Masimo Corp (MASI) 2007 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Third Quarter of 2007 Masimo Corporation's Earnings Conference Call. My name is Jeremy and I will be your coordinator for today.

(Operator Instructions)

We will be facilitating a question-and-answer session toward the end of the conference.

(Operator Instructions)

I would now like to turn the presentation over to your host for today's call, Mr. Nick Laudico from The Ruth Group.

Sir?

Thanks, operator.

Welcome to the Masimo Corporation Third Quarter 2007 Earnings Conference Call. Masimo senior management joining us on the call today will be Joe E. Kiani, Chairman, President and Chief Executive Officer, and Mark P. deRaad, 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 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 ours 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 risks outlined under "Risk Factors" in our prospectus dated 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 as 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 may be required under the federal securities laws.

And with that, I'd like to turn it over to Joe Kiani.

Thank you, Nick.

And thank you, ladies and gentlemen, for joining us here today for our second quarterly announcement conference call. And this has been, I guess, less than six weeks since we had our last call. And as much fun as we have to have these calls, please don't expect another one in six weeks.

With me on the call today is Mark deRaad, who is our Executive Vice President and Chief Financial Officer. And as I did in our last call and on the presumption that we have some new shareholders joining us for the first time, I would like to reiterate some things I mentioned in our first call just six weeks ago.

The big picture is that Masimo's long term mission is to improve patient outcome and reduce the cost of patient care by taking noninvasive monitoring to new [spikes] in application. We are doing this by automating patient monitoring and making it reliable and making some invasive measurements noninvasive.

This mission requires a continued and unwavering focus on innovation and what is right for patients and our business in the long term.

Our ability to change the face of noninvasive monitoring relies partly with Masimo through the introduction of breakthrough noninvasive technologies and partly with the care provider community.

We believe education is our friend and that an educated care providing community will embrace our innovations for the betterment of patient care and improved efficiency.

Our growth to date suggests that the clinical community is indeed embracing us, and despite difficult and sometimes [illegal] obstacles with time, commitment and patience, we continue to make good progress.

I am thrilled that Masimo has a proven history for being innovators. We have broken technological barriers and have introduced new products that both our customers and our competitors had felt were impossible to create.

Our past innovations have allowed us to become the company we are today, and as some of the analysts have pointed out, Masimo's potential addressable markets has become about $2 billion to $3 billion.

Through a continued passion for continued innovation and improved patient care, we hope to continue to raise the ceiling of Masimo's total market opportunity.

In our call today, I would like to discuss a variety of topics, including our Q3 financial highlights. I'll start off with the financial highlights and then I'll ask Mark to discuss more details of our financials. And I apologize to Mark and to you, some of the things I'm going to say might be repetitive to what Mark will say.

And finally, I'll provide some closing comments, at which time I'd like to open the call to any questions that you may have that may not have been addressed in our remarks.

Now I'd like to turn to our Q3 results. Q3 2007 revenues were a record $51.1 million, compared to $39.8 million in Q3 2006, which is an increase of 29%. Including the royalties from Nellcor, our Q3 2007 revenues were a record $64.4 million.

For the first nine months of 2007, our product revenues were $144.5 million, which was an increase of 29% over the same prior year period, with total revenues, including royalties from Nellcor were $187 million.

We shipped a record 30,800 new Masimo SET and Masimo Rainbow SET pulse oximeters and pulse co-oximeters, excluding hand-held devices, worldwide. These devices that we shipped represented a 32% increase over the prior year. And for the first nine months of the year, we shipped nearly 87,000 Masimo SET and Masimo Rainbow SET units.

This total represents a 25% increase over the prior year period and continues to provide evidence of our ability to grow in excess of the industry estimate of 6% to 8%.

Our product gross margins for Q3 were 63.2%, compared to 63% for the same period last year, and for the nine months our margins were 62.9% in 2007 compared to 59.2% in 2006. Our total gross margin, including the royalties for Q3 2007, was 70.8% and our gross margin for the nine months of 2007 was 71.3%.

