SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Policies)

9 Months Ended

Sep. 30, 2018

In the opinion of management, the accompanying unaudited Condensed Consolidated Financial Statements (“Financial Statements”) of Intuitive Surgical, Inc. and its wholly- and majority-owned subsidiaries have been prepared on a consistent basis with the audited Consolidated Financial Statements for the fiscal year ended December 31, 2017, and include all adjustments, consisting of only normal recurring adjustments, necessary to fairly state the information set forth herein. The Financial Statements have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission (“SEC”) and therefore, omit certain information and footnote disclosure necessary to present the Financial Statements in accordance with accounting principles generally accepted in the United States (“U.S.”) (“U.S. GAAP”). These Financial Statements should be read in conjunction with the audited Consolidated Financial Statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2017, which was filed with the SEC on February 2, 2018. The results of operations for the first nine months of fiscal year 2018 are not necessarily indicative of the results to be expected for the entire fiscal year or any future periods.

Recent Accounting Pronouncements

Recent Accounting Pronouncements Not Yet Adopted

In February 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2016-02, Leases (Topic 842), which amends the existing accounting standards for leases. The new standard requires lessees to record a right-of-use (“ROU”) asset and a corresponding lease liability on the balance sheet (with the exception of short-term leases). The new standard also requires expanded disclosures regarding leasing arrangements. The new standard becomes effective for the Company beginning January 1, 2019, with early adoption permitted. In July 2018, the FASB issued ASU No. 2018-11, Leases (Topic 842): Targeted Improvements, which provides an alternative modified retrospective transition method. Under this method, the cumulative-effect adjustment to the opening balance of retained earnings is recognized on the date of adoption. The Company intends to elect this transition method.

The Company leases certain facilities for some of its operations, which represents a majority of its operating leases it has entered into as a lessee. The Company’s customers finance purchases of da Vinci systems and ancillary products, including directly with the Company as the lessor. It is currently unknown whether the new standard will change customer buying patterns or behaviors. While the Company is evaluating the effect that this new standard will have on its Financial Statements and related disclosures, the Company currently anticipates the primary impact will be the recognition of ROU assets and lease liabilities on its balance sheet associated with the operating leases it has entered into as a lessee.

In August 2018, the FASB issued ASU No. 2018-15, Intangibles (Topic 350): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract, which aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software. This new standard also requires customers to expense the capitalized implementation costs of a hosting arrangement that is a service contract over the term of the hosting arrangement. This new standard becomes effective for the Company in the first quarter of fiscal year 2020, with early adoption permitted. This new standard can be applied either retrospectively or prospectively to all implementation costs incurred after the date of adoption. The Company is currently evaluating the impact of adopting this new standard on its Financial Statements.

Adopted Accounting Pronouncement

Revenue from Contracts with Customers

The Company adopted FASB Accounting Standards Codification Topic 606 (“ASC 606”), Revenue from Contracts with Customers in the first quarter of the Company’s fiscal year that began on January 1, 2018, using the full retrospective method, which required the Company to restate each prior reporting period presented. This new standard replaced the previous revenue recognition guidance in U.S. GAAP. Please see the Company’s “Revenue Recognition” policy in the “Significant Accounting Policies” section below.

The areas impacted include future contractual billings related to services included in the Company’s multi-year contracts, which are considered performance obligations that should be part of the contract consideration allocated to all performance obligations rather than being excluded due to its contingent nature as required under the previous revenue standard. Accordingly, the amount of contract consideration allocated to the performance obligations identified in the Company’s system arrangements is different from the amounts allocated under the previous revenue standard. In general, revenue is recognized earlier as a greater amount of the contract consideration is allocated to the product-related performance obligations that generally are delivered upfront, and therefore, less consideration is allocated to the service performance obligation that is generally recognized over the service period.

In addition, the Company recognized an asset associated with the incremental costs of obtaining revenue generating customer contracts that it expects to benefit from over a period longer than one year. The Company capitalized sales commissions paid in connection with system sale arrangements that include multi-year service obligations and is amortizing such asset over the economic life of those contracts. Previously, sales commissions were expensed as incurred. The impact of this change on operating expenses in any given period will depend, in part, on the amount of such commissions incurred and capitalized in relation to the amount of ongoing amortization expense.

Adoption of the standard using the full retrospective method also required the Company to restate certain previously reported results, including the impact to provision for income taxes. The adjustments to the unaudited Condensed Consolidated Statements of Comprehensive Income for the three and nine months ended September 30, 2017, are as follows (in millions, except per share amounts):



