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<title>Q3 2004 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, 2004
</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>
<P ALIGN="CENTER"><IMG SRC="logo.gif">
<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 33,990,854 shares of Common Stock, $0.001 par value per
share, outstanding as of October 31, 2004.

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<B><P ALIGN="CENTER">
                                Intuitive Surgical, Inc.<BR>
                                TABLE OF CONTENTS
</B></p>


<P><TABLE BORDER=0 CELLSPACING=1 CELLPADDING=2 WIDTH=85%>
  <TR vAlign=bottom>
<TD WIDTH="90%">
<font size="2"><B>
    PART I.   FINANCIAL INFORMATION
</font></B>
</TD>

<TD WIDTH="10%">
<font size="2"><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="2">
         Item 1. Financial Statements (Unaudited):
</font>
</TD>


<TD>
<font size="2">
<CENTER>&nbsp;</CENTER>
</font>
</TD>
</TR>

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

  <TR vAlign=top>
<TD>
<font size="2">
&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;
         Condensed consolidated balance sheets as of September 30, 2004 and<BR>
&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;
           December 31, 2003

</font>
</TD>

<TD>
<font size="2">
<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="2">
&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, 2004 and September 30, 2003

</font>
</TD>

<TD>
<font size="2">
<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="2">
&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, 2004 and September 30, 2003
</font>
</TD>

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

<TD>
<font size="2">
<CENTER><A HREF="#mda">13</A></CENTER>
</font>
</TD>
</TR>

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

  <TR vAlign=top>
<TD>
<font size="2">
Item 3.   Quantitative and Qualitative Disclosures About Market Risk

</font>
</TD>

<TD>
<font size="2">
<CENTER><A HREF="#market">36</A></CENTER>
</font>
</TD>
</TR>

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

  <TR vAlign=top>
<TD>
<font size="2">
Item 4.   Controls and Procedures

</font>
</TD>

<TD>
<font size="2">
<CENTER><A HREF="#control">36</A></CENTER>
</font>
</TD>
</TR>

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

  <TR vAlign=top>
<TD>
<font size="2"><B>
        PART II.  OTHER INFORMATION
</font></B>
</TD>

<TD>
<font size="2">
<CENTER>&nbsp;</CENTER>
</font>
</TD>
</TR>


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

  <TR vAlign=top>
<TD>
<font size="2">
            Item 1.  Legal Proceedings
</font>
</TD>

<TD>
<font size="2">
<CENTER><A HREF="#item1">37</A></CENTER>
</font>
</TD>
</TR>


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

  <TR vAlign=top>
<TD>
<font size="2">
        Item 2.   Unregistered Sales of Equity Securities and Use of Proceeds
</font>
</TD>

<TD>
<font size="2">
<CENTER><A HREF="#item2">41</A></CENTER>
</font>
</TD>
</TR>

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

  <TR vAlign=top>
<TD>
<font size="2">
Item 3.  Defaults Upon Senior Securities
</font>
</TD>

<TD>
<font size="2">
<CENTER><A HREF="#item3">42</A></CENTER>
</font>
</TD>
</TR>


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

  <TR vAlign=top>
<TD>
<font size="2">
Item 4.  Submission of Matters to a Vote of Security Holders
</font>
</TD>

<TD>
<font size="2">
<CENTER><A HREF="#item4">42</A></CENTER>
</font>
</TD>
</TR>


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

  <TR vAlign=top>
<TD>
<font size="2">
Item 5.  Other Information
</font>
</TD>

<TD>
<font size="2">
<CENTER><A HREF="#item5">42</A></CENTER>
</font>
</TD>
</TR>

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

  <TR vAlign=top>
<TD>
<font size="2">
        Item 6.   Exhibits
</font>
</TD>

<TD>
<font size="2">
<CENTER><A HREF="#item6">42</A></CENTER>
</font>
</TD>
</TR>


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

  <TR vAlign=top>
<TD>
<font size="2"><B>
        Signatures
</font></B>
</TD>

<TD>
<font size="2">
<CENTER><A HREF="#sign">42</A></CENTER>
</font>
</TD>
</TR>
</TABLE>

<font FACE="Times New Roman" SIZE="2">

<B><P>PART I.  FINANCIAL INFORMATION </P></B>

<P>Item 1. Financial Statements </P>

<br>
<br>
<br>
<HR WIDTH="85%">
<br>
<br>
<br>
<P style="PAGE-BREAK-BEFORE: always" align=left>
<A NAME="bs"></A>
<B><P ALIGN="CENTER">
                            INTUITIVE SURGICAL, INC.
<br>
                          CONSOLIDATED BALANCE SHEETS
<br>
                       (IN THOUSANDS, EXCEPT SHARE DATA)
<br>
                                (UNAUDITED)
</B>
<PRE>

                                                          September 30,  December 31,
                                                               2004          2003
                                                           ------------  ------------
                                                                         (See Note 1)
                        ASSETS
Current assets:
  Cash and cash equivalents.............................. $     11,268  $     11,335
  Short-term investments.................................      109,947       101,614
  Accounts receivable, net...............................       26,361        26,820
  Inventory..............................................        6,596         8,788
  Prepaids and other current assets......................        3,688         3,203
  Restricted cash equivalents............................          204           188
                                                           ------------  ------------
          Total current assets...........................      158,064       151,948
Property and equipment, net..............................       27,779        10,288
Restricted cash equivalents..............................          319           642
Intangible assets, net...................................        6,688         8,089
Goodwill.................................................      143,332       143,106
Other assets.............................................          641           921
                                                           ------------  ------------
          Total assets...................................      336,823       314,994
                                                           ============  ============
         LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
  Accounts payable....................................... $      5,214  $      5,894
  Accrued compensation and employee benefits.............        7,450         5,267
  Restructuring accrual..................................          806           971
  Other accrued liabilities..............................        7,488         9,134
  Deferred revenue.......................................       14,092        11,345
  Current portion of notes payable.......................          813         1,030
                                                           ------------  ------------
          Total current liabilities......................       35,863        33,641
Long-term notes payable..................................           52           695
Deferred revenue.........................................        1,077         1,148
Other accrued liabilities................................           57           553
                                                           ------------  ------------
          Total non-current liabilities..................        1,186         2,396
Commitments and contingencies (Note 11)..................           --            --
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, 2004  and
     and December 31, 2003, respectively.................           --            --
  Common stock, 100,000,000 shares authorized, $0.001
     par value, 33,977,398 and 33,051,631 shares
     issued and outstanding as of September 30, 2004
     and December 31, 2003, respectively.................           34            33
  Additional paid-in capital.............................      426,390       416,559
  Deferred compensation..................................           --           (99)
  Accumulated deficit....................................     (126,618)     (138,414)
  Accumulated other comprehensive income (loss)..........          (32)          878
                                                           ------------  ------------
          Total stockholders' equity.....................      299,774       278,957
                                                           ------------  ------------
          Total liabilities and stockholders' equity..... $    336,823  $    314,994
                                                           ============  ============

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


<br>
<br>
<br>
<HR WIDTH="85%">
<br>
<br>
<br>
<P style="PAGE-BREAK-BEFORE: always" align=left>
<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,
                                               ----------------------  ----------------------
                                                  2004        2003        2004        2003
                                               ---------- -----------  ---------- -----------
Sales:
  Products................................... $   29,262  $   20,515  $   77,583  $   56,958
  Services...................................      6,231       2,878      16,026       7,123
                                               ----------  ----------  ----------  ----------
Total sales..................................     35,493      23,393      93,609      64,081
Cost of sales:
  Products...................................      9,798       9,397      27,871      24,075
  Services...................................      2,973       1,932       7,552       5,513
                                               ----------  ----------  ----------  ----------
Total cost of sales..........................     12,771      11,329      35,423      29,588
                                               ----------  ----------  ----------  ----------
    Gross profit.............................     22,722      12,064      58,186      34,493
                                               ----------  ----------  ----------  ----------
Operating costs and expenses:
  Selling, general, and administrative.......     12,600      11,320      34,378      29,303
  Research and development...................      4,635       4,407      13,571      11,457
                                               ----------  ----------  ----------  ----------
    Total operating costs and
     expenses................................     17,235      15,727      47,949      40,760
                                               ----------  ----------  ----------  ----------
Income (loss) from operations................      5,487      (3,663)     10,237      (6,267)
Other income, net ...........................        692         310       1,924       1,499
                                               ----------  ----------  ----------  ----------
Income (loss) before taxes...................      6,179      (3,353)     12,161      (4,768)

Income tax expense...........................         66          --         365          --
                                               ----------  ----------  ----------  ----------
Net income (loss)............................ $    6,113  $   (3,353) $   11,796  $   (4,768)
                                               ==========  ==========  ==========  ==========
Net income (loss) per share:
  Basic...................................... $     0.18  $    (0.12) $     0.35  $    (0.22)
                                               ==========  ==========  ==========  ==========
  Diluted ................................... $     0.17  $    (0.12) $     0.34  $    (0.22)
                                               ==========  ==========  ==========  ==========
Shares used in computing net income
 (loss) per share:
  Basic......................................     33,823      26,878      33,556      21,296
                                               ==========  ==========  ==========  ==========
  Diluted....................................     35,305      26,878      34,534      21,296
                                               ==========  ==========  ==========  ==========


</PRE>

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


<br>
<br>
<br>
<HR WIDTH="85%">
<br>
<br>
<br>
<P style="PAGE-BREAK-BEFORE: always" align=left>
<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,
                                                         ------------------------
                                                            2004         2003
                                                         -----------  -----------
OPERATING ACTIVITIES:
Net income (loss)...................................... $    11,796  $    (4,768)
Adjustments to reconcile net income (loss) to net cash
  provided by (used in) operating activities:
  Depreciation.........................................       3,859        3,021
  Provision for doubtful accounts......................        (320)         707
  Loss on disposition of property and equipment........         270            5
  Amortization of deferred compensation and stock
   compensation........................................          99          379
  Amortization of intangible assets....................       1,401        1,350
Changes in operating assets and liabilities:
  Accounts receivable..................................         779       (3,000)
  Prepaids and other current assets....................        (590)        (314)
  Inventory............................................       2,192          664
  Other assets.........................................         280       (1,087)
  Accounts payable.....................................        (688)      (5,021)
  Accrued compensation and employee benefits...........       2,149         (841)
  Restructuring accrual................................        (312)      (2,112)
  Other accrued liabilities............................      (1,762)      (4,660)
  Deferred revenue.....................................       2,676        2,987
                                                         -----------  -----------
Net cash provided by (used in) operating activities....      21,829      (12,690)
                                                         -----------  -----------
INVESTING ACTIVITIES:
Acquisition of property and equipment..................     (21,960)      (1,914)
Disposition of property and equipment..................          26          192
Acquisition of business, net of cash acquired..........          --       (4,088)
Release of restricted cash equivalents.................         307           70
Purchase of short-term investments.....................     (77,441)     (10,866)
Proceeds from sales of short-term investments..........      46,257       21,224
Proceeds from maturities of short-term investments.....      21,986        4,899
                                                         -----------  -----------
Net cash (used in) provided by investing activities....     (30,825)       9,517
                                                         -----------  -----------
FINANCING ACTIVITIES:
Proceeds from issuance of common stock.................       9,832        5,181
Repurchase of common stock.............................          --           (6)
Repayment of notes payable.............................        (860)      (1,243)
                                                         -----------  -----------
Net cash provided by financing activities..............       8,972        3,932
                                                         -----------  -----------
Effect of exchange rate changes on cash................         (43)        (168)
                                                         -----------  -----------
Net (decrease) increase in cash and cash equivalents...         (67)         591
Cash and cash equivalents, beginning of period.........      11,335        8,052
                                                         -----------  -----------
Cash and cash equivalents, end of period............... $    11,268  $     8,643
                                                         ===========  ===========

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

<br>
<br>
<br>
<HR WIDTH="85%">
<br>
<br>
<br>
<A NAME="notes"></A>
<B><P ALIGN="CENTER">
                            INTUITIVE SURGICAL, INC.
<br>
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
<br>
                                  (UNAUDITED)
</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, 2003 were derived from the audited financial statements included
in  Intuitive Surgical, Inc.'s Annual Report on Form 10-K (&quot;Annual
Report&quot;) for the year ended December 31, 2003. The financial statements
included in this report should be read in conjunction with the audited financial
statements for the year ended December 31, 2003 included in the Annual Report.
The results for the interim period ended September 30, 2004 are not necessarily
indicative of the results to be expected for the full year ending December 31,
2004 or future operating periods.  The condensed consolidated financial
statements include the accounts of the Company and its subsidiaries.  All
significant intercompany accounts and transactions have been eliminated in
consolidation.  Certain reclassifications have been made to prior year balances
in order to conform to the current year presentation.  These reclassifications
had no impact on previously reported net income or stockholders' equity.</P>
<B><I><P ALIGN="JUSTIFY">Use of Estimates</P>
</B></I><P ALIGN="JUSTIFY">The preparation of financial statements in conformity
with accounting principles generally accepted in the United States requires
management to make estimates and assumptions that affect the amounts reported in
the consolidated financial statements and accompanying notes.  Actual results
could differ materially from these estimates.</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 (&quot;EITF&quot;) 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 represents 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">The Company's distributors do not have price protection or
return rights. </P>
<P ALIGN="JUSTIFY">Revenue from sales of instruments and accessories is
recognized upon shipment.  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 represent 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 Statement of Position (&quot;SOP&quot;) 97-2, &quot;Software Revenue
Recognition,&quot; 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
(&quot;APB&quot;) Opinion No. 25, &quot;Accounting for Stock Issued to
Employees,&quot; 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
(&quot;SFAS&quot;) No. 148, &quot;Accounting for Stock-Based Compensation -
Transition and Disclosure,&quot; the Company has provided the following pro
forma net income (loss) and pro forma net income (loss) per share disclosures
for stock-based awards as if the fair value-based method defined in SFAS 123,
&quot;Accounting for Stock-Based Compensation,&quot; had been applied (amounts
in thousands, except per share amounts):</P>

<PRE>

                                                     Three Months Ended   Nine Months Ended
                                                        September 30,       September 30,
                                                     ------------------  -------------------
                                                       2004      2003      2004       2003
                                                     --------  --------  ---------  --------
Net income (loss), as reported..................... $  6,113  $ (3,353) $  11,796  $ (4,768)
Add:  Total stock-based employee
  compensation expense included in reported
  net income (loss), net of $0 related tax effect..       --        83         99       379
Deduct: Total stock-based employee
  compensation expense determined
  under fair value based method for
  all awards, net of $0 related tax effect.........   (2,429)   (2,123)    (7,546)   (6,107)
                                                     --------  --------  ---------  --------
Pro forma net income (loss)........................ $  3,684  $ (5,393) $   4,349  $(10,496)
                                                     ========  ========  =========  ========

Net income (loss) per share:
  Basic - as reported.............................. $   0.18  $  (0.12) $    0.35  $  (0.22)
  Basic - pro forma................................ $   0.11  $  (0.20) $    0.13  $  (0.49)

  Diluted - as reported............................ $   0.17  $  (0.12) $    0.34  $  (0.22)
  Diluted - pro forma.............................. $   0.10  $  (0.20) $    0.13  $  (0.49)


</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,
                                     -------------------   ------------------
                                        2004      2003        2004      2003
                                     --------  ---------   --------  --------
Stock Option Plans:
   Average risk free interest rate.     3.24 %     2.52 %     3.10 %    2.51 %
   Average expected life (years)...      4.0        4.0        4.0       4.0
   Volatility......................       68 %       80 %       70 %      80 %

