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MASI > SEC Filings for MASI > Form 10-Q on 8-May-2013All Recent SEC Filings

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Form 10-Q for MASIMO CORP


8-May-2013

Quarterly Report


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 program; 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," 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 Form 10-Q and in our other Securities and Exchange Commission, or SEC, filings, including our Annual Report on Form 10-K for the fiscal year ended December 29, 2012, which we filed with the SEC on February 15, 2013. 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.

Overview

We are a global medical technology company that develops, manufactures and markets noninvasive patient monitoring products. Our mission is to improve patient outcomes and reduce cost of care by taking noninvasive monitoring to new sites and applications. We invented Masimo SET ® which provides the capabilities of Measure-Through Motion and Low Perfusion pulse oximetry to address the primary limitations of conventional pulse oximetry. Pulse oximetry is the noninvasive measurement of the oxygen saturation level of arterial blood, or the blood that delivers oxygen to the body's tissues, and pulse rate. Pulse oximetry is one of the most common measurements made in and out of hospitals around the world. Masimo SET® has been validated in over 100 independent clinical studies and is the only pulse oximetry technology we are aware of that has been proven to help clinicians detect critical congenital heart disease in newborns, reduce retinopathy of prematurity in neonates and decrease intensive care unit transfers and rapid response activations on the general floor.

Our products consist of a monitor or circuit board, and a recently introduced "Board-in-Cable" solution, for use with our proprietary single-patient use and reusable sensors and cables. We sell our products to end-users through our direct sales force and certain distributors, and also sell some of our products to our OEM partners, for incorporation into their products. As of March 30, 2013, we estimate that the worldwide installed base of our pulse oximeters and OEM monitors that incorporate Masimo SET ® was 1,117,000 units, based on an estimated 10 year field life assumption. Our installed base is the primary driver for the recurring sales of our sensors, most notably, single-patient adhesive sensors. Based on industry reports, we estimate that the worldwide pulse oximetry market was over $1 billion in 2012, the largest component of which was the sale of sensors.

After introducing Masimo SET®, we have continued to innovate by introducing breakthrough noninvasive measurements beyond arterial blood oxygen saturation level and pulse rate, which create new market opportunities in both the hospital and non-hospital care settings. In 2005, we launched our Masimo rainbow® SET platform utilizing both Masimo SET® and licensed rainbow®technology, which we believe includes the first devices cleared by the Food and Drug Administration, or FDA, to noninvasively and continuously monitor multiple measurements that previously required invasive or complicated procedures. Also, in 2005, we launched noninvasive carboxyhemoglobin, or SpCO®, allowing measurement of carbon monoxide levels in the blood. Carbon monoxide is the most common cause of poisoning in the world. In 2006, we launched noninvasive methemoglobin, or SpMet®, allowing for the measurement of methemoglobin levels in the blood. Methemoglobin in the blood leads to a dangerous condition known as methemoglobinemia, which occurs as a reaction to some common drugs used in hospitals and outpatient procedures. In 2007, we launched Masimo PVI®. Fluid administration is critical to optimizing fluid status in surgery and critical care, but traditional invasive methods to guide fluid administration often fail to predict fluid responsiveness and newer methods are complicated and costly. In March 2008, we debuted noninvasive hemoglobin, or SpHb®, and in March 2009, we began full market release of SpHb®. Hemoglobin is the oxygen-carrying component of red blood cells and is one of the most frequent invasive laboratory measurements in the world, often measured as part of a complete blood count. A low hemoglobin status is called anemia, which is generally caused by bleeding or the inability of the body to produce red blood cells. In June 2010, we began a full commercial release of continuous and noninvasive monitoring of respiration rate,


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or RRaTM, via rainbow Acoustic MonitoringTM. Respiration rate is the number of breaths per minute. A low respiration rate is indicative of respiratory depression and high respiration rate is indicative of patient distress. Traditional methods used to measure respiration rate are often considered inaccurate or are not tolerated well by patients. In October 2010, we debuted the Halo IndexTM, which allows continuous global trending and assessment of multiple physiological measurements of a patient with a single number displayed on the Patient SafetyNetTM screen. Halo IndexTM is pending FDA 510(k) clearance.

