could have a material adverse effect on theCompany's business, financial position, and future results of operations. Although there is a reasonable possibility that a loss in excess of the amountrecognized exists, the Company is unable to estimate the possible loss or range of loss in excess of the amount recognized at this time. As of December 31,2014, a total of $49.5 million of the charges recorded during 2014 was included in other accrued liabilities in the accompanying Consolidated BalanceSheets related to the tolled product liability claims.In February 2011, the Company was named as a defendant in a product liability action that had originally been filed in Washington State Superior Courtfor Kitsap County against the healthcare providers and hospital involved in plaintiff’s decedent’s surgery (Josette Taylor, as Personal Representative of theEstate of Fred E. Taylor, deceased; and on behalf of the Estate of Fred E. Taylor v. Intuitive Surgical, Inc., No. 09-2-03136-5). In Taylor, plaintiff assertedwrongful death and product liability claims against the Company, generally alleging that the decedent died four years after surgery as a result of injuriespurportedly suffered during the surgery, which was conducted with the use of the da Vinci Surgical System. The plaintiff in Taylor asserted that such injurieswere caused, in whole or in part, by the Company's purported failure to properly train, warn, and instruct the surgeon. The lawsuit sought unspecifieddamages for past medical expenses, pain and suffering, loss of consortium as well as punitive damages. A trial commenced in the action on April 15, 2013. OnMay 23, 2013, the jury returned a defense verdict, finding that the Company was not negligent. Judgment was entered in the Company's favor on June 7,2013. Plaintiff has filed a notice of appeal.79Table of ContentsFalse Claims Act LitigationIn October 2013, the Company was served in a case entitled Rose v. Intuitive Surgical, Inc., No. 12-cv-1812, in the Middle District of Florida. RelatorBryan Rose, a former employee of Intuitive Surgical, brought the action on behalf of the United States of America, alleging violations of the False ClaimsAct, 31 U.S.C. § 3729 et seq., and the analogous false-claims statutes of 21 states and of the District of Columbia. The parties reached a settlement in the caseand the court granted their joint motion for dismissal on May 21, 2014. The settlement did not have a material adverse effect on the Company's business,financial position or results of operations.Insurance LitigationIn October 2013, the Company was named as a defendant in an insurance action entitled Illinois Union Insurance Co. v. Intuitive Surgical, Inc., No.3:13-cv-04863-JST, filed in the Northern District of California. Plaintiff Illinois Union Insurance Co. seeks to rescind the Life Sciences Products-CompletedOperations Liability Policy issued by plaintiff to the Company, which provides coverage for products liability claims first made against the Company duringthe policy period March 1, 2013 to March 1, 2014. In December 2013, the Company was named as a defendant in another insurance action entitledNavigators Specialty Insurance Co. v. Intuitive Surgical, Inc., No. 5:13-cv-05801-HRL, filed in the Northern District of California. Plaintiff NavigatorsInsurance Co. alleges that the Follow Form Excess Liability Insurance Policy issued by plaintiff to the Company for product liability claims first madeagainst the Company during the policy period March 1, 2013 to March 1, 2014, should be rescinded. Both plaintiffs generally allege that the Company didnot disclose the existence of tolling agreements, the number of claimants incorporated within those agreements, and that those agreements were material toplaintiffs’ underwriting processes. The Company intends to vigorously defend these actions. Based on currently available information, the Company doesnot believe the resolution of this matter will have a material adverse effect on the Company's business, financial position or future results of operations.NOTE 8. STOCKHOLDERS’ EQUITYSTOCK REPURCHASE PROGRAMThe Company's Board of Directors has authorized an aggregate of $3.0 billion of funding for the Company's common stock repurchase program (the“Repurchase Program”) since originally established in March 2009. As of December 31, 2014, the Company had used all amounts authorized for stockrepurchases under the Repurchase Program.On January 29, 2015 subsequent to the end of fiscal year 2014, the Company's Board of Directors authorized the Company to repurchase up to $1.0billion of the Company’s outstanding common stock.On May 2, 2014, the Company entered into an accelerated share repurchase program (the “2014 ASR Program”) with Goldman, Sachs & Co.(“Goldman”) to repurchase $1.0 billion of the Company’s common stock under the Repurchase Program. Under the 2014 ASR Program, the Company madean up-front payment of $1.0 billion to Goldman and received and retired approximately 2.5 million shares of its common stock. On September 19, 2014,Goldman exercised its early termination option under the 2014 ASR Program and the pricing period was closed. No additional shares were received by theCompany.On July 29, 2013, the Company entered into an accelerated share repurchase program (the “2013 ASR Program”) with Goldman to repurchase $500.0million of the Company’s common stock under the Repurchase Program. Under the 2013 ASR Program, the Company made an up-front payment of $500.0million to Goldman and received and retired an initial delivery of approximately 1.2 million shares of its common stock. On September 11, 2013, Goldmanexercised its early termination option under the 2013 ASR Program and the pricing period was closed. Based on the settlement price, the final number ofshares repurchased by the Company and delivered by Goldman under the 2013 ASR Program was 1.3 million shares. The Company received the additional0.1 million shares from Goldman on September 16, 2013 to settle the difference between the initial share delivery and the total number of shares repurchased.Remaining shares were repurchased in the open market for the year ended December 31, 2013.The following table provides the stock repurchase activities during the years ended December 31, 2014, 2013, and 2012 (in millions, except per shareamounts): Years Ended December 31, 2014 2013 2012Shares repurchased2.5 2.6 0.4Average price per share$397.52 $429.09 $503.05Value of shares