Stock Purchase Plan:
   Average risk free interest rate.     1.47 %     1.21 %     1.34 %    1.48 %
   Average expected life (years)...      1.4        0.5        1.2       0.5
   Volatility......................       62 %       48 %       62 %      48 %

</PRE>

<B><I><P>Recent Accounting Pronouncements</P>
</B></I><P ALIGN="JUSTIFY">In December 2003, the Financial Accounting Standards
Board (&quot;FASB&quot;) issued Interpretation No. 46R, (&quot;FIN 46R&quot;),
(revised December 2003), &quot;Consolidation of Variable Interest Entities, an
Interpretation of Accounting Research Bulletin No. 51,&quot; which addresses how
a business enterprise should evaluate whether it has a controlling interest in
an entity through means other than voting rights and accordingly should
consolidate the entity. FIN 46R replaces FASB Interpretation FIN&nbsp;46, which
was issued in January 2003. As of the effective date of FIN 46R, an enterprise
must evaluate its involvement with all entities or legal structures created
before February 1, 2003, to determine whether consolidation requirements of FIN
No. 46R apply to those entities. There is no grandfathering of existing
entities. The adoption of FIN No. 46R did not have a significant impact on the
Company's consolidated financial position, results of operations or cash flow.
</P>
<P ALIGN="JUSTIFY">In December 2003, the SEC issued Staff Accounting Bulletin
(&quot;SAB&quot;) No. 104, &quot;Revenue Recognition.&quot; SAB No. 104 revised
and rescinded portions of the interpretative guidance included in Topic 13 of
the codification of staff accounting bulletins in order to make that
interpretive guidance consistent with current authoritative accounting and
auditing guidance and SEC rules and regulations. The adoption of SAB No. 104 did
not have a significant impact on the Company's consolidated financial position,
results of operations or cash flow.</P>
<P ALIGN="JUSTIFY">In March 2004, the EITF reached a consensus on recognition
and measurement guidance previously discussed under EITF 03-01. The consensus
clarifies the meaning of other-than-temporary impairment and its application to
investments classified as either available-for-sale or held-to-maturity under
SFAS 115, &quot;Accounting for Certain Investments in Debt and Equity
Securities,&quot; and investments accounted for under the cost method or the
equity method. The recognition and measurement guidance for which the consensus
was reached is to be applied to other-than-temporary impairment evaluations. In
September 2004, FASB issued a final FASB Staff Position, FSP EITF Issue 03-01-1,
that delays the effective date for the measurement and recognition guidance of
EITF 03-01. The Company is currently evaluating the impact of adopting EITF 03-01.</P>

<P ALIGN="JUSTIFY">On October 13, 2004, the FASB concluded that Statement 123R,
&quot;Share-Based Payment,&quot; which would require all companies to measure
compensation cost for all share-based payments, including employee stock
options, at fair value, would be effective for public companies, except small
business issuer as defined in SEC Regulation S-B, for interim or annual periods
beginning after June 15, 2005.  The Company is currently evaluating the impact
of the adopting Statement 123R.</P>
<B><P>NOTE 2. CONCENTRATIONS OF RISK</P>
</B><P ALIGN="JUSTIFY">Financial instruments that 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 three months and nine months ended
September 30, 2004 and 2003, 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.</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 and
accessories accounted for all of the Company's product sales for the three
months and nine months ended September 30, 2004 and 2003. 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.   The distribution of sales
by geographic location is as follows (in thousands): </P>

<PRE>

                                 Three Months Ended     Nine Months Ended
                                    September 30,         September 30,
                               --------------------- ---------------------
                                   2004       2003       2004       2003
                                ---------  ---------  ---------  ---------
Domestic...................... $  27,819  $  19,962  $  72,999  $  50,759
International.................     7,674      3,431     20,610     13,322
                                ---------  ---------  ---------  ---------
Total sales................... $  35,493  $  23,393  $  93,609  $  64,081
                                =========  =========  =========  =========

</PRE>

<B><P ALIGN="JUSTIFY">NOTE 3. 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, 2004 and December 31, 2003.  Approximately $4.0
million and $4.8 million of money market instruments were included in cash and
cash equivalents at September 30, 2004 and December 31, 2003, respectively.</P>

<B><P>NOTE 4. 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 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>

<P ALIGN="JUSTIFY">The following table presents the fair value of available-for-sale
securities included in short-term investments as of the respective dates (in thousands):</P>

<PRE>

                          September 30, 2004  December 31, 2004
                          ------------------  -----------------
U.S. corporate debt...... $          48,773  $          44,904
U.S. government debt.....            31,924             28,210
Municipal debt...........            17,450             11,950
Commercial paper.........            11,800             16,550
                           -----------------  -----------------
Total.................... $         109,947  $         101,614
                           =================  =================

</PRE>

<B><P ALIGN="JUSTIFY">NOTE 5. INVENTORY</P>
</B><P ALIGN="JUSTIFY">Inventory is stated at the lower of cost or market value.
Cost is computed using standard costs, which approximates actual cost on a
first-in, first-out basis.  Inventory consists of the following (in thousands):</P>

<PRE>

                               September 30,  December 31,
                                   2004          2003
                               ------------  ------------
Raw materials................ $      1,753  $      1,247
Work-in-process..............        1,235         1,797
Finished goods...............        3,608         5,744
                               ------------  ------------
Total........................ $      6,596  $      8,788
                               ============  ============

</PRE>

<B>
<P>NOTE 6. GOODWILL AND INTANGIBLE ASSETS</P>
</B><I><P ALIGN="JUSTIFY">Goodwill and Intangible Assets</P>
</I><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; rather, they will be tested for impairment at least once each fiscal
year (more frequently if certain indicators are present), which the Company will
do in the fourth quarter.  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 Company's
acquisition of Computer Motion on June 30, 2003, $143.3 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"> Net intangible assets is comprised of the following (in thousands):</P>

<PRE>

                                                  September 30, 2004
                                    -----------------------------------------------
                                                 Accumulated
                                      Gross     Amortization  Impairment     Net
                                    ---------   ------------  ----------  ---------
Developed technology.............  $   3,500   $        250  $    3,250  $      --
Core technology..................      3,300            589          --      2,711
Customer relationships...........      1,300            433          --        867
Patents..........................      7,310          4,340          --      2,970
Other intangible assets..........        500             69         291        140
                                    ---------   ------------  ----------  ---------
Total intangible assets, net.....  $  15,910   $      5,681  $    3,541  $   6,688
                                    =========   ============  ==========  =========

                                                  December 31, 2003
                                    -----------------------------------------------
                                                 Accumulated
                                      Gross     Amortization  Impairment     Net
                                    ---------   ------------  ----------  ---------
Developed technology.............  $   3,500   $        250  $    3,250  $      --
Core technology..................      3,300            236          --      3,064
Customer relationships...........      1,300            233          --      1,067
Patents..........................      7,310          3,511          --      3,799
Other intangible assets..........        500             50         291        159
                                    ---------   ------------  ----------  ---------
Total intangible assets, net.....  $  15,910   $      4,280  $    3,541  $   8,089
                                    =========   ============  ==========  =========

</PRE>

<P ALIGN="JUSTIFY">Amortization expense related to intangible assets was $0.5
million and $0.6 million for the three months ended September 30, 2004 and 2003,
respectively.  Amortization expense related to intangible assets was $1.4
million and $1.4 million for the nine months ended September 30, 2004 and 2003,
respectively.</P>

<P ALIGN="JUSTIFY">Estimated future amortization expense related to intangible
assets at September 30, 2004 is as follows (in thousands):</P>

<PRE>

        Fiscal Year
----------------------------
2004 (remaining 3 months)...  $      467
2005........................       1,868
2006........................       1,275
2007........................       1,077
2008........................         811
Thereafter..................       1,190
                                ---------
Total.......................  $    6,688
                                =========

</PRE>

<I><P ALIGN="JUSTIFY">Impairment of Goodwill</P>
</I><P ALIGN="JUSTIFY">The Company has elected to perform an annual analysis of
goodwill during the fourth quarter of each year.  Based on our 2003 impairment
analysis, no impairments were identified, and no indicators of impairment were
identified during the nine months ended September 30, 2004.</P>
<I><P ALIGN="JUSTIFY">Impairment of Long-Lived Assets</P>
</I><P ALIGN="JUSTIFY">SFAS No. 144, &quot;Accounting for the Impairment or
Disposal of Long-Lived Assets,&quot; requires recognition of impairment of long-
lived assets when circumstances indicate an impairment has occurred and in the
event the net book value of such assets exceeds the future undiscounted cash
flows attributable to such assets.  Accordingly, the Company evaluates asset
recoverability when an event occurs that may impair recoverability of the asset.
The Company determines the recoverability of the carrying amount of each asset
by reviewing the following factors: the undiscounted value of expected operating
cash flows; the estimated useful or contractual life of the asset; and the
contract or product supporting the asset.  No impairment losses were incurred
during the nine months ended September 30, 2004 and 2003.</P>

<B><P>NOTE 7. 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. Effective July 1, 2003, the Company adopted the
provisions of EITF No. 00-21 on a prospective basis. Under EITF No. 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 recognizes warranty and related service costs as
incurred for these arrangements. 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 warranty
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                            Balance at
                                         Beginning   Warranty     Warranty      End of
                                         of Period     Usage       Accrued      Period
                                        -----------  ---------  -------------  ---------
Nine months ended September 30, 2004.  $       702  $    (703) $         149  $     148

</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 products. 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 indemnification clauses and no liabilities have
been recorded for this obligation on its balance sheets as of September 30, 2004
or December 31, 2003.</P>
<B><P ALIGN="JUSTIFY">NOTE 8. RESTRUCTURING CHARGES </P>
</B><P ALIGN="JUSTIFY">In connection with the acquisition of Computer Motion in
June 2003, the Company recorded an accrual for acquisition integration
liabilities, which includes the incremental costs to exit and consolidate
activities at Computer Motion locations, termination of certain Computer Motion
employees, and for other costs to integrate operating locations and other
activities of Computer Motion.  The accrual was recorded using the guidance
provided by EITF 95-3, &quot;Recognition of Liabilities in Connection with a
Purchase Business Combination,&quot; which requires that these acquisition
integration expenses, which are not associated with the generation of future
revenues and have no future economic benefit, be reflected as assumed
liabilities in the allocation of the purchase price to the net assets acquired.
During 2003, the Company recorded a $3.4 million accrual in accordance with EITF
95-3.  The accrual was comprised of $2.6 million for employee severance costs
and $0.8 million for estimated losses to be incurred to sublet vacated
facilities.  During the nine months ended September 30, 2004, the Company
increased the accrual for the estimated losses to be incurred to sublet vacated
facilities by $0.2 million due to the change in estimates on assumptions used to
calculate the losses on subleasing the vacated facilities.  </P>
<P ALIGN="JUSTIFY">During the three months ended December 31, 2003, based on the
Company's cost structure and future development plans,
the Company planned to completely shut down the Goleta
research and development facility.  In accordance with SFAS No. 146,
&quot;Accounting for Costs Associated with Exit or Disposal Activities,&quot;
the Company recorded restructuring charges of $0.2 million, which are related to
the costs of one-time employee terminations.   SFAS No. 146 requires that a
liability for costs associated with an exit or disposal activity be recognized
and measured initially at fair value only when the liability is incurred.  As
employees are generally required to render service beyond the minimum retention
period or 60 days, the severance payments are recognized ratably over the
service periods.  During the nine months ended September 30, 2004, the Company
completed the shutdown of the Goleta research and development facilities and
accrued $0.2 million of employee severance costs and $0.5 million of lease
commitment costs to exit the leased facility.  The charges incurred in the nine
months ended September 30, 2004 were recorded in research and development
expenses on the income statement.  The Company expects to fully utilize the
accrual by the third quarter of 2007, when existing lease commitments
expire.</P>
<P ALIGN="JUSTIFY">The following table summarizes the restructuring activitiy
for the nine months ended September 30, 2004 (in thousands):</P>

<PRE>

                                                  EITF No. 95-3          SFAS No. 146
                                             ----------------------  ---------------------
                                              Employee     Lease     Employee     Lease
                                             Severance   Commitments Severance  Commitments Total
                                             ----------  ----------  ---------  ---------  --------
Cost accrued............................... $    2,628  $      816  $     186  $      --  $  3,630
Cash payments, net of subleasing proceeds..     (2,310)       (303)        --         --    (2,613)
Currency impact............................        (23)        (23)        --         --       (46)
                                             ----------  ----------  ---------  ---------  --------
Balance at December 31, 2003...............        295         490        186         --       971
Cost accrued...............................         --         226        224        525       975
Cash payments, net of subleasing proceeds..       (291)       (268)      (410)      (177)   (1,146)
Currency impact............................         --           6                               6
                                             ----------  ----------  ---------  ---------  --------
Balance at September 30, 2004.............. $        4  $      454  $      --  $     348  $    806
                                             ==========  ==========  =========  =========  ========

</PRE>

<B><P>NOTE 9. COMPREHENSIVE INCOME (LOSS)</P>
</B><P ALIGN="JUSTIFY">Comprehensive income (loss) includes net income (loss)
and other comprehensive income (loss), which primarily consists of unrealized
gains and losses on available-for-sale securities and cumulative translation
adjustments.  Total accumulated other comprehensive income (loss) is displayed
as a separate component of stockholders' equity in the accompanying condensed
consolidated balance sheets.  The components of comprehensive income (loss)
consist of the following (in thousands):</P>

<PRE>

                                         Three Months Ended    Nine Months Ended
                                             September 30,       September 30,
                                        --------------------  --------------------
                                           2004       2003       2004       2003
                                        ---------  ---------  ---------  ---------
Net income (loss)..................... $   6,113  $  (3,353) $  11,796  $  (4,768)
Other comprehensive income (loss):
  Foreign currency translation
    adjustments.......................        11        (13)       (46)      (168)
  Change in unrealized gain (loss)
    on available-for-sale securities..       243       (198)      (864)      (654)
                                        ---------  ---------  ---------  ---------
Comprehensive income (loss)........... $   6,367  $  (3,564) $  10,886  $  (5,590)
                                        =========  =========  =========  =========

</PRE>

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

<PRE>

                                            September 30, December 31,
                                                2004         2003
                                            ------------  -----------
Accumulated net unrealized gain on
  available-for-sales securities.......... $         76  $       940
Foreign currency translation
  adjustments.............................         (108)         (62)

Total accumulated other comprehensive       ------------  -----------
  (loss) income........................... $        (32) $       878
                                            ============  ===========

</PRE>

<B><P>NOTE 10. NET INCOME (LOSS) PER SHARE</P>
</B><P ALIGN="JUSTIFY">The following table presents the computation of basic and
diluted net income (loss) per share (in thousands, except per share data).
Basic net income (loss) per share is computed using the weighted-average number
of common shares outstanding.  Diluted net income (loss) per share is computed
using the weighted-average number of common shares outstanding and potential
dilutive common shares from the assumed exercise of options and warrants
outstanding during the period, if any, using the treasury method.</P>

