Discussion and analysis by MASIMO CORP management of the financial situation and operating results (form 10-Q)

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 January 2, 2021, which we filed with the SEC on February 23,
2021. 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 patient monitoring technologies, hospital
automation solutions, home monitoring devices and consumer products. Our mission
is to improve patient outcomes, reduce the cost of care and take noninvasive
monitoring to new sites and applications. Our patient monitoring solutions
generally incorporate a monitor or circuit board, proprietary single-patient use
or reusable sensors, software and/or cables. We primarily sell our products to
hospitals, emergency medical service (EMS) providers, home care providers,
physician offices, veterinarians, long-term care facilities and consumers
through our direct sales force, distributors and original equipment manufacturer
(OEM) partners. We were incorporated in California in May 1989 and
reincorporated in Delaware in May 1996.
Our core measurement technologies are Measure-through Motion and Low Perfusion™
pulse oximetry, known as Masimo Signal Extraction Technology® (SET®) pulse
oximetry, and advanced rainbow® Pulse CO-Oximetry parameters such as noninvasive
hemoglobin (SpHb®), alongside many other modalities, including brain function
monitoring, hemodynamic monitoring, regional oximetry, acoustic respiration rate
monitoring, capnography, nasal high-flow respiratory support therapy, patient
position and activity tracking and neuromodulation technology for the reduction
of symptoms associated with opioid withdrawal. Masimo's measurement technologies
are available on many types of devices, from bedside hospital monitors like the
Root® Patient Monitoring and Connectivity Hub, to various handheld and portable
devices, and to the tetherless Masimo SafetyNet™ remote patient surveillance
solution. The Masimo Hospital Automation™ Platform facilitates data integration,
connectivity, and interoperability through solutions like Patient SafetyNet™,
Replica® and UniView™ to facilitate more efficient clinical workflows and to
help clinicians provide the best possible care, both in-person and remotely.
Leveraging our expertise in hospital-grade technologies, we are also expanding
our suite of products intended for use outside the hospital and products for
consumers, including Sleep™, a sleep quality solution and the Radius Tº™
wireless, wearable continuous thermometer. 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 ended January 2, 2021, filed with
the SEC on February 23, 2021.
In January 2021, we announced the global launch of iSirona™, a compact,
versatile connectivity hub designed to maximize interoperability across the
continuum of care. The iSirona™ hub offers an efficient way to physically
connect up to six medical devices at the bedside and automatically route the
data to the Masimo Hospital Automation™ Platform. The iSirona™ hub helps ensure
that whatever the source, all patient data can be accurately and efficiently
captured and presented to clinicians in the most suitable ways.