repurchased$1,000.0 $1,109.2 $238.3The Company uses the par value method of accounting for its stock repurchases. As a result of the share repurchases during the years ended December 31,2014, 2013, and 2012, the Company reduced common stock and additional paid-in capital by an aggregate of $89.5 million, $84.2 million, and $13.2million, respectively, and charged $910.5 million, $1,025.0 million, $225.1 million, respectively, to retained earnings.80Table of ContentsACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)The components of accumulated other comprehensive income (loss) net of tax, for the years ended December 31, 2014, and 2013 are as follows (inmillions): Year Ended December 31, 2014 Gains (Losses)on HedgeInstruments Unrealized Gains(Losses) onAvailable-for-Sale Securities ForeignCurrencyTranslationGains (Losses) EmployeeBenefit Plans TotalBeginning balance$— $1.7 $0.4 $—$2.1Other comprehensive income before reclassifications8.6 (3.9) (2.5) (4.2) (2.0)Reclassified from accumulated other comprehensive income (loss)(7.5) 2.0 — 0.3 (5.2)Net current-period other comprehensive income (loss)1.1 (1.9) (2.5) (3.9) (7.2)Ending balance$1.1 $(0.2) $(2.1) $(3.9) $(5.1) Year Ended December 31, 2013 Gains (Losses)on HedgeInstruments Unrealized Gains(Losses) onAvailable-for-Sale Securities ForeignCurrencyTranslationGains (Losses) EmployeeBenefit Plans TotalBeginning balance$— $6.2 $0.4 $— $6.6Other comprehensive income before reclassifications(1.8) (3.9) — — (5.7)Reclassified from accumulated other comprehensive income (loss)1.8 (0.6) — — 1.2Net current-period other comprehensive income (loss)— (4.5) — — (4.5)Ending balance$— $1.7 $0.4 $— $2.1NOTE 9. SHARE-BASED COMPENSATIONStock Plans2010 Incentive Award PlanIn April 2010, the Company’s stockholders approved the 2010 Incentive Award Plan (“2010 Plan”). Under this plan, the Company issues nonqualifiedstock options (“NSOs”) to employees and certain consultants. The 2010 Plan generally permits NSOs to be granted at no less than the fair market value of thecommon stock on the date of grant, with terms of 10 years from the date of grant. The 2010 Plan expires in 2020. On April 25, 2013, the Company'sstockholders approved an amended and restated 2010 Incentive Award Plan (“2010 Plan”) to provide for an increase in the number of shares of commonstock reserved for issuance from 3,650,000 to 4,850,000. As of December 31, 2014, approximately 1.0 million shares were reserved for future issuance underthe 2010 Plan.2009 Employment Commencement Incentive PlanIn October 2009, the Board of Directors adopted the 2009 Employment Commencement Incentive Plan (“New Hire Plan”). The New Hire Plan providesfor the shares to be used exclusively for the grant of NSOs to new employees (“New Hire Options”), who were not previously employees or non-employeedirectors of the Company. The Compensation Committee approves all equity awards under the New Hire Plan, which are granted to newly-hired employeesonce a month on the fifth business day of each month after their hire. Options are granted at an exercise price not less than the fair market value of the stockon the date of grant and have a term not to exceed 10 years.In May 2013, the Board of Directors amended and restated the New Hire Plan to provide for an increase in the number of shares of common stockauthorized for issuance pursuant to awards granted under the New Hire Plan from 855,000 to 1,155,000. As of December 31, 2014, approximately 0.1 millionshares were reserved for future issuance under the New Hire Plan.2000 Equity Incentive PlanIn March 2000, the Board of Directors adopted the 2000 Equity Incentive Plan (“2000 Plan”), which took effect upon the closing of the Company’sinitial public offering. Under this plan, certain employees, consultants and non-employee directors81Table of Contentscould be granted Incentive Stock Options (“ISOs”) and Nonstatutory Stock Options (“NSOs”) to purchase shares of the Company’s common stock. The 2000Plan permitted ISOs to be granted at an exercise price not less than the fair value on the date of the grant and NSOs at an exercise price not less than 85% ofthe fair value on the date of grant. Options granted under the 2000 Plan generally expire 10 years from the date of grant and become exercisable upon grantsubject to repurchase rights in favor of the Company until vested. The 2000 Plan expired in March 2010. However, options granted prior to the plan’sexpiration continue to vest or remain outstanding until their original expiration date.Employee Option VestingPrior to 2012, annual stock options were granted to employees on February 15 of each year or the next business day if the date was not a business day(“Annual Grant”). The grants generally vested 6/48 upon completion of 6 months service and 1/48 per month thereafter. Beginning in 2013, the Companysplit the annual grant into a grant on February 15 (or the next business day if the date is not a business day) and a separate grant on August 15 (or the nextbusiness day if the date is not a business day). The February 15 grants vest 6/48 upon completion of 6 months service and 1/48 per month thereafter. TheAugust 15 stock option grants vest 7/48 at the end of one month and 1/48 per month thereafter through a 3.5 year vesting period.Prior to 2014, New Hire Options generally vested 6/48 upon completion of 6 months service and 1/48 per month thereafter. Beginning in 2014, New HireOptions generally vest 12/48 upon completion of one year service and 1/48 per month thereafter. Option vesting terms are determined by the Board ofDirectors and, in the future, may vary from past practices.2000 Non-Employee Directors’ Stock Option PlanIn March 2000, the Board of Directors adopted the 2000 Non-Employee Directors’ Stock Option Plan (the “Directors’ Plan”). In October 2009, theautomatic evergreen increase provisions were eliminated so that no further automatic increases will be made to the number of shares reserved for issuanceunder the Directors’ Plan. In addition, the common stock authorized for issuance under the Directors’ Plan was reduced to 150,000. Options are granted at anexercise price not less than the fair market value of the stock on the date of grant and have a term not to exceed 10 years. Initial stock option grants are vestedover a three-year period with 12/36 of the shares vesting after one year from the date of grant and 1/36 of the shares vesting monthly thereafter. Annual stockoption grants are vested one