<PRE>

                                            Three Months Ended        Nine Months Ended
                                              September 30,            September 30,
                                         -----------------------  -------------------------
                                            2004         2003        2004         2003
                                         -----------  ----------  -----------  ------------
Numerator used for basic and
  diluted net income (loss) per
  common share......................... $     6,113  $   (3,353) $    11,796  $     (4,768)
                                         ===========  ==========  ===========  ============
Denominator used for basic and
  diluted net income (loss) per common
  share:
  Weighted-average shares
    outstanding........................      33,823      26,881       33,556        21,301
  Less weighted-average
    shares subject to
    repurchase.........................          --          (3)          --            (5)
                                         -----------  ----------  -----------  ------------
  Weighted-average shares used in
    computing basic net income (loss)
    per common share...................      33,823      26,878       33,556        21,296
                                         ===========  ==========  ===========  ============

  Add common stock equivalents.........       1,482          --          978            --
  Weighted-average shares used
    in computing diluted net income
    (loss) per common share............      35,305      26,878       34,534        21,296
                                         ===========  ==========  ===========  ============

Net income (loss) per common share:
  Basic................................ $      0.18  $    (0.12) $      0.35  $      (0.22)
                                         ===========  ==========  ===========  ============
  Diluted.............................. $      0.17  $    (0.12) $      0.34  $      (0.22)
                                         ===========  ==========  ===========  ============

</PRE>

<P ALIGN="JUSTIFY">Potential weighted-average common shares excluded from the
computation of diluted net income per share as their effect would be
antidilutive were 193,000 shares and 359,000 shares, respectively, for the three
months and nine months ended September 30, 2004.  The exercise price of these
options exceeded the average market price during the three-month and nine-month
periods mentioned above.  These shares could, however, potentially dilute basic
income per share in the future.  For the three months and nine months ended
September 30, 2003, the Company did not include options outstanding to purchase
4,977,000 and 3,803,000 shares, respectively, of common stock in the diluted net
loss per share since their effect was antidilutive due to the reported loss.</P>

<B><P ALIGN="JUSTIFY">NOTE 11. COMMITMENTS AND CONTINGENCIES </P>
</B><P ALIGN="JUSTIFY">OPERATING LEASES</P>
<P ALIGN="JUSTIFY">The Company entered into a lease arrangement of office and
manufacturing space in Sunnyvale, California effective January 2002 (the
&quot;Sunnyvale Lease&quot;).  Under the Sunnyvale Lease, the Company was
required to lease additional space in the same building starting in January
2004.  The Sunnyvale Lease was scheduled to expire on April 30, 2007. On April
30, 2004, the Company purchased the property for approximately $20.0 million and
canceled the Sunnyvale Lease.  In addition, the Company leases office space for
research and development in Milford, Connecticut and sales office space in St.
Germain en Laye, France.  In connection with the acquisition of Computer Motion,
the Company assumed leases in Goleta, California.  These leases have varying
terms, the longest of which extends to September 2007.  As of September 30,
2004, the Company sublet approximately 90% of its office space in Goleta.  </P>
<P ALIGN="JUSTIFY">Future minimum lease commitments, net of sublease income of
$1.4 million throughout the next 4 years, under the Company's operating leases
as of September 30, 2004 are as follows (in thousands):</P>

<PRE>

2004 (remaining 3 months)..... $     112
2005..........................       408
2006..........................       399
2007..........................       236
2008..........................        36
Thereafter....................        34
                                ---------
Total......................... $   1,225
                                =========

</PRE>

<P ALIGN="JUSTIFY">Rent expense was approximately $0.1 million and $0.9 million
for the three months ended September 30, 2004 and 2003, respectively.  Rent
expense was approximately $1.0 million and $2.4 million for the nine months
ended September 30, 2004 and 2003, respectively.</P>
<P ALIGN="JUSTIFY">CONTINGENCIES</P>
<P>The discussion of the Company's legal proceedings is incorporated by
reference from Part II, Item 1. Legal Proceedings of this report.</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, &quot;Intuitive Surgical,&quot;
&quot;Intuitive,&quot; &quot;Company,&quot; &quot;we,&quot; &quot;us,&quot; and
&quot;our&quot; refer to Intuitive Surgical, Inc.</P>
<P ALIGN="JUSTIFY">This management's discussion and analysis of financial
condition as of September 30, 2004 and results of operations for the three
months and nine months ended September 30, 2004 and September 30, 2003 should be
read in conjunction with the management's discussion and analysis of financial
condition and results of operations included in the Annual Report.  </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
&quot;Factors Affecting Operating Results&quot; below as well as those discussed
elsewhere.</P>
<P ALIGN="JUSTIFY">Intuitive Surgical&reg;, <I>da Vinci</I>&reg;, InSite&reg;,
EndoWrist&reg;, <I>Zeus</I>&reg;, <I>Hermes</I>&reg;, and <I>Aesop</I>&reg; are
registered trademarks of Intuitive Surgical, Inc.</P>
<B><I><P>OVERVIEW&nbsp;</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 &quot;wristed&quot; 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. The <I>da Vinci</I>
Surgical System is sold for use in multiple surgical specialties, principally
urology, cardiac and general surgery.</P>

<B><I><P>RESULTS OF OPERATIONS</P>
</B><P>Product Sales (dollars in millions) </P>
</I>

<PRE>

                                     September 30,  September 30,                %
                                         2004           2003        Change    Change
                                     -------------  -------------  --------- ---------
Three months ended................. $        29.3  $        20.5  $     8.8        43 %
Nine months ended.................. $        77.6  $        57.0  $    20.6        36 %

</PRE>

<P ALIGN="JUSTIFY">Product sales increased to $29.3 million for the three months
ended September 30, 2004 from $20.5 million for the three months ended September
30, 2003. This 43% increase in product sales resulted primarily from higher
<I>da Vinci</I> Surgical System unit sales and higher recurring instrument and
accessory revenue. </P>

<P ALIGN="JUSTIFY">Total third quarter 2004 system revenue was $19.0 million
compared to $15.5 million during the third quarter of 2003. We shipped 18 <I>da
Vinci</I> Surgical Systems during the third quarter of 2004: 13 in North
America, 1 in Europe, and 4 in the rest of the world. The 18 total units shipped
represented a 3 unit increase compared to 15 units shipped during the third
quarter of 2003. As of September 30, 2004 we have shipped a total of 261 <I>da
Vinci</I> Surgical Systems: 184 in North America, 52 in Europe, and 25 in the
rest of the world. We shipped 15 <I>da Vinci</I> Surgical System fourth arms
during the third quarter of 2004, compared to 16 during the third quarter of
2003. We shipped 8 <I>Aesop</I> systems during the third quarter of 2004,
compared to 5 during the third quarter of 2003. </P>

<P ALIGN="JUSTIFY">Third quarter 2004 instrument and accessory revenue increased
to $10.3 million from $5.0 million for the third quarter of 2003, reflecting a
growing number of surgical procedures performed by our customers, such as those
for radical prostatectomy procedures. This growth resulted from a larger base of
installed <I>da Vinci</I> Surgical Systems and improved system utilization per
site.</P>

<P ALIGN="JUSTIFY">Product sales increased to $77.6 million for the nine months
ended September 30, 2004 from $57.0 million for the nine months ended September
30, 2003. This 36% increase in product sales resulted primarily from higher
recurring instrument and accessory revenue, higher <I>da Vinci</I> Surgical
System unit sales, and higher fourth arm unit sales.</P>

<P ALIGN="JUSTIFY">Total system revenue for the nine months ended September 30,
2004 was $51.7 million compared to $44.3 million for the nine months ended
September 30, 2003. We shipped 51 <I>da Vinci</I> Surgical Systems during the
first nine months of 2004, compared to 43 units shipped during the first nine
months of 2003. We shipped 17 <I>Aesop</I> systems during the first nine months
of 2004, compared to 5 for the first nine months of 2003.</P>

<P>Instrument and accessory revenue for the nine months ended September 30, 2004
increased to $25.9 million from $12.7 million for the nine months ended
September 30, 2003, reflecting a growing number of surgical procedures performed
by our customers, such as those for radical prostatectomy procedures. This
growth resulted in large part from a larger base of installed <I>da Vinci</I>
Surgical Systems and improved system utilization per site.</P>

<P>&nbsp;<I>Service Sales (dollars in millions) </P>
</I>

<PRE>

                                     September 30,  September 30,                %
                                         2004           2003        Change    Change
                                     -------------  -------------  --------- ---------
Three months ended................. $         6.2  $         2.9  $     3.3       114 %
Nine months ended.................. $        16.0  $         7.1  $     8.9       125 %

</PRE>

<P ALIGN="JUSTIFY">Service sales, comprised of system service, installation and
customer training, increased to $6.2 million for the three months ended
September 30, 2004 from $2.9 million for the three months ended September 30,
2003. The increase was primarily due to a larger base of <I>da Vinci</I>
Surgical Systems generating service revenue. The base of systems generating
service revenue grew by 125 systems entering the third quarter of 2004 compared
to the third quarter of 2003. The increase of 125 was comprised of 59 systems
sold between the third quarter of 2002 and the second quarter of 2003 coming out
of the warranty period onto service contracts and 66 systems sold between the
third quarter of 2003 and the second quarter of 2004, with first year service
deferred according to EITF 00-21, which was adopted prospectively effective July
1, 2003. In addition, the average service revenue per active system under a
service contract increased in 2004 due to higher rates charged for four-arm
systems. </P>

<P>Service sales increased to $16.0 million for the nine months ended September
30, 2004 from $7.1 million for the nine months ended September 30, 2003. The
increase was primarily due to a larger base of <I>da Vinci</I> Surgical Systems
generating service revenue.</P>

<I><P>Product Sales Gross Profit (dollars in millions)</P>
</I>

<PRE>

                                     September 30,  September 30,                %
                                         2004           2003        Change    Change
                                     -------------  -------------  --------- ---------
Three months ended................. $        19.5  $        11.1  $     8.4        76 %
Percentage of product sales........          66.5 %         54.2 %

Nine months ended.................. $        49.7  $        32.9  $    16.8        51 %
Percentage of product sales........          64.1 %         57.7 %

</PRE>

<P ALIGN="JUSTIFY">Product sales gross profit for the three months ended
September 30, 2004 was $19.5 million, or 66.5% of product sales, compared to
$11.1 million, or 54.2% of product sales for the three months ended September
30, 2003. The $8.4 million increase in product gross profit was driven by $8.8
million higher product sales during the third quarter of 2004, as described
previously, in combination with a higher third quarter 2004 gross profit
percentage.  Our increased third quarter 2004 gross profit percentage was driven
by maintaining product pricing, leveraging fixed manufacturing costs across
higher product sales volume, and reducing system and instrument material costs.
In addition, third quarter 2003 product margin was negatively impacted by
approximately $1.0 million, or 4.9 margin points, due to integration costs
incurred associated with the Computer Motion entity acquired on June 30,
2003.</P>

<P>Product sales gross profit for the nine months ended September 30, 2004 was
$49.7 million, or 64.1% of product sales, compared to $32.9 million, or 57.7% of
product sales for the nine months ended September 30, 2003. The increase was
driven by maintaining product pricing, leveraging fixed manufacturing costs
across higher product sales volume, and reducing system and instrument material
costs.</P>

<I><P>Service Sales Gross Profit (dollars in millions)</P>
</I>

<PRE>

                                     September 30,  September 30,                %
                                         2004           2003        Change    Change
                                     -------------  -------------  --------- ---------
Three months ended................. $         3.3  $         0.9  $     2.4       267 %
Percentage of service sales........          52.3 %         32.9 %

Nine months ended.................. $         8.5  $         1.6  $     6.9       431 %
Percentage of product sales........          52.9 %         22.6 %

</PRE>

<P>Service sales gross profit for the three months ended September 30, 2004 was
$3.3 million, or 52.3% of service sales, compared to $0.9 million, or 32.9% of
service sales for the three months ended September 30, 2003. Service sales gross
profit for the nine months ended September 30, 2004 was $8.5 million, or 52.9%
of service sales, compared to $1.6 million, or 22.6% of service sales, for the
nine months ended September 30, 2003. Higher 2004 service sales gross profit was
driven by increased service revenue, as described above, in combination with
increased leverage of the mostly fixed service and training organization
expenses across a larger base of installed systems.</P>

<P>&nbsp;<I>Selling, General and Administrative Expenses (dollars in millions)</P>
</I>

<PRE>

                                     September 30,  September 30,                %
                                         2004           2003        Change    Change
                                     -------------  -------------  --------- ---------
Three months ended................. $        12.6  $        11.3  $     1.3        12 %
Nine months ended.................. $        34.4  $        29.3  $     5.1        17 %

</PRE>

<P ALIGN="JUSTIFY">Selling, general and administrative expenses include
personnel costs for sales, marketing and administrative personnel, tradeshow
expenses, legal expenses, regulatory fees and general corporate expenses. </P>

<P ALIGN="JUSTIFY">Selling, general and administrative expenses for the three
months ended September 30, 2004 were $12.6 million, up 12% from $11.3 million
for the three months ended September 30, 2003. Selling, general and
administrative expenses for the nine months ended September 30, 2004 were $34.4
million, up 17% from $29.3 million for the nine months ended September 30, 2003.
The year over year increases were primarily due to higher incentive compensation
and other variable costs associated with achieving higher revenues, incremental
patent costs associated with maintaining the Computer Motion patent portfolio,
and additional accounting personnel, consulting, and auditing resources added to
support compliance with the Sarbanes Oxley Act of 2002.  These items were
partially offset by the elimination of Computer Motion integration costs
incurred during the third quarter of 2003.</P>

<P>We expect selling, general and administrative expenses to increase in the
future to support our expanding business.</P>

<I><P>Research and Development Expenses (dollars in millions)</P>
</I>

<PRE>

                                     September 30,  September 30,                %
                                         2004           2003        Change    Change
                                     -------------  -------------  --------- ---------
Three months ended................. $         4.6  $         4.4  $     0.2         5 %
Nine months ended.................. $        13.6  $        11.5  $     2.1        18 %

</PRE>

<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. </P>

<P ALIGN="JUSTIFY">Research and development expenses for the three months ended
September 30, 2004 were $4.6 million, up 5% compared to $4.4 million for the
three months ended September 30, 2003. The increase was primarily due to higher
third quarter 2004 incentive compensation and product development project costs,
partially offset by the elimination of the Computer Motion integration and
operating costs incurred during the third quarter of 2003.  </P>

<P ALIGN="JUSTIFY">Research and development expenses for the nine months ended
September 30, 2004 were $13.6 million, up 18% compared to $11.5 million for the
nine months ended September 30, 2003. The increase during the nine months ended
September 30, 2004 was due in large part to expenses incurred in the first
quarter of 2004 to close the former Computer Motion facilities located in
Goleta, California. In accordance with our restructuring plan, we completely
shut down the Goleta site on March 31, 2004 and terminated all remaining
Goleta-based employees, resulting in a $0.8 million restructuring expense recorded in
the first quarter of 2004.  The remainder of the increase for the nine months
ended September 30, 2004 was primarily due to higher incentive compensation and
product development costs.</P>
<P> </P>
<P>Research and development costs are expensed as incurred. We expect to
continue to make substantial investments in research and development and
anticipate that research and development expenses will increase in the
future.</P>

<P>&nbsp;<I>Other Income, Net, and Income Tax Expense (dollars in millions) </P>
</I>

<PRE>

                                     September 30,  September 30,                %
                                         2004           2003        Change    Change
                                     -------------  -------------  --------- ---------
Three months ended................. $         0.6  $         0.3  $     0.3       100 %
Nine months ended.................. $         1.6  $         1.5  $     0.1         7 %