Net income for the second quarter was $10.6 million, or $0.18 per share on a non-GAAP earnings which was (inaudible) expectation.

I would now like to ask Mark to give you the detailed presentation of our financials, and I'd like to come back, as I said, and address a few other issues and answer any questions you have.

Mark?

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 all my comments will relate to financial results on a GAAP basis. The only exception will be our earnings per share, which we will present in both GAAP and non-GAAP format in order to provide shareholders with information that we believe is relevant to our post-IPO capitalization structure and therefore relevant to future quarterly earnings per share calculations.

Included with our release today is a schedule reconciling the GAAP earnings per common share to the non-GAAP earnings per common share calculations.

As Joe noted, our third quarter revenues were a record $64.4 million, and consisted of a record product revenue number of $51.1 million and total royalty revenues of $13.3 million. This represented a 29% increase over the prior year period.

During the third quarter, we shipped approximately 1.4 million Rainbow-related products, which was up from 1.3 million in the prior year period. And on a year-to-date basis, we have shipped 4.5 million in Rainbow-related products, which is up 103% from the approximate 2.2 million in the same prior year period.

These new Rainbow revenues relate almost entirely to the sale of our handheld Rad-57 products.

Third quarter 2007 product revenues generated from our direct and distribution channel totaled $35.7 million, or 70% of total product revenues while our OEM revenues totaled $15.4 million, or 30% of total product revenues.

This compares to approximately 68% and 32% in the same prior year periods. And on a year-to-date basis, our direct and distribution revenues totaled $101.9 million, or 71% of total product sales compared to $75.7 million, or 67% of total product sales in the comparable prior year period.

We believe that the increased percentage of direct and distribution channel revenues is the result of our continuing investment in building our direct sales organizations throughout the world.

During the third quarter, our U.S. shipments totaled $40.5 million, or 79% of total shipments, compared to $31.3 million, or 80% in the prior year period. And on a year-to-date basis, our direct shipments within the U.S. were $113.2 million, or 78% of total product revenues, compared to $89.3 million, or 80% in the prior year period.

The increase in international revenues as a percent of total revenues is due to our continuing investment focus on international market opportunities.

Our third quarter royalty and license fee revenues decreased to $13.3 million from $17.9 million in the prior year period due to a lower royalty rate associated with our 2006 settlement agreement with Nellcor, now known as Covidien.

Just to remind you, per our settlement agreement with Nellcor, the royalty rate declined from approximately 20% in 2006 to 15% in 2007. In addition, it's important to mention that we have received 15% royalty payment from the first and second quarter of 2007 and have accrued at a similar 15% rate for the third quarter ended September 29, 2007.

Any differences between our third quarter accrual and the actual royalty payments which we received will be, in accordance with our stated accounting policy, reflected in our fiscal Q4 results.

Now moving on to the gross profit margins, our total third quarter gross profit margins rose to 63.2% from 63.0% in the same period year period. The year-over-year increase in product margins was due primarily to an increase in the percent of sensor revenues relative to total product solution revenues.

Total gross profit margins for the third quarter declined to 70.8% from 74.5% in the prior year period due to the impact of the $4.6 million decrease in royalties which I previously noted.

Third quarter engineering expense increased to $6.5 million, up from $4.3 million in the prior year period. This increase was directly related to additional staffing as we've aggressively added engineering resources as we expand our new product support and development capability. As of September 2007, we now have a total of 130 engineering and engineering-related staff positions, which is up from 98 in the same period year period.

Third quarter selling, general and administrative expense rose to $21.6 million, up from $18.3 million in the prior year period. This increase was primarily the result of our continuing efforts to build out our sales and marketing organizations in both the U.S. and throughout the world and expand our marketing programs and activities.

