Overview

Open surgery remains the predominant form of surgery and is used in almost every area of the body. However, the large incisions required for open surgery create trauma to the patient, typically resulting in longer hospitalization and recovery times, increased hospitalization costs and additional pain and suffering relative to MIS, where MIS is available. Over the past two decades, MIS has reduced trauma to the patient by allowing selected surgeries to be performed through small ports rather than large incisions. MIS has been widely adopted for certain surgical procedures, but it has not been widely adopted for complex reconstructive surgeries.

The da VinciSurgical System enables surgeons to extend the benefits of MIS to many patients who would otherwise undergo open surgery by using computational, robotic and imaging technologies to overcome many of the limitations of conventional MIS. Surgeons using the da Vinci system operate while seated comfortably at a console viewing a high resolution, 3-D, HD image of the surgical field. This immersive visualization connects

surgeons to the surgical field and their instruments. While seated at the console, the surgeon manipulates instrument controls in a natural manner, similar to the way he or she has been trained to do in open surgery. Our technology is designed to provide surgeons with a range of motion in the surgical field analogous to the motions of a human wrist, while filtering out the tremor inherent in a surgeon's hand. In designing our products, we focus on making our technology easy to use.

Our products fall into four broad categories - da VinciSurgical Systems, InSite and Firefly Fluorescence imaging systems, instruments and accessories (e.g., EndoWrist, EndoWrist One, da Vinci Single-Site) and training technologies. We have commercialized three generations of da Vinci Surgical Systems; the first is our da Vinci standard Surgical System, first commercialized in 1999, the second is our da Vinci S Surgical System, commercialized in 2006, and the third and most current is our da Vinci Si Surgical System, commercialized in 2009. Systems include a surgeon's console, imaging electronics, a patient-side cart and computational hardware and software. Instruments and accessories are used with systems to allow surgeons the flexibility in choosing the types of tools needed in a particular surgery. Lastly, training technologies include our recently developed da Vinci Skills Simulator and our dual console for use in surgeon proctoring and collaborative surgery.

We model patient value as equal to procedure efficacy / invasiveness. Here procedure efficacy is a measure of the success of the surgery in resolving the underlying disease and invasiveness is how disruptive and painful the treatment is itself. When the patient value of a da Vinci procedure is greater than that of alternative treatment options, patients may benefit from seeking out surgeons and hospitals that offer da Vinci surgery, which potentially could result a local market share shift. Adoption occurs procedure by procedure, and is driven by the relative patient value of da Vinci procedures compared to alternative treatment options for the same disease state.

Procedures

Worldwide Procedures

The adoption of da Vinci surgery has the potential to progress for those procedures that offer greater patient value than non da Vinci alternatives. We focus our organization and investments on developing, marketing and training for those products and procedures where we believe da Vinci can bring significant patient value relative to competitive therapies. In 2012, da Vinci was used primarily in gynecology, urology, general surgery, cardiothoracic surgery and head and neck surgery. Target procedures in gynecology include da Vinci Hysterectomy ("dVH"), Sacrocolpopexy, Myomectomy, and Endometriosis Resection. Target procedures in urology include da Vinci Prostatectomy ("dVP"), Partial Nephrectomy and Pyeloplasty. Target procedures in general surgery include Single-Site Cholecystectomy and colorectal procedures. In cardiothoracic surgery, they include da Vinci Lobectomy and da Vinci Mitral Valve Repair. Lastly, in head and neck surgery, the target procedures include da Vinci Trans-oral Robotic Surgery ("TORS") for throat and base of tongue cancers.

In 2012, approximately 450,000 surgical procedures were performed with the da Vinci Surgical System, compared to approximately 360,000 and 278,000 procedures performed in 2011 and 2010 respectively. The growth in our overall procedure volume was driven by growth in U.S. gynecologic procedures, U.S. general surgery procedures, and international dVP procedures, partially offset by a decline of approximately 15% in U.S. dVP procedures compared to 2011.

U.S. Procedures

Overall U.S. procedure volume grew to approximately 367,000 in 2012, compared to approximately 292,000 in 2011 and 228,000 in 2010.