year from the date of the grant. Beginning in 2014, equity awards granted to non-employee directors include a mix of stockoptions and RSUs. Initial RSU grants are vested in one-third increments over a three-year period while annual RSU grants are vested one year from the date ofgrant. As of December 31, 2014, approximately 58,000 shares were reserved for future issuance under the Directors’ Plan.2000 Employee Stock Purchase PlanIn March 2000, the Board of Directors adopted the 2000 Employee Stock Purchase Plan (ESPP). Employees are generally eligible to participate in theESPP if they are customarily employed by the Company for more than 20 hours per week and more than 5 months in a calendar year and are not 5%stockholders of the Company. Under the ESPP, eligible employees may select a rate of payroll deduction up to 15% of their eligible compensation subject tocertain maximum purchase limitations. The duration for each offering period is 24 months long and is divided into four shorter purchase periodsapproximately six months in length. Offerings are concurrent. The purchase price of the shares under the offering is the lesser of 85% of the fair market valueof the shares on the offering date or 85% of the fair market value of the shares on the purchase date. A two-year look-back feature in the ESPP causes theoffering period to reset if the fair value of the Company’s common stock on the first or last day of the purchase period is less than that on the original offeringdate. ESPP purchases by employees are settled with newly-issued common stock from the ESPP’s previously authorized and available pool of shares.The Company issued 0.1 million, 0.1 million and 0.1 million shares under the ESPP, representing approximately $29.4 million, $28.8 million, and $27.8million in employee contributions for the years ended December 31, 2014, 2013, and 2012, respectively. As of December 31, 2014, there were approximately0.3 million shares reserved for grant under the ESPP.Restricted Stock UnitsBeginning in 2014, equity awards granted to employees include a mix of stock options and RSUs. The RSUs vest in 1/4 increments annually over a four-year period. The number of shares issued on the date the RSUs vest is net of the minimum statutory tax withholdings, which are paid in cash to theappropriate taxing authorities on behalf of the Company's employees. 82Table of ContentsStock Option InformationOption activity during fiscal 2014 under all the stock plans was as follows (in millions, except per share amounts): Stock Options Outstanding NumberOutstanding Weighted AverageExercise Price PerShareBalance at December 31, 20135.6 $380.71Options granted0.7 $446.91Options exercised(0.9) $296.77Options forfeited/expired(0.4) $478.19Balance at December 31, 20145.0 $395.85The aggregate intrinsic value of options exercised under our stock plans determined as of the date of option exercise was $146.2 million, $130.2 million,and $375.7 million during the years ended December 31, 2014, 2013, and 2012, respectively. Cash received from option exercises and employee stockpurchase plans for the years ended December 31, 2014, 2013, and 2012 was $283.6 million, $160.6 million, and $263.3 million, respectively.The following table summarizes significant ranges of outstanding and exercisable options as of December 31, 2014 (number of shares in millions): Options Outstanding Options ExercisableRange ofExercise Prices Numberof Shares WeightedAverageRemainingContractual Life WeightedAverageExercise PricePer Share AggregateIntrinsicValue (1) Numberof Shares WeightedAverageRemainingContractual Life WeightedAverageExercise PricePer Share AggregateIntrinsicValue (1)$47.86 - $333.42 1.0 3.38 $200.98 1.0 $200.82 $334.30 - $358.40 1.0 5.62 $339.17 0.9 $338.96 $358.57 - $451.50 1.0 8.51 $403.95 0.4 $397.19 $459.14 - $517.31 1.4 7.78 $498.68 0.8 $505.75 $518.29 - $579.24 0.6 7.83 $564.92 0.3 $564.70 TOTAL 5.0 6.62 $395.85 $683.1 3.4 5.77 $363.03 $573.1 (1)The aggregate intrinsic value represents the total pre-tax intrinsic value, based on the Company’s closing stock price of $528.94 at December 31, 2014, which would have beenreceived by the option holders had all in-the-money option holders exercised their options as of that date.As of December 31, 2014, a total of 4.8 million shares vested and expected to vest had a weighted average remaining contractual life of 6.5 years, anaggregate intrinsic value of $672.2 million, and a weighted average exercise price of $393.76.Restricted Stock Units InformationRSU activity for the year ended December 31, 2014, was as follows (in millions, except per share amounts): Shares Weighted AverageGrant Date Fair ValueUnvested balance at December 31, 2013— $—Granted0.2 $441.36Vested— $—Canceled0.0 $443.99Unvested balance at December 31, 20140.2 $441.0783Table of ContentsShare-Based Compensation ExpenseThe following table summarizes share-based compensation expense (in millions): Years Ended December 31, 2014 2013 2012Cost of sales—products$19.1 $17.6 $14.1Cost of sales—services13.5 12.7 12.9Total cost of sales32.6 30.3 27.0Selling, general and administrative99.0 101.4 93.1Research and development37.5 37.2 33.2Share-based compensation expense before income taxes169.1 168.9 153.3Income tax effect53.5 58.5 47.5Share-based compensation expense after income taxes$115.6 $110.4 $105.8The Black-Scholes option pricing model is used to estimate the fair value of stock options granted under the Company’s share-based compensation plansand rights to acquire stock granted under the Company’s employee stock purchase plan. The weighted average estimated fair values of stock options, therights to acquire stock granted, and the weighted average assumptions used in calculating those fair values during the years ended December 31, 2014, 2013,and 2012, were as follows: Years Ended December 31,STOCK OPTION PLANS2014 2013 2012Average risk free interest rate1.5% 1.2% 0.8%Average expected term (years)4.3 4.5 4.3Average volatility31% 30% 33%Weighted average fair value at grant date$122.39 $126.50 $146.26EMPLOYEE STOCK PURCHASE PLAN Average risk free interest rate0.2% 0.2% 0.2%Average expected term (years)1.2 1.3 1.3Average volatility33% 34% 32%Weighted average fair value at grant date$124.60 $153.33 $138.61As share-based compensation expense recognized in the Consolidated Statements of Income during the years ended December 31, 2014, 2013, and 2012is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures. Share-based