As a result of this expansion effort, we have increased our worldwide sales staff from 86 in September 2006 to 105 as of September 2007.

In addition to increased sales staff, we have also increased staffing throughout the marketing organization as well as expanded general and administrative organizations in order to support our expanding worldwide business and to operate as a public company.

Third quarter income, before taxes, was $17.5 million, down from $21.3 million in the prior year period. This decline is entirely due to the $4.6 million decline in royalty revenues as was contemplated in our 2006 patent litigation settlement. Importantly, without the impact of the lower royalty payments, our pre-tax operating income rose in the 2007 third quarter compared to the same prior year period.

Our effective tax rate for the third quarter was approximately 39.7%, down from 42.3% in the same prior year period. And on a year-to-date basis, our tax rate is approximately 40.3%, which is down from 42.2% in the comparable prior year period. Our prior year effective tax rate was due to a non-deductible dividend payment made in the first quarter of 2006.

As we have previously noted, net income for our 2007 third quarter was $10.6 million, or $0.16 GAAP earnings per common share, or $0.18 non-GAAP earnings per common share. This compares to prior year third quarter net income of $12.3 million, or $0.16 per GAAP earnings share and $.22 non-GAAP earnings per common share.

The pro forma EPS calculation assumes the conversion of all of 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 FAZ-128, which will be used by the company to compute all future earnings per share calculations after the initial public offering.

We are providing this pro forma earnings per share information because we believe that this method is more comparable and relevant to future GAAP EPS calculations.

Now I'll make just a few comments on our balance sheet. For the nine month period ended September 30, 2007, total cash increased from $55.4 million to $88.6 million. During this period, we generated $14.9 million in cash from operations while using $4.7 million in investing activities.

We generated a net of $23.6 million in cash from financing activities primarily resulting from a combination of the net proceeds of our initial public offering of $47.8 million and other Q1 and Q2 borrowings of $20.1 million. These increases were offset by the February 2007 dividend payment of approximately $37.4 million.

At June 30, 2007, our day sales outstanding was 48 while our inventory turns were 3.3. These compared to day sales outstanding numbers of 47 and inventory turns of 3.7 as of December 31, 2006. And both these ratios are within our expected ranges.

The slight decline in our inventory turns ratio is consistent with our philosophy of ensuring that we have sufficient inventory levels to be able to be responsive to both our business growth requirements and flexibility that our customers require.

I'd like to spend just a few minutes touching on guidance. In our first earnings call in September 2007, we indicated that our intention was to provide annual financial guidance at the beginning of each fiscal year as part of our first earnings call in that year.

We also indicated that we would intend to adjust that annual guidance as we progressed throughout the year. We emphasized that we did not intend to provide any specific quarterly guidance consistent with our focus on the long term opportunities within our marketplace.

In accordance with these guidelines and given the third quarter results that we have shared with you today, we are revising our full year financial guidance to account for the impact of our actual Q3 results. We now expect our full year total revenues to be about $250 million, including product revenues of approximately $197 million, which is up from $245 million including total product revenues of approximately $195 million.

We now expect our full year GAAP earnings per common share to be approximately $0.50, up from $0.43, and our non-GAAP earnings per common share, adjusted only for the assumed conversion of preferred stock into common stock in connection with our recently completed IPO, to be approximately $0.63 per share, up from $0.55.

Thank you for your time. And now I will turn the call back to Joe.

Thank you, Mark.

I didn't repeat too many of the things you said.

These quarterly results, obviously, are positive. It's better than I think we had forecasted and the estimates on the street had been.

But I think what's leading to all these, or kind of the big picture, which I'd like to just quickly review for our shareholders on this call today. Number one, we have revolutionized pulse oximetry with Masimo SET and made pulse oximetry into a foul-weather friend instead of the fair-weather friend that many believed it was.

