Masimo Earnings 2019-03-30

MASI 10Q Quarterly Report

Balance Sheet	Income Statement	Cash Flow

10-Q 1 masi-20190330x10q.htm 10-Q Document

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
________________________________________________
FORM 10-Q
________________________________________________
(Mark One)
ý	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 30, 2019
OR
¨	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 001-33642

MASIMO CORPORATION
(Exact Name of Registrant as Specified in its Charter)

Delaware				33-0368882
(State or Other Jurisdiction of Incorporation or Organization)				(I.R.S. Employer Identification Number)
52 Discovery Irvine, California				92618
(Address of Principal Executive Offices)				(Zip Code)
(949) 297-7000
(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 such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No ¨

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ý No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.



Large accelerated filer	ý	Accelerated filer	¨

Non-accelerated filer	¨	Smaller reporting company	¨

		Emerging growth company	¨



If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No ý

Securities Registered pursuant to Section 12(b) of the Act:
Title of each class	Trading Symbol(s)	Name of each exchange on which registered
Common Stock, $0.001 par value	MASI	The Nasdaq Stock Market LLC

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:
Class		Number of Shares Outstanding as of March 30, 2019
Common stock, $0.001 par value		53,337,183

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MASIMO CORPORATION

FORM 10-Q FOR THE QUARTER ENDED MARCH 30, 2019

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PART I. Financial Information

Item 1.	Financial Statements (unaudited):

	Condensed Consolidated Balance Sheets as of March 30, 2019 and December 29, 2018	3

	Condensed Consolidated Statements of Operations for the three months ended March 30, 2019 and March 31, 2018	4

	Condensed Consolidated Statements of Comprehensive Income for the three months ended March 30, 2019 and March 31, 2018	5

	Condensed Consolidated Statements of Stockholders’ Equity for the three months ended March 30, 2019 and March 31, 2018	6

	Condensed Consolidated Statements of Cash Flows for the three months ended March 30, 2019 and March 31, 2018	7

	Notes to Condensed Consolidated Financial Statements	8

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	33

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	41

Item 4.	Controls and Procedures	42

PART II. Other Information

Item 1.	Legal Proceedings	42

Item 1A.	Risk Factors	42

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	64

Item 5.	Other Information	65

Item 6.	Exhibits	66

Signatures		67

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PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

MASIMO CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

(unaudited, in thousands, except par values)



	March 30, 2019			December 29, 2018
ASSETS
Current assets
Cash and cash equivalents	$	412,861		$	552,490
Short-term investments	180,000			—
Trade accounts receivable, net of allowance for doubtful accounts of $1,738 and $1,535 at March 30, 2019 and December 29, 2018, respectively	117,822			109,629
Inventories	93,259			94,732
Other current assets	46,355			29,227
Total current assets	850,297			786,078
Lease receivable, noncurrent	41,149			—
Deferred costs and other contract assets	15,599			126,105
Property and equipment, net	167,288			165,972
Intangible assets, net	27,830			27,924
Goodwill	22,376			23,297
Deferred tax assets	30,464			21,210
Other non-current assets	24,373			4,232
Total assets	$	1,179,376		$	1,154,818
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities
Accounts payable	$	32,970		$	40,388
Accrued compensation	30,040			49,486
Deferred revenue and other contract-related liabilities, current	22,677			33,106
Other current liabilities	35,470			24,627
Total current liabilities	121,157			147,607
Other non-current liabilities	53,143			38,146
Total liabilities	174,300			185,753
Commitments and contingencies
Stockholders’ equity
Preferred stock, $0.001 par value; 5,000 shares authorized; 0 shares issued and outstanding at March 30, 2019 and December 29, 2018	—			—
Common stock, $0.001 par value; 100,000 shares authorized; 53,337 and 53,085 shares issued and outstanding at March 30, 2019 and December 29, 2018, respectively	53			53
Treasury stock, 15,255 shares at March 30, 2019 and December 29, 2018	(489,026		)	(489,026		)
Additional paid-in capital	547,225			533,164
Accumulated other comprehensive loss	(6,776		)	(6,199		)
Retained earnings	953,600			931,073
Total stockholders’ equity	1,005,076			969,065
Total liabilities and stockholders’ equity	$	1,179,376		$	1,154,818

The accompanying notes are an integral part of these condensed consolidated financial statements.

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MASIMO CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited, in thousands, except per share amounts)



	Three Months Ended
	March 30, 2019		March 31, 2018
Revenue:
Product	$	230,548	$	204,389
Royalty and other revenue	1,116		8,564
Total revenue	231,664		212,953
Cost of goods sold	80,022		69,292
Gross profit	151,642		143,661
Operating expenses:
Selling, general and administrative	74,204		70,217
Research and development	21,415		19,559
Total operating expenses	95,619		89,776
Operating income	56,023		53,885
Non-operating income	3,886		1,647
Income before provision for income taxes	59,909		55,532
Provision for income taxes	10,587		9,902
Net income	$	49,322	$	45,630

Net income per share:
Basic	$	0.93	$	0.88
Diluted	$	0.87	$	0.82

Weighted-average shares used in per share calculations:
Basic	53,210		51,709
Diluted	56,799		55,496

The accompanying notes are an integral part of these condensed consolidated financial statements.

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MASIMO CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(unaudited, in thousands)



	Three Months Ended
	March 30, 2019			March 31, 2018
Net income	$	49,322		$	45,630
Other comprehensive income, net of tax:
Unrealized losses from foreign currency translation adjustments	(577		)	(270		)
Comprehensive income	$	48,745		$	45,360

The accompanying notes are an integral part of these condensed consolidated financial statements.

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MASIMO CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (in thousands)

	Three Months Ended March 31, 2018
	Common Stock				Treasury Stock				Additional Paid-In Capital			Accumulated Other Comprehensive Loss			Retained Earnings			Total Stockholders’ Equity
	Shares		Amount		Shares	Amount			Additional Paid-In Capital			Accumulated Other Comprehensive Loss			Retained Earnings			Total Stockholders’ Equity
Balance at December 30, 2017	51,636		$	52	15,059	$	(472,536	)	$	461,494		$	(2,941	)	$	737,956		$	724,025
Stock options exercised	314		—		—	—			8,880			—			—			8,880
Restricted/Performance stock units vested	31		—		—	—			—			—			—			—
Shares paid for tax withholding	(2	)	—		—	—			(168		)	—			—			(168		)
Stock-based compensation	—		—		—	—			5,332			—			—			5,332
Repurchases of common stock	(196	)	—		196	(16,490		)	—			—			—			(16,490		)
Net income	—		—		—	—			—			—			45,630			45,630
Adoption of ASU 2016-16	—		—		—	—			—			—			(426		)	(426		)
Foreign currency translation adjustment	—		—		—	—			—			(270		)	—			(270		)
Balance at March 31, 2018	51,783		$	52	15,255	$	(489,026	)	$	475,538		$	(3,211	)	$	783,160		$	766,513

	Three Months Ended March 30, 2019
	Common Stock				Treasury Stock				Additional Paid-In Capital			Accumulated Other Comprehensive Loss			Retained Earnings			Total Stockholders’ Equity
	Shares		Amount		Shares	Amount			Additional Paid-In Capital			Accumulated Other Comprehensive Loss			Retained Earnings			Total Stockholders’ Equity
Balance at December 29, 2018	53,085		$	53	15,255	$	(489,026	)	$	533,164		$	(6,199	)	$	931,073		$	969,065
Stock options exercised	224		—		—	—			6,867			—			—			6,867
Restricted/Performance stock units vested	29		—		—	—			—			—			—			—
Shares paid for tax withholding	(1	)	—		—	—			(123		)	—			—			(123		)
Stock-based compensation	—		—		—	—			7,317			—			—			7,317
Cumulative effect of adoption of ASU 2016-02	—		—		—	—			—			—			(26,795		)	(26,795		)
Net income	—		—		—	—			—			—			49,322			49,322
Foreign currency translation adjustment	—		—		—	—			—			(577		)	—			(577		)
Balance at March 30, 2019	53,337		$	53	15,255	$	(489,026	)	$	547,225		$	(6,776	)	$	953,600		$	1,005,076

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MASIMO CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited, in thousands)



	Three Months Ended
	March 30, 2019			March 31, 2018
Cash flows from operating activities:
Net income	$	49,322		$	45,630
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization	5,419			5,241
Stock-based compensation	7,317			5,332
Loss on disposal of property, equipment and intangibles	65			429
Provision from doubtful accounts	234			(394		)
Benefit from deferred income taxes	(31		)	—
Changes in operating assets and liabilities:
(Increase) decrease in accounts receivable	(8,531		)	17,776
Decrease in inventories	1,357			1,139
Decrease (increase) in other current assets	3,043			(204		)
Increase in lease receivable, net	(3,104		)	—
Decrease (increase) in deferred costs and other contract assets	7,120			(5,706		)
(Increase) decrease in other non-current assets	(115		)	644
(Decrease) increase in accounts payable	(6,097		)	2,363
Decrease in accrued compensation	(19,364		)	(11,074		)
(Decrease) increase in accrued liabilities	(2,736		)	2,193
Increase in income tax payable	5,566			6,318
Increase in deferred revenue and other contract-related liabilities	2,377			2,381
Increase (decrease) in other non-current liabilities	626			(73		)
Net cash provided by operating activities	42,468			71,995
Cash flows from investing activities:
Purchases of short-term investments	(180,000		)	—
Purchases of property and equipment, net	(6,963		)	(3,788		)
Increase in intangible assets	(1,040		)	(3,583		)
Net cash used in investing activities	(188,003		)	(7,371		)
Cash flows from financing activities:
Proceeds from issuance of common stock	6,288			8,415
Payroll tax withholdings on behalf of employees for vested equity awards	(123		)	(168		)
Repurchases of common stock	—			(18,479		)
Net cash provided by (used in) financing activities	6,165			(10,232		)
Effect of foreign currency exchange rates on cash	(261		)	(225		)
Net (decrease) increase in cash, cash equivalents, and restricted cash	(139,631		)	54,167
Cash, cash equivalents and restricted cash at beginning of period	552,641			315,483
Cash, cash equivalents and restricted cash at end of period	$	413,010		$	369,650

The accompanying notes are an integral part of these condensed consolidated financial statements.

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MASIMO CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

1. Description of the Company

Masimo Corporation (the Company) is a global medical technology company that develops, manufactures and markets a variety of noninvasive patient monitoring technologies and hospital automation solutions. The Company’s mission is to improve patient outcomes and reduce the cost of care. The Company’s patient monitoring solutions generally incorporate a monitor or circuit board, proprietary single-patient use or reusable sensors, software and/or cables. The Company primarily sells its products to hospitals, emergency medical service providers, home care providers, physician offices, veterinarians, long term care facilities and consumers through its direct sales force, distributors and original equipment manufacturer (OEM) partners.

