News Column

ICU MEDICAL INC/DE - 10-K - Management's Discussion and Analysis of Financial Condition and Results of Operations.

February 21, 2014

We are a leader in the development, manufacture and sale of innovative medical devices used in infusion therapy, oncology and critical care applications. Our products improve patient outcomes by helping to prevent bloodstream infections through the use of hemodynamic monitoring for critically ill patients and protecting healthcare workers from exposure to infectious diseases or hazardous drugs. Our complete product line includes needlefree infusion connectors, custom infusion systems, catheters and hemodynamic monitoring systems and closed system transfer devices and automated compounders for handling hazardous drugs.

Business Overview

In the early 1990's, we launched the Clave, an innovative one-piece, needlefree infusion connection device. The Clave is a leader in worldwide connector sales. The Clave's unique design ensures compliance with needlefree policies because of its passive technology which cannot accept a needle. Our Clave products accounted for 35% of our revenues in 2013.

In the late 1990s, we commenced a transition from a product-centered company to an innovative, fast, efficient, low-cost manufacturer of custom infusion sets, using processes that we believe can be readily applied to a variety of disposable medical devices. This strategy has enabled us to capture revenue on the entire infusion delivery system, and not just a component of the system. We have furthered this effort to include all of our proprietary devices beyond the Clave.

One of our growth strategies is through acquisitions of companies, assets or product lines. We are continuously exploring acquisition opportunities, however there is no assurance that we will be successful in finding future acquisition opportunities or integrating new product lines into our existing business.

Another strategy for reducing our dependence on our current proprietary products has been to introduce new products. In 2013, we introduced CardioFlo and ChemoLock closed system transfer device and components. CardioFlo is a minimally invasive monitoring sensor for use on critical care patients to deliver accurate and reliable hemodynamic monitoring data. ChemoLock prevents the escape of hazardous drug or vapor concentrations, blocks the transfer of environmental contaminants into the system, and eliminates needlestick injuries while minimizing hazardous drug exposure. In 2011 and 2012, we introduced the Neutron, a catheter patency device using Clave technology, the NanoClave, a smaller Clave product designed for neonatal and pediatric patients and the Diana Hazardous Drug Compounding System, an automated sterile compounding system for preparing hazardous drugs. We can provide no assurance that we will be able to successfully manufacture, market and sell these new products.

We are also expanding our business through increased sales to medical product manufacturers, independent distributors and through direct sales to the end users of our product. These expansions include, but are not limited to, our 2014 agreement with Premier, the extension of the term of our agreement with MedAssets and our 2011 agreement with Novation covering all our critical care products. Each of these organizations is a U.S. healthcare purchasing network. We also potentially face substantial increases in competition in our Clave business. Therefore, we are focusing on increasing product development, acquisition, sales and marketing efforts to custom infusion systems, oncology products, critical care products and other products that lend themselves to customization and new products in the U.S. and international markets.

Our products are used in hospitals and alternate medical sites in more than 55 countries throughout the world. We categorize our products into three main market segments: Infusion Therapy, Critical Care and Oncology. Products outside of our main market segments are grouped under Other. Our primary products include:

Infusion Therapy •Needlefree connector products •MicroClave and MicroClave Clear •Anti-Microbial MicroClave •Neutron •NanoClave •Clave •Y-Clave •Anti-Microbial Clave •Custom infusion sets 27



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Critical Care •Hemodynamic monitoring systems •Transpac disposable pressure transducers •Safeset closed needlefree blood conservation systems •CardioFlo hemodynamic monitoring sensor system •Custom monitoring systems •Catheters •Advanced sensor catheters •Pulmonary artery thermodilution catheters •Central venous oximetry catheters •Multi-lumen central venous catheters •Custom angiography and interventional radiology kits



Oncology

•ChemoLock closed system transfer device and components •ChemoClave closed system transfer device and components including: •Genie closed vial access device •Spiros closed male luer •Custom preparation and administration sets and accessories •Diana hazardous drug compounding system



Other

•Tego needlefree hemodialysis connector •Lopez enteral valve



Our largest customer is Hospira. Hospira accounted for 39%, 42% and 42% of our worldwide revenues in 2013, 2012 and 2011, respectively. Our relationship with Hospira has been and will continue to be important. We currently manufacture custom I.V. sets for sale by Hospira and jointly promote the products under the name SetSource. We expect revenues from sales to Hospira of Clave products, custom infusion sets, oncology products and new products to remain a significant percentage of our revenues. Hospira has a significant share of the I.V. set market in the U.S. and provides us access to that market. We expect that worldwide sales to Hospira will be important to our growth for Clave, custom infusion sets, oncology products and our other products worldwide.