And it's become a clinically useful tool. Not only have false alarms been reduced by over 90%, but true alarms have been improved to over 97% of the time. And because of the accuracy and reliability, clinicians are using it to titrate therapy and detect problems -- for example, reducing blindness and eye damage in babies, known as ROP, or detecting congenital heart defects in babies and children.

As a result of our contribution that we've made, technically and clinically, we have a solid business now and a solid business model because of this breakthrough in Read-Through motion pulse oximetry -- and with room to grow.

As we grow from product revenues of less than $200 million and a billion-plus market of just pulse oximetry - and keeping in mind that our 2006 revenues were about 15% of the total market. Yet, according to industry analysts, our market share for new shipments of pulse oximetry last year was 38%. And even if we maintain that 38% shipment level, then in the next several years our revenue should catch up with our installed base as it becomes 38% and should become effectively about 38% of the total market.

But as I think you've seen today, in actuality it looks like our market share of new shipments has increased.

We have revolutionized oximetry again with Rainbow-SET, which has allowed clinicians and emergency professionals to measure carbon monoxide, methemoglobin and PVI in real time and non-invasively for the first time. A PVI, by the way, will be called "Plus Variability Index," which now a few studies have come out to show that it could hopefully be a good indication of fluid volume in a patient, which is very important.

And analysts have projected that Masimo's total market opportunity to now be between $2 billion to $3 billion with our existing products -- so growing from less than $200 million, hopefully, to a market potential of $2 billion to $3 billion.

Now, Rainbow to us is exciting beyond what it's going to do for us in terms of growth. With it, I'm convinced we have and will continue to save and improve the lives of many people around the world. But, as I've cautioned before, it is difficult to predict when our revenues from Rainbow will fall on the steep part of the S curve of technology adoption in the health care market.

I think you guys are all familiar with the health care market. There is some time before the knowledge reaches the broad audience and things will happen. And while we expect great things to happen long term, I cannot predict when we're going to be on that steep part of that S curve growth.

And last but not least, we have a great innovation engine. We have a team of very bright and talented engineers and they are not done yet in introducing tomorrow's breakthroughs.

So with that, I'd like to thank you all for joining us today. I know it's a very busy day for many of you. And I'd like to now, with Mark, answer any questions that you may have.

(Operator Instructions)

And, sir, your first question comes from the line of Bill Quirk with Piper Jaffray.

Go ahead.

Yes, thanks. Good afternoon, guys, and congratulations on another strong quarter.

Thanks, Bill.

Thanks, Bill. Congratulations to you for a strong new baby.

Thanks, Joe. We're having a lot of fun, albeit a little less sleep than normal.

Plenty of time to write up tonight.

Exactly, exactly.

Joe -- and I'm sorry, I missed the first few minutes of the call, but -- if you've touched on this, I apologize. But if we look at your performance and if we extrapolate from the royalty line what we're seeing out of the U.S. side of Nellcor, it certainly looks like the markets are growing kind of in excess of this high single digit number that we think about. And we'd certainly love to hear your commentary there.

And is this sustainable? And what should we look at as the key growth drivers?

Bill, thanks for your question. I think you're asking whether we think the total oximetry market is growing by more than 10%. And that I can't be certain about. I believe you may be right, but I do believe we have been growing above that.

I know we've been growing compared to last year, if you look at just this quarter, 32% as far as our new oximetry shipments. If you look at it for the first nine months, 0.5%. So I think you're right that that means some of that growth is, of course, above the market growth. But it could mean the market isn't growing at 6% to 8%. It might be at 8% to 10%.

And, certainly, Joe, should we think about incremental contributions here from general ward monitoring? That certainly seems, coming from our perspective, to be the obvious avenue here for expanding market growth.

Bill, I think you're right. I think the most obvious answer we see is we're in the market day to day. It's really expansion into the general floor market. The clinicians are now recognizing this problem of patients being found dead in the bed. They call it "dead in the bed" phenomena.