Gynecology is our largest U.S. surgical specialty. Overall U.S. gynecology procedure volume grew from approximately 123,000 cases in 2010 to approximately 170,000 in 2011 and to approximately 222,000 in 2012. Growth in gynecology was driven by continued adoption of dVH, our highest volume procedure, and other

gynecologic procedures, including Sacrocolpopexy, Endometriosis Resection, and Myomectomy. U.S. dVH procedure volume grew from approximately 140,000 cases in 2011 to approximately 176,000 cases in 2012, of which approximately 38,000 were for the treatment of cancer and approximately 138,000 related to benign conditions. We estimate the total annual U.S. addressable robotic hysterectomy market to be approximately 300,000 to 350,000 cases, of which approximately 50,000 are for cancer.

Urology is our second largest surgical specialty. U.S. urology procedure volume was approximately 88,000 in 2012, compared to approximately 93,000 in 2011 and 85,000 in 2010. The 2012 urology decline was driven by lower dVP procedure volume. We consider dVP to be the standard of care for the surgical treatment of prostate cancer in the U.S. About 62,000 dVPs were performed in 2012, compared to 73,000 in 2011 and 68,000 in 2010. The approximately 15% reduction in 2012 dVP procedures in the U.S. reflects pressures from reduced levels of PSA testing and increased use of non-surgical disease management. Other (non-dVP) urology procedures, including partial and full nephrectomy, increased approximately 27% in 2012 to 26,000 cases.

General surgery is our third largest and fastest growing specialty. Overall U.S. general surgery procedure volume grew from approximately 10,000 cases in 2010 to approximately 15,000 in 2011 and to approximately 42,000 in 2012. General surgery growth was led by an increase in cholecystectomy and colorectal procedures. da Vinci Single-Site instrumentation was FDA cleared for U.S. cholecystectomies in December 2011. Since launch, over 450 customers have purchased Single Site instruments. Multi-port robotic cholecystectomies are also being performed.

International Procedures

Overall international procedure volume grew to approximately 83,000 in 2012, compared to approximately 68,000 in 2011 and 50,000 in 2010. dVP accounted for the majority of international procedures, having grown from about 30,000 in 2010 to 40,000 in 2011 and to 47,000 in 2012. The overall international procedure growth rate of approximately 22% in 2012 was lower than the 36% growth rate in 2011, primarily due to lower European growth rates resulting from austerity measures, PSA testing, non-surgical disease management trends and other Company specific matters.

Business Model

We generate revenue from both the initial capital sales of da Vinci Surgical Systems as well as recurring revenue, derived from sales of instruments, accessories, and service. The da Vinci Surgical System generally sells for between $1.0 million and $2.3 million, depending upon configuration and geography, and represents a significant capital equipment investment for our customers. We generate recurring revenue as our customers consume our EndoWrist instruments and accessory products used in performing procedures with the da Vinci Surgical System. EndoWrist instruments and accessories have a limited life and will either expire or wear out as they are used in surgery, at which point they are replaced. We also generate recurring revenue from ongoing system service. We typically enter into service contracts at the time systems are sold at an annual rate of approximately $100,000 to $170,000 per year, depending upon the configuration of the underlying system. These service contracts have generally been renewed at the end of the initial contractual service periods.

Recurring revenue has grown at a rate equal to or faster than the rate of growth of system revenue. Recurring revenue increased from $752.7 million, or 53% of total revenue in 2010 to $979.5 million, or 56% of total revenue in 2011 to $1,245.9 million, or 57% of total revenue in 2012. The increase in recurring revenue relative to system revenue reflects continuing adoption of procedures on a growing base of installed da Vinci Surgical Systems. We expect recurring revenue to become a larger percentage of total revenue in the future. The installed base of da Vinci Surgical Systems has grown to 2,585 at December 31, 2012, compared with 2,132 at December 31, 2011 and 1,752 at December 31, 2010.

We provide our products through a direct sales organization in the U.S. and in Europe, excluding Spain, Italy, Greece and Eastern European countries. In January 2012, we acquired our Korean distributor and began selling directly to Korean customers. Beginning in 2013, we also will provide our products through a direct sales organization in the Czech Republic, Slovakia, and Hungary, whereas prior to 2013, these markets were served by a distributor. In the remainder of our world markets, we provide our products through distributors.

Regulatory Activities

We believe that we have obtained the clearances required to market our products to our targeted surgical specialties within the U.S. and most of Europe. As we make additions to target procedures and introduce new products, we will continue to seek necessary clearances.