The Company invented Masimo Signal Extraction Technology^®(SET^®), which provides the capabilities of Measure-through Motion and Low Perfusion^™ pulse oximetry to address the primary limitations of conventional pulse oximetry. Over the years, the Company’s product offerings have expanded significantly to also include rainbow^® Pulse CO-Oximetry, with its ability to monitor carboxyhemoglobin (SpCO^®), methemoglobin (SpMet^®), total hemoglobin concentration (SpHb^®), fractional arterial oxygen saturation (SpfO₂^™), Oxygen Content (SpOC^™), Pleth Variability Index (PVi^®), rainbow^® Pleth Variability Index (RPVi^™), respiration rate from the pleth (RRp^® and Oxygen Reserve Index (ORi^™); as well as acoustic respiration monitoring (RRa^®), SedLine^® brain function monitoring, NomoLine^® capnography and gas monitoring and O3^® regional oximetry. These technologies are based upon Masimo SET^®, rainbow^® and other proprietary algorithms and are incorporated into a variety of product platforms depending on customers' specifications. The Company’s current technology offerings also include remote patient monitoring, connectivity, and hospital automation solutions, including Masimo Patient SafetyNet¹, Masimo Patient SafetyNet Surveillance¹, Replica^™, Iris^®, MyView^®, UniView^® and Trace^™. The Company's technologies are supported by a substantial intellectual property portfolio that the Company has built through internal development and, to a lesser extent, acquisitions and license agreements.

2. Summary of Significant Accounting Policies

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (SEC). Certain information and note disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (GAAP) have been condensed or omitted pursuant to such rules and regulations. The accompanying condensed consolidated financial statements have been prepared on the same basis as the annual financial statements and, in the opinion of management, reflect all adjustments, including normal recurring accruals, necessary to present fairly the Company’s condensed consolidated financial statements. The accompanying condensed consolidated balance sheet as of December 29, 2018 was derived from the Company’s audited consolidated financial statements at that date. The accompanying condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and related notes contained in the Company’s Annual Report on Form 10-K for the fiscal year ended December 29, 2018 (fiscal year 2018), filed with the SEC on February 26, 2019. The results for the three months ended March 30, 2019 are not necessarily indicative of the results to be expected for the fiscal year ending December 28, 2019 (fiscal year 2019) or for any other interim period or for any future year.

As further discussed below in this Note 2 to these condensed consolidated financial statements, the Company adopted Accounting Standards Codification (ASC) Topic 842, Leases (ASC 842), effective December 30, 2018. The Company applied the modified retrospective approach using the current-period adjustment method of adoption, whereby all periods beginning on or after December 30, 2018 are presented under ASC 842 with a cumulative effect adjustment to the opening balance sheet as of the first day of fiscal year 2019, and all prior period amounts are not adjusted and continue to be reported in accordance with the legacy accounting requirements under ASC Topic 840, Leases.

Fiscal Periods

The Company follows a conventional 52/53 week fiscal year. Under a conventional 52/53 week fiscal year, a 52 week fiscal year includes four quarters of 13 fiscal weeks while a 53 week fiscal year includes three 13 fiscal week quarters and one 14 fiscal week quarter. The Company’s last 53 week fiscal year was fiscal year 2014. Fiscal year 2019 is a 52 week fiscal year. All references to years in these notes to condensed consolidated financial statements are fiscal years unless otherwise noted.

^{__________________________________________}

¹ The use of the trademark Patient SafetyNet is under license from the University HealthSystem Consortium.

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MASIMO CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

Use of Estimates

The Company prepares its financial statements in conformity with GAAP, which requires the Company to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Significant estimates include the determination of total contract consideration and how such consideration should be allocated to each performance obligation within a contract, credit loss allowances on accounts and lease receivables, inventory reserves, warranty reserves, rebate accruals, valuation of the Company’s equity awards, goodwill valuation, deferred taxes and any associated valuation allowances, deferred revenue, uncertain income tax positions, and litigation costs and related accruals. Actual results could differ from such estimates.

Reclassifications

Certain amounts in the accompanying condensed consolidated financial statements have been reclassified to conform to the current period presentation, including previously reported selling, general and administrative expenses that have been reclassified as research and development expenses within the condensed consolidated financial statements for the three months ended March 31, 2018.

Fair Value Measurements

Authoritative guidance describes a fair value hierarchy based on three levels of inputs, of which the first two are considered observable and the last unobservable, that may be used to measure fair value:


●	Level 1—Quoted prices in active markets for identical assets or liabilities.


●	Level 2—Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that can be corroborated by observable market data for substantially the full term of the assets or liabilities.


●	Level 3—Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

Pursuant to current authoritative guidance, entities are allowed an irrevocable option to elect the fair value for the initial and subsequent measurement for specified financial assets and liabilities on a contract-by-contract basis. The Company did not elect to apply the fair value option under this guidance to specific assets or liabilities on a contract-by-contract basis. There were no transfers between Level 1, Level 2 and Level 3 inputs during the three months ended March 30, 2019. The Company carries cash and cash equivalents at cost, which approximates fair value.

The following tables represent the Company’s financial assets (in thousands), measured at fair value on a recurring basis as of March 30, 2019:



									Reported as
	Adjusted Basis Cost		Gross Unrealized Gains		Gross Unrealized (Losses)		Estimated Fair Value		Cash and Cash Equivalents		Short-Term Investments
Cash	$	412,861	$	—	$	—	$	412,861	$	412,861	$	—
Level 1:
Certificates of deposit	180,000		—		—		180,000		—		180,000
Subtotal	180,000		—		—		180,000		—		180,000
Level 2:
None	—		—		—		—		—		—
Level 3:
None	—		—		—		—		—		—
Total assets measured at fair value	$	592,861	$	—	$	—	$	592,861	$	412,861	$	180,000

As of December 29, 2018, the Company had an insignificant amount of other financial assets that were required to be measured under the fair value hierarchy, the measurement of which were based on Level 1 inputs.

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MASIMO CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

Cash and Cash Equivalents

The Company considers all highly liquid investments with an original maturity from date of purchase of three months or less, or highly liquid investments that are readily convertible into known amounts of cash, to be cash equivalents.

Short-Term Investments

The Company classifies its investments in certificates of deposits maturing in one year or less as short-term investments. The carrying value of such investment approximates fair value and are accessible without any significant restrictions, taxes, or penalties. During the three months ended March 30, 2019, the Company invested $180.0 million in certificates of deposits with maturities ranging from 6 months to one year.

Accounts Receivable and Allowance for Doubtful Accounts

Accounts receivable consist of trade receivables recorded upon recognition of revenue for product revenues, reduced by reserves for estimated bad debts and returns. Trade accounts receivable are recorded at the invoiced amount and do not bear interest. Credit is extended based on an evaluation of the customer’s financial condition. Collateral is generally not required. The allowance for doubtful accounts is determined based on historical write-off experience, current customer information and other relevant factors, including specific identification of past due accounts, based on the age of the receivable in excess of the contemplated or contractual due date. Accounts are charged off against the allowance when the Company believes they are uncollectible.

Inventories

Inventories are stated at the lower of cost or net realizable value. Cost is determined using a standard cost method, which approximates the first in, first out method, and includes material, labor and overhead costs. Inventory reserves are recorded for inventory items that have become excess or obsolete or are no longer used in current production and for inventory items that have a market price less than carrying value in inventory.

Property and Equipment

Property and equipment are stated at cost. Depreciation is calculated using the straight-line method over estimated useful lives as follows:



	Useful Lives
Aircraft and components	10 to 20 years
Buildings	39 years
Building improvements	7 to 15 years
Computer equipment	2 to 6 years
Demonstration units	3 years
Furniture and office equipment	2 to 6 years
Leasehold improvements	Lesser of useful life or term of lease
Machinery and equipment	5 to 10 years
Tooling	3 years
Vehicles	5 years

Land is not depreciated and construction-in-progress is not depreciated until placed in service. Normal repair and maintenance costs are expensed as incurred, whereas significant improvements that materially increase values or extend useful lives are capitalized and depreciated over the remaining estimated useful lives of the related assets. Upon sale or retirement of depreciable assets, the related cost and accumulated depreciation or amortization are removed from the accounts and any gain or loss on the sale or retirement is recognized in income.

For the three months ended March 30, 2019 and March 31, 2018, depreciation and amortization expense of property and equipment was $5.4 million and $5.2 million, respectively.

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MASIMO CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

Lessee Right-of-Use (ROU) Assets and Lease Liabilities

As further discussed below in this Note 2 to these condensed consolidated financial statements, the Company adopted ASC 842 effective December 30, 2018. The Company determines if an arrangement contains a lease at inception. ROU assets represent the Company’s right to use an asset underlying an operating lease for the lease term and lease liabilities represent the Company’s obligation to make lease payments arising from an operating lease. ROU assets and lease liabilities are recognized at the commencement date based on the present value of lease payments over the lease term. The Company generally estimates the applicable discount rate used to determine the net present value of lease payments based on available information at the lease commencement date. Many of the Company’s lessee agreements include options to extend the lease, which the Company does not include in its lease terms unless they are reasonably certain to be exercised. The Company utilizes a portfolio approach to account for the ROU assets and liabilities associated with certain equipment leases. The Company has also made an accounting policy election not to separate lease and non-lease components for its real estate leases and to exclude short-term leases with a term of twelve months or less from its application of ASC 842. Rental expense for lease payments related to operating leases is recognized on a straight-line basis over the lease term.

Intangible Assets

The Company’s policy is to renew its patents and trademarks. Total renewal costs for patents and trademarks for the three months ended March 30, 2019 and March 31, 2018 were $0.3 million and $0.1 million, respectively. As of March 30, 2019, the weighted-average number of years until the next renewal was less than one year for patents and six years for trademarks. Costs to renew patents and trademarks are capitalized and amortized over the remaining useful life of the intangible asset. The Company continually evaluates the amortization period and carrying basis of patents and trademarks to determine whether any events or circumstances warrant a revised estimated useful life or reduction in value. Capitalized application costs are charged to operations when it is determined that the patent or trademark will not be obtained or is abandoned.

Impairment of Goodwill, Intangible Assets and Other Long-Lived Assets

Goodwill is recorded as the difference, if any, between the aggregate consideration paid for an acquisition and the fair value of the acquired net tangible and intangible assets. Goodwill is not amortized, but instead is tested annually for impairment, or more frequently when events or changes in circumstances indicate that goodwill might be impaired. In assessing goodwill impairment, the Company has the option to first assess the qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. The Company’s qualitative assessment of the recoverability of goodwill considers various macroeconomic, industry-specific and Company-specific factors, including: (i) severe adverse industry or economic trends; (ii) significant Company-specific actions; (iii) current, historical or projected deterioration of the Company’s financial performance; or (iv) a sustained decrease in the Company’s market capitalization below its net book value. If, after assessing the totality of events or circumstances, the Company determines it is unlikely that the fair value of a reporting unit is less than its carrying amount, then a quantitative analysis is unnecessary. However, if the Company concludes otherwise, or if the Company elects to bypass the qualitative analysis, then the Company must perform a quantitative analysis that compares the fair value of the reporting unit with its carrying amount, including goodwill. If the fair value of the reporting unit exceeds its carrying amount, goodwill is not considered impaired; otherwise, a goodwill impairment loss is recognized for the lesser of: (a) the amount that the carrying amount of a reporting unit exceeds its fair value; or (b) the amount of the goodwill allocated to that reporting unit. The annual impairment test is performed during the fourth fiscal quarter.

The Company reviews long-lived assets and identifiable intangibles for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to the future undiscounted operating cash flows expected to be generated by the asset. If such asset is considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount exceeds the fair value of the asset. Long-lived assets to be disposed of are reported at the lower of carrying amount or fair value less costs to sell.

No impairment of goodwill, intangible assets or other long-lived assets was recorded during each of the three months ended March 30, 2019 and March 31, 2018.

