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Form 10-Q MASIMO CORP For: Apr 02

May 3, 2022 4:53 PM
masi-20220402
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Table of Contents

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
________________________________________________
FORM 10-Q
________________________________________________
(Mark One)
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended April 2, 2022
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
masi-20220402_g1.jpg
________________________________________________
MASIMO CORPORATION
(Exact Name of Registrant as Specified in its Charter)
________________________________________________
Delaware33-0368882
(State or Other Jurisdiction of
Incorporation or Organization)
(I.R.S. Employer
Identification Number)
52 DiscoveryIrvine,California92618
(Address of Principal Executive Offices)(Zip Code)
(949)297-7000
(Registrant’s Telephone Number, Including Area Code)
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 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
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
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 filerAccelerated filer
Non-accelerated filerSmaller 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
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
April 2, 2022
Common stock, $0.001 par value
55,504,374


Table of Contents

MASIMO CORPORATION
FORM 10-Q FOR THE QUARTER ENDED APRIL 2, 2022
TABLE OF CONTENTS
 
Item 1.
Item 2.
Item 3.
Item 4.
Item 1.
Item 1A.
Item 6.

2

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PART I. FINANCIAL INFORMATION
Item 1.     Financial Statements
MASIMO CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(unaudited, in thousands, except par values)
April 2,
2022
January 1,
2022
ASSETS
Current assets
Cash and cash equivalents$720,108 $745,250 
Trade accounts receivable, net of allowance for credit losses of $2,528 and $2,182 at April 2, 2022 and January 1, 2022, respectively
199,876 200,765 
Inventories213,485 201,370 
Other current assets91,273 91,027 
Total current assets1,224,742 1,238,412 
Lease receivable, non-current73,922 73,688 
Deferred costs and other contract assets33,033 28,093 
Property and equipment, net299,544 272,793 
Intangible assets, net72,278 72,502 
Goodwill99,328 100,334 
Deferred tax assets51,328 52,607 
Other non-current assets54,621 48,581 
Total assets$1,908,796 $1,887,010 
LIABILITIES AND STOCKHOLDERS EQUITY
Current liabilities
Accounts payable$87,453 $75,627 
Accrued compensation49,930 70,835 
Deferred revenue and other contract liabilities, current48,735 50,877 
Other current liabilities68,193 70,397 
Total current liabilities254,311 267,736 
Other non-current liabilities72,347 69,029 
Total liabilities326,658 336,765 
Commitments and contingencies - (Note 21)
Stockholders’ equity
Preferred stock, $0.001 par value; 5,000 shares authorized; 0 shares issued and outstanding
  
Common stock, $0.001 par value; 100,000 shares authorized; 55,504 and 55,335 shares issued and outstanding at April 2, 2022 and January 1, 2022, respectively
56 55 
Treasury stock, 16,539 and 16,539 shares at April 2, 2022 and January 1, 2022, respectively
(767,655)(767,655)
Additional paid-in capital740,735 752,513 
Accumulated other comprehensive loss(8,455)(5,530)
Retained earnings1,617,457 1,570,862 
Total stockholders’ equity1,582,138 1,550,245 
Total liabilities and stockholders’ equity$1,908,796 $1,887,010 

The accompanying notes are an integral part of these condensed consolidated financial statements.
3

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MASIMO CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited, in thousands, except per share amounts)
 
Three Months Ended
April 2,
2022
April 3,
2021
Revenue$304,241 $299,043 
Cost of goods sold99,477 102,168 
Gross profit204,764 196,875 
Operating expenses:
Selling, general and administrative108,900 96,700 
Research and development36,119 34,511 
Total operating expenses145,019 131,211 
Operating income59,745 65,664 
Non-operating loss(608)(737)
Income before provision for income taxes59,137 64,927 
Provision for income taxes12,542 11,544 
Net income$46,595 $53,383 
Net income per share:
Basic$0.84 $0.97 
Diluted$0.81 $0.92 
Weighted-average shares used in per share calculations:
Basic55,420 55,200 
Diluted57,310 57,901 

The accompanying notes are an integral part of these condensed consolidated financial statements.
4