Revenues for 2013, 2012 and 2011 were $313.7 million, $316.9 million and $302.2 million, respectively. We currently sell substantially all of our products to medical product manufacturers, independent distributors and through direct sales to the end user. Most of our independent distributors handle the full line of our infusion administration products. We sell our I.V. administration and oncology products under two agreements with Hospira. Under a 1995 agreement, Hospira purchases Clave products, principally bulk, non-sterile connectors and oncology products. Under a 2001 agreement, we sell custom infusion sets to Hospira under a program referred to as SetSource. Our 1995 and 2001 agreements with Hospira provide Hospira with conditional exclusive and nonexclusive rights to distribute all existing ICU Medical products worldwide with terms that extend to 2018. We sell invasive monitoring and angiography to independent distributors and through direct sales. We also sell certain other products to a number of other medical product manufacturers.

We believe that as healthcare providers continue to either consolidate or join major buying organizations, the success of our products will depend, in part, on our ability, either independently or through strategic relationships such as our Hospira relationship, to secure long-term contracts with large healthcare providers and major buying organizations. As a result of this marketing and distribution strategy we derive most of our revenues from a relatively small number of distributors and manufacturers. The loss of a strategic relationship with a customer or a decline in demand for a manufacturing customer's products could have a material adverse effect on our operating results.

We believe that achievement of our growth objectives worldwide will require increased efforts by us in sales and marketing and product development; however, there is no assurance that we will be successful in implementing our growth strategy. The custom products market is small, when compared to the larger market of standard products, and we could encounter customer resistance to custom products. Further, we could encounter increased competition as other companies see opportunity in this market. Product development or acquisition efforts may not succeed, and even if we do develop or acquire additional products, there is no assurance that we will achieve profitable sales of such products. An adverse change in our relationship with Hospira, or a deterioration of Hospira's position in the market, could have an adverse effect on us. Increased expenditures for sales and marketing and product acquisition and development may not yield desired results when expected, or

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at all. While we have taken steps to control these risks, there are certain risks that may be outside of our control, and there is no assurance that steps we have taken will succeed.

The following table sets forth, for the periods indicated, total revenues by market segment and its major product groups as a percentage of total revenues:

Product line 2013 2012 2011 Clave products 35 % 37 % 36 % Custom infusion therapy 29 % 27 % 25 % Other infusion therapy 3 % 4 % 5 % Infusion therapy 67 % 68 % 66 % Critical care 17 % 17 % 20 % Oncology 12 % 10 % 8 % Tego 3 % 3 % 3 % Other products/other revenue 1 % 2 % 2 % Other 4 % 5 % 6 % 100 % 100 % 100 %



We have an ongoing effort to increase systems capabilities, improve manufacturing efficiency, reduce labor costs, reduce time needed to produce an order, and minimize investment in inventory. These include the use of automated assembly equipment for new and existing products and use of larger molds and molding machines. In 2006, we centralized our proprietary molding in Salt Lake City and expanded our production facility in Mexico, which took over the majority of our manual assembly previously done in Salt Lake City. In 2010 and early 2011, we expanded our production facility in Mexico. In late 2010, we completed construction of an assembly plant in Slovakia that serves our European product distribution. We are also converting existing warehouse space into manufacturing space and a new clean room in our Salt Lake City plant, which we expect to be completed by the second half of 2014. We may establish additional production facilities outside the U.S. There is no assurance that we will achieve success in establishing manufacturing facilities outside the U.S.

We distribute products through three distribution channels. Product revenues for each distribution channel as a percentage of total channel product revenue were as follows:

Channel 2013 2012 2011



Medical product manufacturers 35 % 40 % 39 % Domestic distributors/direct sales 36 % 35 % 35 % International customers

29 % 25 % 26 % Total 100 % 100 % 100 %



Sales to international customers do not include bulk Clave products sold to Hospira in the U.S. but used in I.V. products manufactured by Hospira and exported. Those sales are included in sales to medical product manufacturers. Other sales to Hospira for destinations outside the U.S. are included in sales to international customers.

Seasonality/Quarterly Results

The healthcare business in the United States is subject to quarterly fluctuations due to frequency of illness during the seasons, elective procedures, and over the last few years, the economy. In Europe, the healthcare business generally slows down in the summer months due to vacations resulting in fewer elective surgeries. Also in Europe, hospitals' budgets tend to finish at the end of the year which may cause fewer purchases in the last three months of the year as hospitals await their new budgets in January. In addition, we can experience fluctuations in net sales as a result of variations in the ordering patterns of our largest customers, which may be driven more by production scheduling and their inventory levels, and less by seasonality. Our expenses often do not fluctuate in the same manner as net sales, which may cause fluctuations in operating income that are disproportionate to fluctuations in our revenue.