In July 2010, we began selling the SEDLine® monitor, which measures the brain's electrical activity and provides information about a patient's response to anesthesia. In January 2012, we received FDA clearance for the Pronto-7®, a product designed specifically for spot-checking hemoglobin, along with oxygen saturation and pulse rate. In December 2012, we released iSpO2™, a pulse oximeter cable and sensor with Measure-Through Motion and Low Perfusion Masimo SET® technology for use with an iPhone, iPad or iPod touch. We also offer a remote monitoring and clinician notification solution called Patient SafetyNetTM, which includes our Masimo SET® or rainbow ® SET monitors at the patient's bedside along with a central assignment station and wired or wireless server. Patient SafetyNetTM wirelessly notifies clinicians who are taking care of multiple patients in different rooms when one of their patients has an alarm, allowing them to intervene sooner and provide potentially life-saving support.

In July 2012, we acquired Phasein (currently Masimo Sweden), a developer and manufacturer of ultra-compact mainstream and sidestream capnography and gas monitoring technologies. The acquisition of Phasein's technologies complements our breakthrough innovations for patient monitoring with a portfolio of products ranging from OEM solutions for external "plug-in-and-measure" capnography and gas analyzers and integrated modules to handheld capnometer devices.

We offer Masimo SET® and rainbow® SET through our OEMs and our own end-user products, including the Radical-7®, Rad-87 ®, Rad-57TM, Pronto®, Pronto-7®, Rad-8 ®, Rad-5® and Rad-5vTM. Our solutions and related products are based upon our proprietary Masimo SET® and rainbow® algorithms. This software-based technology is incorporated into a variety of product platforms depending on our customers' specifications. 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 exclusively licensed from our development partner, Cercacor, the right to OEM rainbow® technology and incorporate rainbow® technology into our products intended to be used by professional caregivers, including, but not limited to, hospital caregivers and alternate care facility caregivers.

Cercacor

Cercacor is an independent entity spun off from us to our stockholders in 1998. Joe Kiani and Jack Lasersohn, members of our board of directors, are also members of the board of directors of Cercacor. Joe Kiani, our Chairman and Chief Executive Officer, is also the Chairman and Chief Executive Officer of Cercacor. We are a party to a cross-licensing agreement with Cercacor, which was amended and restated effective January 1, 2007, or the Cross-Licensing Agreement, which governs each party's rights to certain intellectual property held by the two companies.

Under the Cross-Licensing Agreement, we granted Cercacor an exclusive, perpetual and worldwide license, with sublicense rights to use all Masimo SET owned by us, including all improvements on this technology, for the monitoring of non-vital signs measurements and to develop and sell devices incorporating Masimo SET for monitoring non-vital signs measurements in any product market in which a product is intended to be used by a patient or pharmacist rather than a professional medical caregiver, which we refer to as the Cercacor Market. We also granted Cercacor a non-exclusive, perpetual and worldwide license, with sublicense rights to use all Masimo SET for the measurement of vital signs in the Cercacor Market.

We exclusively license from Cercacor the right to make and distribute products in the professional medical caregiver markets, which we refer to as the Masimo Market, that utilize rainbow® technology for the measurement of carbon monoxide, methemoglobin, fractional arterial oxygen saturation and hemoglobin, which includes hematocrit. To date, we have developed and commercially released devices that measure carbon monoxide, methemoglobin and hemoglobin using licensed rainbow ® technology. We also have the option to obtain the exclusive license to make and distribute products that utilize rainbow® technology for the monitoring of other non-vital signs measurements, including blood glucose, in product markets where the product is intended to be used by a professional medical caregiver.

In February 2009, in order to accelerate the product development of our hemoglobin spot-check measurement device, we agreed to fund additional Cercacor's engineering expenses. Specifically, these expenses included third party engineering materials and supplies expense, as well as 60% of Cercacor's total engineering and engineering related payroll expenses, during both the three months ended March 30, 2013 and March 31, 2012. We expect this arrangement to continue in the future. During the three months ended March 30, 2013, the total funding for Cercacor's additional expenses totaled $1.1 million. For additional discussion of Cercacor, see Note 3 to the condensed consolidated financial statements.


