MASIMO CORPORATION 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 programs; 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 otherSecurities and Exchange Commission (SEC) filings, including our Annual Report on Form 10-K for the fiscal year endedDecember 28, 2019 , which we filed with theSEC onFebruary 19, 2020 . 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 and hospital automation solutions. Our mission is to improve patient outcomes and reduce the cost of patient care. Our patient monitoring solutions generally incorporate a monitor or circuit board, proprietary single-patient use or reusable sensors, software and/or cables. We provide our products to hospitals, emergency medical service (EMS) providers, home care providers, long-term care facilities, physician offices, veterinarians and consumers through our direct sales force, distributors and original equipment manufacturers (OEM) partners. We were incorporated inCalifornia inMay 1989 and reincorporated inDelaware inMay 1996 . Our core business is Measure-through Motion and Low Perfusion™ pulse oximetry, known as Masimo Signal Extraction Technology® (SET®) pulse oximetry. Our product offerings have expanded significantly over the years to also include noninvasive monitoring of blood constituents with an optical signature, optical regional oximetry monitoring, electrical brain function monitoring, acoustic respiration monitoring and exhaled gas monitoring. In addition, we have developed the Root® patient monitoring and connectivity platform, the Radical-7® and Rad-97® bedside and portable patient monitors and the Radius-7® wearable wireless patient monitor. We have also developed hospital automation and connectivity solutions, such as the Masimo Patient SafetyNet™ supplemental remote patient surveillance and monitoring system, which currently allows up to 200 patients to be monitored and viewed simultaneously and remotely through a PC-based monitor or by care providers through their pagers, voice-over-IP phones or smartphones; Iris® and Iris Gateway®, which allow the transfer of data from Masimo and third-party devices to hospital electronic medical records; and UniView™, which provides an integrated display of real-time data from Masimo and third-party devices. For an overview of our product offerings and technologies, please refer to "Business" in Part I, Item 1 of our Annual Report on Form 10-K for the fiscal year endedDecember 28, 2019 , filed with theSEC onFebruary 19, 2020 . InMarch 2020 , we announced 510(k) clearance for continuous RRp® (respiration rate from the photoplethysmograph) monitoring of adult and pediatric patients with Rad-97®, Radical-7® and Radius-7® Pulse Co-Oximeters®. With this clearance, both continuous and spot-check RRp® are now available in theU.S. , supported in a variety of pulse oximetry sensors and configurations, including a non-cabled, tetherless, wearable Radius PPG™. With the acquisition of TNI medical AG (TNI®) onMarch 30, 2020 , TNI softFlow® technology was added to the Masimo product portfolio. This novel technology provides efficient, quiet and comfortable respiratory support by generating a precisely regulated, stable high flow of room air or a mix of room air and oxygen. 35 -------------------------------------------------------------------------------- Table of Contents InApril 2020 , we announced the full market release of Masimo SafetyNet™. The Masimo SafetyNet™ solution provides continuous tetherless pulse oximetry and respiration rate monitoring coupled with a patient surveillance platform. It is available worldwide to help clinicians and public health officials combat the COVID-19 pandemic. In addition, we announced a partnership withSamsung Electronics America (Samsung) to make the Masimo SafetyNet™Patient App available on select Samsung smartphones, pre-installed and pre-configured. InJune 2020 , we announced Masimo SafetyNet-Open™, designed to help businesses, governments, and schools more responsibly manage employee and student health and safety during the COVID-19 pandemic. As the COVID-19 pandemic continues, companies and organizations worldwide struggle to find the appropriate balance between reopening and keeping people safe by reducing the risk of infection. As a global leader in noninvasive patient monitoring technologies and advanced connectivity and automation solutions, we believe we are uniquely positioned to provide organizations with tools to assist them in reopening safely. Also inJune 2020 , we announced a new health and wellness home monitoring solution, Masimo Sleep™, designed to help consumers better understand the quality of their sleep. Masimo Sleep™ is fueled by the same expertise in signal processing and sensor development that drives our hospital products used by leading institutions to monitor millions of patients a year. Additionally, inJune 2020 , we announced Centroid™, a wearable wireless patient orientation, activity and respiration rate sensor, with 510(k) clearance. Centroid™ helps clinicians monitor a patient's position to avoid preventable pressure ulcers and can alert clinicians to sudden movements such as fall-like events. In addition, Centroid™ detects chest movements to continuously provide respiration rate, providing clinicians with additional data that may inform care decisions. Furthermore, inJune 2020 , we announced Bridge™, an opioid withdrawal