Masimo Corp (MASI) 2007 Q2 法說會逐字稿

Good day, ladies and gentlemen. Thank you, very much, for your patience and welcome to the second quarter 2007 Masimo Corporation earnings conference call.

My name is Bill, and I will be your conference coordinator for today. At this time all participants are in a listen-only mode. We will be conducting a question-and-answer session towards the end of today's conference. (OPERATOR INSTRUCTIONS) As a reminder, today's conference is being recorded for replay purposes.

I would now like to turn the call over to our host for today's presentation, Mr. Nick Laudico. Please proceed, sir.

Thanks, operator.

Welcome to the Masimo Corporation second quarter 2007 earnings conference call. Masimo's senior management joining us on the call today will be Joe E. Kiani, Chairman and Chief Executive Officer and Mark P. de Raad, Executive Vice President and Chief Financial Officer.

Before we begin, Masimo cautions you that this conference call includes forward-looking statements. All statements other than statements of historical facts included in this conference call that address activities, events, or developments that we expect, believe, or anticipate will or may occur in the future are forward-looking statements. These include statements about our plans, objectives, strategies, and prospects regarding, among other things, the financial condition, results of operation, and business of hours and our subsidiaries.

These forward-looking statements are based on current expectations about future events affecting us and are subject to uncertainties and factors relating to our operations and business environment, all of which are difficult to predict and many of which are beyond our control. Certain factors mentioned in this conference call including the risk outlined under risk factors in our prospectus stated August 7, 2007, will be important in determining future results.

Although we believe that the expectations reflected in our forward-looking statements are reasonable, we do not know whether our expectations will prove correct. They can be affected by inaccurate assumptions we might make or by known or unknown risks and uncertainties. All forward-looking statements included in this conference call are expressly qualified in their entirety by the foregoing cautionary statements.

You are cautioned not to place undue reliance on these forward-looking statements, which speak only of the date hereof. We do not undertake any obligation to update, amend, or clarify these forward-looking statements or the risk factors contained in our prospectus dated August 7, 2007, whether as a result of new information, future events, or otherwise, except as maybe required under the federal securities laws.

With that, I would like to turn the call over to Joe Kiani.

Thank you, Nick, and thank you, ladies and gentlemen, for joining us on our first quarterly announcement conference call.

As Nick said, with me today I've got Mark de Raad, who is our Executive Vice President and Chief Financial Officer. We're very excited to be on this call. It was just a little over a month ago that after about 18 years of being a private company, we were able to complete our IPO. We were extremely happy with the level of investor interest in our company and of course we believe in our long-term mission, which is namely to improve patient outcome and reduce the cost of care by taking non-invasive monitoring to new sites and applications.

I want to extend a special thank you to everyone who took the time to meet us on the road show to learn more about our business. We're so happy that many of you decided to become shareholders. Today in our conference call, I would like to provide you some comments about our financial results, our business overall, then I'll ask Mark to give you detailed results of our financial announcement that we just put on the wire, and lastly I would like to come back for some closing comments and then answer with Mark any questions you have.

Before I get into the quarterly details, I just want to reiterate that we have a long-term mission at Masimo and that has been to have a dramatic positive impact on patient safety and to reduce the total cost of delivering care. We have been and will continue to accomplish our mission by automating patient monitoring, by making them reliable and non-invasive. This has been our long-term vision and it's going to require a continued and unwavering long-term view and focus on innovation and what is right for patient care.

Our ability to change the face of non-invasive monitoring, which really is underlying who we are, relies partly with Masimo, of course, through the introduction of breakthrough non-invasive technologies and products, but it also partly lies on the shoulders of care provider community. Now, we believe an educated care provider community will embrace our innovation for the betterment of patient care and improve efficiencies and I think our growth to date suggests we and the clinical community for the most part are doing our job.

Despite unfair obstacles with time, persistence, commitment, patience we are making good progress. I am thrilled that we have been able to make ourselves and show to the world that we are serial innovators. We've been able to break technological barriers and introduce products that our customers and our competitors thought were impossible to create. These innovations have set Masimo up for a very exciting future and growth, and as some of the analysts have pointed out, Masimo's potential addressable market size today is well over $2 billion, up from $1 billion before the introduction of Rainbow SET in 2005. With continued innovation, I can't guarantee, but we hope to double the size of our opportunity.

