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<title>Q3 2003 10Q DOC</title>
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<FONT SIZE="3"><B><P ALIGN="CENTER">UNITED STATES<br>
SECURITIES AND EXCHANGE COMMISSION<br>
Washington, D.C. 20549</B></font></p>

<br>
<HR WIDTH="25%">
<br>

<p align="center"><font size="5"><B>FORM 10-Q</B></font></p>

<br>
<HR WIDTH="25%">

<p>&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;<i>(Mark One)</i>


<FONT SIZE="3"><B><P ALIGN="CENTER">
</font><font face=Wingdings>x</font><font>&nbsp; QUARTERLY REPORT PURSUANT TO SECTION 13 OR
     15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
</B></font></p>
<font size="4" color="FF0000"><B><p align="center">
               For the quarterly period ended September 30, 2003
</B></font></p>

<FONT SIZE="3"><B><P ALIGN="CENTER"> OR </P></font></B>

<FONT SIZE="3"><B><P ALIGN="CENTER">
</font><font face=Wingdings>o</font><font>&nbsp; TRANSITION REPORT PURSUANT TO SECTION 13 OR
  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
</P></font></B>
<FONT SIZE="3"><B><P ALIGN="CENTER">
 For the transition period from ________to _________
</P></font></B>
<FONT SIZE="3"><B><U><P ALIGN="CENTER">
                       Commission file number 000-30713
</U></B></font></p>
<font size="6" color="#0000FF"><B><U><p align="center">
                                Intuitive Surgical, Inc.
</U></B></font><br>
<font size="2">
               (Exact name of Registrant as specified in its Charter)
</font></p>

<P>&nbsp;
<TABLE COLS=2 WIDTH="100%" >
<TR>
<TD>
<font size="3"><B>
<CENTER><u>Delaware</u></CENTER>
</font></B>
</TD>
<TD>
<font size="3"><B>
<CENTER><u>77-0416458</u></CENTER>
</font></B>
</TD>
</TR>
<TR>
<TD>
<font size="2">
<CENTER>&nbsp; (State or Other Jurisdiction of Incorporation or Organization)&nbsp;</CENTER>
</font>
</TD>
<TD>
<font size="2">
<CENTER>(I.R.S. Employer Identification Number)</CENTER>
</font>
</TD>
</TR>
</TABLE>
<BR>



<FONT SIZE="3"><B><P ALIGN="CENTER">
                            950 Kifer Road
<BR><U>
                         Sunnyvale, California  &nbsp;&nbsp;  94086
</U></B></font><br>


<font size="2">
        (Address of Principal Executive Offices including Zip Code)
</font></p>

<FONT SIZE="3"><B><U><P ALIGN="CENTER">
                                    (408) 523-2100
</U></B></font><br>

<font size="2">
                 (Registrant's Telephone Number, Including Area Code)
</font></p>



<font size="3">
<p>&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;
Indicate 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 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file reports), and (2) has been subject to such filing
requirements for the past 90 days. &nbsp;&nbsp; YES
</font><font face=Wingdings>x</font><font>&nbsp; NO
</font><font face=Wingdings>o</font><font>&nbsp; </p>


<font size="3">
<p>&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;
Indicate by check mark whether the registrant is an accelerated filer (as defined
in Rule 12b-2 of the Exchange Act). &nbsp;&nbsp; YES
</font><font face=Wingdings>x</font><font>&nbsp; NO
</font><font face=Wingdings>o</font><font>&nbsp; </p>


<p>&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;
     The Registrant had 32,212,144 shares of Common Stock, $0.001 par value per
share, outstanding as of November 5, 2003.

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<P ALIGN="CENTER"><IMG SRC="logo.gif">
<B><P ALIGN="CENTER">
                                Intuitive Surgical, Inc.<br>
                                TABLE OF CONTENTS
</B></p>


<P ALIGN="LEFT"><TABLE BORDER=0 CELLSPACING=1 CELLPADDING=2 WIDTH=700>
  <TR vAlign=bottom>
<TD WIDTH="90%">
<font size="3"><B>
    PART I.   FINANCIAL INFORMATION
</font></B>
</TD>

<TD WIDTH="10%">
<font size="3"><B>
<u>Page No.</u>
</font></B>
</TD>
</TR>

<TR>
<TD>
&nbsp;&nbsp;
</TD>
<TD>
&nbsp;&nbsp;
</TD>
</TR>

  <TR vAlign=top>
<TD>
<font size="3">
         Item 1. Financial Statements (Unaudited):
</font>
</TD>


<TD>
<font size="3">
<CENTER>&nbsp;</CENTER>
</font>
</TD>
</TR>

<TR>
<TD>
&nbsp;&nbsp;
</TD>
<TD>
&nbsp;&nbsp;
</TD>
</TR>

  <TR vAlign=top>
<TD>
<font size="3">
&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;
         Condensed consolidated balance sheets as of September 30, 2003 and<br>
&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;
           December 31, 2002

</font>
</TD>

<TD>
<font size="3">
<CENTER><A HREF="#bs">1</A></CENTER>
</font>
</TD>
</TR>

<TR>
<TD>
&nbsp;&nbsp;
</TD>
<TD>
&nbsp;&nbsp;
</TD>
</TR>

  <TR vAlign=top>
<TD>
<font size="3">
&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;
         Condensed consolidated statements of operations for the three-month<br>
&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;
             and nine-month periods ended September 30, 2003 and September 30, 2002

</font>
</TD>

<TD>
<font size="3">
<CENTER><A HREF="#ops">2</A></CENTER>
</font>
</TD>
</TR>


<TR>
<TD>
&nbsp;&nbsp;
</TD>
<TD>
&nbsp;&nbsp;
</TD>
</TR>

  <TR vAlign=top>
<TD>
<font size="3">
&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;
         Condensed consolidated statements of cash flows for the nine-month<br>
&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;
           periods ended September 30, 2003 and September 30, 2002
</font>
</TD>

<TD>
<font size="3">
<CENTER><A HREF="#flows">3</A></CENTER>
</font>
</TD>
</TR>

<TR>
<TD>
&nbsp;&nbsp;
</TD>
<TD>
&nbsp;&nbsp;
</TD>
</TR>

  <TR vAlign=top>
<TD>
<font size="3">
&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;
         Notes to condensed consolidated financial statements
&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;
</font>
</TD>

<TD>
<font size="3">
<CENTER><A HREF="#notes">4</A></CENTER>
</font>
</TD>
</TR>

<TR>
<TD>
&nbsp;&nbsp;
</TD>
<TD>
&nbsp;&nbsp;
</TD>
</TR>

  <TR vAlign=top>
<TD>
<font size="3">
        Item 2.   Management's Discussion and Analysis of Financial
                      Condition and Results of Operations
</font>
</TD>

<TD>
<font size="3">
<CENTER><A HREF="#mda">11</A></CENTER>
</font>
</TD>
</TR>

<TR>
<TD>
&nbsp;&nbsp;
</TD>
<TD>
&nbsp;&nbsp;
</TD>
</TR>

  <TR vAlign=top>
<TD>
<font size="3">
Item 3.   Quantitative and Qualitative Disclosures About Market Risk

</font>
</TD>

<TD>
<font size="3">
<CENTER><A HREF="#market">26</A></CENTER>
</font>
</TD>
</TR>

<TR>
<TD>
&nbsp;&nbsp;
</TD>
<TD>
&nbsp;&nbsp;
</TD>
</TR>

  <TR vAlign=top>
<TD>
<font size="3">
Item 4.   Controls and Procedures

</font>
</TD>

<TD>
<font size="3">
<CENTER><A HREF="#controls">26</A></CENTER>
</font>
</TD>
</TR>

<TR>
<TD>
&nbsp;&nbsp;
</TD>
<TD>
&nbsp;&nbsp;
</TD>
</TR>

  <TR vAlign=top>
<TD>
<font size="3"><B>
        PART II.  OTHER INFORMATION
</font></B>
</TD>

<TD>
<font size="3">
<CENTER>&nbsp;</CENTER>
</font>
</TD>
</TR>


<TR>
<TD>
&nbsp;&nbsp;
</TD>
<TD>
&nbsp;&nbsp;
</TD>
</TR>

  <TR vAlign=top>
<TD>
<font size="3">
            Item 1.  Legal Proceedings
</font>
</TD>

<TD>
<font size="3">
<CENTER><A HREF="#item1">27</A></CENTER>
</font>
</TD>
</TR>


<TR>
<TD>
&nbsp;&nbsp;
</TD>
<TD>
&nbsp;&nbsp;
</TD>
</TR>

  <TR vAlign=top>
<TD>
<font size="3">
        Item 2.   Changes in Securities and Use of Proceeds
</font>
</TD>

<TD>
<font size="3">
<CENTER><A HREF="#item2">28</A></CENTER>
</font>
</TD>
</TR>

<TR>
<TD>
&nbsp;&nbsp;
</TD>
<TD>
&nbsp;&nbsp;
</TD>
</TR>

  <TR vAlign=top>
<TD>
<font size="3">
Item 3.  Defaults Upon Senior Securities
</font>
</TD>

<TD>
<font size="3">
<CENTER><A HREF="#item3">28</A></CENTER>
</font>
</TD>
</TR>


<TR>
<TD>
&nbsp;&nbsp;
</TD>
<TD>
&nbsp;&nbsp;
</TD>
</TR>

  <TR vAlign=top>
<TD>
<font size="3">
Item 4.  Submission of Matters to a Vote of Security Holders
</font>
</TD>

<TD>
<font size="3">
<CENTER><A HREF="#item4">28</A></CENTER>
</font>
</TD>
</TR>


<TR>
<TD>
&nbsp;&nbsp;
</TD>
<TD>
&nbsp;&nbsp;
</TD>
</TR>

  <TR vAlign=top>
<TD>
<font size="3">
Item 5.  Other Information
</font>
</TD>

<TD>
<font size="3">
<CENTER><A HREF="#item5">29</A></CENTER>
</font>
</TD>
</TR>

<TR>
<TD>
&nbsp;&nbsp;
</TD>
<TD>
&nbsp;&nbsp;
</TD>
</TR>

  <TR vAlign=top>
<TD>
<font size="3">
        Item 6.   Exhibits and Reports on Form 8-K
</font>
</TD>

<TD>
<font size="3">
<CENTER><A HREF="#item6">29</A></CENTER>
</font>
</TD>
</TR>


<TR>
<TD>
&nbsp;&nbsp;
</TD>
<TD>
&nbsp;&nbsp;
</TD>
</TR>

  <TR vAlign=top>
<TD>
<font size="3"><B>
        Signatures
</font></B>
</TD>

<TD>
<font size="3">
<CENTER><A HREF="#sign">29</A></CENTER>
</font>
</TD>
</TR>
</TABLE>

<font FACE="Times New Roman" SIZE="2">
<P>&nbsp;</P>
<B><P>PART I -- FINANCIAL INFORMATION </P></B>

<P>Item 1. Financial Statements


<br>
<br>
<br>
<HR WIDTH="85%">
<br>
<br>
<br>
<A NAME="bs"></A>
<B><P ALIGN="CENTER">
                            INTUITIVE SURGICAL, INC.
<br>
                          CONSOLIDATED BALANCE SHEETS
<br>
                       (IN THOUSANDS, EXCEPT SHARE DATA)
</B>
<PRE>

                                                            September 30,December 31,
                                                               2003          2002
                                                           ------------  -----------
                                                           (Unaudited)   (See Note 1)
                        ASSETS
Current assets:
  Cash and cash equivalents.............................. $     12,478  $    17,607
  Short-term investments.................................       22,971       33,232
  Trade receivables, net.................................       23,656       16,887
  Inventory, net.........................................       12,746        8,738
  Prepaid expenses.......................................        2,983        1,912
                                                           ------------  -----------
          Total current assets...........................       74,834       78,376
Property and equipment, net..............................       10,688       10,388
Intangible assets, net...................................        9,917        2,568
Goodwill.................................................      142,995           --
Other assets.............................................          330          249
                                                           ------------  -----------
          Total assets...................................      238,764       91,581
                                                           ============  ===========
         LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
  Accounts payable....................................... $     11,420  $     9,282
  Accrued compensation and employee benefits.............        5,248        4,666
  Warranty accrual.......................................        1,331        2,269
  Restructuring accrual..................................        1,332           --
  Other accrued liabilities..............................        2,629        3,497
  Deferred revenue.......................................        8,824        4,638
  Current portion of notes payable.......................        1,156        1,511
                                                           ------------  -----------
          Total current liabilities......................       31,940       25,863
Long-term notes payable..................................          950        1,838
Deferred revenue.........................................        1,227          200
Commitments and contingencies............................           --           --
Stockholders' equity:
  Preferred stock, 2,500,000 shares authorized, $0.001
     par value, issuable in series; no shares issued
     and outstanding as of September 30, 2003 and
     and December 31, 2002, respectively.................           --           --
  Common stock, 100,000,000 shares authorized, $0.001
     par value, 27,152,326 and 18,357,513 shares
     issued and outstanding as of September 30, 2003
     and December 31, 2002, respectively.................           27           18
  Additional paid-in capital.............................      337,738      191,038
  Deferred compensation..................................         (375)        (223)
  Accumulated deficit....................................     (133,559)    (128,791)
  Accumulated other comprehensive income ................          816        1,638
                                                           ------------  -----------
          Total stockholders' equity.....................      204,647       63,680
                                                           ------------  -----------
          Total liabilities and stockholders' equity..... $    238,764  $    91,581
                                                           ============  ===========

</PRE>
<p align="center">
          See accompanying notes to condensed consolidated financial statements.


<br>
<br>
<br>
<HR WIDTH="85%">
<br>
<br>
<br>
<A NAME="ops"></A>
<B><P ALIGN="CENTER">
                            INTUITIVE SURGICAL, INC.
<br>
                     CONSOLIDATED STATEMENTS OF OPERATIONS
<br>
                                  (UNAUDITED)
<br>
                    (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
</B>
<PRE>

                                                  Three Months Ended      Nine Months Ended
                                                     September 30,           September 30,
                                               ----------------------  ----------------------
                                                  2003        2002        2003        2002
                                               ---------- -----------  ---------- -----------
Sales:
  Products................................... $   20,651  $   15,723  $   57,317  $   47,424
  Services...................................      2,742       1,358       6,764       3,453
                                               ----------  ----------  ----------  ----------
Total sales..................................     23,393      17,081      64,081      50,877
Cost of sales:
  Products...................................      9,398       7,499      24,075      22,666
  Services...................................      1,009         841       2,976       2,406
                                               ----------  ----------  ----------  ----------
Total cost of sales..........................     10,407       8,340      27,051      25,072
                                               ----------  ----------  ----------  ----------
    Gross profit.............................     12,986       8,741      37,030      25,805
                                               ----------  ----------  ----------  ----------
Operating costs and expenses:
  Selling, general, and administrative.......     12,242      11,693      31,840      30,262
  Research and development...................      4,407       3,890      11,457      12,767
                                               ----------  ----------  ----------  ----------
    Total operating costs and
     expenses................................     16,649      15,583      43,297      43,029
                                               ----------  ----------  ----------  ----------
Loss from operations.........................     (3,663)     (6,842)     (6,267)    (17,224)
Other income, net ...........................        310         378       1,499       1,403
                                               ----------  ----------  ----------  ----------
Net loss..................................... $   (3,353) $   (6,464) $   (4,768) $  (15,821)
                                               ==========  ==========  ==========  ==========

Basic and diluted net loss per common share . $    (0.12) $    (0.35) $    (0.22) $    (0.87)
                                               ==========  ==========  ==========  ==========
Shares used in computing basic and diluted
  net loss per common share..................     26,878      18,250      21,296      18,199
                                               ==========  ==========  ==========  ==========

</PRE>

<p align="center">
          See accompanying notes to condensed consolidated financial statements.


<br>
<br>
<br>
<HR WIDTH="85%">
<br>
<br>
<br>
<A NAME="flows"></A>
<B><P ALIGN="CENTER">
                            INTUITIVE SURGICAL, INC.
<br>
                     CONSOLIDATED STATEMENTS OF CASH FLOWS
<br>
                                  (UNAUDITED)
<br>
                                 (IN THOUSANDS)
</B>
<PRE>

                                                            For the Nine Months
                                                             Ended September 30,
                                                         ------------------------
                                                            2003         2002
                                                         -----------  -----------
OPERATING ACTIVITIES:
Net loss............................................... $    (4,768) $   (15,821)
Adjustments to reconcile net loss to net cash used in
  operating activities:
  Depreciation.........................................       3,021        2,247
  Loss on sales of fixed assets........................           5           64
  Amortization of deferred compensation and stock
    compensation.......................................         379          543
  Amortization/Impairment of intangible assets.........       1,350          584
Changes in operating assets and liabilities:
  Trade receivable.....................................      (2,294)      (5,796)
  Prepaid expenses.....................................        (823)       1,106
  Inventory............................................         664       (3,689)
  Other assets.........................................          11           --
  Accounts payable.....................................      (5,754)         799
  Accrued compensation and employee benefits...........      (1,477)       1,520
  Warranty accrual.....................................      (1,238)         648
  Restructuring accrual................................      (2,112)          --
  Other accrued liabilities............................        (868)       1,530
  Accrued royalty expense..............................          --       (1,000)
  Deferred revenue.....................................       2,987          645
                                                         -----------  -----------
Net cash used in operating activities..................     (10,917)     (16,620)
                                                         -----------  -----------
INVESTING ACTIVITIES:
Acquisition of property and equipment..................      (1,914)      (5,228)
Disposition of property and equipment..................         192           62
Acquisition of business, net of cash acquired..........      (5,861)          --
Purchase of short-term investments.....................      (5,966)     (11,527)
Proceeds from sales of short-term investments..........      10,674       21,216
Proceeds from maturities of short-term investments.....       4,899       17,167
                                                         -----------  -----------
Net cash provided by investing activities..............       2,024       21,690
                                                         -----------  -----------
FINANCING ACTIVITIES:
Proceeds from issuance of common stock.................       5,181        1,948
Repurchase of common stock.............................          (6)          (1)
Proceeds from notes payable............................          --        2,338
Repayment of notes payable.............................      (1,243)      (1,562)
                                                         -----------  -----------
Net cash provided by financing activities..............       3,932        2,723
                                                         -----------  -----------
Foreign currency translation adjustments...............        (168)          60
                                                         -----------  -----------
Net increase (decrease) in cash and cash equivalents...      (5,129)       7,853
Cash and cash equivalents, beginning of period.........      17,607       10,487
                                                         -----------  -----------
Cash and cash equivalents, end of period............... $    12,478  $    18,340
                                                         ===========  ===========

Non-cash investing activity:
  Common stock issued in connection with acquisition of
    business........................................... $   141,437  $        --

</PRE>
<p align="center">
          See accompanying notes to condensed consolidated financial statements.



<B><P ALIGN="CENTER"><A NAME="notes"></A>INTUITIVE SURGICAL, INC. <BR>
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS <BR>
(UNAUDITED) </P>
</B><P>In this report, &quot;Intuitive Surgical, &quot; &quot;Intuitive,&quot;
and the &quot;Company&quot; refer to Intuitive Surgical, Inc.</P>
<B><P>NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES</P>
<I><P>Basis of Presentation</P>
</B></I><P ALIGN="JUSTIFY">The accompanying unaudited condensed consolidated
financial statements have been prepared in accordance with generally accepted
accounting principles for interim financial information and with the
instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do
not include all of the information and notes required by accounting principles
generally accepted in the United States for complete financial statements. In
the opinion of management, all normal, recurring adjustments considered
necessary for a fair presentation have been included. The consolidated balances
at December 31, 2002 were derived from the audited financial statements included
in  Intuitive Surgical, Inc.'s Annual Report on Form 10-K/A for the year ended
December 31, 2002, or the Annual Report. The financial statements should be read
in conjunction with the audited financial statements for the year ended December
31, 2002, included in the Annual Report. The results for the interim period
ended September 30, 2003 are not necessarily indicative of the results to be
expected for the full year ending December 31, 2003 or future operating periods.
Certain reclassifications have been made to prior year balances in order to
conform to the current year presentation.</P>
<P ALIGN="JUSTIFY">On June 30, 2003, Intuitive Surgical acquired Computer
Motion, Inc. through the merger of Computer Motion with a wholly owned
subsidiary of Intuitive Surgical.  In the merger, each outstanding share of
Computer Motion common stock was converted into 0.51426943 shares of Intuitive
Surgical common stock and Intuitive Surgical assumed all of Computer Motion's
outstanding options and warrants based on the same ratio. See "Note 3:
Acquisition of Computer Motion, Inc."</P>
<P ALIGN="JUSTIFY">In accordance with Statement of Financial Accounting
Standards ("SFAS") No. 141, "Business Combinations," Intuitive Surgical, Inc.
has included in its results of operations the results of Computer Motion, Inc.
from its date of acquisition, June 30, 2003.</P>
<B><I><P ALIGN="JUSTIFY">Revenue Recognition</P>
</B></I><P ALIGN="JUSTIFY">The Company recognizes revenue when persuasive
evidence of an arrangement exists, delivery has occurred or service has been
rendered, the price is fixed or determinable and collectibility is reasonably
assured. </P>
<P ALIGN="JUSTIFY">In certain cases, revenue from direct system sales is
generated from multiple-element arrangements that require judgment in the areas
of customer acceptance, collectibility, the separability of units of accounting,
and the fair value of individual elements.  Effective July 1, 2003, the Company
adopted the provisions of Emerging Issues Task Force, or EITF, Issue No. 00-21,
&quot;Revenue Arrangements with Multiple Deliverables&quot; on a prospective
basis.  The principles and guidance outlined in EITF 00-21 provide a framework
to (a) determine whether an arrangement involving multiple deliverables contains
more than one unit of accounting, and (b) determine how the arrangement
consideration should be measured and allocated to the separate units of
accounting in the arrangement. The Company determined that its multiple-element
arrangements are generally comprised of the following elements that would
qualify as separate units of accounting: system sales, service, installation,
and training.  Each of these elements represent individual units of accounting
as the delivered item has value to a customer on a stand-alone basis, objective
and reliable evidence of fair value exists for undelivered items, and
arrangements generally do not contain a general right of return relative to the
delivered item.  The Company determines fair value based on the price of the
deliverable when it is sold separately or based on third-party evidence.  In
accordance with the guidance in EITF 00-21, the Company uses the residual method
to allocate the arrangement consideration when it does not have fair value of
the system sale.  Under the residual method, the amount of consideration
allocated to the delivered item equals the total arrangement consideration less
the aggregate fair value of the undelivered items.  Assuming all other criteria
for revenue recognition have been met, the Company recognizes revenue for system
sales when delivery and acceptance occurs, for installation and training when
the services are rendered, and for service ratably over the service period,
which is generally one year.</P>
<P ALIGN="JUSTIFY">Upon adoption of the provisions of EITF 00-21, the Company
deferred approximately $1.7 million of revenue related to the fair value of the
first year service for system sales delivered during the third quarter of 2003.
This amount will be recognized as service revenue on a straight-line basis over
the related service period, which is generally one year.  Previously, in
accordance with Staff Accounting Bulletin No. 101, "Revenue Recognition in
Financial Statements," the Company accrued costs associated with these
arrangements as warranty expense in the period the system was delivered and
accepted. </P>
<P ALIGN="JUSTIFY">The Company's distributors do not have price protection
rights. One of the Company's distributors has return rights under limited
circumstances. Such rights are accounted for under the provisions of SFAS No.
48, "Revenue Recognition When Right of Return Exists." </P>
<P ALIGN="JUSTIFY">Revenue from sales of instruments and accessories is
recognized upon delivery. Revenue related to future commitments under separately
priced service contracts is deferred and recognized ratably over the service
period. All costs associated with the provision of service and maintenance,
including salaries, benefits, travel, spare parts and equipment, are recognized
in cost of sales as incurred. </P>
<P ALIGN="JUSTIFY">Amounts billed in excess of revenue recognized are included
as deferred revenue in the condensed consolidated balance sheets.</P>
<P ALIGN="JUSTIFY">The Company's <I>da Vinci </I>Surgical System, <I>Hermes</I>
Control Center and <I>AESOP</I> Endoscope Positioner contain a software
component. The Company believes that this software element is an incidental part
of each system. The software element within the Company's products is not sold
or marketed separately to customers, and the software does not operate
independently of each system. Furthermore, the software development effort does
not require a significant cost to the Company relative to the overall
development cost of the product. As such, the software the Company provides is
incidental to each system as a whole and the software revenue guidance provided
in SOP 97-2 is not applicable to the Company's revenues.</P>
<B><I><P>Stock-Based Compensation</P>
</B></I><P ALIGN="JUSTIFY">The Company applies Accounting Principles Board, or
APB, Opinion No. 25, "Accounting for Stock Issued to Employees," and related
interpretations in accounting for its stock option plans. Accordingly, no
compensation expense has been recorded for stock option grants issued with an
exercise price equal to the market value of the underlying stock on the date
granted.  The Company has recorded stock-based compensation, primarily related
to deferred compensation arising from the Company's initial public offering in
2000 and its acquisition of Computer Motion in June 2003.  As required under
Statement of Financial Accounting Standards Board, or SFAS, No. 148, "Accounting
for Stock-Based Compensation - Transition and Disclosure," the Company has
provided the following pro forma net loss and pro forma net loss per share
disclosures for stock-based awards as if the fair value-based method defined in
SFAS 123, "Accounting for Stock-Based Compensation," had been applied (amounts
in thousands, except per share amounts):</P>


<PRE>

                                                 Three Months Ended   Nine Months Ended
                                                    September 30,       September 30,
                                                 ------------------  -------------------
                                                   2003      2002      2003       2002
                                                 --------  --------  ---------  --------
Net loss, as reported.......................... $ (3,353) $ (6,464) $  (4,768) $(15,821)
Add:  Total stock-based employee
  compensation expense included in reported
  net loss, net of $0 related tax effect.......       83       148        379       543
Deduct: Total stock-based employee
  compensation expense determined
  under fair value based method for
  all awards, net of $0 related tax effect.....   (2,123)   (1,875)    (6,107)   (5,370)
                                                 --------  --------  ---------  --------
Pro forma net loss............................. $ (5,393) $ (8,191) $ (10,496) $(20,648)
                                                 ========  ========  =========  ========

Loss per share:
  Basic and diluted - as reported.............. $  (0.12) $  (0.35) $   (0.22) $  (0.87)
  Basic and diluted - pro forma................ $  (0.20) $  (0.45) $   (0.49) $  (1.13)

</PRE>

<P>The fair value for each stock option award granted was estimated at the date
of grant using the Black-Scholes option-pricing model, assuming no expected
dividends and the following weighted average assumptions:</P>

<PRE>

                                      Three Months Ended     Nine Months Ended
                                         September 30,         September 30,
                                     -------------------   --------------------
                                        2003       2002       2003       2002
                                     ---------  --------   ---------  ---------
Stock Option Plans:
   Average risk free interest rate.     2.52 %    3.90 %      2.51 %     3.90 %
   Average expected life (years)...      4.0       4.0         4.0        4.0
   Volatility......................       80 %      80 %        80 %       80 %

Stock Purchase Plan:
   Average risk free interest rate.     1.21 %    1.71 %      1.48 %     1.71 %
   Average expected life (years)...      0.5       0.5         0.5        0.5
   Volatility......................       48 %      48 %        48 %       48 %


</PRE>

<B><I><P>
<P>Recent Accounting Pronouncements</P>
</B></I><P ALIGN="JUSTIFY">In June 2002, the FASB issued SFAS 146, "Accounting
for Costs Associated with Exit or Disposal Activities," which addresses
accounting for restructuring, discontinued operation, plant closing, or other
exit or disposal activity. SFAS 146 requires companies to recognize costs
associated with exit or disposal activities when they are incurred rather than
at the date of a commitment to an exit or disposal plan. The provisions of SFAS
146 are effective for exit or disposal activities that are initiated after
December 31, 2002. Since SFAS 146 does not involve an entity newly acquired in a
business combination, the restructuring accrual, recorded as a component of the
purchase price in connection with the acquisition of Computer Motion (Note 3),
was established based on the provisions of EITF Issue No. 95-3,
&quot;Recognition of Liabilities in Connection with a Purchase Business
Combination&quot; and, therefore, SFAS 146 has not had an impact on the
Company's results of operations or financial position during the nine months
ended September 30, 2003.</P>
<P ALIGN="JUSTIFY">In January 2003, the FASB issued Interpretation No. 46, or
FIN 46, "Consolidation of Variable Interest Entities." FIN 46 requires a
variable interest entity to be consolidated by a company if that company is
subject to a majority of the risk of loss from the variable interest entity's
activities or entitled to receive a majority of the entity's residual returns or
both. A variable interest entity is a corporation, partnership, trust, or any
other legal structures used for business purposes that either (a) does not have
equity investors with voting rights, or (b) has equity investors that do not
provide sufficient financial resources for the entity to support its activities.
A variable interest entity often holds financial assets, including loans or
receivables, real estate or other property. A variable interest entity may be
essentially passive or it may engage in research and development or other
activities on behalf of another company. The consolidation requirements of FIN
46 apply immediately to variable interest entities created after January 31,
2003. FIN 46 also requires consolidation of variable interest entities entered
into prior to January 31, 2003 in the first fiscal year or interim period
beginning after June 15, 2003.  However, the FASB issued a subsequent FASB Staff
position that delays this requirement until the end of the first interim or
annual period ending after December 15, 2003. Certain of the disclosure
requirements apply to all financial statements issued after January 31, 2003,
regardless of when the variable interest entity was established. The adoption of
FIN 46 has not had an impact on the Company's financial position or results of
operations during the nine months ended September 30, 2003. The Company is
currently evaluating the possible impact of the adoption of FIN 46 for potential
variable interest entities entered into prior to January 31, 2003.</P>
<P ALIGN="JUSTIFY">In October 2002, the Emerging Issues Task Force reached
consensus on issue 00-21, or EITF 00-21, "Revenue Arrangements with Multiple
Deliverables." The principles and application guidance of EITF 00-21 should be
used to determine (a) how the arrangement consideration should be measured, (b)
whether the arrangement should be divided into separate units of accounting, and
(c) how the arrangement consideration should be allocated among the separate
units of accounting. The guidance in this issue is effective for revenue
arrangements entered into in fiscal periods beginning after June 15, 2003.
Effective July 1, 2003, the Company prospectively adopted the provisions of EITF
00-21.</P>
<B><P>NOTE 2. CONCENTRATIONS OF RISK</P>
</B><P ALIGN="JUSTIFY">Financial instruments which subject the Company to
potential risk consist of its cash equivalents, short-term investments, accounts
receivable, and foreign exchange contracts. The counterparties to the agreements
relating to the Company's investment securities and foreign exchange contracts
consist of various major corporations and financial institutions of high credit
standing. The Company believes the financial risks associated with these
financial instruments are minimal. For the nine months ended September 30, 2003
and 2002, no customer accounted for more than 10% of total sales. The Company
extends reasonably short collection terms but does not require collateral. The
Company provides reserves for potential credit losses but has not experienced
significant losses to date. </P>
<P ALIGN="JUSTIFY">The Company's <I>da Vinci</I> Surgical System, <I>Hermes</I>
Control Center, <I>AESOP</I> Endoscope Positioner and related instruments,
accessories and service, accounted for all of the Company's product sales for
the three months and nine months ended September 30, 2003 and 2002. Purchases of
key parts and components used to manufacture the Company's products are from
limited supply sources. The inability of any of these suppliers to fulfill the
Company's supply requirements may negatively impact future operating
results.</P>
<P ALIGN="JUSTIFY">The Company operates in one segment, the development and
marketing of products designed for use in surgery. For the three months ended
September 30, 2003, U.S. and international sales accounted for 86% and 14%,
respectively, of total sales. For the three months ended September 30, 2002,
U.S. and international sales accounted for 90% and 10%, respectively, of total
sales.</P>
<B><P>NOTE 3.  ACQUISITION OF COMPUTER MOTION, INC.</P>
</B><P ALIGN="JUSTIFY">On June 30, 2003, the Company acquired all of the
outstanding shares of Computer Motion, Inc. through a merger of Computer Motion
with a wholly owned subsidiary of Intuitive Surgical.  In the merger, each
outstanding share of Computer Motion common stock has converted into 0.51426943
shares of Intuitive Surgical common stock and Intuitive Surgical assumed all of
Computer Motion's outstanding options and warrants to purchase Computer Motion
common stock based on the same ratio. The acquisition of Computer Motion is
intended to enhance the Company's combined competitive position in key
industries, while strengthening its work force.  It also eliminated ongoing
intellectual property litigation between the two companies. The acquisition is
intended to enable the Company to focus on strategic products and customers,
achieve significant cost synergies and economies of scale and improve results of
its combined application of robotics to minimally invasive surgery bringing
benefits to patients, surgeons and medical centers throughout the world.  The
exchange ratio in the acquisition was derived from estimates of future revenue
and earnings of the combined company, in addition to measuring the relative
ownership of the combined company implied by their contributions.  The purchase
price of this acquisition was $148.5 million resulting from the issuance to
former Computer Motion stockholders the right to receive approximately 8.0
million shares of Intuitive Surgical common stock on June 30, 2003, after giving
effect to the 1-for-2 stock reverse split effected on July 1, 2003, or the
Reverse Split, with a fair value of approximately $125.7 million, the assumption
of options and warrants to purchase approximately 1.4 million and 0.7 million
shares, respectively, of Intuitive Surgical common stock at weighted average
exercise prices of $13.68 and $20.52, after giving effect to the Reverse Split,
with an aggregate Black-Scholes fair value of approximately $15.7 million, the
funding of Computer Motion's second quarter operations through a working capital
loan in the amount of $5.3 million, and estimated direct transaction costs of
$1.8 million.  The fair value of the Company's common stock was derived using an
average market price per share of the Company's common stock of $15.64, after
giving effect to the 1-for-2 stock reverse split effected on July 1, 2003, which
was based on the closing prices for a range of trading days prior to and
including the date of the acquisition, June 30, 2003 (June 24, June 25, June 26,
June 27, and June 30). The measurement date for this transaction was the June
30, 2003 closing date, as the number of shares to be issued to Computer Motion
stockholders was not fixed until that date.</P>
<P ALIGN="JUSTIFY">In accordance with SFAS No. 141, the Company allocated the
purchase price of the acquisition to the tangible assets, liabilities and
intangible assets acquired, including in-process research and development, or
IPR&amp;D, based on their estimated fair values.  The excess purchase price over
those fair values is recorded as goodwill.  The fair value assigned to
intangible assets acquired is based on valuations prepared by an independent
third party appraisal firm using estimates and assumptions provided by
management.  The goodwill recorded as a result of the acquisition is not
expected to be deductible for tax purposes. In accordance with SFAS No. 142,
goodwill and purchased intangible assets with indefinite useful lives acquired
after June 30, 2001 are not amortized but will be reviewed at least annually for
impairment.  Purchased intangible assets with finite lives are amortized on a
straight-line basis over their respective useful lives.  (See Note 7.)</P>
<P ALIGN="JUSTIFY">The total purchase price was comprised of the following (in
thousands):</P>