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MASIMO CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

Revenue Recognition, and Deferred Revenue and Other Contract Liabilities

The Company derives the majority of its product revenue from four primary sources: (i) direct sales under deferred equipment agreements with end-user hospitals where the Company provides up-front monitoring equipment at no up-front charge in exchange for a multi-year sensor purchase commitment, (ii) other direct sales of noninvasive monitoring solutions to end-user hospitals, emergency medical response organizations and other direct customers; (iii) sales of noninvasive monitoring solutions to distributors who then typically resell to end-user hospitals, emergency medical response organizations and other customers; and (iv) sales of integrated circuit boards to OEM customers who incorporate the Company’s embedded software technology into their multiparameter monitoring devices. Subject to customer credit considerations, the majority of such sales are made on open account using industry standard payment terms based on the geography within which the specific customer is located.

The Company generally recognizes revenue following a single, principles-based five-step model to be applied to all contracts with customers and generally provides for the recognition of revenue in an amount that reflects the consideration to which the Company expects to be entitled, net of allowances for estimated returns, discounts or sales incentives, as well as taxes collected from customers that are remitted to government authorities, when control over the promised goods or services are transferred to the customer. Revenue related to equipment supplied under sales-type lease arrangements is recognized once control over the equipment is transferred to the customer, while revenue related to equipment supplied under operating-type lease arrangements is generally recognized on a straight-line basis over the term of the lease.

While the majority of the Company’s revenue contracts and transactions contain standard business terms and conditions, there are some transactions that contain non-standard business terms and conditions. As a result, contract interpretation, judgment and analysis is required to determine the appropriate accounting, including: (i) the amount of the total consideration, including variable consideration, (ii) whether the arrangement contains an embedded lease, and if so, whether such embedded lease is a sales-type lease or an operating lease, (iii) how the arrangement consideration should be allocated to each performance obligation when multiple performance obligations exist, including the determination of standalone selling price, (iv) when to recognize revenue on the performance obligations, and (v) whether uncompleted performance obligations are essential to the functionality of the completed performance obligations. Changes in judgments on these assumptions and estimates could materially impact the timing of revenue recognition.

The Company enters into agreements to sell its monitoring solutions and services, sometimes as a part of arrangements with multiple performance obligations that include various combinations of product sales, equipment leases and services. In the case of contracts with multiple performance obligations, the authoritative guidance provides that the total consideration be allocated to each performance obligation on the basis of relative standalone selling prices. When a standalone selling price is not readily observable, the Company estimates the standalone selling price by considering multiple factors including, but not limited to, features and functionality of the product, geographies, type of customer, contractual prices pursuant to Group Purchasing Organization (GPO) contracts, the Company’s pricing and discount practices, and other market conditions.

Sales under deferred equipment agreements are generally structured such that the Company agrees to provide certain monitoring-related equipment, software, installation, training and/or warranty support at no up-front charge in exchange for the hospital’s agreement to purchase sensors over the term of the agreement, which generally ranges from three to six years. The Company allocates contract consideration under deferred equipment agreements containing fixed annual sensor purchase commitments to the underlying lease and non-lease components at contract inception. In determining whether any underlying lease components are related to a sales-type lease or an operating lease, the Company evaluates the customer’s rights and ability to control the use of the underlying equipment throughout the contract term, including any equipment substitution rights retained by the Company, as well as the Company’s expectations surrounding potential contract/lease extensions or renewals and the customer’s exercise of any purchase options. Revenue allocable to non-lease performance obligations is generally recognized as such non-lease performance obligations are satisfied. Revenue allocable to lease components under sales-type lease arrangements is generally recognized when the lease commences. Revenue allocable to lease components under operating lease arrangements is generally recognized over the term of the operating lease. The Company generally does not expect to derive any significant value in excess of such asset’s unamortized book value from equipment underlying its operating leases arrangements after the end of the agreement.

Revenue from direct sales of products to the Company’s end-user hospitals, emergency medical response organizations and other direct customers, as well as to its distributors, is generally recognized upon shipment or delivery to the customer based on the terms of the contract or underlying purchase order.

Sales of integrated circuit boards and other products to the Company’s OEM customers are generally recognized as revenue at the time of shipment. Revenue related to OEM rainbow^® parameter software licenses is generally recognized upon shipment of the OEM’s product to its customers, as reported to the Company by the OEM.

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MASIMO CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

The Company provides certain customers with various sales incentives that may take the form of discounts or rebates. The Company estimates and provides allowances for these programs as a reduction to revenue at the time of sale. In general, customers do not have a right of return for credit or refund. However, the Company allows returns under certain circumstances. At the end of each period, the Company estimates and accrues for these returns as a reduction to revenue. The Company estimates the revenue constraints related to these forms of variable consideration based on various factors, including expected purchasing volumes, prior sales and returns history, and specific contractual terms and limitations.

The majority of the Company’s royalty and other revenue arose from one agreement and was due and payable quarterly in arrears. An estimate of these royalty revenues was recorded quarterly in the period earned based on historical results, adjusted for any new information or trends known to management at the time of estimation. This estimated revenue was adjusted prospectively when the Company received the underlying royalty report, approximately sixty days after the end of the previous quarter. For the three months ended March 30, 2019 and March 31, 2018, the Company recognized royalty revenue pursuant to this agreement of approximately $0.7 million and $8.1 million, respectively. The Company received its final royalty payment from this agreement during the three months ended March 30, 2019.

The Company also recognizes revenue from time-to-time related to non-recurring engineering (NRE) services. NRE service revenue is generally recognized over time based on actual costs incurred by the Company.

Shipping and Handling Costs and Fees

All shipping and handling costs are expensed as incurred and are recorded as a component of cost of goods sold in the accompanying consolidated statements of operations. Charges for shipping and handling billed to customers are included as a component of product revenue.

Taxes Collected From Customers and Remitted to Governmental Authorities

The Company’s policy is to present revenue net of taxes collected from customers and remitted to governmental authorities.

Deferred Costs and Other Contract Assets

The costs of monitoring-related equipment provided to hospitals under operating lease arrangements within the Company’s deferred equipment agreements are generally deferred and amortized to cost of goods sold over the life of the underlying contracts. Some of the Company’s deferred equipment agreements also contain provisions for certain payments to be made directly to the end-user hospital customer at the inception of the arrangement. These contractual incentive payments are generally allocated to the lease and non-lease components and recognized as a reduction to revenue as the underlying performance obligations are satisfied.

The Company generally invoices its customers under deferred equipment agreements as sensors are provided to the customer. However, the Company may recognize revenue for certain non-lease performance obligations under deferred equipment agreements with fixed annual commitments at the time such performance obligations are satisfied and prior to the customer being invoiced. When this occurs, the Company records an unbilled contract receivable related to such revenue until the customer has been invoiced pursuant to the terms of the underlying deferred equipment agreement.

The incremental costs of obtaining a contract with a customer are capitalized and deferred if the Company expects such costs to be recoverable over the life of the contract and the contract term is greater than one year. Such deferred costs generally relate to certain incentive sales commissions earned by the Company’s internal sales team in connection with the execution of deferred equipment agreements and are amortized to expense over the expected term of the underlying contract.

Product Warranty

The Company generally provides a warranty against defects in material and workmanship for a period ranging from six to forty-eight months, depending on the product type. In traditional sales activities, including direct and OEM sales, the Company establishes an accrued liability for the estimated warranty costs at the time of revenue recognition, with a corresponding provision to cost of sales. Customers may also purchase extended warranty coverage separately or as part of a deferred equipment agreement. Revenue related to extended warranty coverage is recognized over the extended life of the contract, which is reasonably expected to be the period over which such services will be provided. The related extended warranty costs are expensed as incurred.

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MASIMO CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

Changes in the product warranty accrual were as follows (in thousands):



	Three Months Ended
	March 30, 2019			March 31, 2018
Warranty accrual, beginning of period	$	1,910		$	1,149
Accrual for warranties issued	720			430
Changes to pre-existing warranties (including changes in estimates)⁽¹⁾	2,447			(278		)
Settlements made	(524		)	(161		)
Warranty accrual, end of period	$	4,553		$	1,140

______________

⁽¹⁾

In connection with its adoption of ASC 842 on December 30, 2018, the Company recorded an adjustment to pre-existing warranties of $2.5 million related to equipment previously capitalized under its deferred equipment agreements where the embedded leases were treated as operating leases under prior guidance. See “Recently Adopted Accounting Pronouncements” to these condensed consolidated financial statements for additional information related to the Company’s adoption of ASC 842.

Litigation Costs and Contingencies

The Company records a charge equal to at least the minimum estimated liability for a loss contingency or litigation settlement when both of the following conditions are met: (i) information available prior to issuance of the financial statements indicates that it is probable that a liability had been incurred at the date of the financial statements, and (ii) the range of loss can be reasonably estimated. The determination of whether a loss contingency or litigation settlement is probable or reasonably possible involves a significant amount of management judgment, as does the estimation of the range of loss given the nature of contingencies. Liabilities related to litigation settlements with multiple elements are recorded based on the fair value of each element. Legal and other litigation related expenses are recognized as the services are provided. The Company records insurance and other indemnity recoveries for litigation expenses when both of the following conditions are met: (a) the recovery is probable, and (b) collectability is reasonably assured. Insurance recoveries are only recorded to the extent the litigation costs to which they relate have been incurred and recognized in the financial statements.

Comprehensive Income

Comprehensive income includes foreign currency translation adjustments and any related tax benefits that have been excluded from net income and reflected in stockholders’ equity.

The change in accumulated other comprehensive loss was as follows (in thousands):



	Three Months Ended March 30, 2019
Accumulated other comprehensive loss, beginning of period	$	(6,199	)
Unrealized gains from foreign currency translation	(577		)
Accumulated other comprehensive loss, end of period	$	(6,776	)

Net Income Per Share

Basic net income per share is computed by dividing net income by the weighted-average number of shares outstanding during the period. Net income per diluted share is computed by dividing the net income by the weighted-average number of shares and potential shares outstanding during the period, if the effect of potential shares is dilutive. Potential shares include incremental shares of stock issuable upon the exercise of stock options and the vesting of both restricted share units (RSUs) and performance share units (PSUs). For the three months ended March 30, 2019 and March 31, 2018, weighted options to purchase 0.3 million and 0.9 million shares of common stock, respectively, were outstanding but not included in the computation of diluted net income per share because the effect of including such shares would have been antidilutive in the applicable period. Certain RSUs are considered contingently issuable shares as their vesting is contingent upon the occurrence of certain future events. Since such events had not occurred and were not considered probable of occurring as of each of March 30, 2019 and March 31, 2018, 2.7 million weighted average shares related to such RSUs have been excluded from the calculation of potential shares for each of the three month periods then ended.

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MASIMO CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

A reconciliation of basic and diluted net income per share is as follows (in thousands, except per share amounts):



	Three Months Ended
	March 30, 2019		March 31, 2018
Net income	$	49,322	$	45,630
Basic net income per share:
Weighted-average shares outstanding - basic	53,210		51,709
Net income per basic share	$	0.93	$	0.88
Diluted net income per share:
Weighted-average shares outstanding - basic	53,210		51,709
Diluted share equivalent: stock options, RSUs and PSUs	3,589		3,787
Weighted-average shares outstanding - diluted	56,799		55,496
Net income per diluted share	$	0.87	$	0.82

Supplemental Cash Flow Information

Supplemental cash flow information includes the following (in thousands):



	Three Months Ended
	March 30, 2019		March 31, 2018
Cash paid during the year for:
Interest	$	13	$	169
Income taxes	2,157		1,023
Operating lease payments included in the measurement of lease liabilities	1,748		—

Non-cash operating activities:
ROU assets obtained in exchange for lease liabilities⁽¹⁾	$	22,983	$	—

Non-cash investing activities:
Unpaid purchases of property, plant and equipment	$	1,127	$	1,492

Non-cash financing activities:
Unsettled common stock proceeds from option exercises	$	583	$	794

Reconciliation of cash, cash equivalents and restricted cash:
Cash and cash equivalents	$	412,861	$	369,498
Restricted cash	149		152
Total cash, cash equivalents and restricted cash shown in the statement of cash flow	$	413,010	$	369,650

______________


⁽¹⁾	In connection with its adoption of ASC 842 on December 30, 2018, the Company recorded a lessee operating lease ROU asset of $22.5 million. See “Recently Adopted Accounting Pronouncements” to these condensed consolidated financial statements for additional information related to the Company’s adoption of ASC 842.