In November 2009, we received Shonin approval from the MHLW for our da Vinci S Surgical System in Japan. The initial sales were primarily made to early adopters. Since receiving the approval, we have been focusing our efforts on obtaining specific reimbursement for da Vinci procedures in Japan and building our own organization, Intuitive Surgical Japan. Prior to April 2012, we had partnered with the experienced regulatory team from JJKK to assist in navigating the Japanese regulatory process. In April 2012, the Marketing Authorization Application for da Vinci products was transferred to Intuitive Surgical Japan from JJKK, and Intuitive Surgical Japan now has primary responsibility for regulatory support of our products in Japan. We continue to partner with Adachi Co., LTD as our separate independent distribution partner for marketing, selling, and servicing our products in Japan. Effective April 2012, we obtained national reimbursement for the dVP procedures in Japan, our only reimbursed procedure to date. In October 2012, we obtained MHLW approval for da Vinci Si Surgical Systems in Japan. If we are not successful in obtaining additional regulatory clearances, importation licenses, and adequate procedure reimbursements for future products and procedures, then the demand for our products in Japan could be limited.

2012 Business Events and Trends

Economic Environment. The credit and sovereign debt issues impacting Europe have slowed capital sales and curtailed procedure growth throughout most of 2012. European procedure growth was lower than we anticipated in 2012. Although capital sales and procedure growth outside of Europe have been strong, European uncertainties could adversely impact demand for our products globally. Demand for da Vinci systems fluctuates quarter to quarter based upon changing economic and geopolitical factors.

da Vinci Prostatectomy. We believe the U.S. Preventive Services Task Force recommendation against PSA screening, as well as suggested changes in treatment pattern for low risk prostate cancer away from definitive treatment have led to a decline in our dVP business. We estimate that dVP procedures in the U.S. declined approximately 15% during the year ended December 31, 2012 compared with 2011. We are unable to predict the extent to which these recommendations and treatment pattern changes will be followed by governments or clinicians in non-U.S. jurisdictions.

New Product Introductions

da Vinci Skills Simulator. In the first quarter of 2011, we began shipping our da Vinci Skills Simulator. The simulator is a practice tool for the da Vinci Si Surgical System that gives a user the opportunity to efficiently practice in his or her facility with the da Vinci surgeon console controls. The simulator incorporates three-dimensional, physics-based computer simulation technology to immerse the user within a virtual environment. The user navigates through the environment and completes exercises by controlling virtual instruments from the surgeon console. Upon completion of a skills exercise, the simulator provides a quantitative assessment of user performance based on a variety of task-specific metrics. The simulator is intended to augment, not replace, existing training programs for the da Vinci Si Surgical System. Most da Vinci Skills Simulators have been sold in connection with new da Vinci Si Surgical System sales. We sold 425 and 383 da Vinci Skills Simulators during the years ended December 31, 2012 and 2011, respectively.

da Vinci Single-Site Instruments. da Vinci Single-Site is a set of non-wristed instruments and accessories that allow the da Vinci Si systems to work through a single incision, typically in the umbilicus, rather than multiple incisions. Single incision surgery is intended to minimize invasiveness to patients by reducing the number of ports required to enter the body and is typically utilized for less complex surgery than multi-port surgery. Non-robotic single incision surgery today is typically performed with modified laparoscopic instruments. Early clinical adoption of this manual technique has been mostly positive, although physicians have reported that manual single incision surgery is technically and ergonomically challenging. da Vinci Single-Siteinstruments and accessories were designed to address these issues. In February 2011, we received the CE mark for our da Vinci Single-Site instrument kit and began selling these new products in Europe. The majority of da Vinci Single-Site procedures performed in Europe to date have been cholecystectomies. In December 2011, we received U.S. FDA regulatory clearance to market our Single-Site instrumentation in the U.S. for laparoscopic cholecystectomy procedures, our only U.S. clearance to date. We are encouraged by hospital, surgeon, and patient interest in da Vinci Single-Site, with over 450 U.S. customers having purchased da Vinci Single-Site kits as of December 31, 2012. However, as we are in the early stages of introducing this instrumentation to the U.S. market, we are not able to predict the extent to which da Vinci Single-Site may be adopted. During the third quarter of 2012, we submitted our 510(k) submission to the FDA for Single-Site instruments and indications for use in benign Hysterectomy and Salpingo Oophorectomy.

da Vinci Firefly Fluorescence Imaging. In the first quarter of 2011, we launched our Firefly Fluorescence Imaging product ("Firefly") for use with the da Vinci Si Surgical System in the U.S. and Europe. This new imaging capability combines a fluorescent dye with a specialized da Vinci camera head, endoscope and laser-based illuminator to allow surgeons to identify vasculature in three dimensions beneath tissue surfaces to visualize critical anatomy. Firefly kits configured into new da Vinci system sales are included in systems revenue, while Firefly kits sold separately for existing systems are included in instruments and accessories revenue. Adoption of Firefly is progressing, with its primary utilization in partial nephrectomy procedures. Firefly is also being used in certain gynecology and general surgery cases.