<PRE>


Value of Intuitive Surgical common stock issued....  $ 125,734
Assumption of Computer Motion warrants and options.     15,703
                                                      ---------
Total value of Intuitive Surgical securities.......    141,437

Direct transaction costs...........................      1,774
Bridge loan facility...............................      5,302
                                                      ---------
Total estimated purchase price.....................  $ 148,513
                                                      =========

</PRE>

<P ALIGN="JUSTIFY">At September 30, 2003, the Company decreased its valuation of
the net property, plant, and equipment acquired by $0.4 million, with an
offsetting increase to goodwill, based on updated information relating to
assumptions made in the Company's purchase price allocation. The following
purchase price allocation is preliminary, as future business results may differ
from inherent estimates contained in the allocation, including employee severance
costs, obligations related to exiting lease commitments, and other underlying
assumptions.  The total purchase price has been allocated as follows (in thousands):</P>

<PRE>


Cash and cash equivalents............... $    1,214
Accounts receivable, net................      4,476
Inventories, net........................      4,672
Prepaid and other assets................        269
Property, plant, and equipment..........      1,605
Other assets............................         70
Amortizable intangible assets:.
  Customer relationships................      1,300
  Developed and core technology.........      6,800
  Trademark.............................        200
  Internal use software.................        300
  In-process research and development...        100
Goodwill................................    142,995
Accounts and notes payable..............     (7,892)
Restructuring accrual...................     (3,444)
Other accrued liabilities...............     (2,361)
Deferred revenue........................     (2,225)
Deferred compensation...................        434
                                           ---------
Total purchase price.................... $  148,513
                                           =========

</PRE>

<I><P ALIGN="JUSTIFY">Goodwill</P>
</I><P ALIGN="JUSTIFY">Of the total purchase price, $143.0 million was allocated
to goodwill.  Goodwill represents the excess of the purchase price over the fair
value of the underlying net tangible and intangible assets.  Goodwill is not
deductible for tax purposes.  In accordance with SFAS No. 142, &quot;Goodwill
and Other Intangible Assets,&quot; goodwill will not be amortized, but instead
will be tested for impairment at least annually (more frequently if certain
indicators are present).  In the event management determines that goodwill has
been impaired, the Company will incur an accounting charge for the impairment
during the fiscal quarter in which the determination is made.  (See Note 7.)</P>
<I><P ALIGN="JUSTIFY">Amortizable Intangible Assets</P>
</I><P ALIGN="JUSTIFY">Of the total purchase price, approximately $8.6 million
was allocated to amortizable intangible assets, comprised of developed
technology of $3.5 million, core technology of $3.3 million, customer
relationships of $1.3 million, and other intangible assets totaling $0.5
million. (See Note 7.)</P>
<P ALIGN="JUSTIFY">Developed technology, comprised of products that have reached
technological feasibility, includes most of Computer Motion's current products,
including Aesop, Zeus, Socrates, and Hermes.  Developed technology will be
amortized on a straight-line basis over a period of seven years, representing
the weighted average of the remaining product lives of the developed
technology.</P>
<P ALIGN="JUSTIFY">Core technology represents the value of patents, processes,
and trade secrets, including certain designs and product features that Intuitive
may integrate into future products.  Core technology will be amortized on a
straight-line basis over a period of seven years.</P>
<P ALIGN="JUSTIFY">Customer relationships represent the value of Computer
Motion's relationships with existing customers and is valued based upon the fair
value of future business with these customers.  Customer relationships and other
intangible assets will be amortized on a straight line basis over a period of
approximately seven years. </P>
<I><P ALIGN="JUSTIFY">In-process research and development</P>
</I><P ALIGN="JUSTIFY">Of the total purchase price, $0.1 million was allocated
to in-process research and development.  Projects which qualify as IPR&amp;D
represent those that have not yet reached technological feasibility and for
which no future alternative uses exist.  IPR&amp;D was immediately, fully
amortized into Intuitive Surgical's results for the three months ended June 30,
2003.</P>
<I><P ALIGN="JUSTIFY">Deferred Compensation</P>
</I><P ALIGN="JUSTIFY">Of the total purchase price, $0.4 million was allocated
to deferred compensation for unvested options assumed, which represents the
intrinsic value of unvested stock options for employees and fair value for
non-employees. Deferred compensation will be amortized into expense for
approximately three years using the graded vesting method.</P>
<I><P ALIGN="JUSTIFY">Restructuring charges</P>
</I><P ALIGN="JUSTIFY">Upon the consummation of the acquisition of Computer
Motion, Intuitive's management approved plans to restructure the operations of
the combined entity. The current restructuring plan provides for the elimination
of redundant activities and infrastructure and will result in eliminating
approximately 150 employees, or 75%, of the Computer Motion positions by
December 31, 2003 generally with immediate severance payment upon termination.
The plan includes vacating and subleasing 78% of the leased space in Goleta,
California, consolidating European operations into a single site, and closing
Computer Motion's Asia office, and transitioning to the Intuitive distribution
sales model for the area.  The Company will have a single sales and marketing
organization and consolidate all manufacturing and administrative functions in
Sunnyvale, California.  Based upon this plan, the Company recorded a $3.4
million accrual in accordance with EITF 95-3, &quot;Recognition of Liabilities
in Connection with a Purchase Business Combination.&quot;  In accordance with
EITF 95-3, the restructuring accrual has been recorded as a component of the
purchase price.  The accrual is comprised of $2.6 million for employee severance
costs, which are expected to be substantially paid out by the end of 2003, and
$0.8 million to exit existing lease commitments, based upon total future lease
commitments for facilities to be vacated of $2.6 million, offset by subleasing
proceeds of $1.8 million.  The Company has estimated vacancy periods of between
1 month and 3 years between exiting various sites and realizing subleasing
proceeds. </P>
<P ALIGN="JUSTIFY">The following table summarizes the restructuring activitiy
for the nine months ended September 30, 2003 (in thousands):</P>

<PRE>


                                             Employee      Lease
                                             Severance   Commitments  Total
                                             ---------   ---------   --------
Balance at December 31, 2002............... $      --  $       --  $      --
Costs incurred.............................     2,628         816      3,444
Cash payments, net of subleasing proceeds..    (2,018)        (86)    (2,104)
Currency impact............................        (8)         --         (8)
                                             ---------   ---------   --------
Balance at September 30, 2003.............. $     602  $      730  $   1,332
                                             =========   =========   ========

</PRE>

<I><P>Pro forma results of operations</P></I>
<P ALIGN="JUSTIFY">The following unaudited pro forma financial information for
the three and nine months ended September 30, 2003 and September 30, 2002 give
effect to the acquisition by Intuitive Surgical of Computer Motion as if it had
occurred on January 1, 2003 and January 1, 2002, respectively.  The pro forma
financial information excludes charges for acquired in-process research and
development.  The unaudited pro forma financial information is not intended to
represent or be indicative of the consolidated results of operations that
Intuitive would have reported had the acquisition been completed as of the dates
presented, and should not be taken as representative of the future consolidated
results or financial position of Intuitive Surgical.</P>

<PRE>

                                    Three Months Ended        Nine Months Ended
                                       September 30,            September 30,
                                  ---------------------     ---------------------
                                    2003        2002          2003        2002
                                  ---------   ---------     ---------   ---------
Sales........................... $  23,393   $  21,233     $  74,491   $  65,036
Net loss........................ $  (3,353)  $ (12,726)    $ (24,277)  $ (32,947)
Net loss per share.............. $   (0.12)  $   (0.48)    $   (0.83)  $   (1.26)



</PRE>


<B>
<P>NOTE 4. CASH AND CASH EQUIVALENTS</P>
</B><P ALIGN="JUSTIFY">Intuitive Surgical considers all highly liquid
investments with an original maturity from date of purchase of 90 days or less
to be cash equivalents for the purpose of balance sheet and statement of cash
flows presentation. The carrying value of cash and cash equivalents approximates
market value at September 30, 2003 and December 31, 2002.</P>

<B><P>NOTE 5. SHORT-TERM INVESTMENTS</P>
</B><P ALIGN="JUSTIFY">All short-term investments are classified as
available-for-sale, and therefore, are carried at fair market value. The Company views its
available-for-sale portfolio as available for use in its current operations.
Accordingly, all investments are classified as short-term, even though the
stated maturity date may be one year or more beyond the current balance sheet
date. Available-for-sale securities are stated at fair market value based upon
quoted market prices of the securities. Unrealized gains and losses on such
securities are reported as a separate component of stockholders' equity.
Realized gains and losses on available-for-sale securities, together with
amortization of premiums and discounts on debt securities, are included in
interest income. The cost of securities sold is based on the specific
identification method. Interest and dividends on securities classified as
available-for-sale are included in interest income.</P>

<B><P>NOTE 6. INVENTORY</P>
</B><P ALIGN="JUSTIFY">Inventory consists of the following (in thousands): </P>

<PRE>

                               September 30,  December 31,
                                   2003          2002
                               ------------  ------------
Raw materials................ $      3,285  $      3,420
Work-in-process..............        2,610           780
Finished goods...............        6,851         4,538
                               ------------  ------------
                              $     12,746  $      8,738
                               ============  ============

</PRE>


<B><P>NOTE 7. GOODWILL AND INTANGIBLE ASSETS</P>
</B><P ALIGN="JUSTIFY">Goodwill represents the excess of the purchase price over
the fair value of the underlying net tangible and intangible assets.  In
accordance with SFAS No. 142, &quot;Goodwill and Other Intangible Assets,&quot;
goodwill and intangible assets with indefinite useful lives can no longer be
amortized; however, they will be tested for impairment at least annually in the
fourth quarter of each fiscal year (more frequently if certain indicators are
present).  Intangible assets with finite useful lives will continue to be
amortized over their respective useful lives.  In the event management
determines that goodwill has been impaired, the Company will incur an accounting
charge for the impairment during the fiscal quarter in which the determination
is made.  Of the total purchase price related to the acquisition of Computer
Motion, $143.0 million was allocated to goodwill and $8.6 million was allocated
to amortizable intangible assets, comprised of developed technology of $3.5
million, core technology of $3.3 million, customer relationships of $1.3
million, and other intangible assets totaling $0.5 million. </P>
<P ALIGN="JUSTIFY">Other purchased intangible assets represent patents which are
carried at cost less accumulated amortization. Amortization is computed using
the straight-line method over the expected useful life of six or seven years.
</P>
<P ALIGN="JUSTIFY">For the three months ended September 30, 2003, in accordance
with SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets," the Company impaired $0.1 million of developed technology intangible assets
related to a product the Company no longer intends to produce and $0.1 million of
other intangible assets related to internal software that has no future use.</P>
<P ALIGN="JUSTIFY">At December 31, 2002, net intangible assets was $2.6 million
comprised of patents with a gross value of $4.7 million and accumulated
amortization of $2.1 million.</P>
<P ALIGN="JUSTIFY">At September 30, 2003, net intangible assets is comprised of
the following (in thousands):</P>

<PRE>


                                           Accumulated
                                 Gross     Amortization  Impairment     Net
                               ---------   -----------   ---------   ---------
Developed Technology........  $   3,500   $      (129)  $     (93)  $   3,278
Core Technology.............      3,300          (118)         --       3,182
Customer Relationships......      1,300          (167)         --       1,133
Patents.....................      4,710        (2,735)         --       1,975
Other intangible assets.....        500           (27)       (124)        349
                               ---------   -----------   ---------   ---------
Total intangible assets, net  $  13,310   $    (3,176)  $    (217)  $   9,917
                               =========   ===========   =========   =========

</PRE>

<P>Amortization expense related to intangible assets was $0.6 million and $1.1 million
for the three and nine months ended September 30, 2003 and $0.2 million and $0.6 million
for the three and nine months ended September 30, 2002.</P>

<P ALIGN="JUSTIFY">Estimated future amortization expense related to intangible
assets at September 30, 2003 is as follows (in thousands):</P>

<PRE>



Fiscal Year
2003 (remaining 3 months)...  $      526
2004........................       2,105
2005........................       2,105
2006........................       1,479
2007........................       1,248
Thereafter..................       2,454
                                ---------
Total.......................  $    9,917
                                =========

</PRE>

<B><P>NOTE 8. COMPREHENSIVE LOSS</P>
</B><P ALIGN="JUSTIFY"> The components of comprehensive loss consist of the
following (in thousands):</P>

<PRE>

                                           Three Months Ended    Nine Months Ended
                                              September 30,         September 30,
                                        --------------------  --------------------
                                           2003       2002       2003       2002
                                        ---------  ---------  ---------  ---------
Net loss.............................. $  (3,353) $  (6,464) $  (4,768) $ (15,821)
Other comprehensive loss:
  Foreign currency translation
    adjustments.......................       (13)       109       (168)        60
  Change in unrealized gain (loss)
    on available-for-sale securities..      (198)       689       (654)       847
                                        ---------  ---------  ---------  ---------
Comprehensive loss.................... $  (3,564) $  (5,666) $  (5,590) $ (14,914)
                                        =========  =========  =========  =========

</PRE>
<P ALIGN="JUSTIFY">The components of accumulated other comprehensive income were
as follows (in thousands):</P>

<PRE>

                                          September 30, December 31,
                                              2003         2002
                                          ------------  -----------
Accumulated net unrealized gain on
  available-for-sales securities........ $        969  $     1,623
Foreign currency translation
  adjustments...........................         (153)          15

Total accumulated other comprehensive     ------------  -----------
  income................................ $        816  $     1,638
                                          ============  ===========

</PRE>


<B><P>NOTE 9. NET LOSS PER SHARE</P>
</B><P ALIGN="JUSTIFY">The following table presents the computation of basic and
diluted net loss per share (in thousands, except per share data):</P>

<PRE>

                                        Three Months Ended         Nine Months Ended
                                           September 30,              September 30,
                                     -------------------------  -------------------------
                                        2003         2002          2003         2002
                                     -----------  ------------  -----------  ------------
Numerator used for basic and
  diluted net loss per common
  share............................ $    (3,353) $     (6,464) $    (4,768) $    (15,821)
                                     ===========  ============  ===========  ============
Denominator used for basic and
  diluted net loss per common share:
  Weighted-average shares
    outstanding....................      26,881        18,260       21,301        18,213
  Less weighted-average
    shares subject to
    repurchase.....................          (3)          (10)          (5)          (14)
                                     -----------  ------------  -----------  ------------
  Weighted-average shares used in
    computing basic and diluted net
    loss per common share..........      26,878        18,250       21,296        18,199
                                     ===========  ============  ===========  ============
Basic and diluted net loss per
  common share..................... $     (0.12) $      (0.35) $     (0.22) $      (0.87)
                                     ===========  ============  ===========  ============

</PRE>


<P>Potential common shares excluded from the computation of diluted net loss per
share as their effect would be antidilutive were 4,977,000 and 3,803,000 shares
respectively for the three and nine months ended September 30, 2003, and
2,556,000 and 2,440,000 shares, respectively, for the three and nine months
ended September 30, 2002.</P>
<B><P>NOTE 10. PRODUCT WARRANTY PROVISIONS</P>
</B><P ALIGN="JUSTIFY">The Company's standard policy is to warrant all shipped
systems against defects in design, materials and workmanship by replacing failed
parts during the first year of ownership. The Company's estimate of costs to
service the warranty obligations is based on historical experience and current
product performance trends. Prior to July 1, 2003, these costs were included in
cost of goods sold at the time revenue is recognized. The warranty provision was
reduced by material and labor costs used for replacement activities over the
warranty period. Effective July 1, 2003, the Company adopted the provisions of
EITF 00-21, &quot;Accounting for Revenue Arrangements with Multiple
Deliverables&quot; on a prospective basis.  Under EITF 00-21, for certain
arrangements, a portion of the overall system price attributable to the first
year service is deferred and recognized as revenue over the service period.  As
such, the Company no longer accrues warranty costs upon delivery but rather
recognizes warranty and related service costs as incurred.  The warranty
provision resulting from transactions prior to July 1, 2003 will be reduced in
future periods for material and labor costs incurred as related product is
returned during the warranty period or when the warranty period elapses.   A
review of warrany obligations is performed regularly to determine the adequacy
of the reserve. Based on the outcome of this review, revisions to the estimated
warranty liability are recorded as appropriate.</P>
<P ALIGN="JUSTIFY">The following table reconciles the changes to the product
warranty liability for the period indicated (in thousands):</P>

<PRE>


                                          Balance at                         Warranty   Balance at
                                          Beginning   Warranty   Warranties Assumed in   End of
                                          of Period     Usage    Expensed   Acquisition  Period
                                         -----------  ---------  ---------  ----------  ---------
Three months ended September 30, 2003.  $     2,005  $    (674) $      --  $       --  $   1,331
Nine months ended September 30, 2003..  $     2,269  $  (1,450) $     212  $      300  $   1,331


</PRE>

<P ALIGN="JUSTIFY">The Company from time to time enters into agreements to
indemnify its customers against liability and damages arising from patent claims
against the Company's product. The term of these agreements vary, but generally,
a maximum obligation is not explicitly stated within the agreements.
Historically, the Company has not been obligated to make any significant
payments related to its customer indeminification clauses and no liabilities
have been recorded for this obligation on its balance sheets as of September 30,
2003 and December 31, 2002.</P>
<B><P>NOTE 11.  REVERSE STOCK SPLIT</P>
</B><P ALIGN="JUSTIFY">Intuitive Surgical's stockholders approved a one-for-two
reverse stock split, or the Reverse Split, on June 30, 2003 and the Reverse
Split was effected on July 1, 2003. The par value of Intuitive's common stock
after the Reverse Split remained at $0.001 per share.  The rights of the holders
of these securities were not otherwise modified.  All shares outstanding and
earnings per share information for all periods presented in these financial
statements give effect to the Reverse Split.  All shares, per share and market
price data related to Intuitive's common shares outstanding and under employee
stock plans reflect the retroactive effects of the Reverse Split.</P>
<B><P ALIGN="JUSTIFY">NOTE 12. CONTINGENCIES</P>
</B><P ALIGN="JUSTIFY">In September 2000, Brookhill-Wilk 1, LLC, or Wilk, filed
a lawsuit against Intuitive Surgical in the United States District Court for the
Southern District of New York (Case No. 00 Civ. 6599 (NRB)) alleging that by
making, using, selling or offering for sale our <I>da Vinci</I> Surgical System,
the Company is infringing United States Patent Nos. 5,217,003 and 5,368,015 in
willful disregard of Wilk's patent rights. These patents concern methods and
devices for "remote" surgery. In March 2001, Wilk withdrew its assertion of the
'015 patent against the Company. On November 8, 2001, in response to a motion on
one of Intuitive Surgical's noninfringement defenses, the District Court granted
summary judgment of noninfringement of the '003 patent in the Company's favor
and dismissed Wilk's complaint in its entirety without prejudice. Wilk appealed
the summary judgment ruling to the U.S. Court of Appeals for the Federal
Circuit. In April 2003, the Court of Appeals reversed the District Court's
judgment and remanded the case for further proceedings. This reversal is based
on the Court of Appeals' determination that the particular claim limitation at
issue should be interpreted differently than as construed by the District Court.
</P>
<P ALIGN="JUSTIFY">Upon remand, Intuitive Surgical intends to continue to
vigorously defend its rights and, if necessary, is prepared to conduct discovery
and file further motions on whether the patent is infringed, valid and/or
enforceable. Intuitive Surgical believes that it has multiple meritorious
defenses to Wilk's allegations. However, litigation is unpredictable and
Intuitive Surgical may not prevail. Both parties have expressed a desire to
engage in non-binding mediation before engaging in further proceedings in the
District Court.  The District Court has not yet set a schedule for further
proceedings if mediation is unsuccessful.</P>
<P ALIGN="JUSTIFY">In July 2003, Wilk filed a new lawsuit against three of
Intuitive Surgical's customers: Mt. Sinai Hospital, Lenox Hill Hospital and the
New York and Presbyterian Hospital.  Pursuant to agreements with those
customers, the Company is defending the lawsuit on behalf of its customers.  The
Company does not expect this lawsuit to significantly impact the scope of the
existing litigation with Wilk since any resolution of the existing Wilk
litigation, whether on the merits or by settlement, will likely resolve this new
lawsuit at the same time.</P>
<P ALIGN="JUSTIFY">In September 2003, Wilk amended its complaint against
Intuitive Surgical to include Computer Motion within the lawsuit and to allege
that Computer Motion's Zeus product also infringes Wilk's '003 patent.  Prior to
the Company's acquisition of Computer Motion, Wilk sued Computer Motion but
dismissed that lawsuit voluntarily in order to await the outcome of the appeal
proceedings in Wilk's litigation with Intuitive Surgical.  Intuitive Surgical
believes that it has multiple meritorious defenses to Wilk's allegations against
Computer Motion, including many of the same defenses that apply to Wilk's
allegations against Intuitive Surgical.  However, litigation is unpredictable
and Intuitive Surgical may not prevail. Wilk's allegations against Computer
Motion are directed only to Computer Motion products.</P>
<P ALIGN="JUSTIFY">If the Company loses Wilk's suit against us and the three
hospital customers, it will hurt our competitive position, may be costly and may
prevent the Company from selling its products. If the Company loses the patent
suit, it may need to obtain from Wilk a license to this technology to continue
to market its products that have been found to infringe Wilk's patents. This
license could be expensive, which could seriously harm the Company's business.
If Wilk is successful in its suit against the Company and is unwilling to grant
a license, the Company may be required to stop selling its products that are
found to infringe Wilk's patents unless the Company can redesign them so they do
not infringe Wilk's patents, which it may be unable to do. In addition, the
Company could be required to pay Wilk damages, including treble damages, which
could be substantial and harm its financial position. Due to the inherent
uncertainties of litigation, however, the Company cannot accurately predict the
ultimate outcome of the Wilk litigation at this time and, therefore, cannot
estimate the range of possible loss.</P>
<P ALIGN="JUSTIFY">During the second quarter of 2003, two former patients of The
Valley Hospital in New Jersey filed suit against The Valley Hospital, their
surgeons and Intuitive Surgical, Inc. alleging various harms caused during their
surgeries.  Intuitive was named because the <I>da Vinci</I> Surgical System was
utilized for a portion of the surgeries and the detachable tip of an
<I>EndoWrist</I> instrument is alleged to have remained in each patient after
each surgery.  Each suit alleges, among other things, negligence, carelessness
and/or recklessness by each defendant, that the <I>da Vinci</I> Surgical System
was defectively designed and manufactured, that Intuitive failed to properly
instruct and train the surgeons in its use, and that the defendants failed to
properly apprise the patients of the risks involved.  Each suit seeks an
unspecified amount of general, special and punitive damages from the defendants,
in addition to a request to recover the costs of suit and attorney fees.  As
each suit was just recently filed, both are in very early stages and discovery
has recently commenced.  Due to the inherent uncertainties of the litigation,
and the early stage of this case, the Company cannot accurately predict the
outcome of this litigation at this time and therefore, cannot estimate the range
of possible loss.</P>
<P ALIGN="JUSTIFY">The foregoing proceedings could be expensive to litigate, may
be protracted and the Company's confidential information may be compromised.
Whether or not the Company is successful in these lawsuits, these proceedings
could consume substantial amounts of its financial and managerial resources. At
any time, the other parties may file additional claims against the Company, or
the Company may file claims against them, which could increase the risk, expense
and duration of the litigations. For more information on the Company's
litigation with Wilk, see "Part II-Item 1: Legal Proceedings."</P>
<B><P ALIGN="JUSTIFY">NOTE 13. SUBSEQUENT EVENT</P>
</B><P ALIGN="JUSTIFY">On October 31, 2003, the Company sold 5,000,000 shares of
newly issued common stock in an underwritten public offering at a price of
$14.50 per share. The Company received net proceeds of approximately $67.7
million, after deducting the underwriting discount and offering expenses. The
Company intends to use the net proceeds for general corporate purposes.  The
underwriters also have the option to purchase up to 750,000 additional shares at
a price of $14.50 per share to cover over-allotments.</P>


<B><P><A NAME="mda"></A>ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS</P>
</B><P ALIGN="JUSTIFY">In this report, "Intuitive Surgical," "Intuitive," the
"Company, " "we," "us," and "our" refer to Intuitive Surgical, Inc.</P>
<P ALIGN="JUSTIFY">This Management's Discussion and Analysis of Financial
Condition as of September 30, 2003 and Results of Operations for the three month
and nine month periods ended September 30, 2003 and September 30, 2002 should be
read in conjunction with the Management's Discussion and Analysis of Financial
Condition and Results of Operations included in our Annual Report on Form 10-K/A
for the year ended December 31, 2002. </P>
<P ALIGN="JUSTIFY">Except for historical information, the discussion in this
report contains forward-looking statements that involve risks and uncertainties,
such as statements of our plans, objectives, expectations, and intentions. The
cautionary statements made in this report should be read as applying to all
related forward-looking statements wherever they appear in this report. Our
actual results could differ materially from those discussed here. Factors that
could cause or contribute to these differences include those discussed in
"Factors Affecting Operating Results" below as well as those discussed
elsewhere. </P>
<P ALIGN="JUSTIFY">Intuitive&reg;, da Vinci&reg;, InSite&reg;, EndoWrist&reg;,
Zeus&reg;, Hermes&reg;, and Aesop&reg; are registered trademarks of Intuitive
Surgical, Inc.</P>
<B><I><P>OVERVIEW</P>
</B></I><P ALIGN="JUSTIFY">We design, manufacture and market the <I>da Vinci</I>
Surgical System, an advanced surgical system that we believe represents a new
generation of surgery-the third generation. The <I>da Vinci</I> Surgical System
consists of a surgeon's console, a patient-side cart, a high performance vision
system and proprietary "wristed" instruments. The <I>da Vinci</I> Surgical
System seamlessly translates the surgeon's natural hand movements on instrument
controls at a console into corresponding micro-movements of instruments
positioned inside the patient through small puncture incisions, or ports. We
believe that the <I>da Vinci</I> Surgical System is the only commercially
available technology that can provide the surgeon with the intuitive control,
range of motion, fine tissue manipulation capability and 3-D visualization
characteristic of open surgery, while simultaneously allowing the surgeons to
work through the small ports of minimally invasive surgery, or MIS. By placing
computer-enhanced technology between the surgeon and the patient, we believe
that the <I>da Vinci</I> Surgical System enables surgeons to perform better
surgery in a manner never before experienced. </P>
<P ALIGN="JUSTIFY">In 1999, we obtained permission from the European Union to
affix the CE Mark to the<I> da Vinci</I> Surgical System and <I>EndoWrist</I>
instruments for general surgical and cardiac surgical use. Based on this
approval, we recognized revenue for the first time in the second quarter of 1999
for the sale of our products. In July 2000, we received clearance from the U.S.
Food and Drug Administration, or FDA, to begin commercialization of our <I>da
Vinci</I> Surgical System in the United States for use in laparoscopic surgical
procedures. In March 2001, we received clearance from the FDA for use of our
<I>da Vinci</I> Surgical System in non-cardiac thoracoscopic surgical
procedures. In May 2001, we received market clearance from the FDA to promote
use of the<I> da Vinci</I> Surgical System for performance of laparoscopic
radical prostatectomy procedures. In November 2002, we received clearance from
the FDA for use of the <I>da Vinci</I> Surgical System in thoracoscopically-assisted
cardiotomy procedures. In January 2003, we began promoting atrial
septal defect closure surgery under the November 2002 cardiotomy clearance.</P>
<P ALIGN="JUSTIFY">To date, the majority of our revenues have come from the
sales of the <I>da Vinci</I> Surgical System, which are high revenue dollar
items. A smaller, but increasing, percentage of revenues come from sales of
<I>EndoWrist</I> instruments and accessories and ongoing service of installed
<I>da Vinci</I> Surgical Systems. During the useful life of each installed <I>da
Vinci</I> Surgical Systems, we expect to generate recurring revenue through
sales of the <I>EndoWrist</I> instruments and accessories and ongoing service.
Although we expect the majority of our revenues to continue to come from the
sale of <I>da Vinci</I> Surgical Systems over the next few years, we believe
that the percentage of revenue from our <I>EndoWrist </I>instruments and
accessories and service will continue to increase. The percentage of revenue
derived from recurring instrument, accessory, and service revenue has grown from
23% for the quarter ended September 30, 2002 to 33% for the quarter ended
September 30, 2003. </P>
<P ALIGN="JUSTIFY">Due to the high dollar revenue per system sold, small
variations in system unit sales may cause revenue to vary significantly from
quarter to quarter.</P>
<B><I><P ALIGN="JUSTIFY">ACQUISITION OF COMPUTER MOTION</P>
</B></I><P ALIGN="JUSTIFY">In June 2003, we acquired Computer Motion, Inc. in a
stock transaction pursuant to which a wholly owned subsidiary of our company
merged with and into Computer Motion.  In connection with the merger, each
outstanding share of Computer Motion common stock was converted into the right
to receive 0.51426943 of one share of our common stock prior to giving effect to
our 1-for-2 reverse stock split effective July 1, 2003. In addition, we assumed
all of Computer Motion outstanding options and warrants.  The total purchase
price was approximately $148.5 million.  In connection with our acquisition of
Computer Motion, all pending patent litigation between the companies was
dismissed and Robert Duggan, the Chief Executive Officer and Chairman of the
Board of Directors of Computer Motion, and Eric Halvorson, a director of
Computer Motion, were appointed to our board of directors.</P>
<P ALIGN="JUSTIFY">Upon the consummation of the acquisition of Computer Motion,
our management approved plans to restructure the operations of the combined
entity.  The current restructuring plan provides for the elimination of
redundant activities and infrastructure and will result in eliminating
approximately 150 employees, or 75%, of the Computer Motion positions by
December 31, 2003 generally with immediate severance payment upon termination.
The plan includes vacating and subleasing 78% of the leased space in Goleta,
California, consolidating European operations into a single site, and closing
Computer Motion's Asia office, and transitioning to our distribution sales model
for the area. We will have a single sales and marketing organization and
consolidate all manufacturing and administrative functions in Sunnyvale,
California.<I> </I>We expect to achieve annual pre-tax cost savings of at least
$18 million to be phased in beginning in the third quarter of 2003.  Based upon
this plan, we have recorded a $3.4 million accrual in accordance with EITF 95-3,
&quot;Recognition of Liabilities in Connection with a Purchase Business
Combination.&quot;  In accordance with EITF 95-3, the restructuring accrual has
been recorded as a component of the purchase price.  The accrual is comprised of
$2.6 million for employee severance costs, which are expected to be
substantially paid out by the end of 2003, and $0.8 million to exit existing
lease commitments, based upon total future lease commitments for facilities to
be vacated of $2.6 million, offset by subleasing proceeds of $1.8 million.  We
have estimated vacancy periods of between 1 month and 3 years between exiting
various sites and realizing subleasing proceeds.<I> </I>  </P>
<P ALIGN="JUSTIFY">As of  September 30, 2003, we have made significant progress
toward the implementation of our restructuring plan.  We have consolidated the
sales and marketing resources of the two companies into a single organization
and all manufacturing and administrative functions into our Sunnyvale,
California headquarters.  In addition, we are currently positioned to
substantially realize annual pre-tax cost savings of at least $18 million.</P>
<P ALIGN="JUSTIFY">The following table summarizes the restructuring activity for
the nine months ended September 30, 2003 (in thousands):</P>