solution that uses neuromodulation to aid in the reduction of symptoms associated with opioid withdrawal. Bridge™, which has been granted a 510(k) de novo classification, is the first evidence-based, drug-free, non-surgical device of its kind. InJuly 2020 , we announced our latest automation and connectivity solution, UniView: 60™. UniView: 60™ uses the Masimo Hospital Automation™ platform to aggregate and display pertinent patient information on a digital display just outside each patient's room, allowing clinicians to familiarize themselves with the most relevant details of each patient's case at the door in 60 seconds or less before they see the patient. InAugust 2020 , we announced that PlethVariability Index (PVi®) has received 510(k) clearance as a continuous, noninvasive, dynamic indicator of fluid responsiveness in select populations of mechanically ventilated adult patients. PVi® is a measure of the dynamic changes in perfusion index that occur during the respiratory cycle. Also inAugust 2020 , we announced that O3® Regional Oximetry has received 510(k) clearance for expanded use in monitoring somatic tissue oxygenation saturation in all patient populations and monitoring relative changes in hemoglobin, oxyhemoglobin, and deoxyhemoglobin in adult brains. With this 510(k) clearance, O3® Regional Oximetry is now indicated for use in both cerebral and somatic applications, both in theU.S. and in CE Mark countries, for all patient populations. COVID-19 Pandemic The COVID-19 pandemic has created significant uncertainty in theU.S. and around the globe, resulting in both challenges and opportunities for our business. We are committed to being as transparent as possible with our investors, employees, customers, suppliers and business partners as we collectively work to respond to this crisis. In response to this situation, we have implemented a number of precautionary measures at our facilities, including: requiring certain personnel to work remotely from home and enacting social distancing, requiring face masks and screening for symptoms for critical personnel that are required to report to our facilities to work. We have recently introduced new products, such as Masimo SafetyNet™ and Masimo SafetyNet-Open™, to help combat the COVID-19 pandemic, and have made charitable pledges to various global health organizations to support global relief efforts. In response to the increased product demand that we are seeing from our customers as they respond to and prepare for COVID-19 patient volumes, we have continued to increase our manufacturing capacity. We currently believe that our existing liquidity position will be sufficient to fund these initiatives and our response efforts. Given the uncertainties related to the COVID-19 pandemic, we cannot predict how long such increased product demand or any resulting changes in our product mix will continue. In addition, this increase in current demand could result in potential reductions in future demand if there has been overbuying of our products as our customers consume their excess inventory. Furthermore, we continue to be exposed to potential disruptions to our manufacturing operations, disruptions in the supply of critical manufacturing components and in our workforce as circumstances surrounding the global impact of the COVID-19 pandemic continue to change. Please see "Risks Related to Our Revenues" and "Risks Related to our Business and Operations" in Part II, Item 1A of this Quarterly Report on Form 10-Q for additional information on potential negative impacts to us resulting from the COVID-19 pandemic. 36 -------------------------------------------------------------------------------- Table of Contents CercacorCercacor Laboratories, Inc. (Cercacor) is an independent entity spun off from us to our stockholders in 1998.Joe Kiani , our Chairman and Chief Executive Officer (CEO), is also the Chairman and CEO of Cercacor. We are a party to a cross-licensing agreement with Cercacor, which was amended and restated effectiveJanuary 1, 2007 (the Cross-Licensing Agreement), which governs each party's rights to certain intellectual property held by the two companies. See Note 3 to our accompanying condensed consolidated financial statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q for additional information related to Cercacor. Results of Operations The following table sets forth, for the periods indicated, our results of operations expressed asU.S. Dollar amounts and as a percentage of revenue (dollars in thousands). Three Months Ended Nine Months EndedSeptember 26 , PercentageSeptember 28 , PercentageSeptember 26 , PercentageSeptember 28 , Percentage 2020 of Revenue 2019 of Revenue 2020 of Revenue 2019 of Revenue Revenue: Product$ 278,112 100.0 %$ 228,916 100.0 %$ 848,690 100.0 %$ 688,974 99.8 % Royalty and other revenue - - 95 - - - 1,353 0.2 Total revenue 278,112 100.0 229,011 100.0 848,690 100.0 690,327 100.0 Cost of goods sold 99,186 35.7 72,743 31.8 292,551 34.5 228,078 33.0 Gross profit 178,926 64.3 156,268 68.2 556,139 65.5 462,249 67.0 Operating expenses: Selling, general and administrative 90,376 32.5 80,354 35.1 278,714 32.8 232,718 33.7 Research and development 28,852 10.4 24,282 10.6 86,971 10.2 69,872 10.1 Litigation awards - - - - (474) (0.1) - - Total operating expenses 119,228 42.9 104,636 45.7 365,211 43.0 302,590 43.8 Operating income 59,698 21.5 51,632 22.5 190,928 22.5 159,659 23.1 Non-operating income 1,357 0.5 2,723 1.2 6,108 0.7 10,138 1.5 Income before provision for income taxes 61,055 22.0 54,355 23.7 197,036 23.2 169,797 24.6 Provision for income taxes 11,650 4.2 5,270 2.3 27,403 3.2 26,502 3.8 Net income$ 49,405 17.8 %$ 49,085 21.4 %$ 169,633 20.0 %$ 143,295 20.8 % 37