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MASIMO CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

Recently Adopted Accounting Pronouncements

In February 2018, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2018-02, Income Statement - Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income (ASU 2018-02). The new standard allows a reclassification for certain stranded tax effects from accumulated other comprehensive income to retained earnings, and requires certain disclosures about stranded tax effects. ASU 2018-02 is effective for annual and interim periods beginning after December 15, 2018. The Company adopted this standard during the three months ended March 30, 2019 and such adoption did not have a material impact on its condensed consolidated financial statements.

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842) (ASU 2016-02). Subsequent to the issuance of ASU 2016-02, the FASB clarified the guidance through several ASUs. The collective guidance was codified by the FASB in ASC 842, which, among other things (i) requires the Company to recognize an ROU asset and a lease liability for all operating leases for which the Company is the lessee; (ii) changes the classification of certain embedded leases within the Company’s deferred equipment agreements with its customers from operating to sales-type leases, resulting in the acceleration of revenue under certain contracts, as well as the immediate expensing of certain costs that were previously deferred and expensed over the term of the lease; and (iii) requires disclosures by the Company as a lessor and lessee about the amount, timing and uncertainty of cash flows arising from its leases.

On December 30, 2018, the Company adopted ASC 842 using the modified retrospective method for all lease arrangements at the beginning of the period of adoption. Results for reporting periods beginning December 30, 2018 are presented under ASC 842, while prior period amounts were not adjusted and continue to be reported in accordance with the Company’s historic accounting under ASC 840, Leases. Adoption of this new accounting standard had a material impact on the Company’s condensed consolidated balance sheet as of March 30, 2019, but did not have a significant impact on the Company’s consolidated net earnings and cash flows for the three months ended March 30, 2019. For leases that commenced before the effective date of ASC 842, the Company did not elect any of the permitted practical expedients. However, the Company utilized a portfolio approach for purposes of determining the discount rate associated with certain equipment leases and made certain accounting policy elections not to separate lease and non-lease components for its real estate leases and to exclude short-term leases with a term of twelve months or less from its application of ASC 842.

In connection with its adoption of ASC 842, the Company recorded lessee operating lease ROU assets and lessee operating lease liabilities of $22.5 million as of December 30, 2018, primarily related to real estate and equipment leases, based on the present value of the future lease payments on such date. As a lessor, the Company also recorded customer lease receivables of $57.7 million, a reduction to equipment leased to customers (formerly titled deferred cost of goods sold) of $103.5 million, an increase to deferred tax assets of $8.6 million, a decrease to deferred revenue and contract-related liabilities of $13.4 million, an increase in other current liabilities of $3.0 million and a cumulative net decrease to retained earnings of $26.8 million, all related to the reclassification of certain embedded leases in existing deferred equipment agreements from operating to sales-type leases as of December 30, 2018. See Notes 6, 7 and 9 to these condensed consolidated financial statements for additional disclosures required by ASC 842.

Recently Issued Accounting Pronouncements

In August 2018, the FASB issued ASU 2018-15, Intangibles–Goodwill and Other–Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract (ASU 2018-15). The new standard 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 (and hosting arrangements that include an internal-use software license). ASU 2018-15 is effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2019. Early adoption is permitted, including adoption in an interim period. The Company does not expect this standard will have a material impact on its consolidated financial statements upon adoption.

In July 2018, the FASB issued ASU No. 2018-09, Codification Improvements (ASU 2018-09). This new standard amends, clarifies, corrects errors in and makes minor improvements to the ASC. The transition and effective date guidance is based on the facts and circumstances of each amendment. Some of the amendments of ASU 2018-09 do not require transition guidance and are effective upon issuance. The Company does not expect this standard will have a material impact on its consolidated financial statements.

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MASIMO CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (ASU 2016-13). In November 2018, the FASB clarified this guidance with ASU 2018-19, Codification Improvements to Topic 326, Financial Instruments - Credit Losses. The collective new guidance (ASC 326) generally requires entities to use a current expected credit loss model, which is a new impairment model based on expected losses rather than incurred losses. Under this model, an entity would recognize an impairment allowance equal to its current estimate of all contractual cash flows that the entity does not expect to collect. The entity’s estimate would consider relevant information about past events, current conditions, and reasonable and supportable forecasts. ASC 326 is effective for annual and interim fiscal reporting periods beginning after December 15, 2019, with early adoption permitted for annual reporting periods beginning after December 15, 2018. The Company is continuing to evaluate the expected impact of this ASC 326 but does not expect it to have a material impact on its consolidated financial statements upon adoption.

3. Related Party Transactions

The Company’s Chairman and CEO is also the Chairman and CEO of Cercacor. The Company is a party to the following agreements with Cercacor:

•

Cross-Licensing Agreement - The Company and Cercacor are parties to the Cross-Licensing Agreement, which governs each party’s rights to certain intellectual property held by the two companies. The Company is subject to certain annual minimum aggregate royalty obligations for use of the rainbow^® licensed technology. The current annual minimum royalty obligation is $5.0 million. Aggregate liabilities to Cercacor arising under the Cross-Licensing Agreement were $2.9 million and $2.5 million for the three months ended March 30, 2019 and March 31, 2018, respectively.

•

Administrative Services Agreement - The Company is a party to an administrative services agreement with Cercacor (G&A Services Agreement), which governs certain general and administrative services that the Company provides to Cercacor. Amounts charged by the Company pursuant to the G&A Services Agreement were less than $0.1 million for each of the three months ended March 30, 2019 and March 31, 2018.

•

Sublease Agreement - In March 2016, the Company entered into a sublease agreement with Cercacor for approximately 16,830 square feet of excess office and laboratory space located at 40 Parker, Irvine, California (Cercacor Sublease). The Cercacor Sublease began on May 1, 2016 and expires on November 30, 2019. The Company recognized less than $0.1 million in sublease income for each of the three months ended March 30, 2019 and March 31, 2018.

Net amounts due to Cercacor at each of March 30, 2019 and December 29, 2018 were $2.4 million and $2.9 million, respectively.

The Company’s CEO is also the Chairman of the Masimo Foundation for Ethics, Innovation and Competition in Healthcare (Masimo Foundation), a non-profit organization that was founded in 2010 to provide a platform for encouraging ethics, innovation and competition in healthcare. In addition, the Company’s Executive Vice President (EVP), General Counsel and Corporate Secretary and its EVP, Chief Financial Officer (CFO) are both directors and also serve as Secretary and Treasurer, respectively, of the Masimo Foundation.

The Company’s CEO is also the Chairman of both the Patient Safety Movement Foundation (PSMF), a non-profit organization which was founded in 2013 to work with hospitals, medical technology companies and patient advocates to unite the healthcare ecosystem and eliminate the more than 200,000 U.S. preventable hospital deaths that occur every year by 2020, and the Patient Safety Movement Coalition (PSMC), a not-for-profit social welfare organization that was founded in 2013 to promote patient safety legislation. The Company’s EVP, CFO also serves as the Treasurer of both PSMF and PSMC, and the Company’s EVP, General Counsel and Corporate Secretary also serves as the Secretary for PSMC.

The Company maintains an aircraft time share agreement, pursuant to which the Company has agreed from time to time to make its aircraft available to the Company’s CEO for lease on a time-sharing basis. The Company charges the Company’s CEO for personal use based on agreed upon reimbursement rates. For each of the three months ended March 30, 2019 and March 31, 2018, the Company charged the Company’s CEO less than $0.1 million related to such reimbursements.

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MASIMO CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

4. Inventories

Inventories consist of the following (in thousands):



	March 30, 2019		December 29, 2018
Raw materials	$	41,520	$	38,955
Work-in-process	10,677		9,036
Finished goods	41,062		46,741
Total inventories	$	93,259	$	94,732

5. Other Current Assets

Other current assets consist of the following (in thousands):



	March 30, 2019		December 29, 2018
Lease receivable, current	$	19,677	$	—
Prepaid expenses	11,957		10,582
Indirect taxes receivable	5,472		6,516
Customer notes receivable	3,402		3,780
Prepaid income taxes	452		3,071
Other current assets	5,395		5,278
Total other current assets	$	46,355	$	29,227

6. Lease Receivable

The Company adopted ASC 842, the new lease accounting standard, effective as of December 30, 2018. Among other things, the Company’s adoption of ASC 842 resulted in changes to the classification of certain embedded leases within its deferred equipment agreements from operating to sales-type leases. As a result, the Company now recognizes revenue and costs, as well as a lease receivable, at the time the lease commences pursuant to deferred equipment agreements containing embedded sales-type leases. Revenue and costs related to embedded leases within the Company’s deferred equipment agreements are included in product revenue and cost of goods sold, respectively. See “Recently Adopted Accounting Pronouncements” under Note 2 to these condensed consolidated financial statements for additional information related to the Company’s adoption of ASC 842.

Lease receivable consists of the following (in thousands):



	March 30, 2019
Lease receivable	$	61,161
Allowance for credit loss	(335		)
Lease receivable, net	60,826
Less: Current portion of lease receivable	(19,677		)
Lease receivable, noncurrent	$	41,149

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MASIMO CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

As of March 30, 2019, estimated future maturities of customer sales-type lease receivables for each of the following fiscal years are as follows (in thousands):



Fiscal year	Maturities of Customer Lease Receivables
2019 (balance of year)	$	16,617
2020	15,820
2021	9,838
2022	8,124
2023	5,196
Thereafter	5,231
Total	$	60,826

Estimated future operating lease payments expected to be received from customers under deferred equipment agreements are not material as of March 30, 2019.

7. Deferred Costs and Other Contract Assets

Contract-related assets consist of the following (in thousands):



	March 30, 2019		December 29, 2018
Prepaid contract incentives	$	6,487	$	7,036
Deferred commissions	5,158		5,085
Unbilled contract receivables	3,432		5,567
Equipment leased to customers, net⁽¹⁾	522		108,417
Total contract-related assets	$	15,599	$	126,105

______________

⁽¹⁾

Formerly titled “Deferred cost of goods sold”. In connection with its adoption of ASC 842 on December 30, 2018, the Company recorded a reduction to equipment leased to customers, net, of $103.5 million as a result of the reclassification of certain embedded leases within the Company’s deferred equipment agreements with its customers from operating to sales-type leases. See “Recently Adopted Accounting Pronouncements” to these condensed consolidated financial statements for additional information related to the Company’s adoption of ASC 842.

For the three months ended March 30, 2019 and March 31, 2018, $0.2 million and $7.3 million, respectively, of equipment leased to customers was amortized to cost of goods sold. As of March 30, 2019 and December 29, 2018, accumulated amortization of equipment leased to customers was $0.5 million and $103.1 million, respectively.

For the three months ended March 30, 2019 and March 31, 2018, $0.5 million and $0.4 million, respectively, of prepaid contract incentives was amortized as a reduction to revenue.