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In February 2021, we announced the full market release of Masimo
SafetyNet-OPEN™, a web and mobile app solution that helps businesses, schools
and other organizations screen, trace and manage users entering their facilities
with respect to COVID-19 and other infectious illnesses, such as seasonal flu.
SafetyNet-OPEN™ helps organizations bring their people back to the workplace
responsibly and stay open safely. Tailored for each organization's safety
protocols and needs, SafetyNet-OPEN™ is capable of covering all stages of
back-to-work management, including risk screening, exposure contact tracing and
recovery management.
Also in February 2021, we announced the U.S. introduction of softFlow®, which
provides nasal high-flow warmed and humidified respiratory gases to
spontaneously breathing patients. The technology offers adult patients high-flow
respiratory support through a soft nasal cannula by generating a consistent high
flow of warm, humidified air or air/oxygen mixture.
In March 2021, we announced the CE Marking of the Rad-G™ with temperature, a
rugged handheld device that provides clinically proven SET® pulse oximetry,
respiration rate from the pleth (RRp®) parameter and other important parameters
alongside clinical-grade, non-contact infrared thermometry. With its
long-lasting rechargeable battery, robust rubber casing, light weight and
integrated noninvasive, real-time forehead temperature measurement, Rad-G™ with
temperature makes it easier for clinicians to quickly assess patients and make
informed care decisions anywhere pulse oximetry or vital signs monitoring is
needed in a compact, portable form factor. Coupled with the universal Mini-Clip™
pulse oximeter sensor to provide the ultimate in handheld versatility, Rad-G™
with temperature can be used in a variety of settings, including but not limited
to, entry screening, physicians' offices, outpatient services, long-term care
facilities, wellness clinics, first-response scenarios and limited-resource
environments both indoors and in the field. Rad-G™ can provide both spot-check
measurement and continuous monitoring.
In April 2021, we announced that Radius PCG™, a portable real-time capnograph
with wireless Bluetooth® connectivity, received FDA 510(k) clearance. Radius
PCG™ connects with the Root® Patient Monitoring and Connectivity Platform to
provide seamless, tetherless mainstream capnography for patients of all ages.
Radius PCG™ offers Masimo SET® Measure-through Motion and Low Perfusion pulse
oximetry, continuous temperature measurements with no routine calibration, along
with accurate end-tidal carbon dioxide (EtCO2) and respiration rate
measurements.
In June 2021, we announced that Radius T°™, a wearable, wireless thermometer
that measures body temperature continuously and noninvasively, received FDA
510(k) clearance for both prescription and over-the-counter use on patients and
consumers five years and older. Featuring continuously trending temperature
measurements and Bluetooth® connectivity, Radius T°™ automates remote,
continuous body temperature status for clinicians through its paired connection
to a Masimo patient monitoring or telehealth solution, and for consumers through
the Masimo Radius T°™ smartphone application.
In July 2021, we announced the release of the MX-7™ board, our latest and most
advanced rainbow SET® board. Designed for integration into the more than 200
multi-parameter monitors available from our more than 90 OEM partners, MX-7™ has
the ability to support all 13 of Masimo's SET® pulse oximetry and rainbow® Pulse
CO-Oximetry measurements in an advanced module re-engineered to reduce power
needs.
In August 2021, we announced the launch of Masimo SafetyNet Alert™, an arterial
blood oxygen saturation monitoring and alert system designed for use at home.
Masimo SafetyNet Alert™ features a Masimo SET® fingertip pulse oximetry sensor
that communicates wirelessly to an accompanying Home Medical Hub and smartphone
app. The system provides escalating visual and audible alerts that are designed
to alert the patient, or anyone nearby, to help prompt action if oxygen levels
continue to decline and designated emergency contacts are also notified via text
message. Masimo SafetyNet Alert™ has received the CE Mark in Europe.
In September 2021, we announced the launch of the single-patient-use rainbow®
SuperSensor™, compatible for use with both Masimo monitors and third-party
monitors with Masimo rainbow® technology inside. The rainbow® SuperSensor™ uses
12 LEDs to simultaneously offer 12 noninvasive, continuous Masimo SET® and
rainbow® parameters, providing a comprehensive and convenient fingertip solution
for assessing patient status. The rainbow® SuperSensor™ has received the CE Mark
in Europe.
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COVID-19 Pandemic
The COVID-19 pandemic has created significant uncertainty in the U.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 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 mandatory screening for symptoms associated with COVID-19 for critical
personnel that are required to report to our facilities to work. We also
introduced new products, such as Masimo SafetyNet™ and Masimo SafetyNet-OPEN™ to
help combat the COVID-19 pandemic and made pledges to various charitable
organizations to support global COVID-19 relief efforts. We currently believe
that our existing liquidity position will be sufficient to fund these ongoing
initiatives and our response efforts.
Given the continuing uncertainties related to the COVID-19 pandemic, we cannot
predict how it will continue to affect our product demand or our product mix. In
addition, the increase in demand we have experienced due to the COVID-19
pandemic could result in potential reductions in future demand if our customers
have over purchased our products and need to consume their excess inventory
before purchasing additional products. Furthermore, we continue to be exposed to
potential disruptions to our manufacturing operations and 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. In addition, given the recent presidential executive order mandating
federal contractors and subcontractors to be fully vaccinated against COVID-19
by November 22, 2021, we expect that our employees will be required to be
vaccinated per the federal mandate, and current employees and candidates seeking
employment with Masimo may be opposed to being vaccinated and may risk possible
termination or may seek employment with an employer that is not required to
follow the federal mandate. 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.
Cercacor
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
(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
effective January 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.
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Results of Operations
The following table sets forth, for the periods indicated, our results of
operations expressed as U.S. Dollar amounts and as a percentage of revenue
(dollars in thousands).
                                                            Three Months Ended                                                                           Nine Months Ended
                            October 2,            Percentage             September 26,            Percentage            October 2,            Percentage             September 26,            Percentage
                               2021               of Revenue                 2020                 of Revenue               2021               of Revenue                 2020                 of Revenue