<PRE>


                                             Employee      Lease
                                             Severance   Commitments  Total
                                             ---------   ---------   --------
Balance at December 31, 2002............... $      --  $       --  $      --
Costs incurred.............................     2,628         816      3,444
Cash payments, net of subleasing proceeds..    (2,018)        (86)    (2,104)
Currency impact............................        (8)         --         (8)
                                             ---------   ---------   --------
Balance at September 30, 2003.............. $     602  $      730  $   1,332
                                             =========   =========   ========

</PRE>

<B><I><P>RESULTS OF OPERATIONS</P>
</B><P ALIGN="JUSTIFY">Sales</I>. Total sales for the three months ended
September 30, 2003 were $23.4 million, up 37% from $17.1 million for the three
months ended September 30, 2002. The increase in third quarter 2003 sales was
driven by continued recurring revenue growth, consisting of instruments,
accessories and service.  Third quarter 2003 recurring revenue totaled $7.7
million, up $3.8 million over the prior year and up $1.4 million sequentially
over the second quarter of this year.  Higher recurring revenue was driven by
growth in the installed base of <I>da Vinci</I> Surgical Systems and the number
of surgical procedures performed with the system. </P>
<P ALIGN="JUSTIFY">We shipped 15 <I>da Vinci</I> Surgical Systems during the
third quarter of 2003, compared to 14 in the third quarter of 2002. During the
third quarter of 2003, we shipped 16 fourth surgical arms, after having shipped
9 fourth arms during the second quarter of 2003.  Overall, third quarter 2003
system revenue increased to $15.7 million from $13.2 million during the third
quarter of last year.  As of September 30, 2003, there were 192 cumulative <I>da
Vinci</I> Surgical Systems shipped, compared to 132 as of September 30, 2002.
</P>
<P ALIGN="JUSTIFY">Total third quarter 2003 product sales and service revenue
from Computer Motion products, consisting of Aesop&reg;, Hermes&reg; and
Zeus&reg;,  totaled $1.3 million, or 6% of total sales.  We shipped five Aesop
systems during the third quarter of 2003.  We had no revenue from Computer
Motion products in the third quarter of 2002 as the acquisition of  Computer
Motion was completed on June 30, 2003.</P>
<P ALIGN="JUSTIFY">Effective July 1, 2003, we prospectively adopted the
provisions of EITF 00-21, &quot;Accounting for Revenue Arrangements with
Multiple Deliverables.&quot;  As a result, we deferred $1.7 million of revenue
related to the fair value of the first year service for system sales delivered
during the third quarter of 2003.  This amount will be recognized as service
revenue on a straight-line basis over the related service period, which is
generally one year.  Previously, in accordance with Staff Accounting Bulletin
No. 101, "Revenue Recognition in Financial Statements," we accrued costs
associated with these arrangements as warranty expense in the period the system
was delivered and accepted.  Since we adopted EITF 00-21 on a prospective basis,
only third quarter results reflect the impact of this accounting change and none
of the previous periods have been restated. </P>
<P ALIGN="JUSTIFY">On a year-to-date basis, total sales for the nine months
ended September 30, 2003 were $64.1 million, up 26% from $50.9 million for the
nine months ended September 30, 2002.  The increase was driven by continued
growth in recurring revenue.  Sales of instruments, accessories and service grew
to $19.5 million for the nine months ended September 30, 2003 from $10.4 million
for the same period last year.  Overall, system revenue for the nine months
ended September 30, 2003 was $44.6 million, up $4.1 million from $40.5 million
for the same period last year.  The increase was due primarily to sales of 26
fourth arms during 2003, compared with no sales of fourth arms in 2002 as we
began shipping the product in 2003.  There were 43 <I>da Vinci</I> Surgical
Systems shipped during the nine months ended September 30, 2003, equal to last
year's total. </P>
<P ALIGN="JUSTIFY">Product sales for the three months ended September 30, 2003
of $20.7 million were up $5.0 million compared to $15.7 million for the three
months ended September 30, 2002.  The increase was primarily due to higher
instrument and accessory sales of $2.5 million, resulting primarily from a
larger installed base of <I>da Vinci</I> Surgical Systems in 2003, and higher
systems sales of $2.5 million, resulting primarily from fourth arm sales and one
incremental <I>da Vinci</I> Surgical System sale.  </P>
<P ALIGN="JUSTIFY">Product sales for the nine months ended September 30, 2003 of
$57.3 million were up $9.9 million compared to $47.4 million for the nine months
ended September 30, 2002.  The increase was primarily due to higher instrument
and accessory sales of $5.8 million, resulting from a larger installed base of
<I>da Vinci</I> Surgical Systems in 2003, and additional system revenue of $4.1
million driven by incremental revenue derived from the fourth surgical arm
shipments in 2003.</P>
<P ALIGN="JUSTIFY">Service sales for the three months ended September 30, 2003
of $2.7 million were up $1.3 million from $1.4 million for the three months
ended September 30, 2002.  Service sales for the nine months ended September 30,
2003 of $6.8 million were up $3.3 million from $3.5 million for the nine months
ended September 30, 2002.  The year-over-year increases resulted from a larger
base of <I>da Vinci</I> Surgical systems on annual service contracts.</P>
<I><P ALIGN="JUSTIFY">Gross Profit</I>. Total gross profit for the three months
ended September 30, 2003 was $13.0 million, or 55.5% of sales, compared with
$8.7 million, or 51.2% of sales for the three months ended September 30, 2002.
The year-over-year improvement in gross profit percentage resulted primarily
from lower product service costs related to system reliability improvements,
material cost reductions, and improved factory productivity.  The total gross
profit percentage for the three months ended September 30, 2003 decreased on a
sequential basis from 63.2% reported for the three months ended June 30, 2003
due to the impacts of the Zeus trade-in program, Zeus inventory charges, and
intangible asset amortization.  </P>
<P ALIGN="JUSTIFY">Total gross profit for the nine months ended September 30,
2003 was $37.0 million, or 57.8% of sales, compared with $25.8 million, or 50.7%
of sales for the nine months ended September 30, 2002. The year-over-year
improvement in gross profit resulted primarily from significantly lower product
service and warranty costs related to system reliability improvements and
improved factory productivity.   </P>
<P ALIGN="JUSTIFY">Product sales gross profit percentage increased from 52.3%
for the three months ended September 30, 2002 to 54.5% for the three months
ended September 30, 2003.  Product sales gross profit percentage increased from
52.2% for the nine months ended September 30, 2002 to 58.0% for the nine months
ended September 30, 2003.  The year over year increases resulted primarily from
significantly lower warranty costs and improved factory productivity.</P>
<P ALIGN="JUSTIFY">Service sales gross profit percentage increased from 38.1%
for the three months ended September 30, 2002 to 63.2% for the three months
ended September 30, 2003.  Service sales gross profit percentage increased from
30.3% for the nine months ended September 30, 2002 to 56.0% for the nine months
ended September 30, 2003.  The year over year increases resulted primarily from
lower per system service costs derived from system reliability improvements and
field service organization productivity gains.</P>
<I><P ALIGN="JUSTIFY">Selling, General and Administrative Expenses</I>. Selling,
general and administrative expenses for the three months ended September 30,
2003 were $12.2 million, up 5% from $11.7 million for the three months ended
September 30, 2002. The year-over-year increase was primarily due to higher
headcount and travel related costs of $1.7 million associated with providing
sales support to a larger installed base of <I>da Vinci</I> Surgical Systems and
dedicating personnel to support Computer Motion integration activities.  The
increase was also due to other non-recurring Computer Motion integration costs
incurred during the third quarter of 2003, including customer commitments, bad
debts, and audit fees totaling approximately $0.8 million and amortization and
impairment of intangible assets associated with the Computer Motion acquisition
of $0.3 million, offset by lower litigation expenses of $1.5 million, and the
impact of charges taken for unauthorized purchases of administrative supplies
incurred during the third quarter of 2002.</P>
<P ALIGN="JUSTIFY">Selling, general and administrative expenses for the nine
months ended September 30, 2003 were $31.8 million, up 5% from $30.3 million for
the nine months ended September 30, 2002. The year-over-year increase was
primarily due to higher headcount and travel related costs of $2.6 million
associated with supporting a larger installed base of <I>da Vinci</I> Surgical
Systems and integrating Computer Motion activities, and intangible asset
amortization and impairment of $1.3 million, offset by lower litigation costs of
$1.9 million and reduced general operating expenses. </P>
<P ALIGN="JUSTIFY">Selling, general and administrative expenses include costs
for sales, marketing and administrative personnel, tradeshow expenses, legal
expenses, regulatory fees and general corporate expenses. Selling, general and
administrative expenses are expected to increase in the future to support
expanding business activities and integrate the Computer Motion business. </P>
<I><P ALIGN="JUSTIFY">Research and Development Expenses</I>. Research and
development expenses for the three months ended September 30, 2003 were $4.4
million, up 13% from $3.9 million for the three months ended September 30, 2002.
The year-over-year increase resulted primarily from additional headcount assumed
in the Computer Motion acquisition. </P>
<P ALIGN="JUSTIFY">Research and development expenses for the nine months ended
September 30, 2003 were $11.5 million, down 10% from $12.8 million for the nine
months ended September 30, 2002. The year-over-year decrease resulted primarily
from lower project materials costs of $1.0 million and lower project consulting
costs of $1.0 million, offset by costs associated with additional headcount
assumed in the Computer Motion acquisition.</P>
<P ALIGN="JUSTIFY">Research and development expenses include costs associated
with the design, development, testing and enhancement of our products. These
enhancements represent significant improvements to our products. Research and
development expenses also include expenditures for clinical trials and purchases
of laboratory supplies. Research and development costs are expensed as incurred.
Research and development expenses are expected to increase in the future due to
the impact of the acquisition of Computer Motion. </P>
<I><P ALIGN="JUSTIFY">Deferred Compensation</I>. We record deferred compensation
as the difference between the exercise price of options granted and the fair
value of our common stock at the time of grant for financial reporting purposes.
Deferred compensation is amortized to research and development expense and
selling, general and administrative expense. Non-cash deferred compensation
expense included in research and development expenses was $0.1 million and $0.1
million for the three months ended September 30, 2003 and 2002, respectively.
Non-cash deferred compensation expense included in selling, general and
administrative expenses was zero and $0.1 million for the three months ended
September 30, 2003 and 2002, respectively. Non-cash deferred compensation
expense included in research and development expenses was $0.2 million and $0.3
million for the nine months ended September 30, 2003 and 2002, respectively.
Non-cash deferred compensation expense included in selling, general and
administrative expenses was $0.2 million and $0.2 million for the nine months
ended September 30, 2003 and 2002, respectively. Deferred compensation related
to below market options granted prior to our initial public offering ($8.9
million) was fully amortized as of June 30, 2003.  In connection with our
acquisition of Computer Motion, we recorded $0.4 million of deferred
compensation on unvested options which began amortizing into compensation
expense over approximately a three year period beginning July 1, 2003 using the
graded vesting method.  The amount of deferred compensation expense to be
recorded in future periods may decrease if unvested options for which deferred
compensation has been recorded are subsequently canceled.</P>
<I><P ALIGN="JUSTIFY">Other Income. </I>Other income for the three months ended
September 30, 2003 was $0.3 million, down $0.1 million compared to $0.4 million
for the three months ended September 30, 2002. The decrease resulted in reduced
interest earnings on lower investment balances.  Other income  for the nine
months ended September 30, 2003 was $1.5 million, up $0.1 million compared to
$1.4 million for the nine months ended September 30, 2002. The increase resulted
primarily from $0.5 million of gains realized during the first quarter of 2003
on sales of investment securities, partially offset by reduced interest earnings
on lower investment balances.  </P>
<B><I><P>LIQUIDITY AND CAPITAL RESOURCES</P>
</B></I><P ALIGN="JUSTIFY">Our operations have been financed through the sales
of our convertible preferred stock, yielding net proceeds of approximately
$127.3 million, public offerings of our common stock, yielding approximately
$114.5 million, and equipment financing arrangements, yielding approximately
$11.0 million. The equipment arrangements provide financing at specific interest
rates for periods of up to 48 months, at which time the principal is repaid to
the lessors. As collateral for the equipment financing, we have granted the
lessors a security interest in equipment specified under each arrangement. </P>
<P ALIGN="JUSTIFY">As of September 30, 2003, we had working capital of $42.9
million, compared to $52.6 million as of December 31, 2002. The decrease during
the nine months ended September 30, 2003 resulted primarily from the impact of
the acquisition of Computer Motion, reflecting cash used to fund the second
quarter 2003 Computer Motion operations of $5.3 million, restructuring costs of
$3.4 million, and the negative fair value of working capital acquired of $1.0
million.  </P>
<P ALIGN="JUSTIFY">Net cash used by operating activities for the nine months
ended September 30, 2003 was $10.9 million, comprised primarily of our net loss
of $4.8 million and changes in net operating assets and liabilities of $10.9
million, offset by non-cash expenses of $4.8 million.   Cash used by operating
activities was $5.7 million less for the nine months ended September 30, 2003
compared to the nine months ended September 30, 2002 primarily due to a decrease
in 2003 net loss of $11.1 million when compared to the 2002 net loss and higher
non-cash expenses of $1.3 million, offset by higher use of net operating assets
and liabilities of $6.7 million, mostly due to the Computer Motion
acquisition.</P>
<P ALIGN="JUSTIFY">Net cash provided by investing activities for the nine months
ended September 30, 2003 of $2.0 million was $19.7 million less than $21.7
million for the nine months ended September 30, 2002 primarily due to decreased
net movement into cash from short-term investments of $17.2 million resulting
from a decrease in 2003 net loss of $11.1 million when compared to the 2002 net
loss and general timing of conversions into cash to support short-term
liquidity.</P>
<P ALIGN="JUSTIFY">Net cash provided by financing activities was $3.9 million
for the nine months ended September 30, 2003, compared to $2.7 million for the
nine months ended September 30, 2002. This increase resulted from higher
proceeds from issuance of common stock of $3.2 million, offset by decreased
long-term borrowings of $2.0 million.</P>
<P ALIGN="JUSTIFY">Our capital requirements depend on numerous factors,
including the effects of our recently completed merger with Computer Motion,
market acceptance of our products, the resources we devote to developing and
supporting our products, and other factors. We expect to devote substantial
capital resources to continue our research and development efforts, to expand
our support and product development activities and for other general corporate
activities. We believe that our current cash and short- term investment
balances, together with revenue to be derived from the sale of our products,
will be sufficient to fund our future operations.  However, our ability to
achieve these goals is subject to economic conditions and unanticipated changes
in business conditions, and therefore, there can be no assurance that these
results will be achieved.</P>
<P ALIGN="JUSTIFY">On October 31, 2003, we sold 5,000,000 shares of newly issued
common stock in an underwritten public offering at a price of $14.50 per share.
We received net proceeds of approximately $67.7 million, after deducting the
underwriting discount and offering expenses. We intend to use the net proceeds
for general corporate purposes.  The underwriters also have the option to
purchase up to 750,000 additional shares at a price of $14.50 per share to cover
over-allotments. </P>
<I><P ALIGN="JUSTIFY">Contractual Obligations and Commercial Commitments</P>
</I><P ALIGN="JUSTIFY">The following table summarizes all significant
contractual payment obligations by payment due date:</P>
<B><P ALIGN="JUSTIFY">Payments by Periods (in millions)</P></B></FONT>
<TABLE BORDER CELLSPACING=1 CELLPADDING=7 WIDTH=572>
<TR><TD WIDTH="31%" VALIGN="TOP">
<FONT SIZE=2><P ALIGN="CENTER">Contractual Obligation</FONT></TD>
<TD WIDTH="13%" VALIGN="TOP">
<FONT SIZE=2><P ALIGN="CENTER">Total</FONT></TD>
<TD WIDTH="16%" VALIGN="TOP">
<FONT SIZE=2><P ALIGN="CENTER">Under 1 Year</FONT></TD>
<TD WIDTH="13%" VALIGN="TOP">
<FONT SIZE=2><P ALIGN="CENTER">1-3 Years</FONT></TD>
<TD WIDTH="13%" VALIGN="TOP">
<FONT SIZE=2><P ALIGN="CENTER">3-5 Years</FONT></TD>
<TD WIDTH="16%" VALIGN="TOP">
<FONT SIZE=2><P ALIGN="CENTER">Over 5 Years</FONT></TD>
</TR>
<TR><TD WIDTH="31%" VALIGN="TOP">
<FONT SIZE=2><P ALIGN="JUSTIFY">Long-term debt</FONT></TD>
<TD WIDTH="13%" VALIGN="TOP">
<FONT SIZE=2><P ALIGN="RIGHT">$ 2.2</FONT></TD>
<TD WIDTH="16%" VALIGN="TOP">
<FONT SIZE=2><P ALIGN="RIGHT">$ 1.3</FONT></TD>
<TD WIDTH="13%" VALIGN="TOP">
<FONT SIZE=2><P ALIGN="RIGHT">$ .9</FONT></TD>
<TD WIDTH="13%" VALIGN="TOP">
<FONT SIZE=2><P ALIGN="RIGHT">$ -</FONT></TD>
<TD WIDTH="16%" VALIGN="TOP">
<FONT SIZE=2><P ALIGN="RIGHT">$ -</FONT></TD>
</TR>
<TR><TD WIDTH="31%" VALIGN="TOP">
<FONT SIZE=2><P ALIGN="JUSTIFY">Building lease</FONT></TD>
<TD WIDTH="13%" VALIGN="TOP">
<FONT SIZE=2><P ALIGN="RIGHT">13.3</FONT></TD>
<TD WIDTH="16%" VALIGN="TOP">
<FONT SIZE=2><P ALIGN="RIGHT">3.6</FONT></TD>
<TD WIDTH="13%" VALIGN="TOP">
<FONT SIZE=2><P ALIGN="RIGHT">9.7</FONT></TD>
<TD WIDTH="13%" VALIGN="TOP">
<FONT SIZE=2><P ALIGN="RIGHT">- </FONT></TD>
<TD WIDTH="16%" VALIGN="TOP">
<FONT SIZE=2><P ALIGN="RIGHT">-</FONT></TD>
</TR>
<TR><TD WIDTH="31%" VALIGN="TOP">
<FONT SIZE=2><P ALIGN="CENTER">Total</FONT></TD>
<TD WIDTH="13%" VALIGN="TOP">
<FONT SIZE=2><P ALIGN="RIGHT">$ 15.5</FONT></TD>
<TD WIDTH="16%" VALIGN="TOP">
<FONT SIZE=2><P ALIGN="RIGHT">$ 4.9</FONT></TD>
<TD WIDTH="13%" VALIGN="TOP">
<FONT SIZE=2><P ALIGN="RIGHT">$ 10.6</FONT></TD>
<TD WIDTH="13%" VALIGN="TOP">
<FONT SIZE=2><P ALIGN="RIGHT">$ -</FONT></TD>
<TD WIDTH="16%" VALIGN="TOP">
<FONT SIZE=2><P ALIGN="RIGHT">$ -</FONT></TD>
</TR>
</TABLE>

<B><I><FONT SIZE=2><P ALIGN="JUSTIFY">CRITICAL ACCOUNTING POLICIES</P>
</B></I><P>We believe the following represent our critical accounting
policies:</P>
<B><I><P ALIGN="JUSTIFY">Revenue Recognition</B></I>. We recognize revenue when
persuasive evidence of an arrangement exists, delivery has occurred or service
has been rendered, the price is fixed or determinable and collectibility is
reasonably assured.</P>
<P ALIGN="JUSTIFY">In certain cases, revenue from direct system sales is
generated from multiple-element arrangements that require judgment in the areas
of customer acceptance, collectibility, the separability of units of accounting,
and the fair value of individual elements.  Effective July 1, 2003, we adopted
the provisions of Emerging Issues Task Force (EITF) Issue No. 00-21,
&quot;Revenue Arrangements with Multiple Deliverables&quot; on a prospective
basis.  The principles and guidance outlined in EITF 00-21 provide a framework
to (a) determine whether an arrangement involving multiple deliverables contains
more than one unit of accounting and (b) determine how the arrangement
consideration should be measured and allocated to the separate units of
accounting in the arrangement. We determined that our multiple-element
arrangements are generally comprised of the following elements that would
qualify as separate units of accounting: system sales, service, installation,
and training.  Each of these elements represent individual units of accounting
as the delivered item has value to a customer on a stand-alone basis, objective
and reliable evidence of fair value exists for undelivered items, and
arrangements generally do not contain a general right of return relative to the
delivered item.  We determine fair value based on the price of the deliverable
when it is sold separately or based on third-party evidence.  In accordance with
the guidance in EITF 00-21, we use the residual method to allocate the
arrangement consideration when we do not have fair value of the system sale.
Under the residual method, the amount of consideration allocated to the
delivered item equals the total arrangement consideration less the aggregate
fair value of the undelivered items.  Assuming all other criteria for revenue
recognition have been met, we recognize revenue for system sales when delivery
and acceptance occurs, for installation and training when the services are
rendered, and for service ratably over the service period, which is generally
one year.</P>
<P ALIGN="JUSTIFY">Upon adoption of the provisions of EITF 00-21, we deferred
$1.7 million related to the fair value of the first year  service for system
sales delivered during the third quarter of 2003.  This amount will be
recognized as service revenue on a straight-line basis over the related service
period, which is generally one year.  Previously, in accordance with Staff
Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements," we
accrued costs associated with these arrangements as warranty expense in the
period the system was delivered and accepted. </P>
<P ALIGN="JUSTIFY">Our distributors do not have price protection rights. One of
our distributors has return rights under limited circumstances. Such rights are
accounted for under the provisions of SFAS No. 48, "Revenue Recognition When
Right of Return Exists." </P>
<P ALIGN="JUSTIFY">Revenue from sales of instruments and accessories is
recognized upon delivery. Revenue related to future commitments under separately
priced service contracts is deferred and recognized ratably over the service
period. All costs associated with the provision of service and maintenance,
including salaries, benefits, travel, spare parts and equipment, are recognized
in cost of sales as incurred. </P>
<P ALIGN="JUSTIFY">Amounts billed in excess of revenue recognized are included
as deferred revenue in the accompanying consolidated balance sheets.</P>
<P ALIGN="JUSTIFY">Our <I>da Vinci </I>Surgical System, <I>Hermes</I> Control
Center and <I>AESOP</I> Endoscope Positioner contain a software component.  We
believe that this software element is an incidental part of each system. The
software element within our products is not sold or marketed separately to
customers and the software does not operate independently of each system.
Furthermore, the software development effort does not require a significant cost
to us relative to the overall development cost of the product. As such, the
software we provide is incidental to each system as a whole and the software
revenue guidance provided in SOP 97-2 is not applicable to our revenues</P>
<B><I><P ALIGN="JUSTIFY">Allowance for Doubtful Accounts</B></I>. The allowance
for doubtful accounts is based upon management estimates. Factors underlying
these estimates include analysis of days outstanding, customer payment history
and management judgment. The allowance is adjusted periodically to reflect
current data, activity, and associated risks.</P>
<B><I><P ALIGN="JUSTIFY">Inventory Reserves</B></I>. We write our inventory down
for estimated obsolescence or unmarketable inventory equal to the difference
between the cost of inventory and the estimated market value based upon
assumptions about future demand and market conditions. If actual future demand
or market conditions are less favorable than those projected by management,
additional inventory write-downs may be required in the future.</P>
<B><I><P ALIGN="JUSTIFY">Intangible Assets</B></I>. We have intangible assets on
our balance sheet related to the acquisition of Computer Motion and the
acquisition of other patents. The valuation and classification of these assets
and the assignment of useful amortization lives involves judgments and the use
of estimates. The evaluation of these intangibles for impairment under
established accounting guidelines is required on an ongoing basis. Changes in
business conditions could potentially require future adjustments to asset
valuations.</P>
<B><I><P ALIGN="JUSTIFY">Goodwil</B>l</I>.  We have goodwill on our balance
sheet relating to the acquisition of Computer Motion.  Goodwill is recorded as
the excess of the purchase price over the fair value of the net tangible and
intangible assets acquired.  Goodwill is not amortized, rather is tested for
impairment at least annually.  In the event we determine that goodwill has been
impaired, we will record an accounting charge for the impairment during the
fiscal quarter in which the determination is made. </P>
<B><I><P ALIGN="JUSTIFY">Warranties</I>.</B> Effective July 1, 2003, for certain
arrangements recorded under the provisions of EITF 00-21, we no longer accrue
warranty costs upon delivery of the system.  Actual warranty costs are expensed
in the period incurred.  For all other revenue arrangements, we provide for the
estimated costs of product warranties at the time revenue is recognized. Our
estimate of costs to service our warranty obligations is based upon historical
experience and expectation of future conditions. If warranty claim activity and
the costs associated with servicing those claims differ from our estimates,
revisions to the estimated warranty liability may be required.</P>
<B><I><P ALIGN="JUSTIFY">Contingencies</B></I>. We are subject to proceedings,
lawsuits and other claims related to our products, patents and other matters. We
are required to assess the likelihood of any adverse judgments or outcomes to
these matters as well as potential ranges of probable losses. A determination of
the amount of reserves required, if any, for these contingencies is made after
careful analysis of each individual issue. The required reserves may change in
the future due to new developments in each matter or changes in approach such as
a change in settlement strategy in dealing with these matters.</P>
<B><I><P>FACTORS AFFECTING OPERATING RESULTS</P>
</I><P>OUR FUTURE OPERATING RESULTS MAY BE BELOW SECURITIES ANALYSTS' OR
INVESTORS' EXPECTATIONS, WHICH COULD CAUSE OUR STOCK PRICE TO DECLINE.</P>
</B><P ALIGN="JUSTIFY">Because of our limited operating history, we have limited
insight into trends that may emerge in our market and affect our business. The
revenue and income potential of our market are unproven, and we may be unable to
generate significant revenues. In addition, our costs may be higher than we,
securities analysts or investors expect. If we fail to generate sufficient
revenues or our costs are higher than we expect, our results of operations will
suffer, which in turn could cause our stock price to decline. Further, future
revenue from sales of our products is difficult to forecast because the market
for new surgical technologies is still evolving. Our results of operations will
depend upon numerous factors, including:</P>

<UL>
<LI>the extent to which our products gain market acceptance;</LI>
<LI>actions relating to regulatory matters;</LI>
<LI>our timing and ability to develop our manufacturing and sales and marketing
capabilities; </LI>
<LI>demand for our products; </LI>
<LI>the size and timing of specific sales and any collection delays related to
those sales;</LI>
<LI>the progress of surgical training in the use of our products; </LI>
<LI>our ability to develop, introduce and market new or enhanced versions of our
products on a timely basis; </LI>
<LI>product quality problems; </LI>
<LI>our ability to protect our proprietary rights and defend against third party
challenges; </LI>
<LI>our ability to license additional intellectual property rights;</LI>
<LI>the integration of Computer Motion with our company;</LI>
<LI>the progress and results of clinical trials; and</LI>
<LI>third-party payor reimbursement policies. </LI></UL>

