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MASI > SEC Filings for MASI > Form 10-Q on 31-Oct-2013All Recent SEC Filings

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Form 10-Q for MASIMO CORP


31-Oct-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," 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, 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 September 28, 2013, we estimate that the worldwide installed base of our pulse oximeters and OEM monitors that incorporate Masimo SET® was 1,180,000 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


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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, 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 a 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 CE marked, but not available for sale in the U.S.

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 June 2013, we initiated an international limited market release of our RootTM product. RootTM is a powerful new patient monitoring and connectivity platform that integrates our breakthrough rainbow® and SET® measurements with multiple additional parameters through Masimo Open ConnectTM (MOC-9TM) in an integrated, clinician-centric platform. The first two MOC-9TMtechnologies for RootTM are SEDLine® brain function monitoring and Phasein capnography. Iris connectivity in Root enables 3rd party devices such as intravenous pumps and ventilators to connect through RootTM and enables display, notification, and documentation to the electronic medical record through Masimo Patient SafetyNetTM. In combination with a Radical-7® handheld monitor, RootTM will instantly interpret and display other measurements thus simplifying patient care workflows, empowering caregivers to help make quicker patient assessments, earlier interventions and better clinical decisions throughout the continuum of care. Phasein capnography and some RootTM features such wireless radio and Iris connectivity are not available for sale in the U.S. as of September 28, 2013.

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®, RootTM, 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.


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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 engineering expenses of Cercacor. 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 September 28, 2013 and September 29, 2012. We expect this arrangement to continue in the future. During the three and nine months ended September 28, 2013, the funding for Cercacor's additional expenses totaled $1.0 million and $3.1 million, respectively. For additional discussion of Cercacor, see Note 3 to the condensed consolidated financial statements.

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 obligated to absorb Cercacor's expected losses, or do not have the ability to direct the activities that most significantly impact Cercacor's economic performance, 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 may be carried out at the discretion of a committee comprised of our Chief Executive Officer and Chief Financial Officer through open market purchases, one or more 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 September 28, 2013, no shares were repurchased. During the nine months ended September 28, 2013, 1.0 million shares were repurchased, at an average price of $19.79 per share, totaling $19.8 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 and nine months ended September 28, 2013, our medical device excise tax expense was $1.6 million and $4.9 million, respectively, 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                                                  Nine Months Ended
                                           September 28,        % of         September 29,        % of         September 28,        % of         September 29,        % of
                                               2013           Revenue            2012           Revenue            2013           Revenue            2012           Revenue
Revenue:
Product                                   $       124,522         94.7 %    $       112,108         94.2 %    $       382,725         94.5 %    $       339,644         94.1 %
Royalty                                             6,925          5.3                6,961          5.8               22,086          5.5               21,428          5.9

Total revenue                                     131,447        100.0              119,069        100.0              404,811        100.0              361,072        100.0
Cost of goods sold                                 43,968         33.4               40,736         34.2              136,519         33.7              122,002         33.8

Gross profit                                       87,479         66.6               78,333         65.8              268,292         66.3              239,070         66.2
Operating expenses:
Selling, general and administrative                53,090         40.4               48,260         40.5              159,536         39.4              142,381         39.4
Research and development                           13,646         10.4               12,121         10.2               41,692         10.3               33,736          9.4

Total operating expenses                           66,736         50.8               60,381         50.7              201,228         49.7              176,117         48.8


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                                                                    Three Months Ended                                                      Nine Months Ended
                                              September 28,         % of          September 29,        % of          September 28,         % of          September 29,         % of
                                                  2013             Revenue            2012            Revenue            2013             Revenue            2012             Revenue
Operating income                                      20,743           15.8               17,952          15.1               67,064           16.6               62,953           17.4
Non-operating income (expense)                          (676 )         (0.5 )                912           0.8               (3,240 )         (0.8 )               (132 )         (0.0 )