For the three months ended March 30, 2019 and March 31, 2018, $0.5 million and $0.6 million, respectively, of deferred commissions was amortized to selling, general and administrative expenses.

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MASIMO CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

8. Property and Equipment

Property and equipment, net, consists of the following (in thousands):



	March 30, 2019			December 29, 2018
Building and building improvements	$	90,974		$	88,449
Machinery and equipment	57,001			54,525
Aircraft and vehicles	25,555			25,555
Land	23,762			23,762
Computer equipment	18,334			16,582
Leasehold improvements	16,896			16,428
Tooling	14,465			14,212
Furniture and office equipment	10,558			10,459
Demonstration units	465			470
Construction-in-progress (CIP)	11,360			13,320
Total property and equipment	269,370			263,762
Accumulated depreciation and amortization	(102,082		)	(97,790		)
Property and equipment, net	$	167,288		$	165,972

For the three months ended March 30, 2019 and March 31, 2018, depreciation expense of property and equipment was $4.3 million and $4.0 million, respectively.

The balances in CIP at March 30, 2019 and December 29, 2018 related primarily to capitalized costs associated with the implementation of a new enterprise resource planning software system, capital improvements to various facilities and manufacturing equipment, the underlying assets for which have not been completed or placed into service.

9. Lessee ROU Assets and Lease Liabilities

The Company adopted ASC 842, the new lease accounting standard, effective as of December 30, 2018. Among other things, the Company’s adoption of ASC 842 resulted in: (a) the recognition of lessee ROU assets for the right to use assets subject to operating leases; and (b) the recognition of lessee lease liabilities for its obligation to make operating lease payments. See “Recently Adopted Accounting Pronouncements” under Note 2 to these condensed consolidated financial statements for additional information related to the Company’s adoption of ASC 842.

The Company leases certain facilities in North and South America, Europe, the Middle East and Asia-Pacific regions under operating lease agreements expiring at various dates through November 2026. In addition, the Company leases equipment in the U.S. and Europe that are classified as operating leases and expire at various dates through September 2023. The majority of these leases are non-cancellable and generally do not contain any material residual value guarantees or material restrictive covenants. The Company recognizes lease costs under these agreements using a straight-line method based on total lease payments. Certain facility leases contain predetermined price escalations and in some cases renewal options, the longest of which is for 5 years.

The Company generally estimates the applicable discount rate used to determine the net present value of lease payments based on available information at the lease commencement date. As of March 30, 2019, the weighted average discount rate used by the Company for all operating leases was approximately 3.8%.

Balance sheet classifications related to the Company’s operating leases for the period ended March 30, 2019 are as follows:



	Balance sheet classification	March 30, 2019
Lessee ROU assets	Other non-current assets	$	20,032

Lessee current lease liabilities	Other current liabilities	5,075
Lessee non-current lease liabilities	Other non-current liabilities	16,345
Total operating lease liabilities		$	21,420

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MASIMO CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

The weighted average remaining lease term for the Company’s operating leases was 8.2 years as of March 30, 2019.

As of March 30, 2019, estimated future operating lease payments for each of the following fiscal years were as follows (in thousands):



Fiscal year	Total Operating Leases
2019 (balance of year)	$	4,991
2020	4,130
2021	2,358
2022	1,663
2023	1,487
Thereafter⁽¹⁾	10,567
Total	25,196
Imputed Interest	(3,776		)
Present Value	$	21,420

______________

⁽¹⁾ Includes optional renewal period for certain leases.

As of December 29, 2018, the estimated future minimum lease payments, including interest, under operating leases for each of the following fiscal years ending on or about December 31 were as follows (in thousands):



Fiscal year	Total Operating Leases
2019	$	6,926
2020	4,422
2021	2,384
2022	1,701
2023	1,568
Thereafter⁽¹⁾	9,921
Total	$	26,922

______________

⁽¹⁾ Includes optional renewal period for certain leases.

Lease costs for the three months ended March 30, 2019 were as follows (in thousands):



	March 30, 2019
Operating lease costs	$	1,765
Short-term lease costs	9
Sublease income	(52		)
Total lease cost	$	1,722

For the three months ended March 31, 2018, rental expense related to operating leases was $1.8 million.

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MASIMO CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

10. Intangible Assets

Intangible assets, net, consist of the following (in thousands):



	March 30, 2019			December 29, 2018
Patents	$	21,889		$	21,323
Customer relationships	7,669			7,669
Licenses-related party	7,500			7,500
Acquired technology	5,580			5,580
Trademarks	4,273			4,190
Capitalized software development costs	3,436			3,430
Other	5,466			5,466
Total intangible assets	55,813			55,158
Accumulated amortization	(27,983		)	(27,234		)
Intangible assets, net	$	27,830		$	27,924

Total amortization expense for the three months ended March 30, 2019 and March 31, 2018 was $1.1 million and $1.2 million, respectively. All of these intangible assets have a 10 year weighted average amortization period.

Estimated amortization expense for each of the next fiscal years is as follows (in thousands):



Fiscal year	Amount
2019 (balance of year)	$	4,283
2020	3,805
2021	3,688
2022	2,636
2023	1,747
Thereafter	11,671
Total	$	27,830

11. Goodwill

Changes in goodwill during the three months ended March 30, 2019 were as follows (in thousands):



	Three Months Ended March 30, 2019
Goodwill, beginning of period	$	23,297
Adjustments to goodwill from finalization of purchase price allocation	(651		)
Foreign currency translation adjustment	(270		)
Goodwill, end of period	$	22,376

On September 21, 2018, the Company acquired all of the outstanding shares of a private patient monitoring software company for approximately $4.0 million. Based on the Company’s purchase price allocation, approximately $2.8 million of the purchase price has been assigned to goodwill, $0.7 million of which was recorded as an adjustment to the preliminary purchase price allocation to deferred tax assets based on additional information.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

12. Other Assets, Long-Term

Other assets, long-term consist of the following (in thousands):



	March 30, 2019		December 29, 2018
Lessee ROU assets	$	20,032	$	—
Prepaid deposits	2,992		2,881
Long term investments	1,200		1,200
Restricted cash	149		151
Total other assets, long-term	$	24,373	$	4,232

13. Deferred Revenue and Other Contract Liabilities

Deferred revenue and other contract liabilities consist of the following (in thousands):



	March 30, 2019			December 29, 2018
Deferred revenue⁽¹⁾	$	10,960		$	10,883
Accrued rebates and incentives	6,411			6,282
Accrued customer reimbursements⁽²⁾	4,951			16,194
Other contract-related liabilities	490			432
Total deferred revenue and other contract-related liabilities	22,812			33,791
Less: Non-current portion of deferred revenue	(135		)	(685		)
Deferred revenue and other contract-related liabilities - current	$	22,677		$	33,106

______________

⁽¹⁾

In connection with its adoption of ASC 842 on December 30, 2018, the Company recorded a reduction to deferred revenue of approximately $1.1 million due to the acceleration of revenue as a result of the reclassification of certain embedded leases within the Company’s deferred equipment agreements with its customers from operating to sales-type leases. See “Recently Adopted Accounting Pronouncements” to these condensed consolidated financial statements for additional information related to the Company’s adoption of ASC 842.

⁽²⁾

In connection with its adoption of ASC 842 on December 30, 2018, the Company recorded a reduction to accrued customer reimbursements of approximately $12.3 million related to the derecognition of liabilities and leased equipment assets related to certain OEM equipment reimbursements. See “Recently Adopted Accounting Pronouncements” to these condensed consolidated financial statements for additional information related to the Company’s adoption of ASC 842.

Deferred revenue relates to contracted amounts that have been invoiced to customers for which remaining performance obligations must be completed before the Company can recognize the revenue. These amounts primarily relate to undelivered equipment, sensors and services under deferred equipment agreements, extended warranty agreements and NRE service agreements.

Changes in deferred revenue for the three months ended March 30, 2019 were as follows:



	Three Months Ended March 30, 2019
Deferred revenue, beginning of the period	$	10,883
Revenue deferred during the period	1,573
Recognition of revenue deferred in prior periods	(1,496		)
Deferred revenue, end of the period	$	10,960

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MASIMO CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

Expected revenue from remaining contractual performance obligations (Unrecognized Contract Revenue) includes deferred revenue, as well as other amounts that will be invoiced and recognized as revenue in future periods, when the Company completes its performance obligations. While Unrecognized Contract Revenue is similar in concept to backlog, Unrecognized Contract Revenue excludes revenue allocable to monitoring-related equipment that is effectively leased to hospitals under deferred equipment agreements and other contractual obligations for which neither party has performed.

The following table summarizes the Company’s estimated Unrecognized Contract Revenue as of March 30, 2019 and the future periods within which the Company expects to recognize such revenue.



	Expected Future Revenue By Period (in thousands)
	Less than 1 year		Between 1-3 years		Between 3-5 years		More than 5 years		Total
Unrecognized Contract Revenue	$	192,795	$	274,663	$	120,599	$	26,109	$	614,166

The estimated timing of this revenue is based, in part, on management’s estimates and assumptions about when its performance obligations will be completed. As a result, the actual timing of this revenue in future periods may vary, possibly materially, from those reflected in this table.

14. Other Current Liabilities

Other current liabilities consist of the following (in thousands):



	March 30, 2019		December 29, 2018
Income tax payable	$	8,629	$	3,071
Lessee lease liabilities, current	5,075		—
Accrued warranty	4,553		1,910
Accrued indirect taxes payable	4,234		6,465
Accrued expenses	4,227		2,875
Related party payables	2,436		4,000
Accrued customer rebates, fees and reimbursements	2,205		2,163
Accrued legal fees	1,508		1,481
Other	2,603		2,662
Total accrued and other current liabilities	$	35,470	$	24,627

15. Credit Facilities

On December 17, 2018, the Company entered into a new Credit Agreement (the 2018 Credit Facility) with JPMorgan Chase Bank, N.A., as Administrative Agent and a Lender, and Bank of the West, a Lender (collectively, the Lenders). The 2018 Credit Facility provides for up to $150.0 million of unsecured borrowings in multiple currencies, with an option, subject to certain conditions, for the Company to increase the aggregate borrowing capacity up to $550.0 million in the future with the initial Lenders and additional Lenders, as required. The 2018 Credit Facility also provides for a sublimit of up to $25.0 million for the issuance of letters of credit and a sublimit of $75.0 million for borrowings in specified foreign currencies. All unpaid principal under the 2018 Credit Facility will become due and payable on December 17, 2023. Proceeds from the 2018 Credit Facility are expected to be used for general corporate, capital investment and working capital needs.

Borrowings under the 2018 Credit Facility will be deemed, at the Company’s election, either: (a) an Alternate Base Rate (ABR) Loan, which bears interest at the ABR, plus a spread of 0.125% to 1.000% based upon a Company leverage ratio, or (b) a Eurocurrency Loan, which bears interest at the Adjusted LIBO Rate (as defined below), plus a spread of 1.125% to 2.000% based upon a Company net leverage ratio. Subject to certain conditions, the Company may also request swingline loans from time to time that bear interest similar to an ABR Loan. Pursuant to the terms of the 2018 Credit Facility, the ABR is equal to the greatest of (i) the prime rate, (ii) the Federal Reserve Bank of New York effective rate plus 0.50%, and (iii) the one-month Adjusted LIBO Rate plus 1.0%. The Adjusted LIBO Rate is equal to the Eurocurrency Rate (as defined within the 2018 Credit Facility) for the applicable interest period multiplied by the statutory reserve rate for such period, rounded upward, if necessary, to the next 1/16 of 1%. The Company is also obligated under the 2018 Credit Facility to pay an unused fee ranging from

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

0.150% to 0.275% per annum, based upon a Company leverage ratio, with respect to any unutilized portion of the 2018 Credit Facility.