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Year-to-Year Comparisons

We present summarized income statement data in Item 6. Selected Financial Data. The following table shows, for the three most recent years, the percentages of each income statement caption in relation to revenues.

Percentage of Revenues 2013 2012 2011 Revenue Net sales 100 % 100 % 100 % Other - % - % - % Total revenues 100 % 100 % 100 % Gross margin 49 % 49 % 47 %



Selling, general and administrative expenses 28 % 27 % 28 % Research and development expenses

4 % 3 % 3 % Legal settlement - % - % (1 )% Gain on sale of assets - % - % (5 )% Total operating expenses 32 % 30 % 25 % Income from operations 17 % 19 % 22 % Other income - % - % - % Income before income taxes 17 % 19 % 22 % Income taxes 4 % 6 % 7 % Net income 13 % 13 % 15 % Comparison of 2013 to 2012



Revenues were $313.7 million in 2013, compared to $316.9 million in 2012.

Domestic sales: Net domestic sales in 2013 were $223.1 million, compared to net domestic sales of $237.0 million in 2012, a decrease of 6%.

Net domestic sales to Hospira in 2013 were $108.2 million, a decrease of $12.9 million, or 11%, from 2012. The decrease was primarily due to $12.7 million, or 11%, lower infusion therapy sales in 2013. The decrease in infusion therapy was due to modifications in Hospira's inventory management, resulting in a $9.4 million decrease in unit sales of Clave products, a $1.8 million decrease in unit sales of custom infusion sets and a $1.5 million decrease in unit sales of other infusion products.

Net other domestic sales (excluding Hospira) in 2013 were $114.9 million, a decrease of $1.0 million, or 0.8%, from 2012. Infusion therapy sales increased $3.3 million, or 6%, from 2012, which was primarily from a $3.0 million increase in custom infusion set sales. Oncology sales increased $1.1 million, or 17%, from 2012. Critical care sales decreased $3.5 million, or 8%, from 2012. Other product sales decreased $1.9 million, or 16%, from 2012. The increased custom infusion set and oncology sales were primarily due to increased unit sales. The critical care decrease was due to lower unit sales, primarily from competition in this market. The decrease in other product sales was primarily due to $1.2 million in lower renal sales as a result of lower unit sales and the loss of sales from our former diabetes product line, Orbit, which had contributed $0.3 million to sales in 2012.The Orbit product line was sold in November 2011 and Orbit sales concluded in the first quarter of 2012.

International sales: Net sales to international customers were $90.6 million in 2013, an increase of $10.7 million, or 13%, from 2012. Infusion therapy sales increased $5.3 million, or 11%, from 2012, which was from a $4.0 million increase in custom infusion set sales and a $2.7 million increase in Clave product sales, partially offset by a $1.3 million decrease in other infusion therapy sales. Oncology sales increased $6.2 million, or 41%, from 2012. Critical care sales decreased by $0.5 million, or 4%, from 2012. Other product sales decreased by $0.3 million, or 6%, from 2012. The increases in infusion therapy and oncology sales were from increased unit sales from increased market share and demographic growth. The decrease in critical care sales was from lower unit sales, primarily due to competition in this market. The decrease in other product sales was primarily from the loss of sales from our former diabetes product line, Orbit, which had contributed $0.6 million to sales in 2012.

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Geographically, our 2013 international sales were primarily in Europe, the Pacific Rim, Latin America and Canada. Sales in Europe, the Pacific Rim and Canada increased by $9.1 million. Our 2013 international sales were favorably impacted by approximately $1.5 million due to the increase in the average exchange rate of the Euro to the U.S. dollar compared to 2012.

Sales by market segment and other revenue: Net infusion therapy sales were $211.2 million in 2013, a decrease of $4.1 million, or 2%, from 2012. The decrease from 2012 was from $6.5 million in lower Clave product sales, $2.8 million in lower other infusion therapy product sales, partially offset by $5.2 million in increased custom infusion set sales. The decrease in Clave product sales and other infusion therapy sales was primarily from lower sales to U.S. Hospira. The increase in custom infusion sales was from higher sales to domestic distributors and through direct sales and higher international sales.

Net critical care sales were $51.5 million in 2013, a decrease of $4.0 million, or 7%, from 2012. The decrease was primarily due to lower domestic sales due to competition.

Net oncology sales were $37.5 million in 2013, an increase of $7.2 million, or 24%, from 2012. The increase was from $6.2 million in higher international sales, $1.1 million in higher domestic sales to distributors and through direct sales, partially offset by $0.1 million in lower domestic sales to Hospira.

