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Table of Contents

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
________________________________________________
FORM 10-Q
________________________________________________
(Mark One)
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended July 1, 2017
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
_________________________________________________
masimologoq32016-01a02.jpg
MASIMO CORPORATION
(Exact Name of Registrant as Specified in its Charter)
________________________________________________
Delaware
 
33-0368882
(State or Other Jurisdiction of
Incorporation or Organization)
 
(I.R.S. Employer
Identification Number)
 
 
52 Discovery
Irvine, California
 
92618
(Address of Principal Executive Offices)
 
(Zip Code)
(949) 297-7000
(Registrant’s Telephone Number, Including Area Code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ý    No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted 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 and post such files).    Yes  ý    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
 
ý
 
Accelerated filer
 
¨
 
 
 
 
Non-accelerated filer
 
¨  (Do not check if a smaller reporting company)
 
Smaller reporting company
 
¨
 
 
 
 
 
 
 
 
 
 
 
Emerging growth company
 
¨
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  ý
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 July 1, 2017
Common stock, $0.001 par value
 
51,940,147
 

Table of Contents

MASIMO CORPORATION
FORM 10-Q FOR THE QUARTER ENDED JULY 1, 2017
TABLE OF CONTENTS
 
 
 
 
Item 1.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
 
 
 
Item 1.
 
 
 
Item 1A.
 
 
 
Item 6.
 
 


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PART I. FINANCIAL INFORMATION
Item 1.     Financial Statements
MASIMO CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(unaudited, in thousands, except par values)
 
July 1,
2017
 
December 31,
2016
ASSETS
 
 
 
Current assets
 
 
 
Cash and cash equivalents
$
331,448

 
$
305,970

Accounts receivable, net of allowance for doubtful accounts of $1,460 and $1,698 at July 1, 2017 and December 31, 2016, respectively.
104,159

 
101,667

Inventories
88,458

 
72,542

Other current assets
41,929

 
27,048

Total current assets
565,994

 
507,227

Deferred cost of goods sold
93,936

 
79,948

Property and equipment, net
137,723

 
135,996

Intangible assets, net
28,099

 
29,376

Goodwill
20,388

 
19,780

Deferred tax assets
39,012

 
38,975

Other non-current assets
10,516

 
9,223

Total assets
$
895,668

 
$
820,525

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Current liabilities
 
 
 
Accounts payable
$
38,270

 
$
34,334

Accrued compensation
31,871

 
43,180

Accrued and other current liabilities
36,677

 
104,654

Deferred revenue
38,526

 
38,198

Total current liabilities
145,344

 
220,366

Deferred revenue
24,652

 
25,336

Other non-current liabilities
16,268

 
14,587

Total liabilities
186,264

 
260,289

Commitments and contingencies

 

Stockholders’ equity
 
 
 
Preferred stock, $0.001 par value; 5,000 shares authorized; 0 shares issued and outstanding at July 1, 2017 and December 31, 2016
—

 
—

Common stock, $0.001 par value; 100,000 shares authorized; 51,940 and 50,188 shares issued and outstanding at July 1, 2017 and December 31, 2016, respectively
52

 
50

Treasury stock, 14,255 shares at July 1, 2017 and December 31, 2016
(404,276
)
 
(404,276
)
Additional paid-in capital
436,549

 
382,263

Accumulated other comprehensive loss
(4,161
)
 
(7,027
)
Retained earnings
681,240

 
589,226

Total stockholders’ equity
709,404

 
560,236

Total liabilities and stockholders’ equity
$
895,668

 
$
820,525


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

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MASIMO CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited, in thousands, except per share amounts)
 
 
Three Months Ended
 
Six Months Ended
 
July 1,
2017
 
July 2,
2016
 
July 1,
2017
 
July 2,
2016
Revenue:
 
 
 
 
 
 
 
Product
$
182,802

 
$
164,607

 
$
360,899

 
$
327,897

Royalty and other revenue
10,131

 
8,029

 
18,336

 
15,906

Total revenue
192,933

 
172,636

 
379,235

 
343,803

Cost of goods sold
64,496

 
57,501

 
126,664

 
114,455

Gross profit
128,437

 
115,135

 
252,571

 
229,348

Operating expenses:
 
 
 
 
 
 
 
Selling, general and administrative
66,377

 
63,888

 
131,949

 
126,399

Research and development
15,192

 
14,818

 
30,559

 
29,183

Total operating expenses
81,569

 
78,706

 
162,508

 
155,582

Operating income
46,868

 
36,429

 
90,063

 
73,766

Non-operating income
158

 
471

 
1,032

 
969

Income before provision for income taxes
47,026

 
36,900

 
91,095

 
74,735

Provision (benefit) for income taxes
346

 
6,877

 
(919
)
 
17,135

Net income
$
46,680

 
$
30,023

 
$
92,014

 
$
57,600

 
 
 
 
 
 
 
 
Net income per share:
 
 
 
 
 
 
 
Basic
$
0.90

 
$
0.61

 
$
1.80

 
$
1.17

Diluted
$
0.83

 
$
0.57

 
$
1.65

 
$
1.10

 
 
 
 
 
 
 
 
Weighted-average shares used in per share calculations:
 
 
 
 
 
 
 
Basic
51,677

 
49,256

 
51,164

 
49,340

Diluted
56,173

 
52,703

 
55,867

 
52,404

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



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MASIMO CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(unaudited, in thousands)
 
 
Three Months Ended
 
Six Months Ended
 
July 1,
2017
 
July 2,
2016
 
July 1,
2017
 
July 2,
2016
Net income
$
46,680

 
$
30,023

 
$
92,014

 
$
57,600

Other comprehensive income, net of tax:
 
 
 
 
 
 
 
Foreign currency translation adjustments
2,300

 
(1,209
)
 
2,866

 
190

Comprehensive income
$
48,980

 
$
28,814

 
$
94,880

 
$
57,790

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




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MASIMO CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited, in thousands)
 
Six Months Ended
 
July 1,
2017
 
July 2,
2016
Cash flows from operating activities:
 
 
 
Net income
$
92,014

 
$
57,600

Adjustments to reconcile net income to net cash (used in) provided by operating activities:
 
 
 
Depreciation and amortization
9,462

 
8,132

Stock-based compensation
6,142

 
6,204

Loss on disposal of property, equipment and intangibles
365

 
401

Gain on deconsolidation of variable interest entity
—

 
(273
)
Provision for doubtful accounts
(193
)
 
(51
)
Provision for deferred income taxes
—

 
5,001

Changes in operating assets and liabilities:
 
 
 
Increase in accounts receivable
(2,094
)
 
(3,739
)
Increase in inventories
(15,554
)
 
(297
)
Increase in other current assets
(14,694
)
 
(7,462
)
Increase in deferred cost of goods sold
(13,700
)
 
(1,566
)
Increase in other non-current assets
(1,288
)
 
(6,596
)
Increase in accounts payable
3,139

 
7,943

Decrease in accrued compensation
(11,679
)
 
(3,937
)
Decrease in accrued liabilities
(67,641
)
 
(13,807
)
Increase in deferred revenue
327

 
5,263

Increase in other non-current liabilities
985

 
3,875

Net cash (used in) provided by operating activities
(14,409
)
 
56,691

Cash flows from investing activities:
 
 
 
Purchases of property and equipment, net
(8,512
)
 
(10,734
)
Increase in intangible assets
(1,574
)
 
(1,349
)
Reduction in cash resulting from deconsolidation of variable interest entity
—

 
(763
)
Net cash used in investing activities
(10,086
)
 
(12,846
)
Cash flows from financing activities:
 
 
 
Borrowings under line of credit
—

 
45,000

Repayments on line of credit
—

 
(55,000
)
Debt issuance costs
—

 
(621
)
Repayments of capital lease obligations
(70
)
 
(69
)
Proceeds from issuance of common stock
48,218

 
18,997

Repurchases of common stock
—

 
(68,218
)
Net cash provided by (used in) financing activities
48,148

 
(59,911
)
Effect of foreign currency exchange rates on cash
1,825

 
(196
)
Net increase in cash and cash equivalents
25,478

 
(16,262
)
Cash and cash equivalents at beginning of period
305,970

 
132,317

Cash and cash equivalents at end of period
$
331,448

 
$
116,055

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

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MASIMO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
1. Description of the Company
Masimo Corporation (the Company) is a global medical technology company that develops, manufactures and markets a variety of noninvasive patient monitoring technologies. The Company’s mission is to improve patient outcomes and reduce cost of care by taking noninvasive monitoring to new sites and applications®. The Company’s patient monitoring solutions generally incorporate a monitor or circuit board, proprietary single-patient use or reusable sensors, software and/or cables. The Company primarily sells its products to hospitals, emergency medical service providers, home care providers, physician offices, veterinarians, long term care facilities and consumers through its direct sales force, distributors and original equipment manufacturer (OEM) partners.
The Company invented Masimo Signal Extraction Technology® (SET®), which provides the capabilities of Measure-through Motion and Low Perfusion™ pulse oximetry to address the primary limitations of conventional pulse oximetry. Over the years, the Company’s product offerings have expanded significantly to also include noninvasive optical blood constituent monitoring, optical organ oximetry monitoring, electrical brain function monitoring, acoustic respiration monitoring and optical gas monitoring. The Company also developed the Root® patient monitoring and connectivity platform and the Masimo Patient SafetyNet1 remote patient surveillance monitoring system. These solutions and related products are based upon Masimo SET®, rainbow® and other proprietary algorithms. These software-based technologies are incorporated into a variety of product platforms depending on customers’ specifications. In addition, these technologies are supported by a substantial intellectual property portfolio that the Company has built through internal development, acquisitions and license agreements.
2. Summary of Significant Accounting Policies
Basis of Presentation
The accompanying unaudited condensed consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (SEC). Certain information and note disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (GAAP) have been condensed or omitted pursuant to such rules and regulations. The accompanying condensed consolidated financial statements have been prepared on the same basis as the annual financial statements and, in the opinion of management, reflect all adjustments, including normal recurring accruals, necessary to present fairly the Company’s condensed consolidated financial statements. The accompanying condensed consolidated balance sheet as of December 31, 2016 was derived from the Company’s audited consolidated financial statements at that date. The accompanying condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and related notes contained in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2016 (fiscal year 2016), filed with the SEC on February 15, 2017. The results for the six months ended July 1, 2017 are not necessarily indicative of the results to be expected for the fiscal year ending December 30, 2017 (fiscal year 2017) or for any other interim period or for any future year.
Principles of Consolidation
The accompanying condensed consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All intercompany balances and transactions have been eliminated in consolidation. In accordance with GAAP, current authoritative guidance is applied when determining whether an entity is subject to consolidation.
Fiscal Periods
The Company follows a conventional 52/53 week fiscal year. Under a conventional 52/53 week fiscal year, a 52 week fiscal year includes four quarters of 13 fiscal weeks while a 53 week fiscal year includes three 13 fiscal week quarters and one 14 fiscal week quarter. The Company’s last 53 week fiscal year was fiscal year 2014. Fiscal year 2017 is a 52 week fiscal year. All references to years in these notes to condensed consolidated financial statements are fiscal years unless otherwise noted.





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

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Table of Contents
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 accounts receivable allowances, inventory reserves, warranty reserves, rebate accruals, valuation of the Company’s stock options, goodwill valuation, deferred taxes and any associated valuation allowances, distributor channel inventory, royalty revenues, deferred revenue, uncertain income tax positions, litigation costs and related accruals. Actual results could differ from such estimates.
Reclassifications
Certain amounts in the accompanying condensed consolidated financial statements for prior periods have been reclassified to conform to the current period presentation.
Fair Value Measurements
Authoritative guidance describes a fair value hierarchy based on three levels of inputs, of which the first two are considered observable and the last unobservable, that may be used to measure fair value:
●
Level 1—Quoted prices in active markets for identical assets or liabilities.
●
Level 2—Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that can be corroborated by observable market data for substantially the full term of the assets or liabilities.
●
Level 3—Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.
Pursuant to current authoritative guidance, entities are allowed an irrevocable option to elect the fair value for the initial and subsequent measurement for specified financial assets and liabilities on a contract-by-contract basis. The Company did not elect to apply the fair value option under this guidance to specific assets or liabilities on a contract-by-contract basis. There were no transfers between Level 1, Level 2 and Level 3 inputs during the six months ended July 1, 2017. The Company carries cash and cash equivalents at cost, which approximates fair value. As of July 1, 2017 and December 31, 2016, the Company did not have any short-term investments or other financial assets that were required to be measured under the fair value hierarchy.
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 Doubtful Accounts
Accounts receivable consist of trade receivables recorded upon recognition of revenue for product revenues, reduced by reserves for estimated bad debts and returns. Trade accounts receivable are recorded at the invoiced amount and do not bear interest. Credit is extended based on evaluation of the customer’s financial condition. Collateral is generally not required. The allowance for doubtful accounts is determined based on historical write-off experience, current customer information and other relevant factors, including specific identification of past due accounts, based on the age of the receivable in excess of the contemplated or contractual due date. Accounts are charged off against the allowance when the Company believes they are uncollectible.
Inventories
Inventories are stated at the lower of cost or net realizable value. Cost is determined using a standard cost method, which approximates the first in, first out method, and includes material, labor and overhead costs. Inventory reserves are recorded for inventory items that have become excess or obsolete or are no longer used in current production and for inventory items that have a market price less than carrying value in inventory.