-------------------------------------------------------------------------------- Table of Contents Comparison of the Three Months endedSeptember 26, 2020 to the Three Months endedSeptember 28, 2019 Revenue. Total revenue increased$49.1 million , or 21.4%, to$278.1 million for the three months endedSeptember 26, 2020 from$229.0 million for the three months endedSeptember 28, 2019 . The following table details our total product revenues by the geographic area to which the products were shipped for each of the three months endedSeptember 26, 2020 andSeptember 28, 2019 (dollars in thousands): Three Months Ended September 26, September 28, Increase/ Percentage 2020 2019 (Decrease) Change United States (U.S.)$ 186,919 67.2 %$ 157,646 68.9 %$ 29,273 18.6 %Europe ,Middle East and Africa 54,257 19.5 42,356 18.5 11,901 28.1 Asia and Australia 27,583 9.9 22,721 9.9 4,862 21.4North and South America (excluding the U.S.) 9,353 3.4 6,193 2.7 3,160 51.0 Total product revenue$ 278,112 100.0 %$ 228,916 100.0 %$ 49,196 21.5 % Royalty and other revenue - 95 (95) (100.0) Total revenue$ 278,112 $ 229,011 $ 49,101 21.4 % Product revenues increased$49.2 million , or 21.5%, to$278.1 million for the three months endedSeptember 26, 2020 , compared to$228.9 million for the three months endedSeptember 28, 2019 . This increase was primarily due to higher revenue from monitors, consumables and boards, a portion of which we believe is related to continued increased demand for our products due to the global COVID-19 pandemic, as well as the impact of approximately$0.8 million of favorable foreign exchange rate movements from the prior year period that decreased theU.S. Dollar translation of foreign sales that were denominated in various foreign currencies. During the three months endedSeptember 26, 2020 , we shipped approximately 151,700 noninvasive technology boards and instruments, an increase of 91,000 units, or 149.9%, from 60,700 units shipped during the three months endedSeptember 28, 2019 . Product revenue generated through our direct and distribution sales channels increased$21.3 million , or 10.8%, to$219.3 million for the three months endedSeptember 26, 2020 , compared to$198.0 million for the three months endedSeptember 28, 2019 . Revenues from our OEM channel increased$27.9 million , or 90.3%, to$58.8 million for the three months endedSeptember 26, 2020 as compared to$30.9 million for the three months endedSeptember 28, 2019 . Gross Profit. Gross profit consists of total revenue less cost of goods sold. Our gross profit for the three months endedSeptember 26, 2020 andSeptember 28, 2019 was as follows (dollars in thousands): Three Months Ended September 26, Gross Profit September 28, Gross Profit Increase/ Percentage 2020 Percentage 2019 Percentage (Decrease) Change Product gross profit$ 178,926 64.3 %$ 156,210 68.2 %$ 22,716 14.5 % Royalty and other revenue gross profit - - 58 61.1 (58) (100.0) Total gross profit$ 178,926 64.3 %$ 156,268 68.2 %$ 22,658 14.5 % 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$26.4 million for the three months endedSeptember 26, 2020 , compared to the three months endedSeptember 28, 2019 , primarily due to higher material and manufacturing costs associated with the increase in product sales volumes, product mix, and increased manufacturing complexity associated with the impact of COVID-19. Product gross margins decreased to 64.3% for the three months endedSeptember 26, 2020 , compared to 68.2% for the three months endedSeptember 28, 2019 , primarily due to unfavorable product mix associated with the increase in board and monitor sales and increased manufacturing complexity associated with the impact of COVID-19. 38 -------------------------------------------------------------------------------- Table of Contents 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 endedSeptember 26, 2020 andSeptember 28, 2019 were as follows (dollars in thousands): Selling, General and Administrative Three Months Ended Percentage of Three Months Ended Percentage of Increase/ Percentage September 26, 2020 Net Revenues September 28, 2019 Net Revenues (Decrease) Change$90,376 32.5%$80,354 35.1%$10,022 12.5% Selling, general and administrative expenses increased$10.0 million , or 12.5%, for the three months endedSeptember 26, 2020 , compared to the three months endedSeptember 28, 2019 . This increase was primarily attributable to higher advertising and marketing-related costs of approximately$7.6 million , higher legal and professional fees of$2.8 million , and higher compensation and other employee-related costs of approximately$2.6 million , which were partially offset by a reduction in travel costs of approximately$3.3 million . Approximately$8.7 million and$8.4 million of stock-based compensation expense was included in selling, general and administrative expenses for the three months endedSeptember 26, 2020 andSeptember 28, 2019 , 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 endedSeptember 26, 2020 andSeptember 28, 2019 were as follows (dollars in thousands): Research