Other product sales were $12.8 million, a decrease of $2.5 million, or 16%, from 2012. The decrease is primarily from $0.4 million in lower renal sales and the loss of sales from our former diabetes product line, Orbit, which had contributed $0.9 million to sales in the first quarter of 2012.

Other revenue consists of license, royalty and revenue share income and was approximately $0.7 million in 2013 and $0.5 million in 2012.

Gross margins for 2013 and 2012 were 49% in both years. Our lower freight expense contributed approximately 0.5% to our gross margin and was offset by lower manufacturing overhead absorption.

Selling, general and administrative expenses ("SG&A") were $90.4 million, or 28%, of revenues in 2013, compared with $84.6 million, or 27%, of revenues in 2012. The new medical device tax, which became effective in 2013, contributed $1.8 million to the SG&A increase in 2013 compared to 2012. Information technology expenses increased $1.1 million and bad debt /warranty reserves increased $0.7 million in 2013 compared to 2012. We also incurred $1.4 million in one-time charges associated with a strategic transaction that did not go forward.

Research and development expenses ("R&D") were $12.4 million, or 4%, of revenue in 2013 compared to $10.6 million, or 3%, of revenue in 2012. The increase in R&D expenses was primarily from increased compensation and benefits from an increase of six R&D employees and increased R&D project expenses. Our R&D projects focus on filling in product line gaps for our product line target markets and creating additional market opportunities.

Other income was $0.8 million in 2013 compared to $0.6 million in 2012.

Income taxes were accrued at an estimated annual effective tax rate of 23% in 2013 compared to 33% in 2012. The effective tax rate differs from that computed at the federal statutory rate of 35% principally because of the effect of foreign and state income taxes, tax credits, deductions for domestic production activities and discrete tax items, including the tax effects of the extension of the federal research and development credit for the 2012 tax year and changes in Mexican tax legislation both enacted in 2013.

Comparison of 2012 to 2011

Revenues were $316.9 million in 2012, compared to $302.2 million in 2011.

Domestic sales: Net domestic sales in 2012 were $237.0 million, compared to net domestic sales of $224.5 million in 2011, an increase of 6%.

Net domestic sales to Hospira in 2012 were $121.1 million, an increase of $5.5 million, or 5%, from 2011. Infusion therapy sales increased $2.7 million, or 2%, from 2011 and oncology sales increased $2.7 million, or 46%, from 2011. Infusion therapy sales included a $0.9 million increase in sales of Clave products and a $1.7 million increase in sales of custom infusion sets. The increase in Clave product, custom infusion product and oncology sales was from higher unit sales due to conversion of products sold for needlefree connectors and increased market share through Hospira.

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Net other domestic sales (excluding Hospira) in 2012 were $115.9 million, an increase of $7.0 million, or 6%, from 2011. Infusion therapy sales increased $8.7 million, or 18%, from 2011, which was primarily from a $4.5 million increase in Clave product sales and a $3.9 million increase in custom infusion set sales. Oncology sales increased $2.0 million, or 44% from 2011. Critical care sales decreased $4.4 million, or 10%, from 2011. The increased Clave, custom infusion set and oncology sales were primarily due to increased unit sales. The decrease in critical care sales was primarily from increased competition that resulted in lower average sales prices and lower unit sales on certain items.

International sales: Net international sales in 2012 were $79.9 million, compared to net international sales of $77.7 million in 2011, an increase of 3%. Infusion therapy sales increased $5.0 million, or 12%, from 2011, which was primarily from a $3.4 million increase in custom infusion set sales and a $1.6 million increase in Clave product sales. Oncology sales increased $1.2 million, or 8%, from 2011. Critical care sales decreased by $1.4 million, or 9%, from 2011. Other product sales decreased by $2.6 million, or 39%, from 2011. The increases in infusion therapy and oncology were from increased unit sales from increased market share and demographic growth. The decrease in critical care sales was primarily due to increased competition and the decline of the Euro to U.S. dollar. The decrease in other product sales was primarily from the sale of the Orbit diabetes product line in 2011.

Geographically, our 2012 international sales were primarily in Europe, the Pacific Rim, Latin America, Canada and Africa. Sales in the Pacific Rim, Canada and Africa increased by $5.5 million and were offset by $3.3 million in lower European sales. The lower European sales in 2012 were impacted by a weak Euro. Our 2012 international sales were negatively impacted by approximately $3.6 million due to the decrease in the average exchange rate of the Euro to the U.S. dollar compared to 2011.

