Commitments and Contingencies

Leases

The Company leases certain facilities in North America, Europe and Asia under operating lease agreements expiring at various dates through December 2020. Some of these leases contain predetermined price escalations and in some cases renewal options. The Company recognizes the lease costs using a straight line method based on total lease payments. As of January 2, 2016 and January 3, 2015, rent expense accrued in excess of the amount paid aggregated $0.2 million and $0.4 million, respectively, and is classified in other liabilities in the accompanying consolidated balance sheets. The Company also leases automobiles in the U.S. and Europe that are classified as operating leases and expire at various dates through December 2019. The majority of these leases are non-cancelable. The Company also has outstanding capital leases for office equipment that are non-cancelable.

Future minimum lease payments, including interest, under operating and capital leases for each of the following fiscal years ending on or about December 31 are (in thousands):



Fiscal year	Operating Leases		Capital Leases		Total
2016	$	3,633	$	88	$	3,721
2017	3,223		82		3,305
2018	3,278		8		3,286
2019	2,482		8		2,490
2020	1,033		3		1,036
Thereafter	—		—		—
Total	$	13,649	$	189	$	13,838

On January 26, 2016, the Company entered into the Third Amendment to Lease with The Irvine Company LLC (Third Amendment) relating to the rental of space in a building located in Irvine, California. Pursuant to the terms of the Third Amendment, the Company’s current lease of certain premises will be terminated in exchange for the Company’s leasing of approximately 70,700 square feet of space in another building in Irvine, California, located near the Company’s new corporate headquarters (New Premises). The Third Amendment also extends the term of the original lease to the end of the month in which the ten-year anniversary of the date of commencement (Commencement Date) of the lease for the New Premises occurs. The Commencement Date will occur following the completion of certain improvements to the New Premises, which the Company currently expects to be on or before November 10, 2016.

Rental expense related to operating leases for the years ended January 2, 2016, January 3, 2015 and December 28, 2013 was $4.8 million, $6.1 million and $5.1 million, respectively. Included in the future capital lease payments as of January 2, 2016 is interest aggregating less than $0.1 million.

Employee Retirement Savings Plan

In 1996, the Company adopted the Masimo Retirement Savings Plan (the Plan), which is a 401(k) plan covering all of the Company’s full-time U.S. employees who meet certain eligibility requirements. In general, the Company matches an employee’s contribution up to 3% of the employee’s compensation, subject to a maximum amount. The Company may also contribute to the Plan on a discretionary basis. The Company contributed $1.8 million, $1.7 million and $1.5 million to the Plan for the years ended January 2, 2016, January 3, 2015 and December 28, 2013, respectively, all in the form of matching contributions.

Employment and Severance Agreements

On November 4, 2015, the Company entered into an Amended and Restated Employment Agreement with Joe Kiani, the Company’s Chairman and Chief Executive Officer (the Restated Employment Agreement). The Restated Employment Agreement, among other things, eliminates the tax gross-up payments, “single trigger” change in control payments and certain survival provisions, as well as phases out the fixed annual stock option grants guaranteed to Mr. Kiani under his previous employment agreement. Pursuant to the terms of the Restated Employment Agreement, upon a “Qualifying Termination” (as defined in the Restated Employment Agreement including a change in control), Mr. Kiani will be entitled to receive a cash severance benefit equal to two times the sum of his then-current base salary and the average annual bonus paid to Mr. Kiani during the immediately preceding three years. In addition, upon a Qualifying Termination prior to 2018, Mr. Kiani will receive 2.7 million shares of common stock (subject to adjustment for recapitalizations, stock splits, stock dividends and the like) upon the vesting of certain RSUs granted to Mr. Kiani in connection with the Restated Employment Agreement, and an additional cash payment of $35.0 million related to a Non-Competition and Confidentiality Agreement between Mr. Kiani and the Company (collectively, the Special Payment). For any Qualifying Termination occurring on or after January 1, 2018, the number of shares to be issued to Mr. Kiani pursuant to the RSUs and the cash payment will each be reduced by 10% of the original amount each year so that after December 31, 2026, no Special Payment will be due to Mr. Kiani upon a Qualifying Termination. As of January 2, 2016, the expense related to the Special Payment that would be recognized in the Company’s consolidated financial statements upon the occurrence of a Qualifying Termination under the Restated Employment Agreement approximated $146.9 million.

As of January 2, 2016, the Company had severance plan participation agreements with seven of its executive officers. The participation agreements (Participation Agreements) are governed by the terms and conditions of the Company’s 2007 Severance Protection Plan, which became effective on July 19, 2007 and was amended effective December 31, 2008. Under the Participation Agreements, each executive officer may be entitled to receive certain salary, equity, medical and life insurance benefits if he is terminated by the Company without cause or terminates his employment for good reason under certain circumstances. The executive officers are also required to provide the Company with six months advance notice of their resignation under certain circumstances.