and Development Three Months Ended Percentage of Three Months Ended Percentage of Increase/ Percentage September 26, 2020 Net Revenues September 28, 2019 Net Revenues (Decrease) Change$28,852 10.4%$24,282 10.6%$4,570 18.8% Research and development expenses increased$4.6 million , or 18.8%, for the three months endedSeptember 26, 2020 , compared to the three months endedSeptember 28, 2019 , primarily due to higher compensation and employee-related costs of approximately$3.6 million and higher equipment and supplies related costs of$0.5 million . Approximately$3.1 million and$2.3 million of stock-based compensation expense was included in research and development expenses for the three months endedSeptember 26, 2020 andSeptember 28, 2019 , respectively. Non-operating Income. Non-operating income consists primarily of interest income, interest expense and foreign exchange gains and losses. Non-operating income for the three months endedSeptember 26, 2020 andSeptember 28, 2019 was as follows (dollars in thousands): Non-operating Income Three Months Ended Percentage of Three Months Ended Percentage of Increase/ Percentage September 26, 2020 Net Revenues September 28, 2019 Net Revenues (Decrease) Change$1,357 0.5%$2,723 1.2%$(1,366) (50.2)% Non-operating income decreased by$1.4 million for the three months endedSeptember 26, 2020 , compared to the three months endedSeptember 28, 2019 , primarily due to lower interest yields realized on our invested cash and short-term investments of approximately$2.9 million , partially offset by net realized and unrealized gains on foreign currency denominated transactions of approximately$1.5 million . Provision for Income Taxes. Our provision for income taxes for the three months endedSeptember 26, 2020 andSeptember 28, 2019 was as follows (dollars in thousands): Provision for Income Taxes Three Months Ended Percentage of Three Months Ended Percentage of Increase/ Percentage September 26, 2020 Net Revenues September 28, 2019 Net Revenues (Decrease) Change$11,650 4.2%$5,270 2.3%$6,380 121.1% 39
-------------------------------------------------------------------------------- Table of Contents For the three months endedSeptember 26, 2020 , we recorded a provision for income taxes of approximately$11.7 million , or an effective tax provision rate of 19.1%, as compared to a provision for income taxes of approximately$5.3 million , or an effective tax provision rate of 9.7%, for the three months endedSeptember 28, 2019 . The increase in our effective tax rate for the three months endedSeptember 26, 2020 resulted primarily from a decrease in the amount of excess tax benefits realized from stock-based compensation of approximately$3.9 million compared to the three months endedSeptember 28, 2019 . InMarch 2020 , the Coronavirus Aid, Relief, and Economic Security Act (the CARES Act) was enacted and signed into law in response to the market volatility and instability resulting from the COVID-19 pandemic. It includes a significant number of tax provisions and lifts certain deduction limitations originally imposed by the Tax Cuts and Jobs Act of 2017. The changes are mainly related to: (1) the business interest expense disallowance rules for 2019 and 2020; (2) net operating loss rules; (3) charitable contribution limitations; (4) employee retention credit; and (5) the realization of corporate alternative minimum tax credits. We continue to assess the impact and future implications of these provisions; however, we do not anticipate any amounts that could give rise to a material impact to our overall condensed consolidated financial statements. Comparison of the Nine Months endedSeptember 26, 2020 to the Nine Months endedSeptember 28, 2019 Revenue. Total revenue increased$158.4 million , or 22.9%, to$848.7 million for the nine months endedSeptember 26, 2020 from$690.3 million for the nine months endedSeptember 28, 2019 . The following table details our total product revenues by the geographic area to which the products were shipped for each of the nine months endedSeptember 26, 2020 andSeptember 28, 2019 (dollars in thousands): Nine Months Ended September 26, September 28, Increase/ Percentage 2020 2019 (Decrease) Change United States (U.S.)$ 571,158 67.3 %$ 469,827 68.2 %$ 101,331 21.6 % Europe, Middle East and Africa 176,781 20.8 136,234 19.8 40,547 29.8 Asia and Australia 73,155 8.6 62,524 9.1 10,631 17.0North and South America (excluding the U.S.) 27,596 3.3 20,389 2.9 7,207 35.3 Total product revenue$ 848,690 100.0 %$ 688,974 100.0 %$ 159,716 23.2 % Royalty and other revenue - 1,353 (1,353) (100.0) Total revenue$ 848,690 $ 690,327 $ 158,363 22.9 % Product revenue increased$159.7 million , or 23.2%, to$848.7 million for the nine months endedSeptember 26, 2020 from$689.0 million for the nine months endedSeptember 28, 2019 . This increase was primarily due to higher revenue from consumables, monitors and boards. Partially offsetting these increases was the impact of approximately$2.4 million of unfavorable foreign exchange rate movements from the prior year period that decreased theU.S. Dollar translation of foreign sales that were denominated in various foreign currencies. During the nine months endedSeptember 26, 2020 , we shipped approximately 389,400 noninvasive technology boards and instruments, an increase of 204,600 units, or 110.7%, from 184,800 units shipped during the nine