So with that said, let me just quickly highlight what happened in Q2 and the first half of 2007 for us. Our total second quarter revenues were a record of $63.7 million and consisted of record product revenue of $47.6 million, which represented an approximate 26% increase in year-over-year product revenue growth. In addition, we shipped a record 29,600 new Masimo SETs and Rainbow SET Pulse Oximeters including hand held--excuse me, excluding the hand held pulse oximeters worldwide. So in these numbers I just gave you, we do not include our shipments of hand held pulse oximeters, mainly, as many of you know because we believe without it, you have a good predictor of where our revenues are going to go due to the nature of how long these Pulse Oximeters end up lasting in the marketplace.

This represents a 25%--by the way, the (inaudible) represent a 25% increase over the prior year and with it our net income for the second quarter was $10.6 million or $0.19 on a non-GAAP earnings base and $0.13 a share on a GAAP base, and the first half revenues were similar. We did $122.6 million, which is a record and of that, $93.4 million was product revenue, which represented an overall 29% increase for the first half of the year compared to last year, and for the first half of the year, we shipped 56,200--56,200 new Masimo SET and Rainbow SET oximeters, again excluding the handheld ones, worldwide.

For the first half that represents a 20% increase over the prior year and given that industry analysts have estimated that placement of units are growing by 7%, we believe that these shipments suggest that we are continuing to gain additional market share. Later in this call, Mark is going to review our second quarter and first half financial results in much more detail. So big picture, as a fellow shareholder, what I like most about Masimo is that number one we have revolutionized Pulse Oximetry with Masimo SET and have made Pulse Oximetry a foul weather friend and a clinically useful tool.

They're separate, a foul winter friend, because now on the toughest situations, during motion, artifact, during very low profusion, we work and the false alarms have been reduced by over 90% while true alarms are improved to 97% and it's become a clinically useful tool because clinicians can now rely on it to diagnose patients with problems or treat, for example, retinopathy of prematurity has been reduced dramatically through the use of sound protocols and including our technology, Pulse Oximetry. Congenital heart defect have been shown to be detectable with amazing sensitivity and specificity because of our accuracy and reliability.

The second reason I'm--the second thing I really like about Masimo, and I'm very happy to be here, is we--as a result of this contribution, we have a solid business, we have a very solid business model, because of the retool motion Pulse Oximetry, and again, we have produced what we call our second revolution, with the introduction of Rainbow SET which allows clinicians and emergency professionals to measure carbon monoxide, met hemoglobin and PVI in real time and non-invasively for the first time.

We have--number four, we have a great innovation engine. We have very bright and talented engineers and they don't think that they are done yet. Number five, Rainbow's exciting in many ways, with it I'm convinced we'll save and improve the lives of many people around the world and we will fuel our continued growth.

And I like Masimo because we have now been able to put more focus on international sales. We are revamping our sales and marketing in Japan with our recently appointed President of Masimo Japan, (inaudible) Manwa. Mr. Manwa had 20 years of successful track record of selling and sales management experience at Becton Dickinson, Japan.

We also have recently appointed Mr. Mark Hardy as President of International Sales and Marketing, and--which is a new position at Masimo to again put more focus on our international opportunity. Mark has had a successful track record of sales, marketing, and general operations management most recently at Edwards.

Now we believe also that continuous monitoring or oxygenation at general ward is happening and Masimo is best situated to make this necessary patient safety net a reality. The one thing I just want to caution you, though, is that with especially Rainbow, which is very promising, predicting when our revenues from Rainbow will fall on the steep part of the S-curve of technology adoption is hard to predict and that is why that we are not making a big, bold prediction of those numbers but I'm confident these measurements are going to make a difference, a huge difference in the clinical community and as the education basically reduces the gap of knowledge and what can be done with these measurements, we believe Rainbow will start really delivering and helping us continue and sustaining our growth.

So with that said, I would like the turn the presentation now to Mark to take you through the detailed financials and then I would like to come back and wrap up and answer your questions.

Thank you, Joe.

On today's call, I will be reviewing our quarterly financial results and some key factors that contributed to these results. Please keep in mind that in all my comments, I'll be relating to financial results on a GAAP basis. The only exception will be our earnings per share, which we'll present in both GAAP and non-GAAP format in order to provide investors with information that we believe is relevant to the post- IPO capitalization structure and therefore relevant to future quarter earnings per share calculations. Included within our earnings release issued today is a schedule reconciling the GAAP earnings per common share to the non-GAAP earnings per common share calculations.