<P ALIGN="JUSTIFY">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, our operating results will be below the expectations of securities
analysts or investors. If this occurs, the price of our common stock, and the
value of your investment, will likely decline.</P>
<B><P>WE EXPERIENCE LONG AND VARIABLE SALES CYCLES, WHICH COULD HAVE A NEGATIVE
IMPACT ON OUR RESULTS OF OPERATIONS FOR ANY GIVEN QUARTER.</B> </P>
<P ALIGN="JUSTIFY">Our <I>da Vinci</I> Surgical System has a lengthy sales and
purchase order cycle because it is a major capital item and generally requires
the approval of senior management at purchasing institutions. These factors may
contribute to substantial fluctuations in our quarterly operating results,
particularly during the periods in which our sales volume is low. Because of
these fluctuations, it is likely that in some future quarters our operating
results will fall below the expectations of securities analysts or investors. If
that happens, the market price of our stock would likely decrease. These
fluctuations also mean that you will not be able to rely upon our operating
results in any particular period as an indication of future performance.</P>
<B><P>BECAUSE A SMALL NUMBER OF CUSTOMERS HAVE AND ARE LIKELY TO CONTINUE TO
ACCOUNT FOR A SUBSTANTIAL PORTION OF OUR REVENUES, OUR REVENUES COULD DECLINE
DUE TO THE LOSS OR DELAY OF A SINGLE CUSTOMER. </P>
</B><P ALIGN="JUSTIFY">A relatively small number of customers account for a
significant portion of our total revenues. During the three months ended
September 30, 2003 and 2002, approximately 65% and 77%, respectively, of our
revenues came from the sales of <I>da Vinci</I> Surgical Systems, which are high
revenue dollar items. During the nine months ended September 30, 2003 and 2002,
approximately 69% and 80%, respectively, of our revenues came from the sales of
<I>da Vinci</I> Surgical Systems. During the three and nine month periods ended
September 30, 2003 and 2002, no customer accounted for more than 10% of total
sales. However, due to the high average selling price of the <I>da Vinci</I>
Surgical System, our failure to add new customers that make significant
purchases of our products could reduce our future revenues. The loss or delay of
individual orders could have a significant impact on revenues and operating
results.</P>
<B><P>IF OUR PRODUCTS DO NOT ACHIEVE MARKET ACCEPTANCE, WE WILL NOT BE ABLE TO
GENERATE THE REVENUE NECESSARY TO SUPPORT OUR BUSINESS.</B> </P>
<P ALIGN="JUSTIFY">Our products represent a fundamentally new way of performing
surgery. Achieving physician, patient and third-party payor acceptance of
<I>Intuitive</I> surgery as a preferred method of performing surgery will be
crucial to our success. If our products fail to achieve market acceptance,
hospitals will not purchase our products and we will not be able to generate the
revenue necessary to support our business. We believe that physicians' and
third-party payors' acceptance of the benefits of procedures performed using our
products will be essential for acceptance of our products by patients.
Physicians will not recommend the use of our products unless we can demonstrate
that they produce results comparable or superior to existing surgical
techniques. Even if we can prove the effectiveness of our products through
clinical trials, surgeons may elect not to use our products for any number of
other reasons. For example, cardiologists may continue to recommend conventional
open-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 of
reimbursement from third-party payors. </P>
<P ALIGN="JUSTIFY">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 will require training of surgical teams. Market acceptance could be
delayed by the time required to complete this training. We may not be able to
rapidly train surgical teams in numbers sufficient to generate adequate demand
for our products. We cannot be certain that our training programs will be cost
effective or sufficient to meet our customers' needs.</P>
<B><P>WE ARE INVOLVED IN INTELLECTUAL PROPERTY LITIGATION WITH BROOKHILL-WILK 1,
LLC THAT MAY HURT OUR COMPETITIVE POSITION, MAY BE COSTLY TO US AND MAY PREVENT
US FROM SELLING OUR PRODUCTS. </P>
</B><P ALIGN="JUSTIFY">In September 2000 Brookhill-Wilk 1, LLC, or Wilk, filed a
lawsuit against Intuitive Surgical in the United States District Court for the
Southern District of New York (Case No. 00 Civ. 6599 (NRB)) alleging that by
making, using, selling or offering for sale our <I>da Vinci</I> Surgical System,
we are infringing United States Patent Nos. 5,217,003 and 5,368,015 in willful
disregard of Wilk's patent rights. These patents concern methods and devices for
"remote" surgery. In March 2001, Wilk withdrew its assertion of the '015 patent
against our company. In November  2001, in response to a motion on one of
Intuitive Surgical's noninfringement defenses, the District Court granted
summary judgment of noninfringement of the '003 patent in our favor and
dismissed Wilk's complaint in its entirety without prejudice. Wilk appealed the
summary judgment ruling to the U.S. Court of Appeals for the Federal Circuit. In
April 2003, the Court of Appeals reversed the District Court's judgment and
remanded the case for further proceedings. This reversal is based on the Court
of Appeals' determination that the particular claim limitation at issue should
be interpreted differently than as construed by the District Court.</P>
<P ALIGN="JUSTIFY">Upon remand, we intend to continue to vigorously defend our
rights and, if necessary, are prepared to continue to conduct discovery and file
further motions on whether the patent is infringed, valid and/or enforceable. We
believe that we have multiple meritorious defenses to Wilk's allegations.
However, litigation is unpredictable and we may not prevail.. Both parties have
expressed a desire to engage in non-binding mediation before engaging in further
proceedings in the District Court.  The District Court has not yet set a
schedule for further proceedings if mediation is unsuccessful.</P>
<P ALIGN="JUSTIFY">In July 2003, Wilk filed a new lawsuit against three of our
customers: Mt. Sinai Hospital, Lenox Hill Hospital and the New York and
Presbyterian Hospital.  Pursuant to agreements with those customers, we are
defending the lawsuit on behalf of our customers.  We do not expect this lawsuit
to significantly impact the scope of the existing litigation with Wilk since any
resolution of the existing Wilk litigation, whether on the merits or by
settlement, will likely resolve this new lawsuit at the same time.</P>
<P ALIGN="JUSTIFY">In September 2003, Wilk amended its complaint against our
company to include Computer Motion within the lawsuit and to allege that
Computer Motion's Zeus product also infringes Wilk's '003 patent.  Prior to our
acquisition of Computer Motion, Wilk sued Computer Motion but dismissed that
lawsuit voluntarily in order to await the outcome of the appeal proceedings in
Wilk's litigation with our company.  We believe that we have multiple
meritorious defenses to Wilk's allegations against Computer Motion, including
many of the same defenses that apply to Wilk's allegations against our company.
However, litigation is unpredictable and we may not prevail.  Wilk's allegations
against Computer Motion are directed only to Computer Motion products.</P>
<P ALIGN="JUSTIFY">If we lose Wilk's suit against us and the three hospital
customers, it will hurt our competitive position, may be costly to us and may
prevent us from selling our products. If we lose the patent suit, we may need to
obtain from Wilk a license to this technology if we are to continue to market
our products that have been found to infringe Wilk's patents. This license could
be expensive, which could seriously harm our business. If Wilk is successful in
its suit against us and is unwilling to grant us a license, we may be required
to stop selling our products that are found to infringe Wilk's patents unless we
can redesign them so they do not infringe Wilk's patents, which we may be unable
to do. In addition, we could be required to pay Wilk damages, including treble
damages, which could be substantial and harm our financial position. Due to the
inherent uncertainties of litigation, however, we cannot accurately predict the
ultimate outcome of the Wilk litigation at this time and, therefore, cannot
estimate the range of possible loss.</P>
<P ALIGN="JUSTIFY">The foregoing proceeding could be expensive to litigate, may
be protracted and our confidential information may be compromised. Whether or
not we are successful in this lawsuit, the proceeding could consume substantial
amounts of our financial and managerial resources. At any time, Wilk may file
additional claims against our company, or we may file claims against Wilk, which
could increase the risk, expense and duration of the litigations. </P>
<B><P>IF WE ARE UNABLE TO PROTECT THE INTELLECTUAL PROPERTY CONTAINED IN OUR
PRODUCTS FROM USE BY THIRD PARTIES, OUR ABILITY TO COMPETE IN THE MARKET WILL BE
HARMED.</B> </P>
<P ALIGN="JUSTIFY">Our commercial success will depend in part on obtaining
patent and other intellectual property protection for the technologies contained
in our products, and on successfully defending our patents and other
intellectual 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. If we fail to obtain adequate protection of our
intellectual property, or if any protection we obtain is reduced or eliminated,
others could use our intellectual property without compensating us, resulting in
harm to our business. We may also determine that it is in our best interests to
voluntarily challenge a third party's products or patents in litigation or
administrative proceedings, including patent interferences or reexaminations. In
addition, the laws of certain foreign countries do not protect intellectual
property rights to the same extent as do the laws of the United States.</P>
<B><P>OTHERS MAY ASSERT THAT OUR PRODUCTS INFRINGE THEIR INTELLECTUAL PROPERTY
RIGHTS, WHICH MAY CAUSE US TO ENGAGE IN COSTLY DISPUTES AND, IF WE ARE NOT
SUCCESSFUL IN DEFENDING OURSELVES, COULD ALSO CAUSE US TO PAY SUBSTANTIAL
DAMAGES AND PROHIBIT US FROM SELLING OUR PRODUCTS.</B> </P>
<P ALIGN="JUSTIFY">We are aware of both United States and foreign patents issued
to third parties that relate to computer-assisted surgery, remote surgery, and
minimally invasive surgery. Some of these patents on their face appear broad
enough to cover one or more aspects of our present technology, and may cover
aspects of our 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 inviting us to license their patents. We may be sued by, or become
involved in an administrative proceeding with, one or more of these third
parties. We cannot assure you that a court or administrative body would agree
with any arguments or defenses we have concerning invalidity, unenforceability
or noninfringement 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
likely to file, patent applications covering surgical products that are similar
or identical to ours. We cannot assure you that any patents issuing from
applications filed by a third party will not cover our products or will not have
priority over our patent applications. </P>
<P ALIGN="JUSTIFY">The medical device industry has been characterized by
extensive litigation and administrative proceedings regarding patents and other
intellectual property rights, and companies have employed such actions to gain a
competitive advantage. If third parties assert infringement or other
intellectual property claims against us as Brookhill-Wilk 1, LLC has, our
technical and management personnel will experience a significant diversion of
time and effort and we will incur large expenses defending 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 substantial royalties. We cannot be
certain that we will have the financial resources or the substantive arguments
to defend our patents from infringement or claims of invalidity or
unenforceability, or to defend against allegations of infringement of
third-party patents. In addition, any public announcements related to litigation or
administrative proceedings initiated by us, or initiated or threatened against
us, could cause our stock price to decline.</P>
<B><P>THE RIGHTS AND MEASURES WE RELY ON TO PROTECT THE INTELLECTUAL PROPERTY
UNDERLYING OUR PRODUCTS MAY NOT BE ADEQUATE TO PREVENT THIRD PARTIES FROM USING
OUR TECHNOLOGY, WHICH COULD HARM OUR ABILITY TO COMPETE IN THE MARKET.</B> </P>
<P ALIGN="JUSTIFY">In addition to patents, we typically rely on a combination of
trade secret, copyright and trademark laws, nondisclosure agreements and other
contractual provisions and technical security measures to protect our
intellectual property rights. Nevertheless, these measures may not be adequate
to safeguard the technology underlying our products. If they do not protect our
rights adequately, third parties could use our technology, and our ability to
compete in the market would be reduced. In addition, employees, consultants and
others who participate in developing our products may breach their agreements
with us regarding our intellectual property, and we may not have adequate
remedies for the breach. We also may not be able to effectively protect our
intellectual property rights in some foreign countries. For a variety of
reasons, we may decide not to file for patent, copyright or trademark protection
outside the United States. We also realize that our trade secrets may become
known through other means not currently foreseen by us. Notwithstanding our
efforts to protect our intellectual property, our competitors may independently
develop similar or alternative technologies or products that are equal or
superior to our technology and products without infringing any of our
intellectual property rights, or may design around our proprietary technologies.
</P>
<B><P>OUR PRODUCTS RELY ON LICENSES FROM THIRD PARTIES, AND IF WE LOSE ACCESS TO
THESE TECHNOLOGIES, OUR REVENUES COULD DECLINE.</B> </P>
<P ALIGN="JUSTIFY">We rely on technology that we license from others, including
technology that is integral to our products. We have entered into license
agreements with SRI International, IBM Corporation, MIT, Olympus Optical Co.,
Ltd., and Heartport, Inc., now part of Johnson &amp; Johnson. Any of these
agreements may be terminated for breach. If any of these agreements is
terminated, we may be unable to reacquire the necessary license on satisfactory
terms, or at all. The loss or failure to maintain these licenses could prevent
or delay further development or commercialization of our products. </P>
<B><P>PUBLIC ANNOUNCEMENTS OF LITIGATION EVENTS MAY CAUSE OUR STOCK PRICE TO
DECLINE.</P>
</B><P ALIGN="JUSTIFY">During the course of our administrative proceedings
and/or lawsuits, there may be public announcements of the results of hearings,
motions, and other interim proceedings or developments in the litigation. If
securities analysts or investors perceive these results to be negative, it could
have a substantial negative effect on the trading price of our stock.</P>
<B><P>OUR PRODUCTS ARE SUBJECT TO A LENGTHY AND UNCERTAIN DOMESTIC REGULATORY
PROCESS. IF WE DO NOT OBTAIN AND MAINTAIN THE NECESSARY DOMESTIC REGULATORY
APPROVALS, WE WILL NOT BE ABLE TO MARKET AND SELL OUR PRODUCTS IN THE UNITED
STATES.</B> </P>
<P ALIGN="JUSTIFY">Our products and operations are subject to extensive
regulation in the United States by the U.S. Food and Drug Administration, or
FDA. The FDA regulates the research, testing, manufacturing, safety, labeling,
storage, recordkeeping, promotion, distribution and production of medical
devices in the United States to ensure that medical products distributed
domestically are safe and effective for their intended uses. 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, or FFDCA. Clearance under Section 510(k) requires
demonstration that a new device is substantially equivalent to another device
with 510(k) clearance or grandfather 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, or PMA, for the modified
product before we are permitted to market the products in the U.S. In addition,
if we develop products in the future that are not considered to be substantially
equivalent to a device with 510(k) clearance or grandfather status, we will be
required to obtain FDA approval by submitting a PMA. </P>
<P ALIGN="JUSTIFY">The FDA may not act favorably or quickly in its review 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 of which could
delay or preclude sale of new products in the United States. Furthermore, the
FDA may request additional data or require us to conduct further testing, or
compile more data, including clinical data and clinical studies, in support of a
510(k) submission. The FDA may also, instead of accepting a 510(k) submission,
require us to submit a PMA, which is typically a much more complex and
burdensome application than a 510(k). To support a PMA, the FDA would likely
require that we conduct one or more clinical studies to demonstrate that the
device is safe and effective. We may not be able to meet the requirements to
obtain 510(k) clearance or PMA approval, or the FDA may not grant any necessary
clearances or approvals. In addition, the FDA may place significant limitations
upon the intended use of our products as a condition to a 510(k) clearance or
PMA approval. Product applications can also be denied or withdrawn due to
failure to comply with regulatory requirements or the occurrence 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 our business, financial condition and
results of operations. </P>
<P ALIGN="JUSTIFY">In order to conduct a clinical investigation involving human
subjects for the purpose of demonstrating the safety and effectiveness of a
device, a company must, among other things, apply for and obtain Institutional
Review Board, or IRB approval of the proposed investigation. In addition, if the
clinical study involves a "significant risk" (as defined by the FDA) to human
health, the sponsor of the investigation must also submit and obtain FDA
approval of an investigational device exemption, or IDE, application.  Most of
our products to date have been considered significant risk devices 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 U.S. 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 comply with the IDE and other regulations
governing clinical investigations or the data from any such trials may not
support clearance or approval of the investigational device. Failure to obtain
such approvals or to comply with such regulations could have a material adverse
effect on our business, financial condition and results of operations. </P>
</FONT><H5>COMPLYING WITH FDA REFULATIONS IS AN EXPENSIVE AND TIME-CONSUMING
PROCESS, AND OUR FAILURE TO COMPLY FULLY COULD SUBJECT US TO SIGNIFICANT
ENFORCEMENT SANCTIONS.</H5>
<FONT SIZE=2><P>Because our products, including the <I>da Vinci</I> Surgical
System, are commercially distributed, numerous postmarket regulatory
requirements apply, including the following: </P>

<UL>
<LI>Quality System Regulation, or QSR, which requires manufacturers to follow
elaborate design, testing, control, documentation and other quality assurance
procedures during the manufacturing process;</LI>
<LI>labeling regulations;</LI>
<LI>the FDA's general prohibition against false or misleading statements in the
labeling or promotion of products for unapproved or &quot;off-label&quot;
uses;</LI>
<LI>the Reports of Corrections and Removals regulation, which requires that
manufacturers report to the FDA recalls and field corrective actions taken to
reduce a risk to health or to remedy a violation of the FFDCA that may pose a
risk to health; and</LI>
<LI>the Medical Device Reporting regulation, which requires that manufacturers
report to the FDA if their 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 serious injury if it were to recur.</LI></UL>

<P ALIGN="JUSTIFY">We are subject to inspection and marketing surveillance by
the FDA to determine our compliance with regulatory requirements. If the FDA
finds that we have failed to comply, it can institute a wide variety of
enforcement actions, ranging from a regulatory letter to a public warning letter
to more severe civil and criminal sanctions. Our failure to comply with
applicable requirements could lead to an enforcement action that may have an
adverse effect on our financial condition and results of operations. </P>
<P ALIGN="JUSTIFY">We have modified the labeling, advertising and user training
for the <I>da Vinci</I> Surgical System to call out specific procedures that we
believe are within the scope of our existing 510(k) clearances. We cannot assure
you that the FDA would agree that all such specific procedures are within the
scope of the existing general clearance or that we have compiled adequate
information to support the safety and efficacy of using the <I>da Vinci</I>
Surgical System for all such specific procedures. We also have modified the
hardware and software in the <I>da Vinci</I> Surgical System since clearance in
ways that we believe do not require new 510(k) clearance. We cannot assure you
that the FDA would agree with our determinations not to seek new 510(k)
clearance for any of these changes. Computer Motion also modified the hardware
and software in its products subsequent to 510(k) clearance without seeking new
clearance. We cannot assure you that the FDA would agree with the determinations
not to seek new 510(k) clearance for any of these changes. The FDA could impose
enforcement sanctions and/or require us to obtain 510(k) clearance for any
modification to our products or Computer Motion's products. We may be prohibited
from marketing the modified device until such 510(k) clearance is granted. </P>
<P ALIGN="JUSTIFY">In December 2002, the FDA inspected our Sunnyvale
manufacturing facility and issued a Form FDA 483 setting forth three observed
compliance deficiencies relating to the QSR and two observed deficiencies
relating to the Reports of Corrections and Removals regulation. In January 2003,
we wrote to the FDA indicating our response to each observation with proposed
corrective actions. That same month, the FDA informed us that the adequacy of
our promised corrections and actions would be verified during the next
inspection of our facility. To date, the FDA has not returned for another
inspection and we continue to evaluate and upgrade our QSR compliance. We cannot
assure you that, upon reinspection, the FDA will find that our promised
corrective actions are appropriate or that they have been adequately
implemented. We also cannot assure you that the FDA will not find other
deficiencies in our compliance with the QSR and other postmarket regulations.
</P>
<P ALIGN="JUSTIFY">We recently acquired Computer Motion and are working to
integrate its FDA compliance system with our own. Our review is not complete,
but we believe that Computer Motion likely has had deficiencies in QSR
compliance, complaint handling, MDR reporting and Corrections and Removals
reporting in the last several years that will require submission of retroactive
reports to the FDA. We are also reviewing whether Computer Motion responded to
complaints with appropriate follow up. We cannot assure you that the FDA will
not seek to impose enforcement sanctions on us for Computer Motion violations
preceding our acquisition of Computer Motion, that the FDA will agree that since
the acquisition we have corrected all regulatory problems, or that our review of
Computer Motion's complaint handling will not lead us to initiate recalls or
field actions to remedy problems with Computer Motion products already in the
field.</P>
<B><P>OUR PRODUCTS ARE SUBJECT TO VARIOUS INTERNATIONAL REGULATORY PROCESSES AND
APPROVAL REQUIREMENTS. IF WE DO NOT OBTAIN AND MAINTAIN THE NECESSARY
INTERNATIONAL REGULATORY APPROVALS, WE WILL NOT BE ABLE TO MARKET AND SELL OUR
PRODUCTS IN FOREIGN COUNTRIES.</P>
</B><P ALIGN="JUSTIFY">To be able to market and sell our products in other
countries, we must obtain regulatory approvals and comply with the regulations
of those countries. These regulations, including the requirements for approvals,
and the time required for regulatory review vary from country to country.
Obtaining and maintaining foreign regulatory approvals are expensive, and we
cannot be certain that we will receive regulatory approvals in any foreign
country in which we plan to market our products. If we fail to obtain regulatory
approval in any foreign country in which we plan to market our products, our
ability to generate revenue will be harmed. </P>
<P ALIGN="JUSTIFY">The European Union requires that manufacturers of medical
products obtain the right to affix the CE mark to their products before selling
them in member countries of the European Union. The CE mark is an international
symbol of adherence to quality assurance standards and compliance with
applicable European medical device directives. In order to obtain the right to
affix the CE mark to products, a manufacturer must obtain certification that its
processes meet certain European quality standards. In January 1999, we received
permission to affix the CE mark to our <I>da Vinci</I> Surgical System and
<I>EndoWrist</I> instruments. </P>
<P ALIGN="JUSTIFY">If we modify existing products or develop new products in the
future, including new instruments, we may need to apply for permission to affix
the CE mark to such products. In addition, we will be subject to annual
regulatory audits in order to maintain the CE mark permissions we have already
obtained. We cannot be certain that we will be able to obtain permission to
affix the CE mark for new or modified products or that we will continue to meet
the quality and safety standards required to maintain the permissions 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 our products in member
countries of the European Union. </P>
<B><P>IF INSTITUTIONS OR SURGEONS ARE UNABLE TO OBTAIN REIMBURSEMENT FROM
THIRD-PARTY PAYORS FOR PROCEDURES USING OUR PRODUCTS, OR IF REIMBURSEMENT IS
INSUFFICIENT TO COVER THE COSTS OF PURCHASING OUR PRODUCTS, WE MAY BE UNABLE TO
GENERATE SUFFICIENT SALES TO SUPPORT OUR BUSINESS.</B> </P>
<P ALIGN="JUSTIFY">Domestic institutions will typically bill the services
performed with our products to various third-party payors, such as Medicare,
Medicaid and other government programs and private insurance plans. If hospitals
do not obtain sufficient reimbursement from third-party payors for procedures
performed with our products, or if government and private payors' policies do
not permit reimbursement for surgical procedures performed using our products,
we may not be able to generate the revenues necessary to support our business.
Our success in international markets also depends upon the eligibility of our
products for reimbursement through government-sponsored health care payment
systems and third-party payors. Reimbursement practices vary significantly by
country. Many international markets have government-managed healthcare systems
that control reimbursement for new products and procedures. Other foreign
markets have both private insurance systems and government-managed systems that
control reimbursement for new products and procedures. Market acceptance of our
products may depend on the availability and level of reimbursement in any
country within a particular time. In addition, health care cost containment
efforts similar to those we face in the United States are prevalent in many of
the other countries in which we intend to sell our products and these efforts
are expected to continue. </P>
<B><P ALIGN="JUSTIFY">BECAUSE OUR MARKETS ARE HIGHLY COMPETITIVE, CUSTOMERS MAY
CHOOSE TO PURCHASE OUR COMPETITORS' PRODUCTS OR MAY NOT ACCEPT INTUITIVE
SURGERY, WHICH WOULD RESULT IN REDUCED REVENUE AND LOSS OF MARKET SHARE.</P>
</B><I><P ALIGN="JUSTIFY">Intuitive</I> surgery is a new technology that must
compete with established minimally invasive surgery and open surgery. These
procedures are widely accepted in the medical community and in many cases have a
long history of use. We also face competition from several companies that are
developing new approaches and products for the minimally invasive surgery
market. In addition, we may face competition from companies that develop robotic
and computer-assisted surgical systems in the future. Our revenues may be
reduced or eliminated if our competitors develop and market products that are
more effective or less expensive than our products. If we are unable to compete
successfully, our revenues will suffer. We may not be able to maintain or
improve our competitive position against current or potential competitors,
especially those with greater resources. </P>
<P ALIGN="JUSTIFY">In many cases, the medical conditions that can be treated
using our products can also be treated by drugs or other medical devices and
procedures. Many of these alternative treatments are also widely accepted in the
medical community and have a long history of use. In addition, technological
advances could make such treatments more effective or less expensive than using
our products, which could render our products obsolete or unmarketable. We
cannot be certain that physicians will use our products to replace or supplement
established treatments or that our products will be competitive with current or
future technologies.</P>
<B><P>IF DEFECTS ARE DISCOVERED IN OUR PRODUCTS, WE MAY INCUR ADDITIONAL
UNFORESEEN COSTS, HOSPITALS MAY NOT PURCHASE OUR PRODUCTS AND OUR REPUTATION MAY
SUFFER.</B> </P>
<P ALIGN="JUSTIFY">Our products incorporate mechanical parts and computer
software, either of which can contain errors or failures, especially when first
introduced. In addition, new products or enhancements may contain undetected
errors or performance problems that, despite testing, are discovered only after
commercial shipment. Because our products are designed to be used to perform
complex surgical procedures, we expect that our customers will have an increased
sensitivity to such defects. We cannot assure you that our products will not
experience errors or performance problems in the future. If we experience flaws
or performance problems, any of the following could occur:</P>

<UL>
<LI>delays in product shipments; </LI>
<LI>loss of revenue; </LI>
<LI>delay in market acceptance; </LI>
<LI>diversion of our resources; </LI>
<LI>damage to our reputation; </LI>
<LI>increased service or warranty costs; or </LI>
<LI>product liability claims. </LI></UL>

<B><P>WE HAVE LIMITED EXPERIENCE IN MANUFACTURING OUR PRODUCTS AND MAY ENCOUNTER
MANUFACTURING PROBLEMS OR DELAYS THAT COULD RESULT IN LOST REVENUE.</B> </P>
<P ALIGN="JUSTIFY">We have manufactured a limited number of our products for
sales to customers. We may be unable to establish or maintain reliable,
high-volume manufacturing capacity. Even if this capacity can be established and
maintained, the cost of doing so may increase the cost of our products and
reduce our ability to compete. We may encounter difficulties in scaling up
production of our products, including:</P>

<UL>
<LI>problems involving production yields; </LI>
<LI>quality control and assurance; </LI>
<LI>component supply shortages; </LI>
<LI>shortages of qualified personnel; and </LI>
<LI>compliance with state, federal and foreign regulations. </LI></UL>

<P ALIGN="JUSTIFY">Manufacturing our products is a complex process. If demand
for our products exceeds our manufacturing capacity, we could develop a
substantial backlog of customer orders. If we are unable to establish and
maintain larger-scale manufacturing capabilities, our ability to generate
revenues will be limited and our reputation in the marketplace would be
damaged.</P>
<B><P>IF OUR MANUFACTURING FACILITIES DO NOT CONTINUE TO MEET FEDERAL, STATE OR
EUROPEAN MANUFACTURING STANDARDS, WE MAY BE REQUIRED TO TEMPORARILY CEASE ALL OR
PART OF OUR MANUFACTURING OPERATIONS, WHICH COULD RESULT IN PRODUCT DELIVERY
DELAYS AND LOST REVENUE.</B> </P>
<P ALIGN="JUSTIFY">Our manufacturing facilities are subject to periodic
inspection by regulatory authorities and our operations will continue to be
regulated by the FDA for compliance with Good Manufacturing Practice
requirements contained in the FDA's Quality System Regulations, or QSR. We are
also required to comply with International Organization for Standardization, or
ISO, quality system standards in order to produce products for sale in Europe.
If we fail to continue to comply with Good Manufacturing Practice requirements
or ISO standards, we may be required to cease all or part of our operations
until we comply with these regulations. We are currently in compliance with ISO
standards. The FDA inspected our Mountain View and Sunnyvale facilities in March
2000 and December 2002, respectively. The Good Manufacturing Practice issues
raised by the FDA during the inspections either were satisfactorily resolved
with the FDA, or we believe can be resolved by us to the FDA's satisfaction,
although we cannot assure you that we will be able to do so. We continue to be
subject to FDA inspections at any time. Maintaining such compliance is difficult
and costly. We cannot be certain that our facilities will be found to comply
with Good Manufacturing Practice requirements or ISO standards in future
inspections and audits by regulatory authorities. </P>
<P ALIGN="JUSTIFY">The FDA inspected the Goleta facilities of Computer Motion in
1998 and noted deficiencies in Computer Motion's systems for reviewing and
reporting product-related complaints and defect information.  We have determined
that these deficiencies may not have been addressed.  While the Goleta
manufacturing facility has been closed and production of certain product has
been transferred to our Sunnyvale facility, these issues raised by the FDA must
nonetheless be resolved.  We are presently addressing the situation to resolve
all the issues to our own and the FDA's satisfaction, although we cannot assure you
that we will be able to do so, nor can we assess what regulatory impact, if any
this may have on our company. </P>
<P ALIGN="JUSTIFY">The state of California also requires that we maintain a
license to manufacture medical devices. Our facilities and manufacturing
processes were inspected in February 1998. In March 1998, we passed the
inspection and received a device manufacturing license from the California
Department of Health Services. In March 2002, our facilities and manufacturing
processes in our Sunnyvale facility were re-inspected by the Food and Drug
Branch, or FDB, and we were issued an updated device manufacturing license for
our Sunnyvale facility. We are subject to periodic inspections by the California
Department of Health Services and, if we are unable to maintain this license
following any future inspections, we will be unable to manufacture or ship any
products.</P>
<B><P>OUR RELIANCE ON SOLE AND SINGLE SOURCE SUPPLIERS COULD HARM OUR ABILITY TO
MEET DEMAND FOR OUR PRODUCTS IN A TIMELY MANNER OR WITHIN BUDGET.</B> </P>
<P ALIGN="JUSTIFY">Some of the components necessary for the assembly of our
products are currently provided to us by sole source suppliers or single source
suppliers. We purchase components through purchase orders rather than long-term
supply agreements and generally do not maintain large volumes of inventory. The
disruption or termination of the supply of components could cause a significant
increase in the costs of these components, which could affect our profitability.
A disruption or termination in the supply of components could also result in our
inability to meet demand for our products, which could harm our ability to
generate revenues, lead to customer dissatisfaction and damage our reputation.
Furthermore, if we are required to change the manufacturer of a key component of
our products, we may be required to verify that the new manufacturer maintains
facilities and procedures that comply with quality standards and with all
applicable regulations and guidelines. The delays associated with the
verification of a new manufacturer could delay our ability to manufacture our
products in a timely manner or within budget.</P>
<B><P>THE USE OF OUR PRODUCTS COULD RESULT IN PRODUCT LIABILITY CLAIMS THAT
COULD BE EXPENSIVE, DIVERT MANAGEMENT'S ATTENTION AND HARM OUR BUSINESS.</B>
</P>
<P ALIGN="JUSTIFY">Our business exposes us to significant risks of product
liability claims. The medical device industry has historically been litigious,
and we face financial exposure to product liability claims if the use of our
products were to cause injury or death. There is also the possibility that
defects in the design or manufacture of our products might necessitate a product
recall. Although we maintain product liability insurance, the coverage limits of
these policies may not be adequate to cover future claims. Particularly as sales
of our products increase, we may be unable to maintain product liability
insurance in the future at satisfactory rates or in adequate amounts. A product
liability claim, regardless of its merit or eventual outcome, could result in
significant legal defense costs. A product liability claim or any product
recalls could also harm our reputation or result in a decline in revenues.</P>
<P ALIGN="JUSTIFY">During the second quarter of 2003, two former patients of The
Valley Hospital in New Jersey filed suit against The Valley Hospital, their
surgeons and Intuitive Surgical, Inc. alleging various harms caused during their
surgeries.  Intuitive was named because the <I>da Vinci</I> Surgical System was
utilized for a portion of the surgeries and the detachable tip of an
<I>EndoWrist</I> instrument is alleged to have remained in each patient after
each surgery.  Each suit alleges, among other things, negligence, carelessness
and/or recklessness by each defendant, that the <I>da Vinci</I> Surgical System
was defectively designed and manufactured, that we failed to properly instruct
and train the surgeons in its use, and that the defendants failed to properly
apprise the patients of the risks involved.  Each suit seeks an unspecified
amount of general, special and punitive damages from the defendants, in addition
to a request to recover the costs of suit and attorney fees.  As each suit was
just recently filed, both are in very early stages and discovery has recently
commenced.</P>
<B><P>IF WE LOSE OUR KEY PERSONNEL OR ARE UNABLE TO ATTRACT AND RETAIN
ADDITIONAL PERSONNEL, OUR ABILITY TO COMPETE WILL BE HARMED.</B> </P>
<P ALIGN="JUSTIFY">We are highly dependent on the principal members of our
management and scientific staff. Our product development plans depend, in part,
on our ability to attract and retain engineers with experience in mechanics,
software and optics. Attracting and retaining qualified personnel will be
critical to our success, and competition for qualified personnel is intense. We
may not be able to attract and retain personnel on acceptable terms given the
competition for such personnel among technology and healthcare companies, and
universities. The loss of any of these persons or our inability to attract and
retain qualified personnel could harm our business and our ability to
compete.</P>
<B><P>INTERNATIONAL SALES OF OUR PRODUCTS ACCOUNT FOR A SIGNIFICANT PORTION OF
OUR REVENUES, WHICH EXPOSES US TO RISKS INHERENT IN INTERNATIONAL OPERATIONS.
OUR GROWTH MAY BE LIMITED IF WE ARE UNABLE TO SUCCESSFULLY MANAGE OUR
INTERNATIONAL ACTIVITIES.</B> </P>
<P ALIGN="JUSTIFY">Our business currently depends in large part on our
activities in Europe and other foreign markets. Sales to markets outside of the
United States accounted for approximately 14% of our sales for the three months
ended September 30, 2003 and 10% for the three months ended September 30, 2002.
Sales to markets outside of the United States accounted for approximately 21% of
our sales for the nine months ended September 30, 2003 and 15% for the nine
months ended September 30, 2002.</P>
<P ALIGN="JUSTIFY">We are subject to a number of challenges that specifically
relate to our international business activities. These challenges include:</P>

<UL>
<LI>failure of local laws to provide the same degree of protection against
infringement of our intellectual property; </LI>
<LI>protectionist laws and business practices that favor local competitors,
which could slow our growth in international markets; </LI>
<LI>the risks associated with foreign currency exchange rate fluctuation; </LI>
<LI>the expense of establishing facilities and operations in new foreign
markets; and </LI>
<LI>building an organization capable of supporting geographically dispersed
operations. </LI></UL>

<P ALIGN="JUSTIFY">Currently, a majority of our international sales are
denominated in United States dollars. As a result, an increase in the value of
the United States dollar relative to foreign currencies could make our products
less competitive in international markets. If we are unable to meet and overcome
these challenges, our international operations may not be successful, which
would limit the growth of our business.</P>
<B><P ALIGN="JUSTIFY">TERMINATION OF RELATIONSHIPS WITH FORMER DISTRIBUTORS OF
COMPUTER MOTION COULD RESULT IN LITIGATION.</P>
</B><P ALIGN="JUSTIFY">Our integration strategy related to our acquisition of
Computer Motion provides that we terminate Computer Motion's relationships with
a number of companies that served as Computer Motion's distributors prior to the
acquisition.  Several of these former distributors have informed us that they
believe that they are entitled to compensation in connection with such
termination.  We may be unable to resolve these claims without litigation.  Due
to the inherent uncertainties of litigation, we cannot accurately predict the
ultimate outcome of any such litigation at this time and, therefore, cannot
estimate the range of possible loss.  If we sue or are sued by any of Computer
Motion's former distributors, these proceddings could be expensive to litgate,
may be protracted and Comptuer Motion's confidential information may be
compromised.  Whether or not we are successful in these lawsuits, these
proceedings could consume substantial amounts of our financial and managerial
resources.</P>
<B><P>THE CONVICTION OF ARTHUR ANDERSEN LLP ON OBSTRUCTION OF JUSTICE CHARGES
MAY ADVERSELY AFFECT ARTHUR ANDERSEN'S ABILITY TO SATISFY CLAIMS ARISING FROM
THE PROVISION OF AUDITING SERVICES TO COMPUTER MOTION. </P>
</B><P ALIGN="JUSTIFY">Arthur Andersen LLP audited Computer Motion's financial
statements for the years ended December 31, 2001 and December 31, 2000. On March
14, 2002, an indictment was unsealed charging Arthur Andersen with federal
obstruction of justice arising from the government's investigation of Enron
Corp. On June 15, 2002, Arthur Andersen was convicted of these charges. The
impact of this conviction on Arthur Andersen's financial condition may adversely
affect the ability of Arthur Andersen to satisfy any claims arising from its
provision of auditing services to Computer Motion.</P>