Product revenue            $  307,414                   100.0  %       $      278,112                   100.0  %       $  911,575                   100.0  %       $      848,690                   100.0  %
Cost of goods sold            103,750                    33.7                  99,186                    35.7             318,124                    34.9                 292,551                    34.5
Gross profit                  203,664                    66.3                 178,926                    64.3             593,451                    65.1                 556,139                    65.5
Operating expenses:
Selling, general and
administrative                100,647                    32.7                  90,376                    32.5             291,180                    31.9                 278,714                    32.8
Research and development       35,406                    11.5                  28,852                    10.4             103,860                    11.4                  86,971                    10.2
Litigation awards                   -                       -                       -                       -                   -                       -                    (474)                   (0.1)
Total operating expenses      136,053                    44.3                 119,228                    42.9             395,040                    43.2                 365,211                    43.0
Operating income               67,611                    22.0                  59,698                    21.5             198,411                    21.8                 190,928                    22.5
Non-operating (loss)
income                            (78)                      -                   1,357                     0.5                (735)                   (0.1)                  6,108                     0.7
Income before provision
for income taxes               67,533                    21.9                  61,055                    22.0             197,676                    21.7                 197,036                    23.2
Provision for income taxes      9,762                     3.2                  11,650                     4.2              36,287                     4.0                  27,403                     3.2
Net income                 $   57,771                    18.7  %       $       49,405                    17.8  %       $  161,389                    17.6  %       $      169,633                    20.0  %



Comparison of the Three Months ended October 2, 2021 to the Three Months ended
September 26, 2020
Revenue. Product revenue increased $29.3 million, or 10.5%, to $307.4 million
for the three months ended October 2, 2021 from $278.1 million for the three
months ended September 26, 2020. The following table details our product
revenues by the geographic area to which the products were shipped for each of
the three months ended October 2, 2021 and September 26, 2020 (dollars in
thousands):
                                                                                   Three Months Ended
                                            October 2,                           September 26,                    Increase/             Percentage
                                               2021                                   2020                        (Decrease)              Change
United States (U.S.)              $ 207,060              67.4  %       $     186,919              67.2  %       $    20,141                    10.8  %
Europe, Middle East and Africa       56,223              18.3                 54,257              19.5                1,966                     3.6
Asia and Australia                   34,878              11.3                 27,583               9.9                7,295                    26.4
North and South America
(excluding the U.S.)                  9,252               3.0                  9,353               3.4                 (101)                   (1.1)
   Product revenue                $ 307,413             100.0  %       $     278,112             100.0  %       $    29,301                    10.5  %


This increase was primarily due to higher revenue from consumables, parameters
and services, as well as the impact of approximately $1.3 million of favorable
foreign exchange rate movements from the prior year that increased the U.S.
Dollar translation of foreign sales that were denominated in various foreign
currencies. During the three months ended October 2, 2021, we shipped
approximately 74,600 noninvasive technology boards and instruments.
Product revenue generated through our direct and distribution sales channels
increased $56.5 million, or 25.7%, to $275.7 million for the three months ended
October 2, 2021, compared to $219.3 million for the three months ended
September 26, 2020. Revenues from our OEM channel decreased $27.2 million, or
46.1%, to $31.7 million for the three months ended October 2, 2021 as compared
to $58.8 million for the three months ended September 26, 2020.
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Gross Profit. Gross profit consists of product revenue less cost of goods sold.
Our gross profit for the three months ended October 2, 2021 and September 26,
2020 was as follows (dollars in thousands):
                                                                 Gross Profit
   Three Months Ended          Percentage of         Three Months Ended          Percentage of            Increase/            Percentage
     October 2, 2021            Net Revenues         September 26, 2020          Net Revenues            (Decrease)              Change

        $203,664                   66.3%                  $178,926                   64.3%                 $24,738                13.8%


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 $4.6 million for the three months ended October 2,
2021, compared to the three months ended September 26, 2020, primarily due to
higher material, manufacturing and distribution costs associated with the
increase in product sales.
Gross profit increased to 66.3% for the three months ended October 2, 2021,
compared to 64.3% for the three months ended September 26, 2020, primarily due
to an increase in product sales and favorable revenue mix.
Selling, General and Administrative. Selling, general and administrative
expenses consist primarily of salaries, stock-based compensation 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
October 2, 2021 and September 26, 2020 were as follows (dollars in thousands):
                                                     Selling, General and Administrative
   Three Months Ended          Percentage of         Three Months Ended          Percentage of           Increase/            Percentage
     October 2, 2021            Net Revenues         September 26, 2020          Net Revenues            (Decrease)             Change
        $100,647                   32.7%                   $90,376                   32.5%                $10,271                11.4%