months endedSeptember 28, 2019 . Product revenue generated through our direct and distribution sales channels increased$96.7 million , or 16.1%, to$698.0 million for the nine months endedSeptember 26, 2020 , compared to$601.3 million for the nine months endedSeptember 28, 2019 . Revenues from our OEM channel increased$63.1 million , or 71.9%, to$150.7 million for the nine months endedSeptember 26, 2020 as compared to$87.7 million for the nine months endedSeptember 28, 2019 . Royalty and other revenue decreased by$1.4 million for the nine months endedSeptember 26, 2020 compared to the nine months endedSeptember 28, 2019 , primarily due to lower royalties from Medtronic as a result of the expiration of their obligation to pay us royalties afterOctober 6, 2018 . We received our final royalty payment from Medtronic during the three months endedMarch 30, 2019 . 40 -------------------------------------------------------------------------------- Table of Contents Gross Profit. Gross profit consists of total revenue less cost of goods sold. Our gross profit for the nine months endedSeptember 26, 2020 andSeptember 28, 2019 was as follows (dollars in thousands): Nine Months Ended September 26, Gross Profit September 28, Gross Profit Increase/ Percentage 2020 Percentage 2019 Percentage (Decrease) Change Product gross profit$ 556,139 65.5 %$ 461,032 66.9 %$ 95,107 20.6 % Royalty and other revenue gross profit - - 1,217 89.9 (1,217) (100.0) Total gross profit$ 556,139 65.5 %$ 462,249 67.0 %$ 93,890 20.3 % Cost of goods sold increased$64.5 million for the nine months endedSeptember 26, 2020 compared to the nine months endedSeptember 28, 2019 , primarily due to higher material and manufacturing costs associated with the increase in product sales volume and increased manufacturing complexity associated with the impact of COVID-19. Product gross margins decreased to 65.5% for the nine months endedSeptember 26, 2020 compared to 66.9% for the nine months endedSeptember 28, 2019 , primarily due to unfavorable product mix associated with the increase in monitor and board sales and increased manufacturing complexity associated with the impact of COVID-19. Royalty and other revenue gross profit decreased by$1.2 million for the nine months endedSeptember 26, 2020 compared to the nine months endedSeptember 28, 2019 , primarily due to lower royalties from Medtronic as a result of the expiration of their obligation to pay us royalties afterOctober 6, 2018 . Selling, General and Administrative. Selling, general and administrative expenses for the nine months endedSeptember 26, 2020 andSeptember 28, 2019 were as follows (dollars in thousands): Selling, General and Administrative Nine Months Ended Percentage of Nine Months Ended Percentage of Increase/ Percentage September 26, 2020 Net Revenues September 28, 2019 Net Revenues (Decrease) Change$278,714 32.8%$232,718 33.7%$45,996 19.8% Selling, general and administrative expenses increased$46.0 million , or 19.8%, for the nine months endedSeptember 26, 2020 compared to the nine months endedSeptember 28, 2019 . This increase was primarily attributable to higher compensation and other employee-related costs of approximately$22.8 million , higher advertising and marketing-related costs of approximately$16.3 million , higher legal and professional fees of approximately$8.8 million and higher contributions and donations of approximately$3.5 million ; which were partially offset by a reduction in travel-related costs of approximately$7.3 million . Stock-based compensation expense of approximately$27.4 million and$23.0 million was included in selling, general and administrative expenses for the nine months endedSeptember 26, 2020 andSeptember 28, 2019 , respectively. Research and Development. Research and development expenses for the nine months endedSeptember 26, 2020 andSeptember 28, 2019 were as follows (dollars in thousands): Research and Development Nine Months Ended Percentage of Nine Months Ended Percentage of Increase/ Percentage September 26, 2020 Net Revenues September 28, 2019 Net Revenues (Decrease) Change$86,971 10.2%$69,872 10.1%$17,099 24.5% Research and development expenses increased$17.1 million , or 24.5%, for the nine months endedSeptember 26, 2020 compared to the nine months endedSeptember 28, 2019 , primarily due to higher compensation-related costs of approximately$13.5 million , higher professional service fees of$1.3 million , higher equipment and supplies related costs of$0.7 million and higher occupancy costs of approximately$0.7 million . Approximately$8.4 million and$6.3 million of stock-based compensation expense was included in research and development expenses for the nine months endedSeptember 26, 2020 andSeptember 28, 2019 , respectively. 