Pursuant to the terms of the 2018 Credit Facility, the Company is subject to certain covenants, including financial covenants related to a net leverage ratio and an interest charge coverage ratio, and other customary negative covenants. The 2018 Credit Facility also includes customary events of default which, upon the occurrence of any such event of default, provide the Lenders with the right to take either or both of the following actions: (a) immediately terminate the commitments, and (b) declare the loans then outstanding immediately due and payable in full. As of March 30, 2019, the 2018 Credit Facility had no outstanding draws and $0.1 million of outstanding letters of credit. The Company was in compliance with all covenants under the 2018 Credit Facility as of March 30, 2019.

In January 2016, the Company entered into an Amended and Restated Credit Agreement (Restated Credit Facility) with JPMorgan Chase Bank, N.A., as Administrative Agent and a Lender, Bank of America, as Syndication Agent and a Lender, Citibank, N.A., as Documentation Agent and a Lender, and various other Lenders (collectively, the Lenders). The Company terminated the Restated Credit Facility in February 2018.

For the three months ended March 30, 2019 and March 31, 2018, the Company incurred total interest expense of $0.1 million and $0.6 million, respectively, under the 2018 Credit Facility and Restated Credit Facility.

16. Other Non-Current Liabilities

Other non-current liabilities consist of the following (in thousands):



	March 30, 2019		December 29, 2018
Income tax payable, noncurrent	$	21,522	$	21,522
Lessee lease liabilities, noncurrent	16,345		—
Unrecognized tax benefits	12,190		11,717
Deferred tax liabilities	2,921		2,956
Deferred revenue, noncurrent	135		685
Other	30		1,266
Total other non-current liabilities	$	53,143	$	38,146

Unrecognized tax benefit relates to the Company’s long-term portion of tax liability associated with uncertain tax positions. Authoritative guidance prescribes a recognition threshold and a measurement attribute for the financial statement recognition and measurement of tax positions taken or expected to be taken in a tax return. See Note 20 to these condensed consolidated financial statements for further details.

17. Stock Repurchase Program

In September 2015, the Company’s Board of Directors (Board) authorized a stock repurchase program, whereby the Company could purchase up to 5.0 million shares of its common stock over a period of up to three years (2015 Repurchase Program). A total of 3.1 million shares were purchased by the Company pursuant to the 2015 Repurchase Program prior to its expiration in September 2018.

In July 2018, the Board approved a new stock repurchase program, authorizing the Company to purchase up to 5.0 million additional shares of its common stock over a period of up to three years (2018 Repurchase Program). The 2018 Repurchase Program became effective in September 2018 upon the expiration of the 2015 Repurchase Program. The Company expects to fund the 2018 Repurchase Program through its available cash, cash expected to be generated from future operations, the 2018 Credit Facility and other potential sources of capital. The 2018 Repurchase Program can be carried out at the discretion of a committee comprised of the Company’s CEO and CFO through open market purchases, one or more Rule 10b5-1 trading plans, block trades and privately negotiated transactions.

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MASIMO CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

The following table provides a summary of the Company’s stock repurchase activities during the three months ended March 30, 2019 and March 31, 2018 (in thousands, except per share amounts):



	Three Months Ended
	March 30, 2019		March 31, 2018
Shares repurchased⁽¹⁾	—		198
Average cost per share	$	—	$	84.14
Value of shares repurchased	$	—	$	16,490

______________


⁽¹⁾	Excludes shares withheld from the shares of its common stock actually issued in connection the vesting of PSU awards to satisfy certain U.S. federal and state tax withholding obligations.

18. Stock-Based Compensation

Total stock-based compensation expense for the three months ended March 30, 2019 and March 31, 2018 was $7.3 million and $5.3 million, respectively. As of March 30, 2019, an aggregate of 11.5 million shares of common stock were reserved for future issuance under the Company’s equity plans, of which 2.6 million shares were available for future grant under the Masimo Corporation 2017 Equity Incentive Plan (2017 Equity Plan). Additional information related to the Company’s current equity incentive plans, stock-based award activity and valuation of stock-based awards is included below.

Equity Incentive Plans

2017 Equity Incentive Plan

On June 1, 2017, the Company’s stockholders ratified and approved the 2017 Equity Plan. The 2017 Equity Plan permits the grant of stock options, restricted stock, RSUs, stock appreciation rights, PSUs, performance shares, performance bonus awards and other stock or cash awards to employees, directors and consultants of the Company and employees and consultants of any parent or subsidiary of the Company. The aggregate number of shares that may be awarded under the 2017 Equity Plan is 5.0 million shares.

The 2017 Equity Plan provides that at least 95% of the equity awards issued under the 2017 Equity Plan must vest over a period of not less than one year following the date of grant. The exercise price per share of each option granted under the 2017 Equity Plan may not be less than the fair market value of a share of the Company’s common stock on the date of grant, which is generally equal to the closing price of the Company’s common stock on the Nasdaq Global Select Market on the grant date.

2007 Stock Incentive Plan

Effective June 1, 2017, upon the approval and ratification of the 2017 Equity Plan, the Company’s 2007 Stock Incentive Plan (2007 Equity Plan) terminated, provided that awards outstanding under the 2007 Equity Plan will continue to be governed by the terms of that plan. In addition, upon the effectiveness of the 2017 Equity Plan, an aggregate of 5.0 million shares of the Company’s common stock registered under prior registration statements for issuance pursuant to the 2007 Equity Plan were deregistered and concurrently registered under the 2017 Equity Plan.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

Stock-Based Award Activity

Stock Options

The number and weighted-average exercise price of options issued and outstanding under all of the Company’s equity plans are as follows (in thousands, except for exercise prices):



	Three Months Ended March 30, 2019
	Shares		Average Exercise Price
Options outstanding, beginning of period	5,676		$	43.61
Granted	227		131.78
Canceled	(44	)	101.29
Exercised	(224	)	30.70
Options outstanding, end of period	5,635		$	47.22
Options exercisable, end of period	3,475		$	30.97

Total stock option expense for the three months ended March 30, 2019 and March 31, 2018 was $3.5 million and $3.4 million, respectively. As of March 30, 2019, the Company had $43.6 million of unrecognized compensation cost related to non-vested stock options that are expected to vest over a weighted average period of approximately 3.6 years. The weighted-average remaining contractual term of options outstanding with an exercise price less than the closing price of the Company’s common stock as of March 30, 2019 was 6.0 years. The weighted-average remaining contractual term of options exercisable, with an exercise price less than the closing price of the Company’s common stock as of March 30, 2019, was 4.7 years.

RSUs

The number of RSUs issued and outstanding under all of the Company’s equity plans are as follows (in thousands, except for weighted average grant date fair value amounts):



	Three Months Ended March 30, 2019
	Units	Weighted Average Grant Date Fair Value
RSUs outstanding, beginning of period	2,707	$	95.54
Granted	88	132.76
Canceled	—	—
Expired	—	—
Vested	—	—
RSUs outstanding, end of period	2,795	$	96.72

Total RSU expense for each of the three months ended March 30, 2019 and March 31, 2018 was $0.2 million. As of March 30, 2019, the Company had $10.7 million of unrecognized compensation cost related to non-vested RSU awards expected to be recognized and vest over a weighted-average period of approximately 4.9 years.

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MASIMO CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

PSUs

The number of PSUs outstanding under all of the Company’s equity plans are as follows (in thousands, except for weighted average grant date fair value amounts):



	Three Months Ended March 30, 2019
	Units		Weighted Average Grant Date Fair Value
PSUs outstanding, beginning of period	313		$	88.34
Granted	128		133.50
Canceled	—		—
Expired	—		—
Vested	(29	)	90.69
PSUs outstanding, end of period	412		$	102.22

During the three months ended March 30, 2019, the Company awarded 128,000 PSUs that will vest three years from the award date, based on the achievement of certain 2021 performance criteria approved by the Board. If earned, the PSUs granted will vest upon achievement of the performance criteria after the year in which the performance achievement level has been determined. The number of shares that may be earned can range from 0% to 200% of the target amount; therefore, the maximum number of shares that can be issued under these awards is twice the original award of 128,000 PSUs or 256,000 shares. Based on management’s estimate of the number of units expected to vest, total PSU expense for the three months ended March 30, 2019 and March 31, 2018 was $3.6 million and $1.7 million, respectively. As of March 30, 2019, the Company had $55.2 million of unrecognized compensation cost related to non-vested PSU awards expected to be recognized and vest over a weighted-average period of approximately 2.5 years.

Valuation of Stock-Based Award Activity

The Black-Scholes option pricing model is used to estimate the fair value of options granted under the Company’s stock-based compensation plans. The range of assumptions used and the resulting weighted-average fair value of options granted at the date of grant were as follows:



	Three Months Ended
	March 30, 2019	March 31, 2018
Risk-free interest rate	2.2% to 2.6%	2.3% to 2.7%
Expected term (in years)	5.2	5.6
Estimated volatility	29.3% to 30.0%	29.3% to 29.7%
Expected dividends	0%	0%
Weighted-average fair value of options granted	$41.01	$28.53

The aggregate intrinsic value of options is calculated as the positive difference, if any, between the market value of the Company’s common stock on the date of exercise or the respective period end, as appropriate, and the exercise price of the options. The aggregate intrinsic value of options outstanding with an exercise price less than the closing price of the Company’s common stock as of March 30, 2019 was $513.1 million. The aggregate intrinsic value of options exercisable with an exercise price less than the closing price of the Company’s common stock as of March 30, 2019 was $372.9 million. The aggregate intrinsic value of options exercised during the three months ended March 30, 2019 was $21.7 million.

The fair value of each RSU and PSU award is determined based on the closing price of the Company’s common stock on the grant date, or the modification date, if any.

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MASIMO CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

19. Non-operating income

Non-operating income consists of the following (in thousands):



	March 30, 2019			March 31, 2018
Interest income	$	3,433		$	1,133
Realized and unrealized foreign currency gain	534			1,113
Interest expense	(80		)	(627		)
Other	(1		)	28
Total	$	3,886		$	1,647

20. Income Taxes

The Company has provided for income taxes in fiscal year 2019 interim periods based on the estimated effective income tax rate for the complete fiscal year and adjusted for discrete tax events, including excess tax benefits or deficiencies related to stock-based compensation, in the period such events occur. The estimated annual effective tax rate is computed based on the expected annual pretax income of the consolidated entities located within each taxing jurisdiction based on legislation enacted as of the balance sheet date. For the three months ended March 30, 2019 and March 31, 2018, the Company recorded discrete tax benefits of approximately $3.4 million and $3.1 million, respectively, related to excess tax benefits realized from stock-based compensation.

Deferred tax assets and liabilities are determined based on the future tax consequences associated with temporary differences between income and expenses reported for accounting and tax purposes. A valuation allowance for deferred tax assets is recorded to the extent that the Company cannot determine that the ultimate realization of the net deferred tax assets is more likely than not. Realization of deferred tax assets is principally dependent upon the achievement of future taxable income, the estimation of which requires significant judgment by the Company’s management. The judgment of the Company’s management regarding future profitability may change due to many factors, including future market conditions and the Company’s ability to successfully execute its business plans or tax planning strategies. These changes, if any, may require material adjustments to these deferred tax asset balances.