Table of Contents

MASIMO CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(unaudited, in thousands)
 
Three Months Ended
April 2,
2022
April 3,
2021
Net income$46,595 $53,383 
Other comprehensive income, net of tax:
Unrealized losses from foreign currency translation adjustments(2,925)(2,884)
Total comprehensive income$43,670 $50,499 

The accompanying notes are an integral part of these condensed consolidated financial statements.
5

Table of Contents


MASIMO CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(in thousands)
Three Months Ended April 2, 2022
Common StockTreasury StockAdditional
Paid-In
Capital
Accumulated
Other
Comprehensive Loss
Retained
Earnings
Total
Stockholders’
Equity
SharesAmountSharesAmount
Balance at January 1, 202255,335 $55 16,539 $(767,655)$752,513 $(5,530)$1,570,862 $1,550,245 
Stock options exercised53  — — 2,729 — — 2,729 
Restricted/Performance stock units vested228 — — — — — — — 
Shares paid for tax withholding(112)1 — — (25,376)— — (25,375)
Stock-based compensation— — — — 10,869 — — 10,869 
Net income— — — — — — 46,595 46,595 
Foreign currency translation adjustment— — — — — (2,925)— (2,925)
Balance at April 2, 202255,504 $56 16,539 $(767,655)$740,735 $(8,455)$1,617,457 $1,582,138 

Three Months Ended April 3, 2021
Common StockTreasury StockAdditional
Paid-In
Capital
Accumulated
Other
Comprehensive
Income (Loss)
Retained
Earnings
Total
Stockholders’
Equity
SharesAmountSharesAmount
Balance at January 2, 202155,251 $55 15,993 $(638,736)$703,693 $1,413 $1,341,215 $1,407,640 
Stock options exercised61  — — 2,886 — — 2,886 
Restricted/Performance stock units vested303 — — — — — — — 
Shares paid for tax withholding(68)— — — (16,691)— — (16,691)
Stock-based compensation— — — — 12,708 — — 12,708 
Repurchases of common stock(547)— 547 (128,917)— — — (128,917)
Net income— — — — — — 53,383 53,383 
Foreign currency translation adjustment— — — — — (2,884)— (2,884)
Balance at April 3, 202155,000 $55 16,540 $(767,653)$702,596 $(1,471)$1,394,598 $1,328,125 
The accompanying notes are an integral part of these condensed consolidated financial statements.
6