And I think, due to many new standards or recommendations by people like JCAHO and APSF, and people's own worry about their patients, they are putting more emphasis in monitoring patients in the general ward.

One example I can tell you. At a recent scientific advisory board meeting, a customer of ours -- we had not sold them a patient safety net type of a product, so we did not know if they had monitoring on the floor. And I learned that they had placed, just recently, over 200 monitors on the general floor, Masimo's SET monitors, and using their nurse call feature just to get the alarm to the nurse.

Perfect.

Mark, a quick question for you as well -- and I guess, maybe from a baseball analogy standpoint. We talked about building infrastructure, obviously building a sales force not only in the U.S., but in Europe. Can you talk to kind of what inning we're in, in terms of that build? Are we still kind of in the middle stages here?

Sure. Well, I think, Bill, in general as we've discussed with people, in fact, even on the road show, our general feeling is we're looking at a build-out plan that will extend throughout the end of 2008. So in terms of the baseball analogy, I would suggest we're probably in about the 5th or 6th inning or so.

Sounds good. Sounds good. So, in other words, no change to the long term plans.

Perfect. Thanks, guys.

Thanks, Bill.

And, sir, your next question comes from the line of Tao Levy with Deutsche Bank.

Go ahead.

Hi, good afternoon.

Hi, Tao.

Just a couple of quick questions. First, you mentioned briefly that part of the growth that you were seeing in the quarter was from international strength. Anything specific going on there? Any geographies that you could highlight where you're seeing bigger interests?

Yes, Germany seems to be really pulling for Masimo technology. I don't want to overstate it -- but just my own perception, and it could be not a good overall perception -- is that we're having a tough time keeping up with the demand as far as putting salespeople on the street to reach the demand of the German community. But I would probably say that's probably the strongest market right now in Europe, although France and the U.K. are doing very well as well.

And are those primarily direct sales-type countries? And if so, is that part of the reason -- I don't know if you used to have distributors selling there and now you've gone direct.

Yes, it is part of being direct, but I think -- maybe I'll just remind you. In Europe, even when we were just relying on old (inaudible) we had a very large demand and market share for our products compared to the U.S. until recently when we were able to break through the GPO barriers and get on contract.

So we always had a healthy demand in Europe. We're direct in several countries. And what we're seeing in all of them -- kind of being direct about the same time. We're just seeing Germany being hotter than the other areas.

Got you.

And I was just curious, the RAD-9, the one-time charge that you talked about last quarter and during the road show, is that within the R&D number or the SG&A, Mark?

Tao, it's actually within our cost of sales number.

Okay.

And we suggested at the time that our estimated range of exposure was between $300,000 and $500,000. We completed our analysis this quarter and included it in cost of sales is a charge for approximately $300,000.

So technically, we should -- if we wanted to back it out, we could -- out of that.

Yes, you could.

And Tao, while we're on the RAD-9 topic, I think you guys will all enjoy hearing this. We, as you know, had bought this device from a company we acquired, and their decision on how to implement alarm features were different than our design considerations. We, for example, think it's right to alarm audibly as well as visually, when a sensor has gone bad, and with RAD-9 the original designers had only done a visual alarm.

After we made that product change when we became aware of it in late 2006, we offered a free software upgrade to all of our customers. And since there weren't many takers -- if you remember in the summer time we decided (inaudible) do a recall and force the issue.

One of the things that's very interesting -- recently we just got a notification from the FDA that basically said to us that, "We don't believe this really requires a recall."

So that's a good sign.

Yes, a good sign. I agree.

And I just have two more questions. I feel like I have to hit on this. And I know you're going to be a little reluctant about talking about it, but I'm going to ask anyway. You presented some interesting data at the ASA, sort of on the new parameters, and specifically hemoglobin and respiratory monitoring.

When should we start thinking about those hitting the revenue lines? What are the next data points? Catalysts? Regulatory? Anything there that you could provide would be really helpful.