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MASIMO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(unaudited)

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
39 years
Building improvements
7 to 15 years
Leasehold improvements
Lesser of useful life or term of lease
Machinery and equipment
5 to 7 years
Vehicles
5 years
Tooling
3 years
Computer equipment
2 to 6 years
Furniture and office equipment
2 to 6 years
Demonstration units
3 years
Land is not depreciated and construction-in-progress is not depreciated until placed in service. Normal repair and maintenance costs are expensed as incurred, whereas significant improvements that materially increase values or extend useful lives are capitalized and depreciated over the remaining estimated useful lives of the related assets. Upon sale or retirement of depreciable assets, the related cost and accumulated depreciation or amortization are removed from the accounts and any gain or loss on the sale or retirement is recognized in income.
Intangible Assets
The Company’s policy is to renew its patents and trademarks. Total renewal costs for patents and trademarks for the six months ended July 1, 2017 and July 2, 2016 were $0.1 million and $0.3 million, respectively. As of July 1, 2017, the weighted-average number of years until the next renewal was one year for patents and six years for trademarks. Costs to renew patents and trademarks are capitalized and amortized over the remaining useful life of the intangible asset. The Company continually evaluates the amortization period and carrying basis of patents and trademarks to determine whether any events or circumstances warrant a revised estimated useful life or reduction in value. Capitalized application costs are charged to operations when it is determined that the patent or trademark will not be obtained or is abandoned.
Impairment of Goodwill, Intangible Assets and Other Long-Lived Assets
Goodwill is recorded as the difference, if any, between the aggregate consideration paid for an acquisition and the fair value of the acquired net tangible and intangible assets. Goodwill is not amortized, but instead is tested annually for impairment, or more frequently when events or changes in circumstances indicate that goodwill might be impaired. In assessing goodwill impairment for each of its reporting units, 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 performing the two-step impairment test is unnecessary. However, if the Company concludes otherwise, then the Company is required to perform the first step of the two-step impairment test by comparing the fair value of the reporting unit, determined using future projected discounted operating cash flows, with its carrying amount, including goodwill. If the fair value of the reporting unit exceeds its carrying amount, goodwill is not considered impaired; otherwise, goodwill is considered impaired and the loss is measured by performing step two. Under step two, the impairment loss is measured by comparing the implied fair value of the reporting unit goodwill with the carrying amount of goodwill. The Company also has the option to bypass the qualitative assessment and proceed directly to performing the first step of the two-step goodwill impairment test. The Company may resume performing the qualitative assessment in any subsequent period. The annual impairment test is performed during the fourth fiscal quarter.

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MASIMO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(unaudited)

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 flow expected to be generated by the asset. If such asset is considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount exceeds the fair value of the asset. Long-lived assets to be disposed of are reported at the lower of carrying amount or fair value less costs to sell.
No impairment of goodwill, intangible assets or other long-lived assets was recorded during the three and six months ended July 1, 2017 and July 2, 2016.
Revenue Recognition and Deferred Revenue
The Company follows the current authoritative guidance for revenue recognition. Based on these requirements, the Company recognizes revenue from the sale of products or services when: (i) persuasive evidence of an arrangement exists, (ii) delivery has occurred or services have been rendered, (iii) the price is fixed or determinable, and (iv) collectability is reasonably assured. In the case of the license or sale of software that does not function together with hardware components to provide the essential functionality of the hardware, revenue is recognized pursuant to the software revenue recognition guidance.
The Company derives the majority of its revenue from four primary sources: (i) direct sales under long-term sensor purchase 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 direct customers; and (iv) sales of integrated circuit boards to OEM customers who incorporate the Company’s embedded software technology into their multiparameter monitoring devices.
The Company enters into agreements to sell its noninvasive monitoring solutions and services, sometimes as part of multiple deliverable arrangements that include various combinations of products and services. While the majority of the Company’s sales transactions contain standard business terms and conditions, there are some transactions that contain non-standard business terms and conditions. As a result, contract interpretation and analysis is sometimes required to determine the appropriate accounting, including: (i) how the arrangement consideration should be allocated among the deliverables when multiple deliverables exist, (ii) when to recognize revenue on the deliverables, and (iii) whether undelivered elements are essential to the functionality of the delivered elements. Changes in judgments on these assumptions and estimates could materially impact the timing of revenue recognition.
In the case of multiple deliverable arrangements, the authoritative guidance provides a hierarchy to determine the selling price to be used for allocating revenue to deliverables as follows: (i) vendor-specific objective evidence (VSOE) of selling price, (ii) third-party evidence of selling price (TPE), and (iii) best estimate of the selling price (ESP). VSOE of selling price is defined as the price charged when the same element is sold separately. VSOE generally exists only when the deliverable is sold separately and is the price actually charged for that deliverable. TPE generally does not exist for the majority of the Company’s products. The objective of ESP is to determine the price at which the Company would transact a sale if the product was sold on a stand-alone basis. In the absence of VSOE and TPE, the Company determines ESP for its products 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 market conditions.
A deliverable in an arrangement qualifies as a separate unit of accounting if the delivered item has value to the customer on a stand-alone basis. Most of the Company’s products in a multiple deliverable arrangement qualify as separate units of accounting. In the case of the Company’s monitoring equipment containing embedded Masimo SET® or rainbow SET™ software, the Company has determined that the hardware and software components function together to deliver the equipment’s essential functionality and, therefore, represent a single deliverable. However, software deliverables, such as rainbow® parameter software, which do not function together with hardware components to provide the equipment’s essential functionality, are accounted for under software revenue recognition guidance.
The revenue for these multiple-element arrangements is allocated to the software deliverables and the non-software deliverables based on the relative selling prices of all of the deliverables in the arrangement using the hierarchy in the revenue recognition accounting guidance for arrangements with multiple deliverables.

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MASIMO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(unaudited)

Sales under long-term sensor purchase contracts are generally structured such that the Company agrees to provide at no up-front charge certain monitoring-related equipment, software, installation, training and/or warranty support in exchange for the hospital’s agreement to purchase sensors over the term of the agreement, which generally ranges from three to six years. These contracts generally do not provide for any payments that are not dependent upon the Company’s future delivery of sensors, which are essential to the functionality of the monitoring equipment and, therefore, represent a substantive performance obligation. As a result, the Company generally does not recognize any revenue when the monitoring and related equipment and software are delivered to the hospitals, but rather recognizes revenue for these delivered elements on a pro-rata basis as the sensors are delivered under the long-term purchase commitment, when installation and training are complete. Accordingly, the cost of the monitoring and related equipment initially placed at the hospitals is deferred and amortized to cost of goods sold over the life of the underlying long-term sensor purchase contract. In cases where such contracts do provide for guaranteed payments that are unrelated to the future delivery of sensors, the Company recognizes the net present value of such payments as revenue from the monitoring and related equipment and expenses the cost of such equipment to cost of goods sold, as the equipment is delivered and when installation and training are complete. Some of the Company’s long-term sensor contracts also contain provisions for certain payments to be made directly to the end-user hospital customer at the inception of the arrangement. These payments are generally treated as prepaid discounts which are deferred and amortized on a straight-line basis as contra-revenue over the life of the underlying long-term sensor purchase contract.
Many of the Company’s distributors purchase sensor products that they then resell to end-user hospitals that are typically fulfilling their purchase obligations to the Company under such end-user hospital’s long-term sensor purchase commitments. Upon shipment to the distributor, revenue is deferred until the distributor ships the product to the Company’s end-user customers based on an estimate of the inventory held by these distributors at the end of the accounting period.
The Company also earns revenue from the sale of integrated circuit boards and other products, as well as from rainbow® parameter software licenses, to OEMs under various agreements. Revenue from the sale of products to the OEMs is generally recognized at the time of shipment. Revenue related to software licenses to OEMs is generally recognized upon shipment of the OEM’s product to its customers, as represented to the Company by the OEM.
The Company also provides certain customers with the ability to purchase sensors under rebate programs. Under these programs, the customers may earn rebates based on their purchasing activity. The Company estimates and provides allowances for these programs at the time of sale as a reduction to revenue.
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 and accounts receivable. The Company estimates returns based on several factors, including contractual limitations and past returns history.
The majority of the Company’s royalty and other revenue arises from an agreement with Medtronic plc (Medtronic, formerly Covidien Ltd.) that provides for quarterly royalty payments to the Company based upon U.S. sales of certain Medtronic products. An estimate of these royalty revenues is recorded quarterly in the period earned based on the prior quarter’s historical results, adjusted for any new information or trends known to management at the time of estimation. This estimated revenue is adjusted prospectively when the Company receives the Medtronic royalty report, approximately sixty days after the end of the previous quarter. From time-to-time, the Company also recognizes revenue upon the achievement of pre-agreed milestones related to non-recurring engineering (NRE) services provided for certain OEM customers. Costs incurred by the Company related to these NRE services are generally deferred until such time that the milestones are achieved and the associated revenue is recognized.
Product Warranty
The Company generally provides a warranty against defects in material and workmanship for a period ranging from six to forty-eight months, depending on the product type. In traditional sales activities, including direct and OEM sales, the Company establishes an accrued liability for the estimated warranty costs at the time of revenue recognition, with a corresponding provision to cost of sales. Customers may also purchase extended warranty coverage separately or as part of a long-term sensor purchase agreement. Revenue related to extended warranty coverage is recognized over the extended life of the contract and the related extended warranty costs are expensed as incurred.

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MASIMO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(unaudited)

Changes in the product warranty accrual were as follows (in thousands):
 
Six Months Ended
 
July 1,
2017
 
July 2,
2016
Warranty accrual, beginning of period
$
910

 
$
1,222

Accrual for warranties issued
606

 
521

Changes to pre-existing warranties (including changes in estimates)
(5
)
 
(40
)
Settlements made
(485
)
 
(488
)
Warranty accrual, end of period
$
1,026

 
$
1,215

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
Authoritative accounting guidance establishes requirements for reporting and disclosure of comprehensive income and its components. Comprehensive income includes foreign currency translation adjustments and any related tax benefits that have been excluded from net income and reflected in stockholders’ equity.
The change in accumulated other comprehensive loss was as follows (in thousands):
 
Six Months Ended 
 July 1, 2017
Accumulated other comprehensive loss, beginning of period
$
(7,027
)
Foreign currency translation adjustments
2,866

Accumulated other comprehensive loss, end of period
$
(4,161
)
Net Income Per Share
Basic net income per share is computed by dividing net income by the weighted-average number of shares outstanding during the period. Net income per diluted share is computed by dividing the net income by the weighted-average number of shares and potential shares outstanding during the period, if the effect of potential shares is dilutive. Potential shares include incremental shares of stock issuable upon the exercise of stock options and the vesting of both restricted share units (RSUs) and performance share units (PSUs). For both the three and six months ended July 1, 2017, weighted options to purchase 0.1 million shares of common stock were outstanding but not included in the computation of diluted net income per share because the effect of including such shares would have been antidilutive in the applicable period. For the three and six months ended July 2, 2016, weighted options to purchase less than 1.6 million and 1.4 million shares of common stock, respectively, were outstanding, but were not included in the computation of diluted net income per share because the effect of including such shares would have been antidilutive in the applicable period. For the three and six months ended July 1, 2017 and July 2, 2016, certain RSUs were considered contingently issuable shares as their vesting is contingent upon the occurrence of certain future events. Since such events had not occurred and were not considered probable of occurring as of July 1, 2017 and July 2, 2016, 2.7 million weighted average shares related to such RSUs have been excluded from the calculation of potential shares.

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MASIMO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(unaudited)

A reconciliation of basic and diluted net income per share is as follows (in thousands, except per share amounts):
 
Three Months Ended
 
Six Months Ended
 
July 1,
2017
 
July 2,
2016
 
July 1,
2017
 
July 2,
2016
Net income
$
46,680

 
$
30,023

 
$
92,014

 
$
57,600

Basic net income per share:
 
 
 
 
 
 
 
Weighted-average shares outstanding - basic
51,677

 
49,256

 
51,164

 
49,340

Net income per basic share
$
0.90

 
$
0.61

 
$
1.80

 
$
1.17

Diluted net income per share:
 
 
 
 
 
 
 
Weighted-average shares outstanding - basic
51,677

 
49,256

 
51,164

 
49,340

Diluted share equivalent: stock options and RSUs
4,496

 
3,447

 
4,703

 
3,064

Weighted-average shares outstanding - diluted
56,173

 
52,703

 
55,867

 
52,404

Net income per diluted share
$
0.83

 
$
0.57

 
$
1.65

 
$
1.10

Supplemental Cash Flow Information
Supplemental cash flow information includes the following (in thousands):
 
Six Months Ended
 
July 1,
2017
 
July 2,
2016
Cash paid during the year for:
 
 
 
Interest (net of amounts capitalized)
$
321

 
$
2,603

Income taxes
81,662

 
19,292

Noncash investing and financing activities:
 
 
 
Unpaid purchases of property, plant and equipment
$
2,113

 
$
1,168

       Unsettled common stock proceeds from option exercises
237

 
187

Seasonality
The healthcare business in the United States and overseas is subject to quarterly fluctuations in hospital and other alternative care admissions. Historically, the Company has typically experienced higher product revenues during the traditional “flu season” that often increases hospital and acute care facility admissions in the Company’s first and fourth fiscal quarters. At the same time, the Company has frequently experienced a sequential decline in product revenues in its second and/or third fiscal quarters, primarily due to the summer vacation season during which the flu season has moderated and people tend to avoid and/or delay elective procedures. Because the Company’s non-sales variable operating expenses often do not fluctuate in the same manner as its quarterly product sales, its quarterly operating income may fluctuate disproportionately to its quarterly revenue.
Recently Issued Accounting Pronouncements
In May 2017, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2017-09, Compensation – Stock Compensation (Topic718) : Scope of Modification Accounting (ASU 2017-09). The new standard is intended to provide clarity and reduce both (1) diversity in practice and (2) cost and complexity when applying the guidance in Accounting Standards Codification (ASC) Topic 718 to a change to the terms or conditions of a share-based payment award. The amendments in this new standard provide guidance about which changes to the terms or conditions of a share-based payment award require an entity to apply “modification accounting” to such changes. ASU 2017-09 will become effective for all entities for annual and interim periods beginning after December 15, 2017, and early adoption is permitted. The Company is currently evaluating the expected impact of this standard, but does not expect it to have a material impact on its consolidated financial statements upon adoption.