EndoWrist One Vessel Sealer. In December 2011, we received FDA clearance for the EndoWrist One Vessel Sealer. The EndoWrist One Vessel Sealer is a wristed, single-use instrument intended for bipolar coagulation and mechanical transection of vessels up to 7 mm in diameter and tissue bundles that fit in the jaws of the instrument. This instrument enables da Vinci Si surgeons to fully control vessel sealing, while providing the benefits of da Vinci Surgery. This instrument is designed to enhance surgical efficiency and autonomy in a variety of general surgery and gynecologic procedures. Clinical response to the EndoWrist One Vessel Sealer has been encouraging, with positive commentary on precision, articulation, vessel sealing quality and thermal spread. We expect applications for the EndoWrist One Vessel Sealer to be centered on general surgery and gynecologic oncology procedures. We are still in the early stages of introducing EndoWrist One Vessel Sealer and are not able to predict the extent to which the EndoWrist One Vessel Sealer may be adopted.

EndoWrist Stapler 45. In October 2012, we received FDA clearance for the EndoWrist Stapler 45 instrument with Blue and Green 45 mm reloads. The EndoWrist Stapler 45 is a wristed, stapling instrument intended for resection, transection and/or creation of anastomoses in general, gynecologic and urologic surgery. This instrument enables operators of the da Vinci Si to precisely position and fire the stapler. We expect its initial surgical use to be directed towards colorectal procedures. We intend to rollout the EndoWrist Stapler 45 to a limited number of customers in early 2013 and slowly to a broader set of customers later in 2013. As we have not begun selling EndoWrist Stapler 45, we are not able to predict the extent to which the EndoWrist Stapler 45 may be adopted.

2012 Financial Highlights

• Total revenue increased 24% to $2,178.8 million during the year ended December 31, 2012 from $1,757.3 million during the year ended December 31, 2011.

• Approximately 450,000 da Vinci procedures were performed during the year ended December 31, 2012, up approximately 25% from the year ended December 31, 2011.

• Instruments and accessories revenue increased 29% to $903.3 million during the year ended December 31, 2012 from $701.1 million during the year ended December 31, 2011.

• Recurring revenue increased 27% to $1,245.9 million during the year ended December 31, 2012, representing 57% of total revenue from $979.5 million during the year ended December 31, 2011, representing 56% of total revenue.

• We sold 620 da Vinci Surgical Systems during the year ended December 31, 2012, compared with 534 for the year ended December 31, 2011.

• System revenue increased 20% to $932.9 million during the year ended December 31, 2012 from $777.8 million during the year ended December 31, 2011.

• As of December 31, 2012, we had a da Vinci Surgical System installed base of 2,585 systems-1,878 in the U.S., 416 in Europe, and 291 in the rest of the world.

• Operating income increased 26% to $878.1 million during the year ended December 31, 2012 compared to $694.8 million during the year ended December 31, 2011. Operating income included $153.3 million and $136.4 million during the years ended December 31, 2012 and 2011, respectively, of stock-based compensation expense related to employee stock programs.

• We ended fiscal 2012 with $2,920.5 million in cash, cash equivalents and investments. Cash, cash equivalents, and investments increased by $748.7 million during 2012 driven by cash flow from operations and $263.3 million generated from employee stock programs, partially offset by $238.3 million used to repurchase and retire 0.4 million shares of common stock, and $114.2 million used for capital expenditures and the purchase of intellectual property.

• We ended fiscal 2012 with 2,362 employees, compared to 1,924 at the end of fiscal 2011. Headcount additions were made predominantly to our field sales, manufacturing, and R&D organizations.

Technology and Other Acquisitions

We continue to make strategic acquisitions of intellectual property and related technologies. Total investments in intellectual property and related technologies during the year ended December 31, 2012 were $41.6 million, compared to $16.8 million during the year ended December 31, 2011. Amortization expense related to purchased intellectual property for the year ended December 31, 2012 and 2011 were $23.1 million and $17.8 million, respectively.