Purchase Commitments

Pursuant to contractual obligations with vendors, the Company had $35.9 million of purchase commitments as of January 2, 2016, which are expected to be fulfilled within one year. These purchase commitments were made for certain inventory items to secure better pricing and to ensure the Company will have raw materials when necessary.

Other Contractual Commitments

In the normal course of business, the Company may provide bank guarantees to support government hospital tenders in certain foreign jurisdictions. As of January 2, 2016, there were approximately $0.3 million of such unsecured bank guarantees outstanding, the majority of which relates to performance obligations with respect to certain government tenders.

Concentrations of Risk

The Company is exposed to credit loss for the amount of cash deposits with financial institutions in excess of federally insured limits. As of January 2, 2016, the Company had approximately $57.2 million of bank balances, of which $2.4 million was covered by either the U.S. Federal Deposit Insurance Corporation limit or foreign countries deposit insurance organizations. The Company invests its excess cash deposits in money market and time deposit accounts with major financial institutions. As of January 2, 2016, the Company had $20.1 million in money market funds and $55.0 million in bank time deposits that were not guaranteed by the U.S. federal government.

While the Company and its contract manufacturers rely on sole source suppliers for certain components, steps have been taken to minimize the impact of a shortage or stoppage of shipments, such as maintaining a safety stock of inventory and designing products that may be easily modified to use a different component. However, there can be no assurance that a shortage or stoppage of shipments of the materials or components that the Company purchases will not result in a delay in production or adversely affect the Company’s business.

The Company’s ability to sell its products to U.S. hospitals depends in part on its relationships with Group Purchasing Organizations (GPOs). Many existing and potential customers for the Company’s products become members of GPOs. GPOs negotiate pricing arrangements and contracts, sometimes exclusively, with medical supply manufacturers and distributors, and these negotiated prices are made available to a GPO’s affiliated hospitals and other members. For the years ended January 2, 2016, January 3, 2015 and December 28, 2013, revenue from the sale of the Company’s pulse oximetry products to customers affiliated with GPOs amounted to $337.4 million, $309.9 million and $287.9 million, respectively.

For the years ended January 2, 2016, January 3, 2015 and December 28, 2013, the Company had sales through two just-in-time distributors, which in total represented approximately 14.6% and 11.7%, 14.0% and 11.1%, and 13.2% and 10.7% of total revenue, respectively. As of January 2, 2016, these two just-in-time distributors represented 5.5% and 5.3% of the accounts receivable balance, respectively. As of January 3, 2015, these two just-in-time distributors represented 5.0% and 8.8% of the accounts receivable balance, respectively.

For the years ended January 2, 2016, January 3, 2015 and December 28, 2013, the Company recorded $30.8 million, $29.9 million and $29.8 million, respectively, in royalty revenues from Medtronic pursuant to a settlement agreement and amendments. In exchange for these royalty payments, the Company provided Medtronic the ability to ship certain products with a covenant not to sue Medtronic as long as Medtronic abides by the terms of the agreement. The current royalty rate is 7.75% and the amended agreement can be terminated by Medtronic upon sixty days written notice.

Litigation

On February 3, 2009, the Company filed a patent infringement suit in the U.S. District Court for the District of Delaware against Philips Electronics North America Corporation and Philips Medizin Systeme Böblingen GmbH (collectively, Philips) related to Philips’ FAST pulse oximetry technology and certain of Philips’ patient monitors. On June 15, 2009, Philips answered the Company’s complaint and Philips Electronics North America Corporation filed antitrust and patent infringement counterclaims against the Company, as well as counterclaims seeking declaratory judgments of invalidity of the patents asserted by the Company against Philips. On July 9, 2009, the Company filed its answer denying Philips’ counterclaims and asserting various defenses. The Company also asserted counterclaims against Philips for fraud, intentional interference with prospective economic advantage and for declaratory judgments of noninfringement and invalidity with respect to the patents asserted by Philips against the Company. Philips later added a claim for infringement of one additional patent. Subsequently, the Court bifurcated Philips’ antitrust claims and its patent misuse defense, as well as stayed the discovery phase on those claims pending trial in the patent case. In addition, the Company asserted additional patents in 2012, and the Court ordered that these patents and some of the originally asserted patents be tried in a second phase. On May 23, 2014, Philips filed a motion for leave to amend its answer and counterclaims to allege inequitable conduct. The Court granted Philips’ motion for leave to amend. A jury trial commenced on September 15, 2014 with respect to two of the Company’s patents and one of Philips’ patents. On October 1, 2014, the jury determined that both of the Company’s patents were valid and that the damages amount for Philips’ infringement was $466.8 million. The jury also determined that the Company did not infringe the Philips patent. Philips has indicated that it intends to appeal the damages award once a final judgment has been rendered in the case. On September 18, 2015, the Court set a schedule for the trial related to the second phase patents and a schedule for the trial related to Philips’ antitrust counterclaims and patent misuse defense, with both trials scheduled to take place in the first quarter of 2017. On November 16, 2015, the Company asserted three antitrust claims against Philips. On December 9, 2015, the Court dismissed with prejudice Philips’ sole remaining patent infringement claim against the Company. On January 4, 2016, the Court granted Philips’ motion to strike the Company’s antitrust counterclaims, ruling that the Company must bring these claims in a separate litigation. The Company believes that it has good and substantial defenses to the remaining antitrust claims asserted by Philips. The Company is unable to determine whether any loss will occur or to estimate the range of such potential loss; therefore, no amount of loss has been accrued by the Company as of the date of filing of this Annual Report on Form 10-K. Furthermore, there is no guarantee that the Company will prevail in this suit or receive any damages or other relief if it does prevail.