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MASIMO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(unaudited)

In January 2017, the FASB issued ASU No. 2017-04, Intangibles – Goodwill and Other (ASU 2017-04). The new standard is intended to eliminate the requirement to calculate the implied fair value of goodwill to measure a goodwill impairment charge. Instead, a goodwill impairment charge will be based on the excess of a reporting unit’s carrying amount over its fair value. ASU 2017-04 is effective for annual and interim fiscal reporting periods beginning after December 15, 2019 and early adoption is permitted. The Company is currently evaluating the expected impact of this standard, but does not expect it to have a material impact on its consolidated financial statements upon adoption.
In January 2017, the FASB issued ASU No. 2017-01, Business Combinations (ASU 2017-01). The new standard is intended to clarify the definition of a business and requires an entity to evaluate if substantially all of the fair value of the gross assets acquired is concentrated in a single identifiable asset or a group of similar identifiable assets. If so, the set of transferred assets and activities is not considered to be a business under ASU 2017-01. ASU 2017-01 also requires a business to include at least one substantive process and narrows the definition of business outputs. The new standard will be effective on January 1, 2018, and early adoption is permitted with prospective application to any business development transaction. The Company is currently evaluating the expected impact of this standard, but does not expect it to have a material impact on its consolidated financial statements upon adoption.
In November 2016, the FASB issued ASU No. 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash (ASU 2016-18). The new standard is intended to reduce diversity in practice by adding or clarifying guidance on classification and presentation of changes in restricted cash on the statement of cash flows. ASU 2016-18 is effective for annual and interim fiscal reporting periods beginning after December 15, 2017, and early adoption is permitted. The Company is currently evaluating the expected impact of this standard, but does not expect it to have a material impact on its consolidated financial statements upon adoption.
In October 2016, the FASB issued ASU No. 2016-16, Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other than Inventory (ASU 2016-16). The new standard eliminates the exception that allowed the income tax consequences of an intra-entity transfer of assets other than inventory to be deferred until the transferred asset was sold to a third party or otherwise recovered through use, and now requires recognition of such income tax consequences at the time the non-inventory asset is transferred. ASU 2016-16 is effective for annual and interim fiscal reporting periods beginning after December 15, 2017, and early adoption is permitted. The Company is currently evaluating the expected impact of this standard, but does not expect it to have a material impact on its consolidated financial statements upon adoption.
In August 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments (ASU 2016-15). The new standard amended the existing accounting standards for the Statement of Cash Flows and provides guidance on eight specific cash flow issues. ASU 2016-15 is effective for annual and interim fiscal reporting periods beginning after December 15, 2019, and early adoption is permitted. The Company is currently evaluating the expected impact of this standard but does not expect it to have a material impact on its consolidated financial statements upon adoption.
In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (ASU 2016-13). The new standard requires entities to use a current expected credit loss model, which is a new impairment model based on expected losses rather than incurred losses. Under this model, an entity would recognize an impairment allowance equal to its current estimate of all contractual cash flows that the entity does not expect to collect. The entity’s estimate would consider relevant information about past events, current conditions, and reasonable and supportable forecasts. ASU 2016-13 is effective for annual and interim fiscal reporting periods beginning after December 15, 2019, with early adoption permitted for annual reporting periods beginning after December 15, 2018. The Company is currently evaluating the expected impact of this standard but does not expect it to have a material impact on its consolidated financial statements upon adoption.
In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842) (ASU 2016-02). The new standard requires lessees to recognize most leases on their balance sheets but continue to recognize lease expenses in their income statement in a manner similar to current practice. The new standard states that a lessee will recognize a lease liability for the obligation to make lease payments and a right-of-use asset for the right to use the underlying asset for the lease term. Expense related to leases determined to be operating leases will be recognized on a straight-line basis, while those determined to be financing leases will be recognized following a front-loaded expense profile in which interest and amortization are presented separately in the income statement. ASU 2016-02 is effective for annual and interim fiscal reporting periods beginning after December 15, 2018, and early application is permitted. The Company is currently evaluating the expected impact of this standard on its consolidated financial statements, but anticipates that, among other things, the required recognition of a lease liability and related right-of-use asset will significantly increase both the assets and liabilities recognized and reported on its balance sheet.

14
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MASIMO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(unaudited)

In addition, the Company anticipates that the classification of certain leases for which the Company is the lessor may change under the new guidance, resulting in the immediate expensing of certain costs that are currently deferred and expensed over the life of the lease. The Company currently expects to complete its assessment of the full financial impact of the new lease accounting guidance during the next six to twelve months and has not yet finalized any decision related to the timing of adoption for this guidance.
In January 2016, the FASB issued ASU No. 2016-01, Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities, (ASU 2016-01). The new standard requires that (i) all equity investments, other than equity-method investments, in unconsolidated entities generally be measured at fair value in net income and (ii) changes in fair value due to instrument-specific credit risk be recognized separately in other comprehensive income when the fair value option has been elected for financial liabilities. ASU 2016-01 is effective for annual and interim fiscal reporting periods beginning after December 15, 2017. The Company is currently evaluating the expected impact of this standard but does not expect it to have a material impact on its consolidated financial statements upon adoption.
In May 2014, the FASB issued ASU No. 2014-09, Revenue (Topic 606): Revenue from Contracts with Customers (ASU 2014-09). The new standard provides a single, principles-based five-step model to be applied to all contracts with customers while enhancing disclosures about revenue, providing additional guidance for transactions that were not previously addressed comprehensively and improving guidance for multiple-element arrangements. ASU 2014-09 will replace most existing revenue recognition guidance under GAAP when it becomes effective. The standard permits the use of either the retrospective or cumulative effect transition method upon adoption. In August 2015, the FASB issued ASU No. 2015-14, Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date, which amended ASU 2014-09, providing for a one year deferral period for the implementation of ASU 2014-09. ASU 2014-09 will now be effective for annual and interim periods beginning on or after December 15, 2017. In March 2016, the FASB issued ASU No. 2016-08, Revenue from Contracts with Customers: Principal versus Agent Considerations under FASB ASC Topic 606, which provides guidance on principal versus agent considerations. In April 2016, the FASB issued ASU No. 2016-10, Revenue from Contracts with Customers (Topic 606) – Identifying Performance Obligations and Licensing, which amended ASU 2014-09 by providing clarity in identifying performance obligations and licensing implementation guidance. In May 2016, the FASB issued ASU No. 2016-12, Revenue from Contracts with Customers (Topic 606) – Narrow-Scope Improvements and Practical Expedients, which further amended ASU 2014-09 by providing additional clarity in recognizing revenue from contracts that have been modified prior to the transition period to the new standard, as well as providing additional disclosure requirements for businesses and other organizations that make the transition to the new standard by adjusting amounts from prior reporting periods via retrospective application. In December 2016, the FASB issued ASU No. 2016-20, Technical Corrections and Improvements to Topic 606, Revenue from Contracts with Customers (ASU 2016-20). ASU 2016-20 affects narrow aspects of ASC Topic 606, including contract modifications, contract costs, and the balance sheet classification of items as contract assets versus receivables. The Company is continuing to evaluate the expected impact of the new revenue guidance contained in ASC Topic 606 on its consolidated financial statements and anticipates, among other things, that the adoption of such standard will result in the acceleration of certain revenue from product sales to distributors that is currently deferred under the “sell-through” method, as well as the capitalization and deferral of certain contract-related costs that are currently expensed when incurred. The Company currently expects to complete its assessment of the full financial impact of the new revenue recognition guidance, including the method of adoption, during the next three to five months and to adopt the guidance when it becomes effective for the Company on December 31, 2017 (fiscal year 2018).
3. Variable Interest Entity (VIE)
The Company follows authoritative guidance for the consolidation of a VIE, which requires an enterprise to determine whether its variable interest gives it a controlling financial interest in a VIE. Determination about whether an enterprise should consolidate a VIE is required to be evaluated continuously as changes to existing relationships or future transactions may result in consolidating or deconsolidating the VIE.
Cercacor is an independent entity that was spun off from the Company to its stockholders in 1998. Joe Kiani, the Company’s Chairman and Chief Executive Officer (CEO), is also the Chairman and CEO of Cercacor. The Company is a party to a Cross-Licensing Agreement with Cercacor, which was most recently amended and restated effective January 1, 2007 (the Cross-Licensing Agreement), that governs each party’s rights to certain intellectual property held by the two companies. The Company is also a party to various other agreements with Cercacor.

15
Table of Contents
MASIMO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(unaudited)

As a result of changes in the capital structure of Cercacor, as well as certain of its contractual relationships with the Company, the Company completed a re-evaluation of the authoritative consolidation guidance during the first quarter of 2016 and determined that although Cercacor remained a VIE, the Company was no longer its primary beneficiary as it could no longer be deemed to have the power to direct the activities of Cercacor that most significantly impact Cercacor’s economic performance and had no obligation to absorb Cercacor’s losses pursuant to the Company’s on-going contractual relationships with Cercacor. Based on such determination, the Company discontinued consolidating Cercacor within its consolidated financial statements effective as of January 3, 2016. However, Cercacor continues to be a related party following its deconsolidation. The Company recognized a gain of $0.3 million upon such deconsolidation, which has been reported within non-operating income in the accompanying condensed consolidated statement of operations. See Note 4 to these condensed consolidated financial statements for a description of the Company’s continuing business relationships with Cercacor.
4. Related Party Transactions
The Company’s Chairman and CEO is also the Chairman and CEO of Cercacor. The Company is a party to the following agreements with Cercacor:
•
Cross-Licensing Agreement - The Company and Cercacor are parties to the Cross-Licensing Agreement, which governs each party’s rights to certain intellectual property held by the two companies. The Company is subject to certain annual minimum aggregate royalty obligations for use of the rainbow® licensed technology. The current annual minimum royalty obligation is $5.0 million. Actual aggregate royalty liabilities to Cercacor under the license were $1.9 million and $1.6 million for the three months ended July 1, 2017 and July 2, 2016, respectively. Actual aggregate royalty liabilities to Cercacor under the license were $3.5 million and $3.1 million for the six months ended July 1, 2017 and July 2, 2016, respectively.
•
Administrative Services Agreement - The Company is a party to an administrative services agreement with Cercacor (G&A Services Agreement), which governs certain general and administrative services that the Company provides to Cercacor. Amounts charged by the Company pursuant to the G&A Services Agreement were less than $0.1 million for each of the three and six months ended July 1, 2017 and July 2, 2016.
•
Sublease Agreement - In March 2016, the Company entered into a sublease agreement with Cercacor for approximately 16,830 square feet of excess office and laboratory space located at 40 Parker, Irvine, California (Cercacor Sublease). The Cercacor Sublease began on May 1, 2016 and expires on November 30, 2019. The Company recognized less than $0.1 million and $0.2 million in sublease income for the three and six months ended July 1, 2017, respectively. The Company recognized less than $0.1 million in sublease income for each of the three and six months ended July 2, 2016.
Net amounts due to Cercacor at each of July 1, 2017 and December 31, 2016 were $0.6 million and $0.4 million, respectively.
The Company’s CEO is also the Chairman of the Masimo Foundation for Ethics, Innovation and Competition in Healthcare (Masimo Foundation), a non-profit organization that was founded in 2010 to provide a platform for encouraging ethics, innovation and competition in healthcare. The Company’s Chief Financial Officer (CFO) is also a Director of the Masimo Foundation.
The Company’s CEO is the Chairman of both the Patient Safety Movement Foundation (PSMF), a non-profit organization that was founded in 2013 to work with hospitals, medical technology companies and patient advocates to unite the healthcare ecosystem and eliminate the more than 200,000 U.S. preventable hospital deaths that occur every year by 2020, and the Patient Safety Movement Coalition (PSMC), a not-for-profit social welfare organization that was founded in 2013 to promote patient safety legislation. The Company’s CFO serves as the Treasurer and Secretary of PSMF, as well as the Secretary of PSMC.
The Company’s CEO also serves on the board of directors of Atheer Labs, which is working with the Company on the development of next generation Root® applications, and the board of directors of Children’s Hospital of Orange County and CHOC Children’s at Mission Hospital, two non-profit hospitals devoted exclusively to caring for children, both of which are also customers of the Company.

16
Table of Contents
MASIMO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(unaudited)

5. Inventories
Inventories consist of the following (in thousands):
 
July 1,
2017
 
December 31,
2016
Raw materials
$
42,562

 
$
32,647

Work-in-process
6,755

 
7,701

Finished goods
39,141

 
32,194

     Total inventories
$
88,458

 
$
72,542

6. Other Current Assets
Other current assets consist of the following (in thousands):
 
July 1,
2017
 
December 31,
2016
Prepaid income taxes
$
16,493

 
$
981

Prepaid expenses
12,941

 
13,051

Royalties receivable
8,000

 
7,500

Employee loans and advances
325

 
305

Due from related party
21

 
77

Other current assets
4,149

 
5,134

     Total other current assets
$
41,929

 
$
27,048

7. Property and Equipment
Property and equipment, net, consists of the following (in thousands):
 
July 1,
2017
 
December 31,
2016
Building and building improvements
$
86,015

 
$
85,966

Machinery and equipment
43,737

 
41,683

Land
23,762

 
23,762

Leasehold improvements
14,908

 
8,289

Computer equipment
14,199

 
13,549

Tooling
13,485

 
12,895

Furniture and office equipment
10,719

 
9,669

Demonstration units
467

 
448

Vehicles
45

 
45

Construction-in-progress
5,654

 
7,923

     Total property and equipment
212,991

 
204,229

Accumulated depreciation and amortization
(75,268
)
 
(68,233
)
     Property and equipment, net
$
137,723

 
$
135,996

For the six months ended July 1, 2017 and July 2, 2016, depreciation expense of property and equipment was $7.0 million and $6.3 million, respectively.

17
Table of Contents
MASIMO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(unaudited)

8. Intangible Assets
Intangible assets, net, consist of the following (in thousands):
 
July 1,
2017
 
December 31,
2016
Patents
$
20,275

 
$
19,950

Customer relationships
7,669

 
7,669

Licenses
7,500

 
7,500

Acquired technology
5,580

 
5,580

Trademarks
3,916

 
3,777

Capitalized software development costs
2,539

 
2,539

Other
3,680

 
3,674

     Total intangible assets
51,159

 
50,689

Accumulated amortization
(23,060
)
 
(21,313
)
     Intangible assets, net
$
28,099

 
$
29,376

Total amortization expense for the six months ended July 1, 2017 and July 2, 2016 was $2.5 million and $1.8 million, respectively. All of these intangible assets have a 10 year weighted average amortization period.

