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MASI > SEC Filings for MASI > Form 10-Q on 1-May-2014All Recent SEC Filings

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Form 10-Q for MASIMO CORP


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 (SEC) filings, including our Annual Report on Form 10-K for the fiscal year ended December 28, 2013, which we filed with the SEC on February 14, 2014. 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. We provide our products directly and through distributors and OEM partners to hospitals, emergency medical service (EMS) providers, physician offices, veterinarians, long term care facilities and consumers. Our mission is to improve patient outcomes and reduce the cost of care by taking noninvasive monitoring to new sites and applications. 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 arterial blood oxygen saturation and pulse rate monitoring, known Masimo Signal Extraction Technology® (Masimo SET®) pulse oximetry. Pulse oximetry enables the noninvasive measurement of the oxygen saturation level of arterial blood, which delivers oxygen to the body's tissues. Pulse oximetry also enables the measurement of pulse rate, which when measured by an electrocardiography (ECG) is called heart rate. Pulse oximetry is one of the most common measurements taken in and out of hospitals around the world. Most pulse oximeter technologies work well when patients are well perfused and not moving. However, when either or both of these conditions occur, conventional pulse oximeters frequently do not provide any measurements, or provide inaccurate measurements. We invented Masimo SET®, which, for the first time, allows pulse oximeters to provide accurate measurements even during patient motion and low perfusion conditions. The performance of Masimo SET® pulse oximetry is proven by more than 100 independent and objective studies and thousands of clinical evaluations. We believe that Masimo SET® is trusted by clinicians to safely monitor approximately 100 million patients each year and is used hospital-wide by eight of the top ten hospitals on the U.S. News & World Report Best Hospitals Honor Roll (2013-2014). Compared to other pulse oximeters during patient motion and low perfusion, Masimo SET® provides measurements when other pulse oximeters cannot, dramatically reduces false alarms (specificity), and accurately detects true alarms (sensitivity) that can indicate a deteriorating patient condition. Masimo SET® pulse oximetry has also been shown to improve patient outcomes by helping clinicians reduce retinopathy of prematurity (ROP) in neonates, screen newborns for critical congenital heart disease (CCHD), reduce ventilator weaning time and arterial blood gas measurements in the intensive care unit (ICU), and save lives and costs while reducing rapid response activations and ICU transfers on the general floor.
After introducing Masimo SET®, we have continued to innovate by introducing breakthrough noninvasive measurements that go beyond arterial blood oxygen saturation and pulse rate, and which create new market opportunities in both the hospital and non-hospital care settings. Our product offerings have expanded significantly over the years to also include noninvasive blood constituent, brain and breath monitoring, including rainbow® Pulse CO-Oximetry, brain function electroencephalogram (EEG) monitoring, respiration rate, capnography and anesthetic agent monitoring. In addition, we have developed the Root™ patient monitoring and connectivity platform and Patient SafetyNet™ remote patient surveillance monitoring system.
Our rainbow® Pulse CO-Oximetry utilizes both Masimo SET® and licensed rainbow® technology. We believe rainbow® Pulse CO-Oximetry includes the first devices cleared by the U.S. Food and Drug Administration (FDA) to noninvasively and

