Variable Interest Entities (VIEs)

Under existing accounting standards, the Company is required to determine whether its variable interest gives it a controlling financial interest in a VIE that is required to be consolidated. 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. The changes in noncontrolling interests for the consolidated VIEs are presented in the accompanying consolidated statements of equity.

Cercacor Laboratories, Inc.

Cercacor Laboratories, Inc., or Cercacor, is an independent entity spun off from the Company to its stockholders in 1998. Joe Kiani and Jack Lasersohn, members of the Company’s board of directors, or Board, are also members of the board of directors of Cercacor. Joe Kiani, the Company’s Chairman and Chief Executive Officer, is also the Chairman and Chief Executive Officer 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, that governs each party’s rights to certain intellectual property held by the two companies. In addition, the Company entered into a Services Agreement with Cercacor effective January 1, 2007 to govern the general and administrative services the Company provides to Cercacor.

Under the Cross-Licensing Agreement, the Company granted Cercacor an exclusive, perpetual and worldwide license, with sublicense rights, to use all Masimo SET^® owned by the Company, including all improvements on this technology, for the monitoring of non-vital signs measurements and to develop and sell devices incorporating Masimo SET^® for monitoring non-vital signs measurements in any product market in which a product is intended to be used by a patient or pharmacist rather than a professional medical caregiver. The Company refers to this market as the Cercacor Market. The Company also granted Cercacor a non-exclusive, perpetual and worldwide license, with sublicense rights to use all Masimo SET^® for the measurement of vital signs in the Cercacor Market. The Company exclusively licenses from Cercacor the right to make and distribute products in the professional medical caregiver markets, which the Company refers to as the Masimo Market, that utilize rainbow^® technology for the measurement of carbon monoxide, methemoglobin, fractional arterial oxygen saturation, and hemoglobin, which includes hematocrit. To date, the Company has developed and commercially released devices that measure carbon monoxide, methemoglobin and hemoglobin using licensed rainbow^® technology. In December 2013, the Company elected to exercise its option to acquire the licensing rights to five additional parameters. The licensing cost for these additional parameters, which was predetermined in the Cross-Licensing Agreement, was $0.5 million per license. The Company also has the option to obtain exclusive licenses to make and distribute products that utilize rainbow^® technology for the monitoring of other non-vital signs measurements, including blood glucose, in product markets where the product is intended to be used by a professional medical caregiver.

The Company’s license to rainbow^® technology for these parameters in these markets is exclusive on the condition that the Company continues to pay Cercacor royalties on its products incorporating rainbow^® technology, subject to certain minimum aggregate royalty thresholds, and that the Company use commercially reasonable efforts to develop or market products incorporating the licensed rainbow^® technology. The royalty is up to 10% of the rainbow^® royalty base, which includes handhelds, tabletop and multiparameter devices. Handheld products incorporating rainbow^® technology will carry up to a 10% royalty rate. For other products, only the proportional amount attributable for that portion of the Company’s devices used to monitor non-vital signs measurements, rather than for monitoring vital signs measurements, and sensors and accessories for measuring only non-vital sign parameters, will be included in the 10% rainbow^® royalty base. Effective January 2009, for multiparameter devices, the rainbow^® royalty base will include the percentage of the revenue based on the number of rainbow^® enabled measurements. For hospital contracts where the Company places equipment and enters into a sensor contract, the Company pays a royalty to Cercacor on the total sensor contract revenues based on the ratio of rainbow^® enabled devices to total devices.

Under the license, the Company is subject to certain specific annual minimum aggregate royalty payments in the amount of $5.0 million. Actual aggregate royalty payment liabilities to Cercacor under the license were $5.4 million, $5 million and $5 million for fiscal years ended December 28, 2013, December 29, 2012 and December 31, 2011, respectively. In addition, in connection with a change in control as defined in the Cross-Licensing Agreement, the minimum aggregate annual royalties payable to Cercacor for carbon monoxide, methemoglobin, fractional arterial oxygen saturation, hemoglobin and/or glucose measurements will increase to $15.0 million per year, and up to $2.0 million per year for other rainbow^® measurements.