Selling, general and administrative expenses increased $10.3 million, or 11.4%,
for the three months ended October 2, 2021, compared to the three months ended
September 26, 2020. This increase was primarily attributable to higher
compensation and other employee-related costs of approximately $11.0 million,
higher legal and professional fees of $4.2 million, higher occupancy and other
office-related costs of approximately $1.5 million and higher travel costs of
approximately $1.4 million, which were partially offset by lower advertising and
marketing-related costs of approximately $8.5 million.
Research and Development. Research and development expenses consist primarily of
salaries, stock-based compensation 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 October 2, 2021 and September 26, 2020 were
as follows (dollars in thousands):
                                                           Research and Development
   Three Months Ended          Percentage of         Three Months Ended          Percentage of            Increase/            Percentage
     October 2, 2021            Net Revenues         September 26, 2020          Net Revenues            (Decrease)              Change
         $35,406                   11.5%                   $28,852                   10.4%                 $6,554                 22.7%


Research and development expenses increased $6.6 million, or 22.7%, for the
three months ended October 2, 2021, compared to the three months ended
September 26, 2020, primarily due to higher compensation and employee-related
costs of approximately $4.6 million and higher engineering project costs of
approximately $2.0 million.
Non-operating (Loss) Income. Non-operating (loss) income consists primarily of
interest income, interest expense and foreign exchange gains and losses.
Non-operating (loss) income for the three months ended October 2, 2021 and
September 26, 2020 was as follows (dollars in thousands):
                                                           Non-operating (Loss) Income
   Three Months Ended          Percentage of         Three Months Ended          Percentage of             Increase/              Percentage
     October 2, 2021            Net Revenues         September 26, 2020          Net Revenues              (Decrease)               Change
          $(78)                     -%                     $1,357                    0.5%                   $(1,435)               (105.7)%


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Non-operating (loss) income was less than $0.1 million for the three months
ended October 2, 2021, as compared to $1.4 million of non-operating income for
the three months ended September 26, 2020. This decrease of approximately $1.4
million was primarily due to lower interest yields realized on our invested
cash.
Provision for Income Taxes. Our provision for income taxes for the three months
ended October 2, 2021 and September 26, 2020 was as follows (dollars in
thousands):
                                                          Provision for Income Taxes
   Three Months Ended          Percentage of         Three Months Ended          Percentage of            Increase/            Percentage
     October 2, 2021            Net Revenues         September 26, 2020          Net Revenues            (Decrease)              Change
         $9,762                    3.2%                    $11,650                   4.2%                 $(1,888)               (16.2)%


For the three months ended October 2, 2021, we recorded a provision for income
taxes of approximately $9.8 million, or an effective tax provision rate of
14.5%, as compared to a provision for income taxes of approximately $11.7
million, or an effective tax provision rate of 19.1%, for the three months ended
September 26, 2020. The decrease in our effective tax rate for the three months
ended October 2, 2021 resulted primarily from an increase in the amount of
excess tax benefits realized from stock-based compensation of approximately $3.3
million compared to the three months ended September 26, 2020.
Comparison of the Nine Months ended October 2, 2021 to the Nine Months ended
September 26, 2020
Revenue. Product revenue increased $62.9 million, or 7.4%, to $911.6 million for
the nine months ended October 2, 2021 from $848.7 million for the nine months
ended September 26, 2020. The following table details our product revenues by
the geographic area to which the products were shipped for each of the nine
months ended October 2, 2021 and September 26, 2020 (dollars in thousands):
                                                                                   Nine Months Ended
                                            October 2,                           September 26,                    Increase/             Percentage
                                               2021                                   2020                        (Decrease)              Change
United States (U.S.)              $ 613,197              67.3  %       $     571,158              67.3  %       $    42,039                     7.4  %
Europe, Middle East and Africa      177,053              19.4                176,781              20.8                  272                     0.2
Asia and Australia                   94,134              10.3                 73,155               8.6               20,979                    28.7
North and South America
(excluding the U.S.)                 27,190               3.0                 27,596               3.3                 (406)                   (1.5)
   Product revenue                $ 911,574             100.0  %       $     848,690             100.0  %       $    62,884                     7.4  %