</PRE>

<P ALIGN="JUSTIFY">Other income, comprised mostly of interest income, increased
to $0.7 million for the three months ended September 30, 2004 from $0.3 million
for the three months ended September 30, 2003. The increase resulted primarily
from higher interest income earned on a larger cash balance position during the
third quarter of 2004 resulting from the proceeds of our public offering of
common stock in the fourth quarter of 2003. </P>

<P ALIGN="JUSTIFY">Other income for the nine months ended September 30, 2004 was
$1.9 million, compared to $1.5 million for the nine months ended September 30,
2003. First quarter 2003 other income included $0.5 million of gains realized on
sales of securities. Excluding these first quarter 2003 capital gains, other
income for the nine months ended September 30, 2004, comprised mostly of
interest income, increased $0.9 million primarily due to higher interest income
earned on a larger cash balance position during the period resulting from the
proceeds of the fourth quarter of 2003 public offering of our common stock. </P>

<P>Income tax expense was $0.1 million and $0.4 million for the three and nine
months ended September 30, 2004, respectively.  This expense represents
estimated income tax based on our profitability for the periods presented.</P>

<B><I><P>LIQUIDITY AND CAPITAL RESOURCES</P>
</B></I>
<P ALIGN="JUSTIFY">Our operations have been financed primarily through the sale
of our equity securities. Sales of convertible preferred stock have yielded
proceeds of approximately $127.3 million and public offerings of our common
stock have yielded proceeds of approximately $124.5 million. We have also
financed operations through employee stock purchase and option plans as well as
equipment financing arrangements. At September 30, 2004 we had total
stockholders equity of $299.8 million and outstanding equipment financing debt
of $0.9 million. As of September 30, 2004, we had cash, cash equivalents and
short-term investments of $121.2 million, compared to $112.9 million at December
31, 2003. Working capital as of September 30, 2004 was $122.2 million, compared
to $118.3 million as of December 31, 2003. The increase in cash, cash
equivalents and short-term investments and in working capital resulted primarily
from our 2004 year-to-date net income of $11.8 million, non-cash operating
expenses of $5.3 million, and net proceeds of $9.8 million realized from stock
option exercises and our employee stock purchase plan, partially offset by the
purchase of our Sunnyvale, California facility during the second quarter of 2004
for approximately $20.0 million in cash and the purchase of other property and
equipment for approximately $2.0 million in cash.  </P>

<P ALIGN="JUSTIFY">Net cash provided by operating activities was $21.8 million
for the nine months ended September 30, 2004, compared to $12.7 million of cash
used in operating activities for the nine months ended September 30, 2003. The
$21.8 million of cash provided by operations during the nine months ended
September 30, 2004 resulted from net income of $11.8 million, non-cash expenses
of $5.3 million and net working capital generated of $4.7 million. The $12.7
million of cash used in operating activities during the nine months ended
September 30, 2003 was comprised primarily of working capital consumed of $13.4
million and our net loss of $4.8 million, partially offset by non-cash expenses
of $5.5 million.  The $13.4 million of working capital consumed during the nine
months ended September 30, 2003 was driven by the payment of net liabilities
acquired in the Computer Motion acquisition which closed on June 30, 2003.</P>

<P ALIGN="JUSTIFY">Net cash used in investing activities was $30.8 million for
the nine months ended September 30, 2004, compared to net cash provided by
investing activities of $9.5 million for the nine months ended September 30,
2003. Net cash used in investing activities during the nine months ended
September 30, 2004 resulted mainly from investments in fixed assets of $22.0
million, comprised mostly of our purchase of our Sunnyvale, California facility
($20.0 million) during the second quarter of 2004, and the net conversion of
cash into short-term investments of  $8.9 million. Net cash provided by
investing activities during the nine months ended September 30, 2003 resulted
primarily from the net conversion of short-term investments into cash of $15.3
million, partially offset by $4.1 million of cash used to acquire Computer
Motion and $1.7 million of cash related to the purchase and disposition of fixed
assets. </P>

<P ALIGN="JUSTIFY">Net cash provided by financing activities was $9.0 million
for the nine months ended September 30, 2004, compared to $3.9 million for the
nine months ended September 30, 2003. Net cash provided by financing activities
for the nine months ended September 30, 2004 resulted primarily from net
proceeds realized from stock option exercises and our employee stock purchase
plan of $9.8 million, partially offset by repayments of long-term debt of $0.9
million. Net cash provided by financing activities for the nine months ended
September 30, 2003 resulted primarily from net proceeds realized from stock
option exercises and our employee stock purchase plan of $5.2 million, partially
offset by repayments of long-term debt of $1.2 million. </P>

<P ALIGN="JUSTIFY">Our capital requirements depend on numerous factors,
including market acceptance of our products, the resources we devote to
developing and supporting our products, and other factors. We expect to devote
substantial capital resources to continue our research and development efforts,
to expand our customer support and product development activities and for other
general corporate activities. We believe that our current cash and cash
equivalents and short-term investment balances, together with revenue to be
derived from the sale of our products, will be sufficient to meet our liquidity
requirements for the foreseeable future.</FONT> <FONT SIZE=2> </FONT> <FONT
SIZE=2> </P>
<I><P ALIGN="JUSTIFY">Contractual Obligations and Commercial Commitments</P>
</I><P ALIGN="JUSTIFY">The following table summarizes all significant
contractual payment obligations, net of sublease income of $1.4 million
throughout the next 4 years, by payment due date:</P>

<B><P ALIGN="JUSTIFY">Payments by Periods (in millions)</P></B>

<TABLE BORDER=0 CELLSPACING=1 CELLPADDING=7 WIDTH=80%>
<TR><TD WIDTH="27%" VALIGN="BOTTOM">
<FONT SIZE=2><P ALIGN="CENTER">Contractual Obligation
<HR NOSHADE SIZE=2>
</FONT></TD>
<TD WIDTH="15%" VALIGN="BOTTOM">
<FONT SIZE=2><P ALIGN="CENTER">Total
<HR NOSHADE SIZE=2>
</FONT></TD>
<TD WIDTH="17%" VALIGN="BOTTOM">
<FONT SIZE=2><P ALIGN="CENTER">Less than 1 year
<HR NOSHADE SIZE=2>
</FONT></TD>
<TD WIDTH="11%" VALIGN="BOTTOM">
<FONT SIZE=2><P ALIGN="CENTER">1-3 years
<HR NOSHADE SIZE=2>
</FONT></TD>
<TD WIDTH="12%" VALIGN="BOTTOM">
<FONT SIZE=2><P ALIGN="CENTER">3-5 years
<HR NOSHADE SIZE=2>
</FONT></TD>
<TD WIDTH="18%" VALIGN="BOTTOM">
<FONT SIZE=2><P ALIGN="CENTER">More than 5 years
<HR NOSHADE SIZE=2>
</FONT></TD>
</TR>

<TR><TD WIDTH="27%" VALIGN="TOP">
<FONT SIZE=2><P ALIGN="JUSTIFY">Long-term debt</FONT></TD>
<TD WIDTH="15%" VALIGN="TOP">
<FONT SIZE=2><P ALIGN="RIGHT">$ 0.9</FONT></TD>
<TD WIDTH="17%" VALIGN="TOP">
<FONT SIZE=2><P ALIGN="RIGHT">$ 0.8</FONT></TD>
<TD WIDTH="11%" VALIGN="TOP">
<FONT SIZE=2><P ALIGN="RIGHT">$ 0.1</FONT></TD>
<TD WIDTH="12%" VALIGN="TOP">
<FONT SIZE=2><P ALIGN="RIGHT">$ 0.0</FONT></TD>
<TD WIDTH="18%" VALIGN="TOP">
<FONT SIZE=2><P ALIGN="RIGHT">$ 0.0</FONT></TD>
</TR>
<TR><TD WIDTH="27%" VALIGN="TOP">
<FONT SIZE=2><P ALIGN="JUSTIFY">Building lease</FONT></TD>
<TD WIDTH="15%" VALIGN="TOP">
<FONT SIZE=2><P ALIGN="RIGHT">1.2</FONT></TD>
<TD WIDTH="17%" VALIGN="TOP">
<FONT SIZE=2><P ALIGN="RIGHT">0.4</FONT></TD>
<TD WIDTH="11%" VALIGN="TOP">
<FONT SIZE=2><P ALIGN="RIGHT">0.7</FONT></TD>
<TD WIDTH="12%" VALIGN="TOP">
<FONT SIZE=2><P ALIGN="RIGHT">0.1</FONT></TD>
<TD WIDTH="18%" VALIGN="TOP">
<FONT SIZE=2><P ALIGN="RIGHT">0.0</FONT></TD>
</TR>
<TR><TD WIDTH="27%" VALIGN="TOP">
<FONT SIZE=2><P ALIGN="JUSTIFY">Purchase commitments</FONT></TD>
<TD WIDTH="15%" VALIGN="TOP">
<FONT SIZE=2><P ALIGN="RIGHT">0.3
<HR NOSHADE SIZE=2>
</FONT></TD>
<TD WIDTH="17%" VALIGN="TOP">
<FONT SIZE=2><P ALIGN="RIGHT">0.3
<HR NOSHADE SIZE=2>
</FONT></TD>
<TD WIDTH="11%" VALIGN="TOP">
<FONT SIZE=2><P ALIGN="RIGHT">0.0
<HR NOSHADE SIZE=2>
</FONT></TD>
<TD WIDTH="12%" VALIGN="TOP">
<FONT SIZE=2><P ALIGN="RIGHT">0.0
<HR NOSHADE SIZE=2>
</FONT></TD>
<TD WIDTH="18%" VALIGN="TOP">
<FONT SIZE=2><P ALIGN="RIGHT">0.0
<HR NOSHADE SIZE=2>
</FONT></TD>
</TR>
<TR><TD WIDTH="27%" VALIGN="TOP">
<FONT SIZE=2><P ALIGN="CENTER">Total</FONT></TD>
<TD WIDTH="15%" VALIGN="TOP">
<FONT SIZE=2><P ALIGN="RIGHT">$ 2.4
<HR NOSHADE SIZE=4>
</FONT></TD>
<TD WIDTH="17%" VALIGN="TOP">
<FONT SIZE=2><P ALIGN="RIGHT">$ 1.5
<HR NOSHADE SIZE=4>
</FONT></TD>
<TD WIDTH="11%" VALIGN="TOP">
<FONT SIZE=2><P ALIGN="RIGHT">$ 0.8
<HR NOSHADE SIZE=4>
</FONT></TD>
<TD WIDTH="12%" VALIGN="TOP">
<FONT SIZE=2><P ALIGN="RIGHT">$ 0.1
<HR NOSHADE SIZE=4>
</FONT></TD>
<TD WIDTH="18%" VALIGN="TOP">
<FONT SIZE=2><P ALIGN="RIGHT">$ 0.0
<HR NOSHADE SIZE=4>
</FONT></TD>
</TR>
</TABLE>

<FONT SIZE=2>
<B><I>
<P ALIGN="JUSTIFY">CRITICAL ACCOUNTING POLICIES</P>
</B></I><P ALIGN="JUSTIFY">The discussion and analysis of our financial
condition and results of operations are based upon our consolidated financial
statements, which have been prepared in accordance with accounting principles
generally accepted in the United States. The preparation of these financial
statements requires us to make estimates and judgments that affect the reported
amounts of assets, liabilities, revenues and expenses, and related disclosure of
assets and liabilities. On an on-going basis, we evaluate our critical
accounting policies and estimates, including those related to revenue
recognition, bad debts, income taxes and intangible assets. We base our
estimates on historical experience and on various other assumptions that we
believe to be reasonable under the circumstances, the results of which form the
basis for making judgments about the carrying values of assets and liabilities
that are not readily apparent from other sources. Actual results may differ from
these estimates under different assumptions or conditions. Our critical
accounting policies and estimates are discussed in our Annual Report.</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 uncertain, 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>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>product quality problems;</LI>
<LI>the extent to which our products gain market acceptance;</LI>
<LI>third-party payor reimbursement policies;</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>actions relating to regulatory matters;</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; and</LI>
<LI>the progress and results of clinical trials.</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, 2004 and 2003, approximately 52% and 65%, 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, 2004 and 2003,
approximately 54% and 69%, respectively, of our revenues came from the sales of
<I>da Vinci</I> Surgical Systems. During the three-month and nine-month periods
ended September 30, 2004 and 2003, 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>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
(&quot;FDA&quot;). 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 (&quot;FFDCA&quot;). 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
(&quot;PMA&quot;), 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 (&quot;IRB&quot;) approval of the proposed investigation. In
addition, if the clinical study involves a &quot;significant risk&quot; (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
(&quot;IDE&quot;), 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>
<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 will
compete with established and emerging treatment options in both disease
management and reconstructive medical procedures.  These competitive treatment
options may take the form of traditional minimally invasive surgery, open
surgery, interventional approaches, or pharmacological regimens.  Some of these
procedures are widely accepted in the medical community and in many cases have a
long history of use.  Technological advances could make such treatments more
effective or less expensive than using our products, which could render our
products obsolete 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>
<P ALIGN="JUSTIFY">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>

<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>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. In the past, we have voluntarily recalled certain
products as a result of performance problems.  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>product recalls;</LI>
<LI>increased service or warranty costs; or </LI>
<LI>product liability claims. </LI></UL>