Sales by market segment and other revenue: Net infusion therapy sales were $215.3 million in 2012, an increase of $16.4 million, or 8%, from 2011. The increase from 2011 was primarily from $7.0 million in increased Clave product sales and $9.0 million in increased custom infusion set sales. The increase in Clave product sales was primarily from higher domestic sales to both Hospira and other domestic customers. Custom infusion set sales increased in all channels from higher unit sales.

Net critical care sales were $55.5 million in 2012, a decrease of $5.9 million, or 10%, from 2011. The decrease was primarily due to lower domestic sales from increased competition. We experienced lower unit sales in certain products and decreased our domestic critical care prices in the middle of 2011 to retain existing customers and attract new customers.

Net oncology sales were $30.3 million in 2012, an increase of $5.9 million, or 24%, from 2011. The increase was from higher sales in all channels. The increased sales was from increased market share and demographic growth.

Other product sales were $15.3 million, a decrease of $1.6 million, or 10%, from 2011. The largest contributor to this change from 2011 was $2.1 million in lower Orbit sales, a product line that we sold in 2011, partially offset by $1.5 million in higher Tego sales.

Other revenue consists of license, royalty and revenue share income and was approximately $0.5 million in 2012 and $0.6 million in 2011.

Gross margins for 2012 and 2011 were 49% and 47%, respectively. Our favorable product mix contributed to approximately one percentage point of the gross margin increase. Favorable exchange rates on the Mexican Peso contributed to approximately one-half of a percentage point of the gross margin increase. The remaining increase in the gross margin was due to plant efficiencies.

SG&A were $84.6 million, or 27%, of revenues in 2012, compared with $85.3 million, or 28%, of revenues in 2011. SG&A expenses for 2011 include one-time expenses for the Long-Term Retention Plan ("LTRP") of $2.0 million and compensation expense related to the sale of our Orbit diabetes infusion set product line of $1.6 million. Our stock compensation expense increased $1.4 million, promotion costs increased $0.7 million, sales and marketing compensation and benefits increased $0.5 million and information technology ("IT") outside services and consulting costs increased by $1.1 million. Our legal expenses decreased $0.8 million. In January 2011, our Compensation Committee approved the pay out of the 2005 LTRP grants, determined to not make any future payments for the 2006 and 2007 awards, and determined that no additional awards would be made under the LTRP in the future, thus effectively cancelling the plan. The increase in sales and marketing compensation and benefits is primarily the result of the expansion of our sales and marketing workforce and compensation increases. The decrease in legal expenses is due to lower legal costs for patent litigation.

R&D were $10.6 million, or 3%, of revenue in 2012 compared to $8.6 million, or 3%, of revenue in 2011. The increase in R&D expenses was primarily from $1.7 million of higher project related R&D expenses supporting our infusion

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therapy, critical care and oncology market segments and $0.6 million in increased compensation and benefits from an expanded workforce, partially offset by the $0.3 million one-time expense for the LTRP payout in 2011.

Legal settlement income of $2.5 million was received in 2011 and recorded in operating expenses. The payment was the result of a settlement of litigation against a law firm that formerly represented us in patent litigation.

Gain on sale of assets of $14.2 million in 2011 resulted from the sale of assets of our Orbit diabetes infusion set product line. We sold this product line because it was one of our smallest, non-core product lines and the sale allows us to focus our operations on our key markets.

Other income was $0.6 million in 2012 compared to $1.2 million in 2011. The decrease is primarily due to lower interest income and a small loss on disposal of assets in 2012 versus a gain on disposal of assets in 2011.

Income taxes were accrued at an estimated annual effective tax rate of 33.2% in 2012 compared to 32.7% in 2011. The rate differed from the statutory corporate rate of 35% principally because of the effect of foreign and state income taxes, tax credits and deductions for domestic production activities.

Liquidity and Capital Resources

During 2013, our cash, cash equivalents and investment securities increased by $70.7 million from $226.2 million at December 31, 2012 to $296.9 million at December 31, 2013.

Operating Activities: Our cash provided by operating activities tends to increase over time because of our positive operating results. However, it is subject to fluctuations, principally from changes in net income, accounts receivable, inventories and the timing of tax payments.

Our cash provided by operations was $65.7 million in 2013. Net income plus adjustments for non-cash net expenses contributed $68.9 million to cash provided by operations and was partially offset by a $3.2 million change in operating assets and liabilities. The $6.4 million increase in income taxes, including excess tax benefits and deferred income taxes and $3.6 million decrease in accounts receivable were the largest changes in operating assets and liabilities. The increase in income taxes is primarily due to the timing of tax payments and excess tax benefits. The decrease in accounts receivable is primarily due to lower revenue in the fourth quarter of 2013 compared to the fourth quarter of 2012.