This increase was primarily due to higher revenue from consumables, services and
parameters, as well as the impact of approximately $9.5 million of favorable
foreign exchange rate movements from the prior year period that increased the
U.S. Dollar translation of foreign sales that were denominated in various
foreign currencies. During the nine months ended October 2, 2021, we shipped
approximately 213,100 noninvasive technology boards and instruments.
Product revenue generated through our direct and distribution sales channels
increased $112.4 million, or 16.1%, to $810.4 million for the nine months ended
October 2, 2021, compared to $698.0 million for the nine months ended
September 26, 2020. Revenues from our OEM channel decreased $49.5 million, or
32.8%, to $101.2 million for the nine months ended October 2, 2021 as compared
to $150.7 million for the nine months ended September 26, 2020.
Gross Profit. Gross profit consists of total revenue less cost of goods sold.
Our gross profit for the nine months ended October 2, 2021 and September 26,
2020 was as follows (dollars in thousands):
                                                                 Gross Profit
    Nine Months Ended          Percentage of          Nine Months Ended          Percentage of            Increase/            Percentage
     October 2, 2021            Net Revenues         September 26, 2020          Net Revenues            (Decrease)              Change

        $593,451                   65.1%                  $556,139                   65.5%                 $37,312                6.7%


Cost of goods sold increased $25.6 million for the nine months ended October 2,
2021 compared to the nine months ended September 26, 2020, primarily due to
higher material, manufacturing and distribution costs associated with the
increase in product sales.
Gross profit decreased to 65.1% for the nine months ended October 2, 2021
compared to 65.5% for the nine months ended September 26, 2020, primarily due to
costs associated with an elevated level of customer installations and higher
material, manufacturing and distribution costs, offset by favorable revenue mix.
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Selling, General and Administrative. Selling, general and administrative
expenses for the nine months ended October 2, 2021 and September 26, 2020 were
as follows (dollars in thousands):
                                                     Selling, General and Administrative
    Nine Months Ended          Percentage of          Nine Months Ended          Percentage of           Increase/            Percentage
     October 2, 2021            Net Revenues         September 26, 2020          Net Revenues            (Decrease)             Change
        $291,180                   31.9%                  $278,714                   32.8%                $12,466                4.5%


Selling, general and administrative expenses increased $12.5 million, or 4.5%,
for the nine months ended October 2, 2021 compared to the nine months ended
September 26, 2020. This increase was primarily due to higher compensation and
other employee-related costs of approximately $14.8 million, higher legal and
professional fees of approximately $12.8 million, higher occupancy and other
office-related costs of approximately $4.4 million and higher travel-related
costs of approximately $0.5 million, which were partially offset by lower
advertising and marketing-related costs of approximately $18.4 million and lower
charitable contributions of approximately $3.1 million.
Research and Development. Research and development expenses for the nine months
ended October 2, 2021 and September 26, 2020 were as follows (dollars in
thousands):
                                                           Research and Development
    Nine Months Ended          Percentage of          Nine Months Ended          Percentage of            Increase/            Percentage
     October 2, 2021            Net Revenues         September 26, 2020          Net Revenues            (Decrease)              Change
        $103,860                   11.4%                   $86,971                   10.2%                 $16,889                19.4%


Research and development expenses increased $16.9 million, or 19.4%, for the
nine months ended October 2, 2021 compared to the nine months ended
September 26, 2020, primarily due to higher compensation-related costs of
approximately $11.6 million and higher engineering project costs of
approximately $5.7 million, which were partially offset by lower professional
service fees of $1.0 million.
Non-operating (Loss) Income. Non-operating (loss) income consists primarily of
interest income, interest expense and foreign exchange gains and losses.
Non-operating (loss) income for the nine months ended October 2, 2021 and
September 26, 2020 was as follows (dollars in thousands):
                                                           Non-operating (Loss) Income
    Nine Months Ended          Percentage of          Nine Months Ended          Percentage of             Increase/              Percentage
     October 2, 2021            Net Revenues         September 26, 2020          Net Revenues              (Decrease)               Change
         $(735)                   (0.1)%                   $6,108                    0.7%                   $(6,843)               (112.0)%