compensation accounting requires forfeitures to beestimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimated.As of December 31, 2014, there were a total of $177.1 million, $65.9 million, and $7.3 million, of total unrecognized compensation expense related tonon-vested stock options, non-vested restricted stock units, and employee stock purchases, respectively. The unrecognized compensation expense isexpected to be recognized over a weighted average period of 2.3 years for non-vested stock options, 3.2 years for non-vested restricted stock units, and 0.7years for rights granted to acquire stock under the ESPP.Excess tax benefits are realized tax deductions for exercised options in excess of the deferred tax assets attributable to share-based compensation expensefor such options. Excess tax benefits of $24.0 million, $38.0 million, and $94.2 million for the years ended December 31, 2014, 2013, and 2012, respectively,have been classified as a financing cash inflow. The total income tax benefit recognized in the consolidated statements of income for share-basedcompensation expense was $53.5 million, $58.5 million, and $47.5 million for the years ended December 31, 2014, 2013, and 2012, respectively.84Table of ContentsNOTE 10. INCOME TAXESIncome before provision for income taxes for the years ended December 31, 2014, 2013, and 2012 consisted of the following (in millions): Years Ended December 31, 2014 2013 2012U.S$353.0 $612.5 $718.5Foreign196.0 258.4 175.4Total income before provision for income taxes$549.0 $870.9 $893.9The provision for income taxes for the years ended December 31, 2014, 2013, and 2012 consisted of the following (in millions): Years Ended December 31, 2014 2013 2012Current Federal$150.5 $216.8 $239.9State7.0 17.4 17.0Foreign7.5 4.3 3.4 $165.0 $238.5 $260.3Deferred Federal$(30.9) $(36.2) $(20.6)State(0.6) (1.9) (1.2)Foreign(3.3) (0.5) (1.2) $(34.8) $(38.6) $(23.0)Total income tax expense$130.2 $199.9 $237.3Income tax expense differs from amounts computed by applying the statutory rate of 35% for the years ended December 31, 2014, 2013, and 2012 as aresult of the following (in millions): Years Ended December 31, 2014 2013 2012Federal tax at statutory rate$192.2 $304.8 $312.9Increase (reduction) in tax resulting from: State taxes, net of federal benefits6.4 15.5 15.8Foreign rate differential(47.4) (73.6) (42.8)Research and development credit(5.0) (12.2) —Share-based compensation not benefited7.7 1.9 5.9Domestic production activities deduction(4.6) (9.2) (8.2)Reversal of unrecognized tax benefits(20.3) (26.7) (46.5)Other1.2 (0.6) 0.2 $130.2 $199.9 $237.385Table of ContentsDeferred income taxes reflect tax carry forwards and the net tax effects of temporary differences between the carrying amounts of assets and liabilities forfinancial reporting and the amounts used for income tax purposes. Significant components of the Company’s deferred tax assets are as follows (in millions): December 31, 2014 2013Deferred tax assets: Share-based compensation expense$140.5 $123.4Expenses deducted in later years for tax purposes52.4 30.3Research and other credits7.7 5.8Other3.5 1.2Gross deferred tax assets$204.1 $160.7Valuation allowance(9.5) (7.2)Deferred tax assets$194.6 $153.5Deferred tax liabilities: Fixed assets$(22.6) $(16.1)Identified intangible assets related to acquisitions(1.7) (1.9)Other(0.4) (2.1)Deferred tax liabilities$(24.7) $(20.1)Net deferred tax assets$169.9 $133.4The Company has not provided U.S. income taxes and foreign withholding taxes on the undistributed earnings of its foreign subsidiaries as ofDecember 31, 2014 because the Company intends to indefinitely reinvest such earnings outside the U.S. If these foreign earnings were to be repatriated in thefuture, the related U.S. tax liability may be reduced by any foreign income taxes previously paid on these earnings. As of December 31, 2014, the cumulativeamount of earnings upon which U.S. income taxes have not been provided was approximately $855.8 million. Determination of the amount of unrecognizeddeferred tax liability related to these earnings is not practicable at this time. The Company has a tax holiday in effect for its business operations inSwitzerland which will continue until the end of year 2017 to the extent certain terms and conditions continue to be met. This tax holiday provides for alower rate of taxation in Switzerland based on various thresholds of investment and employment in such jurisdiction. As of December 31, 2014, the Companyremained in compliance with the terms of the holiday. At the end of the tax holiday, Swiss taxable income may be taxed at a higher rate depending on theapplicable federal and cantonal rules.As of December 31, 2014 and 2013, the Company had valuation allowances of $9.5 million and $7.2 million, respectively, primarily related toCalifornia deferred tax assets generated by California R&D credit forwards which have no expiration period. The Company recorded a valuation allowanceagainst its California deferred tax assets as it is more likely than not these deferred tax assets will not be realized as a result of the computation of Californiataxes under the single sales factor. The Company will continue to monitor and reassess the need for further increases or decreases to the valuation allowance.The Company recorded a net increase of its gross unrecognized tax benefits of approximately $1.5 million during the year ended December 31, 2014.The net increase was primarily related to increases related to 2014 uncertain tax positions, partially offset by the reversal of gross unrecognized tax benefitsof $20.8 million in connection with the conclusion of the Company's IRS audit for years 2010 and 2011, and the expiration of certain statutes of limitationsin multiple jurisdictions in the second half of 2014. The Company had gross unrecognized tax benefits of approximately $75.5 million, $74.0 million, and$88.0 million as of December 31, 2014, 2013, and 2012, respectively, of which $75.5 million, $74.0 million, and $83.8 million, if recognized, would result ina reduction of the Company’s effective tax rate during the years ended December 31, 2014, 2013, and 2012, respectively. The Company included interestexpense and penalties accrued on unrecognized tax benefits as a component of its income tax expense. As of December 31, 2014, 2013, and 2012, grossinterest and penalties related to unrecognized tax benefits accrued was approximately $2.5 million, $3.4 million, and $3.2 