<B><P><A NAME="market"></A>ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK</P>
</B><P ALIGN="JUSTIFY">We are not subject to any meaningful market risks related
to currency, commodity prices or similar matters. We are sensitive to short-term
interest rate fluctuations to the extent that such fluctuations impact the
interest income we receive on the investment of the remaining proceeds from our
public offerings. </P>
<P ALIGN="JUSTIFY">The primary objective of our investment activities is to
preserve principal while at the same time maximizing the income we receive from
our investments without significantly increasing risk. Some of the securities
that we invest in may have market risk. This means that a change in prevailing
interest rates may cause the principal amount of the investment to fluctuate.
For example, if we hold a security that was issued with a fixed interest rate at
the then-prevailing rate and the prevailing interest rate later rises, the
principal amount of our investment will probably decline. To minimize this risk
in the future, we intend to maintain our portfolio of cash equivalents and
short-term investments in a variety of securities. We classify our cash
equivalents and marketable securities as "fixed-rate" if the rate of return on
such instruments remains fixed over their term. These "fixed-rate" investments
include commercial paper and government and non-government debt securities. We
classify our cash equivalents and marketable securities as "variable-rate" if
the rate of return on such investments varies based on the change in a
predetermined index or set of indices during their term. These "variable-rate"
investments primarily include money market accounts. The average time to
maturity of all of our investments as of September 30, 2003 was approximately
1.69 years.  At September 30, 2003, approximately 11% of our investment
portfolio was composed of investments with original maturities of one year or
less. </P>
<B><P ALIGN="JUSTIFY"><A NAME="control"></A>ITEM 4. CONTROLS AND PROCEDURES</P>
</B><P ALIGN="JUSTIFY">We maintain disclosure controls and procedures that are
designed to ensure that information required to be disclosed in our Exchange Act
reports is recorded, processed, summarized and reported within the time periods
specified in the Securities and Exchange Commission's rules and forms and that
such information is accumulated and communicated to our management, including
our Chief Executive Officer and Chief Financial Officer, as appropriate, to
allow for timely decisions regarding required disclosure. In designing and
evaluating the disclosure controls and procedures, management recognizes that
any controls and procedures, no matter how well designed and operated, can
provide only reasonable assurance of achieving the desired control objectives,
and management is required to apply its judgment in evaluating the cost-benefit
relationship of possible controls and procedures.  </P>
<P ALIGN="JUSTIFY">As required by SEC Rule 13a-15(b), we carried out an
evaluation, under the supervision and with the participation of our management,
including our Chief Executive Officer and Chief Financial Officer, of the
effectiveness of the design and operation of our disclosure controls and
procedures as of the end of the quarter covered by this report.&nbsp; Based on
the foregoing, our Chief Executive Officer and Chief Financial Officer concluded
that our disclosure controls and procedures were effective at the reasonable
assurance level. </P>
<P ALIGN="JUSTIFY">There has been no change in our internal controls over
financial reporting during our most recent fiscal quarter that has materially
affected, or is reasonably likely to materially affect, our internal controls
over financial reporting.</P>
<B><P ALIGN="CENTER">PART II. - OTHER INFORMATION </P>
<P><A NAME="item1"></A>ITEM 1. LEGAL PROCEEDINGS</P>
</B><P>BROOKHILL-WILK 1, LLC</P>
<P ALIGN="JUSTIFY">In September 2000, Brookhill-Wilk 1, LLC, or Wilk, filed a
lawsuit against Intuitive Surgical in the United States District Court for the
Southern District of New York (Case No. 00 Civ. 6599 (NRB)) alleging that by
making, using, selling or offering for sale our <I>da Vinci</I> Surgical System,
we are infringing United States Patent Nos. 5,217,003 and 5,368,015 in willful
disregard of Wilk's patent rights. These patents concern methods and devices for
"remote" surgery. In March 2001, Wilk withdrew its assertion of infringement of
the '015 patent against our Company. In November 2001, in response to a motion
on one of Intuitive Surgical's noninfringement defenses, the District Court
granted summary judgment of noninfringement of the '003 patent in our favor and
dismissed Wilk's complaint in its entirety without prejudice. Wilk appealed the
summary judgment ruling to the U.S. Court of Appeals for the Federal Circuit.
In April 2003, the Court of Appeals reversed the District Court's judgment and
remanded the case for further proceedings. This reversal is based on the Court
of Appeals' determination that the particular claim limitation at issue should
be interpreted differently than as construed by the District Court.</P>
<P ALIGN="JUSTIFY">Upon remand, we intend to continue to vigorously defend our
rights and, if necessary, are prepared to continue to conduct discovery and file
further motions on whether the patent is infringed, valid and/or enforceable. We
believe that we have multiple meritorious defenses to Wilk's allegations.
However, litigation is unpredictable and we may not prevail. Both parties have
expressed a desire to engage in non-binding mediation before engaging in further
proceedings in the District Court.  The District Court has not yet set a
schedule for further proceedings if mediation is unsuccessful.</P>
<P ALIGN="JUSTIFY">In July 2003, Wilk filed a new lawsuit against three of
Intuitive Surgical's customers: Mt. Sinai Hospital, Lenox Hill Hospital and the
New York and Presbyterian Hospital.  Pursuant to agreements with those
customers, the Company is defending the lawsuit on behalf of its customers.  The
Company does not expect this lawsuit to significantly impact the scope of the
existing litigation with Wilk since any resolution of the existing Wilk
litigation, whether on the merits or by settlement, will likely resolve this new
lawsuit at the same time.</P>
<P ALIGN="JUSTIFY">In September 2003, Wilk amended its complaint against
Intuitive Surgical to include Computer Motion within the lawsuit and to allege
that Computer Motion's Zeus product also infringes Wilk's '003 patent.  Prior to
the Company's acquisition of Computer Motion, Wilk sued Computer Motion but
dismissed that lawsuit voluntarily in order to await the outcome of the appeal
proceedings in Wilk's litigation with Intuitive Surgical.  Intuitive Surgical
believes that it has multiple meritorious defenses to Wilk's allegations against
Computer Motion, including many of the same defenses that apply to Wilk's
allegations against Intuitive Surgical.  However, litigation is unpredictable
and Intuitive Surgical may not prevail. Wilk's allegations against Computer
Motion are directed only to Computer Motion products.</P>
<P ALIGN="JUSTIFY">If we lose Wilk's suit against us and the three hospital
customers, it will hurt our competitive position, may be costly to us and may
prevent us from selling our products. If we lose the patent suit, we may need to
obtain from Wilk a license to this technology if we are to continue to market
our products that have been found to infringe Wilk's patents. This license could
be expensive, which could seriously harm our business. If Wilk is successful in
its suit against us and is unwilling to grant us a license, we may be required
to stop selling our products that are found to infringe Wilk's patents unless we
can redesign them so they do not infringe Wilk's patents, which we may be unable
to do. In addition, we could be required to pay Wilk damages, including treble
damages, which could be substantial and harm our financial position. Due to the
inherent uncertainties of litigation, however, the Company cannot accurately
predict the ultimate outcome of the Wilk litigation at this time and, therefore,
cannot estimate the range of possible loss. </P>
<P ALIGN="JUSTIFY">OTHER LEGAL MATTERS</P>
<P ALIGN="JUSTIFY">In September 2002, we discovered that one of our employees
had purchased approximately $0.9 million in administrative supplies without the
authorization or knowledge of the Company's management. This matter was
investigated by law enforcement authorities and Company advisors. We have since
terminated this employee's employment and have taken actions intended to ensure
that no similar incidents can occur in the future, including implementing
additional controls relating to our cash disbursement process. In addition, we
are seeking to recover our loss. We have filed a claim with our insurance
carrier, from which we received proceeds of $0.5 million, and filed suit against
the sellers of the administrative supplies in December 2002. Our complaint
alleged that each of the defendants has (i) violated various sections of the
Racketeer Influenced and Corrupt Organization, or RICO, Act through their
extortion, coercion, intimidation, fraud, bribery and racketeering activity in
connection with the unauthorized purchase of office supplies, and (ii) committed
unlawful business acts and practices in violation of Cal. Bus. &amp; Prof. Code
Section 17200 et seq. Our suit seeks to recover actual and treble damages, costs
and attorney fees for the damage caused by each of defendants through their
illegal conduct. In January 2003, we amended our complaint to allege that each
defendant further unlawfully offered prizes and gifts in violation of Cal. Bus.
&amp; Prof. Code Section 17537 and unlawfully failed to advertise limitations on
the quantity of its sales in violation of Cal. Bus. &amp; Prof. Code Section
17500.5. The amended complaint reiterates our claim to recover actual and treble
damages, costs and attorney fees. Discovery has not yet begun.  Defendants have
demurred to the complaint, alleging that the complaint does not contain
sufficiently pled information to support each of Intuitive's causes of action.
The Court will resolve the demurrer before the case continues.</P>
<P ALIGN="JUSTIFY">During the second quarter of 2003, two former patients of The
Valley Hospital in New Jersey filed suit against The Valley Hospital, their
surgeons and our company alleging various harms caused during their surgeries.
Intuitive was named because the <I>da Vinci</I> Surgical System was utilized for
a portion of the surgeries and the detachable tip of an <I>EndoWrist</I>
instrument is alleged to have remained in each patient after each surgery.  Each
suit alleges, among other things, negligence, carelessness and/or recklessness
by each defendant, that the <I>da Vinci</I> Surgical System was defectively
designed and manufactured, that Intuitive failed to properly instruct and train
the surgeons in its use, and that the defendants failed to properly apprise the
patients of the risks involved.  Each suit seeks an unspecified amount of
general, special and punitive damages from the defendants, in addition to a
request to recover the costs of suit and attorney fees.  As each suit was just
recently filed, both are in very early stages and discovery has recently
commenced.</P>
<P ALIGN="JUSTIFY">We are subject to legal proceedings and claims that arise in
the normal course of our business. We do not know whether we will prevail in
these matters nor can we assure that any remedy could be reached on commercially
viable terms, if at all. Due to the inherent uncertainties of litigation, we
cannot accurately predict the ultimate outcome of these matters at this time
and, therefore, cannot estimate the range of possible loss.</P>
<B><P><A NAME="item2"></A>ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS</P>
</B><P>None.</P>
<B><P><A NAME="item3"></A>ITEM 3. DEFAULTS UPON SENIOR SECURITIES</P>
</B><P ALIGN="JUSTIFY">None. </P>
<B><P><A NAME="item4"></A>ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY
HOLDERS</P>
</B><P> None.</P>
<B><P ALIGN="JUSTIFY"><A NAME="item5"></A>ITEM 5. OTHER INFORMATION</P>
</B><P ALIGN="JUSTIFY">None. </P>
<P ALIGN="JUSTIFY"> <A NAME="item6"></A><B>ITEM 6. EXHIBITS AND REPORTS ON FORM
8-K</P>
</B><P ALIGN="JUSTIFY">(a) Exhibits. </P></FONT>
<TABLE CELLSPACING=0 BORDER=0 CELLPADDING=7 WIDTH=600>
<TR><TD WIDTH="14%" VALIGN="BOTTOM">
<B><FONT SIZE=2><P ALIGN="CENTER">Exhibit Number</B></FONT></TD>
<TD WIDTH="86%" VALIGN="BOTTOM">
<B><FONT SIZE=2><P>Description</B></FONT></TD>
</TR>
<TR><TD WIDTH="14%" VALIGN="TOP">
<FONT SIZE=2><P ALIGN="CENTER">31</FONT></TD>
<TD WIDTH="86%" VALIGN="TOP">
<FONT SIZE=2><P>Certifications of the Company's Chief Executive Officer and
Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.</FONT></TD>
</TR>
<TR><TD WIDTH="14%" VALIGN="TOP">
<FONT SIZE=2><P ALIGN="CENTER">32</FONT></TD>
<TD WIDTH="86%" VALIGN="TOP">
<FONT SIZE=2><P>Certifications of the Company's Chief Executive Officer and
Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of
2002</FONT></TD>
</TR>
</TABLE>

<FONT SIZE=2><P>__________ </P>
<P ALIGN="JUSTIFY">&nbsp;(b) Reports on Form 8-K. </P>
<P ALIGN="JUSTIFY">On July 15, 2003, we filed a current report on Form 8-K
announcing the completion of our merger with Computer Motion, Inc.</P>
<P ALIGN="JUSTIFY">On August 7, 2003, we furnished a current report on Form 8-K
announcing our second quarter 2003 financial results.</P>
<P><BR>
<BR>
</P>
<P><HR WIDTH="85%"></P>
<P ALIGN="CENTER"><BR>
<BR>
</P>
<B><P ALIGN="CENTER"><A NAME="sign"></A>SIGNATURE</P>
</B><P>Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized. </P></FONT>

<TABLE CELLSPACING=0 BORDER=0 WIDTH=624>

<TR><TD WIDTH="35%" VALIGN="MIDDLE">
<FONT SIZE=2><P>&nbsp;</FONT></TD>
<TD WIDTH="65%" VALIGN="MIDDLE" COLSPAN=2>
<FONT SIZE=2><P>INTUITIVE SURGICAL, INC. </FONT></TD>
</TR>
<TR><TD WIDTH="35%" VALIGN="MIDDLE">
<FONT SIZE=2><P>&nbsp;</FONT></TD>
<TD WIDTH="65%" VALIGN="MIDDLE" COLSPAN=2>
<I><FONT SIZE=2><P>(Registrant)</I> </FONT></TD>
</TR>
<TR><TD WIDTH="35%" VALIGN="MIDDLE">
<FONT SIZE=2><P>&nbsp;</FONT></TD>
<TD WIDTH="5%" VALIGN="MIDDLE">
<U><FONT SIZE=2><P>By:&nbsp;</U></FONT></TD>
<TD WIDTH="60%" VALIGN="MIDDLE">
<U><FONT SIZE=2><P>/s/ SUSAN K. BARNES </U></FONT></TD>
</TR>
<TR><TD WIDTH="35%" VALIGN="MIDDLE">
<FONT SIZE=2><P>&nbsp;</FONT></TD>
<TD WIDTH="65%" VALIGN="MIDDLE" COLSPAN=2>
<FONT SIZE=2><P>Susan K. Barnes </FONT></TD>
</TR>
<TR><TD WIDTH="35%" VALIGN="MIDDLE">
<FONT SIZE=2><P>&nbsp;</FONT></TD>
<TD WIDTH="65%" VALIGN="MIDDLE" COLSPAN=2>
<I><FONT SIZE=2><P>Senior Vice President, Chief Financial Officer and Assistant
Secretary </P>
</I></FONT></TD>
</TR>
</TABLE>

<FONT SIZE=2><P>Date: November 14, 2003 </P>
<P><BR>
<BR>
</P>
<P>&nbsp;</P>
<P><BR>
<BR>
</P>
<P><HR WIDTH="85%"></P>
<P>&nbsp;</P>
<P><BR>
</P>
<B><P ALIGN="CENTER">EXHIBIT INDEX </P></B></FONT>
<P ALIGN="CENTER"><CENTER><TABLE CELLSPACING=0 BORDER=0 CELLPADDING=7 WIDTH=611>
<TR><TD WIDTH="14%" VALIGN="BOTTOM">
<B><FONT SIZE=2><P ALIGN="CENTER">Exhibit Number</B></FONT></TD>
<TD WIDTH="86%" VALIGN="BOTTOM">
<B><FONT SIZE=2><P>Description</B></FONT></TD>
</TR>
<TR><TD WIDTH="14%" VALIGN="TOP">
<FONT SIZE=2><P ALIGN="CENTER">31</FONT></TD>
<TD WIDTH="86%" VALIGN="TOP">
<FONT SIZE=2><A HREF="exh31.htm"><P>Certifications of the Company's Chief Executive Officer and
Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.</A></FONT></TD>
</TR>
<TR><TD WIDTH="14%" VALIGN="TOP">
<FONT SIZE=2><P ALIGN="CENTER">32</FONT></TD>
<TD WIDTH="86%" VALIGN="TOP">
<FONT SIZE=2><A HREF="exh32.htm"><P>Certifications of the Company's Chief Executive Officer and
Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of
2002</A></FONT></TD>
</TR>
</TABLE>
</CENTER></P>

<br>
<br>
<br>
<HR WIDTH="85%">
<br>
<br>
<br>

</BODY>
</HTML>
{"company-data": {"conformed-name": "INTUITIVE SURGICAL INC", "cik": "0001035267", "assigned-sic": "3842", "irs-number": "770416458", "state-of-incorporation": "DE", "fiscal-year-end": "1231"}, "filing-values": {"form-type": "10-Q", "act": "34", "file-number": "000-30713", "film-number": "031003455"}, "business-address": {"street1": "950 KIFER ROAD", "city": "SUNNYVALE", "state": "CA", "zip": "94086", "phone": "4085232100"}, "mail-address": {"street1": "950 KIFER ROAD", "city": "SUNNYVALE", "state": "CA", "zip": "94086"}}
Q3 2003 10Q DOC
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR
     15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2003
OR
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR
  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For 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)
950 Kifer Road
Sunnyvale, California      94086
(Address of Principal Executive Offices including Zip Code)
(408) 523-2100
(Registrant's Telephone Number, Including Area Code)
Indicate 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 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file reports), and (2) has been subject to such filing
requirements for the past 90 days.    YES
x
NO
o
Indicate by check mark whether the registrant is an accelerated filer (as defined
in Rule 12b-2 of the Exchange Act).    YES
x
NO
o
The Registrant had 32,212,144 shares of Common Stock, $0.001 par value per
share, outstanding as of November 5, 2003.
Intuitive Surgical, Inc.
TABLE OF CONTENTS
PART I.   FINANCIAL INFORMATION
Page No.
Item 1. Financial Statements (Unaudited):
Condensed consolidated balance sheets as of September 30, 2003 and
December 31, 2002
1
Condensed consolidated statements of operations for the three-month
and nine-month periods ended September 30, 2003 and September 30, 2002
2
Condensed consolidated statements of cash flows for the nine-month
periods ended September 30, 2003 and September 30, 2002
3
Notes to condensed consolidated financial statements
4
Item 2.   Management's Discussion and Analysis of Financial
                      Condition and Results of Operations
11
Item 3.   Quantitative and Qualitative Disclosures About Market Risk
26
Item 4.   Controls and Procedures
26
PART II.  OTHER INFORMATION
Item 1.  Legal Proceedings
27
Item 2.   Changes in Securities and Use of Proceeds
28
Item 3.  Defaults Upon Senior Securities
28
Item 4.  Submission of Matters to a Vote of Security Holders
28
Item 5.  Other Information
29
Item 6.   Exhibits and Reports on Form 8-K
29
Signatures
29
PART I -- FINANCIAL INFORMATION
Item 1. Financial Statements
INTUITIVE SURGICAL, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
September 30,December 31,
                                                               2003          2002
                                                           ------------  -----------
                                                           (Unaudited)   (See Note 1)
                        ASSETS
Current assets:
  Cash and cash equivalents.............................. $     12,478  $    17,607
  Short-term investments.................................       22,971       33,232
  Trade receivables, net.................................       23,656       16,887
  Inventory, net.........................................       12,746        8,738
  Prepaid expenses.......................................        2,983        1,912
                                                           ------------  -----------
          Total current assets...........................       74,834       78,376
Property and equipment, net..............................       10,688       10,388
Intangible assets, net...................................        9,917        2,568
Goodwill.................................................      142,995           --
Other assets.............................................          330          249
                                                           ------------  -----------
          Total assets...................................      238,764       91,581
                                                           ============  ===========
         LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
  Accounts payable....................................... $     11,420  $     9,282
  Accrued compensation and employee benefits.............        5,248        4,666
  Warranty accrual.......................................        1,331        2,269
  Restructuring accrual..................................        1,332           --
  Other accrued liabilities..............................        2,629        3,497
  Deferred revenue.......................................        8,824        4,638
  Current portion of notes payable.......................        1,156        1,511
                                                           ------------  -----------
          Total current liabilities......................       31,940       25,863
Long-term notes payable..................................          950        1,838
Deferred revenue.........................................        1,227          200
Commitments and contingencies............................           --           --
Stockholders' equity:
  Preferred stock, 2,500,000 shares authorized, $0.001
     par value, issuable in series; no shares issued
     and outstanding as of September 30, 2003 and
     and December 31, 2002, respectively.................           --           --
  Common stock, 100,000,000 shares authorized, $0.001
     par value, 27,152,326 and 18,357,513 shares
     issued and outstanding as of September 30, 2003
     and December 31, 2002, respectively.................           27           18
  Additional paid-in capital.............................      337,738      191,038
  Deferred compensation..................................         (375)        (223)
  Accumulated deficit....................................     (133,559)    (128,791)
  Accumulated other comprehensive income ................          816        1,638
                                                           ------------  -----------
          Total stockholders' equity.....................      204,647       63,680
                                                           ------------  -----------
          Total liabilities and stockholders' equity..... $    238,764  $    91,581
                                                           ============  ===========
See accompanying notes to condensed consolidated financial statements.
INTUITIVE SURGICAL, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Three Months Ended      Nine Months Ended
                                                     September 30,           September 30,
                                               ----------------------  ----------------------
                                                  2003        2002        2003        2002
                                               ---------- -----------  ---------- -----------
Sales:
  Products................................... $   20,651  $   15,723  $   57,317  $   47,424
  Services...................................      2,742       1,358       6,764       3,453
                                               ----------  ----------  ----------  ----------
Total sales..................................     23,393      17,081      64,081      50,877
Cost of sales:
  Products...................................      9,398       7,499      24,075      22,666
  Services...................................      1,009         841       2,976       2,406
                                               ----------  ----------  ----------  ----------
Total cost of sales..........................     10,407       8,340      27,051      25,072
                                               ----------  ----------  ----------  ----------
    Gross profit.............................     12,986       8,741      37,030      25,805
                                               ----------  ----------  ----------  ----------
Operating costs and expenses:
  Selling, general, and administrative.......     12,242      11,693      31,840      30,262
  Research and development...................      4,407       3,890      11,457      12,767
                                               ----------  ----------  ----------  ----------
    Total operating costs and
     expenses................................     16,649      15,583      43,297      43,029
                                               ----------  ----------  ----------  ----------
Loss from operations.........................     (3,663)     (6,842)     (6,267)    (17,224)
Other income, net ...........................        310         378       1,499       1,403
                                               ----------  ----------  ----------  ----------
Net loss..................................... $   (3,353) $   (6,464) $   (4,768) $  (15,821)
                                               ==========  ==========  ==========  ==========

Basic and diluted net loss per common share . $    (0.12) $    (0.35) $    (0.22) $    (0.87)
                                               ==========  ==========  ==========  ==========
Shares used in computing basic and diluted
  net loss per common share..................     26,878      18,250      21,296      18,199
                                               ==========  ==========  ==========  ==========
See accompanying notes to condensed consolidated financial statements.
INTUITIVE SURGICAL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(IN THOUSANDS)
For the Nine Months
                                                             Ended September 30,
                                                         ------------------------
                                                            2003         2002
                                                         -----------  -----------
OPERATING ACTIVITIES:
Net loss............................................... $    (4,768) $   (15,821)
Adjustments to reconcile net loss to net cash used in
  operating activities:
  Depreciation.........................................       3,021        2,247
  Loss on sales of fixed assets........................           5           64
  Amortization of deferred compensation and stock
    compensation.......................................         379          543
  Amortization/Impairment of intangible assets.........       1,350          584
Changes in operating assets and liabilities:
  Trade receivable.....................................      (2,294)      (5,796)
  Prepaid expenses.....................................        (823)       1,106
  Inventory............................................         664       (3,689)
  Other assets.........................................          11           --
  Accounts payable.....................................      (5,754)         799
  Accrued compensation and employee benefits...........      (1,477)       1,520
  Warranty accrual.....................................      (1,238)         648
  Restructuring accrual................................      (2,112)          --
  Other accrued liabilities............................        (868)       1,530
  Accrued royalty expense..............................          --       (1,000)
  Deferred revenue.....................................       2,987          645
                                                         -----------  -----------
Net cash used in operating activities..................     (10,917)     (16,620)
                                                         -----------  -----------
INVESTING ACTIVITIES:
Acquisition of property and equipment..................      (1,914)      (5,228)
Disposition of property and equipment..................         192           62
Acquisition of business, net of cash acquired..........      (5,861)          --
Purchase of short-term investments.....................      (5,966)     (11,527)
Proceeds from sales of short-term investments..........      10,674       21,216
Proceeds from maturities of short-term investments.....       4,899       17,167
                                                         -----------  -----------
Net cash provided by investing activities..............       2,024       21,690
                                                         -----------  -----------
FINANCING ACTIVITIES:
Proceeds from issuance of common stock.................       5,181        1,948
Repurchase of common stock.............................          (6)          (1)
Proceeds from notes payable............................          --        2,338
Repayment of notes payable.............................      (1,243)      (1,562)
                                                         -----------  -----------
Net cash provided by financing activities..............       3,932        2,723
                                                         -----------  -----------
Foreign currency translation adjustments...............        (168)          60
                                                         -----------  -----------
Net increase (decrease) in cash and cash equivalents...      (5,129)       7,853
Cash and cash equivalents, beginning of period.........      17,607       10,487
                                                         -----------  -----------
Cash and cash equivalents, end of period............... $    12,478  $    18,340
                                                         ===========  ===========

Non-cash investing activity:
  Common stock issued in connection with acquisition of
    business........................................... $   141,437  $        --
See accompanying notes to condensed consolidated financial statements.
INTUITIVE SURGICAL, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
In this report, "Intuitive Surgical, " "Intuitive,"
and the "Company" refer to Intuitive Surgical, Inc.
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The accompanying unaudited condensed consolidated
financial statements have been prepared in accordance with generally accepted
accounting principles for interim financial information and with the
instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do
not include all of the information and notes required by accounting principles
generally accepted in the United States for complete financial statements. In
the opinion of management, all normal, recurring adjustments considered
necessary for a fair presentation have been included. The consolidated balances
at December 31, 2002 were derived from the audited financial statements included
in  Intuitive Surgical, Inc.'s Annual Report on Form 10-K/A for the year ended
December 31, 2002, or the Annual Report. The financial statements should be read
in conjunction with the audited financial statements for the year ended December
31, 2002, included in the Annual Report. The results for the interim period
ended September 30, 2003 are not necessarily indicative of the results to be
expected for the full year ending December 31, 2003 or future operating periods.
Certain reclassifications have been made to prior year balances in order to
conform to the current year presentation.
On June 30, 2003, Intuitive Surgical acquired Computer
Motion, Inc. through the merger of Computer Motion with a wholly owned
subsidiary of Intuitive Surgical.  In the merger, each outstanding share of
Computer Motion common stock was converted into 0.51426943 shares of Intuitive
Surgical common stock and Intuitive Surgical assumed all of Computer Motion's
outstanding options and warrants based on the same ratio. See "Note 3:
Acquisition of Computer Motion, Inc."
In accordance with Statement of Financial Accounting
Standards ("SFAS") No. 141, "Business Combinations," Intuitive Surgical, Inc.
has included in its results of operations the results of Computer Motion, Inc.
from its date of acquisition, June 30, 2003.
Revenue Recognition
The Company recognizes revenue when persuasive
evidence of an arrangement exists, delivery has occurred or service has been
rendered, the price is fixed or determinable and collectibility is reasonably
assured.
In certain cases, revenue from direct system sales is
generated from multiple-element arrangements that require judgment in the areas
of customer acceptance, collectibility, the separability of units of accounting,
and the fair value of individual elements.  Effective July 1, 2003, the Company
adopted the provisions of Emerging Issues Task Force, or EITF, Issue No. 00-21,
"Revenue Arrangements with Multiple Deliverables" on a prospective
basis.  The principles and guidance outlined in EITF 00-21 provide a framework
to (a) determine whether an arrangement involving multiple deliverables contains
more than one unit of accounting, and (b) determine how the arrangement
consideration should be measured and allocated to the separate units of
accounting in the arrangement. The Company determined that its multiple-element
arrangements are generally comprised of the following elements that would
qualify as separate units of accounting: system sales, service, installation,
and training.  Each of these elements represent individual units of accounting
as the delivered item has value to a customer on a stand-alone basis, objective
and reliable evidence of fair value exists for undelivered items, and
arrangements generally do not contain a general right of return relative to the
delivered item.  The Company determines fair value based on the price of the
deliverable when it is sold separately or based on third-party evidence.  In
accordance with the guidance in EITF 00-21, the Company uses the residual method
to allocate the arrangement consideration when it does not have fair value of
the system sale.  Under the residual method, the amount of consideration
allocated to the delivered item equals the total arrangement consideration less
the aggregate fair value of the undelivered items.  Assuming all other criteria
for revenue recognition have been met, the Company recognizes revenue for system
sales when delivery and acceptance occurs, for installation and training when
the services are rendered, and for service ratably over the service period,
which is generally one year.
Upon adoption of the provisions of EITF 00-21, the Company
deferred approximately $1.7 million of revenue related to the fair value of the
first year service for system sales delivered during the third quarter of 2003.
This amount will be recognized as service revenue on a straight-line basis over
the related service period, which is generally one year.  Previously, in
accordance with Staff Accounting Bulletin No. 101, "Revenue Recognition in
Financial Statements," the Company accrued costs associated with these
arrangements as warranty expense in the period the system was delivered and
accepted.
The Company's distributors do not have price protection
rights. One of the Company's distributors has return rights under limited
circumstances. Such rights are accounted for under the provisions of SFAS No.
48, "Revenue Recognition When Right of Return Exists."
Revenue from sales of instruments and accessories is
recognized upon delivery. Revenue related to future commitments under separately
priced service contracts is deferred and recognized ratably over the service
period. All costs associated with the provision of service and maintenance,
including salaries, benefits, travel, spare parts and equipment, are recognized
in cost of sales as incurred.
Amounts billed in excess of revenue recognized are included
as deferred revenue in the condensed consolidated balance sheets.
The Company's
da Vinci
Surgical System,
Hermes
Control Center and
AESOP
Endoscope Positioner contain a software
component. The Company believes that this software element is an incidental part
of each system. The software element within the Company's products is not sold
or marketed separately to customers, and the software does not operate
independently of each system. Furthermore, the software development effort does
not require a significant cost to the Company relative to the overall
development cost of the product. As such, the software the Company provides is
incidental to each system as a whole and the software revenue guidance provided
in SOP 97-2 is not applicable to the Company's revenues.
Stock-Based Compensation
The Company applies Accounting Principles Board, or
APB, Opinion No. 25, "Accounting for Stock Issued to Employees," and related
interpretations in accounting for its stock option plans. Accordingly, no
compensation expense has been recorded for stock option grants issued with an
exercise price equal to the market value of the underlying stock on the date
granted.  The Company has recorded stock-based compensation, primarily related
to deferred compensation arising from the Company's initial public offering in
2000 and its acquisition of Computer Motion in June 2003.  As required under
Statement of Financial Accounting Standards Board, or SFAS, No. 148, "Accounting
for Stock-Based Compensation - Transition and Disclosure," the Company has
provided the following pro forma net loss and pro forma net loss per share
disclosures for stock-based awards as if the fair value-based method defined in
SFAS 123, "Accounting for Stock-Based Compensation," had been applied (amounts
in thousands, except per share amounts):
Three Months Ended   Nine Months Ended
                                                    September 30,       September 30,
                                                 ------------------  -------------------
                                                   2003      2002      2003       2002
                                                 --------  --------  ---------  --------
Net loss, as reported.......................... $ (3,353) $ (6,464) $  (4,768) $(15,821)
Add:  Total stock-based employee
  compensation expense included in reported
  net loss, net of $0 related tax effect.......       83       148        379       543
Deduct: Total stock-based employee
  compensation expense determined
  under fair value based method for
  all awards, net of $0 related tax effect.....   (2,123)   (1,875)    (6,107)   (5,370)
                                                 --------  --------  ---------  --------
Pro forma net loss............................. $ (5,393) $ (8,191) $ (10,496) $(20,648)
                                                 ========  ========  =========  ========

Loss per share:
  Basic and diluted - as reported.............. $  (0.12) $  (0.35) $   (0.22) $  (0.87)
  Basic and diluted - pro forma................ $  (0.20) $  (0.45) $   (0.49) $  (1.13)
The fair value for each stock option award granted was estimated at the date
of grant using the Black-Scholes option-pricing model, assuming no expected
dividends and the following weighted average assumptions:
Three Months Ended     Nine Months Ended
                                         September 30,         September 30,
                                     -------------------   --------------------
                                        2003       2002       2003       2002
                                     ---------  --------   ---------  ---------
Stock Option Plans:
   Average risk free interest rate.     2.52 %    3.90 %      2.51 %     3.90 %
   Average expected life (years)...      4.0       4.0         4.0        4.0
   Volatility......................       80 %      80 %        80 %       80 %