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For the foreseeable future, we anticipate that we will continue to consolidate Cercacor pursuant to the current authoritative accounting guidance; however, in the event that Cercacor is no longer considered a variable interest entity, or VIE, or in the event that we are no longer the primary beneficiary of Cercacor, we may discontinue consolidating the entity.

Stock Repurchase Program

In February 2013, our board of directors authorized us to repurchase up to 6.0 million shares of our common stock under a repurchase program. The stock repurchase program was carried out at the discretion of a committee comprised of our Chief Executive Officer and Chief Financial Officer through open market purchases, Rule 10b5-1 trading plans, block trades and in privately negotiated transactions. We have paid for prior repurchases of stock with available cash and cash equivalents. During the three months ended March 30, 2013, 0.8 million shares were repurchased, at an average price of $19.77 per share, totaling $15.4 million.

Medical Device Excise Tax

In March 2010, the U.S. Congress adopted and President Obama signed into law comprehensive health care reform legislation. Among other initiatives, these laws impose new taxes on medical device makers in the form of a 2.3% excise tax on U.S. medical device sales, with certain exemptions, beginning on January 1, 2013. During the three months ended March 30, 2013, our medical device excise tax expense was $1.8 million, which was recorded within our selling, general and administrative expenses.

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).



                                                                   Three Months Ended
                                                 March 30,         % of        March 31,         % of
                                                    2013         Revenue          2012         Revenue
Revenue:
Product                                          $  128,635          94.6 %    $  112,219          94.1 %
Royalty                                               7,307           5.4           7,009           5.9

Total revenue                                       135,942         100.0         119,228         100.0
Cost of goods sold                                   46,361          34.1          39,923          33.5

Gross profit                                         89,581          65.9          79,305          66.5
Operating expenses:
Selling, general and administrative                  52,273          38.5          46,472          39.0
Research and development                             14,167          10.4          10,505           8.8

Total operating expenses                             66,440          48.9          56,977          47.8

Operating income                                     23,141          17.0          22,328          18.7
Non-operating expense                                (2,326 )        (1.7 )          (582 )        (0.5 )

Income before provision for income taxes             20,815          15.3          21,746          18.2
Provision for income taxes                            4,413           3.2           5,980           5.0

Net income including noncontrolling interest         16,402          12.1          15,766          13.2
Net loss attributable to the noncontrolling
interest                                                 26           0.0               8           0.0

Net income attributable to Masimo Corporation
stockholders                                     $   16,428          12.1 %    $   15,774          13.2 %

Comparison of the Three Months ended March 30, 2013 to the Three Months ended March 31, 2012

Revenue. Total revenue increased $16.7 million, or 14.0%, to $135.9 million for the three months ended March 30, 2013 from $119.2 million for the three months ended March 31, 2012. Product revenues increased $16.4 million, or 14.6%, to $128.6 million in the three months ended March 30, 2013 from $112.2 million in the three months ended March 31, 2012. This increase was primarily due to higher consumable sales resulting from an increase in our installed base of circuit boards and pulse oximeters, which we estimate totaled 1,117,000 units at March 30, 2013, up from 1,005,000 units at March 31, 2012. Also contributing to the increase in our product revenue was our rainbow® technology product revenues, which increased $2.0 million, or 23.9%, to $10.5 million in the three months ended March 30, 2013 from $8.5 million in the three months ended


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March 31, 2012. Product revenue of $128.6 million during the three months ended March 30, 2013 included $2.9 million and $1.0 million from Masimo Sweden and Masimo Semiconductor businesses, respectively. Revenue generated through our direct and distribution sales channels increased $12.1 million, or 12.7%, to $108.0 million for the three months ended March 30, 2013, compared to $95.9 million for the three months ended March 31, 2012. During the three months ended March 30, 2013, revenues from our OEM channel increased $4.3 million, or 26.2%, to $20.6 million from $16.3 million for the three months ended March 31, 2012. Our royalty revenue increased $0.3 million to $7.3 million in the three months ended March 30, 2013 from $7.0 million in the three months ended March 31, 2012.