Well, I think I tried to explain before, that I feel comfortable that Rainbow and ARM, excuse me, hemoglobin and acoustic respiration monitoring -- monitoring for hemoglobin and acoustic respiration monitoring, should begin hitting our revenues within two years of July-August, when I think I was on the road show. And I still feel good about that.

I have to tell you, Plan A is, of course, earlier than that, but I've been around now for a little while and my life has not always been about Plan A. So I'm trying to give you Plan B, hoping I don't disappoint our potential shareholders and current shareholders. So I don't think anything has changed for me to give you an earlier date.

Although the data that was shown at the ASA was interesting, I think it continues to prove the feasibility. But that was done on an engineering prototype. It was not a production prototype. And from engineering to production prototypes -- sometimes left turns and U-turns occur.

Right. Thanks. And my final question. If I were going to critique any part of this quarter I guess it would be that Rainbow sales were sequentially down -- and just your thoughts there. The seasonality? Were there no shows going on? Just any thoughts there.

Sure. I guess, a couple of things. First of all, yes, two or three generally -- and we haven't been in this business for a long time, so I can't speak with a lot of confidence. But compared to even last year, Q3 was lower than the previous quarters. But I really believe the main culprit to our RAD-57 sales, which is really the bulk of our Rainbow sales, is the decision we made to bring on a distributor, EMS distributor in the U.S., that we felt was actually going to increase our reach and therefore our sales.

I can tell you, our first quarter with them has been very disappointing. We have put them on notice that if things don't improve soon, we are going to go back fully to our direct model and increase the sales force in our direct EMS channel.

Great, thanks a lot.

Thank you. I was going to say thank you, Tao.

Anybody else?

Your next question comes from the line of Robert Faulkner with Thomas Weisel Partners.

Go ahead.

Hi, Joe. I'm wondering if you could -- if you've done any more thinking on just what the potential of what the hemoglobin parameter could be. Because I know --yes, I'll just leave it at that for now.

Thank you, Rob. Hi.

Well, you guys have estimated the markets for hemoglobin to be about $1 billion a year and we actually don't disagree with that. We think it should be as ubiquitous as pulse oximetry. But I also believe methemoglobin will become as ubiquitous as pulse oximetry.

But, of course, the difficulties with methemoglobin -- it's not a known problem. People die, things go wrong, and not everyone is aware of why. And we have an education issue. Where with hemoglobin, not only is the market size big, but the problem is well understood. It's the most common blood draw (inaudible) there's a cost associated with doing those blood draws as well as pain and potential infection issues.

So we actually believe that hemoglobin will be a much, I guess, sooner in hitting that steep part of that S-curve.

Okay. And what do you think the role will be? In what kind of patients do you see it being adopted first?

I believe (inaudible) hemoglobin will be used extensively in the OR and the intensive care unit, in the recovery room environment. I believe it will have applications in the emergency environment, the ED, ambulances, doctors' offices. So I actually think the market again, is really everywhere pulse oximetry has gone.

Got you. And finally, you recently had the ASA meeting. Was there anything out of there that you thought was particularly important for Masimo or the competitors or the space?

Now I'll get back in the queue. Thanks.

I think probably the surprise was how interested people were with pleth variability index, PVI, and what -- and I think the surprise to them of how well actually it may be picking up fluid change.

I think we expected, unfortunately, at the trade show to have our competitor to do a negative video which actually is totally false and leads to false conclusions for clinicians. But, surprisingly, it didn't seem like clinicians were that moved by it and I think we had a very effective way of showing why that video was false.

And actually, their video has -- and, by the way, the video I'm referring to is a video where they use a tourniquet cuff to inflate and, as they try to state it, to cut blood flow entirely but basically showing that, "Look, Masimo is still showing a pulse and a reading, and therefore don't trust Masimo's devices."