Estimated amortization expense for future fiscal years is as follows (in thousands):
Fiscal year
Amount
2017 (balance of year)
$
5,244

2018
4,656

2019
3,574

2020
3,259

2021
2,482

Thereafter
8,884

     Total
$
28,099

9. Accrued and Other Current Liabilities
Accrued and other current liabilities consist of the following (in thousands):
 
July 1,
2017
 
December 31,
2016
Contract related payables
$
14,522

 
$
10,673

Income taxes payable
4,848

 
76,316

Accrued customer rebates, fees and reimbursements
4,225

 
3,893

Accrued taxes
4,205

 
5,135

Accrued legal fees
1,510

 
1,362

Accrued warranty
1,026

 
910

Related party payable
670

 
525

Accrued donations
493

 
503

Other
5,178

 
5,337

     Total accrued and other current liabilities
$
36,677

 
$
104,654


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MASIMO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(unaudited)

10. Restated Credit Facility
In January 2016, the Company entered into an Amended and Restated Credit Agreement (Restated Credit Facility) with JPMorgan Chase Bank, N.A., as Administrative Agent and a Lender, Bank of America, N.A., as Syndication Agent and a Lender, Citibank, N.A., as Documentation Agent and a Lender, and various other Lenders (collectively, the Lenders). The Restated Credit Facility currently provides for up to $250.0 million in borrowings in multiple currencies, with an option, subject to certain conditions, for the Company to increase the aggregate borrowing capacity to up to $350.0 million in the future. All unpaid principal under the Restated Credit Facility will become due and payable on January 8, 2021.
Borrowings under the Restated Credit Facility will be deemed, at the Company’s election, either: (i) an Alternate Base Rate (ABR) Loan, which bears interest at the ABR plus a spread (ABR Spread) based upon a Company leverage ratio, or (ii) a Eurodollar Loan, which bears interest at the Adjusted LIBO Rate (as defined below) plus a spread (Eurodollar Spread) based upon a Company leverage ratio. The ABR Spread is 0.125% to 1.00% and the Eurodollar Spread is 1.125% to 2.0%. Subject to certain conditions, the Company may also request swingline loans from time to time (Swingline Loans) that bear interest similar to an ABR Loan.
The ABR is determined by taking the greatest of (i) the prime rate, (ii) the federal funds effective rate plus 0.50%, and (iii) the one-month Adjusted LIBO Rate plus 1.0%. The Adjusted LIBO Rate is equal to LIBOR for the applicable interest period multiplied by the statutory reserve rate for such period.
The Company is obligated under the Restated Credit Facility to pay a fee ranging from 0.175% to 0.300% per annum, based upon a Company leverage ratio, with respect to any unused portion of the line of credit. This fee and interest on any ABR Loan are due and payable quarterly in arrears. Interest on any Eurodollar Loan is due and payable at the end of the applicable interest period (or at each three month interval in the case of loans with interest periods greater than three months). Interest on any Swingline Loan is due and payable on the date that the Swingline Loan is required to be repaid. The Company may prepay the loans and terminate the commitments in whole at any time, without premium or penalty, subject to reimbursement of certain costs in the case of Eurodollar Loans.
Pursuant to the terms of the Restated Credit Facility, the Company is subject to certain covenants, including financial covenants related to a leverage ratio and an interest charge coverage ratio, and other customary negative covenants. The Company’s obligations under the Restated Credit Facility are secured by substantially all of the Company’s personal property, including certain equity interests in U.S. domestic and first-tier foreign subsidiaries.
As of July 1, 2017, the Restated Credit Facility had no outstanding draws and outstanding standby letters of credit totaling $0.3 million. The Company incurred interest expense related to the Restated Credit Facility of $0.3 million and $1.2 million for the six months ended July 1, 2017 and July 2, 2016, respectively. The Company was in compliance with all covenants under the Restated Credit Facility as of July 1, 2017.
11. Other Non-Current Liabilities
Other non-current liabilities consist of the following (in thousands):
 
July 1,
2017
 
December 31,
2016
Unrecognized tax benefit
$
14,308

 
$
13,442

Deferred rent, long-term
1,328

 
558

Deferred tax liability, long-term
339

 
340

Other
293

 
247

     Total other non-current liabilities
$
16,268

 
$
14,587

Unrecognized tax benefit relates to the Company’s long-term portion of tax liability associated with uncertain tax positions. Authoritative guidance prescribes a recognition threshold and a measurement attribute for the financial statement recognition and measurement of tax positions taken or expected to be taken in a tax return. See Note 16 to these condensed consolidated financial statements for further details.

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Table of Contents
MASIMO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(unaudited)

12. Stock Repurchase Program
In September 2015, the Company’s Board of Directors (Board) authorized a stock repurchase program, whereby the Company may purchase up to 5.0 million shares of its common stock over a period of up to three years (2015 Repurchase Program). The 2015 Repurchase Program may be carried out at the discretion of a committee comprised of the Company’s Chief Executive Officer and Chief Financial Officer through open market purchases, one or more Rule 10b5-1 trading plans, block trades and privately negotiated transactions. The total remaining shares authorized for repurchase under the 2015 Repurchase Program approximated 2.9 million shares as of July 1, 2017. The Company expects to fund the 2015 Repurchase Program through its available cash, future cash from operations, funds available under the Restated Credit Facility or other potential sources of capital.
13. Stock-Based Compensation
The total stock-based compensation expense for the six months ended July 1, 2017 and July 2, 2016 was $6.1 million and $6.2 million, respectively. As of July 1, 2017, an aggregate of 14.5 million shares of common stock were reserved for future issuance under the Company’s equity plans, of which 4.6 million shares were available for future grant under the Masimo Corporation 2017 Equity Incentive Plan (2017 Equity Plan). Additional information related to the Company’s current equity incentive plans, stock-based award activity and valuation of stock-based awards is included below.
Equity Incentive Plans
2017 Equity Incentive Plan
On June 1, 2017, the Company’s stockholders ratified and approved the 2017 Equity Plan. The 2017 Equity Plan permits the grant of stock options, restricted stock, restricted stock units (RSUs), stock appreciation rights, performance share units (PSUs), performance shares, performance bonus awards and other stock or cash awards to employees, directors and consultants of the Company and employees and consultants of any parent or subsidiary of the Company. The aggregate number of shares that may be awarded under the 2017 Equity Plan is 5.0 million shares.
The 2017 Equity Plan provides that equity awards issued under the 2017 Equity Plan must generally vest over a period of not less than one year following the date of grant. The exercise price per share of each option granted under the 2017 Equity Plan may not be less than the fair market value of a share of the Company’s common stock on the date of grant, which is generally equal to the closing price of the Company’s common stock on the NASDAQ Global Select Market on the grant date.
2007 Stock Incentive Plan
Effective June 1, 2017, upon the approval and ratification of the 2017 Equity Plan, the Company’s 2007 Stock Incentive Plan (2007 Equity Plan) terminated, provided that awards outstanding under the 2007 Equity Plan will continue to be governed by the terms of that plan. In addition, upon the effectiveness of the 2017 Equity Plan, an aggregate of 5.0 million shares of the Company’s common stock registered under prior registration statements for issuance pursuant to the 2007 Equity Plan were deregistered and concurrently registered under the 2017 Equity Plan.
Stock-Based Award Activity
Stock Options
The number and weighted-average exercise price of options issued and outstanding under all of the Company’s equity plans are as follows (in thousands, except for exercise prices):
 
Six Months Ended 
 July 1, 2017
 
Shares
 
Average
Exercise Price
Options outstanding, beginning of period
8,521

 
$
28.56

Granted
281

 
88.64

Canceled
(109
)
 
32.03

Exercised
(1,745
)
 
27.58

Options outstanding, end of period
6,948

 
$
31.19

Options exercisable, end of period
4,082

 
$
26.42


20
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MASIMO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(unaudited)

Total stock option expense for the three and six months ended July 1, 2017 was $2.5 million and $5.5 million, respectively. As of July 1, 2017, the Company had $28.7 million of unrecognized compensation cost related to non-vested stock options that are expected to vest over a weighted average period of approximately 3.4 years. The weighted-average remaining contractual term of options outstanding with an exercise price less than the closing price of the Company’s common stock as of July 1, 2017 was 5.9 years. The weighted-average remaining contractual term of options exercisable, with an exercise price less than the closing price of the Company’s common stock as of July 1, 2017 was 4.5 years.
RSUs
The number of RSUs issued and outstanding under all of the Company’s equity plans are as follows (in thousands, except for grant date fair value amounts):
 
Six Months Ended 
 July 1, 2017
 
Units
 
Weighted Average Grant
 Date Fair Value
RSUs outstanding, beginning of period
2,706

 
$
41.45

Granted
33

 
86.42

Canceled
(25
)
 
85.79

Expired
—

 
—

Vested
(6
)
 
43.09

RSUs outstanding, end of period
2,708

 
$
41.59

Total RSU expense for the three and six months ended July 1, 2017 was $0.1 million and $0.2 million, respectively. As of July 1, 2017, the Company had $0.6 million of unrecognized compensation cost related to non-vested RSU awards expected to be recognized and vest over a weighted-average period of approximately 0.9 years.
On July 27, 2017, in connection with the First Amendment to November 4, 2015 Amended and Restated Employment Agreement (First Amendment), the Company and Mr. Kiani agreed to, among other things modify certain vesting provisions related to the previous award of 2.7 million RSUs to the Company’s Chairman and Chief Executive Officer (see “Employment and Severance Agreements” in Note 14 to these condensed consolidated financial statements for further details).
PSUs
The number of PSUs outstanding under all of the Company’s equity plans are as follows (in thousands, except for grant date fair value amounts):
 
Six Months Ended 
 July 1, 2017
 
Units
 
Weighted Average Grant
 Date Fair Value
PSUs outstanding, beginning of period
—

 
$
—

Granted
240

 
90.87

Canceled
—

 
—

Expired
—

 
—

Vested
—

 
—

PSUs outstanding, end of period
240

 
$
90.87

During the second quarter of 2017, the Company awarded 240,000 PSUs that will vest in part over time based on the achievement of certain 2017 performance criteria approved by the Board. If earned, 20% of the PSUs granted will vest upon achievement of the performance criteria and the remaining award will vest in equal installments at the beginning of each of the following four years after the year in which the performance achievement level has been determined. The number of shares that may be earned can range from 0% to 100% of the target amount; therefore, the maximum number of shares that can be issued under these awards is 240,000. Total PSU expense for both the three and six months ended July 1, 2017 was $0.6 million. As of July 1, 2017, the Company had $13.9 million of unrecognized compensation cost related to non-vested PSU awards expected to be recognized and vest over a weighted-average period of approximately 2.6 years.

21
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MASIMO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(unaudited)

Valuation of Stock-Based Award Activity
The Black-Scholes option pricing model is used to estimate the fair value of options granted under the Company’s stock-based compensation plans. The range of assumptions used and the resulting weighted-average fair value of options granted at the date of grant were as follows:
 
Three Months Ended
 
Six Months Ended
 
July 1,
2017
 
July 2,
2016
 
July 1,
2017
 
July 2,
2016
Risk-free interest rate
1.8% to 2.0%
 
1.1% to 1.5%
 
1.8% to 2.2%
 
1.1% to 1.9%
Expected term (in years)
5.5
 
5.7
 
5.5
 
5.7
Estimated volatility
29.8% to 30.3%
 
31.7% to 32.8%
 
29.7% to 30.3%
 
31.7% to 35.7%
Expected dividends
0%
 
0%
 
0%
 
0%
Weighted-average fair value of options granted
$28.58
 
$14.7
 
$27.82
 
$13.24
The aggregate intrinsic value of options is calculated as the positive difference, if any, between the market value of the Company’s common stock on the date of exercise or the respective period end, as appropriate, and the exercise price of the options. The aggregate intrinsic value of options outstanding with an exercise price less than the closing price of the Company’s common stock as of July 1, 2017 was $417.0 million. The aggregate intrinsic value of options exercisable with an exercise price less than the closing price of the Company’s common stock as of July 1, 2017 was $264.4 million. The aggregate intrinsic value of options exercised during the six months ended July 1, 2017 was $108.6 million.
The fair value of each RSU and PSU award is determined based on the closing price of the Company’s common stock on the grant date, or the modification date, if any.
14. Commitments and Contingencies
Leases
The Company leases certain facilities in North and South America, Europe, the Middle East and Asia-Pacific regions under operating lease agreements expiring at various dates through November 2026. Certain facility leases contain predetermined price escalations and in some cases renewal options. The Company recognizes the lease costs using a straight-line method based on total lease payments. The Company has received leasehold improvement incentives in connection with certain leased facilities in the U.S. These leasehold improvement incentives have been recorded as deferred rent and are being amortized as a reduction to rent expense on a straight-line basis over the life of the lease. As of each of July 1, 2017 and December 31, 2016, accrued rent expense in excess of the amount paid aggregated $1.4 million and $0.7 million, respectively, which is classified within other current and non-current liabilities in the accompanying condensed consolidated balance sheets. In addition, the Company leases automobiles in the U.S. and Europe that are classified as operating leases and expire at various dates through November 2020. The majority of these leases are non-cancellable. The Company also has outstanding capital leases for office equipment and computer equipment, all of which are non-cancellable.
Future minimum lease payments, including interest, under operating and capital leases for each of the following fiscal years ending on or about December 31 are (in thousands):
 
As of July 1, 2017
 
Operating
Leases
 
Capital
Leases
 
Total
2017 (balance of year)
$
3,130

 
$
2

 
$
3,132

2018
6,017

 
—

 
6,017

2019
5,260

 
—

 
5,260

2020
3,057

 
—

 
3,057

2021
2,526

 
—

 
2,526

Thereafter
7,169

 
—

 
7,169

Total
$
27,159

 
$
2

 
$
27,161


22
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MASIMO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(unaudited)