<B><P>WE 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 maintain reliable, high-volume
manufacturing capacity. Even if this capacity can be 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 maintain
larger-scale manufacturing capabilities, our ability to generate revenues will be
limited and our reputation in the marketplace could 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
(&quot;GMP&quot;) requirements contained in the FDA's Quality System
Regulations, or QSR. We are also required to comply with the Medical Device
Directive (&quot;MDD&quot;) and International Organization for Standardization
(&quot;ISO&quot;), quality system standards in order to produce products for
sale in Europe. If we fail to continue to comply with  GMP requirements, the
MDD, or ISO standards, we may be required to cease all or part of our operations
until we comply with these regulations. We continue to be subject to FDA
inspections at any time, and we are subject to MDD and ISO audits on an annual
basis to maintain our certifications. Maintaining such compliance is difficult
and costly. We cannot be certain that our facilities will be found to comply
with GMP requirements, the MDD, or ISO standards in future inspections and
audits by regulatory authorities. </P>
<P ALIGN="JUSTIFY">The state of California also requires that we maintain a
license to manufacture medical devices.  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 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>
<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 electronics,
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>COMPLYING WITH FDA REGULATIONS IS AN EXPENSIVE AND TIME-CONSUMING PROCESS,
AND OUR FAILURE TO COMPLY FULLY COULD SUBJECT US TO SIGNIFICANT ENFORCEMENT
SANCTIONS</B>.</P>
<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>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 be certain
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 be certain 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>
<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 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 may involve the termination of 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 proceedings may be expensive to litigate,
may be protracted, and Computer 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>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 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">There may be 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 may be 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 be
certain 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 be certain 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, 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 Heartport, Inc., now part of Johnson &amp; Johnson, IBM
Corporation, MIT, Olympus Optical Co., Ltd., and SRI International. 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>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 22% of our sales for the three months
ended September 30, 2004 and 14% for the three months ended September 30, 2003.
Sales to markets outside of the United States accounted for approximately 22% of
our sales for the nine months ended September 30, 2004 and 21% for the nine
months ended September 30, 2003.</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>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>INVESTOR CONFIDENCE AND SHARE VALUE MAY BE ADVERSELY IMPACTED IF WE OR OUR
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM ARE UNABLE TO PROVIDE AN
UNQUALIFIED ATTESTATION OF THE ADEQUACY OF OUR INTERNAL CONTROLS OVER FINANCIAL
REPORTING AS OF DECEMBER 31, 2004, AS REQUIRED BY SECTION 404 OF THE SARBANES-
OXLEY ACT OF 2002.</P>
</B><P ALIGN="JUSTIFY">The Securities and Exchange Commission, as directed by
Section 404 of the Sarbanes-Oxley Act of 2002, adopted rules requiring public
companies to include a report of management on the company's internal controls
over financial reporting in its annual reports on Form 10-K that contain an
assessment by management of the effectiveness of the company's internal controls
over financial reporting. In addition, the company's independent registered
public accounting firm must attest to and report on management's assessment of
the effectiveness of the company's internal controls over financial reporting.
This requirement will first apply to our Annual Report on Form 10-K for the
fiscal year ending December 31, 2004. Although we intend to diligently and
vigorously review our internal controls over financial reporting in order to
ensure compliance with the Section 404 requirements, if we or our independent
registered public accounting firm are not satisfied with our internal controls
over financial reporting or the level at which these controls are documented,
designed, operated, reviewed or tested, or if our independent registered public
accounting firm interprets the requirements, rules or regulations differently
from us, then we or they may decline to attest to management's assessment or may
issue a report that is qualified. This could result in an adverse reaction in
the financial marketplace due to a loss of investor confidence in the
reliability of our financial statements, which ultimately could negatively
impact the market price of our shares.</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 &quot;fixed-rate&quot; if the rate of
return on such instruments remains fixed over their term. These &quot;fixed-
rate&quot; investments include commercial paper and government and non-
government debt securities. We classify our cash equivalents and marketable
securities as &quot;variable-rate&quot; 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 &quot;variable-rate&quot; investments primarily
include money market accounts. The average time to maturity of all of our
investments as of September 30, 2004 was approximately 1.04 years.  At September
30, 2004 and December 31, 2003, approximately 48% and 37%, respectively, of our
investment portfolio was composed of investments with original maturities of one
year or less. </P>
<P ALIGN="JUSTIFY">The majority of our revenue, expense, and capital purchasing
activities are transacted in U.S. dollars. However, since a portion of our
operations consists of sales activities outside of the United States, we have
entered into transactions in other currencies, primarily the euro. On a limited
basis, we have used forward foreign exchange contracts to reduce a portion of
our exposure to foreign currency risk from operational and balance sheet
exposures resulting from changes in foreign currency exchange rates. Such
exposures result from sales denominated in foreign currencies. These contracts
were typically short-term in nature (i.e., less than 6&nbsp;months).</P>
<P ALIGN="JUSTIFY">For the three months ended September 30, 2004 and 2003, sales
denominated in foreign currencies were 7% and 10%, respectively, of total sales.
For the nine months ended September 30, 2004 and 2003, sales denominated in
foreign currencies were 7% and 11%, respectively, of total sales. We did not
enter into forward foreign exchange contracts during the three months and nine
months ended September 30, 2004 and 2003.&nbsp; </P>
<P ALIGN="JUSTIFY">We do not use derivative financial instruments for
speculative trading purposes, nor do we hold or issue leveraged derivative
financial instruments. We have not entered into any forward contracts since July
2002, and as of September 30, 2004 and December 31, 2003, we had no outstanding
derivative instruments.&nbsp;</P>
<P ALIGN="JUSTIFY">Foreign currency fluctuations resulted in $23,000 of foreign
exchange gain for the three months ended September 30, 2004 and $50,000 of
foreign exchange loss for the three months ended September 30, 2003. Foreign
currency fluctuations resulted in $65,000 of foreign exchange loss for the nine
months ended September 30, 2004 and $68,000 of foreign exchange gain for the
nine months ended September 30, 2003.</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 Securities
Exchange Act of 1934 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 period 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 ALIGN="JUSTIFY">In February 2004, a former customer of Computer Motion
filed a lawsuit against our company.  We received the complaint on April 23,
2004.  The customer alleges that it relied to its detriment on representations
made by Computer Motion in connection with Computer Motion's sale of products to
the customer, which representations the customer believes were not fulfilled.
The customer is seeking damages. We believe the allegation is baseless and
intend to vigorously defend this suit. To date, we have filed a motion to
dismiss the fraud-based complaints and an answer defending the breach of
contract claim.  The litigation continues to be in discovery.  </P>
<P ALIGN="JUSTIFY">In November 2003, an Israeli company filed suit against our
company and Computer Motion in Israel alleging breach of a distribution contract
and seeking damages. We received the complaint on April 27, 2004. Following the
acquisition of Computer Motion, we withdrew Computer Motion's distributorship
offer to this Israeli company. We believe the allegation is baseless and intend
to vigorously defend the suit. We have filed a motion to have the case dismissed
on jurisdictional grounds.  The court has not yet ruled on the motion as the
parties are still submitting briefs on the motion.  </P>
<P ALIGN="JUSTIFY">In October 2003, SIC System, S.R.L. (&quot;SIC System&quot;)
a former Italian distributor for Computer Motion, filed suit against our company
and Computer Motion seeking damages in the Civil Court of Rome, Italy (the
&quot;Italian Action&quot;).  In the Italian Action, SIC System alleges that we
breached the distribution agreement between SIC System and Computer Motion when,
following our acquisition of Computer Motion, we deleted two products previously
covered under the distribution agreement.   The distribution agreement provides,
among other things, that (1) it shall be governed and construed under the laws
of the State of California; and (2) in the event of any dispute or controversy
arising under the distribution agreement or the transactions contemplated
thereunder, the parties mutually consent to the exclusive jurisdiction of a
court of competent jurisdiction within Santa Barbara County, California.  We are
defending the Italian Action on both jurisdictional grounds and on the merits.
To date, the Court in the Italian Action has ruled that SIC System's service
process in filing its complaint is defective and has ordered SIC System to
re-file its complaint on or about October 6, 2004.  The court in the Italian Action
has not ruled on jurisdiction or other pending issues pertaining to the
applicable law or appropriate forum.</P>

<P ALIGN="JUSTIFY"> On November 11, 2003, we filed a lawsuit in
the United States District Court for the Central District of California
captioned <I>Intuitive Surgical, Inc., et. al v. SIC System Srl</I>, Case Number
CV-03-08220 for declaratory relief, breach of contract and preliminary and
permanent injunction (the &quot;Federal Action&quot;).  The Federal Action
sought a judicial declaration of the rights and obligations of the parties under
a distribution agreement, specifically that our company effectively
deleted the products from the distribution agreement, and a preliminary and
permanent injunction prohibiting SIC System from proceeding with the Italian
Action.  The complaint in the Federal Action was served on SIC System on
November 28, 2003, and the Court entered Default against SIC Systems on March
31, 2004.  On August 16, 2004, the Court entered a judgment in favor of
our company in the amount of $195,155 for breach of contract.  The Court
also awarded judgment in favor of our company as to its claim for
declaratory relief.  The Court awarded judgment in favor of SIC Systems as to
our company's claim for preliminary and permanent injunction.  The Court
found our company as the prevailing party and awarded taxable costs to
us.</P>

<P ALIGN="JUSTIFY">The foregoing proceedings could be expensive to litigate, may
be protracted and our 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. At any time, the
other parties may file additional claims against us, or we may file claims
against them, which could increase the risk, expense and duration of the
litigations.</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. UNREGISTERED SALES OF EQUITY 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 ALIGN="JUSTIFY">None.</P>

<B><P ALIGN="JUSTIFY"><A NAME="item5"></A>ITEM 5. OTHER INFORMATION</P>
</B><P ALIGN="JUSTIFY">None. </P>

<B><P ALIGN="JUSTIFY"><A NAME="item6"></A>ITEM 6. EXHIBITS </P></B>

<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>

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

<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>
<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>
<P></I></FONT></TD>
</TR>
</TABLE>

<FONT SIZE=2><P>Date: November 8, 2004 </P>

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

<B><P ALIGN="CENTER">EXHIBIT INDEX </P></B>
<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><P><A HREF="exh31.htm">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><P><A HREF="exh32.htm">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": "041125503"}, "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 2004 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, 2004
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 33,990,854 shares of Common Stock, $0.001 par value per
share, outstanding as of October 31, 2004.
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, 2004 and
December 31, 2003
1
Condensed consolidated statements of operations for the three-month
and nine-month periods ended September 30, 2004 and September 30, 2003
2
Condensed consolidated statements of cash flows for the nine-month
periods ended September 30, 2004 and September 30, 2003
3
Notes to condensed consolidated financial statements
4
Item 2.   Management's Discussion and Analysis of Financial
                      Condition and Results of Operations
13
Item 3.   Quantitative and Qualitative Disclosures About Market Risk
36
Item 4.   Controls and Procedures
36
PART II.  OTHER INFORMATION
Item 1.  Legal Proceedings
37
Item 2.   Unregistered Sales of Equity Securities and Use of Proceeds
41
Item 3.  Defaults Upon Senior Securities
42
Item 4.  Submission of Matters to a Vote of Security Holders
42
Item 5.  Other Information
42
Item 6.   Exhibits
42
Signatures
42
PART I.  FINANCIAL INFORMATION
Item 1. Financial Statements
INTUITIVE SURGICAL, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
(UNAUDITED)
September 30,  December 31,
                                                               2004          2003
                                                           ------------  ------------
                                                                         (See Note 1)
                        ASSETS
Current assets:
  Cash and cash equivalents.............................. $     11,268  $     11,335
  Short-term investments.................................      109,947       101,614
  Accounts receivable, net...............................       26,361        26,820
  Inventory..............................................        6,596         8,788
  Prepaids and other current assets......................        3,688         3,203
  Restricted cash equivalents............................          204           188
                                                           ------------  ------------
          Total current assets...........................      158,064       151,948
Property and equipment, net..............................       27,779        10,288
Restricted cash equivalents..............................          319           642
Intangible assets, net...................................        6,688         8,089
Goodwill.................................................      143,332       143,106
Other assets.............................................          641           921
                                                           ------------  ------------
          Total assets...................................      336,823       314,994
                                                           ============  ============
         LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
  Accounts payable....................................... $      5,214  $      5,894
  Accrued compensation and employee benefits.............        7,450         5,267
  Restructuring accrual..................................          806           971
  Other accrued liabilities..............................        7,488         9,134
  Deferred revenue.......................................       14,092        11,345
  Current portion of notes payable.......................          813         1,030
                                                           ------------  ------------
          Total current liabilities......................       35,863        33,641
Long-term notes payable..................................           52           695
Deferred revenue.........................................        1,077         1,148
Other accrued liabilities................................           57           553
                                                           ------------  ------------
          Total non-current liabilities..................        1,186         2,396
Commitments and contingencies (Note 11)..................           --            --
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, 2004  and
     and December 31, 2003, respectively.................           --            --
  Common stock, 100,000,000 shares authorized, $0.001
     par value, 33,977,398 and 33,051,631 shares
     issued and outstanding as of September 30, 2004
     and December 31, 2003, respectively.................           34            33
  Additional paid-in capital.............................      426,390       416,559
  Deferred compensation..................................           --           (99)
  Accumulated deficit....................................     (126,618)     (138,414)
  Accumulated other comprehensive income (loss)..........          (32)          878
                                                           ------------  ------------
          Total stockholders' equity.....................      299,774       278,957
                                                           ------------  ------------
          Total liabilities and stockholders' equity..... $    336,823  $    314,994
                                                           ============  ============
See accompanying notes to 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,
                                               ----------------------  ----------------------
                                                  2004        2003        2004        2003
                                               ---------- -----------  ---------- -----------
Sales:
  Products................................... $   29,262  $   20,515  $   77,583  $   56,958
  Services...................................      6,231       2,878      16,026       7,123
                                               ----------  ----------  ----------  ----------
Total sales..................................     35,493      23,393      93,609      64,081
Cost of sales:
  Products...................................      9,798       9,397      27,871      24,075
  Services...................................      2,973       1,932       7,552       5,513
                                               ----------  ----------  ----------  ----------
Total cost of sales..........................     12,771      11,329      35,423      29,588
                                               ----------  ----------  ----------  ----------
    Gross profit.............................     22,722      12,064      58,186      34,493
                                               ----------  ----------  ----------  ----------
Operating costs and expenses:
  Selling, general, and administrative.......     12,600      11,320      34,378      29,303
  Research and development...................      4,635       4,407      13,571      11,457
                                               ----------  ----------  ----------  ----------
    Total operating costs and
     expenses................................     17,235      15,727      47,949      40,760
                                               ----------  ----------  ----------  ----------
Income (loss) from operations................      5,487      (3,663)     10,237      (6,267)
Other income, net ...........................        692         310       1,924       1,499
                                               ----------  ----------  ----------  ----------
Income (loss) before taxes...................      6,179      (3,353)     12,161      (4,768)