Cost of Goods Sold. Cost of goods sold increased $6.5 million to $46.4 million in the three months ended March 30, 2013 from $39.9 million in the three months ended March 31, 2012. Our total gross margin decreased to 65.9% for the three months ended March 30, 2013 from 66.5% for the three months ended March 31, 2012. Excluding royalties, product gross margin decreased to 64.0% for the three months ended March 30, 2013 from 64.4% for the three months ended March 31, 2012. This decline in product gross margin was primarily due to a negative 1.0% impact during the three months ended March 30, 2013, and a negative 0.3% impact during the three months ended March 31,2012, on product gross margin associated with the Masimo Semiconductor and Masimo Sweden businesses, which were acquired in March 2012 and July 2012, respectively. Excluding the impact of these businesses, our product gross margin would have been 65.0% in the three months ended March 30, 2013, as compared to 64.7% for the three months ended March 31, 2012. This increase was due to a decrease in amortization cost associated with equipment placed at hospitals. We incurred $1.3 million in Cercacor royalty expenses for both the three months ended March 30, 2013 and March 31, 2012, which have been eliminated in our condensed consolidated financial results for the periods presented. Had these royalty expenses not been eliminated, our reported product gross profit margin would have been 63.0% and 63.3% for the three months ended March 30, 2013 and March 31, 2012, respectively.

Selling, General and Administrative. Selling, general and administrative expenses increased $5.8 million, or 12.5%, to $52.3 million for the three months ended March 30, 2013 from $46.5 million for the three months ended March 31, 2012. Excluding the $1.1 million net impact of the Masimo Semiconductor and Masimo Sweden businesses, and the new medical device excise tax of $1.8 million, selling, general and administrative expenses increased $2.9 million, or 6.4%, to $49.3 million for the three months ended March 30, 2013, from $46.4 million for the three months ended March 31, 2012. This increase of $2.9 million was due primarily to increased staffing, legal and other marketing related expenses. Included in total selling, general and administrative expenses are $0.8 million and $0.6 million of direct expenses incurred by Cercacor for the three months ended March 30, 2013 and March 31, 2012, respectively.

Research and Development. Research and development expenses increased $3.7 million, or 34.9%, to $14.2 million for the three months ended March 30, 2013 from $10.5 million for the three months ended March 31, 2012. Excluding the $1.2 million impact of the Masimo Semiconductor and Masimo Sweden businesses, research and development expenses would have increased $2.5 million, or 23.9%, to $13.0 million for the three months ended March 30, 2013. This increase of $2.5 million was primarily due to an increase in payroll and related expenses of $1.6 million. Included in total research and development expenses are $0.9 million and $0.8 million of engineering expenses incurred by Cercacor for the three months ended March 30, 2013 and March 31, 2012, respectively.

Non-operating expense. Non-operating expense was $2.3 million for the three months ended March 30, 2013 as compared to $0.6 million for the three months ended March 31, 2012. This increase of $1.7 million was primarily due to an increase in net realized and unrealized losses on foreign currency denominated transactions during the three months ended March 30, 2013, as compared to the three months ended March 31, 2012. The net realized and unrealized losses recognized during the three months ended March 30, 2013 resulted primarily from the strengthening of the U.S. dollar against the Japanese Yen. The net realized and unrealized losses recognized during the three months ended March 31, 2012 resulted primarily from the strengthening of the U.S. dollar against the Japanese Yen, offset by the weakening of the U.S. dollar against the Euro and British Pound.

Provision for Income Taxes. Our provision for income taxes was $4.4 million for the three months ended March 30, 2013, compared to $6.0 million for the three months ended March 31, 2012. Our effective tax rate decreased to 21.2% for the three months ended March 30, 2013, compared to 27.5% for the three months ended March 31, 2012. This decrease in the effective tax rate was due primarily to the change in law under the American Taxpayer Relief Act of 2012, which was signed into law January 2, 2013 and which extended the federal research tax credit retroactively to 2012 and prospectively through the end of 2013. The effect of the change is that the 2012 federal research tax credit was recognized as a discrete item during the three months ended March 30, 2013. Our future effective income tax rate will depend on various factors, including profits (losses) before taxes, changes to tax law, the recognition and derecognition of tax benefits associated with uncertain tax positions and the geographic composition of pre-tax income.