As of March 30, 2019, the liability for income taxes associated with uncertain tax positions was approximately $15.8 million. If fully recognized, approximately $14.6 million (net of federal benefit on state taxes) would impact the Company’s effective tax rate. It is reasonably possible that the amount of unrecognized tax benefits in various jurisdictions may change in the next twelve months due to the expiration of statutes of limitation and audit settlements. However, due to the uncertainty surrounding the timing of these events, an estimate of the change within the next twelve months cannot currently be made.

The Company conducts business in multiple jurisdictions and, as a result, one or more of the Company’s subsidiaries files income tax returns in U.S. federal, various state, local and foreign jurisdictions. The Company has concluded all U.S. federal income tax matters through fiscal year 2014. All material state, local and foreign income tax matters have been concluded through fiscal year 2011. The Company does not believe that the results of any tax authority examination would have a significant impact on its consolidated financial statements.

21. Commitments and Contingencies

Employee Retirement Savings Plan

The Company sponsors a qualified defined contribution plan or 401(k) plan, the Masimo Retirement Savings Plan (MRSP), covering the Company’s full-time U.S. employees who meet certain eligibility requirements. In general, the Company matches an employee’s contribution up to 3% of the employee’s compensation, subject to a maximum amount. The Company may also contribute to the MRSP on a discretionary basis. The Company contributed $0.5 million and $0.7 million to the MRSP for the three months ended March 30, 2019 and March 31, 2018, respectively.

In addition, the Company also sponsors various defined contribution plans in certain locations outside of the United States (Subsidiary Plans). For each of the three months ended March 30, 2019 and March 31, 2018, the Company contributed $0.1 million to the Subsidiary Plans.

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MASIMO CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

Employment and Severance Agreements

In July 2017, the Company entered into the First Amendment to the certain Amended and Restated Employment Agreement entered into between the Company and Mr. Kiani on November 4, 2015 (as amended, the Amended Employment Agreement). Pursuant to the terms of the Amended Employment Agreement, upon a “Qualifying Termination” (as defined in the Amended Employment Agreement), Mr. Kiani will be entitled to receive a cash severance benefit equal to two times the sum of his then-current base salary and the average annual bonus paid to Mr. Kiani during the immediately preceding three years, the full amount of the Award Shares and the full amount of the Cash Payment. In addition, in the event of a “Change in Control” (as defined in the Amended Employment Agreement) prior to a Qualifying Termination, on each of the first and second anniversaries of the Change in Control, 50% of the Cash Payment and 50% of the Award Shares will vest, subject in each case to Mr. Kiani’s continuous employment through each such anniversary date; however, in the event of a Qualifying Termination or a termination of Mr. Kiani’s employment due to death or disability prior to either of such anniversaries, any unvested amount of the Cash Payment and all of the unvested Award Shares shall vest and be paid in full. Additionally, in the event of a Change in Control prior to a Qualifying Termination, Mr. Kiani’s stock options and any other equity awards will vest in accordance with their terms, but in no event later than in two equal installments on each of the one year and two year anniversaries of the Change in Control, subject in each case to Mr. Kiani’s continuous employment through each such anniversary date. As of March 30, 2019, the expense related to the Award Shares and Cash Payment that would be recognized in the Company’s consolidated financial statements upon the occurrence of a Qualifying Termination under the Restated Employment Agreement was approximately $292.9 million.

As of March 30, 2019, the Company had severance plan participation agreements with eight executive officers. The participation agreements (the Agreements) are governed by the terms and conditions of the Company’s 2007 Severance Protection Plan (the Severance Plan), which became effective on July 19, 2007 and which was amended effective December 31, 2008. Under each of the Agreements, the applicable executive officer may be entitled to receive certain salary, equity, medical and life insurance benefits if he is terminated by the Company without cause or if he terminates his employment for good reason under certain circumstances. The executive officers are also required to give the Company six months’ advance notice of their resignation under certain circumstances.

Purchase Commitments

Pursuant to contractual obligations with vendors, the Company had $87.3 million of purchase commitments as of March 30, 2019, which are expected to be purchased within one year. These purchase commitments have been made for certain inventory items in order to secure sufficient levels of those items and to achieve better pricing.

Other Contractual Commitments

In the normal course of business, the Company may provide bank guarantees to support government hospital tenders in certain foreign jurisdictions. As of March 30, 2019, the Company had approximately $1.0 million in outstanding unsecured bank guarantees.

In certain circumstances, the Company also provides limited indemnification within its various customer contracts whereby the Company indemnifies the parties to whom it sells its products with respect to potential infringement of intellectual property, and against bodily injury caused by a defective Company product. It is not possible to predict the maximum potential amount of future payments under these or similar agreements, due to the conditional nature of the Company’s obligations and the unique facts and circumstances involved. As of March 30, 2019, the Company had not incurred any significant costs related to contractual indemnification of its customers.

Concentrations of Risk

The Company is exposed to credit loss for the amount of its cash deposits with financial institutions in excess of federally insured limits. The Company invests its excess cash in time deposits with major financial institutions. As of March 30, 2019, the Company had $412.9 million of bank balances, of which $3.5 million was covered by either the U.S. Federal Deposit Insurance Corporation limit or foreign countries’ deposit insurance organizations.

While the Company and its contract manufacturers rely on sole source suppliers for certain components, steps have been taken to minimize the impact of a shortage or stoppage of shipments, such as maintaining a safety stock of inventory and designing products that could be modified to use different components. However, there can be no assurance that a shortage or stoppage of shipments of the materials or components that the Company purchases will not result in a delay in production or adversely affect the Company’s business.

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MASIMO CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

The Company’s ability to sell its products to U.S. hospitals depends in part on its relationships with GPOs. Many existing and potential customers for the Company’s products become members of GPOs. GPOs negotiate pricing arrangements and contracts, sometimes exclusively, with medical supply manufacturers and distributors, and these negotiated prices are made available to a GPO’s affiliated hospitals and other members. During the three months ended March 30, 2019 and March 31, 2018, revenue from the sale of the Company’s products to U.S. hospitals that are members of GPOs amounted to $129.7 million and $118.9 million, respectively.

For the three months ended March 30, 2019, the Company had sales through two just-in-time distributors that represented 13.6% and 10.3% of total revenue, respectively. For the three months ended March 31, 2018, the Company had sales through the same two just-in-time distributors that represented 13.6% and 10.7% of total revenue, respectively.

As of March 30, 2019, one just-in-time distributor represented 6.5% of the Company’s accounts receivable balance. As of December 29, 2018, one just-in-time distributor represented 6.7% of the Company’s accounts receivable balance.

Litigation

During the third quarter of fiscal year 2017, the Company became aware that certain amounts had been paid by a foreign government customer to the Company’s former appointed foreign agent in connection with a foreign government tender, but had not been remitted by such agent to the Company in accordance with the agency agreement. On December 28, 2017, the Company initiated arbitration proceedings against this foreign agent after unsuccessful attempts to recover such remittances. As a result, the Company recorded a net charge of approximately $10.5 million during the fourth quarter of fiscal year 2017 in connection with this dispute, of which $2.0 million was recovered during the year ended December 29, 2018. An arbitration hearing was held on February 11, 2019. The parties are awaiting the arbitration decision. Although the Company intends to vigorously pursue collection of the remaining amounts owed by the foreign agent, there is no guarantee that the Company will be successful in these efforts.

On January 2, 2014, a putative class action complaint was filed against the Company in the U.S. District Court for the Central District of California by Physicians Healthsource, Inc. (PHI). The complaint alleges that the Company sent unsolicited facsimile advertisements in violation of the Junk Fax Protection Act of 2005 and related regulations. The complaint seeks $500 for each alleged violation, treble damages if the District Court finds the alleged violations to be knowing, plus interest, costs and injunctive relief. On April 14, 2014, the Company filed a motion to stay the case pending a decision on a related petition filed by the Company with the Federal Communications Commission (FCC). On May 22, 2014, the District Court granted the motion and stayed the case pending a ruling by the FCC on the petition. On October 30, 2014, the FCC granted some of the relief and denied some of the relief requested in the Company’s petition. Both parties appealed the FCC’s decision on the petition. On November 25, 2014, the District Court granted the parties’ joint request that the stay remain in place pending a decision on the appeal. On March 31, 2017, the D.C. Circuit Court of Appeals vacated and remanded the FCC’s decision, holding that the applicable FCC rule was unlawful to the extent it requires opt-out notices on solicited faxes. On April 28, 2017, PHI filed a petition seeking rehearing by the D.C. Circuit Court of Appeals. The D.C. Circuit Court of Appeals denied the requested rehearing on June 6, 2017. The plaintiff filed a petition for a writ of certiorari with the United States Supreme Court on September 5, 2017 seeking review of the D.C. Circuit Court of Appeals’ decision. The Company and the FCC filed oppositions to this petition on January 16, 2018. On February 20, 2018, the Supreme Court denied certiorari. The District Court lifted the stay on April 9, 2018 and set a trial date of November 5, 2019. The current deadline for PHI to file its motion for class certification is May 20, 2019. The Company believes it has good and substantial defenses to the claims in the District Court litigation, but there is no guarantee that the Company will prevail. The Company is unable to determine whether any loss will ultimately occur or to estimate the range of such loss; therefore, no amount of loss has been accrued by the Company in the accompanying condensed consolidated financial statements.

From time to time, the Company may be involved in other litigation and investigations relating to claims and matters arising out of its operations in the normal course of business. The Company believes that it currently is not a party to any other legal proceedings which, individually or in the aggregate, would have a material adverse effect on its consolidated financial position, results of operations or cash flows.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

22. Segment Information and Enterprise Reporting

The Company’s chief operating decision maker, the CEO, reviews financial information presented on a consolidated basis, accompanied by disaggregated information about revenues by geographic region, for purposes of making operating decisions and assessing financial performance. Accordingly, the Company considers itself to be in a single reporting segment, specifically noninvasive patient monitoring solutions and related products. The Company does not assess the performance of its geographic regions on other measures of income or expense, such as depreciation and amortization, operating income or net income. In addition, the Company’s assets are primarily located in the U.S. The Company does not produce reports for, or measure the performance of, its geographic regions on any asset-based metrics. Therefore, geographic information is presented only for revenues and long-lived assets.

The following schedule presents an analysis of the Company’s product revenues based upon the geographic area to which the product was shipped (in thousands, except percentages):



	Three Months Ended
	March 30, 2019				March 31, 2018
Geographic area by destination:
United States (U.S.)	$	156,668	68.0	%	$	141,040	69.0	%
Europe, Middle East and Africa	48,472		21.0		44,037		21.6
Asia and Australia	18,118		7.9		12,915		6.3
North and South America (excluding the U.S.)	7,290		3.1		6,397		3.1
Total product revenue	$	230,548	100.0	%	$	204,389	100.0	%

The Company’s consolidated long-lived assets (total non-current assets excluding deferred taxes, goodwill and intangible assets) by geographic area are (in thousands, except percentages):



	March 30, 2019				December 29, 2018
Long-lived assets by geographic area:
United States	$	229,088	92.2	%	$	280,215	94.6	%
International	19,321		7.8		16,094		5.4
Total	$	248,409	100.0	%	$	296,309	100.0	%

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

This Quarterly Report on Form 10-Q contains “forward-looking statements” as defined in Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, in connection with the Private Securities Litigation Reform Act of 1995 that involve risks and uncertainties, as well as assumptions that, if they never materialize or prove incorrect, could cause our results to differ materially and adversely from those expressed or implied by such forward-looking statements. Such forward-looking statements include any expectation of earnings, revenues or other financial items; any statements of the plans, strategies and objectives of management for future operations; factors that may affect our operating results or financial condition; statements concerning new products, technologies or services; statements related to future capital expenditures; statements related to future economic conditions or performance; statements related to our stock repurchase programs; statements as to industry trends and other matters that do not relate strictly to historical facts or statements of assumptions underlying any of the foregoing. These statements are often identified by the use of words such as “anticipate,” “believe,” “continue,” “could,” “estimate,” “expect,” “intend,” “may” or “will,” the negative versions of these terms and similar expressions or variations. These statements are based on the beliefs and assumptions of our management based on information currently available to management. Such forward-looking statements are subject to risks, uncertainties and other factors that could cause actual results and the timing of certain events to differ materially and adversely from future results expressed or implied by such forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those identified below, and those discussed in the section titled “Risk Factors” included elsewhere in this Quarterly Report on Form 10-Q and in our other Securities and Exchange Commission (SEC) filings, including our Annual Report on Form 10-K for the fiscal year ended December 29, 2018, which we filed with the SEC on February 26, 2019. Furthermore, such forward-looking statements speak only as of the date of this report. We undertake no obligation to update any forward-looking statements to reflect events or circumstances occurring after the date of such statements.