In February 2009, in order to accelerate the product development of an improved hemoglobin spot-check measurement device, Pronto-7^®, the Company’s board of directors agreed to fund additional Cercacor’s engineering expenses. Specifically, these expenses included third-party engineering materials and supplies expense as well as 50% of Cercacor’s total engineering and engineering related payroll expenses from April 2009 through June 2010, the original anticipated completion date of this product development effort. Since July 2010, Cercacor has continued to assist the Company with product development efforts and charged the Company accordingly. Beginning in 2012, due to a revised estimate of the support required by the Company to complete the various Pronto-7^® related projects, the Company’s Board of Directors approved an increase in the percentage of Cercacor’s total engineering and engineering related payroll expenses funded by the Company from 50% to 60%. During the years ended December 28, 2013, December 29, 2012 and December 31, 2011, the total expenses for these additional services, material and supplies totaled $4.1 million, $3.6 million and $2.5 million, respectively.

Pursuant to authoritative accounting guidance, Cercacor is consolidated within the Company’s financial statements for all periods presented. The Company is required to consolidate Cercacor since the Company is deemed to be the primary beneficiary of Cercacor’s activities. This determination is based on the Company’s ability to direct the activities that most significantly impact Cercacor’s economic performance, and the Company’s obligation to absorb Cercacor’s expected losses.

Accordingly, all intercompany royalties, option and license fees and other charges between the Company and Cercacor as well as all intercompany payables and receivables have been eliminated in the consolidation. All direct engineering expenses that have been incurred by the Company and charged to Cercacor, or that have been incurred by Cercacor and charged to the Company, have not been eliminated and are included as research and development expense in the Company’s consolidated statements of comprehensive income. Assets of Cercacor can only be used to settle obligations of Cercacor and creditors of Cercacor have no recourse to the general credit of the Company.

For the foreseeable future, the Company anticipates that it will continue to consolidate Cercacor pursuant to the current authoritative accounting guidance; however, in the event that Cercacor is no longer considered a VIE, the Company may discontinue consolidating the entity.

Below are condensed consolidating schedules of the Balance Sheets as of December 28, 2013 and December 29, 2012, and Statements of Comprehensive Income for the years ended December 28, 2013, December 29, 2012 and December 31, 2011 reflecting Masimo Corporation, Cercacor and related eliminations (in thousands).



	December 28, 2013												December 29, 2012
Balance Sheets:	Masimo Corp			Cercacor			Cercacor Elim			Total			Masimo Corp			Cercacor		Cercacor Elim			Total
ASSETS
Cash and cash equivalents	$	95,296		$	170		$	—		$	95,466		$	71,259		$	295	$	—		$	71,554
Receivables, net	84,059									84,059			75,478			10		(447		)	75,041
Inventories	56,813			—			—			56,813			47,358			—		—			47,358
Prepaid expenses	12,798			185			—			12,983			8,390			197		—			8,587
Deferred tax asset, current	19,636			—			—			19,636			12,048			863		—			12,911
Other current assets	2,841			—			—			2,841			3,896			—		—			3,896
Deferred cost of goods sold	61,714			—			—			61,714			52,103			—		—			52,103
Property and equipment, net	22,931			1,935			—			24,866			21,450			2,474		—			23,924
Intangible assets, net	30,452			4,683			(7,031		)	28,104			28,069			4,200		(4,906		)	27,363
Goodwill	22,793			—			—			22,793			22,824			—		—			22,824
Deferred tax asset, long term	22,565						—			22,565			20,119			959		—			21,078
Other assets, long term	6,787			2,021			(1,986		)	6,822			7,985			637		(600		)	8,022
Total assets	$	438,685		$	8,994		$	(9,017	)	$	438,662		$	370,979		$	9,635	$	(5,953	)	$	374,661
LIABILITIES
Accounts payable	$	27,418		$	586		$	—		$	28,004		$	26,412		$	621	$	—		$	27,033
Accrued liabilities and compensation	51,205			1,309			—			52,514			40,622			1,494		(447		)	41,669
Income taxes payable	2,205			201			—			2,406			1,504			—		—			1,504
Deferred revenue, current	20,755			500			(500		)	20,755			19,278			375		(375		)	19,278
Current portion of capital lease obligations	111			—			—			111			55			—		—			55
Deferred revenue, long-term	566			6,531			(6,531		)	566			576			4,531		(4,531		)	576
Capital lease obligations, less current portion	225			—			—			225			60			—		—			60
Other liabilities	9,459			207			(1,986		)	7,680			9,121			297		(600		)	8,818
EQUITY (DEFICIT)
Common stock	57			11			(11		)	57			57			11		(11		)	57
Treasury stock	(83,454		)	—						(83,454		)	(63,664		)	—		—			(63,664		)
Additional paid-in capital	273,129			427			(427		)	273,129			258,783			424		(424		)	258,783
Accumulated other comprehensive income	3,995			—			—			3,995			3,542			—		—			3,542
Retained earnings (deficit)	133,014			(778		)	506			132,742			74,633			1,882		(2,154		)	74,361
Total Masimo Corporation stockholders’ equity (deficit)	326,741			(340		)	68			326,469			273,351			2,317		(2,589		)	273,079
Noncontrolling interest	—			—			(68		)	(68		)	—			—		2,589			2,589
Total equity	326,741			(340		)	—			326,401			273,351			2,317		—			275,668
Total liabilities and equity (deficit)	$	438,685		$	8,994		$	(9,017	)	$	438,662		$	370,979		$	9,635	$	(5,953	)	$	374,661