Liquidity and Capital Resources

As of March 30, 2013, we had cash and cash equivalents of $81.6 million, of which $30.0 million was invested in U.S. Treasury bills, $9.2 million was in money market accounts with major financial institutions and $42.4 million was in checking accounts. These U.S. Treasury bills are classified as cash equivalents since they are highly liquid investments, with a maturity of three months or less at the date of purchase. We carry cash equivalents at cost which approximates fair value.


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As of March 30, 2013, we have cash totaling $28.3 million held outside of the U.S. A substantial portion of this cash held offshore is accessible without a significant tax cost. In managing our day-to-day liquidity and our capital structure, we do not rely on foreign earnings as a source of funds. We currently have sufficient funds for domestic operations and do not anticipate the need to repatriate funds associated with our permanently reinvested foreign earnings. In the event funds that are treated as permanently reinvested are repatriated, we may be required to accrue and pay additional U.S. taxes to repatriate these funds.

During the three months ended March 30, 2013, we received $7.2 million from Covidien for royalties related to their sales. We expect to continue to receive a royalty based on Covidien's pulse oximetry products sales in the U.S., through the term of the royalty agreement and at least through March 15, 2014. The royalty rate is currently 7.75%.

In February 2013, our board of directors authorized the repurchase of up to 6.0 million shares of common stock under a repurchase program. During the three months ended March 30, 2013, 0.8 million shares were repurchased, at an average price of $19.77 per share, totaling $15.4 million. Under a previously authorized share repurchase program, we repurchased 0.9 million shares at an average price of $22.56 per share, totaling $21.2 million, during the three months ended March 31, 2012. We paid for all of these repurchases with available cash and cash equivalents.

Cash Flows from Operating Activities. Cash provided by operating activities was $25.1 million in the three months ended March 30, 2013. The source of cash consisted primarily of net income including noncontrolling interest of $16.4 million and non-cash activity for share-based compensation and depreciation and amortization of $3.4 million and $2.8 million, respectively. In addition, accounts payable increased by $3.9 million due to timing of payments, and income taxes payable increased by $1.8 million. These sources of cash were offset by a decrease in accrued compensation of $3.4 million primarily as a result of 2012 annual bonus payouts in the first quarter of 2013, and an increase in deferred cost of goods sold of $2.7 million due to continued shipments of equipment to customers pursuant to long-term sensor contracts.

Cash provided by operating activities was $23.2 million in the three months ended March 31, 2012. The source of cash consisted primarily of net income including noncontrolling interest of $15.8 million due to continued growth of our business and non-cash share-based compensation of $3.8 million. Additionally, income taxes payable increased by $4.1 million and prepaid expenses decreased by $3.0 million due to a reduction in prepaid taxes. These sources of cash were partially offset by an increase in accounts receivable of $3.5 million resulting from higher sales, a decrease in accrued compensation of $2.2 million as a result of accrued bonus payouts in the first quarter of 2012, and a $1.9 million increase in inventory due to growth in the business.

Cash Flows from Investing Activities. Cash used in investing activities for the three months ended March 30, 2013 was $2.9 million, consisting of $1.8 million for purchases of property and equipment to support our manufacturing operations and $1.1 million for the increase in intangible assets related to capitalized patent and trademark costs. Cash used in investing activities for the three months ended March 31, 2012 was $9.6 million primarily due to a preliminary payment of $7.2 million for the acquisition of Spire Semiconductor's assets, net of excess liabilities assumed and subject to final adjustment. Additionally, $1.9 million was primarily used for purchases of property and equipment to support our manufacturing operations.

Cash Flows from Financing Activities. Cash used in financing activities for the three months ended March 30, 2013 was $12.2 million, primarily resulting from common stock repurchases totaling $15.4 million, of which, only $12.4 million was for transactions settled and paid prior to March 30, 2013. The remaining $3.0 million was for transactions settled and paid after March 30, 2013. Cash used in financing activities for the three months ended March 31, 2012 was $14.3 million, resulting from common stock repurchases totaling $14.4 million.

Future Liquidity Needs. In the future, in addition to funding our working capital requirements, we anticipate our primary use of cash to be the equipment that we provide to hospitals under our long-term sensor purchase agreements. We anticipate additional capital purchases related to expanding our worldwide international operations including manufacturing, sales, marketing and other . . .

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