Executive Overview

We are a global medical technology company that develops, manufactures and markets a variety of noninvasive monitoring technologies and hospital automation solutions. Our mission is to improve patient outcomes and reduce the cost of care. We provide our products directly and through distributors and original equipment manufacturers (OEM) partners to hospitals, emergency medical service (EMS) providers, home care providers, long-term care facilities, physician offices, veterinarians and consumers. We were incorporated in California in May 1989 and reincorporated in Delaware in May 1996.

Our core business is Measure-through Motion and Low Perfusion^™ pulse oximetry, known as Masimo Signal Extraction Technology^® (SET^®) pulse oximetry. Our product offerings have expanded significantly over the years to also include noninvasive monitoring of blood constituents with an optical signature, optical regional oximetry monitoring, electrical brain function monitoring, acoustic respiration monitoring and exhaled gas monitoring. In addition, we have developed the Root^™ patient monitoring and connectivity platform, the Radical-7^® and Rad-97^™ bedside and portable patient monitors and the Radius-7^®wearable wireless patient monitor. We have also developed the Masimo Patient SafetyNet supplemental remote patient surveillance and monitoring system, which currently allows up to 200 patients to be monitored and viewed simultaneously and remotely through a PC-based monitor or by care providers through their pagers, voice-over-IP phones or smartphones. We have also developed hospital automation and connectivity solutions, such as Iris^® and Iris Gateway^®, which allow the transfer of data from Masimo and third-party devices to hospital electronic medical records, and UniView^™, which provides an integrated display of real-time data from Masimo and third-party devices. For an overview of our product offerings and technologies, please refer to “Business” in Part I, Item 1 of our Annual Report on Form 10-K for the fiscal year ended December 29, 2018, filed with the SEC on February 26, 2019.

Our solutions and related products are based upon our proprietary Masimo SET^® and rainbow^® algorithms. These technologies are incorporated into a variety of product platforms designed to meet our customers’ needs. In addition, we provide our technologies to OEMs in a form factor that is easy to integrate into their patient monitors, defibrillators, infant incubators and other devices.

Our technology is supported by a substantial intellectual property portfolio that we have built through internal development and, to a lesser extent, acquisitions and license agreements. We have also exclusively licensed from Cercacor Laboratories, Inc. (Cercacor) the right to certain OEM rainbow^® technologies and to incorporate certain rainbow^® technology into our products intended to be used by professional caregivers, including, but not limited to, hospital caregivers and alternate care facility caregivers.

In January 2019, we announced the U.S. launch of Iris^® Device Management System (Iris DMS), an automation and connectivity solution designed to streamline management of Masimo devices used throughout a hospital system. Iris DMS is designed to address the challenges of maintaining many patient monitors in a complex hospital environment.

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In January 2019, we announced FDA 510(k) clearance of the measurement of respiration rate from the pleth (RRp^®) on the MightySat^® Rx spot-check fingertip pulse oximeter, as well as its indication for use in the home environment. MightySat^® Rx also measures functional oxygen saturation (SpO₂), pulse rate (PR), perfusion index (Pi), and Pleth Variability index (PVi^®).

In March 2019, we announced the CE marking of Next Generation SedLine^® brain function monitoring for pediatric patients (1-18 years of age). With this clearance, the benefits of Next Generation SedlLine^® are available for all patients one year old and above in CE mark countries. SedLine^® helps clinicians monitor the state of the brain under anesthesia with bilateral data acquisition and processing of four leads of electroencephalogram (EEG) signals.

In March 2019, we announced FDA 510(k) clearance of the Rad-67^™ Pulse CO-Oximeter^® with Spot-check Next Generation SpHb^® monitoring technology and the rainbow^® DCI^®-mini Reusable sensor. Rad-67^™ offers rainbow^® noninvasive hemoglobin measurement (SpHb^®) and Measure-through Motion and Low Perfusion^™ SET^® pulse oximetry in a compact, portable spot-check monitoring device. When used with the rainbow^® DCI^®-mini sensor, Rad-67^™ provides spot-check monitoring with Next Generation SpHb^®.

Cercacor Laboratories, Inc.

Cercacor Laboratories, Inc. (Cercacor) is an independent entity spun off from us to our stockholders in 1998. Joe Kiani, our Chairman and Chief Executive Officer (CEO), is also the Chairman and CEO of Cercacor. We are a party to a cross-licensing agreement with Cercacor, which was amended and restated effective January 1, 2007 (the Cross-Licensing Agreement), which governs each party’s rights to certain intellectual property held by the two companies. See Note 3 to our accompanying condensed consolidated financial statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q for additional information related to Cercacor.

Adoption of New Lease Accounting Standard

Effective December 30, 2018, we adopted Accounting Standards Codification (ASC) Topic 842, Leases (ASC 842). Our adoption of ASC 842 generally resulted in (a) the recognition of lessee right-of-use (ROU) assets for the right to use assets subject to operating leases; (b) the recognition of lessee lease liabilities for our obligation to make payments under operating leases; and (c) the acceleration of when we recognize certain revenue and costs as a lessor of equipment provided to end-user hospitals at no up-front charge under deferred equipment agreements with fixed multi-year sensor purchase commitments. See “Critical Accounting Policies and Estimates” below and Note 2 to our accompanying condensed consolidated financial statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q for additional information related to our adoption of this new accounting standard.

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Results of Operations

The following table sets forth, for the periods indicated, our unaudited results of operations expressed as dollar amounts and as a percentage of total revenues (in thousands, except percentages). Certain amounts for prior periods have been reclassified to conform to the current period presentation, including certain previously reported selling, general and administrative expenses that have been reclassified as research and development expenses for the three months ended March 31, 2018.



	Three Months Ended
	March 30, 2019		Percentage of Revenue		March 31, 2018		Percentage of Revenue
Revenue:
Product	$	230,548	99.5	%	$	204,389	96.0	%
Royalty and other revenue	1,116		0.5		8,564		4.0
Total revenue	231,664		100.0		212,953		100.0
Cost of goods sold	80,022		34.5		69,292		32.5
Gross profit	151,642		65.5		143,661		67.5
Operating expenses:
Selling, general and administrative	74,204		32.0		70,217		33.0
Research and development	21,415		9.2		19,559		9.2
Total operating expenses	95,619		41.3		89,776		42.2
Operating income	56,023		24.2		53,885		25.3
Non-operating income	3,886		1.7		1,647		0.8
Income before provision for income taxes	59,909		25.9		55,532		26.1
Provision for income taxes	10,587		4.6		9,902		4.6
Net income	$	49,322	21.3	%	$	45,630	21.4	%

Comparison of the Three Months ended March 30, 2019 to the Three Months ended March 31, 2018

Revenue. Total revenue increased $18.7 million, or 8.8%, to $231.7 million for the three months ended March 30, 2019 from $213.0 million for the three months ended March 31, 2018. The following table details our total product revenues by the geographic area to which the products were shipped for each of the three months ended March 30, 2019 and March 31, 2018 (dollars in thousands):



	Three Months Ended
	March 30, 2019				March 31, 2018				Increase/ (Decrease)		Percentage Change
United States (U.S.)	$	156,668	68.0	%	$	141,040	69.0	%	$	15,628	11.1	%
Europe, Middle East and Africa	48,472		21.0		44,037		21.6		4,435		10.1
Asia and Australia	18,118		7.9		12,915		6.3		5,203		40.3
North and South America (excluding the U.S.)	7,290		3.1

Closing Price ($)	Shares Out (MM)	Market Cap ($MM)
$140.23	53	$7,480

10-Q	2019-03-30	Quarter: 2019-03-30
10-K	2018-12-29	Annual: 2018-12-29
10-Q	2018-09-29	Quarter: 2018-09-29
10-Q	2018-06-30	Quarter: 2018-06-30
10-Q	2018-03-31	Quarter: 2018-03-31
10-K	2017-12-30	Annual: 2017-12-30
10-Q	2017-09-30	Quarter: 2017-09-30
10-Q	2017-07-01	Quarter: 2017-07-01
10-Q	2017-04-01	Quarter: 2017-04-01
10-K	2016-12-31	Annual: 2016-12-31
10-Q	2016-10-01	Quarter: 2016-10-01
10-Q	2016-07-02	Quarter: 2016-07-02
10-Q	2016-04-02	Quarter: 2016-04-02
10-K	2016-01-02	Annual: 2016-01-02
10-Q	2015-10-03	Quarter: 2015-10-03
10-Q	2015-07-04	Quarter: 2015-07-04
10-Q	2015-04-04	Quarter: 2015-04-04
10-K	2015-01-03	Annual: 2015-01-03
10-Q	2014-09-27	Quarter: 2014-09-27
10-Q	2014-06-28	Quarter: 2014-06-28
10-Q	2014-03-29	Quarter: 2014-03-29
10-K	2013-12-28	Annual: 2013-12-28

8-K	2019-05-30	Officers, Shareholder Vote
8-K	2019-05-16	Regulation FD, Exhibits
8-K	2019-05-06	Earnings, Regulation FD, Exhibits
8-K	2019-01-09	Earnings, Exhibits
8-K	2019-01-02	Officers, Exhibits
8-K	2018-12-21	Enter Agreement, Off-BS Arrangement
8-K	2018-10-31	Earnings, Regulation FD, Exhibits
8-K	2018-09-27	Other Events
8-K	2018-08-01	Earnings, Regulation FD, Exhibits
8-K	2018-07-31	Exhibits
8-K	2018-05-31	Officers, Shareholder Vote
8-K	2018-05-02	Earnings, Regulation FD, Exhibits
8-K	2018-02-27	Earnings, Regulation FD, Exhibits
8-K	2018-02-15	Leave Agreement

TOT	Total	138,050
SBS	Companhia De Saneamento Basico Do Estado De Sao Paulo-Sabesp	8,280
BYD	Boyd Gaming	2,990
LXP	Lexington Realty Trust	2,140
IEA	Infrastructure & Energy Alternatives	101
GSL	Global Ship Lease	61
BBII	Brisset Beer	0
TAQR	Traqer	0
CRDA	Crawford	0
TBTC	Table Trac	0

EX-10.1	masi-20190330x10qex101.htm
EX-21.1	masi-20190330x10qex211.htm
EX-31.1	masi-20190330x10qex311.htm
EX-31.2	masi-20190330x10qex312.htm
EX-32.1	masi-20190330x10qex321.htm