million, respectively. A netdecrease of $0.9 million was included in the Company's 2014 income tax expense as a result of the decreases associated with the above-mentioned changesin unrecognized tax benefits partially offset by current year increases. The Company classified a majority of its net unrecognized tax benefits and relatedinterest in “Other accrued liabilities” on the Consolidated Balance Sheets.The U.S. Internal Revenue Service (“IRS”) completed its audit of the Company’s 2010 and 2011 federal income tax returns in December 2014. At theconclusion of the audit, the IRS provided its Revenue Agent’s Report to the Joint Committee of Taxation, which agreed with the IRS examiner’s Report withno exceptions. As a result, the Company released reserves in connection with years 2010 and 2011 in the fourth quarter of 2014, which were included in the$20.3 million reversal of unrecognized tax benefits and interests described above. In addition, the Company anticipates receiving a refund of $4.5 million in2015 in connection with the conclusion of the audit.86Table of ContentsA reconciliation of the beginning and ending amounts of gross unrecognized income tax benefits for the years ended December 31, 2014, 2013, and2012 are as follows (in millions): Years Ended December 31, 2014 2013 2012Beginning balance$74.0 $88.0 $98.1Increases related to tax positions taken during the current year22.3 22.8 17.5Increases related to tax positions taken during a prior year — 12.9Decreases related to tax positions taken during a prior year— (1.5) (8.3)Decreases related to settlements with tax authorities(19.1) (6.0) —Decreases related to expiration of statute of limitations(1.7) (29.3) (32.2)Ending balance$75.5 $74.0 $88.0The Company files federal, state and foreign income tax returns in many jurisdictions in the U.S. and abroad. Generally, years before 2010 are closed formost significant jurisdictions except for California, for which years before 2008 were considered closed. Certain of the Company’s unrecognized tax benefitscould reverse based on the normal expiration of various statutes of limitations, which could affect the Company’s effective tax rate in the period in whichthey reverse.The Company is subject to the examination of its income tax returns by the Internal Revenue Service and other tax authorities. The outcome of theseaudits cannot be predicted with certainty. Management regularly assesses the likelihood of adverse outcomes resulting from these examinations to determinethe adequacy of the Company’s provision for income taxes. If any issues addressed in the Company’s tax audits are resolved in a manner not consistent withmanagement’s expectations, the Company could be required to adjust its provision for income taxes in the period such resolution occurs.NOTE 11. NET INCOME PER SHAREThe following table presents the computation of basic and diluted net income per share (in millions, except per share amounts): Years Ended December 31, 2014 2013 2012Net income$418.8 $671.0 $656.6Basic: Weighted-average shares outstanding36.9 39.2 39.8Basic net income per share$11.35 $17.12 $16.50Diluted: Weighted-average shares outstanding used in basic calculation36.9 39.2 39.8Add: Dilutive potential shares0.8 0.9 1.3Weighted-average shares used in computing diluted net income per share37.7 40.1 41.1Diluted net income per share$11.11 $16.73 $15.98Share-based compensation awards of approximately 2.4 million, 2.3 million, and 0.9 million shares for the years ended December 31, 2014, 2013, and2012, respectively, were outstanding, but were not included in the computation of diluted net income per share because the effect of including such shareswould have been antidilutive in the periods presented.NOTE 12. EMPLOYEE BENEFIT PLANSThe Company sponsors various retirement plans for its eligible U.S. and non-U.S. employees. For employees in the U.S., the Company maintains theIntuitive Surgical, Inc. 401(k) Plan (the “Plan”). As allowed under Section 401(k) of the Internal Revenue Code, the Plan provides tax-deferred salarycontributions for eligible U.S. employees. The Plan allows employees to contribute up to 75% of their annual compensation to the Plan on a pre-tax and after-tax basis. Employee contributions are limited to a maximum annual amount as set periodically by the Internal Revenue Code. Employer matchingcontributions are made solely at the Company’s discretion. No employer matching contributions were made to the Plan during the years ended December 31,2014, 2013, and 2012.87Table of ContentsSELECTED QUARTERLY DATA(UNAUDITED, IN MILLIONS, EXCEPT PER SHARE AMOUNTS) Three Months Ended March 31,2014 June 30,2014 September 30, 2014 December 31, 2014Revenue$464.7 $512.2 $550.1 $604.7Gross profit$315.4 $344.4 $360.6 $393.4Net income (1)(2)$44.3 $104.0 $123.7 $146.8Net income per common share Basic$1.16 $2.82 $3.43 $4.03Diluted$1.13 $2.77 $3.35 $3.94 (1) Includes one-time discrete tax benefits as follows: Audit settlement and expiration of the statutes of limitations in multiplejurisdictions$0.2 $— $0.2 $19.9Reinstatement of the 2014 federal R&D tax credit$— $— $— $5.0(2) Includes pre-tax charges relating to tolled product liability claims$67.4 $9.6 $— $5.4 Three Months Ended March 31,2013 June 30,2013 September 30, 2013 December 31, 2013Revenue$611.4 $578.5 $499.0 $576.2Gross profit$434.3 $405.2 $356.7 $398.0Net income (1)$188.9 $159.1 $156.8 $166.2Net income per common share Basic$4.69 $3.99 $4.06 $4.36Diluted$4.56 $3.90 $3.99 $4.28 (1) Includes one-time discrete tax benefits as follows: Expiration of the statutes of limitations in multiple jurisdictions$— $— $26.2 $0.5Reinstatement of the 2012 federal R&D tax credit$7.5 $— $— $0.788SCHEDULE IIVALUATION AND QUALIFYING ACCOUNTS(IN MILLIONS) Balance atBeginning ofYear Additions Deductions (1) Balance atEnd of YearAllowance for doubtful accounts and sales returns Year ended December 31, 2014$5.8 $22.2 $(22.5) $5.5Year ended December 31, 2013$8.0 $14.1 $(16.3) $5.8Year ended December 31, 2012$5.6 $15.0 $(12.6) $8.0 (1)Primarily represents products returned.89Table of ContentsITEM 9.CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURESNone.ITEM 9A.CONTROLS AND PROCEDURESConclusion Regarding the Effectiveness of Disclosure Controls and ProceduresWe maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our Exchange Act reports isrecorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms and that such information is accumulated andcommunicated to our