Investing Activities: Our cash used by investing activities was $13.1 million in 2013, which was primarily comprised of $18.4 million in capital purchases offset by net investment sales of $6.3 million. Our property, plant and equipment purchases were primarily comprised of machinery, equipment and mold additions in our United States plant and machinery and equipment in our Mexico plant.

While we can provide no assurances, we estimate that our capital expenditures in 2014 will approximate $18.0 million to $24.0 million. At our Salt Lake City, Utah plant, we expect to complete the conversion of existing warehouse space into manufacturing space and a new clean room by the second half of 2014. We also anticipate making investments in molds, machinery and equipment in our manufacturing operations in the United States and Mexico to support new and existing products and in IT that benefit world-wide operations. We expect to use our cash and investments to fund our capital purchases. Amounts of spending are estimates and actual spending may substantially differ from those amounts.

Financing Activities: Our cash provided by financing activities was $24.4 million in 2013. Cash provided by the exercise of stock options and shares purchased by our employees under the employee stock purchase plan was $20.5 million, resulting in 766,723 shares issued to our employees and directors. The tax benefits from share awards was $7.0 million in 2013, which fluctuates based principally on when employees choose to exercise their vested stock options. In 2013, we withheld 43,188 shares of our common stock from employee option exercises and vested restricted stock units as consideration for making $3.0 million in payments for the employee's share award tax withholding obligations.

In July 2010, our Board of Directors approved a new share purchase plan to purchase up to $40.0 million of our common stock. We have purchased $11.9 million of our stock from this plan, leaving a balance of $28.1 million available for future purchases. This plan has no expiration date. We did not purchase any of our common stock in 2013.

We have a substantial cash and investment security position generated from profitable operations and stock sales, principally from the exercise of employee stock options. We maintain this position to fund our growth, meet increasing

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working capital requirements, fund capital expenditures, buy back our common stock on an opportunistic basis and to take advantage of acquisition opportunities that may arise. Our primary investment goal is capital preservation.

As of December 31, 2013, we have $23.4 million of cash and cash equivalents held outside of the United States, the majority of which is available to fund foreign operations and obligations.

We believe that our existing cash, cash equivalents and investment securities along with funds expected to be generated from future operations will provide us with sufficient funds to finance our current operations for the next twelve months. In the event that we experience illiquidity in our investment securities, downturns or cyclical fluctuations in our business that are more severe or longer than anticipated or if we fail to achieve anticipated revenue and expense levels, we may need to obtain or seek alternative sources of capital or financing, and we can provide no assurances that the terms of such capital or financing will be available to us on favorable terms, if at all.

Critical Accounting Policies

Our significant accounting policies are summarized in Note 1 to the Consolidated Financial Statements. In preparing our financial statements, we make estimates and assumptions that affect the expected amounts of assets and liabilities and disclosure of contingent assets and liabilities. We apply our accounting policies on a consistent basis. As circumstances change, they are considered in our estimates and judgments, and future changes in circumstances could result in changes in amounts at which assets and liabilities are recorded.

Investment securities: Investment securities consist of certificates of deposits, corporate bonds and tax-exempt state and municipal government debt which are classified as available-for-sale. See Item 7A, Quantitative and Qualitative Disclosures about Market Risk. Under our current investment policies, our available for sale securities have no significant difference between the fair value and amortized cost. If there were to be a significant difference, this amount would be reflected as a separate component of stockholders' equity. Unrealized gains and losses on items for which the fair value option has been elected are reported in earnings at each subsequent reporting date.

Revenue recognition: We record sales and related costs when ownership of the product transfers to the customer, persuasive evidence of an arrangement exists, collectability is reasonably assured and the sales price is determinable. Under the terms of all our purchase orders, ownership transfers on shipment. If there are significant doubts at the time of shipment as to the collectability of the receivable, we defer recognition of the sale in revenue until the receivable is collected. Our customers are medical product manufacturers, distributors and end-users. Our only post-sale obligations are warranty and certain rebates. We warrant products against defects and have a policy permitting the return of defective products. We accrue for warranty and product returns based on historical experience. We accrue rebates as a reduction in revenue based on agreements and historical experience.

Accounts receivable: Accounts receivable are stated at net realizable value. An allowance is provided for estimated collection losses based on the age of the receivable or on specific past due accounts for which we consider collection to be doubtful. We rely on prior payment trends, financial status and other factors to estimate the cash which ultimately will be received. Such amounts cannot be known with certainty at the financial statement date. We regularly review individual past due balances for collectability. Loss exposure is principally with international customers for whom normal payment terms are long in comparison to those of our other customers and, to a lesser extent, domestic distributors. Many of these distributors are relatively small and we are vulnerable to adverse developments in their businesses that can hinder our collection of amounts due. If actual collection losses exceed expectations, we could be required to accrue additional bad debt expense, which could have an adverse effect on our operating results in the period in which the accrual occurs.