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continuously monitor multiple blood-based measurements using multiple wavelengths of light, and which previously was only possible through intermittent invasive procedures. SpCO® provides noninvasive and continuous measurement of carboxyhemoglobin, or carbon monoxide levels in the blood. Carbon monoxide is the most common cause of poisoning in the world. When used with other clinical variables, SpCO® may help clinicians and emergency responders detect carbon monoxide poisoning and help determine treatment and additional test options. SpMet® provides noninvasive and continuous measurement of methemoglobin levels in the blood. Elevated 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. When used with other clinical variables, SpMet® may help clinicians detect methemoglobinemia and help determine treatment and additional test options. SpHb® provides noninvasive and continuous measurement of total hemoglobin. Hemoglobin is the oxygen-carrying component of red blood cells (RBC) and, along with oxygen saturation, determines the oxygen content of blood. Hemoglobin measurement is one of the most frequent invasive laboratory measurements in the world and is often measured as part of a complete blood count (CBC), which measures multiple other blood components. A low hemoglobin status is called anemia, which is generally caused by bleeding or the inability of the body to produce RBCs. SpHb® is available as a continuous monitor or a spot check measurement. Continuous SpHb® monitoring provides real-time visibility into the changes, or lack of changes, in hemoglobin, which can otherwise only be measured through intermittent, invasive blood testing. SpHb® has been shown to help clinicians reduce the number of RBC transfusions and, in multiple cases, has demonstrated its lifesaving ability in helping clinicians detect internal bleeding. Spot check SpHb® measurement, when used with other clinical variables, may help clinicians assess whether a patient's hemoglobin is lower or higher than may otherwise be assessed without any hemoglobin measurement, which in turn, may help determine additional test options.
Available in both Masimo SET® and rainbow® SET® sensors, Pleth Variability Index (PVI®), provides for the noninvasive and continuous measurement of fluid responsiveness in patients whose breathing is controlled through mechanical ventilation, such as in the operating room or intensive care unit. Fluid administration is critical to optimizing fluid status in surgery and critical care, but traditional invasive methods to guide fluid administration often fail to help clinicians assess fluid responsiveness. Newer methods are complicated and costly and considered appropriate only for the highest-risk patients. When used with other clinical variables, PVI® may help clinicians assess fluid responsiveness and help determine treatment options.
Our sound-based monitoring technology called rainbow Acoustic Monitoring™ (RAM™) enables noninvasive monitoring of respiration rate (RRa®). 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, such as impedance pneumography, or are not tolerated well by certain patients, such as capnography. When used with other clinical variables, RRa® may help clinicians assess respiratory status and determine treatment options. RAM™ technology is available from the same circuit board as Masimo SET® and rainbow® Pulse CO-Oximetry measurements, which together we refer to as the rainbow® SET technology platform.
Our SedLine® brain function monitoring product measures the brain's electrical activity and provides information about a patient's response to anesthesia. SedLine® may help clinicians assess depth of anesthesia to optimize anesthesia and avoid over- or under-titration of anesthetics.
Although not currently available for sale in the U.S., we received the CE Mark for respiration rate from the plethysmograph waveform (RRp™) in 2011. RRp™ enables monitoring of breathing status from a standard Masimo SET® pulse oximetry or rainbow® Pulse CO-Oximeter sensor®. The RRp™ measurement is determined by the variations in the plethysmograph waveform due to respiration, although the measurement is not possible in all patients or many conditions and may not immediately indicate changes in respiration rate. For patients requiring accurate and sensitive respiration rate monitoring, we believe that our acoustic respiration rate (RRa®) measurement is better at detecting pauses in breathing than RRp™. The RRa® measurement also provides an important visual indication of breathing through the displayed acoustic waveform.
Patient SafetyNet™ provides a patient surveillance or remote monitoring and clinician notification solution which includes Masimo SET® or rainbow® SET platform measurements at the patient's bedside along with a central assignment station and wired or wireless server. Patient SafetyNet™ wirelessly notifies clinicians caring for multiple patients in different rooms when one of their patients has an alarm, allowing them to become aware of changing conditions and intervene sooner, at times with life-saving support. Masimo SET®, along with Patient SafetyNet™, is proven to help clinicians avoid deaths while preventing ICU transfers, rapid response activations and preventable deaths on the medical/surgical floors of the hospital. Today, the majority of medical/surgical floors in the hospital are not continuously monitored. Halo Index™ can be used with our Patient SafetyNet™ to allow continuous global trending and assessment of multiple physiological measurements of a patient with a single number displayed on the Patient SafetyNet™ screen. Halo Index™ is CE marked, but not currently available for sale in the U.S.
Our universal "Board-in-Cable" pulse oximetry solution, uSpO2™, enables easier and faster integration of our products for OEM partners due to the ability to integrate Masimo SET® through software only. SpfO2™, a new parameter not currently