Stock Purchase Plan:
   Average risk free interest rate.     1.21 %    1.71 %      1.48 %     1.71 %
   Average expected life (years)...      0.5       0.5         0.5        0.5
   Volatility......................       48 %      48 %        48 %       48 %
Recent Accounting Pronouncements
In June 2002, the FASB issued SFAS 146, "Accounting
for Costs Associated with Exit or Disposal Activities," which addresses
accounting for restructuring, discontinued operation, plant closing, or other
exit or disposal activity. SFAS 146 requires companies to recognize costs
associated with exit or disposal activities when they are incurred rather than
at the date of a commitment to an exit or disposal plan. The provisions of SFAS
146 are effective for exit or disposal activities that are initiated after
December 31, 2002. Since SFAS 146 does not involve an entity newly acquired in a
business combination, the restructuring accrual, recorded as a component of the
purchase price in connection with the acquisition of Computer Motion (Note 3),
was established based on the provisions of EITF Issue No. 95-3,
"Recognition of Liabilities in Connection with a Purchase Business
Combination" and, therefore, SFAS 146 has not had an impact on the
Company's results of operations or financial position during the nine months
ended September 30, 2003.
In January 2003, the FASB issued Interpretation No. 46, or
FIN 46, "Consolidation of Variable Interest Entities." FIN 46 requires a
variable interest entity to be consolidated by a company if that company is
subject to a majority of the risk of loss from the variable interest entity's
activities or entitled to receive a majority of the entity's residual returns or
both. A variable interest entity is a corporation, partnership, trust, or any
other legal structures used for business purposes that either (a) does not have
equity investors with voting rights, or (b) has equity investors that do not
provide sufficient financial resources for the entity to support its activities.
A variable interest entity often holds financial assets, including loans or
receivables, real estate or other property. A variable interest entity may be
essentially passive or it may engage in research and development or other
activities on behalf of another company. The consolidation requirements of FIN
46 apply immediately to variable interest entities created after January 31,
2003. FIN 46 also requires consolidation of variable interest entities entered
into prior to January 31, 2003 in the first fiscal year or interim period
beginning after June 15, 2003.  However, the FASB issued a subsequent FASB Staff
position that delays this requirement until the end of the first interim or
annual period ending after December 15, 2003. Certain of the disclosure
requirements apply to all financial statements issued after January 31, 2003,
regardless of when the variable interest entity was established. The adoption of
FIN 46 has not had an impact on the Company's financial position or results of
operations during the nine months ended September 30, 2003. The Company is
currently evaluating the possible impact of the adoption of FIN 46 for potential
variable interest entities entered into prior to January 31, 2003.
In October 2002, the Emerging Issues Task Force reached
consensus on issue 00-21, or EITF 00-21, "Revenue Arrangements with Multiple
Deliverables." The principles and application guidance of EITF 00-21 should be
used to determine (a) how the arrangement consideration should be measured, (b)
whether the arrangement should be divided into separate units of accounting, and
(c) how the arrangement consideration should be allocated among the separate
units of accounting. The guidance in this issue is effective for revenue
arrangements entered into in fiscal periods beginning after June 15, 2003.
Effective July 1, 2003, the Company prospectively adopted the provisions of EITF
00-21.
NOTE 2. CONCENTRATIONS OF RISK
Financial instruments which subject the Company to
potential risk consist of its cash equivalents, short-term investments, accounts
receivable, and foreign exchange contracts. The counterparties to the agreements
relating to the Company's investment securities and foreign exchange contracts
consist of various major corporations and financial institutions of high credit
standing. The Company believes the financial risks associated with these
financial instruments are minimal. For the nine months ended September 30, 2003
and 2002, no customer accounted for more than 10% of total sales. The Company
extends reasonably short collection terms but does not require collateral. The
Company provides reserves for potential credit losses but has not experienced
significant losses to date.
The Company's
da Vinci
Surgical System,
Hermes
Control Center,
AESOP
Endoscope Positioner and related instruments,
accessories and service, accounted for all of the Company's product sales for
the three months and nine months ended September 30, 2003 and 2002. Purchases of
key parts and components used to manufacture the Company's products are from
limited supply sources. The inability of any of these suppliers to fulfill the
Company's supply requirements may negatively impact future operating
results.
The Company operates in one segment, the development and
marketing of products designed for use in surgery. For the three months ended
September 30, 2003, U.S. and international sales accounted for 86% and 14%,
respectively, of total sales. For the three months ended September 30, 2002,
U.S. and international sales accounted for 90% and 10%, respectively, of total
sales.
NOTE 3.  ACQUISITION OF COMPUTER MOTION, INC.
On June 30, 2003, the Company acquired all of the
outstanding shares of Computer Motion, Inc. through a merger of Computer Motion
with a wholly owned subsidiary of Intuitive Surgical.  In the merger, each
outstanding share of Computer Motion common stock has converted into 0.51426943
shares of Intuitive Surgical common stock and Intuitive Surgical assumed all of
Computer Motion's outstanding options and warrants to purchase Computer Motion
common stock based on the same ratio. The acquisition of Computer Motion is
intended to enhance the Company's combined competitive position in key
industries, while strengthening its work force.  It also eliminated ongoing
intellectual property litigation between the two companies. The acquisition is
intended to enable the Company to focus on strategic products and customers,
achieve significant cost synergies and economies of scale and improve results of
its combined application of robotics to minimally invasive surgery bringing
benefits to patients, surgeons and medical centers throughout the world.  The
exchange ratio in the acquisition was derived from estimates of future revenue
and earnings of the combined company, in addition to measuring the relative
ownership of the combined company implied by their contributions.  The purchase
price of this acquisition was $148.5 million resulting from the issuance to
former Computer Motion stockholders the right to receive approximately 8.0
million shares of Intuitive Surgical common stock on June 30, 2003, after giving
effect to the 1-for-2 stock reverse split effected on July 1, 2003, or the
Reverse Split, with a fair value of approximately $125.7 million, the assumption
of options and warrants to purchase approximately 1.4 million and 0.7 million
shares, respectively, of Intuitive Surgical common stock at weighted average
exercise prices of $13.68 and $20.52, after giving effect to the Reverse Split,
with an aggregate Black-Scholes fair value of approximately $15.7 million, the
funding of Computer Motion's second quarter operations through a working capital
loan in the amount of $5.3 million, and estimated direct transaction costs of
$1.8 million.  The fair value of the Company's common stock was derived using an
average market price per share of the Company's common stock of $15.64, after
giving effect to the 1-for-2 stock reverse split effected on July 1, 2003, which
was based on the closing prices for a range of trading days prior to and
including the date of the acquisition, June 30, 2003 (June 24, June 25, June 26,
June 27, and June 30). The measurement date for this transaction was the June
30, 2003 closing date, as the number of shares to be issued to Computer Motion
stockholders was not fixed until that date.
In accordance with SFAS No. 141, the Company allocated the
purchase price of the acquisition to the tangible assets, liabilities and
intangible assets acquired, including in-process research and development, or
IPR&D, based on their estimated fair values.  The excess purchase price over
those fair values is recorded as goodwill.  The fair value assigned to
intangible assets acquired is based on valuations prepared by an independent
third party appraisal firm using estimates and assumptions provided by
management.  The goodwill recorded as a result of the acquisition is not
expected to be deductible for tax purposes. In accordance with SFAS No. 142,
goodwill and purchased intangible assets with indefinite useful lives acquired
after June 30, 2001 are not amortized but will be reviewed at least annually for
impairment.  Purchased intangible assets with finite lives are amortized on a
straight-line basis over their respective useful lives.  (See Note 7.)
The total purchase price was comprised of the following (in
thousands):
Value of Intuitive Surgical common stock issued....  $ 125,734
Assumption of Computer Motion warrants and options.     15,703
                                                      ---------
Total value of Intuitive Surgical securities.......    141,437

Direct transaction costs...........................      1,774
Bridge loan facility...............................      5,302
                                                      ---------
Total estimated purchase price.....................  $ 148,513
                                                      =========
At September 30, 2003, the Company decreased its valuation of
the net property, plant, and equipment acquired by $0.4 million, with an
offsetting increase to goodwill, based on updated information relating to
assumptions made in the Company's purchase price allocation. The following
purchase price allocation is preliminary, as future business results may differ
from inherent estimates contained in the allocation, including employee severance
costs, obligations related to exiting lease commitments, and other underlying
assumptions.  The total purchase price has been allocated as follows (in thousands):
Cash and cash equivalents............... $    1,214
Accounts receivable, net................      4,476
Inventories, net........................      4,672
Prepaid and other assets................        269
Property, plant, and equipment..........      1,605
Other assets............................         70
Amortizable intangible assets:.
  Customer relationships................      1,300
  Developed and core technology.........      6,800
  Trademark.............................        200
  Internal use software.................        300
  In-process research and development...        100
Goodwill................................    142,995
Accounts and notes payable..............     (7,892)
Restructuring accrual...................     (3,444)
Other accrued liabilities...............     (2,361)
Deferred revenue........................     (2,225)
Deferred compensation...................        434
                                           ---------
Total purchase price.................... $  148,513
                                           =========
Goodwill
Of the total purchase price, $143.0 million was allocated
to goodwill.  Goodwill represents the excess of the purchase price over the fair
value of the underlying net tangible and intangible assets.  Goodwill is not
deductible for tax purposes.  In accordance with SFAS No. 142, "Goodwill
and Other Intangible Assets," goodwill will not be amortized, but instead
will be tested for impairment at least annually (more frequently if certain
indicators are present).  In the event management determines that goodwill has
been impaired, the Company will incur an accounting charge for the impairment
during the fiscal quarter in which the determination is made.  (See Note 7.)
Amortizable Intangible Assets
Of the total purchase price, approximately $8.6 million
was allocated to amortizable intangible assets, comprised of developed
technology of $3.5 million, core technology of $3.3 million, customer
relationships of $1.3 million, and other intangible assets totaling $0.5
million. (See Note 7.)
Developed technology, comprised of products that have reached
technological feasibility, includes most of Computer Motion's current products,
including Aesop, Zeus, Socrates, and Hermes.  Developed technology will be
amortized on a straight-line basis over a period of seven years, representing
the weighted average of the remaining product lives of the developed
technology.
Core technology represents the value of patents, processes,
and trade secrets, including certain designs and product features that Intuitive
may integrate into future products.  Core technology will be amortized on a
straight-line basis over a period of seven years.
Customer relationships represent the value of Computer
Motion's relationships with existing customers and is valued based upon the fair
value of future business with these customers.  Customer relationships and other
intangible assets will be amortized on a straight line basis over a period of
approximately seven years.
In-process research and development
Of the total purchase price, $0.1 million was allocated
to in-process research and development.  Projects which qualify as IPR&D
represent those that have not yet reached technological feasibility and for
which no future alternative uses exist.  IPR&D was immediately, fully
amortized into Intuitive Surgical's results for the three months ended June 30,
2003.
Deferred Compensation
Of the total purchase price, $0.4 million was allocated
to deferred compensation for unvested options assumed, which represents the
intrinsic value of unvested stock options for employees and fair value for
non-employees. Deferred compensation will be amortized into expense for
approximately three years using the graded vesting method.
Restructuring charges
Upon the consummation of the acquisition of Computer
Motion, Intuitive's management approved plans to restructure the operations of
the combined entity. The current restructuring plan provides for the elimination
of redundant activities and infrastructure and will result in eliminating
approximately 150 employees, or 75%, of the Computer Motion positions by
December 31, 2003 generally with immediate severance payment upon termination.
The plan includes vacating and subleasing 78% of the leased space in Goleta,
California, consolidating European operations into a single site, and closing
Computer Motion's Asia office, and transitioning to the Intuitive distribution
sales model for the area.  The Company will have a single sales and marketing
organization and consolidate all manufacturing and administrative functions in
Sunnyvale, California.  Based upon this plan, the Company recorded a $3.4
million accrual in accordance with EITF 95-3, "Recognition of Liabilities
in Connection with a Purchase Business Combination."  In accordance with
EITF 95-3, the restructuring accrual has been recorded as a component of the
purchase price.  The accrual is comprised of $2.6 million for employee severance
costs, which are expected to be substantially paid out by the end of 2003, and
$0.8 million to exit existing lease commitments, based upon total future lease
commitments for facilities to be vacated of $2.6 million, offset by subleasing
proceeds of $1.8 million.  The Company has estimated vacancy periods of between
1 month and 3 years between exiting various sites and realizing subleasing
proceeds.
The following table summarizes the restructuring activitiy
for the nine months ended September 30, 2003 (in thousands):
Employee      Lease
                                             Severance   Commitments  Total
                                             ---------   ---------   --------
Balance at December 31, 2002............... $      --  $       --  $      --
Costs incurred.............................     2,628         816      3,444
Cash payments, net of subleasing proceeds..    (2,018)        (86)    (2,104)
Currency impact............................        (8)         --         (8)
                                             ---------   ---------   --------
Balance at September 30, 2003.............. $     602  $      730  $   1,332
                                             =========   =========   ========
Pro forma results of operations
The following unaudited pro forma financial information for
the three and nine months ended September 30, 2003 and September 30, 2002 give
effect to the acquisition by Intuitive Surgical of Computer Motion as if it had
occurred on January 1, 2003 and January 1, 2002, respectively.  The pro forma
financial information excludes charges for acquired in-process research and
development.  The unaudited pro forma financial information is not intended to
represent or be indicative of the consolidated results of operations that
Intuitive would have reported had the acquisition been completed as of the dates
presented, and should not be taken as representative of the future consolidated
results or financial position of Intuitive Surgical.
Three Months Ended        Nine Months Ended
                                       September 30,            September 30,
                                  ---------------------     ---------------------
                                    2003        2002          2003        2002
                                  ---------   ---------     ---------   ---------
Sales........................... $  23,393   $  21,233     $  74,491   $  65,036
Net loss........................ $  (3,353)  $ (12,726)    $ (24,277)  $ (32,947)
Net loss per share.............. $   (0.12)  $   (0.48)    $   (0.83)  $   (1.26)
NOTE 4. CASH AND CASH EQUIVALENTS
Intuitive Surgical considers all highly liquid
investments with an original maturity from date of purchase of 90 days or less
to be cash equivalents for the purpose of balance sheet and statement of cash
flows presentation. The carrying value of cash and cash equivalents approximates
market value at September 30, 2003 and December 31, 2002.
NOTE 5. SHORT-TERM INVESTMENTS
All short-term investments are classified as
available-for-sale, and therefore, are carried at fair market value. The Company views its
available-for-sale portfolio as available for use in its current operations.
Accordingly, all investments are classified as short-term, even though the
stated maturity date may be one year or more beyond the current balance sheet
date. Available-for-sale securities are stated at fair market value based upon
quoted market prices of the securities. Unrealized gains and losses on such
securities are reported as a separate component of stockholders' equity.
Realized gains and losses on available-for-sale securities, together with
amortization of premiums and discounts on debt securities, are included in
interest income. The cost of securities sold is based on the specific
identification method. Interest and dividends on securities classified as
available-for-sale are included in interest income.
NOTE 6. INVENTORY
Inventory consists of the following (in thousands):
September 30,  December 31,
                                   2003          2002
                               ------------  ------------
Raw materials................ $      3,285  $      3,420
Work-in-process..............        2,610           780
Finished goods...............        6,851         4,538
                               ------------  ------------
                              $     12,746  $      8,738
                               ============  ============
NOTE 7. GOODWILL AND INTANGIBLE ASSETS
Goodwill represents the excess of the purchase price over
the fair value of the underlying net tangible and intangible assets.  In
accordance with SFAS No. 142, "Goodwill and Other Intangible Assets,"
goodwill and intangible assets with indefinite useful lives can no longer be
amortized; however, they will be tested for impairment at least annually in the
fourth quarter of each fiscal year (more frequently if certain indicators are
present).  Intangible assets with finite useful lives will continue to be
amortized over their respective useful lives.  In the event management
determines that goodwill has been impaired, the Company will incur an accounting
charge for the impairment during the fiscal quarter in which the determination
is made.  Of the total purchase price related to the acquisition of Computer
Motion, $143.0 million was allocated to goodwill and $8.6 million was allocated
to amortizable intangible assets, comprised of developed technology of $3.5
million, core technology of $3.3 million, customer relationships of $1.3
million, and other intangible assets totaling $0.5 million.
Other purchased intangible assets represent patents which are
carried at cost less accumulated amortization. Amortization is computed using
the straight-line method over the expected useful life of six or seven years.
For the three months ended September 30, 2003, in accordance
with SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets," the Company impaired $0.1 million of developed technology intangible assets
related to a product the Company no longer intends to produce and $0.1 million of
other intangible assets related to internal software that has no future use.
At December 31, 2002, net intangible assets was $2.6 million
comprised of patents with a gross value of $4.7 million and accumulated
amortization of $2.1 million.
At September 30, 2003, net intangible assets is comprised of
the following (in thousands):
Accumulated
                                 Gross     Amortization  Impairment     Net
                               ---------   -----------   ---------   ---------
Developed Technology........  $   3,500   $      (129)  $     (93)  $   3,278
Core Technology.............      3,300          (118)         --       3,182
Customer Relationships......      1,300          (167)         --       1,133
Patents.....................      4,710        (2,735)         --       1,975
Other intangible assets.....        500           (27)       (124)        349
                               ---------   -----------   ---------   ---------
Total intangible assets, net  $  13,310   $    (3,176)  $    (217)  $   9,917
                               =========   ===========   =========   =========
Amortization expense related to intangible assets was $0.6 million and $1.1 million
for the three and nine months ended September 30, 2003 and $0.2 million and $0.6 million
for the three and nine months ended September 30, 2002.
Estimated future amortization expense related to intangible
assets at September 30, 2003 is as follows (in thousands):
Fiscal Year
2003 (remaining 3 months)...  $      526
2004........................       2,105
2005........................       2,105
2006........................       1,479
2007........................       1,248
Thereafter..................       2,454
                                ---------
Total.......................  $    9,917
                                =========
NOTE 8. COMPREHENSIVE LOSS
The components of comprehensive loss consist of the
following (in thousands):
Three Months Ended    Nine Months Ended
                                              September 30,         September 30,
                                        --------------------  --------------------
                                           2003       2002       2003       2002
                                        ---------  ---------  ---------  ---------
Net loss.............................. $  (3,353) $  (6,464) $  (4,768) $ (15,821)
Other comprehensive loss:
  Foreign currency translation
    adjustments.......................       (13)       109       (168)        60
  Change in unrealized gain (loss)
    on available-for-sale securities..      (198)       689       (654)       847
                                        ---------  ---------  ---------  ---------
Comprehensive loss.................... $  (3,564) $  (5,666) $  (5,590) $ (14,914)
                                        =========  =========  =========  =========
The components of accumulated other comprehensive income were
as follows (in thousands):
September 30, December 31,
                                              2003         2002
                                          ------------  -----------
Accumulated net unrealized gain on
  available-for-sales securities........ $        969  $     1,623
Foreign currency translation
  adjustments...........................         (153)          15