	Year ended December 28, 2013												Year ended December 29, 2012												Year ended December 31, 2011
Statements of Comprehensive Income:	Masimo Corp			Cercacor			Cercacor Elim			Total			Masimo Corp			Cercacor			Cercacor Elim			Total			Masimo Corp		Cercacor			Cercacor Elim			Total
Total revenue	$	547,245		$	5,732		$	(5,732	)	$	547,245		$	493,233		$	5,375		$	(5,375	)	$	493,233		$	438,988	$	5,375		$	(5,375	)	$	438,988
Cost of goods sold	193,775			—			(5,357		)	188,418			171,982			—			(5,000		)	166,982			149,854		—			(5,000		)	144,854
Gross profit (loss)	353,470			5,732			(375		)	358,827			321,251			5,375			(375		)	326,251			289,134		5,375			(375		)	294,134
Operating expenses:
Selling, general and administrative	213,374			2,470			(375		)	215,469			191,870			2,453			(375		)	193,948			167,634		1,946			(375		)	169,205
Research and development	51,762			3,869			—			55,631			43,412			3,665			—			47,077			35,053		3,359			—			38,412
Litigation award and defense costs	8,010			—			—			8,010			—			—			—			—			—		—			—			—
Total operating expenses	273,146			6,339			(375		)	279,110			235,282			6,118			(375		)	241,025			202,687		5,305			(375		)	207,617
Operating income	80,324			(607		)	—			79,717			85,969			(743		)	—			85,226			86,447		70			—			86,517
Non-operating income (expense)	(3,991		)	—			—			(3,991		)	(1,404		)	(1		)	—			(1,405		)	26		(12		)	—			14
Income before provision for income taxes	76,333			(607		)	—			75,726			84,565			(744		)	—			83,821			86,473		58			—			86,531
Provision for (benefit from) income taxes	17,952			2,053			—			20,005			22,293			(410		)	—			21,883			22,773		(295		)	—			22,478
Net income (loss) including noncontrolling interests	58,381			(2,660		)	—			55,721			62,272			(334		)	—			61,938			63,700		353			—			64,053
Net (income) loss attributable to noncontrolling interests				—			2,660			2,660			—			—			334			334			—		—			(353		)	(353		)
Net income (loss) attributable to Masimo Corporation stockholders	58,381			(2,660		)	2,660			58,381			62,272			(334		)	334			62,272			63,700		353			(353		)	63,700
Other comprehensive income, net of tax:
Foreign currency translation adjustments	453			—			—			453			2,268			—			—			2,268			349		—			—			349
Comprehensive income attributable to Masimo Corporation stockholders	$	58,834		$	(2,660	)	$	2,660		$	58,834		$	64,540		$	(334	)	$	334		$	64,540		$	64,049	$	353		$	(353	)	$	64,049