Income tax expense...........................         66          --         365          --
                                               ----------  ----------  ----------  ----------
Net income (loss)............................ $    6,113  $   (3,353) $   11,796  $   (4,768)
                                               ==========  ==========  ==========  ==========
Net income (loss) per share:
  Basic...................................... $     0.18  $    (0.12) $     0.35  $    (0.22)
                                               ==========  ==========  ==========  ==========
  Diluted ................................... $     0.17  $    (0.12) $     0.34  $    (0.22)
                                               ==========  ==========  ==========  ==========
Shares used in computing net income
 (loss) per share:
  Basic......................................     33,823      26,878      33,556      21,296
                                               ==========  ==========  ==========  ==========
  Diluted....................................     35,305      26,878      34,534      21,296
                                               ==========  ==========  ==========  ==========
See accompanying notes to consolidated financial statements.
INTUITIVE SURGICAL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(IN THOUSANDS)
For the Nine Months
                                                            Ended September 30,
                                                         ------------------------
                                                            2004         2003
                                                         -----------  -----------
OPERATING ACTIVITIES:
Net income (loss)...................................... $    11,796  $    (4,768)
Adjustments to reconcile net income (loss) to net cash
  provided by (used in) operating activities:
  Depreciation.........................................       3,859        3,021
  Provision for doubtful accounts......................        (320)         707
  Loss on disposition of property and equipment........         270            5
  Amortization of deferred compensation and stock
   compensation........................................          99          379
  Amortization of intangible assets....................       1,401        1,350
Changes in operating assets and liabilities:
  Accounts receivable..................................         779       (3,000)
  Prepaids and other current assets....................        (590)        (314)
  Inventory............................................       2,192          664
  Other assets.........................................         280       (1,087)
  Accounts payable.....................................        (688)      (5,021)
  Accrued compensation and employee benefits...........       2,149         (841)
  Restructuring accrual................................        (312)      (2,112)
  Other accrued liabilities............................      (1,762)      (4,660)
  Deferred revenue.....................................       2,676        2,987
                                                         -----------  -----------
Net cash provided by (used in) operating activities....      21,829      (12,690)
                                                         -----------  -----------
INVESTING ACTIVITIES:
Acquisition of property and equipment..................     (21,960)      (1,914)
Disposition of property and equipment..................          26          192
Acquisition of business, net of cash acquired..........          --       (4,088)
Release of restricted cash equivalents.................         307           70
Purchase of short-term investments.....................     (77,441)     (10,866)
Proceeds from sales of short-term investments..........      46,257       21,224
Proceeds from maturities of short-term investments.....      21,986        4,899
                                                         -----------  -----------
Net cash (used in) provided by investing activities....     (30,825)       9,517
                                                         -----------  -----------
FINANCING ACTIVITIES:
Proceeds from issuance of common stock.................       9,832        5,181
Repurchase of common stock.............................          --           (6)
Repayment of notes payable.............................        (860)      (1,243)
                                                         -----------  -----------
Net cash provided by financing activities..............       8,972        3,932
                                                         -----------  -----------
Effect of exchange rate changes on cash................         (43)        (168)
                                                         -----------  -----------
Net (decrease) increase in cash and cash equivalents...         (67)         591
Cash and cash equivalents, beginning of period.........      11,335        8,052
                                                         -----------  -----------
Cash and cash equivalents, end of period............... $    11,268  $     8,643
                                                         ===========  ===========
See accompanying notes to consolidated financial statements.
INTUITIVE SURGICAL, INC.
NOTES TO 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, 2003 were derived from the audited financial statements included
in  Intuitive Surgical, Inc.'s Annual Report on Form 10-K ("Annual
Report") for the year ended December 31, 2003. The financial statements
included in this report should be read in conjunction with the audited financial
statements for the year ended December 31, 2003 included in the Annual Report.
The results for the interim period ended September 30, 2004 are not necessarily
indicative of the results to be expected for the full year ending December 31,
2004 or future operating periods.  The condensed consolidated financial
statements include the accounts of the Company and its subsidiaries.  All
significant intercompany accounts and transactions have been eliminated in
consolidation.  Certain reclassifications have been made to prior year balances
in order to conform to the current year presentation.  These reclassifications
had no impact on previously reported net income or stockholders' equity.
Use of Estimates
The preparation of financial statements in conformity
with accounting principles generally accepted in the United States requires
management to make estimates and assumptions that affect the amounts reported in
the consolidated financial statements and accompanying notes.  Actual results
could differ materially from these estimates.
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 ("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 represents 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.
The Company's distributors do not have price protection or
return rights.
Revenue from sales of instruments and accessories is
recognized upon shipment.  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 represent 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 Statement of Position ("SOP") 97-2, "Software Revenue
Recognition," is not applicable to the Company's revenues.
Stock-Based Compensation
The Company applies Accounting Principles Board
("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
("SFAS") No. 148, "Accounting for Stock-Based Compensation -
Transition and Disclosure," the Company has provided the following pro
forma net income (loss) and pro forma net income (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,
                                                     ------------------  -------------------
                                                       2004      2003      2004       2003
                                                     --------  --------  ---------  --------
Net income (loss), as reported..................... $  6,113  $ (3,353) $  11,796  $ (4,768)
Add:  Total stock-based employee
  compensation expense included in reported
  net income (loss), net of $0 related tax effect..       --        83         99       379
Deduct: Total stock-based employee
  compensation expense determined
  under fair value based method for
  all awards, net of $0 related tax effect.........   (2,429)   (2,123)    (7,546)   (6,107)
                                                     --------  --------  ---------  --------
Pro forma net income (loss)........................ $  3,684  $ (5,393) $   4,349  $(10,496)
                                                     ========  ========  =========  ========

Net income (loss) per share:
  Basic - as reported.............................. $   0.18  $  (0.12) $    0.35  $  (0.22)
  Basic - pro forma................................ $   0.11  $  (0.20) $    0.13  $  (0.49)

  Diluted - as reported............................ $   0.17  $  (0.12) $    0.34  $  (0.22)
  Diluted - pro forma.............................. $   0.10  $  (0.20) $    0.13  $  (0.49)
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,
                                     -------------------   ------------------
                                        2004      2003        2004      2003
                                     --------  ---------   --------  --------
Stock Option Plans:
   Average risk free interest rate.     3.24 %     2.52 %     3.10 %    2.51 %
   Average expected life (years)...      4.0        4.0        4.0       4.0
   Volatility......................       68 %       80 %       70 %      80 %

Stock Purchase Plan:
   Average risk free interest rate.     1.47 %     1.21 %     1.34 %    1.48 %
   Average expected life (years)...      1.4        0.5        1.2       0.5
   Volatility......................       62 %       48 %       62 %      48 %
Recent Accounting Pronouncements
In December 2003, the Financial Accounting Standards
Board ("FASB") issued Interpretation No. 46R, ("FIN 46R"),
(revised December 2003), "Consolidation of Variable Interest Entities, an
Interpretation of Accounting Research Bulletin No. 51," which addresses how
a business enterprise should evaluate whether it has a controlling interest in
an entity through means other than voting rights and accordingly should
consolidate the entity. FIN 46R replaces FASB Interpretation FIN 46, which
was issued in January 2003. As of the effective date of FIN 46R, an enterprise
must evaluate its involvement with all entities or legal structures created
before February 1, 2003, to determine whether consolidation requirements of FIN
No. 46R apply to those entities. There is no grandfathering of existing
entities. The adoption of FIN No. 46R did not have a significant impact on the
Company's consolidated financial position, results of operations or cash flow.
In December 2003, the SEC issued Staff Accounting Bulletin
("SAB") No. 104, "Revenue Recognition." SAB No. 104 revised
and rescinded portions of the interpretative guidance included in Topic 13 of
the codification of staff accounting bulletins in order to make that
interpretive guidance consistent with current authoritative accounting and
auditing guidance and SEC rules and regulations. The adoption of SAB No. 104 did
not have a significant impact on the Company's consolidated financial position,
results of operations or cash flow.
In March 2004, the EITF reached a consensus on recognition
and measurement guidance previously discussed under EITF 03-01. The consensus
clarifies the meaning of other-than-temporary impairment and its application to
investments classified as either available-for-sale or held-to-maturity under
SFAS 115, "Accounting for Certain Investments in Debt and Equity
Securities," and investments accounted for under the cost method or the
equity method. The recognition and measurement guidance for which the consensus
was reached is to be applied to other-than-temporary impairment evaluations. In
September 2004, FASB issued a final FASB Staff Position, FSP EITF Issue 03-01-1,
that delays the effective date for the measurement and recognition guidance of
EITF 03-01. The Company is currently evaluating the impact of adopting EITF 03-01.
On October 13, 2004, the FASB concluded that Statement 123R,
"Share-Based Payment," which would require all companies to measure
compensation cost for all share-based payments, including employee stock
options, at fair value, would be effective for public companies, except small
business issuer as defined in SEC Regulation S-B, for interim or annual periods
beginning after June 15, 2005.  The Company is currently evaluating the impact
of the adopting Statement 123R.
NOTE 2. CONCENTRATIONS OF RISK
Financial instruments that 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 three months and nine months ended
September 30, 2004 and 2003, 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.
The Company's
da Vinci
Surgical System,
Hermes
Control Center,
AESOP
Endoscope Positioner and related instruments and
accessories accounted for all of the Company's product sales for the three
months and nine months ended September 30, 2004 and 2003. 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.   The distribution of sales
by geographic location is as follows (in thousands):
Three Months Ended     Nine Months Ended
                                    September 30,         September 30,
                               --------------------- ---------------------
                                   2004       2003       2004       2003
                                ---------  ---------  ---------  ---------
Domestic...................... $  27,819  $  19,962  $  72,999  $  50,759
International.................     7,674      3,431     20,610     13,322
                                ---------  ---------  ---------  ---------
Total sales................... $  35,493  $  23,393  $  93,609  $  64,081
                                =========  =========  =========  =========
NOTE 3. 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, 2004 and December 31, 2003.  Approximately $4.0
million and $4.8 million of money market instruments were included in cash and
cash equivalents at September 30, 2004 and December 31, 2003, respectively.
NOTE 4. 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 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.
The following table presents the fair value of available-for-sale
securities included in short-term investments as of the respective dates (in thousands):
September 30, 2004  December 31, 2004
                          ------------------  -----------------
U.S. corporate debt...... $          48,773  $          44,904
U.S. government debt.....            31,924             28,210
Municipal debt...........            17,450             11,950
Commercial paper.........            11,800             16,550
                           -----------------  -----------------
Total.................... $         109,947  $         101,614
                           =================  =================
NOTE 5. INVENTORY
Inventory is stated at the lower of cost or market value.
Cost is computed using standard costs, which approximates actual cost on a
first-in, first-out basis.  Inventory consists of the following (in thousands):
September 30,  December 31,
                                   2004          2003
                               ------------  ------------
Raw materials................ $      1,753  $      1,247
Work-in-process..............        1,235         1,797
Finished goods...............        3,608         5,744
                               ------------  ------------
Total........................ $      6,596  $      8,788
                               ============  ============
NOTE 6. GOODWILL AND INTANGIBLE ASSETS
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; rather, they will be tested for impairment at least once each fiscal
year (more frequently if certain indicators are present), which the Company will
do in the fourth quarter.  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 Company's
acquisition of Computer Motion on June 30, 2003, $143.3 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.
Net intangible assets is comprised of the following (in thousands):
September 30, 2004
                                    -----------------------------------------------
                                                 Accumulated
                                      Gross     Amortization  Impairment     Net
                                    ---------   ------------  ----------  ---------
Developed technology.............  $   3,500   $        250  $    3,250  $      --
Core technology..................      3,300            589          --      2,711
Customer relationships...........      1,300            433          --        867
Patents..........................      7,310          4,340          --      2,970
Other intangible assets..........        500             69         291        140
                                    ---------   ------------  ----------  ---------
Total intangible assets, net.....  $  15,910   $      5,681  $    3,541  $   6,688
                                    =========   ============  ==========  =========

                                                  December 31, 2003
                                    -----------------------------------------------
                                                 Accumulated
                                      Gross     Amortization  Impairment     Net
                                    ---------   ------------  ----------  ---------
Developed technology.............  $   3,500   $        250  $    3,250  $      --
Core technology..................      3,300            236          --      3,064
Customer relationships...........      1,300            233          --      1,067
Patents..........................      7,310          3,511          --      3,799
Other intangible assets..........        500             50         291        159
                                    ---------   ------------  ----------  ---------
Total intangible assets, net.....  $  15,910   $      4,280  $    3,541  $   8,089
                                    =========   ============  ==========  =========
Amortization expense related to intangible assets was $0.5
million and $0.6 million for the three months ended September 30, 2004 and 2003,
respectively.  Amortization expense related to intangible assets was $1.4
million and $1.4 million for the nine months ended September 30, 2004 and 2003,
respectively.
Estimated future amortization expense related to intangible
assets at September 30, 2004 is as follows (in thousands):
Fiscal Year
----------------------------
2004 (remaining 3 months)...  $      467
2005........................       1,868
2006........................       1,275
2007........................       1,077
2008........................         811
Thereafter..................       1,190
                                ---------
Total.......................  $    6,688
                                =========
Impairment of Goodwill
The Company has elected to perform an annual analysis of
goodwill during the fourth quarter of each year.  Based on our 2003 impairment
analysis, no impairments were identified, and no indicators of impairment were
identified during the nine months ended September 30, 2004.
Impairment of Long-Lived Assets
SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets," requires recognition of impairment of long-
lived assets when circumstances indicate an impairment has occurred and in the
event the net book value of such assets exceeds the future undiscounted cash
flows attributable to such assets.  Accordingly, the Company evaluates asset
recoverability when an event occurs that may impair recoverability of the asset.
The Company determines the recoverability of the carrying amount of each asset
by reviewing the following factors: the undiscounted value of expected operating
cash flows; the estimated useful or contractual life of the asset; and the
contract or product supporting the asset.  No impairment losses were incurred
during the nine months ended September 30, 2004 and 2003.
NOTE 7. 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. Effective July 1, 2003, the Company adopted the
provisions of EITF No. 00-21 on a prospective basis. Under EITF No. 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 recognizes warranty and related service costs as
incurred for these arrangements. 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 warranty
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                            Balance at
                                         Beginning   Warranty     Warranty      End of
                                         of Period     Usage       Accrued      Period
                                        -----------  ---------  -------------  ---------
Nine months ended September 30, 2004.  $       702  $    (703) $         149  $     148
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 products. 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 indemnification clauses and no liabilities have
been recorded for this obligation on its balance sheets as of September 30, 2004
or December 31, 2003.
NOTE 8. RESTRUCTURING CHARGES
In connection with the acquisition of Computer Motion in
June 2003, the Company recorded an accrual for acquisition integration
liabilities, which includes the incremental costs to exit and consolidate
activities at Computer Motion locations, termination of certain Computer Motion
employees, and for other costs to integrate operating locations and other
activities of Computer Motion.  The accrual was recorded using the guidance
provided by EITF 95-3, "Recognition of Liabilities in Connection with a
Purchase Business Combination," which requires that these acquisition
integration expenses, which are not associated with the generation of future
revenues and have no future economic benefit, be reflected as assumed
liabilities in the allocation of the purchase price to the net assets acquired.
During 2003, the Company recorded a $3.4 million accrual in accordance with EITF
95-3.  The accrual was comprised of $2.6 million for employee severance costs
and $0.8 million for estimated losses to be incurred to sublet vacated
facilities.  During the nine months ended September 30, 2004, the Company
increased the accrual for the estimated losses to be incurred to sublet vacated
facilities by $0.2 million due to the change in estimates on assumptions used to
calculate the losses on subleasing the vacated facilities.
During the three months ended December 31, 2003, based on the
Company's cost structure and future development plans,
the Company planned to completely shut down the Goleta
research and development facility.  In accordance with SFAS No. 146,
"Accounting for Costs Associated with Exit or Disposal Activities,"
the Company recorded restructuring charges of $0.2 million, which are related to
the costs of one-time employee terminations.   SFAS No. 146 requires that a
liability for costs associated with an exit or disposal activity be recognized
and measured initially at fair value only when the liability is incurred.  As
employees are generally required to render service beyond the minimum retention
period or 60 days, the severance payments are recognized ratably over the
service periods.  During the nine months ended September 30, 2004, the Company
completed the shutdown of the Goleta research and development facilities and
accrued $0.2 million of employee severance costs and $0.5 million of lease
commitment costs to exit the leased facility.  The charges incurred in the nine
months ended September 30, 2004 were recorded in research and development
expenses on the income statement.  The Company expects to fully utilize the
accrual by the third quarter of 2007, when existing lease commitments
expire.
The following table summarizes the restructuring activitiy
for the nine months ended September 30, 2004 (in thousands):
EITF No. 95-3          SFAS No. 146
                                             ----------------------  ---------------------
                                              Employee     Lease     Employee     Lease
                                             Severance   Commitments Severance  Commitments Total
                                             ----------  ----------  ---------  ---------  --------
Cost accrued............................... $    2,628  $      816  $     186  $      --  $  3,630
Cash payments, net of subleasing proceeds..     (2,310)       (303)        --         --    (2,613)
Currency impact............................        (23)        (23)        --         --       (46)
                                             ----------  ----------  ---------  ---------  --------
Balance at December 31, 2003...............        295         490        186         --       971
Cost accrued...............................         --         226        224        525       975
Cash payments, net of subleasing proceeds..       (291)       (268)      (410)      (177)   (1,146)
Currency impact............................         --           6                               6
                                             ----------  ----------  ---------  ---------  --------
Balance at September 30, 2004.............. $        4  $      454  $      --  $     348  $    806
                                             ==========  ==========  =========  =========  ========
NOTE 9. COMPREHENSIVE INCOME (LOSS)
Comprehensive income (loss) includes net income (loss)
and other comprehensive income (loss), which primarily consists of unrealized
gains and losses on available-for-sale securities and cumulative translation
adjustments.  Total accumulated other comprehensive income (loss) is displayed
as a separate component of stockholders' equity in the accompanying condensed
consolidated balance sheets.  The components of comprehensive income (loss)
consist of the following (in thousands):
Three Months Ended    Nine Months Ended
                                             September 30,       September 30,
                                        --------------------  --------------------
                                           2004       2003       2004       2003
                                        ---------  ---------  ---------  ---------
Net income (loss)..................... $   6,113  $  (3,353) $  11,796  $  (4,768)
Other comprehensive income (loss):
  Foreign currency translation
    adjustments.......................        11        (13)       (46)      (168)
  Change in unrealized gain (loss)
    on available-for-sale securities..       243       (198)      (864)      (654)
                                        ---------  ---------  ---------  ---------
Comprehensive income (loss)........... $   6,367  $  (3,564) $  10,886  $  (5,590)
                                        =========  =========  =========  =========
The components of accumulated other comprehensive income were
as follows (in thousands):
September 30, December 31,
                                                2004         2003
                                            ------------  -----------
Accumulated net unrealized gain on
  available-for-sales securities.......... $         76  $       940
Foreign currency translation
  adjustments.............................         (108)         (62)