Rental expense related to operating leases was $1.6 million and $3.2 million for the three and six months ended July 1, 2017, respectively, and $1.6 million and $3.1 million for the three and six months ended July 2, 2016, respectively. Included in the future capital lease payments as of July 1, 2017 is interest aggregating less than $0.1 million.
Employee Retirement Savings Plan
The Company sponsors a qualified defined contribution plan or 401(k) plan, the Masimo Retirement Savings Plan (MRSP), covering the Company’s full-time U.S. employees who meet certain eligibility requirements. In general, the Company matches an employee’s contribution up to 3% of the employee’s compensation, subject to a maximum amount. The Company may also contribute to the MRSP on a discretionary basis. The Company contributed $0.6 million and $1.2 million to the MRSP for the three and six months ended July 1, 2017, respectively, and $0.5 million and $1.1 million to the MRSP for the three and six months ended July 2, 2016, respectively.
In addition, the Company also sponsors various defined contribution plans in certain locations outside of the United States (Subsidiary Plans). For the three and six months ended July 1, 2017, the Company contributed $0.1 million and $0.2 million, respectively. For the three and six months ended July 2, 2016, the Company contributed $0.1 million and $0.2 million to the Subsidiary Plans, respectively.
Employment and Severance Agreements
On July 27, 2017, the Company entered into the First Amendment with Joe Kiani, the Company’s Chairman and Chief Executive Officer, which amended that certain Amended and Restated Employment Agreement entered into between the Company and Mr. Kiani on November 4, 2015 (together with the First Amendment, the Amended Employment Agreement). The First Amendment, among other things, eliminates Mr. Kiani’s eligibility for an automatic annual bonus equal to 100% of his base salary, imposes an annual cap on any annual bonus awarded by the Compensation Committee at 200% of his base salary, eliminates his guaranteed grant of 300,000 stock options in fiscal year 2017, modifies certain definitions and conditions related to Mr. Kiani’s ability to terminate his employment with the Company for “Good Reason”, and eliminates the annual 10% reduction of both: (1) the 2.7 million shares subject to the RSU award previously granted to Mr. Kiani (Award Shares) that will vest in certain circumstances, and (2) the $35.0 million cash payment (Cash Payment) that Mr. Kiani will be entitled to receive in certain circumstances.
Pursuant to the terms of the Amended Employment Agreement, upon a “Qualifying Termination” (as defined in the Amended Employment Agreement), Mr. Kiani will be entitled to receive a cash severance benefit equal to two times the sum of his then-current base salary and the average annual bonus paid to Mr. Kiani during the immediately preceding three years, the full amount of the Award Shares and the full amount of the Cash Payment. In addition, in the event of a “Change in Control” (as defined in the Amended Employment Agreement) prior to a Qualifying Termination, on each of the one year and two year anniversaries of the Change in Control, 50% of the Cash Payment and 50% of the Award Shares will vest, subject in each case to Mr. Kiani’s continuous employment through each such anniversary date; however, in the event of a Qualifying Termination or a termination of Mr. Kiani’s employment due to death or disability prior to either of such anniversaries, any unvested amount of the Cash Payment and all of the unvested Award Shares shall vest and be paid in full. Additionally, in the event of a Change in Control prior to a Qualifying Termination, Mr. Kiani’s stock options and any other equity awards will vest in accordance with their terms, but in no event later than in two equal installments on each of the one year and two year anniversaries of the Change in Control, subject in each case to Mr. Kiani’s continuous employment through each such anniversary date. As of July 1, 2017, the expense related to the Award Shares that would be recognized in the Company’s consolidated financial statements upon the occurrence of a Qualifying Termination under the Restated Employment Agreement was approximately $257.9 million.
As of July 1, 2017, the Company had severance plan participation agreements with six executive officers. The participation agreements (the Agreements) are governed by the terms and conditions of the Company’s 2007 Severance Protection Plan (the Severance Plan), which became effective on July 19, 2007 and which was amended effective December 31, 2008. Under each of the Agreements, the applicable executive officer may be entitled to receive certain salary, equity, medical and life insurance benefits if he is terminated by the Company without cause or if he terminates his employment for good reason under certain circumstances. The executive officers are also required to give the Company six months advance notice of their resignation under certain circumstances.

23
Table of Contents
MASIMO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(unaudited)

Purchase Commitments
Pursuant to contractual obligations with vendors, the Company had $77.9 million of purchase commitments as of July 1, 2017, which are expected to be purchased within one year. These purchase commitments have been made for certain inventory items in order to secure sufficient levels of those items and to achieve better pricing.
Other Contractual Commitments
In the normal course of business, the Company may provide bank guarantees to support government hospital tenders in certain foreign jurisdictions. As of July 1, 2017, the Company had approximately $0.3 million in unsecured bank guarantees.
In certain circumstances, the Company also provides limited indemnification within its various customer contracts whereby the Company indemnifies the parties to whom it sells its products with respect to potential infringement of intellectual property, and against bodily injury caused by a defective Company product. It is not possible to predict the maximum potential amount of future payments under these or similar agreements, due to the conditional nature of the Company’s obligations and the unique facts and circumstances involved. As of July 1, 2017, the Company had not incurred any significant costs related to contractual indemnification of its customers.
Concentrations of Risk
The Company is exposed to credit loss for the amount of its cash deposits with financial institutions in excess of federally insured limits. The Company invests its excess cash in time deposits with major financial institutions. As of July 1, 2017, the Company had $331.4 million of bank balances, of which $3.1 million was covered by either the U.S. Federal Deposit Insurance Corporation limit or foreign countries’ deposit insurance organizations.
While the Company and its contract manufacturers rely on sole source suppliers for certain components, steps have been taken to minimize the impact of a shortage or stoppage of shipments, such as maintaining a safety stock of inventory and designing products that could be modified to use different components. However, there can be no assurance that a shortage or stoppage of shipments of the materials or components that the Company purchases will not result in a delay in production or adversely affect the Company’s business.
The Company’s ability to sell its products to U.S. hospitals depends in part on its relationships with GPOs. Many existing and potential customers for the Company’s products become members of GPOs. GPOs negotiate pricing arrangements and contracts, sometimes exclusively, with medical supply manufacturers and distributors, and these negotiated prices are made available to a GPO’s affiliated hospitals and other members. During the three and six months ended July 1, 2017, revenue from the sale of the Company’s products to U.S. hospitals that are members of GPOs amounted to $105.6 million and $205.3 million, respectively, and for the three and six months ended July 2, 2016, revenue from the sale of the Company’s products to U.S. hospitals that are members of GPOs amounted to $93.3 million and $185.3 million, respectively.
For the three months ended July 1, 2017, the Company had sales through two just-in-time distributors that represented 13.3% and 11.3% of total revenue, respectively. For the three months ended July 2, 2016, the Company had sales through the same two just-in-time distributors that represented 14.8% and 12.7% of total revenue, respectively. For the six months ended July 1, 2017, the Company had sales through two just-in-time distributors that represented 13.7% and 11.7% of total revenue, respectively. For the six months ended July 2, 2016, the Company had sales through the same two just-in-time distributors that represented 15.4% and 11.9% of total revenue, respectively.
As of July 1, 2017, two just-in-time distributors represented 8.3% and 5.0% of the Company’s accounts receivable balance. As of December 31, 2016, two different just-in-time distributors represented 7.5% and 5.6% of the Company’s accounts receivable balance, respectively.
For the six months ended July 1, 2017 and July 2, 2016, the Company recorded $18.3 million and $15.9 million, respectively, in royalty revenues from Medtronic. In exchange for these royalty payments, the Company has provided Medtronic the ability to ship its patent infringing product with a covenant not to sue Medtronic as long as Medtronic abides by the terms of the settlement agreement between the companies.

24
Table of Contents
MASIMO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(unaudited)

Litigation
On July 26, 2017, a patent infringement complaint was filed against the Company in the U.S. District Court for the District of Delaware by Silkeen, LLC. The complaint alleges that the Company’s pulse oximetry products infringe certain claims of U.S. Patent No. 7,944,469 titled “System and Method for Using Self-Learning Rules to Enable Adaptive Security Monitoring.”
The Company believes it has good and substantial defenses to the claims, but there is no guarantee the Company will prevail. The Company is unable to determine whether any loss will ultimately occur or to estimate the range of such loss; therefore, no amount of loss has been accrued by the Company in the accompanying condensed consolidated financial statements. The Company’s policy is and has been not to settle patent infringement claims where it does not believe there is infringement of a valid patent, even if the cost of litigation would exceed the cost of settlement.
On January 2, 2014, a putative class action complaint was filed against the Company in the U.S. District Court for the Central District of California by Physicians Healthsource, Inc. (PHI). The complaint alleges that the Company sent unsolicited facsimile advertisements in violation of the Junk Fax Protection Act of 2005 and related regulations. The complaint seeks $500 for each alleged violation, treble damages if the District Court finds the alleged violations to be knowing, plus interest, costs and injunctive relief. On April 14, 2014, the Company filed a motion to stay the case pending a decision on a related petition filed by the Company with the Federal Communications Commission (FCC). On May 22, 2014, the District Court granted the motion and stayed the case pending a ruling by the FCC on the petition. On October 30, 2014, the FCC granted some of the relief and denied some of the relief requested in the Company’s petition. Both parties appealed the FCC’s decision on the petition. On November 25, 2014, the District Court granted the parties’ joint request that the stay remain in place pending a decision on the appeal. On March 31, 2017, the D.C. Circuit Court of Appeals vacated and remanded the FCC’s decision, holding that the applicable FCC rule was unlawful to the extent it requires opt-out notices on solicited faxes. The stay of the District Court litigation has not yet been lifted. On April 28, 2017, PHI filed a petition seeking rehearing by the D.C. Circuit Court of Appeals. The D.C. Circuit Court of Appeals denied the requested rehearing on June 6, 2017. The plaintiffs have stated that they intend to file a petition to the United States Supreme Court seeking review of the D.C. Circuit Court of Appeals’ opinion. The Company believes it has good and substantial defenses to the claims in the District Court litigation, but there is no guarantee that the Company will prevail. The Company is unable to determine whether any loss will ultimately occur or to estimate the range of such loss; therefore, no amount of loss has been accrued by the Company in the accompanying condensed consolidated financial statements.
On January 31, 2014, an amended putative class action complaint was filed against the Company in the U.S. District Court for the Northern District of Alabama by and on behalf of two participants in the Surfactant, Positive Pressure, and Oxygenation Randomized Trial at the University of Alabama. On April 21, 2014, a further amended complaint was filed adding a third participant. The complaint alleges product liability and negligence claims in connection with pulse oximeters the Company modified and provided at the request of study investigators for use in the trial. On August 13, 2015, the U.S. District Court for the Northern District of Alabama granted summary judgment in favor of the Company on all claims. The plaintiffs have appealed the U.S. District Court for the Northern District of Alabama’s decision. The appellate hearing before the Eleventh Circuit Court of Appeals was held on December 13, 2016, and the parties are awaiting a decision. On July 7, 2017, the Eleventh Circuit Court of Appeals (Eleventh Circuit) issued a Certification to the Supreme Court of Alabama seeking guidance on a legal question. In that Certification, the Eleventh Circuit stated that the plaintiffs failed to establish that participation in the clinical study caused any injuries, and that the negligence, negligence per se, breach of fiduciary duty and products liability claims, which includes the claims currently alleged against the Company, were properly dismissed. The Company is unable to determine whether any loss will ultimately occur or to estimate the range of such loss; therefore, no amount of loss has been accrued by the Company in the accompanying consolidated financial statements.
From time to time, the Company may be involved in other litigation and investigations relating to claims and matters arising out of its operations in the normal course of business. The Company believes that it currently is not a party to any other legal proceedings which, individually or in the aggregate, would have a material adverse effect on its condensed consolidated financial position, results of operations or cash flows.

25
Table of Contents
MASIMO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(unaudited)

15. Segment Information and Enterprise Reporting
The Company’s chief decision maker, the Chief Executive Officer, reviews financial information presented on a consolidated basis, accompanied by disaggregated information about revenues by geographic region, for purposes of making operating decisions and assessing financial performance. Accordingly, the Company considers itself to be in a single reporting segment, specifically noninvasive patient monitoring solutions and related products. The Company does not assess the performance of its geographic regions on other measures of income or expense, such as depreciation and amortization, operating income or net income including noncontrolling interest. In addition, the Company’s assets are primarily located in the U.S. The Company does not produce reports for, or measure the performance of, its geographic regions on any asset-based metrics. Therefore, geographic information is presented only for revenues and long-lived assets.
The following schedule presents an analysis of the Company’s product revenues based upon the geographic area to which the product was shipped (in thousands, except percentages):
 
 
Three Months Ended
 
Six Months Ended
 
 
July 1, 2017
 
July 2, 2016
 
July 1, 2017
 
July 2, 2016
Geographic area by destination:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
United States
 
$
126,455

 
69.2
%
 
$
117,045

 
71.1
%
 
$
251,137

 
69.6
%
 
$
230,549

 
70.3
%
Europe, Middle East and Africa
 
33,693

 
18.4

 
25,988

 
15.8

 
64,195

 
17.8

 
57,958

 
17.7

Asia and Australia
 
16,988

 
9.3

 
16,602

 
10.1

 
33,724

 
9.3

 
30,184

 
9.2

North and South America (excluding United States)
 
5,666

 
3.1

 
4,972

 
3.0

 
11,843

 
3.3

 
9,206

 
2.8

     Total product revenue
 
$
182,802

 
100.0
%
 
$
164,607

 
100.0
%
 
$
360,899

 
100.0
%
 
$
327,897

 
100.0
%
The Company’s consolidated long-lived assets (total non-current assets excluding deferred taxes, goodwill and intangible assets) by geographic area are (in thousands, except percentages):
 
 
July 1, 2017
 
December 31, 2016
Long-lived assets by geographic area:
 
 
 
 
 
 
 
 
United States
 
$
232,208

 
95.9
%
 
$
216,784

 
96.3
%
International
 
9,967

 
4.1

 
8,383

 
3.7

     Total
 
$
242,175

 
100.0
%
 
$
225,167

 
100.0
%
16. Income Taxes
The Company has provided for income taxes in fiscal 2017 interim periods based on the estimated effective income tax rate for the complete fiscal year and adjusted for discrete tax events, including excess tax benefits or deficiencies related to stock-based compensation, in the period such events occur. The income tax provision is computed on the estimated pretax income of the consolidated entities located within each taxing jurisdiction based on legislation enacted as of the balance sheet date. For the six months ended July 1, 2017 and July 2, 2016, the Company recorded discrete tax benefits of approximately $30.2 million and $5.1 million, respectively, related to excess tax benefits realized from stock-based compensation.
Deferred tax assets and liabilities are determined based on the future tax consequences associated with temporary differences between income and expenses reported for accounting and tax purposes. A valuation allowance for deferred tax assets is recorded to the extent that the Company cannot determine that the ultimate realization of the net deferred tax assets is more likely than not. Realization of deferred tax assets is principally dependent upon the achievement of future taxable income, the estimation of which requires significant judgment by the Company’s management. The judgment of the Company’s management regarding future profitability may change due to many factors, including future market conditions and the Company’s ability to successfully execute its business plans or tax planning strategies. These changes, if any, may require material adjustments to these deferred tax asset balances.

26
Table of Contents
MASIMO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(unaudited)

As of July 1, 2017, the liability for income taxes associated with uncertain tax positions was approximately $15.3 million. If fully recognized, approximately $13.8 million (net of federal benefit on state taxes) would impact the Company’s effective tax rate. The remaining balance relates to timing differences. It is reasonably possible that the amount of unrecognized tax benefits in various jurisdictions may change in the next twelve months due to the expiration of statutes of limitation and audit settlements. However, due to the uncertainty surrounding the timing of these events, an estimate of the change within the next twelve months cannot currently be made.
The Company conducts business in multiple jurisdictions and, as a result, one or more of the Company’s subsidiaries files income tax returns in U.S. federal, various state, local and foreign jurisdictions. The Company has concluded all U.S. federal income tax matters through fiscal year 2011. All material state, local and foreign income tax matters have been concluded through fiscal year 2009. The Company does not believe that the results of any tax authority examination would have a significant impact on its consolidated financial statements.