On December 21, 2012, the Company filed a suit against Mindray DS USA, Inc. and Shenzhen Mindray Bio-Medical Electronics Co, Ltd. (Shenzhen Mindray) in the U.S. District Court for the Central District of California alleging patent infringement, breach of contract and other claims. On March 6, 2013, Shenzhen Mindray filed a complaint against the Company under the Anti-Unfair Competition Law of the People’s Republic of China (PRC) before the Shenzhen Municipal Intermediate People’s Court. On December 10, 2013, the Company filed a lawsuit against Mindray DS USA, Inc., Shenzhen Mindray and Mindray Medical International Ltd. in the Superior Court of New Jersey alleging breach of contract and related claims, which was removed to the U.S. District Court for the District of New Jersey. Shenzhen Mindray filed a complaint in the Shenzhen Intermediate People’s Court against the Company and Shenzhen Comen Medical Instruments on February 6, 2015, alleging infringement of Chinese Patent No. 00808884.5. Additionally, a separate lawsuit was filed against Masimo Sweden AB (Masimo Sweden) on the same day and in the same court alleging infringement of Chinese Patent No. 200710305061.9. On November 16, 2015, the Company entered into a Settlement and Covenant Not to Sue Agreement (the Settlement Agreement) with Shenzhen Mindray Biomedical Electronics Co., Ltd. and certain of its affiliates (collectively, Mindray). The Settlement Agreement settled each of the claims and legal proceedings between the Company and Mindray described above. Pursuant to the Settlement Agreement, Mindray paid the Company an aggregate of $25.0 million. The Settlement Agreement also contains requirements for the purchase of certain Company products by Mindray. In addition, Mindray assigned certain of its patents to the Company. Certain covenants not to sue for patent infringement were also exchanged. In the U.S. District Court for the Central District of California, Mindray dismissed its claims and counterclaims against the Company on November 19, 2015 and the Company dismissed its claims and counterclaims against Mindray on January 8, 2016. The Company and Mindray dismissed their claims and counterclaims in the U.S. District Court for the District of New Jersey on January 11, 2016. The Chinese courts dismissed the patent cases against the Company and Masimo Sweden on December 8, 2015 and the anti-competition case on December 22, 2015.

In April 2011, the Company was informed by the United States Attorney’s Office for the Central District of California, Civil Division, that a qui tam complaint had been filed against the Company in the U.S. District Court for the Central District of California by three of the Company’s former physician office sales representatives. The qui tam complaint alleged, among other things, that the Company’s noninvasive hemoglobin products failed to meet their accuracy specifications, and that the Company misled the U.S. Food and Drug Administration (FDA) and customers regarding the accuracy of the products. In November 2011, the United States declined to intervene in the case, and in October 2013, the District Court granted summary judgment in favor of the Company. The former sales representatives appealed the District Court’s decision and an argument on the appeal was held in the Ninth Circuit Court of Appeals on February 1, 2016. On February 19, 2016, the Ninth Circuit Court of Appeals affirmed the summary judgment of the District Court.