As Joe noted, our total second quarter revenues were a record $63.7 million and consisted of record product revenues of $47.6 million and royalty revenues of $16.1 million. This represented an approximate 26% increase over the prior year period and as Joe alluded to earlier, included the shipment of 29,600 new drivers into the marketplace, which was also a quarterly record for us. We now estimate that we have a total of approximately 424,000 units net of estimated retirements in the field throughout the world.

During the first six months of 2007, we have placed 56,200 new drivers into the field, compared to approximately 46,600 drivers in the same prior year period. These drivers, depending upon whether they are placed through our OEMs or whether they are placed as part of our own bedside monitors will ultimately combine to generate sensor sales which will continue to represent the most significant component of our total product solution revenues.

During the second quarter, we shipped approximately 1.9 million Rainbow-related products, which was up from about 600,000 in the prior year period. And on a year-to-date basis, we've shipped a little bit over $3 million in Rainbow-related products, which was up from about $1 million in the prior year period. These new Rainbow revenues relate almost entirely to the sale of our handheld Rad 57 products as our new Rainbow software parameters for the bedside only became available in the second quarter.

In the second quarter, product revenues generated from our direct and distribution channel totaled $32.8 million, which represented approximately 69% of our total product revenues while OEM revenues totaled $14.8 million or approximately 31% of the same total product revenues. This compares to approximately 66% and 34%, respectively, in the same prior year periods. On a year-to-date basis, our direct and distribution revenues totaled $66.1 million or 71% of total product sales compared to $48.7 million or 67% of total product sales in the comparable prior year period. The slight increase in the percent of revenues through direct and distribution channels is the result of our continued expansion of our direct business throughout the world.

During the second quarter, our shipments in the U.S. totaled $35.6 million or approximately 75% of our total product revenues compared to $28.6 million or 76% in the prior-year period. On a year-to-date basis, our shipments in the U.S. were $70.2 million or 75% of total product sales compared to $55.9 million or 77% of total product sales in the prior year period. The slight increase in international revenues as a percent of total revenues is due to our continuing investment focus on international market opportunities.

Our second quarter royalty and license fee revenue decreased $1.8 million to $16.1 million from $17.9 million in the prior year period, due to a lower royalty rate associated with our 2006 settlement agreement with Nellcore. As a quick reminder, our royalty rate in 2006 was approximately 20%.

In 2007, the settlement agreement requires royalty rates of either 15% or 12%, depending on whether Nellcore has successfully redesigned their products and in so doing, removed certain infringing elements. To date, we have not received any notice from Nellcore that they intend to take advantage of this provision in the royalty agreement, and as a result they have paid at the 15% rate for both the first and second quarters of fiscal 2007. Also, as a reminder, from 2008 and beyond, the royalty rate will be 13% or 10% based upon the same provisions as I just mentioned.

Moving on to cost of goods sold, our second quarter cost of goods sold increased to $17.9 million from $15 million in the prior year period. During the same period, total product margins, excluding royalties, actually increased to 62.4% in our second quarter from 60.5% in the same prior year period. This increase was due to an increase in the percent of sensor revenues relative to total product solution revenues, lower manufacturing costs, as well as the favorable impact of new Rainbow products.

Our second quarter 2007 gross margins decreased slightly to 71.9% from 73.2% in the prior year period due to the previously noted decline in year-over-year Nellcore royalty payments. Engineering expense in the second quarter increased to $5.5 million which was up $3.1 million from the prior year period, and this increase was directly related to increased staffing as we continue to aggressively add engineering resources to be able to address the many exciting product opportunities on our road map.

As of June 27th, we had 134 engineering and related staff, which was up from 81 just 12 months ago. Selling, general and administrative expenses rose to $21.6 million, up from $15.1 million in the prior year period. This increase was primarily the result of our efforts to aggressively build out our sales and marketing organizations in both the U.S. and throughout the world. As a result of the expansion effort, we have increased our worldwide sales and marketing staff from 262 at June 2006 to 329 in June 2007. In addition, we have increased the staff of various other organizations, including finance, to build the infrastructure necessary to operate as a public company.