But that experiment they had done -- the video they did forced us to kind of go back and look at it one more time and we actually came away with a couple of really great conclusions which we showed to the clinical community there. They wanted that. Masimo's SET is actually not only more sensitive than any other pulse oximeter but is actually more sensitive than invasive arterial line pressure transducers in picking up pulse rate and maybe even detecting a pulse.

Secondly, when we did the experiment, we learned that, unfortunately, many times, or maybe fortunately, when you try to occlude, you're not really simulating the cessation of the heart or the pulse because there's still arterial blood flow through other means -- through the bone marrow, through the bone. And you can actually physiologically get those pulses.

And I think all our competitor has done has just actually -- is going to show our customers that our product is really revolutionary and should be relied upon more than even the arterial line.

Thanks, Joe.

Thank you. I'm sorry if I went too far--

Not at all. That's exactly it.

And, sir, your next question comes from the line of Matthew Dodds with CitiGroup.

You may proceed.

Hey, Joe.

Hi, Matt.

A couple of questions. I assume for the royalty, you haven't heard anything from Covidien yet on them trying to change the technology?

We have not.

Perfect.

And then, for the RAD-57, your comments about the EMS distributor. Is it a free flowing enough agreement where you can kind of leave them on short notice or within a quarter? Is it that short or is there sort of a penalty?

We do have the freedom to walk away on a very short notice, but maybe importantly, for you guys to know is the agreement was exclusive from other companies distributing the RAD-57 but was not exclusive of Masimo's own sales force selling the RAD-57 in the same channel.

So while we're talking with them and hoping that they're going to turn things around, we have begun already to sell ourselves in parallel with them and no longer use our sales force as regional managers of these distributor sales people but rather a sales people as they once were before the signing of this distribution agreement.

And is EMS the largest current component of the RAD-57 if you look at the different markets it can go into?

I believe so, because EMS, we believe, has a potential of 200,000 vehicles that would want to have the ability to measure CO and hopefully measure met and hemoglobin, whereas the opportunity in the emergency departments is maybe 6,000, 7,000 emergency departments.

And now we expect them eventually to buy several or maybe a lot, but at the beginning my expectation is to only buy a few. And, plus, we've been working with the standard bodies and we're hoping that some good news will come out of that work and will help really accelerate the adoption of at least CO monitoring by the EMS community.

Thank you, Joe.

Thank you, Matt.

(Operator Instructions)

Your next question comes from the line of Sara Michelmore with Cowen & Co.

Go ahead.

Yes, thank you. Good afternoon.

Hi, Sara Michelmore.

Hi. Thank you.

They made me say Tao's name "Tao" so I (inaudible)

I really appreciate it. You know, I wanted to ask you, Joe, about the Rainbow software for the bedside monitors. I know that you had just launched it back in Q2.

I know that, given the parameters that you have out today, that the expectations aren't that you guys aren't going to do a lot with that currently, but I was just wondering if you could give us a quick update on where you are and how you are kind of introducing that concept to customers right now.

Well, first of all, to remind you, we really had these parameters, the Rainbow parameters available with the line of sensors that's needed in the hospital for about three months, which I think a month or two was summer time.

But even without that, I wanted to just let you know, as I said earlier, the adoption for these parameters. I don't expect to happen overnight and I don't know when it will happen exactly. So far, we've had negligible parameter sales. We've had some very big institutions take a site license but not permanent; but one year or two year site license as part of their new agreements with us.

And we're hoping through those positive usages by those institutions, which some of them are very, very influential, along with ongoing clinical research that many [thought] leaders are doing on the [damage] to methemoglobin and CO and PVI in hospitals that, over the next two or three years we'll start seeing the results of those coming out and, hopefully, the numbers to become more than negligible.

Joe, is it something that you're actively detailing as a part of some of these account conversions or new account sales as a future capability?