27
Table of Contents

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 31, 2016, which we filed with the SEC on February 15, 2017. 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 original equipment manufacturer (OEM) partners to hospitals, emergency medical service providers, physician offices, veterinarians, long-term care facilities and consumers. Our mission is to improve patient outcomes and reduce the cost of care. We were incorporated in California in May 1989 and reincorporated in Delaware in May 1996.
Our core business is Measure-through Motion and Low Perfusion™ pulse oximetry monitoring, known as Masimo Signal Extraction Technology® (SET®) pulse oximetry. Our product offerings have expanded significantly over the years to also include monitoring blood constituents with an optical signature, optical organ oximetry monitoring, electrical brain function monitoring, acoustic respiration monitoring, exhaled gas monitoring, patient monitoring with connectivity platforms, bedside and portable patient monitors and wearable wireless patient monitors. We have also developed a remote patient surveillance monitoring system, Patient SafetyNet, which currently allows up to 200 patients to be monitored simultaneously and remotely through a PC-based viewing station or by care providers through their pagers, voice-over-IP phones or smartphones.
Masimo SET® was designed to overcome the primary limitations of conventional pulse oximetry by maintaining accuracy in the presence of motion artifact, low perfusion and weak signal-to-noise situations. Pulse oximetry is the noninvasive measurement of the oxygen saturation level of arterial blood, which delivers oxygen to the body’s tissues, and pulse rate. Pulse oximetry is one of the most common measurements taken inside and outside of hospitals around the world. We believe that Masimo SET® is trusted by clinicians to safely monitor approximately 100 million patients each year. Masimo SET® pulse oximetry has been shown by more than 100 independent studies and thousands of clinical evaluations during patient motion and low-perfusion conditions to provide more accurate measurements than other non-Masimo pulse oximeters, as well as to significantly reduce false alarms (specificity) and accurately detect true alarms (sensitivity) that can indicate a deteriorating patient condition. The use of Masimo SET® pulse oximetry has also been shown to improve patient outcomes by helping clinicians reduce retinopathy of prematurity in neonates, screen newborns for critical congenital heart disease, 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 within medical-surgical units.
Our rainbow SET™ platform leverages Masimo SET® technology and incorporates licensed rainbow® technology to provide additional continuous noninvasive measurements. Our rainbow SET™ platform includes our rainbow® Pulse CO-Oximetry products, which we believe are the first devices cleared by the U.S. Food and Drug Administration (FDA) to noninvasively and continuously monitor multiple blood-based measurements using multiple wavelengths of light, which previously was only possible through intermittent invasive procedures. In addition to monitoring oxygen saturation (SpO2), pulse rate (PR), perfusion index (Pi), Pleth Variability Index (PVi®) and Respiration Rate (RRa®), rainbow SET™ Pulse CO-Oximetry has the ability to provide noninvasive monitoring of total hemoglobin (SpHb®), carboxyhemoglobin (SpCO®) and methemoglobin

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(SpMet®), as well as the calculation of Oxygen Content (SpOC™). The rainbow SET™ platform also allows for monitoring of arterial oxygen saturation, even under the presence of carboxyhemoglobin and methemoglobin, known as fractional arterial oxygen saturation (SpfO2™), Respiration Rate from the Pleth (RRp®),Oxygen Reserve Index™ (ORi™) and Rainbow Pleth Variability Index (RPVi™). Although SpfO2™, RRp®, RPVi™ and ORi™ have received the CE Mark, they are not currently available for sale in the U.S.
In March 2017, we announced the CE Mark of our noninvasive blood pressure (NIBP) measurements for the Rad-97™ Pulse Co-Oximeter® and connectivity hub. Rad-97™ with NIBP enables clinicians to measure arterial blood pressure for adult, pediatric and neonatal patients, with three measurement modes: spot-check, automatic interval (which measures blood pressure routinely, at a desired interval) and stat interval (which continually measures blood pressure for a desired duration). An integrated port allows clinicians to connect a blood pressure cuff inflation hose directly to Rad-97™, and is compatible with both disposable and reusable cuffs, for a variety of patient types, designed for reliability and patient comfort.
In May 2017, we announced the introduction of Rad-G™, a combined pulse oximeter designed primarily for use in pneumonia screening and spot-checking of oxygen saturation (SpO2) in low-resource settings. The Rad-G™ is a low-cost, rugged, handheld pulse oximetry device with a rechargeable battery and LCD display. It uses Measure-through Motion and Low Perfusion™ SET® pulse oximetry technology to measure SpO2, RRp®, PR and Pi. The Rad-G™ is not currently available for sale in the U.S.
In June 2017, we announced the limited market release of the Spot-Check Rad-67™ Handheld Pulse CO-Oximeter®. Rad-67™ offers Measure-through Motion and Low Perfusion™ SET® pulse oximetry and upgradeable rainbow® noninvasive monitoring technology in a compact, portable spot-check device. With the universal reusable rainbow® DCI®-mini sensor, Rad-67™ features Next Generation SpHb® technology. The Rad-67™ has received the CE Mark, but is not currently available for sale in the U.S.
Following the introduction of our rainbow SET™ platform, we have continued to expand our technology offerings by introducing additional noninvasive measurements and technologies to create new market opportunities in both the hospital and non-hospital care settings. These offerings include:
•
SedLine® - Brain function monitoring is most commonly used during surgery to help clinicians monitor sedation under anesthesia. SedLine® brain function monitoring technology measures the brain’s electrical activity by detecting electroencephalogram (EEG) signals. In contrast to whole-scalp EEG monitoring, which is used for diagnostic purposes, this form of EEG monitoring is often referred to as processed EEG monitoring or brain function monitoring. Brain function monitors display the patient’s EEG waveforms, but these are difficult for clinicians to interpret, so the EEG signals are processed and displayed as a single number called Patient State Index (PSi), which is related to the effects of anesthetic agents. Our SedLine® brain function monitoring technology can now be delivered through the Masimo Open Connect® (MOC®) connectivity port, MOC-9®, within our Root® patient monitoring and connectivity platform, which integrates our rainbow® and SET® measurements with multiple additional parameters, such as SedLine®. In addition, our SedLine® brain function monitoring technology also displays raw EEG waveforms, the PSI trend and the Density Spectral Array view to allow clinicians to compare EEG power in both sides of the brain over time to facilitate the detection of asymmetrical activity and agent-specific effects on the EEG signal. In 2016, we introduced Next Generation SedLine®, which improved PSi in the presence of EMG (electrical activity due to muscle movement) artifact and in patients with low power EEG signals (such as geriatric patients). Next Generation SedLine® has received CE Mark but is not currently available for sale in the U.S.
•
NomoLine™ Capnography and Gas Monitoring - We offer a portfolio of sidestream and mainstream capnography products, as well as gas monitoring products, which include external “plug-in-and-measure” capnography and gas analyzers, integrated modules and handheld capnograph and capnometer devices. The gas monitoring products have the ability to measure multiple expired gases, such as carbon dioxide (CO2), nitrous oxide (N2O), oxygen (O2) and other anesthetic agents. In the case of capnography, respiration rate is also calculated from the CO2 waveform. These measurements are possible through either mainstream monitoring, which samples gases from a ventilated patient’s breathing circuit, or sidestream monitoring, which samples gases from a breathing circuit in mechanically ventilated patients or through a cannula or mask in spontaneously breathing patients.
•
O3® - Organ oximetry, also known as regional oximetry, tissue oximetry and cerebral oximetry monitoring, uses near-infrared spectroscopy (NIRS) to provide continuous measurement of tissue oxygen saturation (rSO2) to help detect regional hypoxemia that pulse oximetry alone can miss under certain conditions. In addition, our Root® monitor and O3®sensors can automate the differential analysis of regional to central oxygen saturation derived from our SET® pulse oximeters. O3® monitoring involves applying O3® regional oximetry sensors to the forehead and connecting our O3® MOC-9® module to any Root® monitor through one of its three MOC-9® ports. O3® regional oximetry has received the CE Mark and FDA 510(k) clearance for use in subjects larger than 40 kg (approximately 88 lbs). In 2016, O3® regional oximetry with the O3® pediatric sensor received the CE Mark for use in pediatric patients weighing less than 40kg (approximately 88lbs).

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In May 2017, O3® regional oximetry with the O3® pediatric sensor received FDA 510(k) clearance for use in pediatric patients weighing less than 40kg (approximately 88lbs).
•
rainbow Acoustic Monitoring® (RAM™) - Our acoustic-based monitoring technology enables noninvasive monitoring of respiration rate (RRa®). Compared to traditional capnography, which monitors exhaled CO2, most often through a nasal cannula, multiple clinical studies have shown that the noninvasive measurement of RRa® provides as good or better accuracy to monitor respiration rate and detect respiratory pause episodes, defined as a cessation of breathing for 30 seconds or more. Yet, due to its ease of use and wear, RAM™ is better tolerated by patients than capnography. When used with other clinical variables, RRa® may help clinicians assess respiratory depression and respiratory distress earlier and more often to help determine treatment options and potentially enable earlier interventions.
•
Root® - Our Root® patient monitoring and connectivity platform integrates our breakthrough rainbow® and SET® measurements with multiple additional specialty measurements through its MOC-9® connectivity ports in an integrated, clinician-centric platform. The first three Masimo MOC-9® technologies for Root® were SedLine® brain function monitoring, NomoLine™ capnography and gas monitoring, and O3® organ oximetry. In June 2017, we announced our first MOC® partnership, which enables third parties to utilize Root’s® open architecture and built-in connectivity to independently develop, obtain regulatory approvals, and commercialize their own external MOC-9® module or our Open Connect Control (MOC-C™) App for Root® using our MOC® software development kit (SDK). While we support the development efforts of our MOC® partners as needed, and help increase awareness of the availability of MOC-9® modules and MOC-C™ Apps, our MOC® partners use their existing distribution channels to sell their MOC-9® module or MOC-C™ App to customers.
In February 2017, we introduced a limited market release of the Early Warning Score (EWS) for Root®. EWS aggregates information from multiple vital signs and clinical observations to generate a score that represents the potential degree of patient deterioration. There are several EWS protocols, such as Pediatric Early Warning Score (PEWS), Modified Early Warning Score (MEWS) and National Early Warning Score (NEWS). These various scores require vital signs contributors such as oxygen saturation, pulse rate, respiration rate, body temperature and systolic blood pressure along with contributors input by clinicians, such as level of consciousness, use of supplemental oxygen and urine output. The weighting and number of contributors differ depending upon which EWS protocol is used. Root® can be customized for various predefined EWS protocols, or hospitals can configure their own set of required contributors, and their relative weights, to create an EWS unique to their care environment.
•
Patient SafetyNet - Our patient surveillance, remote monitoring and clinician notification solution allows for monitoring of the oxygen saturation, pulse rate, perfusion index, hemoglobin, methemoglobin and respiration rate of up to 200 patients simultaneously from a single server. Patient SafetyNet offers a rich user interface with trending, real-time waveform capability at the central station and remote notification via pager or smart phone. Patient SafetyNet also features the Adaptive Connectivity Engine™, which enables two-way, Health Level 7 (HL7) based connectivity to clinical/hospital information systems. The Adaptive Connectivity Engine™ significantly reduces the time and complexity to integrate and validate custom HL7 implementations and demonstrates our commitment to innovation that automates patient care with open, scalable and standards-based connectivity architecture.
The Patient SafetyNet Series 5000, together with Iris® Connectivity, Kite® and MyView™ through the Root® patient monitoring and connectivity platform, offers a new level of interoperability designed to enhance clinician workflows, and reduce the cost of care, from operating rooms to medical-surgical units. Patient SafetyNet Series 5000 with Iris® enables Root® to intake data from all devices connected to the patient, thereby acting as an in-room patient monitor and connectivity hub. Alarms and alerts for all devices are seamlessly forwarded to the patient’s clinician and all device data are effortlessly documented in the patient’s electronic medical record (EMR). The patient-centric user interface of the Patient SafetyNet Series 5000 displays near real-time data from all devices with Kite®, providing a single unified dashboard of patient information.
•
MyView™ - MyView™ is a wireless, presence-detection system enables clinicians to automatically display customized clinical profiles on our devices, such as Root®, Radical-7® and the Patient SafetyNet View Station. When a clinician approaches the device, a clinician-worn MyView™ badge signals the device to display a preselected set of parameters and waveforms tailored to the individual clinician’s preferences. MyView™ gives clinicians the ability to receive and review medical device information in a manner that is most conducive to optimizing their workflow, while the presence mapping data collected by all the Masimo devices can provide information on how clinicians spend time with their patients. This provides nursing leadership and management with the opportunity to examine analytical data on patient and clinician interactions to optimize workflows across the unit, hospital or hospital system.

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•
Patient SafetyNet Surveillance - Patient SafetyNet Surveillance is a software option for our Patient SafetyNet solution that provides real-time video images of a patient’s room, including the patient with connected monitoring devices, adding existing communication technology to central monitoring. Two-way audio is available to allow the caregiver to listen to and communicate with the patient. The system utilizes the existing hospital information technology network and can provide viewing of images in the same care area.
•
MightySat™ and MightySat Rx™ - Our fingertip pulse oximeters leverage Masimo SET® and are designed for those who want accurate measurements, even under challenging conditions such as movement and low perfusion. MightySat™ is intended for personal use and provides SpO2, PR, RRp®, PVi® and Pi measurements in a compact, battery-powered design with an organic light-emitting diode color screen that can be rotated for real-time display of the pleth waveform as well as measurements. Its Bluetooth® wireless functionality enables measurement display via the free, downloadable Masimo Personal Health app on iOS and Android mobile devices, as well as the ability to trend and communicate measurements and interface with the Apple Health app. MightySat™ is available through online retailers such as Amazon.com and in select Apple stores. In the U.S., MightySat™ is intended for general health and wellness use and is not intended for medical use. However, MightySat Rx™, the medical version of the product with optional Bluetooth® is intended for professional use. MightySat Rx™ received 510(k) clearance in late 2015. In February 2017, MightySat™ Rx with the RRp® measurement received CE Mark, but is not currently available for sale in the U.S.
Our solutions and related products are based upon our Masimo SET®, rainbow® and other proprietary 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. In addition, we have exclusively licensed certain rainbow® technology from Cercacor Laboratories, Inc. (Cercacor) and have the right to incorporate such rainbow® technology into products that are intended for use by professional caregivers, including, but not limited to, hospital caregivers and alternate care facility caregivers.
Cercacor Laboratories, Inc.
Cercacor Laboratories, Inc. (Cercacor) is an independent entity spun off from us to our stockholders in 1998. Joe Kiani, our Chairman and Chief Executive Officer, 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. See Notes 3 and 4 to the condensed consolidated financial statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q for additional information related to Cercacor.
Stock Repurchase Program
In September 2015, our board of directors (Board) authorized a stock repurchase program, whereby we may purchase up to 5.0 million shares of our common stock over a period of up to three years. As of July 1, 2017, approximately 2.9 million shares remained authorized for repurchase under this program.
Our 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. For additional information regarding our current stock repurchase program, see Note 12 to the condensed consolidated financial statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q.