Second quarter operating income was $18.3 million, down from $22.5 million in the prior year period, but up from $15.2 million in the first quarter of 2007. The year-over-year decline is primarily to the previously noted--due to the previously noted increased staffing levels throughout the organization and the incremental marketing spending, as well as the impact of lower year-over-year royalty payments. In total our non-manufacturing staffing increased from about 343 in June a year ago to 463 as of June 2007. Our effective tax rate for the second quarter was approximately 41%, which was down from 42% in the same prior year period, and on a year-to-date basis, our tax rate is approximately 40%, down from the 42% in the comparable prior year period.

As we've previously noted, net income for the 2007 second quarter was $10.6 million or $0.13 GAAP earnings per common share or $0.19 non-GAAP earnings per common share. This compares to prior year second quarter net income of $13.9 million or $0.19 GAAP earnings per share and $0.25 non-GAAP earnings per common share. The pro forma EPS calculation assumes the conversion of all the Company's preferred stock into common stock, consistent with the Company's recently completed initial public offering, and presents earnings per share in a manner consistent with FAS B 128 which will be used by the Company to compute in accordance with GAAP all future earnings per share calculations after the initial public offering date. Management is providing this pro forma earnings per share calculation because it believes that this method is more comparable to the GAAP EPS numbers that will be reported in the future quarters.

Now I wanted to make just a few comments on our balance sheet. For the six-month period ended June 30, 2007, we generated $4.6 million in cash from operations and used $3 million in investing activities and $21.3 million in financing activities, resulting in a total net use of cash of $20.4 million. The total net use was the result of the February 2007 dividend payment made in connection with the board's December 2006 dividend declaration of approximately $0.725 per share on an adjusted basis to all preferred and common shareholders as of record on December 29, 2006. Partially offsetting this was financing of $20 million of our equipment placed at hospitals under long-term sensor purchase agreements, where the only collateral is the equipment actually being financed.

At June 30, 2007, our trade DSO was 52 while our inventory turns were at 3.2. These compared to trade DSO of 47 and inventory turns of 3.7 as of December 2006, and both these figures are within our expected ranges. The slight increase in our inventory days ratio is consistent with our philosophy of ensuring that we have sufficient inventory levels to be able to respond to our customer's needs.

Now I would like to turn very quickly to the topic of guidance. As this is our first public conference call, I would like to take just a quick moment to address our current outlook for the entire fiscal 2007 year, which will obviously end this December. Also going forward, we would like to make it clear that it will be our intention to provide annual financial guidance at the beginning of each fiscal year, then as appropriate, we will adjust that annual guidance as we progress through the year. We do not, therefore, expect to provide any specific quarterly guidance consistent with the focus that Joe noted earlier in his discussions about our long-term focus.

For the full year of 2007, we expect total revenues to be approximately $245 million, which includes a total product revenue of approximately $195 million. We also expect full-year GAAP earnings per common share to be approximately $0.43 while our non-GAAP earnings per share, adjusted again only for the assumed conversion of preferred stock into common stock, we expect that to be approximately $0.55 per share. Obviously, these are projections, they're estimates, and actual results could differ.

That wraps up my portion of the discussion, and Joe, I would like to turn the call back to you.

Thank you very much, Mark.

In closing, I just want to first thank you all again for joining us on the call, again, especially to those who took the time to meet with us during a very rocky period when we were doing our road show. I know that a lot was going on at that time.

I just want you to know that my commitment and my colleague's commitment has not changed. When I started Masimo in 1989, I did it to make a contribution to the society by advancing dramatically non-invasive monitoring of patients. I also did it because I wanted to reward the shareholders, which included me, who joined in to help us accomplish our mission, and it's 18 years later and I just want to let you know that I'm here still with the help of many talented people around me and we're going to continue to do what we set out to do nearly 20 years ago.

So thank you very much. I'm going to turn it back to our moderator and look forward to answering your questions with one caveat that I would like to just state before I do that, and that is, as the third quarter is not yet completed, please don't ask us questions regarding the third quarter, because we cannot answer them, and we are going to do our best in future to hold our quarterly earnings call during the fifth week after the end of the quarter. This quarter was very unusual because as you know, we just completed our IPO and we had to wait before this announcement.

So with that said, Nick, I'm handing it back to you.

Thank you very much, sir. (OPERATOR INSTRUCTIONS)

First question will come from the line of Tao Levy of Deutsche Bank. Please proceed.