Non-operating (loss) income decreased by $6.8 million for the nine months ended
October 2, 2021 compared to the nine months ended September 26, 2020, primarily
due to lower interest yields realized on our invested cash of approximately $4.5
million and a decrease in net realized and unrealized gains on foreign currency
denominated transactions of approximately $2.4 million.
Provision for Income Taxes. Our provision for income taxes for the nine months
ended October 2, 2021 and September 26, 2020 was as follows (dollars in
thousands):
                                                          Provision for Income Taxes
    Nine Months Ended          Percentage of          Nine Months Ended          Percentage of            Increase/            Percentage
     October 2, 2021            Net Revenues         September 26, 2020          Net Revenues            (Decrease)              Change
         $36,287                   4.0%                    $27,403                   3.2%                  $8,884                 32.4%


For the nine months ended October 2, 2021, we recorded a provision for income
taxes of approximately $36.3 million, or an effective tax rate of 18.4%, as
compared to a provision for income taxes of approximately $27.4 million, or an
effective tax rate of 13.9%, for the nine months ended September 26, 2020. The
increase in our tax rate for the nine months ended October 2, 2021 resulted
primarily from a decrease in the amount of excess tax benefits realized from
stock-based compensation of approximately $8.2 million as compared to the nine
months ended September 26, 2020.


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Liquidity and Capital Resources
Our principal sources of liquidity consist of our existing cash and cash
equivalent balances, future funds expected to be generated from operations and
available borrowing capacity under our credit facility. As of October 2, 2021,
we had approximately $909.5 million in working capital, of which approximately
$652.4 million was in cash and cash equivalents. In addition to net working
capital, we had approximately $147.6 million of available borrowing capacity
(net of outstanding letters of credit) under our credit facility.
In managing our day-to-day liquidity and capital structure, we generally do not
rely on foreign earnings as a source of funds. As of October 2, 2021, we had
cash totaling $91.8 million held outside of the U.S., of which
approximately $50.3 million was accessible without additional tax cost and
approximately $41.5 million was accessible at an incremental estimated tax cost
of up to $0.4 million. We currently have sufficient funds on-hand and cash held
outside the U.S. that is 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 additional U.S. taxes to
repatriate these funds.
Cash Flows
The following table summarizes our cash flows (in thousands):
                                                                   Nine Months Ended
                                                             October 2,      September 26,
                                                                2021              2020
Net cash provided by (used in):
Operating activities                                        $  167,151      $      146,545
Investing activities                                           (31,465)            (80,840)
Financing activities                                          (126,666)             38,954
Effect of foreign currency exchange rates on cash                  (89)     

(294)

Increase in cash, cash equivalents and restricted cash $ 8,931 $ 104,365


Operating Activities. Cash provided by operating activities was approximately
$167.2 million for the nine months ended October 2, 2021, generated primarily
from net income from operations of $161.4 million. Non-cash activity included
stock-based compensation of $33.5 million and depreciation and amortization of
$26.4 million. An additional source of cash included a decrease in other
inventories and other current assets and an increase in deferred revenue and
other contract-related liabilities and other non-current liabilities of $12.3
million, $4.4 million, $1.4 million and $0.6 million, respectively. These
sources of cash were partially offset by other changes in operating assets and
liabilities, including a decrease in accounts payable, accrued liabilities,
income taxes payable and accrued compensation of approximately $4.3 million,
$4.0 million, $1.5 million and $1.3 million, respectively, primarily due to the
timing of payments; an increase in accounts receivable of approximately $51.0
million, primarily due to the timing of cash receipts; an increase in lease
receivable of approximately $9.3 million and an increase in deferred costs and
other contract assets of approximately $2.6 million.
For the nine months ended September 26, 2020, cash provided by operating
activities was approximately $146.5 million, 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.
Investing Activities. Cash used in investing activities for the nine months
ended October 2, 2021 was approximately $31.5 million, consisting primarily of
approximately $20.7 million for purchases of property and equipment,
approximately $8.2 million of capitalized intangible asset costs related
primarily to patent and trademark costs and license fees and approximately $2.6
million for strategic investments.