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Results of Operations
The following table sets forth, for the periods indicated, our unaudited results of operations expressed as dollar amounts and as a percentage of total revenues (in thousands, except percentages):
 
Three Months Ended
 
Six Months Ended
 
July 1,
2017
 
Percentage
of Revenue
 
July 2,
2016
 
Percentage
of Revenue
 
July 1,
2017
 
Percentage
of Revenue
 
July 2,
2016
 
Percentage
of Revenue
Revenue:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Product
$
182,802

 
94.7
%
 
$
164,607

 
95.3
%
 
$
360,899

 
95.2
 %
 
$
327,897

 
95.4
%
Royalty and other revenue
10,131

 
5.3

 
8,029

 
4.7

 
18,336

 
4.8

 
15,906

 
4.6

Total revenue
192,933

 
100.0

 
172,636

 
100.0

 
379,235

 
100.0

 
343,803

 
100.0

Cost of goods sold
64,496

 
33.4

 
57,501

 
33.3

 
126,664

 
33.4

 
114,455

 
33.3

Gross profit
128,437

 
66.6

 
115,135

 
66.7

 
252,571

 
66.6

 
229,348

 
66.7

Operating expenses:
 
 
 
 
 
 
 
 
 
 

 
 
 
 
Selling, general and administrative
66,377

 
34.4

 
63,888

 
37.0

 
131,949

 
34.8

 
126,399

 
36.8

Research and development
15,192

 
7.9

 
14,818

 
8.6

 
30,559

 
8.1

 
29,183

 
8.5

Total operating expenses
81,569

 
42.3

 
78,706

 
45.6

 
162,508

 
42.9

 
155,582

 
45.3

Operating income
46,868

 
24.3

 
36,429

 
21.1

 
90,063

 
23.7

 
73,766

 
21.5

Non-operating income
158

 
0.1

 
471

 
0.3

 
1,032

 
0.3

 
969

 
0.3

Income before provision for income taxes
47,026

 
24.4

 
36,900

 
21.4

 
91,095

 
24.0

 
74,735

 
21.7

Provision (benefit) for income taxes
346

 
0.2

 
6,877

 
4.0

 
(919
)
 
(0.2
)
 
17,135

 
5.0

Net income
$
46,680

 
24.2
%
 
$
30,023

 
17.4
%
 
$
92,014

 
24.3
 %
 
$
57,600

 
16.8
%
Comparison of the Three Months ended July 1, 2017 to the Three Months ended July 2, 2016
Revenue. Total revenue increased $20.3 million, or 11.8%, to $192.9 million for the three months ended July 1, 2017 from $172.6 million for the three months ended July 2, 2016. The following table details our total product revenues by the geographic area to which the products were shipped for each of the three months ended July 1, 2017 and July 2, 2016 (dollars in thousands):
 
Three Months Ended
 
July 1, 2017
 
July 2, 2016
 
Increase/
(Decrease)
 
Percentage
Change
United States
$
126,455

 
69.2
%
 
$
117,045

 
71.1
%
 
$
9,410

 
8.0
%
Europe, Middle East and Africa
33,693

 
18.4

 
25,988

 
15.8

 
7,705

 
29.6

Asia and Australia
16,988

 
9.3

 
16,602

 
10.1

 
386

 
2.3

North and South America (excluding United States)
5,666

 
3.1

 
4,972

 
3.0

 
694

 
14.0

     Total product revenue
$
182,802

 
100.0
%
 
$
164,607

 
100.0
%
 
$
18,195

 
11.1
%
Royalty and other revenue
10,131

 
 
 
8,029

 
 
 
2,102

 
26.2

     Total revenue
$
192,933

 
 
 
$
172,636

 
 
 
$
20,297

 
11.8
%
Product revenue increased $18.2 million, or 11.1%, to $182.8 million for the three months ended July 1, 2017 from $164.6 million for the three months ended July 2, 2016. This increase was primarily due to higher sales of consumables and monitors, which was partially offset by the impact of approximately $1.3 million of unfavorable foreign exchange rate movements from the prior year period that reduced the U.S. Dollar translation of foreign sales that were denominated in various foreign currencies, primarily in Europe and Asia. We estimate that our installed base of circuit boards and pulse oximeters increased to approximately 1,545,000 units at July 1, 2017 as compared to 1,459,000 units at July 2, 2016.

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Product revenue generated through our direct and distribution sales channels increased $19.5 million, or 13.8%, to $160.4 million for the three months ended July 1, 2017, compared to $140.9 million for the three months ended July 2, 2016. Revenues from our OEM channel decreased $1.3 million, or 5.4%, to $22.4 million for the three months ended July 1, 2017 as compared to $23.7 million for the three months ended July 2, 2016. Total rainbow® product revenue increased by $2.2 million, or 14.6%, to $17.1 million for the three months ended July 1, 2017, compared to $14.9 million for the three months ended July 2, 2016, primarily due to an increase in rainbow® orders from a large international customer.
Royalty and other revenue consists primarily of royalties received from Medtronic plc (Medtronic, formerly Covidien Ltd.) related to its U.S. sales pursuant to the terms of our settlement agreement, and revenue from non-recurring engineering (NRE) services for certain OEM customers.
Gross Profit. Gross profit consists of total revenue less cost of goods sold. Our gross profit for the three months ended July 1, 2017 and July 2, 2016 was as follows (dollars in thousands):
 
Three Months Ended
 
July 1, 2017
 
Gross Profit
Percentage
 
July 2, 2016
 
Gross Profit
Percentage
 
Increase/
(Decrease)
 
Percentage
Change
Product gross profit
$
118,372

 
64.8
%
 
$
107,106

 
65.1
%
 
$
11,266

 
10.5
%
Royalty and other revenue gross profit
10,065

 
99.4

 
8,029

 
100.0

 
2,036

 
25.4

     Total gross profit
$
128,437

 
66.6
%
 
$
115,135

 
66.7
%
 
$
13,302

 
11.6
%
Cost of goods sold includes labor, material, overhead and other similar costs related to the production, supply, distribution and support of our products. Cost of goods sold increased $7.0 million for the three months ended July 1, 2017 compared to the three months ended July 2, 2016, primarily due to higher product revenue and slightly higher production costs associated with the expansion of our manufacturing capacity. Product gross margins declined slightly to 64.8% for the three months ended July 1, 2017 compared to 65.1% for the three months ended July 2, 2016, primarily due to unfavorable production variances associated with the expansion of our manufacturing capacity.
Selling, General and Administrative. Selling, general and administrative expenses consist primarily of salaries and related expenses for sales, marketing and administrative personnel, sales commissions, advertising and promotion costs, professional fees related to legal, accounting and other outside services, public company costs and other corporate expenses. Selling, general and administrative expenses for the three months ended July 1, 2017 and July 2, 2016 were as follows (dollars in thousands):
Selling, General and Administrative
Three Months Ended 
 July 1, 2017
Percentage of
Net Revenues
Three Months Ended 
 July 2, 2016
Percentage of
Net Revenues
Increase/
(Decrease)
Percentage
Change
$66,377
34.4%
$63,888
37.0%
$2,489
3.9%
Selling, general and administrative expenses increased $2.5 million, or 3.9%, for the three months ended July 1, 2017 compared to the three months ended July 2, 2016. This increase was primarily attributable to higher marketing-related expenses of approximately $2.3 million, higher payroll and employee-related costs of approximately $1.0 million, higher professional services fees of approximately $0.6 million and higher occupancy costs of approximately $0.6 million, which were partially offset by approximately $2.0 million of lower legal fees. Stock-based compensation expense of approximately $2.6 million and $2.5 million was included in selling, general and administrative expenses for the three months ended July 1, 2017 and July 2, 2016, respectively.
Research and Development. Research and development expenses consist primarily of salaries and related expenses for engineers and other personnel engaged in the design and development of our products. These expenses also include third-party fees paid to consultants, prototype and engineering supply expenses and the costs of clinical trials. Research and development expenses for the three months ended July 1, 2017 and July 2, 2016 were as follows (dollars in thousands):
Research and Development
Three Months Ended 
 July 1, 2017
Percentage of
Net Revenues
Three Months Ended 
 July 2, 2016
Percentage of
Net Revenues
Increase/
(Decrease)
Percentage
Change
$15,192
7.9%
$14,818
8.6%
$374
2.5%
Research and development expenses increased $0.4 million, or 2.5%, for the three months ended July 1, 2017 compared to the three months ended July 2, 2016, primarily due to higher payroll-related costs of approximately $1.7 million, higher

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engineering project expenses of approximately $0.4 million and higher professional fees of approximately $0.2 million, which were offset by capitalized costs related customer NRE services of approximately $2.0 million. Included in research and development expenses was approximately $0.6 million of stock-based compensation expense for each of the three months ended July 1, 2017 and July 2, 2016.
Non-operating Income. Non-operating income consists primarily of interest income, interest expense and foreign exchange losses. Non-operating income for the three months ended July 1, 2017 and July 2, 2016 was as follows (dollars in thousands):
Non-operating Income
Three Months Ended 
 July 1, 2017
Percentage of
Net Revenues
Three Months Ended 
 July 2, 2016
Percentage of
Net Revenues
Increase/
(Decrease)
Percentage
Change
$158
0.1%
$471
0.3%
$(313)
(66.5)%
Non-operating income decreased by $0.3 million for the three months ended July 1, 2017 compared to the three months ended July 2, 2016. Non-operating income for the three months ended July 1, 2017 consisted of approximately $0.3 million of net realized and unrealized gains on foreign currency denominated transactions and approximately $0.7 million in net interest income. Non-operating income for the three months ended July 2, 2016 consisted of approximately $1.1 million of interest expense, which was offset by approximately $1.5 million of net realized and unrealized gains on foreign currency denominated transactions.
Provision for Income Taxes. Our provision for income taxes for the three months ended July 1, 2017 and July 2, 2016 was as follows (dollars in thousands)
Provision for Income Taxes
Three Months Ended 
 July 1, 2017
Percentage of
Net Revenues
Three Months Ended 
 July 2, 2016
Percentage of
Net Revenues
Increase/
(Decrease)
Percentage
Change
$346
0.2%
$6,877
4.0%
$(6,531)
(95.0)%
For the three months ended July 1, 2017, we recorded a provision for income taxes of approximately $0.3 million, or an effective tax rate of 0.7%, as compared to a provision for income taxes of approximately $6.9 million, or an effective tax rate of 18.6%, for the three months ended July 2, 2016. The decrease in the provision for income taxes for the three months ended July 1, 2017 resulted primarily from a discrete tax benefit of approximately $15.1 million related to excess tax benefits realized from stock-based compensation pursuant to Accounting Standards Update No. 2016-09, Compensation—Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting (ASU 2016-09), which substantially exceeded the discrete tax benefit of approximately $4.1 million recorded for such excess tax benefits during the three months ended July 2, 2016. Partially offsetting this discrete tax benefit was an increase in our effective tax rate resulting from differences in our expected fiscal 2017 geographic composition of our pre-tax income compared to our expected fiscal 2016 geographic composition as of July 2, 2016.
Comparison of the Six Months ended July 1, 2017 to the Six Months ended July 2, 2016
Revenue. Total revenue increased $35.4 million, or 10.3%, to $379.2 million for the six months ended July 1, 2017 from $343.8 million for the six months ended July 2, 2016. The following table details our total product revenues by the geographic area to which the products were shipped for each of the six months ended July 1, 2017 and July 2, 2016 (dollars in thousands):
 
Six Months Ended
 
July 1, 2017
 
July 2, 2016
 
Increase/
(Decrease)
 
Percentage
Change
United States
$
251,137

 
69.6
%
 
$
230,549

 
70.3
%
 
$
20,588

 
8.9
%
Europe, Middle East and Africa
64,195

 
17.8

 
57,958

 
17.7

 
6,237

 
10.8

Asia and Australia
33,724

 
9.3

 
30,184

 
9.2

 
3,540

 
11.7

North and South America (excluding United States)
11,843

 
3.3

 
9,206

 
2.8

 
2,637

 
28.6

     Total product revenue
$
360,899

 
100.0
%
 
$
327,897

 
100.0
%
 
$
33,002

 
10.1
%
Royalty and other revenue
18,336

 
 
 
15,906

 
 
 
2,430

 
26.2

     Total revenue
$
379,235

 
 
 
$
343,803

 
 
 
$
35,432

 
10.3
%

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Product revenue increased $33.0 million or 10.1%, to $360.9 million for the six months ended July 1, 2017 from $327.9 million for the six months ended July 2, 2016. This increase was primarily due to higher sales of consumables and monitors, which was partially offset by the impact of approximately $2.0 million in unfavorable foreign exchange rate movements from the prior year period that reduced the U.S. Dollar translation of foreign sales that were denominated in various foreign currencies, primarily in Europe and Asia. We estimate that our installed base of circuit boards and pulse oximeters increased to approximately 1,545,000 units at July 1, 2017 as compared to 1,459,000 units at July 2, 2016.
Product revenue generated through our direct and distribution sales channels increased $33.5 million, or 11.9%, to $315.3 million for the six months ended July 1, 2017, compared to $281.9 million for the six months ended July 2, 2016. Revenues from our OEM channel decreased $0.5 million, or 1.0%, to $45.6 million for the six months ended July 1, 2017 as compared to $46.0 million for the six months ended July 2, 2016. Total rainbow® product revenue decreased by $0.9 million, or 2.6%, to $31.0 million for the six months ended July 1, 2017, compared to $31.9 million for the six months ended July 2, 2016.
Royalty and other revenue primarily consists of royalties received from Medtronic plc (Medtronic, formerly Covidien Ltd.) related to its U.S. sales pursuant to the terms of our settlement agreement and revenue from NRE services for certain OEM customers.
Gross Profit. Gross profit consists of total revenue less cost of goods sold. Our gross profit for the six months ended July 1, 2017 and July 2, 2016 was as follows (dollars in thousands):
 