On January 11, 2012, we completed the acquisition of our Korean distributor. The total purchase consideration of the acquisition was not material, and the acquisition has not had a material impact on the results of our operations.

Results of Operations

The following table sets forth, for the years indicated, certain Consolidated
Statements of Income information (in millions):



                                                              Years Ended December 31,
                                                  % of                         % of                         % of
                                                  total                        total                        total
                                    2012         revenue         2011         revenue         2010         revenue
Revenue:
Product                           $ 1,836.2            84 %    $ 1,478.9            84 %    $ 1,189.1            84 %
Service                               342.6            16 %        278.4            16 %        223.9            16 %

Total revenue                       2,178.8           100 %      1,757.3           100 %      1,413.0           100 %
Cost of revenue:
Product                               495.3            23 %        382.3            22 %        297.3            21 %
Service                               113.2             5 %        101.2             6 %         85.7             6 %

Total cost of revenue                 608.5            28 %        483.5            28 %        383.0            27 %
Product gross profit                1,340.9            62 %      1,096.6            62 %        891.8            63 %
Service gross profit                  229.4            11 %        177.2            10 %        138.2            10 %

Gross profit                        1,570.3            72 %      1,273.8            72 %      1,030.0            73 %

Operating expenses:
Selling, general and
administrative                        522.2            24 %        438.8            25 %        358.8            25 %
Research and development              170.0             8 %        140.2             8 %        116.0             8 %

Total operating expenses              692.2            32 %        579.0            33 %        474.8            33 %

Income from operations                878.1            40 %        694.8            39 %        555.2            39 %
Interest and other income
(expense), net                         15.8             1 %         14.9             1 %         17.1             1 %

Income before taxes                   893.9            41 %        709.7            40 %        572.3            41 %
Income tax expense                    237.3            11 %        214.6            12 %        190.5            13 %

Net income                        $   656.6            30 %    $   495.1            28 %    $   381.8            27 %

Total Revenue

Total revenue increased by 24% during the year ended December 31, 2012 from the year ended December 31, 2011. Total revenue increased to $2,178.8 million during the year ended December 31, 2012 from $1,757.3 million during the year ended December 31, 2011 and from $1,413.0 million during the year ended December 31, 2010. Total revenue growth for these periods was driven by the continued adoption of da Vinci Surgery, resulting largely from growth in U.S. gynecologic procedures, including dVH, Sacrocolpopexy, Endometriosis Resection, and Myomectomy; U.S. general surgery procedures, including Cholecystectomy and Colorectal procedures; and dVP in international markets, partially offset by a decline of approximately 15% in dVP procedures in the U.S from 2011 to 2012. We believe the reduction in dVP procedures in the U.S. reflects pressures from reduced levels of PSA testing and increased use of non-surgical disease management. Procedure growth in Europe was lower than our overall growth due to austerity measures, PSA testing, non-surgical disease management trends and other Company specific matters. Revenue within the U.S. accounted for 79%, 78%, and 80% of total revenue during the years ended December 31, 2012, 2011, and 2010, respectively. We believe domestic revenue has accounted for the large majority of total revenue primarily due to the ability of patients to choose their provider and method of treatment in the U.S. Our international revenue grew in absolute dollars compared with the prior year, primarily due to higher system sales in the Japanese market and higher instrument and accessory sales driven by increased procedures. The credit and sovereign debt issues have resulted in a challenging economic environment in Europe.

The following table summarizes our revenue and da Vinci Surgical System unit sales information for the years indicated (in millions, except unit sales and percentages):

                                                           Years Ended December 31,
                                                   2012              2011              2010
Revenue
Instruments and accessories                      $   903.3         $   701.1         $   528.8
Systems                                              932.9             777.8             660.3

Total product revenue                              1,836.3           1,478.9           1,189.1
Services                                             342.6             278.4             223.9

Total revenue                                    $ 2,178.8         $ 1,757.3         $ 1,413.0

Recurring revenue                                $ 1,245.9         $   979.5         $   752.7
% of total revenue                                      57 %              56 %              53 %
Domestic                                         $ 1,726.9         $ 1,378.7         $ 1,126.0
International                                        451.9             378.6             287.0

Total revenue                                    $ 2,178.8         $ 1,757.3         $ 1,413.0

% of Revenue-Domestic                                   79 %              78 %              80 %
% of Revenue-International                              21 %              22 %              20 %

Unit Sales by Region:
Domestic Unit Sales                                    476               400               335
International Unit Sales                               144               134               106
. . .