management, including our principal executive officer and principal financial officer, as appropriate, to allow for timely decisionsregarding required disclosure.As required by SEC Rule 13a-15(b), we carried out an evaluation, under the supervision and with the participation of our management, including ourprincipal executive officer and principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of theend of the period covered by this Annual Report on Form 10-K. Based on the foregoing, our principal executive officer and principal financial officerconcluded that our disclosure controls and procedures were effective at the reasonable assurance level.Inherent Limitations Over Internal ControlsOur internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and thepreparation of financial statements for external purposes in accordance with U.S. GAAP. Our internal control over financial reporting includes those policiesand procedures that:(i)pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets;(ii)provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. GAAP,and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and(iii)provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of our assets that could havea material effect on the financial statements.Management, including our principal executive officer and principal financial officer, does not expect that our internal controls will prevent or detect allerrors and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the objectives ofthe control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must beconsidered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of internal controls can provide absolute assurancethat all control issues and instances of fraud, if any, have been detected. Also, any evaluation of the effectiveness of controls in future periods are subject tothe risk that those internal controls may become inadequate because of changes in business conditions, or that the degree of compliance with the policies orprocedures may deteriorate.Management’s Report on Internal Control Over Financial ReportingOur management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in ExchangeAct Rules 13a-15(f). Under the supervision and with the participation of our management, including our principal executive officer and principal financialofficer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control IntegratedFramework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation under the framework in the2013 Internal Control—Integrated Framework, our management concluded that our internal control over financial reporting was effective as of December 31,2014.The effectiveness of our internal control over financial reporting as of December 31, 2014, has been audited by an independent registered publicaccounting firm, as stated in their report, which is included under "Item 8. Financial Statements and Supplementary Data" of this Annual Report.Changes in Internal Control Over Financial ReportingThere were no changes in our internal control over financial reporting that occurred during the quarter ended December 31, 2014 that have materiallyaffected, or are reasonably likely to materially affect, our internal control over financial statements.ITEM 9B.OTHER INFORMATIONNone.90Table of ContentsPART IIICertain information required by Part III is omitted from this report on Form 10-K and is incorporated herein by reference to our definitive ProxyStatement for our next Annual Meeting of Stockholders (the “Proxy Statement”), which we intend to file pursuant to Regulation 14A of the SecuritiesExchange Act of 1934, as amended, within 120 days after December 31, 2014.ITEM 10.DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCEThe information required by this item concerning our directors and corporate governance is incorporated by reference to the information set forth in thesection titled “Directors and Corporate Governance” in our Proxy Statement. Information required by this item concerning our executive officers isincorporated by reference to the information set forth in the section entitled “Executive Officers of the Company” in our Proxy Statement. Informationregarding our Section 16 reporting compliance is incorporated by reference to the information set forth in the section entitled “Security Ownership of CertainBeneficial Owners and Management and Related Stockholder Matters” in our Proxy Statement.ITEM 11.EXECUTIVE COMPENSATIONThe information required by this item regarding executive compensation is incorporated by reference to the information set forth in the sections titled“Executive Compensation” and “Compensation for Directors” in our Proxy Statement.ITEM 12.SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDERMATTERSThe information required by this item regarding security ownership of certain beneficial owners and management is incorporated by reference to theinformation set forth in the section titled “Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters” in our ProxyStatement.ITEM 13.CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCEThe information required by this item regarding certain relationships and related transactions and director independence is incorporated by reference tothe information set forth in the sections titled “Certain Relationships and Related Transactions” and “Directors and Corporate Governance” in our ProxyStatement.ITEM 14.PRINCIPAL ACCOUNTANT FEES AND SERVICESThe information required by this item regarding principal accountant fees and services is incorporated by reference to the information set forth in thesection titled “Principal Accountant Fees and Services” in our Proxy Statement.91Table of ContentsPART IVITEM 15.EXHIBITS AND FINANCIAL STATEMENT SCHEDULE(a)The following documents are filed as part of this Annual Report on Form 10-K1)Financial Statements—See Index to Consolidated Financial Statements at Item 8 of this report on Form 10-K.2)The following financial statement schedule of Intuitive Surgical, Inc. is filed as part of this report and should be read in conjunction withthe financial statements of Intuitive Surgical, Inc.:Schedule II: Valuation and Qualifying Accounts.All other schedules have been omitted because they are not applicable, not required under the instructions, or the information requested is set forthin the consolidated financial statements or related notes thereto.3)ExhibitsThe exhibits filed as part of this report are listed under “Exhibits” at subsection (b) of this Item 15.