Total accumulated other comprehensive       ------------  -----------
  (loss) income........................... $        (32) $       878
                                            ============  ===========
NOTE 10. NET INCOME (LOSS) PER SHARE
The following table presents the computation of basic and
diluted net income (loss) per share (in thousands, except per share data).
Basic net income (loss) per share is computed using the weighted-average number
of common shares outstanding.  Diluted net income (loss) per share is computed
using the weighted-average number of common shares outstanding and potential
dilutive common shares from the assumed exercise of options and warrants
outstanding during the period, if any, using the treasury method.
Three Months Ended        Nine Months Ended
                                              September 30,            September 30,
                                         -----------------------  -------------------------
                                            2004         2003        2004         2003
                                         -----------  ----------  -----------  ------------
Numerator used for basic and
  diluted net income (loss) per
  common share......................... $     6,113  $   (3,353) $    11,796  $     (4,768)
                                         ===========  ==========  ===========  ============
Denominator used for basic and
  diluted net income (loss) per common
  share:
  Weighted-average shares
    outstanding........................      33,823      26,881       33,556        21,301
  Less weighted-average
    shares subject to
    repurchase.........................          --          (3)          --            (5)
                                         -----------  ----------  -----------  ------------
  Weighted-average shares used in
    computing basic net income (loss)
    per common share...................      33,823      26,878       33,556        21,296
                                         ===========  ==========  ===========  ============

  Add common stock equivalents.........       1,482          --          978            --
  Weighted-average shares used
    in computing diluted net income
    (loss) per common share............      35,305      26,878       34,534        21,296
                                         ===========  ==========  ===========  ============

Net income (loss) per common share:
  Basic................................ $      0.18  $    (0.12) $      0.35  $      (0.22)
                                         ===========  ==========  ===========  ============
  Diluted.............................. $      0.17  $    (0.12) $      0.34  $      (0.22)
                                         ===========  ==========  ===========  ============
Potential weighted-average common shares excluded from the
computation of diluted net income per share as their effect would be
antidilutive were 193,000 shares and 359,000 shares, respectively, for the three
months and nine months ended September 30, 2004.  The exercise price of these
options exceeded the average market price during the three-month and nine-month
periods mentioned above.  These shares could, however, potentially dilute basic
income per share in the future.  For the three months and nine months ended
September 30, 2003, the Company did not include options outstanding to purchase
4,977,000 and 3,803,000 shares, respectively, of common stock in the diluted net
loss per share since their effect was antidilutive due to the reported loss.
NOTE 11. COMMITMENTS AND CONTINGENCIES
OPERATING LEASES
The Company entered into a lease arrangement of office and
manufacturing space in Sunnyvale, California effective January 2002 (the
"Sunnyvale Lease").  Under the Sunnyvale Lease, the Company was
required to lease additional space in the same building starting in January
2004.  The Sunnyvale Lease was scheduled to expire on April 30, 2007. On April
30, 2004, the Company purchased the property for approximately $20.0 million and
canceled the Sunnyvale Lease.  In addition, the Company leases office space for
research and development in Milford, Connecticut and sales office space in St.
Germain en Laye, France.  In connection with the acquisition of Computer Motion,
the Company assumed leases in Goleta, California.  These leases have varying
terms, the longest of which extends to September 2007.  As of September 30,
2004, the Company sublet approximately 90% of its office space in Goleta.
Future minimum lease commitments, net of sublease income of
$1.4 million throughout the next 4 years, under the Company's operating leases
as of September 30, 2004 are as follows (in thousands):
2004 (remaining 3 months)..... $     112
2005..........................       408
2006..........................       399
2007..........................       236
2008..........................        36
Thereafter....................        34
                                ---------
Total......................... $   1,225
                                =========
Rent expense was approximately $0.1 million and $0.9 million
for the three months ended September 30, 2004 and 2003, respectively.  Rent
expense was approximately $1.0 million and $2.4 million for the nine months
ended September 30, 2004 and 2003, respectively.
CONTINGENCIES
The discussion of the Company's legal proceedings is incorporated by
reference from Part II, Item 1. Legal Proceedings of this report.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
In this report, "Intuitive Surgical,"
"Intuitive," "Company," "we," "us," and
"our" refer to Intuitive Surgical, Inc.
This management's discussion and analysis of financial
condition as of September 30, 2004 and results of operations for the three
months and nine months ended September 30, 2004 and September 30, 2003 should be
read in conjunction with the management's discussion and analysis of financial
condition and results of operations included in the Annual Report.
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 Surgical®,
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. The
da Vinci
Surgical System is sold for use in multiple surgical specialties, principally
urology, cardiac and general surgery.
RESULTS OF OPERATIONS
Product Sales (dollars in millions)
September 30,  September 30,                %
                                         2004           2003        Change    Change
                                     -------------  -------------  --------- ---------
Three months ended................. $        29.3  $        20.5  $     8.8        43 %
Nine months ended.................. $        77.6  $        57.0  $    20.6        36 %
Product sales increased to $29.3 million for the three months
ended September 30, 2004 from $20.5 million for the three months ended September
30, 2003. This 43% increase in product sales resulted primarily from higher
da Vinci
Surgical System unit sales and higher recurring instrument and
accessory revenue.
Total third quarter 2004 system revenue was $19.0 million
compared to $15.5 million during the third quarter of 2003. We shipped 18
da
Vinci
Surgical Systems during the third quarter of 2004: 13 in North
America, 1 in Europe, and 4 in the rest of the world. The 18 total units shipped
represented a 3 unit increase compared to 15 units shipped during the third
quarter of 2003. As of September 30, 2004 we have shipped a total of 261
da
Vinci
Surgical Systems: 184 in North America, 52 in Europe, and 25 in the
rest of the world. We shipped 15
da Vinci
Surgical System fourth arms
during the third quarter of 2004, compared to 16 during the third quarter of
2003. We shipped 8
Aesop
systems during the third quarter of 2004,
compared to 5 during the third quarter of 2003.
Third quarter 2004 instrument and accessory revenue increased
to $10.3 million from $5.0 million for the third quarter of 2003, reflecting a
growing number of surgical procedures performed by our customers, such as those
for radical prostatectomy procedures. This growth resulted from a larger base of
installed
da Vinci
Surgical Systems and improved system utilization per
site.
Product sales increased to $77.6 million for the nine months
ended September 30, 2004 from $57.0 million for the nine months ended September
30, 2003. This 36% increase in product sales resulted primarily from higher
recurring instrument and accessory revenue, higher
da Vinci
Surgical
System unit sales, and higher fourth arm unit sales.
Total system revenue for the nine months ended September 30,
2004 was $51.7 million compared to $44.3 million for the nine months ended
September 30, 2003. We shipped 51
da Vinci
Surgical Systems during the
first nine months of 2004, compared to 43 units shipped during the first nine
months of 2003. We shipped 17
Aesop
systems during the first nine months
of 2004, compared to 5 for the first nine months of 2003.
Instrument and accessory revenue for the nine months ended September 30, 2004
increased to $25.9 million from $12.7 million for the nine months ended
September 30, 2003, reflecting a growing number of surgical procedures performed
by our customers, such as those for radical prostatectomy procedures. This
growth resulted in large part from a larger base of installed
da Vinci
Surgical Systems and improved system utilization per site.
Service Sales (dollars in millions)
September 30,  September 30,                %
                                         2004           2003        Change    Change
                                     -------------  -------------  --------- ---------
Three months ended................. $         6.2  $         2.9  $     3.3       114 %
Nine months ended.................. $        16.0  $         7.1  $     8.9       125 %
Service sales, comprised of system service, installation and
customer training, increased to $6.2 million for the three months ended
September 30, 2004 from $2.9 million for the three months ended September 30,
2003. The increase was primarily due to a larger base of
da Vinci
Surgical Systems generating service revenue. The base of systems generating
service revenue grew by 125 systems entering the third quarter of 2004 compared
to the third quarter of 2003. The increase of 125 was comprised of 59 systems
sold between the third quarter of 2002 and the second quarter of 2003 coming out
of the warranty period onto service contracts and 66 systems sold between the
third quarter of 2003 and the second quarter of 2004, with first year service
deferred according to EITF 00-21, which was adopted prospectively effective July
1, 2003. In addition, the average service revenue per active system under a
service contract increased in 2004 due to higher rates charged for four-arm
systems.
Service sales increased to $16.0 million for the nine months ended September
30, 2004 from $7.1 million for the nine months ended September 30, 2003. The
increase was primarily due to a larger base of
da Vinci
Surgical Systems
generating service revenue.
Product Sales Gross Profit (dollars in millions)
September 30,  September 30,                %
                                         2004           2003        Change    Change
                                     -------------  -------------  --------- ---------
Three months ended................. $        19.5  $        11.1  $     8.4        76 %
Percentage of product sales........          66.5 %         54.2 %

Nine months ended.................. $        49.7  $        32.9  $    16.8        51 %
Percentage of product sales........          64.1 %         57.7 %
Product sales gross profit for the three months ended
September 30, 2004 was $19.5 million, or 66.5% of product sales, compared to
$11.1 million, or 54.2% of product sales for the three months ended September
30, 2003. The $8.4 million increase in product gross profit was driven by $8.8
million higher product sales during the third quarter of 2004, as described
previously, in combination with a higher third quarter 2004 gross profit
percentage.  Our increased third quarter 2004 gross profit percentage was driven
by maintaining product pricing, leveraging fixed manufacturing costs across
higher product sales volume, and reducing system and instrument material costs.
In addition, third quarter 2003 product margin was negatively impacted by
approximately $1.0 million, or 4.9 margin points, due to integration costs
incurred associated with the Computer Motion entity acquired on June 30,
2003.
Product sales gross profit for the nine months ended September 30, 2004 was
$49.7 million, or 64.1% of product sales, compared to $32.9 million, or 57.7% of
product sales for the nine months ended September 30, 2003. The increase was
driven by maintaining product pricing, leveraging fixed manufacturing costs
across higher product sales volume, and reducing system and instrument material
costs.
Service Sales Gross Profit (dollars in millions)
September 30,  September 30,                %
                                         2004           2003        Change    Change
                                     -------------  -------------  --------- ---------
Three months ended................. $         3.3  $         0.9  $     2.4       267 %
Percentage of service sales........          52.3 %         32.9 %