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available for sale in the U.S., has received the CE mark and allows for the noninvasive measurement of fractional arterial oxygen saturation. Previously, pulse oximeters could only measure and display functional oxygen saturation (SpO2), so when patients had elevated carboxyhemoglobin and/or elevated methemoglobin, the displayed functional oxygen saturation overestimated the actual oxygen saturation value. SpfO2™ allows more precise arterial oxygenation assessment in patients with elevated dyshemoglobins, common throughout the hospital and pre-hospital setting, compared to functional oxygen saturation. Our portfolio of Phasein™ capnography and gas monitoring products range from OEM solutions for external "plug-in-and-measure" analyzers and integrated modules to handheld devices. With multiple measurements delivered through either mainstream or sidestream options, our customers can benefit from CO2, N2O, O2 and anesthetic agent monitoring in many hospital and pre-hospital environments, such as the operating room (OR), procedural sedation, ICU and EMS scenarios. In addition, our EMMA™ Capnograph with waveform display offers clinicians greater assessment of end-tidal carbon dioxide (EtCO2) and respiration rate, as well as assists in recognition of return to spontaneous circulation, for a variety of clinical settings, including emergency medicine and transport, ORs, ICUs, patient rooms and clinics. EMMA™ fits in the palm of the hand, and we believe it is the smallest and most portable capnograph in the world. iSpO2® uses Masimo SET® technology for Measure-Through Motion and Low Perfusion performance to deliver measurements through a pulse oximeter cable and sensor with technology to an iPhone, iPad or iPod touch. The first version of iSpO2® allows consumers to use their iPhone, iPad or iPod touch to check their own arterial blood oxygen saturation (SpO2), pulse rate and perfusion index measurements. In the U.S., iSpO2® is available online for sports and aviation use only, and is not intended for medical use. In October 2013, iSpO2® was released in Japan for iPhone, iPad and iPod touch. In December 2013, we received the CE mark on iSpO2® for the Android operating system, enabling functionality on select Android-based phones outside of the U.S. The iSpO2® Rx, the professional version for medical use, also received the CE mark in December 2013. The iSpO2® Rx product is not yet available in the U.S. but is available outside of the U.S.
In June 2013, we announced the CE Mark and limited international market release of our Root™ platform. Root™ is a powerful new patient monitoring and connectivity platform that integrates our breakthrough rainbow® and SET® measurements with multiple additional parameters being made available through Masimo Open Connect™ (MOC-9™) in an integrated, clinician-centric platform. The first two MOC-9™ technologies for Root™ were SedLine® brain function monitoring and Phasein™ capnography. In January 2014, we announced the CE Mark for O3™ regional oximetry, our third MOC-9™ technology for Root™, which provides for continuous and simultaneous measurement of tissue oxygen saturation (rSO2) and SpO2 to help detect regional hypoxemia that pulse oximetry alone can miss. Iris™ connectivity in Root™ enables third-party devices such as intravenous pumps and ventilators to connect through Root™ enabling display, notification and documentation to the electronic medical record through Masimo Patient SafetyNet™. In combination with a Radical-7® handheld device using rainbow® Pulse CO-Oximetry and rainbow® Acoustic Monitoring™, Root™ will help clinicians instantly interpret and quickly change display of multiple measurements, helping to simplify patient care workflows and empower caregivers to help make quicker patient assessments, earlier interventions and better clinical decisions throughout the continuum of care. Phasein™ capnography, O3™ and certain other Root™ features such as wireless radio and Iris™ connectivity are not available for sale in the U.S.
Our pulse oximetry technology is generally contained on a circuit board which is placed inside a standalone pulse oximetry monitor, placed inside OEM multiparameter monitors or included as part of an external "Board-in-Cable" solution which is plugged into a port on an OEM or other device. All of these solutions use 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, as well as our OEM partners, for incorporation into their products. In 2013, we also began selling our pulse oximetry products in the consumer market. As of March 29, 2014, we estimate that the worldwide installed base of our pulse oximeters and OEM monitors that incorporate Masimo SET® and rainbow® SET was more than 1.2 million units, excluding handheld devices. Our installed base is the primary driver for the recurring sales of our pulse oximeter and Pulse CO-Oximeter sensors, most notably single-patient adhesive sensors. Based on industry reports, we estimate that the worldwide pulse oximetry market is nearly $1.5 billion in 2014, the largest component being sensors.
Our strategy is to utilize the accuracy and broad clinical benefits of our technologies to:
1) be the leading choice for pulse oximetry in traditionally monitored areas, in and out of the hospital;

2) expand the use of pulse oximetry beyond the critical care settings, including to the general floor of the hospital;

3) create demand for the use of breakthrough rainbow® measurements by our hospital customers;

4) offer rainbow® measurements to new markets such as EMS, and the physician office;

5) penetrate existing noninvasive specialty monitoring markets such as capnography, gas, brain function, and other modalities with technologies that offer clinical and financial advantages; and

6) leverage the revolutionary Root™ platform to provide open access to third-party developers for additional measurements, as well as connectivity to electronic health record systems and for third-party devices.