Inventories: Inventories are stated at the lower of cost (first in, first out) or market. We need to carry many components to accommodate our rapid product delivery, and if we mis-estimate demand or if customer requirements change, we may have components in inventory that we may not be able to use. Most finished products are made only after we receive orders except for certain standard (non-custom) products which we will carry in inventory in expectation of future orders. For finished products in inventory, we need to estimate what may not be saleable. We regularly review inventory and reserve for slow moving items, and write off all items that we do not expect to use in manufacturing, and finished products that we do not expect to sell. If actual usage of components or sales of finished goods inventory is less than our estimates, we could be required to write off additional inventory, which could have an adverse effect on our operating results in the period in which the write-off occurs.

Property and equipment/depreciation: Property and equipment is carried at cost and depreciated on the straight-line method over the estimated useful lives. The estimates of useful lives are significant judgments in accounting for property and

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equipment, particularly for molds and automated assembly machines that are custom made for us. We may retire them on an accelerated basis if we replace them with larger or more technologically advanced tooling. The remaining useful lives of all property and equipment are reviewed regularly and lives are adjusted or assets written off based on current estimates of future use. As part of that review, property and equipment is reviewed for other indicators of impairment. An unexpected shortening of useful lives of property and equipment that significantly increases depreciation provisions, or other circumstances causing us to record an impairment loss on such assets, could have an adverse effect on our operating results in the period in which the related charges are recorded.

Income Taxes: We utilize the liability method of accounting for income taxes as set forth in ASC 740. Under the liability method, deferred taxes are determined based on the temporary differences between the financial statement and tax basis of assets and liabilities using tax rates expected to be in effect during the years in which the basis differences reverse. A valuation allowance is recorded when it is more likely than not that some of the deferred tax assets will not be realized. In determining the need for valuation allowances we consider projected future taxable income and the availability of tax planning strategies. If in the future we determine that we would not be able to realize our recorded deferred tax assets, an increase in the valuation allowance would be recorded, decreasing earnings in the period in which such determination is made.

We are subject to income taxes throughout the United States and in numerous foreign jurisdictions. We recognize the financial statement benefits for uncertain tax positions as set forth in ASC 740 only if it is more-likely-than-not to be sustained in the event of challenges by relevant taxing authorities based on the technical merit of each tax position. The amounts of uncertain tax positions recognized are the largest benefits that have a greater than 50 percent likelihood of being realized upon settlement with the relevant tax authorities. New Accounting Pronouncements

See Note 1 of the Consolidated Financial Statements in this Annual Report on Form 10-K.

Off Balance Sheet Arrangements

In the normal course of business, we have agreed to indemnify our officers and directors to the maximum extent permitted under Delaware law and to indemnify customers as to certain intellectual property matters related to sales of our products. There is no maximum limit on the indemnification that may be required under these agreements. Although we can provide no assurances, we have never incurred, nor do we expect to incur, any liability for indemnification.

Contractual Obligations

We have contractual obligations, at December 31, 2013, of approximately the amount set forth in the table below. This amount excludes inventory-related purchase orders for goods and services for current delivery. The majority of our inventory purchase orders are blanket purchase orders that represent an estimated forecast of goods and services. We do not have a commitment liability on the blanket purchase orders. Since we do not have the ability to separate out blanket purchase orders from non-blanket purchase orders for inventory-related goods and services for current delivery, amounts related to such purchase orders are excluded from the table below. We have excluded from the table below pursuant to ASC 740-10-25 (formerly FIN 48), an interpretation of ASC 740-10 (formerly SFAS 109), a non-current income tax liability of $4.4 million due to the high degree of uncertainty regarding the timing of future cash outflows associated with the liabilities.

Contractual Obligations Total 2014 2015 2016 Operating leases $ 524$ 310$ 151$ 63 Warehouse service agreements 303 303 - - Purchase obligations 5,691 5,691 - - $ 6,518$ 6,304$ 151$ 63 Forward Looking Statements



Various portions of this Annual Report on Form 10-K, including this Management's Discussion and Analysis of Financial Condition and Results of Operations, describe trends in our business and finances that we perceive and state some of our expectations and beliefs about our future. These statements about the future are "forward looking statements," within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as

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amended, and we identify them by using words such as "anticipate," "believe," "expect," "estimate," "intend," "plan," "will," "continue," "could," "may," and by similar expressions and statements about aims, goals and plans. The forward looking statements are based on the best information currently available to us and assumptions that we believe are reasonable, but we do not intend the statements to be representations as to future results. They include, without limitation, statements about:

• future growth; future operating results and various elements of operating results, including future expenditures and effects with respect to sales and marketing and product development and acquisition efforts; future sales and unit volumes of products; expected increases and decreases in sales; deferred revenue; future license, royalty and revenue share income; production costs; gross margins; litigation expense; future SG&A and R&D expenses; manufacturing expenses; future costs of expanding our business; income; losses; cash flow; amortization; source of funds for capital purchases and operations; future tax rates; alternative sources of capital or financing; changes in working capital items such as receivables and inventory; selling prices; and income taxes; • factors affecting operating results, such as shipments to specific customers; reduced dependence on current proprietary products; loss of a strategic relationship; change in demand; domestic and international sales; expansion in international markets, selling prices; future increases or decreases in sales of certain products and in certain markets and distribution channels; maintaining strategic relationships and securing long-term and multi-product contracts with large healthcare providers and major buying organizations; increases in systems capabilities; introduction, development and sales of new products; benefits of our products over competing systems; qualification of our new products for the expedited Section 510(k) clearance procedure; possibility of lengthier clearance process for new products; planned increases in marketing; warranty claims; rebates; product returns; bad debt expense; amortization expense; inventory requirements; lives of property and equipment; manufacturing efficiencies and cost savings; unit manufacturing costs; establishment or expansion of production facilities inside or outside of the U.S.; planned new orders for semi-automated or fully automated assembly machines for new products; adequacy of production capacity; results of R&D; our plans to repurchase shares of our common stock; asset impairment losses; relocation of manufacturing facilities and personnel; effect of expansion of manufacturing facilities on production efficiencies and resolution of production inefficiencies; the effect of costs to customers and delivery times; business seasonality and fluctuations in quarterly results; customer ordering patterns and the effects of new accounting pronouncements; and • new or extended contracts with manufacturers and buying organizations; dependence on a small number of customers; loss of larger distributors and the ability to locate other distributors; future sales to and revenues from Hospira and the importance of Hospira to our growth; effect of the current relationship with Hospira, including its effect on future revenues and our positioning with respect to new product introductions and market share; growth of our Clave products in future years; design features of Clave products; the outcome of our strategic initiatives; regulatory approvals and compliance; outcome of litigation; patent protection and intellectual property landscape; patent infringement claims and the impact of newly issued patents on other medical devices; competitive and market factors, including continuing development of competing products by other manufacturers; improved production processes and higher volume production; innovation requirements; consolidation of the healthcare provider market and downward pressure on selling prices; distribution or financial capabilities of competitors; healthcare reform legislation; use of treasury stock; working capital requirements; liquidity and realizable value of our investment securities; future investment alternatives; foreign currency denominated financial instruments; foreign exchange risk; commodity price risk; our expectations regarding liquidity and capital resources over the next twelve months; capital expenditures; plans to convert existing space; acquisitions of other businesses or product lines, indemnification liabilities and contractual liabilities.



Forward looking statements involve certain risks and uncertainties, which may cause actual results to differ materially from those discussed in each such statement. First, one should consider the factors and risks described in the statements themselves or otherwise discussed herein. Those factors are uncertain, and if one or more of them turn out differently than we currently expect, our operating results may differ materially from our current expectations.

Second, investors should read the forward looking statements in conjunction with the Risk Factors discussed in Item 1A of this Annual Report on Form 10-K. Also, actual future operating results are subject to other important factors and risks that we cannot predict or control, including without limitation, the following:

• general economic and business conditions, both in the U.S. and internationally; • unexpected changes in our arrangements with Hospira or our other large customers; • outcome of litigation; 36



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• fluctuations in foreign exchange rates and other risks of doing business

internationally;

• increases in labor costs or competition for skilled workers;

• increases in costs or availability of the raw materials need to manufacture our products;



• the effect of price and safety considerations on the healthcare industry;

• competitive factors, such as product innovation, new technologies, marketing and distribution strength and price erosion;



• the successful development and marketing of new products;

• unanticipated market shifts and trends;

• the impact of legislation affecting government reimbursement of healthcare costs; • changes by our major customers and independent distributors in their strategies that might affect their efforts to market our products;



• the effects of additional governmental regulations;

• unanticipated production problems; and

• the availability of patent protection and the cost of enforcing and of defending patent claims.



The forward looking statements in this report are subject to additional risks and uncertainties, including those detailed from time to time in our other filings with the Securities and Exchange Commission. These forward-looking statements are made only as of the date hereof and, except as required by law, we undertake no obligation to update or revise any of them, whether as a result of new information, future events or otherwise.


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