Nine months ended.................. $         8.5  $         1.6  $     6.9       431 %
Percentage of product sales........          52.9 %         22.6 %
Service sales gross profit for the three months ended September 30, 2004 was
$3.3 million, or 52.3% of service sales, compared to $0.9 million, or 32.9% of
service sales for the three months ended September 30, 2003. Service sales gross
profit for the nine months ended September 30, 2004 was $8.5 million, or 52.9%
of service sales, compared to $1.6 million, or 22.6% of service sales, for the
nine months ended September 30, 2003. Higher 2004 service sales gross profit was
driven by increased service revenue, as described above, in combination with
increased leverage of the mostly fixed service and training organization
expenses across a larger base of installed systems.
Selling, General and Administrative Expenses (dollars in millions)
September 30,  September 30,                %
                                         2004           2003        Change    Change
                                     -------------  -------------  --------- ---------
Three months ended................. $        12.6  $        11.3  $     1.3        12 %
Nine months ended.................. $        34.4  $        29.3  $     5.1        17 %
Selling, general and administrative expenses include
personnel costs for sales, marketing and administrative personnel, tradeshow
expenses, legal expenses, regulatory fees and general corporate expenses.
Selling, general and administrative expenses for the three
months ended September 30, 2004 were $12.6 million, up 12% from $11.3 million
for the three months ended September 30, 2003. Selling, general and
administrative expenses for the nine months ended September 30, 2004 were $34.4
million, up 17% from $29.3 million for the nine months ended September 30, 2003.
The year over year increases were primarily due to higher incentive compensation
and other variable costs associated with achieving higher revenues, incremental
patent costs associated with maintaining the Computer Motion patent portfolio,
and additional accounting personnel, consulting, and auditing resources added to
support compliance with the Sarbanes Oxley Act of 2002.  These items were
partially offset by the elimination of Computer Motion integration costs
incurred during the third quarter of 2003.
We expect selling, general and administrative expenses to increase in the
future to support our expanding business.
Research and Development Expenses (dollars in millions)
September 30,  September 30,                %
                                         2004           2003        Change    Change
                                     -------------  -------------  --------- ---------
Three months ended................. $         4.6  $         4.4  $     0.2         5 %
Nine months ended.................. $        13.6  $        11.5  $     2.1        18 %
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 expenses for the three months ended
September 30, 2004 were $4.6 million, up 5% compared to $4.4 million for the
three months ended September 30, 2003. The increase was primarily due to higher
third quarter 2004 incentive compensation and product development project costs,
partially offset by the elimination of the Computer Motion integration and
operating costs incurred during the third quarter of 2003.
Research and development expenses for the nine months ended
September 30, 2004 were $13.6 million, up 18% compared to $11.5 million for the
nine months ended September 30, 2003. The increase during the nine months ended
September 30, 2004 was due in large part to expenses incurred in the first
quarter of 2004 to close the former Computer Motion facilities located in
Goleta, California. In accordance with our restructuring plan, we completely
shut down the Goleta site on March 31, 2004 and terminated all remaining
Goleta-based employees, resulting in a $0.8 million restructuring expense recorded in
the first quarter of 2004.  The remainder of the increase for the nine months
ended September 30, 2004 was primarily due to higher incentive compensation and
product development costs.
Research and development costs are expensed as incurred. We expect to
continue to make substantial investments in research and development and
anticipate that research and development expenses will increase in the
future.
Other Income, Net, and Income Tax Expense (dollars in millions)
September 30,  September 30,                %
                                         2004           2003        Change    Change
                                     -------------  -------------  --------- ---------
Three months ended................. $         0.6  $         0.3  $     0.3       100 %
Nine months ended.................. $         1.6  $         1.5  $     0.1         7 %
Other income, comprised mostly of interest income, increased
to $0.7 million for the three months ended September 30, 2004 from $0.3 million
for the three months ended September 30, 2003. The increase resulted primarily
from higher interest income earned on a larger cash balance position during the
third quarter of 2004 resulting from the proceeds of our public offering of
common stock in the fourth quarter of 2003.
Other income for the nine months ended September 30, 2004 was
$1.9 million, compared to $1.5 million for the nine months ended September 30,
2003. First quarter 2003 other income included $0.5 million of gains realized on
sales of securities. Excluding these first quarter 2003 capital gains, other
income for the nine months ended September 30, 2004, comprised mostly of
interest income, increased $0.9 million primarily due to higher interest income
earned on a larger cash balance position during the period resulting from the
proceeds of the fourth quarter of 2003 public offering of our common stock.
Income tax expense was $0.1 million and $0.4 million for the three and nine
months ended September 30, 2004, respectively.  This expense represents
estimated income tax based on our profitability for the periods presented.
LIQUIDITY AND CAPITAL RESOURCES
Our operations have been financed primarily through the sale
of our equity securities. Sales of convertible preferred stock have yielded
proceeds of approximately $127.3 million and public offerings of our common
stock have yielded proceeds of approximately $124.5 million. We have also
financed operations through employee stock purchase and option plans as well as
equipment financing arrangements. At September 30, 2004 we had total
stockholders equity of $299.8 million and outstanding equipment financing debt
of $0.9 million. As of September 30, 2004, we had cash, cash equivalents and
short-term investments of $121.2 million, compared to $112.9 million at December
31, 2003. Working capital as of September 30, 2004 was $122.2 million, compared
to $118.3 million as of December 31, 2003. The increase in cash, cash
equivalents and short-term investments and in working capital resulted primarily
from our 2004 year-to-date net income of $11.8 million, non-cash operating
expenses of $5.3 million, and net proceeds of $9.8 million realized from stock
option exercises and our employee stock purchase plan, partially offset by the
purchase of our Sunnyvale, California facility during the second quarter of 2004
for approximately $20.0 million in cash and the purchase of other property and
equipment for approximately $2.0 million in cash.
Net cash provided by operating activities was $21.8 million
for the nine months ended September 30, 2004, compared to $12.7 million of cash
used in operating activities for the nine months ended September 30, 2003. The
$21.8 million of cash provided by operations during the nine months ended
September 30, 2004 resulted from net income of $11.8 million, non-cash expenses
of $5.3 million and net working capital generated of $4.7 million. The $12.7
million of cash used in operating activities during the nine months ended
September 30, 2003 was comprised primarily of working capital consumed of $13.4
million and our net loss of $4.8 million, partially offset by non-cash expenses
of $5.5 million.  The $13.4 million of working capital consumed during the nine
months ended September 30, 2003 was driven by the payment of net liabilities
acquired in the Computer Motion acquisition which closed on June 30, 2003.
Net cash used in investing activities was $30.8 million for
the nine months ended September 30, 2004, compared to net cash provided by
investing activities of $9.5 million for the nine months ended September 30,
2003. Net cash used in investing activities during the nine months ended
September 30, 2004 resulted mainly from investments in fixed assets of $22.0
million, comprised mostly of our purchase of our Sunnyvale, California facility
($20.0 million) during the second quarter of 2004, and the net conversion of
cash into short-term investments of  $8.9 million. Net cash provided by
investing activities during the nine months ended September 30, 2003 resulted
primarily from the net conversion of short-term investments into cash of $15.3
million, partially offset by $4.1 million of cash used to acquire Computer
Motion and $1.7 million of cash related to the purchase and disposition of fixed
assets.
Net cash provided by financing activities was $9.0 million
for the nine months ended September 30, 2004, compared to $3.9 million for the
nine months ended September 30, 2003. Net cash provided by financing activities
for the nine months ended September 30, 2004 resulted primarily from net
proceeds realized from stock option exercises and our employee stock purchase
plan of $9.8 million, partially offset by repayments of long-term debt of $0.9
million. Net cash provided by financing activities for the nine months ended
September 30, 2003 resulted primarily from net proceeds realized from stock
option exercises and our employee stock purchase plan of $5.2 million, partially
offset by repayments of long-term debt of $1.2 million.
Our capital requirements depend on numerous factors,
including market acceptance of our products, the resources we devote to
developing and supporting our products, and other factors. We expect to devote
substantial capital resources to continue our research and development efforts,
to expand our customer support and product development activities and for other
general corporate activities. We believe that our current cash and cash
equivalents and short-term investment balances, together with revenue to be
derived from the sale of our products, will be sufficient to meet our liquidity
requirements for the foreseeable future.
Contractual Obligations and Commercial Commitments
The following table summarizes all significant
contractual payment obligations, net of sublease income of $1.4 million
throughout the next 4 years, by payment due date:
Payments by Periods (in millions)
Contractual Obligation
Total
Less than 1 year
1-3 years
3-5 years
More than 5 years
Long-term debt
$ 0.9
$ 0.8
$ 0.1
$ 0.0
$ 0.0
Building lease
1.2
0.4
0.7
0.1
0.0
Purchase commitments
0.3
0.3
0.0
0.0
0.0
Total
$ 2.4
$ 1.5
$ 0.8
$ 0.1
$ 0.0
CRITICAL ACCOUNTING POLICIES
The discussion and analysis of our financial
condition and results of operations are based upon our consolidated financial
statements, which have been prepared in accordance with accounting principles
generally accepted in the United States. The preparation of these financial
statements requires us to make estimates and judgments that affect the reported
amounts of assets, liabilities, revenues and expenses, and related disclosure of
assets and liabilities. On an on-going basis, we evaluate our critical
accounting policies and estimates, including those related to revenue
recognition, bad debts, income taxes and intangible assets. We base our
estimates on historical experience and on various other assumptions that we
believe to be reasonable under the circumstances, the results of which form the
basis for making judgments about the carrying values of assets and liabilities
that are not readily apparent from other sources. Actual results may differ from
these estimates under different assumptions or conditions. Our critical
accounting policies and estimates are discussed in our Annual Report.
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 uncertain, 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:
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;
product quality problems;
the extent to which our products gain market acceptance;
third-party payor reimbursement policies;
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;
actions relating to regulatory matters;
our ability to protect our proprietary rights and defend against third party
challenges;
our ability to license additional intellectual property rights; and
the progress and results of clinical trials.
Our operating results in any particular period will not be a
reliable indication of our future performance. It is likely that in some future
quarters, 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, 2004 and 2003, approximately 52% and 65%, 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, 2004 and 2003,
approximately 54% and 69%, respectively, of our revenues came from the sales of
da Vinci
Surgical Systems. During the three-month and nine-month periods
ended September 30, 2004 and 2003, 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.
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
("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 ("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
("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 ("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
("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.
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 will
compete with established and emerging treatment options in both disease
management and reconstructive medical procedures.  These competitive treatment
options may take the form of traditional minimally invasive surgery, open
surgery, interventional approaches, or pharmacological regimens.  Some of these
procedures are widely accepted in the medical community and in many cases have a
long history of use.  Technological advances could make such treatments more
effective or less expensive than using our products, which could render our
products obsolete 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.
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.
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.
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. In the past, we have voluntarily recalled certain
products as a result of performance problems.  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;
product recalls;
increased service or warranty costs; or
product liability claims.
WE 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 maintain reliable, high-volume
manufacturing capacity. Even if this capacity can be 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 maintain
larger-scale manufacturing capabilities, our ability to generate revenues will be
limited and our reputation in the marketplace could 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
("GMP") requirements contained in the FDA's Quality System
Regulations, or QSR. We are also required to comply with the Medical Device
Directive ("MDD") and International Organization for Standardization
("ISO"), quality system standards in order to produce products for
sale in Europe. If we fail to continue to comply with  GMP requirements, the
MDD, or ISO standards, we may be required to cease all or part of our operations
until we comply with these regulations. We continue to be subject to FDA
inspections at any time, and we are subject to MDD and ISO audits on an annual
basis to maintain our certifications. Maintaining such compliance is difficult
and costly. We cannot be certain that our facilities will be found to comply
with GMP requirements, the MDD, or ISO standards in future inspections and
audits by regulatory authorities.
The state of California also requires that we maintain a
license to manufacture medical devices.  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 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.
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 electronics,
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.
COMPLYING WITH FDA REGULATIONS 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:
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 be certain
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 be certain 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.
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.
TERMINATION OF RELATIONSHIPS WITH FORMER DISTRIBUTORS OF
COMPUTER MOTION COULD RESULT IN LITIGATION.
Our integration strategy related to our acquisition of
Computer Motion may involve the termination of 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 proceedings may be expensive to litigate,
may be protracted, and Computer 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.
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 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.
There may be 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 may be 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 be
certain 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 be certain 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, 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 Heartport, Inc., now part of Johnson & Johnson, IBM
Corporation, MIT, Olympus Optical Co., Ltd., and SRI International. 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.
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 22% of our sales for the three months
ended September 30, 2004 and 14% for the three months ended September 30, 2003.
Sales to markets outside of the United States accounted for approximately 22% of
our sales for the nine months ended September 30, 2004 and 21% for the nine
months ended September 30, 2003.
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.
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.
INVESTOR CONFIDENCE AND SHARE VALUE MAY BE ADVERSELY IMPACTED IF WE OR OUR
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM ARE UNABLE TO PROVIDE AN
UNQUALIFIED ATTESTATION OF THE ADEQUACY OF OUR INTERNAL CONTROLS OVER FINANCIAL
REPORTING AS OF DECEMBER 31, 2004, AS REQUIRED BY SECTION 404 OF THE SARBANES-
OXLEY ACT OF 2002.
The Securities and Exchange Commission, as directed by
Section 404 of the Sarbanes-Oxley Act of 2002, adopted rules requiring public
companies to include a report of management on the company's internal controls
over financial reporting in its annual reports on Form 10-K that contain an
assessment by management of the effectiveness of the company's internal controls
over financial reporting. In addition, the company's independent registered
public accounting firm must attest to and report on management's assessment of
the effectiveness of the company's internal controls over financial reporting.
This requirement will first apply to our Annual Report on Form 10-K for the
fiscal year ending December 31, 2004. Although we intend to diligently and
vigorously review our internal controls over financial reporting in order to
ensure compliance with the Section 404 requirements, if we or our independent
registered public accounting firm are not satisfied with our internal controls
over financial reporting or the level at which these controls are documented,
designed, operated, reviewed or tested, or if our independent registered public
accounting firm interprets the requirements, rules or regulations differently
from us, then we or they may decline to attest to management's assessment or may
issue a report that is qualified. This could result in an adverse reaction in
the financial marketplace due to a loss of investor confidence in the
reliability of our financial statements, which ultimately could negatively
impact the market price of our shares.
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, 2004 was approximately 1.04 years.  At September
30, 2004 and December 31, 2003, approximately 48% and 37%, respectively, of our
investment portfolio was composed of investments with original maturities of one
year or less.
The majority of our revenue, expense, and capital purchasing
activities are transacted in U.S. dollars. However, since a portion of our
operations consists of sales activities outside of the United States, we have
entered into transactions in other currencies, primarily the euro. On a limited
basis, we have used forward foreign exchange contracts to reduce a portion of
our exposure to foreign currency risk from operational and balance sheet
exposures resulting from changes in foreign currency exchange rates. Such
exposures result from sales denominated in foreign currencies. These contracts
were typically short-term in nature (i.e., less than 6 months).
For the three months ended September 30, 2004 and 2003, sales
denominated in foreign currencies were 7% and 10%, respectively, of total sales.
For the nine months ended September 30, 2004 and 2003, sales denominated in
foreign currencies were 7% and 11%, respectively, of total sales. We did not
enter into forward foreign exchange contracts during the three months and nine
months ended September 30, 2004 and 2003.
We do not use derivative financial instruments for
speculative trading purposes, nor do we hold or issue leveraged derivative
financial instruments. We have not entered into any forward contracts since July
2002, and as of September 30, 2004 and December 31, 2003, we had no outstanding
derivative instruments.
Foreign currency fluctuations resulted in $23,000 of foreign
exchange gain for the three months ended September 30, 2004 and $50,000 of
foreign exchange loss for the three months ended September 30, 2003. Foreign
currency fluctuations resulted in $65,000 of foreign exchange loss for the nine
months ended September 30, 2004 and $68,000 of foreign exchange gain for the
nine months ended September 30, 2003.
ITEM 4. CONTROLS AND PROCEDURES
We maintain disclosure controls and procedures that are
designed to ensure that information required to be disclosed in our Securities
Exchange Act of 1934 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 period 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
In February 2004, a former customer of Computer Motion
filed a lawsuit against our company.  We received the complaint on April 23,
2004.  The customer alleges that it relied to its detriment on representations
made by Computer Motion in connection with Computer Motion's sale of products to
the customer, which representations the customer believes were not fulfilled.
The customer is seeking damages. We believe the allegation is baseless and
intend to vigorously defend this suit. To date, we have filed a motion to
dismiss the fraud-based complaints and an answer defending the breach of
contract claim.  The litigation continues to be in discovery.
In November 2003, an Israeli company filed suit against our
company and Computer Motion in Israel alleging breach of a distribution contract
and seeking damages. We received the complaint on April 27, 2004. Following the
acquisition of Computer Motion, we withdrew Computer Motion's distributorship
offer to this Israeli company. We believe the allegation is baseless and intend
to vigorously defend the suit. We have filed a motion to have the case dismissed
on jurisdictional grounds.  The court has not yet ruled on the motion as the
parties are still submitting briefs on the motion.
In October 2003, SIC System, S.R.L. ("SIC System")
a former Italian distributor for Computer Motion, filed suit against our company
and Computer Motion seeking damages in the Civil Court of Rome, Italy (the
"Italian Action").  In the Italian Action, SIC System alleges that we
breached the distribution agreement between SIC System and Computer Motion when,
following our acquisition of Computer Motion, we deleted two products previously
covered under the distribution agreement.   The distribution agreement provides,
among other things, that (1) it shall be governed and construed under the laws
of the State of California; and (2) in the event of any dispute or controversy
arising under the distribution agreement or the transactions contemplated
thereunder, the parties mutually consent to the exclusive jurisdiction of a
court of competent jurisdiction within Santa Barbara County, California.  We are
defending the Italian Action on both jurisdictional grounds and on the merits.
To date, the Court in the Italian Action has ruled that SIC System's service
process in filing its complaint is defective and has ordered SIC System to
re-file its complaint on or about October 6, 2004.  The court in the Italian Action
has not ruled on jurisdiction or other pending issues pertaining to the
applicable law or appropriate forum.
On November 11, 2003, we filed a lawsuit in
the United States District Court for the Central District of California
captioned
Intuitive Surgical, Inc., et. al v. SIC System Srl
, Case Number
CV-03-08220 for declaratory relief, breach of contract and preliminary and
permanent injunction (the "Federal Action").  The Federal Action
sought a judicial declaration of the rights and obligations of the parties under
a distribution agreement, specifically that our company effectively
deleted the products from the distribution agreement, and a preliminary and
permanent injunction prohibiting SIC System from proceeding with the Italian
Action.  The complaint in the Federal Action was served on SIC System on
November 28, 2003, and the Court entered Default against SIC Systems on March
31, 2004.  On August 16, 2004, the Court entered a judgment in favor of
our company in the amount of $195,155 for breach of contract.  The Court
also awarded judgment in favor of our company as to its claim for
declaratory relief.  The Court awarded judgment in favor of SIC Systems as to
our company's claim for preliminary and permanent injunction.  The Court
found our company as the prevailing party and awarded taxable costs to
us.
The foregoing proceedings could be expensive to litigate, may
be protracted and our 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. At any time, the
other parties may file additional claims against us, or we may file claims
against them, which could increase the risk, expense and duration of the
litigations.
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. UNREGISTERED SALES OF EQUITY 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
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
__________
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 8, 2004
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