Income before provision for income taxes              20,067           15.3               18,864          15.9               63,824           15.8               62,821           17.4
Provision for income taxes                             4,581            3.5                5,301           4.5               17,288            4.3               15,724            4.4

Net income including noncontrolling
interest                                              15,486           11.8               13,563          11.4               46,536           11.5               47,097           13.0
Net loss attributable to the
noncontrolling interest                                  116            0.1                  231           0.2                2,532            0.6                  168            0.1

Net income attributable to Masimo
Corporation stockholders                     $        15,602           11.9 %    $        13,794          11.6 %    $        49,068           12.1 %    $        47,265           13.1 %

Comparison of the Three Months ended September 28, 2013 to the Three Months ended September 29, 2012

Revenue. Total revenue increased $12.3 million, or 10.4%, to $131.4 million for the three months ended September 28, 2013 from $119.1 million for the three months ended September 29, 2012. Product revenues increased $12.4 million, or 11.1%, to $124.5 million in the three months ended September 28, 2013 from $112.1 million in the three months ended September 29, 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 1,180,000 units at September 28, 2013, up from 1,056,000 units at September 29, 2012. Also contributing to the increase in our product revenue was our rainbow® technology product revenue, which increased $1.0 million, or 9.0%, to $12.0 million in the three months ended September 28, 2013 from $11.0 million in the three months ended September 29, 2012. Revenue generated through our direct and distribution sales channels increased $11.2 million, or 11.8%, to $106.4 million for the three months ended September 28, 2013, compared to $95.2 million for the three months ended September 29, 2012. During the three months ended September 28, 2013, revenues from our OEM channel increased $1.2 million, or 7.0%, to $18.1 million from $16.9 million for the three months ended September 29, 2012, primarily due to the additional capnography revenues associated with our acquisition of Phasein. Our royalty revenue decreased $0.1 million to $6.9 million in the three months ended September 28, 2013 from $7.0 million in the three months ended September 29, 2012.

Cost of Goods Sold. Cost of goods sold increased $3.3 million to $44.0 million in the three months ended September 28, 2013 from $40.7 million in the three months ended September 29, 2012. Our total gross margin increased to 66.6% for the three months ended September 28, 2013 from 65.8% for the three months ended September 29, 2012. Excluding royalties, product gross margin increased to 64.7% for the three months ended September 28, 2013 from 63.7% for the three months ended September 29, 2012. This net increase in product margin was primarily due to the benefit of our continued product cost reduction efforts and other improvements in our manufacturing processes. We incurred $1.3 million in Cercacor royalty expenses for both the three months ended September 28, 2013 and September 29, 2012, which have been eliminated in our condensed consolidated financial statements for the periods presented. Had these royalty expenses not been eliminated, our reported product gross profit margin would have been 63.7% and 62.5% for the three months ended September 28, 2013 and September 29, 2012, respectively.

Selling, General and Administrative. Selling, general and administrative expenses increased $4.8 million, or 10.0%, to $53.1 million for the three months ended September 28, 2013 from $48.3 million for the three months ended September 29, 2012. Excluding the new medical device excise tax of $1.6 million, selling, general and administrative expenses increased $3.2 million, or 6.7%, to $51.5 million for the three months ended September 28, 2013, from $48.3 million for the three months ended September 29, 2012. This increase of $3.2 million was due primarily to increased staffing and legal related expenses. Included in total selling, general and administrative expenses are $0.6 million and $0.7 million of direct expenses incurred by Cercacor for the three months ended September 28, 2013 and September 29, 2012, respectively.


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Research and Development. Research and development expenses increased $1.5 million, or 12.6%, to $13.6 million for the three months ended September 28, 2013 from $12.1 million for the three months ended September 29, 2012. This increase was primarily due to an increase in staffing expenses. Included in total research and development expenses are $0.9 million and $1.0 million of engineering expenses incurred by Cercacor for the three months ended September 28, 2013 and September 29, 2012, respectively.