Total accumulated other comprehensive     ------------  -----------
  income................................ $        816  $     1,638
                                          ============  ===========
NOTE 9. NET LOSS PER SHARE
The following table presents the computation of basic and
diluted net loss per share (in thousands, except per share data):
Three Months Ended         Nine Months Ended
                                           September 30,              September 30,
                                     -------------------------  -------------------------
                                        2003         2002          2003         2002
                                     -----------  ------------  -----------  ------------
Numerator used for basic and
  diluted net loss per common
  share............................ $    (3,353) $     (6,464) $    (4,768) $    (15,821)
                                     ===========  ============  ===========  ============
Denominator used for basic and
  diluted net loss per common share:
  Weighted-average shares
    outstanding....................      26,881        18,260       21,301        18,213
  Less weighted-average
    shares subject to
    repurchase.....................          (3)          (10)          (5)          (14)
                                     -----------  ------------  -----------  ------------
  Weighted-average shares used in
    computing basic and diluted net
    loss per common share..........      26,878        18,250       21,296        18,199
                                     ===========  ============  ===========  ============
Basic and diluted net loss per
  common share..................... $     (0.12) $      (0.35) $     (0.22) $      (0.87)
                                     ===========  ============  ===========  ============
Potential common shares excluded from the computation of diluted net loss per
share as their effect would be antidilutive were 4,977,000 and 3,803,000 shares
respectively for the three and nine months ended September 30, 2003, and
2,556,000 and 2,440,000 shares, respectively, for the three and nine months
ended September 30, 2002.
NOTE 10. PRODUCT WARRANTY PROVISIONS
The Company's standard policy is to warrant all shipped
systems against defects in design, materials and workmanship by replacing failed
parts during the first year of ownership. The Company's estimate of costs to
service the warranty obligations is based on historical experience and current
product performance trends. Prior to July 1, 2003, these costs were included in
cost of goods sold at the time revenue is recognized. The warranty provision was
reduced by material and labor costs used for replacement activities over the
warranty period. Effective July 1, 2003, the Company adopted the provisions of
EITF 00-21, "Accounting for Revenue Arrangements with Multiple
Deliverables" on a prospective basis.  Under EITF 00-21, for certain
arrangements, a portion of the overall system price attributable to the first
year service is deferred and recognized as revenue over the service period.  As
such, the Company no longer accrues warranty costs upon delivery but rather
recognizes warranty and related service costs as incurred.  The warranty
provision resulting from transactions prior to July 1, 2003 will be reduced in
future periods for material and labor costs incurred as related product is
returned during the warranty period or when the warranty period elapses.   A
review of warrany obligations is performed regularly to determine the adequacy
of the reserve. Based on the outcome of this review, revisions to the estimated
warranty liability are recorded as appropriate.
The following table reconciles the changes to the product
warranty liability for the period indicated (in thousands):
Balance at                         Warranty   Balance at
                                          Beginning   Warranty   Warranties Assumed in   End of
                                          of Period     Usage    Expensed   Acquisition  Period
                                         -----------  ---------  ---------  ----------  ---------
Three months ended September 30, 2003.  $     2,005  $    (674) $      --  $       --  $   1,331
Nine months ended September 30, 2003..  $     2,269  $  (1,450) $     212  $      300  $   1,331
The Company from time to time enters into agreements to
indemnify its customers against liability and damages arising from patent claims
against the Company's product. The term of these agreements vary, but generally,
a maximum obligation is not explicitly stated within the agreements.
Historically, the Company has not been obligated to make any significant
payments related to its customer indeminification clauses and no liabilities
have been recorded for this obligation on its balance sheets as of September 30,
2003 and December 31, 2002.
NOTE 11.  REVERSE STOCK SPLIT
Intuitive Surgical's stockholders approved a one-for-two
reverse stock split, or the Reverse Split, on June 30, 2003 and the Reverse
Split was effected on July 1, 2003. The par value of Intuitive's common stock
after the Reverse Split remained at $0.001 per share.  The rights of the holders
of these securities were not otherwise modified.  All shares outstanding and
earnings per share information for all periods presented in these financial
statements give effect to the Reverse Split.  All shares, per share and market
price data related to Intuitive's common shares outstanding and under employee
stock plans reflect the retroactive effects of the Reverse Split.
NOTE 12. CONTINGENCIES
In September 2000, Brookhill-Wilk 1, LLC, or Wilk, filed
a lawsuit against Intuitive Surgical in the United States District Court for the
Southern District of New York (Case No. 00 Civ. 6599 (NRB)) alleging that by
making, using, selling or offering for sale our
da Vinci
Surgical System,
the Company is infringing United States Patent Nos. 5,217,003 and 5,368,015 in
willful disregard of Wilk's patent rights. These patents concern methods and
devices for "remote" surgery. In March 2001, Wilk withdrew its assertion of the
'015 patent against the Company. On November 8, 2001, in response to a motion on
one of Intuitive Surgical's noninfringement defenses, the District Court granted
summary judgment of noninfringement of the '003 patent in the Company's favor
and dismissed Wilk's complaint in its entirety without prejudice. Wilk appealed
the summary judgment ruling to the U.S. Court of Appeals for the Federal
Circuit. In April 2003, the Court of Appeals reversed the District Court's
judgment and remanded the case for further proceedings. This reversal is based
on the Court of Appeals' determination that the particular claim limitation at
issue should be interpreted differently than as construed by the District Court.
Upon remand, Intuitive Surgical intends to continue to
vigorously defend its rights and, if necessary, is prepared to conduct discovery
and file further motions on whether the patent is infringed, valid and/or
enforceable. Intuitive Surgical believes that it has multiple meritorious
defenses to Wilk's allegations. However, litigation is unpredictable and
Intuitive Surgical may not prevail. Both parties have expressed a desire to
engage in non-binding mediation before engaging in further proceedings in the
District Court.  The District Court has not yet set a schedule for further
proceedings if mediation is unsuccessful.
In July 2003, Wilk filed a new lawsuit against three of
Intuitive Surgical's customers: Mt. Sinai Hospital, Lenox Hill Hospital and the
New York and Presbyterian Hospital.  Pursuant to agreements with those
customers, the Company is defending the lawsuit on behalf of its customers.  The
Company does not expect this lawsuit to significantly impact the scope of the
existing litigation with Wilk since any resolution of the existing Wilk
litigation, whether on the merits or by settlement, will likely resolve this new
lawsuit at the same time.
In September 2003, Wilk amended its complaint against
Intuitive Surgical to include Computer Motion within the lawsuit and to allege
that Computer Motion's Zeus product also infringes Wilk's '003 patent.  Prior to
the Company's acquisition of Computer Motion, Wilk sued Computer Motion but
dismissed that lawsuit voluntarily in order to await the outcome of the appeal
proceedings in Wilk's litigation with Intuitive Surgical.  Intuitive Surgical
believes that it has multiple meritorious defenses to Wilk's allegations against
Computer Motion, including many of the same defenses that apply to Wilk's
allegations against Intuitive Surgical.  However, litigation is unpredictable
and Intuitive Surgical may not prevail. Wilk's allegations against Computer
Motion are directed only to Computer Motion products.
If the Company loses Wilk's suit against us and the three
hospital customers, it will hurt our competitive position, may be costly and may
prevent the Company from selling its products. If the Company loses the patent
suit, it may need to obtain from Wilk a license to this technology to continue
to market its products that have been found to infringe Wilk's patents. This
license could be expensive, which could seriously harm the Company's business.
If Wilk is successful in its suit against the Company and is unwilling to grant
a license, the Company may be required to stop selling its products that are
found to infringe Wilk's patents unless the Company can redesign them so they do
not infringe Wilk's patents, which it may be unable to do. In addition, the
Company could be required to pay Wilk damages, including treble damages, which
could be substantial and harm its financial position. Due to the inherent
uncertainties of litigation, however, the Company cannot accurately predict the
ultimate outcome of the Wilk litigation at this time and, therefore, cannot
estimate the range of possible loss.
During the second quarter of 2003, two former patients of The
Valley Hospital in New Jersey filed suit against The Valley Hospital, their
surgeons and Intuitive Surgical, Inc. alleging various harms caused during their
surgeries.  Intuitive was named because the
da Vinci
Surgical System was
utilized for a portion of the surgeries and the detachable tip of an
EndoWrist
instrument is alleged to have remained in each patient after
each surgery.  Each suit alleges, among other things, negligence, carelessness
and/or recklessness by each defendant, that the
da Vinci
Surgical System
was defectively designed and manufactured, that Intuitive failed to properly
instruct and train the surgeons in its use, and that the defendants failed to
properly apprise the patients of the risks involved.  Each suit seeks an
unspecified amount of general, special and punitive damages from the defendants,
in addition to a request to recover the costs of suit and attorney fees.  As
each suit was just recently filed, both are in very early stages and discovery
has recently commenced.  Due to the inherent uncertainties of the litigation,
and the early stage of this case, the Company cannot accurately predict the
outcome of this litigation at this time and therefore, cannot estimate the range
of possible loss.
The foregoing proceedings could be expensive to litigate, may
be protracted and the Company's confidential information may be compromised.
Whether or not the Company is successful in these lawsuits, these proceedings
could consume substantial amounts of its financial and managerial resources. At
any time, the other parties may file additional claims against the Company, or
the Company may file claims against them, which could increase the risk, expense
and duration of the litigations. For more information on the Company's
litigation with Wilk, see "Part II-Item 1: Legal Proceedings."
NOTE 13. SUBSEQUENT EVENT
On October 31, 2003, the Company sold 5,000,000 shares of
newly issued common stock in an underwritten public offering at a price of
$14.50 per share. The Company received net proceeds of approximately $67.7
million, after deducting the underwriting discount and offering expenses. The
Company intends to use the net proceeds for general corporate purposes.  The
underwriters also have the option to purchase up to 750,000 additional shares at
a price of $14.50 per share to cover over-allotments.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
In this report, "Intuitive Surgical," "Intuitive," the
"Company, " "we," "us," and "our" refer to Intuitive Surgical, Inc.
This Management's Discussion and Analysis of Financial
Condition as of September 30, 2003 and Results of Operations for the three month
and nine month periods ended September 30, 2003 and September 30, 2002 should be
read in conjunction with the Management's Discussion and Analysis of Financial
Condition and Results of Operations included in our Annual Report on Form 10-K/A
for the year ended December 31, 2002.
Except for historical information, the discussion in this
report contains forward-looking statements that involve risks and uncertainties,
such as statements of our plans, objectives, expectations, and intentions. The
cautionary statements made in this report should be read as applying to all
related forward-looking statements wherever they appear in this report. Our
actual results could differ materially from those discussed here. Factors that
could cause or contribute to these differences include those discussed in
"Factors Affecting Operating Results" below as well as those discussed
elsewhere.
Intuitive®, da Vinci®, InSite®, EndoWrist®,
Zeus®, Hermes®, and Aesop® are registered trademarks of Intuitive
Surgical, Inc.
OVERVIEW
We design, manufacture and market the
da Vinci
Surgical System, an advanced surgical system that we believe represents a new
generation of surgery-the third generation. The
da Vinci
Surgical System
consists of a surgeon's console, a patient-side cart, a high performance vision
system and proprietary "wristed" instruments. The
da Vinci
Surgical
System seamlessly translates the surgeon's natural hand movements on instrument
controls at a console into corresponding micro-movements of instruments
positioned inside the patient through small puncture incisions, or ports. We
believe that the
da Vinci
Surgical System is the only commercially
available technology that can provide the surgeon with the intuitive control,
range of motion, fine tissue manipulation capability and 3-D visualization
characteristic of open surgery, while simultaneously allowing the surgeons to
work through the small ports of minimally invasive surgery, or MIS. By placing
computer-enhanced technology between the surgeon and the patient, we believe
that the
da Vinci
Surgical System enables surgeons to perform better
surgery in a manner never before experienced.
In 1999, we obtained permission from the European Union to
affix the CE Mark to the
da Vinci
Surgical System and
EndoWrist
instruments for general surgical and cardiac surgical use. Based on this
approval, we recognized revenue for the first time in the second quarter of 1999
for the sale of our products. In July 2000, we received clearance from the U.S.
Food and Drug Administration, or FDA, to begin commercialization of our
da
Vinci
Surgical System in the United States for use in laparoscopic surgical
procedures. In March 2001, we received clearance from the FDA for use of our
da Vinci
Surgical System in non-cardiac thoracoscopic surgical
procedures. In May 2001, we received market clearance from the FDA to promote
use of the
da Vinci
Surgical System for performance of laparoscopic
radical prostatectomy procedures. In November 2002, we received clearance from
the FDA for use of the
da Vinci
Surgical System in thoracoscopically-assisted
cardiotomy procedures. In January 2003, we began promoting atrial
septal defect closure surgery under the November 2002 cardiotomy clearance.
To date, the majority of our revenues have come from the
sales of the
da Vinci
Surgical System, which are high revenue dollar
items. A smaller, but increasing, percentage of revenues come from sales of
EndoWrist
instruments and accessories and ongoing service of installed
da Vinci
Surgical Systems. During the useful life of each installed
da
Vinci
Surgical Systems, we expect to generate recurring revenue through
sales of the
EndoWrist
instruments and accessories and ongoing service.
Although we expect the majority of our revenues to continue to come from the
sale of
da Vinci
Surgical Systems over the next few years, we believe
that the percentage of revenue from our
EndoWrist
instruments and
accessories and service will continue to increase. The percentage of revenue
derived from recurring instrument, accessory, and service revenue has grown from
23% for the quarter ended September 30, 2002 to 33% for the quarter ended
September 30, 2003.
Due to the high dollar revenue per system sold, small
variations in system unit sales may cause revenue to vary significantly from
quarter to quarter.
ACQUISITION OF COMPUTER MOTION
In June 2003, we acquired Computer Motion, Inc. in a
stock transaction pursuant to which a wholly owned subsidiary of our company
merged with and into Computer Motion.  In connection with the merger, each
outstanding share of Computer Motion common stock was converted into the right
to receive 0.51426943 of one share of our common stock prior to giving effect to
our 1-for-2 reverse stock split effective July 1, 2003. In addition, we assumed
all of Computer Motion outstanding options and warrants.  The total purchase
price was approximately $148.5 million.  In connection with our acquisition of
Computer Motion, all pending patent litigation between the companies was
dismissed and Robert Duggan, the Chief Executive Officer and Chairman of the
Board of Directors of Computer Motion, and Eric Halvorson, a director of
Computer Motion, were appointed to our board of directors.
Upon the consummation of the acquisition of Computer Motion,
our management approved plans to restructure the operations of the combined
entity.  The current restructuring plan provides for the elimination of
redundant activities and infrastructure and will result in eliminating
approximately 150 employees, or 75%, of the Computer Motion positions by
December 31, 2003 generally with immediate severance payment upon termination.
The plan includes vacating and subleasing 78% of the leased space in Goleta,
California, consolidating European operations into a single site, and closing
Computer Motion's Asia office, and transitioning to our distribution sales model
for the area. We will have a single sales and marketing organization and
consolidate all manufacturing and administrative functions in Sunnyvale,
California.
We expect to achieve annual pre-tax cost savings of at least
$18 million to be phased in beginning in the third quarter of 2003.  Based upon
this plan, we have recorded a $3.4 million accrual in accordance with EITF 95-3,
"Recognition of Liabilities in Connection with a Purchase Business
Combination."  In accordance with EITF 95-3, the restructuring accrual has
been recorded as a component of the purchase price.  The accrual is comprised of
$2.6 million for employee severance costs, which are expected to be
substantially paid out by the end of 2003, and $0.8 million to exit existing
lease commitments, based upon total future lease commitments for facilities to
be vacated of $2.6 million, offset by subleasing proceeds of $1.8 million.  We
have estimated vacancy periods of between 1 month and 3 years between exiting
various sites and realizing subleasing proceeds.
As of  September 30, 2003, we have made significant progress
toward the implementation of our restructuring plan.  We have consolidated the
sales and marketing resources of the two companies into a single organization
and all manufacturing and administrative functions into our Sunnyvale,
California headquarters.  In addition, we are currently positioned to
substantially realize annual pre-tax cost savings of at least $18 million.
The following table summarizes the restructuring activity for
the nine months ended September 30, 2003 (in thousands):
Employee      Lease
                                             Severance   Commitments  Total
                                             ---------   ---------   --------
Balance at December 31, 2002............... $      --  $       --  $      --
Costs incurred.............................     2,628         816      3,444
Cash payments, net of subleasing proceeds..    (2,018)        (86)    (2,104)
Currency impact............................        (8)         --         (8)
                                             ---------   ---------   --------
Balance at September 30, 2003.............. $     602  $      730  $   1,332
                                             =========   =========   ========
RESULTS OF OPERATIONS
Sales
. Total sales for the three months ended
September 30, 2003 were $23.4 million, up 37% from $17.1 million for the three
months ended September 30, 2002. The increase in third quarter 2003 sales was
driven by continued recurring revenue growth, consisting of instruments,
accessories and service.  Third quarter 2003 recurring revenue totaled $7.7
million, up $3.8 million over the prior year and up $1.4 million sequentially
over the second quarter of this year.  Higher recurring revenue was driven by
growth in the installed base of
da Vinci
Surgical Systems and the number
of surgical procedures performed with the system.
We shipped 15
da Vinci
Surgical Systems during the
third quarter of 2003, compared to 14 in the third quarter of 2002. During the
third quarter of 2003, we shipped 16 fourth surgical arms, after having shipped
9 fourth arms during the second quarter of 2003.  Overall, third quarter 2003
system revenue increased to $15.7 million from $13.2 million during the third
quarter of last year.  As of September 30, 2003, there were 192 cumulative
da
Vinci
Surgical Systems shipped, compared to 132 as of September 30, 2002.
Total third quarter 2003 product sales and service revenue
from Computer Motion products, consisting of Aesop®, Hermes® and
Zeus®,  totaled $1.3 million, or 6% of total sales.  We shipped five Aesop
systems during the third quarter of 2003.  We had no revenue from Computer
Motion products in the third quarter of 2002 as the acquisition of  Computer
Motion was completed on June 30, 2003.
Effective July 1, 2003, we prospectively adopted the
provisions of EITF 00-21, "Accounting for Revenue Arrangements with
Multiple Deliverables."  As a result, we deferred $1.7 million of revenue
related to the fair value of the first year service for system sales delivered
during the third quarter of 2003.  This amount will be recognized as service
revenue on a straight-line basis over the related service period, which is
generally one year.  Previously, in accordance with Staff Accounting Bulletin
No. 101, "Revenue Recognition in Financial Statements," we accrued costs
associated with these arrangements as warranty expense in the period the system
was delivered and accepted.  Since we adopted EITF 00-21 on a prospective basis,
only third quarter results reflect the impact of this accounting change and none
of the previous periods have been restated.
On a year-to-date basis, total sales for the nine months
ended September 30, 2003 were $64.1 million, up 26% from $50.9 million for the
nine months ended September 30, 2002.  The increase was driven by continued
growth in recurring revenue.  Sales of instruments, accessories and service grew
to $19.5 million for the nine months ended September 30, 2003 from $10.4 million
for the same period last year.  Overall, system revenue for the nine months
ended September 30, 2003 was $44.6 million, up $4.1 million from $40.5 million
for the same period last year.  The increase was due primarily to sales of 26
fourth arms during 2003, compared with no sales of fourth arms in 2002 as we
began shipping the product in 2003.  There were 43
da Vinci
Surgical
Systems shipped during the nine months ended September 30, 2003, equal to last
year's total.
Product sales for the three months ended September 30, 2003
of $20.7 million were up $5.0 million compared to $15.7 million for the three
months ended September 30, 2002.  The increase was primarily due to higher
instrument and accessory sales of $2.5 million, resulting primarily from a
larger installed base of
da Vinci
Surgical Systems in 2003, and higher
systems sales of $2.5 million, resulting primarily from fourth arm sales and one
incremental
da Vinci
Surgical System sale.
Product sales for the nine months ended September 30, 2003 of
$57.3 million were up $9.9 million compared to $47.4 million for the nine months
ended September 30, 2002.  The increase was primarily due to higher instrument
and accessory sales of $5.8 million, resulting from a larger installed base of
da Vinci
Surgical Systems in 2003, and additional system revenue of $4.1
million driven by incremental revenue derived from the fourth surgical arm
shipments in 2003.
Service sales for the three months ended September 30, 2003
of $2.7 million were up $1.3 million from $1.4 million for the three months
ended September 30, 2002.  Service sales for the nine months ended September 30,
2003 of $6.8 million were up $3.3 million from $3.5 million for the nine months
ended September 30, 2002.  The year-over-year increases resulted from a larger
base of
da Vinci
Surgical systems on annual service contracts.
Gross Profit
. Total gross profit for the three months
ended September 30, 2003 was $13.0 million, or 55.5% of sales, compared with
$8.7 million, or 51.2% of sales for the three months ended September 30, 2002.
The year-over-year improvement in gross profit percentage resulted primarily
from lower product service costs related to system reliability improvements,
material cost reductions, and improved factory productivity.  The total gross
profit percentage for the three months ended September 30, 2003 decreased on a
sequential basis from 63.2% reported for the three months ended June 30, 2003
due to the impacts of the Zeus trade-in program, Zeus inventory charges, and
intangible asset amortization.
Total gross profit for the nine months ended September 30,
2003 was $37.0 million, or 57.8% of sales, compared with $25.8 million, or 50.7%
of sales for the nine months ended September 30, 2002. The year-over-year
improvement in gross profit resulted primarily from significantly lower product
service and warranty costs related to system reliability improvements and
improved factory productivity.
Product sales gross profit percentage increased from 52.3%
for the three months ended September 30, 2002 to 54.5% for the three months
ended September 30, 2003.  Product sales gross profit percentage increased from
52.2% for the nine months ended September 30, 2002 to 58.0% for the nine months
ended September 30, 2003.  The year over year increases resulted primarily from
significantly lower warranty costs and improved factory productivity.
Service sales gross profit percentage increased from 38.1%
for the three months ended September 30, 2002 to 63.2% for the three months
ended September 30, 2003.  Service sales gross profit percentage increased from
30.3% for the nine months ended September 30, 2002 to 56.0% for the nine months
ended September 30, 2003.  The year over year increases resulted primarily from
lower per system service costs derived from system reliability improvements and
field service organization productivity gains.
Selling, General and Administrative Expenses
. Selling,
general and administrative expenses for the three months ended September 30,
2003 were $12.2 million, up 5% from $11.7 million for the three months ended
September 30, 2002. The year-over-year increase was primarily due to higher
headcount and travel related costs of $1.7 million associated with providing
sales support to a larger installed base of
da Vinci
Surgical Systems and
dedicating personnel to support Computer Motion integration activities.  The
increase was also due to other non-recurring Computer Motion integration costs
incurred during the third quarter of 2003, including customer commitments, bad
debts, and audit fees totaling approximately $0.8 million and amortization and
impairment of intangible assets associated with the Computer Motion acquisition
of $0.3 million, offset by lower litigation expenses of $1.5 million, and the
impact of charges taken for unauthorized purchases of administrative supplies
incurred during the third quarter of 2002.
Selling, general and administrative expenses for the nine
months ended September 30, 2003 were $31.8 million, up 5% from $30.3 million for
the nine months ended September 30, 2002. The year-over-year increase was
primarily due to higher headcount and travel related costs of $2.6 million
associated with supporting a larger installed base of
da Vinci
Surgical
Systems and integrating Computer Motion activities, and intangible asset
amortization and impairment of $1.3 million, offset by lower litigation costs of
$1.9 million and reduced general operating expenses.
Selling, general and administrative expenses include costs
for sales, marketing and administrative personnel, tradeshow expenses, legal
expenses, regulatory fees and general corporate expenses. Selling, general and
administrative expenses are expected to increase in the future to support
expanding business activities and integrate the Computer Motion business.
Research and Development Expenses
. Research and
development expenses for the three months ended September 30, 2003 were $4.4
million, up 13% from $3.9 million for the three months ended September 30, 2002.
The year-over-year increase resulted primarily from additional headcount assumed
in the Computer Motion acquisition.
Research and development expenses for the nine months ended
September 30, 2003 were $11.5 million, down 10% from $12.8 million for the nine
months ended September 30, 2002. The year-over-year decrease resulted primarily
from lower project materials costs of $1.0 million and lower project consulting
costs of $1.0 million, offset by costs associated with additional headcount
assumed in the Computer Motion acquisition.
Research and development expenses include costs associated
with the design, development, testing and enhancement of our products. These
enhancements represent significant improvements to our products. Research and
development expenses also include expenditures for clinical trials and purchases
of laboratory supplies. Research and development costs are expensed as incurred.
Research and development expenses are expected to increase in the future due to
the impact of the acquisition of Computer Motion.
Deferred Compensation
. We record deferred compensation
as the difference between the exercise price of options granted and the fair
value of our common stock at the time of grant for financial reporting purposes.
Deferred compensation is amortized to research and development expense and
selling, general and administrative expense. Non-cash deferred compensation
expense included in research and development expenses was $0.1 million and $0.1
million for the three months ended September 30, 2003 and 2002, respectively.
Non-cash deferred compensation expense included in selling, general and
administrative expenses was zero and $0.1 million for the three months ended
September 30, 2003 and 2002, respectively. Non-cash deferred compensation
expense included in research and development expenses was $0.2 million and $0.3
million for the nine months ended September 30, 2003 and 2002, respectively.
Non-cash deferred compensation expense included in selling, general and
administrative expenses was $0.2 million and $0.2 million for the nine months
ended September 30, 2003 and 2002, respectively. Deferred compensation related
to below market options granted prior to our initial public offering ($8.9
million) was fully amortized as of June 30, 2003.  In connection with our
acquisition of Computer Motion, we recorded $0.4 million of deferred
compensation on unvested options which began amortizing into compensation
expense over approximately a three year period beginning July 1, 2003 using the
graded vesting method.  The amount of deferred compensation expense to be
recorded in future periods may decrease if unvested options for which deferred
compensation has been recorded are subsequently canceled.
Other Income.
Other income for the three months ended
September 30, 2003 was $0.3 million, down $0.1 million compared to $0.4 million
for the three months ended September 30, 2002. The decrease resulted in reduced
interest earnings on lower investment balances.  Other income  for the nine
months ended September 30, 2003 was $1.5 million, up $0.1 million compared to
$1.4 million for the nine months ended September 30, 2002. The increase resulted
primarily from $0.5 million of gains realized during the first quarter of 2003
on sales of investment securities, partially offset by reduced interest earnings
on lower investment balances.
LIQUIDITY AND CAPITAL RESOURCES
Our operations have been financed through the sales
of our convertible preferred stock, yielding net proceeds of approximately
$127.3 million, public offerings of our common stock, yielding approximately
$114.5 million, and equipment financing arrangements, yielding approximately
$11.0 million. The equipment arrangements provide financing at specific interest
rates for periods of up to 48 months, at which time the principal is repaid to
the lessors. As collateral for the equipment financing, we have granted the
lessors a security interest in equipment specified under each arrangement.
As of September 30, 2003, we had working capital of $42.9
million, compared to $52.6 million as of December 31, 2002. The decrease during
the nine months ended September 30, 2003 resulted primarily from the impact of
the acquisition of Computer Motion, reflecting cash used to fund the second
quarter 2003 Computer Motion operations of $5.3 million, restructuring costs of
$3.4 million, and the negative fair value of working capital acquired of $1.0
million.
Net cash used by operating activities for the nine months
ended September 30, 2003 was $10.9 million, comprised primarily of our net loss
of $4.8 million and changes in net operating assets and liabilities of $10.9
million, offset by non-cash expenses of $4.8 million.   Cash used by operating
activities was $5.7 million less for the nine months ended September 30, 2003
compared to the nine months ended September 30, 2002 primarily due to a decrease
in 2003 net loss of $11.1 million when compared to the 2002 net loss and higher
non-cash expenses of $1.3 million, offset by higher use of net operating assets
and liabilities of $6.7 million, mostly due to the Computer Motion
acquisition.
Net cash provided by investing activities for the nine months
ended September 30, 2003 of $2.0 million was $19.7 million less than $21.7
million for the nine months ended September 30, 2002 primarily due to decreased
net movement into cash from short-term investments of $17.2 million resulting
from a decrease in 2003 net loss of $11.1 million when compared to the 2002 net
loss and general timing of conversions into cash to support short-term
liquidity.
Net cash provided by financing activities was $3.9 million
for the nine months ended September 30, 2003, compared to $2.7 million for the
nine months ended September 30, 2002. This increase resulted from higher
proceeds from issuance of common stock of $3.2 million, offset by decreased
long-term borrowings of $2.0 million.
Our capital requirements depend on numerous factors,
including the effects of our recently completed merger with Computer Motion,
market acceptance of our products, the resources we devote to developing and
supporting our products, and other factors. We expect to devote substantial
capital resources to continue our research and development efforts, to expand
our support and product development activities and for other general corporate
activities. We believe that our current cash and short- term investment
balances, together with revenue to be derived from the sale of our products,
will be sufficient to fund our future operations.  However, our ability to
achieve these goals is subject to economic conditions and unanticipated changes
in business conditions, and therefore, there can be no assurance that these
results will be achieved.
On October 31, 2003, we sold 5,000,000 shares of newly issued
common stock in an underwritten public offering at a price of $14.50 per share.
We received net proceeds of approximately $67.7 million, after deducting the
underwriting discount and offering expenses. We intend to use the net proceeds
for general corporate purposes.  The underwriters also have the option to
purchase up to 750,000 additional shares at a price of $14.50 per share to cover
over-allotments.
Contractual Obligations and Commercial Commitments
The following table summarizes all significant
contractual payment obligations by payment due date:
Payments by Periods (in millions)
Contractual Obligation
Total
Under 1 Year
1-3 Years
3-5 Years
Over 5 Years
Long-term debt
$ 2.2
$ 1.3
$ .9
$ -
$ -
Building lease
13.3
3.6
9.7
-
-
Total
$ 15.5
$ 4.9
$ 10.6
$ -
$ -
CRITICAL ACCOUNTING POLICIES
We believe the following represent our critical accounting
policies:
Revenue Recognition
. We recognize revenue when
persuasive evidence of an arrangement exists, delivery has occurred or service
has been rendered, the price is fixed or determinable and collectibility is
reasonably assured.
In certain cases, revenue from direct system sales is
generated from multiple-element arrangements that require judgment in the areas
of customer acceptance, collectibility, the separability of units of accounting,
and the fair value of individual elements.  Effective July 1, 2003, we adopted
the provisions of Emerging Issues Task Force (EITF) Issue No. 00-21,
"Revenue Arrangements with Multiple Deliverables" on a prospective
basis.  The principles and guidance outlined in EITF 00-21 provide a framework
to (a) determine whether an arrangement involving multiple deliverables contains
more than one unit of accounting and (b) determine how the arrangement
consideration should be measured and allocated to the separate units of
accounting in the arrangement. We determined that our multiple-element
arrangements are generally comprised of the following elements that would
qualify as separate units of accounting: system sales, service, installation,
and training.  Each of these elements represent individual units of accounting
as the delivered item has value to a customer on a stand-alone basis, objective
and reliable evidence of fair value exists for undelivered items, and
arrangements generally do not contain a general right of return relative to the
delivered item.  We determine fair value based on the price of the deliverable
when it is sold separately or based on third-party evidence.  In accordance with
the guidance in EITF 00-21, we use the residual method to allocate the
arrangement consideration when we do not have fair value of the system sale.
Under the residual method, the amount of consideration allocated to the
delivered item equals the total arrangement consideration less the aggregate
fair value of the undelivered items.  Assuming all other criteria for revenue
recognition have been met, we recognize revenue for system sales when delivery
and acceptance occurs, for installation and training when the services are
rendered, and for service ratably over the service period, which is generally
one year.
Upon adoption of the provisions of EITF 00-21, we deferred
$1.7 million related to the fair value of the first year  service for system
sales delivered during the third quarter of 2003.  This amount will be
recognized as service revenue on a straight-line basis over the related service
period, which is generally one year.  Previously, in accordance with Staff
Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements," we
accrued costs associated with these arrangements as warranty expense in the
period the system was delivered and accepted.
Our distributors do not have price protection rights. One of
our distributors has return rights under limited circumstances. Such rights are
accounted for under the provisions of SFAS No. 48, "Revenue Recognition When
Right of Return Exists."
Revenue from sales of instruments and accessories is
recognized upon delivery. Revenue related to future commitments under separately
priced service contracts is deferred and recognized ratably over the service
period. All costs associated with the provision of service and maintenance,
including salaries, benefits, travel, spare parts and equipment, are recognized
in cost of sales as incurred.
Amounts billed in excess of revenue recognized are included
as deferred revenue in the accompanying consolidated balance sheets.
Our
da Vinci
Surgical System,
Hermes
Control
Center and
AESOP
Endoscope Positioner contain a software component.  We
believe that this software element is an incidental part of each system. The
software element within our products is not sold or marketed separately to
customers and the software does not operate independently of each system.
Furthermore, the software development effort does not require a significant cost
to us relative to the overall development cost of the product. As such, the
software we provide is incidental to each system as a whole and the software
revenue guidance provided in SOP 97-2 is not applicable to our revenues
Allowance for Doubtful Accounts
. The allowance
for doubtful accounts is based upon management estimates. Factors underlying
these estimates include analysis of days outstanding, customer payment history
and management judgment. The allowance is adjusted periodically to reflect
current data, activity, and associated risks.
Inventory Reserves
. We write our inventory down
for estimated obsolescence or unmarketable inventory equal to the difference
between the cost of inventory and the estimated market value based upon
assumptions about future demand and market conditions. If actual future demand
or market conditions are less favorable than those projected by management,
additional inventory write-downs may be required in the future.
Intangible Assets
. We have intangible assets on
our balance sheet related to the acquisition of Computer Motion and the
acquisition of other patents. The valuation and classification of these assets
and the assignment of useful amortization lives involves judgments and the use
of estimates. The evaluation of these intangibles for impairment under
established accounting guidelines is required on an ongoing basis. Changes in
business conditions could potentially require future adjustments to asset
valuations.
Goodwil
l
.  We have goodwill on our balance
sheet relating to the acquisition of Computer Motion.  Goodwill is recorded as
the excess of the purchase price over the fair value of the net tangible and
intangible assets acquired.  Goodwill is not amortized, rather is tested for
impairment at least annually.  In the event we determine that goodwill has been
impaired, we will record an accounting charge for the impairment during the
fiscal quarter in which the determination is made.
Warranties
.
Effective July 1, 2003, for certain
arrangements recorded under the provisions of EITF 00-21, we no longer accrue
warranty costs upon delivery of the system.  Actual warranty costs are expensed
in the period incurred.  For all other revenue arrangements, we provide for the
estimated costs of product warranties at the time revenue is recognized. Our
estimate of costs to service our warranty obligations is based upon historical
experience and expectation of future conditions. If warranty claim activity and
the costs associated with servicing those claims differ from our estimates,
revisions to the estimated warranty liability may be required.
Contingencies
. We are subject to proceedings,
lawsuits and other claims related to our products, patents and other matters. We
are required to assess the likelihood of any adverse judgments or outcomes to
these matters as well as potential ranges of probable losses. A determination of
the amount of reserves required, if any, for these contingencies is made after
careful analysis of each individual issue. The required reserves may change in
the future due to new developments in each matter or changes in approach such as
a change in settlement strategy in dealing with these matters.
FACTORS AFFECTING OPERATING RESULTS
OUR FUTURE OPERATING RESULTS MAY BE BELOW SECURITIES ANALYSTS' OR
INVESTORS' EXPECTATIONS, WHICH COULD CAUSE OUR STOCK PRICE TO DECLINE.
Because of our limited operating history, we have limited
insight into trends that may emerge in our market and affect our business. The
revenue and income potential of our market are unproven, and we may be unable to
generate significant revenues. In addition, our costs may be higher than we,
securities analysts or investors expect. If we fail to generate sufficient
revenues or our costs are higher than we expect, our results of operations will
suffer, which in turn could cause our stock price to decline. Further, future
revenue from sales of our products is difficult to forecast because the market
for new surgical technologies is still evolving. Our results of operations will
depend upon numerous factors, including:
the extent to which our products gain 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 specific sales and any collection delays related to
those sales;
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;
product quality problems;
our ability to protect our proprietary rights and defend against third party
challenges;
our ability to license additional intellectual property rights;
the integration of Computer Motion with our company;
the progress and results of clinical trials; and
third-party payor reimbursement policies.
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, our operating results will be below the expectations of securities
analysts or investors. If this occurs, the price of our common stock, and the
value of your investment, will likely decline.
WE EXPERIENCE LONG AND VARIABLE SALES CYCLES, WHICH COULD HAVE A NEGATIVE
IMPACT ON OUR RESULTS OF OPERATIONS FOR ANY GIVEN QUARTER.
Our
da Vinci
Surgical System has a lengthy sales and
purchase order cycle because it is a major capital item and generally requires
the approval of senior management at purchasing institutions. These factors may
contribute to substantial fluctuations in our quarterly operating results,
particularly during the periods in which our sales volume is low. Because of
these fluctuations, it is likely that in some future quarters our operating
results will fall below the expectations of securities analysts or investors. If
that happens, the market price of our stock would likely decrease. These
fluctuations also mean that you will not be able to rely upon our operating
results in any particular period as an indication of future performance.
BECAUSE A SMALL NUMBER OF CUSTOMERS HAVE AND ARE LIKELY TO CONTINUE TO
ACCOUNT FOR A SUBSTANTIAL PORTION OF OUR REVENUES, OUR REVENUES COULD DECLINE
DUE TO THE LOSS OR DELAY OF A SINGLE CUSTOMER.
A relatively small number of customers account for a
significant portion of our total revenues. During the three months ended
September 30, 2003 and 2002, approximately 65% and 77%, respectively, of our
revenues came from the sales of
da Vinci
Surgical Systems, which are high
revenue dollar items. During the nine months ended September 30, 2003 and 2002,
approximately 69% and 80%, respectively, of our revenues came from the sales of
da Vinci
Surgical Systems. During the three and nine month periods ended
September 30, 2003 and 2002, no customer accounted for more than 10% of total
sales. However, due to the high average selling price of the
da Vinci
Surgical System, our failure to add new customers that make significant
purchases of our products could reduce our future revenues. The loss or delay of
individual orders could have a significant impact on revenues and operating
results.
IF OUR PRODUCTS DO NOT ACHIEVE MARKET ACCEPTANCE, WE WILL NOT BE ABLE TO
GENERATE THE REVENUE NECESSARY TO SUPPORT OUR BUSINESS.
Our products represent a fundamentally new way of performing
surgery. Achieving physician, patient and third-party payor acceptance of
Intuitive
surgery as a preferred method of performing surgery will be
crucial to our success. If our products fail to achieve market acceptance,
hospitals will not purchase our products and we will not be able to generate the
revenue necessary to support our business. We believe that physicians' and
third-party payors' acceptance of the benefits of procedures performed using our
products will be essential for acceptance of our products by patients.
Physicians will not recommend the use of our products unless we can demonstrate
that they produce results comparable or superior to existing surgical
techniques. Even if we can prove the effectiveness of our products through
clinical trials, surgeons may elect not to use our products for any number of
other reasons. For example, cardiologists may continue to recommend conventional
open-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 of
reimbursement from third-party payors.
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 will require training of surgical teams. Market acceptance could be
delayed by the time required to complete this training. We may not be able to