That's a really good question, Sara. The answer to that is, no, for the most part. We have not (inaudible) planned for our sales force. Because at the time we did it, these parameters were not available for the hospitals and we didn't think they would be until later in 2007; did not have really any incentives or, I guess, (inaudible) for Rainbow sales.

We're planning to have a very large focus on Rainbow beginning in 2008 for the sales force, so I think the detailing will naturally come from that.

Okay. That's helpful. And just a follow on an earlier question. I think there -- it did sound like there was some incremental excitement or enthusiasm on PVI coming out of the ASA meeting. And I'm just wondering if you can kind of elaborate a little bit on terms of the reaction on that meeting and maybe what's going to be required in terms of doing some additional studies on that parameter, et cetera.

Sure. First of all, we presented PVI to our scientific advisory board at the ASA. And some of them kind of did not believe, maybe, this would really be able to measure fluid volume because they cited 20 years earlier a similar effort but done on an invasive line -- was done on actually a mechanically ventilated patient, and it did not pan out to be what they hoped it would be, which was a way to measure fluid volume and know how empty or how full a patient is, which is very important to them.

In fact, one clinician said after they did a test -- maybe some of the guys saw the test -- on me -- when I stood up -- first, I stood up and they measured PVI and the number was high. Then they made me lie down. The number dropped. And they made me (inaudible) my feet. This is in the middle of the trade show. And the number went up.

And sure enough, their conclusion was, "My God, this seems to be working." Because what happens when fluids -- as you raise your feet or you lie down, the fluid goes back to your heart and you start seeing a bigger volume versus standing up.

And the comment was, "Wow, this might be more important than the saturation, oxygen saturation measurement you're showing."

In other words, that was kind of one feedback from a scientific advisory board where they were actually initially not maybe believing it but began to really believe it with some of the crude tests they did.

And I know a few of them are now going to be testing it in their own hospitals under IRB to prove out, using echo and other techniques to know really is it matching to what they think it is.

But on top of it, Dr. [Kadison] has been one of the leaders in looking for ways to measure fluid volume using other techniques. He presented his study at the ASA and his study actually showed that -- I don't know if I can say it's definitive because it wasn't on thousands of patients, but the P-value was less than .05 and showed that it seemed like we could actually measure fluid volume with PVI.

And you know, this just might be a sleeper, but this fluid volume issue is a big deal for clinicians, especially in the OR.

Okay, that's helpful.

And then, lastly, I think you mentioned six weeks ago on the Q2 call that you had kicked off some educational campaigns related to both CO and methemoglobin. I'm just wondering if you can give us an update on those programs. And what should we think about in terms of the scope of those programs heading into 2008? Thanks.

Yes. I think our educational campaigns are more aggressive advertising to link the problems of CO and the ability to measure it with our device as well as methemoglobin and linking it to the popular drugs that are given. Those ads, most of them are now hitting the clinicians' major journals this quarter and will continue ramping in next year.

Plus, we're in the midst of creating many expert speaker programs where different experts who've done studies are going to be presenting both at grand rounds and at kind of regional sessions to discuss, basically, the problem -- CO and met and fluid issues -- and our solutions.

And I expect that to get up and running this quarter as well. We've already done some but we hope to get more done beginning next year.

Great. Thanks, Joe.

My pleasure.

And, by the way, Sara, the biggest part of this education also is the clinical research. There are about 50 to 100 studies under way with these measurements. And we expect them to start coming out in the next year or two. And, hopefully, that will fill out this education campaign that we've engaged.

Great. Thank you so much.

You're welcome, Sara.

And at this time with no further questions, I'd like to turn the call back to management for any closing remarks.

Mark, I don't know if you have anything. I just want to thank you all for joining us, and, I guess, look forward to, hopefully, getting back to you around the end of February.

Have a great day.

Mark, anything?

No, that should do it. Thank you.

Thank you all.

Thank you for your participation in today's conference. Ladies and gentlemen, this does conclude the presentation and you may now disconnect.

Have a wonderful day.