Good afternoon, everyone.

Good afternoon, Tao.

A couple quick questions. Maybe first a couple clarifications on the guidance. What are you assuming, Mark, on the royalty rate in the back half of the year to get to the $50 million?

We continue to assume the most conservative stance, which in this year's case is 12%.

Okay, and you said--and when you said in your prepared remarks that you hadn't heard anything yet from Nellcore in terms of something that could get into this conservative rate, that's up to today, or was that as of the end of the second quarter?

That's actually as of today.

As of today, okay thanks. And also maybe you can touch on a little bit on the international opportunity. Maybe spend a couple minutes, Joe, if you wouldn't mind on Japan, the history there, and just again maybe just touching on the size of the market and where you see the potential opportunity in Japan.

Certainly. We see Japan as a great opportunity for our products, for many reasons. One being that they appreciate technology and what technology can do for the betterment of care.

We have had distribution handling Japan for us along with our OEMs until about a year and a half ago. About a year and a half ago, we decided to go direct and of course we still have to use kind of the distributors that do the just in time for the hospitals, but we're now relying on our own direct sales force. We've recently hired Mr. Manwa, that they mentioned earlier. Mr. Manwa brings very strategic thought process to selling and marketing and I've been very impressed with him before and even after his hire. He's only been with us for about a month now and we're expecting, under his leadership, to really build a very strong sales force and continue to do our best to educate the end users about the clinical advantages of our technology.

Does that answer your question, Tao?

Yes, that's very helpful, also, can I--in the second quarter, if I try to back into what--I guess Nellcore or the U.S. sales that they did in the second quarter based on your royalty rate, I get to something in the order of growth of around 34%. If I can recall correctly, there's some one time-ish stuff in there. Is that right,Mark?

Yes, I think as we've previously discussed. The royalty agreement between Nellcore and Masimo requires notice to Masimo within 60 days after the end of the quarter, and so because of that, obviously, we're in a position to close our books prior to that period of time, and so included in the second quarter was an additional $1.4 million worth of royalties that in a sense related to the January through March period, but we were not notified of that until the second quarter period, and as we stated in our accounting policies, it is our policy to basically recognize any additional royalty that we may receive in the current quarter. So that was a element that provided a little bit of additional increase to the royalty figure for the second quarter.

Got you. Okay, and just my last final question. So taking--even excluding that from your perspective, what did the U.S. market grow in the second quarter, now that you kind of--you have a sense of what Nellcore did. You obviously know what you guys did on the sensor side of things.

Well, I think if you look at our growth, it was about 26% in the second quarter and I think that growth is general across the globe. There's some minor exceptions, like South America or some of the distant parts of Asia, but overall the worldwide growth, which should reflect at least the U.S. growth and I believe from the numbers, you can tell that perhaps Nellcore grew a little bit. So I think overall, we think the analysts, not you guys, but kind of like the Frost and Sullivans of the world who are predicting about a 6% to 8% growth rate in the U.S. is really the growth rate still. So really that difference for what Masimo did has again taken market share and increasing our market share.

Okay, great. Thanks.

Thank you.

Thank you very much, sir, and ladies and gentlemen, your next question comes from the line of Bill Quirk of Piper Jaffray. Please proceed.

Great, good afternoon, and congratulations on the results for your--for the first time as a public company, guys.

Hi, Bill, thank you, and I have to ask what music did you play while you were listening?

I'll shoot you an e-mail on that one, Joe.

A couple of questions. First off, SG&A was handily below our expectations, which is to say better than our expectations, and Mark, correct me if I'm wrong here, but it does look like the guidance implies a ramp in this line item over the back half of the year. Is that the right way to think about it?

Yes. I think in general, obviously, our second quarter total operating expenses were below what we'd initially expected, but we are obviously managing that very carefully, relative to the opportunities that we see ahead of us. In a sense, some of the expenses that we expected in the second quarter are going to roll into the second half of the year, but even with that impact, we believe the guidance that we've already suggested is very, very consistent with where we expect the second half of the year to be.

Okay. Understood. Two additional questions. First is just a capacity question. Obviously, great driver results in the quarter. What is the capacity right now, theoretically for driver installs or shipments, I should say, during a quarter?

Production capacity, Bill?

Yes.

It's limitless.