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MASIMO CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited, in thousands)
Three Months Ended
April 2,
2022
April 3,
2021
Cash flows from operating activities:
Net income$46,595 $53,383 
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization9,134 8,493 
Stock-based compensation10,869 12,708 
Loss on disposal of equipment, intangibles and other assets215 29 
Provision for credit losses495 49 
Changes in operating assets and liabilities:
Decrease in accounts receivable402 6,823 
Increase in inventories(12,357)(915)
(Increase) decrease in other current assets(1,432)16,326 
Increase in lease receivable, net(236)(919)
Increase in deferred costs and other contract assets(14,889)(1,307)
Increase in other non-current assets(50)(77)
Increase (decrease) in accounts payable9,179 (599)
Decrease in accrued compensation(20,698)(23,343)
Decrease in accrued liabilities(3,536)(5,813)
Increase (decrease) in income tax payable1,312 (303)
Decrease in deferred revenue and other contract-related liabilities(1,781)(5,308)
(Decrease) increase in other non-current liabilities(64)33 
Net cash provided by operating activities23,158 59,260 
Cash flows from investing activities:
Purchases of property and equipment, net(20,479)(8,903)
Increase in intangible assets(2,460)(1,572)
Other strategic investing activities(850) 
Net cash used in investing activities(23,789)(10,475)
Cash flows from financing activities:
Proceeds from issuance of common stock3,153 5,756 
Payroll tax withholdings on behalf of employees for vested equity awards(25,376)(16,691)
Repurchases of common stock (128,917)
Net cash used in financing activities(22,223)(139,852)
Effect of foreign currency exchange rates on cash(2,505)279 
Net decrease in cash, cash equivalents and restricted cash(25,359)(90,788)
Cash, cash equivalents and restricted cash at beginning of period748,378 645,004 
Cash, cash equivalents and restricted cash at end of period$723,019 $554,216 
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 monitoring technologies and hospital automation solutions. The Company’s mission is to improve patient outcomes and reduce the cost of patient 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, long-term care facilities, physician offices, veterinarians and consumers through its direct sales force, distributors and original equipment manufacturers (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 SafetyNet™(1), Masimo Patient SafetyNet Surveillance(1), Masimo SafetyNet, Masimo SafetyNet-Open, Replica, Iris®, MyView®, UniView, Uniview : 60, Trace, Masimo Sleep, Centroid, and Bridge. 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.
______________
(1)    The use of the trademark Patient SafetyNet is under license from the University HealthSystem Consortium.
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 January 1, 2022 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 January 1, 2022 (fiscal year 2021), filed with the SEC on February 15, 2022. The results for the three months ended April 2, 2022 are not necessarily indicative of the results to be expected for the fiscal year ending December 31, 2022 (fiscal year 2022) or for any other interim period or for any future year.
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 weeks while a 53 week fiscal year includes three 13 week fiscal quarters and one 14 week fiscal quarter. The Company’s last 53 week fiscal year was fiscal year 2020. Fiscal year 2022 is a 52 week fiscal year ending December 31, 2022. All references to years in these notes to condensed consolidated financial statements are fiscal years unless otherwise noted.
Reclassifications
Certain amounts in the accompanying condensed consolidated financial statements have been reclassified to conform to the current period presentation.
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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 standalone selling prices, variable consideration, total consideration allocated to each performance obligation within a contract, inventory valuation, valuation of the Company’s equity awards, valuation of identifiable assets and liabilities connected with business combinations, 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.
Business Combinations
The Company accounts for business combinations using the acquisition method of accounting, which requires that once control is obtained, all the assets acquired, liabilities assumed and noncontrolling interests in the acquired entity, if applicable, are recorded at their respective fair values at the date of acquisition. The excess of the purchase price over fair values of identifiable assets, liabilities and noncontrolling interests in the acquired entity, if applicable, is recorded as goodwill.
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. The Company did not carry financial assets measured under the fair value hierarchy based on any of the three levels of inputs (Level 1, 2 and 3) other than cash and cash equivalents during either the three months ended April 2, 2022 or April 3, 2021. The Company carries cash and cash equivalents at cost, which approximates fair value, and are Level 1 under the fair value hierarchy.
For certain other financial assets and liabilities, including restricted cash, accounts receivable, accounts payable and other current assets and liabilities, the carrying amounts approximate their fair value primarily due to the relatively short maturity of these balances. The Company also measures certain non-financial assets at fair value on a non-recurring basis, primarily goodwill, intangible assets and operating lease right-of-use assets, in connection with periodic evaluations for potential impairment.
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.
Accounts Receivable and Allowance for Credit Losses
Accounts receivable consist of trade receivables recorded at the time of invoicing of product sales, 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 Company records an allowance for credit losses that it does not expect to collect based on relevant information, including historical experience, current conditions, and reasonable and supportable forecasts. Accounts are charged off against the allowance when the Company believes they are uncollectible. The allowance for credit losses is measured on a collective (pool) basis when similar risk characteristics exist. The Company has identified receivables for U.S. customers and receivables from international customers each as a portfolio, and measures expected credit losses on such receivables using an aging methodology.
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MASIMO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(unaudited)
Inventory