Non-operating income (expense). Non-operating expense was $0.7 million for the three months ended September 28, 2013 as compared to non-operating income of $0.9 million for the three months ended September 29, 2012. This change of $1.6 million was primarily due to the recognition of net realized and unrealized losses on foreign currency denominated transactions during the three months ended September 28, 2013, as compared to the recognition of net realized and unrealized gains on foreign currency denominated transactions during the three months ended September 29, 2012. The net realized and unrealized losses recognized during the three months ended September 28, 2013 resulted primarily from losses due to the weakening of the U.S. Dollar against the Swedish Krona, offset by gains due to weakening of the U.S. Dollar against the Euro. The net realized and unrealized gains recognized during the three months ended September 29, 2012 resulted primarily from the weakening of the U.S. Dollar against the Euro and the Japanese Yen.

Provision for Income Taxes. Our provision for income taxes was $4.6 million, or an effective tax rate of 22.8%, for the three months ended September 28, 2013, compared to $5.3 million, or an effective tax rate of 28.1%, for the three months ended September 29, 2012. This decrease in effective tax rate was due primarily to the conclusion of a prior year tax audit, the changes in law under the American Taxpayer Relief Act of 2012 in the first quarter of 2013, which extended the federal research tax credit prospective through the end of 2013, and the mix of income in which we do business. Our future effective income tax rate will depend on various factors, including profits (losses) before taxes, changes to tax law, valuation allowances, the recognition and derecognition of tax benefits associated with uncertain tax positions and the geographic composition of pre-tax income.

Comparison of the Nine Months ended September 28, 2013 to the Nine Months ended September 29, 2012

Revenue. Total revenue increased $43.7 million, or 12.1%, to $404.8 million for the nine months ended September 28, 2013 from $361.1 million for the nine months ended September 29, 2012. Product revenues increased $43.1 million, or 12.7%, to $382.7 million in the nine months ended September 28, 2013 from $339.6 million in the nine months ended September 29, 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 1,180,000 units at September 28, 2013, up from 1,056,000 units at September 29, 2012. Also contributing to the increase in our product revenue was our rainbow® technology product revenue, which increased $4.9 million, or 16.5%, to $34.1 million in the nine months ended September 28, 2013 from $29.2 million in the nine months ended September 29, 2012. Revenue generated through our direct and distribution sales channels increased $33.2 million, or 11.4%, to $322.6 million for the nine months ended September 28, 2013, compared to $289.4 million for the nine months ended September 29, 2012. During the nine months ended September 28, 2013, revenues from our OEM channel increased $10.0 million, or 19.9%, to $60.2 million from $50.2 million for the nine months ended September 29, 2012, which was primarily due to the additional capnography revenues associated with our acquisition of Phasein. Our royalty revenue increased $0.7 million to $22.1 million in the nine months ended September 28, 2013 from $21.4 million in the nine months ended September 29, 2012.

Cost of Goods Sold. Cost of goods sold increased $14.5 million to $136.5 million in the nine months ended September 28, 2013 from $122.0 million in the nine months ended September 29, 2012. Our total gross margin increased to 66.3% for the nine months ended September 28, 2013 from 66.2% for the nine months ended September 29, 2012. Excluding royalties, product gross margin increased to 64.3% for the nine months ended September 28, 2013 from 64.1% for the nine months ended September 29, 2012. Excluding the product gross margin associated with the Masimo Sweden business, the product margin would have been 64.7% during the nine months ended September 28, 2013, as compared to 64.3% during the nine months ended September 29, 2012. This increase in product margin of 0.4% was primarily due to the benefit of our continued product cost reduction and manufacturing process improvement efforts. We incurred $3.8 million in Cercacor royalty expenses for both the nine months ended September 28, 2013 and September 29, 2012, which have been eliminated in our condensed consolidated financial . . .

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