	Three Months Ended September 30, 2017									Nine Months Ended September 30, 2017
	As Previously Reported			Adjustments			As Restated			As Previously Reported		Adjustments			As Restated
Revenue:
Product	$	659.3		$	3.9		$	663.2		$	1,807.5	$	16.2		$	1,823.7
Service	146.8			(2.2		)	144.6			429.0		(6.5		)	422.5
Total revenue	806.1			1.7			807.8			2,236.5		9.7			2,246.2
Cost of revenue:
Product	195.0			0.4			195.4			543.1		2.5			545.6
Service	44.3			—			44.3			132.6		—			132.6
Total cost of revenue	239.3			0.4			239.7			675.7		2.5			678.2
Gross profit	566.8			1.3			568.1			1,560.8		7.2			1,568.0
Operating expenses:
Selling, general and administrative	204.8			(0.7		)	204.1			591.7		0.9			592.6
Research and development	83.4			—			83.4			241.5		—			241.5
Total operating expenses	288.2			(0.7		)	287.5			833.2		0.9			834.1
Income from operations	278.6			2.0			280.6			727.6		6.3			733.9
Interest and other income, net	10.8			—			10.8			29.6		—			29.6
Income before taxes	289.4			2.0			291.4			757.2		6.3			763.5
Income tax (benefit) expense	(8.1		)	0.9			(7.2		)	58.4		2.7			61.1
Net income attributable to Intuitive Surgical, Inc.	$	297.5		$	1.1		$	298.6		$	698.8	$	3.6		$	702.4
Net income per share attributable to Intuitive Surgical, Inc.:
Basic	$	2.66		$	0.01		$	2.67		$	6.26	$	0.03		$	6.29
Diluted	$	2.55		$	0.01		$	2.56		$	6.03	$	0.03		$	6.06
Total comprehensive income attributable to Intuitive Surgical, Inc.	$	298.1		$	1.1		$	299.2		$	698.5	$	3.6		$	702.1

Selected Condensed Consolidated Statements of Balance Sheet line items, which reflect the impact of adopting the new standard, are as follow (in millions) as of December 31, 2017:



	December 31, 2017
	As Previously Reported		Adjustments			As Restated
ASSETS
Accounts receivable, net	$	511.9	$	(4.0	)	$	507.9
Prepaids and other current assets	$	97.2	$	2.0		$	99.2
Deferred tax assets	$	87.3	$	(15.3	)	$	72.0
Intangibles and other assets, net	$	159.7	$	36.1		$	195.8

LIABILITIES AND STOCKHOLDERS’ EQUITY
Deferred revenue	$	284.5	$	(40.7	)	$	243.8
Other accrued liabilities	$	169.5	$	(0.6	)	$	168.9
Other long-term liabilities	$	327.1	$	6.5		$	333.6
Retained earnings	$	61.4	$	53.6		$	115.0

In addition, the cumulative effect of ASC 606 to the Company’s retained earnings at January 1, 2016, was $40.3 million. Adoption of the standard had no impact to total net cash from or used in operating, investing, or financing activities within the Condensed Consolidated Statements of Cash Flows.

As part of the Company’s adoption of ASC 606, the Company elected to use the following practical expedients: (i) to exclude disclosures of transaction prices allocated to remaining performance obligations when the Company expects to recognize such revenue for all periods prior to the date of initial application of ASC 606; (ii) not to adjust the promised amount of consideration for the effects of a significant financing component when the Company expects, at contract inception, that the period between the Company’s transfer of a promised product or service to a customer and when the customer pays for that product or service will be one year or less; (iii) to expense costs as incurred for costs to obtain a contract when the amortization period would have been one year or less; (iv) not to recast revenue for contracts that begin and end in the same fiscal year; and (v) not to assess whether promised goods or services are performance obligations if they are immaterial in the context of the contract with the customer.

Intra-Entity Transfer of Assets Other than Inventory

Beginning fiscal 2018, the Company adopted ASU 2016-16, Income Taxes (Topic 740): Intra-Entity Transfer of Assets Other than Inventory, which requires the recognition of the income tax consequences of an intra-entity transfer of an asset, other than inventory, when the transfer occurs. The Company adopted this standard using the modified retrospective approach, and as a result, recorded a deferred tax asset with a corresponding cumulative adjustment to retained earnings of $390.8 million as of January 1, 2018, associated with an intra-entity transfer of certain intellectual property rights related to the Company’s non-U.S. business to its Swiss entity. The adjustment may be materially different as a result of recording additional deferred taxes upon finalization of the assessment of global intangible low-taxed income and other aspects from additional guidance and interpretations by U.S. regulatory and standard-setting bodies related to the Tax Cuts and Jobs Act (the “Tax Act”) enacted on December 22, 2017.

Business Combinations: Clarifying the Definition of a Business

Beginning fiscal 2018, the Company adopted ASU 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business, which clarifies the definition of a business to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses, and applied the new guidance prospectively. During 2018, the Company acquired certain assets that were accounted for as business combinations. Refer to “Note 4. Balance Sheet Details and Other Information” for further information on the acquisitions.

Statement of Cash Flows: Restricted Cash

Beginning fiscal 2018, the Company adopted ASU No. 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash, which requires the statement of cash flows to explain the change during the period relating to total cash, cash equivalents, and restricted cash. The Company adopted this standard using the retrospective transition method by restating its condensed consolidated statements of cash flows to include restricted cash of $15.0 million in the beginning and ending cash, cash equivalents, and restricted cash balances for all periods presented. Net cash flows for the nine months ended September 30, 2017, did not change as a result of including restricted cash with cash and cash equivalents when reconciling the beginning-of-period and end-of-period amounts presented on the statements of cash flows. Restricted cash was included in intangible and other assets, net on the Company’s condensed consolidated balance sheets.