41 -------------------------------------------------------------------------------- Table of Contents Non-operating Income. Non-operating income consists primarily of interest income, interest expense and foreign exchange gains and losses. Non-operating income for the nine months endedSeptember 26, 2020 andSeptember 28, 2019 was as follows (dollars in thousands): Non-operating Income Nine Months Ended Percentage of Nine Months Ended Percentage of Increase/ Percentage September 26, 2020 Net Revenues September 28, 2019 Net Revenues (Decrease) Change$6,108 0.7%$10,138 1.5%$(4,030) (39.8)% Non-operating income decreased by$4.0 million for the nine months endedSeptember 26, 2020 compared to the nine months endedSeptember 28, 2019 , primarily due to lower interest yields realized on our invested cash and short-term investments of approximately$5.6 million , partially offset by net realized and unrealized gains on foreign currency denominated transactions of approximately$1.6 million . Provision for Income Taxes. Our provision for income taxes for the nine months endedSeptember 26, 2020 andSeptember 28, 2019 was as follows (dollars in thousands): Provision for Income Taxes Nine Months Ended Percentage of Nine Months Ended Percentage of Increase/ Percentage September 26, 2020 Net Revenues September 28, 2019 Net Revenues (Decrease) Change$27,403 3.2%$26,502 3.8%$901 3.4% For the nine months endedSeptember 26, 2020 , we recorded a provision for income taxes of approximately$27.4 million , or an effective tax rate of 13.9%, as compared to a provision for income taxes of approximately$26.5 million , or an effective tax rate of 15.6%, for the nine months endedSeptember 28, 2019 . The decrease in our tax rate for the nine months endedSeptember 26, 2020 resulted primarily from an increase in the amount of excess tax benefits realized from stock-based compensation of approximately$7.1 million as compared to the nine months endedSeptember 28, 2019 . Liquidity and Capital Resources Our principal sources of liquidity consist of our existing cash and cash equivalent balances, short-term investments, future funds expected to be generated from operations and available borrowing capacity under our credit facility. As ofSeptember 26, 2020 , we had approximately$926.2 million in working capital, approximately$669.1 million in cash and cash equivalents, approximately$50.0 million in short-term investments and approximately$148.1 million of available borrowing capacity (net of outstanding letters of credit) under our credit facility. We carry short-term investments at cost, which approximates fair value. In managing our day-to-day liquidity and capital structure, we generally do not rely on foreign earnings as a source of funds. As ofSeptember 26, 2020 , we had cash totaling$77.8 million held outside of theU.S. , of which approximately$51.5 million was accessible without additional tax cost and approximately$26.3 million was accessible at an incremental estimated tax cost of up to$0.2 million . We currently have sufficient funds on-hand and available without additional tax cost to fund our global operations. In the event funds that are treated as permanently reinvested are repatriated, we may be required to accrue and pay additionalU.S. taxes to repatriate these funds. Cash Flows The following table summarizes our cash flows (in thousands): Nine Months Ended September 26, September 28, 2020 2019 Net cash provided by (used in): Operating activities$ 146,545 $ 151,416 Investing activities (80,840) (184,221) Financing activities 38,954 (5,341) Effect of foreign currency exchange rates on cash (294) (983)
Increase (decrease) in cash, cash equivalents and restricted cash
$ 104,365 $ (39,129) 42 -------------------------------------------------------------------------------- Table of Contents Operating Activities. Cash provided by operating activities was approximately$146.5 million for the nine months endedSeptember 26, 2020 , generated primarily from net income from operations of$169.6 million . Non-cash activity included stock-based compensation of$36.4 million and depreciation and amortization of$21.2 million . Additional sources of cash included an increase in accounts payable, deferred revenue and other contract-related liabilities, accrued liabilities and accrued compensation of$31.8 million ,$10.0 million ,$4.7 million and$3.7 million , respectively. These sources of cash were partially offset by other changes in operating assets and liabilities, including a decrease in income tax payable of approximately$2.8 million , an increase in inventory of approximately$86.8 million , an increase in other current assets of approximately$23.5 million , an increase in accounts receivable of approximately$9.5 million , primarily due to the timing of cash receipts, and an increase in lease receivable of approximately$6.3 million . For the nine months endedSeptember 28, 2019 , cash provided by operating activities was approximately$151.4 million , generated primarily from net income from operations of$143.3 million . Non-cash activity included stock-based compensation of$29.6 million , and depreciation and amortization of$17.6 million . Additional sources of cash included a decrease in deferred costs and other contract assets of approximately$8.9 million and an increase in deferred revenue and other contract-related liabilities of approximately$6.8 million and an increase in income tax payable of$3.4 million , primarily due to the timing of payments. These sources of cash were partially offset by other changes in operating assets and liabilities, including an increase in accounts receivable of approximately$21.7 million , primarily due to the timing of cash receipts, an increase in inventory of approximately$15.2 million and increases in other current assets and lease receivable of approximately$12.1 million and$9.4 million , respectively, primarily due to the timing of payments. Investing Activities. Cash used in investing activities for the nine months endedSeptember 