In September 2011, two of the same former sales representatives filed employment-related claims against the Company in arbitration also stemming from their allegations regarding the Company’s noninvasive hemoglobin products. On January 16, 2014, the Company was notified that the arbitrator awarded the plaintiffs approximately $5.4 million in damages (the Arbitration Award), which the Company accrued in fiscal 2013. In addition, the Company’s insurance carrier notified the Company that it believed certain defense costs related to the arbitration may no longer be reimbursable in view of the arbitration decision. As a result, the Company also accrued a liability of $2.6 million in fiscal 2013 for the costs estimated to have been paid by the insurance carrier. The Company challenged the arbitration award in the U.S. District Court for the Central District of California, and on April 3, 2014, the District Court vacated the award. Accordingly, the Company reversed the $8.0 million charge in the quarter ended March 29, 2014. The former sales representatives appealed the District Court’s decision, and the appeal argument was held in the Ninth Circuit Court of Appeals on February 1, 2016. On February 19, 2016, the Ninth Circuit Court of Appeals reversed the decision of the District Court vacating the award, and remanded the case to the District Court with instructions to confirm the Arbitration Award. As a result, the Company reinstated the $5.4 million charge for the arbitration award that was previously reversed, plus approximately $0.7 million of estimated interest, as of January 2, 2016. However, the Company has not reinstated the $2.6 million charge for defense-related costs previously reimbursed by the insurance company based upon its current assessment of this matter. The Company is unable to predict the final outcome or the final amount of any resulting loss related to this matter. Therefore, the actual loss, if any, could differ from the amount that the Company has currently estimated and accrued.

On January 2, 2014, a putative class action complaint was filed against the Company in the U.S. District Court for the Central District of California by Physicians Healthsource, Inc. The complaint alleges that the Company sent unsolicited facsimile advertisements in violation of the Junk Fax Protection Act of 2005 and related regulations. The complaint seeks $500 for each alleged violation, treble damages if the District Court finds the alleged violations to be knowing, plus interest, costs and injunctive relief. On April 14, 2014, the Company filed a motion to stay the case pending a decision on a related petition filed by the Company with the Federal Communications Commission (FCC). On May 22, 2014, the District Court granted the motion and stayed the case pending a ruling by the FCC on the petition. On October 30, 2014, the FCC granted some of the relief and denied some of the relief requested in the Company’s petition. Both parties appealed the FCC’s decision on the petition. On November 25, 2014, the District Court granted the parties’ joint request that the stay remain in place pending a decision on the appeal. The Company believes it has good and substantial defenses to the claims, but there is no guarantee that the Company will prevail. The Company is unable to determine whether any loss will ultimately occur or to estimate the range of such loss; therefore, no amount of loss has been accrued by the Company as of the date of filing of this Annual Report on Form 10-K.

On January 31, 2014, an amended putative class action complaint was filed against the Company in the U.S. District Court for the Northern District of Alabama by and on behalf of two participants in the Surfactant, Positive Pressure, and Oxygenation Randomized Trial at the University of Alabama. On April 21, 2014, a further amended complaint was filed adding a third participant. The complaint alleges product liability and negligence claims in connection with pulse oximeters the Company modified and provided at the request of study investigators for use in the trial. On August 13, 2015, the U.S. District Court for the Northern District of Alabama granted summary judgment in favor of the Company on all claims. The plaintiffs have appealed the U.S. District Court for the Northern District of Alabama’s decision. The Company is unable to determine whether any loss will ultimately occur or to estimate the range of such loss; therefore, no amount of loss has been accrued by the Company as of the date of filing of this Annual Report on Form 10-K.

On October 21, 2015, Medtronic plc (Medtronic) filed three separate inter partes review petitions (the Petitions) with the Patent Trial and Appeal Board (the PTAB) of the U.S. Patent and Trademark Office (PTO), challenging several of the claims of U.S. Patent Nos. 7,496,393 (the ’393 Patent), titled “Signal processing apparatus,” and 8,560,034 (the ’034 Patent), also titled “Signal processing apparatus,” which are owned by the Company. A patentability trial will commence if the PTAB decides to institute the inter partes review proceedings after considering the Petitions and the Company’s preliminary response to the Petitions. Medtronic has the right to stop paying royalties to the Company, subject to certain notice requirements, under its existing settlement agreement with the Company, and has informed the Company that it will terminate the settlement covenants and stop paying royalties to the Company when it feels it has reached an appropriate point in the process. The Company has opposed the requests to institute proceedings relating to the Petitions, including on the basis that Medtronic is estopped from challenging the patentability of the ’034 patent, because the claims were previously the subject of an interference proceeding between the Company and Medtronic’s subsidiary, Covidien plc, in which the PTO awarded the claimed subject matter to the Company. If the PTAB institutes the proceedings, the Company intends to defend the ’393 Patent and the ’034 Patent. The Company believes it has good and substantial responses to the Petitions, but there is no guarantee that the Company will prevail. The Company is unable to determine whether any loss will occur or to estimate the range of such loss; therefore, no amount of loss has been accrued by the Company as of the date of filing of this Annual Report on Form 10-K.

From time to time, the Company may be involved in other litigation and investigations relating to claims and matters arising out of its operations in the normal course of business. The Company believes that it currently is not a party to any other legal proceedings which, individually or in the aggregate, would have a material adverse effect on its consolidated financial position, results of operations or cash flows.