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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 Cercacor Laboratories, Inc. (Cercacor) the right to OEM selected rainbow® technology and to incorporate selected 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 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 (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 certain non-invasive measurements, including carbon monoxide, methemoglobin, fractional arterial oxygen saturation and hemoglobin. 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. To date, we have developed and commercially released devices that measure carbon monoxide, methemoglobin and hemoglobin using licensed rainbow® technology. Additionally, we make and distribute products that monitor respiration rate via rainbow Acoustic Monitoring ™, which is not required to be licensed from Cercacor.
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 March 29, 2014 and March 30, 2013. We expect this arrangement to continue in the future. During the three months ended March 29, 2014, the funding for Cercacor's additional expenses totaled $0.9 million. For additional discussion of Cercacor, see Note 3 to the condensed consolidated financial statements included in this Quarterly Report on Form 10-Q and Part I, Item 1. "Business-Cercacor Laboratories, Inc." in our Annual Report on Form 10-K for the fiscal year ended December 28, 2013, filed with the SEC on February 14, 2014.
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 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 March 29, 2014, no shares were repurchased under the program. As of March 29, 2014, approximately 5.0 million shares remain authorized for repurchase under the program.

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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 29, 2014, and March 30, 2013, our medical device excise tax expense was $1.6 million and $1.7 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
                                         March 29,        % of        March 30,        % of
                                            2014         Revenue         2013         Revenue
Product                                 $  132,232         94.6  %   $  128,635         94.6  %
Royalty                                      7,582          5.4           7,307          5.4
Total revenue                              139,814        100.0         135,942        100.0
Cost of goods sold                          47,513         34.0          46,361         34.1
Gross profit                                92,301         66.0          89,581         65.9
Operating expenses:
Selling, general and administrative         56,122         40.1          52,273         38.5
Research and development                    13,996         10.0          14,167         10.4
    Litigation award and defense costs      (8,010 )       (5.7 )             -            -
Total operating expenses                    62,108         44.4          66,440         48.9
Operating income                            30,193         21.6          23,141         17.0
Non-operating income (expense)                 200          0.1          (2,326 )       (1.7 )
Income before provision for income
taxes                                       30,393         21.7          20,815         15.3
Provision for income taxes                   7,902          5.6           4,413          3.2
Net income including noncontrolling
interest                                    22,491         16.1          16,402         12.1
Net loss attributable to the
noncontrolling interest                        141          0.1              26          0.0
Net income attributable to Masimo
Corporation stockholders                $   22,632         16.2  %   $   16,428         12.1  %

Comparison of the Three Months ended March 29, 2014 to the Three Months ended March 30, 2013
Revenue. Total revenue increased $3.9 million, or 2.8%, to $139.8 million for the three months ended March 29, 2014 from $135.9 million for the three months ended March 30, 2013. Product revenues increased $3.6 million, or 2.8%, to $132.2 million for the three months ended March 29, 2014 from $128.6 million for the three months ended March 30, 2013. This increase was primarily due to rainbow technology revenues which rose from $10.5 million in the three month period ended March 30, 2013 to $12.9 million in the three month period ended March 29, 2014. Also contributing to higher product revenues were consumable sales resulting from an increase in our installed base of circuit boards and pulse oximeters, which we estimate totaled 1,231,000 units at March 29, 2014, up from 1,117,000 units at March 30, 2013. Such increase in revenue was partially offset by a current quarter true-up for deferred revenue of approximately $2.6 million resulting from new information related to inventory on-hand at one distributor.
Revenue generated through our direct and distribution sales channels increased $3.1 million, or 2.9%, to $111.1 million for the three months ended March 29, 2014, compared to $108.0 million for the three months ended March 30, 2013. During the three months ended March 29, 2014, revenues from our OEM channel increased $0.5 million, or 2.4%, to $21.1 million from $20.6 million for the three months ended March 30, 2013. Our royalty revenue increased $0.3 million to $7.6 million for the three months ended March 29, 2014 from $7.3 million for the three months ended March 30, 2013.
Cost of goods sold. Cost of goods sold includes the cost of producing, . . .

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