rapidly train surgical teams in numbers sufficient to generate adequate demand
for our products. We cannot be certain that our training programs will be cost
effective or sufficient to meet our customers' needs.
WE ARE INVOLVED IN INTELLECTUAL PROPERTY LITIGATION WITH BROOKHILL-WILK 1,
LLC THAT MAY HURT OUR COMPETITIVE POSITION, MAY BE COSTLY TO US AND MAY PREVENT
US FROM SELLING OUR PRODUCTS.
In September 2000 Brookhill-Wilk 1, LLC, or Wilk, filed a
lawsuit against Intuitive Surgical in the United States District Court for the
Southern District of New York (Case No. 00 Civ. 6599 (NRB)) alleging that by
making, using, selling or offering for sale our
da Vinci
Surgical System,
we are infringing United States Patent Nos. 5,217,003 and 5,368,015 in willful
disregard of Wilk's patent rights. These patents concern methods and devices for
"remote" surgery. In March 2001, Wilk withdrew its assertion of the '015 patent
against our company. In November  2001, in response to a motion on one of
Intuitive Surgical's noninfringement defenses, the District Court granted
summary judgment of noninfringement of the '003 patent in our favor and
dismissed Wilk's complaint in its entirety without prejudice. Wilk appealed the
summary judgment ruling to the U.S. Court of Appeals for the Federal Circuit. In
April 2003, the Court of Appeals reversed the District Court's judgment and
remanded the case for further proceedings. This reversal is based on the Court
of Appeals' determination that the particular claim limitation at issue should
be interpreted differently than as construed by the District Court.
Upon remand, we intend to continue to vigorously defend our
rights and, if necessary, are prepared to continue to conduct discovery and file
further motions on whether the patent is infringed, valid and/or enforceable. We
believe that we have multiple meritorious defenses to Wilk's allegations.
However, litigation is unpredictable and we may not prevail.. Both parties have
expressed a desire to engage in non-binding mediation before engaging in further
proceedings in the District Court.  The District Court has not yet set a
schedule for further proceedings if mediation is unsuccessful.
In July 2003, Wilk filed a new lawsuit against three of our
customers: Mt. Sinai Hospital, Lenox Hill Hospital and the New York and
Presbyterian Hospital.  Pursuant to agreements with those customers, we are
defending the lawsuit on behalf of our customers.  We do not expect this lawsuit
to significantly impact the scope of the existing litigation with Wilk since any
resolution of the existing Wilk litigation, whether on the merits or by
settlement, will likely resolve this new lawsuit at the same time.
In September 2003, Wilk amended its complaint against our
company to include Computer Motion within the lawsuit and to allege that
Computer Motion's Zeus product also infringes Wilk's '003 patent.  Prior to our
acquisition of Computer Motion, Wilk sued Computer Motion but dismissed that
lawsuit voluntarily in order to await the outcome of the appeal proceedings in
Wilk's litigation with our company.  We believe that we have multiple
meritorious defenses to Wilk's allegations against Computer Motion, including
many of the same defenses that apply to Wilk's allegations against our company.
However, litigation is unpredictable and we may not prevail.  Wilk's allegations
against Computer Motion are directed only to Computer Motion products.
If we lose Wilk's suit against us and the three hospital
customers, it will hurt our competitive position, may be costly to us and may
prevent us from selling our products. If we lose the patent suit, we may need to
obtain from Wilk a license to this technology if we are to continue to market
our products that have been found to infringe Wilk's patents. This license could
be expensive, which could seriously harm our business. If Wilk is successful in
its suit against us and is unwilling to grant us a license, we may be required
to stop selling our products that are found to infringe Wilk's patents unless we
can redesign them so they do not infringe Wilk's patents, which we may be unable
to do. In addition, we could be required to pay Wilk damages, including treble
damages, which could be substantial and harm our financial position. Due to the
inherent uncertainties of litigation, however, we cannot accurately predict the
ultimate outcome of the Wilk litigation at this time and, therefore, cannot
estimate the range of possible loss.
The foregoing proceeding could be expensive to litigate, may
be protracted and our confidential information may be compromised. Whether or
not we are successful in this lawsuit, the proceeding could consume substantial
amounts of our financial and managerial resources. At any time, Wilk may file
additional claims against our company, or we may file claims against Wilk, which
could increase the risk, expense and duration of the litigations.
IF WE ARE UNABLE TO PROTECT THE INTELLECTUAL PROPERTY CONTAINED IN OUR
PRODUCTS FROM USE BY THIRD PARTIES, OUR ABILITY TO COMPETE IN THE MARKET WILL BE
HARMED.
Our commercial success will depend in part on obtaining
patent and other intellectual property protection for the technologies contained
in our products, and on successfully defending our patents and other
intellectual 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. If we fail to obtain adequate protection of our
intellectual property, or if any protection we obtain is reduced or eliminated,
others could use our intellectual property without compensating us, resulting in
harm to our business. We may also determine that it is in our best interests to
voluntarily challenge a third party's products or patents in litigation or
administrative proceedings, including patent interferences or reexaminations. In
addition, the laws of certain foreign countries do not protect intellectual
property rights to the same extent as do the laws of the United States.
OTHERS MAY ASSERT THAT OUR PRODUCTS INFRINGE THEIR INTELLECTUAL PROPERTY
RIGHTS, WHICH MAY CAUSE US TO ENGAGE IN COSTLY DISPUTES AND, IF WE ARE NOT
SUCCESSFUL IN DEFENDING OURSELVES, COULD ALSO CAUSE US TO PAY SUBSTANTIAL
DAMAGES AND PROHIBIT US FROM SELLING OUR PRODUCTS.
We are aware of both United States and foreign patents issued
to third parties that relate to computer-assisted surgery, remote surgery, and
minimally invasive surgery. Some of these patents on their face appear broad
enough to cover one or more aspects of our present technology, and may cover
aspects of our 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 inviting us to license their patents. We may be sued by, or become
involved in an administrative proceeding with, one or more of these third
parties. We cannot assure you that a court or administrative body would agree
with any arguments or defenses we have concerning invalidity, unenforceability
or noninfringement 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
likely to file, patent applications covering surgical products that are similar
or identical to ours. We cannot assure you that any patents issuing from
applications filed by a third party 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
intellectual property rights, and companies have employed such actions to gain a
competitive advantage. If third parties assert infringement or other
intellectual property claims against us as Brookhill-Wilk 1, LLC has, our
technical and management personnel will experience a significant diversion of
time and effort and we will incur large expenses defending 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 substantial royalties. We cannot be
certain that we will have the financial resources or the substantive arguments
to defend our patents from infringement or claims of invalidity or
unenforceability, or to defend against allegations of infringement of
third-party patents. In addition, any public announcements related to litigation or
administrative proceedings initiated by us, or initiated or threatened against
us, could cause our stock price to decline.
THE RIGHTS AND MEASURES WE RELY ON TO PROTECT THE INTELLECTUAL PROPERTY
UNDERLYING OUR PRODUCTS MAY NOT BE ADEQUATE TO PREVENT THIRD PARTIES FROM USING
OUR TECHNOLOGY, WHICH COULD HARM OUR ABILITY TO COMPETE IN THE MARKET.
In addition to patents, we typically rely on a combination of
trade secret, copyright and trademark laws, nondisclosure agreements and other
contractual provisions and technical security measures to protect our
intellectual property rights. Nevertheless, these measures may not be adequate
to safeguard the technology underlying our products. If they do not protect our
rights adequately, third parties could use our technology, and our ability to
compete in the market would be reduced. In addition, employees, consultants and
others who participate in developing our products may breach their agreements
with us regarding our intellectual property, and we may not have adequate
remedies for the breach. We also may not be able to effectively protect our
intellectual property rights in some foreign countries. For a variety of
reasons, we may decide not to file for patent, copyright or trademark protection
outside the United States. We also realize that our trade secrets may become
known through other means not currently foreseen by us. Notwithstanding our
efforts to protect our intellectual property, our competitors may independently
develop similar or alternative technologies or products that are equal or
superior to our technology and products without infringing any of our
intellectual property rights, or may design around our proprietary technologies.
OUR PRODUCTS RELY ON LICENSES FROM THIRD PARTIES, AND IF WE LOSE ACCESS TO
THESE TECHNOLOGIES, OUR REVENUES COULD DECLINE.
We rely on technology that we license from others, including
technology that is integral to our products. We have entered into license
agreements with SRI International, IBM Corporation, MIT, Olympus Optical Co.,
Ltd., and Heartport, Inc., now part of Johnson & Johnson. Any of these
agreements may be terminated for breach. If any of these agreements is
terminated, we may be unable to reacquire the necessary license on satisfactory
terms, or at all. The loss or failure to maintain these licenses could prevent
or delay further development or commercialization of our products.
PUBLIC ANNOUNCEMENTS OF LITIGATION EVENTS MAY CAUSE OUR STOCK PRICE TO
DECLINE.
During the course of our administrative proceedings
and/or lawsuits, there may be public announcements of the results of hearings,
motions, and other interim proceedings or developments in the litigation. If
securities analysts or investors perceive these results to be negative, it could
have a substantial negative effect on the trading price of our stock.
OUR PRODUCTS ARE SUBJECT TO A LENGTHY AND UNCERTAIN DOMESTIC REGULATORY
PROCESS. IF WE DO NOT OBTAIN AND MAINTAIN THE NECESSARY DOMESTIC REGULATORY
APPROVALS, WE WILL NOT BE ABLE TO MARKET AND SELL OUR PRODUCTS IN THE UNITED
STATES.
Our products and operations are subject to extensive
regulation in the United States by the U.S. Food and Drug Administration, or
FDA. The FDA regulates the research, testing, manufacturing, safety, labeling,
storage, recordkeeping, promotion, distribution and production of medical
devices in the United States to ensure that medical products distributed
domestically are safe and effective for their intended uses. 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, or FFDCA. Clearance under Section 510(k) requires
demonstration that a new device is substantially equivalent to another device
with 510(k) clearance or grandfather 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, or PMA, for the modified
product before we are permitted to market the products in the U.S. In addition,
if we develop products in the future that are not considered to be substantially
equivalent to a device with 510(k) clearance or grandfather status, we will be
required to obtain FDA approval by submitting a PMA.
The FDA may not act favorably or quickly in its review 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 of which could
delay or preclude sale of new products in the United States. Furthermore, the
FDA may request additional data or require us to conduct further testing, or
compile more data, including clinical data and clinical studies, in support of a
510(k) submission. The FDA may also, instead of accepting a 510(k) submission,
require us to submit a PMA, which is typically a much more complex and
burdensome application than a 510(k). To support a PMA, the FDA would likely
require that we conduct one or more clinical studies to demonstrate that the
device is safe and effective. We may not be able to meet the requirements to
obtain 510(k) clearance or PMA approval, or the FDA may not grant any necessary
clearances or approvals. In addition, the FDA may place significant limitations
upon the intended use of our products as a condition to a 510(k) clearance or
PMA approval. Product applications can also be denied or withdrawn due to
failure to comply with regulatory requirements or the occurrence 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 our business, financial condition and
results of operations.
In order to conduct a clinical investigation involving human
subjects for the purpose of demonstrating the safety and effectiveness of a
device, a company must, among other things, apply for and obtain Institutional
Review Board, or IRB approval of the proposed investigation. In addition, if the
clinical study involves a "significant risk" (as defined by the FDA) to human
health, the sponsor of the investigation must also submit and obtain FDA
approval of an investigational device exemption, or IDE, application.  Most of
our products to date have been considered significant risk devices 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 U.S. 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 comply with the IDE and other regulations
governing clinical investigations or the data from any such trials may not
support clearance or approval of the investigational device. Failure to obtain
such approvals or to comply with such regulations could have a material adverse
effect on our business, financial condition and results of operations.
COMPLYING WITH FDA REFULATIONS IS AN EXPENSIVE AND TIME-CONSUMING
PROCESS, AND OUR FAILURE TO COMPLY FULLY COULD SUBJECT US TO SIGNIFICANT
ENFORCEMENT SANCTIONS.
Because our products, including the
da Vinci
Surgical
System, are commercially distributed, numerous postmarket regulatory
requirements apply, including the following:
Quality System Regulation, or QSR, which requires manufacturers to follow
elaborate design, testing, control, documentation and other quality assurance
procedures during the 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;
the Reports of Corrections and Removals regulation, which requires that
manufacturers report to the FDA recalls and field corrective actions taken to
reduce a risk to health or to remedy a violation of the FFDCA that may pose a
risk to health; and
the Medical Device Reporting regulation, which requires that manufacturers
report to the FDA if their 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 serious injury if it were to recur.
We are subject to inspection and marketing surveillance by
the FDA to determine our compliance with regulatory requirements. If the FDA
finds that we have failed to comply, it can institute a wide variety of
enforcement actions, ranging from a regulatory letter to a public warning letter
to more severe civil and criminal sanctions. Our failure to comply with
applicable requirements could lead to an enforcement action that may have an
adverse effect on our financial condition and results of operations.
We have modified the labeling, advertising and user training
for the
da Vinci
Surgical System to call out specific procedures that we
believe are within the scope of our existing 510(k) clearances. We cannot assure
you that the FDA would agree that all such specific procedures are within the
scope of the existing general clearance or that we have compiled adequate
information to support the safety and efficacy of using the
da Vinci
Surgical System for all such specific procedures. We also have modified the
hardware and software in the
da Vinci
Surgical System since clearance in
ways that we believe do not require new 510(k) clearance. We cannot assure you
that the FDA would agree with our determinations not to seek new 510(k)
clearance for any of these changes. Computer Motion also modified the hardware
and software in its products subsequent to 510(k) clearance without seeking new
clearance. We cannot assure you that the FDA would agree with the determinations
not to seek new 510(k) clearance for any of these changes. The FDA could impose
enforcement sanctions and/or require us to obtain 510(k) clearance for any
modification to our products or Computer Motion's products. We may be prohibited
from marketing the modified device until such 510(k) clearance is granted.
In December 2002, the FDA inspected our Sunnyvale
manufacturing facility and issued a Form FDA 483 setting forth three observed
compliance deficiencies relating to the QSR and two observed deficiencies
relating to the Reports of Corrections and Removals regulation. In January 2003,
we wrote to the FDA indicating our response to each observation with proposed
corrective actions. That same month, the FDA informed us that the adequacy of
our promised corrections and actions would be verified during the next
inspection of our facility. To date, the FDA has not returned for another
inspection and we continue to evaluate and upgrade our QSR compliance. We cannot
assure you that, upon reinspection, the FDA will find that our promised
corrective actions are appropriate or that they have been adequately
implemented. We also cannot assure you that the FDA will not find other
deficiencies in our compliance with the QSR and other postmarket regulations.
We recently acquired Computer Motion and are working to
integrate its FDA compliance system with our own. Our review is not complete,
but we believe that Computer Motion likely has had deficiencies in QSR
compliance, complaint handling, MDR reporting and Corrections and Removals
reporting in the last several years that will require submission of retroactive
reports to the FDA. We are also reviewing whether Computer Motion responded to
complaints with appropriate follow up. We cannot assure you that the FDA will
not seek to impose enforcement sanctions on us for Computer Motion violations
preceding our acquisition of Computer Motion, that the FDA will agree that since
the acquisition we have corrected all regulatory problems, or that our review of
Computer Motion's complaint handling will not lead us to initiate recalls or
field actions to remedy problems with Computer Motion products already in the
field.
OUR PRODUCTS ARE SUBJECT TO VARIOUS INTERNATIONAL REGULATORY PROCESSES AND
APPROVAL REQUIREMENTS. IF WE DO NOT OBTAIN AND MAINTAIN THE NECESSARY
INTERNATIONAL REGULATORY APPROVALS, WE WILL NOT BE ABLE TO MARKET AND SELL OUR
PRODUCTS IN FOREIGN COUNTRIES.
To be able to market and sell our products in other
countries, we must obtain regulatory approvals and comply with the regulations
of those countries. These regulations, including the requirements for approvals,
and the time required for regulatory review vary from country to country.
Obtaining and maintaining foreign regulatory approvals are expensive, and we
cannot be certain that we will receive regulatory approvals in any foreign
country in which we plan to market our products. If we fail to obtain regulatory
approval in any foreign country in which we plan to market our products, our
ability to generate revenue will be harmed.
The European Union requires that manufacturers of medical
products obtain the right to affix the CE mark to their products before selling
them in member countries of the European Union. The CE mark is an international
symbol of adherence to quality assurance standards and compliance with
applicable European medical device directives. In order to obtain the right to
affix the CE mark to products, a manufacturer must obtain certification that its
processes meet certain European quality standards. In January 1999, we received
permission to affix the CE mark to our
da Vinci
Surgical System and
EndoWrist
instruments.
If we modify existing products or develop new products in the
future, including new instruments, we may need to apply for permission to affix
the CE mark to such products. In addition, we will be subject to annual
regulatory audits in order to maintain the CE mark permissions we have already
obtained. We cannot be certain that we will be able to obtain permission to
affix the CE mark for new or modified products or that we will continue to meet
the quality and safety standards required to maintain the permissions 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 our products in member
countries of the European Union.
IF INSTITUTIONS OR SURGEONS ARE UNABLE TO OBTAIN REIMBURSEMENT FROM
THIRD-PARTY PAYORS FOR PROCEDURES USING OUR PRODUCTS, OR IF REIMBURSEMENT IS
INSUFFICIENT TO COVER THE COSTS OF PURCHASING OUR PRODUCTS, WE MAY BE UNABLE TO
GENERATE SUFFICIENT SALES TO SUPPORT OUR BUSINESS.
Domestic institutions will typically bill the services
performed with our products to various third-party payors, such as Medicare,
Medicaid and other government programs and private insurance plans. If hospitals
do not obtain sufficient reimbursement from third-party payors for procedures
performed with our products, or if government and private payors' policies do
not permit reimbursement for surgical procedures performed using our products,
we may not be able to generate the revenues necessary to support our business.
Our success in international markets also depends upon the eligibility of our
products for reimbursement through government-sponsored health care payment
systems and third-party payors. Reimbursement practices vary significantly by
country. Many international markets have government-managed healthcare systems
that control reimbursement for new products and procedures. Other foreign
markets have both private insurance systems and government-managed systems that
control reimbursement for new products and procedures. Market acceptance of our
products may depend on the availability and level of reimbursement in any
country within a particular time. In addition, health care cost containment
efforts similar to those we face in the United States are prevalent in many of
the other countries in which we intend to sell our products and these efforts
are expected to continue.
BECAUSE OUR MARKETS ARE HIGHLY COMPETITIVE, CUSTOMERS MAY
CHOOSE TO PURCHASE OUR COMPETITORS' PRODUCTS OR MAY NOT ACCEPT INTUITIVE
SURGERY, WHICH WOULD RESULT IN REDUCED REVENUE AND LOSS OF MARKET SHARE.
Intuitive
surgery is a new technology that must
compete with established minimally invasive surgery and open surgery. These
procedures are widely accepted in the medical community and in many cases have a
long history of use. We also face competition from several companies that are
developing new approaches and products for the minimally invasive surgery
market. In addition, we may face competition from companies that develop robotic
and computer-assisted surgical systems in the future. Our revenues may be
reduced or eliminated if our competitors develop and market products that are
more effective or less expensive than our products. If we are unable to compete
successfully, our revenues will suffer. We may not be able to maintain or
improve our competitive position against current or potential competitors,
especially those with greater resources.
In many cases, the medical conditions that can be treated
using our products can also be treated by drugs or other medical devices and
procedures. Many of these alternative treatments are also widely accepted in the
medical community and have a long history of use. In addition, technological
advances could make such treatments more effective or less expensive than using
our products, which could render our products obsolete or unmarketable. We
cannot be certain that physicians will use our products to replace or supplement
established treatments or that our products will be competitive with current or
future technologies.
IF DEFECTS ARE DISCOVERED IN OUR PRODUCTS, WE MAY INCUR ADDITIONAL
UNFORESEEN COSTS, HOSPITALS MAY NOT PURCHASE OUR PRODUCTS AND OUR REPUTATION MAY
SUFFER.
Our products incorporate mechanical parts and computer
software, either of which can contain errors or failures, especially when first
introduced. In addition, new products or enhancements may contain undetected
errors or performance problems that, despite testing, are discovered only after
commercial shipment. Because our products are designed to be used to perform
complex surgical procedures, we expect that our customers will have an increased
sensitivity to such defects. We cannot assure you that our products will not
experience errors or performance problems in the future. If we experience flaws
or performance problems, 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;
increased service or warranty costs; or
product liability claims.
WE HAVE LIMITED EXPERIENCE IN MANUFACTURING OUR PRODUCTS AND MAY ENCOUNTER
MANUFACTURING PROBLEMS OR DELAYS THAT COULD RESULT IN LOST REVENUE.
We have manufactured a limited number of our products for
sales to customers. We may be unable to establish or maintain reliable,
high-volume manufacturing capacity. Even if this capacity can be established and
maintained, the cost of doing so may increase the cost of our products and
reduce our ability to compete. We may encounter difficulties in scaling up
production of our products, including:
problems involving production yields;
quality control and assurance;
component supply shortages;
shortages of qualified personnel; and
compliance with state, federal and foreign regulations.
Manufacturing our products is a complex process. If demand
for our products exceeds our manufacturing capacity, we could develop a
substantial backlog of customer orders. If we are unable to establish and
maintain larger-scale manufacturing capabilities, our ability to generate
revenues will be limited and our reputation in the marketplace would be
damaged.
IF OUR MANUFACTURING FACILITIES DO NOT CONTINUE TO MEET FEDERAL, STATE OR
EUROPEAN MANUFACTURING STANDARDS, WE MAY BE REQUIRED TO TEMPORARILY CEASE ALL OR
PART OF OUR MANUFACTURING OPERATIONS, WHICH COULD RESULT IN PRODUCT DELIVERY
DELAYS AND LOST REVENUE.
Our manufacturing facilities are subject to periodic
inspection by regulatory authorities and our operations will continue to be
regulated by the FDA for compliance with Good Manufacturing Practice
requirements contained in the FDA's Quality System Regulations, or QSR. We are
also required to comply with International Organization for Standardization, or
ISO, quality system standards in order to produce products for sale in Europe.
If we fail to continue to comply with Good Manufacturing Practice requirements
or ISO standards, we may be required to cease all or part of our operations
until we comply with these regulations. We are currently in compliance with ISO
standards. The FDA inspected our Mountain View and Sunnyvale facilities in March
2000 and December 2002, respectively. The Good Manufacturing Practice issues
raised by the FDA during the inspections either were satisfactorily resolved
with the FDA, or we believe can be resolved by us to the FDA's satisfaction,
although we cannot assure you that we will be able to do so. We continue to be
subject to FDA inspections at any time. Maintaining such compliance is difficult
and costly. We cannot be certain that our facilities will be found to comply
with Good Manufacturing Practice requirements or ISO standards in future
inspections and audits by regulatory authorities.
The FDA inspected the Goleta facilities of Computer Motion in
1998 and noted deficiencies in Computer Motion's systems for reviewing and
reporting product-related complaints and defect information.  We have determined
that these deficiencies may not have been addressed.  While the Goleta
manufacturing facility has been closed and production of certain product has
been transferred to our Sunnyvale facility, these issues raised by the FDA must
nonetheless be resolved.  We are presently addressing the situation to resolve
all the issues to our own and the FDA's satisfaction, although we cannot assure you
that we will be able to do so, nor can we assess what regulatory impact, if any
this may have on our company.
The state of California also requires that we maintain a
license to manufacture medical devices. Our facilities and manufacturing
processes were inspected in February 1998. In March 1998, we passed the
inspection and received a device manufacturing license from the California
Department of Health Services. In March 2002, our facilities and manufacturing
processes in our Sunnyvale facility were re-inspected by the Food and Drug
Branch, or FDB, and we were issued an updated device manufacturing license for
our Sunnyvale facility. We are subject to periodic inspections by the California
Department of Health Services and, if we are unable to maintain this license
following any future inspections, we will be unable to manufacture or ship any
products.
OUR RELIANCE ON SOLE AND SINGLE SOURCE SUPPLIERS COULD HARM OUR ABILITY TO
MEET DEMAND FOR OUR PRODUCTS IN A TIMELY MANNER OR WITHIN BUDGET.
Some of the components necessary for the assembly of our
products are currently provided to us by sole source suppliers or single source
suppliers. We purchase components through purchase orders rather than long-term
supply agreements and generally do not maintain large volumes of inventory. The
disruption or termination of the supply of components could cause a significant
increase in the costs of these components, which could affect our profitability.
A disruption or termination in the supply of components could also result in our
inability to meet demand for our products, which could harm our ability to
generate revenues, lead to customer dissatisfaction and damage our reputation.
Furthermore, if we are required to change the manufacturer of a key component of
our products, we may be required to verify that the new manufacturer maintains
facilities and procedures that comply with quality standards and with all
applicable regulations and guidelines. The delays associated with the
verification of a new manufacturer could delay our ability to manufacture our
products in a timely manner or within budget.
THE USE OF OUR PRODUCTS COULD RESULT IN PRODUCT LIABILITY CLAIMS THAT
COULD BE EXPENSIVE, DIVERT MANAGEMENT'S ATTENTION AND HARM OUR BUSINESS.
Our business exposes us to significant risks of product
liability claims. The medical device industry has historically been litigious,
and we face financial exposure to product liability claims if the use of our
products were to cause injury or death. There is also the possibility that
defects in the design or manufacture of our products might necessitate a product
recall. Although we maintain product liability insurance, the coverage limits of
these policies may not be adequate to cover future claims. Particularly as sales
of our products increase, we may be unable to maintain product liability
insurance in the future at satisfactory rates or in adequate amounts. A product
liability claim, regardless of its merit or eventual outcome, could result in
significant legal defense costs. A product liability claim or any product
recalls could also harm our reputation or result in a decline in revenues.
During the second quarter of 2003, two former patients of The
Valley Hospital in New Jersey filed suit against The Valley Hospital, their
surgeons and Intuitive Surgical, Inc. alleging various harms caused during their
surgeries.  Intuitive was named because the
da Vinci
Surgical System was
utilized for a portion of the surgeries and the detachable tip of an
EndoWrist
instrument is alleged to have remained in each patient after
each surgery.  Each suit alleges, among other things, negligence, carelessness
and/or recklessness by each defendant, that the
da Vinci
Surgical System
was defectively designed and manufactured, that we failed to properly instruct
and train the surgeons in its use, and that the defendants failed to properly
apprise the patients of the risks involved.  Each suit seeks an unspecified
amount of general, special and punitive damages from the defendants, in addition
to a request to recover the costs of suit and attorney fees.  As each suit was
just recently filed, both are in very early stages and discovery has recently
commenced.
IF WE LOSE OUR KEY PERSONNEL OR ARE UNABLE TO ATTRACT AND RETAIN
ADDITIONAL PERSONNEL, OUR ABILITY TO COMPETE 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 ability to attract and retain engineers with experience in mechanics,
software and optics. Attracting and retaining qualified personnel will be
critical to our success, and competition for qualified personnel is intense. We
may not be able to attract and retain personnel on acceptable terms given the
competition for such personnel among technology and healthcare companies, and
universities. The loss of any of these persons or our inability to attract and
retain qualified personnel could harm our business and our ability to
compete.
INTERNATIONAL SALES OF OUR PRODUCTS ACCOUNT FOR A SIGNIFICANT PORTION OF
OUR REVENUES, WHICH EXPOSES US TO RISKS INHERENT IN INTERNATIONAL OPERATIONS.
OUR GROWTH MAY BE LIMITED IF WE ARE UNABLE TO SUCCESSFULLY MANAGE OUR
INTERNATIONAL ACTIVITIES.
Our business currently depends in large part on our
activities in Europe and other foreign markets. Sales to markets outside of the
United States accounted for approximately 14% of our sales for the three months
ended September 30, 2003 and 10% for the three months ended September 30, 2002.
Sales to markets outside of the United States accounted for approximately 21% of
our sales for the nine months ended September 30, 2003 and 15% for the nine
months ended September 30, 2002.
We are subject to a number of challenges that specifically
relate to our international business activities. These challenges include:
failure of local laws to provide the same degree of protection against
infringement of our intellectual property;
protectionist laws and business practices that favor local competitors,
which could slow our growth in international markets;
the risks associated with foreign currency exchange rate fluctuation;
the expense of establishing facilities and operations in new foreign
markets; and
building an organization capable of supporting geographically dispersed
operations.
Currently, a majority of our international sales are
denominated in United States dollars. As a result, an increase in the value of
the United States dollar relative to foreign currencies could make our products
less competitive in international markets. If we are unable to meet and overcome
these challenges, our international operations may not be successful, which
would limit the growth of our business.
TERMINATION OF RELATIONSHIPS WITH FORMER DISTRIBUTORS OF
COMPUTER MOTION COULD RESULT IN LITIGATION.
Our integration strategy related to our acquisition of
Computer Motion provides that we terminate Computer Motion's relationships with
a number of companies that served as Computer Motion's distributors prior to the
acquisition.  Several of these former distributors have informed us that they
believe that they are entitled to compensation in connection with such
termination.  We may be unable to resolve these claims without litigation.  Due
to the inherent uncertainties of litigation, we cannot accurately predict the
ultimate outcome of any such litigation at this time and, therefore, cannot
estimate the range of possible loss.  If we sue or are sued by any of Computer
Motion's former distributors, these proceddings could be expensive to litgate,
may be protracted and Comptuer Motion's confidential information may be
compromised.  Whether or not we are successful in these lawsuits, these
proceedings could consume substantial amounts of our financial and managerial
resources.
THE CONVICTION OF ARTHUR ANDERSEN LLP ON OBSTRUCTION OF JUSTICE CHARGES
MAY ADVERSELY AFFECT ARTHUR ANDERSEN'S ABILITY TO SATISFY CLAIMS ARISING FROM
THE PROVISION OF AUDITING SERVICES TO COMPUTER MOTION.
Arthur Andersen LLP audited Computer Motion's financial
statements for the years ended December 31, 2001 and December 31, 2000. On March
14, 2002, an indictment was unsealed charging Arthur Andersen with federal
obstruction of justice arising from the government's investigation of Enron
Corp. On June 15, 2002, Arthur Andersen was convicted of these charges. The
impact of this conviction on Arthur Andersen's financial condition may adversely
affect the ability of Arthur Andersen to satisfy any claims arising from its
provision of auditing services to Computer Motion.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK
We are not subject to any meaningful market risks related
to currency, commodity prices or similar matters. We are sensitive to short-term
interest rate fluctuations to the extent that such fluctuations impact the
interest income we receive on the investment of the remaining proceeds from our
public offerings.
The primary objective of our investment activities is to
preserve principal while at the same time maximizing the income we receive from
our investments without significantly increasing risk. Some of the securities
that we invest in may have market risk. This means that a change in prevailing
interest rates may cause the principal amount of the investment to fluctuate.
For example, if we hold a security that was issued with a fixed interest rate at
the then-prevailing rate and the prevailing interest rate later rises, the
principal amount of our investment will probably decline. To minimize this risk
in the future, we intend to maintain our portfolio of cash equivalents and
short-term investments in a variety of securities. We classify our cash
equivalents and marketable securities as "fixed-rate" if the rate of return on
such instruments remains fixed over their term. These "fixed-rate" investments
include commercial paper and government and non-government debt securities. We
classify our cash equivalents and marketable securities as "variable-rate" if
the rate of return on such investments varies based on the change in a
predetermined index or set of indices during their term. These "variable-rate"
investments primarily include money market accounts. The average time to
maturity of all of our investments as of September 30, 2003 was approximately
1.69 years.  At September 30, 2003, approximately 11% of our investment
portfolio was composed of investments with original maturities of one year or
less.
ITEM 4. CONTROLS AND PROCEDURES
We maintain disclosure controls and procedures that are
designed to ensure that information required to be disclosed in our Exchange Act
reports is recorded, processed, summarized and reported within the time periods
specified in the Securities and Exchange Commission's rules and forms and that
such information is accumulated and communicated to our management, including
our Chief Executive Officer and Chief Financial Officer, as appropriate, to
allow for timely decisions regarding required disclosure. In designing and
evaluating the disclosure controls and procedures, management recognizes that
any controls and procedures, no matter how well designed and operated, can
provide only reasonable assurance of achieving the desired control objectives,
and management is required to apply its judgment in evaluating the cost-benefit
relationship of possible controls and procedures.
As required by SEC Rule 13a-15(b), we carried out an
evaluation, under the supervision and with the participation of our management,
including our Chief Executive Officer and Chief Financial Officer, of the
effectiveness of the design and operation of our disclosure controls and
procedures as of the end of the quarter covered by this report.  Based on
the foregoing, our Chief Executive Officer and Chief Financial Officer concluded
that our disclosure controls and procedures were effective at the reasonable
assurance level.
There has been no change in our internal controls over
financial reporting during our most recent fiscal quarter that has materially
affected, or is reasonably likely to materially affect, our internal controls
over financial reporting.
PART II. - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
BROOKHILL-WILK 1, LLC
In September 2000, Brookhill-Wilk 1, LLC, or Wilk, filed a
lawsuit against Intuitive Surgical in the United States District Court for the
Southern District of New York (Case No. 00 Civ. 6599 (NRB)) alleging that by
making, using, selling or offering for sale our
da Vinci
Surgical System,
we are infringing United States Patent Nos. 5,217,003 and 5,368,015 in willful
disregard of Wilk's patent rights. These patents concern methods and devices for
"remote" surgery. In March 2001, Wilk withdrew its assertion of infringement of
the '015 patent against our Company. In November 2001, in response to a motion
on one of Intuitive Surgical's noninfringement defenses, the District Court
granted summary judgment of noninfringement of the '003 patent in our favor and
dismissed Wilk's complaint in its entirety without prejudice. Wilk appealed the
summary judgment ruling to the U.S. Court of Appeals for the Federal Circuit.
In April 2003, the Court of Appeals reversed the District Court's judgment and
remanded the case for further proceedings. This reversal is based on the Court
of Appeals' determination that the particular claim limitation at issue should
be interpreted differently than as construed by the District Court.
Upon remand, we intend to continue to vigorously defend our
rights and, if necessary, are prepared to continue to conduct discovery and file
further motions on whether the patent is infringed, valid and/or enforceable. We
believe that we have multiple meritorious defenses to Wilk's allegations.
However, litigation is unpredictable and we may not prevail. Both parties have
expressed a desire to engage in non-binding mediation before engaging in further
proceedings in the District Court.  The District Court has not yet set a
schedule for further proceedings if mediation is unsuccessful.
In July 2003, Wilk filed a new lawsuit against three of
Intuitive Surgical's customers: Mt. Sinai Hospital, Lenox Hill Hospital and the
New York and Presbyterian Hospital.  Pursuant to agreements with those
customers, the Company is defending the lawsuit on behalf of its customers.  The
Company does not expect this lawsuit to significantly impact the scope of the
existing litigation with Wilk since any resolution of the existing Wilk
litigation, whether on the merits or by settlement, will likely resolve this new
lawsuit at the same time.
In September 2003, Wilk amended its complaint against
Intuitive Surgical to include Computer Motion within the lawsuit and to allege
that Computer Motion's Zeus product also infringes Wilk's '003 patent.  Prior to
the Company's acquisition of Computer Motion, Wilk sued Computer Motion but
dismissed that lawsuit voluntarily in order to await the outcome of the appeal
proceedings in Wilk's litigation with Intuitive Surgical.  Intuitive Surgical
believes that it has multiple meritorious defenses to Wilk's allegations against
Computer Motion, including many of the same defenses that apply to Wilk's
allegations against Intuitive Surgical.  However, litigation is unpredictable
and Intuitive Surgical may not prevail. Wilk's allegations against Computer
Motion are directed only to Computer Motion products.
If we lose Wilk's suit against us and the three hospital
customers, it will hurt our competitive position, may be costly to us and may
prevent us from selling our products. If we lose the patent suit, we may need to
obtain from Wilk a license to this technology if we are to continue to market
our products that have been found to infringe Wilk's patents. This license could
be expensive, which could seriously harm our business. If Wilk is successful in
its suit against us and is unwilling to grant us a license, we may be required
to stop selling our products that are found to infringe Wilk's patents unless we
can redesign them so they do not infringe Wilk's patents, which we may be unable
to do. In addition, we could be required to pay Wilk damages, including treble
damages, which could be substantial and harm our financial position. Due to the
inherent uncertainties of litigation, however, the Company cannot accurately
predict the ultimate outcome of the Wilk litigation at this time and, therefore,
cannot estimate the range of possible loss.
OTHER LEGAL MATTERS
In September 2002, we discovered that one of our employees
had purchased approximately $0.9 million in administrative supplies without the
authorization or knowledge of the Company's management. This matter was
investigated by law enforcement authorities and Company advisors. We have since
terminated this employee's employment and have taken actions intended to ensure
that no similar incidents can occur in the future, including implementing
additional controls relating to our cash disbursement process. In addition, we
are seeking to recover our loss. We have filed a claim with our insurance
carrier, from which we received proceeds of $0.5 million, and filed suit against
the sellers of the administrative supplies in December 2002. Our complaint
alleged that each of the defendants has (i) violated various sections of the
Racketeer Influenced and Corrupt Organization, or RICO, Act through their
extortion, coercion, intimidation, fraud, bribery and racketeering activity in
connection with the unauthorized purchase of office supplies, and (ii) committed
unlawful business acts and practices in violation of Cal. Bus. & Prof. Code
Section 17200 et seq. Our suit seeks to recover actual and treble damages, costs
and attorney fees for the damage caused by each of defendants through their
illegal conduct. In January 2003, we amended our complaint to allege that each
defendant further unlawfully offered prizes and gifts in violation of Cal. Bus.
& Prof. Code Section 17537 and unlawfully failed to advertise limitations on
the quantity of its sales in violation of Cal. Bus. & Prof. Code Section
17500.5. The amended complaint reiterates our claim to recover actual and treble
damages, costs and attorney fees. Discovery has not yet begun.  Defendants have
demurred to the complaint, alleging that the complaint does not contain
sufficiently pled information to support each of Intuitive's causes of action.
The Court will resolve the demurrer before the case continues.
During the second quarter of 2003, two former patients of The
Valley Hospital in New Jersey filed suit against The Valley Hospital, their
surgeons and our company alleging various harms caused during their surgeries.
Intuitive was named because the
da Vinci
Surgical System was utilized for
a portion of the surgeries and the detachable tip of an
EndoWrist
instrument is alleged to have remained in each patient after each surgery.  Each
suit alleges, among other things, negligence, carelessness and/or recklessness
by each defendant, that the
da Vinci
Surgical System was defectively
designed and manufactured, that Intuitive failed to properly instruct and train
the surgeons in its use, and that the defendants failed to properly apprise the
patients of the risks involved.  Each suit seeks an unspecified amount of
general, special and punitive damages from the defendants, in addition to a
request to recover the costs of suit and attorney fees.  As each suit was just
recently filed, both are in very early stages and discovery has recently
commenced.
We are subject to legal proceedings and claims that arise in
the normal course of our business. We do not know whether we will prevail in
these matters nor can we assure that any remedy could be reached on commercially
viable terms, if at all. Due to the inherent uncertainties of litigation, we
cannot accurately predict the ultimate outcome of these matters at this time
and, therefore, cannot estimate the range of possible loss.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY
HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM
8-K
(a) Exhibits.
Exhibit Number
Description
31
Certifications of the Company's Chief Executive Officer and
Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.
32
Certifications of the Company's Chief Executive Officer and
Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of
2002
__________
(b) Reports on Form 8-K.
On July 15, 2003, we filed a current report on Form 8-K
announcing the completion of our merger with Computer Motion, Inc.
On August 7, 2003, we furnished a current report on Form 8-K
announcing our second quarter 2003 financial results.
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
INTUITIVE SURGICAL, INC.
(Registrant)
By:
/s/ SUSAN K. BARNES
Susan K. Barnes
Senior Vice President, Chief Financial Officer and Assistant
Secretary
Date: November 14, 2003
EXHIBIT INDEX
Exhibit Number
Description
31
Certifications of the Company's Chief Executive Officer and
Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.
32
Certifications of the Company's Chief Executive Officer and
Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of
2002