Okay. All right, and then last question is just, was hoping to get an update on the discussions concerning some of the OEM partners that are also considered to be infringers. I don't know if we have an update here. I'm thinking specifically about Phillips and GE, guys. Any comments here?

The only thing I can say, given of course the sensitivity of our discussion is that we're making better progress with one than the other and that we're going to obviously exhaust discussion with even the other and at some point if we feel like things aren't going the way we want, we'll have to defend our IP at minimum, so we'll see. I'm sorry I can't tell you more.

No, fair enough, but would it--presumably, Joe, once we get--assuming that we get agreements in place with these parties, I assume you'll obviously be free to talk about it at that point, presumably on a conference call? In other words, we'll get an update on this down the road, correct?

Absolutely. If something happens that is worth--as far as a milestone, we will obviously bring it up and we're hoping maybe even--if not the next one, the following one we'll be able to update you on it.

Okay, great. Thanks very much, guys.

Thank you very much, sir.

Ladies and gentlemen, your next question comes from the line of Robert Faulkner, Thomas Weisel Company. Please proceed.

Thank you. Hi, Joe, and Mark.

Hello, Rob.

I wondered if you could talk a little bit about market dynamics in the U.S. and then I'll move on to Japan, are we seeing any change in pricing or strategies by Nellcore or others to slow you down?

Well, good question. I think obviously with the technology advancement that we have, it really leaves--and I guess with the rate of adoption and conversion of accounts that we target, it leaves maybe the composition with what they perceive to be a little choice, but to get into pricing game, I think the two things we're seeing is number one, Nellcore is continuing to rely on bundling as a means to try to protect their installed base.

That is bundling discounts of unrelated products with Pulse Oximetry, which as you know, it's a complaint we have in an antitrust case. And on the price wide, we're seeing overall they're trying to, of course, compete more effectively and many years ago, our products, we were pricing at below Nellcore, then for a while, we were pricing it at Nellcore. Today I would probably say we're pricing it at a premium to Nellcore, but at the same time, we're not going to lose any customers.

So if we ever feel that a customer is hung up on price, that is not going to be a reason we're going to lose that customer. So I don't believe that tactic of price reduction is going to have any impact on our business or Nellcore being able to stop what is happening.

Right. That's very helpful. When I think about you taking your businesses direct internationally, what kind of impact does that have on gross margins?

Obviously, it's positive. We have gone direct in Germany, France, U.K., in the process of going direct in Italy and Spain. Like I've said, we've gone direct in Japan, so no countries that we've done that direct jump in the past year and a half, Germany, U.K., France, and Japan. You're not going to see our numbers, an improvement in our margins nor our revenues because of going direct, that has already happened. So it's really as we go direct in some of these other countries like Italy, Spain, and Australia and places like that that you'll see some, but given that the revenue contribution is little compared to this bigger market, I don't think that's going to be a significant factor, Rob.

Okay. So not a big factor. Then following on to some of Tao's questions, what is the market in Japan like? Is it the typical half the U.S., and what is your market share there at this point?

Okay. We believe the market in Japan is about anywhere from one fifth to one sixth of the U.S. market and we believe our market share in Japan is significantly lower today than it is in the U.S. We think our market share in Japan is probably less than 20%. So we believe a direct operation under strong leadership of Mr. Manwa should allow us to catch up with our overall market share worldwide.

Is the competitive set the same?

Yes. The competitive set is the same, and to some extent, I would say maybe more favorable, because the decisions in Japan are still primarily made by the leading clinicians. So we, of course, leading clinicians appreciate what we do much more than a committee of people that are sometimes hard to get your arms around people who are not day to day carrying for patients.

Looking forward, are there any medical conferences that we should look toward for clinical data or anything of that nature?

The ASA, which is going to be in San Francisco in October should be a good place for a lot of updated clinical data published there. Also, the Society of Critical Care Medicine, which is going to be in Hawaii, finally, a good place to have meetings, it's going to be in February--first week of February. That should also be another place to look for new data coming out.

Do you want to elaborate on what we might see at ASA, which is coming up sooner?

I think at the ASA, you'll continue seeing data supporting the Masimo Set rethro mothion Pulse Oximetry is the best. No surprises there. There'll also be some more early studies of our non-invasive hemoglobin prototype and non-invasive acoustic respiration monitoring prototype. That data will also be presented there. Again, no surprises. It's looking like it's looked before. So, of course, I caution you with that data, because the product is not ready yet and so therefore it's just really more for the clinical and scientific community to kind of appreciate what's going on.