26, 2020 was approximately$80.8 million , consisting primarily of approximately$78.3 million for business combinations,$60.0 million for purchases of property and equipment,$6.8 million for strategic investments and$5.8 million of capitalized intangible asset costs related primarily to patent and trademark costs, which were partially offset by cash provided by net maturities of short-term investments of approximately$70.0 million . For the nine months endedSeptember 28, 2019 , cash used in investing activities was approximately$184.2 million , consisting of approximately$120.0 million for purchases of short-term investments,$56.1 million for purchases of property and equipment, approximately$5.2 million for purchases of strategic investments and approximately$3.0 million of capitalized intangible asset costs related primarily to patent and trademark costs. Financing Activities. Cash provided by financing activities for the nine months endedSeptember 26, 2020 was approximately$39.0 million , consisting primarily of proceeds from the issuance of common stock related to employee equity awards of approximately$41.0 million , which was partially offset by the withholding of shares for employee payroll taxes for vested equity awards of approximately$1.4 million and repurchases of our common stock of approximately$0.6 million . For the nine months endedSeptember 28, 2019 , cash used in financing activities was approximately$5.3 million , consisting primarily of repurchases of our common stock of approximately$27.9 million , which was partially offset by proceeds from the issuance of common stock related to employee equity awards of approximately$22.7 million . Capital Resources and Prospective Capital Requirements We expect to fund our future operating, investing and financing activities through our available cash and short-term investments, future cash from operations, our credit facility and other potential sources of capital. In addition to funding our working capital requirements, we anticipate additional capital expenditures during fiscal year 2020, primarily related to investments in infrastructure growth. Possible additional uses of cash may include acquisitions of and/or strategic investments in technologies or technology companies, investments in property and equipment and repurchases of common stock under our authorized stock repurchase program. However, any repurchases of common stock will be subject to numerous factors, including the availability of our stock, general market conditions, the trading price of our stock, available capital, alternative uses for capital and our financial performance. In addition, the amount and timing of our actual investing activities will vary significantly depending on numerous factors, including the timing and amount of capital expenditures, costs of product development efforts, our timetable for infrastructure expansion, 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 and amounts available under our 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. 43 -------------------------------------------------------------------------------- Table of Contents 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 ofSeptember 26, 2020 , we did not have any off-balance sheet arrangements, as defined in Item 303(a)(4)(ii) of Regulation S-K promulgated by theSEC . 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 inthe 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, inventory valuation, lessee right-of-use (ROU) assets and lease liabilities, the fair value of identifiable assets and liabilities connected with business combinations, stock-based compensation, 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. As a result of certain acquisitions during the nine months endedSeptember 26, 2020 , we are updating our list of the most significant accounting policies for purposes of fully understanding and evaluating our reported financial results to include "Business Combinations" as follows: Business Combinations We account for business combinations using the acquisition method of accounting, which requires that once control is obtained, all the assets acquired and liabilities assumed are recorded at their respective fair values at the date of acquisition. The determination of fair values of identifiable assets and liabilities requires estimates and the use of valuation techniques when market value is not readily available. For intangible assets acquired in a business combination, we typically use the income method. Significant estimates in valuing certain intangible assets include, but are not limited to, the amount and timing of future cash flows, growth rates, discount rates and useful lives. The excess of the purchase price over fair values of identifiable assets and liabilities is recorded as goodwill. Other Critical Accounting Policies There have been no material changes to any of our other critical accounting policies during the nine months endedSeptember 26, 2020 . For a description of these 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 endedDecember 28, 2019 , which was filed with theSEC onFebruary 19, 2020 . Recent Accounting Pronouncements See Note 2 to our accompanying 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 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 or other financial instruments for trading or speculative purposes. 