(b)Exhibits92Table of ContentsEXHIBIT INDEX3.1(1) Amended and Restated Certificate of Incorporation of the Company. 3.2(1) Certificate of Amendment to Amended and Restated Certificate of Incorporation of the Company. 3.3(2) Certificate of Amendment to Amended and Restated Certificate of Incorporation of the Company. 3.4(3) Amended and Restated Bylaws of the Company. 4.1(4) Specimen Stock Certificate. 10.1(4) Form of Indemnity Agreement. * 10.2(4) 2000 Equity Incentive Plan. * 10.3(4) 2000 Non-Employee Directors’ Stock Option Plan. * 10.4(4) 2000 Employee Stock Purchase Plan. * 10.5(5) 2009 Employment Commencement Incentive Plan, as amended and restated. * 10.6(6) 2010 Incentive Award Plan, as amended and restated. * 10.7(7) Severance Plan. * 10.8(8) Third Amendment effective as of July 1, 2010, to Employment Agreement between the Company and Lonnie M. Smith, dated February 28,1997. * 10.9(9) Form of Intuitive Surgical, Inc. 2000 Equity Incentive Plan Stock Option Agreement (Incentive and Nonstatutory Stock Options). * 21.1 Intuitive Surgical, Inc. subsidiaries. 23.1 Consent of Independent Registered Public Accounting Firm. 23.2 Consent of Ernst & Young - Independent Registered Public Accounting Firm 31.1 Certification of Principal Executive Officer. 31.2 Certification of Principal Financial Officer. 32.1 Certification of Chief Executive Officer and Principal Financial Officer Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section906 of the Sarbanes-Oxley Act of 2002. 101 The following materials from Intuitive Surgical, Inc.’s Annual Report on Form 10-K for the year ended December 31, 2014, formatted inXBRL (Extensible Business Reporting Language): (i) Consolidated Balance Sheets, (ii) Consolidated Statements of Income, (iii)Consolidated Statement of Stockholders’ Equity, (iv) Consolidated Statements of Cash Flows, and (v) Notes to Consolidated FinancialStatements, tagged at Level I through IV. (1)Incorporated by reference to exhibits filed with the Company’s 2008 Annual Report on Form 10-K filed February 6, 2009 (File No. 000-30713).(2)Incorporated by reference to Exhibit A filed with the Company’s Definitive Proxy Statement on Schedule 14A filed March 1, 2012 (File No. 000-30713).(3)Incorporated by reference to Exhibit 3.1 filed with the Company’s Current Report on Form 8-K filed April 24, 2012 (File No. 000-30713).(4)Incorporated by reference to exhibits filed with the Company’s Registration Statement on Form S-1 filed March 22, 2000 (File No. 333-33016).(5)Incorporated by reference to Exhibit 10.5 to the Company’s Annual Report on Form 10-K filed February 3, 2014 (File No. 000-30713).(6)Incorporated by reference to Exhibit 4.1 filed with the Company’s Registration Statement on Form S-8 filed June 17, 2013 (File No. 333-189399).(7)Incorporated by reference to Exhibit 10.1 filed with the Company’s Current Report on Form 8-K filed December 2, 2008 (File No. 000-30713).(8)Incorporated by reference to Exhibit 10.1 filed with the Company’s Current Report on Form 8-K filed July 26, 2010 (File No. 000-30713).(9)Incorporated by reference to Exhibit 10.2 filed with the Company’s Quarterly Report on Form 10-Q filed July 23, 2009 (File No. 000-30713).* Management contract or compensatory plan or arrangement.93Table of ContentsSIGNATURESPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed onits behalf by the undersigned thereunto duly authorized.INTUITIVE SURGICAL, INC. By: /S/ GARY S. GUTHART Gary S. Guthart, Ph.D.President and Chief Executive OfficerDate: February 5, 2015Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of theRegistrant and in the capacities and on the dates indicated.Signature Title Date /S/ GARY S. GUTHART President, Chief Executive Officer and Director (Principal Executive Officer) February 5, 2015Gary S. Guthart, Ph.D. /S/ MARSHALL L. MOHR Senior Vice President and Chief Financial Officer (Principal Financial Officer) February 5, 2015Marshall L. Mohr /S/ JAMIE E. SAMATH Vice President, Corporate Controller, and Principal Accounting Officer February 5, 2015Jamie E. Samath /S/ LONNIE M. SMITH Chairman of the Board of Directors February 5, 2015Lonnie M. Smith /S/ CRAIG H. BARRATT Director February 5, 2015Craig H. Barratt, Ph.D. /S/ AMAL M. JOHNSON Director February 5, 2015Amal M. Johnson /S/ ERIC H. HALVORSON Director February 5, 2015Eric H. Halvorson /S/ ALAN J. LEVY Director February 5, 2015Alan J. Levy, Ph.D. /S/ MARK J. RUBASH Director February 5, 2015Mark J. Rubash /S/ GEORGE STALK JR. Director February 5, 2015George Stalk Jr. 94Exhibit 21.1INTUITIVE SURGICAL, INC.SUBSIDIARIES (All 100% Owned)Subsidiaries of the RegistrantState or Other Jurisdiction of IncorporationIntuitive Surgical Holdings, LLCDelaware, U.S.Intuitive Surgical S. de R. L. de C.V.MexicoIntuitive Surgical SarlSwitzerlandIntuitive Surgical International Ltd.CaymanIntuitive Surgical S.A.S.FranceIntuitive Surgical Deutschland GmbHGermanyIntuitive Surgical SPRLBelgiumIntuitive Surgical LimitedUnited KingdomIntuitive Surgical Pte. Ltd.SingaporeIntuitive Surgical HK LimitedHong KongIntuitive Surgical Operations, Inc.Delaware, U.S.Intuitive Surgical GKJapanIntuitive Surgical Brasil Importacao E Comercio De Equipamentos Cirurgicos Ltda.BrazilIntuitive Surgical ABSwedenIntuitive Surgical Medical Device and Technology (Shanghai) Co., Ltd.ChinaIntuitive Surgical Korea LimitedKoreaIntuitive Surgical s.r.o.Czech RepublicI.S. Netherlands C.V.NetherlandsI.S. Holdings C.V.NetherlandsIntuitive Surgical BVNetherlandsIntuitive Surgical India Private LimitedIndiaExhibit 23.1CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRMWe hereby consent to the incorporation by reference in the Registration Statements on Form S-8 (Nos. 333-189399, 333-184488, 333-180863, 333-175904,333-173803, 333-166833, 333-164586, 333-159228, 333-152558, 333-143433, 333-135004, 333-127162, 333-116499, 333-107196, 333-99893, 333-65342, and 333-43558) and Form S-3 (Nos. 333-110972, 333-110229, and 333-65158) of Intuitive Surgical, Inc. of our report dated February 5, 2015,relating to the consolidated financial statements, financial statement schedule, and the effectiveness of internal control over financial reporting, whichappears in this Form 10-K./s/ PricewaterhouseCoopers LLPSan Jose, CaliforniaFebruary 5, 2015Exhibit 23.2CONSENT OF ERNST & YOUNG - INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRMWe consent to the incorporation by reference in the Registration Statements on Form