And will these be the same studies, let's say on hemoglobin we've seen in the past or are these going to be new studies?

Similar studies, of course larger patient population now. So I think it's becoming more statistically powerful, although even before the statistical power was good with P of less than 0.05.

Good, okay, great. Thank you. I'll hop back in the queue. Thanks, Joe.

Thank you, Rob.

Thank you very much, sir.

Ladies and gentlemen, your next question comes from the line of Sarah Michelmore of Cowen & Company. Please proceed.

Yes, thank you. Good afternoon.

Hi, Sara.

I guess first thing, Mark, I understand you don't want to give quarterly guidance, but if you could just give us a sense of the seasonality of the business, particularly as we think about soccer--sorry, socket driver shipments Q2 to Q3 and Q3 to Q4 and specifically if there's any difference there in the shipment volumes or the shipment seasonality between what you guys see directly and what you do to the OEM partners?

I think I'll answer that two ways.

There's a theoretical way to answer it, which is that during the winter flu season, intuitively, you would think that a business like ours would see an increase from a seasonal standpoint. Contrasting that assumption, though, is that the reality that given our size and given our consistent quarter-over-quarter growth rate, we have yet to see any kind of significant seasonality in any of our numbers, whether that be our topline product revenue numbers or our driver numbers. So I think the quick answer to your question is, no, there's no significant waves of seasonality that we have yet been able to discern, at least within our cycle right now and as far as we can see for the next couple of years.

Okay, and Joe, I appreciate you talking about Rainbow both in an enthusiastic manner, but also one with some candor in terms of the visibility there. As we kind of look out on that product over the next couple of years, can you walk us through some milestones or at least some sign posts that maybe we should be paying attention to both in terms of some of the parameters that you have out today and possibly what the time lines may be for some of the other stuff?

I will try. Sara, I guess first of all, I want to just say that until something is out, it's not out. Science is very cruel. Just when you think you have it, you don't. We expect over the next two years to introduce non-invasive hemoglobin and within the Rainbow platform, of course, and that should be a softer upgrade to our current system, and we also expect to be announcing and introducing our acoustic respiration monitoring technology. I think beyond those two major parameters, it's probably too early to talk about the next ones, but once we get those out, then hopefully we can maybe start thinking about the others.

Okay, and can you talk a little bit about the development efforts you have ongoing and the kind of carbon monoxide end market, hemoglobin market and PBI and what we should be paying attention to there over the next 12 to 18 months?

Yes, yes, please. We think there's a huge market opportunity with all those three parameters or measurements. Carbon monoxide, it's a big problem in the EMS environment, Emergency Medical Response teams, as well as the emergency departments and we think it's a great product for the perioperative environment.

We think carbon monoxide--non-invasive carbon monoxide monitoring has a market potential of $400 million to $500 million a year. And kind of to tell you what we're doing about that, we're aggressively marketing it in the EMS environment. We have a small, direct sales force team in the U.S., augmented by Bountry Medical, which is one of the biggest distributors in the EMS environment. At the same time, med hemoglobin and PBI, which was just announced this year, those are important in the EMS environment, but their natural home and market is really the hospital market because med hemoglobin is an acquired problem in the hospital where the same drugs that are being given to these patients to treat them are in some cases unfortunately killing them by causing med hemoglobinania.

So PBI, of course is a fluid volume, we think it's a measurement of fluid volume, which is a first-time, hopefully clinicians can titrait the fluid volume with their patients, which is a critical parameter since too much volume can put pressure on the heart and even cause stroke, too little can lead to sepsis. So those two parameters are hospital-oriented parameters. In the second quarter we announced those parameters being finally made available in our bedside device for the hospital along with a family of adhesive sensors that are suitable for that are environment from neonates to adults. Initially we got clearance for all patient populations except for neonates and infants. Just about a month ago we also got clearance for them as well.

So you're going to see us pushing very hard with education campaigns to make sure clinicians become aware of the availability of these non-invasive parameters in the hospitals, but also the awareness of the problems that are caused by not measuring it and what the drugs can do. So we're finally kind of unleashed, I think, in the U.S. and Europe. You'll see us marketing that aggressively with a lot of educational campaigns that are going to be happening, starting at the ASA and we hope within a year we'll be able to start making an impact there and we'll keep you posted.