Six Months Ended
 
July 1, 2017
 
Gross Profit
Percentage
 
July 2, 2016
 
Gross Profit
Percentage
 
Increase/
(Decrease)
 
Percentage
Change
Product gross profit
$
234,301

 
64.9
%
 
$
213,442

 
65.1
%
 
$
20,859

 
9.8
%
Royalty and other revenue gross profit
18,270

 
99.6

 
15,906

 
100.0

 
2,364

 
14.9

     Total gross profit
$
252,571

 
66.6
%
 
$
229,348

 
66.7
%
 
$
23,223

 
10.1
%
Cost of goods sold includes labor, material, overhead and other similar costs related to the production, supply, distribution and support of our products. Cost of goods sold increased $12.2 million for the six months ended July 1, 2017 compared to the six months ended July 2, 2016, primarily due to higher product revenue and slightly higher production costs associated with the expansion of our manufacturing capacity. Product gross margins decreased slightly to 64.9% for the six months ended July 1, 2017 compared to 65.1% for the six months ended July 2, 2016, primarily due to unfavorable production variances related to our ramp up of additional manufacturing capacity.
Selling, General and Administrative. Selling, general and administrative expenses consist primarily of salaries and related expenses for sales, marketing and administrative personnel, sales commissions, advertising and promotion costs, professional fees related to legal, accounting and other outside services, public company costs and other corporate expenses. Selling, general and administrative expenses for the six months ended July 1, 2017 and July 2, 2016 were as follows (dollars in thousands):
Selling, General and Administrative
Six Months Ended 
 July 1, 2017
Percentage of
Net Revenues
Six Months Ended 
 July 2, 2016
Percentage of
Net Revenues
Increase/
(Decrease)
Percentage
Change
$131,949
34.8%
$126,399
36.8%
$5,550
4.4%
Selling, general and administrative expenses increased $5.6 million, or 4.4%, for the six months ended July 1, 2017 compared to the six months ended July 2, 2016. This increase was primarily attributable to higher payroll and employee-related expenses of approximately $5.0 million, higher marketing-related costs of approximately $2.8 million and higher occupancy costs of approximately $1.2 million, which were partially offset by approximately $4.0 million of lower legal fees. Stock-based compensation expense of approximately $4.6 million and $4.8 million was included in selling, general and administrative expenses for the six months ended July 1, 2017 and July 2, 2016, respectively.
Research and Development. Research and development expenses consist primarily of salaries and related expenses for engineers and other personnel engaged in the design and development of our products. These expenses also include third-party fees paid to consultants, prototype and engineering supply expenses and the costs of clinical trials. Research and development expenses for the six months ended July 1, 2017 and July 2, 2016 were as follows (dollars in thousands):

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Research and Development
Six Months Ended 
 July 1, 2017
Percentage of
Net Revenues
Six Months Ended 
 July 2, 2016
Percentage of
Net Revenues
Increase/
(Decrease)
Percentage
Change
$30,559
8.1%
$29,183
8.5%
$1,376
4.7%
Research and development expenses increased $1.4 million, or 4.7%, for the six months ended July 1, 2017 compared to the six months ended July 2, 2016, primarily due to higher payroll-related costs of approximately $2.4 million and higher engineering project costs of approximately $0.5 million, which were partially offset by capitalized costs related to customer NRE services of approximately $2.0 million. Included in research and development expenses was approximately $1.3 million of stock-based compensation expense for each of the six months ended July 1, 2017 and July 2, 2016.
Non-operating Income. Non-operating income consists primarily of interest income, interest expense and foreign exchange losses. Non-operating income for the six months ended July 1, 2017 and July 2, 2016 was as follows (dollars in thousands):
Non-operating Income
Six Months Ended 
 July 1, 2017
Percentage of
Net Revenues
Six Months Ended 
 July 2, 2016
Percentage of
Net Revenues
Increase/
(Decrease)
Percentage
Change
$1,032
0.3%
$969
0.3%
$63
6.5%
Non-operating income increased by $0.1 million for the six months ended July 1, 2017 compared to the six months ended July 2, 2016. Non-operating income for the six months ended July 1, 2017 consisted of approximately $0.1 million of net realized and unrealized gains on foreign currency denominated transactions and approximately $1.2 million in net interest income. Non-operating income for the six months ended July 2, 2016 consisted of $1.8 million of interest expense offset by $2.3 million of net realized and unrealized gains on foreign currency denominated transactions and a $0.3 million gain resulting from our deconsolidation of Cercacor.
(Benefit) Provision for Income Taxes. Our provision for income taxes for the six months ended July 1, 2017 and July 2, 2016 was as follows (dollars in thousands):
(Benefit) Provision for Income Taxes
Six Months Ended 
 July 1, 2017
Percentage of
Net Revenues
Six Months Ended 
 July 2, 2016
Percentage of
Net Revenues
Increase/
(Decrease)
Percentage
Change
$(919)
(0.2)%
$17,135
5.0%
$(18,054)
(105.4)%
For the six months ended July 1, 2017, we recorded a benefit for income taxes of approximately $0.9 million, or an effective tax benefit rate of 1.0%, as compared to a provision for income taxes of approximately $17.1 million, or an effective tax rate of 22.9%, for the six months ended July 2, 2016. The benefit for income taxes for the six months ended July 1, 2017 resulted primarily from a discrete tax benefit of approximately $30.2 million related to excess tax benefits realized from stock-based compensation pursuant to ASU 2016-09, which substantially exceeded the discrete tax benefit of approximately $5.1 million recorded for such excess tax benefits during the six months ended July 2, 2016. Partially offsetting this discrete tax benefit was an increase in our effective tax rate resulting from differences in our expected fiscal 2017 geographic composition of our pre-tax income compared to our expected fiscal 2016 geographic composition as of July 2, 2016.

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Liquidity and Capital Resources
Our principal sources of liquidity consist of our existing cash and cash equivalent balances, funds expected to be generated from operations and funds available under our revolving credit agreement. At July 1, 2017, we had approximately $420.7 million in working capital and approximately $331.4 million in cash and cash equivalents as compared to approximately $286.9 million in working capital and approximately $306.0 million in cash and cash equivalents at December 31, 2016. We carry cash equivalents at cost that approximates fair value. We currently do not maintain an investment portfolio but have the ability to invest in various security holdings, types and maturities that meet credit quality standards in accordance with our investment guidelines.
As of July 1, 2017, we had cash totaling $169.3 million held outside of the U.S., of which approximately $17.7 million was accessible without additional tax cost and approximately $151.6 million was accessible at an incremental estimated tax cost of approximately $45.9 million. In managing our day-to-day liquidity and capital structure, we do not rely on foreign earnings as a source of funds. We currently have sufficient funds on-hand and available under our line of credit to fund our domestic operations and do not anticipate the need to repatriate funds associated with our permanently reinvested foreign earnings. In the event funds that are treated as permanently reinvested are repatriated, we may be required to accrue and pay additional U.S. taxes with respect to any such repatriation.
Our Amended and Restated Credit Agreement (Restated Credit Facility) with JPMorgan Chase Bank, N.A., as Administrative Agent and a Lender, Bank of America, N.A., as Syndication Agent and a Lender, Citibank, N.A., as Documentation Agent and a Lender, and various other Lenders (collectively, the Lenders) provides for up to $250.0 million in borrowings in multiple currencies, with an option, subject to certain conditions, for us to increase the aggregate borrowing capacity to up to $550.0 million in the future. The Restated Credit Facility also provides for a sublimit of up to $50.0 million for the issuance of letters of credit and a sublimit of $125.0 million in specified foreign currencies. All unpaid principal under the Restated Credit Facility will become due and payable on January 8, 2021. See Note 10 to the condensed consolidated financial statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q for additional information.
Cash Flows
The following table summarizes our cash flows (in thousands):
 
 
Six Months Ended
 
 
July 1,
2017
 
July 2,
2016
Net cash (used in) provided by:
 
 
 
Operating activities
$
(14,409
)
 
$
56,691

Investing activities
(10,086
)
 
(12,846
)
Financing activities
48,148

 
(59,911
)
Effect of foreign currency exchange rates on cash
1,825

 
(196
)
Increase (decrease) in cash and cash equivalents
$
25,478

 
$
(16,262
)
Operating Activities. Cash used in operating activities was approximately $14.4 million for the six months ended July 1, 2017. Net income from operations was $92.0 million, which was offset by non-cash activity including depreciation and amortization of $9.5 million and stock-based compensation of $6.1 million. In addition, during the six months ended July 1, 2017, accounts payable increased by $3.1 million due to the timing of payments. These sources of cash were offset by other changes in operating assets and liabilities, including a decrease in accrued liabilities of $67.6 million, primarily related to tax payments for the year ended December 31, 2016, an increases in inventories and deferred cost of goods sold of $15.6 million and $13.7 million, respectively, an increase in other current assets of $14.7 million, primarily related to estimated tax payments for the current fiscal year, a decrease in accrued compensation of $11.7 million, primarily due to the timing of payments, and an increase in accounts receivable of $2.1 million, primarily due to the timing of cash receipts.
Cash provided by operating activities was approximately $56.7 million for the six months ended July 2, 2016, arising primarily from net income of $57.6 million. Non-cash activity included depreciation and amortization of $8.1 million, stock-based compensation of $6.2 million and deferred income taxes of $5.0 million. In addition, accounts payable, deferred revenue and other liabilities increased by $7.9 million, $5.3 million and $3.9 million, respectively, during the six months ended July 2, 2016. These sources of cash were primarily offset by other changes in operating assets and liabilities including a decrease in accrued liabilities of $13.8 million and accrued compensation of $3.9 million, as well as an increase in other current assets of $7.5 million, all due to the timing of related payments; an increase in other assets of $6.6 million; and an increase in accounts receivable of $3.7 million due to the timing of collections.

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Investing Activities. Cash used in investing activities for the six months ended July 1, 2017 was $10.1 million, consisting of $8.5 million for purchases of property and equipment and $1.6 million of intangible assets related primarily to capitalized patent and trademark costs. Cash used in investing activities for the six months ended July 2, 2016 was $12.8 million, consisting of $10.7 million for purchases of property and equipment, $1.3 million of intangible assets related to capitalized patent and trademark costs and $0.8 million related to the deconsolidation of Cercacor. See Note 3 to the condensed consolidated financial statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q for additional information related to the deconsolidation of Cercacor.
Financing Activities. Cash provided by financing activities for the six months ended July 1, 2017 was $48.1 million, primarily driven by proceeds from the exercise of employee options totaling $48.2 million. Cash used in financing activities for the six months ended July 2, 2016 was $59.9 million, primarily driven by common stock repurchase transactions during the six month period totaling $68.2 million and repayments under our Restated Credit Facility of $10.0 million, offset by proceeds from the exercise of employee stock options totaling $19.0 million.
Capital Resources and Prospective Capital Requirements
As of July 1, 2017, we did not have any outstanding loan draws and had $0.3 million in outstanding letters of credit under our Restated Credit Facility, leaving available borrowing capacity of $249.7 million. We also had outstanding capital lease obligations of less than $0.1 million related primarily to office and computer equipment. We had no other debt obligations and were in compliance with all bank covenants.
In September 2015, the Board authorized a stock repurchase program for the repurchase of up to 5.0 million shares of our common stock over a period of up to three years. 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.  As of July 1, 2017, approximately 2.9 million shares remained authorized for repurchase under this stock repurchase program. For additional information regarding our stock repurchase program, see Note 12 to the condensed consolidated financial statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q.
We expect to fund our future operating, investing and financing activities through our available cash, future cash from operations, funds available under our Restated Credit Facility and other potential sources of capital. In addition to funding our normal working capital requirements, we anticipate additional capital purchases related to renovating our new corporate headquarters. We also anticipate that we will continue to repurchase stock under our authorized stock repurchase program subject to the availability of our stock, general market conditions, the trading price of our stock, available capital, alternative uses for capital and our financial performance. Possible additional uses of cash may include the acquisition of technologies or technology companies.
The amount and timing of our actual investing activities will vary significantly depending on numerous factors, including the timing and amount of costs related to the renovation of our new corporate headquarters facility and other capital expenditures, costs of product development efforts, stock repurchase activity and costs related to our domestic and international regulatory requirements. Despite these investment requirements, we anticipate that our existing cash and cash equivalents, as well as amounts available under the Restated Credit Facility, will be sufficient to meet our working capital requirements, capital expenditures and other operational funding needs for at least the next 12 months.
Off-Balance Sheet Arrangements
We do not currently have, nor have we ever had, any relationships with unconsolidated entities or financial partnerships, such as entities referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or for other contractually narrow or limited purposes. In addition, we do not engage in trading activities involving non-exchange traded contracts. As a result, we are not materially exposed to any financing, liquidity, market or credit risk that could arise if we engaged in these relationships. As of July 1, 2017, we did not have any off-balance sheet arrangements, as defined in Item 303(a)(4)(ii) of Regulation S-K promulgated by the SEC.
Critical Accounting Policies and Estimates
The discussion and analysis of our financial condition and results of operations is based on our condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these condensed consolidated financial statements requires management to make estimates and judgments that affect the reported amounts of net revenues, expenses, assets and liabilities. We regularly evaluate our estimates and assumptions related to our critical accounting policies, including revenue recognition and deferred revenue, inventory and related reserves for excess or obsolete inventory, allowance for doubtful accounts, stock-based compensation,

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goodwill, deferred taxes and related valuation allowances, uncertain tax positions, tax contingencies, litigation costs and loss contingencies. We base our estimates and assumptions on current facts, historical experience and various other factors that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities and the recording of revenue, costs and expenses that are not readily apparent from other sources. Changes in judgments and uncertainties relating to these estimates could potentially result in materially different results under different assumptions and conditions. If these estimates differ significantly from actual results, the impact on our condensed consolidated financial statements and future results of operations may be material. For a description of our critical accounting policies, please refer to “Critical Accounting Estimates” in Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of our Annual Report on Form 10-K for the fiscal year ended December 31, 2016, filed with the SEC on February 15, 2017. There have been no material changes to any of our critical accounting policies during the six months ended July 1, 2017.
Recent Accounting Pronouncements
See Note 2 to the condensed consolidated financial statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q for a description of recently issued or adopted accounting standards.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Market risk represents the risk of changes in the value of market risk sensitive instruments caused by fluctuations in interest rates, foreign exchange rates and commodity prices. We are exposed to various market risks that may arise from adverse changes in market rates and prices, such as interest rates, foreign exchange fluctuations and inflation. We do not enter into derivatives, including forward contracts