S-8 (Nos. 333-189399, 333-184488, 333-180863, 333-175904, 333-173803, 333-166833, 333-164586, 333-159228, 333-152558, 333-143433, 333-135004, 333-127162, 333-116499, 333-107196, 333-99893, 333-65342,and 333-43558) pertaining to the 2009 Employment Commencement Incentive Plan, 2010 Incentive Award Plan, 2000 Equity Incentive Plan, 2000Employee Stock Purchase Plan, 2000 Non-Employee Directors’ Stock Option Plan, Computer Motion, Inc. Tandem Stock Option Plan, and ComputerMotion, Inc. 1997 Stock Incentive Plan, and Form S-3 (Nos. 333-110972, 333-110229, and 333-65158) of our reports dated February 3, 2014, with respect tothe consolidated financial statements and schedule of Intuitive Surgical, Inc., included in this Annual Report (Form 10-K) for the year ended December 31,2014./s/ ERNST & YOUNG LLPSan Francisco, CAFebruary 5, 2015Exhibit 31.1Certification of Chief Executive OfficerPursuant to Section 302 of the Sarbanes-Oxley Act of 2002I, Gary S. Guthart, certify that:1.I have reviewed this annual report on Form 10-K of Intuitive Surgical, Inc.;2.Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to makethe statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period coveredby this report;3.Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respectsthe financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;4.The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined inExchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a–15(f) and15d–15(f)) for the registrant and have:a)designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under oursupervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made knownto us by others within those entities, particularly during the period in which this report is being prepared;b)designed such internal control over financial reporting, or caused such internal control over financial reporting to be designedunder our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation offinancial statements for external purposes in accordance with generally accepted accounting principles;c)evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusionsabout the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on suchevaluation; andd)disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during theregistrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materiallyaffected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and5.The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, tothe registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):a)all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting whichare reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information;andb)any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’sinternal control over financial reporting.Date: February 5, 2015 By:/S/ GARY S. GUTHART Gary S. Guthart, Ph.D.President and Chief Executive OfficerExhibit 31.2Certification of Principal Financial OfficerPursuant to Section 302 of the Sarbanes-Oxley Act of 2002I, Marshall L. Mohr, certify that:1.I have reviewed this annual report on Form 10-K of Intuitive Surgical, Inc.;2.Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to makethe statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period coveredby this report;3.Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respectsthe financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;4.The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined inExchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a–15(f) and15d–15(f)) for the registrant and have:a)designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under oursupervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made knownto us by others within those entities, particularly during the period in which this report is being prepared;b)designed such internal control over financial reporting, or caused such internal control over financial reporting to be designedunder our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation offinancial statements for external purposes in accordance with generally accepted accounting principles;c)evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusionsabout the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on suchevaluation; andd)disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during theregistrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materiallyaffected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and5.The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, tothe registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):a)all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting whichare reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information;andb)any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’sinternal control over financial reporting.Date: February 5, 2015/S/ MARSHALL L. MOHRMarshall L. MohrSenior Vice President and Chief Financial OfficerExhibit 32.1Certification of Chief Executive OfficerPursuant to Section 906 of the Sarbanes-Oxley Act of 2002Pursuant to 18 U.S.C. § 1350, as created by Section 906 of the Sarbanes-Oxley Act of 2002, the undersigned officer of Intuitive Surgical, Inc. (the“Company”) hereby certifies, to such officer’s knowledge, that:(i)the accompanying Annual Report on Form 10-K of the Company for the period ended December 31, 2014 (the “Report”) fully complies withthe requirements of Section 13(a) or Section 15(d), as applicable, of the Securities Exchange Act of 1934, as amended; and(ii)the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of theCompany./S/ GARY S. GUTHARTGary S. Guthart, Ph.D.President and Chief Executive OfficerDate: February 5, 2015Certification of Principal Financial OfficerPursuant to Section 906 of the Sarbanes-Oxley Act of 2002Pursuant to 18 U.S.C. § 1350, as created by Section 906 of the Sarbanes-Oxley Act of 2002, the undersigned officer of Intuitive Surgical, Inc. (the“Company”) hereby certifies, to such officer’s knowledge, that:(i)the accompanying Annual Report on Form 10-K of the Company for the period ended December 31, 2014 (the “Report”) fully complies withthe requirements of Section 13(a) or Section 15(d), as applicable, of the Securities Exchange Act of 1934, as amended; and(ii)the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of theCompany./S/ MARSHALL L. MOHRMarshall L. MohrSenior Vice President and Chief Financial OfficerDate: February 5, 2015

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