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For the nine months ended September 26, 2020, cash used in investing activities
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 maturities of short-term
investments of approximately $70.0 million.
Financing Activities. Cash used in financing activities for the nine months
ended October 2, 2021 was approximately $126.7 million, consisting primarily of
repurchases of our common stock of approximately $128.9 million and withholding
of shares for employee payroll taxes for vested equity awards of approximately
$16.7 million, which were partially offset by the proceeds from the issuance of
common stock related to employee equity awards of approximately $19.0 million.
For the nine months ended September 26, 2020, cash provided by financing
activities 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.
Capital Resources and Prospective Capital Requirements
We expect to fund our future operating, investing and financing activities
through our available cash, 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 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 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 common stock, general market conditions, the trading price of our common
stock, availability of 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, any stock repurchase activity and
costs related to our domestic and international regulatory requirements. Despite
these investment requirements and potential expenditures, 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. For additional information related to our credit facility, please see
Note 15 to our accompanying condensed consolidated financial statements included
in Part I, Item 1 of this Quarterly Report on Form 10-Q.
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 had engaged in these relationships. As of
October 2, 2021, 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, inventory valuation, lessee
right-of-use (ROU) assets and lease liabilities, stock-based compensation,
business combinations, deferred taxes and related valuation allowances,
uncertain tax positions, tax contingencies, litigation costs and loss
contingencies.
These estimates and judgments are based on historical experience and on various
other factors that we believe to be reasonable under the circumstances, and form
the basis for making management's most difficult, subjective or complex
judgments, often as a result of the need to make estimates about the effects of
matters that are inherently uncertain. Although we regularly evaluate these
estimates and assumptions, 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 to the condensed consolidated financial
statements may be material.
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There have been no material changes to any of our critical accounting policies
during the nine months ended October 2, 2021. 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
ended January 2, 2021, which was filed with the SEC on February 23, 2021.
Recent Accounting Pronouncements
For details regarding any recently adopted and recently issued accounting
standards, see Note 2 to our accompanying condensed consolidated financial
statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q.
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.
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 on the increase or decrease in the amount of interest
expense we must pay with respect to our various outstanding debt instruments. As
of October 2, 2021, the carrying value of our cash equivalents 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 in the United States in
U.S. Dollars and a majority of our sales and expenditures are transacted in U.S.
Dollars. However, we also transact with foreign customers in currencies other
than the U.S. Dollar. These foreign currency revenues, when converted into U.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 into U.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 the U.S. Dollar are translated into U.S. Dollars at the rate of exchange
at the balance sheet date and the statements of comprehensive income and cash
flows are translated into U.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 the U.S. Dollar is included in
equity as a component of accumulated other comprehensive income.
Our foreign currency exchange rate exposures are primarily with the Canadian
Dollar, Euro, Japanese Yen, Swedish Krona, the British Pound, Mexican Peso,
Turkish Lira and Australian Dollar. Foreign currency exchange rates may
experience significant volatility from one period to the next. Specifically,
during the nine months ended October 2, 2021, we estimate fluctuations in the
exchange rates between the U.S. Dollar and other foreign currencies, including
the Euro, the Australian Dollar, the Canadian Dollar, the British Pound and the
South Korean Won, favorably impacted our revenues by $9.5 million.
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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 the U.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 of October 2, 2021 would
have resulted in an estimated reduction of $13.0 million in reported pre-tax
income for the nine months ended October 2, 2021. 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.
Item 4. Controls and Procedures
We maintain disclosure controls and procedures that are designed to ensure that
information required to be disclosed in our reports filed under the Securities
Exchange Act of 1934, as amended (the Exchange Act), is recorded, processed,
summarized and reported within the time periods specified in the Securities and
Exchange Commission's (SEC) regulations, rules and forms and that such
information is accumulated and communicated to our management, including our CEO
and Chief Financial Officer (CFO), as appropriate, to allow for timely decisions
regarding required disclosure.
In designing and evaluating our disclosure controls and procedures, management
recognizes that any controls and procedures, no matter how well designed and
operated, can provide only reasonable assurance of achieving the desired control
objectives, and management is required to apply its judgment in evaluating the
cost-benefit relationship of possible controls and procedures. As required by
Rule 13a-15(b) or Rule 15d-15(b) promulgated by the SEC under the Exchange Act,
we carried out an evaluation, under the supervision and with the participation
of our management, including our CEO and CFO, of the effectiveness of the design
and operation of our disclosure controls and procedures as of the end of the
period covered by this Quarterly Report on Form 10-Q. Based on the foregoing,
our CEO and CFO concluded that our disclosure controls and procedures were
effective as of the end of the period covered by this Quarterly Report on Form
10-Q. During the three months ended October 2, 2021, there were no changes in
our internal control over financial reporting (as such term is defined in Rules
13a-15(f) and 15d-15(f) under the Exchange Act) that have materially affected,
or are reasonably likely to materially affect, our internal control over
financial reporting.

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