44 -------------------------------------------------------------------------------- Table of Contents Interest Rate Risk Our exposure to market risk for changes in interest rates relates to the increase or decrease in the amount of interest income we can earn on our cash and cash equivalents and short-term investments, as well as the increase or decrease in the amount of interest expense we must pay with respect to any outstanding debt instruments. We do not believe our cash, cash equivalents and short-term investments are subject to significant interest rate risk due to the short-term periods such amounts are invested. As ofSeptember 26, 2020 , the carrying value of our cash equivalents and short-term investments approximated fair value. We currently do not have any significant risks associated with interest rates fluctuations related to interest expense. Under our current policies, we do not use interest rate derivative instruments to manage exposure to interest rate changes. Therefore, declines in interest rates over time will reduce our interest income while increases in interest rates will increase our interest income. A hypothetical 100 basis point change in interest rates along the entire interest rate yield curve would increase or decrease our interest rate yields on our investments and interest income by approximately$0.1 million for each$10.0 million in interest-bearing investments. Foreign Currency Exchange Rate Risk A majority of our assets and liabilities are maintained inthe United States inU.S. Dollars and a majority of our sales and expenditures are transacted inU.S. Dollars. However, we also transact with foreign customers in currencies other than theU.S. Dollar. These foreign currency revenues, when converted intoU.S. Dollars, can vary depending on average exchange rates during a respective period. In addition, certain of our foreign subsidiaries transact in their respective country's local currency, which is also their functional currency. As a result, expenses of these foreign subsidiaries, when converted intoU.S. Dollars can also vary depending on average monthly exchange rates during a respective period. We are exposed to foreign currency gains or losses on outstanding foreign currency denominated receivables and payables, as well as our foreign currency denominated cash balances and certain intercompany transactions. In addition, other transactions between us or our subsidiaries and a third-party, denominated in a currency different from the functional currency, are foreign currency transactions. Realized and unrealized foreign currency gains or losses on these transactions are also included in our statements of operations as incurred. The balance sheets of each of our foreign subsidiaries whose functional currency is not theU.S. Dollar are translated intoU.S. Dollars at the rate of exchange at the balance sheet date and the statements of comprehensive income and cash flows are translated intoU.S. Dollars using an approximation of the average monthly exchange rates applicable during the period. Any foreign exchange gain or loss as a result of translating the balance sheets of our foreign subsidiaries whose functional currency is not theU.S. Dollar is included in equity as a component of accumulated other comprehensive income. Our primary foreign currency exchange rate exposures are with the Australian Dollar, the British Pound, Canadian Dollar, Euro, Japanese Yen, South Korean Won, Mexican Peso and Swedish Krona. Foreign currency exchange rates may experience significant volatility from one period to the next. Specifically, during the nine months endedSeptember 26, 2020 , we estimate fluctuations in the exchange rates between theU.S. Dollar and other foreign currencies, including the Euro, the Australian Dollar, the Canadian Dollar, and the South Korean Won, adversely impacted our revenues by$2.4 million . We currently do not enter into forward exchange contracts to hedge exposures denominated in foreign currencies and do not use derivative financial instruments for trading or speculative purposes. The effect of additional changes in foreign currency exchange rates could have a material effect on our future operating results or cash flows, depending on which foreign currency exchange rates change and depending on the directional change (either a strengthening or weakening against theU.S. Dollar). We estimate that the potential impact of a hypothetical 10% adverse change in all applicable foreign currency exchange rates from the rates in effect as ofSeptember 26, 2020 would have resulted in an estimated reduction of$2.9 million in reported pre-tax income for the nine months endedSeptember 26, 2020 . As our foreign operations continue to grow, our exposure to foreign currency exchange rate risk may become more significant. Inflation Risk We do not believe that inflation has had a material effect on our business, financial condition or results of operations during the periods presented. If our costs were to become subject to significant inflationary pressures, we may not be able to fully offset such higher costs through price increases. Our inability or failure to do so could have a material adverse effect on our business, financial condition and results of operations. 45
--------------------------------------------------------------------------------
Table of Contents
© Edgar Online, source