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 valuation adjustments 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. The Company generally determines inventory valuation adjustments based on an evaluation of the expected future use of its inventory on an item by item basis and applies historical obsolescence rates to estimate the loss on inventory expected to have a recovery value below cost. The Company also records other specific inventory valuation adjustments when it becomes aware of unique events or circumstances that result in an expected recovery value below cost. For inventory items that have been written down, the reduced value becomes the new cost basis.
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
Buildings and building improvements
7 to 39 years
Computer equipment and software
2 to 12 years
Demonstration units3 years
Furniture and office equipment
2 to 6 years
Leasehold improvementsLesser of useful life or term of lease
Machinery, equipment and tooling
3 to 10 years
Operating lease assetsLesser of useful life or term of lease
Transportation, vehicles and other
4 to 20 years
The Company classifies assets subject to operating leases within property, plant, and equipment, which are presented net of accumulated depreciation. 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.
Lessee Right-of-Use (ROU) Assets and Lease Liabilities
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 ROU assets and lease liabilities. Rental expense for lease payments related to operating leases is recognized on a straight-line basis over the lease term.
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MASIMO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(unaudited)
Intangible Assets
Intangible assets consist primarily of patents, trademarks, software development costs, customer relationships and acquired technology. Costs related to patents and trademarks, which include legal and application fees, are capitalized and amortized over the estimated useful lives using the straight-line method. Patent and trademark amortization commences once final approval of the patent or trademark has been obtained. Patent costs are amortized over the lesser of 10 years or the patent’s remaining legal life, which assumes renewals, and trademark costs are amortized over 17 years, and their associated amortization cost is included in selling, general and administrative expense in the accompanying condensed consolidated statements of operations. For intangibles purchased in an asset acquisition or business combination, which mainly include patents, trademarks, customer relationships and acquired technologies, the useful life is determined largely by valuation estimates of remaining economic life.
The Company’s policy is to renew its patents and trademarks. Costs to renew patents and trademarks are capitalized and amortized over the remaining useful life of the intangible asset. The Company periodically 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.
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MASIMO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(unaudited)
Revenue Recognition, Deferred Revenue and Other Contract Liabilities
The Company derives the majority of its 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 from fixed lease payments 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 lease arrangements with fixed lease payments is recognized on a straight-line basis over the term of the lease and variable lease payments are recognized as they occur.
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, as well as 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) the identification of the distinct performance obligations contained within the arrangement, (iv) how the arrangement consideration should be allocated to each performance obligation when multiple performance obligations exist, including the determination of standalone selling price, and (v) when to recognize revenue on the 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 customer’s commitment to purchase sensors over the term of the agreement, which generally ranges from three years 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 likelihood to exercise any purchase options. Beginning January 2, 2022, for contracts that contain variable lease payments, the Company also classifies as operating leases components that would result in a day one selling loss should they be otherwise classified as a sales-type lease. 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 control over the equipment is transferred to the customer. 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 lease arrangements after the end of the agreement.
Revenue from the sale of products to end-user hospitals, emergency medical response organizations, other direct customers, distributors and OEM customers, is recognized by the Company when control of such products transfer to the customer based upon the terms of the contract or underlying purchase order.
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MASIMO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(unaudited)
Revenue related to OEM rainbow® parameter software licenses is recognized by the Company upon the OEM’s shipment of its product to its customer, as reported to the Company by the OEM.
The Company provides certain customers with various sales incentives that may take the form of discounts or rebates. The Company records estimates related to 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.
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 condensed consolidated statements of operations. Charges for shipping and handling billed to customers are included as a component of 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 customers 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 allowances to be made directly to the end-user hospital customer at the inception of the arrangement. These allowances 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.
Warranty
The Company generally provides a warranty against defects in material and workmanship for a period ranging from six months 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 goods sold. Customers may also purchase extended warranty coverage or service level upgrades separately or as part of a deferred equipment agreement. Revenue related to extended warranty coverage and service level upgrades is generally recognized over the life of the contract, which reasonably approximates the period over which such services will be provided. The related extended warranty and service level upgrade costs are expensed as incurred.
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MASIMO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(unaudited)
Changes in the warranty accrual were as follows (in thousands):
Three Months Ended
April 2,
2022
April 3,
2021
Warranty accrual, beginning of period$2,487 $2,740 
Accrual for warranties issued2,229 1,112 
Changes in pre-existing warranties (including changes in estimates)(2,162)(733)
Settlements made(93)(406)
Warranty accrual, end of period$2,461 $2,713 
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.
Net Income Per Share
A computation of basic and diluted net income per share is as follows (in thousands, except per share data):
Three Months Ended
April 2,
2022
April 3,
2021
Net income$46,595&#