Revenue Recognition

The Company adopted ASC Topic 606, Revenue from Contracts with Customers, on January 1, 2018. The Company’s revenue consists of product revenue resulting from the sale of systems, system components, instruments and accessories, and service revenue. The Company accounts for a contract with a customer when there is a legally enforceable contract between the Company and its customer, the rights of the parties are identified, the contract has commercial substance, and collectability of the contract consideration is probable. The Company’s revenues are measured based on the consideration specified in the contract with each customer, net of any sales incentives and taxes collected from customers that are remitted to government authorities.

The Company’s system sale arrangements generally contain multiple products and services. For these bundled sale arrangements, the Company accounts for individual products and services as separate performance obligations if they are a distinct product or service that is separately identifiable from other items in a bundled package; and if a customer can benefit from the product or service on its own or with other resources that are readily available to the customer. The Company’s system sale arrangements include a combination of the following performance obligations: system(s); system components; system accessories; instruments; accessories; and system service. The Company’s system sale arrangements generally include a five-year period of service. The first year of service is generally free and included in the system sale arrangement and the remaining four years are generally included at a stated service price. The Company considers the service terms in the arrangements that are legally enforceable to be performance obligations. Other than service, the Company generally satisfies all of the performance obligations up-front. System components, system accessories, instruments, accessories, and service are also sold on a stand-alone basis.

The Company recognizes revenue as the performance obligations are satisfied by transferring control of the product or service to a customer. The Company generally recognizes revenue for the performance obligations at the following points in time:

•System sales. For systems, system components, and system accessories sold directly to end customers, revenue is recognized when the Company transfers control to the customer, which is generally at the point when acceptance occurs that indicates customer acknowledgment of delivery or installation, depending on the terms of the arrangement. For systems sold through distributors, revenue is recognized generally at the time of shipment. The Company’s system arrangements generally do not provide a right of return. The systems are generally covered by a one-year warranty. Warranty costs were not material for the periods presented.

•Instruments and accessories. Revenue from sales of instruments and accessories is recognized when control is transferred to the customers, which generally occurs at the time of shipment, but also occurs at the time of delivery depending on the customer arrangement. The Company allows its customers in the normal course of business to return unused products for a limited period of time subsequent to initial purchase and records an allowance against revenue for estimated returns.

•Service. Service revenue is recognized ratably over the term of the service period as the customers benefit from the service throughout the service period. Revenue related to services performed on a time-and-materials basis is recognized when performed.

The Company offers its customers the opportunity to trade in their older systems for a credit towards the purchase of a newer generation system. The Company generally does not provide specified price trade-in rights or upgrade rights at the time of system purchase. Such trade-in or upgrade transactions are separately negotiated based on the circumstances at the time of the trade-in or upgrade, based on the then fair value of the system, and are generally not based on any pre-existing rights granted by the Company. Accordingly, such trade-ins and upgrades are not considered as separate performance obligations in the arrangement for a system sale.

As part of a trade-in transaction, the customer receives a new generation system in exchange for its pre-owned system. The trade-in credit is negotiated at the time of the trade-in and is applied towards the purchase price of the new unit. Traded-in systems generally can be reconditioned and resold. The Company accounts for the fair value of the traded-in system in the total consideration in the arrangement by including the net realizable value of the traded-in system less a normal profit margin. The value of the traded-in system is determined as the amount, after reconditioning costs are added, that will allow a normal profit margin on the sale of the reconditioned unit to be generated. When there is no market for the traded-in units, no value is assigned. Traded-in units are reported as a component of inventory until resold, or otherwise disposed.

In addition, customers may also have the opportunity to upgrade their systems at a price determined at the time of the upgrade, for example, by adding a second surgeon console for use with the da Vinci Surgical System. Such upgrades are performed by completing component level upgrades at the customer’s site. Upgrade revenue is recognized when the component level upgrades are complete and all revenue recognition criteria are met.

For multiple-element arrangements, revenue is allocated to each performance obligation based on its relative standalone selling price. Standalone selling prices are based on observable prices at which the Company separately sells the products or services. If a standalone selling price is not directly observable, then the Company estimates the standalone selling price considering market conditions and entity-specific factors including, but not limited to, features and functionality of the products and services, geographies, and type of customer. The Company regularly reviews standalone selling prices and updates these estimates as necessary.

Assets Recognized from the Costs to Obtain a Contract with a Customer

The Company has determined that certain sales incentives provided to the Company’s sales team are required to be capitalized when the Company expects to generate future economic benefits from the related revenue-generating contracts subsequent to the initial capital sales transaction. When determining the economic life of the contract acquisition assets recognized, the Company considers historical service renewal rates, expectations of future customer renewals of service contracts, and other factors that could impact the economic benefits that the Company expects to generate from the relationship with its customers.