As for the EMS, it's already happening. People are appreciating it, and that product line is growing for us faster than any product line we've ever introduced today.

Great. That's very helpful, Joe. I appreciate it and thanks very much.

Thank you, Sara.

Thank you very much, ma'am.

Ladies and gentlemen, your next question comes from the line of Matthew Dodds of Citigroup. Please proceed.

Hello, Joe. Hello, Mark.

Hey, Matt.

A couple questions. First, you said earlier for Clovidian, they're still relying on their broad-based bundling and it sounds like to a degree it's still working, as one of their strategies. Have you ever looked into or tried bundling with maybe one of the large surgical suppliers and is it meaningful enough to try? That's the first question.

That's a really good idea. We'll look into it.

It's taken you 20 years. Have you tried this before, have you partnered before? I just don't know the history of that.

Well, I think, obviously, the thought has come to our mind, and we're not certain that that's a legal practice, let alone an ethical practice. So we have to come to grips with it as you know, when we sued Tyco for that practice, the jury initially found that that was illegal conduct. The judge in our case reversed that bundling, although she gave us sole source contracting and market share-based pricing as being illegal conduct, but now we're at the appeals court and I'm not sure.

The recent case at our ninth circuit, which is the appellate court that we're going to be in front of came up with a case that I think is very helpful with our belief that that type of unrelated product bundling should be illegal and we'll see. So I think we need to kind of see that through. If at the end of the day the courts and the laws say that's a legal activity, then of course as you suggested, we have our options too.

Perfect. A second question on Japan, just to clarify a couple more things there. Is that market very similar to the U.S. in terms of it's all disposable based, long-term contracts versus Europe, which is obviously different?

Yes, except that they don't do contracts. They do hopefully long-term handshakes, but yes. It's disposable, typically you place a device and the hospitals use it for years, but they won't sign a contract.

But the handshakes are not, in terms of length, they're similar to the U.S?

Yes, where we're six months to a year within our handshake, we'll see how long they last. It looks like they do last, it looks like they're people of honor and hopefully they're as good as contracts.

Perfect, thanks, Joe.

Thank you.

Thank you very much, sir.

Ladies and gentlemen, your next question comes from the line of Matthew Buten of Catapult. Please proceed.

Hi, thanks for taking my question. I was curious about the product revenue growth rate, which I guess started the year in the low 30s and then this quarter put up a great 26%. Are you expecting it to continue to decelerate into the sort of low 20s, is that correct for the second half of the year?

Well, it's--I think you can see from our numbers what our growth is going to be compared to last based on the guidance we gave. But I think given that the majority of our revenue comes from our sensor sales, as we--as we kind of keep putting Pulse Oximeters are on the top of our current installed base of Pulse Oximeters, that kind of becomes our growing limitation or growth. For example, by the end of last year, we had 377,000 Masimo SET Pulse Oximeters in the market, so this year, based on our current run rate we put another 112,000 out there, that is pretty much 100 out of 500, right, so it's 20%.

That would kind of imply that that's kind of the growth you ought to be expecting. But our total growth really depends on the S-curve technology adoption of Rainbow, which could potentially help us grow above that, but as I said earlier, those are unfortunately not easy to predict when you start falling into the sweet spots of those technology upticks.

Okay. So by the end of the year, sort of--or maybe next year without Rainbow is sort of 20% product type growth?

Yes, probably. I think that's a conservative and good assumption. We're doing our best everyday to do the best we can, but I think the one thing that I really don't want Masimo to focus on is just quarterly numbers, although they're important, I think we get ultimately to where our investors want us to get to by focusing on innovation, on customer service, and a long-term thought process.

Thank you very much and nice quarter.

Thank you.

Thank you very much, sir.

At this time, we have no further questions in queue.

Well, thank you, all, for joining us today. We look forward to our announcement coming up, I guess, it'll be first week of November and we'll also--we're also considering having perhaps an Analyst Day where we can bring you all in to have kind of like an open house to help you guys get the chance to meet the Company and see our place. As soon as we get that set up, we will inform you of that meeting. Thank you all again.

Thank you very much, sir, and thank you, ladies and gentlemen, for your participation in today's conference call. This concludes your presentation for today. You may now disconnect. Have a good day.